Download Mutual Fund Fees, Characteristics, and Regulations and more Exams Business Fundamentals in PDF only on Docsity! SIE FINRA Exam 555 Questions with Verified Answers Purpose of securities industry - CORRECT ANSWER matching investors with money to issuers that need that money to finance issuer - CORRECT ANSWER legal entity that sells securities in order to finance its operations (business, governments) ie. us treasury, us gov agencies, foreign governments, state and local governments, corps, banks methods issuers use to raise capital - CORRECT ANSWER 1) issue debt securities (bonds) and 2) issues equity securities (stocks) debt securities - CORRECT ANSWER publically traded loans = bonds, notes, or debt instruments. The person loaning money/buying a bond is considered a creditor to the issuer and the amount they paid for is the principal that the issuer owes them and also makes interest payments throughout the duration of the loan -can be issued by banks, corps, etc equity securities (common vs preferred) - CORRECT ANSWER raise capital by issuing stock (equity), this time when you buy this, you have ownership in the company and if the company is profitable then you may be entitled to a portion of the profits (this is received through dividend distribution). differs from bonds bc 1) typically no maturity date and 2) dividend payments are optional -only banks/corporations sell these and can do so publically or privately to specific group of investors preferred=paid a predetermined dividend (usually received first and higher than those of common holders, but don't get a vote in company matters) common=paid a dividend based on company fortunes broker dealer = brokerage firm (2 capacities) - CORRECT ANSWER 2 capacities 1) broker= (ABC - agency, broker, commission)engages in agency transactions in security accounts of others. they match up buys and sells and earn a commission for their work (like a real estate broker, acting on behalf of customers to make commission). no risk to firm, they find party willing to take other side of trade 2) dealer= (PDM - principal, dealer, markup/markdown) firms buying and selling securities for its own accounts. buy securities from clients and hold them in inventory and allow clients to buy from them. like a car dealer... buys for its inventory and sells from its inventory and can mark up and down accordingly. acts as principal and can take other side of the trade, MARK UP OR MARK DOWN -risk & Inventory broker-dealer departments/structure of firms (5) - CORRECT ANSWER 1) investment banking 2) research 3) sales/private client 4) trading 5) operations broker dealer - Investment banking - CORRECT ANSWER referred to as underwriters of securities... they provide advise to issuers in who are looking to issue stocks, bonds, or a combo (structure/arrange security offerings) also can assist with M&A or restructuring for bankruptcy broker dealer - research - CORRECT ANSWER analysts!! study market and issuers to make reccomendations (buy, sell, hold) broker dealer - sales (stock or bond brokers aka registered representatives RR or investment advisor representatives IAR) - CORRECT ANSWER financial professionals who market bonds, stocks, but also packaged products such as mutual funds to people and institutions broker dealer - trading - CORRECT ANSWER execute trades for the firm and the firm's clients and occur in electronic market places NASDAQ or hybrid ones such as NYSE broker dealer - operations - CORRECT ANSWER make sure things are up to standard (paperwork, trades, etc) also generate statements, etc primary market - CORRECT ANSWER where securities are issued, new company issuing stock for ex. beginning of a shares existence = primary distribution of issuers shares. funds are directed to the issuer secondary market - CORRECT ANSWER where securities are traded: those who bought those in the primary market will want to sell them and this is where the secondary market comes into play. funds are no longer directed to the issuer, and instead pass between investors -sells securities with help of underwriter -issuer (needs capital)--> underwriter (facilitates distribution/buys from issuer/resell to investor)--> investor IPO/follow-on - CORRECT ANSWER IPO=initial public offering, primary market, sell some % of the co. and safe some to sell later on usually follow-on=existing company sells equities @ a later date=subsequent offering markets within the secondary market (2) - CORRECT ANSWER exchange market, dealer-to-dealer market 1) exchange market= electonric of phsysical (NYSE- has one DMM) centralized trading venue that functions as an auction, auctioneer who controls trading in a given stock is DMM (designated market maker) 2) dealer to dealer market= when stocks don't quality for physical or electronic markets they trade over the counter (OTC, usually low priced/thinly traded, done between two parties without the supervisory role of an exchange) people connect over phones or computers, usually less trading acivity than Nasdaq. most bonds (non-equities) are traded in the OTC market (no organized exchanges aside from certain bonds). securities that are traded over the counter are traded in a dealer to dealer market. for companies that cannot meet requirements to trade on larger/more centralized exchanges. in otc market, spread between bid and ask is larger, usually smaller co since it is timely and expensive ot get on exchange -NASDAQ (has several market makers), is a dealer market but not considered OTC exchanges - CORRECT ANSWER NYSE (where trading is maintained by the DMM), NASDAQ (unlimited # of market makers) quotation systems - CORRECT ANSWER OTCBB, OTC Pink Markets - they check which firms trade in certain stocks market maker - CORRECT ANSWER stand ready to buy/sell at least 100 shraes at their quoted prices at any given time traders - CORRECT ANSWER do not keep any inventory, executed trades for the firm/client listed securities - CORRECT ANSWER equity securities that meet standars for trading on a national exchange (NYSE and NASDAQ) Nasdaq (electronic) - CORRECT ANSWER national association of securities dealers automated quotation system third market - CORRECT ANSWER trading away from traditional exchanges or OTC, on internet, etc. can accommodate after hours - usually between broker -dealers and large institutions fourth market - CORRECT ANSWER institution to institution trading, doesn't involve public markets or exchanges. many times broker dealers are setting up these trades ECN - CORRECT ANSWER electronic communication networks -act in only agency capacity -connect buyers and sellers electronically, anonymously, during and after trading hours dark pools - CORRECT ANSWER provides liquidity for large institutional investors or high-frequency traders -details are concealed from the public, (no dissemination of quotes) -anonymous -low transaction costs and little market impact settlement - CORRECT ANSWER simultaneous delivery of security and buying of security in the marketplace (when a transaction is executed) DTCC - deposit trust & Clearing corporation - CORRECT ANSWER securities depository and national clearinghouse for the settlement of transactions in equities, bonds, mortgage baked securityes, derivatives, etc , insurance products, money marke, mutual funds -will do securities issues by US and foreign entities -automate and centralize transactions -DO NOT HOLD SECURITIES -non-profit -within DTCC=NSCC (national securities clearing corp=for equity side and FICC (Fixed inc clearing corp) hedge fund - CORRECT ANSWER privately managed investment fund that attempts to have above average rates of return using speculation, short selling, margin, arbitrage -pools of capital used to invest, very important customer to broker dealer since they do a lot of trading clearing firms/introducing firms (omnibus vs fully disclosed accounts) - CORRECT ANSWER 1) clearing firms: many smallers firms will hand off all of part of this process bc it can be expensive and a lot of initial investment costs -aka full-service firms -they have many more customers than just small broker firms, they also serve hedge funds, investment companies, etc. 2) introducing firms: broker-dealers that do not do their own clearing operations, the clients of these firms actually have their securities held at the clearing firm from which they receive statements/confirms other vocab: fully disclosed accounts=when the clearning firm has all client info and is responsible for all paperwork/ets up account at the vlrstninh gitm omnibus accounts=when the clearing firm only does clearing, the introducing firm in this case has their own back office/operations and will not provide client account details to the clearing firm. does NOT hold specific client info DTCC vs OCC - CORRECT ANSWER **buyer for all sellers and seller for all buyers** day-to-day rules that brokerage firms must follow are set by the SRO even though the SEC is in charge of overall regulation -FINRA (financial industry regulatory authority) -MSRB (municipal securities rule-making board) -CBOE (chicago board options exchange) maintain rules to treat customers fairly (fair and equitable trading) the trouble is that they have no ability to punish violators all broker dealers must join an SRO firm (in house) rules (3 types of employees) - CORRECT ANSWER WSP - written supervisory procedures, outline policies and procedures to to supervise workers. this is essentially a manual. 3 types of personel 1) registered principals 2) registered representatives 3) and unregistered employees state (blue sky) regulation (NASAA) - CORRECT ANSWER states often require broker dealers and their agents to be registered in the state in order to conduct business there, in addition, issuers are required in many states to register their securities before selling in a given state. these rules are established under USA (uniform securities act) which = blue sky laws -the USA are established by the NASAA (north american securities administrators association=oldest international investor protector agency, with focus on preventing fraud) -also created USA -set rules for licensing/exams which includes all 50 states (commissioner/administrator =person in each state appointed by gov setting these rules) and puerto rico/other territories as well, but states can have more stringent rules than those outlines in the uSA (model law) -MAIN GOAL=PROTECT INVESTORS FROM FRAUD securities act of 1933 (4 main parts) - CORRECT ANSWER first legislation to cover securities industry, focus on the primary market 1) prospectus= required that investors be given full and fair information to be provided with full and fair disclosure to be able to make informed investment decisions=disclosure doc with all relevant info. the SEC doesn't approve this, just need to see info has been filed 2) outlines rules of conduct for both issuers and investment bankers (underwriting firms). underwriters must perform reasonable investigation/due diligence =liability 3)regulates raising of capital 4)requires SEC registration of new issues the maloney act of 1938 (3 important events) - CORRECT ANSWER 1) created non- exchange SRO, so NASD (national association of securities dealers) was created in 1939 to self regulate the OTC market 2) 1975 this act's scope created the MSRB (municipal securities rule making board) 3) in 2007 NYSE and NASD merged member regulation and created FINRA securities exchange act of 1934 ( 4 major parts) - CORRECT ANSWER rules for activities in the secondary market (two highly recognized exchanges are the NYSE and Nasdaq) 1) created the SEC (regulatory authority in prim/sec markets) to help delegate to SROs 2)created margin requirements (Reg T) even though fed enforces this 2) regulatory oversight to the Fed Reserve board regarding the extension of credit (use of margin) for borrowing money or short selling (borrowing the shares that are sold with the assumption that the stock will decline in value allowing them to buy it borrowed stock at a lower price 4)creates registration requirements for broker dealers/RR and trading and insider regulation investment advisers act of 1940 (ABC rule for defining AI, which means they regulated by SEC, what are the exclusions (4) - CORRECT ANSWER -defines and provides exclusions for firms acting as IA (investment advisors who are regulated by SEC) ABC rule for defining IA: providing advice in securities/asset allocation, operating as a business, receiving compensation for the advice, ex=mutual fund companies and firms that manage wrap accounts (charge fee for service and fee for transactions as one). this also includes firms that manage wrap accounts=charging one fee for advice and transactions -exclusions are available to broker dealers, some professionals (so long as the advise is incidental to their actual profession): 1) broker dealers that receive commissions and are already in the business of doing so as broker dealer=no need to register 2) banks, savings inst, trust co = aready regulated as banks/unless getting more commission = no need 3) professionals, LATE (lawyers, accountants, teachers, engineers) bc advice is incidental to their business BUT if they charge an additional fee just for that advice then they lose exemption/become IA. 4)publishers (newspapers, etc) bc it is general advice, not tailored **purpose of