Investments Flashcards
Unsystematic Risks
Business Risk
Financial Risk
Systematic Risks
PRIME
Purchasing power risk
Reinvestment rate risk
Interest rate risk
Market risk
Exchange rate risk
Brokered CDs risk
Interest rate risk, because they are traded (negotiable). Regular CDs do not have interest rate risk
Yield Ladder
Discounted Bonds
Y - Yield to call
M - Yield to Maturity
C - Current yield
—— A - Annual coupon rate (nominal) ——–
C - Current yield
M - Yield to Maturity
Y - Yield to call
Premium Bonds
STRIPS
Zero-coupon treasury securities
Direct obligation of the federal govt
Discount on STRIPS is taxed as taxable (phantom) income, earned annually.
Typically purchased by tax-deferred entities becasue they don’t need to recognize the phantom income
TIPS
Treasury Inflation-Protection Securities
Taxed annually on interest payment + appreciation in face value
No state and local tax
Increase in face value is phantom income
EE Bonds
Nonmarketable, nontransferable, and can’t be used for collateral
Issued at face value
EE Bond term
20 years, but if not redeemed at maturity, they will accrue for additional 10 years
EE Bond taxation
Not subject to federal taxes until bonds are redeemed or reach maturity (unless an EE education bond)
Interest not subject to state or local tax
EE “education” bonds
Has to be owned by parent
Tax free if parent’s AGI is less than the phaseout at redemption
Can’t be education EE bonds if in a UTMA because they would be owned by the student
I Bonds
inflation-indexed accrual securities issued by the US gov’t
Nonmarketable, non-transferable, and nonnegotiable
Interest compounded every 6 months on semi-annual anniversary of bond’s issue date
Issued in same denominations as EE bonds but no guaranteed rate of earnings
I Bonds interest rate
Two parts: fixed base rate and an inflation adjustment additional amount
inflation adjustment is updated every 6 months
I Bonds taxation
Same as EE bonds and can also qulaify for “education” status
GNMA
Ginnie Mae securities purchase a pool of FHA/VA guaranteed mortgages
Guaranteed by federal government
FNMA / FHLMC
Fannie Mae and Freddie Mac are not guaranteed.
They have been taken over by federal government and are placed into conservatorship of the FHFA (Federal Housing Finance Agency)
CMOs
Mortgage-backed pools
Mortgage payments receieved are distributed ona “cash flow” basis
A to Z tranches – A is fast pay, M is medium pay, and Z bears no coupon but receieves cash flow from collateral remaining after the other tranches are satified (most risky)
Corporate and Muni bond risks
DRIP
Default risk
Reinvesment risk
Interest rate risk
Purchasing power risk
UITs
Unmanaged security portfolio offered by a sponsor and handled by an independent trustee
Passive investment because its assets are not traded, but frozen
Self liquidating because as funds are receieved, they are distributed to unit holders. Sponsor will redeem units at NAV
Black-Scholes option valuation model
Considers 5 variables to value the option of a non-divident paying stock (Think “call up”)
- Exercise price of option
- Time remaining to expiration of option
- Interest rate
- Volatility of underlying stock
- Price of underlying stock
Call option taxability
At time of purchase - nondeductible capital expenditure
Taxability to writer due to lapse - premium receieved is short-term gain
Taxability to writer due to exercise - premium receieved is added to sale price (taxed as LTCG if held over 12 months, otherwise it’s all STCG)
LEAPs
Long-term Equity AnticiPation
Expiration ranges from 9-mos to 3 years
Once a LEAP is exercised, investor must hold shares of stock for over a year in order to pay LTCG rates
Warrants
Similar to call options
Right to purchase issuer’s common stock at a specified price
- Warrants are issued by corps
- Maturities of several years vs. 9-mos
- Terms are not standardized
Short selling
- Short sales must be made in a margin acct
- Net proceeds plus required margin are held by broker
- No time limit on short sale
Private placement (Reg. D)
Offered to max 35 “non-accredited” investors
Exempt from registration, but must provide an “offering memoranDum”
1-2-3 test
Accredited investor has $1M net worth, or $200k annual income, or joint $300k income
What does covariance measure?
Covariance measures the extent to which two stocks are related to each other
COV
Correlation coefficient symbol
ρij
What does correlation coefficient of +1 mean?
Securities are perfectly positively correlated
Maximum risk
What does correlation coefficient of -1 mean?
Securities are perfectly negatively correlated
Securites move opposite of each other, completely elimiating risk (std dev of 0)
What does coefficient of variation measure?
Measures relative variability to compare investments with widely varying rates of return and standard deviations
Std deviation divided by mean
CV indicates risk per unit of expected return
Standard deviation curve
68%, 95%, and 99%
What does beta measure?
Systematic risk
Volatility of security’s return relative to a market index (Beta = 1)
What does a negative Beta mean?
Moves opposite to the market
Risk-adjusted return calculation
Realized return / beta
How to calculate geometric mean
Add 1 to each return, then multiply together
Use answer as FV and -1 as PV
N is number of years, and solve for i
What type of return is geometric mean?
Time-weighted return
What is holding period return?
