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Certifications > Investments > Flashcards

Investments Flashcards

1
Q

Investment Policy Statement

A

written document provides general guidelines for investment manager

Includes:
- Objectives (risk & return)
- Constraints (time horizon, taxes, liquidity, legal considerations, unique needs/special circumstances)

does NOT identify specific investments

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2
Q

Holding Period Return HPR

A

return measure

HPR = (SP - PP +- CFs) / PP = made / paid

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3
Q

Arithmetic Mean

A

return measure

sum the returns & divide by n

more misleading w/ larger variations in return

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4
Q

Geometric Mean

A

return measure

compound ROR

will ALWAYS be less than or equal to arithmetic mean

use PV, FV, n, then solve for i

IRR, YTM, YTC, time-weighted return (use the security cash flows), & dollar-weighted return (use the investor’s cash flows) are ALL geometric mean calculations

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5
Q

Weighted Average

A

return measure

portfolio expected return, portfolio beta, & portfolio duration are all calculated as weighted averages

portfolio standard deviation is NOT a weighted average

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6
Q

Real Rate (inflation adjusted return)

A

return measure

use w/ education funding & retirement needs questions

Real Rate = [(1+nominal)/(1+inflation) - 1] x 100

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7
Q

Tax Adjusted

A

return measure

used to determine the after-tax ROR from an investment

After-Tax Return = Pre-Tax Return x (1 - Marginal Rate)

= corporate rate x (1 - tax rate)

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8
Q

Required Return

A

use CAPM to determine the required ROR on an investment given its systematic risk

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9
Q

Expected Return

A

use current price & expected future cash flows to calculate the expected return on an investment

RR < expected return = invest (asset undervalued)

RR = expected return = invest

RR < expected return = do NOT invest (asset overvalued)

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10
Q

Actual Return

A

use w/ Sharpe/Treynor/Jensen to determine risk-adjusted performance

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11
Q

Which measure should you use to evaluate a manager’s performance?

A

High r^2 = all three measures are reliable

Low r^2 = use Sharpe (bad beta!)

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12
Q

Sharpe Ratio

A

relative risk measure

excess return divided by total risk (SD)

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13
Q

Treynor Ratio

A

relative risk measure

excess return divided by systematic risk (beta)

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14
Q

Jensen’s Alpha

A

absolute risk measure

portfolio return minus CAPM (uses beta)

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15
Q

Information Ratio

A

ratio of a portfolio’s return in excess of the returns of a benchmark (such as an index) to the standard deviation of those excess returns (tracking error)

the ratio indicates the portfolio manager’s ability to consistently beat the index

the higher the IR the more consistent the manager is in generating excess returns

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16
Q

P/E Ratio

A

market price of the common stock divided by EPS

= expected price per share / EPS

how much investors are willing to pay for each dollar of earnings

growth stocks = high P/E ratios

value stocks = low P/E ratios

earnings are accounting based & thus do NOT reflect cash flow which is central to equity valuation

P/E ratios also tend to be lower during times of higher inflation

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17
Q

Earnings Per Share (EPS)

A

= (Net Income - Preferred Dividends) / # common shares outstanding

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18
Q

P/CF Ratio

A

market price of the common stock divided by cash flow

useful ratio for evaluating non-dividend paying firms

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19
Q

P/S Ratio

A

market price of the common stock divided by sales

useful ratio for evaluating non-dividend paying firms or firms w/ low or negative profits

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20
Q

PEG Ratio

A

stock’s P/E ratio divided by 3-5 year growth rate in earnings

PEG < 1.0 = stock may be undervalued; P/E ratio less than average growth in earnings

PEG > 1.0 = stock may be overvalued; P/E ratio greater than average growth in earnings

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21
Q

Yield Curve Theories - 3

A

attempt to explain the shape of the yield curve

  1. Expectations Theory
  2. Liquidity Preference Theory
  3. Market Segmentation Theory
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22
Q

