Investment Planning - Pre Study

Question 1

Real Rate of Return

Answer 1

Question 2

Benchmark need for lie insurance

Answer 2

10-16 x gross income

Question 3

Health insurance benchmark

Answer 3

A client needs at least a $1 million lifetime cap pre-Affordable Care Act. ACA eliminated per illness or per lifetime caps

Question 4

Disability insurance benchmark

Answer 4

If a client is paying premiums with after-tax dollars, then a policy paying about 60-70% of gross income is necessary.

Question 5

Property and auto insurance benchmark

Answer 5

A policy that covers both home and auto for fair market value is appropriate.

Question 6

LTC benchmark

Answer 6

A policy that covers both home and auto for fair market value is appropriate.

Question 7

Personal Liability Umbrella Policy

Answer 7

Clients need a PLUP with $1-3M in liability protection.

Question 8

Housing ratio benchmark

Answer 8

A client’s primary mortgage, which includes principal, interest, taxes and homeowner’s insurance should not exceed 28% of gross income.

Question 9

The Housing Ratio Plus All Other Debt Ratio

Answer 9

A client’s primary mortgage plus all other recurring debt payments should not exceed 36% of gross income.

Question 10

Retirement Benchmark Amount

Answer 10

A client’s primary mortgage plus all other recurring debt payments should not exceed 36% of gross income.

Question 11

Education Funding Benchmark

Answer 11

Depending upon the university, a client should save $3,000, $6,000 or $9,000 per year for 18 years to fund a child’s education.

Question 12

recession

Answer 12

six consecutive months (or two quarters) of declining GDP.

Question 13

depression

Answer 13

if the recession lasts for 18 months or six consecutive quarters.

Question 14

examples of debts that are not discharged through Chapter 7 bankruptcy

Answer 14

Students and Government loans. * 3 years of back taxes. * Alimony and Child support. * Monies owed due to malicious acts, drunk driving, criminal fines and penalties, or embezzlement. Debts related to fraud.

Question 15

assets exempt from creditors through chapter 7 bankruptcy

Answer 15

Exempt property: homestead, life insurance, qualified plans

Question 16

Emergency Fund Ratio

Answer 16

Current Assets ÷ Monthly Nondiscretionary Expenses

Question 17

Consumer debt payments should not exceed…

Answer 17

20% of NET income

Question 18

Housing debt should be less than or equal to…

Answer 18

28% of GROSS income

Question 19

Housing plus all other recurring debt should be less than or equal to

Answer 19

36% of GROSS income.

Question 20

Housing Debt Ratio Formula

Answer 20

Monthly Housing Costs (P+I+T+I) / Monthly Gross Income

Question 21

Housing and all other debt ratio formula

Answer 21

Monthly Housing Costs (P+I+T+I) + all other recurring debt payments/ Monthly Gross Income

Question 22

It’s appropriate to rent or lease if:

Answer 22

The client’s time in the property is going to be short (1-3 years).

Question 23

2/6 ARM

Answer 23

the interest rate cannot increase more than 2% per year or 6% during the term of the loan.

Question 24

Savings Ratio

Answer 24

Annual Savings (Employee + Employer Contributions) / Annual Gross Income

Question 25

- Required investment advisors to register with the SEC or state.

Answer 25

Investment Advisers Act of 1940

Question 26

- Required investment advisors to register with the SEC or state.

Answer 26

Securities Act of 1933

Question 27

Regulates the secondary market and trading of securities. - Created the SEC to enforce compliance with security regulations and laws.

Answer 27

Securities Act of 1934

Question 28

- Authorized the SEC to regulate investment companies. - Three types of investment companies: Open, Closed, Unit Investment Trusts

Answer 28

Investment Company Act of 1940

Question 29

Established SIPC to protect investors for losses resulting from brokerage firm failures. - Does not protect investors from incompetence or bad investment decisions. - Protects accounts member firms open for clients, regardless of the client’s citizenship.

Answer 29

Securities Investors Protection Act of 1970

Question 30

- Defines an insider as anyone with information that is not available to the public. - Insiders cannot trade on that information.

Answer 30

Insider Trading and Securities Fraud Enforcement Act of 1988

Question 31

What are defined as money Market Securities?

