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Series 66 > Unit 20 (7) > Flashcards

Unit 20 (7) Flashcards

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Series 66 flashcards
1
Q

An analyst who recommends allocating to industries based on changes to the business cycle would most likely be said to be

  1. Sector rotating
  2. Tactician
  3. Contrarian
  4. Laddering
A

Sector rotating is the practice of changing investment emphasis based on patterns to the business cycle. It could be a form of tactical management, but sector rotating is the best choice.

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2
Q

Monte Carlo advantages

A
  1. Clearly display trade offs of risk and return
  2. Clearer understanding of short term to long term risk
  3. Better model return over time - starting value of the period plus additions or subtractions to the portfolio
  4. Ask questions along the timeline “Can I retire earlier?” “Do I need to reduce my withdrawal rate?” Etc.
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3
Q

Rebalancing

A

Usually takes place quarterly but never less than annually. If equities are outperforming, the proportion of stocks to bonds would be out of balance, so stock would be sold and bonds purchased to bring back to balance

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4
Q

An efficient portfolio is one that offers

A

The most return for a given amount of risk

The least risk for a given amount of return

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5
Q

Cash and cash equivalents

A

Passbook savings and checking accounts, money market accounts, money market funds, bank insured cds, t-bills

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6
Q

A portfolio that maximizes an investors preferences with respect to return and risk is called

  1. The efficient frontier
  2. A diversified portfolio
  3. An uncorrelated portfolio
  4. An optimal portfolio
A
  1. An optimal portfolio. An optimal portfolio lies on the efficient frontier, which is a graph, not a portfolio. The special nature of an optimal portfolio is that it may not always be the most efficient because it takes into consideration the specific preferences of the individual investor, which might create a bias
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7
Q

Your portfolio is 60/40 debt to equities. Initial investment is $250k. One year later acct is worth 260k and 90k is stocks. What do you do to bring the it back to 60/40?

A

40 percent of 260k is 104k so you would buy 14k of equity and sell 14k of debt.

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8
Q

Efficient frontier

A

Curve that represents the set of portfolios that has the maximum rate of return for every given level of risk. The objective is for the portfolio to lie on the curve. Then, by being on the board efficient frontier the optimal portfolio has been created

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9
Q

Optimal portfolio

A

Returns the highest rate of return consistent with the amount of risk an investor is willing to take.

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10
Q

Tactical asset allocation

A

tACTical - ACTive

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11
Q

Weak EMH

A

Technical analysis is no good.

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12
Q

Disadvantages to MCS

A

Simplistic use of historical data
Models simulate return of asset classes but not the assets themselves. Simulating the return of the SNP 500 in a fund with fees could significantly overstate the future value

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13
Q

Capital appreciation

A

Moderate to aggressive. Growth stocks, options, futures, special situation stocks (potential takeover or merger candidate), futures, Ipos, and day trading. Must determine the risk appetite of the fund and match to similar clients.

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14
Q

Purpose of dollar cost averaging

A

Reduce the investors average cost to acquire a security over the buying period relative to its average price

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15
Q

Active management

A

Relies on the managers stock picking and market timing ability to outperform market indices

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16
Q

Longer duration has what risk?

A

The longer the duration the greater the interest rate risk.

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17
Q

Semi-strong EMH

A

Technical and fundamental analysis is no good.

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18
Q

Security market line

A

Allows us to evaluate the individual securities for use in a diversified portfolio. You need:

  1. Expected rate of return for the asset
  2. Risk free rate
  3. Return on market
  4. Beta of the asset
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19
Q

Asset allocation steps

A
  1. Determine objectives and constraints of asset owner
  2. Create the Investment Policy Statement
  3. Determine the asset allocation based on the IPS
  4. Capital Allocation
  5. Monitor and evaluate investments
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20
Q

Capital asset pricing model

A

How much risk should you assume for an expected rate of return. Solely on the basis of the assets systematic risk.

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21
Q

Modern portfolio theory

A

Focuses on relationships between all investments in a portfolio. Specific risk can be diversified away with portfolios with noncorrelated assets. Reduce risk and also increase return. Portfolio with least amount of volatility would do better than one with higher volatility.

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22
Q

Equities

A

Preferred and common stocks of all kinds, income appreciation, and stock mutual funds.

