Investments Flashcards
Accredited investors
(appendix)
FINANCIAL CRITERIA
Net worth over $1 million, excluding primary residence (individually or with spouse or partner), or, Income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years, and reasonably expects the same for the current year.
PROFESSIONAL CRITERIA
Investment professionals in good standing holding the general securities representative license (Series 7), the investment adviser representative license (Series 65), or the private securities offerings representative license (Series 82), or, Directors, executive officers, or general partners (GP) of the company selling the securities (or of a GP of that company), or, Any “family client” of a “family office” that qualifies as an accredited investor, or, For investments in a private fund, “knowledgeable employees” of the fund.
Benchmarks
Large US stocks: S&P 500
Small US stocks: Russell 2000
All pub traded US: Wilshire 5000
Developed nonUS: MSCI EAFE
Emerging nonUS: MSCI EM
US Bonds: Barclays cap agg bong
Public traded REITS: DJ US Select REIT
Commodities: Deutsche bank liquid comm
Cash: 3 month Tbill
Lg US stocks & bonds: Vang Bal Index VBIAX
Bond prices Sensitivity to changes in rates
The longer the duration and the lower the coupon the more sensitive to changes in rates
The shorter the duration and the higher the coupon the less sensitive to changes in rates
Bond relationships
The smaller the bonds coupon,
the greater the relative price fluctuation
The lower the reinvestment rate risk
The lower the interest rate the greater the relative price fluctuation
The longer the term to maturity the greater the relative price fluctuation
Higher inflation = higher interest rates = lower bond values
Bond yields and pricing
Think about that seesaw!
Cy = annual income or interest /current mkt price
Ytm and ytc use TVM, compute I/y
When deciding to invest take ytw yield to worst the lower of ytc or ytm
Remember yield to call is at the end of the seesaw on the right
When the bond is trading at a discount yield to call is the highest figure
when the bond is trading at a premium yield to call is the lowest figure
Bonds: discount and premium
Remember if the current yield is more than the coupon it is a discount Bond
That is it would be trading for less than par now since the coupon is less than what you can currently get in the market
Mean and std deviation: Calculate
(And beta and r if two data sets )
2nd 7 (Data)
Enter data set
If only 1 set hit down arrow two times
If two sets can enter both
When done 2nd8 (stat)
Down arrows
N is number in set
X mean (simple average)
Sx is std deviation
Further down is beta and r when entering a 2nd data set
CAPM
A model to price an individual security or portfolio
An investors expected or required rate of return
CAPM components
Risk-free rate plus the stock risk premium equals capm
Market risk premium
Market rate minus risk free rate
Stock mkt premium is
market risk premium times beta
Options: Collar
“zero cost” collar
Bullish
Protective put + short the call
Long the stock, long the put, short the call
$ from selling the call goes towards paying for the put
So I own the stock, buy/own a put and I sell a call
This is probably done because the investor has concentrated their position and the financial planner thinks it’s risky so they do this since since the client won’t diversify more
It’s not really zero cost cuz puts are generally more expensive than calls. So I’m paying more for the put then I’m generating from selling the call but premiums earned on selling call does help offset it
They also say a collar strategy is writing out of the money calls and buying out of the money puts
Stocks. Correlation. R
Used to compare two stocks or a stock and the market therefore it can give you a stock’s return relative to the market
I can calculate DATA function
Options. Covered call
Know it
Long the stock, short the call
Generate income for the portfolio
I own the stock and with my call I have an obligation to sell but I don’t think the price is going up in near term
I’m bearish in near term but bullish in long term that’s why I’m keeping my stock.
Bonds: Current yield on a bond
Annual income divided by market price
Also remember the seesaw and if price is at or below par and order of yields. Can often get right without calculating. Plus use as a sanity check after calculating!
Bonds: Dividend calc
If they simply ask to calculate the dividend at the end of the year. Take the current dividends divided by the shares times 1 plus the growth rate.
Bonds. Duration
Calculate change in bond price based on duration
CFP provided formula
Y in denominator is ytm
Bonds. Duration relationships
Higher coupon =lower duration= lower interest rate risk
As interest rate decreases, duration increases.
As interest rates increase duration decreases.
