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CFP > Investments > Flashcards

Investments Flashcards

1
Q

Investment Policy Statement

A

RR TLLU

Objectives:

  • Return requirements
  • Risk tolerance

Constraints:

  • Time Horizon
  • Laws and Regs
  • Liquidity needs
  • Unique circumstances
    • Permitted investments
  • Prohibited investments
  • Tax constraints
  • No investment selection
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2
Q

Primary Market

A

Market in which new issues of securities are sold to the public.

  • public offering
  • rights offering (give existing shareholders the rights to buy new issues)
  • private placement (not open market)
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3
Q

Secondary Market

A
  • provides investors way of buying and selling securities that were issued in primary market
  • NYSE, NASDAQ, OTC, AMEX
  • Provides liquidity to shareholders
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4
Q

IPO Process

A
  • Investment banking firm or syndicate underwrites the IPO
    • Buys the stock from firm
    • Advises firm
  • Selling group: join and accept responsibility for selling shares
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5
Q

Accredited investor

A
  • $200K/year income or
  • 1M of net worth excluding personal residence or
  • Trusts > 5M
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6
Q

Underwriting types (3)

A

Underwriting takes 3 forms:

  • firm commitment - underwriter buys all the stock and takes risk it won’t sell
  • best efforts approach - any stock not sold is returned to the company
  • private placement
    • sold to no more than 35 unaccredited investors
    • avoids SEC registrations
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7
Q

American Depository Receipts

A
  • A US Bank’s foreign branch holds stock of a foreign company
  • Bought and sold on US market
  • Prices quoted in US dollors
  • Exchange rate risk
  • Represent shares held in foreign foreign branch
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8
Q

Yankee Bonds

A
  • No exchange rate risk
  • US$ denominated bonds sold by a foreign entity in the US
  • Because they are US denominated, there is no exchange rate risk.
  • Registered with SEC
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9
Q

Securities Act of 1933

A
  • Regulates primary market
  • Deals with new security issues
  • Paper act
  • Prospectuses
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10
Q

Securities Act of 1934

A
  • Regulates secondary market
  • Gives SEC power to regulate markets, disclosure requirements of new and current securities
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11
Q

The Investment Advisors Act of 1940

A
  • Investment Advisors must disclose all relevant info about
    • Advice (investment advice)
    • Background
    • Conflicts of interest
  • If under 100M AUM register with the state
  • Greater than 100M AUM register with SEC
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12
Q

Insider Trading and Fraud Act of 1988

A
  • Defines insiders as:
    • Directors, officers, shareholders, anyone who obtains nonpublic information.
  • Established penalties
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13
Q

Sarbanes-Oxley Act of 2002

A
  • Protects against corporate fraud
  • requires instant disclosure of stock sales
  • tightened audit regulations
  • established conflict of interest guidelines.
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14
Q

SEC Fair Disclosure (FD)

A
  • requires distribution of market-moving information
  • prohibits “pre-release” of information to market professionals.
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15
Q

US Patriot Act

A

Requires broker-dealers:

  • to have anti-money laundering policies
  • to have anti-money laundering officer
  • gather information on clients
  • source large deposits and transfers
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16
Q

initial margin

A
  • amount of equity that must be put up
  • Fed minimum margin amt is 50%
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17
Q

maintenance margin

A

the amount of equity that must maintained

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18
Q

Debit balance

A
  • amount borrowed to purchase security
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19
Q

Margin position equation

A

Margin position = (Value of sec. - Debit balance)/Value of securties

Margin call stock price = Debit balance/ (1 - Maintenance Margin)

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20
Q

Market Cap of Indexes

A

S & P: Large cap

Wilshire 5000: Broad index - all caps

Russell 2000: small cap

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21
Q

Stop-limit order

A

Turns a stop-loss order into a limit order at a certain price

Prevents selling at a too-low price if the price declines rapidly.

Might not result in sale

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22
Q

Stop-loss order

A

Executes a market order once the stock drops to a certain price (can sell for much lower if rapidly decline)

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23
Q

Required Rate of Return

A

Required Rate of Return = Real rate + expected inflation premium + risk premium

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24
Q

Time-weighted return

A

The return of one security during the time period.

Investment’s cash flows

(InvestmenT, Time)

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25
Q

Dollar-weighted return

A

Return on the number of stocks that a specific investor transacts

Investor’s cash flows

(dollaR, investoR)

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26
Q

Systematic Risk

A

market-driven risk; Non-diversifiable risk

  • Purchasing power (inflation - cash, bonds)
  • Reinvestment Rate (risk that interest rates go down)
  • Interest rates
  • Market risk (general market movements, business cycle)
  • Exchange Rate

Measured by beta

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27
Q

Unsystematic risk

A
  • diversifiable risk
    • business risk
      • accounting/audit risk
      • executive risk
    • country risk
    • default risk
    • financial risk
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28
Q

Total Risk

A
  • Systematic risk + unsystematic risk
  • measured by Standard Deviation
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29
Q

Beta

A
  • Sensitivity of a security to market movement
  • indication of a security’s volatility relative to the market.
  • Only measures systematic, undiversifiable (market) risk.
  • Derived by plotting a security’s return vs. market return; slope = beta
  • Security return = Beta * Market change
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30
Q

Standard Deviation

A
  • Absolute measure of risk.
  • Measure of total risk (systematic + unsystematic)
  • Based on an individual security’s historical return
  • Higher standard deviation = more risk
  • σ
  • Measures variation of return around an average
  • +1/-1 SD : 68% probability
  • +2/-2 SD: 95% probability
  • +3/-3 SD: 98% probability
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31
Q

