3. Investment Planning - All Questions and Comprehensive Course Exam Flashcards

Question

Which of the following securities would be considered a money market security? * Four-year AAA-rated bond * Common Stock * Preferred Stock * Bankers’ Acceptance

Answer 1

Bankers’ Acceptance * Money market securities are short-term instruments that typically mature in less than a year.

Answer 2

discount * Rates have risen forcing the price of existing bonds lower (discount).

Answer 3

6.76% * The Tax Equivalent Yield (TEY) helps investors determine whether or not they are better off investing in the lower yielding but tax-free municipal bond or in a higher-yielding taxable bond. TEY = Tax free rate ÷ (1- Marginal tax bracket) 0.0527 ÷ (1- 0.22) = 0.0527 ÷ 0.78 = 0.06756, or 6.76% (rounded)

Answer 4

No * Since the conversion price is $1,000/75, or, $13.34 per share, the investor can convert and sell the shares for $12.75. This would create a $0.59 loss per share or a total loss of $44.25 ($0.59 x 75 shares). * Because the conversion would result in a loss, the bondholder should not convert.

Answer 5

Principal * TIPS’ principal is adjusted every six months to reflect the inflation rate.

Answer 6

7.59% * The Current Yield on Oran’s bond is calculated as follows: **Annual Coupon Payment = Par x Coupon** = $1,000 x 0.07 = $70 **Current Yield = Annual Coupon Payment ÷ Market Price** $70 ÷ $922 = 7.59%

Answer 7

the common stock of the issuer * Convertible bonds can be converted into the common stock of the issuer.

Answer 8

5.90% * TEY = r(1 − t) TEY = 0.0425 / (1 - 0.28) = 0.0425/0.72 = 0.059 = 5.90%

Answer 9

general obligation bond * General obligation bonds are backed by the full faith and credit of the issuer. If the issuer were to miss a principal or interest payment, they would raise taxes to meet the obligation.

Answer 10

Callable Bond * The company will likely issue callable bonds so they can take advantage of the future low rates and refinance the debt.

Answer 11

decreases * **When interest rates increase above the stated interest of the debt (the coupon rate), then new debt will be paying a higher rate than the existing debt. Therefore, in order for the existing debt to be as appealing to buyers in the secondary market, its market price must decrease below par value, otherwise known as a discount bond**.

Answer 12

* Voting - The right to influence/control the company increases proportionately with the number of shares owned * Preemptive - Maintain the same amount of control when company issues new shares * Information - Regulation enforces full disclosure of all material and relevant information * Dividends - Receive a share of the company's profits

Answer 13

* Par Value - The value of Common Stocks listed in Shareholder's Equity * Book Value - Retained Earnings + Common Stock + Capital Contributed in Excess of Par * Bid Price - The price that sellers receive for a stock. * Ask Price - The price that buyers pay for a stock.

Answer 14

False * Stocks typically outperform other investments in the long run. However, stocks carry a lot of risk for shorter holding periods. Stock prices can drop below your original purchase and you would have received a better return from a bank CD or something less volatile within the same short-term holding period.

Answer 15

It is a security that represents ownership in a corporation. Holders may elect a board of directors and vote on corporate policy. * Common stock is a security that represents ownership in a corporation. Holders of common stock elect board of directors and vote on corporate policy. They have rights to the company's assets and earnings only after all preferred shareholders and debt holders have been paid in full.

Answer 16

Cyclical stocks perform well when the economy is booming. Defensive stocks may perform better in economic downturns. * Cyclical stocks' performance correlates with the economy. Defensive stocks are less sensitive to the movement of the economy. Growth stocks tend to keep earnings as retained earnings rather than paying dividends. Blue chip stocks are from large and well-established companies, therefore are likely to be traded in the NYSE as conservative large cap stocks.

Answer 17

Current income from dividends * The biggest benefit to investing in preferred stocks is their promise to pay dividends. Only some preferred stocks have the right to vote. Since some preferred stocks are likely to be called or converted, the potential capital appreciation is limited. The call feature is an advantage for the issuer, compensated through higher yield than non-callable shares, but would not be the most attractive feature to a preferred stock.

Answer 18

* Cumulative - Receive dividends in arrears * Non-cumulative - Does not receive dividends in arrears * Adjustable - Dividend rate changes * Convertible - Can exchange shares for common stock

Answer 19

Sell the warrant Exercise the warrant * If the market price of the underlying stock exceeds that of the warrant's exercise price, the warrant holder would benefit from selling the warrant or exercising the warrant, then selling the shares at the open market.

Answer 20

Honor preemptive rights * A right is issued to give existing shareholders a chance to purchase shares of a new issue of stock before they are available to the public. * It honors the preemptive right of shareholders. * Rights are not related to paying debt, lowering interest expense or being callable.

Answer 21

Call Option * Warrants and rights are both similar to call options in that they give the holder the right to purchase shares of the underlying security at a stated price. * Warrants and rights derive their value from the underlying security. * They do not resemble stocks, bonds or money market instruments.

Answer 22

True * The DJIA, one of the most widely followed indices, is a price-weighted index. It involves the prices of **30 stocks** that generally represent **large-size firms**. * Dow Jones calculates stock market indices for each of several countries as well as an Asia/Pacific index and two World Indices, one with and one without the United States.

Answer 23

Value weighting or capitalization weighting * **S&P 500 uses the value weight** method to calculate its index. * This method adjusts for the weight of each stock's market value within the composite along with their prices. * **Price Weight** method is used by the DJIA. Its divisor must be adjusted to compensate for the lack of value weighting. * **Equal Weight** looks at today's price relative to that of the previous day's. This method is employed by the Value Line Composite (Arithmetic) Index. * **The Value Line Composite (Geometric) Index** uses the geometric method to determine its value.

Answer 24

Issued by the firm * Warrants are issued by the firm and allow the holder the ability to purchase additional shares of the company’s stock.

Answer 25

Nikkei * It is important to match the appropriate index with a particular stock or a portfolio of stocks. * The Nikkei index that is comprised of companies listed on the Japanese stock exchange, would be the best alternative for a Japanese company.

Answer 26

price-weighted * The Dow Jones Industrial is a price-weighted index. The DJIA takes into consideration only the price of the stocks rather than the market value of the company.

Answer 27

warrant; right * **The exercise price is typically set above the stock's market price at issuance for a warrant and below it for a right**.

Answer 28

Dow Jones Industrial Average (DJIA) * The DJIA is the only price-weighted index.

Answer 29

participating * **Owners of participating preferred stock are entitled to a fixed rate of cash dividends**. They may receive higher than normal dividend payments if the company turns a larger than expected profit.

Answer 30

market value * The market value of a stock is dependent on the demand and supply of its shares.

Answer 31

250 shares worth $15 each * A 2-for-1 stock split will double the number of shares and halve the value per share. The total value of the shares remains the same, in this case $3,750. * $3,750 ÷ 250 (doubled shares) = $15 per share

Answer 32

$15,000 * After a split, the total value of an investor’s holdings will remain the same.

Answer 33

Blue chip * Blue chip stocks are common stocks that are issued by large companies with solid dividend growth records. * Examples of blue chip stocks include Apple (NASDAQ:AAPL) and Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B).

Answer 34

Cumulative Preferred * Cumulative preferred stock gives the owner the right to accumulate dividend payments skipped due to financial problems.

Answer 35

First Liquidation Priority * Good stocks tend to outperform all other investment vehicles over longer holding periods. * Stock investing is a necessity for outpacing inflation for long-term investment objectives. * Unsystematic risks can be reduced through common stock diversification. * A healthy secondary market ensures that you may find buyers for most common stocks. * In the event of liquidation, however, holders of common stock are paid last.

Answer 36

Right to Convert to Fixed Income * There is no conversion right for stockholders.

Answer 37

preemptive right * The preemptive right grants existing stockholders the right-of-first-refusal on any new stock the corporation issues. * This means that existing investors are guaranteed the right to maintain their previous fraction of total outstanding shares and prevents dilution of ownership control.

Answer 38

record * Dividends are only paid to shareholders on record as of the record date.

Answer 39

Primary Market * IPOs are traded initially on the primary market.

Answer 40

Right to Buy/Sell Priority to Dividends Right to Information Dividend Arrears **Preferred Stock** * Right to Information * Right to Buy/Sell * Dividend Arrears * Priority to Dividends

Answer 41

secondary * NYSE, AMEX, and the OTC are a part of the secondary market.

Answer 42

owner * Common stock represents ownership in a firm.

Answer 43

Bond Value * Market, book, and par values are all valuation methods.

Answer 44

**NAV Per Share** **(Assets – Liabilities) ÷ Shares Outstanding = NAV** * So the total assets of the investment company at the end of the day was **$300** = ($10 x 10 shares) + ($20 x 10 shares). * If the investment's total liabilities for the day was $50, then the net asset value would be **$250** = $300 - $50. * The per share NAV is **$12.50** ($250 / 20 shares) at the close of the day.

Answer 45

The ability to save money on transaction costs and get a better price of securities The ability to sell shares back to an issuer who stands ready to buy them back The ability to lower risk by investing in a greater variety of securities at once * Investing in mutual funds provides investors with many benefits. For instance, by investing in more than one company, the fund increases its diversification, creating less risk for investors. Investing in mutual funds is also more cost efficient, and provides individual investors with both volume discounts and exposure to a wider variety of stocks. Another benefit to investors is that open-end funds stand ready to buy back sahres, making it easy fo investors to sell their shares.

Answer 46

Minimal transaction costs Marketability Flexibility Service * The **advantages of mutual funds are diversification, professional management, minimal transaction costs, marketability, flexibility, and service**. * **Distributed capital gains from mutual funds could lead to unplanned tax payments**.

Answer 47

True * When calculating the net asset value of securities, the total liabilities of a mutual fund are deducted from the market value of all securities owned. The difference is then divided by the number of shares issued. NAV is an important measure of how investment companies perform.

Answer 48

It is a premium Its demand is greater than its supply * The Fund is at premium because its market price is greater than its NAV. Therefore, its demand is greater than its supply.

Answer 49

secondary market * Closed-end funds are traded in the secondary market after the initial public offering. * When the company is initially offered, it is sold in the primary market. * From then on, the shares are traded through brokers in the open market. The fund company/issuer can only engage in the trading of its shares through the secondary market.

Answer 50

Supply and demand * In the case of a closed-end fund, the fund's price is determined by its supply and demand in the open (secondary) market. * The net asset value becomes a benchmark to tell whether or not the shares are trading at a discount or premium. * The public offering price is the price that the shares are originally offered to the market from the fund.

Answer 51

The effective dividend yield will be greater than the equivalent open-end fund. The investor's overall return may be more than the equivalent open-end fund. * Since the fund is selling at a discount, $1/$9 (closed-end fund) is a greater dividend yield than $1/$10 (open-end fund). * Holding all other factors the same, as the price of the shares increases, the return will be greater for the lower cost basis of the discounted closed-end shares.

Answer 52

Japan Fund * The Japan Fund is more aggressive because the risks associated with Japan specifically cannot be diversified away by investing in companies of other countries. * An International Fund can spread country specific risks among several countries.

Answer 53

Closed-end funds are traded in the secondary market. Open-end funds are limitless in the number of new shares they issue. * **Closed-end funds are traded in the secondary market** whereas **open-ended funds are bought and sold from the issuer**. * Open-end funds can issue as many shares as they choose assuming they can find appropriate investments in which to invest. * Closed-end funds issue a finite number of shares.

Answer 54

* Front Load - Commission collected when purchasing a fund * CDSC - Commission collected when selling fund before certain holding period, proceeds go to distributor * 12b-1 - Fee to cover marketing expenses * Redemption Fee - Charge for leaving fund before certain holding period, proceeds go back to the pool

Answer 55

* Acme Money Fund - Safety and liquidity * Massachusetts Municipal Bond Fund - Tax-free income * S&P Index Fund - Long-term growth by mimicking the performance of the market * Jackson Internet Fund - Long-term growth by investing in stocks of one industry

Answer 56

Average returns earned by the fund over various time periods. Hypothetical returns of $10,000 investment over a specific period. Percentile ranks of the fund's average return relative to all mutual funds. * Performance figures can show historical trends and allow investors to know how well the fund has performed in the past. Hypothetical $10,000 investments can help investors to understand the historic performance figures. By comparing historic performance of a fund to its peers and its benchmark, investors can see how well the fund managers did against other funds with similar objectives. Historic performance is not indicative of future returns.

Answer 57

Projected returns for the next 12 months * Morningstar's Mutual Fund analysis compares a fund's average ratings with the average rating of an index and a peer group. The rating is risk-adjusted to factor in the downside risk of the fund. The rating does not project future returns of any kind.

Answer 58

False * There are several caveats to the Morningstar ratings. Morningstar categories are sometimes more broad and may match some funds against others that do not have the same investment approach. * Morningstar also uses limited number of indexes for benchmark. The indices used may not be the best benchmark for some funds.

Answer 59

Rent Property Value Mortgage Revenue generated from property * REITs generate return to investors from income and gains associated with the underlying properties. A REIT that owns apartment buildings will pass the rent to investors as income. A REIT that owns mortgages will pass mortgage payments to investors. A REIT that owns equity in properties will pass the profits of the property. A change in the property value would increase the price of the REIT that owns it. REITs invest in real estate and therefore would not own equipment.

Answer 60

False * **Limited partners will receive profits before tax**. They are **able to deduct losses from operations from their income tax that are proportionate to their investment**. * However, their limited liability is dependent on their passivity in general partners' management decisions.

Answer 61

Funds of Funds * A Funds of Funds invests in a variety of other hedge funds. Risk is controlled through the diversification of holding other funds.

Answer 62

Arbitrage/Relative Value Funds **Arbitrage/Relative Value Funds** * Investment Strategy: Seek out basic mispriced securities. * Use of Leverage: A high degree of leverage is used to capitalize on otherwise small pricing differences. * Risk Control: Necessary to eliminate broad market risk in order to capitalize on relative mispricing.

Answer 63

* Money Market - Fund Safety and liquidity * Los Angeles Municipal - Bond Fund Tax-free income * S&P Index Fund - Long-term growth by mimicking the performance of the market * Valley Technology Fund - Long-term growth by investing in stocks of one industry

Answer 64

$18.34 * NAV Per Share **(Assets – Liabilities) ÷ Shares Outstanding = NAV** ($750 - $200) ÷ 30 = $18.34

Answer 65

Taxes * When mutual funds sell securities within their portfolios for a profit, the majority of the capital gain is distributed to the shareholders. There is a lack of control of the holding period, so the distributed gains can have more short-term gains (which are taxed as income) than long-term gains (which are taxed at a lower fixed percentage). * Therefore, taxation is a potential disadvantage of mutual fund investing.

Answer 66

Service Quality * Mutual funds can provide you with a number of services including book-keeping services, checking accounts and automatic systems which help you to add or withdraw from your account, as well as buy or sell over the phone or the Internet. * Thus, service is an advantage of mutual fund investing.

Answer 67

Class B * Typically, Class B shares of a fund are shares with CDSC charge plus a 12b-1 fee. * After the CDSC’s term is up, the Class B share may convert to Class A shares.

Answer 68

asset allocation * Asset allocation funds attempt to time the market but in doing so, focus on total return instead of current income. * The most significant type of an asset allocation funds are target funds. * These funds are targeted to a specific time horizon (e.g., PQR Mutual Fund 2025). * Target funds are of particular interest for retirement and college funding goals.

Answer 69

90% * As long as 90% of their income is distributed to shareholders, that income is free from taxation for the REIT. * At least 75% of a REIT's assets and income must be derived from real estate equity or mortgages.

