Series 6 - Unit 11 - Account Analysis and Recommendations

11.1 - Portfolio Analysis Theories

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Buy low, sell high investor

aggressive. Trying to time the market. Okay with risk and fees of lots of trades

Buy-and-hold investor

medium aggressiveness because they're invested in stocks, but concerned with long-term growth

Conservative Investor

probably closer to retirement, main concern is income. Important to be aware of interest rates for debt securities and the amount of dividends from stocks and mutual funds

Most important thing when measuring the performance of an investment through comparison is to…

compare apples to apples, not oranges

Asset Allocation

dividing money in a portfolio between different investments ("asset classes")

(3) types of asset classes:

1. Stocks (equity)

2. Bonds (income)

3. Cash (or equivalents)

What is the cash-equivalent, "risk free" investment?

13 week T bill

Why are tangible assets like real estate, gold, art sometimes included in asset allocation?

protect against inflation risk because their value rises when prices rise

(3) "alternate asset classes" used by institutional/wealthy investors

1. Hedge Funds

2. Private Equity

3. Venture Capital

Strategic Asset Allocation

setting long-term targets of % of each asset class

Tactical Asset Allocation

 short term changes based on what's happening in the market

Modern Portfolio Theory (MPT)

scientific way to look at how different combos of investments can lead to different results

What did MPT prove about volatility?

portfolio with less volatility can do better over time than one with more volatility

What did MPT say about nonsystematic risk?

can be reduced through diversification

Capital Asset Pricing Model (CAPM)

says more risk should equal more return, uses beta coefficient to measure the risk and alpha to measure the return

Which investment is the market standard with a beta of 1.0?

S&P 500

If beta = 1.0…

stock moves the same as the market

If beta > 1.0

stock is more volatile than the market

If beta < 1.0

stock is less volatile than the market

Alpha shows you…

how much better/worse investment did compared to the expectation

If stock has a beta of 1.5 and the market goes up 10%, how much is it expected to go up?

15%

If it actually went up 11%, what is Alpha?

negative

When using CAPM to predict, if expected return is higher than required return….

alpha is positive

What is the main goal of Modern Portfolio Theory (MPT)?

A)

To maximize returns by investing in assets with the highest beta

B)

To avoid all market risk by investing in only government-backed securities

C)

To reduce overall portfolio risk by combining noncorrelated investments

D)

To choose only the most profitable stocks based on past performance

C

11.2 - Fundamental Analysis

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(4) business cycle:

1. Expansion

2. Peak

3. Contraction

4. Trough

Defensive Industries

least affected by changes in economy. Nondurable consumer goods. Less risk, lower returns

Cyclical Industries

most sensitive to economy. Durable goods

Countercyclical example

precious metals

(4) stages every industry goes through:

1. Introduction

2. Growth

3. Maturity

4. Decline

Growth Industry

unaffected by economy during this phase. Don't pay much dividends. Ex. Computers

Special Situation Stock

unusual profit potential due to unique event like releasing a new innovative product, getting new management etc.

Fundamental Analyst

 looks at overall economy, focuses on industries doing well, narrows it down to find the best company to invest

(2) reports public companies must file quarterly and annually with the SEC

1. Balance Sheet

2. Income Statement

Basic Balance Sheet Equation:

Assets - Liabilities = Owners Equity

or

Assets = Liabilities + Owners Equity

A balance sheet is great for showing a company's X, but not a company's Y

current value, if they're getting better or worse over time

(3) types of assets:

1. Current

2. Fixed

3. Other

Current Assets

can convert to cash within 12 months

Fixed Assets

buildings/machines, hard to liquidate

Other Assets

patents/IP, public goodwill. not physical, hard to value

(4) current assets:

1. Cash

2. Accounts receivable

3. Inventory

4. Prepaid expenses- rent, insurance, advertising

(3) fixed assets:

1. Property

2. Plant

3. Equipment

Current Liabilities

due within 12 months (bills, short term loans)

Long-term liabilities

future debts, often from issuing bonds

Net Worth/Owners Equity includes (2)

1. Invested capital - money from investors

2. Retained earnings - profits the company kept rather than paying dividends

If a company has the following items on its balance sheet, what is the net worth of the company?

