Investment (CFP 2018)
Assume there are three stocks in ABC average and their values are $44, $60 and $100. What is the price average?
($44+$60+$100)/3= $68
Lisa has been looking at mutual funds and her advisor tells her about a great fund with the following expected returns and probability of obtaining each return. What is the total expected return? Expected return= 10%, 15% and 18% Probability of return= 30%, 60% and 10%
- (.1x.3)+(.15x.6)+(.18x.1)= .138 or 13.8%
if mutual fund XYZ has a correlation coefficient of .80. What is the r-squared?
- .8^2= .64 or 64% .64 means use SD not beta and funds return is due to the market
What is the beta of the market?
- 1 - remember beta is on a scale of -1 to 1 - 1 indicates positive correlation - greater then 1 indicates more risk/volatility in comparison to the market
what is a 10K and 10Q?
- 10K= annual report of financial statements filed with SEC, it is audited - 10Q= quarterly report, filed with SEC, not audited
What is a 2 for 1 stock split, if investor buys 100 shares at $50?
- 2 for 1 for a investment with 100 shares at $50 per share how many shares= 100 shares*2= 200 how much is the stock after the split =$50 per share/2= $25
What is a 3 for 2 stock split for an investor with 100 shares at $60 per shares?
- 3 for 2 split for an investor with 100 shares at $60 per share how many shares after the split?= 100*1.5(3/2)= 150 shares How much is the stock after the split?= $60 per share/1.5(3/2)= $40
If I have a beta of .92 and the market moves 10%, how much does my portfolio move in comparison to the market?
- 9.2%
what is the optimal portfolio for our client? Example
- C in between high and low on the efficient frontier
What is the capital asset pricing model or CAPM?
- CAPM calculates the relationship between risk and return of an individual security using beta as the measure of risk - market risk premium in the equation is (rm-rf), this amount indicates how much an investor should be compensated to take on a market portfolio versus risk free asset - need to know
What is the similarity between CAPM and SML?
- CAPM= relationship between risk and return - SML= graphically plots results from CAPM, uses beta as a measure of risk and could be used with individual securities -both CAPM (CML) and SML assumes the investor should earn a rate of return at least equal to the risk free rate of return - the SML intersects with the y-axis at the risk free rate - portfolio with a return above SML= undervalued and should be purchased - portfolio with a return below SML= it would be considered overvalued and should not be purchased
what indice is used for large cap stocks?
- Dow Jones industrial average (simple price weighted average), does not incorporate market capitalization - S&P (value weighted index, incorporated market capitalization of individual stocks
What is IRR and how do I calculate it?
- IRR= internal rate of return - it is the discount rate that sets the NPV formula equal to zero - also thought of as compounded rate of return - IRR should be calculated when you have uneven cash flows and asked to calculate compounded rate of return
what is NPV and how do I calculate it?
- NPV= net present value - used to evaluate capital expenditures that will result in differing cash flows over useful life or investment period - if negative= investor shouldn't invest - if positive= investor should invest if 0= make the investment
If an investor believes the markets are efficient, what investment strategy should they use?
- Passive - active if investor believes markets are inefficient and they can achieve above market returns
what dividends are treated as ordinary income?
- REIT, money market mutual fund, scerb, mutual fund
what indice is best as a benchmark for small cap stocks?
- Russell 2000
What is standard deviation?
- SD is a measure of risk and variability of returns - higher the SD, higher the riskiness of investments - SD measures how far from an average - used to determine total risk of an undiversified portfolio
What are the following securities regulations, such as securities act of 1933 and 1934?
- Securities act of 1933= regulated the issuance of new securities (primary market), requires new issues to be accompanied with a prospectus before purchase - Securities Act of 1934= results the secondary market, created SEC
What are examples of nonmarketable US treasury issues?
- Series EE/Series E bonds= sold at face value, $25 minimum purchase ($10,000 annual maximum) available only through treasury direct online; nonmarketable/nontransferable; don't pay interest, but slowly increases in value over 30 years based on fixed rate and time of purchase; redeemable after 1 year; 3 month interest penalty on those redeemed before 5 years - Series HH/series H bonds= pay interest semiannually, income received is ordinary tax once matured (20 years) - Series I bonds= inflation indexed bonds issued by the U.S. government, I bonds are sold at face value with no guaranteed rate or return; 2 interest rates consists of a fixed rate and a adjusted every 6 months. Will receive fixed rate plus inflation.
What are examples of marketable US treasury issues?
- US treasury bills= mature in less than 1 year; sold at discount yield basis; don't pay interest; mature at par value - US treasury notes= mature between 2-10 years; interest is paid semi-annually - US treasury bonds= bonds have maturities greater than 10 years; interest paid semi-annually; sold at denominations of $100 or more
example for yield to call
- a company would call a bond if they wanted to raise money to pay off the higher premium bonds currently in the market - unlikely an investor will hold the bond until maturity
Joe is your client and he believes you can help him improve his returns by assisting him with his investment selections. What type of method is appropriate?
- active asset allocation with active security selections
What is the difference between active and passive investment strategies?
- active= investors believe markets are inefficient and that they can make above average market returns through active investing/market timing - passive= investors believe the markets are efficient, passive buy/hold strategy (UITS, index investing, laddered bonds, ETFS and barbell bonds)
Describe agency bonds (On-budget and off-budget debt)
- agency bonds= not backed by the full faith and credit of the US government - GNMA (ginnie mae) are backed by the full faith and credit of the US government -Off budget= FNMA (fannie mae), FHLMC (Freddie Mac), SLMA (Sallie Mae), federal farm credit banks (FFCB), federal intermediate credit banks (FICB) and federal home loan bank (FHLB)
What is the arbitrage pricing theory?
- also known as APT - assets that pricing imbalances cannot exist for any significant period of time, otherwise investors would exploit the price imbalance until market goes back to equilibrium - multi-factor model, attempts to explain return based on factors - attempts to take advantage of pricing imbalances - SD and beta are not inputs - inputs= inflation, risk premium, and expected returns
What is arithmetic average?
- also known as the mean or simple average - add all the numbers, divide by the number of observations
What is the optimal portfolio?
- an indifference curve represents how much return and investor needs to take on risk - risk averse investor= very steep indifference curve, requires lot of return to take on a little risk - risk seeking investor= relatively flat indifference curve, investor will not require significant amount of return to take on more risk - optimal portfolio= when indifference curve is tangent to efficient frontier
What is a tax characteristic of US treasury securities?
- are nontaxable at the state and local level
which is a better investment?
- assume investors are risk averse (take risk with appropriate take aways) - Option A is the better choice, since the mean is the same, but the spread or volatility is less then Option B
What are the assumptions made for duration?
- assumes that there is a linear relationship between a change in interest and a bond's price change - duration does a good job of estimating the price change of bond for small changes in interest rate - duration DOES NOT= do a good job of estimate the price change of bond for large changes in interest rates - duration understates the price appreciation when interest rates decrease - duration overstates the price depreciation when interest rates increase
What is a real estate investment trust (REI)?
- attractive because of low correlation with stock market - diversity benefits - hedge against inflation - distribute 90% of investment income to shareholders to maintain tax-exempt status - three types= equity, mortgage and hybrid
What is the investment act of 1940?
- authorized SEC to regulate investment companies - investment companies= open, closed and unit investment trust (UIT)
What is normal distribution?
- bell shaped - it is appropriate if an investor is considering a range of investment returns as was covered above
CML and SML example
- bill took on less risk then the market - his return should be less than 18% and above 10%
bond pricing example
- bond is selling less then $1,000 because it's trading in the market for 9.5% interest, when the market interest is 10%
What are the bond rating agencies and how are bonds rated?
- bonds rated based on liquidity, total amount of debt and earnings/stability of earnings 1. Moody's= Aaa-Baa are investment qualify bonds; Ba and below are junk 2. S&P= AAA-BBB are investable bonds; BB and below are junk
What is herd mentality?
- buying and selling based on what everyone else is doing - buying high - selling low
What is dollar weighted return?
- calculated IRR using investor's cash flows
What is a call option? What is a put option?
- call open= gives the holder of the call option the right, BUT NOT the obligation, to buy the stock at a predetermined price (strike or exercise price) within a predetermined time period - put option= gives the holder of the put option the right, BUT NOT the obligation, to sell the stock at a predetermined price (strike or exercise price) within a predetermined time period
What is the difference between CML and SML?
- capital market line (relates to efficient frontier)= only deals with portfolios, accounts for systematic/unsytematic rates - security market line (SML)= can be used to determine the risk/return of a single stock, helps to determine the required rate of return based on it's systematic risk, relates to CAPM
What is the annual report?
- chairman of the board produces a message in it, outlines progress in the prior year and outlook for the current year - sent directly to shareholders
What is the coefficient of variation?
- coefficient of variation is useful in determining which investment has more relative risk when investments have different returns - tells us the probability of actually experiencing a return close to average return - higher the coefficient the more risk an investment per unit of return - CV= SD/average return (know)
What is a CMO?