Expectations Theory

A

expectations of inflation & the effect on future ST interest rates determine shape

could explain normal & inverted curves

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23
Q

Liquidity Preference Theory

A

investors accept lower yields for ST investments (price for liquidity) & require premiums for longer term maturities

explains only a normal curve

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24
Q

Market Segmentation Theory

A

the supply/demand for funds in ST & LT markets determine the shape of yield curve

could explain normal & inverted curves

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25
Q

Efficient Market Hypothesis

A

efficient markets = asset prices reflect all relevant information

3 forms:
1. Weak Form
2. Semi-Strong Form
3. Strong Form

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26
Q

Weak Form - EMH

A

past prices & volume information reflected in asset prices

investor CANNOT use TECHNICAL analysis to achieve risk-adjusted excess returns

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27
Q

Semi-Strong Form - EMH

A

all public information is reflected in asset prices; market prices rapidly adjust to new information

investor CANNOT use TECHNICAL or FUNDAMENTAL analysis to achieve risk-adjusted excess returns

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28
Q

Strong Form - EMH

A

all public & private information is reflected in asset prices

investor CANNOT achieve risk-adjusted excess returns

indexed options only

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29
Q

Standard Deviation of a Portfolio vs Weighted Average of the SD of the assets that comprise the portfolio

A

the SD of a portfolio will ALWAYS be LESS THAN the weighted average of the SD of the assets that comprise the portfolio

EXCEPTION = if the correlation b/t the assets is perfect positive (+1.0) then the portfolio SD will be EQUAL to the weighted average

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30
Q

Total Risk

A

Systematic + Unsystematic

measured by SD

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31
Q

Systematic Risk

A

undiversifiable risk

measured by beta

PRIME

purchasing power risk

reinvestment rate risk

interest rate risk

market risk

exchange rate risk

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32
Q

Unsystematic Risk

A

diversifiable

ABCDEFG

accounting risk

business risk

country risk

default risk

event/executive risk

financial risk

government/regulatory risk

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33
Q

Measures of Total Risk

A

standard deviation

variance = SD^2

coefficient of variation = relative risk

semi variance = measures downside risk (measures volatility of returns that fall below the mean)

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34
Q

Normal Distribution

A

68-95-99

68% of returns +-1 SD

95% of returns +-2 SD

99% of returns +-3 SD

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35
Q

Kurtosis

A

measure that indicates whether a distribution is more or less peaked than a normal distribution

Leptokurtic = more peaked than normal; have flat tails

Platykurtic = less peaked than normal

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36
Q

Measure of Systematic Risk

A

beta; appropriate measure of a well diversified portfolio

market beta = 1

beta 1.5 = 50% more volatile than the market

r^2 should be high to ensure reliability of beta r^2 > 0.70

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37
Q

Portfolio Risk

A

combines the individual risks of the securities along w/ their interactive risk

SD of a two-asset portfolio formula on formula sheet

COV = SDi x SDj x r

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38
Q

Long Call

A

pays the premium

right to buy stock @ strike price

bullish

maximum loss = premium paid

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39
Q

Short Call

A

sells the option (receives premium)

obligation to sell underlying asset at strike price

bearish

maximum gain = amount of premium received

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40
Q

Long Put

A

pays the premium

right to sell at strike price

bearish

maximum loss = premium paid

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41
Q

Short Put

A

sells the option (receives premium)

obligation to buy at strike price

bullish

maximum gain = premium received

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42
Q

Black Scholes Option Pricing Model

A

attempts to price a call option

interest rate

volatility

exercise price

stock price

time

*ONLY the EXERCISE PRICE (STRIKE PRICE) is inversely related to the value of a call option

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43
Q

Flat Market

A

better for option seller (writer, short position)

collects premium & hopes stock price movement will NOT negate the profit

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44
Q

Volatile Market

A

better for option buyer (if speculating)

must be enough movement in the price of the underlying asset for the option buyer to recover the premium & make a profit

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45
Q

Protective Strategy

A

short stock

long call

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46
Q

Portfolio Insurance Protective Strategy

A

long stock

long put

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47
Q

Short Straddle

A

income strategy

sell call sell put

not expecting volatility

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48
Q

Long Straddle

A

buy call buy put

expecting volatility unsure of which direction

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49
Q

Collar

A

protects gain in appreciated stock

long stock, short call, long put

concentrated stock positions lack diversification, selling a large amount of the position in one tax year can push the taxpayer up to a higher tax bracket or initiate the net investment income tax

a collar strategy can be used to spread the sale over multiple tax years while protecting the gain

50
Q

Covered Call

A

income strategy

long stock short call

51
Q

LEAPs

A

Long Term Equity Anticipation Securities

similar to exchange traded puts & calls but w/ expirations extending out to 3 years

52
Q

Warrants

A

like a call option issued by a company; much longer expiration & NOT standardized (call options have shorter maturities & ARE standardized)

often included in a new debt offering to make the bond more attractive to investors

