Investments Flashcards
Describes a Collar Strategy?
- Long the stock
- Short the call
- Long the put
Collar = LSL
A collar involves buying a put to protect a long position in the stock. Additionally, you would sell the call to offset the cost of the put.
Positively Skewed
Skeyed Right
Negatively Skeyed
Skeyed Left
Mesokurtic Distribution
“Normal” Distribution
M = In the Middle of L and P
Leptokurtic Distribution
“Slender” Distribution
L come before M and P
Platykurtic Distribution
“Broad” Disrtribution
L - M - P
Platypus has flat beak
Forms of EMH
Strong Form = No info. or analysis can beat market.
Semi-Strong = Insider info. can beat the market.
Weak Form = Insider info. AND Fundamental Analysis can beat market. Not TA.
Anomalies of EMH
There are anomalies to the EMT that cannot be explained away by EMT believers.
- Low P/E Effect
- Small Firm Effect
- Neglected Firm Effect
- January Effect
- Value Line Phenomenon
Describes a Protective Put
Long the Stock
Long the Put
A protective put is established to protect a long position in the stock. This is accomplished by buying a put. This is the very definition of portfolio insurance.
Systematic (Non-Diversifiable) Risk
PRIME
- Purchasing Power Risk (Inflation)
- Reinvestment Risk
- Interest Rate Risk
- Market Risk
- Exchange Rate Risk
Unsystematic (Diversifiable) Risks
BFDRS
- Business Risk
- Financial Risk
- Default or Credit Risk
- Regulatory Risk
- Sovereignty Risk
Intrinsic Value of a Call Option
COME
Call Option = Market Value - Exercise Price
The lowest level that intrinsic value will ever be is $0!
Intrinsic Value of a Put option
POEM
Put Option = Exercise Price - Market Value
The lowest level that intrinsic value will ever be is $0!
What are the two basic variables that determine an option contract’s total price?
- Intrinsic Value
- Time Premium
What are the 2 variables that make up Intrinsic Value for an option’s price?
- Market Price of the underlying stock
- Exercise Price of the option contract
Intrinsic Value = PRICE
Intrinsic Value can NEVER be less than $0.
What are the 3 variables that make up Time Premium for an option’s price?
- Risk-Free Rate of Return
- Time to Expiration
- Variability of the Underlying Stock (as measured by standard deviation)
The greater any or all of the three variables above, the greater the time premium.
Time premium is the greatest at the creation of the contract and approaches $0 at the expiration of the contract.
Options contracts can be used to (BLANK) existing stock positions or to (BLANK) on stock without having a long position in the stock.
Options contracts can be used to hedge existing stock positions or to speculate on stock without having a long position in the stock.
Covered Call Writing
“Covered Calls”
- Long the stock - Short the call
- Only considered covered if you own enough shares to cover all contracts sold.
- Used to generate income for the portfolio
Naked Call Writing
“Naked Calls”
- Does not own the underlying stock - Short the call
- Writer bears UNLIMITED risk.
Protective Puts
- Long the stock - Long the Put
- This is the very essence of portfolio insurance
Protective Calls
- Short the stock - Long the call
- Used to protect a short position in the stock.
Covered Puts
- Short the stock - Short the puts
- Writer used the stock put to cover their short stock position.
Collar
(Zero-Cost Collar)
- Long the Stock - Short the Call - Long the Put
- LSL (Lasso—l)
- The put is used to protect against a stock price decrease, and the call premium is used to offset the cost of the put.
Good strategy for someone with big unrealized gain who is ok selling at a higher price but wants some downside protection at no cost.
Straddle
- Long a put and a call on the same underlying stock with the same expiration date and strike price.
- Straddle = Same
- Used to capitalize on volatility regardless of the direction.
Spread
- Involves purchasing and selling the same type of contract
- Benefit from stability (minimum moves in the underlying stock’s price
Spread peanut butter to make stable
A futures contract is an agreement to buy or sell a specific amount of a (BLANK), a (BLANK), or a (BLANK) at a particular price on a stipulated future date.
