CFP Review F.I.I. (Part I) Flashcards
(300 cards)
1
Q
Practice Standards for Financial Planning Process
A
Understand the client’s circumstances and financial circumstances
Identify and select goals
Analyze current trajectory and potential alternative courses of action
Develop recommendations
Present recommendations
Implement recommendations
Monitor and Update
2
Q
aleatory contract
A
an agreement where one party pays, the other only has to perform their end at a random chance ( pay premiums, IF something happens, insurance pays )
3
Q
indemnity principle
A
” to make whole again “
- insured cannot profit, can only be compensated to the extent of the loss
4
Q
12b-1 fees…
A
Sales Related Compensation
cover the costs of distribution – marketing and selling mutual fund shares
5
Q
Liquidity ratios measure the ability to meet…
A
short-term obligations
- current ratio (current assets / current liabilities)
- Emergency Fund 3-6 months
6
Q
Debt ratios indicate how well a client manages…
A
debt
7
Q
The pie chart approach provides..
A
a visual representation of how the client spends his money
8
Q
The cash flow approach…
A
income statement approach to recommendations
9
Q
The financial statement approach helps…
A
where the client is today and uses ratio analysis to determine the client’s weaknesses and strengths
10
Q
The metrics approach utilizes…
A
quantitative benchmarks to determine where a client should be
(ex. by 30 have 1x your annual salary in retirement savings)
11
Q
Types (degrees) of CFP Fitness violations..
A
Permanently barred - all felonies that occurred within the last 5 years, revoked financial professional license
Barred until hearing with DEC - two or more bankruptcies, certain violent felonies 5 or more years ago, certain non violent felonies within the last 5 years, Suspension of financial license, revocation of non financial professional license
Other adverse conduct - complaints, civil proceedings, non violent felonies more than 5 years ago, misdemeanors, terminations/investigations
12
Q
CFP Fitness Standards
A
are for current candidates and former CFP Professionals seeking reinstatement (bars can be temporary depending on the crimes)
13
Q
Fiduciary Duty (3 Parts)
A
Duty of Loyalty - put client interests above firm & CFP professional, disclose material conflicts of interest, “best interest of client”
Duty of Care - prudence, diligence, care about the client’s goals & circumstances
Duty to Follow Client Instructions - “reasonable and lawful” w/ terms of Engagement
14
Q
Standards of Conduct
A
A. Duties Owed to Clients (LOTS)
B. Financial Planning & Application of the Practice Standards for the Financial Planning Process
C. Practice Standards for the Financial Planning Process
D. Duties Owed to Subordinates and Firms
15
Q
Financial Planning Definition
A
a collaborative process that helps maximize a client’s ability to meet life goals through financial advice that incorporates relevant and realistic elements of the client’s personal and financial circumstances
16
Q
Qualitative (subjective) Information
A
values, goals, risk tolerance, earnings potential, attitudes, expectations, health, life expectancy, family circumstances, needs, priorities, current course of action
17
Q
Quantitative (objective) Information
A
age, number of dependents, other professional advisors, income, expenses, cash flow, savings, assets, liabilities, available resources, liquidity, taxes, employee benefits, government benefits, insurance coverage, estate plans, education and retirement accounts and benefits, capacity for risk
18
Q
Risk tolerance vs. risk capacity
A
risk tolerance = a bubble of how much risk you can handle (a level of comfort), risk capacity = how much of that you are willing to expand the bubble
19
Q
debenture
A
unsecured debt by a corporation
20
Q
Equipment Trust Certificate
A
used to purchase equipment that is then used as collateral
21
Q
Bond Ratings
A
Investment -> Junk
(AAA) (BBB/Baa) (C’s)
22
Q
Three Schools of Counseling
A
humanistic, developmental, cognitive-behavioral
23
Q
Developmental School of Counseling
A
human development occurs in stages (predictable sequence) - more directive than humanistic, but not as directive as CB
In financial planning, the “baby steps” approach is an example of a developmental approach
24
Q
Humanistic School of Counseling
A
humanity is generally good and has the capability of self-direction and growth under the right set of circumstances
In financial planning, the advisor serves as more of a guide than an expert
25
Cognitive-Behavioral School of Counseling
highly directive approach!
humans are beings that are subject to the same learning principles established in animal research (operant conditioning, reinforcement)
the financial advisor in this paradigm is more likely to use goals and feedback as 'carrots'
26
active listening
give feedback ("go on" "yes" "right") to encourage the speaker to continue speaking
27
reflective listening
seek first to understand, then to be understood
I understand that ... you mentioned that .... is that correct?
28
Traditional Finance
"Modern Portfolio Theory"
- Investors are rational
- Returns are determined by risk (beta)
- Markets are efficient
- The Mean-Variance Portfolio Theory governs (CAPM)
29
heuristic
mental shortcut, rule of thumb - can lead to biases
30
affect heuristic
judge by its cover (beautiful or ugly - immediate effect)
"oh that's a great stock"
"oh that stock sucks"
31
availability heuristic
I know what I know, I will not do research to find out why I should or should not (based on info that is available to me already)
32
similarity heuristic
tendency or aversion to act on things that are "similar"
i.e. I always have done this at this time
33
anchoring bias
makes us too quick to make decisions based off of the first piece of information that we receive.
