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CFP Study > Investment Planning > Flashcards

Investment Planning Flashcards

1
Q

What is the formula for Modified Duration?

A

D/ (1+(y/n)

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2
Q

What is the relationship between durational and coupons sensitivity to changes in rate?

A

Higher coupon and shorter duration, lower sensitivity to changes
Lower coupon and longer duration, higher sensitivity to changes

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3
Q

What is the linear estimate that tends to overestimate the impacts on prices?

A

Duration

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4
Q

what is a more accurate indicator in changes in Bond price than duration?

A

Convexity

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5
Q

What is the calculation formula for a change in bond price based on hypothetical rates?

A

-D ((Change in Yield/ (1+Yield))

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6
Q

What is the formula for duration of a bond

A

1+ Y/ Y

Long hand - [(1+Y) + T( C-Y)]/[1+y)^t - 1) + y

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7
Q

What plots the rates of fixed income securities?

A

The yield curve

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8
Q

What 3 forms can the yield curve take?

A
  1. upward sloping (positive/normal) ST<LT rates
  2. Flat ST similar to LT rates
  3. Downward sloping (negative/inverse) ST> LT rates
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9
Q

What does an inversion in the yield curve indicate?

A

looming recession

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10
Q

What 2 things is the yield curve a function of and how does the short and long end react?

A

The business cycle and Fed policy
Short end - sensitive to Fed policy
Long end - market rate, predicts economic conditions

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11
Q

What is the present value of a bond given current market conditions and characteristics?

A

Intrinsic value

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12
Q

What 4 things are a function of valuation of a bond?

A

1.Coupon payments
2. Market value of interest for comparable bonds
3. Amount of time remaining to maturity
4. Maturity value ( par value - always 1k unless stated)

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13
Q

What is the order of yields for premium and discount bonds?

A

Teeter totter
Premium YTC - YTM - CY - Coupon(nominal)
Discount Coupon(nominal) - CY - YTM - YTC

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14
Q

What is the stated or coupon yield of a bond?

A

the nominal yield

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15
Q

What is the annual income paid by a bond dividend by the current market price?

A

The current yield

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16
Q

What is used to estimate sensitivity of a bond to changes in rates?

A

Duration

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17
Q

What is yield to worst?

A

The lesser of YTM or YTC
The appropriate yield to make an investment decision on

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18
Q

What calculates, on a TVM basis, the time to recoup your money on a bond investment?

A

Duration

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19
Q

What is the weighted average of the present value of future cash flows of a bond?

A

Duration

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20
Q

For normal income producing and zero-coupon bonds, what is the duration relationship to maturity?

A

Normal income - Duration will always be less than maturity
Zero-coupon bonds - will always be the same

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21
Q

What does a higher coupon mean for duration?

A

Shorter duration

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22
Q

How does duration estimate changes in bond prices?

A

1% change in interest rate would result in duration as a % change in bonds price

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23
Q

What does duration tend to do for risk in rising and lowering interest rate environments?`

A

Rising - overestimates risk
Lowering - underestimates benefits

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24
Q

What does matching duration of a fixed income portfolio to an investors time horizon do?

A

Immunizes the assets
Reduces purchasing power and reinvestment rate risk

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25
Q

How do you find R^2 if correlation coefficient is given?

A

Square it ( multiply by itself)

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26
Q

What measures how closely the performance at an asset can be attributed to performance of benchmark?

A

R^2

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27
Q

What type of distribution curve is more peaked than normal?

A

Leptokurtic

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28
Q

What type of efficient frontier curve do risk averse investors have?

A

Steep

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29
Q

What are points below the efficient frontier curve deemed?

A

Inefficient

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30
Q

What are the 2 main financial markets?

A
  1. Money Markets
  2. Capital Markets
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31
Q

What is a statistical measure that describes when a distribution is more or less peaked than normal?

