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CFP Flash Cards > Investments > Flashcards

Investments Flashcards

1
Q

How do Negotiable CD work, what are some insurances and what is the risk?

A

Issued by American banks
Can be bought and sold on the open markets
$250k fdic insured per individual
Deposit plus interest
Carry interest rate risk

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2
Q

Money market deposit account fdic limit per person

A

$250k

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3
Q

Money market mutual funds(mmfs)

A

Open-end investment companies offer mmfs.
Not fdic insured
Some offer insurance
Interest can be taxable or exempt
Taxable hold tbills, negotiable cds, and prime commercial paper.
Average maturity is 90 days
Tax-exempt contain short-term municipal securities

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4
Q

Treasury bills are

A

Short-term, 1 year or less.
Issued at a discount from face value

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5
Q

Commercial paper is

A

Short-term, 270 days or less
Unsecured promissory note by large well known and financial strong companies
Denominations of $100k
Usually sold at a discount and is rated by a rating service for quality

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6
Q

What is a bankers acceptance?

A

Instrument used to finance imports and exports transactions
Basically an assurance of payment
Bearer securities held 9 month or less
Trades at a discount

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7
Q

What are eurodollars?

A

A deposit in any foreign bank that is denominated in dollars

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8
Q

What is a yankee bond?

A

Dollar-denominated bonds issued in the US by foreign banks/corporations
The bonds are issued in the US when market conditions are more favorable than on the Eurobond market or in domestic markets overseas

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9
Q

Discount bond example

A

A $1000 par bond is quoted at 90 and is selling at a discount of 10 points ($100) from par. A bond point is $10

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10
Q

The yield ladder

A

Discount bonds-yields higher than $500

Remember YMCACMY

Yield to call
10%+gain yield to Maturity
10% Current yield
5%/$50 Annual coupon (nominal yield)
ABOVE THE LINE
BELOW THE LINE
2.5% Current yield
2.5%+losses yield to Maturity
Yield to call

Yields lower than coupon ($2000)
Premium bond

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11
Q

When is a corporation most likely to call it’s bond

A

When bonds are selling at a premium, newly issued bonds are offered with lower coupons. The company can recapitalize with lower coupon bonds.

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12
Q

When interest rates are expected to drop, should a corporation call a bond

A

Just because interest rates drop (1%) 8% to 7% doesn’t mean that’s lower than the company’s coupon rate

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13
Q

Nominal yield is the coupon rate

A

Coupon rate is the nominal rate

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14
Q

Bonds earn interest daily, if selling

A

The buyer must compensate for the accrued interest from the last interest date due to the “Regular Way” settlement date of the trade is calculated

The buyer pays this accrued interest in addition to the quoted amount and commission

The buyer will be reimbursed for this amount when the issuer makes the next payment

For the test all bond trades are assumed to be “with accrued” or “plus accrued.”

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15
Q

Accrued interest bond example

A

Remember bond pay in arrears

On july 1 Harry purchased 10 bonds for 8% interest 10/1/2029 at 105. Commission was $100. He pays $10,800. On Oct 1 he will be paid $400. He already paid $200 of the $400
He will report $400 on schedule b (form 1099-int) and subtract $200 as accrued interest

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16
Q

Things to look for on Accrued interest

A

Calculate the bond payment to determine 1099
How much is the accrued interest? Subtract that from the 1099 and the cost of the bond ie basis

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17
Q

Original issue discount (OID) from par when it is issued

A

Many OIDs are zero coupon bonds
No interest until maturity
The discount must be accredited over the bond life
Interest is included in interest income(phantom income) and the bond basis increases

Muni bond OID- interest is not taxable during or after maturity

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18
Q

T bill characteristics

A

Maturities 3, 6 12 months
Issued $100 to $1 million (discount yield basis)
Risk- none/safest (benchmark for risk free rate)
Default risk: none
Callable NA
No coupon interest(interest is the discount)
Subject to taxation on federal level, not state and local
Auction:weekly

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19
Q

Treasury notes characteristic

A

Maturities 1-10 years
Issued $1000 to more than $100000 at par
Risk- reinvestment, interest rate, purchasing power (RIP)
Default risk: none
Callable Not callable
Interest paid semiannually
Subject to taxation on federal level, not state and local
Auction:monthly

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20
Q

Treasury bond details

A

Maturities 10-30 years
Issued $1000 to more than $1million at par
Risk- reinvestment, interest rate, purchasing power (RIP)
Default risk: none
Callable 15 years* priory to maturity
Interest paid semiannually
Subject to taxation on federal level, not state and local
Auction:quarterly

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21
Q

Treasury bond that is callable

A

Are not callable for at least 15 years from the first day of the delivery month, or if not callable, have a maturity of at least 15 years from the first day of the delivery month. The invoice price equals the future settlement price times a conversion factor plus accrued interest
The conversion factor is the price of the delivered bond ($1 par value) to yield 6%

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22
Q

Treasury bonds are not riskless

A

Reinvestment risk, interest rate risk and purchasing power (inflation) risk RIPI

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23
Q

Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities)

A

Zero coupon bond issued by treasury
Investors acquire a direct obligation of the federal govt
The discount on STIRPS is treated as taxable income, earned annually

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24
Q

Treasury Inflation Protection (TIPS)

A

Tips offer inflation protection. Marketable security. The face value (principle) of tips is adjusted SEMIANNUALLY to keep up with inflation as measured by CPI over a 6 month period

TIPS are offered with lower stated coupon rate compared to conventional treasuries. The amount of semiannual interest rises as the face amount is adjusted higher with inflation. Higher inflation equates to a higher face amount of the bond (fixed percent but not fixed amount) semiannual interest payments.

