Investments

Question 1

Describes a Collar Strategy?

Answer 1

• Long the stock
• Short the call
• Long the put

Collar = LSL

A collar involves buying a put to protect a long position in the stock. Additionally, you would sell the call to offset the cost of the put.

Question 2

Positively Skewed

Answer 2

Skeyed Right

Question 3

Negatively Skeyed

Answer 3

Skeyed Left

Question 4

Mesokurtic Distribution

Answer 4

“Normal” Distribution
M = In the Middle of L and P

Question 5

Leptokurtic Distribution

Answer 5

“Slender” Distribution
L come before M and P

Question 6

Platykurtic Distribution

Answer 6

“Broad” Disrtribution
L - M - P
Platypus has flat beak

Question 7

Forms of EMH

Answer 7

Strong Form = No info. or analysis can beat market.

Semi-Strong = Insider info. can beat the market.

Weak Form = Insider info. AND Fundamental Analysis can beat market. Not TA.

Question 8

Anomalies of EMH

Answer 8

There are anomalies to the EMT that cannot be explained away by EMT believers.

• Low P/E Effect
• Small Firm Effect
• Neglected Firm Effect
• January Effect
• Value Line Phenomenon

Question 9

Describes a Protective Put

Answer 9

Long the Stock
Long the Put

A protective put is established to protect a long position in the stock. This is accomplished by buying a put. This is the very definition of portfolio insurance.

Question 10

Systematic (Non-Diversifiable) Risk

Answer 10

PRIME

• Purchasing Power Risk (Inflation)
• Reinvestment Risk
• Interest Rate Risk
• Market Risk
• Exchange Rate Risk

Question 11

Unsystematic (Diversifiable) Risks

Answer 11

BFDRS

• Business Risk
• Financial Risk
• Default or Credit Risk
• Regulatory Risk
• Sovereignty Risk

Question 12

Intrinsic Value of a Call Option

Answer 12

COME

Call Option = Market Value - Exercise Price

The lowest level that intrinsic value will ever be is $0!

Question 13

Intrinsic Value of a Put option

Answer 13

POEM

Put Option = Exercise Price - Market Value

The lowest level that intrinsic value will ever be is $0!

Question 14

What are the two basic variables that determine an option contract’s total price?

Answer 14

1. Intrinsic Value
2. Time Premium

Question 15

What are the 2 variables that make up Intrinsic Value for an option’s price?

Answer 15

1. Market Price of the underlying stock
2. Exercise Price of the option contract

Intrinsic Value = PRICE

Intrinsic Value can NEVER be less than $0.

Question 16

What are the 3 variables that make up Time Premium for an option’s price?

Answer 16

1. Risk-Free Rate of Return
2. Time to Expiration
3. Variability of the Underlying Stock (as measured by standard deviation)

The greater any or all of the three variables above, the greater the time premium.

Time premium is the greatest at the creation of the contract and approaches $0 at the expiration of the contract.

Question 17

Options contracts can be used to (BLANK) existing stock positions or to (BLANK) on stock without having a long position in the stock.

Answer 17

Options contracts can be used to hedge existing stock positions or to speculate on stock without having a long position in the stock.

Question 18

Covered Call Writing
“Covered Calls”

Answer 18

• Long the stock - Short the call
• Only considered covered if you own enough shares to cover all contracts sold.
• Used to generate income for the portfolio

Question 19

Naked Call Writing
“Naked Calls”

Answer 19

• Does not own the underlying stock - Short the call
• Writer bears UNLIMITED risk.

Question 20

Protective Puts

Answer 20

• Long the stock - Long the Put
• This is the very essence of portfolio insurance

Question 21

Protective Calls

Answer 21

• Short the stock - Long the call
• Used to protect a short position in the stock.

Question 22

Covered Puts

Answer 22

• Short the stock - Short the puts
• Writer used the stock put to cover their short stock position.

Question 23

Collar
(Zero-Cost Collar)

Answer 23

• Long the Stock - Short the Call - Long the Put
• LSL (Lasso—l)
• The put is used to protect against a stock price decrease, and the call premium is used to offset the cost of the put.

Good strategy for someone with big unrealized gain who is ok selling at a higher price but wants some downside protection at no cost.

Question 24

Straddle

Answer 24

• Long a put and a call on the same underlying stock with the same expiration date and strike price.
• Straddle = Same
• Used to capitalize on volatility regardless of the direction.

Question 25

Spread

Answer 25

* Involves purchasing and selling the same type of contract * Benefit from **stability** (minimum moves in the underlying stock's price Spread peanut butter to make stable

Question 26

A futures contract is an agreement to buy or sell a specific amount of a *(BLANK)*, a *(BLANK)*, or a *(BLANK)* at a particular price on a stipulated future date.

