Investments - Cfp March 2010 Exam Review By M©

Front 1

Underwriting: Best efforts

Back 1

Risk resides with the issuing firm. Unsold shares are returned to the company.

Front 2

Underwriting: Firm commitment

Back 2

Underwriter agrees to buy the entire issue of stock from a company. Risk lies with the underwriter. Underwriter profits from the spread [public price minus purchase price].

Front 3

Key documents:
Prospectus

Back 3

- Outlines risks, management team, business operations, fees and expenses.
- Must be issued by an investment company prior to selling shares to an investor.

Front 4

Key documents:
Red Herring

Back 4

Preliminary prospectus, not approved by SEC, used to determine investor interest.

Front 5

Key documents:
10K, 10Q

Back 5

10K - Annual financial reports (audited)
10Q - Quarterly financial reports (NOT audited)
Filed with the SEC

Front 6

Key documents:
Annual report

Back 6

Message from the Chairman of the Board about the past year and outlook for the next year, sent to shareholders.

Front 7

Liquidity

Back 7

How quickly something can be turned to cash, with little or no loss of cash. Usually short-term investments. Stocks, bonds, mutual funds are not considered liquid because of potential price fluctuations.

Front 8

Marketability

Back 8

Existence of a ready-made market. Are there buyers? For example, real estate is marketable, but not very liquid.

Front 9

Types of Orders:
Market Order

Back 9

For buys and sells:
Timing and speed are the priority. Price is not a factor in transaction. Appropriate for high volume securities.

Front 10

Types of Orders:
Limit Order

Back 10

Buy or sell a set number of shares at a specified price or better. May not be executed. ex: limit buy will buy if the price falls to X. Limit sell will sell if the price rises to Y. Appropriate for low volume or highly volatile securities.

Front 11

Types of Orders:
Stop Order - Buy

Back 11

A buy order that is held until a security rises to a specified price, then turns into a market order.

Front 12

Types of Orders:
Stop Order - Sell

Back 12

A sell order that is held until a security falls to a specified price, then turns into a market order.

Front 13

Types of Orders:
Stop-Limit or Stop Loss Limit Order Buy

Back 13

An order that combines the features of stop order with those of a limit order. A stop-limit order will be executed at a specified price (or better) after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to buy (or sell) at the limit price or better.

For example, ABC is trading at $40 and an investor wants to buy the stock once it begins to show some upward momentum. The investor has put in a stop-limit order to buy with the stop price at $45 and the limit price at $46. If the price of ABC moves above $45 stop price, the order is activated and turns into a limit order. As long as the order can be filled under $46 (the limit price), then the trade will be filled. If the stock gaps above $46, the order will not be filled.

Front 14

Types of Orders:
Stop-Limit or Stop Loss Limit Order Sell

Back 14

An order that combines the features of stop order with those of a limit order. A stop-limit order will be executed at a specified price (or better) after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to sell at the limit price or better.

For example, XYZis trading at $100 and an investor wants to sell the stock once it begins to drop in value. The investor has put in a stop-limit order to sell with the stop price at $95 and the limit price at $90. If the price of ABC moves below $95 stop price, the order is activated and turns into a limit order. As long as the order can be filled above $90 (the limit price), then the trade will be filled. If the stock gaps below $90, the order will not be filled.

Front 15

Short Selling

Back 15

- Sell "borrowed shares" in hopes of buying at a lower price to return it to the original owner
- Make money when price falls
- No time limit
- When dividends are paid, short seller must pay the amount to the original owner

Front 16

Margin:
Initial margin

Back 16

The % of equity an investor must contribute to enter a martin transaction.

e.g. to purchase 100 shares of ABC @$50 with an initial margin requirement of 75%, you must deposit 100 x $50 x 0.75 = $3,750 in cash or securities. Then you borrow the rest, $1,250, from the broker.

Front 17

Margin:
Reg T (Initial Margin)

Back 17

The Federal Reserve has set the initial margin at 50%. The required initial margin can be more restrictive (higher), as set by the broker.

Front 18

Margin:
Maintenance Margin

Back 18

The minimum amount of equity required before a margin call.

