Section 103 Unit 4

Question 1

Real Estate Investment Classifications

Answer 1

Unimproved, or raw, land
Commercial or residential rental property
Real estate limited partnerships (RELPs) or real estate investmnet trusts (REITs)

Question 2

Unimporved Land

Answer 2

Passive investment and produces negative cash flows while generating no income. (Just an undeveloped piece of land)

Question 3

Commercial or Residential Rental Property Valuation

Answer 3

Net Operating Income (NOI)
Gross rental receipts from property
\+Nonrental or other income
= Potential gross income
- Vacancy and Collection losses
=Effective gross income
- Operating expenses (excluding interest and depreciation
= Net operating income (NOI)

The focus of the NOI computation is the property’s cash flow, not the investor’s cash flow.

Question 4

Real Estate Limited Partnerships (RELPs)

Answer 4

A syndicated limited partnership consists of two owners; one is the syndicate or promoter who serves as the general partner. The second is the investor or limited partner.

Question 5

Real Estate Investment Trusts (REITs)

Answer 5

Serves as a source of long-term financing for real estate projects by investing in real estate, short-term construction loans, and mortgages. Pools capital in a manner similar to an investment company. Can be publicly traded.

Question 6

Equity REITs

Answer 6

Acquiring real estate for the purpose of renting the space to other companies. Income is generated from the rents and sales of the real estate properties.

Question 7

Mortgage REITs

Answer 7

Are in the business of financing real estate ventures. Generally, a mortgage REIT makes loans to develop property or finance construction.

Question 8

Hybrid REITs

Answer 8

Have characteristics of both equity and mortgage REITs, as they rent properties and make construction loans.

Question 9

Real Estate Mortgage Investment Conduit (REMIC)

Answer 9

Is a self-liquidating, flow-through entity (similar to a Partnership) that invests exclusively in real estate mortgages or mortgage-backed securities and terminates when the mortgages that constitute the investment of the REMIC are repaid.

Question 10

Collaterallized Mortgage Oblications (CMOs)

Answer 10

A form of REMIC. Similar to mortgage-backed securities (Ginnie Mae, Freddie Mac, and Fannie Mae) in that they are both backed by large pools of mortgages. Each of the tranches receives regular interest payments. Tranch A is less risky than Tranch Z because A is paid off first and Z is last.

Question 11

Tranches

Answer 11

Repayment periods

Question 12

Guaranteed Investment Contracts (GICs)

Answer 12

Similar to CDs, but are issued by insurance companies, not commercial banks.

Question 13

Derivatives

Answer 13

Is an investment vehicle whose value is based on that of another security, such as listed stock. Options and future contracts are an example.

Question 14

Options

Answer 14

Is a two-party contract that allows the holder the right, but no the obligation, to buy (call) or sell (put) shares of underlying security at a specified price on or before the expiration date. No longer than 9 months. Each option contract represents 100 shares of underlying stock.

Question 15

Long-term Anticipation Securities (LEAPS)

Answer 15

A long term option that expires beyond two years.

Question 16

Call Option

Answer 16

Gives the buyer the right to purchase the underlying security for a specified price within a specified period (Like a warrant)

Question 17

Put Option

Answer 17

Gives the buyer the right to sell the underlying security for a specified price within a specified period.

Question 18

Four option positions

Answer 18

Purchasing (or being long) a call
Writing (or going short) a call
Purchasing (or being long) a put
Writing (or going short) a put

Question 19

Intrinsic Value of an Option

Answer 19

Is the minimum price at which the option will trade on an exchange. Option can never have a negative intrinsic value.

Question 20

In-the-Money

Answer 20

An option is in-the-money when its intrinsic value is positive.

Question 21

Out-of-the Money

Answer 21

An option is out-of-the-money when its intrinsic value is zero and the exercise price does not equal the market price of the underlying security.

Question 22

At-the-Money

Answer 22

An option is at-the-money when the exercise price of the option equals the market price of the underlying stock.

Question 23

Naked

Answer 23

A call option is naked when it is written on a security that is not owned by the writer. This is the most risky form of option transactions, because the writer is subject to an unlimited potential loss.