Coefficient of Variation

A
  • compares assets that have different risk and different return.
  • higher CV, the greater the risk
  • Standard deviation/average expected return
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32
Q

Semi-variance

A
  • only measures instances where returns are below the mean
  • used so risk isn’t understated by being influenced by high returns
  • better measure of downside risk
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33
Q

Distributions of returns

A
  • normal distributions - bell curve
  • lognormal distribution - not symmetrical
    • skews either negative or positive
      • skewness - measures lack of symmetry
      • kurtosis - degree to which bell curves are flat or peaked
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34
Q

Correlation

A
  • drives risk reduction in diversification
  • ranges from -1 to 1
  • r or Rho
  • -1: always move in opposite directions - no diversification benefit
  • 0: not correlated at all
  • 1: always move in the same direction
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35
Q

Calculating SD of a 2-fund portfolio

A

Wa = %age weight of stock a

Wb= %age weight of stock b

σ=standard deviation

COV = covariance = Rho * σa* σb

rho=correlation

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36
Q

R2

A

Coefficient of determination

  • Correlation coefficient squared
  • Shows what percentage of return can be attributed to the market
  • The higher the r-squared, the better the measure to the benchmark
  • R2 should be at least .7 or 70%
  • If R2is > or equal to .7, then Beta is a good measure of risk because the market is not correlated enough to the investment for Beta to determine risk level.
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37
Q

Efficient Frontier

A
  • Portfolios that offer the highest level of return for a given level of risk
  • Created by Harry Markowitz
  • Portfolios that lie outside of the frontier - upper left - are not attainable
  • assumes that investors have perfect knowledge and want to maximize returns
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38
Q

Capital Market Line

A
  • A well-diversified portfolio will fall along the CML,
  • Standard Deviation is the measure of risk
  • The CML is derived by drawing a tangent line from the intercept point on the efficient frontier to the point where the expected return equals the risk-free rate of return.
  • M represents the market portfolio, so named since all rational investors (minimum variance criterion) should hold their risky assets in the same proportions as their weights in the market portfolio.
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39
Q

Security Market Line

A
  • Provides a measure for fund performance
  • Beta is the measure of risk
  • Line from the risk free rate (x-axis)
  • CAPM is the equation of this line
  • M (market return) is the intersection between efficient frontier and SML.
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40
Q

Capital Asset Pricing Model

A
  • Gives a required or expected rate of return, given the riskiness of the asset
  • ri= Investors required rate of return
  • rf= Risk free rate
  • rm=Return of the market
  • ß= Beta
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41
Q

Market Risk Premium

A

rm- rf= market risk premium

The difference between market returns and returns at the risk free rate.

The amount of returns required to undertake market risk (Beta = 1)

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42
Q

Arbitrage Pricing Theory

A

Multi-factor model.

Beta is not an input

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43
Q

Probability Analysis

A
  • Probability Analysis used to determine the expected return or expected risk based on the likelihood of different scenarios
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44
Q

Sensitivity Analysis

A
  • Quantifies how a client reacts to extreme low probability outcomes and determine how changes in risk/return impact asset allocations.
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45
Q

Monte Carlo Simulation

A
  • employs many scenarios to build a probability distribution table for retirement planning.
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46
Q

Traditional Portfolio Management vs. Modern Portfolio Theory

A
  • Trad: Based on diversifiying between sectors
  • MPT: Based on SD, Beta, Efficient frontier, low correlation securities
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47
Q

Fixed weighted asset allocation

A
  • predetermined asset class allocation
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48
Q

Flexible weighted asset allocation

A

Weights for each asset class are adjusted periodically based on market analysis.

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49
Q

Tactical asset allocation

A

use stock-index futures and bond futures to change a portfolios asset allocation

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50
Q

Sharpe Ratio

A
  • how much risk-adjusted return are we receiving per unit of risk taken. The higher the better.
  • Risk measure is SD

Sp= Sharpe Index

rp= return of portfolio

rf=Risk free rate of return

σ= standard deviation of the portfolio.

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51
Q

Treynor’s measure

A
  • Uses the Beta of the portfolio to measure the portfolio’s return in relationship to risk.
  • The higher the better
  • Relative measure
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52
Q

Jenson’s measure (alpha)

A
  • Difference between actual returns and expected returns
  • Actual return minus CAPM
  • Positive returns are good.
  • Absolute measure - not relative
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53
Q

When to use Sharpe, Treynor or Alpha

A
  • if r2 is greater than or equal to .70, then it’s okay to use Treynor or Sharpe
  • If r-squared is less than .70 then use Sharpe
  • R-squared indicates how reliable Beta is as a measure of risk.
  • Sharpe is the only one not affected by Beta (low r-squared is an indication that Beta is not a good measure)
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54
Q

Dollar-cost averaging

A

Fixed dollar amount is invested at fixed intervals.

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55
Q

Constant-dollar plan

A
  • portfolio has a speculative and a conservative portion
  • When the specualtive portion increases to a predetermined dollar amount, profits are transferred to the conservative
  • and vice versa
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56
Q

Constant Ratio Plan

A
  • portfolio has a speculative and a conservative portion
  • When the specualtive portion increases to a predetermined percentage, profits are transferred to the conservative
  • and vice versa
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57
Q

Variable ratio plan

A

Ratio varies based on market timing

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58
Q

Rights Offering

A

An offer to existing share holders to purchase new stocks (can be at a preferred price)

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59
Q

Stock spin off

A

Conversion of one of the firm’s subidiaries to a stand-alone company by distribution of stock in that new company to existing shareholders.

