Section 103 Unit 10 Flashcards Preview

CFP > Section 103 Unit 10 > Flashcards

Flashcards in Section 103 Unit 10 Deck (23):

Formula Investing

Means that the investor does not actively trade or manage his portfolio, but instead follows certain automatic rules regardless of market conditions. The most commonly known form of formula investing is dollar cost averaging.


Dollar Cost Averaging (DCA)

is the systematic process of purchasing securities over time by investing a predetermined amount of money at regular intervals.


Dividend Reinvestment Plans (DRIPs)

The term dividend reinvestment refers to dividends from a stock or mutual fund that are reinvested in the investment from which they were earned.


Bond Ladders

The use of bond ladders is a popular long-term strategy for staggering the maturity of a client’s bond portfolio and, subsequently, for establishing a schedule for reinvesting the bond proceeds as they mature.


Bond Barbells

The use of bond barbells (also known as the dumbbell strategy) is an active strategy for buying short-term and long-term bond issues. The long-term end of the barbell allows the investor to lock in attractive long-term interest rates, whereas the short-term end ensures that the investor will have the opportunity to invest in other assets if the bond market declines in value.


Bond Bullets

The use of bond bullets is a strategy for having several bonds mature at the same time, thus minimizing interest rate risk.


substitution swap

A substitution swap involves selling bonds with identical characteristics but different selling prices. This price difference is an arbitrage opportunity and will exist only shortly, until the market corrects the price inefficiency.


intermarket spread swap

An intermarket spread swap involves the exchange of one type of bond (e.g., government bond) with another type of bond (e.g., corporate bond). This occurs when investors believe one type of bond is currently mispriced in relation to the other. The goal of this type of swap is to capitalize on a YTM disparity across bond markets.


Rate anticipation swap

A rate anticipation swap attempts to take advantage of expected changes in interest rates. For example, if rates are expected to increase, long-term bonds are swapped for short-term bonds. If rates are expected to decline, short-term bonds are swapped for bonds with long maturity dates.


pure yield pickup swap

In a pure yield pickup swap, a bond with a lower YTM is exchanged for a bond with a higher YTM. The new bond that replaces the old bond is either a longer-term bond or a lower-quality bond sufficient to generate a higher overall YTM.


tax swap

A tax swap is motivated by current tax law. One such swap involves gaining from a capital loss by selling a previously purchased bond at a loss due to rising interest rates. For example, two years ago an investor bought a bond for $1,000. The bond currently trades for $800 in the secondary market. The investor may sell the bond for a $200 loss, reinvest the $800 proceeds, and hold the new bond to maturity. Assuming a 25% tax bracket, the investor would experience a tax savings of $50 ($200 × 0.25).


Market Timing

Is an attempt to predict the overall direction of the securities market and to take advantage of changes in the prices of those securities, whether those prices go up (going long) or down (selling short).


Buy and Hold

A buy-and-hold strategy is the conceptual opposite of market timing—that is, in its purest form, buy and hold means that no purchases or sales of an investor’s existing portfolio will be done over a very long period (i.e., investment horizon).



Investing in index mutual funds, is indicative of an investor who believes in passive portfolio management. The purpose of an indexed portfolio is not to beat the targeted index (e.g., the S&P 500 Index) but merely to match its long-term performance, less any management fees and administrative costs.



A common way of constructing an indexed portfolio is simply to buy and hold the securities in the index in their appropriate weightings. This method is known as replication and is characterized by a low tracking error with the actual index that is targeted.


Sector Rotation

an active portfolio management strategy, means emphasizing or over allocating certain economic sectors or industries in response to the next expected phase of the business cycle. This strategy requires investors to time the entry and the exit of specific sectors based on economic business cycles. For many investors, the ability to accurately identify and transition from one cycle to another may be difficult.


Short Selling

Normally, investors purchase stock (or go long) with the hope that the shares of stock will appreciate. However, investors can also make money when the price of the shares decline if they engage in a strategy known as short selling.

1. The investor uses a stockbroker to borrow stock from another investor’s account. This requires the short seller to make a deposit, equal to the margin requirement (currently 50%) times the fair market value of the stock, to the broker. As an outgrowth of this requirement, the investor must also establish a margin account with the broker/dealer.
2. The investor sells the borrowed stock in the open market.
3. The investor repurchases the stock in the open market.
4. Finally, the investor replaces, or covers, the borrowed stock.



Leveraging is the use of borrowed money to achieve an individual’s investment objectives.


Debit Balance

In relation to margins the amount owed to the broker/dealer is known as the debit balance, and includes the original amount borrowed by the investor plus any accrued interest.



When an investment is purchased on margin, one-half of the funds are deposited by the investor (known as the initial margin percentage, as established by Federal Reserve Regulation T), and the other half may be borrowed from the broker/dealer.


Margin Call

The stock price when the investor would owe more money.

Margin call = debit balance / ( 1 - Maintenance Margin (35%))
Margin call = ((1- inital margin percentage ) / (1 - Maintenance Margin )) * purchase price of stock


Core and Satellite Investment Strategy

The core would be the core investment of indexes where Satellite would be invested in riskier investments to achieve higher than market returns.


Wash Sales

A wash sale occurs if the taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities. If this event occurs, the basis of the new stock or securities will include the unrecovered portion of the basis of the formerly held stock or securities. The wash sale rules are easily avoided in the case of fixed-income securities by substituting a bond with the same or similar characteristics (i.e., coupon, term, and quality), as long as it is issued by a different company.