Chapters 1-5

Question 1

Real Return

Answer 1

Inflation Adjusted return, adjusting stated (nominal) return gives investor more real assessment of actual return.

Question 2

Expected Return

Answer 2

Average of distribution of possible returns. Take the probability of each possible return outcome and multiply it by the return outcome and adding both together. Can be used to forecast the future value of a portfolio and acts as a guide to measure actual returns. Built into the CAPM – Capital Asset Pricing Model and calculates the expected return.

Question 3

Risk Adjusted Return

Answer 3

Assesses if the amount of risk is comparable with the risk taken.

Question 4

Current Yield

Answer 4

Divide annual interest payment by current market price

Question 5

Return on Investment

Answer 5

Measure of performance adding all the dividends, interest, return of principal, and capital gains together then divide by the number of years held then divide by original investment amount. (Div, int, cap gain, return of prin / years held / original inv $)

Question 6

Holding Period Return

Answer 6

Return for the period of time the investment was actually held. Particularly for investments held short term.

Question 7

Annualized return

Answer 7

(Average Return) Geometric rate of return over any given period into an annual basis. Provides the average annual return per year over that holding period.

Question 8

Risk Free Rate of Return

Answer 8

Current Rate for 90 day treasury bills typically used for calculations for risk adjusted returns or Sharpe Ratio. (Average return earned in excess of the risk free rate per unit or volatility or total risk)

Question 9

Total Return

Answer 9

Rate of Return from all sources, including appreciation or depreciation, interest and dividends

Question 10

Risk Premium

Answer 10

A Higher return expected for taking on greater risk with investing in a growth stock vs. a blue chip or more established company.

Question 11

Benchmark Portfolio’s

Answer 11

Way to evaluate portfolio returns by comparing them to benchmark index such as the S&P 500, Russell 2000 or EUR AUS and FarEast Index (EAFE)

Question 12

Yield to Maturity

Answer 12

Rate of return based on actual purchase price of bond, takes any prem or discount into account and uses actual time to maturity for the number of compounding periods. If the bond was purchased at par the YTM would equal stated coupon rate.

Question 13

Real Interest Rate

Answer 13

Receives this rate after inflation is taken into account. Nominal Int rate = the real interest rate PLUS an inflation premium.

Question 14

Family Limited Partnership

Answer 14

Used to minimize estate and gift taxes, but must have a legit business purpose (managing real estate, family business, etc.)

Question 15

C Corp

Answer 15

Pays corporate income tax, and the owners pay personal income taxes on profits received as dividends (double taxation)

Question 16

S Corp

Answer 16

Suitable for small companies (less than 75 shareholders) that want legal protection of a corporation but flow through of taxation partnerships. *Key word: FLOWssss-through

Question 17

Limited Liability

Answer 17

Provides owners with protection from debts, but is taxed as a sole proprietorship.

Question 18

Preservation of Capital

Answer 18

Investor would be concered with safety, invest in Treasury Bills or Money Market Funds.

Question 19

Current Income

Answer 19

Needs income for living expenses. Invest in high dividend stocks like utilities.

Question 20

Growth and Income

Answer 20

Invest in a mix of Bonds and Stocks.

Question 21

Growth

Answer 21

Most concerned with retirement growth. Invest in a diversified stock or mutual fund portfolio. Sector funds.

Question 22

Speculation

Answer 22

High risk investments with potential of VERY large returns. Rarely an overall portfolio goal but may have a dedicated portion of the portfolio to this goal. Aggressive growth funds and small cap issues would be appropriate.

Question 23

Cost Basis

Answer 23

Start with original price including transaction costs, add the dollar value of dividends invested that were reinvested. Cost Basis = Original Price + Transaction costs + Dividends. *Stepped UP Cost Basis is applied with inherited stock and is the cost on the date of death.

Question 24

Corporate Income Taxes

Answer 24

Dividend Exclusion of 70% that applies to Corps that own less than 20% of another company. If the company owns MORE than 20% then the exclusion is 80%. No tax break on Bonds, so companies do not buy them.

Question 25

Trust Income Taxes

Answer 25

Rev Trusts taxed at grantor’s personal income tax rate-max of 39.6%. Trust is IRREV on Grantor’s death, Grantor has the right to change or terminate trust anytime and can serve as TTEE. IRREV Trusts are taxed at special trust income rates (need a TIN) and will be created during the grantor’s lifetime or contained in a will and become active upon death.

Question 26

Estate Taxes

Answer 26

Surviving Spouses are not subject to deceased Spouses Estate Tax. Estates valued at LESS than 5.34MM are free from taxes.

Question 27

Gift Tax

Answer 27

Up to 14k/year to an unlimited number of people. Married couple is 28k/year per beneficiary.

Question 28

Defined Benefit Plan

Answer 28

Benefits based on a formula of years of service and salary, and an age factor is used as well. Employer makes all contributions, all investment decisions, and bears all the risk.

Question 29

Qualified Plan

Answer 29

A retirement plan that qualifies for special tax treatment. The investment policy statement is a written document that outlines the plans investment objectives and guidelines

Question 30

Non- Qualified Plan

Answer 30

The employer cannot deduct their employer contributions.

Question 31

Defined Contribution Plan

Answer 31

Allocate money to participant’s base on a percentage of each employee’s earnings. Employees can choose their own investment mix and plans may be structured as a Profit sharing plan, 401k, Money Purchase Pension Plan or 403b. *403B is ONLY available to employees of schools, hospitals, and non-profits.

Question 32

457 Plan

Answer 32

Non-Qualified deferred comp plan established by state and local governments, and tax exempt governments and employers. Eligible employees can salary deferral cont, and earnings grow on tax deferred basis.

Question 33

Call Risk

Answer 33

interest rates fall, bonds more likely to be called in and reissued at a lower coupon rate.

Question 34

Reinvestment Risk

Answer 34

Reinvestment of principal after a bond is called or dividends from a high coupon bond being invested in a lower coupon rate.

Question 35

Credit Risk

Answer 35

bond Issue may not be able to pay expected interest rate pmts or principal.

Question 36

Interest Rate Risk

Answer 36

If interest rates rise bond prices fall; not concern if holding the bond to maturity.

Question 37

Purchasing Power Risk

Answer 37

Inflation risk, refers to the possibility as inflation increases the purchasing power of the bond will decrease.

Question 38

Liquidity Risk

Answer 38

Bond Marketability, certain issues may be less marketable than others

Question 39

Event Risk

Answer 39

Leveraged buyouts, restructurings, mergers and acquisitions and bankruptcies can have a negative effect on bond prices.

Question 40

Currency Risk

Answer 40

AKA Exchange risk, only applies to foreign bonds.

Question 41

Systematic risk

Answer 41

Market risk that the entire market will decline, cannot diversify away.

Question 42

Beta

Answer 42

Measures stock volatility based on general market movements. Typically, the market as a whole is assigned a beta of 1.0. So, a stock or a portfolio with a beta higher than 1.0 is predicted to have a higher risk and, potentially, a higher return than the market. Conversely, if a stock (or fund) had a beta of .85, this would indicate that if the market increased by 10%, this stock (or fund) would likely return only 8.5%. However, if the market dropped 10%, this stock would likely drop only 8.5%.

Question 43

Alpha

Answer 43

Measure of stock price volatility based on the specific stock.

Question 44

Sharpe Ratio

Answer 44

(Total Return – Risk free rate of return) Lower ratio = lower return; higher ratio = higher return.