Front 19

Margin:
Margin Position

Back 19

The equity position of the investor.
Margin position = Equity ∻ FMV = [stock price - loan] ∻ FMV.

e.g. Buy ABC at $100 using 75% initial margin. Stock falls to $80. New margin position = [$80- ($100 x 0.25)] ∻ 80 = 68.75%

Front 20

Margin:
Margin Call Formula (not provided on exam)

Back 20

Margin Call =

Loan per share
--------
[1 - Maintenance Margin]

Front 21

Margin:
Margin Call Definition and example

Back 21

The price at which an investor will receive a margin call.

Question: Purchase 100 shares DEF at $50 with initial margin 75% and maintenance margin 25%. At what price is there a margin call?

Answer: [Loan per share]/[1-Maintenance Margin]. [$50x0.25]/[1-0.25] = $16.66

Front 22

How much equity to contribute?

Back 22

Contribute to get back to maintenance margin.
[Required equity] - [Actual equity] x # of shares.

e.g. purchase 100 shares of JKL at $50 with initial margin of 75% and maintenance margin of 35%. Price calls to $15. How much to contribute?
[Required Equity = $15 x 0.35 = $5.25] - [Actual Equity = $15- [loan = $50 x 0.25 = $12.50] = $2.50. Must add $2.75 per share, or $275.

Front 23

Research Reports:
Morningstar

Back 23

Rates Mutual Funds, 1 to 5 stars

Front 24

Research Reports:
Value Line

Back 24

Rates stocks, 1 (buy), 5 (sell)

Front 25

Dividend Dates:
Ex-Dividend Date

Back 25

The day the stock trades without the dividend. If you sell on the ex date, you get the dividend. If you buy on or after the ex date, you will NOT get it. It is 2 days before the date of record.

e.g. ex date Jan 3, rec date Jan 5.

Front 26

Dividend Dates:
Date of Record

Back 26

Date on which you need to be the registered shareholder in order to receive the dividend. 2 days after the ex-date. Must purchase 3 days before the date of record to receive the dividend.

Front 27

Dividend Dates:
When do you need to purchase a stock in order to receive the dividend?

Back 27

At least 3 days before the date of record or 1 day before the ex date, since on the ex date, the seller would receive the dividend.

Front 28

Securities Act of 1933

Back 28

Regulates new issues (Primary market), requires prospectus.

Front 29

Securities Act of 1934

Back 29

Regulates the secondary market (trading). Created the SEC.

Front 30

Investment Company Act of 1940

Back 30

Authorizes SEC to regulate investment companies (open, closed, UITs).

Front 31

Investment Advisors Act 1940

Back 31

Requires advisors to register with the SEC or state.

Front 32

Securities Investors Protection Act of 1970

Back 32

Established SIPC.

Front 33

Insider Trading and Securities Fraud Enforcement Act of 1988

Back 33

Defines insider as anyone with non-public information; insiders cannot trade on that information.

Front 34

4 Types of Money Market securities

Back 34

T-Bills
Commercial Paper
Bankers Acceptance
Eurodollars

Front 35

Money Market:
Treasury Bills

Back 35

- Come in 4, 13, 26, 52 week maturity
- Denomination of $1,000

Front 36

Money Market:
Commercial Paper

Back 36

- ST loans between corporations
- 270 days or less
- Not registered with SEC
- $100K and sold at discount

Front 37

Money Market:
Bankers Acceptance

Back 37

- Used in import/export
- 9 months or less maturity
- Can be held to maturity or traded.

Front 38

Money Market:
Eurodollars

Back 38

US dollars deposited in foreign banks

Front 39

Investment Policy Statement

Back 39

Establishes objectives and invesment manager limitations.
- Return and Risk objectives
- Time, Liquidity, Tax, Law limitations

Front 40

Indicies:
Dow Jones

Back 40

Simple price weighted average:
Add the prices of each stock in index and divide by the number of different stocks.

Front 41

Indicies:
S&P 500

Back 41

Value weighted, takes into account market cap. Large companies.

Front 42

Indicies:
Russell 2000

Back 42

Value weighted for small market cap stocks.

Front 43

Indicies:
Wilshire 5000

Back 43

Broadest index, value weighted.