A futures contract is an agreement to buy or sell a specific amount of a commodity, a currency, or a financial instrument at a particular price on a stipulated future date.
Futures and Forwards are different in that…
Forward Contracts are not standardized (they can take any form the parties agree to) and are not executed through a clearinghouse (thus they carry counterparty risk).
What determines where an investor plots on the efficient frontier?
An investor’s risk tolerance determines where they plot on the efficient frontier.
What are the 5 Systematic / Non-Diversifiable Investment Risks?
(PRIME)
- Purchasing Power Risk
- Reinvestment Risk
- Interest Rate Risk
- Market Risk
- Exchange Rate Risk
What are the 5 Unsystematic / Diversifiable Investment Risks?
- Business Risk
- Financial Risk
- Default or Credit Risk
- Regulatory Risk (Pharma)
- Sovereignty Risk (China)
What are the 5 anaomalies to the EMT/EMH that cannot be expained away by EMT/EMG believers?
- Low P/E Effect
- Small Firm Effect
- Neglescted Firm Effect
- January Effect
- Value Line Phenomenon
The lower the time to maturity and the higher the coupon the (BLANK) the duration.
**The lower the time to maturity and the higher the coupon the shorter the duration.
- The zero-coupon’s duration will equal the maturity.
What is the probability of the following on the distribution curve?
1 SD
2 SD
3 SD
- 1SD = 68%
- 2SD = 95%
- 3SD = 99%
What does the result of the NPV calculation tell us?
- If the result is positive, the investor should undertake the investment. The actual return will be greater than the required return.
- If the result is negative, the investor should avoid the investment. The actual return will be less than the required return.
- If the result is zero, the investor should undertake the investment. The actual return will equal the required rate of return.
What is a weakness of the IRR calculation?
The IRR calculation **assumes the reinvestment rate is the IRR **(this is a weakness).
What does the IRR allow financial planners to do?
Internal Rate of Return (IRR) allows the financial planner to compare the computed rate to the required rate of return.
Yield to maturity (YTM) and yield to call (YTC) are examples of IRR calculations.
Which is considered a superior model, NPV or IRR?
- The NPV is considered a superior model to IRR when comparing investment projects of unequal lives. Investing at the required rate of return is more reasonable than at the IRR.
- With changes of more than two inflows or outflows in an investment project there will be only one NPV, however, multiple IRRs.
Define the Four basic types of Financial Ratios:
Liquidity ratios: Used to determine the ability to meet?
Activity ratios: Used to determine the?
Profitability ratios: Used to measure?
Debt ratios: Used to determine the ability to meet?
Four basic types:
Liquidity ratios: Used to determine the ability to meet short-term obligations.
Activity ratios: Used to determine the relative efficiency of financial management.
Profitability ratios: Used to measure relative profitability.
Debt ratios: Used to determine the ability to meet long-term obligations.
Gross Profit Margin Formula
Gross Profit / Sales
Operating Profit Margin
Operating Income / Revenue
Return on Assets (ROA)
EAT (Earnings After-Taxes) / Total Assets
Return on Equity (ROE)
EAT (Earnings After-Taxes) / Equity
Current Ratio
Current Assets / Current Liabilities
Quick Ratio
Current Assets - Inventories / Current Liabilities
Debt Ratio
Total Debt / Total Assets
Lower is Better!
The (BLANK) stands in between the option buyer and option seller and eliminates counterparty risk.
The Options Clearing Corporation (OCC) stands in between the buyer and seller and eliminates counterparty risk.
According to the wash sale rules, a taxpayer realizes a loss on a sale of a security and acquires a substantially identical security within a _____ period.
61-Day
Taxpayer realizes a loss on a sale of a security and acquires a substantially identical security within a 61-day period.
When illustrating investment returns over a period of time greater than one year, what is the appropriate measure of return that should be used?
The appropriate measure to use for periods of greater than one year is time-weighted rate of return.
