Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
114 Cards in this Set
- Front
- Back
|
What is a private placement? |
A private placement is an issue of securities that is not required to be registered with the SEC. The issue must be sold to more than 35 unaccredited investors.
*The advantage of a private placement is that it can be quickly placed in the market at a low cost. |
|
|
Describe the New York Stock Exchange (NYSE) |
The NYSE is the oldest & largest organized exchange w/in the USA.
Membership on the NYSE is in the form of a seat on the exchange. These seats, approximately 1,500 in total, are prices by supply and demand.
Members on the exchange will have 1 of 4 roles: commission, broker, floor broker, registered trader, or specialist. |
|
|
Differentiate b/t a commission broker & a floor broker |
Commission brokers execute orders for the firm's clientele, often the large brokerage houses.
*Floor brokers are not affiliated w/ serving the public. Instead, they fill the excess orders that the commission brokers do not handle. |
|
|
Who are specialists? |
*Specialists, who make up approximately 25% of the members of the NSE, are positioned on the floor of the exchange and make a mkt in 1 or more stocks.
*The specialist must maintain an orderly mkt for the individual stock & adjust the mkt for the stock to accomplish this task.
*Specialists make commissions from the other brokers by acting as a broker, and they are permitted to act as a dealer for their own accounts. |
|
|
OTC |
OTC = Over-The-Counter market
* OTC market does not have physical location, rather it is a network of brokers communicatinf via telephones & computers.
* The types of securities w/in the OTC mkt include stocks of various sizes, mutual fund shares, bank shares, and finace stocks. Also, the majority of U.S. government, corporate, and municipal bonds are traded OTC. |
|
|
Who are Market Makers? |
Market Makers are brokers w/in the OTC mkt that specialize in particular stocks/ securities and maintain an inventory of these stocks to trade w/ other brokers and the public. |
|
|
What is the Third Marktet? |
*The Third Market consists of stocks traded both on the organized exchanges and on the OTC mkt.
*Usually, these orders are large block trades (10,000 shares or more). |
|
|
What is the Fourth Market? |
*The Fourth Market is comprised of traders who trade w/o the help of brokers. They trade directly w/ other interested parties.
*These traders can make use of communication systems such as Instinet to allow them to find other interested parties.
*Most of these traders are institutiional-type investors w/ very large volumes. |
|
|
Describe the Securities Act of 1933 |
* The Securities Act of 1933 is primarily concerned w/ new issues of the securities or issues in the primary mkt.
*The Act requires that all relevant information on new issues be fully disclosed, requires that new securites are registered with the SEc, requires audited financial statement information w/in the registration stmts, and forbids fraud and deception. All securities must be accompanied by a prospectus when sold. |
|
|
Describe the Securities Exchange Act of 1934 |
*The Exchange Act regulates securities sold in the secondary mkts.
*The Act established the SEC, whose primary function is to regulate the securities mkts.
*The Act also requires annual reports and other finacial reports to be filed w/ the SEC prior to listing on the organized exchanges. These reports include the annual 10K Report, which must be audited, and the quarterly 10Q Report, which is not required to be audited. |
|
|
Which securites are exempt from registering w/ the SEC? |
The following securities are exempt from registration: 1. Securities of federal, state, and local govt. 2. Securities that are not traded across state lines. 3. Any other securities specified by the SEC, including Treasury bonds and municipal bonds.
*Also, companies can issue securities in the form of a private placement and avoid SEC registration. |
|
|
Define an investment advisor under the Investment Advisors Act of 1940 |
An investment adviser is a person who: 1. Provides advice, or issues reports or analyses regarding securities. 2. Provides such services in the natural course of business. 3. Provides such services for compensation ( compensation is "the receipt of any economic benefit" including commissions on the sale of products).
*Investment advisers are generally required to registered w/ the SEC if they manage over $25M in assets. |
|
|
Which organizations & individuals are excluded from being classified as investment advisers? |
*The following organizations and individuals are excluded from being classified as investment advisers: 1. Banks and bank holding companies. 2. Lawyers, accountants, teachers, or engineers (L.A.T.E.) if their performance of advisory services is soley incidental to their professions. 3. Brokers or dealers. 4. Publishers of newspapers, magazines, or financial publications of regular circulation. 5. Those persons whose advice is related only to securities that are direct obligations of or guaranteed by the US. |
|
|
Which investment advisers are exempt from the registration with the SEC? |
Investment advisers who, during the course of the preceding 12 mths, had fewer than 15 clients and did not hold themselves out generally to the public as investment advisers. |
|
|
What does "due diligence" mean? |
*Due diligence requires that investment advisers investigate any security prior to offering it for sale to a client.
*The security must also be suited to the client's needs and objectives.