Generally speaking, for every 1 percentage-point change in interest rates, a bond will rise or fall in the opposite direction by an amount equal to its duration number
Bonds. Duration shortcut
Don’t choose the answer closest to the number of years to maturity select one down from the closest . Example from Zahn below
if the years to maturity are 5 and the answers are
5 4.6 4.17 and 3.18
…select 4.6
Dwrr/IRR
Affected by timing and size of cash flows
CF wksht
CF, 2nd clr work
Watch signs!
Cf0 = initial outflow
Cf1 etc
Then down arrow
IRR CPT
Investments negative
Dividends, selling price positive
Sometimes two CF in that same last year. Enter net.
Map it out on paper first
Economic Indicators: coincident
(Appendix)
Coincident indicators tend to change at the same time as the economy:
Employees on non-agricultural payrolls Personal income less transfer payments Industrial production Manufacturing and trade sales
Economic indicators: Leading
(Appendix)
Leading indicators tend to rise and fall in advance of the economy:
Average weekly hours of production workers (manufacturing) Initial claims for unemployment insurance Manufacturers’ new orders Percentage of companies reporting slower deliveries New orders of non-defense capital goods New private housing starts Yield curve S&P 500 Money supply (M2) growth rate Index of consumer expectation
Bonds. Effective rate on bonds
2nd 2
Arrows to scroll through
Enter nominal rate
Enter comp per /year
Hit CPT when on effective rate
Efficient Frontier
Return relative to Std deviation
Inefficient below curve
Impossible above curve
Risk averse have flatter curves
where you plot depends on risk tolerance
Steeper part at bottom is for the risk averse. They need more coaxing to get in. Approaching 100% bonds at bottom
Flattered at top is for the risk tolerant . Approaching 100% stocks
Bonds. Using duration to estimate change in price
For each percentage change in the market rate
Percent *years = approx change in price
Use negative for decreasing rates
Holding period return
Basically profit/cost
Includes Price appreciation and dividends in profit
Sometimes asks for just capital appreciation return or dividend return
Numerator
Price-cost+ div - margin interest
Denominator
Cost - $ committed on margin
So on margin your return will be higher bc your cost is lower
Bonds. How does duration relate to yield to maturity
The duration of a zero coupon bond will be the years to maturity
The duration of an income producing Bond will be less than the years to maturity
A higher coupon will result in a lower duration
Duration increases with maturity
Bonds. Intrinsic value of bond
Think of it as the present value!
Jensens alpha
Relative or absolute?
Absolute
Zero or postive is good
At or above the SML
Actual minus expected
Where actual is Port return
Expected is CAPM
Margin : fed minimums
Initial 50%
maintenance 25%
Holding period calculation
When bought on margin
(1-im)/(1-mm)*PS=margin call price
Ps = purchase price of stock plus commissions per share
Bonds. Multistage dividend growth model
CFP formula sheet is step 2 only!
Step 1. calculate the last dividend in the first series
Then in step two D1 is that last dividend times 1 plus the new growth rate. Use it to calculate stock value in first year of new dividend
V=D1/(r-g)
Step 3 solve for npv using cash flow worksheet
Cf0 equals 0
Cf1 equals D1 in step 1
Next are the other steps 1 dividends but on last one add the PV from step 2
Option premiums
Pricing per lot or per share?
Multiply by the number of shares of stock
premium * # puts or calls * 100
Option strategy : Straddles
Capitalize on volatility or stability?
And what do I do?
Straddle to capitalize on volatility either way
BUY both put and call
Long a put and a call on the same stock at the same exercise price at the same date
Im paying a premium for this because I expect volatility
I am buying the right to buy or the right to sell. I win either way. Except for premiums I paid!
Option strategy
How to protect shorts in the stock
PS with a PC or CP
Protect shorts in the stock with
Protective call or covered put
(Buy a call or sell a put)
- protective call. Buy a call when short the stock. Like if I borrowed stock from my broker I want to have the right to buy the stock at a certain price so I can repay him.
-covered put.
Own the stock and sell a put.
Trying to understand…
So I own the stock… so when buyer of my put makes me buy his stock, I can sell the stock I already own…to get the $ to buy his stock?!