TIPs are sold in $1000 denominations

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25
Q

TIP Example

A

$1000, 10 year TIP has a fixed rate of 3.625
If CPI rises ANNUALLY by 6.5%, the principle is adjusted to $1032.5 (1st semiannually) and the first interest payment is $18.13. The second interest payment would be ($1032.5.03625/2)=$18.71. The principal at the end of the year is 1065. The second year interest would be ($1065.03625/2)=$19.30

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26
Q

Taxation of a TIP

A

Federal tax but no state or local tax
Interest and appreciation are taxed
(appreciation is phantom) because nothing is received and Taxes are paid this raises the basis

If inflation goes down then it will reduce interest income to the semiannual interest and if there is excess, the excess will be an ordinary deduction

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27
Q

TIP increase basis in bond

A

The inflation adjustment increases the basis of the bond, the interest payment does not increase the basis of the bond. The interest received is taxable interest

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28
Q

EE bonds

A

Interest is based on the 10 year treasury note.
Nonmarketable
Fixed rate applies to 30 year life of the bond but only 20 years but adds a 10 year extended maturity period.
Denominations as low as $50. New issue rates are adjusted may 1 and Nov 1.
Interest accrues monthly and is compounded semi annually
Must be held for 1 year
There is a three month interest penalty for bonds held less than 5 years
Treasury guarantees the bond value will double after 20 years
It will continue to earn the fixed rate unless a new rate or structure is announced. If the bond doesn’t double then the treasury will make a one-time adjustment at maturity

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29
Q

Series EE bond taxation

A

Not taxed federally until bonds are redeemed or reach final maturity
The owner has the option to have the interest taxed each year
Interest is not subject to state and local taxes

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30
Q

Hh bonds

A

Exchanging from bonds at $500. Not available after 2004 but still may be out there
HH bonds are taxed yearly

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31
Q

I bonds or inflation-indexed accrual securities of the gov’t

A

Sold at face value
Accumulate interest monthly
Compounded every six months on the bond issue
$50 is the minimum
No guaranteed interest unlike EE bonds
Interest rate is fixed rate plus inflation adjustment
Inflation is traced ever 6 months based on CPI
Rate is announced by treasury May 1 and Nov 1
The owner determines tax. Owners typically def tax and rarely choose to recognize tax

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32
Q

Govt national mortgage association (gnma)

A

Buys fha, va, farmer home admin insured mortgages and places them into mortgage pools
Issue pass through certificates (min $25k) representing interests in the pool
Since they are not issued by the fed they are taxed federally, state and local
Direct guarantee by the US gov’t
Default:none
Interest rate risk: fixed interest, so interest rate risk if prices fall and interest rates rise
Reinvestment risk: reduced certainty of monthly payments because homeowners repaying their mortgages sooner when interest rates fall (prepayment)

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33
Q

Yield on GNMA

A

Should be aware that payments received is interest and return of principal (no par at maturity) decline in NAV. People can move in an increasing interest environment paying off their loan

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34
Q

Federal home loan Bank(FHLB)
Federal National Mortgage Association (FNHA) Fannie Mae is a profit making corporation
Federal Home loan mortgage corporation (FHLMC) is a privatized company issue Freddie Mac

A

The US govt does not directly back these issues. They are backed implicitly through lines of credit

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35
Q

Gnma is not subject to default risk

A

Fnma is subject to default risk because it is a for-profit corporation. Likely that treasury would step in if default was a concern

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36
Q

GO (general obligation) bonds

A

Are typically the safest munibond. Think bridges and roads. Can levy taxes

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37
Q

Revenue bond

A

Backed by specific source of revenue like a new stadium to pay back the bond holders
It is not pledged of the full faith and credit of the issuer (toll roads, hospitals, dorm rooms)
Greater risk equates to higher yields

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38
Q

Every munibond wants AAA

A

If insured they virtually have a rating of AAA
Credit rating agencies are
AMBAC, MBIA and BAM

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39
Q

Mortgage bonds (corporate)

A

Considered the safest among long-term corporate issues because the bonds are back by real property and can sell property if the issuer defaults

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40
Q

Collateralized Mortgage Obligations (CMOs)

A

Based on the expected cash flow to be received over the life of the pool, separate classes of securities called tranches are created

The tranches are separated into a to z. Represents fast pay, slow play (z). Z bears no coupon but receives cash flow from collateral from the remaining after the tranch is satisfied

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41
Q

Tranche Z has the following

A

Longest duration of all the classes (like 0)
It receives interest and principal after all other tranches have been liquidated
Since it has the longest duration it will have the highest interest rate risk
Since it is last to be paid it has the highest yield

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42
Q

What is debenture?

A

Corporate debt obligation back only by the insurer (corp)

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43
Q

Indenture debt agreement/deed of trust

A

A formal agreement, also called a deed of trust, between issuer of bonds and trustee
Appoints a trustee to act on behalf of bondholders
Form of bond (coupon or zero)
Amount of issue
Property pledged
Protective covenant, including provisions for sinking fund
Working capital and current ratio
Redemption rights

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44
Q

Default risk

A

A creditor may seize collateral and sell to recoup the principal (credit risk)

No government issued bond has this. Govt bonds have rip sans zero coupon bonds

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45
Q

High yield bond or junk bond rating

A

BB or lower and pays higher yield for the risk

Seldom the correct answer

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46
Q

Convertible bonds

A

Conversion depends on the price of the security depends on the value of the stock and the interest rate the bond pays

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47
Q

Bond conversion value calculation

A

Cv=(par/CP)*Ps

CP=conversion price
Ps=current market price of underlying stock
PAR=par value, presume zero

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48
Q

Floor value for convertible security

A

Every CVPs has a floor
A CVB will NOT SELL for less than the LARGER of the following
-its value as a bond
-its convertible value

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49
Q

Convertible bond securities sacrifice

A

An investor sacrifices yield to hold the convertible bond (the market price)

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50
Q

Financial distressed individuals are recommended to move their funds from CD to investment grade bonds. 3 months go by

A

They will state they haven’t had the time because risk adverse investors will put off making the required changes