*Due diligence is addressed in the Securities Act of 1933. |
|
|
What is the Investment Company Act of 1940? |
*The Investment Company Act of 1940 governs the management of investment companies.
*This Act requires that investment companies register with the SEC, provide prospectiuses to investors prior ro the sale of shares, disclose the investment goals of the company, have outside members on the board of directors, use uniform accounting practices, and gain approval by shareholders for changes in management. |
|
|
What is the Employee Retirement Income Securities Act of 1974 (ERISA)? |
*This act was designed to protect the retirement benefits of employees.
*The Act established the Pension Benefit Guarantee Corporation (PBGC) which is designed to insure benefits of insolvent defined-benefit retirement plans.
*Many of the requirements of ERISA are synonymous with requirements of the Internal Revenue Code. Both provide for vesting rights, minimum coverage requirements, minimum participation, and minimum benefits. |
|
|
What is the purpose of diversification?` |
*The purpose of diviersification is to reduce unsystematic risk (risks associated with a single industry or security) w/in a portfolio
*An inverse relationship exists b/t the number of stocks and the amount of unsystematic risk w/in portfolio.
*As the number of stocks increases, the level of systematic risk should decline. However, there is a point of dimishing returns w/ regard to adding securities to a portfolio.
*Diversification works b/c the differenct asset classes w/in a portfolio are not perfectly correlated. |
|
|
What is the purpose of the correlation coefficient? |
*The correlation coefficient identifies two aspects of the relationship b/t 2 securitiries. These aspects include the strength of the relationship b/t the 2 securities and the direction of the relationship. The range for the correlation coefficient is from +1 to -1.
*If the movement b/t the securities is identical, in rate and direction, the correlation coefficient equals +1.
*If the securities move in opposite directions at the same rate, the correlation coefficient equals -1.
*A correlation of zero means that there is no relationship b/t the 2 securities. |
|
|
What does covariance measure? |
*Covariance is a measure of how asset returns move together. Covariance can be positive, negative, or zero. *Postive covariance indicates that when one asset has a positive return, then the other asset has a positive return; if one asset has a negative return then the other has a negative return. *A negative covariance implies that when one asset has a positive return, the other asset has a negative return. *If the returns b/t the assets are unrrelated, the covariance will be zero. |
|
|
What does beta measure? |
*Beta is a measure of systematic risk.
*The mkt is defined to have a beta of 1.0. A security or portfolio w/ a beta of 1.25 would be considered 25% more volatile than the mkt. Securities w/ a beta less than 1.0 are less risky than the mkt. |
|
|
Describe the coefficient of determination. |
*The coefficient of determination (generally denoted as R squared) describes the percentage of variability of the dependent variable explained by changes in the independent variable. When applied to a mutual fund, R squared measures the portion of the return that is directly attributable to an index.
*The coefficient of determination is calculated by squaring the correlation coefficient.
*The coefficient of determination is an important concept b/c unless it equals 1, beta will not measure total risk. |
|
|
Describe Standard Deviation. |
*Standard deviation is a measurement of risk or dispersion of outcomes (returns) around the mean or expected mean.
*Approximately 68% of outcomes fall w/in 1 standard deviaton (both above and below) of the mean.
* Approximately 95% of outcomes fall w/in 2 standard deviations (both above and below) of the mean.
* Approximately 99% of outcomes fall w/in 3 standard deviations (both above and below) of the mean. |
|
|
How is historical standard deviation calculated? |
*The calculation for historical standard deviation can be done in 5 steps: 1. For each observation, take the difference b/t the average return and the individual observations. 2. Square each difference. 3. Sum the squared differences. 4. Divide this sum by one less than the number of observations (if there are 10 observations, divide by 9). 5. Take the square root of this division. |
|
|
What is semivariance? |
*Semivariance is a statistical measure of risk that only considers the downside volatility of an investment.
*Semivariance measures the variability of returns below the average or expect return. |
|
|
What is the Sharpe Performance Index? |
*The Sharpe Performance Index is a relative measure of the risk adjusted performance of a portfolio based on total risk (systematic and unsystematic risk). The Sharpe PErformance Index uses standard deviation as the measure of total risk.
*Since it is a relative performance measure, the Sharpe Performance Index, must be used to compare alternative investments.
*The Sharpe Performance Index Formula is: Sp =(Rp-Rf)/Sd, where: Sp = Sharpe Performance Rp = The average rate of return Rf = The average rate of return Sd = The standard deviation
|
|
|
What is the Treynor Performance Index? |
The Treynor Performance Index is a relative measure of the risk-adjusted performance of a portfolio based on systematic (mkt) risk. The Treynor Performance Index uses beta as a measure of mkt.
