Investments

Question 1

CDs carry interest rate risk

Question 2

Treasury bills – one year or less
Commercial paper – short term, unsecured, promissory note issued by large financially, strong company (270 days or less)

Question 3

Bankers acceptance

Answer 3

Before a foreign exporter will ship goods to US, they want assurance of payment. Bankers acceptances are bearer securities, and can be held to maturity. (nine months or less)

Question 4

Euro dollar

Answer 4

Deposit in any foreign bank that is denominated in dollars

Question 5

Yankee bond

Answer 5

Dollar denominated bonds issued in US by foreign banks and corporations. Must be registered with SEC.

Question 6

Commission gets added to bonds basis

Question 7

Original issue discount (OID)

Answer 7

Typically zero coupon bonds, but issued far below par value.

No interest until maturity

Each year portion of discount hat has been earned is included in taxable interest income and bonds basis is increased. Zero coupon bond holders must report interest income although bond pays no interest before maturity (phantom income)

Question 8

Treasury notes and bonds have reinvestment, interest rate, and purchasing power risk (RIP)

Question 9

Treasury bills, notes, and bonds all are subject to federal income tax, exempt from state and local income tax

Question 10

Treasury issues it’s own zero-coupon bonds, called STRIPS

Answer 10

They are a direct obligation of the federal government

STRiPS do not distribute interest in form of coupon payment. Interest is accrued and phantom income.

Question 11

TIPS

Answer 11

Min denominations of 1,000

Interest rate is fixed

Interest payments vary as the principal is adjusted for inflation

Obligations of federal government

Question 12

EE bonds

Answer 12

Fixed rate based on 10 yr treasury

Guaranteed to reach face value in 20 yes but can earn interest for 30 yrs

Only subject to federal tax

Question 13

GNMA

Answer 13

(Government national mortgage association) (Ginnie Mae)

Prepayment risk!

These are guarantee of US govt but not issued by the treasury

Fed state and locally taxed

Minimum sold is 25,000

Rates increase causes NAV of GNMA to decrease. Also principals being paid off can cause value to lower

Question 14

Reports

Answer 14

10k- required to be filed with SEC. Annually
10q- required to be filed with SEC. Quarterly
Prospectus- for potential buyers of new stock issue
Red herring - preliminary prospectus

Question 15

Preferred stock

Answer 15

Pays a fixed dividend rate.

Can be cumulative or non cumulative.
Cumulative- if dividend payments are missed, it will pay dividends in full before common shareholders.
Non cumulative- missed dividends do not have to be made up

No maturity date but can be callable

C corps will likely buy to get 50% of dividends excluded from taxation

Question 16

ADR

Answer 16

A way for Americans to buy foreign shares in the US. An ADR is a receipt for the shares of a foreign based corp held in US vault.
Dividends are paid in US dollars, but declared in currency of country of origin

Question 17

Hedge funds

Answer 17

Aggressively managed portfolio that uses long short, leveraging and derivative positions.

Open to a limited number of investors and require large minimum investment.

Often illiquid and require money in fund for at least one year.

Laws require a majority of investors to be accredited (must earn minimum amount of money annually, or have a net worth of more than 1 million. Primary residence does not count toward 1 million.)

Question 18

GICS do not have interest rate risk

Answer 18

Guaranteed Investment Contract like a CD generally purchased by institutional companies

Question 19

Net operating Income

Answer 19

Any income, less vacancy, less operating expenses = NOI

*do not do anything with any mortgage info they give you or depreciation info. It is not included in calculation
**if they ask for monthly income, that factors in mortgage payments

Question 20

Put option

Answer 20

Gives owner right to sell a specific number of shares at a set price. Investors buy puts when they are bearish. Writers (sellers) of the put are bullish on price. They believe it won’t decrease and options won’t be exercised

Question 21

In the money and out of the money for PUTS

Answer 21

When market price is less than the exercise price, a put is in the money.

When market price is greater than the exercise price, about is out of the money.

Question 22

Call

Answer 22

Contract that gives holder the right to purchase a specific number of shares at a set price. Investors buy cars when they are bullish. Call writers (sellers) premium income. If an individual writes a covered call, a call is written on stock already owned by the call writer.

Question 23

In the money and out of money for CALLS

Answer 23

When market price is greater than the exercise price, a call is in the money. When the market price is less than exercise price, a put is out of the money.

Question 24

Intrinsic value of a put = exercise price - market price

Intrinsic value of a call = market price - exercise price

Question 25

Warrants vs calls

Answer 25

Warrants are issued by corporations. Calls are created by individuals on exchanges. Warrants generally have maturities of several years. Calls usually expire within 9 months Warrants are issued with no intrinsic value

Question 26

Collectibles long term capital gain rate is 28%

Answer 26

Real Property (1250) LT gains are taxed at capital gains rate. A special 25% depreciation recapture is applied when the property is sold. (This is just on the amount that was taken for depreciation.

