Investments

Question 1

Unsystematic Risk

Answer 1

Diversifiable Risk

• Business Risk: refers to the nature of the firms operation (loss due to new technology)
• Financial Risk: refers to how the firm finances its assets (loss due to heavy debt financing)

Question 2

Systematic Risk

Answer 2

Non-diversifiable Risk: (PRIME)

• Purchasing Power Risk: inflation
• Reinvestment Risk: risk that proceeds available for reinvestment must be reinvested at lower rates than the instrument that generated the proceeds
• Interest Rate Risk: risk that change in rates will cause value of fixed income securities to fall
• Market Risk: overall market
• Exchange Rate Risk: associated with changes in values of currencies

Question 3

I Bonds and EE Bonds

Answer 3

• non-marketable, nontransferable, cannot be used for collateral
• sold at face value
• rate based on 10-year note yield
• fixed interest rate that is in effect at time of purchase (EE)
• interest rate is composed of: a fixed base rate (remains the same for life of bond) and inflation adjustment (every 6 months) (I)
• subject to federal tax when redeemed (unless used as education bonds)
• EE NO R AND B
• not subject to state and local tax

Question 4

Types of Municipal Securities

Answer 4

GO Bonds: backed by full faith, credit, and taxing power of the issuer. Safest muni bond.

Revenue Bonds: backed by a specific source of revenue which the full faith and credit of issuer has not backed. (toll roads, hospitals, power plants). Riskier. Higher yields.

Insured Muni Bonds: insurers pay timely interest and principal when the issuer is in default (AMBAC and MBIA)

Question 5

Corp, Muni, Gov Bonds (DRIP) Risks

Answer 5

Default Risk: creditor may seize the collateral and sell it to recoup the principal (not with gov bonds)

Reinvestment Risk: as payments are received, interest rates fall, and funds reinvested at lower yields

Interest Rate Risk: rising rates may cause bond prices to fall

Purchasing Power Risk: inflation lowers value of payments

greatest risks to bonds could be said to be price volatility

Question 6

Capitalization Market Value of Company

Answer 6

Large ($10B)
Mid ($2-$10B)
Small (less than $2B)
Micro (less than $300M)

Question 7

American Depository Receipt (ADR)

Answer 7

• Prices of ADR’s quotes in USD
• Dividend paid in USD
• Dividends declared in foreign currency
• Exchange rate risk
• Investors get foreign tax credit

Question 8

Warrants vs Call Options

Answer 8

• warrants are issued by corporations, calls are created by individuals
• warrants typically have maturities of several years
• warrant terms are not standardized, calls are

Question 9

Futures Contracts

Answer 9

Long Commodity Position: if a farmer is long corn he needs to short hedge and will sell a futures contract

Short Commodity Position: if Kellogg’s is short corn, they need a long hedge and will buy a futures contract

Question 10

Regulation D: Accredited vs Non Accredited

Answer 10

Accredited (unlimited) (123 Test):

1) net worth of $1m or
2) individual with an annual income of $200k
3) couple with joint income of $300k

Non Accredited (max 35):

1) sold to a max of 35 investors
2) must use a purchaser representative if not “sophisticated”

Question 11

Zero Coupon Bonds

Answer 11

• duration = maturity
• no coupon interest, yet produces phantom income
• no reinvestment risk
• sold at deep discount
• fluctuate more than bonds with similar yields

Question 12

Convexity

Answer 12

• the degree which duration changes as YTM changes
• largest for low coupon bonds, long maturity bonds
• allows investor to improve the duration approximation for bond price changes.

Question 13

EMH (three types)

Answer 13

Strong: prices fully reflect all information. no analysis can produce superior returns over time. (random walk)

Semi: prices reflect all public information. insider info can achieve superior results. no analysis can help.

Weak: historical data is reflected. technical analysis will not help. fundamental analysis can help

Question 14

Tax Basis of Mutual Funds

Answer 14

• FIFO method treats shares aquired first as being sold first45
• specified ID requires seller to identify shares of funds that are sold (allows investor to create gain, neutralize gain, or loss - most flexible)
• Average cost method allows investor to divide the total cost of all shares held by number of shares held

Question 15

Passive Investment Strategies

Answer 15

• buy and hold
• DCA
• index investing
• strategic asset allocation (review every few years)

Question 16

Active Investment Strategies

Answer 16

• market timing
• tactical asset allocation
• technical analysis (charts and trends)
• Fundamental analysis (interest rates, GDP, ect.)
• Ratio analysis (company ratios)

Question 17

Arbitrage Pricing Theory (APT) Keys

Answer 17

Price movements are explained by:

• Unexpected inflation
• Unexpected changes in industrial production
• Unanticipated shifts in risk premium
• Unanticipated shifts in structure of yields.

Question 18

Asset Backed Securities (MBS)

Answer 18

• GNMA: purchase a pool FHA/VA mortgages, guaranteed by US government
• FNMA/FHLMC: not guaranteed, mortgages and student loan bundles
• CMO: bundle mortgages, separated into tranches based on risk and speed of payment, Z tranche has no coupon (risky) but receives income from the collateral remaining after other tranches are paid

Question 19

Ex-Dividend Date

Answer 19

To be listed on corporations books as a holder (eligible for dividend), you need to own the stock on the records date. You must purchase the stock before the ex-dividend date (1 business day before record date)

Essentially: Buy 2 business days before record

Question 20

Preferred Stock Keys

Answer 20

• Hybrid of Equity and Fixed Income
• fixed dividends
• cumulative dividends (before common)
• Typical purchaser would be treasurer
• For test, think this has little chance of any growth…
• warrants can be added

Question 21

Eurodollar vs Yankee Bonds

Answer 21

Eurodollar: a deposit in any foreign bank that is denominated in USD. Any country.

Yankee Bond: dollar-denominated bonds issued in the US by foreign banks and companies

Question 22

ETF
UIT
OEMF
CEMF

Answer 22

EFT: index, traded on exchange, tax efficient
UIT: unmanaged, no new, units not shares, income distrib, NAV
OEMF: continue sell, NAV
CEMF: no new, trade on exchange at premium or discount of their NAV

Question 23

Call and Put Bonds

Answer 23

Callable: issuer has right to redeem bond at specific price and date. Likely to happen if interest rates have dropped. To do this the issuer pays a call premium. Investors are protected from this for a stated period.

Put: permits the holder to sell the bond back to the issuer at specific price and date. If rates were to rise (dropping price) a holder would exercise the put to get the higher stated par value. For this option, the holder sacrifices some yield.

Question 24

CD’s and Brokered CD’s

Answer 24

CD: You buy a CD and the bank promises to pay it back with interest at maturity. Must hold until term or penalty (you wont get full amount). Liquid.

Brokered CD: A CD that was bought by a wire house and is not being bought and sold on the secondary market by individuals. You do not need to hold until term. Marketable.