*Since it is a relative performance measure, the Treynor Performance Index must be used to compare alternative investments.
*The formula for the Treynor Performance Index is: Tp = (Rp - Rf) / Bp, where: Tp = Treynor Performance Index Rp = The average rate of return of the portfolio Rf = The risk-free rate of return Bp = The beta of the portfolio |
|
|
What is the Jenson Performance Index? |
*The Jenson Performance Index is determines by solving for alpha. Alpha denotes how well the managed porfolio performed relative to an unmanaged porfolio of equal risk.
*The Sharpe and Treynor indexes are relative measures while Jensen's alpha is an absolute measure of performance.
*The formula for the Jensen Performance Index is: Alpha = Rp - [Rf+Bp(Rm-Rf)], where: Bp = Beta Rm = The return on the mkt Rf = The risk-free rate of return Rp = Actual portfolio return |
|
|
Describe the efficient frontier |
The efficient frontier consists of portfolios w/ the hightest expected return for given level of risk. Thus, portfolios may exist below the efficient frontier, but may not exist above the efficient frontier. |
|
|
What are the 3 rules for choosing efficient assets? |
*The 3 rules for choosing efficient assets are: 1. For any 2 risky assets w/ the same expected return, choose the one w/ the lowest risk. 2. For any 2 assets w/ the same risk, choose the one w/ the highest expected returned. 3. Choose any assets that has a higher expected return and lower risk. |
|
|
What are indifference curves? |
*Indifference curves are used to measure thr risk-reward tradeoffs that investors are willing to make. Indifference curves slope upeard.
*The indifference curve will cross the efficient frontier in 2 locations, unless it is tangent to the indifference curve. In that case, the indifference curve and the efficient frontier have only one intersection point.
* The portfolio that lies at the tangent of the indifference curve and the efficient frontier is the optimum portfolio for the investor. |
|
|
Describe the Capital Asset Pricing Model (CAPM). |
*The Capital Asset Pricing Model (CAPM) relies on and expands the concepts developed by Harry Markowitz.
*The CAPM advances the relationship b/t risk and return and adds the possibility of earning a risk-free rate.
*The CAPM concept is applied in both a macro context w/ the Capital Mrkt LIne (CML) and a micro context w/ the Securities Mrkt Line (SML). |
|
|
What are the key assumptions used in developing the CAPM? |
*The key assumptions used in developing the CAPM are: 1. All informed investors have unifrom expectations about the risk-return relationship of risky assets. 2. Investors can both borrow and lend at a specific positive risk-free rate of return (Rf). 3. Transaction costs are equal to zero. 4. Taxes are equal to zero. |
|
|
What is the Capital Mrkt Line (CML)? |
*The CML is the macro aspect of the CAPM. It is a representation of the relatonship of risk and return for efficient portfolios.
*The line intersects the mrkt portfolio and the risk-free asset. The CML is an efficient frontier.
*The CML uses stndard deviation as the risk measure. |
|
|
What is the equation for the CML? |
*Rp=Rf+[(Rm-Rf)/Sm]*Sp, where: Rp=The return of the portfolio Rf=The risk-free rate of return Rm=The return on the mrkt (Rm-Rf)= The risk premium (the return from the mrkt that exceeds the risk-free rate of return). Sm=The standard deviation of the mrkt. Sp=The standard deviation of the portfolio. |
|
|
What is the Security Market Line (SML)? |
*The SML depicts the risk-return relationship for efficient portofios of securities.
*The SML uses beta as a risk measure. The CML uses standard deviation.
*The SML may be used w/ individual securities. The equation for the SML is the equation that is generally thought of as the Capital Asset Pricing Model (CAPM) |
|
|
What is the equation for the SML? |
*Rs= Rf + B(Rm-Rf), where: Rs = The return for a portfolio Rf = The risk-free rate of return B = Beta ( a measure of the portfolio's systematic risk) (Rm - Rf) = The risk premium (the additional return of the mkt over the risk-free rate of return). |
|
|
What is the Arbitrage Pricing Theory? |
*The Arbitrage Pricing Theory (APT) attempts to explain the return for a security in terms of multiple factors or variables.
