Section 1 Chapter 2: Investment Management

Question 1

What is the main focus of investment management in government?

Answer 1

Using available cash to generate income until the cash is needed for operating or other purposes.

Question 2

Why do governments have available cash?

Answer 2

• The receive large amounts of cash from tax collections and other sources periodically.
• Pension plans, endowment funds, and other fiduciary activities frequently receive contributions and other large sums of monies that will be needed to meet various obligations.

Question 3

Tax Reform Act of 1986

Answer 3

Codified and clarified regulations dealing with arbitrage by state and local governments.
- Controls virtually every form of debt financing by state and local governments.

Question 4

Elements of Investing

Answer 4

• Safety (Risk avoidance)
• Liquidity
• Yield

Question 5

Risk Types

Answer 5

• Safety Risk
• Credit Risk (Default Risk)
• Custodial Credit Risk
• Market Risk
• Interest Rate Risk
• Currency Risk
• Political Risk

Question 6

Credit Risk

Answer 6

• Risk that the investment will not be paid back.
• Also called default risk.

Question 7

Market Risk

Answer 7

Risk that the investments will lose money based on the daily fluctuations of the market.

Question 8

Interest Rate Risk

Answer 8

The risk that a fixed income security’s value will change due to an adjustment in the interest rates. A type of market risk.

Question 9

Currency Risk

Answer 9

Risk that the value of a foreign currency will fluctuate against the US dollar.

Question 10

Political Risk

Answer 10

Risk that investments may be adversely affected by nationalization, taxation, war, government instability, or other economic or political actions or factors.

Question 11

What is Liquidity?

Answer 11

The ease with which financial assets can be converted to cash without suffering from a substantial change in price or value.

Question 12

What are the most liquid investments?

Answer 12

Money market funds and interest bearing checking accounts.

Question 13

What is Yield?

Answer 13

The dividend or interest paid by a company expressed as a percentage of the current price.

Question 14

Yield to Maturity

Answer 14

The total return received on a bond, note, or other fixed income security if the investment is bought and held to its maturity date.

Question 15

Total Return

Answer 15

A performance measure that takes into account all three components of an investment’s performance - income, capital gains, and price appreciation over time.

Question 16

Types of Investment Instruments

Answer 16

• Fixed Income Securities
  
  • Short Term
  • Long Term
• Equity Securities
• International Securities
• Alternative Investments
• Other Investments

Question 17

Commercial Paper

Answer 17

Unsecured short-term promissory notes that are used by companies to obtain cash.

Question 18

Certificate of Deposit

Answer 18

A fixed income security that pays a fixed rate of interest for a specific period of time with a penalty for early withdrawal.

Question 19

Banker’s Acceptance

Answer 19

Draft drawn by corporate borrowers, and guaranteed (for a fee) by banks, to raise money against future production or sale of goods.

Question 20

Repurchase Agreements

Answer 20

Short Term (usually overnight) loans.

Question 21

Short Term Mutual Funds

Answer 21

Offer investors the opportunity to pool money with other investors with similar investment objectives.

Question 22

Short Term Investment Funds

Answer 22

Large financial institutions and many states (or other large governments) offer pooled short-term investments. Daily basis.

Question 23

Bond

Answer 23

Debt certificates issued by corporations or governments. The issuer of the bond promises to pay the bondholder a specific amount of interest for a specific length of time. On the maturity date, the loan is repaid. (Long Term)

Question 24

Debenture

Answer 24

Debt certificate. Backed only by the general credit of the issuer, not its assets. Generally pays a higher rate. (Long Term)

Question 25

Zero Coupon Bonds

Answer 25

Fixed income securities that do not make interest payments each year like regular bonds. (Long Term)

Question 26

Separate Trading of Registered Interest and Principal of Securities (STRIPS)

Answer 26

A book entry system operated by the Federal Reserve permitting separate trading and ownership of the principal and coupon portions of selected Treasury securities. This in effect creates zero-coupon Treasury securities from designated whole bonds. (Long Term)

Question 27

Equity Securities

Answer 27

Often referred to as stocks, equities securities represent and ownership in a corporation.

Question 28

Mutual Funds

Answer 28

Also called stock funds, they are funds that invest primarily in equities.

Question 29

Index Funds

Answer 29

Funds that attempt to match the performance of a particular index. The objective is to mirror an index, rather than beat it.

Question 30

American Depository Receipt

Answer 30

Negotiable registered certificates, issued in the U.S. market, and are evidence of title to non-U.S. investments.

Question 31

Yankee Bonds

Answer 31

Foreign bonds denominated in U.S. dollars and issued in the United States by foreign banks and corporations.

Question 32

Alternative Investments

Answer 32

Because of their risk and lack of liquidity, the are appropriate only for entities that can afford a small loss in order to have the opportunity for a sizeable return. Namely, large pension and endowment funds.

Question 33

Private Equity or Venture Capital

Answer 33

Money provided by investors to privately held companies with perceived long-term growth potential.

Question 34

Private Equity / Venture Capital Types

Answer 34

• Buyout or takeover investing: Direct purchase of companies with potential.
• Mezzanine investing: Lending money above the amount loaned by financial institutions.
• Fund of fund investing: Investing in a fund that invests in multiple venture capital funds
• Investments of secondary holding: Private equity sold on secondary markets.

Question 35

Real Estate Investment Trust (REIT)

Answer 35

A corporation or trust that uses the pooled capital of many investors to purchase and manage income property (equity REIT) and/or mortgage loans (mortgage REIT).

Question 36

Hedge Funds

Answer 36

Similar to mutual funds, except the fund manage is authorized to invest in derivatives and borrow to provide a higher return.

Question 37

Derivatives

Answer 37

Financial instruments, traded on or off exchange, the price of which is directly dependent upon (“derived from”) the value of a traditional security, asset, or market index.

Question 38

Most common types of derivatives

Answer 38

• Futures contracts
• Foreign exchange contracts
• Forward contracts
• Interest rate swaps
• Options

Question 39

Diversification Areas

Answer 39

• Asset allocation (Type of investment)
• Sectors (Financial services, oil and gas, etc.)
• Companies
  -Countries

Question 40

Prudent Person Rule

Answer 40

Those with responsibility to invest for others should act with prudence, discretion, intelligence, and regard for the safety of capital as well as income. (1830, Judge Samuel Putnam)

Question 41

Brokers

Answer 41

Arrange for the purchase or sale of the investments.

Question 42

Market Exchanges

Answer 42

Developed in the U.S. to facilitate the sale or purchase of securities.

Question 43

NASDAQ

Answer 43

National Association of Securities Dealers Automated Quotation; computerized information system that facilitates trading and provides brokers, dealers, and others price quotations on securities traded over the counter.

Question 44

Depository Trust Company System

Answer 44

DTC. Central repository, through which, members electronically settle trades in corporate, mortgage backed, and municipal securities, and electronically transfer the security certificates.