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60
Q

Stock split

A
  • Increases the number of shares and decreases the value of the stock by an equal amount.
  • Mutiply number of shares times the ratio and share price times reciprocal. e.g. 5 to 3 = 5/3
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61
Q

Treasury stock

A
  • Stocks that have been sold and subsequently bought back by the company.
  • Buybacks are considered a positive signal
  • Often used to fund management stock option plans rather than issue new shares.
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62
Q

Classified common stock

A
  • different classes of stock have different benefits
  • e.g Class A - non-voting stock; Class B - voting stock
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63
Q

Book Value for common stock

A
  • assets - liabilities - preferred stock = book
  • Book = shareholders equity
  • amount of equity shareholders have in the company.
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64
Q

Market value of common stock

A
  • the prevailing market price of the security
  • market capitalization = market value * number of shares outstanding
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65
Q

Investment value

A
  • The amount that investors believe a security should be trading for or what they think it’s worth.
  • Based on expectations of risk and return and how return is expected from dividends and capital appreciation.
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66
Q

EPS

A
  • Earnings per share
  • Profit after taxes - preferred dividends/number of shares outstanding.
  • Retained earnings are the percentage of EPS not paid to stockholders.
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67
Q

Date of record

A
  • Date on which one has to be a shareholder in order to receive the dividend
  • Takes 3 days to settle - must buy 3 days before Date of Record
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68
Q

ex-Dividend Date

A
  • 3 trading days up to and including the date of record (2 trading days before) where stocks trade without the dividend
  • if you sell on or after the ex-dividend date you still receive dividend.
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69
Q

Dividend Yield

A

Annual dividend/current share price

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70
Q

Dividend payout ratio

A
  • Ratio of amount paid out in dividends vs. amount reinvested in company
  • Dividends per share/earnings per share
  • High DPR could suggest difficulty in paying future dividends (not enough growth)
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71
Q

Blue chip stocks

A

Issued by large, financially stable companies

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72
Q

Income stocks

A
  • High dividend payouts
  • Sometimes have low growth potential
  • subject to interest rate risk
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73
Q

Growth Stocks

A
  • Issued by companies that are experiencing rapid growth
  • Usually pay little or no dividends
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74
Q

Cyclical Stocks

A
  • issued by companies are closely linked to the overall economy
  • move up and down with the business cycle
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75
Q

Defensive stocks

A

Pricing remains stable despite economic changes

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76
Q

Mid-Cap Stocks

A
  • Market cap from 2 - 10 Billion
  • Good market return with less volatility than small-cap
  • baby blue chips: have same characteristics of blue-chips but smaller
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77
Q

Small-cap stocks

A
  • Less than $2 Billion Market Cap
  • High risk exposure
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78
Q

Intrinsic Value

A
  • The determined value of a stock based on economic analysis, industry analysis, and fundamental analysis (analysis of the company’s financial and operations condition
  • dependent on future cash flows, discount rate used to determine future value, risk associated with future performance
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79
Q

Economic Analysis

A

General study of the prevailing economic environment to establish a foundation for the valuation of common stock.

Looks at:

  • Fiscal policy
  • Monetary policy
  • Inflation
  • Consumer Spending
  • Currency rates
  • GDP
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80
Q

Stock Dividends

A
  • Dividends are received as stock instead of cash.
  • Generally not taxable until sold.
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81
Q

DRIP

A
  • Dividend Re-Investment Plan
  • Automatically re-invest in the security
  • Taxed as if received as cash
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82
Q

PE Ratio

A
  • Price to earnings ratio
  • How much investors are willing to pay for each dollar of income.
  • Price per share/Earnings per share
  • Value stocks have lower PE ratios
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83
Q

Industry Analysis

A
  • Perform SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis.
  • Establish the competitive position of an industry relative to others..
  • Develop industry outlook
  • Looks at the following
    • monopolistic vs. competitive
    • regulation
    • labor relations
    • role of technology
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84
Q

Fundamental Analysis

A
  • Ratio study of particular company
  • Use financial statement, income statement, statement of cash flows.
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85
Q

Company balance sheet

A
  • summary of assets, liabilities, and shareholder equity (assets - liabilities = shareholder equity)
  • at a point in time.
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86
Q

Company Income Statement

A
  • Revenues and expenses over a period of time.
  • Reports net income
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87
Q

Statement of Cash Flows

A
  • Summary of a firm’s cash flow and other events that caused changes in the cash position
  • Determines how cash was used or generated during period.
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88
Q

Firm Liquidity Analysis

A
  • Measures company’s ability to meet day to day operating expenses and short-term obligations
  • Current Ratio = Current Assets/Current liabilities
  • Net Working Capital = Current Assets - Current liabilities
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89
Q

Activity Ratios

A
  • Measure how well a firm is managing its assets
  • The higher the better:
    • Accounts receivable turnover = Sales/Accounts Receivable (how many times/year are we able to collect our accounts receivable)
    • Inventory turnover = Sales/Inventory (how many times/year are we turning over our inventory)
    • Total Asset Utilization = Sales/Total Assets (how is a firm utilizing their assets to generate sales?)
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90
Q

Leverage Ratios

A

How much fixed financing has the firm been using?

