103-3 Equity & Managed Assets

Question 1

Disadvantage of issuing equity instead of debt from the standpoint of the issuing corporation

Answer 1

Dividends are not tax deductible for income-tax purposes, wheres bond interest is tax deductible

Question 2

Stock’s par value

Answer 2

The specified value of the stock on the stock certificate or corporate charter

Question 3

Wash Sale

Answer 3

Occurs if the taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities

Question 4

Shareholder of record

Answer 4

Any owner who is listed as such on the record date

Question 5

Record date

Answer 5

First business day after the ex-dividend date

Question 6

Ex-dividend date

Answer 6

The first date on which a security is traded that a buyer is not entitled to receive a previously declared dividend

Question 7

Dates to know for dividend payment

Answer 7

Day 1: to receive dividend, last chance to be owner
Day 2: ex-dividend date
Day 3: record date

Question 8

Dividend reinvestment plans (DRIPs)

Answer 8

The shareholder is entitled to purchase the additional shares directly from the issuer paying little or no commission and often at a discount to market price

Most companies permit investors in these plans to add money along w/ the reinvested dividend

Question 9

Stock dividend

Answer 9

A dividend paid to shareholders of record in the form of additional shares of company stock, rather than in cash

The market price of each share of stock should decrease on a basis relative to the stock dividend

Receipt of the stock dividend is generally not taxable for federal income tax purposes
The stockholder’s basis per share of stock is adjusted downward to reflect the stock dividend

Question 10

Stock split

Answer 10

The par value of each share of stock is reduced, and the # of shares is increased proportionately

Question 11

Reverse stock split

Answer 11

The company reduces the total # of shares outstanding

Companies typically do this to increase the price of the outstanding shares, thereby making the company less likely to be delisted by an exchange and more attractive to potential investors

Question 12

Rights

Answer 12

Aka subscription rights

Issued by a corporation that plans to raise funds by issuing new stock to the public
Normally, each current shareholder is given 1 right for each share of stock
Rights usually are only for a few weeks
Stockholders may purchase the company’s stock below the current market price

Question 13

Warrants

Answer 13

Essentially long-term, customized call options used to purchase the stock of the underlying corporation

On issuance, exercise price higher than market price

Guarantee, for a small premium, the opportunity to buy stock at a fixed price during a particular period of time

Warrants are often issued in conjunction w/ new bond issues or preferred stock issues to make them more attractive to buyers

Question 14

Preferred stock

Answer 14

Has characteristics of both a bond and common stock

Like a bond, shareholders of preferred stock receive dividends each year equal to a stated % of the par value of the stock

Like a common stock, a shareholder of a preferred stock is not guaranteed the payment of the dividend

Large corporations the most prominent purchasers of preferred stock because of favorable tax treatment

Sensitive to IR changes

Question 15

Country risk

Answer 15

A composite of all the risks of investing in a particular country

Question 16

American depositary receipts (ADRs)

Answer 16

Trust receipts issued by a U.S. bank for shares of a foreign company purchased and held by a foreign branch of the bank
An alternative to direct investing in foreign companies or mutual funds
Denominated and pay dividends in U.S. dollars

Exchange rate risk not completely eliminated because dividends are declared in local currency then converted to U.S. dollars

Dividends paid are taxed to the investor as ordinary income in the year earned

Question 17

Net Asset Value (NAV)

Answer 17

Mutual funds must calculate the NAV of fund shares at least once per business day because purchase and redemption prices are based on the NAV

Fund’s NAV = assets (cash + current value of securities) - liabilities

NAV per share = fund’s NAV / # of shares outstanding

Question 18

3 Methods to Calculate Basis for Mutual Funds

Answer 18

1) Specific Identification Method: generally the most favorable to the investor (i.e., result in the highest cost basis and least tax due)
2) Average Cost Method
3) First in, first out (FIFO): least favorable, the method used by the IRS in the event that the investor-taxpayer cannot identify the specific shares or use the average cost method

Question 19

Closed-end fund

Answer 19

Shares trade in the same manner that publicly traded stocks trade

The manager does not have to worry about cash redemptions (as w/ a MF), which in turn, may permit the manager to invest in less liquid securities

Question 20

Unit Investment Trust (UIT)

Answer 20

Type of investment company whose units are sold in the secondary market but not on the major exchanges

Unmanaged, or passively managed, funds because professional managers initially select the securities to be included in the portfolio and then hold those securities (usually bonds) until they mature

UIT investors generally purchase units (instead of shares) sold at NAV + commission

Question 21

Separately managed account

Answer 21

An account comprising a diversified portfolio of individual securities managed by a professional money manager

Question 22

Exchange-traded fund (ETF)

Answer 22

Because they mimic indexes, ETFs typically have lower annual expenses than mutual funds

They also have lower turnover of assets than mutual funds and are, as a result, more tax efficient

Usually passively managed and attempts to track a specific index (e.g., S&P 500 Index) or sector within the index

The price of the fund shares is based on the value of the underlying securities; thus, this price may or may not be equal to the NAV, which is calculated every business day, of the fund because of supply and demand for the shares

Question 23

Indexing

Answer 23

Investing in index mutual funds or ETFs, is indicative of an investor who believes in passive portfolio management

Index funds tend to be distinguished by their low administrative costs and low turnover of existing assets

Question 24

Hedge fund

Answer 24

Usually structured as a partnership w/ the GP acting as the investment manager and investors constituting the LP’s

Unlike a MF manager, whose compensation depends on the amount of assets under management, a hedge fund manager is paid on the basis of fund performance and commonly owns a significant % of the fund’s shares

Risks associated w/ hedge funds:

• Leverage
• Short selling
• Higher risk investments
• Lack of transparency

Question 25

Fund of Funds (FOF)

Answer 25

A hedge fund that consists of several, usually 10 to 30, hedge funds

Question 26

Venture Capital

Answer 26

Financing for privately held companies (e.g., start-ups) typically in the form of convertible preferred stock and is characterized by high risk w/ the potential for high return

Question 27

Private Placements

Answer 27

Used to sell an issue, most commonly bonds, to a small group of institutions or sophisticated individual investors

Avoid the SEC registration requirements of an IPO and a company’s info is not accessible by the general public

Limited to 35 unaccredited investors, but are available to an unlimited # of accredited investors (individuals w/ $200k+ of annual income or net worth of $1 million or more)

Question 28

Limited partnerships

Answer 28

Characterized by a partnership entity that consists of a GP and LP’s
GP controls business activities, determines when distributions are made to the LP’s, and has unlimited liability
The LP’s do not participate in the management of the partnership and have limited liability

LP investments tend to be relatively risky and generally unsuitable for the average investor