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23
Q

Three forms of efficient market hypothesis

A

Weak
Semi-strong
Strong

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24
Q

Barbell

A

Bonds maturing in one or two years, equal amount maturing in 10+ years. Nothing in between. Active strategy. Cash from shorter term bonds can be reinvested at higher rates.

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25
Q

Three major asset classes

A

Stock, bonds cash

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26
Q

Capital market line

A

Provides an expected return based on the level of risk. Equation uses:

  1. Expected return of the portfolio
  2. Risk free rate
  3. Return on the market
  4. Standard deviation of market and standard deviation of portfolio
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27
Q

How do large portfolio managers like pension funds use options to hedge?

A

If the portfolio consisted of large cap stocks, you could buy puts on an index that mirrors the portfolio

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28
Q

The capital asset pricing model is used to assess the expected return of a security. If the risk free rate is 2%, the current return on the market is 10%, and the stock’s beta is 1.5 with a standard deviation of 3.2, the expected return would be?

A

Take the market return and subtract the risk free = 8 then multiply that by the beta of 1.5 to get 12 and add back the risk free rate. The answer is 14%. The standard deviation is not relevant

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29
Q

Ladder

A

Bonds all bought at the same time but mature at different times like steps in a ladder. As shorter maturities come due they are reinvested. Common strategy for buying CDs

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30
Q

Hard assets

A

Real estate, collectibles, precious metals, stones

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31
Q

Followers of EMH believe that

A

An efficient market is one that produces random results

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32
Q

Optimal or efficient portfolio

A

Under modern portfolio theory, the optimal or efficient portfolio is the one that has the most return for a given amount of risk.

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33
Q

Strong EMH

A

Even insider information is known - the market is totally efficient.

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34
Q

Asset allocation

A

Diversifies into different asset classes and reduced unsystematic risk

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35
Q

Are REITS considered an asset class?

A

Yes. REITs are a proxy for actual real estate

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36
Q

Weak form EMH

A

Current stock prices have already incorporated all historical market data and that historical price trends are therefore, of no value in predicting future price. Technical analysis is no good

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37
Q

Portfolio insurance

A

Using an option to limit downside

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38
Q

Major asset classes

A 
Equity
Debt
Cash
Real Estate
Commodities
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39
Q

Tactical asset allocation

A

Short term portfolio adjustments that adjust the portfolio mix between asset classes in consideration of current market conditions and investor sentiment.

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40
Q

Efficient set/efficient frontier

A

Collection of efficient portfolios

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41
Q

Value

A

Stocks that are cheaper and trading at lower p/e and price to book multiples. Focus on financial statement. Higher dividend yields found here.

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42
Q

The optimal portfolio is one that

A

Lies on the efficient frontier. Portfolios on the line provide the highest rate of return for a given amount of risk. Below the frontier is inefficient and a portfolio cannot be above the line.

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43
Q

Dollar cost averaging allows

A

You to buy fewer shares when the price is high and more shares when the price is low

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44
Q

Market Cap

A

Outstanding shares * Market Price = Market Cap

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45
Q

What are the two active bond strategies?

A

Barbell and ladder have bonds maturing at regular intervals so it requires an active role in reinvesting the principal

46
Q

Bullet

A

Pick a target. Purchase bonds to hit that target. 2 years from now buy shorter maturity bonds to hit same target. Allows you to capture current rates as they change rather than the whole investment at the same rate.

47
Q

Portfolio diversification

A

Reduces unsystematic risk, such as business risk, and enhances returns. Enhanced by adding foreign securities to the portfolio.

48
Q

Semi-strong EMH

A

Current prices reflect all historical price data and fundamental data. Only insider info may produce above market returns. Technical and fundamental are no good.

49
Q

Contrarian

A

Manager thinks majority is wrong do they do the opposite

50
Q

Strategic asset allocation

A

The proportion of various types of investments composing a long term investment portfolio

51
Q

Contrarian

A

Takes opposite position of other managers. You buy when everyone else is selling and vice versa.

52
Q

What is rebalancing?

A

It is done periodically to bring a portfolio back to target allocation percentages. It is a passive strategy

53
Q

Constant dollar plan

A

Maintain a constant dollar amount in stocks, moving money in and out of a money market account when necessary. You want 70k in stocks and stock value goes up to 90k, you sell 20k and that goes into a money market account. If the value drops to 75k, you take 15k from the money market fund and buy stocks.