investment company act and investment advisers act is such that mutual fund companies must register with the SEC and the firm that manages the assets must register as an investment advisor investment company act of 1940 (what are the 3 types of investment companies) - CORRECT ANSWER -identifies 3 types of investment companies: management companies, unit investment trusts, face amount companies -regulates mutual fund and like companies (which tend to pool together money from investors and invest the funds in securities - more than 100 shares, min 100,000 in assets, annual reports to SEC SEC regulates securities industry/can take action against civil penalties but cannot imprison you, the DOJ goes to criminal court not SEC. SEC can only take action against civil penalties (fines, expulsion from membership). - CORRECT ANSWER Employee retirement income security act of 1974 (ERISA) - CORRECT ANSWER provides standards for funding and eligibility of private retirement plans such as 401K as well as fiduciary responsibilities of trustees securities investor protection act of 1970 (SIPA) - what is specific about a margin account in terms of determining value -what is not covered -what is the procedure - CORRECT ANSWER created the Securities Investor Protection Corporation (SIPC) (NOT A GOVT AGENCY) which is industry funded, FINRA (an SRO) (rules can be broken into 4 categories) - CORRECT ANSWER -NYSE and NASD merged to make FINRA in 2007 main SRO for securities industry, their rules can be broken down into 4 categories -local cop for all broker dealers/RR -must register to be a member/pay fee/take exam 1) conduct rules 2) uniform practice code (UPC) 3) code of procedure (COP) 4) code of arbitration FINRA - conduct rules - CORRECT ANSWER cover interactions between clients and firms re compensation, communications, sales practice violations -one of largest components -governs interactions between firms/customers FINRA - uniform practice code - CORRECT ANSWER rules govern trading and proper settlement of transaction goal=to standardized these rules ex=settlement and corporate actions -back office, create standards for trading, little customer interaction FINRA - code of procedure - CORRECT ANSWER outlines process to discipline anyone who breaks FINRA rules, acting as a COP -parties involved=FINRA and broker-dealers and or FINRA and registered reps -can result in fine, censure, expulsion, suspension AND INVOLVES APPEAL PROCESS -only SEC through DOJ can imprison you FINRA - code of arbitration - CORRECT ANSWER process to resolve disputes between members/as well as those that involve customers -settles monetary disputes mostly -parties are broker-dealers, RR, customers -can result in monetary settlements & NO APPEAL PROCESS -doesn't have to be rule violation can be customer complaint etc -cheaper than litigation arbitration=determine if person is owed an amount, etc rules, reg, creation of SROs are always reactionary - CORRECT ANSWER CBOE (Chicago board options exchange) (an SRO) - CORRECT ANSWER trading platform for options, stock indexes, interest rates, and ETF -is the SRO for the options market -largest options market in us and is regulated by SEC Firm specific rules - CORRECT ANSWER not all oversight comes from SEC and FINRA, but principals providing oversight within the firm by constant monitoring to uncover any misuse/wrongdoing -compliance works with sales professional to ensure ethical trading environment -compliance creates rules that form WSP (written supervisory procedures) ** internal rules tend to be more stringent and materially different than those set by SEC and SROs MSRB (an SRO) ( 2 things you must do if transacting business in muni securities business) - CORRECT ANSWER -securities acts amendments of 1975 required that broker-dealers transacting in municipal securities must a) register with the SEC and 2) create their own municipal securities rulemaking board -SRO charged with rulemaking for municipal securities, FINRA enforces -main concerns with standards of professional practice, including broker-dealer qualifications, rules of fair practice, and recordkeeping ****rules do not apply to issuers of municipal securities ***no enforcement abilities, the SEC does this/or another regulator industry *for bank dealers, SEC does not enforce these rules but rather the FDIC, or Fed Reserve, or comptroller of currency who enforces rules... - CORRECT ANSWER broker dealers: FINRA, SEC bank dealer: FDIC, FRB, controller of currency shareholders have limitd liability - CORRECT ANSWER meaning they are not held responsible for corp debts, and are a separate person under the law. the worst they can incur is losing their initial investment coporations structure - board of directors - CORRECT ANSWER sharedholders elect a board of directors who oversees management team, corporate governance, declare dividends bondholders - CORRECT ANSWER the corp using money from investors with promise of paying principal.interest back over the predetermined lifespan of the bond -interest -principal at maturity -liquidation preference over stock holders -CREDITOR status stockholders - CORRECT ANSWER no maturity date, they are part owners of the company hence (equity) and no guaranteed int. payments -if company prospers, the shareholders can expect to share in its profits in the form of cash or stock distributions (dividends) and their shares also increase in value *** if company fails they are more likely than other investors to lose entire investments since bondholders have higher claim in assets and are paid out first -dividends -potential capital appreciation Two types of equity securities (basic info) - CORRECT ANSWER 1) common stock: traiditional form of equity, paid out last if bankruptcy (considered junior), receive dividend only after bondholders are paid interest and preferred stock holders are paid dividend 2) preferred stock: considered a senior security. first payout is secured creditors, then unsecured creditors, then preferred stock owners, and lastly common stock owners authorized shares - CORRECT ANSWER during incorporation (articles of incorp/charter) specify how many total shares can be issues, this can only be changed by a majority vote among the BOD and thus a change in the articles. most companies issues fewer than this number in order to safe some for future use issued shares - CORRECT ANSWER number of shares that are actually issued/have been sold by the corp outstanding stock - CORRECT ANSWER number of shares that have been issued to the public MINUS any stock that has been repurchased by the company (treasury stock). this stock receives dividends and has voting rights market capitalization - CORRECT ANSWER used to indicated a company's size. this can be calculated by multiplying current market price of the stock by the number of outstanding shares classification of stock (ways they are typically sorted) (5) - CORRECT ANSWER 1) based on size (large, mid, small cap) 2) type of issuing company 3) assumed risk 4) expected return 5) correlation to business cycle stock classification: blue chip stocks - CORRECT ANSWER describes common stock of large, well established stable mature companies with great financial strength (with long unbroken records or earnings and dividend payments) stock classification: growth stocks - CORRECT ANSWER stock of a company whose sales, earnings and share of the market are expanding faster that the general economy/industry average stock classification: defensive stocks - CORRECT ANSWER associated with companies that are resistant to a recession including service related industries (utilities), production of stable products (groceries, pharmaceuticals). these companies perform well regardless of how the economy is doing *** defense stock does not equal defensive stock, defense stock is associated with production of armed services, etc. stock classification: income stocks - CORRECT ANSWER associated with companies that pay higher than average dividends in relation to their market price -attractive to older/retired investors who are interested in current income and not capital appreciation -ex = utility stocks stock classification: cyclical stocks - CORRECT ANSWER associated with businesses whose earnings fluctuate with the business cycle -examples include household appliances, steel, construction, and automobile companies American Depository Receipts (ADRs) (sponsored vs unsponsored) - CORRECT ANSWER -represents a claim in foreign securities though they are held in the U.S. banks located oversees -trade in U.S. exchanges or OTC and pay dividends in U.S. dollars -can be sponsored or unsponsored: sponsored means the company pays a depository bank to issue ADR shares in the U.S. the sponsorship permits the company to to raise capital in the U.S and list the ADR on the NYSE or Nasdaq. the larger ADRs are sponsored. Unsponsored ADR=the company does not pay for the cost of the trading in the U.S. and instead the depository bank issues the ADR (OTC) preferred stock - CORRECT ANSWER issued by companies that already have common stock outstanding -better for investors interested in income not capital appreciation (like bondholders) -lack voting rights -issued with a par/face value of $100 corresponding to it's initial market price and will pay a specified dividend (for example a 5% preferred stock will pay $5 per value of $100) this dividend rate can also be listed as $5 for ex and this represents the max the shareholders will receive, but if the company is not doing well they can pay less types of preferred stocks (5) cnbcc - CORRECT ANSWER 1) cumulative 2) non cumulative 3) participating 4) callable 5) convertible types of preferred stocks (5) - CORRECT ANSWER 1) cumulative 2) non cumulative 3) participating 4) callable 5) convertible non cumulative preferred stock - CORRECT ANSWER missed dividend payments don't accumulate, only current year dividends need to be paid out before common stock owners (preference is only for the current year) -so if a company was not paying out full dividends bc the market was poor, the year in which they are able to pay out the dividends, they do not need to make back tracking (missing) payments and only current year preference applies Cumulative preferred stock - CORRECT ANSWER if the company doesn't pay all of it's owed dividends, if it is cumulative then the preferred stockholders receive dividends first (before common stock holders) **most preferred stock is cumulative** -missed dividends accumulate and are paid back to preferred stock owners before common stock owners Participating preferred stock - CORRECT ANSWER preferred stock return is generally the max annual return that an investor can expect to receive, but for those who buy participating preferred stock, they can receive greater dividends if ... 1)the company is doing well 2)common dividends exceed a certain amount callable preferred stock - CORRECT ANSWER company has the right to repurchase back/call back the stock at a specified price, usually a price higher than the stock's par/face value so that investors want to buy it (so when itnerest rates go down... then they can also pay lower payments, this is an environment when call protection is most valuable to customer, when i-rates decrease) convertible preferred stock - CORRECT ANSWER caters to investors who care more about capital appreciation than income, the trade off is obviously a lower dividend rate -investors can convert the par value of the stock into a predetermined number of common shares at a specified price 3) the bid or purchase price is limited: the price can not be higher than the highest independent bid 4) the amount of stock purchased on a single day is limited, cannot exceed 25% of average trading volume for that security 3 reasons why corp would buy back their own stock - CORRECT ANSWER 1) so there are less outstanding shares 2) increase the market price of the security (rule 10b has rules around this) 3) buy back to give to employees in the form of stock option plans market cap = market capitalization - CORRECT ANSWER # of outstanding shares * market value per share earnings per share - CORRECT ANSWER increases when you repurchase a share since it is how much $ they made divided by the number of shares outstanding... so same profitability divdied by a smaller number of shares (since they were bought back) --> bigger earnings per share common stock owners have the right to... - CORRECT ANSWER 1) inspection of books (co. statements, etc) 2) right to vote on election board/authorized shares NOT ON DIVIDENDS 3) evidence of ownership (certificate usually in street name) 4) dividends (entitled but no guaranteed) 5) transfer of ownership (secondary market) restricted stock (investment letter/lockup agreement) - CORRECT ANSWER received through private placement (whether gifted or bought) --> restrictions in place before they can be resold -lockup agreement basically means you are holding the security for a defined time period since you are not able to turn around and sell it right away (can drive price down if people can sell these with no rules) restricted vs control stock - CORRECT ANSWER restricted: 6 month holding period, received through private placement or as compensation for senior exec control/affiliated stock: no min requirement holding period, registered stock, purchased in open market by officers, directors, (anyone owning 10% of more) **both must follow rule 144, and a control person can own both types of stock since they can acquire privately but also purchase on the market** rule 144 - CORRECT ANSWER used when trying to sell restricted or control securities -once filed with SEC you are letting them know that you are going to sell... they give you a 90 day period for which you can sell the greater of 1% of oustanding shares or the average weekly trading volume over the last 4 weeks. purpose=limit market impact by limiting Q that can be sold -NOT required for shares with value under $50K or under 5k shares ADR =american depository receipt (2 types) - CORRECT ANSWER -shares or foreign stock sold in the U.S. so investors can buy using US$ and get dividends in US$ 1) sponsored=issued in cooperation with foreign co and traded on US exchanges, co pays for sponsorship program by giving shares to US bank to convert 2) unsponsored=issued without involvement of foreign company, trades in OTC market, brokerage firms pays for ADT program bc they think they can make a commission off of these stocks preferred stock - CORRECT ANSWER no voting rights, bought bc of dividends (paid before common holders), designed to provide returns similar to bonds, DIVIDENDS ARE PAID QUARTERLY types of common stock (5) - CORRECT ANSWER 1) blue chip 2) growth 3) income 4) defensive 5) cyclical types of preferred stock (5) - CORRECT ANSWER 1) non cumulative=no payment of back up dividends=no entitle to unpaid dividends 2) cumulative=investor is entitled to unpaid div. they must be paid to pref. before common can be paid at all, unless all are paid to pref then none go to common). IF NO divident pair to pref. holders OR only some was paid then zero will go to common holders unless full payout went to pref. first. 