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Personal Investment > FINAL > Flashcards

FINAL Flashcards

Weeks 11-15

1
Q

Bond Price Relationship

A

interest rates and bond price have an inverse relationship

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2
Q

Bond Price Movements

A
  1. Maturity (longer maturity = greater price sensitivity)
  2. Coupon (lower coupon = greater price sensitivity)
  3. Initial YTM (lower YTM has greater price sensitivity, greater PV of cash flows, higher duration)
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3
Q

Bond with a Warrant

A

warrant = give holder the right to buy a fixed number of stocks at a predetermined price by a certain expiration date.
Pricing = straight value of bond + market value of warrant

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4
Q

Convertible Bond

A

Convertible bond gives holder the right to convert the par value of the bond to common stock at a pre-determined price (conversion) by a certain date.
conversion ratio = par value of bond/ per-share conversion price

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5
Q

Macaulay’s Duration

A

weighted average time before the owner of the bond receives half of the present value of the bond’s cash flows
- based on maturity date, timing of intermediate and ending cash flows and YTM

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6
Q

Portfolio Duration

A

weighted duration of each bond in the portfolio

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7
Q

Duration vs Modified Duration

A

duration is a measure of how sensitive a bond is to changes in interest rates. modified duration quantified the bond’s price sensitivity to a change in interest rates
modified duration = duration (1+y)

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8
Q

Expected $ Change in Bond Price

A

$ change = -modified duration * change in y * bond price

% change = -modified duration * change in y

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9
Q

Limitations of Modified Duration

A

only considers changes in interest rates, assumes a linear relationship; therefore, only accurate for small interest rate changes

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10
Q

Convexity of the Price Change

A

duration is a good measure of price change for small interest rate changes but less accurate for larger moves. prices appreciate more than calculated with duration alone, when yield decreases

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11
Q

Convexity and Callable Bonds

A

price appreciation is capped with callable bonds because the company can call at a premium and refinance. price appreciation is capped with mortgages because holders can refinance.

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12
Q

Bond Characteristics

A

bond portfolios can provide the investor with a range of risk and return characteristics.
returns: coupon payments, accrued interest with zero coupon bonds, capital appreciation/loss
risks: changes in interest rates, credit-rating changes, default risk, liquidity risk, call risk, pre-payment risk

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13
Q

Bond Index Investing

A

create portfolio that replicates a bond market index, portfolio does not necessarily have to match the exact index but rather closely match characteristics

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14
Q

Cash Flow Matching

A

matching the bond’s maturity to when the liability is due. minimizes risk that interest rate moves would reduce the future value of the bond

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15
Q

Portfolio Immunization

A

matching the duration of bond portfolio with the investment horizon of the future liability or duration of liabilities. balances the overall effect of interest rate moves.

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16
Q

Active Bond Management

A

open account with firm offering individual bonds, research (type of bond, coupon rate, etc), interest rate anticipation, yield curve strategy, sector rotation (over or under weighting sectors), credit analysis (front-running a credit upgrade or downgrade)

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17
Q

Bond Swaps (active management)

A
  • maturity swap (sell bond and buy another to alter overall maturity of portfolio)
  • quality swap (sell bond and buy another to alter the overall quality rating of the portfolio)
  • yield swap (swap bond to improve yield)
  • tax swap (sell one bond and buy another similar yet different bond to harvest capital loss and offset capital gain up to $3,000 of ordinary income)
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18
Q

Formula Bond Investing

A

Bond Ladders: staggered maturity dates
Bond Barbells: average maturity based on portfolio of short and long term bonds
Bond Bullet: staggered purchase date with same maturity
Riding the yield curve: duration of bond portfolio exceeds duration of liability

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19
Q

Capitalized Earnings

A

normalized earnings divided by an appropriate capitalization rate

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20
Q

Preferred stock valuation

A

price of preferred stock = dividend/k (rate)

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21
Q

Dividend Discount Model

A

D1 = D0 (1+g)
Constant growth DDM = D0(1+g)/(k-g)

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22
Q

Reversion to the Mean

A

stock prices tend to trade above and below intrinsic value because of market sentiment

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23
Q

Bottom-up vs Top-down

A

bottom-up: individual securities to sectors/industries to economy
top-down: reverse order

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24
Q

Fundamental Analysis

A
  1. Economic and Industry Prospects (macroeconomic analysis, seasonality and cycles, industry prospects and trend projections)
  2. Company Operational Analysis (financial statements, ratio/trend, company prospects)
  3. Valuation (TVM, market multiples)
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25
Q