*Arbitrage is profiting from a distortion in the price of a security
*Arbitrage transaction have the following characteristics: 1. They require no risk. 2. They require no capital expenditure since profits are earned by trading on imbalances in the mkt price. |
|
|
What is the equation for Arbitrage Pricing Theory? |
*R = a+ b1F1 + b2F2 + ...+bnFn + e, where: R = The Return from the security a = The return (expected for all securities when the value of all factors is zero). bn = The sensitivity of the security to factor Fn Fn = The factor that affects the security, such as GNP of 3%. e = AN error term. (This term should drop out if all relevant factors are captured by the equation). |
|
|
10K Report |
The annual audited financail stmt of corporate issuers that are filed w/ the SEC, and which are a public record. Included in the 10K are the corporation's balance sheet; income stmt; retained earnings stmt; and sources and uses of cash stmt. |
|
|
12-b-1 plan |
named after the SEC rule, a plan which allows mutual funds, under strictly controlled circumstances, to charge their shareholders for the fund's advertising expenses and costs associated w/ attracting new investors. |
|
|
401(k) Plan |
A corporate pension plan to which an employee contributes a defined percentage of his or her salary via payroll deduction up to a maximum dollar amount. These contributions are made w/ pre-tax dollars. In some cases, the employer will match each employee's contribution to the plan up to a certain percentage. A 401(k) plan with this feature is sometimes called a matching plan. |
|
|
403(b) Plan |
A pension plan specificaly for certain tax-exempt, non-profit organizations - e.g., schools, universities, hospitals, etc. - to which an employee contributes a defined percentage to a tax-deferred annuity or mutual fund via payroll deduction. The amount contributed is always made w/ pre-tax dollars and is therefore a salary reduction for the employee. |
|
|
529(b) Plan |
A state-sponsored education savings plan that allows non-tax deductable contributions to be made to a trust to pay for a beneficiary's qualified higher education expenses. Maximum annual contributions and funding are set by each state. Earnings build tax deferred and distributions to pay for qualified higher education expenses are not taxable. |
|
|
8K Report |
A corporate filing made w/ the SEC for any unusal events that occur, such as a declaration of a merger, divestiture, bankruptcy, or change in the composition of the Board of Directors of the corporation. |
|
|
Accelerated Depreciation |
A deduction taken from income to reflect the "using up" over time of a fixed asset such as machinery or buildings. Accelerated depreciation methods allow for larger deductions in the earlier years of an asset's life; compensated for by smaller deductions in the later yrs of an asset's life. In aggregate, the total deduction over the asset's life is the cost of the asset. (compare straight line depreciation) |
|
|
Accommodation Liquidation |
Also known as a "Cabinet Trade," a procedure on the CBOE that allows options contract holders and writers to liquidate worthless contracts at an aggregate premium of $1.00. |
|
|
Accounts Recievable Turnover Ratio |
The ratio of annual sales to yr end accounts receivable for a company. This measures how quickly the sales made by the company (which are booked at the sale date, with collection to occur later) are being collected by the company. |
|
|
Accreditated Investor |
Under Regulation D, a purchaser of a private placement who has a net worth of at least $1M; or an annual income of at least $200K for the past 2 yrs (or a couple w/ joint annual income of $300K); or an officer of director of the issuer; or is an institution, such as a pension fund or insurance company. |
|
|
What is an investment policy stmt? |
* An investment policy stmt is a written document that sets forth a client's objectives and certain limitations for the investment manager.
* The investment policy stmt gives guidance to the investment manager and provides a means for evaluating investment performance. |
|
|
What is Monte Carlo analysis? |
* Monte Carlo analysis is a technique used to model uncertainty.
* Monte Carlo analysis uses a random number generator to provide an output w/ specific probabilities of outcomes. It provides insight into the most likely outcome and other possible outcomes.
* With the analysis, the user also get a best case scenario and a worst case scenario. |
|
|
What is the purpose of bond rating agencies? |
* Bond rating agencies analyze the financial information of companies to determine a credit rating for their various debt issues.
* The largest and most popular rating agencies are Standard & Poor's, Moody's, Duff and Phelps, and Fitch. |
|
|
How are bond prices affected by interest rates? |
* Bond prices move inversely with changes in interest rates.
* If interest rates increase, the price of bonds decreases. This occurs b/c the bond is yielding a lower rate than is currently available in the mkt. Investors are unwilling to purchase the lower yielding bond for the same price as a current higher yielding bond.
* Similarly, bond prices will increases if interest rates decline. |
|
|
How does the term of a bond affect its volatility? |
* Bonds with longer terms are subject to more volatility w/ changing interest rates than bonds with shorter terms.
* For example, a 30-yr Treasury bond will be more volatile than a 5-yr Treasury note. |
|
|
How does the coupon rate of a bond affect its volatility? |
* Bonds with higher coupon rates are more resistant to interest rate changes than bonds w/ lower coupon rates.
* For example, a zero-coupon bond's value will generally be more volatile than that of a bond w/ a 10% coupon. |
|
|
What is a yield curve? |
* A yield curve is a graph of interest rate yields for bonds ranging from 31 days to 30 yrs. Typically, yield curves include Treasury instruments for these various maturities.
