Investments Flashcards
ADR
American depository receipts
-us investors buy foreign stock
-no voting
-dividends quoted in foreign currency but paid in US currency
ETFs (type of fund, investment company type, traded?, sold short?)
- May be open end or close ended fund
- open-end operate as unit trust or investment company
- traded on stock exchange
- can be sold short and bought on margin
UIT unit Investment Trusts
Set it and forget it.
Assets not traded.
Can be traded itself on the secondary market.
Self liquidating
GIC
Guaranteed Investment Contracts
Basically CD from insurance companies
Net Operation Income for real estate
Gross receipts
+non rental income
= potential gross income
-vacancy losses
= effective gross income
-Operating expenses
=Net operating income
** not include depreciation**
What can ALWAYs be purchased at NAV?
No-load balance mutual fund
What corporate reports always have to be sent to the SEC?
– 10Q quarterly
– 10k annually
Buyer of Call Option
- The right to buy at certain price
- intrinsic value = Market value minus exercise price
- intrinsic value cannot be zero
Buyer of Put Option
- Right to sell stock at certain price
- intrinsic value = exercise price - market price
- total premium = Intrinsic value + Time value
- If out of the money, no strike
Selling a naked call
The most risky option
Why would an option be expensive?
The stock is very volatile.
Futures: Who is going short? Who is going long?
Farmer with abundance is going short
Kelloggs who is longing for corn is going long
Warrants
- option to buy a specific price at a specific time
Collectibles ltcg tax rate
28%
Correlation coefficient formula
Coefficient of variation
STD deviation / avg return
STD deviation Definition
STD deviation: measure later VARIABILITY in a NON-DIVERSIFIED portfolio and is a measure of TOTAL risk.
Calculating std deviation of a single investment
1st, 2nd, 3rd std deviation
68%, 95%, 99%
Beta Formula
Risk adjusted returns
Return / beta
Systematic risks
P.R.IM.E.
Purchasing power risk
Reinvestment rate risk
Interest rate risk
Market risk
Exchange rate risk
BETA Definition
Beta: measure VOLATILITY in a DIVERSIFIED portfolio and is a measure of SYSTEMATIC risk.
Correlation Coefficient
How synchronized are you?
+1 perfectly correlated
-1 perfectly not correlated
Coefficient of Variation formula
STD deviation / AVG return
What taxes do you pay with muni bonds?
Federal
or state only if you are not a resident of that state.
Price that will trigger margin call formula
Solving Geometric Mean Return
- Add 1 to each annual return
- Multiply them by each other
- Input that number as FV
- Put negative 1 as PV if not given
- Enter other info given and solve for Interest
Holding period return
Bond Teeter Totter Order
N, CY, YTM, YTC
T-Bills, Notes, and Bonds
Basis and phantom income
When you recognize phantom income you can add it to your basis
EE bonds
Either pay tax now (over time) or later
For college tuition only
GNMA
-Guaranteed but not by the treasury
- Based on mortgages
CMO
-collateralized mortgage obligations
-tranches a-z z is the most risky
Muni bonds tax
Free from federal tax not local tax rates
Large, mid, small, micro
Large cap: 10billion
Mid cap: 2b to 10b
Small cap: anything less than 2b
Micro: less than 300million
What is Unsystematic Risk?
Known as Diversifiable Risk, may also be referred to a Non-systematic Risk.
-Business Risk: Refers to the nature of the firm’s operations (i.e., possibility of loss due to new technology)
-Financial Risk: Refers to how the firm finances its assets (i.e., the possibility of loss due to heavy debt financing)
What is Systematic Risk?
Also known as Non-Diversifiable Risk.
This part of risk is inescapable because no matter how well an investor diversifies, the risk of the overall market cannot be avoided.
What are the Types of Systematic Risk?
- Purchasing Power Risk: Loss of purchasing power through inflation.
- Reinvestment Risk: Risk that proceeds available for reinvestment must be reinvested at a lower interest rate than the instrument that generated the proceeds.
- Interest Rate Risk: The risk that a change in interest rates will cause the market value of the fixed income security to fall.
- Market Risk: Risk of the overall market
- Exchange Rate Risk: Risk associated with changed in the value of the currency.
Study Hint: Remember P.R.I.M.E.
FDIC Insured Amounts (per bank/per type of account)
Individual: $250k
Joint (per owner): $250K
Trust (per beneficiary): $250k
IRA/Keogh: $250k
What are the provisions of EE Bonds?
- Non-marketable, Non-transferrable, can’t be used for collateral
- Sold at Face Value
- Interest Rate based on 10 yr Treasury Note Yields
- Fixed Interest Rate that is in effect at the time of purchase
- Subject to federal taxation when redeemed, unless used as education bonds
- Not subject to state or local taxes
What are the provisions of I bonds?