3) callable=company can buy back shares or stock, typically over par value ($100), since some pref. stock doesn't have a maturity if a company raised the money they needed then can minimize outstanding shares) 4) participating= can receive extra dividends if co. did well that year 5) convertible= can convert to common stock pref. stock cumulative vs non cumulative ex - CORRECT ANSWER non cum 8% --> year 1=0, year 2=$2 cum 6% --> year 1=0, year 2=$2 *common stock owners earn no dividends for year 1 or 2 since pref. weren't paid the full amount what is payout in year 3 for each 1) non cum=8 2) cum= 16 (since they need to pay the full 6 for each of the previous years first) convertible preferred stock (conversion ratio & price of pref stock equations) - CORRECT ANSWER less risky than common stock bc you still receive dividends and if common stock rises so does pref. stock -conversion ratio (how many shares of common stock would i receive per 1 pref stock you own)= par (usaully 100)/conversion price -price of pref. stock = market value common stock * conversion ratio ex: investor bought 4%, $100 par convertible pref stock at $110, stock is convertible at $10 and common stock price has risen to $12.... sooo if you convert if you will get 10 shares of common stock * 12 =$120, if you keep it in pref. you only have a value of $110.... premtive rights (rights offering) 2 different types - CORRECT ANSWER =type of derivative since value is derived from common stock value shareholders right to maintain % ownership in the company, no dilution... this is distributed through a rights offering -rights offering=issue more shares at discounted (shareholders exercise right at price below market value) rate to EXISTING shareholders, usually one right per share owned. ONLY if you have common stock shares do you receive any rights. this discounted price is am immediate value to shareholders since -trades flat=no accrued i-rate when sold (typically with bonds you pay price of bond and accrued interest rate that previous owner is owed) -accreted=adjustment cost basis which is accredeted up to par value, you pay taxes on this why bond prices fluctuate from par (2) - CORRECT ANSWER 1) i rate risk: inverse relationship between i-rate and price of bond. when i-rate increases other bonds are issued with higher rates of return thus already issued bonds have to be discounted to be copmetitive, must be discounted enough to match increase in irate. since bond was issued, if i-rates go up price of bond will go down to make it more attractive/comparable 2) credit risk: risk that company won't be able to pay back investors... we use credit rating agencies to tell us this.. more risky the company usually higher the yield/rate of return to compensate. return=risk free rate + premium for taking risk (general rule of thumb) -lowest risk=fed gov/treasury (will have lower yield) can be either discount or premium bond quoted at 94.5... what is the price, bonds price is stated as % of par - CORRECT ANSWER means you are paying 945, since you take 94.5*10+945 (since it is measured against par which is 1000, you take 100*10=1000) bond rating agencies/credit rating=how investors measure/are sure they will get their money back -who pays for these ratings -what are the concerns of the raters? - CORRECT ANSWER S&P and Fitch use all caps and +/- system Moody's use Aaa and 1,2,3 AAA, AA, A, BBB =investment grade BB, B....=speculative grade=junk bond=high yield bonds -the issuers pay bc if bond wasn't rated then it would be hard to market to investors/they couldn;t determine risk -the risk of default is their main concern, they look at liklihood they can be paid back corp/muni bonds prices can be expressed in terms of points and trade in increments of.... - CORRECT ANSWER - trade in increments of 1/8, 1/8=.125 * 10 = 1.25 = 1/8 of 1% of par sooo .. 93 5/8 = 93.625 * 10 = trades at 936.25 93 1/8 = 93.125 * 10 = trades at 931.25 rate: 5 1/4, 92 1/2 Decimal: 5.25, 92.5 $ value: 52.5, 925 - 1 point=1% of bond par value or = to $10 - government security pricing (treasury market) trades at. ___ fraction of a point - CORRECT ANSWER 1/32, bc this allows for smaller price movements, since this is a very liquid market quote: 87.24, fract = 87 24/32, dec=87.75 (24/32=.75), dollar= 877.5 treasury bill quoted by ____ not ____ - CORRECT ANSWER -quoted by yield NOT dollar price -higher yield bid represents lower price but ask's lower yield represents higher price types of bond yields (3) - CORRECT ANSWER 1) nominal yield:coupon rate, fixed, does not change. 7% coupon = $70 per year (.07*1000) or 35$ semi annually 2) current yield: relates annual interest to price of bond.... = annual interest/current market price of bond 3) yield to maturity: overall rate of return if held to maturity. assumes 1) reinvestment of coupon annually and 2) takes into consideration loss/gain @ maturity depending on if you paid discount or premium for bond if you paid $900 you will make $100. YTM=overall rate of return=Basis=most IMPORTANT of all yields -if bond is trading at par, ALL THREE WILL BE EQUAL -if trading above par meaning i-rates went down, NY doesn't change, CY is smaller since you are dividing by a larger denominator, and YTM is even smaller since it takes into consideration losses at maturity for paying premium -if trading below par=meaning i-rates went up. NY does not change, CY will be higher since denominator is smaller, and YTM is even higher since takes into account gains at maturity nominal and current do not give you overall return on investment, only YTM does basis point= - CORRECT ANSWER .01%, so there are 100 basis points in 1%, so yield changes are referred to in these small increments, 6--> 6.25 yield = 25 basis points (helpful to think of this as .06-->.0625, full percentage would be to .07, only went quarter of the way or quarter of 1% so 25 basis points) why pay premium for a bond? - CORRECT ANSWER bc i-rates offered by purchasing the bond are better than the market can offer/other bonds are being issued at . premium is high enough price to match/be competitive with today's market rates of lower interest YTM=overall rate of return=Basis=most IMPORTANT of all yields, when people say bond it trading to yield they are referring to this - CORRECT ANSWER bond current yield DOES NOT EQUAL basis - CORRECT ANSWER retiring debts prior to maturity (2, call and put provisions) - CORRECT ANSWER 1) call provision= issuer can call back bonds prior to maturity. used when i-rates fall since they can reissue and have less irate obligation. similar to refinancing, you can pay lower rate so they call in bonds and reissue at lower irate. can be 1) whole or partial/lottery call (random lot is chosen) -call premium= amount above par issuer will pay to call in bonds since investor will usually receive a premium since the call price is a premium -call protection=period of time when bonds cannot be called -why buy these? higher yield = comp for having this feature also call protection and call premium offer protection stripped securities (3) - CORRECT ANSWER =when security is stripped of interest payments and final principal payments and then repackaging and selling as zero coupon bonds. ... though these repackaged securities were not issued by the treasury, their cash flowers were secure since they were a direct obligation of the U.S. govt----> led to issuance of 1) TR (treasury receipts) which are backed by treasury securities that are owned by the issuing broker dealer NOT directly backed by u.s treasury 2) T-STRIPS=sep trading of registered int. and principal securities program= dealers can buy t-bonds, t notes and separately sell coupon adn principal payments as zero coupon (interest=dif between purchase price and face value paid at maturity) after requesting this through fed reserve bank. backed by us treasury quoted on yield basis 3) CMBs=cash management bills=issued at discount but mature at face value, very short (1 day sometimes) used to smooth out cash flow of treasury U.s treasury auctions - primary market (competitive vs non competitive tenders) - CORRECT ANSWER securities firms compete by bidding on these auctions=competetive tenders since they specify price and yield firm is willing ti buy them at (similar to limit orders, may not be filled). -non competitive tenders: do not specify a price and are guaranteed to be ordered. these are filled first however bidder must accept yield and price determined by the auction -all winners pay lowest price of accepted competitive tenders=dutch auction agency securities (bonds) (2) - CORRECT ANSWER -issued by gov agencies (backed in full faith by u.s. govt) and government sponsored enterprises, not direct oblgiation of u.s. government but are considered very safe and tend to have a bit higher yield than u.s. treasuries (logic is that since u.s. gov created these they will not let them default) -quoted in 1/32 of a point 1) fed agencies: direct extensions of U.s. gov=backed in full faith includes govt national mortgage association (GNMA) 2) GSE: publically chartered by privatey ownded allow for creation of low cost loans for certain segments of the population. issues securiteis trhough selling group of dealers proceeds go to bank (ex= fed farm credit banks/fed home loan banks) -FFCB: provide funds to banks that make ag loans to farmers -FHLB: provide liquidity to savings and loan inst. that need extra funds to meet demand for money. U.S treasury bond (3 main types, general info, why are they safe) - CORRECT ANSWER issued by the fed government and therefore backed by the full credit/faith of US govt= effectively no credit risk, and highly liquid -they are safe bc, 1) highly liquid, ability to convert to cash quickly and cheaply, 2) no risk -interest is only taxed at the federal level not at state and local level types: all are marektable in secondary market type 1: t bills type 2: t notes type 3: t bonds U.S Treasury - t bills - CORRECT ANSWER -issued at a discount and mature at face value, effectively are zero discount bonds -up to 1 year maturity, offered at $100 or multiples of this, book entry form, interest rate=par value paid at maturity - discount -weekly auction usually monday or tuesaday and settles on thursday -quoted on a discounted yield basis meaning for ex (bid is 2.94% and ask is 2.90%) think of this as % discount, so the 2.94% though is a higher numeric value represents a larger discount off of face value and therefore a lower price whereas the 2.90% is a lower number but is less of a discount and therefore higher price (inverse relationship between discount or price and yield) U.S. Treasury - t notes: - CORRECT ANSWER interest bearing paid semi annually 2-10 year maturity, traded at $100 or multiples of, book entry form, periodic auctions -quotes at % of par in points and 1/32 of a points U.S. Treasury - t-bonds - CORRECT ANSWER interest bearing, paid semi annually, book entry, periodic auctions, $100 or multiples of, maturity = 10 + years -accrued interest is paid by taking actual number of days since last payment/365 as opposed to other methods that assume 30 days in each month -quotes at % of par in points and 1/32 of a points U.S Treasuries types quick comparison - CORRECT ANSWER 1) t bill: up to 1 year maturity, book entry, $100 or multiples of, weekly auction, pays discount and thus similar to zero coupon bond 2) t notes = 2-10 year maturity, book entry, 100$ of multiples of, periodic auction, pays interest semi annually, quote at % of par value in points and in 1/32 of a