A

Kurtosis

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32
Q

What is the Sharpe ratio formula? (provided on the CFP formula sheet for test)

A

(Rp - Rf) / SD

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33
Q

What is the formula for the Jensen’s Performance Index (Alpha)? ( provided on the CFP formula sheet for test)

A

Rp - [Rf+ (Rm-Rf)B

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34
Q

What is the formula for the CAPM and the 2 components within it? (provided on exam sheet)

A

Rf + (Rm-Rf)B

Market risk premium= Rm-rf
Stock premium = (rm-rf)B

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35
Q

What ratio measures the risk-adjusted performance of a portfolio in terms of Standard Deviation?

A

The Sharpe ratio

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36
Q

When is it appropriate to use the Sharpe ratio?

A

When R^2<.7

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37
Q

What is a Sharpe ratio useful for?

A

To compare against other investment Sharpe ratios

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38
Q

What does a higher Sharpe ratio mean?

A

A higher risk-adjusted rate of return

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39
Q

What measures the risk adjusted performance of a portfolio manager using beta?

A

The Treynor ratio

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40
Q

When is it appropriate to use the Treynor ratio?

A

R^2 > .7

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41
Q

What does a higher Treynor ratio mean?

A

Higher risk-adjusted rate of return

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42
Q

What is the Treynor ratio formula? [ Provided on CFP formula sheet]

A

(Rp-Rf)/Bp
uses beta instead of Standard deviation as in the Sharpe ratio

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43
Q

What is used to quantify expected return given a market return and a Beta to the Market? Also quantifies investors required rate of return

A

Capital Asset Pricing Model (CAPM)

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44
Q

What is CAPM used to plot?

A

Security market line (SML)

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45
Q

How do you determine Alpha given CAPM?

A

Subtract CAPM from the actual return

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46
Q

What is the excess return of an investment relative to a benchmark?

A

Alpha

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47
Q

What is used to measure/evaluate the benefit of a portfolio mangaer?

A

Alpha (Jensen’s performance index)

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48
Q

When is Alpha valid?

A

R^2 > .7

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49
Q

Is Alpha an absolute or relative value?

A

Absolute

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50
Q

What is the difference between absolute and relative value?

A

absolute measures intrinsic value without comparing to others, relative compares.

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51
Q

What are the 3 plot points of alpha on the security market line?

A

Above 0 - good (better than expected)
On 0- Good (expected)
Below 0 - Bad (less than expected)

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52
Q

What 3 attributes are used to differentiate the different forms of Efficient market theory?

A
  1. Insider information
  2. Technical analysis
  3. Fundamental analysis
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53
Q

What are the three forms of efficient market theory?

A
  1. Strong
  2. Semi-strong
  3. Weak
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54
Q

What theory states that the stock market is efficient and all stocks reflect all relevant information and are priced in equilibrium?

A

Efficient market theory

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55
Q

What are points above the efficient frontier curve deemed?

A

Impossible

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56
Q

Which of the 3 forms of Efficient market theory have access to technical analysis?

A

None

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57
Q

In a normal distribution curve what are the 3 different probability levels for standard deviation?

A

68%
95%
99%

Remember the curve is symmetrical

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58
Q

What is used in probability analysis of expected returns around an average return?

A

Normal distribution curve

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59
Q

What 3 factors influence an investors capacity for risk?

A
  1. Time horizon
  2. Liquidity needs
  3. Total investable assets
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60
Q

What is systematic risk quantified by?

A

Beta

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61
Q

What is the measurement for total risk?

A

Standard Deviation

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62
Q

What is the equation for total risk?

A

Systematic plus Unsystematic risk

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63
Q

What are the 5 unsystematic risks?

A
  1. Business
  2. Financial
  3. Default/credit risk
  4. Regulation
  5. Sovereignty
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64
Q

What are the 5 systematic risks?

A

PRIME
1. Purchasing power
2. Reinvestment
3. Interest rate
4. Market
5. Exchange rate

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65
Q

What are the 2 types of investment risk?

A
  1. Systematic (non-diversifiable)
  2. Unsystematic ( diversifiable)
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66
Q

When should use beta vs SD with regards to R^2?

A

Beta when R^2 < .7
Standard deviation when R^2 >.7

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67
Q

What kind of distribution curve is less peaked than normal?

A

Platykurtic

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68
Q

What is the term for movements of stock being utterly unpredicatable?

A

Random walk

69
Q

What type of strategy does weak and semi-strong Efficient market theory use?