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51
Q

Someone who wants to change from a conservative investor may

A

Morph into an aggressive investor

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52
Q

When solving for intrinsic and convertible bond values

A

Use Par, not market price of bond

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53
Q

Calculate current yield

A

Coupon payment/bond price= current yield

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54
Q

Describe feature of GNMAs

A

Payments include interest and principal
The amount received each month may vary
The yield can be somewhat variable
Certs guaranteed by us govt
If mortgage rates decrease, prepayment may increase

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55
Q

Describe I Bonds

A

Series I bonds earn interest for 30 years
Accrue earning based on fixed rate of return and the semiannual inflation rate
Tax credit applies to both EE and I
The difference between the purchase price and the redemption value is taxable interest

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56
Q

Common stock when it comes to creditors

A

Most junior security
Secured/unsecured, owners of bonds, preferred stock take precedence

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57
Q

Capitalization or cap refers to the market value of the corporation

A

Large cap stocks-cap exceeding $10 billion
Mid cap stocks- cap exceeding $10 billion (large) and $2 billion (small)
Small cap anything less than $2 billion
Micro cap- cap less than $300 million

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58
Q

10Qs and 10ks (think k1)

A

Quarterly reports from corporations to the SEC

And

Annual reports from corporations to the SEC

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59
Q

Corporate annual report

A

Sent to shareholders annually speaking of the prior year’s results
Provides information to independent auditors

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60
Q

Preferred stock is a hybrid vehicle comprised of equity and debt

A

Usually used at $25 par or $100 par with a stated dividend.
Pays a fixed dividend rate
Duration is perpetual or infinite
Because of this interest rate change has a deeper impact then bonds

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61
Q

Preferred stock cumulative or non- commutative

A

Cumulative-when dividend payments are missed shares will be paid to preferred before any payment to common shareholders as well. Non-cumulative-payments don’t need to be made up

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62
Q

Preferred stock investors

A

The typical purchaser of a preferred share is corporate treasurer with excess funds on hand. If the treasurer buys bonds, all the interest is taxable however, the corporation buys preferred stock, 50% of the dividend received or generally excluded from taxation.

A corporation can take advantage of 50% or more dividend exclusion

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63
Q

Preferred stocks can be callable

A

like bonds

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64
Q

American Depository Receipt ADRs

A

ADRs are receipts of foreign shares held in a US bank vault

Entitle share holder to dividends

In USD, dividend in USD, declared in country of origin’s currency

ADR holders cannot vote for board of directors of the company

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65
Q

ADRs additional information on taxes if foreign issuer incurs tax on dividend

A

Then investor is taxed but investor may receive a corresponding tax credit

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66
Q

UITs are

A

A basket of funds that are not purchased and are rarely sold

The trust/sponsor makes a market for the security for the unit holders, not shareholders

Generally redeemed at NAV

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67
Q

Open-ended Mutual funds are

A

Redeemable
Continuously issued
Non negotiable

Not tradable

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68
Q

Just because someone has a high risk tolerance

A

Doesn’t mean they are very aggressive

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69
Q

A couple making good money in their 40s what should their portfolio be. They are worried about taxes and AMT

A

They should get a global fund and S&P

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70
Q

Hedge funds

A

Used to be unregulated by SEC.
Now if AUM is $100 million more they must register and provide the sec certain information pertaining to their trading

Net worth- residents needs to be over $1 million or earn a minimum amount of money

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71
Q

Blind-pool limited partnerships

A

The objective is known but actual property to be included is not
The performance of the general partner in past partnership is a major consideration

Can be used for various real estate acquisitions or oil and gas programs

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72
Q

Guaranteed investment contracts (GICs)

A

Similar to CD by commercial banks but issued by insurance companies. Term is 2-5 years
Bear a guaranteed interest rate
Unlike bonds, GIC do not fluctuate with the interest rate, their value does. Demands on financial strength of the issuer

Popular investment for defined benefit plans. Insurance company assumes the interest rate risk of gics

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73
Q

Real estate and inflation

A

Can be an effective hedge
Real estate has a low correlation with US stocks
This potential diversification is Reason for including real estate in a portfolio

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74
Q

Real estate investor differences in land for investment

A

Unimproved land is a passive investment. Unimproved land cannot generate income and depreciation. It’s return as potential price appreciation. In fact, it can produce negative cash flow due to insurance upkeep, etc..
Improve land typically generates income from rentals. Income properties include residential rental, commercial and industrial properties. Intrinsic value of real estate property can be computed using an operating income computation.

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75
Q

Net Operating Income (NIO) Calculation

A

NOI is critical in real estate analysis

Gross rental receipts
+non-rental income (vending machines, laundromat equipment, late fees)
=Potential gross income (PGI)
-vacancy and collection losses
=effective gross income
-operating expenses (excluding interest and depreciation)
= net operating income property, cash flow

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76
Q

Operating expenses for operating income is the following

A

Operating expenses include only actual cash, expenses depreciation and amortization expenses are not operating expenses. Also not included debt service, interest,
expense, on mortgage financing that property. Financing is non-operating function.
The focus of operating expenses, the properties cash flow not the investors cash flow. Once the NOI has been computed, it must be divided by the capitalization rate to arrive at a properties, intrinsic value, the appropriate captors of function of manufacturers, including the type location, age of property and the quality of the properties tenants

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77
Q

Intrinsic value on an investment property using NOI and cap rate

A

intrinsic value=NOI $143,600/capitalization rate (cap) 12%=$1,196,666

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78
Q

Reits are similar to a closed-end

A

The reit invests in real estate, short-term construction loans, and mortgages
With publicly traded reits the investor achieves diversification and marketability

Trust shares are either traded on an exchange or traded over the counter

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79
Q

Non-public REits

A

Are not liquid or marketable

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80
Q

Equity reits invest

A

Mainly income producing properties ie office buildings, hotels, shopping center then lease the property out
Use a modest amount of leverage to finance the properties

Too much leverage and not enough occupancy can reduce dividends and NAC

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81
Q

Mortgage reits investment gets money from

A

Lending out funds to develop property or finance construction
Construction loans can earn high interest rates but with high interest rates comes more risk
Higher default risk
These instruments are particularly vulnerable to purchasing power risk

