Book 3 Pages 1-51 Flashcards

Question

under a repurchase agreement, the repurchase price is ___ than the selling price

Answer 1

greater **Repo Trade Date** 1. Investor transfers money into its cash account at the custodian 1. $100 cash to Repo Dealer's Cash Account 2. Rep dealers deliver eligible collateral (including haircut) to the collateral account at the custodian 1. $102 collateral to Investor's Collateral Account **Repo Maturity Date** 1. Investor receives - The principal amount, plus interest, is transferred from the repo dealer’s cash account to the investor’s cash account 2. Repo Dealer - Upon receipt of the cash, the custodian will release the collateral from the investor's account back to the repo

Answer 2

banker's acceptance Banker's acceptances can be created as letters of credit, documentary drafts and other financial transactions. If you are trying to obtain an acceptance, approach a bank with which you have a good working relationship. You need to be able to prove, or offer collateral against, your ability to repay the bank at a future date. Many, but not all banks offer acceptances. A banker's acceptance operates much like a short-term, fixed-rate loan. You go through a credit check and possibly additional underwriting processes. You are also charged a percentage of the total acceptance to purchase it. If you are looking to purchase a banker's acceptance for a short-term investment, there is a relatively liquid secondary market for partially aged banker's acceptances. They are normally sold at prices near or below the London Interbank Offer Rate, or LIBOR.

Answer 3

$5million \* 4% \* (1/360) = $555.55

Answer 4

individual bonds

Answer 5

registered bonds

Answer 6

bearer bonds

Answer 7

book-entry form

Answer 8

sinking funds

Answer 9

treasury notes

Answer 10

treasury bonds

Answer 11

treasury inflation protected securities (TIPS)

Answer 12

5, 10, 30 years Suppose an investor owns $1,000 in TIPS at the end of the year, with a coupon rate of 1%. If there is no inflation as measured by the CPI, the investor will receive $10 in coupon payments for that year. If inflation rises by 2%, however, the $1,000 principal will be adjusted upward by 2% to $1,020. The coupon rate will remain the same at 1%, but it will be multiplied by the adjusted principal amount of $1,020 to arrive at an interest payment of $10.20 for the year. Conversely, if inflation were negative, known as deflation, with prices falling 5%, the principal would be adjusted downward to $950. The resulting interest payment would be $9.50 over the year. However, at maturity, the investor would receive no less than the principal amount invested of $1,000 or an adjusted higher principal, if applicable.

Answer 13

$4% / 2 = 2%

Answer 14

$100k x [1 + (4%/2)] = $102,000

Answer 15

$100k x [1 + (4%/2)] = $102,000 $102,000 \* (4.5% / 2) = $2,295

Answer 16

treasury strips (Separate trading of registered interest and principal of securities)

Answer 17

3 month interest penalty

Answer 18

yes Minimum term of ownership: 1 year Interest-earning period: 30 years Early redemption penalties: Before 5 years, forfeit interest from previous 3 months * After 5 years, no penalty Savings bonds are exempt from taxation by any State or political subdivision of a State, except for estate or inheritance taxes. Interest earnings are subject to Federal income tax. Interest earnings may be excluded from Federal income tax when bonds are used to finance education (see education tax exclusions). Restrictions apply.

Answer 19

no Interest earnings are exempt from state and local income taxes but are subject to federal, state, and local estate, inheritance, gift, and other excise taxes. Interest earnings are subject to federal income tax.

