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Jenn's CFP Exam Prep > Investment Planning > Flashcards

Investment Planning Flashcards

1
Q

Types of Underwriting Agreements

for Securities

A
  1. Best Efforts
  2. Firm Commitment
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2
Q

Red Herring

A

Preliminary prospectus

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3
Q

Prospectus

A

The offering document for the sale of securities.

Disclosure

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4
Q

Green Shoes

A

The right to increase the size of an offering

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5
Q

Initial Public Offering (IPO)

(of securities)

A

A company’s first public offering of securities

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6
Q

Secondary Offering

(of securities)

A

As opposed to IPO

A sale of securities to the public by insiders or other affiliated persons

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7
Q

Managing Underwriter

Lead Underwriter

or

Originating House

A

The investment banker that takes the lead role in an underwriting group

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8
Q

Syndicate

A

The investment banking companies that participate with the managing underwriter to assist in the distribution of the new issue

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9
Q

Selling Group

A

Brokerage firms that help distribute securities in an offering but that are not members of the syndicate

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10
Q

Broker-Dealer

A

Broker: Agent of seller of securities who receive a commission for executing a transaction

Dealer: Principals who buy and sell securities for their own accounts

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11
Q

Other names for Dealers

(depends on the market)

A

Market Maker: OTC Market

Specialist: Securities Exchange

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12
Q

A dealer quotes prices on a ….

A

bid and ask basis.

Bid: The price at which the dealer will BUY

Ask: The price at which the dealer will SELL

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13
Q

Venture Capital

A

Financing for privately held companies

Typically in the form of convertible preferred stock

Characterized by:

  • HIGH risk with potential for HIGH return
  • Lack of liquidity
  • Low correlation with equities
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14
Q

Stages of Venture Capital (7)

A
  1. Seed capital
  2. Start-up capital
  3. First-stage financing
  4. Second-stage financing
  5. Mezzanine financing
  6. Bridge financing
  7. Acquisition financing
  8. Leveraged buyout (LBO) financing
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15
Q

Private Placements

A

Used in place of an IPO (avoids SEC registration requirements).

Securities sold privately to meet cap needs.

Usually bonds

Limited to 35 unaccredited investors // unlimited accredited investors

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16
Q

Accredited Investors

A
  • Bank, insurance company, registered investment company, business development company, or small business investment co
  • Charitable organization, corp, partnership with assets > $5M
  • Director, executive officer, or general partner of the company selling the securities
  • A business in which all equity owners are accredited investors
  • A natural person with NW > $1M at time of purchase (not including value of primary residence)
  • A natural person with income > $200,000 in each of the two most recent years (> $300K if married) and a reasonable expectation of same income in current year
  • A trust with assets > $5M, not formed to acquire securities offered, whose purchase a sophisticated person makes
  • Employee benefit plan
    • By ERISAs definition
    • if a bank, insurance company or RIA makes investment decisions OR if plan has assets > $5M
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17
Q

Limited Partnerships

A

General partner + limited partners

General Partner: Unlimited liability

Limited Partner: Limited Liability

  • Advantages
    • business venture participation with limited liability
    • shared start up costs
    • receipt of periodic income payment
  • Disadvantages
    • generally riskier investments than bonds or exchange-traded equities
    • usually illiquid
    • limited partners can’t participate in management of partnership
    • sale of partnership interest may be restricted
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18
Q

Regular Certificates of Deposit (CDs)

A
  • Deposits made with bank or savings and loan
  • For a specific period (1 mo - 5 yrs)
  • Interest subject to OI tax in year earned
  • Penalty due if redeemed before maturity
  • FDIC insured up to $250,000 per ownership category
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19
Q

Prompt - what is it?