Answer 70

* Writer - The person selling the contract * Buyer - The person selling the contract * Premium - The price of the contract * Underlying Asset - The contract derives its value from this

Answer 71

Ben would not exercise the option. * If the price remained below $50, then Ben would not exercise the option. Wilma would make $300, the premium for the contract while Ben would lose $300 plus transaction costs.

Answer 72

Daily marking-to-market procedure Margin requirements * A futures contract is replaced every day by adjusting the equity in the investor's account and drawing up a new contract that has a purchase price equal to the current settlement price. The daily marking-to-market procedure, coupled with margin requirements, results in the clearinghouse's always having a security deposit of sufficient size to protect it from losses owing to the actions of the individual investors.

Answer 73

1. Write a put 2. Buy a call 3. Buy a future

Answer 74

1. Write a call 2. Buy a put 3. Sell a future

Answer 75

True * An option is a contract between two people where one person grants the other person the right to buy a specific asset at a specific price within a specific time period. There are two parties to the contract, the seller, who agrees to sell an asset to another, the buyer, at an agreed price before the expiration of a certain date.

Answer 76

Buy a call option on the stock Write a put option on the stock * If the price of a stock is expected to **rise**, then you would want to **buy a call or write (sell) a put option**. Buying a call option would give you the option to buy the stock at a set price. **If the price of the stock increases, you will be able to buy it at a cheaper price**. * Put options allow the writer to sell you shares at a set price. If the price of the shares increases, the buyer would not exercise the contract because he or she can sell the shares at a higher price in the market. * **Writers of calls and buyers of puts expect the price to fall**.

Answer 77

$1,000 * A July wheat futures contract for 5,000 bushels at $4 per bushel would have a total purchase price of $20,000. If the initial margin requirement is 5%, buyer and seller would each have to make a deposit of $1,000 (0.05 X $20,000).

Answer 78

$1,300 * If the maintenance margin is roughly 65% of initial margin, then the investor must have equity equal to or greater than 65% of the initial margin, or $2,000(0.65) = $1,300.

Answer 79

Exchanges begin trading a new set of options on a given stock every three months. Newly created options have roughly nine months before they expire. Exchanges may decide to introduce long-term options or LEAPS. Exchanges may decide to allow customized options or FLEX options for flexible exchange options. * In options trading, exchanges begin trading a new set of options on a given stock every three months. The newly created options have roughly nine months before they expire, and options might be introduced in January, April, July, and October, with expiration dates in, respectively, September, December, March, and June. * The exchange might decide to introduce long-term options also called LEAPS by the exchanges for long-term equity anticipation securities that expire as far into the future as two years. * The exchange might also decide to allow the creation of customized options called FLEX options for flexible exchange options, that have exercise prices and expiration dates of the investor's choosing. * **Daily marking to market is a practice used for futures contracts**.

Answer 80

True * The OCC has to see that the writer is able to fulfill the terms of the contract. The exchanges where the options are traded have set margin requirements, to relieve the OCC of this concern. * In the case of a call, shares are to be delivered by the writer in return for the exercise price. * In the case of a put, cash is to be delivered in return for shares. * In either case the net cost to the option writer will be the absolute difference between the exercise price and the stock's market value at the time of exercise. * The OCC is at risk if the writer is unable to bear this cost. It has a system known as “margin” to protect itself from the actions of the writers.

Answer 81

There are two basic types of annuities: * Fixed * Variable Exam Tip: If annuity payments continue beyond the life expectancy noted on IRS Table V, all income generated from the annuity is considered **taxable income**.

Answer 82

* **Liquidation period**. When benefit is distributed through lump sum or annuity * **Fixed annuity**. Principal is always guaranteed while interest rate is guaranteed for a brief period, then becomes changeable * **Accumulation Period**. Principal builds through investments and returns on investments reinvested * **Variable annuity**. A mutual fund with an insurance wrapper

Answer 83

Principal invested in a portfolio of securities. Future worth depends on the portfolio's financial performance. * The value of a variable annuity is dependent on market performance of a specified investment fund. * The principal is invested in a portfolio of securities. * The value of a variable annuity increases or decreases with the changing value of the underlying securities. * The future worth of the annuity will depend on the portfolio's financial performance. If it does poorly, you could lose some or the entire principal.

Answer 84

Long-term growth * Guaranteed Investment Contracts (GICs) are conservative by nature. Funds made up of GICs are sometimes called stable funds. They are ideal for very conservative objectives such as a temporary holding place, safe haven, or nearing distributions. * They are not suitable for long-term growth because they do not provide sufficient yield to outpace inflation in the long-run.

Answer 85

Revival - nostalgic trend led to a resurgence of interest in collecting beanie babies Limited edition - limited number were produces Retired - production ceased for the particular version * The change in price of a collectible is driven by basic micro-economic factors. Price will increase due to scarcity caused by limited editions, discontinued versions, and increase in demand while quantity supplied remained the same. The premise of an Internet auction such as eBay runs on the basis of price movements caused by supply and demand.

Answer 86

True * The IRS allows owners of income-producing property certain deductions, which result in tax savings.

Answer 87

Correct Answer: A., B. and D. * Explanation: There are certain advantages of holding gold coins, bullion and certificates. * Gold companies stock provides a current return in the form of annual dividends. * Gold coins can be stored in bank safe deposit boxes. They are standardized in weight and purity and can be purchased anywhere. * **Commissions on gold certificates are lower than bullion or coins**.

Answer 88

Correct Answer: B. and C. * Explanation: A major draw for investing in real estate is the income the property can generate coupled with the opportunity for capital gains. The tax advantages that were available in the past are largely gone or are on the way out. Investment in real estate is illiquid. If you sell your property holdings, it may take months to find a buyer, and there's no guarantee that you'll actually get what you feel is a fair price. In addition, overbuilding in some areas has actually resulted in a decline of property prices. The bottom line is that real estate investment is not well suited to the novice investor.

Answer 89

Correct Answer: A. and D. * Explanation: ADRs are certificates issued by U.S. banks that represent ownership in shares of foreign company stocks. They provide investors access into foreign companies that they otherwise may not be able to. * Regulation requires companies to follow Generally Accepted Accounting Principles to report financial information in order to qualify as ADRs. * They lower the overall risk of a portfolio because their low correlation to the movement of U.S. markets.

Answer 90

The return on physical assets is normally negatively correlated with returns on financial assets. * Inflation, while bearish to stocks and bonds, may be beneficial for collectibles. That John would not be subject to the same elements of risk attributable to the stock market is a good answer, but the correct answer is better.

Answer 91

A receipt for shares of a foreign-based corporation.

Answer 92

For enjoyment. * With the exception of dealers, an investor who invests in collectibles realizes a gain subject to long-term capital gains rates of 28% upon sale (if held long-term). Acquisition and commissions are relatively high compared to alternative investments. Prices change frequently and unpredictably due to their markets.

Answer 93

Generally * Most (but not all) ADRs satisfy the IRS definition of a "qualified foreign corporation". Most ADRs fit the Internal Revenue Code, but some ADRs do not meet the definition.

Answer 94

Buying S&P 500 Index calls * If the large-cap market were to rise, the manager could profit from increased prices by buying calls.

Answer 95

Selling a naked call. * If the price of the stock rises, the seller of the naked call is forced to buy the stock at the higher market price in order to supply it to the option buyer. This is the riskiest option because the stock may rise without limit.

Answer 96

The annuity is tax-deferred. * This contract is owned by a natural person (Bob). Taxation is deferred.

Answer 97

III, IV * Collectibles and natural resource funds are negatively correlated with the market. * The collectible may be perfect with her style of living. * The index option is correlated. * The puts may expire. * The global fund includes US stocks.

Answer 98

ADR holders receive foreign tax credits for income tax paid to a foreign country. * ADR holders cannot vote for the Board of Directors. Dividends are declared in local currencies but are paid in U.S. dollars.

Answer 99

II * If the client sells a call, he will receive premium income, but the stock may be called away. A stop-limit order is a specialized order in which a limit order and a stop order are combined. A stop-limit order to sell must have a stop-limit price below the security's market price. * Example: "Sell 100 GM 70 stop-limit." Once the stock sells at or below $70, the order becomes a limit order to sell 100 shares at $70. * Limit orders can also be placed on the buy side. The put protects the downside risk.

Answer 100

Change the manufacturer process CEO charged with unethical business practices Leverage buy out * Business specific risks are uniquely associated with the company or entity issuing the security. Change is processes may increase short-term expenses but improve a company's efficiency in production in the lon-term. A company being bought out can be beneficial (company is broken up and sold in pieces). Charges for any illegal activities or business practices can be detrimental for the company's stock.

Answer 101

False * Market risk is associated with overall market movements, not just changes in interest rate. * The interest rate risk is, in fact, associated specifically with changes in the market interest rate.

Answer 102

Interest rates are decreasing * When interest rates decrease, it gives a company incentive to exercise its right to call its outstanding bonds and issue new bonds in the current interest environment. This helps to lower the interest expense for the company and allow it to use the money on other things. Therefore when interest rates rise, companies would not call its debt because its existing interest expense is lower than current rates. Inflation and exchange rates have no direct relationship with the decision to call a bond issue.

Answer 103

* Business Risk - Can be caused by management decisions * Liquidity Risk - Inability to find a buyer at a fair market price * Financial Risk - Associated with the use of debt by firms * Sovereign Risk - Subject to foreign country seizing investment

Answer 104

* The correlation coefficient squared is called the coefficient of determination, "R2", or "R-squared." R-squared measures the portion of the asset's performance that can be attributed to the returns of the overall market. Since the correlation of coefficient''s value is between -1 and 1, R-squared's values can only be between 0 and 1 (the square of anything less than zero will equal a positive number). * If R-squared = 1, then the asset's return is perfectly correlated with the return of the market. * If R-squared = 0, then the asset's return has nothing to do with the market's return. * The closer to one that an asset's R-squared value is, the more reliable its beta. if an asset's R-squared is below .7, then Beta and everything that uses Beta (like the Treynor ratio and Jensen's Alpha) would be a meaningless statistic.

Answer 105

Montaigne Fund * The Montaigne Fund is more likely to outperform the market during an expansion. With an R2 of 0.24, Lamarck Fund’s Beta is not reliable. As a result, the Montaigne Fund is more likely to outperform the market due to its reliable R2 of 0.89, and a Beta of 1.04 that suggests that it will outperform the market.

Answer 106

* **Covariance Formula**: * **Multiply the standard deviation of asset I, by the standard deviation of asset J**. * **And then multiply by the correlation between asset I and J** Numbers will be provided. Just multiply. Real trick with covariance is understanding what it actually measures. Used in finance to **measure how 2 assets change in value in comparison to one another**

Answer 107

* Used in finance to measure how 2 assets change in value in comparison to one another **Positive – move in tandem** * Ex. Hot Summer – high temperatures, high usage of AC **Negative – move in opposite directions** * Ex. Hot Summer – sales down in coat sales, sales high for AC

Answer 108

Modern Portfolio Theory – portfolio managers will actually seek out negative correlated assets as a way to diversify their holdings and hedge their bets. * When one loses, another would gain. **Two big problems with relying on covariance are**: 1. Past performance does not predict future results. 2. Covariance only tells us that the 2 assets will move in the same direction. It does not tell us how closely they will follow each other. * One asset could increase by 5% and the other by 50% or 500%. * Without more information, we won’t be able to make full use of that data. That’s when we **need to incorporate correlation**.

Answer 109

The standard deviation equals the square root of the variance.

Answer 110

The variance of an asset’s rates of return is a statistic that measures the asset’s **wideness**. The variance is represented by the symbols **s2** and **VAR(r)**.

Answer 111

* **68%** probability that the actual return you will obtain next year, will be plus / or minus one standard deviation from the mean (expected return). * **95%** of the time, the actual return will be plus / or minus two standard deviations from the mean; and finally, * **99%** of the time, the actual return will be plus / or minus three standard deviations from the mean. * These ranges (68%, 95%, and 99%) are referred to as **confidence intervals**.

Answer 112

* **1 dev – 68% = 34% + 34%** * **2 dev – 95% = 13.5% + 13.5%** * **3 dev – 99.7% = 2.35% + 2.35%**

Answer 113

* Correlation is a statistical measure that offers advisors information on the direction that assets move in relation to one another. * Correlation **shows the strength of a relationship between two variables and is expressed numerically by the correlation coefficient**. * The correlation coefficient's values **range between -1.0 and 1.0**. * Understanding how to calculate the correlation coefficient as well as what it can tell us about an investment portfolio is key to success on both the CFP exam as well as a career as a CFP.

Answer 114

* Correlation – part of the co-variance formula * Adjust the co-variance formula to make the Correlation formula * +1 – they behave exactly the same, ex. S&P 500 ETF and S&P 500 * -1 – they behave completely opposite. When one goes up, the other goes down by the exact same amount, ex. Shorting a security * 0 – no relationship Good to balance holdings in a portfolio

Answer 115

* The beta coefficient is an index of undiversifiable (market, systematic) risk. You can rank betas from different assets to compare the undiversifiable risk of the assets. * Since the beta of the market (Bm) equals 1, if the beta of the investment (Bi)= 1, then the asset has the same volatility as the market. * If Bi > 1, then the rates of return from the asset are more volatile than the returns from the market and the asset is classified as an aggressive asset. The return will be higher than the market if the market return increases. However, if the market return decreases, then the asset's return will decrease more. * If Bi < 1, then the asset is a defensive asset. Its rates of return are less volatile than the market's. The asset will earn a positive return when the market return increases, but not as much. Similarly, when the market does poorly, it will do less poorly than the market.

Answer 116

An investment's total risk, measured by its variance of returns, can be partitioned into two components: * Unsystematic or Diversifiable risk * Systematic or Nondiversifiable risk By rearranging the characteristic line, you can attribute the returns that are diversifiable vs. nondiversifiable. **Total Return Bi (rm, t) + (ai, t + ei, t) = ri, t** **Undiversifiable + Diversifiable = Total Return of Period for Asset**

Answer 117

The percentage of total risk that is diversifiable can be measured by subtracting the coefficient of determination or **R-squared from one**. The percentage of total risk that is nondiversifiable can be measured by the coefficient of determination or **R-squared**.

Answer 118

0.616 * The nondiversifiable portion would be the R2 or the correlation coefficient-squared (0.785)2 = 0.616, or 61.6%. * Therefore, 61.6% of Coca-Cola’s return for that period is based on the, nondiversifiable, systematic risk.

Answer 119

Systematic/Non-diversifiable * Purchasing Power Risk (Inflation Risk) * Reinvestment Rate Risk * Interest Rate Risk * Market Risk * Exchange Rate Risk

Answer 120

Unsystematic/Diversifiable * Business Risk * Financial Risk * Credit (Default) Risk * Regulation Risk * Sovereignty Risk

Answer 121

Expected rate of return * The **expected rate of return** is defined as the weighted average of various rates of return in one probability distribution. * **Alpha** is the value on the vertical axis where the characteristic line intersects that axis, while **beta** measures the slope of one asset's characteristic line. *** Systematic risk** is that portion of a stock's risk that cannot be eliminated through diversification.

Answer 122

Characteristic line * The **characteristic line** is a simple linear regression **used to measure an investment's beta and residual variance**. * The **standard deviation is the square root of the variance**. * Undiversifiable risk is that portion of a stock's risk or variability that cannot be eliminated through diversification. * The **correlation coefficient** is a goodness-of-fit statistic that measures how well the data points fit a regression line.

Answer 123

The degree of risk associated with asset * **Variance represents the amount of risk associated with an asset**. * The higher the value (the wider the distribution) the more likely the actual return will vary from the expected return. * **Covariance describes the relationship between two or more assets**. * The **characteristic line identifies the diversifiable and undiversifiable risks**.