HPR is the total return (income + price appreciation and divs or int receieved, less margin interest paid) divided by the price of the investment (out-of-pocket cost)
Taxable Equivalent Yield calculation
tax-exempt yield / 1 - marginal tax rate
What is the intersection of the CML called?
Rf or risk-free (100% T-bills)
Strong form EMH
stock prices fully reflect all information, both public and private.
No fundamental
No technical
Semi-strong EMH
All publicly known information is fully reflected in stock price
Yes to insider information
No fundamental
No technical
Weak form EMH
historical price data is already reflected in current stock prices and is of no value in predicting future price changes
Fundamental
No technical
Fundamental analysis
Can include research of factors such as interest rates, GDP, inflation, unemployment, and inventories. Can also include balance sheets and income statements to forecast future stock price movements. Also consider past company performance in predicting future trends
Technical analysis
Follows charts or computer programs to identify and project price trends in a market
What are considered investment grade bonds?
BBB and better (S&P)
What are considered bad bonds?
BB and below (S&P)
What entities are most likely to purchase preferred stock?
C Corps because at least 50% of the dividends are tax-free
When to use Sharpe ratio
When R^2 is under 60
When to use Alpha
When R^2 is over 60
When to use Treynor
When R^2 is over 60 and alpha is not given
What to use when various R^2s are given?
Sharpe
Alpha/Treynor risk measured in terms of ___
Beta
Sharpe risk measured in terms of ___
Standard deviation
Calculation for “at margin” price (margin requirement)
1 - initial margin percentage / 1 - maintenance margin percentage x purchase price of stock
Calculate margin call
30% (maint. %) X current value of stock (all shares) = equity required
equity required - initial margin loan amt = actual equity
equity required - actual equity = maintenance call amount
Ex-dividend date
Day after purchase date
Date of record
2 days after purchase date, 1 day after ex-dividend date
What entity controls margin?
Federal Reserve Board
What is Reg T?
Determined the initial margin amount of 50%
What entity controls minimum maintenance margin requirements?
FINRA and exchanges
EMH anomalies
P/E effect
Small-firm effect
January effect
Neglected-firm effect
Value line
Ratio analysis
Comparing one of the following
- Compare individual ratios for a firm over a period of time or establish norms for the firm
- Compare the individual firm’s ratios to an industry average
A ___ is a deposit in any foreign bank that is denominated in dollars
Eurodollars
How are TBills sold?
Competitive bids
What are GICs?
Guaranteed Investment Certificates
Issued by insurance companies, there is no interest rate risk because the issuer takes all the interest rate risk
How much of REIT income can come from securities like GNMAs?
Up to 15% of investment income can come from securities like GNMAs
Mortgage REIT income comes from the spread between the _______ and the _______
Lending rate and the borrowing rate
What is the “daily limit” in a futures contract?
The maximum permissible price increase or decrease relative to the settlement price the previous day
Which index is price weighted?
Dow Jones
Bottom-Up method
Focuses on the individual stock performance before considering broader economic trends
Which performance evaluation measures total risk?
Sharpe
Measures risk through standard deviation (systematic and unsystematic risk because the portfolio is non-diversified)
Shortcut to measure duration
When bond pays a coupon, pick the next lower number under years to maturity
Zero coupon bonds have duration equal to YTM
Determine which of two stocks is riskier
Coefficient of variation
Relative measure of volatility = standard deviation / mean (pick higher answer)
Are CDs marketable?
No, unless they are brokered CDs
Are T-bills marketable?
No, because they can be easily converted to cash (liquid)
How are UITs issued?
Issued in units, not shares
What is a dollar-denominated bond issued in the US by foreign banks and corporations?
Yankee bond
Interest rate risk
Change in interest rates will cause the market value of the fixed income security to fall
Purchasing power risk
Loss of purchasing power through inflation
Reinvestment rate risk
Risk that proceeds available for reinvestment must the be invested at a lower interest rate than the instrument that generated the proceeds
Time-weighted return
geometric mean
Dollar-weighted return
IRR/NPV
Current yield
Annual interest in dollars / Bond’s current price
Top-down method
An investor first looks at trends in the general economy, then selects industries, and ultimately selects companies that should benefit from those trends
Activity ratio
Measure of how rapidly a firm is able to convert various accounts into cash (or sales). The quicker, the more effectively the firm is being run
Support level
Where a security tends to stop falling because there is more demand than supply (temporary price floor)
Resistance level
Price ceiling at which technical analysts note persistent selling of a commodity or security
Dow theory
Aggregate measure of securities prices and thus does not predict the direction of changes in individual stock prices. Its purpose is to show the direction of the overall market
Barron’s Confidence Index
Presumes that the differential between the returns on quality bonds and bonds of lesser quality will forecast future price movements
How is S&P 500 weighted?
Float weighted
Russell 2000
Capitalization weighted index of stock price performance of smallest 2000 stocks in Russell 3000 index
Willshire 5000
Broadest measure of activity and movement of the overall stock market
Value weighted index
Value line benchmark
Equally weighted index consisting of 1700 selected issues that are on the NYSE, AMEX, and OTC market
NASDAQ
Broadest measure of OTC trading
Capitalization weighted index includes all the issues that trade on the NASDAQ system
EAFE index
Relative performance of the US and international equity markets