- collateralized mortgage obligation (CMOs)= investors are divided into tranches, which determines which investors will receive pricipal repayment; investors are in A-Z tranch which represents short, intermediate and long-term - investor in tranch A gets paid before Z
chart outlining efficient frontier
- compared A to C= investor would want A because same level or return, but less risk - compare B to C= investor prefers B, higher level of return for same amount of risk - compare B to E= investor wants B, less risk and more return - compare A to B= neither wanted because it is on the efficient frontier line - portfolios below efficient frontier= inefficient since there is a portfolio that provides more return for that level of risk - portfolio above efficient frontier line= considered unattainable
What is the difference between corporate bond risk and US government bond risk?
- corporate bonds can default, US government bonds cannot
what is correlation and correlation coefficient?
- correlation and the covariance measures of one security relative to another - correlation ranges from +1 to -1 - provides investor with insight as to the strength and direction two assets move relative to each other - correlation of +1= perfectly positively correlated (assets move in the same direction at the same time/position) - correlation of 0= assets are completely uncorrelated - correlation of -1= perfectly negative correlation - perfect diversification would be a 50/50 split between -1 to +1 assets in a portfolio= 0 correlation - diversification benefits (risk is reduced), begin anytime correlation is less than 1 - which is the most diversified? A. 0 B. +.25 C. -.53 Answer= -.53 (closer to -1 more diversified)
How do you determine coupon rate (CR) or nominal yield?
- coupon rate is the annual payment amount in dollars, divided by the par value - coupon rate= coupon payment/par
If a bond pay $100 per year with a par value of $1,000,000 what is the coupon rate?
- coupon rate= coupon payment/par - coupon= $100/$1,000= 10%
What is current yield (CY)?
- current yield is the annual payment amount in dollars divided by the current price of the bond - current yield= coupon payment/price of the bond
A bond pays $100 per year total, with a current market price of $876.00. What is the current yield?
- current yield= coupon payment/price of the bond - current yield= $100/$876= 11.42%
what are unsecured bonds?
- debentures - subordinated debentures (jr bonds) - income bonds (muni)
What are examples of corporate bond risk?
- default risk -reinvestment rate risk - interest rate risk - purchasing power risk
What is the insider trading and securities fraud enforcement act of 1988?
- defines an insider as anyone with information that is not available to the public - cannot trade on that info
What is a eurodollars?
- deposits in foreign banks that are dominated in US dollars
What is the dividend discount model and expected rate of return?
- dividend discount= values a company's discounting the future stream of cash flows - expected rate of return= uses price and value, similar equation to the discount model
What is dividend yield formula?
- dividend/stock price - states the annual dividend as a percentage of stock price
What are main dividend dates?
- dividends are declared by Board of directors and typically paid quarterly - two important dates= ex-dividend date and date of record - ex-dividend date= date stock trades without the dividend, sell the stock on ex-dividend date (will receive dividend), if you buy the stock on or after ex (no dividend), ex-divdend is one day before date of record - date of record= date on which you must be a registered shareholder in order to receive to receive the dividend; a day after ex-dividend date; investor must purchase a stock 2 days prior to receive divd
What is estimating bond price and how do you calculate it?
- duration can also be used to estimate the price change of bond, based upon a change in interest rate
What is bond duration?
- duration is the weighted average of all cash flows - if bond duration for A is 4.2 and B is 8.7, while interest rates are expected to drop, which would you buy? answer= B (more volatile but we want that in this case) - bigger the duration= more price sensitivity or volatile the bonds is to interest rate changes - duration= the moment in the investor is immunized from interest rate risk and reinvestment rate risk - modified duration= bond's price sensitivity to changes in interest rates - bond portfolio should have duration equal to investor's time horizon
What is the securities investment protection act of 1970?
- established the SIPC to protect investors from losses resulting from brokerage firm failures -doesn't protect investors from incompetence or bad investment decisions
What are bankers acceptance?
- facilitates imports/exports - maturities of 9 months or less - can be held until maturity or traded
What is effective annual rate?
- formula calculates the effective annual interest rate earned on an investment when the compounding occurs more often than once a year
What is a preferred stock?
- has both equity and debt features - stated as par value or stated dividend rate as a percentage of par (example= XYZ preferred pays 5% dividend with a par value of $20. The preferred stock would pay $20x5%= $1.00 per share) - equity features= price of preferred stock may move with the price of common stock - difference= dividends does not fluctuate like a common stock, no maturity like a bond, preferred stock is closely tied to interest rates - tax advantage= C corporations receive a 50 or 65% deduction of dividends (preferred and common stock) based on percentage of ownership of the company paying dividends (covered in tax)
Which investment is more risky?
- how to calculate SD?
example of bond question related to interest rates
- if interest is doing to rise= you want shortest duration - if interest is doing to decrease= you want longest duration/maturity
Jensen model formula
- indicates a managers performance - positive is good, negative is bad - higher positive alpha is better then a negative or less high alpha
What does r^2 indicate?
- indicates what percent of return is due to the market - measures how well diversified our portfolio is - if our beta is .90, r^2 is .81, 81% is systematic risk and 19% is unsytematic risk - if r-squared is less than .70 then beta can't be used (above .70 then beta is a good measure and indicates it is well diversified)
What is initial margin?
- initial margin reflects the amount of equity an investor must contribute to enter a margin transaction - regulation T set the initial margin at 50% (Fed established) - initial margin could be higher for more volatile stocks - on exam assume 50% unless otherwise told
What is bond immunization?
- interest goes up, PV decreases, reinvestment increases - interest decreases, PV increases and reinvestment decreases - bond immunization occurs when the average duration of the bond portfolio just equals the investment time horizon
What is a municipal bond?
- interests are nontaxable at federal, state and local level, if you live in the issuing state (buy NYC bond is nontaxable at fed, state and local; buy NY bond it is nontaxable at state/federal level) - still taxed as cap gains if a gain occurs - three types= general obligation (backed by the taxing authority), revenue bonds (not backed by the full faith, credit and taxing authority; backed by revenue from a project) and private activity bonds (used to finance things like stadiums)
What is a IPS?
- investment policy statement - establishes a client's objectives and limitations on investment manager - measures investment managers performance - does not include investment section - establishes RR TTLLU (risk, return, taxes, timeline, liquidity, legal and unique circumstances)
What is behavioral finance?
- investors are "normal"= normal investors have normal wants and desires, but may commit cognitive errors through biases - normal investors may be misled by emotions - markets are not efficient= deviations in price from fundamental value so that there are opportunities to buy at a discount or sell at a premium - behavioral portfolio theory= investors segregate their money into various mental accounting layers, mental process occurs when people compartmentalize certain goals to accomplished in different categories based on risk rather than viewing their entire portfolio as a whole - risk along does not determine returns= behavioral asset pricing model determines the expected return of a stock using beta, book to market ratios, market capitalization ratios etc.
What is the efficient market hypothesis (EMH)?
- investors cannot consistently achieve above average market returns - prices reflect all information available and change very quickly with new information - stock prices follow a "random walk" - investors who believe in this hypothesis believe a passive investment strategy is appropriate (buy and hold an index)
What is the capital market line (CML)?
- is the macro aspect of the capital asset pricing model (CAPM) - outlines relationship between risk and return in all portfolios - portfolio returns should be on the CML - inefficient portfolios are below CML - not used to evaluate the performance of a single security
What is market interest rates?
- is the yield that is currently being earned in the marketplace on comparable securities - used to discount a bond to determine what is currently selling for the market -keystroke= i (I/Y or I/YR in some cases)
What is an original issue discount (OID)?
- issued at a discount from par value - example of an OID is zero-coupon bond that is sold at a deep discount to par value - zero coupon bonds= bond holder must recognize income each year, even though no interest is received
What is a unit investment trust (UIT)?
- it is a type of investment company - equity or fixed income unit investment trust - typically fixed income - self liquidating - passive management - no trading of assets within the trust - issues units not shares
When thinking about efficient frontier, where does the best option or market portfolio lie?
- it is the portfolio on the efficient frontier, which hits the risk free rate line once drawn (capital market line CML)
what goes against the EMH?
- january effect - small firm effect - value line effect - P/E effect (value investing) - AFC/NFC - presidential elections
What are the three yield curve theories?
- liquidity preference theory - market segmentation theory - expectations theory
What is the difference between liquidity and marketability?
- liquidity= how quickly something is turned into cash, with little to no price concession (short term assets are considered liquid), stocks/bonds/mutual funds are not liquid because an investor suffers price concessions - marketability= exists when there is a ready-made market - example= real estate is marketable, but not liquid
What is the maintenance margin and margin position?
- maintenance margin= minimum amount of equity required before a margin call -margin position= represents the current equity position of the investor (equity/FMV)
At what price does an investor receive a margin call price?
- margin call= loan/1-maintenance margin **must know**
What are treasury bills?
- maturities of 4, 13, 26 and 52 weeks
Draw negative skewness
- mean, median, mode (left to right)
What is covariance?
- measures of relative risk - price movements between two securities are related to each other - COV is used in SD of two asset portfolio formula
What is the sharpe index?
- measures portfolio performance using a risk-adjusted measure that standardizes returns for their variability - measures reward to total variability, or total risk - risk adjusted - measures how much return will be achieved per unit of risk - similar to treynor - well diversified portfolios tend to have identical results - higher the sharpe the better, means more return per unit of risk (1 is acceptable, 2 very good and 3 excellent)
What is beta?