Seeing a "price cut" or a "stock drop" can lead to a quick "buy - it's on sale" mentality
34
confirmation bias
people tend to filter information and focus on the pieces that support their own opinions
35
recency bias (experiential bias, availability bias)
too much care is given to recent observations or stimuli versus long-term historical trends (can affect insurance and retirement spending)
36
gambler's fallacy
100 coin flips - the chance is always the same.
in gambling - losing consistently does not make you "due" for a win
37
herding
mimic the actions of the larger group, socially to "fit in"
38
hindsight bias
"if the past is so obvious, the future is predictable"
39
overconfidence bias
the opposite of herding. Mostly occurs when the investor only listens to themselves. Often results in over-trading
-overconfidence leads to overstating risk tolerance!
40
overreaction
stock drops, sell all
stock raises, buy all
41
Regret avoidance (disposition effect)
refuse to act in hopes of minimizing any regret over their actions or inactions
-continue to mark stocks at purchase price instead of market price
42
Belief perseverance
people are unlikely to change their views given new information.
43
mental accounting
our tendency to mentally sort our funds into separate “accounts,” which affects the way we think about our spending.
(ex. that money is for down payment, not for daycare costs)
44
Loss aversion
people more strongly prefer to avoid losses than to seek gains
45
substitute product
used in substitute; affects demand
ex. plastic bags vs. paper bags - if the price of plastic bags drops, the demand for paper bags will go down unless they also drop prices
46
complement product
bought alongside another product; affects demand
ex. tennis rackets & tennis balls - if the price goes down on tennis rackets (or demand goes up), the demand for tennis balls will go up
47
elasticity
how much the demand will change with price being affected
ex. If cars go 50% off, sales may go up 500% (highly elastic), if gasoline drops 50% and sales only go up 1%, this is highly inelastic
airline tickets are highly elastic, if they go half off, demand may increase 500%
48
Monetary Policy
The Federal Reserve can:
Make banks hold more reserve, increase the rate that banks are charged for borrowing money from the Fed, or perform open market operations
49
Fiscal Policy
Congress can:
Increase or decrease spending (stimulus), raise or lower taxes
50
Goals of Both Fiscal & Monetary Policy
1. Maintain Full Employment
2. Maintain Prices
3. Maintain Long Term Economic Growth
51
Open Market Operations
Follow the money flow, is the Fed giving money to the market, or taking? (Sell vs Buy, where is the money going?)
52
Leading Economic Indicators
Initial Unemployment Claims Filed
Housing Starts
Money Supply (M2)
Manufacturing Orders
Hours Worked (manufacturing)
Stock Prices (500 best stocks)
Consumer Sentiment
53
Lagging Economic Indicators
CPI
Duration of Unemployment
Prime Rate Average
Inventory to Sales ratio (how much is being sold)
54
GDP
Gross Domestic Product - measures the production within geographic borders, regardless of nationality
55
GNP
Gross National Product - measures the production of nation, regardless of geographic borders
56
Business Cycle vs. Market Cycle
The Market Cycle precedes (indicates) the Business Cycle.
Both share the following:
Trough, Expansion, Peak, Contraction
57
Inflation
the decrease in purchasing power, the increase in prices that people are paying
58
Interest Rates
Affect the price of borrowing money; increases in interest rates will decrease the likelihood people can afford borrowing money
59
Sectors of Market
Consumer Cyclical "durable" (luxuries)
Consumer Non-Cyclical "non durable" (staples, necessities)
Healthcare
Energy (raw materials for energy use - oil)
Utilities (delivery to consumers)
Technology
Capital Goods (equipment to manufacture goods)
Transportation
Financial
Basic Industry - non energy raw materials
Precious Metals
60
treasury yield curve
shows the rates at various maturity dates (can be an indicator of economic expectation)
61
Securities Act of 1933
regulation of IPOs, securities to the primary market
62
Securities Exchange Act of 1934
created the SEC;
regulates securities on the secondary market (public stock exchanges)
63
Investment Advisors Act of 1940
requires certain entities of individuals to register (SEC or state) and disclose information
regulates what an investment advisor is by 3 prong test:
- compensation
- "in the business" of financial advice
- advice or analysis regarding securities
64
Securities Investor Protection Corporation (SIPC)
1970
Works to insure up to 500k in securities, of which 250k can be cash in the event a broker/dealer becomes insolvent
65
Federal Deposit Insurance Corporation (FDIC)
1933
Ensures 250k
- Checking, savings, CDs, money market deposit accounts
"per depositor, per institution, per legal acct. ownership"
66
Chapter 7 Bankruptcy
- wage earners that liquidate in order to pay debts
67
Chapter 13 Bankruptcy
- wage earners that pay over time in order to meet debt obligation (36-60 months)
68
Chapter 11 Bankruptcy
- business shuffle
69
Dodd Frank Act
2010
Reg BI "Best Interest" - Fiduciary standard of care now applies to B/D
70
FINRA
Series Exams to sell products
71
How to register as an investment adviser?
Form ADV with SEC
72
Brochure Rule
ADV 2A & 2B - disclosures, credentials
73
Reg FD
"Full Disclosure" & "Fair Disclosure"
74
representativeness bias
running all new info through a perceptual lens of the past
(tech stocks crashing, this is the Dot Com bubble all over again!)
75
chance of loss or injury
risk
76
anything that may cause loss
peril
77
anything that increases the chance or likelihood of loss
hazard
78
something that physically increases the chance of a loss
physical hazard
79
If a motorist slides on a slick road and collides with a motorist, what is the hazard? What is the peril?