  • Debt to equity ratio = Long-term debt/shareholder equity
  • Times interest earned = Expenses Before Interest and Taxes (EBIT) /Interest expense (the higher the better)
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91
Q

Return on Equity

A
  • Return on the amount invested
  • Net income/equity
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92
Q

Profitability Ratios

A
  • Measures relative success:
    • Net profit margin = Net income/sales
    • Return on assets = Net profit after taxes/Total assets (assets = liabilities + equity)
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93
Q

PEG Ratio

A

Stock’s PE Ratio/3-5 year growth rate in earnings

  • If less than or equal to 1: growth is dues to earnings
  • If greater than 1: PE is outpacing earnings growth
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94
Q

Book Value per Share

A
  • Shareholders’ equity/Number of shares outstanding
  • Compare to market cap to determine if overvalued or undervalued.
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95
Q

Price to Book Ratio

A
  • Market price/Book value per share
  • Book value = Shareholder’s equity/number of shares.
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96
Q

Estimate future stock price

A

Look at future:

  • Sales
  • Profit margin
  • earnings
  • dividends per share
  • PE
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97
Q

Zero Growth Dividend Valuation Model

A
  • Best for Blue Chip Stocks with constant dividend
  • Stock price = Dividend/Required Rate of Return
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98
Q

Constant Growth Rate Dividend Valuation Model

A
  • Assumes dividends will grow at a constant and determinable rate
  • D1 = D0 + (1 + g) = Next year’s expected dividend
  • V= Value of stock
  • r = Required rate of return
  • g = growth rate of dividend
  • P = Market price for security
  • V = D1 / (r-g)
  • r = ( D1/P )+ g
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99
Q

Variable Growth Model Dividend Valuation

A
  • Solve for return at and beyond the time period of constant growth using constant growth model
  • Use cash flows to calculate NPV. Cash flow 0 is 0. Final cash flow solution from constant growth model. Input interest rate and solve for NPV.
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100
Q

Expected Growth Rate

A
  • g = ROE * rr
  • g= growth
  • ROE = Return on Equity
  • rr = rentention rate (amt. retained after dividend payout = 1 - dividend payout rate
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101
Q

P/E approach to valuation

A
  • Stock Price = EPS * P/E ratio
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102
Q

Technical Analysis

A
  • Forcasting stock prices based on
    • charting of stock movements
    • looking for patterns
    • looking at supply and demand for stocks
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103
Q

The Dow Theory

A
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104
Q

Market Technical Indicators

A
  • Supply and demand
  • Volume
  • Breadth of the market (number of advancing stocks is greater than the number declining)
  • Short interest (lots of short selling indicates future demand, measures pessimism/optimism)
  • Odd-lot trading
  • Advance-decline line
  • New highs, new lows
  • charting
  • Moving average
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105
Q

Random Walk

A
  • Stock prices are unpredictable and follow a random pattern
  • Contradicts techinical analysis
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106
Q

Efficient Market Hypothesis

A
  • Markets have a large number of knowledgeable investors who react quickly to new information
  • Asset prices reflect all relevant information.
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107
Q

Weak-form Market Efficiency

A
  • Past prices and volume is reflected in market pricing.
  • If markets follow weak-form efficiency
    • techical analysis is not useful
    • fundamental analyis is useful
    • inside information
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108
Q

Semi-strong form market efficiency

A

All relevent public information is reflected in market prices:

  • Technical analysis not useful
  • Fundamental analysis not useful
  • Inside information useful
109
Q

Strong-Form market efficiency

A

All public and private information is reflected in market pricing.

Diversification is helpful; manage risk.

110
Q

Market Anomalies

A
  • January effect
  • Small-firm effect
  • Earnings announcements - drift
  • P/E effect
111
Q

Behavioral Finance - Overconfidence

A

Investor’s underestimate risk associated with investment

112
Q

Behavioral Finance - Biased Self-Attribution

A

Attributes success to self, failure to others/factors

113
Q

Loss Aversion

A
  • Investors dislike loss more than gain
  • Investors will hang on to losers thingking they will bounce back
114
Q

Narrow framing

A
  • Investors analyze stocks in isolation while ignoring larger conflicts
  • e.g. ignoring asset allocation
115
Q

Belief perserverance

A
  • investors ignore information that conflicts with their existing beliefs
116
Q

Recency Effect

A

What has just happened will continue to happen.

117
Q

Use behavioral finance to improve results

A
  • Sell losing stocks
  • Don’t chase performance
  • Be humble and open-minded
  • Review performance periodically
  • Don’t trade too much
118
Q

Interest Rates and Bonds

A
  • Interest rates and bond values are inversely related
  • Interest rates are the single biggest determinant of bond price
  • Bond markets are bullish when interest rates are falling.
119
Q

Bond Risk

A
  • Interest rate risk (price risk)
  • purchasing power risk (inflation)
  • liquidity risk
  • Call risk
120
Q

Coupon Rate

A
  • Annual interest payment of a bond stated as a percentage of par value
  • usually paid semiannually
121
Q

Par Value

A
  • Principal amount
  • face value
122
Q

Maturity Date

A
  • Date that the principal must be paid back
  • Longer maturity more risky - the closer to the maturity date, the closer the value gets to par.
  • Longer maturity more sensitive to interest rate changes.
123
Q

Term Bond

A
  • Has one maturity date
124
Q

Serial Bond

A
  • Has several maturity dates
  • Portions of the bond mature at different dates
125
Q

Freely Callable Bond

A

Can be called at any time.

126
Q

Non-callable Bond

A

Can never be called.