54
Q

Jones and Smith enter retirement with 1mil. Both withdraw 50k per year and both get 10%. Yearly results are the same but come in diff order. Jones has 15 up years followed by 5 down years. Smith has 5 down years followed by 15 up years. Who is better off?

A

Jones is better off. Smith will deplete her portfolio in the early years and wont benefit fully from the positive returns down the line

55
Q

Micro cap

A

Market cap < 300mil

56
Q

What type of strategy is rebalancing?

A

Passive

57
Q

Calculating the security market line

A

Start by comparing the markets return to the risk free rate. Then multiply that difference by the stocks beta and add that number to the risk free rate.

58
Q

Dollar cost averaging

A

Investing a fixed dollar amount on a regular basis and purchasing at different prices

59
Q

Expected return on the mkt is 20% and the risk free is 4%. Stock with beta of .8 would have a expected return under capm of?

A

(Market rate - risk free) * beta
20-4 = 16 * .8 = 12.8

Take .128 and add the risk free
.128 + .04 = .168 or 16.8%

60
Q

Fixed income investments

A

Corporate bonds, muni bonds, treasuries, bond funds, mortgage backed securities

61
Q

Cash asset class

A

Focus mainly on the standard risk free investment, the 91 day (13 week) treasury bill, but also including other short term money market instruments

62
Q

Random walk

A

Throwing darts is as good a method as any for selecting stocks

63
Q

Bonds are a hedge against what and equities are a hedge against what?

A

Bonds are a hedge against deflation, equities are a hedge against inflation

64
Q

What do you need to know to compute the capital market line?

A

Standard deviation. You don’t need to know the alpha or beta.

65
Q

Passive portfolio manager

A

Believes no particular management style will consistently outperform market averages. Constructs a portfolio that mirrors a market index.

66
Q

Active management is tactical

A

Passive management is strategic

67
Q

Bond asset class

A

Subclasses based on maturity (intermediate vs long term) and issuer (treasury vs Corp vs non-US issuers)

68
Q

Covered call writer

A

Limits potential gain in exchange for partial protection

69
Q

An individual is a participant in a 403b plan with his employer. He invests $200 per month into one of the growth sub accounts. What is he doing?

A

Dollar cost averaging. Dollar cost averaging is investing the same amount at regular intervals.

70
Q

Buy and hold

A

Lower transaction costs. Gains taxed at lower long term rate. Common reason for selling is changing objectives.

71
Q

Growth

A

Focus on stocks of companies whose earnings are growing faster than most other stocks and are expected to continue to do so. Growth investment managers are likely to buy at the high end of the 52 week price range. Might seem like they are buying overvalued stocks. Looking for earnings momentum.

72
Q

Stochastic

A

Forecast how returns on different asset classes vary over time. “To aim or guess”. Uses simulations to produce probability distributions for various outcomes.

73
Q

Best way to protect a loss on a short sale?

A

Buy a call option

74
Q

Rainy day fund

A

Stocks with a large cash value. Sign of value stock.

75
Q

Constant ratio plan

A

Maintains a ratio in a portfolio of stocks to bonds or other assets. The account is periodically rebalanced to get back to the desired ratio

76
Q

Is there semi-weak EMH?

A

No. There is only weak, semi-strong, and strong

77
Q

Probable return

A

An estimate of all probable returns an investment is expected to yield

78
Q

Which of the following is the simplest portfolio management style for individual stocks?

  1. Indexing
  2. Buy and hold
  3. Moving averages
  4. Core
A

Buy and hold. The key to answering this question is recognizing that it’s asking about individual stocks. If the question dealt with managing a portfolio, then indexing would be the simplest style.

79
Q

What is not used in the CML?

A

Alpha and beta. It uses standard deviation

80
Q

Asset allocation

A

Spreading of portfolio funds among diff asset classes with diff risk/return characteristics, based on the investment policy statement IPS

81
Q

Efficient market hypothesis

A

Security prices adjust rapidly to new information. Security prices fully reflect all available information. I.E. markets are efficiently priced as a a result.

82
Q

Which bond strategy is least active?

A

Bullet. Bullet involves investing in bonds that all mature at or around the same time. Once the portfolio is established you sit and wait for the bonds to mature.