A

Active

70
Q

What type of investment strategy does a strong form Efficient market theory use?

A

Passive

71
Q

What risk is used in efficient frontiers?

A

Standard deviation

72
Q

What type of efficient frontier curves do risk tolerant investors have?

A

Flat

73
Q

What chart determines the optimal amount of return given a unit of risk taken?

A

Efficient frontier

74
Q

What are the 5 anomalies that Efficient market theory can’t Explain?

A
  1. Low P/e Effect
  2. Small firm effect
  3. Neglected firm effect
  4. January effect
  5. Value line phenomenon
75
Q

Which of the 3 forms of Efficient market theory have access to fundamental analysis?

A

Weak form

76
Q

Which of the 3 forms of Efficient market theory have access to inside information?

A

Semi-strong and weak

77
Q

What type of Kurtosis does a normal distribution have?

A

Mesokurtic

78
Q

What are the 2 types of skewness in distribution curves?

A

Right tailed - positive
Left tailed - negative

79
Q

What is the extent to which a distribution is not symmetrical?

A

Skewness

80
Q

What are the 2 forms of secondary capital markets?

A

Exchange and OTC

81
Q

What law created the SEC?

A

The securities act of 1934

82
Q

What laws overlooks the primary and secondary capital markets?

A

Primary - The securities act of 1933
Secondary -The securities act of 1934

83
Q

What are the 2 types of capital markets?

A

Primary - New securities
secondary - trade among investors

84
Q

What are the 3 types of order entrys?

A
  1. Market
  2. Limit
  3. Stop
85
Q

Is the holding period return indexed for time?

A

No

86
Q

What are the two components of the holding period return?

A

Capital appreciation - (Pe-Pb)/Pb
Income yield - D/Pb

87
Q

How do you calculate holding period return?

A

(Pe-Pb+D)/Pb

88
Q

What measure of return is used with specific clients that does not account of when investments are made?

A

Dollar weighted return (IRR)

89
Q

Describe a buy/sell limit and buy/sell stop

A

Buy limit - below price
Sell limit - above price
Sell stop - below price
Buy stop - above price

90
Q

What is the calculation for TWRR?

A

Geometric mean
[(1+x)(1+x)^(1/n)] -1

91
Q

What measure of return is the global standard for fund performance, used to evaluate portfolio mangers, and based solely on appreciate/depreciation from period to period?

A

Time Weighted return
(geometric mean)
(I on calculator, use beginning value as PV, ending value as FV) and number of periods solving for as N)

92
Q

What is the tax equivalent yield formula?

A

Tax free yield / (1-t)

93
Q

What is the tax free equivalent yield?

A

Taxable yield x (1-T)

94
Q

What do you want to match duration to?

A

Expected time horizon
Price is right rules, closest duration to the time frame without going over

95
Q

What doe a flat yield curve mean?

A

transitory - curve in process of inverting

96
Q

What happens when people get nervous about the economy and pour money into long term bonds as a safe haven?

A

Interest rates decrease, yield curve inverts

97
Q

Unless specifically described as an annual bond, what time frame do all bonds pay at?

A

Semi - annual (including zero coupon bonds)

98
Q

What is the difference between nominal and current yield?

A

Nominal - printed on paper (coupon)
Current - what you actually earn on the bond

99
Q

What is used in situations where a dividend-paying security has a temporary expected growth rate that stabilizes to constant growth?

A
  1. Multistage dividend discount model
100
Q

What are the 3 steps in the multistage dividend discount model?

A

Step 1. Calculate end of year dividend for the beginning time frame. Ex. D1= (D0 x (1+g) D2=(D1 x(1+G) D3=(D2 x (1+g)

Step 2. Calculate stock value based on constant growth
V= D1/ (r-g)
D1 will be the end of period from step 1

Step 3. Find NPV
Use CF in calculator
CF 0 will be 0. Then the D1, D2, and D3+ V (whatever the last period is)

101
Q

What is the process of pledging securities in your brokerage account for a loan from your brokerage firm?

A

Margin

102
Q

What are the 2 minimum equity standards set by the federal reserve for margin?