Answer 20

Series HH bonds

Answer 21

mortgage backed securities

Answer 22

Ginnie Mae (GNMA) For the most part, the government-backed mortgage guarantee companies have assumed the nicknames they picked up many years ago. Ginnie Mae is a corporation entirely owned by the Federal Housing Administration. The GNMA is in all respects a federal government agency. Ginnie Mae provides a government guarantee on mortgage-backed securities that are backed by pools of home loans originated through a government program. The home loans behind a GNMA MBS bond will be FHA, VA, Public and Indian Housing and Rural Development Agency program home loans. Fannie Mae mortgage securities are backed by pools of conventional loans, which are home loans originated by a bank or lender and not under any specific government program. The loans in a Fannie Mae pool must meet the lending standards set by Fannie. The Government National Mortgage Association (GNMA or Ginnie Mae) issues agency bonds backed by the full faith and credit of the U.S. government. GNMA guarantees principal and interest on mortgage-backed securities (MBS) backed by loans insured by the Federal Housing Administration and the Department of Veterans Affairs. New GNMAs are issued in $25,000 minimum denominations. **Credit rating** GNMA securities, like U.S. Treasuries, are guaranteed and backed by the full faith and credit of the U.S. government and generally are considered to be of the highest credit quality. **Taxability** The interest income on GNMAs generally is subject to federal **_and_** state taxes. GNMA securities may subject investors to capital gains taxes when sold or redeemed. Investors should consult a tax professional for additional information. **Liquidity** Vanguard Brokerage Services ® does not make a market in GNMA bonds. If you want to sell your GNMAs prior to maturity, Vanguard Brokerage can provide access to a secondary over-the-counter market. The secondary market generally provides liquidity for GNMA bonds, but liquidity will vary depending on a bond’s features, lot size, and other market conditions. It may be difficult to sell GNMAs that have experienced significant principal pay-down. **Risks** GNMA prices can rise or fall depending on interest rates. If interest rates rise, the market price of outstanding GNMA bonds generally will decline. Changes in interest rates have an additional impact on MBS because they affect mortgage prepayment rates. The prepayment rate for a mortgage pool affects the average life and yield. Prepayments often speed up as interest rates decline because mortgage holders are able to refinance at lower rates. Rising interest rates tend to slow loan prepayments. Principal may be returned to bondholders sooner than expected if mortgage holders prepay their loans. Bondholders then may have to reinvest the returned principal at a lower interest rate. Principal may be returned to bondholders later than expected if mortgage holders delay the prepayment of their loans. Bondholders then could miss an opportunity to reinvest the returned principal at a higher interest rate. All bonds carry the credit risk that the issuer will default or be unable to make timely payments of interest and principal. However, GNMAs generally carry minimal credit risk because they are backed by the U.S. government. GNMAs sold prior to maturity may be subject to substantial gain or loss. The secondary market may also be limited.

Answer 23

interest rate risk prepayment risk reinvestment rate risk

Answer 24

collateralized mortgage obligations (CMO) A collateralized mortgage obligation (CMO) refers to a type of mortgage-backed security that contains a pool of mortgages bundled together and sold as an investment. Organized by maturity and level of risk, CMOs receive cash flows as borrowers repay the mortgages that act as collateral on these securities. In turn, CMOs distribute principal and interest payments to their investors based on predetermined rules and agreements. Investors in CMOs, sometimes referred to as Real Estate Mortgage Investment Conduits (REMICs), want to obtain access to mortgage cash flows without having to originate or purchase a set of mortgages. Organizations that purchase CMOs include hedge funds, banks, insurance companies, and mutual funds.

Answer 25

scheduled interest scheduled principal unscheduled principal

Answer 26

1. market risk 2. prepayment risk 3. liquidity risk 4. interest rate risk **_SEC_** = CMOs are often highly sensitive to changes in interest rates and any resulting change in the rate at which homeowners sell their properties, refinance, or otherwise pre-pay their loans. Investors in these securities may not only be subjected to this prepayment risk, but also exposed to significant market and liquidity risks

Answer 27

revenue bonds

Answer 28

general obligation bonds

Answer 29

general obligation bonds

Answer 30

revenue bonds

Answer 31

false, revenue bonds are more risky

Answer 32

Private activity bonds 1. Private activity bonds are municipal bonds which are used to attract private investment for projects that have some public benefit; however, there are strict rules as to which projects qualify. Qualified projects that may be financed by private activity bonds include funding and refinancing student loans, airports, private universities, hospitals, affordable rental housing, mortgage provision for first-time lower-income borrowers, etc. In no event may proceeds of a private activity bond be used to finance an airplane, certain health club facilities, a gambling facility, stadium, golf course, oil refinery, or a liquor store. This type of bond results in reduced financing costs because of the exception of federal tax. 1. States and cities, through private activity bonds, are able to borrow on behalf of private companies and nonprofits, lowering borrowing costs for entities that might otherwise turn to corporate bonds or bank loans. Private activity bonds are issued to attract businesses and labor to a region in order to derive a public benefit, which would qualify the bond for tax-exempt status. These bonds pay taxable interest unless specifically exempted by the federal government.