Answer 31

*Treasury Bills - Issued in varying maturities up to 52 weeks. - Denominations in $100 increments through Treasury Direct up to $5 million per auction. Larger amounts available through a competitive bid. * Commercial Paper - Short-term loans between corporations. - Maturities of 270 days or less and it does not have to register with the SEC. - Commercial paper has denominations of $100,000 and are sold at a discount. * Bankers Acceptance - Facilitates imports/exports. - Maturities of 9 months or less. - Can be held until maturity or traded. * Eurodollars - Deposits in foreign banks that are denominated in US dollars

Question 32

What does the investment policy statement establish?

Answer 32

“RR TTLLU” --> Risk, Return, Taxes, Time-line, Liquidity, Legal, and Unique circumstances

Question 33

Buying Government Securities:

Answer 33

Increases the money supply and decreases interest rates.

Question 34

Selling Government Securities:

Answer 34

Decreases the money supply and increases interest rates.

Question 35

1 standard deviation percentage

Answer 35

68%

Question 36

2 standard deviation percentages

Answer 36

95%

Question 37

3 standard deviation percentages

Answer 37

99

Question 38

what is coefficient of variation?

Answer 38

* Coefficient of variation tells us the probability of actually experiencing a return close to the average return. * The higher the coefficient of variation the more risky an investment per unit of return. CV= standard deviation/average return.

Question 39

Covariance

Answer 39

* Covariance is the measure of two securities combined and their interactive risk. In other words, how price movements between two securities are related to each other. * Covariance is a measure of relative risk. covariance is calculated as the deviation of investment ‘A’ times the deviation of investment ‘B’ times the correlation of investment ‘A’ to investment ‘B’

Question 40

Correlation or Correlation Coefficient

Answer 40

Correlation ranges from +1 to -1 and provides the investor with insight as to the strength and direction two assets move relative to each other. COV of ab / (standard dev a) (standard dev b)

Question 41

beta

Answer 41

measures the volatility of a diversified portfolio against the market which is a beta of 1. Beta= COV /variance of the market, or standard dev of market x standard dev of individual security x correlation coefficient/ standard deviation of the market squared (or variance of market)

Question 42

R squared, or correlation coefficient

Answer 42

a measure of how much return is due to the market or what percentage of a security’s return is due to the market. Square correlation coefficient.

Question 43

what must r squared be greater or equal to than for beta to be an appropriate level of total risk?

Answer 43

0.70

Question 44

the lowest level of risk one could expect in a fully diversified portfolio. It is inherent in the “system” as a result of the unknown element existing in securities that have no guarantees

Answer 44

systematic risk

Question 45

the risk that exists in a specific firm or investment that can be eliminated through diversification. Through ownership of a number of different securities or investments, the investor can eliminate this risk and insulate their investments

Answer 45

unsystematic risk

Question 46

Examples of systematic risk

Answer 46

PRIME Purchasing power risk Reinvestment rate risk Interest rate risk Market Risk Exchange Rate Risk

Question 47

Unsystematic Risks

Answer 47

ABCDEFG Accounting Risk Business Risk Country Risk Default Risk Executive Risk Financial Risk Government/Regulation Risk

Question 48

information ratio

Answer 48

relative risk-adjusted performance measure. Measures the excess return and the consistency provided by a fund manager, relative to a benchmark. - The higher the excess return (or Information Ratio) the better. - Excess return can be positive or negative depending on the fund’s performance relative to its benchmark.

Question 49

Treynor Index

Answer 49

beta of a portfolio as its denominator, and the difference between the portfolio return and the risk-free return as the numerator, A measure of how much return was achieved for each unit of risk. The higher the Treynor ratio, the better because that means more return was provided for each unit of risk.

Question 50

sharpe ratio

Answer 50

a “relative” risk-adjusted performance indicator. A measure of how much return was achieved for each unit of risk. The higher the Sharpe ratio, the better because that means more return was provided for each unit of risk. Sharpe Index measures risk premiums of the portfolio relative to the total amount of risk in the portfolio.

Question 51

when is it appropriate to use treynor ratio or alpha ratio?