- Non-marketable, non-transferrable, can’t be used for collateral
- Sold at Face Value
- Interest Rate is composed of two parts:
- A Fixed Base Rate (remains the same for the life of the bond)
- An Inflation Adjustment (adjusted every 6 months)
Subject to federal taxation when redeemed (unless used as education bonds)
Not subject to state or local taxation
What are the Types of Municipal Securities?
- General Obligation Bonds (GO Bonds): Backed by the full faith,
credit and taxing power of the issuer. GO Bonds are generally
considered the safest types of municipal credit. - Revenue Bonds: Backed by a specific sources of revenue to which
the full faith and credit of the issuer is NOT pledged. Because
revenue bonds are backed by a single source of funds (like toll
roads, hospitals, power plants, etc.), they have a greater credit risk
than GO Bonds. As such, they trade at higher yields. - Insured Municipal Bonds: The insurers pay timely interest and
principal when the issuer is in default. Municipal bond insurers are
AMBAC and MBIA.
What do Indenture Agreements Cover?
- Form of Bond
- Amount of Issue
- Property Pledged
- Protective covenant, including any provision for a sinking fund
- Working Capital and Current Ratio
- Redemption Rights
What are the Risks of Corporate and Municipal Bonds?
- Default: A creditor may seize the collateral and sell it to recoup the
principal - Reinvestment: As payments are received from an investment,
interest rates may fall. When the funds are reinvested the investor
receives a lower yield. - Interest Rate: Rising interest rates may cause bond prices to fall
- Purchasing Power: Inflation may lower the value of bond interest
payments and principal repayment, thereby forcing bond prices to
fall.
Study Hint: Remember: D.R.I.P.
What are the Risks of Government Bonds?
RIP only! No default or credit risk.
What are the market values to define
Market Capitalizations of Companies?
Large: > $10 billion
Mid: $2-10 billion
Small: < $2 billion
Micro: < $300 million
American Depository Receipt (ADR)
- Bank issued certificates that represent shares in a foreign company
for trade on American stock exchange - Prices of ADRs quoted in US dollars
- Dividends paid in US dollars
- Dividends declared in foreign currency
- Attain diversification and risk reduction due to lower correlation of
foreign securities with US securities.
What are General Definitions for Options?
- Intrinsic Value is the minimum price the option will command as an
option. It is the difference between the market price and exercise
price of the stock. - Exercise Price is the price at which the stock can be purchased or
sold on exercise of the option. - Premium is the market price of an option. As the option approaches
its expiration date the market price of the option (Premium)
approaches its Intrinsic Value Time. Premium is the amount the
market prices of an option exceeds its intrinsic value.
Study Hint: IV + TV = Premium
What is the Taxability of Call Options?
- At the Time of Purchase: Non-deductible Capital Expenditure
- To the Writer Due to Lapse: Premium received is a short-term gain
- To the Writer Due to Exercise: Premium received is added to sale
price (can be long term gain if underlying security was held more
than 12 months, otherwise short term). Covered Call.
To the Holder: If the option is NOT exercised, then the option is considered sold (it expires) and it is a short-term loss. The option period is 9 months or less.
Define: Hedging Strategies - Straddles, Collar, Protective Put
Straddle: Buying a Put and Buying a Call - The buyer does NOT own the stock.
Collar: Selling a Call (out-of-the-money) at one strike price and buying a Put at a lower strike price; investor OWNS the stock.
Protective Put: Buying a stock (or already owning it) and a Put for the stock serving as insurance against the decline in the underlying stock. (Hint: A good answer for the exam)
Compare: Warrants vs. Call Options
Warrants are issued by corporations, whereas Calls are issued by individuals.
Warrants typically have maturities of several years.
Warrant terms are not standardized. Call options are standardized.
What are the Hedging Positions of Futures Contracts?
Long Commodity Position: If a farmer is long a commodity (for example, corn) he needs a short hedge and will sell a futures contract.
Short Commodity Position: If Kellogg’s is short a commodity (for example, corn), they need a long hedge and will buy a futures contract.
Compare: Reg D Accredited vs. Non-Accredited Investors
Accredited (Unlimited):
Net worth of $1 million or,
Individual with income of $200,000 or,
Couple with income of $300,000
Non-Accredited
Issue sold to a maximum of 35 investors
Must use a purchaser representative if not “sophisticated”
Coefficient of Determination R2
R² is the square of the correlation coefficient, showing how much of one variable’s variation is explained by another.
On the exam, R² indicates the percentage of a fund’s movement explained by the S&P 500.
- Index/diversified funds tied to the S&P 500 have R² close to 100%.
- Sector funds (NOT diversified) have low R² (5%–25%).
Geometric Return vs. Internal Rate of Return (IRR)
Geometric Return or Time-Weighted Return: Evaluates the performance of a portfolio manager.
IRR or Dollar Weighted Return: Compares absolute dollar amounts.
“Real” vs. Nominal Rate of Returns
Real: The inflation adjusted interest rate
Nominal: Actual returns not adjusted for inflation.