1. Current assets of $1 million

2. Inventory of $300,000

3. Fixed assets of $2 million

4. Liabilities of $2 million

A)

$1 million

B)

$300,000

C)

$1.3 million

D)

$5.3 million

A - inventory is part of current assets. Trick question

11.3 - Investment Risk

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(3) types of systematic risk

1. Market Risk

2. Interest Rate Risk

3. Inflation Risk

Market Risk

risk the overall market declines

Interest Rate Risk

potential change in bond prices caused by a change in market interest rates

Inflation/Purchasing Power Risk

purchasing power risk, the effect of continually rising prices

Duration

how much a bond's price will change in response to changes in interest rates

The higher the duration…..

the more sensitive the bond is to changes in interest rates. Higher interest rate risk

Inflation/purchasing power risk is present in all securities that….

pay a fixed income

Nonsystematic Risk

unique to specific industry, business, investment type. Can be reduced through diversification

Credit Risk

investor loses their investment due to financial strength of issuer

Capital Risk

risk investor won’t get all of their original investment back

Business risk

poor management decisions

Liquidity Risk

inability to sell quickly at market price

Regulatory Risk

new regulation / way regulation is enforced is changed and affects business

Legislative Risk

new law impacts business

ex. changes to tax code

Social Risk

change in societal norms

ex. drop in smoking has negative impact on big tobacco

Political Risk

political instability in emerging economies

Sovereign Risk

risk a country defaults on its debts

“Other” risk

not easily defined as systematic or nonsystematic

(4) Types of "other" risk:

1. Call Risk

2. Reinvestment Risk

3. Prepayment Risk

4. Currency Risk

Call risk

risk that bond is called before maturity (when interest rates fall) and you can't reinvest at the same rate

Reinvestment Risk

when interest rates go down, can't invest at the same rate

Prepayment Risk

risk a borrower will repay principal before maturity

Why would GNMA, FNMA, FHLMC certificates be subject to prepayment risk?

if interest rates fall, people refinance their mortgages

Currency Risk

investment in foreign currency declines if the value of the currency declines relative to the USD

4.1 - Investment Recommendations

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(3) things to know about your customer before making a recommendation

1. Check the foundation (insurance, emergency savings)

2. Financial considerations (measured in dollars, show up on their balance sheet/income statement)

3. Nonfinancial considerations (age, kids, risk tolerance)

(2) important "foundational" things to check making recommendations

1. Are insurance needs met?

2. Are there enough emergency savings?

How much emergency savings should one have?

3-6 months of expenses

(4) suitable investments for Safe Preservation of Capital

1. Money market mutual funds

2. Certificates of deposit

3. US treasury securities

4. Principal-protected funds

what is a money market mutual fund btw?

low risk mutual fund that invests in short term money market securities like t-bills and commercial paper

(5) suitable investments for Current Income

1. Bonds (corporate, government, municipal, agency)

2. Preferred Stock

3. Utility stock

4. Blue-Chip stock (history of dividends)

5. Income-focused mutual funds

Best investment for capital appreciation is….

stocks, of course

(3) best investments for tax advantages

1. Municipal bonds

2. IRAs

3. Annuities

(2) good investments for diversification

1. Balanced/Asset Allocation Mutual Funds

2. International, global, and foreign funds

(2) of the most liquid investments you can make

1. Exchange listed stocks/Nasdaq securities

2. Mutual funds

(4) of the most illiquid investments

1. Unlisted/non Nasdaq securities

2. Real estate

3. Limited partnership

4. Annuities?

(6) most speculative investments

1. Options

2. Junk bonds

3. Unlisted/non Nasdaq securities

4. Sector funds

5. Precious metals

6. Special situation funds

(3) steps to make a suitable recommendation

1. Identify/match the primary objective

2. Look for secondary options (by considering nonfinancial considerations)

3. Compare similar investments

(4) risks that must always be disclosed

1. Illiquid investments

2. Options (risk disclosure document)

3. Surrender Fees - annuities

4. Deferred Sales charges - class b mutual fund shares

Which of the following should a representative assess before making investment recommendations for a new client?

A)

The current performance of the S&P 500

B)

Whether the client wants short-term or long-term investments

C)

The client’s insurance coverage and emergency savings

D)

The client’s favorite investment product

 

C

Which of the following investments is considered illiquid and may come with surrender fees that must be disclosed?

A)

A mutual fund

B)

A Nasdaq-listed stock

C)

A variable annuity

D)

A publicly traded REIT

C