* Yield curves have a tendency to slope upward and outward denoting that as the maturity of bonds increase, the corresponding interest rate yields increase. However, yield curves can be flat or inverted. |
|
|
Describe the Liquidity Premium Theory. |
*The Liquidity Premium Theory is based on the concept that longer-term bonds are more price sensitive to interest rate changes than shorter-term bonds.
* The theory also implies that investors pay a premium (i.e. lower yields) for shorter maturity bonds to avoid the high interest rate risk associated with longer-term bonds. |
|
|
What is the Mkt Segmentation Theory? |
* The Mkt Segmentation Theory relies on the concepts of supply and demand for various maturities of borrowing and lending.
*These different maturities make up different mkts. The mkts can be broken into short-term, intermediate-term, and long-term categories.
*Borrowers attempt to match the terms of indebtedness w/ the period of time needed to borrow the funds. |
|
|
Describe the Expectations Theory. |
*The Expectations Theory is based on the concept that long-term rates consist of many short-term rates, and that long-term rates will be the average (or geometric mean) of short-term rates.
*The current rate is known as the spot rate.
*The rate is expected in the future is called the forward rate. |
|
|
Define duration |
*Duration is a present value, time-weighted measure of the number of years until payback of a bond's interest and principal occurs.
*There is an inverse relationship b/t the coupon rate of a bond and the duration.
*Zero-coupon bonds will always have a duration equal to maturity. This occurs b/c all cash flows are at maturity.
*A bond with coupon payments will always have a duration less than its maturity b/c some of its cash flows occur before maturity. |
|
|
List the steps to calculate the duration for a bond. |
*To calculate duration for a bond: 1. List the yrs 2. List the cash flows each yr. 3. Determine the present value of the cash flows using the yr and the YTM for the bond. 4. Multiply the digit associated w/ the yr by the present value (e.g., 2nd yr x PV of 60 = 120). 5. Sum the amounts in step 4 and divide the total by the current mkt price of the bond.
|
|
|
What is the goal of immunization? |
*The goal of immunization is to protect the bond portfolio from interest rate fluctuations and reinvestment rate risk.
*The portfolio is immunized if the realized rate of return is at least as great as the computed YTM calculated at inception.
*If an investor were to match the duration of a bond portfolio to his time horizon for his goal, then his portfolio would be considered initially immunized. |
|
|
What steps should you take to immunize a portfolio? |
*The following steps should be taken to immunize a portfolio:
1. Choose a time horizon that matches that of the investor, such as 10 yrs.
2. Purchase bonds w/ varying maturities, both less than 10 yrs and greater than 10 yrs. The duration of the portfolio should be equal to 10 yrs.
3. The portfolio should be rebalanced every 6 mths - yr. When 6 mths pass, the portfolio should be rebalanced so that the duration equals 9.5 yrs instead of 10 yrs. |
|
|
Describe the laddered bond portfolio approach. |
*The laddered bond portfolio approach is accomplished by establishing a portfolio of bonds with staggered maturities.
*Since there is a combination of long-term and short-term bonds in the portfolio, the laddered portfolio will provide higher yields than a portfolio consisting entirely of short-term bonds.
*As bonds mature each yr, cash is available to the investor to be used or reinvested. |
|
|
Describe the Dumbbell Strategy. |
*With the Dumbbell Strategy, funds are invested in short-term and long-term bonds.
*This approach provides the advantage of only selling one group of bonds in the event that the structure of the portfolio needs to be changed due to changing interest rates.
*This structure will not maintain its original structure, b/c each yr the short-term bonds mature and need to be reinvested. |
|
|
What is Bond Swapping? |
*Bond swapping is the process of selling one debt instrument and replacing it with another. Generally, the goal of this technique is to increase the overall rate of return.
*Types of bond swaps: 1. Substitution swap. 2. Intermarket spread swap. 3. Rate anticipation swap. 4. Pure yield pickup. 5. Tax swap. |
|
|
Describe the substitution swap. |
*This substitution swap involves exchanging bonds with identical characteristics (including credit rating, maturity, etc.) selling for different prices.
*The price difference is an arbitrage opportunity and will only last until the lower priced bond is bid upward. |
|
|
Describe the intermarket spread swap. |
*The intermarket spread swap is designed to take advantage of expected investments in the yield relationship b/t 2 bonds and bond mkts.
*The goal of this type of swap is to capitalize on the spread b/t 2 similar bonds. |
|
|
Describe the rate anticipation swap. |
*The rate anticipation swap involves buying and/or selling bonds based on changes in interest rates. When interest rates are expected to increase, long-term bonds should be sold and short-term bonds should be purchased. With rising interest rates, the price for long-term bonds will decline.