Answer 33

Serial Bonds The Differences Between Sinking Funds and Serial Bond Issues In a sinking fund, the issuer makes periodic payment to the bond issue's trustee, and the trustee purchases bonds in the open market and retires the bonds. The trustee represents the interests of the bondholders and must use the sinking fund payments to buy bonds and retire them. Instead of retiring bonds according to a specific schedule, the trustee purchases bond from any bondholder who is willing to sell his holdings. Both sinking funds and serial bond issues reduce the total dollar amount of bonds outstanding over time.

Answer 34

5% / (1 - 25%) = 6.67%

Answer 35

indenture agreement

Answer 36

Secured bonds

Answer 37

mortgage bonds

Answer 38

collateral trust bonds

Answer 39

debentures

Answer 40

investment grade bonds

Answer 41

standard and poors Fitch Moody's Moodys is the weird one * Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Fitch and Standard & Poor * AAA AA+ AA AA- A+ AA A- BBB+ BBB BBB-

Answer 42

BBB- = Standard & Poor + Fitch - Last Investment Grade BB+ = Standard & Poor + Fitche - Non Investment Grade Bbb3 = Fitch - Last Investment Grade Bb1 = Fitch - Non Investment Grade

Answer 43

non-investment grade bonds

Answer 44

anything BB+ or lower

Answer 45

junk or high yield

Answer 46

callable bond

Answer 47

convertible bond

Answer 48

conversion price

Answer 49

conversion ratio **FIRST example, Twitter (TWTR)** issued a convertible bond, raising $1.8 billion in September 2014. The notes were in two tranches, a five-year due in 2019 with a 0.25% interest rate, and a seven-year due in 2021 at 1%. The conversion rate is 12.8793 shares per $1,000, is about $77.64 per share. The price of the stock has ranged between $35 and $56 over the last year. To make a profit on the conversion, one would have to see the stock more than double from the $35 to $40 range. The stock certainly could double in short order, but clearly, it's a volatile ride. And given a low-interest rate environment, the principal protection isn't worth as much as it might otherwise be. SECOND Example 1. Suppose that TSJ Sports issues $10 million in three-year convertible bonds with a 5% yield and a 25% premium. This means TSJ will have to pay $500,000 in interest annually, or a total $1.5 million over the life of the converts. 2. If TSJ's stock was trading at $40 at the time of the convertible bonds issue, investors would have the option of converting those bonds for shares at a price of $50—$40 x 1.25 = $50. 3. So, if the stock was trading at $55 by the bond's expiration date, that $5 difference per share is profit for the investor. However, there is usually a cap on the amount the stock can appreciate through the issuer's callable provision. For instance, TSJ executives won't allow the share price to surge to $100 without calling their bonds and capping investors' profits. 4. Alternatively, if the stock price tanks to $25, the convert holders would still be paid the face value of the $1,000 bond at maturity. This means while convertible bonds limit the risk if the stock price plummets, they also limit exposure to upside price movement if the common stock soars.

Answer 50

par value of convertible security / conversion price Convertible Bonds 1. A stock trading for $40 has a conversion ratio equal to $1,000 divided by $40, or 25. Convertible Preferred 1. For example, if a company issues convertible preferred with a 5% dividend and a _conversion ratio of five,_ it means the investor gets five common shares for each share of preferred shares. If the preferred stock is trading at $100, the conversion break-even price on common shares can be determined by dividing the price by the conversion ratio, which is $20.

Answer 51

market conversion price

Answer 52

$1,100 / 50 = $22

Answer 53

conversion value Floor Value 1. Bond Floor of Convertible Bond vs. Comparable Bond 2. To find the bond floor, calculate the present value (PV) of the coupon and principal payments discounted at the straight bond interest rate. 3. Even if stock drops, conertible bond should trade for a minimum of x price. **For example** 1. assume a convertible bond with a $1,000 par value has a coupon rateof 3.5% to be paid annually. 2. The bond matures in 10 years. A comparable straight bond has the same face value, credit rating, interest payment schedule, and maturity date of the convertible bond, but has a coupon rate of 5%. 3. To find the bond floor, calculate the present value (PV) of the coupon and principal payments discounted at the straight bond interest rate.

