Investment Products & Financial Instruments Flashcards

An investor writes (sells) a covered call on 100 shares of XYZ stock they own. What is the PRIMARY risk of this strategy?

Answer: The obligation to sell the shares at the strike price, capping upside gains

When writing a covered call, the investor collects a premium but must sell shares at the strike price if exercised, limiting participation in any stock price appreciation above the strike.

Which of the following private equity strategies focuses on acquiring established companies using significant amounts of borrowed capital?

Answer: Leveraged buyout (LBO)

Leveraged buyouts (LBOs) use substantial debt financing — typically 60–80% of the purchase price — to acquire mature companies, with the target's assets and cash flows serving as collateral for the debt.

A bond's duration is best described as:

Answer: A measure of the bond's weighted average time to receive cash flows, indicating interest rate sensitivity

Duration measures the weighted average time to receive all cash flows and serves as a key indicator of a bond's price sensitivity to interest rate changes — higher duration means greater price volatility.

A commodity swap in which an oil producer receives a fixed price per barrel and pays the floating market price is primarily used to:

Answer: Hedge against falling oil prices by locking in revenue

By receiving a fixed price and paying the floating market price, the oil producer hedges downside risk — if prices fall, the swap's fixed leg compensates for lost revenue.

Which statement about closed-end funds is CORRECT?

Answer: They trade on exchanges at prices that can differ significantly from NAV due to fixed share counts

Closed-end funds issue a fixed number of shares in an IPO and trade on exchanges, where supply and demand can push prices to persistent premiums or discounts relative to the fund's net asset value.

Mezzanine financing in a corporate capital structure is characterized by which of the following?

Answer: It is unsecured or subordinated debt often paired with equity warrants, offering higher yields

Mezzanine financing sits between senior debt and equity, is typically unsecured or subordinated, and often includes equity warrants or conversion features to compensate investors for its higher risk with higher yields.

A variable annuity differs from a fixed annuity primarily because variable annuities:

Answer: Invest premiums in subaccounts tied to market performance, with returns and income varying accordingly

Variable annuities invest in market-linked subaccounts (similar to mutual funds), so the account value and eventual income payments fluctuate based on investment performance, unlike fixed annuities with guaranteed rates.