Peril - collision
Hazard - slick road
80
Dishonesty or character defects that increase the likelihood of a loss
Moral hazard
81
Bank risks lack of insurance hoping for a government bailout
Moral Hazard
(ex. cutting corners (cheating, dishonest) because the government can bail you out)
82
Carelessness or indifference to a loss based on the existence of insurance
Morale Hazard
(ex. leaving car unlocked because of insurance "So What?")
83
Tactical Asset Allocation
an active management portfolio strategy that shifts the percentage of assets held in various categories to take advantage of market pricing anomalies or strong market sectors
i.e. energy sector during the Russian invasion of Ukraine, consumer staples sector during high inflation
84
Strategic asset allocation
a portfolio strategy whereby the investor sets target allocations for various asset classes based on factors such as the investor’s risk tolerance, time horizon, and investment objectives and rebalances the portfolio periodically
85
Market timing
moving investment money in or out of a financial market—or switching funds between asset classes— based on predictive methods
86
Core & Satellite allocation
The core of the portfolio consists of passive investments. Additional positions, known as satellites, are added to the portfolio in the form of actively managed investments.
87
bond duration
measurement of a bond's interest rate risk that considers a bond's maturity, yield, coupon and call feature
88
derivatives
financial contract whose value is dependent on the underlying asset
(futures, options [puts, calls, warrants], swaps, forwards)
89
futures contract
farmers use these a lot to sell their harvest before it is ready
production uses futures to lock in stable prices
hedgers, speculators use
90
options contract
offer the holder the option, but not the obligation, to buy or sell the underlying asset or security at a specific "strike" price on or before the option's expiration date
91
put
buying a put is buying the option to sell your stock at a certain price (can't lose money - insurance)
selling a put is selling the option to someone to acquire their stock at a certain price (if you are more risk tolerant than they are, longer time horizon, think long-term it'll be better)
92
call
buying a call is buying the option to buy a stock at a certain price (earnest money for house buying process)
selling a call is selling the option to someone to 'wait and see' if they want to buy that stock for the strike price (if it goes up)
93
forward vs future contract
forward contracts are not settled daily, they are settled at the end of the contract
futures are more for speculators and are traded on exchanges
94
Types of Pooled Investments
- mutual funds
- hedge funds
- ETFs
- closed ended fund (number of shares is set)
- REITs
- UITs (expire and split the assets)
- Pension Funds
95
How to incorporate closing costs into mortgage payment?
On a 500k house with 20% down, 3% closing costs rolled in:
500,000 * 0.80 * 1.03
96
TVM bonds (semi annual)...
n x 2
i / 2
97
Are mortgage payments BEG or END?
END
98
Customer Complaints
Misdemeanor Convictions
Employer Investigations/Terminations
may result in delay/denial of certification
99
Items that must be provided in writing during FINANCIAL PLANNING
-disclaimer of compensation methods
- privacy policy
-Services and Products
-How client pays
-public discipline and bankruptcy
- referral compensation agreements
-terms of engagement and responsibilities of implementation / monitoring
100
If a client disagrees with your assumptions for inflation and rates of return...
limit the scope of the engagement
101
UIADPIM
Understand the Client's Personal & Financial Circumstances
Identify and Select Goals
Analyze the current course of action and explore alternative courses of action
Develop
Present
Implement
Monitor
102
housing ratios
28% = PITI / monthly gross income
36% = PITI + Recurring Debt Payments / gross monthly income
103
Life Insurance needs
10-16 times gross pay
104
Disability needs
60-70% gross pay
105
Long-term care needs
36-60 months (inflation protected)
106
Personal Liability Umbrella Policy needs
$1-3Mil
107
Emergency Fund needs
formula = current assets / monthly fixed expenses
3 months - both spouses work, or one spouse works and there is another income source
6 months - one spouse works or the work situation isn't as stable
108
three panel retirement approach
16 x pre-retirement income
10-12% savings rate
8-10% return
Risk/St Dev 8-14%
109
property coverage
should be able to replace at FMV
110
good debt vs bad debt
lifetime of the asset vs. the payment plan
7 year note on a 10 year old car is not good
111
education savings benchmarks
savings for 18 yr
public/state school - 3k/ yr
semi-private - 6k / yr
competitive private - 9k/yr
112
retirement rule of thumb
16x annual pre-retirement $ needs
113
savings rate
10-12%
114
benchmark for risk / return
8-10 % return over long-term horizon
8-14% std deviation of a diversified portfolio
115
legacy planning benchmark
- will
- durable power of attorney for healthcare
- advanced medical directive
116
financial enmeshment
"using your child as your therapist or advisor" when they are not equipped emotionally or cognitively to serve in that capacity
117
undue influence or control
"you tell everyone what to do with the money and you don't even make a cent"
118
self determination theory
intrinsic motivation requires three needs:
- competence, autonomy, relatedness
119
qualitative information
health, life expectancy, family circumstances, values, attitudes, expectations, earnings potential, risk tolerance, goals, needs , priorities, current course of action
120
when interest rates increase...
stocks and bonds decrease in value
purchasing power decreases (homes are less affordable just on interest rate changes, interest rates are 'the cost of money')
121
unemployment rate & wage rate
the more people employed, the more fighting over workers by businesses (wages go up)
the less people employed, the less fighting over workers by businesses (wages can stagnate or go down)
122
supply curve
related to efficiency, new firms entering, technological improvements:
MORE supply at a CHEAPER price if market gets more efficient, technology improves production
LESS supply at a more EXPENSIVE price if market has increased costs of production, supply can't keep up
123
recession vs depression
recession - 6 months or 2 straight qtrs
depression - 18 months or 6 straight qtrs
124
deflation vs disinflation
disinflation is the SLOWDOWN of inflation rate (6% to 3%)
deflation is the increase in value of the money (negative inflation rate)
125
Producer Price Index (PPI)
measures price changes in the wholesale and manufacturing sectors
126
reserve requirement (Fed)...