Answer 54

$70 x $15 = $1,050

Answer 55

true A Yankee bond is a bond issued by a foreign entity, such as a bank or company, but is issued and traded in the United States and denominated in U.S. dollars. Yankee bonds are governed by the Securities Act of 1933, which requires the bonds to be registered with the Securities and Exchange Commission (SEC) prior to being offered for sale. Foreign issuers usually favor issuing Yankee bonds when there is a low-interest rate environment in the United States, since that means the issuer is able to offer the bond with lower interest payments.

Answer 56

promissory notes

Answer 57

Guaranteed Investment Contract

Answer 58

cumulative

Answer 59

shareholder has 100 shares, there are two vacant positions.... this means the shareholder can put 100 votes towards each vacant position For example, if the election is for four directors and you hold 500 shares (with one vote per share), under the regular method you could vote a maximum of 500 shares for each one candidate (giving you 2,000 votes total—500 votes per each of the four candidates). With cumulative voting, you are afforded the 2,000 votes from the start and could choose to vote all 2,000 votes for one candidate, 1,000 each to two candidates, or otherwise divide your votes whichever way you wanted. Cumulative voting can be beneficial to minority voters because they can use all of their votes for a single candidate, improving the chance that they can get at least one sympathetic member on the board; statutory voting ensures that their votes get spread out amongst several candidates, making it less likely that any one of them is elected.

Answer 60

shareholder has 300 shares, there are three positions vacant...this means the shareholder can cast 300 total votes combined between the 3 vacant spots

Answer 61

preemptive right

Answer 62

rights offering

Answer 63

street name stock

Answer 64

declaration date

Answer 65

ex-dividend date. Now...generally 1 day before the Record Date. THUS...NEED TO BUY THE STOCK TWO DAYS BEFORE RECORD DATE TO GET DIVIDEND Apple: Declaration Date = Tuesday, 4/30/2019 Ex-Dividend Date = Friday, 5/10/19 Record Date = Monday, 5/13/2019 As mentioned above, the legal definitions are pretty straightforward: the ex-date is one day prior to the record date. So if you want the dividend, you need to be an owner the day before the ex-date. Many people use the term "trading ex" which means the time has already passed to get the dividend. So if a stock is "trading ex," that means you can buy it but will not get that current period dividend. And the stock may be trading lower (hypothetically by the amount of the dividend) on the ex-date.

Answer 66

record date

Answer 67

two business days after the ex-dividend date

Answer 68

payable date

Answer 69

1 million x 10% = 100,000 new shares $11 million / 1.1 million shares = $10 per share

Answer 70

stock splits

Answer 71

300 shares at $50 per share ($150/3 = $50) (100 x 3 = 300)

Answer 72

reverse stock split

Answer 73

100 shares at $10 (500/5 = 100) ($2 x 5 = $10)

Answer 74

blue-chip stocks

Answer 75

false, they usually do

Answer 76

growth stocks

Answer 77

false, they don't usually pay dividends

Answer 78

cyclical stocks Include 1. restaurants, 2. hotel chains, 3. airlines, 4. furniture, 5. high-end clothing retailers, and 6. automobile manufacturers. These are also goods and services people tend to forgo when times are tough. When people stop or hold off buying because of a reduction in purchasing power, company revenues may start to fall. This, in turn, puts pressure on stock prices, which also start to drop. In the event of a long downturn, some of these companies may even go out of business.

Answer 79

automobile, construction, air travel Cyclical stocks are known for following the cycles of an economy through expansion, peak, recession, and recovery. Cyclical stocks typically refer to companies that sell discretionary items consumers can afford to buy more of in a booming economy. Alternatively, cyclical stocks are also companies that consumers choose to spend less with and cut back on during a recession Durable goods companies are involved in the manufacture or distribution of physical goods that have an expected life span of more than three years. Companies that operate in this segment include automakers such as **Ford Motor Company**, appliance manufacturers such as **Whirlpool Corporation**, and furniture makers such as **Ethan Allen Interiors Inc.** The measure of durable goods orders is an indicator of future economic performance. When durable goods orders are up in a particular month, it may be an indication of stronger economic activity in the ensuing months. Nondurable goods companies produce or distribute soft goods that have an expected life span of fewer than three years. Examples of companies operating in this segment are sports apparel manufacturer **Nike Inc.** and retail stores such as **Nordstrom Inc**. and **Target Inc.** Services is a separate category of cyclical stocks because these companies do not manufacture or distribute physical goods. Instead, they provide services that facilitate travel, entertainment, and other leisure activities for consumers. **Walt Disney Company (DIS)** is one of the best-known companies operating in this space, but it is joined by many companies operating in the new digital area of streaming media, such as **Netflix Inc.** and **Time Warner Inc.**