point 3) t bonds: 10+ maturity, $100 or multiples of, book entry, semi annual, periodic auctions, quotes at % of par in points and 1/32 of a points other types of U.S. Treasuries (2) - CORRECT ANSWER 1) TIP: teasury inflation protected 2) T-STRIP: separate trading registration interest principal securites U.S. Treasury - TIP - CORRECT ANSWER treasury inflation protected, since high inflation hurts bonds especially since an investor is holding onto them for a long period of time, this can change the purchasing power but specifically inflation hurts bonds for 2 reasons 1) purchasing power decreasing, if you i-rate is 4% but interest is 5% you are not keeping up with inflation= negative real rate of return 2) increasing inflation --> fed usually tightens --> increase i-rate--> decrease in bond price *** so the good thing about TIPS is that they have a fixed/stated coupon rate but the principal is adjusted based on the rate of inflation or CPI -at maturity you get the adjusted prinicpal not par and if there is deflation it is adjusted downward but never below $1000 so you always get par value at maturity so you get the greater of the adjusted value or par value - so for example say due to inflation the principal rises from $1000 to $1030 on a fixed 4% rate, then your annual interest is going from $40 to 41.2 U.S. Treasury - t-strip - CORRECT ANSWER treasury, separate trading registartion interest princiapl securities. these are not issued by the federal government, but created in the secondary market. a broker dealer or bank take the treasury note and separate each interest and principal payment as an individual security and if you buy it you are only entitled to that one payment --> creation of many zero coupon instruments from only 1 t bond or 1 note = not interest bearing -issued at discount and mature at face value -issued with variety of maturities two types: 1) general obligation 2) revenue bonds municipal bonds - general obligation (ad valorem tax) - CORRECT ANSWER -issued by state, city, town, schools, for GENERAL PURPOSE for wide array of needs, backed BY FULL FAITH CREDIT AND TAX abilities of the municipalities -the sources of debt service=full faith tax/credit opportunties of muni (-sales/income taxes at state level) and at local level of government they collect money with ad valorem tax=based on assessed value (such as property taxes) -requires voter approval -higher credit rating thus lower yield -lower yield -subject to debt limitation = max debt muni can take on (ONLY applicable here bc it is backed by taxes) municipal bonds - revenue bonds - CORRECT ANSWER =self supporting debt bc it is backed by the revenue produced by the facility (pay toll to use road or bridge for ex) -NOT backed by full faith credit/taxing abilities but instead by specific revenue producing facilities -airports, sports stadium (payment for entrance/user fees) -if this revenue is not enough then --> default -more risk than GO -DO not require voter approval since not backed by taxes *** usually will have feasibility study which is conducted to determine the costs/revenue capacities of a project*** -higher yield thus more risk -NOT subject to debt limitation ***many different types of these, see next card** types of revenue bonds (rev bonds=type of muni bond) (12) - CORRECT ANSWER anything not backed by full faith/credit faith of the municipality 1) transportation revenue: used of toll/user fees 2) special tax: backed by one specific tax, ex=gas or tobacco or excise tax on alcohol 3) special assessment: backed by one time fee charged to people who benefit from a project (side walk or sewer system) they can charge assessment fee on benefiting properties 4) double barreled: backed by 2 sources of revenue provided by the facility. if revenue isn't sufficient, it is also general obligation of the municpality's full faith in tax/credit 5) moral obligation: if project revenue is insufficient, the state legislature is morally, NOT legally obligated to cover short fall (not double barrelled, but will vote to disburse funds if needed 6) private activity: bond where 10 or more % of proceeds will benefit a private entity (ex. sports team) ex) = industrial development bond: issued by municipality to build facility for corporation to use it, the muni will lease the facility to the corporation and it is the lease payments that pledge to back the bonds 7) house revenue bonds: bonds issued by state/local housing finance agencies in an effort to help fund single family or multi family housing for normal to low income families 8) dormitory bonds: issued to build housing for students at public universities, repaid by tuition 9) health care revenue bonds: used to construct non profit hospitals and health care facilities 10) utility revenue bonds: to finance gas, water, sewer, and electric power systemed onwed by government unit (backed by issuer fees charged to customers) 11) lease rental bonds: one muni leasing a facility to another (state building authority may issue bond to build dorm and then the authority will lease the dorm to the college ) 12) taxable muni bonds: may not always be able to issue tax free bon municipal notes (6 types) - CORRECT ANSWER shorter term than bonds, , year or less usually, issued to assist with cash flow needs. tax free at fed level -issued in anticpation of future event that will provide money to pay off debt 1) tax anticipation notes (TAN): issued in anticipation of future tax receipts they will collect 2) revenue anticipation notes (RAN): issued in anticipation of future revenue they will receive from state or fed subsidies 3) tax and revenue anticipation notes: when TANS and RANS are issued together 4) bond anticipation notes (BAN): issued in future anticipation of future long term bond they will issue 5) grant anticipation notes (GAN): issued in anticipation of fed grant to muni 6) construction anticipation noten (CLNS): issued by municipalities to provide funds for the construction of a project that will eventually be funded by bond issue. auction rate securities (muni security)=ARS - CORRECT ANSWER - long term holdings with interest they pay are reset at frequent intervals through auctions -2 types, one that is a bond with 20-30 yr maturity and 2) preferred shares with cash divident. VRDO - variable rate demand obligations - CORRECT ANSWER long term, marketed as short term investment -interest rate is adjusted at specified intervals (daily, weekly, monthly) and in many cases there is a put option (to give back to issuer) on the date that a new rate is established ratings for municipal notes - CORRECT ANSWER S&P: SP 1+, SP 1, SP2 = invesment grade, SP# = speculative grade or junk bond or high yield Moodys: MIG 1, MIG 2, MIG 3 (literally stands for moodys investment grade) =investment grade, SG=speculative grade/junk bond municipal bond underwriting (4 parts, 1 role of underwriter and underwriting process/how underwriter is selcted, 2 types and 4) syndicate offering) - CORRECT ANSWER 1) role of underwriter: municipalities use competitive/negotiated process and can select investment bankers to help. Basically an underwritier acts as a link between the issuer and investor. they assist the issuer in pricing/structure of inancing/ and preparing the disclosure or official statement (though not legally required for munis since they are exempt from securities 1933 act) but many issue these to help market to customers NOT THE SAME as a prospectus 2/3) underwriting process/how underwriter is selected: - negotiated method: state/city selects investment bankers to work with and together negotiate details and guidelines between both parties 5) repurchase agreements (repos): dealer selling to another dealer with agreement to repurchase at a higher price the different = your interest) this involves 2 transactions return on equity investments (2 main ways) and 4 important dividend dates - CORRECT ANSWER 1) dividends 2) capital appreciation 1) declaration date: BOD says we will pay a divdident of $x at some future date, this is an announcement 2) payment date: set by BOD, date dividend is distributed 3) record date: set by BOD, determines for ownership purposes, to receive dividend, you must be an owner on this date (ownership occurs 2 days after payment=t+2 settlement, so settlement day). for buyer to receive dividends, transaction must settle on or before record date. 4) ex-dividend date: NOT set by BOD but is function of settlement date. this literally means without dividend. = when stock began to sell without the dividend = one business day before record date, on this day the price of the stock is discounted by the value of the dividend ** cash transactions/cash trades=settlement is same day=you become owner same day** order of events for cash dividends (the dates) - CORRECT ANSWER declaration --> ex divident --> record --> payout - ex: if i buy stock on the 11th, it settles on the 13th. but they open the ownership books on the 12th (record date) you wont receive a dividend, last day you could have bought it was the 10th so you were owner on record date. if buyer does not get dividend the seller is entitled due bill - CORRECT ANSWER a check that the seller gives to the buyer as a transfer payment along with the delivery of the securities that were not issued on the correct date. the buyer was entitled to a dividend that the seller received instead due to back office issues, so seller incorrectly received it and must pay back to buyer. seller incorrectly remains stock owner/gets div. - this due bill accompanies delivery of stock **happens when SECURITIES are not delivered by record date** dividend dates ex - CORRECT ANSWER t/f declare div on june 1, payable on jul 25, to owners on jul 12 1) stock trades ex div on jul 11 - T 2) seller is entiteld to divident on a trade executed on july 10 - F (seller is not, BUYER is) 3) if securities aren't delivered by jul 12 a due bill will accompany the securities - T 4) cash trade can be done as late as jul 25 to receive dividend - F you wouldn;t be owner by the 12th if this was teh case stock dividends (impact and tax abilities) - CORRECT ANSWER NOT cash dividends, this is when you receive extra shares of stock not cash. what is the impact: no gain/loss, no change in equity, same % ownership as before since you receive more shares, the price is adjusted accordingly so the overall real value is the same as before. -no tax ability for this since cost basis is adjusted and therefore there is no additional compensation that occurs such as income/capital gains. simply number of shares increase ex: investor owns 100 shares of co. at $60 per share. the copany declares 10% stock dividend thus... increase in 10 shares so before the dividend you had 100* 60 = 6000$ market value and after the dividend you had 110 shares but the price per share was 54.54 so --> $6000. what you can do is just divide the b4 value by the number of shares after the stock dividend to find the price. **no change in value owned unless the price then goes back up to $60** stock dividends usually paid quarterly bond i payments semi annually/every 6 months - CORRECT ANSWER calculating current yield for EQUITIES=dividend yield - CORRECT ANSWER =annual income (as a dollar value)/current market price = annual income from dividends compared to stocks current market price NOT original market price, this is presented as a % ex. stocks trading at $40 per share has paid quarterly divident of $.30, the current yield is... (.3*4)/40= 1.2/40=3.00% return on stocks T/F - CORRECT ANSWER 1) stock dividends change the overall value of a portfolio - F 2) cost basis of shares is reduced after a stock divident - T 3) stock dividend is taxable income - F 4) if a cash dividend remains the same the CY on the stock will increase after the stock dividend is paid. T bc with stock dividend the price goes down... so you are dividing the annual dividend by a smaller number. also we know that it is the same amount of dividends but there are more shares return on bond investments (4 main types of yields) - CORRECT ANSWER 1) NY - nominal yield = coupon rate=annual return 2) CT - current yield = annual interest payments ($ value)/current market price NOT purchase price 3) YTM- yield to maturity=basis=total yield: Total yield includes the following: semiannual interest rate payments, interested earned from reinvesting interest or coupon and the gain or loss you receive at maturity depending on if you bought the bond at a premium or discount 4) YTC- yield to call= an investors yield if the bond is called at par. only relevant is two things are true, 1) the bond is callable and 2) entire issue is callable, whole call -for callable bonds, you always quote the LOWER of the YTM and YTC=yield to worst -if trading at par, all 4 yields are equal, if trading at discount YTC is highest bc it is always better to make money quicker... and not wait 30 years till maturity so ytm<ytc (you would then use ytm since lower) and vice versa, if trading at a premium, always better to lose money over a longer period of time so ytm>ytc yield to call has the lowest yield in this case (use ytc since lower) at discount: ny--> cy --> ytm --> ytc (highest) at premium: ny--> cy -->> ytm --> ytc (lowest) ex: yield: 8, 9, 6.5% unrealized gains= appreciation=not taxed=you own the securities and it's now trading at a higher price than