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82
Q

75% of REIT’s in one must come from

A

Real estate investments. 15% can come from securities like gnmas
If REIT distributes 90% or more of it’s investment income it only pays taxes on the undistributed amount
If it fails to distribute 90% it pays taxes on the whole net amount of income is taxable
Since TCJA, shareholders may deduct 20% of the pass-through income from reits.
The top effective rate will now be 29.6%

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83
Q

Reits are prohibited from investing in in

A

Limited partnerships
Limited partnerships are often tax shelters

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84
Q

Real estate limited partnerships

A

Relps are non-publicly traded and are illiquid. Has a thin secondary market
They last between 10-20 year or until the property is liquidated
Relps are subject to the passive loss rules

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85
Q

Real estate mortgage investment conduits (remics)

A

Limited life, self-liquidating equity that invests in mortgages or security backed by real mortgages. Like CMO but the trenches but unlike CMOs (AAA rated) they can both separate mortgages from maturity but risk classes

REMICs MAY replace CMOs

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86
Q

REMIC is set up as a corporation, how is it taxed

A

As a pass-through income, the set of a corporation is ignored

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87
Q

Current yield on mutual fund

A

What you are paid by the capital gain dividend by investment amount

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88
Q

Who would be likely to buy a preferred stock?

A

A pension plan for the income, A C Corporation with extra cash because at least 50% is not taxable and a person in a 12% bracket because they most likely won’t pay taxes

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89
Q

What account would buy a reit in?

A

Qualified account due to substantial taxable income

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90
Q

High yield doesn’t necessarily mean

A

Junk bonds

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91
Q

Mutual funds are open-end investment companies

A

They continue to sell shares after initial offering. Capitalization is always changing due to buying and selling. Each day the fund company computes Net Asset Value. Mfs are marked to market and divided by outstanding shares

No loads, customer pays NaV

Redemptions are always NaV

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92
Q

Closed-end funds

A

Are publicly traded. They issue stock once then the books are closed, meaning no new shares are issued. Traded on an exchange and valued like any other security.

Closed end funds may hold illiquid securities. Illiquid stocks are not sold by investors

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93
Q

Shares are purchased directly with the issuer

A

Open-end fund and no-load balanced mutual fund

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94
Q

Intrinsic value of an option

A

The minimum price an option will command. Difference between market price and option price

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95
Q

Time premium of an option

A

The amount the market price of an option exceeds its intrinsic value

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96
Q

What is an Exercise price for options?

A

Is the price the stock can be purchased or sold when exercising an option

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97
Q

What is Premium for an option?

A

Is the price/cost of an option. As the option approaches its expiration date, the market price of the option (the premium) approaches its intrinsic value

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98
Q

Intrinsic value on an option formula

A

IV=Exercise price- market price

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99
Q

Option value based on time-to-expiration versus volatility(speculative)

A

The time value of an option may be the most importance element when market and exercise is equal. The greater the volatility, the greater the price of an option because the increase potential for the stock to move up or down

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100
Q

Call option taxation (9 months or less)

A

At the time of purchase, the premium paid is a capital expenditure (basis)

If call lapses and premium is received it’s a short-term gain rate(ordinary income rate)

If the call is exercised and security was held more than 12 months then long term gain. The premiums are added to the sale price-basis to get to taxable amount

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101
Q

Taxation for holder of an option(bought)

A

If expired, it produces a short-term loss.

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102
Q

Long-term equity anticipation securities (LEAPs)

A

Maturity of 2 years and beyond
S&P 500 index option is a useful hedge for money managers

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103
Q

Warrants compared to options

A

An option to purchase within a specified time period a stated number of shares at a specified price

Warrants are created by corporations/options are created by individuals on exchanges

Warrants maturity is several years/options are typically 9 months

Warrants terms are not standardized/options are

Warrants are issued with no intrinsic value

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104
Q

Future contracts in commodities

A

Spot price-current market price of the commodity in the cash market
Open interest-the number of future contracts trading for a commodity
Daily limit-the max permissible price increase or decrease relative to settlement price of the previous day

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105
Q

Future trading consists of

A

Commodity futures, currency futures, financial futures

Initial margin/deposit is good faith amount.

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106
Q

With future contracts if markets move against an investor and the value drops by more than the difference between good faith and maintenance margin

A

A margin call by the broker will require the investor to additional cash to restore margin

107
Q

A futures contract can be settled by delivery or offset (typical)

A

Delivery means settlement (delivery of pork bellies)
Offset means the buyers will sell their position and sellers buy their position sometime prior to delivery (the reverse what was done originally)

108
Q

Business may buy futures

A

To hedge against certain business risks
Future contracts are speculative and very risky

109
Q

Collectibles can diversify a portfolio

A

Typically go up during inflation
No market, limited buyers and sellers

Long-term capital gain rate is 28%

110
Q

Natural resources/commodies

A

May offer advantage of diversification

Most of these assets are negatively correlated with the stock market, rising when financial assets decline

If the supply or demand of a commodity is elastic it is highly responsive to price changes

111
Q

Precious metals are believed to be an inflation hedge

A

You can buy gold through bullion, gold mining stocks, futures, coins, and gold securities

Precious metals are treated as collectibles tax wise-28% capital gains

112
Q

Private placement Reg D

A

Not publicly offered
Can be offered to a maximum of 35 non-accredited investors (sophisticated) and must sign an investment letter. If they cannot evaluate on their own they need an attorney or cpa to evaluate (the evaluator signs)
And an unlimited amount accredited, over $1 million net worth excluding primary residence, $200k income for single, $300k for married. 321

Full disclosure is required through a offering memorandum

113
Q

Future contract is not a security

A

It is regulated by Commodity Futures Trading Commission and not by the SEC

A futures contract is a formal agreement between buyer and seller that operates through the commodity exchange

114
Q

A person who is hurt by 25% reduction has done nothing since with new money. He watched tv during the next downturn with $200k on the sideline. What will he do?