higher- tighter supply
lower- loosen supply
127
excess rate reserve (Fed)...
higher - tighter supply of money
lower- loosen supply of money
128
open market operations (Fed)...
sell securities = tighten supply (Fed gets cash)
buy securities = loosen supply (Fed sends out cash)
129
discount rate (Fed)...
higher= tighter
lower = loosen
130
normal yield curve
expansionary policy.. longer term securities have higher yields than shorter term
131
inverted yield curve
contractionary policy... longer term securities have lower yields than shorter term
132
What assets are protected from Ch. 7 bankruptcy?
Contributory IRAs (up to 1.3m), homestead, life insurance, qualified plans, converted IRAs if marked as rollover (no commingle)
inherited IRAs are NOT protected from creditors unless named to a trust
133
Debts that cannot be discharged during Ch. 7 bankruptcy
Student / Gov't Loans
3 years back taxes
Alimony / Child Support
Monies owed to criminal fines, fraud (negligence is discharged)
134
Unemployment timeline..
26 weeks regular benefit, 13 extra weeks during "high unemployment" times; total and maximum of 39 weeks
135
T/F
Age is the most important element in financial planning
TRUE
136
Balance sheet...
snapshot of current financial standing
does not explain "how" assets got there - depreciation, appreciation, inheritance
movements on balance sheet are tricky - purchases are net -0-
137
current assets
money market, cash, savings, CD < 12 mo. , debts you are owed
138
consumer debt expenses should not exceed...
20% of NET income
139
reverse mortgage
bank pays the homeowner while homeowner retains right to live in home
at death, bank receives the home
requires age 62 or older (can generate income for older homeowners)
140
adjustable rate mortgage (ARM)
2/6 means that interest rates cannot increase more than 2% per year or 6% total over the life of the loan
* someone has 4% currently, they risk a 10% interest rate in 3 years if that were to happen
141
if anticipated sale of assets is upcoming...
balance sheet should reflect taxes owed as a 'reserve liability account'
142
NEED based financial aid programs (Dept of Ed)
Federal Pell Grant (depends on EFC)
Subsidized Stafford (Direct) Loan - no interest accrual while in school
Campus-based
Federal Work Study
Federal Supplemental Education Opportunity Grant (FSEOG)
143
Student Loans paid by student
- primary type of aid provided (undergrad and grad)
- 6 hr or more
- payment is generally due after a 6 month grace period
- Sub vs Unsub (interest accrual timing, basis of need)
- NOT for parent repayment
- Grad PLUS
144
Student Loans paid by parent
- PLUS
- 6 hr or more
- not eligible for Income-Based-Repayment
145
repayment types
graduated - starts smaller, 10 years
extended - 25 years, forgiven at end
-IBR evaluates discretionary income (20 yr forgiveness)
146
prepaid tuition...
- can limit financial aid
- locks in tuition at today's cost
- does not include room & board
- student may not have interest in available programs
- can be refunded, but only principal
147
529 Plans
-can limit financial aid
- 5x gift exclusion lump sum (85k) or 170k for gift splitting couple
- no AGI phase out
- owner controls assets
- beneficiary can be changed at any time
- 10% penalty and gross income on NQ withdrawals
-- waived for disability, scholarship, death
- used for qual ed expenses or 10k for private school
- 10k can be used for student loans
148
529 ABLE
- balance must remain under 100k for Federal SSI
- one acct per beneficiary
- beneficiaries must be entitled to SSI, SS disability or have disability cert with IRS
149
Coverdell ESA (phase out)
- not only COLLEGE savings, can be used K-12. This is a use > 529
- can pay for tutoring
- 2k max
150
Roth IRA as Education Savings Vehicle
- no 10% penalty, but the earnings are NOT tax free anymore (ordinary income)
- 5 year holding period remains
- contribution limit, requires earned income
151
Series EE Savings Bond
- purchased in parent's name
-no local or state taxation
- 10k per year max
- non marketable, non transferable
- safest investment vehicle (dependent on risk tolerance)
152
UGMA / UTMA
- asset of child when determining financial aid
- kiddie tax (and other tax implications) so beware of interest payments and rental properties as gifts
- child can use assets for something other than education
UT can include real estate, UG cannot
153
Education Funding (additional tax advantages)
- $2500 student loan interest ABOVE THE LINE adjustment
- Lifetime Learning Credit 20% of up to 10k in qualified ed expenses per year (max credit per family is 2k but unlimited # of years)
- American Opportunity Credit ( four years post-secondary only)
--per student max is 2500
--100% of first 2k, 25% of next 2k up to $2500
BOTH HAVE (phase out)
154
Employer Education Assistance
- employer may reimburse for education expenses up to $5,250
155
Can you claim both Lifetime and American Opportunity credit for the same student ?
NO
156
objective risk
measurable, quantifiable
measures the variation of an actual loss from an expected loss (data)
"Law of Large Numbers"
157
subjective risk
based on individual's perception of risk
158
pure risk
loss or no loss
159
speculative risk
loss, no loss, GAIN
160
peril
the actual cause of a loss
161
hazard
conditions that increase the likelihood of loss occurring
162
moral hazard
intentional acts to cause accident or increase its severity (character flaw)
163
morale hazard
indifference due to insurance coverage
164
physical hazard
tangible condition that increases the likelihood of a peril occurring
(coastal house = hurricane likelihood)
165
adverse selection
people are more likely to seek out insurance if they have higher-than-average risk
(there needs to be a balance in the pool for it to work - underwriters need to manage adverse selection)
166
things that must happen for a risk to be insurable...