Intangible Assets

A

People, relationships, infrastructure, knowledge

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26
Q

Ratio Analysis

A

Provides for meaningful comparisons based on SEC industry code and company size

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27
Q

Liquidity Ratios

A

Current ratio: current assets/current liabilities
Quick ratio: (current assets - inventory)/ current liabilities
Working capital: current assets- current liabilities

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28
Q

Coverage Ratios

A

times interest earned: operating profit (EBIT)/ interest payment

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29
Q

Leverage Ratios

A

Debt to equity: debt/equity
Debt to assets: debt/assets

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30
Q

Asset Utilization Ratios

A

Account Receivable Turnover: sales/((begin receivables+end receivables)/2)
Average Sales Credit Period: days in year/turnover ratio

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31
Q

Management Performance Ratios

A

Return on Assets: net income/assets
Return on equity: net income/ equity

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32
Q

Profitability

A

Gross Profit Margin: GP/Revenue
Operating Profit Margin: EBIT. Revenue
Net Income Profit Margin: Net income/ revenue

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33
Q

Dupont Analysis

A

expanded return on equity equation
2-lever model: ROE=ROA (NI/assets)/Financial Leverage (total assets/equity)
3-lever model: ROE = profitability (NI/sales)asset turnover (sales/assets) financial leverage

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34
Q

Dividend Policy

A

Board of Directors Establish dividend policy
payout ratio = total dividends paid/ total earnings
Retention (plowback ratio) = 1-payout ratio

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35
Q

Dividend Growth

A

contingent on company’s return on equity and plowback ratio
dividend growth = ROE * (1-payout ratio)

36
Q

Valuation

A
  1. replacement value
  2. TVM
  3. market multiples
    value isn’t a number, it’s a range
37
Q

Technical Security Analysis

A

everything the market knowns is already contained in price action of the stock
1. Price (trend lines, moving averages, price oscillators)
2. Volume
3. Patterns
4. Time (cycles)
5. Sentiment
Contrarian Thinking: percentage of bullish advisors, mutual fund cash positions, market reaction to news, overbought or oversold indicators

38
Q

Gross Domestic Product

A

total production within the U.S., indicator of economic health
GDP = C (household consumption) + I (business investment) + G (government spending) + NE (net exports)

39
Q

Business Cycle

A

cyclical pattern of general level of economic activity (GDP): expansion, peak, contraction, trough

40
Q

Yield Curve Changes

A

graphical representation showing the relationship between YTM and term to maturity. Changes in yield curve reflect change in expectations

41
Q

Market Cycles

A

Business Cycle: recurring patterns of boom and bust economic activity measured by GDP growth or contraction
Financial Cycle: recurring pattern of expansion/recession in financial markets. tends to precede business cycle by 6-12 months

42
Q

Sector Rotation

A

active strategy of over and under weighting sectors based on economic and market cycle analysis

43
Q

Cyclical vs Defensive Industries

A

cyclical: tend to outperform during times of macro-economic expansion and peak
- ex: basic material and consumer cyclicals (lodging, auto, retail, airlines, real estate)
defensive industry: do well during recession
- ex: consumer non-cyclicals (food, lodging, healthcare, utilities)

44
Q

Pooled versus Individual Investments

A

advantages with pooled investing (fund or ETF)
- broad diversification on low-dollar investment, professional management, high liquidity, automatic reinvestment of interest and dividends

advantages with individual investments
- total control of buy and sell decisions, ability to sell short, no management fees, liquidity varies, speculation with options and futures

45
Q

Passive Equity Strategy

A

purchase a diversified portfolio of securities with intent of long-term investing, believe markets are efficient, low fees/time spent
- ex: buy and hold, indexes (basket of securities, low costs), smart beta indexing (non-market capitalization weighting), low portfolio turnover, passively-managed funds

46
Q

Active Equity Strategy

A

market is inefficient, out-perform, high fees/trading costs
- ex: individual security selection, sector rotation, value or growth investing, factor investing, ESG investing

47
Q

Combination of Passive/Active

A

Satellite approach (key passive index and many smaller active investments)

48
Q

Dollar-cost-averaging

A

fixed dollar investment at specified intervals, automatic investment plan, more shares purchased when share price is low, fewer purchased when price is high