127
Q

Deferred Call Bond

A

Not callable for a specified period, then callable

128
Q

Call Premium

A

Additional amount paid to bond holder upon call

129
Q

Call Price

A

Par value + call premium

130
Q

Refunding Provision

A
  • Prohibits premature retirement of a bond in order to issue another bond at a lower rate.
  • Issuer can use cash on hand to issue a bond at a lower rate (just not the proceeds from the first bond)
131
Q

Sinking Fund

A
  • Repayment schedule for the bond
  • Only applies to term bonds
  • Issuer is obligated to pay off bond over time.
  • Issuer must systematically put money aside to pay off the debt or must pay off the bond over time.
132
Q

Senior Bonds

A

Back by a legal claim to specific assets

133
Q

Mortgage bonds

A
  • Backed by real estate
134
Q

Collateral Trust Bond

A

Backed by securities or bonds

135
Q

Equipment Trust Certificates

A

Backed by specific pieces of equipment

136
Q

Junior Bonds

A

Unsecured bonds

Backed only by good faith

137
Q

Debenture Bonds

A
  • Unsecured bonds (junior bonds)
138
Q

Subordinated Debenture Bond

A
  • Unsecured bond whose claim is secondary to other claims
139
Q

Income Bond

A
  • Requires interest to be paid only after a certain amount of income has been earned
  • least secure type of bond
140
Q

Premium Bond

A
  • Sells for more than par value
141
Q

Discount Bond

A
  • Sell for less than par value
142
Q

Treasury Bond

A
  • Considered default-risk free
  • Interest exempt from state and local taxes
  • Sold in $1,000 denominations
143
Q

Treasury Bills

A

Mature in less than 1 year

144
Q

Treasury Notes

A

Mature in 2 - 10 Years

145
Q

Treasury Bonds

A

Maturity greater than 10 years

146
Q

TIPS

A
  • Treasury Inflation Protected Securities
  • Principal adjusts based on inflation
  • Interest payments based on current principal amount.
  • At maturity pays at greater of par value or inflation adjusted par value.
147
Q

I Bonds

A
  • Inflation-adjusted bonds
  • Up to 30 years
  • Returns = fixed rate plus semi-annual CPI-adjusted rate
  • Can be redeemed after 12 months
148
Q

Agency Bonds

A
  • Issued by US Government Agencies
  • Almost no default risk
  • Moral obligations of the US government - only the
  • Interest rates higher than treasury bond
149
Q

General Obligation Municipal Bonds

A
  • Backed by the taxing authority that issues the bonds
  • Safer than revenue bonds
150
Q

Municipal Revenue Bonds

A
  • Paid from the revenues of the project being financed.
  • If not enough revenues, bond may default
151
Q

Private Activity Bonds

A
  • Usually issued to finance stadiums
  • Can be subject to AMT
152
Q

Municipal Bonds Taxation

A
  • Interest income exempt from Fed taxation
  • May be non-taxable by issuing state if holder is resident.
  • TEY: Taxable Equivalent Yield = Yield on Muni/(1 - tax rate)
153
Q

Corportate Bonds

A
  • Fully taxable
  • Higher rate of return than gov’t bonds
154
Q

Zero-coupon Bonds

A
  • Does not pay interest
  • Sold at deep discount from par value - value increases the closer it gets to maturity.
  • Subject to high price volatility from interest rate changes.
  • Treasury Strips are zero-coupon bonds created from Treasury bonds
  • Interest must be reported and taxed annually despite not receiving any payment until maturity.
155
Q

Mortgage Backed Securities

A
  • Secured by mortgages
  • Investor received payments of both interest and principal (only interest taxed)
  • Collaterallized Mortgage Obligations (CMO) created as pools of mortgages
  • Tranches created based on maturity. Principal goes to shortest term tranche
156
Q

Asset-backed securities

A
  • Backed by pools of loans:
    • auto loans
    • credit cards
    • home equity loans
  • High yields and high credit quality because loans are greater than bond issuance.
  • Short maturities - 3-5 years
  • Interest and principal payments are monthly.
157
Q

Junk Bonds

A
  • High yield bonds
  • Highly speculative
  • Below BBB rating
158
Q

Dollar-denominated bonds

A
  • Sold in US - Yankee Bonds
  • Eurodollar bonds - Can be sold outside the US; not registered with SEC
159
Q

Bond quotes

A
  • Stated as a percentage of Par Value - e.g. 97 would be 97% of par
160
Q

Convertible Bonds

A
  • Can be exchanged for a predetermined amount of common stock
  • Said to have an “equity kicker”
  • Company can sometimes force conversion if the bond is called
  • Limits downside risk - if price of stock goes too low, can remain as bond
  • Current income is usually higher than dividend
161
Q

Conversion Value of Convertible Bond

A

Convertible Value (CV) = (Par Value/Conversion Price) * Stock Price

Conversion Ratio = Par Value/Conversion Price

162
Q

Conversion Period

A
  • Time during which convertible issue can be converted
  • Can be freely convertible or not.
163
Q

Conversion Price

A
  • Stated price per share that convertible issues can be converted into
164
Q

Conversion Premium

A
  • Pay a premium for the opportunity to hold the stocks in the convertible issue as opposed to simply purchasing the stocks.
  • = market price of convertible issue - conversion value
165
Q

Conversion Equivalent

A
  • how much would a share of the stock have to sell for to make it worth it to pay conversion premium.
  • = Market price of convertible bond/conversion ratio
166
Q

Current Bond Yield

A
  • Annual interest (coupon) / Market price
167
Q

Bond Duration (Macauley Duration)