53
Q

Stock Rights

A

rights granted to existing shareholders to purchase new shares of a new stock issue before it is offered to the public

this allows shareholders to maintain their existing proportionate share of the company following a new equity offering

54
Q

Duration (Macaulay)

A

Time-Weighted Payback

weighted average maturity of a bond’s cash flows

greater the duration, the more sensitive a bond’s price is to interest rate changes

55
Q

3 Variables to determine a bond’s duration

A
  1. coupon rate
  2. YTM
  3. time to maturity
56
Q

Variables relationship to duration (Coupon, YTM, Time)

A

Coupon = INverse relationship (lower cpn, higher duration)

YTM = INverse relationship

Time = Direct relationship

57
Q

Modified Duration

A

equals the value of Macaulay duration divided by 1 plus the YTM of the bond (1+y)

modified duration gives us a linear approximation of the change in bond value that will result d/t changes in yield

the estimated price change = -1 x modified duration x change in yield

58
Q

Immunization

A

occurs at the point of duration

at that point (in the life of the bond) interest rate risk & the reinvestment rate risk exactly offset one another

59
Q

Duration of a zero coupon bond

A

equals its maturity

the duration of a coupon paying bond < its maturity

60
Q

Buying Stock on Margin

A

when the stock price falls below the trigger price (TP) the equity percentage has fallen below the required maintenance level & a margin call will result

TP = Loan / (1 - MM)

61
Q

Short Sales

A

“sell high, buy low”

short seller is responsible for dividends paid during short sale period

62
Q

Rate Anticipation Swap

A

if interest rates are expected to increase (decrease), reduce (increase) duration of portfolio

you would swap long (short) duration bonds for shorter (longer) duration bonds

63
Q

Tax Swap

A

swap a bond (w/ a capital loss) for a similar bond

be careful – avoid wash sale rule

64
Q

Pure Yield Pickup Swap

A

swap lower coupon bond for a higher coupon bond to pick up yield

65
Q

Bond Ladder

A

portfolio of bonds w/ staggered maturities (ST to LT)

maturing bonds are reinvested in LT bonds

66
Q

Bond Barbell

A

portfolio consists of bonds w/ ST & LT maturities; few intermediate

strategy requires periodic rebalancing

67
Q

Bullet Strategy

A

bonds w/ similar maturities are focused around a point in time

68
Q

Derivative

A

an asset whose value is derived from the value of an underlying asset

examples = options, futures

69
Q

Forward Contract

A

an agreement (initiated at one time) that involves the purchase or sale of an asset at a later time

the price & quantity are specified at the inception of the contract

forward contracts are traded OTC w/ contract terms negotiated b/t the parties

70
Q

Futures Contract

A

a “forward-type” contract that trades on an exchange

contract is standardized (terms, quantity, expiration date)

LONG position agrees (today) to buy the asset in the future

SHORT position agrees (today) to sell the asset in the future

for hedging, take the position that is opposite to the current position

Corn Farmer is long corn so hedge is to go short

Frito Lay Inc is short corn so hedge is to go long

71
Q

Option

A

long position buys the option (pays a premium)

short position (writer) sells the option (receives the premium)

72
Q

Intrinsic Value

A

how much the option is in-the-money

cannot be negative, lowest value is zero

73
Q

Option Value

A

= Intrinsic Value + Time Value

74
Q

Modern Portfolio Theory

A

Markowitz

identifies efficient portfolios (in terms of risk/return); efficient frontier

inputs = asset volatility, security returns, & covariance of returns

portfolios on frontier = efficient; under = attainable, not efficient; above = unattainable

75
Q

Capital Market Line CML

A

x axis = risk; y axis = return

CML connects w/ y axis at risk-free rate

shows the risk & return trade-off b/t a risk free asset & a well-diversified risky portfolio

uses portfolio SD as risk measure

76
Q

CAPM

A

determines required ROR given an asset’s systematic risk (beta)

77
Q

SML

A

security market line

graphical depiction of CAPM

slope of SML = market risk premium = (Rm - Rf)

slope becomes steeper if investors become more risk averse (i.e. require higher ROR to invest in the market instead of investing in risk free assets)

SML shifts (no change in slope) when market interest rates change

securities ABOVE SML = undervalued; return higher than expected given level of risk

securities BELOW SML = overvalued; return lower than expected given level of risk

uses beta as the risk measure

78
Q

Coefficient of Variation

A

SD divided by expected return (total risk per unit of return)