Answer 51

when r squared is greater that 0.70 or when the portfolio is a diversified portfolio since these ratios use beta as the measure of risk.

Question 52

when is it appropriate to use sharpe ratio?

Answer 52

when r squared is less than 0.70 or when the portfolio is not well diversified since this ratio uses standard deviation as the measure of risk.

Question 53

relative performance measures

Answer 53

sharpe and treynor. always choose the higher one for optimal relative performance

Question 54

stand alone performance measure

Answer 54

alpha

Question 55

positive alpha

Answer 55

good

Question 56

negative alpha

Answer 56

bad

Question 57

Holding period return formula

Answer 57

(selling price - purchase price +/- cash flows) / purchase price or equity invested

Question 58

ARBITRAGE PRICING THEORY (APT)

Answer 58

multi factor model, sensitivity to those factors, and STD and Beta are not inputs.

Question 59

combined total payroll tax

Answer 59

a combined total payroll tax of 12.4 percent for OASDI up to $160,200 and 2.9 percent for Medicare (100 percent of compensation).

Question 60

Advantages to the Employer of QUALIFIED RETIREMENT PLANS

Answer 60

* Employer contributions are currently tax deductible * Employer contributions to the plan are not subject to payroll tax

Question 61

What are the two types of DB Pension Plans?

Answer 61

DB pension plan and cash balance pension plan

Question 62

What are the two types of DC Pension Plans

Answer 62

Money Purchase Pension Plan and Target Benefit Pension Plan

Question 63

What are all 4 types of pension plans?

Answer 63

Defined Benefit Cash Balance Money Purchase Target Benefit

Question 64

Which pension plans require annual actuaries?

Answer 64

Defined Benefit Pension plan and Cash Balance Pension Plan (both DB plans)

Question 65

Which pension plan requires actuary at inception?

Answer 65

Target Benefit Pension Plan

Question 66

Which social security integration can you use for both DB and DC plans?

Answer 66

Excess Method - provides an excess benefit to those participants whose earnings are in excess of soc sec wage base

Question 67

Which social security integration can you use for only DB plans?

Answer 67

Offset Method - reduces the benefit to those employees whose earnings are below the soc sec wage base.

Question 68

What are the entities that are allowed to establish a 401k?

Answer 68

Corporations Partnerships LLCs Proprietorships Tax-exempt entities

Question 69

Exceptions to 10% Early Withdrawal Penalty

Answer 69

*Death * Attainment of age 591⁄2 * Disability * Substantially equal periodic payments (Section 72(t)) * Medical expenses that exceed 7.5 percent of AGIa * $5,000 per taxpayer for Birth or Legal Adoption * Qualified Domestic Relations Order (QDRO) * Qualified public safety employee, firefighter, or correction officer who separates from service after age 50 or with 25 years of service. * Attainment of age 55 and separation from service * Terminal illness. Effective for distributions after 12/29/22.b * Distributions up to an aggregate amount of $22,000 for qualified individuals in a qualified disaster zone. Effective retroactively for disasters occurring on or after January 26, 2021.c

Question 70

what is considered earned income?

Answer 70

-W-2 income -Schedule C net income -K-1 income from an LLC -K-1 income from a partnership where the partner is a material participant -Alimony (If divorce agreement was signed prior to or by 12/31/18. TCJA 2017)

Question 71

what is not considered earned income?

Answer 71

-Earnings and profits from property, such as rental income, interest income, and dividend income -Capital gains -Pension and annuity income -Deferred compensation received (compensation payments postponed from a past year) -Income from a partnership for which you do not provide services that are a material income-producing factor -Any amounts excluded from income, such as foreign income and housing costs -Alimony from a divorce agreement signed after 12/31/2018. -Unemployment benefits -Investment returns as a limited partner in a partnership Income flowing from an S-corporation via Schedule K-1 -Social Security benefits -Worker’s compensation

Question 72

Prohibited IRA transactions

Answer 72

o Selling, exchanging, or leasing of any property to an IRA; o Lending money to an IRA o Receiving unreasonable compensation for managing an IRA; o Pledging an IRA as security for a loan; o Borrowing money from an IRA; or o Buying property for personal use (present or future) with IRA funds.