Options bullish
Vs bearish
Buy a call if you think the price will go up. Bc you want to lock in price and sell at a gain when it rises
So buying a call or selling a put is bearish
Buying a put or selling a call is bearish
If I think the price is going to go down I don’t think the buyer of my call is going to exercise it and I just get to keep the premium
Options strategies other
Uncovered option positions are always written options, or in other words options where the initiating action is a sell order. This is also known as selling a naked option.
Options strategy
How to generate money for a portfolio?
Sell a call to generate $ in portfolio
Options strategy: spreads
To capitalize on volatility or stability?
What do I do?
Spread is to benefit from STABILITY purchase and sell the same type for example buy a call and sell a call
Mostly just remember that straddles are for volatility and spreads over stability
Options: Protective put
Bullish or bearish?
What do I do and why?
Bullish but want to protect myself in case price drops.
Portfolio insurance!
Long the stock, long the put
I own the stock, I have the right to sell it
The put contract is a floor in case the price drops but it is expensive to keep buying puts therefore I might do a …
collar
R2
Coefficient of determination
Measure systematic risk
This percentage tells you the percent of the variation of stock x that can be explained by variability in market returns
If it’s less than .7 use Sharpe ratio
If greater than .7 use treynor
So we are using Treynor which uses the Beta when more of the variation can be explained by the market
R2 Coefficient of determination
Measure systematic risk
1-r2= unsystematic risk
Real rate of return
((1+Rp) / (1+Ri)- 1) *100
*100 to get into format for entering I/Y
Or shortcut example.
if 8 and 3. (8-3)/1.03
Margin. Schwab example
Remember the amount of DEBT you owe the broker. When price falls your equity goes down and you have to bring it up by paying cash or buying more securites..looks like exam has us usually buying securites. We need more value there to get up to the margin req
Equity needed divided by 1-mm
Vs margin call will be at initial price times (1-im/1-mm
Sharpe ratio
When to use?
Comparative or absolute?
Beta or std dev
Use if r2 is less than .7
S is for std dev
(Portfolio return - risk-free rate) / std dev of the portfolio
Comparative only useful to compare the sharp ratio of other investments
Risk free return is usually the 3-month t-bill
Std deviation and normal dist curve
1 68%
2 95%
3 99%
Draw it out
Options. Stock option premiums
Intrinsic
from perspective of buyer
Intrinsic
Instrinsc is NEVER below zero
Call COME
Market - exercise
Put POEM
When exercise>market
A CALL is “In the money” when exercise is below market. I can buy at less than market
Options. Stock options:Buyer
Buyer =holder= the long
RIGHT to
Purchase. CALL
Sell. PUT
Premium is the buyers max loss
And the sellers Max gain
Options. Stock options: Sellers
Seller=writer=short
Seller is OBLIGATED
Seller wants premiums
Hopes they won’t be exercised
Max gain is the premium
Market. Systematic risk
Diversifiable or not?
Quantified by std dev, beta or neither?
List types
Quantified by beta
Not diversifiable
PRIME
Purchasing power
reinvestment
interest rate
market
exchange rate
Bonds. Tey taxable equivalent yield
Tax exempt yield / 1- marginal tax rate
Options. Time Premiums increase by…
Risk free rate
Time to exercise
Variability
An increase in any of the above leads to a greater premium
Treynor
When to use?
standard deviation or beta? comparative or absolute?
When r2>.7
Risk adjusted return, a relative measure
(Port return - risk free)/beta
TWRR (geometric mean)
Set p/y to 1
Use tvm where
PV=-1
N=#peroids
Fv is 1.x*1.x etc or 1-x if return was negative
Cpt I/y
Or. Do the fv part and raise to
1/n power and then subtract 1 ,(and multiply by 100 if need to input as I/y
see formula sheet
Bonds. What does duration calculate and what is it used for?
Duration calculates, on a time value of money basis, the time to recoup your money on a bond investment
It’s the effective maturity
Duration is used to calculate changes in bond prices based on hypothetical changes in rates
Matching the duration of a fixed income portfolio to an investor’s time horizon immunizes those assets. You should match duration NOT years to maturity!
Duration is a linear estimate
Convexivity is more precise
Options. When does an investor buy and sell options
An investor who expects LARGE price fluctuations would BUY a call or a put
An investor who expects SMALL price fluctuations would SELL a call or a put. *Seeking premium income
Market. Yield Curve
Normal,positive,upward sloping
Inverted,negative,downward slopomg (Convex)
Short end VERY sensitive to fed policy
Normal curves point to economic expansion or stable economic conditions.
