Investments Flashcards
Collateralized Mortgage obligations
-Mortgage payments received are distributed on a cash flow basis.
-Based on expected cash flow to be received over the life of the pool, separate “tranches” are created
-Yield varies because there’s no yield if no mortgage is paid
-Z tranche: bears no coupon (most risk) but receives CF after other tranches are satisfied (zero-coupon)
Standard deviation versus beta
Standard deviation measures variability of returns used in a non-diversified portfolio and is a measure of total risk.
Beta measures volatility of returns, used in a diversified portfolio as a measure of systematic risk.
Brokered CDs
- extra word = extra risk
- CDs, issued by a commercial bank, traded through a brokerage firm rather than issued directly by the savings institution itself
- subject to interest rate risk
Original issue discount bond
- Usually zero coupon bond
- the bond is discounted from par value when it’s first issued
- Each year the portion of the discount that has been earned is included as taxable interest income, and the basis is correspondingly increased
- must report phantom income
STRIPS
- Zero coupon treasury securities
- Treasury issued
- Phantom income!
- No state income tax
Treasury inflation protection securities (TIPS)
- Taxed annually on the interest payment plus the appreciation in face value
- Increase in face value is phantom income, but increases the basis
- Interest is not subject to state and local taxes
Mortgage-Backed Securities
1) GNMA (Ginnie Mae): pool of FHA/VA mortgages, GGGuaranteed by US govt
2) FNMA/FHLMC (Fannie Mae and Freddie Mac): NOT guaranteed- you can get F’d
Preferred Stock
-Hybrid (resembles stock and bond), C-CORPORATIONS usually buy (only pay taxes on 50% of earned income)
-Issued at $25 (or $100) par w/ stated dividend rate
-PAYS FIXED DIVIDEND
-Perpetual; infinite maturity… so price fluctuates!!! (Long maturity/duration)
REITs
1) Equity REIT- Operating rental properties (growth)
2) Mortgage REIT- interest from mortgages
*at least 75% of income must come from Real Estate (15% can be from securities like GNMA)
*Must distribute 90% of net investment income (or taxed on all of it)
Black-Scholes Valuation Model
Considers five variables to value the option of a non-dividend paying stock (“call up”)
1) the exercise price or stock price of the option (bad - inverse relationship)
2) the time remaining to the expiration of the option (good)
3) the interest rate (good)
4) the volatility of the underlying stock (good)
5) the price of the underlying stock (good)
LEAPs - Long term Equity AnticiPation
- expiration can range from nine months to three years
- Buyers will be taxed at long-term rates if they held the contract for at least a year and one day (otherwise short)
- Once a leap is exercised. The investor must then hold the shares of stock for more than 12 months in order to pay long-term capital gains rates.
Standard Deviation Bell Curve
68% = within +/- 1 standard deviation
95% = within +/- 2 standard deviations
Simple/Arithmetic Return/Effective
Average obtained by dividing sum of items by number of item.
A+b+c/3
Geometric Mean/Return
Time weighted..
GM = [(1+r1) x (1+r2) x (1+r3)]^1/3 -1
Or use calculator to solve!! Set answer to FV, PV is -1, years is n, solve for I
IRR
Discount rate at which PV of future cash flow equals cost of investment
Investment’s effective return
When NPV is zero, discount rate is IRR. When IRR exceeds discount rate, investment is acceptable.
Duration
HOW LONG IT TAKES TO GET YOUR MONEY BACK
Zero coupon, duration=maturity
Risk averse=low duration
Aggressive=high duration
Rates UP (shorten), Fall (Lengthen)
Capital market line (CML)
- MACRO aspect of Capital Asset Pricing Model (CAPM)
- Specifies relationship between risk and the return on a portfolio
- straight line is tangent to the Markowitz efficient frontier at the optimal risky portfolio
Security Market Line (SML)
- MICRO
- expresses the relationship between risk and return for one individual asset
- the SML can be used to value any asset, whether an individual security or a portfolio
- doesn’t matter if portfolio is diversified or non-diversified
- CAPM: r = Rf + (Erm - Rf) b, return required by investors
Market Risk Premium v Stock Risk Premium
Market Risk: (ERm-Rf)
Stock Risk: (ERm-Rf)b
Ex-Dividend Date for Stock
- the date of record for the corporation is the first business day after the ex dividend date
- to be listed on the corporation’s book as holder of record. The investor must purchase its stock BEFORE the ex dividend date.