83
Q

Monte Carlo simulation

A

Stochastic modeling. Uses random number generator to provide an output with specific probabilities of outcomes. Provides best case and worst case scenarios.

84
Q

Security market line

A

Determines the expected rate of return for a security on the basis of its beta and the expectations about the market and the risk free rate.

85
Q

Investment strategy where a higher price is paid based on expected returns?

A

Growth investing. Growth investors buys shares that have exhibited faster than average gains in earnings over the past few years that is likely to continue to show high levels of margin.

86
Q

Mid cap

A

2-10bil

87
Q

What does the CML use as a measure of risk?

A

Like markowitz’s efficient frontier, it uses standard deviation

88
Q

Form of portfolio management that rotates between sectors based on changes to the business cycle?

A

Segment rotation. Even though this uses the word “cycle” use that as your clue that cycle is NOT part of the answer

89
Q

Who invented the capital asset pricing model

A

William Sharpe. Basic premise is every asset has systematic and nonsystematic risk. Systematic cannot be diversified away. Nonsystematic can

90
Q

Three techniques for minimizing interest rate risk

A

Barbell
Bullet
Laddering

91
Q

Value

A

Undervalued or out of favor stocks. Price low relatively to earnings or book value. Sometimes cos operating at a loss. Buy undervalued cos before they report positive earnings. Study balance sheet. Buys stocks at low end of 52 week range.

92
Q

Large cap

A

Greater than 10bil

93
Q

Strong EMH

A

The market is totally efficient. Even insider information is known. Full reflects all information from both public and private sources.

94
Q

Stock asset class

A

Subclasses based on market cap, value vs growth, and foreign equity

95
Q

Small cap

A

300mil - 2bil

96
Q

The beta of ABC co is 1.2 and the market return is expected to be 13% with a risk free return of 3%. Then the expected return of ABC is 15%

A

Diff between risk free and market (13-3)=10
Multiply the expected return in excess of the risk free rate by the beta 10 * 1.2 = 12
Add 12 to risk free of 3 = 15

97
Q

Investors wishing to employ a passive strategy for their bond portfolios would most likely elect which of the following?

  1. Barbell
  2. Bullet
  3. Laddering
  4. Buy and hold
A

Buy and hold is the most passive strategy no matter what you’re investing in. The other three options involve some level of activity.

98
Q

Tangible assets

A

Placed in a portfolio to reduce inflation risk

99
Q

Income

A

Generate portfolio income. If dividends on common are better, skew that way. Sometimes foreign securities and/or high yield bonds. For the most part relies heavily on debt.

100
Q

When asking about limited partnerships vs general, look for something indicating how they want to share control

A

If the control is limited, it will be an LP. If the control is general and has no qualifiers, use GP

101
Q

Growth

A

Stocks that trade at higher price to earnings and price to book ratios than value stocks. Earnings momentum is important. Growth is more volatile and requires higher risk tolerance

102
Q

Indexing

A

Portfolios constructed to mirror the components of a particular index. Not actively managed so costs are relatively low. Less frequent portfolio turnover.

103
Q

A well diversified investor following a rebalancing portfolio strategy in a rising market will most likely what?

A

Sell part of the stock in the portfolio. Rebalancing seeks to maintain a constant ratio of a portfolios original investment allocation. If stock increases in value, some of it will be sold to maintain the proportion of stock in the portfolio

104
Q

Computing alpha with risk free given

A

(Actual return - risk free) - (beta x (market return - risk free))

105
Q

Computing alpha with no risk free rate

A

Actual return - (beta x market return)

106
Q

Sharpe ratio

A

Actual return - risk free / standard deviation

107
Q

Average market price

A

Share price total / number of investments

108
Q

The CAPM is an investment theory that serves as a model for

A

Pricing securities based on their systematic risk only

109
Q

In a Monte Carlo simulation, a small change in the projected rate of return will result in?

A

Large differences in the outcome

110
Q

The term feasible set has to do with what?

A

The efficient frontier

111
Q

What is not a type of diversification achieved by investing in international equities?

  1. Asset class
  2. Currency
  3. Geographic
  4. Style
A

Style is not achieved by diversifying internationally. Style is something like value or growth or buy and hold

Series 66 (22 decks)

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