- loss cannot be Catastrophic to the insurer
- losses cannot make the insurer financially insolvent
- large Homogenous pool
- losses must be Accidental (not intentional)
- losses must be measurable and Determinable (provable value)
CHAD - not Catastrophic, Homogenous, Accidental, Determinable
167
A legal contract requires COALL..
Competent parties, Offer and Acceptance, Legal consideration, Lawful purpose
void vs. voidable
168
SUBrogation clause
insured cannot get paid twice for the same claim.
the insurer will SUBSTITUTE the insured and take any 3rd party payments while settling claim
169
insurable interest principle
insurable interest - hardship resulting from loss
property & liability - must have insurable interest at inception and at time of loss
life insurance - must have insurable interest only at time of inception
170
adhesion principle
"take it or leave it" - ambiguities are in favor of insured
171
unilateral principle of contract
only one side is promising - the insurer
* NOT the insured!!
172
estoppel
clause that states that insured will not be denied assertion of a right to which they are otherwise entitled ("but you said...")
173
types of authority
express - written agency agreement
implied - public perception & written agency agreement
apparent - public perception ONLY
174
replacement cost vs. actual cash value
car
replacement cost - like-kind current cost of replacement
actual cash value - replacement cost minus depreciation (not great for insured)
175
coinsurance formula (only if coverage is less than coinsurance requirement)
([Face value of policy / (coinsurance * replacement cost)] * loss) - deductible
ex. 300k replacement cost house, 200k insurance face value, 80% coinsurance, 40k loss, $500 deductible =
[200k / (.8 *300k)] * 40k - 500
= $32,833
* DO NOT forget the final step (multiply by loss, subtract deductible)
176
Needs Approach to Life Insurance Estimates
$ that will be used for:
- final expenses, lump-sum cash needs (debt, education), income needs (readjustment and future), dependency and spousal needs (blackout period for Soc Sec)
177
Human Life Value Approach
Salary of the decedent minus their own personal consumption. Include estimates of salary growth and earnings growth (real return must be used), use estimate for their remaining work expectancy
178
CRAP-O (dividend options for participating policies)
Cash
Reduced Premium
Accumulate at interest
Paid-up additions (purchase additional DB)
One year term (purchase one year of term insurance)
179
settlement options (payouts)
lump sum
interest only (capital retention)
annuity payments (income retention)
- fixed amount, life income, fixed period, life income with period certain
180
nonforfeiture options (termination)
Cash Surrender Value (minus fees for surrender)
Reduced-paid up insurance (get a paid-up policy with a smaller death benefit, no premiums)
Extended Term Insurance - paid up term policy in exchange for cash value (same DB)
Accelerated Death Benefit - 24 months or less to live, non taxable, used for anything
181
annuity options (contribution & distribution)
contribution:
- lump sum
- periodic installment premium
distribution:
-immediate
-deferred (Flex Pay vs Single Pay (life insurance can be used for SPDA))
182
annuity options (investment options)
fixed annuity - accumulates at fixed rate over a period of time (more security)
-- equity-indexed annuity is a type of fixed annuity linked to index
variable annuity - may be invested (more risk), no guarantees, keeps pace with inflation
183
life insurance death benefit taxation..
tax free!
184
borrowing against cash surrender value...
not taxable unless the policy has been front-loaded (MEC)
- if loan is outstanding at death, the DB will be reduced by the amount
185
Accelerated DB
in the event of terminal illness, an accelerated death benefit may be elected. Just know that the DB will be reduced by the accelerated DB payments
186
surrendering the cash surrender value taxation..
ordinary income on the GAINS
187
taxation of annuities
exclusion ratio = premiums paid (basis) / total expected payments
500000/1,000,000 = 50% taxable
any payments beyond life expectancy are 100% taxable as ordinary income
188
HMO vs PPO
HMO - in network ONLY
PPO - up to the patient's preference
189
HSA can be used for...
long term care premiums
dental / orthodontics / vision care
COBRA premiums
health care coverage while drawing unemployment
Medicare and other health care coverage if over 65
190
COBRA (continuation of health insurance)
20 employees
60 days to make your COBRA election
Can have coverage for:
18 months if reduced or terminated
36 months for death, divorce, Medicare, loss of dependency status
29 months if disabled (SS)
Employee pays 102% of the full premium if COBRA'd
191
Medicaid (Long Term Care)
-5 year (60 month) look back at gifts
-spend down assets
-Long Term Care is covered by Medicaid only once the two above situations are addressed
192
Basic Coverage Perils
* Fire
* Smoke
* Lightning
* Wind
*Volcano
* Hail
*Theft
*Vandalism
*Aircraft
*Explosion
* Riots
* Vehicles
193
Broad Coverage (6 additional)
-Falling Objects
-Ice, Snow, Sleet Weight (roof)
-Accidental overflow / discharge of Water
-Sudden & accidental cracking, burning, bulging of appliances
-Freezing of plumbing, heating, air conditioning, fire sprinklers or appliances
-Sudden and accidental damage from artificial electric currents
194
General Exclusions from Homeowner's
Flood
Earthquake
War
Nuclear
Neglect
Intentional Acts
TERMITES
195
Endorsements on Insurance Policies
"additions" purchased separately:
- sink hole
- flood (National Flood Insurance Program)
- Earthquake
- sewage backup
- refrigerated property coverage
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Property Insurance Coverages
SECTION I:
A: Dwelling
B: Other Structures ()
C: Personal Property
D: Loss of Use
SECTION II:
E: Personal Liability
F: Medical Payments to Others
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Coverage A: Dwelling (Coinsurance)
* 80% of replacement cost is the target
* If less than 80%, take what you have divided by the 80% replacement cost to multiply by the damage (don't forget to subtract the deductible at end)
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Coverage B: Other Structures
* Detached
* 10% of Coverage A limit is typical (replacement cost)
* If used for business, must get a separate business coverage!