Front 44

EAFE

Back 44

Value weighted, Europe, Australia, FAR EAST

Front 45

Standard Deviation definition

Back 45

- Measure of risk and variability of returns
- Variation around an average
- TOTAL RISK in an undiversified portfolio
- 68%, 98%, 99% for 1, 2, 3δ

Front 46

Standard deviation key strokes on 10BII

Back 46

- enter [return #1 (as decimal, 0.075 for 7.5%)] then E+ (sigma)
- enter return #2....
- Orange key, SxSy (on number 8)
- Also x,y average available

Front 47

Coefficient of Variation definition

Back 47

The likelihood of actually experiencing a return close to the average.
Higher = riskier

Front 48

Coefficient of Variation formula

Back 48

CV = Standard Deviation / Average Return.

If std is low, spread is low so return are tighter around the average..

Front 49

Monte Carlo

Back 49

- Simulation in which probabilistic distribution of events is given
- Multiple iterations with different value for variables (such as returns)

Front 50

Covariance definition

Back 50

- The measure of interactive risk between two securities, since:
COV12 = sd*sd2*Correlation12.
- A relative measure

Front 51

Correlation Coefficient definition

Back 51

- Ranges from +1 to -1
- Diversification begins anytime correlation is less than +1
- 0 = completely uncorrelated.
Perfect opposite correlation = -1

Front 52

Correlation Coefficient formula

Back 52

ρ1,2 = [SD1*SD2]/ COV

Front 53

Beta

Back 53

- Coefficient that measures volatility relative to the market.
- Best used to measure the volatility of a DIVERSIFIED portfolio (has a high r^2)
- Market beta =1
- A higher beta indicated greater systematic risk
- Measure or systematic risk (vs. sd which is total risk)

Front 54

R^2 (definition)

Back 54

Measure of how much return is due to the market or what % of return is due to the market.

Front 55

R^2 (formula)

Back 55

r^2 = correlation coefficient^2.

e.g. if correlation coefficient is 0.60 then r^2 = 0.36 which means 36% of the fund's return is due to the market.

Front 56

Systematic Risk definition

Back 56

- Undivirsifiable risk
- Market Risk
- Economy-based

Front 57

Unsystematic Risk definition

Back 57

- Diversifiable
- Unique
- Company specific
- Goes down as # holdings increase

Front 58

Kinds of Systematic Risk

Back 58

PRIME
P- Purchase power (inflation)
R - Reinvestment rate risk (bonds)
I - Investment rate (inverse relation to bond pricing)
M - Market risk (Economic)
E - Exchange Rate

Front 59

Kinds of Unsystematic Risk

Back 59

ABCDEFG
A - Accounting
B - Business (industry risks)
C - Country (Instability)
D - Default
E - Executive (poor management)
F - Financial (too much leverage)
G - Government regulations

Front 60

Modern Portfolio Theory

Back 60

Acceptance of a given level of risk while maximizing return objectives.

Front 61

Efficient frontier

Back 61

Best possible returns given level of risk for ALL portfolios/combinations

Front 62

Efficient portfolio

Back 62

When indifference curve is tangent to efficient frontier.

Front 63

Capital Market Line

Back 63

MARCO level of CAPM
Rp= Rf+δm((Rm-Rf)/δm
Return/Risk relationship for all efficient PORTFOLIOS
Uses SD of PORTFOLIO as risk measure.

Front 64

Capital Asset Pricing Model (CAPM)

Back 64

Security Market Line
MICRO level of CAPM
R= Rf+B(Rm-Rf)
Measure both security and portfolios.
Beta is risk measure.

Front 65

Security Market Line

Back 65

- Risk and return graph for s security
- If a portfolio is above the line, it's undervalued and s/b purchased.
If below, it is overvalued and s/b sold.

Front 66

Information Ratio

Back 66

- Relative risk-adjusted performance measure.
- Measures excess return by a PM vs. benchmark
- Can be +/-
= IRa = (Rp-Rbench)/δa

Front 67

Treynor Index

Back 67

- Risk-adjusted performance measure.
- Relative (must be compared to another Treynor)
- Measures return per unit of risk (Beta)
- Assumes well diversified (unsystematic risk =0)
- Tp= (Rp-Rf)/B

Front 68

Sharpe Index

Back 68

- Risk-adjusted performance measure.
- Relative (must be compared to another Sharpe).
- Return gained per unit of stdev.

Front 69

Jensen Model/Jensen Alpha

Back 69

- Measures performance on an absolute risk-adjusted basis (not relative)
- + is good. - is bad, 0 is expected per CAPM
- = Actual return of Portf - Expected.
- Uses BETA as risk measure, so good for higher R^2.