A
  • Measures bond’s sensitivity to changes in interest rates.
  • Weighted average time until an investor receives all coupon payments and principal
  • The moment in time an investor is immunized against interest rate and reinvestment rate risk
  • Y = yield
  • t = term (n)
  • C = coupon
168
Q

Duration Effects

A
  • Longer duration = higher price volatility
  • Higher YTM = Shorter Duration
  • Longer maturity = longer duration
  • Higher coupon = shorter duration
  • The INterest rate variables are INversley related to duration.
169
Q

Bond Immunization

A
  • Occurs when duration equals investment time horizon
  • Seeks to offset the opposite changes in bond valuation caused by price effect (caused by interest rate changes) and reinvestment effect (as income is received, it is reinvested at a higher or lower rate).
  • Zero coupon bonds have no reinvestment rate risk (duration = maturity).
170
Q

Convexity

A
  • In a low interest rate environment, interest rate affect bond price more significantly than in a higher interest rate environment.
  • If there are large changes in interest rates, duration price change formula is not effective.
  • Convexity is good. Higher = better. Pay more for convexity so lower yield.
  • Duration overstates price depreciation when interest rates rise and understates price appreciation when interest rate decline.
171
Q

Bond Risk

A

Risk premium depends on:

  • Default risk
  • Term-to-maturity
  • Call risk
172
Q

Yield Spread

A
  • Difference in interest rates between different types of securities
173
Q

Yield Curve

A
  • Shows the relationship between YTM and Term to maturity.
  • Upward sloping (normal) - short-term rates lower than long-term rates
  • Downward sloping - Short-term rates higher than long-term rates.
174
Q

Expectations Hypothesis

A
  • Inflation is determining factor
  • Explains both normal and inverted yield curve
  • If investors expect higher inflation they demand higher interest rates on longer maturities
  • Decreasing inflation expectations may result in inverted curve
175
Q

Liquidity Preferences Theory

A
  • Only explains upward sloping yield curve
  • Because short-term securities have more liquidity, rates are lower.
  • Compensated for lower-liquidity in long-term investments.
176
Q

Market segmentation theory

A
  • Supply and demand
  • Explains both upward-sloping and downward-sloping curves.
  • Higher demand on the part of the borrower/issuer pushes interest rates up. If demand is high for long-term securities rates are higher. And vice versa.
177
Q

Bond price sensitivity

A
  • long-term bonds are more price-sensitive when interest rates change (more volitile)
  • short-term are less affected by interest rate changes
178
Q

Yield-to-Maturity

A
  • Approximates the true return if bond is held to maturity.
  • Solve for i
  • Assumes reinvestment rate as same rate as yield (market rate at time of purchase)
179
Q

Yield-to-call

A
  • Calculates yield using time to first date of call and call price
180
Q

Bond Premium/Discount

A
  • If selling at a discount, Coupon < CY < YTM
  • If selling at a premiun, Coupon > CY > YTM
181
Q

Effective Rate of Return on Bond

A

Takes into account changes in interest rates for reinvestment of bond cash flows.

  • Step 1: Calculate future value of only coupon payments at reinvestment rate
  • Step 2: Add that future value to redemption/sale value of the bond and to get new FV of bond to calculate I.
  • NO PMT because that is already accounted for in step 1
182
Q

Determining Price Change of a Bond Using Duration

A
  • Step 1: Calculate Duration - Y: YTM, C: Percent Coupon (as decimal), T: Years to Maturity.
  • Step 2: Calculate Modified Duration: Duration / (1 + YTM)
  • Step 3: Modified Duration * Change in interest rates
  • OR
  • Step 2: Calculate Percentage Change:
    • -D [(Percentage change in interest rates)/(1 + YTM)]
183
Q

Preferred Stock

A
  • Hybrid security with characteristics of stocks and bonds
  • Dividends are fixed amounts as a percentage of par value
  • Preferred dividends paid before common dividends
  • Yields are similar to high-quality bonds.
  • For corps that own stock, they are able to exclude 70% of received dividends from taxes.
  • Many preferred dividends taxed at ordinary income tax rate (trust preferreds)
  • Some preferred stock is convertible
184
Q

Preferred stock valuation

A
  • Price of preferred stock = Annual Dividend Income (percent of par value)/Prevailing Market Yield (or required rate of return)
  • Inversely related to interest rates.
185
Q

Adjustable Rate Preferred

A
  • Dividend rate is not fixed.
  • Can change with interest rates.
186
Q

Preference (Prior) Preferred

A
  • Paid before other preferred stock
187
Q

Cumulative/Noncumulative Provisions

A
  • Cumulative: all past unpaid dividends must be paid before common stock dividends are paid (including all those in arrears)
  • If buyer buys after dividends are in arrears, does not receive extra dividends.
  • Noncumulative: don’t have to pay all dividends in arrears
188
Q

Book Value of Preferred Stock

A
  • (Assets - Liabilties) / preferred stock outstanding
189
Q

Dividend Yield of preferred stock

A
  • Annual dividend income/current market price of stock.
190
Q

Open End Mutual Funds

A
  • Investors buy and sell shares directly through the fund
  • Unlimited number of shares
  • All purchases and sales completed at EOD
  • NAV = Fair market value of assets - liabilities/number of shares outstanding
191
Q

Closed End Mutual Funds

A
  • Investment company only sells in the intial offering
  • Later trading happens on secondary market
  • Purchase and selling price based on supply and demand (not NAV)
  • Usually sell at a discount to NAV
192
Q