A

Nothing, he is paralyzed by all the negative reporting. He cannot make a decision

115
Q

A person in their 40s is worried about recessions. She has 75% of her portfolio in US stocks. What would you suggest to diversify?

A

Fine art/collectibles and a natural resource fund are negatively correlated with the stock market. Global fun would overlap her US stock position
She may enjoy the art, may suit her lifestyle
Index option is correlated
Put options may expire

116
Q

A person that owns an orange crop and is afraid prices will drop with an oversupply of fruit coming from another country

A

When they own OJ they are long OJ( they don’t have the oj yet.)
Owner would hedge against lower prices in the future by going short (selling a contract) of orange juice at today’s prices for delivery tomorrow (when prices may be lower)
This would hedge against the other countries oj prices

117
Q

Read the

A

F’ing question

118
Q

Intrinsic value has nothing to do with premium paid

A

Market price-strike price

119
Q

Time value and intrinsic value

A

Time value is market price-(strike+premium)
Intrinsic is market price-strike price

120
Q

Investment risk is

A

Uncertainty that the realized return will not equate to expected return

121
Q

Systematic risk involves risk that is inescapable

A

It’s non-diversifiable risk. Remember PRIME
PURCHASING POWER RISK (inflation)
Reinvestment risk(new security has Lower yield)
Interest rate risk (the risk that a change to interest rates will cause fixed income securities to fall)
Market risk (as it is, cannot be avoided if in market)
Exchange rate risk( risk with changes in currency)

122
Q

Country risk or political risk

A

The risk or uncertainty of returns caused by the possibility of major changes in the political or economic environment of a country

Closely related to exchange rate risk

123
Q

Systemic risk is different than systematic risk

A

Systemic risk is a risk to a particular company could collapse an entire sector/economy. Think Enron or Silicon Valley Bank

124
Q

Unsystematic risk can be avoided. What are unsystematic risks

A

Business risk( risk related to firm’s operations) Doesn’t adapt to technology

financial risk (credit or default risk) (risk related to how the firm finances its assets. Forced to close because it’s can’t service its debt

125
Q

Total risk

A

Is expressed by standard deviation while systematic risk is expressed by beta 1
Total risk is the combination of systematic and unsystematic risk that a portfolio presents

126
Q

Unsystematic risk can be diversified

A

By buying low or zero or negative uncorrelated securities

Systematic risk cannot be minimized by owning more securities

127
Q

One may argue there is no-risk free investment. If a client invest for the short-term what risk does this person have

A

Reinvestment risk because the client could miss out on the possibility to reinvest at the rate equal to that of which he could have initially locked in

Think GNMA because interest and principal is getting paid out. The reinvestment could be a lower yield

128
Q

Non-diversifiable risk is systematic risk. It is associated with

A

S&P index. Carries systematic risk

129
Q

Political or sovereign risk

A

Is the risk a foreign govt will default on its loans or fail to honor business commitments because of change in national policy

130
Q

Global funds count as investing internally

A

Buying an eft is not because it doesn’t specify what kind of etf

131
Q

Liquidity implies that a security or commodity can be sold or purchased

A

without delay and without substantial change in price absent of new information. Liquidity refers to transaction speed and stability in price

Marketability refers to the speed of the transaction. Marketability is necessary but not the only condition for liquidity

132
Q

Assets generally considered liquid

A

Cash, CD maturing shorly, life insurance cash value, money market fund (hold the buck)

Government bond fund and growth fund are longer settlements and could fluctuate
Negotiable CDs, etfs, closed end funds

133
Q

What financial instruments are redeemed?

A

Savings, checking, money market, and mutual funds

134
Q

True marketability implies

A

Trading amongst buyers and sellers
Reits, closed-end funds, etfs, and brokered cds are considered marketable

135
Q

Mean is the middle point between two extremes

A

The arithmetic mean is the sum of each of the values being considered divided by the total number of values

136
Q

Distribution of returns

A

Normal distribution applies when referring range of returns (%)
Any portfolio can produce negative or positive returns

If you are considering the possible ending portfolio value ($) as of some future date, a lognormal distribution applies because an unleveraged portfolio can never be worth less than zero

137
Q

Normal distribution when referring to investments

A

The mean value, center, is the most likely return
The return is symmetrical about the mean
It is more likely to be close to the mean than far away
Period return %
Leveraged ($)

138
Q

Lognormal distribution

A

The upper limit is unlimited but values cannot fall below zero
Distribution is positively skewed with most values near the lower limit
Mean will be the right of the highest point of the curve
Ending portfolio value ($)
No margin

139
Q

Correlation coefficient (infinite possibilities) and covariance (falls between a specific range) both express

A

The extent to which the movements of securities in the same portfolio are similar or not

140
Q

The correlation is the standardized version of covariance (infinite). What’s the correlation range and meanings?

A

+1 perfectly correlated
-1 perfectly negatively correlated

141
Q

To determine the correlation coefficient of the returns in a portfolio on the exam

A

THE STANDARD DEVIATION of each securities return and covariance between returns on the securities are needed

142
Q

Using covariance (COV) formula

A

COVij=PijOiOj

Standard deviation of Stock I is .10
Standard deviation of Stock j is .20
What is the covariance if correlation between the two stocks is .6 Pij

.6.10.20=0.012

143
Q

Using the correlation coefficient (Pij) formula

A

Pij=COVij/Oi*Oj

.012/(.10*.2)=0.6

144
Q

Perfectly negative correlated security -1 has what risk

A

Systematic but risk is completely eliminated and standard deviation is 0

145
Q

Perfectly positively correlated +1

A

has maximum risk
Only when Pij (correlation) is +1 is the standard deviation O of the portfolio equal to the weighted average of standard deviations of two assets

146
Q

Coefficient of Variation (CV) is

A

A measure of RELATIVE variability used to compare investments with widely varying rates of returns and standard deviations

Standard deviation O alone may not express whether one stock carries more risk relative to return of another