what you bought it at but you havent sold the security, once you do it becomes realized gains return of capital - CORRECT ANSWER getting your OWN money back=not taxable, doesn't occur on a lot of investments, but it is when the investor receives some or the original investment back t/f cost basis and capital events - CORRECT ANSWER 1) cost basis is = to amount paid for a security minus commission, F 2) sale of security held for more than 1 year results in long term capital gain and loss, T 3) holding period of a security is measured from trade date to trade date, T 4) any amount of original investment received by an investor is considered return on capital, T total return (equation) - CORRECT ANSWER applies to stock AND bond investments -all cash flows (cash dividends, interest, etc) PLUS any appreciation or MINUS any depreciation in value - this doesnt reference a time period, it equals = (end value-beginning value) + investment income (TOTAL PAID OVER TIME NOT per yr/beginning value) - ex: investor bought stock for $25/share and received $5 in income since the start. stock is now trading at 30. total return(expressed in %)=(30-25)+5/25= 10/25=40% you don't have the actual total return on an asset until you sell it but you can calculate it theoretically measuring investment return (3 ways) - CORRECT ANSWER 1) real rate/inflation adjusted= rate of return minus inflation rate 2) risk adjusted return: rate of return minus risk free return 3) risk free return: rate of return found on a U.S. treasury bill since risk is considered to be very very low ex. 6% rate of return while inflation is 1.5% and t bills are yielding at 2% real return=6-1.5=4.5 risk adjusted=6-2=4 averages/indexes (narrow vs broad based) - CORRECT ANSWER how we talk about how someone's portfolio is looking -investment returns are often compared against a benchmark of a group of securities -narrows based indexes: follows a specific sector (not concerned with the number of stocks) -broad based: follows a general market like S&P and Dow Jones (also not concerned with the number of stocks) S&P 500 (what is composition) - CORRECT ANSWER most widely followed=most compared to this benchmark -400 industrial co -20 transportation -40 utility -40 financial dow jones (3 dif averages, which is the most widely followed) - CORRECT ANSWER broken into 3 averages -broad sector not many stocks -smallest index -dow jones industrial average=30 stocks (most widely quoted of the three and it the most popular stocks, and is what people reference when asking how the market looks) -dow jones transportation= 20 stocks - dow jones utility= 15 stocks equity indexes (4) - CORRECT ANSWER wilshire: largest index of 5000 stocks russell 2000=focus on small cap stocks (small company) nasdaq composite=all nasdaq listed securities nasdaq 100=largest 100 companies on nasdaq bond indexes (1) - CORRECT ANSWER barclays capital tracking performance - CORRECT ANSWER -like grades, your portfolio is looking at how you measure up to your peers -measure porfolio against benchmark, for example if you have a large cap portfolio you may be measuring/comparing to S&P, so if S&P is up 10% and you are up 15% you are beating the benchmark per say investment companies, investment company act of 1940 (established 3 types of investment companies) - CORRECT ANSWER corporation or trust that invests the pooled funds of investors in diversified portfolios -act of 1940: prebuilt portfolios mainly for diversitification and established 3 tyeps of investment companies 1) face amount certificate company 2) unit investment trusts 3) management company: subset of which is a mutual fund investors give money to --> investment copmanies---> give money to the portfolio main breakdown of mutual fund (2, open vs closed) a type of management company which is a type of investment company - CORRECT ANSWER open v closed refer to the capitalization of funds 1) open end: issued and redeemed at 4:00 value, these are not traded. ongoing $ raising, more and more money is taken in=continue to issue new shares so the investment pool/capital to invest is always increasing. can ONLY issue common stock to raise money, shares are ALWAYS new issues=will always come with a prosectus regardless of how old the fund is, since it is coming directly from the issue=always in primary market **shares sold at NAV+sales charge *sponsor stands ready to redeemd your shares or ell you new ones at all times *can't buy on margin and can't buy short since new issue 5) _______ must preceded or accompany any solicitation of mutual fund shares (prospectus) mutual fund structure (5 parts) - CORRECT ANSWER fund company=HH=brand name, will have a lot of investment options each with own target goal. think of this as a car company, offering many dif models XYZ fund=one offering within the HH has many different parts 1) custodian bank=holds funds, cash, securities for safekeeping 2) board of directors: protect shareholders, independent =no employees, set agenda for fund 3) underwriter/distributor/wholesaler: market product line to broker dealesrs who market to their clients 4) investment advisor: earn a fee to render advice, AKA portfolio manager 5) transfer agent: does all back office/paperwork, issues, redeems, cancels funds, paperwork MF board of directors - CORRECT ANSWER 1) independent, investment co act of 1940 required majtority to be independent parties 2) set agenda for fund 3) protect shareholders 4) elected by and responsible to shareholders 5) deals with policy and admin related matters, and hires other parties invovled such as bank, transfer agent, etc 6) DO NOT MANAGE but do set agenda MF investment advisor - CORRECT ANSWER chooses securities, IAR= investment advisor representative -is the fund manager, will adjust holdings/allocations as market changes (liquidate and reinvest in something new) -subject to SEC scrutiny under 1940 act -manages based on objectives from BOD -invests assets, provides analysis and research, implement appropriate diversification -earn management fee=NOT transactional based, it is recurring and expressed as a % of assets under management (AUM) ***usuually the largest expense of the fund *may pay sales charge once, but pay fees recurring MF transfer agent - CORRECT ANSWER act as registrar, paperwork center, computes net asset value, sends confirms, receives recurring fee for services MF Custodian bank - CORRECT ANSWER keeps assets safe, responsible for payable/receivable functions -receives fee for services MF expense ratio - CORRECT ANSWER =how expensive it is for you to own the fund =total of my fees in a given year =% of a funds assets paid for opearting expenses/yearly operating costs=ongoing costs of ownership NOT sales charges MF underwriter/wholesaler/distributor - CORRECT ANSWER *in sum--> able to buy shares at NAV and sell directly to investors or market the shares through independent dealers with who they can they share the sales charge with (wholesaling) this type of relationship where the broker dealer is involved, the broker dealers acts as a conduit between investor and underwriter/wholesaler -market the product line to broker dealer to market to investors -appointed by board, their job is to push the product to encourage broker dealers to sell brand name -receive portion of sales charge for marketing/selling, though most of it is paid to RR so the broker dealer/RR get the majority while the wholesalers gets smaller portion -BUT they may receive an ongoing 12b-1 fee/distribution fee which they can share with RR or broker dealer if they want Mutual Fund complex - CORRECT ANSWER idea to to collect as much money as possible and have as many fund options available as possible so as to cater to variety of investors -so one fund complex can include international fund, global fund, growth fund, target date fund, money market, etc. -usually can transfer one from fund to another within the same family without paying an additional sales charge BUT this is a taxable event. if you go from fund family to fund family this is taxable AND you will pay additional sales charge POP (also what is SEC max), POP equation - CORRECT ANSWER public offering price=NAV plus any applicable sale charge -set by the fund NOT broker dealer so POP =price you pay to acquire fund, and NAV is price to liquidate/sell fund SEC says POP can max out at 8.5% POP=NAV/100-sales charge %) ex calculate sales charge (sales charge equation) - CORRECT ANSWER NAV=bid=9.2 POP=ask=10 sales charge=(POP-NAV)/POP=10-9.2/10=.8/10=.08=8% ex, using NAV and sales charge to calculate offering price - CORRECT ANSWER sales charge=5% NAV=$69.8 NAV/(100-sales charge %)=POP, denominator=complement of your sales charge sooo 69.8/100-5=69.8/95=.734=73.4$ sales charge=8.5% NAV=45.95$ 45.95/100-8.5=49.5/91.5=.5021 or 50.2$ MF, pop, nav, sales charge ex - CORRECT ANSWER mf has NAV of $24 and POP of 26.09 methods to decrease sale charge (breakpoint and letter of intent and rights of accumulation (ROA)) - CORRECT ANSWER -breakpoints: provdided by fund family to incentive investors to concentrate purchases w in a fund name, this is a volume discount, when you invest/buy beyond a certain threshold they will give you a discount (ALL PURCHASES within a FUND FAMILY=within the brand name count toward this)--> leads to lower sales charge *purchases within same family are consolidated to determine sales charge ex: if sales charge =4.5% based on investor investing 60K, NAV=19.61, max offering price=21.32, the fund charges 1% redemption fee, how many shares can investor purchase. we are looking for POP first here.... which is NAV/100-sales charge %=19.61/95.5=.2053=20.5$ per share... and we have 60K soooo we take 60,000/20.5=2926.552 shares (CAN BUY FRACTIONAL SHARES OF MF) letter of intent: if investor does not currently qualify for breakpoint, they can be granted a grace period =we will give you extra time to get to the breakpoint level -13 month window they give you -you can also backdate (MAX 90 days).... to include a prior purchase in this qualificaiton BUT if you do so, however back you backdated it counts toward your total 13 month window ** this is NOT binding, if investor intends to come up with money to invest at breakpoint level but cant there are no penalties, sales charges will just be adjusted to be normal ROA (Rights of accumulation): purchase in fund family by your family=right to add all purchases made from some family of funds by your immediate family as well as fiduciary for single account, trustee, pension/profit sharing plans, investment clubs =ability to reduce sales charges as valye of shares reaches breakpoint dollar cost averaging (DCA) what are important RR disclosures re this? (4) - CORRECT ANSWER when investors try to take this fear/emotions out of investing and invest fixed number of shares or put away X dolllars regardless of market conditions (what we do with retirement assets etc) =method of investing involving making the SAME PERIODIC investment regardless of share price over fixed period of time= number of shares bought changes since if price decreased you will have more shares and vice versa bc based on dollar amount NOT shares -important disclosure RR must tell: 1) this does not guarantee a profit 2) no promise of LT growth 3) prices can change 4) contributions must continue even when prices decrease, otherwise losses occur t/f MF ex - CORRECT ANSWER 1) sales charges are based on total investments within same complex of funds (FUND FAM NOT INDIV FUND), T 2) letter or intent allows purchaser over 15 month period be consolidated to determine sales charge, F (13 months) 3) ability to decrease sales charge as valyue of shares reaches a breakpoint is referred to as rights of accumulation (T) 4) use of dollar cost averaging assumes LT growth (F) redeeming MF shares (redemption process and redemption fee) - CORRECT ANSWER means liquidation of sale redemption process: MF investor may redeem shares and receive shares next calculated NAV (MINUS any contingent deferred sales charges or redemption fees if applicable) -funds are required to send investors the payment for these shares within 7 calendar days of receinv the request (MF Liqudation is not a trade... but a redemption) redemption fee: depends on how long you have helpd the fund... used to prevent in and out trading which can cause the portfolio manager to sell out of positions they may not want to MF withdrawal plans (opposite of DCA) - CORRECT ANSWER -allows investors to receive regular payments from accounts or can say liquidate X shares each month, etc. -minimum account value is required -variety of methods include 1) fixed dollar 2) fixed % 3) fixed time 4) fixed # shares -payments aren't guaranteed for life, when $ is gone, $ is gone ***as RR you cannot advise clients to parcipate in DCA and withdrawal plans at the same time bc sales charged are levied on teh purchase and it makes no sense if you are then just withdrawing the funds MF Sales practice violations (3) - CORRECT ANSWER -for breakpoint sale: a violation is when an RR is trying to prevent client from getting breakpoint by failing to disclose letter of intent as an option, recommending allocation of funds across multiple fund families to diversity (prevent accumulation toward breakpoint), fail to let client know they are close to breakpoint -RR has to disclose tax events associated