*If rates are expected to decline, long-term bonds should be purchased to capitalize on the price increase for these bonds. |
|
|
Describe the pure yield pickup swap. |
*The pure yield pickup swap involves exchanging a lower YTM bond w/ a higher YTM bond.
*The new bond that replaces the old bond will have to be either a longer-term bond or a lower quality bond to make this swap effective. |
|
|
What is riding the yield curve? |
*Riding the yield curve is a "buy and hold" strategy applicable when long-term rates are higher than short-term rates.
*The investor will purchase long-term bonds and hold them until the maturity of the bonds shortens and the bonds begin to travel down the yield curve.
*As the bond travels down the yield curve, the bond will increase in value compared with newly issued bonds with the same maturity. |
|
|
Describe convertible securities. |
*Convertible securities are hybrid securities that allow the holder to acquire shares of common stock from the issuing company by exchanging the currently held security under a specific formula.
*Convertible securities provide the holder with a steady stream of cash flow and the ability to participate in the growth of the underlying company. |
|
|
What is the conversion ratio? |
*The conversion ratio is the number of shares of the issuing company's common stock that can be acquired by exchanging the convertible security.
*The conversion ratio is calculated by dividing the par value of the convertible security by the conversion price.
*The conversion price is the price that is paid for each share of common stock that is acquired through the conversion of the convertible security. |
|
|
What is the holding period return? |
*The holding period return is equal to the return on the investment (ROI) for the time the asset has been held.
*The formula for the holding period return is (SP-PP+CF)/PP, where: SP = The sales price for the asset. PP = The initial purchase price of the asset. CF = Any cash flows that occur (dividends, interest, or other income). |
|
|
Describe the Internal Rate of Return (IRR) |
*The IRR is the interest rate is the interest rate that equates the present value of all of a future investment's cash inflows w/ the present cost of the investment.
*The IRR assumes that cash inflows are reinvested at the investment's IRR.
*The IRR is also equivalent to the YTM, the compound average rate of return, and the geometric average return. |
|
|
What is the Constant Dividend Growth Model? |
*The Constant Dividend Growth Model is a model used to determine the price of security in which dividends are growing at a constant rate.
*The formula for this model is P=D1/(k-g), where: P = Price for the security D1 = The dividend paid @ period 1. k = The investor's required rate of return. g = The growth rate of the dividends. |
|
|
What is a perpetuity? |
*A perpetuity is a constant stream of income from an investment, such as a preferred stock.
*The following formula is used to value a perpetuity P = D/k, where: P = Price for the security. D = The dividend for the preferred stock. k = The investor's required rate of return. |
|
|
Describe the active asset allocation strategy. |
* The active asset allocation strategy refers to changing the mix of investment classes based on changing mkt conditions.
*This strategy is often referred to as mkt timing and is based on the belief that investors can increase returns over time by switching among asset classes.
*Active asset allocation may generate high transaction costs from constantly changing the mix b/t asset classes. |
|
|
What is the capitalized earnings approach to valuation? |
*Capitalized earnings is a simplistic method for valuing a firm.
*The formula for capitalizing earnings is V = E/Rd, where: V = The value of the company or firm. E = The earnings used to value the firm. Rd = The discount rate.
*This is effectively the same formula used for valuing perpetuities. |
|
|
What are the margin accounts? |
*Margin accounts allow investors to borrow funds from a broker for the purpose of leveraging their investment.
*The initial margin, set by the Federal Reserve, is 50%. The initial margin represents the amount that the investor is required to find in the margin account.
*When an investment is purchased on margin, one half of the funds is put up by the investor and one-half is borrowed from the broker (assumes a 50% initial margin). |
|
|
What is the maintenance margin? |
*The maintenance margin is the level (equity %) at which an investor will be required to add additional funds to the margin account.
*Maintenance margins are usually set at 35%, but may differ from broker to broker. |
|
|
Describe a margin call. |
*A margin call occurs when the amount of collateral (equity %) on the brokerage account falls below a specified level (maintenance margin). The broker can require that the investor add additional assets to the account.
*A margin call will occur when the stock price equals: Loan Amount/(1-Maintenance Margin). |
|
|
What are the 3 traditional methods for valuing real estate? |
*The 3 traditional methods of valuing real estate are: 1. The Sales Comparison Approach 2. The Cost Approach/ 3. The Income Capitalization Approach.
*Not all methods of valuation are appropriate for every type of real estate. |
|
|
Describe the Sales Comparison Approach to the valuation of real estate. |
*The Sales Comparison Approach is the most appropriate when there are several properties in a mkt that have recently been sold and have characteristics similar to the property that is being valued.