Answer 124

A stock with R-squared of 70% has a return that was mostly caused by systematic risk. A stock with alpha of .04 had a better return than the market. * **R-square represents the portion of return attributed to undiversifiable or systematic risk**. * **Positive alpha values represent a better return than market**, while negative ones denote that the market performed better. * **If beta is greater than 1, then the stock is aggressive and if it is less than 1, then the stock is defensive**. * **The closer to 1 R-squared is, the more correlated to the market it is**.

Answer 125

**If beta is greater than 1, then the stock is aggressive**. **If it is less than 1, then the stock is defensive**.

Answer 126

True * **The closer to 1 R-squared is, the more correlated to the market it is**.

Answer 127

the distribution is skewed to the right and will have fat tails * A positively skewed distribution is skewed to the right and a negatively skewed distribution is skewed to the left. * Excess kurtosis greater than 0 describes a Leptokurtic distribution and will have fat tails.

Answer 128

Lose 24% * 10% x 2.4 = 24%

Answer 129

Liquidity risk

Answer 130

I, II, III *** Answers IV and V are the risk level quantification of Beta**.

Answer 131

Stock #2 **HP 12C** 8 Σ + 12 Σ + 16 Σ + 8 CHS Σ + g key, x̄ (0 key) g key, S (. key) Stock #1 has a mean of 5.75% and a standard deviation 7.59%.

Answer 132

-1.84% to 13.34% * Mean = 5.75%, SD = 7.59% 1σ = 5.75% - 7.59% = -1.84% 1σ = 5.75% + 7.59% = 13.34%

Answer 133

II * At this time very little credit, marketability, and default risk exists.

Answer 134

0% to 32% * 16% ± 16%

Answer 135

15.75% * 15% x 1.05 = 15.75%

Answer 136

The U.S. dollar was revalued. * By definition, the U.S. dollar was revalued. * **Revaluation refers to an increase in the currency's value**.

Answer 137

Non-diversifiable risk * The S&P index would have a systematic risk. * Actually, all of the other answers refer to unsystematic risk (diversifiable risk).

Answer 138

I, III, IV * The stocks must have low positive correlations. * Fifteen stocks in differing industries such as Microsoft, Exxon, Merck, Ford, GE, etc. will greatly reduce unsystematic risk. * All technology stocks provide little risk reduction. * A strike is a business risk (or an unsystematic risk).

Answer 139

Equal to the weighted beta. * By definition, a portfolio beta is the weighted average of each security in the portfolio and its beta.

Answer 140

Systematic risk * A portfolio with a beta of +1 is one that moves in the same direction and at the same rate as the market. * Therefore the portfolio only has market risk which is also known as systematic risk.

Answer 141

I, II * III, IV, V refer to standard deviation.

Answer 142

**HPR=(PE+D−PB) / PB** **Where: PE = price in the end of the period PB = price at the beginning of the period D = any dividend, interest, or cash flow paid.** Holding period is defined as the length of time over which an investor is assumed to invest a given sum of money. * The holding period return has a major weakness because it does not consider the time or how long it took to earn the return. * When this procedure is applied, the performance of a security can be measured by comparing the value obtained in this manner at the end of the holding period with the value at the beginning. * Please note that in the formula below, any coupon (from a bond), interest, dividend, or any other cash flow received from the investment does not assume reinvestment. * Any reinvestment (like capital gains distributions and dividends from a mutual fund) would be imbedded in the ending value (P1) and the separate addition of theses payments would overstate the return.

Answer 143

$540 - $400 ÷ $400 = 0.35 = 35%

Answer 144

$1,000 - $875 + $420 ÷ $875 = 62.3% In reference to point (1), this could have been asked as a capital appreciation and income yield component: $1,000 - $875 / $875 = 14.3% (Capital gain component) and $420 (7 coupon payments x $60) divided by $875 = 48%. The two together would sum to the total of 62.3%.

Answer 145

($3,200 + $400 - $2,000) ÷ $2,000 = **0.80 or 80%**

Answer 146

Growth & Income Fund * The Growth & Income Fund had the best holding period return. * Growth & Income Fund = ($5,699 - $4,000) ÷ $4,000 = 0.42, or 42% * Growth Fund = ($2,782 - $2,000) ÷ $2,000 = 0.39, or 39% * Small Company Fund = ($3,127 - $2,500) ÷ $2,500 = 0.25, or 25%

Answer 147

The arithmetic average rate of return is a summary of a great deal of information and provides a good way to compare the performance of different investments. The arithmetic mean return (AM), an average of historical one-period rates of return, is computed as follows: **AM=a1+a2+a3+...+an / n** where n denotes the terminal time period. The arithmetic mean of historical annual returns must be measured over a representative sample period. A representative sample might cover one complete business cycle, measured from either peak to peak, or from trough to trough. For example, Kerry held an S&P Index Fund for three years. Her returns during that time were 20%, -10%, and 5% respectively. What was her arithmetic mean return? (.2)+(−.1)+(.05)3 = .05 or 5% **Practitioner Advice: Arithmetic mean is less telling because the standard deviation of the period can vary significantly — the price of the investment could have been very volatile during that period. If so, then the return is not reflective of the movement of the investment during that time.**

Answer 148

10.36% Keystrokes (HP 12C) 0.80 ENTER 1.40 x 1.20 x 3 1/x yx 1 - The calculator returns: 0.10357, which is also expressed as 10.357%

Answer 149

**After Tax Return = Total Return (1 - tax bracket)** Taxes can take away from return as well. It is important to consider how much is paid in taxes on investment gains when evaluating how much you have really earned. For example, if your investments yield long-term capital gains of $1,000, then 15% of the long-term gains, or $150, is due to the IRS as Federal tax on the gains. Depending on the state you live in, there could be an additional amount due for state taxes as well.

Answer 150

31.05% * Jed's after tax return is equal to his taxable return times reciprocal of his tax bracket. * 45%(1-0.31)= * 31.05%

Answer 151

**(1+r)(1+i)−1 Where: r= rate of return i= rate of inflation** In times of changing prices, the nominal return (dollars received) on an investment may be a poor indicator of the real return (also known as the real rate) obtained by the investor. This is because part of the additional dollars received from the investment may be needed to recoup the investor's lost purchasing power due to inflation. As a result, adjustments to the nominal return are needed to remove the effect of inflation in order to determine the real return. Frequently, the consumer price index (CPI) is used for this purpose. For example, let's assume the rate of investment return over some time period is 9%. Over that same time persiod, inflation averaged 3%. One could estimate that the inflation adusted rate of return would be 6% (9%-3%). However, it is important to be exact as small differences in return estimates can lead to large differences in dollars over time. If we apply the formula, we will find the actual inflation adjusted rate of return: (1+.09)(1+.03)−1 = .05825 or 5.83% While the .17% difference between the estimated and the actual inflation adjusted returns may seem insignificant, when applied to dollars over a long period of time it can lead to big differences.

Answer 152

43.85% * The $550 dividend was reinvested at a price of $11.00, increasing the number shares owned to 1,050. ($550 / $11.00 = 50 shares). * Therefore, the value of the dividend is imbedded in the ending account value of $14,385 ($13.70 x 1,050 shares). * In this case, the HPR would simply be the price at the end, minus the price at the beginning, divided by the price at the beginning. Plugging in the numbers, the calculation yields: * {($14,385 - $10,000) / $10,000} * = .4385 = 43.85%

Answer 153

Assuming that the fund's interest is not reinvested, the price at the end of the year was lower than the beginning The interest was assumed to have been reinvested * The total return for the fund was 2%, which was comprised of a 4% loss of principal, and a 6% interest payment. * **Using the HPR formula, and assuming a starting value of $1,000, we would calculate the total return as** * **($960 + $60 - $1,000) / $1,000 = 2%.**

Answer 154

9% * The arithmetic mean return (AMR), an average of historical one-period rates of return, is computed as follows: * AMR = [10+(-1)+15 +12]/4 = 9%

Answer 155

8.8% * The geometric mean return from this 4-year investment is calculated as follows: * **GMR = [(1.10)(.99)(1.15) (1.12)]^.25 = 8.8%**

Answer 156

YTM is based on maturity date of the bond YTC is based on first callable date * YTM is the yield to the maturity date of the bond. The YTC is the yield up to the first date that the yield can be called. The appropriate yield to choose for callable bonds may be the lower of the YTC and YTM. YTC cannot be determined for a non-callable bond.

Answer 157

The bond is held to maturity; coupons are reinvested immediately at YTM; all payments are received on time. The bond is a zero coupon bond and is held to maturity; par payment is received on time. * For YTM to be realized, the bond must be held to maturity, the issuer must make full payments of coupon and par on time, and the cash flows must be reinvested immediately at YTM. * Pure-discount (zero coupon) bonds do not have cash flows to reinvest, so if held to maturity, the holder earns YTM.

Answer 158

Corporate Bond * The tax equivalent yield for the municipal bond at Molly's tax bracket is 7.638%. * Although it is higher than the bond fund, it is not as high as the corporate bond. * If Molly was basing her decision purely on how much yield she would receive, the corporate bond would be the best investment choice.

Answer 159

Yield to maturity = 6% * After computing the two different yields, you must select the lower yield for investment decision-making purposes, because that return represents the minimum yield that the investor can expect to earn.

Answer 160

Yield to maturity is higher for a premium bond than for a discount bond. * YTM does depend on whether the bond is selling at a premium or a discount. * **YTM is less for a premium bond because the premium is amortized over the remaining years to maturity, so less money is available for compounding**. * If a bond is selling at a premium, then the nominal yield is divided by a larger price to obtain the current yield, therefore the current yield would be lower. * If the bondholder reinvests cash flows at a rate below YTM, there will be less interest to compound. * Bond equivalent yield makes a pure discount bond's yield equivalent to a coupon paying bond.

Answer 161

3.108% The return for first half year = ($19,178 - $20,000)/$20,000 = -.0411. The return for second half year = ($25,998 – $19,178 – $5,000) /($19,178 + $5,000) = .075275. The time-weighted return = [(1-.0411)(1+.075275)-1] = .03108 or 3.108%.

Answer 162

The return is strongly influenced by the size and timing of the cash flows. The investment manager typically has no control over the deposits and withdrawals. * In general, the dollar-weighted return method of measuring a portfolio's return for purposes of evaluation is regarded as inappropriate. * The reason behind this view is that the return is strongly influenced by the size and timing of the cash flows (namely, deposits and withdrawals), over which the investment manager typically has no control.

Answer 163

2.5% * Return = [(1+.025)(1+.017)(1-.036)(1+.02)]-1 = 2.5%.

Answer 164

Returns of investments with similar risk Historic returns of the investment Average returns of a relevant market Personal required rate of return Average returns of company's industry index * To determine how an investment performed, the returns should be compared to the returns of: a client's personal objectives, other investments of similar risks, the benchmark market index, the relevant industry index, and the investment's own past performance.

Answer 165

yield to maturity (YTM) * **The rate of return on bonds that is most often quoted for investors is the yield to maturity (YTM), which is defined as the discount rate that equates the present value of all the bond’s future cash flows with its current market price (purchase price)**. The YTM is the compounded rate of return of a bond.

Answer 166

standard deviation * The arithmetic mean is less informative as a metric because the standard deviation of the period can vary significantly; the price of the investment could have been very volatile during that period. If so, then the return is not reflective of the movement of the investment during that time.

Answer 167

114% Holding Period return is calculated by taking the total profit and dividing it by the cost. Buying the stock for $70 and selling it for $130 results in a gain of $60. Plus, a dividend of $20 results in a total profit of $80. $80 divided by an original cost of $70 results in a 114% holding period return. (20 + (130 - 70)) ÷ 70 = 114%

Answer 168

dollar-weighted * Difficulties are encountered when deposits or withdrawals occur sometime between the beginning and end of the period. One method that has been used for calculating a portfolio's return in this situation is the dollar-weighted return (or internal rate of return). * **Dollar-weighted return is what an investor should use to determine how well their investment performed**.

Answer 169

1.94% Inflation-adjusted rate of return: [(1.05 ÷ 1.03) – 1] x 100 = 1.9417 = 1.94%

Answer 170

geometric mean return * The compound average rate of return (geometric return) is similar to the arithmetic mean return, except the **geometric return, because it does take compounding into account, will always be less than the arithmetic return**. * The compound average rate of return is also called the geometric mean return (GMR), where the GMR is computed over n successive time periods.

Answer 171

Time-weighted return * Time-weighted return is the only acceptable method to display the results of a portfolio manager's performance. * The time-weighted return on a portfolio only concerns itself with the portfolio appreciation or depreciation in value from one period to the next. * That is, all cash flows into and out of the fund are totally disregarded from the return data.

Answer 172

reinvestment * Many corporate bonds, as well as some government bonds, are callable by the issuers, typically after some deferred call period. * Since bonds would only be called when interest rates are lower, all of the remaining cash flows are exposed to reinvestment risk.

Answer 173

10.26% The equation for the TEY is: **TEY = r ÷ (1 - t)** Where: r = tax-free yield t = Investor's marginal tax bracket 8 ÷ (1 - 0.22) = 8 ÷ 0.78 = 10.26%

Answer 174

80% Holding Period return is calculated by taking the total profit and dividing it by the cost. Buying the stock for $50 and selling it for $80 results in a gain of $30. Plus, a dividend of $10 results in a total profit of $40. $40 divided by an original cost of $50 results in a 80% holding period return. (10 + (80 - 50)) ÷ 50 = 80%

Answer 175

**NPV = PV of Future Cash Flows - Purchase Price**

Answer 176

A positive NPV means that the present value of all the expected cash inflows is greater than the cost of making the investment. Conversely, a negative NPV means that the present value of all the expected cash inflows is less than the cost of making the investment.

Answer 177

The following shows how the equation for determining the one-period rate of return is derived by rearranging the equation so that it is equal to the time value model: **r = (Terminal value - Present value)/Present value r = (Terminal value/Present value) - 1 (1 + r) = Terminal value/Present value (Present value)(1 + r) = Terminal value**

Answer 178

**Present value = (Terminal value)/(1 + r)**

Answer 179

**k = Rf + bi(Rm - Rf)** k = Market Capitalization Rate Rf = Risk-Free Return bi = Beta for security (how closely the security correlates with movements of the market) (Rm - Rf) = Risk Premium: the difference between the market return and the risk free return.

Answer 180

The following are created based on a combination of risk premiums to compute a security's Required Rate of Return (Cost of Capital): * For Treasury bills, k = 4.5% * For Treasury notes, k = 5.5% * For Treasury bonds, k = 5.9% * For corporate bonds, k = 6.3% * For large-cap stocks, k = 13.0% * For small-cap stocks, k = 14.5%

Answer 181

Present value, or PV = CF1/(1+k)1 + CF2/(1+k)2 + CFT/(1+k)T This valuation model says that the value of a series of cash flows equals the discounted present value of all future cash flows. * CF stands for cash flow (either inflows or outflows). The cash flows could be cash dividends from a common stock, coupon interest from a bond, rent from a piece of real estate, the asset's selling price, or other cash flows. * The subscripts and exponents are time period indicators. The terminal time period, when the cash flow occurs, is denoted T. These cash flows are expected to arrive at the end of successive time periods denoted t = 1, t = 2, t = 3,...., t = T. * The term k represents the required rate of return that is appropriate for the investment.