with moving within fund family and also sales charges associated with moving to other fund families=considered new purchase -excessive purchases of class B shares is a volation since these do not qualify for breakpoint.... so shouldn't be recommended large purchases MF t/f check in - CORRECT ANSWER 1) redemption fee is assessed on ALL sales of MF, F (only some depending on holding period) 2) client should not be engaged in withdrawal plan while also purchasing shares, T 3) class B shares shouldn't be recommended to investor who is considering buying a lot of shares, T 4) switching form one fund to another within the same fund family is a tax-free exchange, F other types of investment companies - CORRECT ANSWER 1) face amount certificate copmany (FAC): issue debt certs, promises face value at maturity or surrender value is presented =zero coupon bond. 2) unit investment company: no portfolio turnover since it is constructed and then left alone=remains fixed for fixed for the life of the the trust +: transparency, you know exactly what is it it and is cheaper and more tax efficient since no turnover=not as much g/l that would be passed along to from them (ex maturity June 2030 --> receives interest on june 1st and December 1st each year) why bond prices fluctuate from par (discount vs premium) (interest rate risk/credit risk) - CORRECT ANSWER par value differs from price investors pay to purchase the bond (market price) although most are sold at par value -if sold below par = discount -if sold above par = premium 2 reasons why these discounts or premiums exist 1) interest rate risk: this implies that as market prices increase, investors will not be interested in purchasing existing bonds at par since they're able to obtain higher yields by purchasing new bonds SO existing bonds will need to be offered at discount to attract buyers and conversely if I-rates fall, the bond will trade at a premium since they can't get higher yields elsewhere 2) credit risk: recognition that issuer may default and may not be able to meets obligations to pay interest and principal, those issuers that are a higher credit risk must pay higher interest to induce buyers (lower bond value if co. is risky) bond credit risk - how to measure - CORRECT ANSWER U.S. gov have lowest credit risk since risk of gov defaulting is zero since they are backed by full faith/credit and taxing abilities -harder to judge this for co/municipalities so customers rely on credit risk analyzers such as Moody's/standar and Poor (S&P) they evaluate likelihood a co. will default and assigns a credit rating, this CAN be adjusted from time to time changing value of bond -best quality = AAA then AA, then A, then BAA/BBB, anything else is speculative grade. Moody's also subdivides each section into 1,2,3 so AAA1 is highest followed by AAA2, etc. S&P use + and - such as A+ is better than A- ****keep in mind that it is large issuers that are rated, just bc a co. doesn't have a rank does not mean it is bad, just may mean it is too small to apply a rating to**** bond pricing (% vs points) (factional prices) - CORRECT ANSWER -stated as % of par value, a bond with price of 100/1000 is selling at 100% of its par value, a bond selling at 90 is a discount equal to 90% of par value or $900, price of 110 is premium, 110% of par value or $1100. -may ALSO be expressed in terms of points: each point is equal to 1% of bond's par value or 10$, quote of 99 points = 99% = $990, if quoted at 101 = 101 %= $1010 EX: - bond price = 99 = 99% of par value = $990 price in dollars (discount) - bond price = 101 = 101% % of par value = $1,010 price in dollars (premium) -many bonds trade on fractional prices: 1) corp/muni bonds trades in increments of 1/8 of a point = .125 and 5/8 = .625 2) treasury notes/bonds: 1/32 of a point ex: bond quoted at 93 5/8 = 93.625% or 936.25$ interest bearing bonds vs zero coupon bonds - CORRECT ANSWER interest bearing bonds = pay interest at regular intervals and are for investors who desire CURRENT income zero coupon bonds=pay interest (technically) at maturity in lump sum payment, and is for investors who desire a lump sump payment at a future date bond prices and yields: an inverse relationship (how to calculate bond yield -> 3 dif ways) - CORRECT ANSWER if interest rates rise then the value (price) of existing bonds will fall since the demand for them will fall since they offer lower rates, conversely if interest rates fall then the value of existing bonds will rise since theyre worth more than a NEW bond issued with lower coupon rate. -bond yield 1) nominal yield: coupon 2) current yield: (annual interest in $/ current market price) 3) yield to maturity: (effective return) redeeming bonds prior to maturity (2) - CORRECT ANSWER 1) call provisions: 2)convertible bonds redeeming bonds prior to maturity - call provisions (call premium, call protection, call types (3), put provisions) - CORRECT ANSWER -if a bond offering includes this the issuer can redeem the bonds before maturity, if called, the bondholder gets the full principal and any accrued interest. Issuers like this because they don't have to pay the rest of the interest payments and can take advantage of declining interest rates (call it back and reissue at lower I-rate=less payment obligations). to entice buyers, usually these have higher coupon rates in general -call protection=restriction on how soon the bonds may be called (usually 5-10 years). if the call period runs out and the bond is called, the issuer is usually required to pay additional par value to compensate for early redemption, this additional amount = call premium -call types 1) in-whole=whole issue is called at once 2) partial (lottery calls) meaning some of the issue is being called while others can remain outstanding 3) catastrophe call enacted when bond's underlying collateral is destroyed (ex raising money to build bridge, but flood destroys this... the issue can be called with bondholders paid back with insurance) *** in-whole and partial/lottery calls must be disclosed but due to unlikihood of occurrence catastrophe calls are exempt -put provisions: opposite of call feature, this allows bondholder to redeem bond at given date PRIOR to maturity. yields are generally lower for these bonds since they can be redeemed if interest rates go up redeeming bonds prior to maturity - convertible bonds - CORRECT ANSWER -way to entice buyers if an issuer has a poor credit rating for ex, they give the investor the ability to convert the par value into predetermined number of shares of company's common stock. the tradeoff=this bonds usually have lower coupon rates. this alters capital structure of issuer as debt is converted to equity -conversion price =price at which bond can be reverted to stock and is SET WHEN BOND IS ISSUED -conversion ratio= # of shares investor will receive at conversion when surrendering $1000 face amount of bonds = par value of bond/conversion price **conversion ratio X conversion price = $1000 always ** -determining when to convert: (you want to compute conversion ratio and then multiply by mkt value of stock by which you will compare the value of your bond, the higher one=determines what you do) depends on what stock is trading at compared to underlying value of bond (ex, you have bond convertible at $40 and the bond is trading at 85% of par. The same co. stock is trading at $35 per share.... soo if you convert you will have 1000/40=25 shares X market price of 35=$875 value. if you keep the bond (85% of par) you have a value of $850. +/- of convertible bonds: -similar to MF, pricing is at the end of the day= AUV=accumulation unit value so if you periodically fund the annuity you pay different pricing each time -like MF, for sub accounts it is like a menu and as we change age/go through dif life changes these will change receiving benefits - withdrawal (annuity), two ways to take money out - CORRECT ANSWER two ways to take money out 1) normal withdrawal 2) loans (later...we learn you can also annuitize) annuitizing (you lose control of the contract once you do this and the insurance co will pay you an income until you die) 1) withdrawal: if we remove $ before age 59.5 this distrbitution if taxable but also there will be additional penalty. the annuitant is in control of the timing and amount they are taking. if you put in 100K and it grew by 200K, and you want to take out 25K that comes out of accumulated earnings first (LIFO=last in first out) meaning that the entirety of this dist is taxable bc it is all earnings. ** only this earnings portion is taxable, not the original contribution** 2) loans: considered taxable, can pay myself back as interest is charged against this dist, this interest decreased your total number of accumulated units death during accumulation phase (annuity - CORRECT ANSWER ex 1) if you put in 100K and it grows to 300K, when they die the benef. would get 300K, the account value. the 200K that grew from the oringal contributon is taxable and must be paid by benef as regular income tax ex 2) puts in 100K and the accounts falls to 60K, benef will still get 100K = you cannot lose $ if you die while contract is under water... beneficiary will get the greater of original contribution OR market value of contract annuity ex - CORRECT ANSWER money is dep into general account = fixed investor determines where $ is dep = variable (dif sub accounts) investor assumes investment risk - variable insurance co assumes risk - fixed (interest rate promise falls to insurance co) t/f annuity - CORRECT ANSWER 1) accum units are purchased after tax and grow tax deferred (T) 2) withdrawals are 1st considered a part of cost basis and not taxable (F) comes from income first so they are taxable 3) death beneficiary gets greater of cost basis or current value (T) 4) death benefits above cost basis are tax free (F) ****cost basis=original contribution*** annuity phase - phase 2 (annuitization and 4 payout options) - CORRECT ANSWER =payout=dependent on age, gender, life expectancy, payout option selected, value of separate account= fixed # annuity units * fluctuating value -annuitization, as investor you are giving up control of your contract and the insurance co pays out x amount to them into retirement -insurance co guarantees some amount of income -accumulation units are converted into a fixed number of annuity units -insurance co makes a guess about your group.overall life expenctancy based on age, gender but there are always 2 unknowns 1) your actual life expectancy (this is risky for them..) 2) how much $ will grow in the insurance co hands -they give you options for payout (4 options) irrevocable=choose carefully: 1) straight life contract: highest possible payout, leaves nothing for benef=high risk, high reward. receive payments for life (always has largest payment) 2) life annuity with period certain: life income with period certain annuity. Annuity that guarantees regular payment of a certain sum for the life of the annuitant. In case he or she dies before the completion of a specified period, the payments are made to a designated beneficiary until the end of that period. payments made to annuitant for life or to benef for specified # of years (10 or 20 yr guarantee for ex), lower per month payment but with longer guarantee. so it is a min guarnatee in the event you die prematurely... but it is still a lifetime annuity soo if you are still alive after the guarantee period then you're still paid 3) joint and last survivor annuity: takes a double death to cease payments... if you die, payments to to spouse. Looks at combined life expectancy of 2 parties.. if older=higher payout 4) unit refund life annuity: @ least gets original investment back (of principal), and @ death remaining paid to benef annuity charges/expenses (4 types of expenses) - CORRECT ANSWER (one of the drawbacks) - like MF, have charges and fees that aren't invested and are more expense than traditional MF -no max on sales charge... just has to be fair/reasonable -they are expensive bc they are complicated prodcuts, have investment attributes and insurance attributes, they have life income potential=won't run out of $ hence why no cap on sales charge -like class B MF... the longer you are in the contract, the less you will have to pay 1) management fee: advisor fee for making investment decisions in separate account 2) expense risk charges: charged if expenses are greater than estimated by insruanc co 3) admin expenses: cost of issuing/servicing contracts (bookkeeping, etc) 4) mortality risk charges: a guarantee annuitants will be paid for life even if they lice beyond life expectancies=life insurance co makes up the difference****** qualified vs non qualified annuity - CORRECT ANSWER non qual= contract yuo bought personally, unrelated to employment status. available to anyone, and no limitation on contributions. but also no up front tax benefit bc they are after tax dollars used so these after tax dollars determine cost basis (or principal) so the good thing is the cost basis is dist tax free, any growth is taxed though qual= bought through work, funded on a pre tax basis, offerred to certain types of employees (mostly tax exempt organizations or public schools, 401K are typically tied to corporate world), since pre tax basis, this is deductible in the sense that this is deducted from your pay so