49
Q

Dividend Reinvestment Plan

A

dividends are automatically reinvested in the company’s stock, no additional costs, application of dollar-cost-averaging, reinvested dollars are taxed in year they could have been taken out

50
Q

Margin Accounts

A

offers trading leverage, pays interest on margin loan, security is pledges as collateral, margin account agreements
maximum leverage depends on initial margin % set by federal law, broker-dealer
- minimum account balance ($2,000 or 100% purchase price)
- initial margin %
- maintenance margin (set by broker-dealer), if account fails, margin call
maintenance call = (1-50%)/*1-maintenance margin) * initial stock price

51
Q

Short Sales

A

margin rules apply, broker retains proceeds from the short sale and marked to market each day

52
Q

Qualified Stock Dividends

A

a qualified dividend is income treated as a long-term capital gain: qualifying companies (dividends from domestic and certain foreign companies that meet IRS definition) and minimum holding period for common stock dividends (more than 60 days out of 121-day period. 91 days out of 181 for preferred stock)

53
Q

Worthless Security Rule

A

treated as a capital loss, assumes sale was made on last day of the year

54
Q

Wash Sale Rule

A

Stock or other investment security is sold at a loss and repurchased a substantially identical security within 30 days before or after the sale.
- losses are not recognized for tax purposes
- adjusted basis reflects repurchase price plus loss realized on date of sale
- holding period for replacement stock includes holding period of original sales

55
Q

Taxable vs Tax-advantaged Accounts

A

Taxable: municipal bonds, US T-bills, note and bonds, growth stocks with long-term capital gains

Tax-advantaged: high-income producing assets, short-term stocks, zero coupon bonds, TIPS

56
Q

Call Option

A

Buyer: right to buy (believe market will increase)
Seller (write): obligation to sell (believe market will decrease)

57
Q

Put Option

A

Buyer: right to sell an asset (believe market will increase)
Seller (write): obligation to buy
Buyer pays a premium to writer to secure right

58
Q

Option Clearing

A

listed options - standardized contracts traded on exchanges. clear through options clearing corp (OCC). options are standardized.
over-the-counter options: not listed on exchanges, lack the standardization and clearing house intermediary

59
Q

Option Contracts

A

strike price: (price which the call buyer can buy, price at which the put buyer can sell)
premium cost: (price per share buyer must pay writer)
expiration date: (date that the right no longer exists)
type of contract: (call or put)

60
Q

Traditional Options vs LEAPS

A

traditional options: expires within 6 months, liquid, available on many underlying securities
LEAPS: long-term equity anticipation securities have expiration dates out to 3 years, limited in respect to number of underlying securities, often illiquid

61
Q

Cost of the Option Premium

A

value of an option is dependent on five factors:
1. current price of asset
2. strike price
3. time to expiration
4. volatility
5. risk-free interest rate

62
Q

European vs American Options

A

European option: grants option holder right to exercise only at a specific time

American option: grants the option holder the right to exercise anytime up to expiration date, flexibility will result in higher premium

63
Q

Option Settlement

A

Stock & ETF option: security delivered, settlement is made by delivering appropriate number of shares
Index option: cash settlement, index-based options are settled in cash

64
Q

Premium’s Intrinsic and Time Value

A

Intrinsic value: current value of the option
Time value: amount investor will pay for the likelihood that the option will be in-the-money before expiration

65
Q

Writing Call and Put Option

A

writer benefits from receipt of the premium; however, if the option is exercised then there can be a loss
- maximum gain is the premium received
- maximum loss depends on the type of position
- covered call/put: max loss is limited since security already owned
-uncovered (naked) put/call: max loss for uncovered call if infinity. max loss for naked put is the difference between strike price and zero.

66
Q

Characteristics and Risks of Standardized Options

A

broker-dealer offering the options account is required to send investor the ODD
- Options disclosure document explains characteristics and risk of standardized options
- options account must be approved by the registered options principal at the firm

67
Q

Forward versus Futures Contract

A

Forward: agreement between two parties, one party agrees to buy and second party agrees to deliver
Future: standardized forward contract that gives buyer right to buy/sell, clearing house, contract can be sold on secondary market before delivery date, settled in cash

68
Q

Long Option vs Future

A

Long the Option
Pro: buyer has right, max loss is premium, variety of premiums, unique combos to create payoff pattern
Con: time decay, bid-ask premium spread, lower liquidity, options not available on all securities

