Flashcards in Section 103 Unit 4 Deck (44):
Real Estate Investment Classifications
Unimproved, or raw, land
Commercial or residential rental property
Real estate limited partnerships (RELPs) or real estate investmnet trusts (REITs)
Passive investment and produces negative cash flows while generating no income. (Just an undeveloped piece of land)
Commercial or Residential Rental Property Valuation
Net Operating Income (NOI)
Gross rental receipts from property
+Nonrental or other income
= Potential gross income
- Vacancy and Collection losses
=Effective gross income
- Operating expenses (excluding interest and depreciation
= Net operating income (NOI)
The focus of the NOI computation is the property's cash flow, not the investor's cash flow.
Real Estate Limited Partnerships (RELPs)
A syndicated limited partnership consists of two owners; one is the syndicate or promoter who serves as the general partner. The second is the investor or limited partner.
Real Estate Investment Trusts (REITs)
Serves as a source of long-term financing for real estate projects by investing in real estate, short-term construction loans, and mortgages. Pools capital in a manner similar to an investment company. Can be publicly traded.
Acquiring real estate for the purpose of renting the space to other companies. Income is generated from the rents and sales of the real estate properties.
Are in the business of financing real estate ventures. Generally, a mortgage REIT makes loans to develop property or finance construction.
Have characteristics of both equity and mortgage REITs, as they rent properties and make construction loans.
Real Estate Mortgage Investment Conduit (REMIC)
Is a self-liquidating, flow-through entity (similar to a Partnership) that invests exclusively in real estate mortgages or mortgage-backed securities and terminates when the mortgages that constitute the investment of the REMIC are repaid.
Collaterallized Mortgage Oblications (CMOs)
A form of REMIC. Similar to mortgage-backed securities (Ginnie Mae, Freddie Mac, and Fannie Mae) in that they are both backed by large pools of mortgages. Each of the tranches receives regular interest payments. Tranch A is less risky than Tranch Z because A is paid off first and Z is last.
Guaranteed Investment Contracts (GICs)
Similar to CDs, but are issued by insurance companies, not commercial banks.
Is an investment vehicle whose value is based on that of another security, such as listed stock. Options and future contracts are an example.
Is a two-party contract that allows the holder the right, but no the obligation, to buy (call) or sell (put) shares of underlying security at a specified price on or before the expiration date. No longer than 9 months. Each option contract represents 100 shares of underlying stock.
Long-term Anticipation Securities (LEAPS)
A long term option that expires beyond two years.
Gives the buyer the right to purchase the underlying security for a specified price within a specified period (Like a warrant)
Gives the buyer the right to sell the underlying security for a specified price within a specified period.
Four option positions
Purchasing (or being long) a call
Writing (or going short) a call
Purchasing (or being long) a put
Writing (or going short) a put
Intrinsic Value of an Option
Is the minimum price at which the option will trade on an exchange. Option can never have a negative intrinsic value.
An option is in-the-money when its intrinsic value is positive.
An option is out-of-the-money when its intrinsic value is zero and the exercise price does not equal the market price of the underlying security.
An option is at-the-money when the exercise price of the option equals the market price of the underlying stock.
A call option is naked when it is written on a security that is not owned by the writer. This is the most risky form of option transactions, because the writer is subject to an unlimited potential loss.
Intrinsic Value of an Option
E X A M P L E Assume that the market price of ABC stock is currently $50 per share and that the investor has previously purchased a call option on ABC stock with an exercise price of $30 per share. Therefore, the option is $20 in-the-money ($50 less $30) and the call will likely be exercised. The option also has an intrinsic value of $20.
Alternatively, if the market price of ABC stock has declined to $20 per share and the investor is still holding the same call option, the option is $10 out-of-the-money ($20 less $30). Thus, the option will go unexercised and currently has an intrinsic value of zero.
Binomial Option Pricing Model (Binomial Model)
Attempts to estimate the price of a call option. Assumes that the price of the option will change in discrete increments.
Black-Scholes Option Valuation Model
Is designed to determine the estimated price of a European call option. Assumes the price of the option will change constantly.
Derives the value from five factors:
Stock price on which the option is written
Option exercise price
Time to expiration of option
Risk-free rate of return
The volatility (standard deviation) of the security's returns.
For the CFP Exam you need to know only two things concerning estimating the price of the option using Black-Scholes
Understand the difference in assumptions used for Black-Scholes versus the binomial model; and
Understand that, for any call option, an increase in the option’s exercise price leads to a decrease in the value of the option because the price of the underlying stock has to increase further before the option has intrinsic value.
Is the difference between the call price and the put price and equals the difference between the market price of the stock and the present value of the exercise price continuously discounted at the risk-free rate.
Combining different types of option contracts allows the investor to create a new risk/return relationship for derivatives.
Is an options strategy combining the use of a call option and a put option with the same exercise price and expiration date.
Long straddle is the simultaneous purchase of a call option and a put option with the same exercise price and expiration date.
A short straddle occurs when both options are sold or written.
A spread is the simultaneous purchase of one option and the sale of another option on the same side or position within the market.
A call spread is the purchase of a call and the sale of a call at the same time.
A put spread is the purchase of a put and the sale of a put at the same time.
Bull Call Spread
A bull call spread involves purchasing a call option with a strike price that is lower than the call option sold.
Bull Put Spread
A bull put spread involves purchasing a put option with a lower strike price than the put option sold.
Bear Call Spread
A bear call spread involves purchasing a call option with a higher strike price than the call option sold.
Bear Put Spread
A bear put spread involves purchasing a put option with a higher strike price than the put option sold.
A zero-cost, or cashless, collar
is a strategy used to protect a gain in a long position of a stock. This strategy consists of:
a long (or buy) position in the underlying stock;
a long put option; and
a short (or writing of a) call option.
Specifically, the investor purchases a put option to protect against a decline in the value of the underlying stock and sells a call option to generate premium income to cover the cost of the premium for the put option. As a result, the premium received on the call option pays for the premium paid on the put option (thus, the term zero-cost or cashless).
A futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset (equity) at a future time, place, and unit price. At completion, delivery is not always necessary. Traded on exchanges such as New York or Chicago Mercantile Exchane
Taxation of Futures Contracts
At the end of the calendar year, net gains or losses on the contract are treated as 60% long-term and 40% short-term, regardless of the actual breakdown of the gain or loss. In addition, these gains and losses are considered capital gains or losses, regardless of the tax character of the underlying asset.
Investments take the form of either collectibles or, sometimes, precious metals (e.g., gold or silver).