*The appraiser generally looks at the characteristics of comparable properties and the property he is valuing so that he can make adjustments, either up or down, to what he thinks the value of the property should be in comparison to the recently sold properties.
*The most common application of this method is the valuation of personal residences. |
|
|
Describe the Cost Approach to the valuation of real estate. |
*The Cost Approach is designed to estimate the value of a property by determining how much it would cost to replace the property and then making any adjustments for depreciation or deterioration of the property.
*The first step is to separate the value of the land from the building. The value of the land can be estimated by looking at comparable properties. The next step is to estimate the current cost of constructing such a building.
*The cost approach is appropriate when valuing special use buildings (e.g. church) and also newly constructed property. |
|
|
Describe the Income Capitalization Approach to the valuation of real estate. |
*The Income Capitalization Approach assumes that the value of the property is based on the income that can be generated from the property. This income stream is approximated and then discounted. The 2 methods for doing this are:
1. Direct Capitalization - The value is determined by dividing the net operating income from the property by the discount rate.
2. Discounted Cash Flow (DCF) - DCF analysis is appropriate when the assumption that income will remain constant into the future is not reasonable. |
|
|
Describe net operating income. |
*Net operating income is net income (income less fixed & variable operating expenses) before depreciation & mortgage debt service (interest & principal).
*The value of a property should not be impacted by the method the current owner has used to finance the property. Therefore, the impact of mortgage interest and principal should be eliminated from the measure of income.
*Since depreciation is a non-cash expense, it should be added back to net income before determining the level of income used to value the property. |
|
|
Describe the arithmetic average return. |
*The arithmetic average return, which is the same as a normal average or mean, is equal to the sum of the returns per interval divided by the number of observation.
*The arithmetic average return is an approximation of the earnings rate for an investment over time. |
|
|
Describe the geometric average return. |
*The geometric average return is the average compounded return or the internal rate of return (annualized return).
*This return is calculated by subtracting 1 from the Nth root of the product of each interval plus 1.
*The reason the arithmetic and geometric average returns are different is that the arithmetic return does not take into consideration the compounding effect of the returns.
*The geometric return will always be less than or equal to the arithmetic average return. |
|
|
What is the real return? |
*The real return reflects the excess earnings from an investment that are above the inflation rate.
*The real return can be calculated using the formula: [(1+Nr) / (1+Ir) - 1] x 100, where: Nr = Nominal rate. Ir = Inflation rate. |
|
|
Define Total Return. |
*The total return for any investment is the sum of the appreciation and the earnings from that investment.
*For stocks, this would be the appreciation in stock price plus dividends received.
*The total return for bonds includes appreciation and interest payments. |
|
|
What is a tax-adjusted return? |
*A tax-adjusted return is the realized return multiplied by (1- tax rate).
*The after-tax yield on a municipal bond may be higher than the after-tax yield for a corporate bond, even though the corporate bond carries a higher stated rate of return.
*The after-tax return should reflect both federal and local taxes. |
|
|
What is the weighted average return? |
*The weighted average return represents the return for a set of securities, such as portfolio, where each return is weighted by the proportion of the security to the entire group of securities or portfolio. |
|
|
What is dollar cost averaging? |
*Dollar cost averaging is the process of purchasing securities over a period of time by investing a predetermined amount at regular intervals.
*The goal of dollar cost averaging is to reduce the effects of mkt price fluctuations.
*When the mkt is rising, shares benefit from the price increases. When the mkt is declining, the additional shares per dollar invested. |
|
|
What is dividend reinvestment? |
*Dividend reinvestment refers to dividends being invested back into the investment from which they were earned.
*Dividends reinvested are treated the same for tax purposes as dividends received in the form of cash.
*These dividends will be reported to the IRS on Form 1099-DIV and are subject to income tax in the yr distributed.
|
|
|
What is asset allocation? |
*Asset allocation refers to the process of apportioning assets available for investment among various investment classes.
*The objective in building an asset allocation model is to determine which investment categories will be used and the appropriate %'s for each asset class.
*Asset allocation is important b/c approximately 90% of long-term performance is determined by the asset allocation of the portfolio. |
|
|
Describe the buy-and-hold strategy. |
*The buy-and-hold strategy begins w/ a set % of assets in each class. Over time, this ratio will change as the value of each asset classes changes.
*The major benefit of a buy-and-hold strategy is that transaction costs and taxes are minimized. |
|
|
Describe the passive asset allocation strategy. |
*The passive asset allocation strategy begins by setting specific %'s for each asset class.
*These %'s should be maintained over time. To achieve % maintenance, the portfolio will require periodic rebalancing.