- measures securities volatility relative to the market - measured to measure the volatility of a diversified portfolio - beta of the market= 1 (expected to mirror the market in terms of direction, return and fluctuation) - beta higher than 1= stock is more volatile then market and greater risk - beta less than 1= security fluctuates less relative to market movements - measures systemic risk or market risk
what is the information ratio?
- measuring active return per unit of risk - higher the numerator the better - relative measure of risk adjusted performance measure
Draw positive skewness
- mode, median mean (left to right)
Describe the modern portfolio theory
- modern portfolio theory= acceptance by an investor of a given level of risk while maximizing expected return objectives - efficient frontier= curve that outlines the best possible returns that could be expected from all possible portfolios - indifference curves= constructed using selections made based on the highest level of return given an acceptance level of risk - efficient portfolio= investor's indifference curve is tangent to the efficient frontier - optimal portfolio= the one selected from all efficient portfolios; investor seeks highest return at any level or risk; want lowest risk at any level or return and assumptions made that investors are risk averse (reluctant to take risk)
sharpe index calculation
- need to have two, higher the better - measures risk adjusted return
What is the difference between preferred stock, common stock and a bond?
- no maturity like a bond - dividends do not fluctuate like common stock - preferred stock closely tied to interest rates
What is the difference between rational investors and a normal one?
- normal investor= prone to making cognitive mistakes due to beliefs or biases - types of bias= affect heuristic, anchoring, available heuristic, bounded rationality, confirmation bias, cognitive dissonance, disposition effect, familiarity bias, fabler's fallacy, herding, hindsight bias, illusion of control bias, overconfidence, overreaction, prospect theory and similarity heuristic
What is the lognormal distribution?
- not a normal distribution - appropriate if an investor is considering a dollar amount or portfolio value at a point in time - if an investor invests $1 into the market 60 years ago, it would be worth $60 today
What is the holding period return?
- not compounded rate of return - no consideration for time the sec was held - add dividends to the numerator, margin interest subtracted from numerator, taxes paid will be subtracted from numerator only if it asks for after-tax gain or loss
Standard deviation graph
- note each deviation in green are increasing or decreasing by 6 which is the SD in scenario 1 - 12 is the average return (in green) - the yellow represents the probability of a return less than zero (2.5%)
what is the probability of having a return less than 0% if x bar= 12% (mean) and sigma= 6% (SD)?
- note the mean up and down is being added or subtracted by SD (6) - .05 on both side accounts for 100%-99%= 1% therefore 0.5 above 0 and 0.5 below
example of coefficient of variation
- option B is more risk relative to return - option A is more risk relative to return, prefer option B
What is a prospectus?
- outlines the risks, management team, business operations, fees and expenses - might be issued by an investment company prior to selling shares to an investor
What is a coupon rate?
- periodic interest payment received by a bond holder - a bond with a 10% coupon pays $50 semi-annually ($1,000 par*.10 coupon/2)(keystroke= PMT)
What is an exchange traded fund (ETF)?
- portfolio of stocks that represent an index - traded on an exchange like stocks - investors don't buy/sell blindly - low cost of ownership because they are passive investments - no active trading because ETFs track a stock index - tax efficient investment because of low asset turnover and passive investment strategy - examples= QQQQ--> NASDAQ 100; SPY--> S&P 500
What is a red herring?
- preliminary prospectus issued before the SEC approval and is used to determine investor interest in a security
What is P/E ratio?
- price to earnings ratio - represents how much an investor is willing to pay for each dollar of earnings - measures relationship between stock's price and earnings - useful if the company does not pay divds
What is the difference between price weighted average and value weighted average?
- price weighted average= ratio of the value traded to total volume traded over a particular time horizon - value weighted average= average of values which are scaled by importance, sum of weights times values divided by the sum of the weights
What is PEG ratio?
- price/earnings to growth (PEG) ratio compares a stock's P/E ratio to the company's 3-to-5 year growth rate in earnings - 3-to-5 year growth rate in earnings is the historical earning growth rate - use to determine if the stocks P/E is keeping pace with growth rate in earnings - PEG equal to 1= stock is fairly valued, P/E is in line with earnings growth rate - PEG ratio greater then 1= stock price is fully valued or even overvalued because expanding P/E ratio is contributing to the stock price appreciating
What is par value?
- principal amount which is generally $1,000 on most issues - par value is the amount that will be repaid to bond investors at the end of the loan period (keystroke= FV)
What is technical analysis?
- process of charting and plotting a stocks; trading volume and price movement - does not involve ratio analysis or financial statement analysis - analysts believe supply and demand drive stock price - resistance= develop when investors who brought on an earlier high may now view this change to get even (opportunity to make a profit) - support= will develop when a stock goes down to a lower level of trading because investors act on a purchase opportunity they previously passed on
What is the fundamental analysis?
- process of conducting ratio analysis (liquidity, activity, profitability and common share measurements) on the balance sheet and income statement to determine future financial performance and a forecasted stock price upon the future financial performance - looks at economic data (inflation, GDP and unemployment) to determine how economy will impact various industries - investors estimate the stock's future price behavior - easy to determine if sec is mispriced
What is the coefficient of determination or R-squared?
- r-squared is a measure of how much return is due to the market or what percentage of a security's return is due to the market - square the correlation coefficient - provides the investor insight on how well-diversified a portfolio is - higher the r-squared= higher the percentage of return from the market (systemic risk), less from unsystemic risk - tells investor if beta is the right measure of risk - r-squared greater or equal to .7, then use beta to measure total risk - r-squared less then .7 beta is not the right measure use SD, return due to market - example: if mutual fund XYZ has a correlation coefficient of .80, then its r-square is .64, which means 64% of fund XYZ's return is due to the market (systematic risk), 36% due to unsystematic risk. r-squared less then .70 is undiversified portfolio
Define skewness
- refers to normal distribution curve shifted to the left or right of the mean - example= commodities are usually skewed
What is kurtosis?
- refers to variations of returns - positive kurtosis= high peak and little variations of returns - negative kurtosis= returns are widely dispersed and the peak of the curve is low - leptokurtic= high peak, fat tails (higher chance of extreme events), tight distribution - platykurtic= low peak and thin tails (lower chance of extreme events), wide distribution
What is expectations theory?
- reflects investors' inflation expectations - expectations theory relates to inverted yield curve (impacts long term bonds more then short term) - investors believe inflation will be higher in the future, therefore long-term yields are higher then short-term yields - if inflation is expected to be lower in the future= long-term rates will be lower than short term rates (results in inverted yield curve)
What are examples of US government bond risk?
- reinvestment rate risk - interest rate risk - purchasing power risk
What is the unbiased expectations theory (UET)?
- related to the term structure of interest rates - hold's that today's long-term interest rates have embedded in them expectations about future short-term interest moves
What is the information ratio?
- relative risk adjusted performance measure - measures excess return and the consistency provided by a fund manager, relative to a benchmark - higher the excess return the better - can be positive or negative depending on fund's performance relative to benchmark
yield to maturity example
- remember to change the PV to a negative or you won't get the right answer
What is an american depository receipts (ADRs)?
- represent foreign stock held in domestic banks' foreign branch - entitle the shareholder to dividends and cap grain - cap gains include currency fluctuation - traded on US exchanges - divd paid in US dollars - DO NOT eliminate exchange risk
what is the disadvantage of the dividend discount model?
- requires constant, perpetual growth rate of divd - many stocks don't pay divds so the sec value may not be estimated with this model - growth rate cannot be greater than the expected return or else the sec price becomes very sensitive to expected return when nearing growth rate
What is the investment advisers act of 1940?
- requires investment advisors to register with SEC or state
What is ROE?
- return on equity - measures the overall profitability of a company - direct relationship between ROE, earnings and divd growth - earnings per share/stockholders equity per share
What is portfolio risk?
- risk of the portfolio measures through determination of the interactivity of the SD and covariance of securities in a portfolio - utilizes the weight of both securities, deviation of respective securities and correlation coefficient of the two securities - equation given
What is short selling?
- selling first at a higher price, in hopes of purchasing the stock back at a lower price - goal is to sell high and buy low - investor profits are made when price declines - opposite of taking a long position, where the investor makes a profit at price increase - investor must have a margin account to protect against any price appreciation of stock - no time limit - divd paid by company is covered by short seller - characteristics of a short sale: 1. investor must have a margin account 2. investor must deposit cash or securities to cover any potential price appreciation of the stock 3. sale proceeds are held by the broker 4. no time limit on how long an investor can maintain the short position 5. dividends paid by corporation must be covered by the short seller
What is a commercial paper?
- short term loans between corporations - maturities of 270 days or less - does not have to register with SEC - denominations of $100,000 - sold at a discount
How is the Dow Jones Industrial average priced?
- simple price-weighted average - does not incorporate market capitalization
What is monte carlo simulation?
- spreadsheet simulation that gives a probabilistic distribution of events occurring - example= what is the proability of running out of money in retirement with a client who has a withdrawal rate of 3%, 4%, or 5%. - adjusts assumptions and returns of the probability of occurring
What does SD mean?