Answer 26

A futures contract is an agreement to buy or sell a specific amount of a **commodity**, a **currency**, or a **financial instrument** at a particular price on a stipulated future date.

Question 27

Futures and Forwards are different in that...

Answer 27

Forward Contracts are not standardized (they can take any form the parties agree to) and are not executed through a clearinghouse (thus they carry counterparty risk).

Question 28

What determines where an investor plots on the efficient frontier?

Answer 28

An investor’s **risk tolerance** determines where they plot on the efficient frontier.

Question 29

What are the 5 Systematic / Non-Diversifiable Investment Risks? (PRIME)

Answer 29

1. Purchasing Power Risk 2. Reinvestment Risk 3. Interest Rate Risk 4. Market Risk 5. Exchange Rate Risk

Question 30

What are the 5 Unsystematic / Diversifiable Investment Risks?

Answer 30

1. Business Risk 2. Financial Risk 3. Default or Credit Risk 4. Regulatory Risk (Pharma) 5. Sovereignty Risk (China)

Question 31

What are the 5 anaomalies to the EMT/EMH that cannot be expained away by EMT/EMG believers?

Answer 31

1. Low P/E Effect 2. Small Firm Effect 3. Neglescted Firm Effect 4. January Effect 5. Value Line Phenomenon

Question 32

The lower the time to maturity and the higher the coupon the ***(BLANK)*** the duration.

Answer 32

****The lower the time to maturity and the higher the coupon the shorter the duration. * The zero-coupon’s duration will equal the maturity.

Question 33

What is the probability of the following on the distribution curve? 1 SD 2 SD 3 SD

Answer 33

* 1SD = 68% * 2SD = 95% * 3SD = 99%

Question 34

What does the result of the NPV calculation tell us?

Answer 34

* If the result is **positive**, the investor **should undertake** the investment. The actual return will be greater than the required return. * If the result is **negative**, the investor **should avoid** the investment. The actual return will be less than the required return. * If the result is **zero**, the investor **should undertake** the investment. **The actual return will equal the required rate of return.**

Question 35

What is a weakness of the IRR calculation?

Answer 35

The IRR calculation **assumes the reinvestment rate is the IRR **(this is a weakness).

Question 36

What does the IRR allow financial planners to do?

Answer 36

**Internal Rate of Return (IRR)** allows the financial planner to **compare the computed rate** to the **required rate of return**. Yield to maturity (YTM) and yield to call (YTC) are examples of IRR calculations.

Question 37

Which is considered a superior model, NPV or IRR?

Answer 37

* **The NPV is considered a superior model to IRR when comparing investment projects of *unequal lives*.** Investing at the required rate of return is more reasonable than at the IRR. * With changes of more than two inflows or outflows in an investment project there will be only one NPV, however, multiple IRRs.

Question 38

**Define the Four basic types of Financial Ratios:** **Liquidity ratios:** Used to determine the ability to meet? **Activity ratios:** Used to determine the? **Profitability ratios:** Used to measure? **Debt ratios:** Used to determine the ability to meet?

Answer 38

**Four basic types:** **Liquidity ratios:** Used to determine the ability to meet **short-term obligations**. **Activity ratios:** Used to determine the **relative efficiency of financial management**. **Profitability ratios:** Used to measure **relative profitability**. **Debt ratios:** Used to determine the ability to meet **long-term obligations**.

Question 39

Gross Profit Margin Formula

Answer 39

Gross Profit / Sales

Question 40

Operating Profit Margin

Answer 40

Operating Income / Revenue

Question 41

Return on Assets (ROA)

Answer 41

EAT (Earnings After-Taxes) / Total Assets

Question 42

Return on Equity (ROE)

Answer 42

EAT (Earnings After-Taxes) / Equity

Question 43

Current Ratio

Answer 43

Current Assets / Current Liabilities

Question 44

Quick Ratio

Answer 44

Current Assets - Inventories / Current Liabilities

Question 45

Debt Ratio

Answer 45

Total Debt / Total Assets Lower is Better!

Question 46

The *(BLANK)* stands in between the option buyer and option seller and eliminates counterparty risk.

Answer 46

The **Options Clearing Corporation (OCC)** stands in between the buyer and seller and eliminates counterparty risk.

Question 47

According to the wash sale rules, a taxpayer realizes a loss on a sale of a security and acquires a substantially identical security within a _____ period.

Answer 47

**61-Day** Taxpayer realizes a loss on a sale of a security and acquires a substantially identical security within a **61-day period**.

Question 48

When illustrating investment returns over a period of time greater than one year, what is the appropriate measure of return that should be used?

Answer 48

The appropriate measure to use for periods of greater than one year is **time-weighted rate of return**.