147
Q

To create a relative measure of variability

A

Divide standard deviation by the mean of each stock

148
Q

Standard deviation vs BETA

A

Both used to express risk of a security
Standard Deviation O measures variability of returns used in NONDIVERSIFIED portfolios and is a measure of total risk
BETA measures volatility of returns used in a DIVERSIFIED portfolio and is a measure of systematic risk (undiversifiable risk)

149
Q

Standard deviation of a nondiversified portfolio is

A

Variability and total risk

150
Q

Beta of a diversified portfolio is

A

Volatility and systematic risk

151
Q

Standard deviation O and mean of a single investment calculation

A

Number E+
Number E+
Number- E+
Gold 7(X) for mean
Gold 8(Sx X) for standard deviation O

152
Q

Applying standard deviation O

A

Standard deviation O is the absolute measure of variability of results around average or mean of those results

153
Q

In a normal bell curve distributions

A

68% fall within 1 standard deviation
95% fall within 2 standard deviations
99% fall within 3 standard deviations

154
Q

Portfolio weighted standard deviation

A

The risk and return of a portfolio maybe determined by multiplying the risk and return for each stock and adding them together

155
Q

Portfolio weighted standard deviation example

A

Take two securities
Weighted A 40% and B60%
Expected return for A is 10% B is 14%
(.40.10)+(.60.14)=12.4 (return of portfolio.

156
Q

Risk is standard deviation. What would be the risk if the portfolio was weighted the same

A

Average of the given risk

157
Q

If the correlation coefficient of an equal weighted portfolio is less than 1,

A

the risk must be lower

158
Q

When standard deviation is given for an equal weighted portfolio and correlation coefficient is less then one

A

Choose the number next of average number

159
Q

Coefficient variation formula measuring risk

A

CV=SD/average(mean)
The lower the number the lower the risk per unit
Coefficient variance is a measure or risk

160
Q

A negative correlation will make beta negative

A

And reduce the portfolio risk
The formula for beta includes the correlation coefficient

161
Q

When it comes to USD and movement of another security

A

When foreign currency goes up and USD remains the same
USD is revalued
Foreign currency is devalued

162
Q

Exchange rate formula when trading USD for foreign security and buying foreign stock

A

Initial investment $10k usd in pesos. Peso value on security is 29-so 10k buys 290000 pesos. Increases by 20% 348000 peso. Need to exchange back. So divid by new price of 30. Equates to $11,600

163
Q

Beta calculation when measuring a security

A

Price movement * BETA

164
Q

Geometric mean is also called time-weighted return

A

Reflects compound returns over more than one time period. Often used when finding an average numbers presented by %

Superior measure of change of wealth over multiple periods

165
Q

Calculating geometric mean

A
  1. Add 1 to the percentage and make it a number
  2. Times the returns in step 1
  3. The results of step 2 become FV
  4. -1 is always PV
  5. N is the number of YEARS of the investment
  6. Use financial calculator to solve for I
166
Q

Main point of time-weighted return/geometric mean is to

A

Evaluate performance of a portfolio

Unlike IRR it is not affected by cash flows

167
Q

Time weighted return is

A

The measurement of investment performance (income and price changes) as a % of capital at work

It effectively eliminates effects of additions and withdrawals and their timing that distorts dollar-weighted average

Overall performance

168
Q

Dollar-weighted return is

A

Measures change in total dollar value, treating additional and withdrawals of capital as part of the return, along with income and capital gains

SAME AS iRR and NPV

169
Q

Money managers/advisors use what to measure performance

A

Time-weighted return

170
Q

IRR rate is constant and does not account for reinvestment risk

A

This is the biggest mistake made with dollar weighted return or IRR

171
Q

Holding period return or HPR is total return over the period from the purchase to end period divided by the basis. What is the weakness in this process?

A

Fails to consider timing of when cash flows occurred. If time period is great than 1 year, the hpr overstates the true annualized return. Under a year it understates the return

172
Q

Buying stock on margin creates a scenario where

A

The downside risk is greater than the upside gain for the same rate of return. Margin magnifies the downside risk

173
Q

Yield to maturity is

A

The effective yield of the bond. YTM is compounded rate of return someone will receive from a bond at the current market price if held to maturity

174
Q

YTM takes into account market price/capital gains and losses if held to maturity

A

When calculating YTM always use semiannually even with zero coupon bonds

175
Q

Reinvestment risk

A

YTM assumes an investor invests at the same rate as what they started. If the investment is at a different rate then the realized rate will be different than YTM

176
Q

Zero coupon bonds and reinvestment risk

A

Zero coupon bonds eliminates reinvestment rate risk because there are no interest payment to be reinvested
Still carries interest rate risk and inflation risk

177
Q

Current yield is calculated

A

Annual coupon/current price

178
Q

Taxable equivalent yield is calculated

A

Tey=tax-exempt yield/1-tax rate
Tax-exempt yield=tey*(1-tax rate)

179
Q

Taxable equivalents yield examples

A

Municipal bond issues in state 5.2% (tax free) this is the base
Municipal bond out of state (.064 1-.06)=6.02
Treasury 7%1-.24=5.35%
Corporate 7.8%*1-(.24+.06 state tax)=5.46

180
Q

Current yield if demand increases causing the bond value to increase

A

Current yield will decrease

181
Q

Required rate of return calculation

A

1.101.31.851.2=1.459
Take 1.48 FV
PV is -1
N5

182
Q

Bond duration calculation. Formula provided on the test. What does y, c, t stand for

A

Y- current yield on a comparative bond
C-annual coupon
T-years to maturity

183
Q

Duration is inversely related to

A

Yield to maturity-market interest rate increase bond duration decreases
Current yield-remember coupon and yield are interest rates inversely related
Years to maturity-duration and years to maturity are positively related-remember time is on top and rules us all

184
Q

What does Duration reveal?