The “Real” rate is defined as the Nominal Rate of return adjusted for inflation.
Holding Period Return (HPR)
The total return (income plus price appreciation and dividends less margin interest) over the entire period divided by the out of pocket cost of the investment.
Taxable Equivalent Yield (TEY)
To make the returns on municipal bonds comparable to those of taxable bonds, the TEY can be calculated.
TEY = Tax Exempt Yield / (1-Marginal Tax Rate)
OR
TEY x (1-Marginal Tax Rate) = Tax Exempt Yield
Duration (Principles to Remember)
Years to Maturity: Remember duration and maturity are positively related
Annual Coupon: Remember duration is inversely related to coupon rate
YTM: The current yield on comparative bonds (duration is inversely related)
Remember, Coupon and Yield are Interest Rates - Inversely Related.
Zero Coupon Bonds
- Duration equal to Maturity
- No coupon interest, yet produces “phantom” income
- No reinvestment rate risk
- Sold at deep discounts to PAR
- Fluctuate more than coupon bond with the same maturities
Rules for using Duration to Manage Bond Portfolios
If interest rates are expected to rise, shorten duration (Interest rates up, shorten Duration)
Remember: UPS: UP for “up” and S for “shorten”)
If interest rates are expected to fall, lengthen duration. Buy low coupon bonds with long maturities.
Interest rates fall → lengthen duration.
Remember: FALLEN - FAL for “fall” and LEN for “Lengthen.”
Conclusions to Fluctuations in Bond Prices
The smaller the coupon, the greater the Relative Price Fluctuation
The longer the term to maturity, the greater the Price Fluctuation
The lower the market interest rate, the greater the Relative Price Fluctuation
Convexity
The degree which duration changes as the yield-to-maturity (YTM) changes.
Largest for low coupon bonds, long-maturity bonds and low-YTM bonds allows investor to improve the duration approximation for bond price changes.
What is Return on Equity (ROE)?
ROE = Earnings Available for Common (EPS)
Common Equity (net worth or book value)
How to Calculate Dividend Payout Ratio
Dividend Payout Ratio = Common Dividends Paid divided by Earnings Available for Common (EPS)
Strong Form (EMH)?
Strong Form: Asserts that stock prices fully reflect all information, public and private. Not even access to inside info can be expected to result in superior investment performance over time. Neither fundamental analysis nor technical analysis can produce superior results over time on a risk-adjusted basis.
Semi-Strong Form (EMH)?
Semi-Strong Form: Asserts that all publicly known information is reflected in stock prices. Neither technical analysis nor fundamental analysis can produce superior results over time on a risk-adjusted basis. Only an investor with access to inside information may consistently achieve superior results (but such access is illegal)
Weak Form (EMH)?
Suggests that historical price data is already reflected in current stock prices and is of no value in predicting future price changes.
Technical analysis will not produce superior results. Fundamental Analysis may produce superior results.
Dow Jones
30 industrial stocks, price weighted
S&P 500 (large caps):
Broader measure of NYSE activity, value weighted
Russell 2000 (small caps):
Smallest 2000 stocks of the Russell 3000 index, value weighted
Wilshire 5000
Broadest measure of the activity and movement of the overall stock market, cap weighted.
Value Line (Benchmark)
±1700 stocks, equally weighted
NASDAQ
Broadest measure of OTC trading, value weighted
Europe, Australia and Far East (EAFE)
Equity performance of the major foreign markets, value weighted.
Barclays Aggregate Bond
More than 5000 US Government, corporate and mortgage backed and asset backed bonds.
Tax Basis of a Mutual Fund
First-in, First-out method treats shares acquired first as being sold first.
Specific ID requires the seller to identify the shares of the fund that are sold. Specific ID allows the investor to create gain, neutralize gain or create a loss (most flexible).
Average Cost allows the investor to divide the total cost of all shares held by the number of shares sold.
Steps to Risk-Adjusted Measures of Performance (Sharpe)
Step 1: Look for a low R2 (less than 60), or a non-diversified portfolio.
Step 2: Look for the highest Sharpe number.
Steps to Risk Adjusted Measures of Performance
Jensen (Alpha) / Treynor
Step 1: Look for high R2 (60+) or a diversified portfolio.
Step 2: Look for the highest positive Alpha. If no Alpha is given, then look for the highest Treynor.
What is a Margin (Maintenance) Call?
The formula for calculating when an investor will receive a margin call is:
(1 - Initial Margin % ÷ 1 - Maintenance Margin %) x Purchase Price of stock
Shortcut: 2/3 of the purchase price if the minimum maintenance is 25%. If it’s 30%, take 2/3 and then choose the next highest number.
Examples of Active Investment Strategies
Market Timing
Tactical Asset Allocation
Technical Analysis
Arbitrage Pricing Theory (APT) Keys
Unexpected Inflation
Unexpected changes in industrial production
Unanticipated shifts in risk premium
Unanticipated changes in structure of yields.