Negotiable CD

A
  • Deposits of $100K +
  • Term up to 1 yr
  • usually purchased by institutional investors
  • Regular CDs redeemable by issuing bank; negotiable CDs bought/sold on secondary market
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20
Q

Money Market Deposit Accounts (MMDAs)

A
  • not the same as money market mutual funds
  • bank obligations
  • federally insured up to $250,000 per ownership cat
  • safe
  • highly liquid
  • min balance mx req
  • limited check writing (6/cycle)
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21
Q

Money Market Mutual Funds

A
  • offered by open-ended investment companies
  • taxable and tax-exempt (fed and state)
  • typically invest in US treasury bills, commercial paper, negotiable CDs
  • min investment is $1,000
  • check writing capabilities
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22
Q

US Treasury Bills

A
  • short-term gov’t securities
    *
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23
Q

Risks Associated with Investing in Bonds (8)

A
  1. Interest Rate
  2. Reinvestment Rate
  3. Call
  4. Financial
  5. Default (Credit)
  6. Purchasing Power
  7. Liquidity
  8. Event
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24
Q

Interest Rate Risk

A

The risk associated with a decline in the price of a bond as market interest rates rise. As IR go up, bond prices go down (inverse relationship).

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25
Q

Reinvestment Rate Risk

A

Variability in the rate at which reinvestments are made.

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26
Q

Call Risk

A

The risk that an issuer will exercise a call option on a bond. The issuer will call a bond when IR fall so that $ can be saved by refinancing the bonds at this lower IR.

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27
Q

Financial Risk

A

The risk associated with the level of debt an issuer has outstanding. High debt levels increase the risk to bondholders that the firm will not generate sufficient cash flow to meet its obligations to repay interest or principal when due.

28
Q

Credit (Default) Risk

A

The risk that an issuer may not be able to make principal and interest payments when due on a bond.

Note: US Treasury securities are considered to be free of default risk (but they are not risk free - they have IR risk, reinvestment rate risk, and purchasing power risk)

29
Q

Purchasing Power (Inflation) Risk

A

The risk associated with the devaluation of cash flows from inflation, as measured in terms of purchasing power. The bond holder is exposed to this risk because usually the coupon rate is fixed (in dollar amt, not %) for the term of the bond.

30
Q

Liquidity Risk

A

The ease with which an issue can be sold at or near its current market value.

31
Q

Event Risk

A

The possibility that a bond issue will be affected by an unanticipated and damaging event.

32
Q

US Gov’t Securities

A

T-Notes

T-Bonds

STRIPS

TIPS

Savings Bonds

33
Q

US Gov’t AGENCY Securities

(Diff than Gov’t Securities)

A

The following agencies of the federal gov’t are authorized to issue debt securities:

  1. Farm Credit Administration
  2. GNMA

In addition, some private corporations have an indirect backing/guarantee of US gov’t and issue debt securities:

  1. FHLMC
  2. FNMA
  3. SLMA
34
Q

US T-Notes and T-Bonds

A

Maturity:

T-Notes: 2, 3, 5, 7, 10 years

T- Bonds: 30 years

Issued @ Par

Semiannual coupons

Issued in increments of $100

Min $100

Default Risk Free

Exempt from SALT

Fed Taxes: all interest taxable at OI in year earned

Trade in secondary market

Sold on bid-ask manner from standpoint of seller

Ask - what seller wants for it

Bid - what buyer will pay for it

OID

35
Q

OID

(Original Issue Discount)

A

Applies to T-Notes and T-Bonds

If investor did not pay MORE THAN face value (after Jul 1, 1982) then they must include OID and pay tax on income yet to be received.

Basis is increased by amount of OID tax paid each year

36
Q

Treasury STRIPS

A

Separate Trading of Registered Interest and Principal of Securities

Zero-Coupon Bonds

Created by separating semiannual coupon payments and principal of T-Notes or T-Bonds

Issued at a deep discount

Can’t be purchased directly from US Treasury

Sensitive to IR changes,

No (or very little) … call, liquidity or default risk

37
Q

TIPS

Treasury Inflation Protection Securities

A

Principal is adjusted by changes in CPI

Maturity: 5, 10, 30 years

Sold in increments of $100

Min $100

Semi-annual interest payments determined by multiplying inf-adj principal value by ½ fixed IR

Coupon Rate stays the same, but the amount of the coupon payment changes on basis of inf-adj principal (or par)

All interest federally taxed at OI levels in year earned

Increase in principal is also federally taxed at OI levels

38
Q

Savings Bonds

A

Series …

E (replaced by EE in 1980)

EE (replaced E)

H (replaced by HH in 1980)