A
  1. Initial margin = 50%
  2. Maintenance margin = 25%
103
Q

What is the formula for a margin call? (not on the formula sheet, need to memorize)

A

(1-IM/1-mm) x Purchase Price of stock (+ commission)

104
Q

What is the equation for sustainable growth rate where retention rate and ROE are given?

A

ROE x Retention rate

105
Q

What is margin also referred to

A

Leveraging a position

106
Q

What is used to speculate on and hedge individual stock positions?

A

Stock options

107
Q

For stock options, what is the buyer and seller also known as?

A

Buyer - holder-Long
Seller - writer-short

108
Q

What right does the buyer have with call and put options?

A

Call - right to buy
Put - right to sell

109
Q

What obligation does the seller have for call and put options?

A

call - obligated to sell
put - obligated to buy

110
Q

How many shares does an options contract cover?

A

100 shares

111
Q

What does the options clearing corporation guarantee and what does it eliminate?

A

performance of both parties and eliminates counterparty risk

112
Q

When is a call and put in the money?

A

Call - MP>EP
PUT MP<EP

113
Q

What 2 items (and 5 sub items) determine an options prices?

A
  1. intrinsic value
    market price of stock
    exercise price of contract
  2. Time value
    risk free rate of return
    time to expiration
    variability of stock

greater any 3 are, greater Time premium

114
Q

Can intrinsic value of an option be less than 0?

A

no

115
Q

What is the intrinsic value for call and put opitons?

A

COME - Call Option = MV-EP
POEM - Put Option = EP-MV

116
Q

What stock option strategy long the underlying stock and short the call?

A

Covered call
Used to generate income

117
Q

What Stock option strategy does not own the stock but shorts the call?

A

Naked call writing

118
Q

What stock option strategy long the stock and long the put?

A

Protective put - stock insurance

119
Q

What stock option short stock and long call?

A

protective call

protects short positions in stock

120
Q

What stock option strategy short the stock and short a put?

A

Covered put - uses stock put to cover short position

121
Q

What stock option strategy longs the stock, long the put, and shorts a call?

A

Collar (zero - cost) - put protects decrease, premium offsets cost

122
Q

What stock option strategy long put and call on same stock for the same date and price?

A

Straddle - capitalize on volatility

123
Q

What stock option strategy involves purchases and selling the same type of contract?

A

Spread - benefits from stability

124
Q

What is an agreement to buy or sell a specific amount of a commodity, currency, or financial instrument at a price in the future?

A

Future contract

125
Q

For futures contracts, what is the current MV of an item it todays market known as?

A

Spot price

126
Q

Are futures contracts standardized?

A

yes

127
Q

For futures contracts, what are long and short positions?

A

Long - owns something (farmer/corn)

Short - buys something (construction needs lumber)

128
Q

What are futures hedging strategies for long and short positions?

A

Long hedge - if short, buy one
short hedge - if long, sell one

129
Q

What are the 2 difference between futures and forwards?

A

Forwards are not standardized and not executed through a clearing house

130
Q

What is used to evaluate the cash flows associated with capital project and capital expenditures?

A

Net present value NPV

131
Q

What are the 3 results NPV can have and what does it tell us?

A
  1. Positive - Take on the project Actual return is greater than required
  2. Zero- Take on the project.
    Actual return is equal to required
  3. Negative - do not take on the project
    Actual return is less than required
132
Q

What allows a planner to compare computed rate to required rate of return?

A

IRR - internal rate of return

133
Q

What is the Weakness of IRR?

A

The weakness of IRR is that it assumes reinvestments are made at the IRR

134
Q

On the calculator what do you use to find NPV and IRR?

A

NPV = Time value functions and NPV key

IRR = CF functions and IRR key

135
Q

What are the examples of IRR calculations?

A

YTM and YTC

136
Q

Which is better to use when comparing projects of unequal lives, IRR or NPV?

A

NPV

137
Q

What occurs when a taxpayer realizes a loss on the sale of security and acquires a substantially identical security within 61 days?

A

Wash sale

138
Q

Who can deduct losses a wash sale?

A

If it occurred during the normal course of business as a dealer in stock or securities

139
Q

What is the time frame of a wash sale?