- standard deviation measure absolute measure of risk (higher the more risky) - measures variation of returns around an average - check picture for example of SD (orange shift to clear) - solving find the average of the returns (add all up then divide by the number of returns); take each return and subtract by the average and square it (repeat for all returns), then take the n-1 (put in denominator)
what are examples of systematic risk?
- systematic (non-diversifiable risk, impacts all companies at the same time) 1. purchasing power (inflation) 2. reinvestment rate (interest rate will decline, reinvest cash flows at lower rate) 3. interest rate (interest rates go up) 4. market risk 5. exchange rate (value of the dollar to other currencies) (remember PRIME) - measured by beta
Define systemic and unsytemic risk plus examples
- systemic risk= the lowest level of risk one could expect from a fully diversified portfolio - unsystemic risk= the risk that exists in a specific firm or investment that can be eliminated through diversification - example of systemic risk= nondiversifiable risk, market risk and economy based risk - example of unsystemic risk= diversifiable risk, unique risk and company specific risk
What is phantom interest income?
- the OID (original issue discount) must be accreted (recognized) each year, therefore the bond owner is paying an income tax on "phantom" interest income since they are not actually receiving the interest - example= zero coupon bonds
What is the random walk theory?
- the behavior of a stock price resembles a random walk - stock prices are unpredictable - prices are not arbitrary - impossible to consistently achieve above average returns
What is risk?
- the chance that the actual return from an investment may differ from what is expected - the more risk, the higher return required before investing - risk consists of systematic and unsystematic risk
What is a dividend payout ratio?
- the relationship between the amount of earnings paid to shareholders in the form of a dividend, relative to earnings per share - higher the divd payout= more mature the company/possibility of a divd being reduced - low dividend payout ratio= indicates that the dividend may increase, thereby increasing stock price - common stock divd/earnings per share KNOW, IGNORE Preferred Dvd (P/S)
Which to use when with regards to sharpe, treyon and alpha?
- they are all risk adjusted performance measures - treyon and alpha both use beta to measure risk (use for diversified portfolios, r-squared is greater the .7) - use SD as a risk measurement aka Sharpe ratio when the r-squared is less than or equal to .7 therefore not a diversified portfolio
What is the length of maturity?
- time remaining until the bond holder receives the par - time to maturity can be described as the 'number of periods' to maturity, or that the loan will be outstanding - example= for a bond paying semi-annually, there will be 2 periods per years; quarterly payments will have 4 periods per year; and monthly, there will be 12 periods per year (keystroke= N)
What are treasury inflation protected securities (TIPS)?
- tips provide inflation protection and purchasing power protection - interest rate is fixed, par value adjusts based on inflation (1000 bond will increase in value to say 1001 based on inflation) - principal/par value adjusts for inflation and, then, the coupon rate is applied to the new principal amount - coupon rate does not change
how do you calculate total risk?
- total risk= systematic+unsystematic risk - total risk is measured by SD - systematic risk is measured by beta
what is the taxable equivalent yield on a treasury security paying 3.5% if the marginal federal tax rate is 35% and state income tax rate is 5%? A) 5.8% B) 3.68% C) 5.1% D) 4.8%
- treasury security- exempt from state and local taxes - remember interest/(1-tax exempt) - .035/(1-.05)= 3.68% - if it were a muni bond it would be .035/(1-.35) - if it were double tax exempt then it would be .035/(1-.4)
What is an open end?
- type of an investment company - unlimited number of shares - as long as the fund receives contributions, it will continue issuing shares - shares are bought/redeemed directly from the fund family - share trade at NAV -NAV= assets-liabilities/shares outstanding
What is a close end?
- type of investment company - have a fixed initial market capitalization because a specific number of shares are initially sold to the public - shares are traded on a organized exchange - no new shares are issued in the fund - shares trade at a premium or discount to NAV
What is an option?
- types of options= puts and calls - is a derivative security, which derives their value from the price behavior of an underlying real or financial asset
What does the underwriter do and what did the firm commit to do?
- underwriter agrees to sell as much of the offering as possible - the risk of the issue not selling resides with the firm because any shares not sold to the public are returned to the company - firm commitment= underwriter agrees to buy the entire issuance of stock from the company, underwriter may buy stock from the company for $18 and sell to the public for $20 (making a spread), the risk that an issuance may not sell resides with the underwriter
what are examples of unsystematic risks?
- unsystematic risk (diversifiable risk) 1. accounting 2. business 3. country (where sales come from/production?) 4. default risk 5. executive 6. financial (how a firm is financed) 7. government/regulations (remember A, B, C, D, E, F, G)
How much does SIPC cover in securities?
- up to 500k
What is property valuation?
- use to determine how much an investor is willing to pay for a piece of property - restatement of dividend yield formula - does NOT include depreciation or amortization, payments on debt service since financing expense - capitalized value= net operating income (NOI)/capitalization rate - Capitalized rate= NOI/cost
What is geometric mean?
- used to find a set of observations - it is a time weighted compounded rate of return
What is the Treynor Index?
- uses beta in denominator and to measure risk - risk adjusted performance measure - needs to be compared to another Treynor ratio since it is relative risk adjusted performance indicator - measures how much return will be achieved for each unit of risk - doesn't indicate whether a portfolio manager has outperformed or under-performed the market
What does value line and morningstar rank?
- value line= ranks stocks of 1 to 5 for timeliness and safety (ranking of 1 signals a buy, 5 is the lowest ranking signaling a sell) - Morningstar= ranks mutual funds 1 to 5 stars (1 star represents the lowest ranking)
where would we look for research reports on stock, mutual funds and ETF ranks?
- value line= ranks stocks on a scale of 1 to 5 (1 is highest) - morningstar= ranks mutual funds, ETF, stock (1 to 5 stars, 1 is worst)
What is a convertible bond and how to calculate it?
- value of a convertible bond= terms of the stock into which it can be converted - primary benefit= if the stock does not perform well, the investor has a floor built in (floor is par value)
What is the EAFE?
- value weighted index that tracks stocks in Europe, Australia, Asia and the Far East
How is a S&P 500 priced?
- value-weighted index incorporate market capitalization of individual stocks into the average - contains 30 companies - used to compare portfolio performance - large cap/blue chip stocks
How is the Russell 2000 priced?
- value-weighted index of the smallest market capitalization stocks in the Russell 3000 - small cap
What is accured interest?
- when a bond is purchased, the buyer pays the seller interest that has accrued since the last interest payment - new buyer then receives the full amount of interest due at the next interest payment - buyer will receive a 1099-INT which reflects the full period interest received
Immunization exam question example
- when you see immunization look at the time frame in the question to the duration in the answers. Closer the duration to time horizon, choose that answer
What is the segmentation theory?
- yield curve depends on supply and demand at a given maturity and there are distinct markets for given maturities with distinct buyers/sellers at each maturity - supply greater then demand= rates are low, rates will then have to increase for demand to increase - demand is greater then supply= rates are high, rates will then decreases to drive demand down
What is liquidity preference theory?
- yield curve results in lower yields for shorter maturities because some investors prefer liquidity and are willing to pay for liquidity in the form of lower yields - states that long-term yields should be higher than short-term yields because of the added risks associated with long-term maturities
How do you calculate bond duration?
- zero coupon bond will always have a duration equal to its maturity - coupon rate increases= duration decreases - for example (estimates only for duration) - bond A= 30 year zero coupon, duration= 30 - bond B= 30 year 5%, duration= 27 - bond C= 30 year 10% coupon, duration= 25 - coupon increases= duration decreases - coupon decreases= duration increases - yield to maturity increases= duration decreases - yield to maturity decreases= duration increases
What are the seven examples of unsystemic risk?
1. accounting risk 2. business risk= inherent risk a company faces by operating in a specific industry 3. country risk= risk a company faces doing business in a specific country 4. default risk= risk a company defaulting on their debt payments 5. executive risk= mental/ethical characters of management 6. financial risk= amount of leverage deployed by firm 7. government and regulation risk= tariffs or restrictions from government **ABCDEFG on test**
What are the types of mutual funds?
1. aggressive growth 2. growth 3. growth and income 4. value fund 5. balance fund 6. bond fund 7. money market fund 8. index fund 9. sector funds 10. asset allocation funds or life-cycle funds 11. global funds 12. international funds
What are dividends and splits?
1. cash dividend= qualified dividends receive capital gains treatment; taxed upon receipt 2. stock dividends= not taxable to the shareholder until stock is sold 3. stock splits= increase share outstanding, reduces price
What are the tools used for technicians?
1. charting 2. market volume 3. short interest 4. odd lot trading 5. dow theory 6. breadth of the market 7. advance decline line
what are the three types of investment companies?
1. close end 2. open end 3. unit investment trust (UIT)
What are the four basic premises of traditional finance?