79
Q

Correlation

A

ranges from -1.0 to +1.0

maximum risk reduction occurs at perfect negative -1.0

no risk reduction occurs at perfect positive +1.0

a correlation of zero indicates that the assets move independently of one another

80
Q

Covariance

A

measure of how much two assets move together

81
Q

Coefficient of Determination

A

known as r^2

tells us the percentage variation in portfolio returns that is explained by the variation in the benchmark returns

82
Q

Stock Valuation

A

intrinsic value (PV) of future CFs generated by the security

constant growth model assumes constant growth (g)

NOTE: the required ROR (r) from CAPM > g

P0 = D1 / (r - g)

83
Q

Relationship b/t valuation model & P/E ratio:

A

P0 / E = (D/E) / (r - g) = Div Payout / (r - g)

84
Q

Technical Analysis

A

relies on movements in stock price to predict future stock price movement

using charts, moving averages & other tools, technical analysists use volume & stock price data to identify trends that will be useful in making profitable buy & sell decisions

85
Q

Fundamental Analysis

A

examines internal data (from financial statements) & external economic factors (industry characteristics & market variables) to assess the market & company conditions

use ratio analysis, stock price multiples (P/E ratio) & discounted cash flow analysis to determine the intrinsic value of the company

the intrinsic value can then be compared to current market prices to make a buy/sell decision

86
Q

Bonds

A

FV = par value

n = # of periods until maturity

i = market rate of interest (YTM) per period

PMT = coupon payment per period

PV = bond value or price

87
Q

Bond Valuation

A

enter FV, n, PMT, i, then solve for PV

88
Q

Yield to Maturity YTM

A

expected ROR on a bond

enter FV, PMT, PV (as negative #), n, then solve for “i”

assumes reinvestment of coupon payments at the YTM rate

89
Q

Yield to Call YTC

A

enter FV (call price), PMT, PV (as negative #), n (# periods until callable), then solve for “i”

assumes reinvestment of coupon payments at the YTC rate

90
Q

Current Yield CY

A

annual coupon interest / current bond price

91
Q

Coupon Rate CR

A

annual interest rate

92
Q

Premium Bond

A

CR > CY > YTM > YTC

**alphabetical except for YTC

CR comes before CY which comes before YTM

93
Q

Par Bond

A

CR = CY = YTM

YTC equal if same callable price

94
Q

Discount Bond

A

CR < CY < YTM < YTC

95
Q

Primary Bond Risks (3)

A
  1. Interest rate risk (interest rates increase)
  2. Reinvestment rate risk (interest rates decrease)
  3. Default risk, purchasing power risk
96
Q

Real Estate Valuation

A

Value = NOI / capitalization rate

NOI = gross income - vacancy, operating expenses, property taxes

do NOT subtract depreciation, income taxes, mortgage payments/interest from total revenue to calculate NOI

NOI = Net operating income

97
Q

Investment Company

A

corporation that is governed by the Investment Company Act of 1940

investment company pools funds from many investors & invests those funds in a portfolio of securities, typically combinations of stocks & bonds

98
Q

Closed-End Fund

A

think stocks

fixed capitalization

shares trade in secondary market on an organized exchange

price determined by supply & demand for the shares

shares tend to trade at a discount or premium relative to NAV

99
Q

Open-End Fund

A

think mutual funds

capitalization NOT fixed

allowed to issue unlimited # of shares

shares bought & sold through the investment company; trade at NAV

100
Q

NAV Formula

A

NAV = (Market value of assets in fund - Outstanding liabilities) / Number of shares outstanding

101
Q

Exchange Traded Fund ETF

A

investment fund that trades on an organized exchange

most designed to track an index

generally trade at prices close to NAV

like the shares of a closed-end company ETF shares trade throughout the day

like an open-end fund the capitalization of an ETF is NOT fixed

ETFs generally are tax efficient & have low costs

102
Q

Unit Investment Trust UIT

A

unmanaged portfolio of stocks & bonds

trust has finite life; self-liquidating

may have income &/or capital appreciation objectives

“units” (NOT SHARES) are sold to investors

103
Q

Common Stock

A

stockholders are owners of the firm

return to stockholders dependent on success of the firm & generally takes the form of dividends &/or stock price appreciation