Downward sloping/inverted point to economic recession . Investors expect yields on longer maturity bonds to trend lower in the future.
A steep normal curve implies strong economic growth with conditions often accompanied by higher inflation and higher interest rates
Market Structure
Money - ST Debt instruments
Commercial paper is usually 9 months or less
Capital - LT debt AND equity inst
SEC 33 regulates PRIMARY CAPITAL mkts
SEC 34 regulates 2ndARY
Investment risks
Total = std deviation
Includes systematic and unsystematic
Systematic is beta is prime
UNsystematic can be eliminated through DIVERSIFYing the portfolio . Firm specific risk
Investment risk graph
Certain sectors carry higher systematic risks
Financials
Pharmaceuticals
Energy
Systemic is the amount up to the standard deviation of the market
UNsystematic is the amount above
Risk return relationship
low and high risk investments
Lower risk
Cash and money market securities
Treasury securities
Investment grade bonds
Higher risk
Common and preferred stock
Junk bonds
Options futures and forwards
Small cap and growth oriented funds
Remember cfp always says large cap are less risky than small
Factors that influence an investors capacity for risk
Time horizon
Liquidity needs
Total investable assets
if I have some cushion I’m willing to take more risk
Skewness
Skewness refers to the extent to which a distribution is not symmetrical
Positively skewed have many outliers in the upper or right tail
Stock markets are positively skewed
Negatively skewed have outliers in the lower or left tail
Upper and lower don’t make sense to me but just know the outliers are on the skewed part of the curve
Kurtosis
-Mesokurtic normal
-Leptokutic slender. Tbills.. predictable
-Playtykurtic broad. Smcapstocks
Fundamental analysis vs Technical analysis
Fundamental. WHAT to buy. look @ underlying company’s business & conditions in Industry & Economy
Technical. WHEN to buy. Share price, mkt mvmnts, prices/volumes/patterns. used in review of ST trading.
Efficient market theory
Stock market is efficient and therefore all stocks reflect all relevant information and are priced in equilibrium
Investors who accept this in strong form would only be passive
See chart..know
Random walk theory
The theory that the movement of stocks are utterly unpredictable lacking any pattern that can be exploited by an investor
Efficient frontier
Standard deviation is the risk measure
All points on the curve are equally efficient
Points below are inefficient
Points above are impossible
The rescavers are at the bottom the state park. The risk tolerant are the top work flattens out
Risk adjusted measurements
Sharp Treynor and Jensen’s
Sharp vs Treynor
Uses standard deviation and measures the performance of the portfolio
Treynor uses Beta and measures the performance of the portfolio manager
Use when planning a portion of your portfolio of specific sections
Wash sales
When a taxpayer realizes a loss on the sale of a security and acquires a substantially identical security within a 61 day.
Looks 30 days back and 30 days forward
Substantially identical is broadly defined
Bonds is hard to violate the rule unless you buy the exact Bond or Bond fund
Stocks. These may be substantially identical
Convertible Bond to same stock
Purchase a call for same stock
The unallowed loss is added to the basis of new securities purchased. So you would be able to use it when your new securities are sold as long as you don’t violate the rules again
Rates of return
Nominal
Effective
Real
Nominal is the actual rate the coupon rate
Effective builds in compounding
On my TI use the 2nd2 (iconv)
for data
Enter the coupon rate
Enter the compounding periods per year usually two
Hit CPT when on effective
Real rate counts for inflation
1 + portfolio divided by 1 + inflation - 1 * 100
Watch it will be negative if inflation is more than portfolio rate
Duration relationships
Higher coupon equals lower duration equals lower interest rate risk
As interest rates decrease duration increases
As interest rates increase duration decreases
Makes sense remember it’s all about the time it takes to recover your investment
Beta,standard deviation, and r2
S in S. Std dev for Sharp
T in beTa. Beta in Treynor
S comes before T.
Less than .7 is Sharpe and higher is Treynor
When do I buy or sell puts and calls
Expect large price fluctuation up
Buy a call, sell a put
Expect a large price fluctuation down
buy a put, sell a call
Bullish is buying a call and selling a put.
