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AAMS Notecards
standard deviation - Answer Variability around the mean; a measure of total risk; absolute. Beta - Answer Volatility relative to a benchmark; a measure of relative risk; not static What did the Brinson study evaluate? - Answer Security selection, market timing, and asset allocation policy. What conclusion did the Brinson study reach? - Answer More attention should be given to the asset allocation process and less given to securities selection and market timing. What's the importance of asset allocation in a clients investment strategy? - Answer Clients must be active in determining their asset allocation and explicit about objectives, risk, and liquidity over the long term. T-Bills average (geometric) rate of returns, as well as inflation, since 1926 - Answer 3.3% Long-term U.S. government bonds average (geometric) rate of returns, as well as inflation, since 1926 - Answer 5.5% Long-term corporate bonds average (geometric) rate of returns, as well as inflation, since 1926 - Answer 5.9%
Intermediate-term U.S. government bonds average (geometric) rate of returns, as well as inflation, since 1926 - Answer 5.1% Large-company stocks average (geometric) rate of returns, as well as inflation, since 1926 - Answer 10% Small-company stocks average (geometric) rate of returns, as well as inflation, since 1926 - Answer 11.8% Inflation average (geometric) rate of returns, as well as inflation, since 1926 - Answer 2.9% Define strategic asset allocation - Answer The identification of the asset mix that will provide the optimal balance between expected risk and return for a long-term investment horizon. How is strategic asset allocation maintained? - Answer With periodic rebalancing by repositioning higher performing assets into lower performing assets. Define tactical asset allocation - Answer This is the use of securities selection, sector rotation, and market timing to periodically revise the asset mix of a portfolio. Define core/satellite asset allocation - Answer This approach involves a combination of strategic and tactical asset allocation enabled by dividing a portfolio into a core holding of stocks and bonds, often broad based, low cost index mutual funds or etfs, and a satellite portion. What are the characteristics of common stock? - Answer Shareholders receive dividends on a pro rata basis, vote on the election of corporate board members, are residual owners of the firm (meaning their interests are subordinate to creditors and bond holders), and the shares have no maturity What are the sources of risk for common stock? - Answer A downturn in economic growth, high interest rates, loss of product or service competitiveness, failures of management, and government action What are the characteristics of preferred stock? - Answer Dividends are usually fixed, qualified and not tax-deductible to the paying corporation, they're paid ahead of common shares, limited voting rights,
What are treasury bonds? - Answer T-bonds have maturities over 10 and up to 30 years, are sold at or near face value, pay interest semi-annually, have a minimum denomination of $100 and are sold in multiples of $100 face value What are treasury inflation protected securities (TIPS)? - Answer These bonds offer a rate of return that increases with inflation as measured by the consumer price index (CPI). As inflation increases, the bonds principal increases at the same percentage as the increase in the CPI. The coupon rate stays fixed but is paid on that larger principal. The minimum denomination is $100 and they are sold in multiples of $ face value. What are treasury STRIPS? - Answer These are zero coupon instruments sold at deep discounts to face value, with the difference being interest instead of periodic interest payments. What is a corporate bond indenture? - Answer The indenture spells out the terms of the issue What is a corporate bond trustee? - Answer The trustee acts as a fiduciary on behalf of bond holders to ensure that the indenture provisions are being met What is a corporate bonds interest taxation? - Answer Interest is fully taxed at both the federal and state levels What are corporate mortgage bonds? - Answer Bonds that are secured by property, usually real estate What are corporate bond debentures? - Answer These are unsecured bonds What are corporate bonds equipment trust certificates? - Answer Bonds that are secured by specific equipment, usually airplanes or railroad cars List characteristics of mortgage backed securities - Answer Major issuers are GNMA, FHLMC, and FNMA, make monthly payments, and payments represent interest and principal (total payments can change over time - due to refinancings)
What are corporate convertible bonds? - Answer These bonds can be converted into the underlying stock at the option of the bond holder List the risks for mortgage backed securities - Answer Uncertainty of cash flows, interest rate risk, purchasing power risk, reinvestment risk, and FHLMC and FNMA have a slight potential for default risk (since they're not backed by the US government) What are the characteristics of a treasury bill? - Answer These have US government obligations and are issued at a discount to face value. The minimum denomination is $100 and they are sold in multiples of $100. Interest on Treasury bills is free from state income taxation but taxable at the federal level. What are the characteristics of negotiable certificates of deposit? - Answer CDs of $100k or more, pay a fixed rate of interest taxes at both the federal and state levels, quality depends on the issuing bank What are the characteristics of a Eurodollar certificate of deposit? - Answer US dollar denominated CDs issued by foreign branches of major US and foreign banks, not FDIC insured, no reserve requirements on these CDs, no maximum maturity but usually are three to six months What are the characteristics of a Yankee certificate of deposit? - Answer US dollar denominated CDs issued by foreign banks from their US branches, maturities of one year or less pay interest at maturity, maturities longer than one year pay interest semiannually or annually What are the characteristics of commercial paper? - Answer Unsecured IOUs of corporations, usually sold at a discount with maturities up to 270 days What are the characteristics of banker's acceptances? - Answer Discounted time drafts used mainly in financing international trade, the bank stamping "accepted" promises to pay the draft at maturity, and maturities are generally 30 to 180 days What are the characteristics of repurchase agreements? - Answer The agreement involves purchasing securities and a commitment to buy back those securities plus interest within a typical one day to one year, smallest trade is usually $1 million