Answer 182

PV = [CF1/(1+k)1]+[CF2/(1+k)2]+[CFT/(1+k)T] = [$2/(1.145)1] + [$3/(1.145)2] + [$40/(1.145)2] = $1.7467 + $2.2883 + $30.5105 = $34.5455 Brenda makes a wealth-maximizing decision to buy the stock if she can get it for less than $34.5455 Keystrokes 0 g CF0 2 g CFj 43 g CFj 14.5 i f NPV The calculator returns: 34.5455

Answer 183

PV = [CF1/(1+k)1]+[CF2/(1+k)2]+[CFT/(1+k)T] = [$2/(1.145)1] + [$3/(1.145)2] + [$40/(1.145)2] = $1.7467 + $2.2883 + $30.5105 = $34.5455 Brenda makes a wealth-maximizing decision to buy the stock if she can get it for less than $34.5455 Keystrokes 0 g CF0 2 g CFj 43 g CFj 14.5 i f NPV The calculator returns: 34.5455

Answer 184

PV = DIV 0 (1+g) / (k−g) = $3 (1.03) / (.13 – .03) = $30.90 Based on these calculations Jana decides not to buy the stock because it is overpriced by $51.50 – $30.90 = $20.60 per share.

Answer 185

PV = DIV0 / k = $4.50/.13 = $34.615 The stock’s perpetual stream of constant cash dividends is worth $34.615 per share. Alex maximizes his wealth by deciding not to buy the stock, because it is overpriced by $50 - $34.62 = $15.38 per share.

Answer 186

**Sustainable growth rate = (1 – Payout ratio)ROE** The following are sources of growth rates: historical average, industry average, and sustainable growth rate*.

Answer 187

**P=∑∞t=1 Ct / (1+k∗)t** Again, since k* will be compounded over t periods, time has a significant influence over the internal rate of return. Calculating the internal rate of return (IRR) associated with the investment is similar to the NPV method and offers an alternate method for making investment decisions. The IRR for a given investment is the discount rate that makes the NPV of the investment equal to zero. To compute the IRR, the NPV is set equal to zero, and the discount rate, which is unknown, is then calculated. The decision rule for IRR involves comparing the investment's IRR (denoted by k*) with the required rate of return for an investment of similar risk (denoted by k). Specifically, the investment is viewed favorably if k* greater than k, and unfavorably if k* less than k. As with NPV, the same decision rule applies if either a real asset or a financial asset is being considered for possible investment. PRACTITIONER ADVICE In comparing the NPV and IRR methods, the NPV method is superior in that the underlying assumption in the calculation is the opportunity to reinvest future cash flows at the investors required return. IRR however, makes the unrealistic assumption that the investor has an opportunity to reinvest at the IRR! This difference is significant, and the ramifications are such that given a choice on these methods, the NPV should always be used.

Answer 188

**FVn = PV(1+k)^n** FVn = the future value of the investment at the end of n years n = the number of years during which the compounding occurs k = the annual interest rate, and PV = the present value, or the current value in today's dollars. The value of an investment at a future point in time is called future value. To derive the future value, we do not look at the present value of future cash flow through discounting. Instead, we look at the future value of investment through compounding. The future value of an investment for any number of years can be calculated using the following equation, where: Again, time influences future value through compounding. Time also allows for compounding of inflation rate to erode away the purchasing power of the investment. The inflation adjusted compounding rate or the real rate is equal to: Real rate = [(1 + interest rate)/(1 + inflation rate)] -- 1 For example, if a stock investment is expected to yield 11% on average over the next 10 years and the inflation rate is expected to average 4% during the same time, then the real rate = (1.11/1.04) - -1 = .0673 or 6.73%. The real rate can be used for the compounding rate to solve for the future value of the investment to show the return net of inflation.

Answer 189

An alternative method for calculating the real interest rate is to **subtract the inflation rate from the nominal return (as a whole number), and then dividing that amount by 1 plus the inflation rate**. Using the same example above, 11 - 4 = 7. Then 7/1.04 = 6.73. This is the real (or inflation adjusted) return, and is already expressed in the correct format for your calculator. The other method requires you to convert the decimal expression to a whole number.

Answer 190

Cash flows are discounted backward to calculate the PV. Cash flows are compounded forward to calculate the FV. * The future values of cash flows are discounted backward to calculate the present value. * This valuation method can be used to compare the present value of an investment to its current market price. * The initial investment and expected cash flows can also be compounded forward to determine the future value of an investment.

Answer 191

$944.98 * 5(2) = N; * 6.3/2 = I; * 1000 = FV; * 50/2 = PMT; * PV = -944.98 or $944.98.

Answer 192

$13,426 Real rate = [(1 + interest rate)/(1 + inflation rate)] - 1 = (1.11/1.04) - 1 = 6.73% FV = $7,000(1 + .0673)^10 = $13,426

Answer 193

It is the present value of future cash flows minus the purchase price of an investment. * When the cost of an investment is deducted from its present value (PV) of the future inflows, net present value (NPV) is obtained. * **NPV = PV of Future Cash Flows – Purchase Price**

Answer 194

* Cash flows characterizing a typical bond involve the payment of a lump sum on a stated date. This payment is known as the bond's principal or **par value**. * Most corporate bonds will have a par value of $1,000.

Answer 195

* Cash flows characterizing a typical bond involve the payment of a lump sum on a stated date. This payment is known as the bond's principal or **par value**. * Most corporate bonds will have a par value of $1,000. * If the market price of a bond is greater than its par value, the bond is said to be selling at a **premium**. * If the market price of a bond is less than its par value, the bond is said to be selling at a **discount**.

Answer 196

Par Value * Market price = Par value * Yield-to-maturity = Coupon rate Discount Value * Market price < Par value * Yield-to-maturity > Coupon rate Premium Value * Market price > Par value * Yield-to-maturity < Coupon rate

Answer 197

Specifically, the formula for a bond's duration D is **D = (1+y/ y) − (1+y) + T(c−y)c[(1+y)T−1]+y** * where **c denotes coupon**, * **T denotes the number of compounding periods** to maturity, and * **y denotes the market rate of interest which can easily be determined by calculating the bond's yield-to-maturity**. There are three variables that determine a bond's duration: **Coupon rate, market interest rate, and the number of compounding periods until maturity**. * Note that "price" is not a determinant in calculating duration. * Price is a function of the market rate of interest.

Answer 198

Par Principal * Cash flows characterizing a typical bond involve the payment of a lump sum on a stated date. This lump sum payment is known as the bond's principal or par value.

Answer 199

False * The second bond-pricing theorem states that if a bond's yield does not change over its life, then the size of its discount or premium will decrease as its life gets shorter.

Answer 200

False * When yields change, most bond prices also change, but some react more than others do. * Bonds with the same maturity date can react differently to a given change in yields. However, the percentage change in a bond's price is related to its duration. So the prices of two bonds that have the same duration will react similarly to a given change in yields.

Answer 201

a premium * If the market price of a bond is greater than its par value, the bond is said to be selling at a premium. * Conversely, if the market price of a bond is less than its par value, the bond is said to be selling at a discount.

Answer 202

time value * One way of valuing an investment is to use the discounted present value model, which assumes that money has time value. * This assumption is relevant because borrowers pay interest to lenders to induce them to make loans. Interest is the rent on borrowed money. It causes money to have a terminal value in the future that differs from its present value. The discounted present value model can be used to help you estimate the value of securities like stocks, bonds, or even rental property.

Answer 203

convexity * The relationship between bond prices and yields is referred to as convexity. * Although this is true for standard types of bonds, the degree of curvature is not the same for all bonds. Instead, it depends on, among other things, the size of the coupon payments, the life of the bond, and its current market price.

Answer 204

Present Value of Future Cash Flows * When the cost of an investment is deducted from PV, Net Present Value (NPV) is obtained. * **Net Present Value (NPV) = PV of Future Cash Flows - Purchase Price**

Answer 205

Internal Rate of Return * IRR stands for Internal Rate of Return.

Answer 206

duration * Duration is a measure of the "average maturity" of payments associated with a bond. * More specifically, it is a weighted average of the length of time until the remaining payments are made.

Answer 207

higher than * The true price of the bond will always be higher than the modified duration estimate. This is due to the convex shape of the price/yield function.

Answer 208

equal to zero * The IRR for a given investment is the **discount rate that makes the NPV of the investment equal to zero**. * To compute the IRR, the NPV is set equal to zero, and the discount rate, which is unknown, is then calculated.

Answer 209

a discount * If the market price of a bond is less than its par value, the bond is said to be selling at a discount. * If the market price of a bond is greater than its par value, the bond is said to be selling at a premium.

Answer 210

Dividend Discount Model * The Dividend Discount Model (DDM), is a specific valuation model where you assume a constant dividend with no future growth (known as a perpetuity).

Answer 211

Call premium when the bond is called early. **Most bond investors obtain three types of cash flows**: * periodic coupon interest payments, * reinvestment of those coupon payments, and * repayment of principal when the bond matures. While some bonds have a call premium, it is not a typical cash flow for most bonds.

Answer 212

Market Price * There are three variables that determine a bond's duration: Coupon rate, market interest rate, and the number of compounding periods until maturity. Note that "price" is not a determinant in calculating duration. Price is a function of the market rate of interest.

Answer 213

If the intrinsic value – purchase price = **a positive number (or if NPV > 0), then the bond is underpriced or undervalued and the bond should be purchased**. If the intrinsic value – purchase price = **a negative number (or if NPV < 0), then the bond is overpriced or overvalued and the bond should not be purchased**.

Answer 214

$9,632.00 * PV = $550(PVIFA 5.5%,10) + $10,000 (PVIF 5.5%,10) or 10000 FV, 550 PMT, 10N, 6 I, PV = $9,632.00.

Answer 215

$924.06 * PV $60 (PVIFA 9%,3) + $10,000 (PVIF 9%,3) or, using a financial calculator, 1000 FV, 60 PMT, 3 N, 9 I, PV = $924.06. Note that - $25.94 is the net present value of the bond, or the difference between the value of the bond and the purchase price. (NPV = V-P). Therefore, this bond is overpriced and should not be bought.

Answer 216

Implied return * The present value of expected dividends can be calculated for a given required rate of return. However, many investment firms use a computerized trial and error procedure to determine the discount rate that equates the present value of the stock's expected dividends with its current price. Sometimes this long-run internal rate of return is referred to as the security's implied return.

Answer 217

$1978.13 * The first step is to establish a cash flow line: Time / Cash Flows 0 / (10,000) 1 / 3,000 2 / 3,000 3 / 3,000 4 / 3,000 5 / 3,000 * Keystrokes: 10000 CHS g CFo 3000 g CFj 5 g Nj 8 i f NPV * The Calculator Returns: 1,978.13 * The Project should be accepted since the NPV is positive.

Answer 218

The stock is an unfavorable investment * Since k^ is less than k, or the IRR is less than the appropriate discount rate, the stock is an unfavorable investment. There is not enough information to determine whether or not the net present value is positive or negative.

Answer 219

Undervalued * V = $2.00 ÷ 0.10 = $20. * Since the price of the share is trading currently at $18.50, Mountainside Electric Company stock is undervalued by $1.50 per share, according to the zero growth dividend model.

Answer 220

V=$26 Overvalued * V=$1(1+.04)/(.08-.04)=$26. $29-$26=$3. * The stock is $3 overvalued.

Answer 221

12% * Assuming that a stock is fairly valued if its dividend is growing at a constant rate, the internal rate of return can be found by solving the intrinsic value equation for k * = (D2/V)+g = [($3X 1.06)/ $53] + 0.06 = .12 or 12%.

Answer 222

-$1.08 * DT+1 = D3 = $3(1 + 0.10) = $3.30. VT- = $2/(1+.15)^1 + $3/(1+0.15)^2 = $4.01. VT+ = $3.30/(0.15-0.10)(1+0.15)^2= $49.91. V = $4.01 + $49.91 = $53.92. With a current stock price of $55 per share, NPV = -$1.08. The company appears to be fairly priced. That is, A&B Co. is not significantly mispriced because V and P are nearly of equal size.

Answer 223

* Zero-growth Model - Dividend will remain the same amount forever. * Constant-growth Model - Dividend will grow at the same rate forever. * Multiple-growth Model - Dividend will have different amounts until time T, then it will have the same growth rate forever.

Answer 224

Undervalued * Calculate payout ratio=($2/$4)=50%. * According to the equation indicating the normal price/earnings ratio=[(0.5)(1+0.06)]/(0.10-0.06)=13.25. * This is more than Rock Rulez Guitar's actual price/earnings ratio of=$38/$4=9.50, which means the stock is undervalued.

Answer 225

Payout Ratio Expected Earnings * Dt = (Pt)(Et); dividends are replaced by the payout ratio multiplied by expected earnings. * When solving for the normal price/earnings ratio, the expected earnings is divided into the intrinsic value.

Answer 226

Stock's P/E = 20 Stock's V/E = 21.2 * Payout ratio = ($2/$2.50) = 80%. * V/E = [(0.80)(1+0.06)]/(0.10 – 0.06) = 21.2. * This is greater than Jameson and Sons Company's actual price/earnings ratio of $50/$2.50 = 20. * This means stock of Jameson and Sons Company's is undervalued, but not by much.

Answer 227

10.60 * Payout ratio = $4/$8 = 50% * V/E = .50(1.06)/.05 = 10.60

Answer 228

The dividend payout ratio is low * Assuming that no new capital is obtained externally and no shares are repurchased, the portion of earnings not paid to stockholders as dividend will be used to pay for the firm's new investments. The portion not paid out is the retention ratio. Growth rate depends on the proportion of earnings that are retained and the average return on equity for the earnings that are retained.

Answer 229

The more free cash flow, the lower the price/free cash flow (P/FCF) ratio would be. **Low price to free cash flow ratios are favorable.**

Answer 230

* The explosion in Internet stocks forced investors to look for ways to value companies with lots of potential, but no earnings. Moreover, many investors do not trust net earnings anymore, since they are often manipulated through write-offs and other creative accounting practices. Sales are much harder to disguise. * **The price/sales ratio is the company's price divided by its sales (or revenue). This value is arrived by dividing revenue by the number of shares outstanding, and then dividing the revenue per share into the price per share. But because the sales number is rarely expressed as a per-share figure, it's easier to divide a company's total market value by its total sales for the last 12 months**. * Price/Sales **works well in analyzing large-cap companies, whose sales are so great, that it is closer to their market capitalization**. * The ratio is less appropriate for service companies like banks or insurers that don't really have sales. * **Most value investors set their P/S hurdle at 2 and below when looking for undervalued situations**. Again, with ratios, it is better to compare a company's P/S value to its competitors and its own history.

Answer 231

* The PEG ratio helps quantify this idea. PEG stands for price/earnings growth and is calculated by dividing the P/E by the projected earnings growth rate. So if a company has a P/E of 15, and analysts expect its earnings will grow 10% annually over the next few years, its PEG = 1.5. * **A PEG above 1 would indicate that the company is trading at a premium to its growth rate**. * Therefore, **a favorable PEG would be below 1**. * If a company has a P/E of 20 times its earnings, but its peers have P/E of 10 times, it may appear that the company is expensive relative to its peers. However, if the company's growth rate is at 25% while its competitors are averaging 8%, then the company's PEG is .80 while its competitors are at 1.25. This will lead to the conclusion that the company's expected growth rate makes it more attractive than its competitors even though it had a higher P/E. * PEG ratio **works better for smaller or growth companies because they are effected by growth rate more than large and more mature companies**. * The one **drawback is that the ratio is dependent on earnings estimates, which are less reliable than free cash and revenue**. * If a company **does not pay dividends, it will have a greater PEG ratio**.

Answer 232

PRACTITIONER ADVICE: Most of the ratios will not need to be memorized because the name of the formula usually guides your calculation. * The word "**margin**" usually means **sales in the denominator** * The word "**turnover**" usually means **sales in the numerator**.

Answer 233

P/FCF is free from accounting assumptions and P/E is not * Because Price/Free Cash Flow is net of non-cash accounting assumptions, it gives a clearer picture of how well a company can reinvest in itself, pay down its debt, or pay out dividends.