ETF’s

A

Exchange-Traded Funds

  • Trade like individual stocks
  • Trade immediately
  • Trade close to NAV
  • Diamonds - track DJIA; Spiders - track S & P; Qubes - track NASDAQ
  • Haven’t been tested to a significant degree
  • no phantom capital gains
193
Q

Load and no-load funds

A
  • only apply to open-end mutual funds
  • low-load fund is 2-3%
  • 12 (b)1 fees: annual fee charged by mutual find company. Max: 1% of assets.
  • For no-load funds, max 12(b)1 fee: .25%
  • Max total load and 12b1 charges: 8.5%
194
Q

UIT’s

A
  • Unit Investment Trusts
  • Fixed pool of securities
  • Sold in units, not shares
  • Passively managed; securities are fixed
  • Can be costly due to high upfront sales charges.
195
Q

Hedge Funds

A
  • Private limited partnerships
  • Not subject to same regulations as mutual funds
  • General partners takes 10-20% of profits
  • Only sold to accredited investors
196
Q

Growth Fund

A
  • Emphasis on capital appreciation
  • Few dividends
  • Moderately risky
  • High P/E ratio
197
Q

Aggressive Growth Fund

A
  • Highly speculative
  • High P/E
  • smaller companies
  • High risk
  • Turnaround situations
198
Q

Value funds

A
  • High dividend yields
  • low P/E ratios
  • more appropriate for conservative investors
199
Q

Equity-income Funds

A
  • High current income with long-term gains
  • Blue-chip stocks
  • Dividends
  • Preferred stocks
  • less risky
  • less volatility
200
Q

Balanced Fund

A
  • Combination of stocks and bonds
  • allocation typically remains constant
  • relatively conservative
  • diversified
201
Q

Growth-and-income funds

A
  • Stocks and bonds
  • higher percentage in stocks than in a balanced fund
  • more risky than balanced fund
  • long-term capital appreciation with some income
  • Moderate risk investment
202
Q

Bond Funds

A
  • More liquid than individual bonds
  • Steady income
  • some price volatility because of interest rates
  • cannot be held to maturity
203
Q

Money Market Funds

A
  • Invest in short-term securities with maturities of less than 90 days
  • interest rates move up and down with market rates
  • cash substitute
204
Q

SEC mandated yields

A
  • SEC Yield - compares yields on bond funds
  • Money Market funds 7 day yield
  • Money Market funds 7 day compound yield
  • Mutual fund 30 day yield
205
Q

Asset Allocation Funds

A
  • invest in stocks, bonds, and money market securities based on asset allocation
  • age-based funds
206
Q

International Funds

A
  • International - exclude US
  • Global - include US
  • for CFP - conservative investor would want some international
207
Q

Mutual Fund buy/sell

A
  • Buy at offer (ask)
  • Sell at NAV (bid)
208
Q

Warrants

A
  • written by a corporation
  • in effect for years
  • illiquid and nonstandarized
209
Q

Fundamental (instrinsic) Value of a Call

A

(Market price of underlying security - strike price) * 100 shares

210
Q

Fundamental value of a put

A

(Strike price - Market value of underlying security) * 100 shares

211
Q

Option Premium

A

Price of the option

212
Q

Time value of option

A

Difference between premium (price of option) and fundamental value of option

213
Q

In-the-money

A

Call option - buyer: Market price greater than strike price

Call option - seller: Market price less than strike price

Put option - buyer: Market price less than strike price

Put option - seller: Market price greater than strike price

214
Q

Out-of-the money

A

Call: Market price less than strike price

Put: Market price greater than strike price

215
Q

Futures Contract

A
  • Both seller and the buyer have an obligation to either make delivery of a good or purchase delivery of a good.
  • All trading is done a margin basis
216
Q

Call

A
  • Option to buy a security at a certain price (strike or excersize price) at a certain point in time
  • Person who buys the option is the long position
217
Q

Put

A
  • Option to sell a security at a certain point in time for a certain price (strike price)
  • Person who buys the option has the long position
218
Q

Option Writer

A
  • Seller of the option
  • short position
219
Q

Naked Option

A

An option sold by a writer on a security the option writer does not own.

Unlimited loss; most risky option.

220
Q

Portfolio insurance/Hedge/Married Put

A
  • Buy a put option on one’s long position to protect price or
  • buy a call option on one’s short position to protect sale
221
Q

Value of an option

A

Value = price of option = premium

Intrinsic (fundamental) value + time value

If option is out of the money, intrinsic value is 0

222
Q

Intrinsic Value

A

Amount an option is in the money. If out of the money, intrinsic value is 0.

223
Q

Black-Scholes Option Pricing Model

A
  • Value of a call option
  • in - interest rate (risk free rate)
  • V - volatility
  • E - exercise price (inversely related)
  • S - stock price
  • T - time value
224
Q

Long Straddle

A
  • Buy a call and a put on the same stock at the same strike price
  • Breakeven points are price changes above or below total premiums paid
  • Used when volatility is expected
225
Q

Short Straddle

A
  • used when volatility is not expected
  • appropriate in a flat market
  • sell both a call and a put on the same stock at the same strike price.
226
Q

Stock-index options

A

Options bought on entire market.