1. investors are rational 2. markets are efficient 3. the mean variance portfolio theory governs 4. returns are determined by risk
List and explain the four types of orders
1. market order= timing and speed of execution are more important than price; most important for stocks that are not thinly traded (low volume securities) 2. limit order= price at which the trade is executed is more important then timing, used for stock that are very volatile and not traded often 3. stop order= price hits a certain level and turns to a market order, a stop order to sell means that once the stop order price is reached stock is sold, primary risk is that the investor may receive significantly less than anticipated if the market is moving too quickly 4. stop limit or stop loss limit order= investor sets two prices (first is the stop loss price, once the price reached the order turns to a limit order; second price is the limit price an investor will not sell below that price), risk is if the market moves quickly the order may not fill and the investor will be left with the stock at a much lower price, appropriate for investors with significant gain built in stock
What are the two examples of secured bonds?
1. mortgage backed securities (MBS)= backed by a pool of mortgages, payments of both interest/principal, biggest risk is prepayment risk 2. collateral trust bonds= backed by an asset owned by the company issuing the bonds; assets are held by a third party; in event of default, bondholders are entitled to the asset held in trust
what are the fund expenses?
1. no load funds= do not charge a sales commission when purchased or redeemed 2. load funds= load funds charge a sales commission when purchased or redeemed (shares A/B/C) 3. A shares= shares are front load, small 12b-1 fee (marketing fee used to pay commission), no redemption fee/back-end load 4. B shares= high 12b-1 fee (max 1%), contains back-end sale load (redemption fee) no front end sales load, can be converted into share A 5. C shares= do not charge a front-end load, usually charge a small back-end load and a maximum 12b-1 fee of 1%, cannot be converted to A shares
What are the five specific types of systemic risk?
1. purchasing power risk= inflation will erode amount of goods/services purchased and a dollar today cannot purchase the same number of goods/services tomorrow; impacts equities and bonds 2. reinvestment rate risk= risk an investor will not be able to reinvest at the same rate of return that is currently being received 3. interest rate risk= interest rate risk impacts equities and bonds 4. market risk 5. exchange rate risk *likely tested remember PRIME
What are the bond strategies?
1. tax swap= involves selling a bond that has a gain and a bond will a loss will offset each other 2. barbells= involves owning both short-term and long-term bonds; when interests move, only one set of positions needs to be sold and restructured 3. laddered bonds= requires purchasing bonds with varying maturities; bonds mature, new bonds are purchased with longer maturities 4. bullets= have very little payments during the interim period and then lump sun at the some specific date in the future; examples= zero-coupon bonds, treasuring and corporate
What are the three forms of the efficiency market hypothesis?
1. weak= historical information will not help investors achieve above average market returns (directly refutes technical analysis) 2. semi-strong= both historical and public information will not help investors achieve above average market returns 3. strong form= asserts historical, public and private information will not help investors get above average return; stock price reflect all information and reacts immediately to new info, believes in passive investment strategy ALL forms reject technical analysis; semi strong also rejects fundamental
if a fund has a return of 20% and the market has a return of 10%. What is the beta?
20/10= 2 stock is more volatile then market, greater risk (above beta of 1)
if a fund has a return of 5% and the market has a return of 10%, the beta would be what?
5/10= .05 Beta less than 1= less volatile then market
How does the user of the "intrinsic value" formula arrive at the appropriate rate of return (r and k) used in the model? A) by using the CAPM model B) by using the arbitrage pricing model C) by using the jensen model D) by using the expect rate of return model
A
Jennifer's portfolio experiences the following returns over a three-year period: 12%, -5% and 8%. What is her geometric average return? A) 4.7% B) 5% C) 8% D) 8.7%
A
Series "I" US treasury bonds would best be described to a client as: A) nonmarketable securities that adjust for inflation B) marketable securities that adjust for inflation C) nonmarketable securities that provide growth D) marketable securities that provides growth to combat inflation
A
What is the intersection on the y-axis of the CML/SML? A) risk free rate of return B) market portfolio C) undervalued asset D) overvalued asset
A
what is the intersection on the y-axis of the CML/SML? A) risk free rate of return B) market portfolio C) undervalued asset D) overvalued asset E) undeterminable
A
assume a fund has an average return of 10% with a standard deviation of 5%. What is the probability of achieving a return less than 0%? A) 2.5% B) 5% C) 16% D) 100%
A 10%-5%= 5% at -1 SD from the average. 5%-5%= 0% at -2 SD from the average. Based on the normal distribution, we know that 95% of the returns will be between +/-2 SD from the average 100%-95%= 5%= 5%/2= 2.5%
John has determined that he will need cash at the end of 8 years. Which of the following bonds may initially immunize his portfolio? A) a 10 year maturity coupon bond B) a 8 year maturity coupon bond C) a series of Treasury bills D) a 15 year zero coupon bond
A A is the best answer because the 8 year maturity coupon bond will have a duration of less than 8 years, whereas the 10 year could be 8 years.
John has determined that he will need cash at the end of 8 years. Which of the following bonds may initially immunize his portfolio? A) A 10-year maturity coupon bond B) A 8-year maturity coupon bond C) A series of treasury bills D) A 15 year zero coupon bond
A Answer A because the 8 year maturity coupon bond will have a duration less than 8 years, whereas the 10 year bond will be closer to 8 years. A 15 year zero coupon bond will have a duration equal to 15 years
What methodology can be used to price (or value) a stock that is a growth stock that pays no dividends? A) P/E multiplier B) intrinsic value model C) security market line equation D) constant growth model
A B and D need divds; C needs rate of return not value
Which broad market index would be more appropriate to use when conducting comparisons between large-cap, blue chip portfolio, and the securities market? A) S&P 500 B) DIJA C) Russell 5000 D) value line 300
A DIJA only has 30 stocks Russell is too broad no such thing as the value line 300
Which of the following is not a value weighted index? A) DJIA B) S&P 500 C) Russell 2000 D) Wilshire 5000
A DJIA is not a value-weighted indexed not price weighted
An investor believes that regardless of the information source, it is not possible to create a strategy that will consistently earn excess risk adjusted returns. The investor relies on index funds. Which of the following form of EMH is the investor advocating? A) strong B) semi-strong C) weak D) all of the above
A EMH asserts that investors cannot achieve above average market returns, therefore investors should take a passive strategy
treasury zero coupon bonds are particularly suited to which of the following types of accounts? A) IRA B) trust C) corporate D) joint
A IRA- does not require current taxes to be paid all the other options would require you to pay current taxes on pro-rata appreciation while receiving no cash payments
you are interviewing James Smith, CFP to manage your investments and provide financial guidance in other areas of your life. James states that his investment philosophy is as a contrarian; he buys securities that are losing favor and sells securities that are gaining favor. You review his previous track record, which is about equal with the market. His investments are typically in a security that has lost at least 10% from its most rennet high. What type of bias is James exhibited? A) anchoring B) herding C) overconfidence D) belief perseverance
A James believes the stock will fall 10% and is now fixated on the high price it used to be
Joe purchased a bond for $880 with a 9% coupon. He sold the bond after one year when it was paying him a current yield of 10%. What is the holding period return? A) 12.5% B) 9.0% C) 10.0% D) 9.5%
A SP-PP plus or minus CF/PP 900-880+90/880= 12.5% 90 came from 1,000x.09 900 from 90/.1
John is considering the two mutual funds below, but is uncertain which performed better over the past year. Growth Fund has a beta of 1.2 relative to the market. The risk free rate of return was 3%. Which fund would you recommend based on the Treynor ratio? Growth fund= actual return 12% Index fund= actual return of 9% A) growth B) index C) growth and index fund have the same risk adjusted returns D) non of the above
A Select the growth fund because it has a higher treynor growth fund treynor= (0.12-0.03)/1.2= 0.075 index fund treynor= (0.09-0.03)/1= 0.06 index fund beta is 1 because it tracks the market
Which of the following bond's value is adjusted to provide purchasing power protection? A) TIPS B) I bonds C) EE bond D) zero coupon bonds
A TIPS have par value adjusted; I bonds adjust coupon rate and the others dont provide protection
All of the following statements regarding a UIT are true except? A) investors redeem shares directly with the trust B) they are self-liquidating C) they are passively managed D) UITs can invest in equities or bond
A UITs are units not shares
if the yield ratio is Rtf(tax free)/Rt(taxable), how does a higher ratio affect the attractiveness of municipal bonds? A) the higher the ratio, the more appealing B) the lower the ratio, the more appealing C) both A and B D) neither A or B E) investors are indifferent to the ratio
A as tax free interest return increases, the ratio becomes larger
If an investor is a proponent of index funds, which of the following forms of the efficient market hypothesis is the investor advocating? A) strong B) semi-strong C) weak D) all of the above E) none of the above
A assets that investors cannot achieve above average market returns, therefore investors should take a passive investment strategy
A mutual fund has a correlation coefficient of .80. What percent of return is due to unsystemic risk? A) 36% B) 64% C) 80% D) 100%
A correlation coefficient= .80 r-square= .80^2= .64 100%-64%= 36% 64%= systemic risk 36%= unsystemic risk
Treasury zero coupon bonds are particularly suited to which of the following types of accounts? (CFP examination, released 2004) A) IRA B) trust C) corporate D) joint