A

30 days before day of trade and 30 days after

61 days total

140
Q

For a wash sale, what are the considerations for bonds and stocks?

A

Bonds - hard to violate

Stocks - call option and convertible bonds

same stock or identical

141
Q

What happens to the disallowed loss on a wash sale?

A

It is added back to the basis of the new purchase

142
Q

What benchmark would be appropriate for a portfolio with primarily large US Stocks?

A

S&P500

143
Q

What benchmark would be appropriate for a portfolio with primarily small US stocks?

A

Russell 2000 Index

144
Q

What benchmark would be appropriate for a portfolio with primarily stocks in developed non-US economies?

A

MSCI Europe, Autralasia, Far East Index (EAFE)

145
Q

What benchmark would be appropriate for a portfolio with primarily stocks in emerging non-US economies?

A

MSCI Emerging markets index (EM)

146
Q

What benchmark would be appropriate for a portfolio with primarily US bonds?

A

Barclays capital aggregate Bond Index

147
Q

What benchmark would be appropriate for a portfolio with primarily publicly trade REITS?

A

Dow Jones US select REIT index

148
Q

What benchmark would be appropriate for a portfolio with primarily commodities?

A

Deutsche Bank liquid commodity index

149
Q

What benchmark would be appropriate for a portfolio with primarily cash?

A

3-month treasury bill

150
Q

What benchmark would be appropriate for a portfolio with primarily large US stocks and US bonds?

A

Vanguard Balanced index (VBIAX)

151
Q

What benchmark would be appropriate for a portfolio with primarily all publicly traded U.S. Companies?

A

Wilshire 5000

152
Q

What would be the appropriate allocation for a client who wants current income, investment stability, and capital preservation with a timeframe of 3-5 years?

A

Conservative

153
Q

What would be the appropriate allocation for a client who wants current income and investment stability, but also some opportunity to row their investments, with a time frame of 5 years?

A

Moderately conservative

154
Q

What would be the appropriate allocation for a client who wants current income, solid growth, and relative stability, and who can tolerate low levels of portfolio volatility with a 10 year time frame?

A

Moderate

155
Q

What would be the appropriate allocation for a client who is most concerned about growing their investments and who can tolerate moderate levels of portfolio volatility with a time frame at least 10 years?

A

Moderately aggressive

156
Q

What would be the appropriate allocation for a client who is most concerned about growing their investments and who can tolerate high levels of portfolio volatility with a time frame of 15 or more years?

A

Aggresive

157
Q

What are closed-end investment companies that invest in real estate instead of financial assets and serve as a conduit for earnings on investments in real estate or loans secured by real estate?

A

Real estate investment trust (REITs)

158
Q

What % of taxable income must be distributed by a REIT to shareholders annually in order to be income tax free for the REIT?

A

90%

159
Q

What % of assets and income for a REIT must be derived from real estate equity or mortgages?

A

75%

160
Q

What type of REIT receives a stream of income from the mortgage payments?

A

Mortgage REITs
A.K.A real estate mortgage investment conduits (REMICs)

161
Q

What type of REIT offers investors the potential growth of their investments through realized capital gains, as well as the pass-through from rental income?

A

Equity REITS

162
Q

What asset class has low levels of correlation with other asset classes, is likely to keep pace with inflation, but illiquid?

A

Real Estate

163
Q

What asset class has low correlation with equities, is a hedge against inflation, has no natural income, and can be highly volatile?

A

Commodities

164
Q

What asset class has no capital loss, highly liquid, typically a low return, and value is eroded by inflation?

A

Cash

165
Q

What asset class historically outperform cash and bonds, benefits from economic growth, can have high volatility and can see periods of negative returns?

A

Equities

166
Q

What asset class has less volatility than equities, delivers stable income, historically, returns lag equities, and returns are driven by interest rates?

A

Government and investment grade bonds

167
Q

What asset class has low correlation with other assets, has a variety of drivers and return characteristics, can be illiquid, and can be complex?

A

Alternatives

168
Q

What asset class is a diverse asset class, can provide higher yield and inflation protection, and is riskier than government bonds but less risky that equities?

A

High yield and emerging market bonds

CFP Study (6 decks)

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