HH (replaced H)

I

39
Q

E Series Savings Bond

A

Replaced by EE in 1980

40
Q

EE Series Savings Bond

A

Replaced E in 1980

Electronic

Sold at 100% face value

Denominations: $25 to $10,000

Eligible to earn interest up to 30 years

IR fixed for life of bond

new issue IR adjusted semi-annually

Must be held min 12 mos

3-mo interest penalty if redeemed w/in 5 y of issue

41
Q

Gov’t Sponsored Enterprises (GSEs)

A
  • They are instrumentalities, NOT agencies
  • Created by Congress to increase flow of credit to the economy
  • Authorizes these agencies to issue debt securities
  1. Farm Credit
  2. GNMA
42
Q

TEY

(Taxable Equivalent Yield)

A
  • TEY of the muni bond
  • Used to compare the advisability of investing in municipal, tax-exempt issues to taxable, corporate issues

TEY = tax-exempt yield

1 - marginal tax rate

Example:

  • Kate owns a muni bond
  • 3% coupon rate
  • 32% federal marginal tax bracket
  • TEY = 3/1-.32 = 4.41%*
  • Therefore, t_o achieve the same yield on a taxable corporate bond,_ the corporate bond must have a coupon rate of at least 4.41%.*
43
Q

Mortgage Pass-Through Security

A

GNMA, FHLMC and FNMA create these mortgage-backed securities

44
Q

Municipal Bond

A

2 Types

  1. General Obligation Bonds (GOs)
  2. Revenue Bonds

Interest income excluded from taxable income for both fed and SALT (SALT only excluded if bondholder is a resident of state/municipality)

45
Q

General Obligation Bond (GO)

A

Muni bonds

issued to finance capital improvements benefitting the community

typically these improvements do not produce revenue

P&I backed by revenues of the issuer (full faith and credit bonds)

backed by taxes

taxpayer vote usually required to approve new issues

46
Q

TEY

(Taxable Equivalent Yield)

A
  • TEY of the muni bond
  • Used to compare the advisability of investing in municipal, tax-exempt issues to taxable, corporate issues

TEY = tax-exempt yield

1 - marginal tax rate

Example:

  • Kate owns a muni bond
  • 3% coupon rate
  • 32% federal marginal tax bracket
  • TEY = 3/1-.32 = 4.41%*
  • Therefore, t_o achieve the same yield on a taxable corporate bond,_ the corporate bond must have a coupon rate of at least 4.41%.*
47
Q

TEY

(Taxable Equivalent Yield)

A
  • TEY of the muni bond
  • Used to compare the advisability of investing in municipal, tax-exempt issues to taxable, corporate issues

TEY = tax-exempt yield

1 - marginal tax rate

Example:

  • Kate owns a muni bond
  • 3% coupon rate
  • 32% federal marginal tax bracket
  • TEY = 3/1-.32 = 4.41%*
  • Therefore, t_o achieve the same yield on a taxable corporate bond,_ the corporate bond must have a coupon rate of at least 4.41%.*
48
Q

After-Tax Yield

A
  • ATY of the taxable corporate bond
  • Compare advisability of investing in taxable issues with that of investing in muni tax-exempt issues

After-Tax Yield = (pretax return) X (1-marginal tax rate)

For a _taxable corporate bond_ that yields 4.35%, the after-tax yield to an investor with a 35% marginal tax rate is 2.83%.

ATY = (4.35%) X (1-.35)

= (4.35%) X (0.65)

= 2.8275 or 2.83%

49
Q

Corporate Bonds

A
  • debt securities
  • a loan made to the corporation by an investor for a specific period of time at a fixed annual interest rate
  • Most issued in the form of debentures (unsecured)
  • Higher coupon rates than secured bonds, munis or other US treasury securities
  • Callable or noncallable
50
Q

Types of Secured Corporate Issues

A
  • Mortgage Bonds
  • Collateral Trust Bonds
  • Equipment Trust Certificates
51
Q

Market Discount Bond

A
  • A bond acquired at a discount (d2 decline in value of obligation after issue)
  • Distinguish between this and OID
  • The amount attributed to market discount isn’t included in income until sale/disposition and then it’s treated as interest income
52
Q