*Rebalancing incurs transactions costs and taxes (unless the investments are held in a qualified plan or other tax-advantaged entity). |
|
|
Accretion |
the annual earning, taken as income, of a portion of the discount on a bond purchased below par, as that bond's value increases towards par as it approached maturity. Each year, the accretion amount is shown as interest income earned; and the bond's cost basis is adjusted upwards towards par by that accretion amount. Note that there is both accretion for tax purposes, as defined by IRS rules; and accretion for book purposes, as defined by FASB (Financial Accounting Standards Board rules). |
|
|
Accured Interest |
The amount of interest that builds up b/t semi-annual interest payments on a bond. This amount must be paid from buyer to seller on settlement date of a bond trade. For corporate, municipal, and agency bonds, accured interest is calculated based on an abitrary 30-day month and 360-day yr. For U.S. gov't securities, accured interest is calculated based on the actual days of each month and the actual number of days in the yr. |
|
|
Accumulation Account |
An account established by the sponsor of a fixed unit investment trust to accumulate bond positions that will be subsequently formally transferred into a trust, and sold to investors as trust units that represent an undivided interest in the trust portfolio. |
|
|
Accumulation Units |
The legal name for the "shares" that a customer acquires in the separate account when purchasing a variable annuity, since this is a "unit" trust form of investment company. The dividends and capitals gains received during the investment period are reinvested in the separate account, purchasing additional accumulation units. |
|
|
Acid Test |
A slang term for a company's "Quick" ratio, since the ratio is based upon the company's assets that are quickly convertible into cash - this is the ratio of all current assets minus inventories and prepaid expenses to all current liabilities. This is a liquidity measure that is a more stringent test than the Current ratio. |
|
|
Acquisition |
In Investment Banking, the purchase of a smaller company by a larger company. Investment bankers advise both the buyer and seller in such transactions. Usually, the acquisition is made at a premium to that company's current market price - which serves as an inducement for the BoD of the targeted company to approve the acquisition. Payment can be made in either cash; or in the stock of the acquiring company. |
|
|
Active Asset Management |
The pursuit of investment returns in excess of the specific benchmark return. Active asset managers believe that undervalued stocks exist in the marketplace, and that by investing in them, they can surpass the performance of a similar index fund. |
|
|
Active Return |
The excess return achieved by an asset manager above the specified benchmark |
|
|
Ad Valorem Taxes |
The formal name for property taxes (which are based upon property value, hence the name "ad valorem" - latin for "to the value" - that back a municipal general obligation (G.O.) bond |
|
|
Additional Paid in Capital |
Also called Capital Surplus or Capital in excess of par value, the amount above par value paid for the common shares by an investor on the initial public offering. |
|
|
Additional Takedown |
The portion of the total takedown on a municipal bond new issue that syndicate member receives when selling group member sells a bond. |
|
|
Adjustable Rate Debt |
A debt security whose interest rate is reset periodically (e.g., semi-annually) to reflect current interest rates, as determined by a formula specified in the bond's trust indenture. Unlike fixed rate debt, whose price moves inversely with market interest rate movements; the interest rate on adjustable rate debt changes w/ market interest rates, hence the price stays at par. |
|
|
Adjustable Rate Preferred (ARP) |
A preferred stock whose dividend is adjusted periodically to reflect interest rate changes. The rate may change monthly, quarterly, or annually. Usually the rate is set to the highest of either a selected Treasury Bill or Treasury Bond rate. Unlike fixed rate preferred, whose price moves inversely with market interest rate movements; the dividend rate on adjustable rate preferred changes with market interest rates, hence the price stays at par. |
|
|
Adjustment Bond |
AKA Income Bond. This debt security pays interest only if the company earns the interest or to the extent that the company earns the interest or to the extent that the company earns the interest. These are usually issued by a corporation trying to reorganized its capitalization in order to avoid bankruptcy. W/ the existing bondholders' approval, the corporation exchanges its regular bonds for adjustment bonds, where the interest rate or par value is adjusted upwards; however the new bonds pay interest only if the corporation has sufficient earnings (thus, these are also known as "income bonds"). Adjustment bonds trade flat, that is, w/o accrued interest. |
|
|
ADR |
American Depositary Receipt. These are negotiable securities representing ownership of the common or preferred stock of a foreign company that is held in trust. The securities of the foreign company are deposited in a foreign branch of an American bank. Receipts (ADRs) are issued against the shares on deposit may or may not be on a one-for-one basis. ADSs are perhaps the easiest and most popular way for Americans to invest in the securities of foreign companies. Another name for these securities is American Depositary Shares (ADSs) |
|
|
Advance / Decline Ratio |
The ratio of the number of stock issues advancing in price on a given trading day versus the number of stock issues falling in price on that day. This ratio gives an indication of the "strength" of any market. |