Answer 234

12.25% * The growth rate is return on equity times the retention ratio. * Since the firm is paying out 12.5% of its earnings ($0.90 / $7.20) then it is retaining 87.5% of its earnings. * The ROE of 14%, multiplied by 87.5% (.14 x .875) equals .1225 or 12.25%.

Answer 235

Price/Sales Ratio

Answer 236

Price/Book Value Ratio

Answer 237

Price/Earnings Growth Ratio

Answer 238

7.36 * P/E = (D1/E1)/(k-g) = * ($1.03/$2.00)/(0.10 - 0.03) * = 7.36

Answer 239

$200,000 * The current ratio was 2.5 to 1 and the current liabilities were $200,000 before the equipment purchase. * Using a current ratio of 2.5 to 1, this implies that current assets were $500,000. * Since cash (a major component of current assets) was used to buy the equipment, current assets are reduced to $400,000. * **Working capital is current assets minus current liabilities**. * After the purchase, working capital amounted to $400,000 - $200,000 = $200,000. Please note that a fixed asset does not affect current assets.

Answer 240

semi-annual * Most bonds make semi-annual interest payments. * Every 6 months investors will receive half of their annual coupon payment.

Answer 241

Zero-Growth Model * The Zero-Growth Model assumes that future dividends will remain at a fixed dollar amount. * That is, the dollar amount of dividends per share that were paid over the past year (D0) will also be paid over the next year (D1), the year after that (D2), the year after that (D3), and so on.

Answer 242

Multiple-Growth Model * Under the Multiple-Growth Model, the focus is on a time in the future (denoted by T), after which dividends are expected to grow at a constant rate (g).

Answer 243

Yield to Maturity (YTM) * The most common rate used when discounting a bond's value is the Yield to Maturity (YTM) which is the total return anticipated on a bond if the bond is held until it matures.

Answer 244

dividends * The cash flows associated with an investment in common stock are the dividends expected to be paid on the shares purchased.

Answer 245

Constant-Growth Model * The Constant-Growth Model assumes that dividends will grow from period to period at the same rate, forever.

Answer 246

intrinsic value * Once investment analysts calculate a required rate of return, it is easy to compute various values required for determining the Multiple Growth Model. The intrinsic value of a company is forecasted based on these figures.

Answer 247

Fast Ratio Liquidity ratios provide information about the liquidity or short-term debt paying ability of the firm. Examples include: * **Working Capital** = current assets - current liabilities * **Current Ratio** = current assets ÷ current liabilities * **Quick Ratio** = (current assets - inventory) ÷ current liabilities. (This ratio is also known as the **acid test**.) * **Cash Ratio** = (cash + marketable securities) ÷ current liabilities

Answer 248

zero * In computing the IRR, the NPV is set to zero and the discount rate becomes unknown, so the discount rate has to be calculated. * The IRR for a given investment is defined as the discount rate that makes the NPV of the investment equal to zero.

Answer 249

positive * The Net Present Value (NPV) equation can be used to determine whether or not an investment is worthwhile. * **An investment is viewed favorably if its NPV is positive or neutral and unfavorably if its NPV is negative**.

Answer 250

22% * Portfolio Expected Return = * ($20,984 - $17,200) ÷ $17,200 * = 0.22, or 22%

Answer 251

22% * Portfolio Expected Return = The sum of the contribution to portfolio expected returns = * 3.77% + 10.01% + 8.22% * = 22%

Answer 252

Asset D has a return of 17%; beta=1.25; standard deviation=21% * Based on the information provided, the risk assessment investment statistic under the CAPM that details relative efficiency is Coefficient of Variation, which is Standard Deviation, divided by return. Since the risk measure is the numerator, the lower the result the better the risk-return relationship; that is, it is more efficient. * The CV for asset D is 1.235 which is the lowest. Simply, for every unit of return (for which Asset D has 17), there is 1.235 units of risk. Asset A, B, and C have CV of 1.286, 1.4 and 1.263, respectively.

Answer 253

Expected returns and standard deviations * According to Markowitz, the investor should view the rate of return associated with any portfolio by considering the random variables of expected (or mean) value and standard deviation.

Answer 254

Risk-averse * It is assumed that investors are risk-averse, which means that the investor will choose a portfolio with a smaller standard deviation. * Risk-averse investors are willing to forego some expected terminal wealth (that is, accept lower expected returns) in exchange for less risk.

Answer 255

8% * The investment in IBM is 50% of the portfolio, so the return of 20% times the portfolio weight of 50% yields a contribution to the portfolio return of 10% (50% weight x 20% return). * Calculate the same for Texaco (30% weight x -10% return = -3%), and * the same for Motorola (20% weight x 5% return = 1%). * Adding the three together generates the portfolio return * (10% + -3% + 1% = 8%).

Answer 256

Less than zero * When the correlation coefficient is greater than zero, it indicates the securities in the portfolio are moving in tandem. * Whereas, when the correlation coefficient is zero, the movement of one security in comparison to the other in the portfolio is not predictable. * **When the correlation coefficient is less than zero, the movement of one security as against the other is exactly opposite, indicating the most diversified situation**.

Answer 257

**CAPM-based measures** of **portfolio performance** are: * **Sharpe ratio** * **Treynor ratio** * **Jensen's ratio** Each one of these measures provides an estimate of a portfolio's risk-adjusted performance, thereby allowing the client to see how the portfolio performed relative to other portfolios and relative to the market.

Answer 258

Ranking portfolios' returns averaged over several years is oversimplified because such rankings ignore risk. Thus, what is needed is an index of portfolio performance, which is determined by both the return and the risk. William F. Sharpe devised the reward-to-variability index of portfolio performance, denoted SHARPEp. This defines a single parameter portfolio performance index that is calculated from both the risk and return statistics.

Answer 259

* Dow Jones Industry Average (DJIA) 30 of the largest U.S.-based companies * Standard & Poor's 500 (S&P 500) 500 U.S.-based companies. Widely accepted as the standard index to benchmark against for large cap U.S. stocks. According to the S&P, 97% of money managers and pension funds are indexed against the S&P 500. * Wilshire 5000 Contains of 6,500 U.S.-based companies. Considered the broadest index for U.S. Stocks. * Russell 2000 Commonly used as a benchmark for small company portfolios. The capitalization ranges from approximately $1.3 billion to $128 million. * NASDAQ Typically, a benchmark for technology companies and mid-size companies.

Answer 260

Alternative portfolios that could have been chosen instead of the one chosen * Comparing the returns obtained by the investment manager with appropriate alternative portfolios that could have been chosen for investment helps evaluate portfolio performance. * In selecting the benchmark portfolio, the client should be certain that they are relevant, feasible, and known in advance, meaning that they should represent alternative portfolios that could have been chosen for investment instead of the portfolio being evaluated.

Answer 261

Dollar-weighted returns * The dollar-weighted return (or internal rate of return) is the method that helps in situations when deposits or withdrawals occur sometime between the beginning and end of the period.

Answer 262

Modern Portfolio Theory * Understanding how risk-averse investors construct portfolios to optimize expected returns against market risk is best described as Modern Portfolio Theory (MPT).

Answer 263

14.27% The expected return is solved by adding the proportionate weighting of each component’s expected contribution: * Adam Stock. 33% x 15% = 0.0495 * Brendan Stock. 22% x 11% = 0.0242 * Jerry Stock. 25% x 6% = 0.015 * Mike Stock. 20% x 27% = 0.054

Answer 264

non-satiation * The assumption that investors, given the same level of risk, will always choose the portfolio with the greatest return is known as non-satiation.

Answer 265

the Correlation Coefficient * Only the correlation coefficient has a standardized scale.

Answer 266

Negatively correlated securities * Negatively correlated securities will have the most diversifying benefit.

Answer 267

Security A * The question is asking about the coefficient of variation or standard deviation divided by the expected return. A = 0.11 ÷ 0.15 = 0.733 B = 0.12 ÷ 0.07 = 1.71 C = 0.22 ÷ 0.23 = 0.956 Security A has the most efficient return.

Answer 268

0.017934 * COVij = ρijσiσjCOVij * = 0.61 × 0.14 × 0.21 * COVij = 0.017934

Answer 269

perfectly positively correlated * These securities would have a correlation coefficient of 1.0 and be considered perfectly positively correlated.

Answer 270

18.47% σp=((0.67×0.23)2+(0.33×0.12)2+2(0.67)(0.33)(0.01987))√= σp=(0.02375+0.00157+0.00879)‾‾ ‾‾‾√= σp=0.03411‾‾‾‾‾‾‾‾√ =σp=0.1847=18.47%

Answer 271

17.13% * σp=((0.45×0.27)2 + (0.55 × 0.16)2 + 2(0.45)(0.55)(0.01382))‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾ * ‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾√ =σp= (0.01476 + 0.00774 + 0.00684)‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾ * ‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾√=σp= 0.02934‾‾‾‾‾‾‾‾√=σp=0.1713=17.13%

Answer 272

8.18% * The return for the dollar-cost averaging investment was ($4,327 - $4,000) ÷ $4,000 = 8.175%, or 8.18% (rounded).

Answer 273

They choose between these options based on their expectations of the direction of the yield curve. * Those investors who anticipate the **yield curve to become steeper** will use a **bullet** strategy. * Those who expect the yield cure to **flatten** will pick the **barbell**. * Those who are **neutral or uncertain** will buy a **ladder**.

Answer 274

* A barbell is a strategy of holding **more bonds at the short and long end of the yield curve** with **intermediate bonds being underweighted**. * This allows a portfolio's price to match the volatility of an intermediate-term liability. * **When there is a likelihood that the Federal Reserve will loosen monetary policy in the near term, a barbelled portfolio may increase a bond portfolio's return**. * High-yield municipal and corporate bonds have two advantages that can be utilized in a barbelled portfolio. * First, high-yield bonds help diversify a portfolio. Their performance is largely isolated from what's happening with government interest rates because their yields depend almost entirely on default risk. * Second, compared to equity alternatives, they are often undervalued. If the yield curve continues to flatten, the return on a barbelled portfolio is optimized.

Answer 275

* A bullet-structured portfolio benefits when the yield curve is expected to **steepen**. * A bullet structure usually **weighs heavier around intermediate term assets**. * A bulleted maturity tends to outperform a barbell structure when the yield curve steepens because **in a rising rate environment,** **intermediate-term securities usually hold up better than long-term securities**. * Also, **in a declining interest-rate environment, intermediate securities produce significantly greater price appreciation than do short-term securities**.

Answer 276

Dollar Cost Averaging * Dollar cost averaging is the practice of purchasing a fixed dollar amount of stock at specified intervals. The logic behind dollar cost averaging is that by investing the same dollar amount each period instead of buying in one lump sum, you'll be averaging out price fluctuations by buying more shares of common stock when the price is lowest, and fewer shares when the price is highest.

Answer 277

The reinvestments will have a dollar cost average effect on the account. The reinvested amounts will purchase additional shares. * Reinvestment of dividends and distributed capital gains is a method to purchase additional shares rather than taking the amounts as cash. * Since it is a purchase on a regular basis, it is gives the effect of dollar cost averaging. * The cost basis of the account will change because the additional shares will be purchased at different share prices. * Although the client does not take the money out of the account, the dividends and distributed gains are still taxable.

Answer 278

Short-term yield is lower than long-term yield. A portfolio with a ladder strategy is best suited to this environment. * A **ladder structure** will be the most beneficial in a **normal upward sloping yield curve** indicating **higher yield at longer maturities**, with a stable interest rate environment. * **Barbells** work better in a **flat** yield curve while * **bullet** works better for a **steep** yield curve.

Answer 279

Stock price is on the rise * Dollar cost averaging can help investors lower their overall average cost per share in most market conditions except for when the stock price is continuously increasing. * In that case, the investor would have been better off investing everything at the lower price in the beginning.

Answer 280

**Head and Shoulders Top has three successive peaks, forms after an uptrend, and is viewed as a sell signal**. * A head and shoulders reversal pattern forms after an uptrend, and its completion marks a trend reversal. A technician would view this price pattern as a distinct sell signal. **Head and Shoulders Bottom has three successive troughs, forms after a downtrend, and is viewed as a buy signal**. * As a major reversal pattern, the head and shoulders bottom forms after a downtrend, and its completion marks a change in trend. A technician would view this price pattern as a distinct buy signal.

Answer 281

Yes * If the market was efficient, the difference between the returns should be approximately zero. * Since all three methods yield significant differences between buy day and sell day returns, it can be said that technical analysis would have made a difference during this period.

Answer 282

* First - Region (e.g. Europe or Pacific rim) * Second - Country (e.g. Germany or Japan) * Third - Industry (e.g. Technology or healthcare services) * Fourth - Company (e.g. IBM or Tyco)

Answer 283

Rates go above cap * A collar is beneficial when the rate goes above the cap.

Answer 284

Sells securities that are doing well Buys securities that are doing poorly * **Contrarians invest in a manner that is completely opposite to momentum investors**. * They tend to **buy stocks that have had recent bad news and sell the ones that have recently performed well**.

Answer 285

20.2 * Zero coupon bonds have a duration that equals its maturity. * (40%)(10)+(60%)(27) = 20.2

Answer 286

* Market Timing - Buy and Hold * Momentum - Contrarian * Passive - Active * Technical Analysis - Fundamental Analysis

Answer 287

True * The only instance where dollar cost averaging will not work is if the stock or stock fund’s price continues to rise and never drops. If that was the case and your client had a lump sum to invest, it would have been cheaper to buy it in the beginning.

Answer 288

Hold a high-beta portfolio when the expected market return is greater than the risk-free return. A market-timer structures a portfolio to have a relatively high beta when he expects the market to rise and a relatively low beta when a market drop is anticipated. In other words, a market timer will: * **Hold a high-beta portfolio when Expected Market Return > Risk-free Return**, and * **Hold a low-beta portfolio when Expected Market Return < Risk-free Return**.

Answer 289

Under dollar-cost averaging, stock investments are made at random intervals. * Dollar-cost averaging is the practice of purchasing a fixed dollar amount of stock or stock funds at specified (not random) intervals.

Answer 290

Charting * **Charting a stock’s price is a tool used by technical analysts**, not for fundamental analysis.

Answer 291

Company Financial Statements * Technical analysts are not concerned with the fundamental prospects of a firm. In fact, what the company does, what they make, their relative market share, etc., is all unimportant information according to a technician.

Answer 292

Bullet structure * A **bullet**-structured portfolio benefits when the yield curve is expected to **steepen**. * A bullet structure usually **weighs heavier around intermediate-term assets**.

Answer 293

Ladder structure * A ladder structure is a portfolio of bonds that mature at regular intervals throughout the various maturities of the yield curve. * To perpetuate a ladder structure, as each bond matures, the proceeds are used to purchase a bond that will mature at the next interval after the one with the longest maturity in the portfolio.

Answer 294

Under a dividend reinvestment plan (DRIP), automatically reinvested dividends are not subject to current taxation. * Under a dividend reinvestment plan (DRIP), the reinvested dividends are subject to current taxation and become part of the investor’s cost basis.

Answer 295

A small company aggressive growth fund * A small company aggressive growth fund is actively managed, not passive.

Answer 296

Barbell structure * A **barbell** is a strategy of **holding more bonds at the short and long end of the yield curve with intermediate bonds being underweighted**. * This allows a portfolio's price to match the volatility of an intermediate-term liability.

Answer 297

Yes * Yes. A client could have multiple investment goals, each with its own time horizon. * For example, in creating a financial plan, you may discover that your client wants to retire in 35 years, pay for her son’s college education in 18 years, and buy a new home in 5 years. Each of these is a different goal carrying a different time horizon.