A held in IRA to avoid current taxation
which of the following returns do mutual funds use when reporting a five-year historical return? A) time-weighted return B) dollar-weighted C) arithmetic mean D) holding period return
A mutual funds use the security's cash flow, which is time weighted return
which of the following are nondiversifiable risk? 1. business risk 2. management risk 3. company or industry risk 4. market risk 5. interest rate risk 6. purchasing power risk A) 4, 5 and 6 B) 1, 2, and 3 C) 5, 6 and 2 D) 1, 3 and 4 E) 1, 4 and 6
A remember PRIME
your client, age 35, is considering investing in a mutual fund that offer A, B and C shares. Your client's objective is to invest in the mutual fund to help meet her retirement goal. Which class of share would you recommend? A) A shares B) B Shares C) C shares D) None of the above
A shares A are appropriate for long-term investing because of low 12b-1 fees
which of the following are non-diversifable risk? 1. business risk 2. management risk 3. company or industry risk 4. market risk 5. interest rate risk 6. purchasing power risk A) 4,5 and 6 B) 1,2 and 3 C) 5,6 and 2 D) 1,3 and 4
A think PRIME
A bond is paying a 12% coupon and selling for $1,200. Which of the following accurately reflects (from lowest to highest) the yield relationship? A) YTC-YTM-CY-CR B) CR-CY-YTM-YTC C) YTM-YTC-CY-CR D) CY-CR-YTC-YTM
A this is a premium bond, for premium bonds, the yields from lowest to highest are YTC-YTM-CY-CR premium since it is over $1,000
MSFT declared a dividend payable to shareholders on the record date of Wednesday, May 15th. Which is the last possible date an investor could purchase the stock and still receive the dividend? A) stock purchased on May 13th B) stock purchased on May 12th C) stock purchased on May 11th D) stock purchased on May 10th
A two days before record date
Your client has asked what you mean when you speak of the difference between the variability of a security and the volatility of a security. You begin to explain this to him by saying that: A) variability is measured deviation B) volatility is measured using the coefficient of variation C) variability is measured using the beta D) volatility is measured using COV
A variability is measured using deviation volatility is measured by beta
Which of the following ratios gives the investor insight into whether the stock's price earnings multiplier is keeping pace with the earning growth rate? A) PEG B) P/E C) dividend yield D) lognormal distribution
A PEG ratio provides the investor with insight regarding whether or not P/E ratio is ahead of the earnings growth rate
A client asks about an article that she read in the WSJ. It discussed US government securities and the meaning of an inverted yield curve. You tell her that: A) the curve currently indicates long-term rates being lower than short-term rates B) the curve currently indicates short-term rates being lower than long-term rates C) the curve currently indicates long-term rates and short-term rates on a par D) the curve currently indicates long-term rates being higher than short-term rates
A standard yield curve has long rates higher than short rates B and D describe standard yield curve C describe a flat yield curve
As a planner, you client asks you what all of the various portfolio theories (e.g. Capital asset pricing model, arbitrage pricing theory) calculate? You tell her these models are used to calculate A) expected rate of return B) required rate of return C) risk adjusted rate of return D) alphas
B
What is the yield to maturity of a bond that is selling at a 5% discount to par, paying 11.25% in annual interest on a semiannual basis and maturing in 7 years? A) 11.23% B) 12.34% C) 13.10% D) 13.79%
B
Which of the following is a fundamental analyst unlikely to be using? A) financial statements B) bar charts C) 10K D) executive interviews
B
Which of the following is not a marketable security? A) T-bill B) EE bond C) T-note D) T-bond
B
craig is evaluating two sector mutual funds that are not well diversifed. How would you recommend that craig evaluate the funds on a risk adjusted return basis? A) calculate the treynor ratio and select the fund with the highest Treynor B) calculate the sharpe ratio and select the fund with the highest sharpe C) calculate the treynor and select the fund with the lowest treynor D) calculate the sharpe ratio and select the fund with the lowest sharpe
B
what is meant by US treasury bills are sold at a discount to par? A) US treasury bills are sold at par value and a discount is provided to purchasers of large amounts B) US treasury bills are sold at less than par and return par value to the holder at time of maturity C) US treasury bills are sold in an auction format and the highest bidders are then provided with a discount D) US treasury bills are sold at a discount and a premium to par value
B
Sydney buys a stock for $50 using an initial market of 75% and a maintenance margin of 40%. At what price will she receive a margin call? A) $13.12 B) $20.83 C) $25.25 D) $66.67
B ($50*.25)/(1-.40)= $20.84 *.25 is from 100%-75%= 25%
What is the taxable equivalent yield on a treasury security paying 3.5% if the marginal federal tax rate is 35% and the state income tax rate is 5%? A) 5.8% B) 3.7% C) 5.1% D) 4.8%
B .035/(1-.05)= 3.68%
which form of EMH rejects an investors reading 10-K filings? I. weak II. semi-strong III. strong A) I only B) II and III C) III only D) all of the above
B 10-K filings is fundamental analysis
You, a CFP practitioner, have been instructed to provide your client with the most appropriate portfolio for her needs. She is 76 years old and does not have many assets. You have requested an intern to put together several hypothetical portfolios for this client for you to choose from later. The intern has provided you with the following. portfolio A= expected return 4%, risk 3% portfolio B= expected return 6%, risk 3% portfolio C= expected return 8%, risk 5% portfolio D= expected return 8%, risk 8% portfolio E= expected return 10%, risk 12% Which portfolio above is most likely on the efficient frontier? A) A and C B) B and C C) B and D D) D and E
B A and B are both the same level of risk, but B has a higher return, this leads one to believe that B is on the efficient frontier or at least more efficient than A C and D both have the same level of return but C is less risky then D, therefore C is likely to be on the efficient frontier over D *compare in groups of 2, so which is better A or B, B since it has higher return with same risk as A; which is better C or D, C since it has the same return as D but less risk*
What is the weighted average duration of a bond portfolio with 5k invested in bond A with a duration of 4.4; 10k invested in Bond B with a duration of 9.5 and 15k in Bond C with a duration of 20? A) 9.9 B) 13.9 C) 14.4 D) 20
B Bond A= ($5,000/$30,000)*4.4= .07333 Bond B= ($10,000/$30,000)*9.5= 3.1667 Bond C= $15,000/$30,000)*20= 10.0 (0.7333+3.1667+10)= 13.9
Which of the following agency bonds are backed by the full faith and credit of the US government? A) FNMA B) GNMA C) SLMA D) FFCB
B Ginnie Mae is GNMA
Which formula carries out a direct or absolute comparison between a manager's performance and the performance of the market? A) treynor index B) jensen model C) sharpe index D) belth model
B Jensen model allows a direct comparison between portfolio performance and the market performance
When combining asset classes, an investor begins to receive diversification benefits when correlation is: A) equals -1 B) less than 1 C) less than 0 D) less than or equal to 1 E) equals 0
B Most diversification benefits are received when correlation is equal to -1, but begins at less than 1
what is the tield to call for a 10 year term bond paying a semiannual 6% coupon rate, selling for $1,200, but callable in 5 years at $1,050? A) 1.3% B) 2.6% C) 3% D) 6%
B N= 5x2 I= ? 1.3x2= 2.6% PV= (1,200) PMT= 60/2 FV= 1,050
what is the yield to maturity for a 5-year term bond paying a semiannual 8% coupon rate, selling for $930? A) 8% B) 9.8% C) 4.9% D) 4%
B N= 5x2 I= ? 4.9x2= 9.8% PV= (930) PMT= 80/2 FV= $1,000
what is the yield to maturity of a bond that is selling at a 5% discount to par, paying 11.25% interest and maturing in 7 years? A) 11.23% B) 12.34% C) 13.10% D) 13.79%
B N= 7x2 I= ?? 6.16x2= 12.34% PV= (950) PMT= (1,000x.1125)/2 FV= 1,000 assume par of 1,000
which risk measure is appropriate to use when measuring the risk of a nondiversified portfolio? A) covariance B) SD C) beta D) correlation
B SD used for nondiversified portfolio beta is used for diversified portolio
when considering a diversified portfolio, which of the following is an appropriate measure of risk? A) SD B) beta C) covariance D) Coefficient of determination
B SD- does systematic and unsystematic risk Beta- assumes diversified portfolio, high R-squared and measures only systematic risk
when considering a diversified portfolio, which of the following is a appropriate measure of risk? A) SD B) beta C) covariance D) coefficient of determination E) correlation coefficient
B beta is an appropriate measure of risk for a diversified portolio
A bond paying a 9% coupon and is selling for $970. Which of the following is accurately reflects (from lowest to highest) the yield relationship? A) YTC-YTM-CY-CR B) CR-CY-YTM-YTC C) YTM-YTC-CY-CR D) CY-CR-YTC-YTM
B bond is selling at a discount, therefore the yields from lowest to highest are CR-CY-YTM-YTC
Which of the following would you use to ascertain the chairman's perspective for progress completed and expected for the coming year? A) 10K report B) annual report C) 10Q report D) quarterly report
B chairman's perspective is written in the annual report
Mutual fund XYZ has a 5 year return of 12%, with SD of 15%. Fund XYZ has a beta of 1.4, with a correlation of .90 to the S&P 500. What percentage of return from fund XYZ is due to the S&P 500? A) 91% B) 81% C) 19% D) 10%
B correlation= .90 therefore r-squared= .81 81% of return is due to market (systematic risk) and 19% is due to unsystematic risk
Mutual fund XYZ has a 5-year return of 12%, with a standard deviation of 15%. Fund XYZ has a beta of 1.4, with a correlation of .90 to the S&P 500. What is the percentage of return from fund XYZ is due to S&P 500? A) 90% B) 81% C) 19% D) 10%
B correlation= .90, therefore r-squared is .81 or 81% of the return is due to the market, 19% is unsystemic risk
If June is the date of record, when must Joe purchase the stock in order to receive the dividend? A) June 1 B) June 2 C) June 3 D) June 4 E) May 31
B date of record minus 2 business days
You own 1,000 shares of a stock. You purchase these shares for $25 per share on margin with a 50% initial margin requirement and a 25% maintenance margin requirement. The shares experienced some reversals in the pummeling that tech stock have received recently. The price dropped to $13 a share. Will there be a margin call? If so, how much?