Question 27

Private placement (regulation D)

Answer 27

Is an issue offered privately that can be sold to a maximum of 35 nine accredited investors and an unlimited amount of accredited investors. This issue would be exempt from registration. Accredited investor - individual with net worth $1 million, one individual with an annual income of 200,000, or a couple with joint income of 300,000 (remember 123 rule 100,000,000/200,000/300,000) 1 million excludes primary residence volume

Question 28

Systematic risk

Answer 28

PRIME Purchasing power risk, reinvestment, right risk, interest rate risk, market risk, exchange rate risk * S&P index would carry a systematic risk

Question 29

Unsystematic risk is diversifiable risk, and can be largely eliminated

Answer 29

Business risk and financial risk

Question 30

Future Contracts

Answer 30

Farmer may sell a contract on corn if he wants to hedge against lower crop prices in the future. He will make a short hedge if worries prices will be lower in the future. Food processor may hedge to guard against increase in commodity's price at the time of delivery. The processor wants to buy the crop at today's price to hedge against higher price in the future. (This is the processors going long)

Question 31

Total risk is expressed by standard deviation while systematic risk is expressed by Beta.

Question 32

Revaluation

Answer 32

Generally means an increase in the currencies value Devaluating is the lowering of the value of currency relative to currencies of other nations

Question 33

Life insurance cash value is considered to be liquid. So is open ended money market mutual funds.

Question 34

Savings, checking, money market accounts, and mutual funds are redeemed rather than marketable. Treasury bonds, and common stock are marketable.

Question 35

Correlation coefficient, and covariance, both express the extent of which movements of stocks in the same portfolio are similar or not

Answer 35

+1 = perfectly positively correlated -1 = perfectly negatively correlated When correlation coefficient of an equally weighted portfolio is less than one, the risk must be lower than the average risk.

Question 36

Coefficient of variation is the standard deviation, divided by the average return

Answer 36

The higher the coefficient of variation, the riskier the stock

Question 37

Standard deviation and beta are used to express risk of security

Answer 37

Standard deviation measures variability of returns used in a non-diversified portfolio, and it’s a measure of total risk Beta measures volatility of returns, used in a diversified portfolio and is a measure of systematic risk

Question 38

Standard deviation

Answer 38

This is the bell curve chart. The mean is at the center. 1 standard deviation = 68% 2 standard deviations = 95% 3 standard deviations = 99%.

Question 39

Correlation coefficient example

Answer 39

Correlation coefficient is .5 Fund A mean = 10% and risk = 20% Fund B mean = 8% and risk = 12% Portfolio is equally weighted. What is standard deviation? Add the risks 20% +12%, then divide by two = 16%. Since the correlation coefficient is less than one, choose the next Lowest answer under 16%. if the correlation coefficient were exactly 1, the portfolio standard deviation would’ve been exactly 16.

Question 40

Beta

Answer 40

Volatility of assets or portfolios rate of return compared to market. The market constant beta is 1.0. 1.5 beta is a stock with 50% more volatility than market .75 beta is only 75% as volatile as market Beta can be negative. Negative beta can lower volatility of portfolio

Question 41

Risk adjusted return

Answer 41

Divide individual funds realized return by its beta coefficient.

Question 42

Reinvestment rate risk

Answer 42

GNMA have greatest reinvestment risk because payments include interest and return of principal. Zeros and STRIPS have lowest since there are no coupon payments to reinvest

Question 43

Geometric return

Answer 43

Used to reflect compound returns over more than one time period. 1. Add to returns (25% becomes 1.25, -12 become .88) 2. Multiply returns 1.25x.88 3. That result is your FV 4. -1 is always your PV 5. N is the the number of years of investment 6. Solve for I

Question 44

Time weighted returns, such as geometric, allows investors to compare managers. This is not possible with dollar weighted returns

Answer 44

Time weighted return is normal

Question 45

Holding period return

Answer 45

Income plus price appreciation and dividends less margin interest. If time period is over 1yr, then HPR overstates annualized returns. If under 1 yr, it understates.

Question 46

HPR

Answer 46

Sell price factoring in interest - cost basis factoring in any interest - any margin / initial investment

Question 47

When calculating yield to maturity, always use semi annual compounding, even with zero coupon bond

Question 48

Zero-coupon bonds

Answer 48

One advantage is the elimination of reinvestment rate risk, because there are no interest payments to be reinvested. Zeros still carry interest rate and inflation risk.