Market Premium Bond

A
  • A bond purchased at a premium
  • when interest is greater than that of the current market on bonds of similar quality and risk
  • Investors taxed at OI rates (fed and state) as bond interest is paid
53
Q

Zero-Coupon Bonds

A
  • Sold at a deep discount … OID
  • Investors receive the difference in value at bond’s maturity date rather than in the form of periodic interest payments
    • eliminates opportunity to reinvest proceeds at higher interest rate
  • Prices more volatile than other bonds
  • not subject to reinvestment rate risk
  • Phantom Income
  • Best inside tax-deferred account (since tax is paid on phantom income)
54
Q

Convertible Bonds

A
  • Corporate bonds
  • may be exchanged for a fixed number of shares of the issuing company’s common stock
  • pay lower interest rates than straight bonds
  • price is less volatile than common stock
  • low correlation with regular corporate bonds, moderate correlation with common stock
  • conversion exercised at investor’s discretion
  • conversion price
55
Q

The conversion price of a convertible bond is

A

The stock price at which a convertible bond can be exchanged for shares of the issuer’s common stock.

56
Q

The conversion ratio (rate) of a convertible bond is

A
  • The number of shares of stock into which a bond may be converted (ie how many shares of stock can i get for this convertible bond)

Conversion Ratio = Par Value of Convertible Security

Conversion Price

Example:

  • Convertible Bond has conversion price of $40/share of common stock
  • Par Value of Bond = $1,000

Conversion Ratio = $1,000/$40

  • Conversion Ratio = 25*
  • So 25 shares of stock can be obtained for 1 $1,000 par value bond at a conversion price of $40/share. Or, in other words, this bond is convertible into 25 shares of stock*
57
Q

The conversion value of a convertible bond is

A

Conversion Value = (Conversion Ratio) X (market price of common stock)

Conversion Ratio = 25

Market Price of stock = $50/share

Conversion Value = 25 x $50 = $1250

So, if the current. market price of the bond is less than $1,250 investors would buy the bond because it’s conversion value is greater than its current market price.

58
Q

A convertible bond’s straight value is …

A

The price a convertible security would sell for in the secondary market if the bond did not contain the convertible option.

59
Q

A convertible bond’s investment value is …

A

the same as its intrinsic value as a straight bond

60
Q

Portfolio Immunization

A

an interest rate risk management technique that offsets interest rate risk against reinvestment rate risk

61
Q

Bond Ladders

A
  • Long-term strategy for diversifying and staggering maturity dates
  • Establishes a schedule for reinvesting bond proceeds as they mature
  • ST bonds minimize losses if rates rise
  • LT bonds give opportunity for price appreciation if rates fall
62
Q

2 advantages of bond ladders are …

A
  1. higher yields d2 combo of LT and ST bonds (compared to portfolio w/only ST bonds)
  2. Cash is more avail to investor since each bond matures at a different time

10 bonds purchased at $20,000 each

Maturities range from 1 to 10 years

Total Portfolio = $200,000

63
Q

Bond Barbells

A
  • An active strategy
  • only ST and LT bonds are purchased
  • As ST bonds mature investor can reinvest
  • ST bonds minimize losses if rates rise
  • LT bonds give opportunity for price appreciation if rates fall
64
Q

6 Categories

Financial Ratios Used by Fundamental Analysts

A
  1. Liquidity Ratios
  2. Activity Ratios
  3. Profitability Ratios
  4. Leverage Ratios
  5. Ratios for Bond Analysis
  6. Ratios for Stock Analysis
65
Q

2

Liquidity Ratios

A
  1. Current Ratio

Current Assets

____________

Current Liabilities

  1. Acid Test (Quick Ratio)

Current Assets - Inventory

______________________

Liabilities

66
Q

3

Activity Ratios

A

Inventory Turnover Ratio

Cost of Goods Sold

_________________

Average Inventory

Accounts Receivable Turnover

Sales

_____

Average Accounts Receivable

Fixed-Asset Turnover

Annual Sales

___________

Fixed Assets

67
Q

Profitability Ratios

A

Jenn's CFP Exam Prep (9 decks)

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