What variables are taken into account for economic analysis? - Answer Business cycle, federal reserve policies, new tax policies, unemployment, wage rates, inflation, public confidence, economic trends, trade issues and savings rates What variables are taken into account for industry analysis? - Answer Competition, technology, change, accounting conventions, cost structure, demand factors, business cycle, financial norms What variables are taken into account for company analysis? - Answer Earnings, dividends, cost of capital, cash flow, products, financials, R&D, strategy, competition, management, financial ratios What are the characteristics of expansion as it relates to the business cycle? - Answer High interest rates, high capacity utilization, increasing wage demands, and inflation What are the characteristics of a recession as it relates to the business cycle? - Answer Increased unemployment, falling interest rates, slowing consumer demand and purchases of capital equipment, and decreased lending What are the characteristics of a recovery as it relates to the business cycle? - Answer Longer hours worked, increased economic output, reduction in unemployment, and increased consumer spending How does fiscal policy affect the economy? - Answer In times of recession, government fiscal policy aims to stimulate the economy through tax reduction (so that consumers have more money to spend) and increased government expenditures, which also tend to increase the level of economic activity How does monetary policy affect the economy? - Answer During periods of recession, the Federal Reserve generally increases the money supply, loosens credit restrictions, and attempts to drive down interest rates as these actions tend to stimulate the economy. The reserve prevails during times of expansion, when inflation is the Fed's key concern. What is a liquidity ratio? - Answer Measure of a company's ability to meet its short term financial obligations What is current ratio? - Answer Current assets/current liabilities
What is a quick ratio? - Answer (Current assets - inventory)/current liabilities What is a profitability ratios? - Answer Measure the relative profitability of a company What is return on equity? - Answer Net earnings/net worth What is return on common equity? - Answer (Net earnings - preferred stock dividends)/(equity - preferred stock) What is return on assets? - Answer Net earnings/total assets What is a debt ratio? - Answer Measure the extent to which the firm finances its assets by debt What is debt to equity? - Answer Total debt/net worth What is debt to assets? - Answer Total debt/total assets What is an activity ratio? - Answer Measure the rate at which a company is turning its inventory or accounts receivable into cash What is inventory turnover? - Answer Cost of goods sold/average inventory What is average collection period? - Answer Receivables/sales per day What is receivables turnover? - Answer Annual sales/accounts receivable What is technical analysis? - Answer Technical analysis attempts to predict future stock prices by analyzing a range of market information related to supply and demand
Which industries are expected to do well during a expansion; early stage? - Answer Consumer credit, transportation, energy, and consumer cyclicals Which industries are expected to do well during a expansion; middle stage? - Answer Basic materials Which industries are expected to do well during a expansion; late stage? - Answer Capital goods Which industries are expected to do well during a recession? - Answer Consumer staples and utilities Define sector rotation - Answer A timing strategy that shifts portfolio assets from one sector of the economy to another in anticipation of broad based economic developments Describe the following technical indicators used by contrarians: short selling - Answer Increasing short selling in a stock indicates a growing herd consensus that the market will decline; the contrarian should consider an opposite move Describe the following technical indicators used by contrarians: specialist's sentiment - Answer Considered to be the "smart money," increased bullishness by specialists in a stock makes contrarians bullish as well, and vise versa Describe the following technical indicators used by contrarians: mutual fund cash positions - Answer Mutual fund managers are considered to be herd animals; when mutual funds have low and decreasing cash positions, contrarians take this as a sell signal; the reverse is true as well Describe the following technical indicators used by contrarians: investment advisory opinions - Answer This theory suggest that the aggregate opinion of investment advisors is often wrong. That is when the majority of investment advisors are bullish (bearish) a contrarian should sell (buy) securities Describe the following technical indicators used by contrarians: put call ratio - Answer High and increasing put call ratios suggest buying opportunities to the contrarian, and low or decreasing put call ratios suggest the opposite
List three general guidelines for low P/E investors - Answer 1. Select only contrarian (low p/e) stocks, but only if the companies have superior performance characteristics.