Question 49

Current yield

Answer 49

Current Yield = annual interest in dollars / bonds current price

Question 50

Taxable equivalent yield (TEY)

Answer 50

Taxable equivalent yield = tax exempt yield / 1 - tax rate

Question 51

Treasury securities are exempt from state and local tax

Question 52

Duration is inversely related to Yield to maturity and annual coupon. When market interest rates increase, duration decreases.

Answer 52

Duration and maturity are positively related. (Remember time is on top, positively related)

Question 53

Duration

Answer 53

Enables investors to compare the price volatility of bonds with equal coupons, but different terms Most important measure of how risky bones are because it measures are sensitivity to interest rate changes

Question 54

Interest rate risk is neutralized if duration is equal to the preselected investment horizon

Question 55

Zero-coupon bonds are most volatile if interest rates move quickly. The duration of the zero coupon bond is the same as its maturity.

Question 56

Remember UPS

Answer 56

If interest rates go UP, Shorten duration

Question 57

Remember fallen

Answer 57

If interest rates FALL, LENgthen duration

Question 58

Convexity

Answer 58

Expresses degree to which duration changes as a bonds yield to maturity changes. Convexity is the largest for low coupon bonds, long maturity bonds, and low yield to maturity bonds.

Question 59

Constant Growth Model

Answer 59

Dividend (1+ Growth Rate of dividend)/Required rate of return - growth rate of dividends *If constant growth model is higher than price, then the stock is undervalued. *This model assumes dividends grow at a constant rate over time.

Question 60

When intrinsic value is lower than the MV of stock, the investor earns a lower rate of return than he requires.

Question 61

If dividend changes over time use TVM calculation.

Answer 61

Step #1 - Find PV. Input FV, Interest, and N. Do this for each year, then total the years PV. Step #2 - Use constant growth model. D(1+G)/r-g *D=the last dividend you figured from step 1. Step #3 - discount this value back to PV. Then add that and step #1 value together USE shortcut!!! not this..

Question 62

Dividend discount model shortcuts

Answer 62

shortcut #1 - If the FIRST growth rate is lower than the second growth rate, then do the discount model equation using the second growth rate (the highest). Once you have that figure, pick the answer that is the next lowest. shortcut #2 - If the FIRST growth rate is higher than the second growth rate, then do the discount model equation using the second growth rate (the lowest). Once you have that figure, pick the answer that is the next highest. ***Always use the second growth rate. If it gets lower, pick the next lowest answer. If it gets higher, pick the next highest growth rate.

Question 63

Yield curve shows market rates of interest for bonds of different maturities with similar credit ratings.

Question 64

Current market price = Earnings x P/E ratio

Answer 64

if PE Ratio is more than price, it is undervalued.

Question 65

Return On Equity (ROE)

Answer 65

Earnings available for common (EPS) / Common Equity (net worth or book value) *preferred dividends don’t factor in

Question 66

Dividend payout ratio

Answer 66

Common dividend paid/ EPS

Question 67

Short selling involves borrowing a security who’s price you think is going to fall and then selling it on the market. your plan is to then buy the same stock at a lower price and pocket the difference after repaying the loan

Answer 67

If stock goes up you have to buy stock on open market to close position. The stock could rise to infinity.

Question 68

Utility stocks typically have a high dividend payout ratio

Question 69

Change in interest rate formula

Answer 69

-Duration(change on interest/current interest rate)

Question 70

Capital Market Line

Answer 70

Specifies relationship between risk and return on a portfolio rather than on one investment Individual securities or an efficient portfolios fall below the CML . Diversified portfolios should fall somewhere along the CML. It can’t be used to evaluate a single security

Question 71

Modern asset allocation by Harry Markowitz

Answer 71

Risk, return, and covariance of assets are important input variables in creating portfolios Risk adverse investor will have a steep indifference curve which demands a significant amount of return to take on more risk. Someone who is less risk adverse would have a relatively flat indifference curve

Question 72

Market risk premium

Answer 72

Return of market - risk free rate

Question 73

Stock risk premium

Answer 73

(Return of market - risk free rate)Beta

Question 74

Security market line (SML)

Answer 74

If security is above line, it’s undervalued. It offers more expected return than investor requires. If under line, it’s overvalued

Question 75

Efficient market hypothesis

Answer 75

EMH justifies passive investing Strong form -fully reflect all public and private info. Neither fundamental or technical analysis produces superior results over time. Semi strong form - reflects, publicly known information. Neither technical analysis nor fundamental analysis produces superior results. Only an investor with the inside info could achieve superior results (illegal). Week form - suggests historical price data is already reflected in current prices and is of no value in predicting future price changes. Technical analysis will not produce superior results. Fundamental analysis may produce superior results.

