investments quiz 4/23

Investment companies

They sell shares to the public and use the proceeds to invest in a portfolio of securities

*Interest income, dividends, and capital gains all flow through from the investment company to the shareholders.

Mutual Funds (Open-End Companies)

Not limited in the number of shares sold; total capitalization is constantly changing.

• bought or sold once per day after the market closes

actively managed

Exchange Traded Funds (ETFs):

Basket of securities traded on an exchange like individual stocks; price is determined by supply and demand. Index based.

Passively managed

Investment companies Tax Treatment

• Generally don’t pay tax

• At least 90% of its income is from investments in stocks, bonds,currencies, or other securities.​

• At least 90% of the investment company’s taxable income must be distributed to its shareholders.​

• Timing: Capital gains are specifically distributed at year-end.

Advantages of mutual funds

Low initial investment, diversification, professional management, and liquidity.

Disadvantages of mutual funds

Performance variability, Fees/Loads/Expenses, No insurance (not FDIC insured), Market impact, and Built-in gains.

Management Fee

Charged by the investment adviser for the management of the fund assets.

Internal Expenses:

Administrative and operating costs.

Trading/Transaction Costs:

Includes brokerage costs, spread costs, and market-impact costs. Generally do not pay tax at the fund level, but these costs range from 1% to 2% and are not included in the expense ratio.

fees and expenses

• List of shareholder fees, including sales fees, purchase fees, account fees, and redemption fees​

• annual operating expenses, including the management fee, any 12 b-1 fees, and other relevant expenses​

• Sales Charges (Loads): Commissions paid to brokers.

• Redemption Fees: Fees charged when an investor sells or "redeems" their shares.

mutual funds don't pay preformance, get their fee no matter what

Portfolio Turnover

The process of buying and selling securities inside the fund.

• Rule: Higher turnover creates higher transaction expenses and potentially more tax liabilities.

low: 20% or less

high: don't want in taxable account

Coefficient of determination (R-Squared)

Measures how much of the variation in a fund's return is explained by the benchmark portfolio returns. 90% R-Squared means 90% of the movement is due to the benchmark; only 10% is due to the manager's unique picks.

Beta

Measures the systematic risk of a portfolio. A mutual fund beta is a weighted average of the betas of the assets in the portfolio.

Sharpe Ratio (Layman's Terms)

It measures the "excess return per unit of risk." Essentially: "How much extra profit am I getting for the extra stress/risk I'm taking on?"

Higher is better

Performance/return / risk

Standard Deviation

Measures the total risk (volatility) of the fund.

Derivative

A financial security whose value is derived from the value of an underlying security or asset (e.g., coffee, oil).

Contracts or agreements between two parties

Futures Contract

A standardized agreement between two parties to buy/sell an asset at a specified quality, time, place, and price.

Characteristics: contract size, value, price limits (amount daily $ can change), margin requirements, margin requirements (minimum balance you must keep in your account, If your account falls below this → you get a margin call (add more $)

Forward vs. Futures Differences

Futures: Standardized, traded on exchange, daily settlement (Mark-to-Market), and virtually no counterparty risk.

• Forwards: Private, negotiated, not standardized, and have counterparty risk.

Swap Contract

Agreement to exchange cash flows at regular intervals.

Interest Rate Swaps

Used by financial institutions to manage risk when there is a mismatch in maturity structure (e.g., deposits are short-term/variable, but investments are long-term/fixed).

Margin Requirements

Initial Margin: The "good faith" deposit to start a position.

• Maintenance Margin: The minimum level the account must stay at to avoid a "Margin Call."

Call Option

The right but not the obligation to buy an underlying asset at a specified price (Strike Price) for a given time.

• Purpose: To speculate on price increases or hedge a short position

You use a call when you think the price will go UP

What the buyer does:

• They exercise the option

• Buy at $50 (even though market is $70)
  👉 That’s a win

What the seller must do:

• They are forced to sell at $50

• But the asset is worth $70
  👉 They lose $20 of value

Put Option

Allows the holder (buyer) to sell the underlying security at a specified price over a set period of time to the seller/writer in exchange for the premium.specified price.

• Purpose: To protect against a price drop (insurance) or speculate on a decline.

You use a put when you think the price will go DOWN

Intrinsic Value

The actual value if the option was exercised right now.

• Call = Stock Price - Strike Price (if > 0).

• Put = Strike Price - Stock Price (if > 0).

Time Value

The extra amount people pay for the option because they hope it will become more valuable before it expires (Premium - Intrinsic Value)

12B-1 FEES​

Pays for marketing and distribution expenses directly from a fund’s asset base. ​

• Another 25 basis points can be charged as a “shareholder service fee,”which effectively raises the annual potential 12b-1 to 1% of assets per year.​

Brokerage costs

result from the buying and selling of securities within the mutual fund. ​(service fee for using platform)

bid ask spread

the difference between the price that an investor must pay (the ask price) to buy the security and the price the investor will receive (the bid price) if they sell their shares. ​

market implied cost

result from a market change in a security due to a large trade. ​

fund prospectus

The SEC requires mutual funds to disclose important information to investors in the fund’s prospectus:​

exp: the fund’s investment objectives or goals​, strategies for reaching goals​, principal risks of investing in the fund​, fund’s fees and expenses​, past performance

correlation coefficient

the strength and direction of the relationship. ​

spot & future price

• The spot price is the price of a commodity or asset to be delivered today. The spot price is also called the cash price.​

• A futures price is the price of the commodity or asset at some time in the future.​

The difference between the spot and futures price is known as the basis.

futures position

Purchasing a contract is termed a long position (take delivery). ​

Selling a contract is called a short position (make delivery). ​

EFT and mutual fund differences

Mutual fund: higher fees, actively managed, bought and sold once a day

EFT: passively managed, lower fees, more flexible, price fluctuates during the day