Answer 298

Money Market Fund * Liquidity needs such as emergency funding or a temporary place to hold some money must be met by liquid asset. * Money market mutual funds are the most liquid investments in the list. * The low eating of the high yield bond makes it tough to sell. * Foreign stocks may be harder to sell than domestic ones, especially from emerging markets. * Land and shares to a partnership are typically classified as illiquid investments as well.

Answer 299

Reference point for risk objectives Measure performance against Reference point for return objectives * Funds are professionally managed based on a previously determined strategy. Investors do not get to choose which securities should be purchased or sold.

Answer 300

* Highest potential risk and reward - 10% money market instruments, 10% bonds, 80% stocks * Higher potential risk and reward - 10% money market instruments, 20% bonds, 70% stocks * Conservative potential risk and reward - 20% money market instruments, 30% bonds, 50% stocks * Most conservative potential risk and reward - 25% money market instruments, 60% bonds, 15% stock

Answer 301

True * SAA is the asset mix that is intended to accomplish investment objectives over the long run. * TAA is designed to deviate from SAA when temporary market conditions make it profitable to do so.

Answer 302

* **The plots on the line are the most efficient**. * **Plot below the line – achievable, but not efficient**. * **Plot above the line – not achievable at all**.

Answer 303

**Plotting out Mean variance optimization** – investor is getting an optimal amount of return given a unit of risk they’re willing to take * T bills 6% and Stocks 14% (higher return, higher risk) * **Risk averse will plot on left and lower end of curve** * **Risk tolerant will plot on right and upper end of curve**

Answer 304

* Strategic Asset Allocation - Derive long-term asset allocation weights * Tactic Asset Allocation - Change in weights to meet temporary market conditions * Dynamic Asset Allocation - Change in weights to meet a change in investor's circumstances * Integrated Asset Allocation - Optimize based on investment goals and market conditions

Answer 305

Technical analysts * **Technical analysts study historical market data**. They prepare graphs of stock prices and study statistics in **hopes of discerning patterns that will repeat themselves in the future**. Technical analysts typically analyze dozens of different assets and market indexes, but they typically prepare their forecasts for one asset or one market index at a time.

Answer 306

Integrated asset allocation * Integrated asset allocation considers the investor's goals and policies and capital market conditions, and then uses these data as inputs to some kind of optimizer. * The optimizer's solution becomes the new inputs that are reconsidered along with the investor's latest goals and policies and most recent market conditions when revising the asset allocation.

Answer 307

Involves selecting the classes of assets in which funds will be invested. * The **asset allocation decision involves selecting the classes of assets, rather than the specific securities, in which to invest**. It needs to be based on the objectives and constraints of the investor, which may not be investing to offer the highest expected return. It must be revisited regularly to ensure that the objectives and constraints are still being met and to make any necessary changes if the objectives and constraints are modified due to changes in the investor's circumstances.

Answer 308

* First - Gain understanding of the client's goals, circumstances and risk tolerance. * Second - Create and agree upon an investment policy, then forecast expected risk and return. * Third - Allocate funds. * Fourth - Review performance and make changes as necessary.

Answer 309

Technical * Technical analysis is involved with short-term predictions of security price movements based on past patterns of prices and trading volumes, and then makes recommendations concerning the timing of purchases and sales of stocks.

Answer 310

Mis-priced securities * Financial analysts are active mangers who focus their research efforts on analyzing company financial statements. Such research permits an analyst to better understand a company's business operations, as well as the characteristics of securities, group of securities, and which securities might be mis-priced.

Answer 311

Security selection * Security selection is a component of the investment process where assets are identified for investment and the proportion of funds to invest in each of the assets is determined. The investment manager makes a forecast of expected returns, standard deviations, and co-variances for all available securities. This results in the identification of the optimal portfolio.

Answer 312

$3,000 * If the sale of stock results in a net loss, then it can be deducted up to $3,000 per year. If the amount of the loss is greater than $3,000, the investor can carry that amount to future tax years and continue to deduct up to $3,000 per year.

Answer 313

4.76% **Tax equivalent yield = Tax-exempt rate ÷ (1 – Tax bracket).** 0.03 ÷ (1 - 0.37) 0.03 ÷ 0.63 = 0.0476, or 4.76%

Answer 314

on the efficient frontier * The most efficient portfolios lie directly on the efficient frontier.

Answer 315

Statistics for individual foreign and domestic stocks. * In preparing forecasts for asset allocation Investment managers typically overlook individual stocks, individual bonds, and individual pieces of real estate, and focus instead on the categories of homogeneous assets.

Answer 316

Reallocation of existing assets. * Reallocation of existing assets would occur at a later step and is not considered in Step 1.

Answer 317

Lifecycle asset allocation * Lifecycle asset allocation attempts to address the client’s portfolio asset allocation based on the typical needs of a person in a similar lifecycle stage.

Answer 318

I only * Every Markowitz efficient portfolio: * has the maximum expected return available at its level of risk, and * the minimum risk at its level of expected return.

Answer 319

Adviser fee structure disclosures * The purpose of a written investment policy statement carefully sets forth the client’s investment goals and policies. Adviser compensation is discussed at the commencement of the engagement and is not part of the written investment policy statement.

Answer 320

Rose: 37% marginal federal income tax bracket * The investor in the highest federal income tax bracket has the highest taxable equivalent yield because they experience the highest tax savings by holding the municipal bond.

Answer 321

Small company stock funds * Small company stick funds would be expected to have the greatest volatility.

Answer 322

Stock Index Funds * In a perfectly efficient market, there is no opportunity to gain abnormal returns beyond the market. Therefore, a stock index fund would produce the most returns possible.

Answer 323

A weak form efficient market * A weak form efficient market exists when the market prices reflect only previous or historical information. * In a semi-strong efficient market, the market prices reflect all public information. * A strong form or perfectly efficient market exists when the market prices reflect everything that is knowable. This includes both historical and public information in addition to other information.

Answer 324

Historical information Public information Inside information of the company Additional information that is more difficult to obtain * A strong form or perfectly efficient market exists when the market prices reflect everything that is knowable. This includes both historical and public information in addition to other information. Knowable information also includes inside information of the company. However, this must be used only in a legally approved manner.

Answer 325

True * The random walk model is a situation in which changes in the value of a random variable are independent and identically distributed. * When applied to common stocks, it refers to a situation in which security price changes are independent and identically distributed. This means that the size of a security's price change, from one period to the next, can be viewed as being determined by the spin of a roulette wheel.

Answer 326

Under or overvaluation of securities can be expected. Abnormal profits can be made by using a set of information to formulate buying and selling decisions. Investors must make full and accurate use of the available information set. * In an efficient market it is impossible to make abnormal profits by using a particular set of information to formulate buying and selling decisions. That is, investors should expect to make only normal profits by earning a normal rate of return on their investments. An efficient market is defined as one in which every security's price equals its investment value at all times. In an efficient market, a set of information is fully and immediately reflected in market prices.

Answer 327

Professional investors should fare no better in stock selection than the uninformed investors. * In a perfectly efficient market, prices always reflect investment value, and hence, professional investors do not have an edge over ordinary investors when it comes to stock selection. Therefore, investors need not rely on investment advisors or analysts for pricing decisions.

Answer 328

Were most often lucky * Though some investment advisors or analysts may display impressive performance records, it is merely due to luck or chance. Their past performance cannot be relied upon as a basis for predicting their future performance.

Answer 329

False * Analysts may be able to show abnormal returns on their gross returns, but these gains will be offset by the increased cost incurred in using special data and analytical software. * The resulting net returns will show that they have earned a fair return and nothing more.

Answer 330

The net return of passive and active managers will be similar Active managers' returns will be offset by cost to acquire information and make frequent trades * Active managers may be able to find better returns, but their costs for information and transactions will offset any additional gains. This will result in a similar net return for both passive and active managers.

Answer 331

* Event - The speed with which the price adjusts to the equilibrium after an event, such as announcement of a stock split * Patterns - Seeking for consistent repetition of abnormal gains * Performance - Seeking investment managers who can consistently earn abnormal returns.

Answer 332

The existence of market "anomalies” has been discovered. * Various market “anomalies” have been discovered in tests of a semi-strong form market. Securities with certain characteristics or during certain time periods appear to produce abnormally high returns. * The help of an active portfolio manager aware of such anomalies would help an investor. It is in highly efficient markets, such as the U.S., that analysts have incorporated information quickly and accurately. In weak form markets technical analysis based on past records has proved to be ineffective.

Answer 333

Event studies * Event studies reveal how fast security prices react to release of information. * Pattern searches and performance tests are methods used for testing other aspects of market efficiency. * Inside information is not used in testing for market efficiency.

Answer 334

Stocks tend to open below their Friday closing prices on Monday. * The day-of-the-week effect shows that returns on Monday are lower and in the negative. * The January effect and size effect indicate the other regularities. * No regularity has been found stating that small firms have lower returns on Monday.

Answer 335

Purchase stocks of Deltapro in late December or earlier. Purchase stocks of Instapro in early February or later. * Market anomalies suggest that Jack Jones should: * **purchase stocks of small firms (Deltapro) in late December or earlier**; * **sell stocks of small firms (Softpro) in mid-January or later**; * **purchase stocks of large firms (Instapro) in early February or later**; * and **sell stocks of large firms (Techpro) in late December or earlier**.

Answer 336

False * In addition to the size effect, the January effect and the day-of-the-week effect also exist in Japan. This also includes the interrelationship between the January effect and size effect.

Answer 337

Value managers * **Value** managers tend to invest in stocks issued by corporations that have **low rates of earnings growth, high current yields, and low P/E ratios**. * **Growth** managers tend to invest in stocks issued by firms with **high rates of earnings growth, low current yields, and high P/E ratios**.

Answer 338

None of these * None of the forms of the efficient market theory consider technical analysis to be worthwhile. * **Each assumes all technical analysis is already incorporated into the security’s current FMV**.

Answer 339

Random walk * Random walk is, in general, a situation in which changes in the value of a random variable are independent and identically distributed. When applied to common stocks, it refers to a situation in which security price changes are independent and identically distributed.

Answer 340

Stock D, rated 1 by Value Line with a return last year of 6% * Stocks ranked 1 or 2 are forecasted to outperform the market over the next 6 to 12 months. * Stocks ranked 3 are expected to return amounts that mirror the general market average, and * stocks ranked 4 or 5 are expected to underperform the stock market returns over the next 6 to 12 months.

Answer 341

small-firm effect * Empirical studies showing that the stocks issued by small companies earned higher rates of return, on average, than stocks issued by large companies are referred to as the small-firm effect.

Answer 342

Weak form * Under the **weak** form of efficient market theory technical analysis is not considered worthwhile but this form **considers fundamental analysis to remain worthwhile**.

Answer 343

Insider information * The semi-strong form of the efficient market theory does not consider technical analysis and fundamental analysis worthwhile but does consider insider information worthwhile in determining the current FMV of a security.

Answer 344

Strong form * The strong form considers insider information worthless and already reflected in the security’s FMV.

Answer 345

neglected firm effect * Basically, these stocks are "below the radar screen" and have been proven to be a method for investors to outperform the general stock market.

Answer 346

Technical analysis * **Technical** analysis focuses on **historical** information on a company that would be available from libraries, bookstores, computer databases, and the Internet. This information represents past data. * **Technical analysts rely on past performance data that would lead to security selection**.

Answer 347

* Highly-testable calculation: The Capital Asset Pricing Model (CAPM) * **Security Market Line (SML) is simply CAPM expressed in a graphic form** * Likely will have to calculate * One of the provided formulas – be able to recognize it by sight and recognize that’s what they’re asking for in the question * **Order of operations:** * **Rm – Rf: market return minus the risk-free retur**n * **Multiply by beta** * **Add to risk free return** * And that would be **CAMP – risk free return**

Answer 348

(rm – rf) * The ‘market risk premium’ is the difference between the market return and the risk-free rate [i.e., (rm – rf)]. * This is the premium given to investors for taking on systematic risk. * When multiplied by ß, it becomes the ‘stock risk premium.’

Answer 349

Taxes and transaction costs reduce market liquidity. * The assumption regarding taxes and transactions costs **under CAPM** is that **they are irrelevant**. It is not assumed that they reduce market liquidity. * The CAPM also assumes that **investors are risk averse and therefore prefer portfolios with lower standard deviations**. Other assumptions are that **assets are infinitely divisible** and that **investors may borrow or lend at a single risk-free rate**.

Answer 350

12.8% * The expected rate of return * = 4% + (12.0 – 4) (1.1) * = 12.8%.

Answer 351

Is not owned by investors Has an equilibrium price of zero Has a market value of zero * The market portfolio is the risky portfolio held by all investors. Therefore, **a security that is not part of the market portfolio is not attractive to the risk-averse investor**. * An important feature of the CAPM is that in equilibrium each security must have a nonzero proportion in the composition of the tangency portfolio. * That is, **no security can, in equilibrium, have a proportion in the portfolio that is zero**. * Hence, **the market portfolio is a set of securities that can be freely owned by investors**.

Answer 352

* Market risk - The portion of a security's total risk that is related to movements in the market portfolio and hence to the beta of the security. * Non-market risk - The portion of a security's total risk that is related to events specific to the security and not to the movements in the market portfolio. * Risk-free rate of return - In the CAPM world, the expected return of a security with a beta of zero equals this rate of return. * Total risk of a security - It is composed of market risk and non-market risk.

Answer 353

10.4% * The one factor model for this security is * r = .04+(.8)(.08) * =10.4%

Answer 354

Investors will take advantage of arbitrage opportunities thus eliminating them. Arbitrage has fewer assumptions than the CAPM. * The **logic behind APT is that investors will observe and take advantage of arbitrage opportunities and eliminate them**. * When all arbitrage possibilities have been eliminated, the equilibrium expected return on a security will be a linear function of its sensitivities to the factors.

Answer 355

Differential pricing * Investors who take advantage of differential pricing for the same physical asset or security engage in the arbitrage process. * Abnormal returns, low stock price and volatility of stock do not figure in the arbitrage process.

Answer 356

Inflation Term structure of interest rates Corporate earnings and dividends * The most commonly identified **factors that affect expected returns are indicators of aggregate economic activity, inflation and interest rates**. Researchers have not identified the price of gold as a factor.

Answer 357

Betas are determined with respect to the preferences of noise traders. Determining Beta is difficult because the preferences of noise traders change over time. Beta is determined using both utilitarian and value-expressive measures. * **BAPM is based on the interaction between information traders and noise traders, while CAPM only considers information traders**. * **CAPM uses utilitarian factors in determining supply and demand for a stock, while BAPM also considers value-expressive measures**.

Answer 358

Behavioral finance recognizes the contributions of standard finance. Behavioral finance considers how investors act and feel. Mental accounting is a key concept of "prospect theory." * Investors, assumed to be "rational" under the standard finance view, do not make mistakes using these standard finance models.

Answer 359

* Cognitive Errors - Investors make mistakes. * Biased Expectations - Investors are overly confident in their ability. * Mental Accounting - Investors segment their money into separate accounts. * Loss Aversion - Investors are more risk adverse when faced with gains and less risk adverse when faced with losses.