A

Compares the price volatility of bonds with equal coupons but different terms
Risk adverse investors prefer shorter duration
Aggressive investors should prefer bonds with long duration when they anticipate interest rates will decline and should consider short duration when they anticipate interest will rise

185
Q

A High bond rate, its duration is shorter than a similar maturity with a smaller coupon

A

High coupon(interest)=low duration(inversely related)
Smaller coupon(interest) =high duration (inversely related)

186
Q

Bond immunization

A

A bond portfolio with an average duration of the time horizon needed or wanted

187
Q

By matching duration of the bond to time horizon you can offset these risks:

A

Interest rate risk and reinvestment risk

188
Q

Zero coupon bonds have a duration of what?

A

Equal to their maturities
Because they have new coupon, their price fluctuate more than those coupons for the same maturities

189
Q

Change in bond price calculation is

A

🔺P=change in price
D=duration
🔺Y change in interest rates inversely related

190
Q

Bond price volatility, guidelines

A

When the coupon is smaller, the relative place fluctuation is greater
When the term to maturities longer, the relative price fluctuation is great
When the market interest rate is lower, the relative price fluctuation is greater

191
Q

Zero growth model calculation

A

Price equals dividend divided by required rate of term

192
Q

Constant growth model calculation

A

Price equals dividend times 1+ growth rate of dividend divided by required rate of return minus growth rate of dividends

193
Q

A stocks expected rate of return that has a dividend

A

Expected rate of return equals dividend times 1+ growth rate of divided by price plus growth

194
Q

Dividend discount model is

A

-If the market lowers the require rate of transfer stock, the value of the common stock will rise
-The opposite higher require rate of return or lower dividend lower the value of the common stock
-If investors expect that growth and dividends will be higher as a result of favorable development for the firm the value of the common rise

195
Q

Current market price calculation

A

Current market price equals earnings times PE ratio

196
Q

Price – free cash flow calculation

A

Intrinsic value equals free cash flow times 1 plus growth divided by rate minus growth

197
Q

Return on equity equation ROE is

A

ROE equals earnings available for common EPS earnings per share divided by common equity (net worth, or book value)

198
Q

Dividend payout ratio equation is

A

Dividend payment equals common dividend paid divided by earnings available for common EPS or EPS equals ROE per share times book value or net worth per share

199
Q

What factor does not go into figuring the intrinsic value using the dividen model

A

Gross earnings of the company
Beta is used to calculate the required rate of return R equals RF plus RM minus Rs.
Be handy

200
Q

What would least be affected by an interest rate change?

A

Short duration not coupon rate

201
Q

How do you figure common equity?

A

ROE return on equity equals EPS divided by book value

202
Q

How do you figure dividend payout ratio?

A

Common dividends paid divided by EPS

203
Q

How do you figure stocks yield?

A

Stocks yield equals dividend divided by closing price

204
Q

Modern portfolio theory enables someone to classify, estimate and maybe control the nature and amount of return and risk. It involves four steps

A

Security valuation
Asset allocation decision
Portfolio optimization
Performance measurements

205
Q

Risk equals

A

Standard deviation

206
Q

Capital (Marco) market line is the macro version of

A

Modern portfolio theory

207
Q

Modern asset allocation is

A

The risk return and covariance of assets are important input variables in creating portfolios

208
Q

Security (micro) line is micro is used to value what?

A

Any asset, whether it is a single security or a portfolio.

209
Q

Security market line calculation is also required rate of return. What is it? Also capital pricing model or CAPM

A

Ri=rf+(rm-rf)Bi

210
Q

Market risk premium calculation is

A

(Erm-rf)=market risk premium

211
Q

Stock risk premium calculation is

A

Erm-rf)B=stock risk premium calculation

212
Q

If a securities market security market, all assets plot along the SML security market line

A

They expect your return for any asset should be equal to its required rate of return

213
Q

A stock above the security market line and a stock below the security market line is what?

A

Security above the security market line is undervalued and the security below the market security market line is overvalued

214
Q

Efficient market hypothesis suggests investors cannot outperform the market. Price changes are unpredictable (random walk). What are three forms of EMH

A

Strong form-fully reflect all information, no one has an edge. Beneficiary for passive investors

Semi-strong form-all publicly know information is fully reflected. Only edge is insider trading

Weak form-reflects historical prices. Technical analysis does not produce better results but fundamentals may produce better results

215
Q

The EMH suggest that financial planner should direct their activity selecting securities based on what?

A

Risk-return profile

216
Q

Well recognized anomalies-pe effect

A

Stocks with low Pe ratios perform better than stocks with high PE ratios

217
Q

Well recognized anomalies-small firm effect

A

Stocks of small firms, outperform stocks of large firms. A small firm is one with total market value in the lowest 20% of all stocks.

218
Q

Well recognized anomalies-January effect

A

Stocks client at the end of the year and rebound in January, especially in the last five trading days

219
Q

Well recognized anomalies-neglected firm effect

A

Stocks of firms, not commonly studied by analyst outperformed stocks of firms that receive considerable attention from analyst

220
Q

Well recognized anomalies-value line phenomenon

A

Stocks rated 1 of (the top ranking) by the value line investment survey outperform those ranked 5 by the survey.

221
Q

Anomalies would most likely not happen with EMH

A

PE effect

222
Q

SML graph if stock is above the line

A

Carries less risk than below the line based on risk adjusted return
Risk adjusted return is return/beta

223
Q

Market containing all information including insider information, public or private information

A

Strong market

224
Q

Risk is the most fundamental distinguishing factor in the efficient frontier

A

Complementing factors are return covariance, correlation

225
Q

Fundamental analysis is

A

Economics is research of such factors as interest rates, gross domestic product, inflation, employment, and inventory as tools in order to predict the direction of economy

In investing, the fundamental analysis exam as the balance sheet income forecast future stock, price movement fundamental analysis consider current and past company records in predicting future trends

226
Q

Activity ratio is

A

How fast a company can turn its inventory or assets into sales to sales or cash. In general, the faster company can convert assets into cash or sales the more effectively the firm is being run.