you you have less gross pay to be taxed by the IRS (immediate benefit) = zero cost basis so the entirely of the contract will be taxed upon distribution - contribution amount is limited -the state does a backwards calculation based on tuition costs in the future and they say pay me an amount right now and you will get access to much larger tuition costs when ready to use -investor buys college tuition credits and locks in the tuitition costs at the current level=protects against future costs 529 plans (muni fund secruities) - CORRECT ANSWER investor set aside $ and select between different mutual funds, grow tax deferred and any earnings grow tax deferred AND can be taken out tax free if the money is used for the right purposes, doesn't limit schools you can go to like the state tuition plan. -funded with after tax dollars -most investors choose to fund one from own state.... if you purchase plan in the state in which you don't live, you may be subject to state tax, if you bought in your own state you are exempt at state and fed level... - money used in one state plan can be used in another state -max contribution=15K per year to avoid gift tax (this is doubled for married couples), OR you can front load five years of contributions so 75K up front or 150K per married couple (for people who haen't contributed enough yet or are just opening account adn kid is of age) -withdrawals that are qualified (tuition, books, room/board) can come out tax free. for grades k-12 there is a max withdrawal of 10K **** 529 plans remain property of donor not like an UGMA or UMA which become property of child when they are of age... so with this plan you can use one kids plan on another kid if one got full scholarship, etc.... 529 direct sold vs 529 advisor sold - CORRECT ANSWER direct sold: involves no salesperson, can do online, sold directly through 529 savings plan website advisor sold: sold through broker dealer that has selling agreement with primary distributor of 529 plan 529 able plan= acheiving a better life experience - CORRECT ANSWER if you are disabled and receving social security disability, medicaid, or private insurance payouts, this allows you to continue receiving medicare payments -max contribution is 15K per year NO front loading -disability payments continue so long as account value doesn't exceed 100K -distribution are tax free if used to pay qualifying expenses and grows tax deferred t/f ex - CORRECT ANSWER 1) local govt investment pools are investments for muni entities (t) 2) prepaid tuition plan allows individual to decided to have $ invested... (F) 3) 529 plan allows investors to front load with 5 year worth of contributions (t) ETFS (alternative investment) inverse vs leverage (2 types) and also active vs passive types). vs mutual fund - CORRECT ANSWER exchange traded fund: fixed portfolio product tht trdes throughout the day like a stock... but is actually a fund. so it issues shares (and has ticker like a stock) that represent an interest in a basket of securities which mirror a fund. This is a low cost way to gain exposure to certain sections of the market. shares trade in the secondary market and may be sold short or bought on margin similar to stock. commission is paid to buy and sell. price is determined by supply and demand -there are 2 types: 1) leverage: a lot of risk but better performance and 2) inverse: performance is opposite of fund -can also be active or passive, active is when there is active management by portfolio manager and they attempt to OUTPERFORM the market whereas a passive style is simply attempting to match the market by tracking the index index fund( sub type MF): for comparison purposes attempts to mirror an index, new issue always so in the primary market = will need prospectus, can't buy on margin or sell short, higher fees than ETFs, similar in that it is a low cost way to gain exposure to lot of different types of stocks/market in general. usually can buy at NAV since no load fund. can't employ leverage, forward pricing= once daily like MF two types of ETFS (leveraged vs inverse) - CORRECT ANSWER 1) inverse ETF 2) leveraged 1) inverse ETF: negative correlation to stock portfolio. so when market goes up for ex, your etf goes down (if index falls by 2%, ETF rises by 2%)... you can bet on either side. 2) leveraged: you get multiplier of market performance, can come in inverse forms as well, you get 2x or 3x of the market effect... this is an overall more aggressive vehicle **both portfolios reset daily, they are designed for short term trading as they take advantage of intraday swings/change an index (unlike most packaged products). so if you have a strong indication market will go up or down in the next couple of days, you may want to buy into them but again this is risky ETN - exchange traded note - CORRECT ANSWER structured products issued as unsecured debt. trade on exchanges, have low fees, provide access to challenging areas of the market. appears to be bond like but its linked to an index and can be an equity index. you are promised a rate of return, but unlike bond you have to worry about how the benchmark is doing bc you can lose $. **if benchmark doesn't perform the principal and product is NOT PROTECTED bc only backed by full faith and credit of issuer.... *in sum it is linked to performance of benchmark but principal isn't principal protected* *issuer is obligated to deliver performance @ maturity* *index may be delivered back to you -not for the average investor -can purchase on margin/can short them alternative packaged products (2 types) - hedge funds and private equity/venture capital funds - CORRECT ANSWER 1) hedge funds 2) private equity/venture capital funds 1) very aggressive part, marketed to very wealthy investors/accredited investors. -does not fall under investment co act of 1940 so they can perform certain actions that others cannot... like using short stock, derivatives, leverages, illiquidity (may not be able to get $ out = gaiting provisions, generally there are a lot of restrictions on withdrawing money) -does not publish NAV on daily basis decisions so this person's approval may be required to sell, also means lack of voting power, in addition owning this makes tax filing difficult and if tax code changes, some initial tax benefits may no longer apply. *also... partnership has the ability to ask for additional capital in a year or so time and if you can't up your capital you can lose your original interest in the partnership. general and limited partner (limited partnership) - CORRECT ANSWER general partner=managerial=job is to manage program but also protect LP interest... they are viewed as fiduciary toward the LP. they make choices on who to hire, fire, pick properties. they have UNLIMITED personal liability. they also have to have at least 1% interest in the fund so if 100mil raised they have to put in at least 1 mil. limited partner: write checks, they're investors but passively, not involved with management, can't negotiate contracts, have certain rights such as the ability to lend money to the partnership, inspect books, contribute capital. ways to endanger this status=do things that only GP can do Limited partnership offering practices (2) - CORRECT ANSWER 1) public offering: offered under act of 1933, registration required under act of 1933 underwriter is used to facilitate, prospectus is used 2) private placement: offered through reg d=private placement=opened to accredited investors=exemption from registration through reg d what are they investing in.... types of LP (real estate programs, 4 total) - CORRECT ANSWER 1) raw land deal=speculation on land appreciation=most aggressive. you buy land and pray bigger business will eventually want to buy it. the property doesn't make any money, few tax benefits. can go on for decades 2) new construction: buy property, put up housing, etc. then sell it. shorter time horizon but risk of overbuilding, cost overruns, etc. 3) existing construction: safter=buy existing property, will have operational history so you know approx costs of upkeeping, details, problems, etc. 4) low income/government assisted: safest investment bc government backs them, tax benefits/credits but high maintenance costs what are they investing in.... types of LP (oil/gas programs, 4 total) - CORRECT ANSWER 1) exploratory=riskiest=looking for oil where none has been found before=called wild cating=high risk with high potential reward 2) developmental: safest of first 3=drilling near existing field/area it has been found before (proven reserves) 3) balanced=middle risk=combo of exploratory and developmental 4) income=safest overall= purchase of existing wells/already in production creates immediate cashflow, we know what we are buying DPP (direct participation program)- risk summary - CORRECT ANSWER -did you pick a good manager? up to management abilities of general partner -tend to generate losses in first years -illiquid/in product for a long time, can lost capital -unpredictable income -may be asked to come up with additional fund=assessment (can be mandatory) -high operating costs -tax law change an impact value of investment -gas/oil projects can have a large economic and environmental impact LP investor considerations (role of RR) - CORRECT ANSWER - investors need to know risks, this is job of RR who must inform them of this and make sure they can absorb any losses, would not be a good idea to put too much money into these... *** even in discretionary accounts.. the RR CANNOT exercise discretion in these products, they must be solicited=MUST talk to the client LP example fill in the blank - CORRECT ANSWER 1) LPs pass through ______ to investors (income and loss) 2) GP must invest no less than 1% in partnership 2) LP ______ have a fiduciary responsibility to partnership (DO NOT) that is job of GP 3) LPs generally avoid registration by offering securities through _____ (reg d offerings) 4) ______ is considered the riskiest real estate program (raw land) 5) overbuilding is a risk in _______ LP (new construction) 6) riskiest oil/gas program is ______ (exploratory) t/f LP - CORRECT ANSWER 1) partnerships may require LPs to deposit additional funds (T) 2) investors are not required to receive info regarding risk of investments (F) 3) RR can use discretion to purchase LP for clients (F) 4) customers must provide RRs with written approval to purchase LPS (T) DPP--> one type is LP which then breaks down into 1) real estate LP and oil/gas LPs. REIT is separate thing entirely packaged products=ETN, ETF, hedge fund, private equity - CORRECT ANSWER option - CORRECT ANSWER contract between 2 parties. buyer always pays premium for their rights and sell receives the premium for their obligation 1) buyer/owner: said to be "long" the option, paid premium=cost of the option. they are buying the right to do something to the underlying stock=why you pay the premium, you haven;t acquired the stock yet but you establish the right to buy the stock at a set price 2) writer/seller: said to be short the option, they were selling something they didn;t own. the seller receives the premium, seller takes on the assumed obligation to do something if buyer chooeses to exercise their right (they would then have to go buy the stock and sell it to the buyer at specified price in the contract) option table general (call vs put and buyer and seller obligations) and what each party hopes for each contract - CORRECT ANSWER call option= 1) buyer has right to buy underlying stock. their hope is that the stock goes up in price... bc regardless of how high it goes you can acquire at the same price. it is nice to acquire something at this "deal" price... since it is worth a lot more 2) seller has obligation to sell stock if buyer chooses to call it away from seller. they hope that the market goes down... bc they don't actually own the position so they have to go buy it if the buyer exercises their right, they don't want to buy something at a higher price than they are able to sell it at. if the stock is at the money what is it's worth....