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Coverage C: Personal Property
* Tangible
* 50% of Coverage A = limit
* Actual Cash Value :( not replacement cost - but you can purchase that endorsement
* certain items are limited in coverage ( firearms, money, jewelry)
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Coverage D: Loss of Use
* additional living expenses incurred when unable to occupy the dwelling due to damages caused by a covered peril
* 30% of Coverage A except for HO-6 & 8 (condo and modified coverage form)
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Coverage E: Personal Liability
* covers claims that result from bodily injury and property damage to others, when the insured or members of the insured's family are responsible
* 100k per occurrence minimum (legal defense and settlement costs also)
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Coverage F: Medical Payments to Others
* covers all necessary medical expenses without regard to liability for others arising out of the insured's activities, premises or animals
- within 3 years of accident
1k-5k typical, some go up to 10k
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HO Policy Forms
HO-2: Broad Form - 18 named perils
HO-3: Special Form - open perils except personal property (named perils)
HO-4: Renters Form - C,D,E No (dwelling coverage)
HO-5: Comprehensive Form - open perils on dwelling and personal property
HO-6: Condo Form- 'within the walls', broad perils coverage, lower personal property coverage and modified loss of use 50%
HO-8: Modified Coverage Form- repair cost vs. replacement cost (expensive materials)
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Personal Auto Policy (PAP)
A- Liability (Bodily Injury and Property Damage)
B- Medical Payments
C- Uninsured Motorist
D- Coverage to Insured's Auto (Comprehensive and Collision)
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HO-4
Renters
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HO-2
Broad Perils (18 named)
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HO-3
Open Perils, but not for personal property
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HO-5
Comprehensive, open perils on dwelling and personal property
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HO-6
Condo
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HO-8
Modified Form
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Medicare Parts
A - Hospital Insurance
B- Health Care (not dental, eyes or hearing aids)
C- Medicare Advantage (includes other missing coverages like dental vision and hearing)
D- DRUGS
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NOT covered in Medicare Part B
Dental (dentures), Vision, Hearing (hearing aids)
Cosmetic Surgery
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Activities of Daily Living (ADLs)
Bathing & washing
Eating
Toileting
Mobility
Transferring
Dressing
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market order
buy/sell at next available price (quickest)
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limit order
buy/sell at determined price (takes more time)
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stop order
at this price, turn into market order
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stop limit order
extra layer of protection for seller to not sell below the limit price after stop price has been reached
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best efforts & firm commitment
- make best efforts to sell as much of the offering as possible
- firm commitment = buy entire issuance of stock
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prospectus
outlines risks, management, business operations, fees and expenses
* trial run with red herring before SEC approval
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10K & 10Q
10K - annual & audited
10Q - quarterly earnings report not audited, but still filed with SEC
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Annual report goes to...
all shareholders
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margin call
(loan) / (1 - maintenance margin)
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Morning5tar
grades/ranks mutual funds and bonds (1-5, 5 being best)
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Value L1ne
ranks stocks (1-5, 1 being best)
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when should you purchase a stock in order to receive a dividend?
two days before the record date
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qualified dividends taxation
CAPITAL GAINS > ordinary income!
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Insider Trading & Securities Fraud Enforcement Act (1988)
insider - anyone with info not available to public
- cannot trade with that knowledge
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Investment Company Act (1940)
created 3 types of investment companies & allowed SEC to regulate:
* open, close and unit investment trusts
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money market securities
-t-bills (< a year)
-commercial paper (corporations loan between each other, 270 day maturity or less, no registration with SEC)
-Bankers acceptance - 9 months or less
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What does an Investment Policy Statement define?
- Risk & Return
- Time-line & liquidity (always related)
- Taxes
- Legal (if a trust or special account)
- Unique circumstances
RR TL, TL, U (Risk/return, Timeline/liquidity, taxes & legal, unique)
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price vs value weighted indicies
DOW = price weighted
S&P, NASDAQ, RUSSELL, EAFE, Wilshire = value weighted (market cap considered)
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traditional finance
1. investors are rational
2. markets are efficient
3. mean-variance portfolio theory governs
4. returns are determined by risk alone
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behavioral finance
1. investors are human and irrational
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Prospect Theory
Would you rather have:
-given $25
-given $50 then lose $25
people want to avoid losses
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familiarity bias
People tend to overestimate/underestimate the risk of investments with which they are unfamiliar / familiar
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cognitive dissonance
misinterpret information to only pay attention to the information that supports an existing opinion
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socialization
the process of acquiring values, beliefs and behaviors that are acceptable/expected by society
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multicultural psychology
aspects of identity influence a person's worldview
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social consciousness
awareness / sense of responsibility for problems or injustices that exist within society
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beta
measures systematic (PRIME) risk of a security relative to the market
best used as a measure of volatility of a diversified portfolio
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standard deviation (probability)
68% - 1 std dev
95% - 2 std dev
99% - 3 std dev
total risk of undiversified portfolio
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leptokurtic +
high peak, fat tails
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platykurtic -
low peak, thin tails
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Monte Carlo Simulation
tests the probability over MANY simulations of portfolio success/failure (assumptions include withdrawal rate, etc)
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measures movement of one security relative to that of another
correlation & covariance
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Risk is reduced (diversification begins) any time the correlation is ...