227
Q

Warrant

A
  • Option that gives a right to buy a stock at a specified price
  • Issued by companies
  • Can be long-term
  • Non-standardized
  • Can be added to a bond issue
  • Not as liquid as listed options
  • Valued the same way as options (intrinsic value plus time value)
228
Q

Futures long/short position

A

Buyer of contract is long position

Seller of contract of short position

229
Q

Characteristics of futures

A
  • obligation to buy and sell
  • to get out of contract, short the same contract.
  • delivery price set by supply and demand
  • bought on margin - leverage
  • no limit on potential loss
  • priced daily - “marked-to-market”
230
Q

Futures Hedgers

A
  • Producers and processors
  • Protecting interest in underlying commodity or financial instrument
231
Q

Futures speculators

A
  • Investors who buy/sell futures contracts between origination and delivery
  • provide liquidity for the market
232
Q

Real Estate Advantages

A
  • Hedge against inflation
  • diversification
  • Tax benefits - deduct mortgage interest, property tax
233
Q

Income approach to real estate valuation

A
  • The discounted present value of future cash flows.
  • NOI/Cap rate
  • NOI: (income less all expenses including vacancies) plus depreciation and interest expense (for CFP questions - depreciation and financing not generally included)
  • Capitalization rate: required rate of return
  • Gross income multiplier: sales price/annual gross income
234
Q

REIT

A
  • Closed-end diversified portfolio of real estate
  • securitized real estate
  • Must distribute 90% of income as dividends and must keep 75% of assets in real estate investments
235
Q

3 types of REITS

A
  • Equity REITs - own real estate
  • Mortgage REITs - holds mortgages
  • Hybrid REITs - holds both real estate and mortgages.
236
Q

Gold

A
  • Diversification
  • Hedge against inflation
237
Q

Guaranteed Investment Contract

A
  • Guarantees a fixed or floating rate of return over a period of time.
  • issued by insurance companies
  • have higher rate of return than savings account
  • purchasing power risk
238
Q

Beta

A

security return/market return

239
Q

Muni Bond Insurance Companies

A

AMBAC

MBIA

240
Q

Tax-equivalent Yield

A

Yield a coporate bond must pay to be equivalent to a muni bond.

=Tax-exempt yield/ (1-marginal tax rate)

241
Q

Tax-exempt yield

A

After-tax yield of corporate bond

=Corporate rate * (1-Marginal Tax Rate)

242
Q

Bond discount

A

IF you see a discount: Call Mom’s Cell Now

YTC (highest)

Yield to Maturity

Current Yield

Nomimal Yield - coupon - (Lowest)

243
Q

Black Scholes

A

Values a call option using the following variables:

  • Price of underlying asset
  • Time until call
  • Volatility of underlying asset
  • Risk free rate
244
Q

Put Call Parity

A

Values a put option based on the price a of call option on that security

245
Q

Binomial Pricing Model

A
  • explains prices based on the underlying asset price moving in opposite directions; can be extrapolated out over time.
246
Q

LEAPs

A

Long Term options.

  • Term is up to 2 years.
  • More expensive than regular options
247
Q

Subsitution Swap

A

Designed to take advantage of anticipated and potential yield differentials between bonds that are similar with regard to coupons, rating, maturities, and industry.

248
Q

Rate anticipation swaps

A

Rate anticipation swaps utilize forecasts of general interest rate changes.

249
Q

yield pickup swap

A

The yield pickup swap is designed to alter the cash flow of the portfolio by exchanging similar bonds having different coupon rates.

250
Q

tax swap

A

The tax swap replaces bonds with offsetting capital gains and losses.

251
Q

Bottom up analysis

A

Detailed look at specific companies

Value managers and technicians do this.

252
Q

Top down analysis

A

Analysts look at overall market conditions

Group Rotations and Market timers

253
Q

Components of interest rates

A
  • Real Risk-Free Rate
  • Expected Inflation
  • Default-Risk Premium
  • Liquidity Premium
  • Maturity Premium
254
Q

Modified Duration

A

D/(1+y)

255
Q

Registered Bonds

A

Pay interest to whoever is the registered owner

256
Q

Investment grade bonds - lowest rating

A

Baa - Moody’s

BBB - S & P rating

257
Q

Barbell strategy - bonds

A

Bonds for the portfolio are purchased with both long and short periods of time to maturity, with little in between

258
Q

Weighted average Beta

A

Use dollar value of portfolio not number of shares.

259
Q

12b1 fees

A

Used for marketing and distribution costs.

260
Q

Limited general obligation bond

A

The limited general obligation bond is a bond issued by an entity that has some ability to levy taxes to support itself (for example, a school district). However, this ability is limited when compared to that of the general taxing power of the state.

261
Q

Head of household - dependent

A

Can file HOH if dependent qualifies but doesn’t live with taxpayer.

262
Q

Tax Payer subject to accuracy related penalty

A
  • makes a substantial understatement of tax liability, generally more than 10 percent of the correct tax liability and
  • at least a $5,000 tax deficiency.
263
Q

Basis for property

A

All costs of making property ready for use are capitalized and added to basis.

(can include legal fees)

264
Q

Medical Expense Deduction Non-dependent exception

A

Can deduct medical expenses paid on behalf of another individual who would qualify as a dependent except that his/her income is too high.

265
Q

Life annuity with cash refund

A

Guarantees payments for life, but refunds principal amount to beneficiary if not fully distributed in life

266
Q

Section 1244 stock

A

First $1M in stock issued by company. $50K/100K MFJ in losses can be deducted against OI.

267
Q

Financial Risk

A

It is the possibility of loss due to the overuse of debt financing for a company

268
Q

Put Bond

A

the bondholder has the right to sell the bonds back to the issuer at a specified date for its principal.

269
Q

point-in-time risk

A

uncertainty that the initial portfolio returns may have a drastic effect on the likelihood of the portfolio successfully providing the income required for the client’s lifetime

CFP (8 decks)

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