B debt= 1,000*$25= $12,500 New portfolio value= 1,000*$13= $13,000 margin= $13,000*.25= $3,250 remaining= $13-$12.50*1,000= 500 when will the call happen? $3,250- $500= $2,750
all of the following funds invest in US stocks except? A) growth fund B) international fund C) global fund D) balanced fund
B international funds do not invest in US equities
Kevin has subscribed to various investment magazines and data resources, which he religiously reads and analyzes. Kevin utilizes this analysis to make shifts in his high beta portfolio on a daily basis. Which behavioral finance bias is kevin subject to? A) hindsight bias B) overconfidence C) regret avoidance D) herd mentality
B kevin believes the information is perfect, his analysis is perfect, so he trades too often and has a very risky portfolio
Charlie has noticed that the stock she purchased tends to have very tight distribution around the mean but there seems to be a high probability of "outliers." This is most indicative of what type of curve? A) positive skewness B) leptokurtosis C) normal D) lognormal
B leptokurtic distribution reflects the tendency of observations to fall closely around the mean creating a peak distribution at the mean with thicker tails. Leptokurtosis then there is much more reserved variation in periodic returns but higher probability of large multi-sigma deviations (fat tails)
How do the stock split and the stock dividend impact and the stock dividend impact the shareholders without bringing about any charges any changes in the value of the company on the balance sheet? A) the value of the stock split and value of the stock dividend are generally small enough that the impact on the balance sheet is minimal B) the value of the stock split and value of the stock dividend increase the number of shares but not the total value of those shares C) the value of the stock split and the value of the stock dividend cause dilution, which keeps the value of the stock up, but without increasing the overall value on the balance sheet D) the value of the stock split and the value of the stock dividend offset one another, thereby eliminating any change that might occur to the balance sheet of the company
B stock dividends and stock splits increase the number of shares, but not the value of the shares
Lindsey is your client and she believes that you can help her improve her returns by assisting her with her investment selections. What type of method is appropriate? A) ladder bonds and UITS B) strategic asset allocation C) passive investments in ETFs D) dollar cost averaging in index funds
B strategic allocation is the only active investment strategies
If an investor expects interest rates to increase, which type of bond would the investor prefer? - Bond A: AAA rate, 10 year maturity, 8.86 duration, 11% coupon, selling for $954 - Bond B: AA rated, 5 year maturity, 4.2 duration, 12.5% coupon selling for $982 - Bond C: AA rated, zero-coupon, 30 year maturity, selling for $575 A) bond A B) bond B C) bond C
B the bond with the smallest duration will be the least sensitive to changes in interest rates. The bond with the smallest duration will have the shortest term and highest coupon/YTM
stocks that have experienced volatility with positive and negative returns through the investment period being tracked should use which of the following methods to determine their true returns? A) arithmetic average B) geometric average C) weighted average D) average appraised stock return
B D doesn't exist and A/C would yield false results
Your client is considering purchasing stocks. The actual return of one of his choices follows here. Assist him by calculating the SD and advise him what the risk is. Stock A actual return 6%, 12%, 8% and 10% A) 0.0164 B) 0.0258 C) 0.0542 D) 0.1072
B check pic for breakdown on calc
Your company has a portfolio made up of two assets, one from the US and the other from Swaziland. Their information is as follows: Check pic The company has asked you to estimate risk involved in the existing portfolio (correlation is .30). After calculating, you tell them the portfolio deviation is: A) 20.6% B) 12.9% C) 8.5% D) 18.9%
B take the shortcut and find the simple average simple average= (10.5+23.8)/2= 17.15% choose the answer less that 17.15%
Which of the following types of investor benefits most from the tax advantages of preferred stocks? A) government B) individuals C) corporate D) mutual funds E) nonprofit institutions
C
the yield to maturity of a 10-year bond selling in the market at $1,148, while the coupon is 8% annually. What is the duration of this bond? A) 4.62 years B) 6.78 years C) 7.45 D) 9.93 years
C
which of the following would serve as an analytical tool to provide information to a client regarding small cap growth stocks? A) wilshire 5000 B) S&P 500 C) Russell 2000 D) dow jones small cap average
C
If the risk free rate of return is 3% and the beta of a security is 1.5 and the market risk premium is 9%, what is the expected return? A) 13.5% B) 12.5% C) 16.5% D) 12%
C .03+1.5(0.9)= 16.5%
Point A represents? A) dow theory B) resistance C) support D) odd lot
C A= support B= resistance
Will purchased a bond for $1,050. The conversion price is $40 and the market price of the common stock is $35. What is the conversion value of the bond? A) $300 B) $400 C) $875 D) $1,050
C CV= 1,000/$40x$35 CV= $875
which of the performance models measures risk using a different variable than the others? A) treynor index B) jensen model C) sharpe index D) capital asset pricing model
C Treynor, Jensen and CAPM all use beta as a measure of risk sharpe uses SD
Your client has expressed a desire to completely minimize market risk exposure. Under the time classification of markets listed in the study guide, which instrument would best meet her requirement? A) a 30 day call option B) a treasury bond with 60 days to maturity C) a treasury bill with a 1 year maturity D) a 180 day commercial paper
C US T-bill is the only investment that does not have market exposure risk
Which form of the efficient market hypothesis directly refutes technical analysis? A) strong form B) semi strong form C) weak form
C although all forms refute technical analysis the weak form directly refutes it
Stock index funds and ETFs are subject to which of the following risks? A) financial risk B) interest rate risk C) systematic risk D) unsystematic risk
C attempt to meet market return, which involves systematic risk
All of the following statements regarding close-end funds are true except? A) they trade at a premium B) shares trade on an exchange C) they have unlimited initial market capitalization D) they trade with the help of a broker
C close end funds have a limited initial market capitalization, once the shares are sold, no additional shares are sold to the public
If mutual fund ABC has a correlation of .80 to the S&P, which of the following risk permance measures would be appropriate to measure the performance of fund ABC? A) treynor B) jensen C) sharpe D) treynor and sharpe E) treynor and jensen
C correlation of .80 is a r-squared of .64 or 64% less the .7 r-squared means nondiversifiable portfolio, therefore can't use treynor or alpha must use sharpe based on r-squared
Paul is considering buying a bond with a current yield of 8% and selling for $900. Assuming the bond pays an annual coupon, what is the coupon rate of this bond? A) 5.5% B) 6.0% C) 7.2% D) 8.2% E) 9.0%
C current yield= coupon payment/price of the bond coupon yield= 0.08= x/$900 x= $900x8%= $72 $72/$1,000= 7.2%
if mutual fund ABX has a correlation of .80 to the S&P 500, which of the following risk adjusted performance measures would be appropriate to measure the performance of the fund ABC? A) treynor B) jensen C) sharpe D) treynor and sharpe
C find r-squared= .80 squared= .64, less then .70, therefore not a diversified portfolio
Two securities, A and B, have perfect negative correlation (-1). This means that if A goes up 10 points in value, B goes down by 10 points. Under these circumstances, how can a client ever hope to make any money? A) if the client buys twice as much of A as she does of B, she can make money B) the client should be striving for perfect correlation instead C) the two will provide the mean expected return and offset any risk D) the client should sell the rising stock and take profit to buy the falling stock
C if each sec is expected to return 12% and each offsets both loss and gain in the marketplace, while maintaining its average, the closer the correlation is to -1, the better the portfolio
which of the following indices is the most appropriate benchmark for Sam to measure his portfolio against? Index 1= beta of .90, SD 10% and r-square .85 Index 2= beta 1, SD 12% and r-squared .89 index 3= beta 1.5, SD 15% and r-squared .95 A) index 1 B) index 2 C) index 3 D) index 1 and 2 E) index 1 and 3
C index 3 because r-squared is highest (.95 or 95%) of return in Sam's portfolio
the optimal portfolio occurs at the point of tangency between: A) the utility curve and efficient frontier B) the indifference curve and portfolio deviation C) the efficient frontier and indifference curve D) the optimal curve and the utility function
C no such thing as a utility curve or optimal curve portfolio deviation has nothing to do with optimal portfolio
An old Wall Street saying is "cut your losses and let your profits run." However, investors often do the opposite. It seems that people are reluctant to admit they made a mistake in purchasing a stock that subsequently performs poorly. This behavior is most consistent with: A) anchoring B) herding mentality C) regret avoidance D) representativeness
C regret avoidance leads investors to take action or to refuse to act in hopes of minimizing any regret over actions or inactions