Less than 1
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correlation coefficient (r)
covariance = r * sd1 * sd2
r^2 is the coefficient of determination
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coefficient of determination r^2
how much return is due to the market
i.e. corr coeff of .8 has a coefficient of determination of .64 (.8^2) which means 64% of the returns are due to the market
since we cannot diversify away systematic (market) risk, we want the coefficient of determination to be higher (.70)
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Systematic Risks
Purchasing Power Risk - dollar cannot purchase tomorrow what it can purchase today
Reinvestment Risk - mostly bonds (if called or interest rates drop)
Interest Rate Risk - bonds (when not holding - if looking to sell, lower rates are worth less)
Market Risk
Exchange Rate Risk
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Unsystematic Risks
Accounting Risk (books are being cooked)
Business Risk (unique to the sector or trade)
Country Risk (diamond mining in Tunisia)
Default Risk (how likely they will not pay debt)
Executive Risk (Elon Musk)
Financial Risk (company has a lot of debt)
Government/Regulation Risk (tariffs, restrictions on industry may hurt some businesses)
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market premium
(rm - rf)
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risk premium
(rm-rf)B -- incorporates BETA as a measure of risk
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Information Ratio, Jensen's Alpha, Sharpe & Treynor Ratios
IR - can be compared with other IRs to determine which performed against the market
Jensen's Alpha - tracks manager's performance vs market (SML) + is better, - is worse
Treynor - return per unit of risk, uses beta, r^2 must be higher than 0.70
Sharpe - return per unit of risk, uses std deviation
Neither Sharpe nor Treynor track performance vs. market (no performance indicators), only risk
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NPV is deterministic...
IF + or 0 --> make the investment
IF - then do not make the investment
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IRR (aka Dollar Weighted Return)
should be calculated with uneven cash flows and you are asked to calculate the compounded rate of return (this is NPV 0)
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Arbitrage Pricing Theory (APT)
- asserts that pricing imbalances cannot exist for long
- attempts to take advantage of the pricing imbalances
- multi-factor model that attempts to explain return based on those factors
- beta and std deviation are not inputs into APT
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P/E
How much an investor is going to pay for a dollar of earnings
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PEG Ratio
P/E ratio to 3-5 year growth
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Dividend Payout Ratio
[Common Stock Dividend / Earning Per Share (EPS)]
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Return on Equity
Earnings Per Share / Stockholders Equity Per Share
** measures overall profitability of a company
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Fundamental Analysis
Ratio analysis, financial statement analysis to determine value or misplaced value. Also considers economic data that may influence pricing
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Technical Analysis
largely determined by supply and demand
- charts of trading volume and price movements
- moving averages used
- Dow Theory, Market Breadth
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Efficient Market Hypothesis (EMH)
* Supports passive trading (buy & hold index)
- Investors cannot consistently achieve above-average market returns
- Stock prices will follow "random walk"
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Forms of Efficient Market Hypothesis (EMH)
Strong Form: Asserts that stock prices fully reflect all information, public and private. Not even access to inside info can be expected to result in superior investment performance over time. Neither fundamental analysis nor technical analysis can produce superior results over time on a risk-adjusted basis.
Semi-Strong Form: Asserts that all publicly known information is reflected in stock prices. Neither technical analysis nor fundamental analysis can produce superior results over time on a risk-adjusted basis. Only an investor with access to inside information may consistently achieve superior results (but such access is illegal)
Weak Form: Suggests that historical price data is already reflected in current stock prices and is of no value in predicting future price changes.
**Technical analysis will not produce superior results. Fundamental Analysis may produce superior results.
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Required Rate of Return is derived from...
Capital Asset Pricing Model (CAPM)
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Treasury Securities that are NOT marketable (no secondary market)
Series EE
Series I
**Series HH (have not been offered since 2004)
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Marketable Treasury Securities
Bills <1yr
Notes 2-10 yr
Bonds > 10 yr
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Agency Bonds (GNMA, SLMA, etc)
All except GNMA are not backed by the full faith and credit of the US Govt
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What are the Risks of Corporate and Municipal Bonds?
Default: A creditor may seize the collateral and sell it to recoup the principal
Reinvestment: As payments are received from an investment, interest rates may fall. When the funds are reinvested the investor receives a lower yield.
Interest Rate: Rising interest rates may cause bond prices to fall
Purchasing Power: Inflation may lower the value of bond interest payments and principal repayment, thereby forcing bond prices to fall.
Study Hint: Remember: D.R.I.P.