227
Q

Profitability ratios are

A

Ratios that compare to more financial variables, providing a relative measure of firms income earning performance

228
Q

Sediment indicator are

A

Measures the bullshit bars, moved to investor many technical analyst look at these indicators as contrarian so if people are bullish, the technical anal will be bearish and vice versa

Other examples include court sales by specialist, mutual fund, cash positions, and the amount of margin debt

229
Q

Stock splits are

A

An adjustment of par value of an outstanding stock
Par value is reduced and the number of common shares is increased

The reason for a stock split is to make ownership more affordable

230
Q

Reverse split

A

Opposite of stock split. Price is too low for institutional investors or the stock is about to be delisted

231
Q

Sharp ratio is

A

The Measure expressed as the ratio of the excess return of the portfolio to a standard deviation

Sp=(Rp-Rf)/Op

This number calculated is meaningless unless it’s compared to the market or other mutual funds

232
Q

Sharp ratio is defined as and what is the calculation?

A

The Measure expressed as the ratio of the excess return of the portfolio to a standard deviation

Sp=(Rp-Rf)/Op

This number calculated is meaningless unless it’s compared to the market or other mutual funds

233
Q

Treynor ratio is

A

This ratio is the excess return of the portfolio to its beta

Tp=(Rp-rf)/Beta

234
Q

Rp
Rm
Rf
B

A

Return of portfolio
Return of market
Risk free return
Beta-Beta is the systematic risk of the asset, not the market’s systematic risk

235
Q

Treynor ratio has a high number

A

Compared to other assets. Buy that.

Treynor is meaningless unless compared against the market or other mutual funds

236
Q

Jensen ratio is

A

An index that is commonly referred to as alpha.
Alpha is the portfolio return-the expected return

Alpha fishp=rp-(rf+(rm-rf)B)

237
Q

R2 or r squared is

A

The square of the correlation coefficient, which explains the movement in one variable explained by the movement of another variable

238
Q

R2 or Rsquared reveals

A

It’s the movement that is explained in the s&p 500

Index funds/diversified fund will have a R2 very close to 100%
Sector funds will have very low R2 (5-25%)

239
Q

The keys to selecting the most appropriate performance measure are the following chart

A
240
Q

Correlation coefficient is .75

A

R2=.75*.75=0.563
Lowe than 60 chose shape ratio

241
Q

Information ratio is

A

Portfolio returns from an investment manager or fund manager compared to a benchmark. The higher, the IR the more consistent manager is and consistency is an ideal trait.

242
Q

Information ratio calculation is

A

IR(info rate)=Rp-Rb(expected value)/O
Rp is asset return
Rb is the benchmark asset

243
Q

What are the differences between the sharp ratio and the information ratio?

A

Sharp ratio compares the excess return of an asset against the risk, free asset. Information ratio compares active return to the most relevant equity or debt to the benchmark index.

Return to notes the return over the risk free asset will active return to note the return over the benchmark

244
Q

Ratios help an analyst or client when

A

having multiple ratios for the same industry, not multiple industries

245
Q

The Dow theory contradicts

A

Modern portfolio theory and EMH, it looks for trends

246
Q

Probability distributions have more than a dozen recognized distributions, some examples are

A

Triangular, lognormal, normal, and uniform

247
Q

Floating rate note collar

A

A floating rate, no collar specifies, a maximum and minimum rate of interest that will be paid on a floating rate note a floating rate note is a debt instrument with a variable interest rate interest adjustments are made periodically. They are tied to a money market in instrument such as T bills, they usually mature in five years, they provide holders with production against higher interest rates, but pay lower yields than fixed rate notes of the same maturity. An example of a float would be buying a 5 to 9% collar on so far secured overnight financing rate a client would get paid if the price went over nine, but would have to make payments if it went below 5%.

248
Q

Bullets for bond portfolio strategy

A

An investor purchases, intermediate duration bonds, and does not acquire a long duration, short, duration bonds

249
Q

Barbell bond portfolio strategies

A

Half the portfolio is in short term and half the portfolio is in long-term here requires periodic rebalancing the portfolio if the portfolio needs to be restructured due to changing interest rates, only one group of bonds needs to be sold

250
Q

Maintenance margin (FINRA requirement)formula

A

Margin requirements=(1-intial margin percentage)/1-maintenance margin percentage)*purchase price

251
Q

Risk capacity is

A

Risk capacity is the amount of risk that an investor must take in order to reach financial goals

252
Q

Control of volatility through beta

A

Choose stocks with low betas or diversify the portfolio to reduce its weighted beta

253
Q

CAPM compared to CML

A

CML the risk of the portfolio
CAPM (Security market line) is the specification of the relationship between risk and return for an individual security

254
Q

Arbitrage pricing theory (APT) is

A

Security returns are the results of arbitrage as investors seek to take advantage of perceived differences in prices

Unexpected inflation
Unexpected change in level of production
Unexpected shifts in risk premium
Unanticipated changes in structured yields

255
Q

Arbitrage pricing theory focuses on

A

Using many factors to explain the rate of return
If factor is zero, the factor has no impact on return
Apt focuses on unexpected changes or unanticipated shifts

256
Q

The black-schooled option valuation using five factors for a non-dividend producing stock. What are they?

A

The price of the underlying stock. The exercise price strike price of the option.
The time remaining to the expiration option.
The interest rate.
The volatility of the underlying stock.

257
Q

Markowitz model ie the efficient frontier uses beta or standard deviation?

A

Standard deviation

Covariance, correlation coefficient and return

258
Q

An upward movement in the yield curve shows that interest rates have increased. What does that do to duration?

A

Lowers duration, inverse relationship

259
Q

Zero coupon duration is equal to what?

A

Maturity

260
Q

To calculate gross profit you must do the following

A

Income+gain/basis

261
Q

Holding period return calculation can only be calculated at what time?

A

Any

262
Q

A company most likely to pay dividends

A

One that’s earnings are less than the dividend/earnings
Yield times price to get dividend

263
Q

Current yield and tax rate

A

Coupon/current price
Take calculation/1-tax rate

CFP Flash Cards (13 decks)

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