stock index funds and exchanged traded funds that track the market indices are subject to which of the following risks? A) financial risk B) business risk C) systemic risk D) unsytemic risk E) diversifiable risk
C systemic risk= market risk all other options are examples of unsystemic risk
All of the following are unsystemic risks except? A) business risk B) default risk C) exchange rate risk D) financial risk
C unsystemic risks are ABCDEFG, the E stands for executive risk not exchange rate risk exchange rate risk= systemic risk
Your best friend Alex came to your house party for a football game. During the game he starts telling you about his amazing portfolio performance. He tells you about several positions that experienced double digit returns in a matter of days. He says that he lost on a few but not very much. Impressed you decide to invest some money with him. What behavioral finance bias does your friend Alex portray? A) overconfidence B) anchoring C) cognitive dissonance D) belief perseverance
C Alex is likely exaggerating gains and minimizing or forgetting about his losses
Which risk is appropriate to use when measuring the risk of a diversified portfolio? A) covariance B) SD C) beta D) correlation
C SD is used for nondiversifed portfolio beta is used for a diversified portfolio
A business is considering purchasing a piece of new equipment for $120,000. The equipment will generate the following revenues: year 1 $50,000, year 2 $30,000, year 3 $20,000 and year 4 $10,000, then the machine is sold at the end of year four for $25,000. Assume the discount rate of 8%. Should they purchase the new piece of equipment? Determine NPV and IRR
CF0= (120,000) CFj= 50,000 CFj= 30,000 CFj= 20,000 CFJ= 10,000+25,000 I= 8 NPV= (-6,381) (don't make the investment) IRR= 5.354%
Sydney buys a stock at $40 and it pays the following divds. Year 1= $2.00 Year 2= $2.50 Year 3= 0 Year 4= $2.75 What is Sydney's compounded rate of return if the stock can be sold for $45 in Year 4:
CF0= (40) CFj= 2.00 CFj= 2.50 Cfj= 0 CFj= 2.75+45 IRR= 7.34%
American depository receipts (ADRs) are use to: 1. finance foreign exports 2. eliminate currency risk 3. sell US securities in overseas markets 4. trade foreign securities in US markets A) 1 and 3 B) 1 and 4 C) 2 and 4 D) 4 only E) 1, 2, and 4
D
calculate the new price of the following bond when interest rates change: A 10 year bond selling in the marketplace for $1,071. It pays investors $80 annually with a $1,000 maturity value. If interest rates in the marketplace fall 100 basis point, the new price of this bond will: A) fall $40 B) rise $68 C) fall $71 D) rise $74
D
A stock pays a divd of $2 and is expected to grow at 10% and is trading at $40 per share. Assuming an investor has a required rate of return of 14%, would the stock be undervalued or overvalued using the constant growth formula? A) its intrinsic value is $50, so it is overvalued B) its intrinsic value is $50, so it is undervalued C) its intrinsic value is $55, so it is overvalued D) its intrinsic value is $55, so it is undervalued
D $2.00(1.10)/0.14-.10)= $55. Stock is selling for $40, so it is undervalued because the investor thinks it is worth $55
if Tuesday, June 4th is the date of record, when must Joe purchase the stock in order to receive the dividends? A) June 1 B) June 2 C) June 3 D) May 31
D - date of record-2 days - don't count weekends or holidays, only business days
A firm has earnings per share of $5 with a dividend of $1, a P/E ratio of 22 and a SD of 12%. What is the firm's dividend payout ratio? A) 5% B) 10% C) 15% D) 20%
D 1/5= 20% dividend/earnings per share
What investment information do weighted average portfolio return and weighted average portfolio beta, respectively, provide you as an investment advisor? A) the lowest possible risk available given any level of return to the investor B) the highest possible return on any investment given any level of risk available to the investor C) the risk involved in a portfolio given a certain level of return D) the risk and return on a proportionate basis per unit of investments in the overall portfolio
D A, B and C are modern portfolio theory
Which of the following bonds mitigate against purchasing power risk? A) TIPS and STRIPS B) STRIPS and EE Bonds C) TIPS and EE Bonds D) I Bonds and TIPS E) I Bonds and EE bonds
D I bonds adjust the interest paid for inflation, and TIPS adjust the par value for inflation. All other bonds provide no purchasing power risk protection
A client is looking to achieve equity type returns, but is concerned about tax consequences. Which of the following investments would you recommend? A) convertible preferred stock B) REIT C) zero coupon bond D) stock index fund
D index funds are tax efficient, low turnover and provide equity type returns
Your client has asked you about structuring a passive equity portfolio. Which of the following would you not recommend? A) benchmark portfolio B) exchange traded funds C) UIT (unit investment trust) D) Market timing
D market timers are active; rest are passive
Which of the following forms of the EMH supports technical analysis? A) strong B) semi-strong C) weak D) none of the above
D none of these three forms suggest technical analysis will not help you achieve above average market returns
which of the following is not a nondiversifiable risk? A) interest rate risk B) market risk C) purchasing power risk D) regulation risk
D remember PRIME risks are systemic risks regulation risk is government risk which is unsystemic risk or nondiversifiable (can't get ride of the risk with diversification)
Which of the following statements is true regarding the Securities Investors Protection Act of 1970? A)the act protects investors from losses arising from bad investment decisions B) the act requires a prospectus to accompany all new issues C) the act protects investors from negligence on the part of an investment advisor D) the act protects investors from losses arising from brokerage firms failures
D securities act of 1933 requires new issues to be accompanied with a prospective
What does the term overvalued refer to with regards to the SML in this chapter? A) the alpha of the security is above the security market line B) the security is returning more value than was expected C) the security is selling at a low price compared to its calculated value D) the security is selling at a high price compared to its calculated value
D when market premium (high price) on a security relative to its calculated valuation (intrinsic value), that is when we refer to it as an overvalued asset
which of the following terms captures the difference between duration's estimate of bond's price change and the actual price change of a bond based upon changes in interest rate? A) modified duration B) skewness C) yield curve D) convexity
D convexity measures the difference between duration's estimate of a bond's price change and the actual price change of a bond
Which of the following are tools of the technical analysis? 1. market indicators 2. price indicators 3. volume indicators 4. charting A) 1 and 3 B) 2 and 4 C) 2,3 and 4 D) 1,2,3 and 4
D all are used by technical analysts to determine future prices
Joe purchases 1 share of XYZ for $50. One year later the stock pays a divd of $4 and Joe purchases an additional share for $65. Joe sold the stock one year later for $75 per share. What was Joe's dollar weighted return?
Dollar weighted: 0= (50) 1= (61) 65-4 2= 150 (2 shares sold at $75) IRR= 22.63% Dollar weighted= investor performance Time weighted= how did the stock do? time weighted: 0= (50) 1= 4 2= 75 IRR= 26.54%
Which of the following forms of the efficiency market hypothesis supports technical analysis? A) strong B) semi-strong C) weak D) all of the above E) none of the above
E rejects technical analysis, because it will not help achieve better then market averages
Mike is savings for his child's education, which is approximately 4 years from now. Which of the following bonds should Mike invest in to immunize his portfolio? Bond A: AAA rate, 5 year maturity, 3.86 duration, 11% coupon, selling for $954 Bond B: AA rated, 4-year maturity, 3.2 duration, 12.5% coupon, selling for $982 Bond C: A rated, zero coupon, 5 year maturity, selling $575 A) bond B, because its maturity matches the goal time frame B) bond A, because it has a higher credit rating then A C) bond C, because it's a zero coupon, its duration is 5 years D) Bond C, because it has a greater discount that Bond A E) bond A, because its duration matches the goal time frame
E to immunize a portfolio, the duration must equal the time horizon. Bond B's duration is too low and does not match time horizon of the investor. Bond C is too long. FOCUS on duration
duration example
check word doc
To purchase 100 share of starbucks at $50 per share with an initial margin requirement of 75%. How much must Joe contribute and borrow?
contribution= 100*50*.75= $3,750 borrow= 100*50*.25= $1,250
bob purchased 100 shares of Starbucks trading at $50 per share with an initial margin requirement of 75% and a maintenance margin of 25%. At what price would Bob receive a margin call?
margin call= loan/1-maintenance margin loan= price per share*(1-margin requirement) Loan= $50*(1-.75)= $12.50 per share price to receive a margin call= $12.50/(1-.25)= $16.67 when price of stock drops below $16.67 investor will receive margin call and must contribute equity to restore position
Joe bought Starbucks when it was at $50 per share, using 75% initial margin. Within two minutes of Joe's purchase of Starbucks, the price fell to $40 a share. What is Joe's new margin position and equity?
margin position= equity/FMV margin position= ($40-$12.50)/$40= 68.75% equity= stock price-loan equity= $40-($50*.25)= $27.50 *$12.50 came from $50*.25 (100%-initial margin of 75%)*