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Municipal Bond Types
* not taxable at Fed, State or Local Level
- General Obligation Bond (backed by guarantee of muni authority)
- Revenue Bond (toll road)
- Private Activity Bond
insured by AMBAC & MBIA
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Muni Bond Tax Equivalent Yield
Take into consideration:
- Federal Marginal Rate
- State Income Tax Rate
- Whether or not the client itemizes
= (yield) / [1 - (fed + [state (1-fed)])]
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Yield to Maturity
solve for i
* assume semi annual and par value of 1000
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Yield to Call
solve for i, but use the call price instead of par value
** ALWAYS check the time period to CALL, not the length of the bond
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Bond prices and Interest Rates
Bond prices drop with increased interest rates, and they rise with a drop in interest rates
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Bond Yield Ladder
for Discount (Call Mat Curr Now)
Call
Maturity
Current
--Nominal--
Current
Maturity
Call
for Premium (No Current Mat Call)
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Yield Curve Theories
Market Segmentation - Supply & Demand (normal)
Liquidity Preference - longer maturities are compensated with higher returns for risk (normal)
Expectations Theory - inflation expectations invert the curve (inflation will cool off in the long run, invert the curve)
Unbiased Expectations Theory- term rate structure follows geometric average
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bond duration
* bigger duration = more sensitive to interest rate changes
* duration is the time at which investors are immunized from interest and reinvestment risks
* Modified Duration is a bond's price sensitivity to changes in interest rates
* A bond portfolio should have equal duration to the investor's time horizon
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portfolio immunization
duration matches time horizon
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convexity
The degree which duration changes as the yield-to-maturity (YTM) changes.
Largest for low coupon bonds, long-maturity bonds and low-YTM bonds allows investor to improve the duration approximation for bond price changes.
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bond strategies
bullet - for balloon payments, set the target date, they don't pay much coupon
ladder - like dollar cost averaging for stocks
barbell - hedge the short vs long term, only reshuffle one side at a time
tax swap - loss for gain
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Rules for using Duration to Manage Bond Portfolios
If interest rates are expected to rise, shorten duration (Interest rates up, shorten Duration)
Remember: UPS: UP for “up” and S for “shorten”)
If interest rates are expected to fall, lengthen duration. Buy low coupon bonds with long maturities.
Interest rates fall → lengthen duration.
Remember: FALLEN - FAL for “fall” and LEN for “Lengthen.”
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What is the NOI calculation for Improved Land/Real Estate?
Improved land is normally income producing.
Income properties include residential rental, commercial and industrial properties. The intrinsic value of a real estate property can be computed using a Net Operating Income (NOI) calculation.
Gross Rental Receipts plus Non-rental Income (parking, laundry, etc.) equals Potential Gross Income (PGI) minus Vacancy and collection losses minus Operating Expenses (excludes interest and depreciation) = Net Operating Income (NOI)
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Investment Company Types
Open-Ended - mutual funds, unlimited shares that trade at NAV (Net Asset Value)
Closed-Ended- limited number of shares
Unit Investment Trust- passive, self-liquidating (end on certain date) and split
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alternative investments
real estate, hedge funds, precious metals, cryptocurrency, collectibles
- regulation, liquidity, marketability, valuation, theft, taxation all to be considered
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intrinsic value of calls and puts
call option -
Intrinsic value = stock price - strike price (CallStoStri = StoStriC)
put option-
Intrinsic value = strike price - stock price (PutStriSto = StriStoP)
** intrinsic value cannot be less than zero
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Compare: Warrants vs. Call Options
Warrants are issued by corporations, whereas Calls are issued by individuals.
Warrants typically have maturities of several years.
Warrant terms are not standardized. Call options are standardized.
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What are the Hedging Positions of Futures Contracts?
Long Commodity Position: If a farmer is long a commodity (for example, corn) he needs a short hedge and will sell a futures contract.
Short Commodity Position: If Kellogg's is short a commodity (for example, corn), they need a long hedge and will buy a futures contract.
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Define: Hedging Strategies - Straddles, Collar, Protective Put
Straddle: Buying a Put and Buying a Call - The buyer does NOT own the stock.
Collar: Selling a Call (out-of-the-money) at one strike price and buying a Put at a lower strike price; investor OWNS the stock.
Protective Put: Buying a stock (or already owning it) and a Put for the stock serving as insurance against the decline in the underlying stock. (Hint: A good answer for the exam)
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Black Scholes Model
Price of CALL option considers:
- current price of underlying asset
- time until expiration (longer = more expensive)
- risk-free rate of return
- volatility of underlying asset (std dev)
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Put/Call Parity
Attempts to value a PUT option based on the value of a corresponding CALL option
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Binomial Pricing Model
price can move two ways, forms a tree
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taxation of options
IF contract lapses or expires, premiums paid/gained are SHORT TERM losses or gains
IF the contract is exercised, the premium is added to the basis of the underlying asset. If held for more than 12 months, long term gain or loss, if less, short term
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Split dollar life insurance ...
is an arrangement where an employee and employer generally share the premium cost and cash value for death benefit of a life insurance policy covering the life of the employee.
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The lower the coupon...
the more volatile the bond (interest rate risk)
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The longer the maturity date...
the more volatile the bond (purchasing power risk, reinvestment rate risk, interest rate risk)
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cash dividend effect on call option prices
cash dividends drive value of stock down, which also lowers the call option prices
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To immunize a bond portfolio over a specific investment horizon, an investor would ..
Match the average weighted duration of the bond portfolio to the investment horizon.
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pricing methods of Indexes
Value Line - Geometric Average
DOW - simple price weighted
S&P, Wilshire, NASDAQ, Russell - value weighted
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Riding the yield curve is...
a trading strategy that involves buying a long-term bond and selling it before it matures so as to profit from the declining yield that occurs over the life of a bond
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When evaluating the return of two investment managers, the performance measurement approach generally used is the
Time-weighted return