Duration strategy
LONGER durations in a HIGH interest rate environment allows the investor to participate more fully in price APPRECIATION as rates DROP
Conversely in a LOW interest rate environment , LOW durations allow an investor to participate LESS fully in price DEPRECIATION as rates INCREASE
Counterparty risk
Options
Futures
Forwards
Options.
OCC Options clearing corporation
guarantees performance of both parties and
eliminates counterparty risk
Futures are standardized and carry no counterparty risk
Forwards are not standardized and they do carry counterparty risk
Stock option premiums
Price components
- Intrinsic value
Market vs exercise
Can’t be below zero - Time premium
-risk-free rate
-Time to expiration
-Variability (std deviation)
The greater any of these three the greater the premium
Time premium is greatest at creation of contract approaches zero at expiration
Which has unlimited risk
Naked call writing
Naked put writing
Naked call writing
I have obligation to sell stock I don’t own. I have to buy at market price. Could go up and definitely
Versus naked put I have an obligation to buy at x price. It’s known what I have to pay. It’s limited to my number of options times the known exercise price
Put call chart
Memorize including straddle and spread
Futures
Someone who is long needs a short hedge (sell futures)
Someone who is short needs a long hedge (buy futures)
A farmer is long he owns corn he needs to sell it . Sell futures vs sell in local mkt at time of harvest
Builder needs lumber he is short he needs to buy it. Buy futures
Forwards
No intermediary
There’s counter party risk
Premiums
Whose max loss?
Whose max gain ?
Premium is the buyers max loss
And the sellers Max gain
Remember generally the sellers are just in it to make money on these premiums and hope they aren’t exercised. They’re just generating some income on their portfolio.
Three most important option strategies
Covered call
Protective put
Collar
Cc. Own stock, sell a call.
To generate income on the portfolio
You are keeping the stock, you are bearish in the short term so you sell a call which you don’t think will be exercised
You’re only covered if you have enough shares to cover all of your contracts
Protective put
The essence of portfolio insurance! Put is insurance against the price drop
Own the stock, buy a put to have option to sell if the price happens to go down
Long the stock, long a put
Then add a collar. sell a call to help pay for the cost of the put
Risks of corporate bonds
DRIP
Default risk
Reinvestment risk
Interest rate risk
Purchasing power risk
T-Bonds. RIP bc no default risk
CMOs
Collateral mortgage obligation
Ztranche is lowest ranked specific structure
No coupon
Longest duration
No cash flow until the more senior tranches are retired or paid off
Go bonds versus revenue bonds
General obligation
Back solely by the credit and taxing power of the issuing jurisdiction
Revenue bonds back by collateral and the basis of income generated from funded projects
Revenue bonds are generally riskier and default more. However when go bonds to default the downside is worse
Asset class overview
Appendix
Also see asset allocation card 90 review the chart that I built in Excel from the appendix on what percentage is you should have in your portfolio at various risk tolerances and years to retirement
TIPS
Wealth protection or wealth building ?
Difference bw traditional bonds
Treasury inflation protected securities
Interest is not fixed
It can go up and down based on CPI changes
Historically under perform stocks in the long run
Generally a wealth PROTECTION tool rather than a wealth building tool
No default risk, no inflation risk
But still has interest rate risk (mkt rates affect price)
I bonds
Maximum purchase per year is $10,000 per person
20,000 for a couple
Have to wait 5 years to redeem without penalty
Option to defer tax until the bond is cashed in or matures
Matures in 30 years
Cannot be cashed in during their first 12 months
From one year to 5 years redemption is a loss of 3 months of interest
Lagging economic indicators
Average duration of unemployment
Ratio of trade inventories to sales
Change in index of labor cost per unit of output
Average prime rate
Commercial and industrial loans outstanding
Ratio of consumer installment credit outstanding to personal income
Change in CPI
Asset allocation
See appendix
Duration
Picture the graph
With linear duration vs convexity
Y is price of bond
X is YTM
Yield curve
Steep curve suggested growing economy and possibly higher inflation to come
Flat shows little difference in yields from short to long term indicates uncertainty
Inverted signals trouble ahead short-term bonds are paying a lot better than long term.