Answer 360

**C - P = S - PV(X)** C = S - PV(X) + P (Tip: Add P to each side to isolate C) C = S - [ X / (1+r) T ] + P (Tip: Present value of the strike price.) C = 22 - [20 / (1.015)(30/365)] + 3 C = 22 - [20 / 1.0012] + 3 C = 22 - [19.98] + 3 C = $5.02

Answer 361

**Delta** - Delta measures the impact of a change in the underlying stock price on the value of a stock option. **Delta is positive for a call option and negative for a put option**. * A $1 change to the stock price is approximately equivalent to change in option price by delta dollars. **Eta** - Eta measures the percentage impact of a change in the stock price on the option value. Eta is positive for a call option and negative for a put option. * A 1% change to the stock price is approximately equivalent to change in option price by eta%. **Vega** - Vega measures the impact of a change in the volatility of the stock on the stock option. Vega is positive for both a call option and a put option. * A 1% change to the stock's standard deviation is approximately equivalent to change in option price by vega. **Gamma** - Gamma measures delta's sensitivity to a stock price change. * A $1 change in the stock price causes the delta to change by approximately the amount of gamma. **Theta** - Theta measures the option price sensitivity to a change in time till expiration. * A one-day change to time to expiration will cause the option price to change approximately by theta. **Rho** - Rho measures the option price sensitivity to a change in interest rate. * A 1% change to the interest rate will cause the option price to change approximately by rho. * **TEST TIP: Since the Black-Scholes-Merton-Merton Model is calculated using computer software in real life, it is not as important to know the equation or how to calculate options prices using this model as it is to know how changes in various components of the model affect the price of the option.**

Answer 362

The option pricing model factors listed below illustrate how changes in certain variables will affect the price of puts and calls. * **Price**: Change of share price beyond the parity will affect the price of calls and puts inversely. * As the **price of the stock increases, the call premium increases and the put premium decreases**. * If the **stock price decreases, the opposite will occur**. * **Time**: The **longer the time to expiration, the higher the premium of a call and a put option**. However, the **put premium will level out while the call premium will continue to rise**. * **Risk**: Will affect put and call premiums the same way (directly). The higher the standard deviation, the higher the premium. * **Interest**: Will have an inverse relationship with calls and puts. **As interest rates increase, call premiums will increase but put premiums will decrease**.

Answer 363

BOPM * The **binomial option pricing model assumes that stock prices will attain one of two possible known prices at the end of each of a finite number of periods**. * The **Black-Scholes-Merton model is a continuous time model**. * The **CAPM and APT are not option pricing models**.

Answer 364

Time remaining before expiration Risk-free rate of return Stock volatility * The **Black-Scholes-Merton formula shows that the fair value of an option is determined by the following** **five factors: stock price, exercise price, risk-free rate, life of the option and the volatility of the common stock**. It does not consider taxes and transaction costs as a factor in determining the fair value of an option.

Answer 365

Both options have the same exercise prices and the same expiration dates * The **payoff from buying a put option on a stock and a share of the stock will be the same as buying a call option on the stock and a risk-free bond**. * This is under the assumption that both options have the same exercise price and expiration date. * This is called **put-call parity**.

Answer 366

Pay dividends over the life of the option * One limitation of the Black-Scholes-Merton model is that it **can only be applied to options that will not pay dividends** over the life of the option. * The other limitation is that it is **applicable only to European options** and not to American options.

Answer 367

13.50% **The formula for CAPM is ri = rf + (rm – rf) βi** * (rm – rf) is referred to as the “market premium” * The CAPM for CAP Corporation is ri * = 0.01 + 0.10(1.25) * .0.01 + 0.125 * = 0.1350 or 13.50%

Answer 368

There is significant nonfactor risk. * There is negligible nonfactor risk in an arbitrage portfolio.

Answer 369

purchase * A **call option that is found to be selling for substantially less than its Black-Scholes-Merton value is a candidate for purchase**, whereas * **one that is found to be selling for substantially more is a candidate for writing**.

Answer 370

1.2247 **The formula for CAPM is ri = rf + (rm – rf) βi** * ri = 0.011 + (0.10 – 0.011) βi * 0.12 = 0.011 + 0.0890(βi) * 0.12 - 0.011 = 0.089(βi) * 0.109 / 0.089 = 0.089(βi) /0.089 * 1.2247 = (βi)

Answer 371

put-call parity * The relationship between the market prices of a call and a put on a given stock that have the same exercise price and expiration date is known as the Put-Call Parity. * Given the price of a call for a security, you can determine the price of a put for the same security with the same expiration date and strike price.

Answer 372

The risk factor used in the capital market line (CML) is Beta. * The **distinguishing feature of the capital market line** is that the **denominator is the standard deviation of the market**. * This **will help you recognize the capital market line equation on the CFP® exam**.

Answer 373

Capital Asset Pricing Model * SML is a graphical depiction of the CAPM and plots risks relative to expected returns. * It is an **equilibrium relationship between the expected return and covariance with the market portfolio for all securities and portfolios**. * The **slope** of the SML **is the risk premium on the market portfolio**.

Answer 374

12.25% **The formula for CAPM is ri = rf + (rm – rf) βi** * CAPM for CAP Corporation is * ri = 0.01 + (0.10 – 0.01)1.25 * 0.01 + 0.1125 * = 0.1225, or 12.25%

Answer 375

Yes * The expected return for CAP Corporation meets the investor’s required rate of return. **The formula for CAPM is ri = rf + (rm – rf) βi** * ri = 0.01 + (0.10 – 0.01)1.60 * 0.01 + 0.1440 * = 0.1540 or 15.40%

Answer 376

Binomial option pricing model * The binomial option pricing model can be used to estimate the fair value of a call or put option.

Answer 377

market premium * In the CAPM formula, (rm - rf) is often referred to as the "market premium.”

Answer 378

No * The expected return for CAP Corporation does not meet the investor’s required rate of return. **The formula for CAPM is ri = rf + (rm – rf) βi** * ri = 0.01 + (0.10 – 0.01)1.50 * 0.01 + 0.1350 * = 0.145 or, 14.50%

Answer 379

* Round Lot - 200 shares * Odd Lot - 65 shares * Mixed Lot - 369 shares * Block trade - 10,000 shares

Answer 380

It is a round lot It is a day order It is a limit order * Since the size was a multiple of 100, the order was a round lot. * Execution within the same day is a day order. * The specified ceiling price of $49/share makes it a limit order.

Answer 381

Time to fill the order * The investor needs to specify a time limit within which the broker should attempt to fill the order.

Answer 382

Stop-limit order * Natasha can use a stop-limit order to activate a market order at a certain price, and then limit the transaction from going beyond an unwanted price.

Answer 383

Fill-or-kill * Fill-or-kill orders are those that get cancelled if the broker is unable to fully execute them immediately.

Answer 384

76.67% * Initial purchase was for $2,000. * At 65% initial margin, $1,300 was paid in cash and $700 was a loan. * When assets increase to $3,000, the loan is still $700 and the equity is $2,300. * The actual margin = $2,300/$3,000 * =76.67%.

Answer 385

* The break-point formula yields the lowest possible price where the margin level is still acceptable. Any price below this however, will result in a margin call. **This break-point form is: [(1 - I.M.) / (1 - M.M)] x Ps** Where: I.M. = initial margin requirement (%) M.M. = maintenance margin requirement (%) Ps = purchase price of the stock [(1 - .50) / (1 - .30)] x $100.128 = $71.52 Any closing price below $71.52 will generate a margin call. * **Formula is: Market value x (1 - M.M,) = maximum debt allowable. Then subtract this amount from current debt amount to determine margin call**. = $60,000, multiplied by (1 - .30) = $42,000 = maximum debt allowable. The current debt amount was 50% of the original transaction of $100,128 or $50,064. **Therefore, the margin call = $50,064 - $42,000 = $8,064.**

Answer 386

* If she buys those shares in a margin account with an initial margin of 60%, then she would pay $3,000 for them. * If the price went to $60/share, then Donna's return for the cash account is ($6,000 - $5,000)/$5,000 = 20%. * But if she bought the shares in a margin account, then her return would be ($6,000 - $5,000)/$3,000 = 33%. * Therefore, **through leverage, Donna can earn a greater return on her margin account**.

Answer 387

Yes * Actual Margin = Equity ÷ Margin Value * = $4,000 ÷ $12,000 * = 33.3%. * Since 33.3% is less than 40% a margin call will be made for the account.

Answer 388

Yes * The short sale proceeds = $10,000 Initial margin = $6,000 Therefore, the loan amount = $11,400 The actual maintenance is 40.35%. Mei will receive a margin call and she has to either add cash or securities, or buy back stock to pay off part of her short position.

Answer 389

Hypothecation * When opening a margin account with a brokerage firm, an investor must sign a hypothecation agreement. This agreement grants the brokerage firm the right to pledge the investor's securities as collateral for bank loans, provided that securities are purchased using a margin account. * Most brokerage firms also expect investors to allow them to lend their securities to others who wish to sell them short.

Answer 390

Initial margin requirement * The minimum percentage of the purchase price that must come from the investor's own funds is known as the initial margin requirement.

Answer 391

A short sale * Most investors buy securities first and sell them later. * But with short selling, investors sell securities first and then buy them back later. * If VJ short sells Hermes Wireless shares, he will be borrowing the securities to sell to someone, then when the prices drop, he will buy the shares back and return the shares to the original lender.

Answer 392

$57.14 * The maintenance margin is 30% = $12,000 (500 x 80 x 0.30). * The initial margin provides a price movement of ± 50% i.e. up to $20,000. Therefore, beyond a price volatility of ± $12,000, the broker is likely to give an additional margin call. * When the total value of the stock falls to $28,000 (initial investment – maintenance margin), the broker will ask for a margin call. So he calls for the highest price that allows him not to go beyond $28,000. * At the price of $57.14 (500 x 57.14 = 28,570) the broker is likely to give margin call, since the total value of the shares is only $28,570.

Answer 393

Aggregated * An investor with a margin account can purchase multiple securities on margin account or may short sell securities. The investor can also purchase some on margin and short sell others. To determine whether the account is under-margined, restricted, or over-margined depends on how the transactions are aggregated.

Answer 394

Liability re-evaluation done every day * With multiple short sales, it is the liabilities that are re-evaluated on the basis of current market prices, because the short seller's liabilities are shares whose market values are changing every day.

Answer 395

True Ivy's Total Assets = $12,750 (Cash from Minnetonka sale=$25/shr x 100 shrs = $2,500; Initial margin = 0.50 x$25/shr x 100 shrs = $1,250; Market value of St. Louis Park stock = $45/shr x200 shrs = $9,000). To remain unrestricted based on the short sale of Minnetonka stock, Ivy must have deposited in the margin account:100 shrs x $36/shr x (1 + 0.50) = $5,400. To remain unrestricted based on the margin purchase of St.Louis Park stock, Ivy must have deposited in the margin account: (200 shrs x $40/shr x 0.50)/(1 - 0.50) = $8,000. Thus to remain unrestricted in aggregate, Ivy's margin account must be worth at least $13,400. But Ivy actually has assets worth $12,750, so the account is restricted as of June 30.

Answer 396

ADR * The best way to buy an individual stock is to buy an ADR.

Answer 397

$1,500 * Required equity: 35% of $50 = $17.50 Current equity: Current stock price – loan amount = $50 - $40 = $10 per share Required equity – current equity = $17.50 - $10 = $7.50 deficit $7.50 x 200 = $1,500

Answer 398

$15,000 * The margin portion refers to the equity (the portion that is paid for already). * A 60% initial margin requirement for a $25,000 stock purchase requires $15,000 (60% x $25,000) be deposited.

Answer 399

$61.54 **Debt ÷ (1 – maintenance margin)** 40 ÷ (1 - 0.35) = $61.54

Answer 400

Market order * If an investor puts in a market order, it would be irrelevant to put time constraints around the order because it is supposed to be filled at whatever the market price is at the time the order is made.

Answer 401

II, III, IV * An employee would not be considered an insider unless the employee had access to key information.

Answer 402

Good-till-canceled order * Open orders or “good-till-canceled” orders remain in effect until they are either filled or canceled by the investor. * However, during the time period before the order has been filled, the orders typically expire in 1 to 2 months and need to be reconfirmed.

Answer 403

Assets are increased by $5,000 * On the day of the purchase, Amy’s assets increased by $5,000. * While not part of this question, Amy’s liabilities increased by $2,000 on the date of purchase.

Answer 404

the account marked to the market * The daily calculation of the actual margin in an investor's account is known as having the account marked to the market. * At the time of the margin purchase, the actual margin and the initial margin are the same. * However, after the purchase, the actual margin can be either greater than or less than the initial margin.

Answer 405

Fill-or-kill order * Fill-or-kill orders are canceled if the broker is unable to fully execute them immediately.

Answer 406

As a percentage of assets under management. * In exchange for an annual fee equal to a percentage of assets under management, a broker creates an investment plan, finds professional money managers to execute it, and waives all commissions for any trading that takes place in the account.

Answer 407

100 * In general, a round lot means that the order is for 100 shares, or a multiple of 100 shares. * Odd lot orders generally are for 1 to 99 shares.

Answer 408

Maria will sell the shares at the market for $48 and make the difference between the current price and the strike price plus premium, or * $48 - $40 - $5 = $3 X 100 shares * = $300. Maria could have decided to sell the option to another party rather than make the election to exercise.

Answer 409

II only * Maria would not exercise the option and Sanjey would make a profit equivalent to the premium ($500). * Note: Maria has the right to exercise the option just to receive the shares, although she would lose money in the process.

Answer 410

She will make the difference between the current price and the strike price plus premium, or * $80 - $65 - $10 = $5 X 100 shares * = $500. Anastasia could also have decided to sell the option to another party rather than exercise it.

Answer 411

False * The adverse movement of the price of the underlying stock need not adversely affect the option buyer because they cannot lose any more than their option premiums. * Thus, their situation is not risky. Instead, they enjoy limited liability.

Answer 412

Decrease in the announced dividend Increase in the price of the underlying stock Increase in the volatility of the underlying stock * Increase in price of underlying stock, volatility or riskiness of the stock and lower cash dividends are factors that increase the market value of a call option. * As the expiration date gets closer, the option value decreases.

Answer 413

$2 * The exercise value of the option for the buyer of the call will be the market price less the strike price and premium. * It would be a profit of * ($35 - $30 - $3) = $2.

Answer 414

$57 * The buyer of a put option would exercise the option on the last day of the option's life if the exercise price is greater than the market price of the stock. The breakeven point for the put is $57. * So as long as Moonstar Company's stock price is $60 or less, Diego will exercise the put or sell it for a premium before expiration.

Answer 415

Short Straddle Short Strangle * A **short straddle or a short strangle position will profit from small price movements around the exercise price.** * A **long straddle or a long strangle position will profit by large price movements**.

Answer 416

Long strangle is a debit transaction. Premiums are received in a short strangle. * **Long strangle** is a **debit** transaction because no premiums from writing options are received. * **Short strangle** is a **credit** transaction because premiums are received.

Answer 417

Writing naked Writing uncovered Writing against cash * If the call writer does not own the underlying stock on which the option is written, it is referred to as **writing naked, writing against cash or writing uncovered**. * This is in contrast to covered call writing, where the writer owns the underlying stock and is thus covered against potential loss. * **Naked call options can increase leveraged returns as well as losses**.

Answer 418

Sell call Buy put THE FOLLOWING TABLE REPRESENTS WHAT BUYERS AND WRITERS HOPE FROM OPTIONS: BUYER SELLER CALL Price of stock to increase Price of stock to decrease PUT Price of stock to decrease Price of stock to increase

Answer 419

Both I and II * For a zero-cost collar, an investor **buys a put (portfolio insurance)** and **also sells (or writes) a call option**. * The "collar" is formed by the premium obtained from writing the call or the premium paid for the protection afforded by buying the put, combined with the long position in the underlying stock.

Answer 420

An increase in the underlying stock price. **Increase Time Until Expiration & Increase Variance of Underlying Asset** * **Increase Put AND Call Premium** **Increase in Underlying Stock Price & Increase in Interest Rates** * **Increase Call Premium** * **Decrease Put Premium** **Increase in Exercise Price** * **Decrease Call Premium** * **Increase Put Premium**

Answer 421

Sell put * **The only way to generate income from an options strategy is to function as the seller**. * Therefore, if the investor **expects the price of the stock to increase and wants income, the only option is to sell a put**.