- Diversify. A diversified portfolio should have an equal weighting in 20-30 different stocks representing 15 or more industries
- Buy only shares of medium to larger companies that are listed on the NYSE or only large companies on NASDAQ/AMEX List four rules of thumb for value investing as developed by Benjamin Graham - Answer 1. Buy stocks for two thirds or less of their net current assets
- The earnings price ratio (earnings yield) should be twice the current 20 year corporate AAA bond yield
- The dividend yield should be no less than two thirds of the 20 year corporate AAA bond yield
- Avoid companies that are currently losing money or that have more than 60% debt to total assets What methods of analysis did Graham use? - Answer Analysis of a company's net current assets, debt to equity ratio, dividend record, earnings growth, and price relative to net current assets (Bottom up) Define gross income - Answer Income from all sources, unless specifically excluded. (Wages, commissions, tips, honorariums, interest, dividends, net business income, rents, royalties, alimony received for divorces prior to Dec 2018, unemployment, gambling income, and partnership income) Define total income - Answer Total income is the amount reported about 3/4ths of the way down the front of Form 1040. Total income may be though of as gross income reduced by all exclusions. Other items that are included in calculating total income are items that reduce the income. Some of these items may include losses from sole proprietorships or up to $3k of net capital losses. Define adjusted gross income - Answer The amount remaining after subtracting adjustments to income Define taxable income - Answer Adjusted gross income reduced by the greater of the standard deduction or itemized deductions Define adjustments to income - Answer Items that reduce total income to arrive at adjusted gross income (IRA contributions, job related moving expenses for armed forces, alimony paid, penalties on early withdrawals. These are known as above the line deductions)
What is income shifting? - Answer The transfer of income producing assets to another taxable entity, typically another individual in a lower marginal income tax bracket than the transferor What is the difference between the marginal and the average income tax rates? - Answer The marginal tax rate applies to the last dollar of taxable income. The average income tax rate is the income tax liability divided by the taxable income. The average rate will always be less than the marginal rate. What is the difference between when income is reported under the cash and the accrual methods of accounting? - Answer Cash income is recognized when it is actually or constructively received. Constructive receipt occurs when there is an unrestricted right to income that has not been reduced to the taxpayers possession. Accrual income is recognized when it is actually earned, which is not necessarily when it is received. How is the cost basis determined when property is acquired by inheritance? - Answer There is generally a step up (or down) in basis. In other words, the basis is the fair market value on the date of death. The basis may also be determined by reference to the FMV on the alternate valuation date, if so elected. How is the cost basis determined when property is acquired by purchase? - Answer The amount that was paid for the property, including costs associated with the purchase, holding or sale of the asset, constitutes the basis. How is the cost basis determined when property is received as a gift? - Answer If the FMV of the asset on the date of gift is greater than the donors basis, then the basis to the recipient is the donors basis. If the FMV on the date of the gift is less than the donors basis, then a gain is measured using the donors basis, whereas a loss is measured using the FMV on the date of the gift. If the sale price is between the donors basis and the FMV on the date of the gift, no loss or gain is recognized. What is a capital asset? - Answer A capital asset is any asset held for personal use or for investment purposes. The definition does not include assets used in a trade or business. How is cash (ordinary) dividend taxed? - Answer These are generally subject to long term capital gain rates, as long as the dividend is considered to be a "qualified" dividend (see box 1b of Form 1099 DIV)
How is a return of capital dividend taxed? - Answer The distribution is generally not taxable. The return of capital reduces the basis in the stock. When, and if, the basis did reduced to zero, any further return of capital dividend is taxed as a capital gain. How are stock dividends taxed? - Answer The stock dividend does not constitute a taxable event, but it does dilute the basis of the shares held and will establish a lower per share basis for the overall holding. Explain the taxation of zero coupon bonds - Answer Although there is no annual income received from these investments, the annual increase in value is taxed to the investor each year. These bonds typically receive bad press due to this phantom income; however, the situation is not much different than dividend reinvestment in a mutual fund - a current tax liability without cash in hand to pay it.