104
Q

Preferred Stock

A

characteristics of both common stock & bonds

preferred dividend is fixed percentage of par value

preferred dividends paid prior to common dividends

many corporations invest in preferred stock

corporate investors tend to like the fixed nature of preferred dividends

at least 50% of dividends received by a corporation (common & preferred) are excluded from taxation

105
Q

Dividends

A

determined by BOD

stock price falls on ex-dividend date (1 business day before record date)

cash dividends are taxable (even if in DRIP)

stock dividends (generally not taxable) similar to stock split (# of shares increase, stock price falls)

106
Q

Municipal Bonds

A

exempt from federal income taxes

General Obligation (GO) = backed by full faith, credit, & taxing power of the issuer

Revenue Bonds = more risky; only the revenues generated by the project (ex toll bridge) are used to service the debt

Private Activity Bonds = issued by local or state government to finance the project of a private nature (ex stadium); the interest is a tax preference for the ATM

107
Q

Comparing municipal securities (exempt from federal taxation) to corporate bonds (subject to federal taxation)

A

calculate the taxable equivalent yield (TEY)

investors in higher tax brackets benefit more from the tax advantage of municipal bonds

TEY = muni rate / (1 - tax rate)

108
Q

Convertible Bond

A

conversion value = (Par / conversion price) x stock price

109
Q

MBS (Mortgage Backed Securities)

A

an asset-backed security that represents a claim on the cash flows generated from a pool of underlying mortgages

examples = GNMA, FNMA, FHLMC securities

investors receive their pro rata share of interest & principal

subject to prepayment risk, interest rate risk, purchasing power risk, & default risk (except GNMA)

110
Q

REMICs

A

investment vehicles that hold mortgages

issue securities that represent interest in the underlying mortgages

example = CMO (collateralized mortgage obligation)

111
Q

CMOs

A

mortgage derivatives backed by residential mortgages

different investment classes (tranches) have different maturities & risks

interest payments & all principal payments flow to tranche #1 (A) until it matures

Tranche #1 (A) has shortest maturity, least risk, lowest expected return

Z-tranche = longest maturity

112
Q

REITs

A

securitized real estate

3 types = equity, mortgage, hybrid

must distribute at least 90% of its taxable income to shareholders annually

at least 75% of gross income must be real estate related

113
Q

Monte Carlo Simulation

A

uses inputs to construct financial models

generates a large # of random samples from a specified probability distribution

useful in determining likely outcomes

114
Q

American Depositary Receipt ADR

A

security issued by a domestic bank, represents shares of foreign stocks (deposited in a foreign custodian bank)

face exchange risk even though they are denominated in U.S. dollars as well as dividends etc

115
Q

Yankee Bonds

A

U.S. dollar-denominated bonds issued in U.S. by foreign firms/governments

investors are NOT exposed to foreign currency risk

116
Q

Foriegn/International Funds

A

open-end & closed-end funds (& ETFs) that invest solely in international stocks & bonds

117
Q

Global Funds

A

hold international & domestic assets

118
Q

Treasury STRIPS

A

zero coupon bonds created from coupon interest & principal payments that are “stripped” from Treasury notes & bonds

STRIPS have considerable interest rate risk but NO reinvestment rate risk

119
Q

Series EE Bonds

A

non-marketable

redeemable after 12 months (w/ 3 months interest penalty); no interest penalty for redemption after 5 years

no inflation adjustment

interest = accrues, paid at redemption

subject to federal taxation, can be deferred until redemption; may be excluded from federal taxation when used for education

120
Q

Series HH Bonds

A

no longer issued (as of 2004)

acquired by exchanging EE bonds for HH bonds; non-marketable, redeem w/ U.S. Treasury

no inflation adjustment

interest paid semiannually

semiannual interest subject to federal taxation in year they occur

121
Q

Series I Bonds

A

non-marketable; redeemable after 12 months (w/ 3 months interest penalty); no interest penalty for redemption after 5 years

inflation adjustment = fixed rate plus variable semiannual inflation adjustment

interest = accrues, paid at redemption

subject to federal taxation, can be deferred until redemption; may be excluded from federal taxation when used for education

122
Q

TIPS

A

marketable (can be sold in secondary market)

inflation adjustment = principal increases (decreases) w/ inflation (deflation)

interest paid semiannually

semiannual interest payments & principal increases subject to federal taxation in year they occur (avoid annual tax by holding in qualified accounts such as IRAs)

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