Answer 422

An increase in the exercise price. **Increase Time Until Expiration & Increase Variance of Underlying Asset** * **Increase Put AND Call Premium** **Increase in Underlying Stock Price & Increase in Interest Rates** * **Increase Call Premium** * **Decrease Put Premium** **Increase in Exercise Price** * **Decrease Call Premium** * **Increase Put Premium**

Answer 423

price volatility * The buyer of a **long straddle** believes the underlying stock has the potential for enough **price fluctuations** to make the straddle profitable before it expires.

Answer 424

Horizontal spreads * **Horizontal spreads** include those combinations of options having **different expiration dates but the same exercise price**. They are called horizontal spreads because different options that all have the same exercise prices are listed in horizontal rows in the newspapers. Horizontal spreads are **also called time spreads and calendar spreads**.

Answer 425

The market capitalization of the underlying stock. **A call option contract specifies four items**: * The company whose shares can be bought. * The number of shares that can be bought. * The purchase price for those shares, known as the exercise price or strike price. * The date when the right to buy expires, known as the expiration date.

Answer 426

* Call buyer's gain or loss = Intrinsic value of call - Call option's premium * Call writer's intrinsic gain = Intrinsic value of call writer's position + Call option's premium * Put buyer's intrinsic gain = Intrinsic value of the put - Put option's premium * Put writer's gain = Intrinsic value of put writer's position + Price of put

Answer 427

Naked Call Writing * The naked call buyer’s gains equal the naked call writer’s losses. * **As the price goes beyond the exercise price, the naked writer’s loss will increase proportionately**. * **Writing naked calls is risky if the optioned security is likely to rise in price**.

Answer 428

$6,691.13 * Carlos' before tax accumulation would be * = 5,000(1+.06)^5 or * $6,691.13

Answer 429

$3,935.15 **Here is how to solve the question algebraically:** 3250 [1 + (0.06 x 0.65)]^5 3250 [1 + (0.039)]^5 3250 [1.039]^5 3250 [1.2108] 3935.1483 That said, there is actually a much easier method to solve this question! **Here is how to solve using Time Value of Money (TVM)**: 6 x 0.65 = 3.90 I/YR 5 N 3250 +/- PV Solve FV 3935.1483

Answer 430

$8,611.20 * Francois' after tax accumulation would be * =2,000(1.10)^20(1-.36) or * $8,611.20.

Answer 431

Pension Model * The Pension Model gives the future value of an investment in a qualified retirement plan when before-tax dollars are invested. * The three other models, Current Model, Deferred Model and Tax Exempt Model, give the future value of an investment when after tax-dollars are invested.

Answer 432

The before-tax rate of returns (BTROR) is constant over time The BTRORs are equal across models Tax rates must be equal and constant over time * **After-tax dollars are invested in both the models**. * However, **the Deferred Model always outperforms the Current Model when the BTRORs and tax rates are constant over time and equal across both models**. * This is because the **earnings on the investment grow at BTROR** and the investors are taxed at the end of the investment horizon.

Answer 433

State and local government obligations Roth IRAs * **State and local government obligations such as municipal bonds**, as well as **Roth IRAs**, are classic examples of the **Exempt Model.**

Answer 434

AAA-rated bond issue from a blue-chip company is sold at a loss and the investor purchases another AA-rated bond from a different blue-chip company. * A AA-rated bond issue from a blue-chip company is sold at a loss and the investor purchases another AA-rated bond from a different blue-chip company. * Unless the investor purchases back the same exact bond or bond fund, it is difficult to violate the wash sale rule with fixed income. * Since the bond is issued from different companies, loss associated with the blue-chip to blue-chip transaction would not be subject to the wash sale rules.

Answer 435

Index Funds * Index funds have the lowest turnover ratio because the manager would not sell any of the stocks in the portfolio except when the benchmark index changes its composition. * Tax-efficient or tax-managed funds try not to have too many short-term trades, but they will harvest losses in a down market to use later to offset capital gains.

Answer 436

Unrealized * The capital gain that Stella makes on her asset is unrealized because she has not exchanged her assets and no tax is due on the unrealized capital gain. Also a change in the market value of a capital asset is not relevant for tax purposes until it is realized as a capital gain (or loss) by sale or exchange.

Answer 437

8.82% * In general, the taxable equivalent yield of a tax-exempt bond is given by: **Taxable bond yield = tax-exempt bond yield ÷ (1 - t).** Thus a taxable bond has to offer 8.82% [6.00 ÷ (1 - 0.32)] before-tax interest rates to be considered equivalent in value to the 6% municipal bond.

Answer 438

Lot 4: cost $55 per share * Although lot 3 would be ideal to reflect the largest return because it cost the cheapest, lot 4 would be more appropriate for tax management because it costs the most.

Answer 439

Joint Tenants WROS * Joint tenants WROS is simply a type of property ownership that does not give the owners any tax advantages. All the other account types give the owners either tax-deferred or tax-exempt growth.

Answer 440

All gains and income are taxed as ordinary income when distributed * Capital gains and dividends grow tax-deferred and are not taxed until the owner takes distributions from the account. At that point, any dollars that were pre-taxed or deducted from taxes, including any gains and income, will be taxed as the owner's ordinary income.

Answer 441

Ohio Tax Free Bond Fund Mississippi state direct obligation bonds Annuities * **Tax-exempt securities such as tax-free funds and municipal bonds, money market instruments, and annuities are not appropriate for tax-advantaged accounts because there is already a tax advantage associated with them**. * The tax advantages from tax-exempt securities already result in a lower nominal return, so there is no additional advantage of holding them in a tax-advantaged account.

Answer 442

tax-exempt * In a Roth IRA, if the investor allows his investment to stay for the required period, the earnings go from tax-deferred to tax-exempt.

Answer 443

Municipal bonds The **current model** gives the future value of an investment having the following characteristics: Only after-tax dollars are invested. * The earnings on the investment are taxed annually (currently), thus the reinvested earnings grow at the after-tax rate of return. * Common examples of investments taxed this way are savings accounts, money market funds, and taxable bonds (if the investor reinvests the after-tax earnings annually). **Municipal bonds are tax-exempt and do not meet the criteria.**

Answer 444

One AA-rated bond issue from a blue-chip company is sold at a loss and the investor purchases another AA-rated bond from a different blue-chip company. * One AA-rated bond issue from a blue-chip company is sold at a loss and the investor purchases another AA-rated bond from a different blue-chip company. * Unless the investor purchases back the same exact bond or bond fund, it is difficult to violate the wash sale rule with fixed income. Since the bond is issued from different companies, loss associated with the blue-chip to blue-chip transaction would not be subject to the wash sale rules.

Answer 445

Both I and II * When you buy a market discount bond, you can choose to accrue the market discount over the period you own the bond and include it in your income currently as interest income. If you do not make this choice, the following rules generally apply. * You must treat any gain when you dispose of the bond as ordinary interest income, up to the amount of the accrued market discount. * You must treat any partial payment of principal on the bond as ordinary interest income, up to the amount of the accrued market discount.

Answer 446

$7,590.64 Here is how to solve the question algebraically: $6,750 [1 + (0.0525 x 0.76)]3 $6,750 [1 + (0.0399)]3 $6,750 [1.0399]3 $6,750 [1.1245] $7,590.6420 Here is how to solve using Time Value of Money (TVM): 5.25 x 0.76 = 3.90, I/YR 3, N 6,750, +/-, PV Solve for FV = 7,590.6420

Answer 447

Municipal Bond * To compare the bond options, the taxable equivalent yield must be calculated for the municipal bond using the following formula (using this formula makes the comparison with the other bond options 'apples-to-apples'): **TEY = Tax-Free Yield ÷ (1 – Marginal Tax Bracket)** For the municipal bond, TEY = 5.20 ÷ (1 – 0.32) = 7.65% As a result, the municipal bond offers the highest yield of the three options and Jerome should select that one above the taxable bond options.

Answer 448

higher * Tax-deferred bonds such as government bonds, Series EE/E savings bonds, municipal bonds, and certain zero-coupon bonds generally yield a return somewhere close to that of taxable bonds, provided the investor is in the higher tax brackets. * Investors in higher tax brackets may wish to take advantage of tax-exempt interest from municipal bonds.

Answer 449

Bond #2 Bond #1 before-tax accumulation = $3,000(1 + 0.04)10 = $4,440.73 Bond #2 before-tax accumulation = $3,000(1 + 0.055)8 = $4,604.06 Bond #3 before-tax accumulation = $3,000(1 + 0.0375)11 = $4.497.70 Bond #4 before-tax accumulation = $3,000(1 + 0.07)6 = $4,502.19

Answer 450

Tax-efficient funds Passively managed index funds * **There are two types of mutual funds that have low turnover rates**. * **Passively managed index funds** have low turnover by design because they only sell a stock when it is no longer on the index that the fund is mimicking. * **Tax-managed or tax-efficient funds** purposely invest in stocks that the managers feel they will buy and hold for a few years, therefore lowering the turnover ratio. **Actively managed funds and growth funds generally have higher turnover ratios**.

Answer 451

$12,886 * Jon’s before tax accumulation * = $7,500(1 + 0.07)8 * = $12,886.40 or, * $12,886 (rounded)

Answer 452

T-Notes T-Bonds * U.S. government bonds such as treasury notes and bonds and agency bonds are direct obligations of the U.S. government and have income that is exempt from state taxes.

Answer 453

Treasury bonds Agency bonds Inflation-protection bonds * The interest on Treasury bonds and agency bonds is taxable for federal income tax purposes, but not state and city income taxes. * The interest on inflation-protection bonds is also subject to federal tax but is deferred until maturity. * Municipal bonds are tax-exempt.

Answer 454

Not subject to taxes * Municipal zero coupon bonds are not subject to any taxes if held to maturity. * If Joan had bought a **U.S Treasury zero coupon bond**, then she would have had to **declare the discount annually through accretion as income**.

Answer 455

Inflation-protection bonds * The redemption values of inflation-protection bonds are adjusted semi-annually to reflect the rate of inflation in the previous six months.

Answer 456

False. * Even when dividends are not paid out in cash they are taxed as ordinary income.

Answer 457

300 shares at $10.50/share * **The shares that provides the greatest capital loss or the least capital gains should be the ones identified to be sold first**. Therefore the lot with $10.50/share would be sold first because the lot can provide a $0.50-loss per share. The $9.50/share lot would be next to be sold in order to offset the remaining 100 shares because it only provides $.50 gain rather than the $8.50 gain from the $1.50/share lot.

Answer 458

On the date the original owner died. * If the person received the stock as an inheritance, the **starting basis is the value of the stock on the date the original owner died**. This is called a **stepped-up basis**.

Answer 459

Share Identification * Specific share identification allows investors to limit capital gains by identifying shares that cost the most to be sold first.

Answer 460

July 30 * The cost basis begins the day Janis exercises the warrants.

Answer 461

* FIFO - Sell the shares that were purchased first; advantage occurs when the market prices have dropped * Specific Share Identification - Sell the shares that were the most expensive first * Average Cost - Combine all purchases and divide by the number of shares owned; great for accounts with many purchases

Answer 462

They can be bought only from redeeming agents of the Treasury department. Interest on savings bonds is exempt from state and local income tax. * **Savings bonds are non-marketable securities**. They may be sold or bought from an issuing and redeeming agent authorized by the Treasury Department. They are **registered securities** and are owned by the person named on them. The interest earned on U.S. Savings Bonds is exempt from state and local income tax.

Answer 463

$1,250 * The expected return is the life expectancy in years times the annual distributions or 20x250x12 = $60,000. * The exclusion ratio is the cost of the annuity divided by the expected return = 0.4167. * The annual exclusion amount is the exclusion ratio times the annual distribution amount or * 0.4167 x 250 x 12 = $1,250.

Answer 464

The partners pay taxes on profits The partners use losses as credits * A limited partnership is a pass-through entity where all the partnership's profits and losses are passed on to the partners.

Answer 465

Both I and II * Mutual funds can distribute dividends and capital gains, both types are taxable. The amount of distribution depends on the nature of the fund. Income-oriented funds, such as bond funds, tax-free bond funds, and money market instruments, will pay a monthly amount.

Answer 466

taxable * The IRS considers **any annual appreciation in value or undistributed interest from zero-coupon bonds to be taxable**. * This income is commonly known as **phantom income**.

Answer 467

specific identification * The specific share identification implies that specific shares are used to apply against the shares sold. * This method is the best method for tax purposes because the investor has absolute control over how much gain from a sale would be recognized.

Answer 468

capital gains * Distributions to shareholders are taxable only to the extent they are made from either the corporation’s current earnings and profits or accumulated earnings and profits. * **Distributions in excess of the basis are classified as capital gains**.

Answer 469

Both I and II * **Any interest received from a municipal bond is free of federal income tax**. This is a major advantage for municipal bonds versus other taxable bonds. * Usually, the state government also does not tax the interest payments on these bonds, as long as the person lives in the state in which the bonds were issued.

Answer 470

$2,708 * Life expectancy = 24.0 years The expected return = $122,400 (24.0 years x ($425 x 12 months)) The exclusion ratio = 0.5310 ($65,000 ÷ $122,400) The excluded (tax-free) amount = $2,708 (0.5310 (exclusion ratio) x $5,100 (annual income))

Answer 471

$5 * Stock splits occur when companies split their shares so that the number of shares a shareholder has will increase. * In Maritza’s case, the three-for-one stock split will result in her receiving 3 shares for each of her 400 shares of WEB, or 3 x 400 = 1,200 shares. * Maritza’s pre-split basis was $15/share for a total basis in WEB of $15 x 400 = $6,000. To calculate the post-split basis, divide the new number of shares by the total basis: $6,000 ÷ 1,200 = $5/share

Answer 472

Schedule K-1 * Schedule K-1 shows the partner's share of the income or loss from a partnership and is mailed within the first three months of the year.

Answer 473

FIFO * The first-in, first-out (FIFO) method is the default method that the IRS will assume a taxpayer is following unless otherwise specified in a statement attached to the income tax return.

Answer 474

$14.00 According to the single category average cost method, Barney would take an average of the purchase prices and divide it by the total number of shares owned: 200 shares at $14.50 = $2,900 150 shares at $11 = $1,650 200 shares at $15.75 = $3,150 Total cost = $7,700 Total shares = 550 Average cost per share = $7,700 ÷ 550 = $14.00

Answer 475

-9.43% to 20.93% Mean = 5.75% SD = 7.59% 2σ = 5.75% - (7.59% + 7.59%) = -9.43% 2σ = 5.75% + (7.59% + 7.59%) = 20.93%

Answer 476

Commercial Paper **Commercial Paper Features**: * Denominations of $100,000 or more * Maturities of up to 270 days * Large institutional investors * Terms are non-negotiable * Issuer may prepay the note

Answer 477

Funding any project which will be supported only by the full faith and credit of the state or local agency. Revenue Bonds are backed by revenues from a designated project, authority, or agency or by the proceeds from a specific tax. Such bonds are only as creditworthy as the enterprise associated with the issuer. Revenue bonds may be issued for the following reasons: * financing publicly owned utilities, * financing quasi-utilities, like transportation, * financing by levying a tax on properties that benefit from the expenditure, for example a new sewer system, and * Industrial Development Bonds are used to finance the purchase or construction of industrial facilities **General Obligation Bonds are issued by state and local agencies and are backed by the full faith and credit of the agency**.

3. Investment Planning - All Questions and Comprehensive Course Exam Flashcards

(543 cards)