Question 76

Fundamental analysis

Answer 76

Factors such as interest rates, gross, domestic product, inflation, unemployment, and inventories are used to predict the direction of the economy

Question 77

Top-Down method

Answer 77

Investor first looks at trends in the general economy, then select industries, and then companies that shod benefit from those trends

Question 78

Bottom-up method

Answer 78

Client searches for individual stock with outstanding performance before considering the impact of economic trends. This approach assumes the individual company will do well, even if the industry doesn’t.

Question 79

Current ratio

Answer 79

Assets/liabilities Assets - bonds count. IRA's do not count Liabilities - only use taxes payable when the material indicates the taxes are due or if it says the taxes are payable. Always use credit card debt even if the credit cards are paid off monthly.

Question 80

Technical Analysis

Answer 80

Most technical analysis looks at short or immediate term outlook. It is not concerned with any specific financial position of a company, unlike fundamental analysis. Bar charts, resistance/support levels, ect

Question 81

Resistance

Answer 81

Price ceiling. If stock breaks through, it’s considered bullish.

Question 82

Support

Answer 82

Price floor, if stock breaks through, it’s considered Bearish

Question 83

Wilshire 5000

Answer 83

Broadest measure of the market but value-weighted.

Question 84

Date of record comes after ex dividend date. You must purchase before the ex dividend date to get dividend

Question 85

Sharpe ratio

Answer 85

Ratio of the excess return of the portfolio to it standard deviation. This number is meaningless unless it’s compared to the market or other mutual funds.

Question 86

Treynor ratio

Answer 86

This measure is expressed as a ratio of the excess return of the portfolio to its beta. Uses beta so portfolio must be diversified (using systematic risk only)

Question 87

Jensen ratio

Answer 87

AKA Alpha. Uses beta so portfolio must be diversified (using systematic risk only) Calculates the portfolio return actually attained and subtract it from what the return should’ve been based on the risk assumed. Positive number signifies that the return exceeded what was expected.

Question 88

R-squared (correlation coefficient squared)

Answer 88

Is the percentage of a funds movements that is explained by movements in the S&P 500. If R-squared is higher than 60, look for highest alpha (Jensen). If alpha/Jensen isn’t option, look for highest Treynor. If R-squared less than 60, look for highest sharpe number.

Question 89

Information ratio

Answer 89

Measures portfolio managers ability to generate returns higher than benchmark. Rp-Rb/standard deviation Rp=asset return Rb=return on benchmark asset

Question 90

Immunization

Answer 90

A portfolio is immunized if duration of portfolio is = to pre-selected time horizon of portfolio

Question 91

Barbell strategy

Answer 91

Buying half very short term and half very long term bonds

Question 92

Margin

Answer 92

Regulation T sets initial margin at 50%. Exchanges and FINRA set the next level, normally 25%. Only actively traded securities are marginable not mutual funds or options. Margins requirement= (1-margin %) / (1-maintenance margin %). x purchase price of stock

Question 93

Margins

Answer 93

If bought 200 shares at $150 on margin. Initial margin requirement is $15,000. Maintenance margin is 25%. What is maintenance call if stock drops to $90. 200 shares x $90. =$18,000 25% x $18,000 = $4,500 equity required $18,000-15,000= -$3,000 actual equity $1,500 maintenance call

Question 94

Long vs short position

Answer 94

Long position means you own it. Short position is generally a sale of a stock you do not own

Question 95

Risk capacity

Answer 95

Amount of risk an investor “must” take to reach their goals

Question 96

Arbitrage Pricing Theory (APT)

Answer 96

The security’s movement and return are not explained by a relationship between risk and return. They suggest four main reasons: unexpected inflation, unexpected changes in level of industrial production, unanticipated shifts in risk premium, and unanticipated changes in structure of yields. When arbitrage pricing theory expect value is zero, the factor has no effect. It was expected.

Question 97

Black Scholes option value model

Answer 97

Valuation of options. An increase in exercise price of call decreases the calls value. Increase in exercise price of put increases the puts value. (Direct relationship)

Question 98

Interest rate risk

Answer 98

Danger that bond could lose value

Question 99

Naked call

Answer 99

Similar to short selling. In short selling you borrow the stock your selling in naked calls, you are selling the right to buy the security at a fixed price. You are aiming to make a profit from collected premium

Question 100

Out of the money

Answer 100

Stock price 39. Call price is 40. Intrinsic value is zero. There is no intrinsic value when you can buy the stock at a lower price than the call prize.

Question 101

Dividends reinvested get input as 0 in the IRR calculation. This then gets added to basis and is treated as phantom income. Dividends taken as cash are just a positive cash flow.

Question 102

Carryforward loss

Answer 102

Only $3,000 can be deducted on the 1041 estate tax return in the year of death. Any remaining losses are lost after year of death.