Question 24

Intrinsic Value of an Option

Answer 24

E X A M P L E Assume that the market price of ABC stock is currently $50 per share and that the investor has previously purchased a call option on ABC stock with an exercise price of $30 per share. Therefore, the option is $20 in-the-money ($50 less $30) and the call will likely be exercised. The option also has an intrinsic value of $20.
Alternatively, if the market price of ABC stock has declined to $20 per share and the investor is still holding the same call option, the option is $10 out-of-the-money ($20 less $30). Thus, the option will go unexercised and currently has an intrinsic value of zero.

Question 25

Binomial Option Pricing Model (Binomial Model)

Answer 25

Attempts to estimate the price of a call option. Assumes that the price of the option will change in discrete increments.

Question 26

Black-Scholes Option Valuation Model

Answer 26

Is designed to determine the estimated price of a European call option. Assumes the price of the option will change constantly.
Derives the value from five factors:
Stock price on which the option is written
Option exercise price
Time to expiration of option
Risk-free rate of return
The volatility (standard deviation) of the security’s returns.

Question 27

For the CFP Exam you need to know only two things concerning estimating the price of the option using Black-Scholes

Answer 27

Understand the difference in assumptions used for Black-Scholes versus the binomial model; and
Understand that, for any call option, an increase in the option’s exercise price leads to a decrease in the value of the option because the price of the underlying stock has to increase further before the option has intrinsic value.

Question 28

Put-call parity

Answer 28

Is the difference between the call price and the put price and equals the difference between the market price of the stock and the present value of the exercise price continuously discounted at the risk-free rate.

Question 29

Hedging

Answer 29

Combining different types of option contracts allows the investor to create a new risk/return relationship for derivatives.

Question 30

Straddle

Answer 30

Is an options strategy combining the use of a call option and a put option with the same exercise price and expiration date.

Question 31

Long Straddle

Answer 31

Long straddle is the simultaneous purchase of a call option and a put option with the same exercise price and expiration date.

Question 32

Short Straddle

Answer 32

A short straddle occurs when both options are sold or written.

Question 33

Spread

Answer 33

A spread is the simultaneous purchase of one option and the sale of another option on the same side or position within the market.

Question 34

Call Spread

Answer 34

A call spread is the purchase of a call and the sale of a call at the same time.

Question 35

Put Spread

Answer 35

A put spread is the purchase of a put and the sale of a put at the same time.

Question 36

Bull Call Spread

Answer 36

A bull call spread involves purchasing a call option with a strike price that is lower than the call option sold.

Question 37

Bull Put Spread

Answer 37

A bull put spread involves purchasing a put option with a lower strike price than the put option sold.

Question 38

Bear Call Spread

Answer 38

A bear call spread involves purchasing a call option with a higher strike price than the call option sold.

Question 39

Bear Put Spread

Answer 39

A bear put spread involves purchasing a put option with a higher strike price than the put option sold.

Question 40

A zero-cost, or cashless, collar

Answer 40

is a strategy used to protect a gain in a long position of a stock. This strategy consists of:

a long (or buy) position in the underlying stock;
a long put option; and
a short (or writing of a) call option.

Specifically, the investor purchases a put option to protect against a decline in the value of the underlying stock and sells a call option to generate premium income to cover the cost of the premium for the put option. As a result, the premium received on the call option pays for the premium paid on the put option (thus, the term zero-cost or cashless).

Question 41

Future Contract

Answer 41

A futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset (equity) at a future time, place, and unit price. At completion, delivery is not always necessary. Traded on exchanges such as New York or Chicago Mercantile Exchane

Question 42

Taxation of Futures Contracts

Answer 42

At the end of the calendar year, net gains or losses on the contract are treated as 60% long-term and 40% short-term, regardless of the actual breakdown of the gain or loss. In addition, these gains and losses are considered capital gains or losses, regardless of the tax character of the underlying asset.

Question 43

Tangible Asset

Answer 43

Investments take the form of either collectibles or, sometimes, precious metals (e.g., gold or silver).

Question 44

Natural Resources

Answer 44

An investment in natural resources includes an investment in oil and gas properties or timber lands.