(how much is time value worth/what determines it) 1) how much time is left till exp... if exp is tomorrow then now likely it will fluctuate much, if 5 mo left then likely many changes can happen (probably higher value to pay for this then) 2) market volatility=how likely it is to change, if very volatile then increase the time value options ex - CORRECT ANSWER option: ABC june 35 call @ 3 mkt price: 36 in/@/out of the $: in the money intrinsic value: 1 time value: 2 option: DEF Apr 60 Put at 7 mkt price: 54 in the money intrinsic value=6 time value =1 RST Jul 35 Put @ 1.5 mkt price: 35 at the money intrinsic value: 0 time value 1.5 XYZ Aug 110 Call @ 2 mkt price: 109 out of the money intrinsic value: 0 time value =2 individual options strategies for calls (rights, obligations, strategy, breakeven, max gain, max loss for Jul 50 cal @ 5 for reference) - CORRECT ANSWER buyer: right: buy at strike price obligations: none strategy: want market to go up (bullish) breakeven: strike price + premium max gain= unlimited (stock can keep increasing in price) max loss= premium (you let call expire) seller: right: none obligations: sell stock to buyer at strike price strategy: hope market goes down (no one will want to buy at strike price is it is cheaper elsewhere so buyer lets it expire and seller keeps premium) breakeven: strike price + premium (you start with the premium already so you can deal with it going up by strike price and still not have lost anything) max gain=premium if buyer lets it expire max loss=unlimited (stock can keep increasing in price) option strategy is considered speculative trading strategy - CORRECT ANSWER long call - breakeven ex - CORRECT ANSWER buy 1 XYZ feb 45 call @ 3 current mkt value = 47 breakeven=strike price + premium = 45+3=48 but why?? cash out: -you pay 3$/share for premium -you also pay 45$ per share if exercised -this totals 48$ spent in the process to establish this position so we need at least 48 to breakeven short call - breakeven ex - CORRECT ANSWER sell 1 XYZ feb 45 call @ 2.5 mkt value=47 since it's a call the breakeven is still strike price + premium = 47.5 cash in: -they get 2.5$ per share for premium -they get 45$ per share if buyer decides to buy it from them -total =47.5..... so the stock can increase to 47.5 and you still haven't lost money... (since you are short the posotion you have to buy it... so don't want to pay more than this price bc you can only sell it for 45 so you are immediately losing money after this (since already received premium=gives you a buffer) individual options strategies for puts (rights, obligations, strategy, breakeven, max gain, max loss) - CORRECT ANSWER buyer: right: put to sell at strike price=sell back to seller at strike price obligation: none strategy: want market to go down (so you can buy it cheap and sell it for more) breakeven: strike price - premium max gain: (strike price-premium) *100 ideally want stock to fall to zero so you are up the full strike price minus the premium... so you can buy it at zero = worst case since the stock is wothless and sell it to seller at strike price so the most you can make is the strike price *100 share BUT also have to factor in wha tyou have paid which is the premium... so you take strike price-premium (since both are per share costs) then multiply by 100 shares max loss: premium (you have this right so you don't have to exercise it... so you can let it expire and thus you are only out the premium you paid) seller: right: none obligation: buy from buyer if they put it to them at strike price strategy: they want the market to go up.... then buyer won't exercise this since it would be pointless to pay 70 dollars for something worth 60.... you would lose money immediately so they keep the premium this way. breakeven: strike price - premium (since you want stock to go up.... but you can handle it to go down the value of the premium since you already pocketed that amount) max gain: premium max loss: (-) of strike price - premium * 100. worst case is that you pay 50$ for worthless stock but you already make the $5 premium so you are losing 4500$ total. which is (50-45) * 100. life of an option (1 of 3 things happen after you establish an option position) - CORRECT ANSWER 1) expire worthless: option is at or out of the money and you let it expire bc no incentive to exercise option. seller gets max gain and buyer gets max loss 2) option can be exercised: buyer does this /has right since they paid premium 3) option can be liquidated: trade your way out of an option=close out position, you can sell it if you bought it and if you wrote/short it, you have to buy it back to close out the position 2 types of exercising of an option - CORRECT ANSWER 1) american style= option can be exercised at any time up until expiration (think americans can do whatever they want). true of all equities on us exchanges 2) european style=can only be exercised on day of exp. index/foreign currency options can be this type how you close out/liquidate options - CORRECT ANSWER long/buyer = need to sell it short/seller=need to buy it so in the end you are left with no position = closing the purchase g/l is determined by the difference between the price paid the price received for an option (compare premiums) exercise vs close out option ex - CORRECT ANSWER mkt = 64 when bought 1 ABC may 65 call @ 3 later market increase to 72 and now premium for some option is much higher = 7 points of intrinsic value and lets assume 1 point of time value so premium is 8 now. scenario 1= exercise option/sell afterward cash out: 65 + 3 = 68$ per share or $6800 cash in: 7200 (what we can make if we turn around and sell it) so we make $400 scenario 2: close out cash out: $300 or $3 per share (we haven't exercise this yet so only have out of pocket paid for premium) cash in: sell it and sellers make premium so it is not selling at 8 premium so we make 800$ differenc ehere is 500$ so better in this case to close out also usually cheaper commission to sell out/liquidate than to exercise an option OCC and options trading - CORRECT ANSWER the OCC guarantees transaction by always being other party in the transaction even tho not actually involved in the trading. they guarantee listed potion contracts (the ones that are listed on central exchanges)=eliminates counterparty risk between buyer and seller... doesn't matter who is on the other side of the contract bc the 3rd party OCC eliminates this bc they become a buyer for all sellers and a seller for all buyers -over the counter options may not be guaranteed by the OCC -deals with broker dealers not customers -creates/requires distribution of options risk tolerance doc which is called the (characteristsics and risks of standardized options) must be sent @ or prior to account being approved for options trading -regulate exchange traded options and settle with broker dealer T+1 deadlines for equity option contracts (3 important times) (counter instructions) - CORRECT ANSWER they expire the 3rd Friday of the month listed when entered into a contract BUT there are 3 important times on that date 1) when option trading closes at 4PM eastern or 3 PM central 2) broker can submit exercise notice to their broker by no later than 5:30 PM ET 3) officially expires at 11:59 PM ET on this day by time 2 or 3, if the option is in the money then the OCC assumes buyer wants to service since it has value so the option will in this case be exercised for you... however you can give counter instructions if you don't want it to be exercised bc it may only be worth a couple of dollars and you don't think you'll have the ability to sell it and make any money exercising an equity option (process) - CORRECT ANSWER 1) investor tells broker dealer (you never go back to the person who shorted it to you bc they may have closed it on their end, et... may no longer be in existence so we don't attempt to rematch up with the original party involved 2) broker dealer tells OCC who then checks records to see what other broker dealers are short the specific option. once they find dealers with this they use RANDOM selection to assign to one of many dealers who are short this position 3) broker dealer chosen may have several investors that are short it and they can use ANY OPTION THEY WANT to match up the option contract... can use random, FIFO, or fair/equitable methods 4) the two brokerage firms now exchange with one another and is treated like normal stock settlement so t+2 index options - CORRECT ANSWER options on an index=provide opportunity to speculate or hedge based o nmovement of the market/index -unlike equity options, (everything previously discussed), these options are cash settled -index=basket of stocks so instead we exercise for cash... seller pays buyer the in the money amount = dif between closing index value and strike price so instead of calling/puting stock the seller pays the buyer the different of these two values -the strategy is the same.. if the market is up you want to buy a call and ice versa options t/f - CORRECT ANSWER 1) OCC issues/guarantees all contracts and deals with broker dealers not customers (T) 2) trade settlement between broker dealers and the OCC is the same business day (F) it is T+1 and for broker dealer to broker dealer is t+2 3) equity options expire at 11:59 PM on ET on third friday of exp month (T) 4) index options provide opportunity to hedge against movement of the market, rather than movement of specified stocks (T) hedging long/short positions - CORRECT ANSWER if you long stock you want to buy a put if stock goes down, gain on put can offset losses from the stock -if short stock you want to buy a call, give you a locked in price to buy @ so not bad if stock goes up... gain on the call if stock increases can offset loss on the stock covered/uncovered positions (options) - CORRECT ANSWER when you sell it it can be covered/uncovered 4) min amount must be sold for deal to go forward... set in terms and if can't reach threshold=deal is canceled. the unsold shares are responsibility of the issuer and the broker dealers act in an agent capacity 5) syndicate stands by to buy any shares not bought by shareholders in a rights offering (when companies give shareholders right to buy new shares @ discount to maintain owner %) = type of firm commitment underwriting. the syndicate is responsible for unsold shares and they act in a principal capacity additional underwriting terms (shelf registration and market-out clause) - CORRECT ANSWER 1) shelf registration= when issuer files registration statement with the SEC but can issue off that statement for up to 3 years, since all major details are disclosed up front... we can come to the market very quickly bc the leg work is already done=allows for flexibility in coming to the market...we disclosure type of securities/up to x amount... we don't want to raise all $ now, we can have this flexibility in coming to the market. we can come to the market many different times, each time however we do need to have prospectus supplement=disclosure for securities sold at that one time. issuer/underwriter can adjust details of the offering to reflect the market conditions at each different time they go to the market. 2) market out clause: provides underwriter with ability to get our of firm commitment underwriting if events that making selling the issue very difficult occur. reasons are limited and disclosed in the clause underwriting t/f - CORRECT ANSWER 1) public offerings are only used for primary offerings (F... can be secondary or a combo) 2) underwriter in a firm commitment is acting as a principal (T) 3) underwriter in a best efforts underwriting is acting as an agent (T) 4) shelf registration allows underwriter the ability to offer securities once within a 3 year period (F) the primary market (underwriter process overview, different agreements signed along the way (3)) - CORRECT ANSWER issuer needs capital, they hire underwriter/broker dealer who assists in the process generally ONE lead manager signs 1) underwriting agreement with issuer they facilitate the distribution and assume liability that varies with offering type. one broker dealer usually does not want to do this along so they do a -syndicate bc it decreases the risk and increases the selling base 2) all syndicate members sign the syndicate agreement with manager which is called the agreement among underwriters=syndicate member agreement this specifies the participation %, unsold securities, etc) 3) broker dealers can be in a selling group which does not assume ANY LIABILITY, instead they assist in the sale only and they sign what is called the selling agreement with MANAGER how does the syndicate make $ (underwriter spread, splits in 3) - CORRECT ANSWER investors invest $, the majority goes to the issuer/whoever is selling them to be invested but there is what is called the -underwriting spread which is the difference between public offering price (what investors pay) and what $ goes to the issuer=what the syndicate earns for selling securities. easy to think of it as issuers get a discount and sell it to public at a higher price, the dif=what they take away how is the spread split (3) *** lead manager is only party that can get all 3*** 1) manager fee (they run syndicate) 2) member/underwriting fee (for risk broker dealers take on) lead manager is also a member 3)concession (selling concession bc it goes to any member who sells, can be manager, external B/D in selling group) underwriting ex - CORRECT ANSWER public price =14 issuer price =13 1000 shares sold manager fee=.15 per share member fee= .25 per share concession = .6 per share if manager sells: -the customer pays 14*1000=14000 -the issuer receives 13*1000=13000 -manager gets... $1000 (takes in all 3 pieces) -member gets...0 -selling group gets...0 member sells: -customer pays 14*1000=14000 -issuer receives 13*1000=13000 -manager gets... .15*1000=150 -member gets... .85*1000=850 selling group get...0 selling groups sells: -customer pays 14*1000=14000 -issuer receives 13*1000=13000 -manager gets... .15*1000=150 -member gets... .25*1000=250 -selling group gets... .6*1000=600 underwriting... participants that have liability for unsold portions of area issues - CORRECT ANSWER 1) managing underwriting 2) member firms NOT selling group underwriting spread ex - CORRECT ANSWER identify how underwriting spread is distributed for sales that are credited to the different market participants managing underwriter: -gets member, managing (only person that can get this), and selling group fees syndicate member: -gets member and selling group fees selling group: -gets selling group fee