Long the Future
Pro: direct move with price of commodity, no time decay, highly liquid contracts, contract multiplier much higher than stock option
Con: rapid price changes, must maintain margin, futures must be settled at expiration or position closed prior

69
Q

Payoff Strategy

A

Protective put: long the stock, long the put
Collar: long the put, long the stock, short the call
Buy Straddle: long the call, long the put
Sell Straddle: short the call, short the put
Strangle: long the call, long the put
Covered Call: payoff pattern for the covered call writer

70
Q

Factors impacting premiums

A
  • strike price
  • time to expiration
  • implied volatility
    option selection: your outlook on the market, risk tolerance
71
Q

Potential Benefits of Alternative Investments

A

enhanced risk-return relationship: possibility of alpha, reduce portfolio risk, improved portfolio diversification
introduction leverage into portfolio

72
Q

Characteristics of Commodities

A

volatility of return
- supply and demand, storage and delivery, scarcity
ways to invest in commodities
- purchase commodity, purchases shares in commodity company, futures indexes, mutual funds, ETFs, hedge funds

73
Q

Collectibles

A

items held for appreciation
categories: artwork, sculptures, antiques, memorabilia, wine, automobiles, tangible property, stamps, coins
characteristics: illiquid market, asynchronous information, subjectivity with valuations
ST = ordinary tax rate
LT = 28% capital gain rate

74
Q

Managed Futures

A

pooled investments managed by professional commodity trading advisers, trade future contracts, active management, high fees plus performance incentives, high volatility of return, uncertain correlation with traditional assets

75
Q

Real Estate Investment Trust (REITs)

A

publicly-traded, closed-end investment companies listed on stock exchanges or over the counter, liquid
- equity REITs, income REIT, hybrid REIT
highly predictable cash flows

76
Q

Real Estate Mortgage Investment Conduits (REMICs)

A

pooling and securitization of commercial and residential mortgages, offers flow-through treatment, form of collateralized mortgage, distribution tranches, illiquid

77
Q

Real Estate Limited Partnerships (RELPs)

A

pass-through entities that pool money to invest in residential and commercial properties, income is considered passive to LPs
- general partners: day-to-day operational decisions
- limited partners: passive investors, share in income and capital appreciation
generally high commissions and management fees, lack of liquidity, due diligence

78
Q

Master Limited Partnerships

A

publicly-traded limited partnership, liquidity as traded on stock exchanges, invest in natural resources and energy, general and limited partners, required to receive pass-through tax treatment

79
Q

Hedge Fund Strategies

A

alternative classes, arbitrage, sectors, country, fixed income, contra funds, market timing, special situations

80
Q

Hedge Fund Characteristics

A

incentive fee, illiquid, lockup period, minimal regulatory oversight, business entity, exempt from SEC, limited to accredited investors

81
Q

Hedge Fund Due Diligence

A

understand investment, fund governance, investment strategy and risk controls, use of leverage, fee structure and performance incentives, investment minimums, withdrawal options, research management team, historical performance, references

82
Q

Venture Capital

A

non-publicly-traded investment companies, pool investor capital to invest in a portfolio of start-ups, realizing only a small number will succeed, venture capital investors have an exit strategy
angel investors: seed funding for early-stage development
venture equity firms: start-up through emerging operations and expansion
venture debt firms: provide bridge loans until next stage of equity funding

83
Q

Private Placement Debt

A

non-public debt security, no SEC registration, qualified institutional buyers (>$100M)
- speed to market, avoid underwriting costs, negotiated terms and schedules, higher interest rates, lack of liquidity

84
Q

Private Placement Equity

A

non-public placement of equity, pooled investments, venture capital and buyout groups, investors offer limited partnership, LT investment with cash-out plan, fees and expenses

85
Q

Private Equity “Evergreen Funds”

A

open to accredited investors, actively managed funds, no fixed end date, diversification, general/limited partners, no lock-up, minimum investment low, need due diligence

86
Q

Investment Policy Statements

A

describes investment course of action, aligned with client’s values and goals. formalized during times of calm decision-making. written document, promotes clarity, written agreement.
1. communicate your core investment tenants
2. allowable asset classes/target allocations & investment assumptions
3. permitted vs excluded security types
4. trading discipline/execution
5. selection criteria (due diligence)
5. distributions, reinvestment and contributions
6. benchmarks: identical in asset class, representative of style and region, passively managed, open to new investors
7. maintain asset allocation, rebalancing rules
8. communicate: format of report and frequency of communication

Personal Investment (6 decks)

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