Answer 80

value stocks

Answer 81

defensive stocks

Answer 82

interest sensitive stocks

Answer 83

insurance financials construction real estate

Answer 84

perpetuity

Answer 85

preferred stock

Answer 86

$5.50 annually per share

Answer 87

cumulative preferred

Answer 88

straight preferred A straight preferred security is "just a piece of paper" that agrees to pay some dividend at some point. But if it ever misses paying that dividend then...oh well, gee whiz, we didn't pay it. Bummer days for you. This kind of preferred stock is called non-cumulative (think: suckers!), and it means it will have to pay a higher dividend to compete against securities of similar risk cumulative preferred securities.

Answer 89

participating preferred **For example** 1. **_Company A_** has one series of non-participating preferred stock with a liquidation preference of $6 million representing 50% of the capital stock of Company A. 1. If Company A were to be sold for $10 million, the investors would receive $6 million (as the $6 million investment amount is greater than the preferred’s 50% share of the $10 million sale proceeds) and the remaining $4 million of proceeds would be distributed to management. 2. **_Company B_** also has one series of preferred stock with a liquidation preference of $6 million representing 50% of the capital stock of Company B, *_but its preferred stock is participating_*. 1. Upon the same $10 million sale event, the investors would receive $8 million (the $6 million liquidation preference plus 50% of residual $4 million of sale proceeds) and the remaining $2 million of the proceeds would be distributed management. Thus, in the same $10 million sale, the different between participating vs. non-participating preferred resulted in a $2 million shift in economics away from management to the investors, which represents one-half of the return that management would have received had the preferred stock been structured as non-participating.

Answer 90

convertible preferred

Answer 91

callable preferred

Answer 92

ADR (american depository receipts)

Answer 93

false ADRs may be listed on a major exchange such as the New York Stock Exchange or may be traded over the counter (OTC). Those that are listed can be traded, settled, and held as if they were ordinary shares of U.S.-based companies. American Depository Receipts (ADRs) offer U.S. investors a means to gain investment exposure to non-U.S. stocks without the complexities of dealing in foreign stock markets. They represent some of the most familiar companies in global business, including household names such as Nokia, Royal Dutch Petroleum (maker of Shell gasoline), and Unilever. These and many other companies based outside the U.S. list their shares on U.S. exchanges through ADRs. In addition to ADRs, Global Depositary Receipts (GDRs) give issuers exposure to the global markets outside their home market. GDRs are offered to investors in 2 or more markets and are most commonly used to raise capital in Europe and the United States. ***_Both ADRs and GDRs are usually denominated in U.S. dollars, but may also be denominated in euros_***.

Answer 94

investment companies

Answer 95

1. at least 90% of income derived from interest, dividends, and capital gains 2. at least 90% of taxable income distributed to shareholders 1. Should the RIC not distribute this share of income, it may be subject to an excise tax by the IRS 3. No more than 25% of the company’s total assets may be invested in securities of a single issuer unless the investments are government securities or the securities of other RICs. 4. Finally, to qualify as a regulated investment company, at least 50% of a company's total assets must be in the form of cash, cash equivalents or securities For example, it may take the form of a 1. mutual fund or exchange-traded fund (ETF), 2. a real estate investment trust (REIT), or 3. a unit investment trust (UIT)

Answer 96

False - although not on an exchange After the initial sales of a new issue have been completed in the underwriting process, the bonds may continue to be bought and sold throughout the life of the security in what is generally called the secondary market. There is no central exchange for municipal securities. Instead, the secondary market for municipal securities historically has been an over-the-counter, dealer market.

Answer 97

false, it varies

Answer 98

aggressive growth stock funds

Answer 99

growth and income funds

Answer 100

global fund

Answer 101

international funds

Answer 102

emerging markets fund

Answer 103

municipal funds

Answer 104

high yield funds

Answer 105

balanced funds

Answer 106

corporate bond fund

Answer 107

stock fund

Answer 108

money market fund

Answer 109

muni bond fund

Answer 110

front-end sales charge

Answer 111

back-end sales charge

Answer 112

12b-1 fees Distribution [and/or Service] (12b-1) Fees This category identifies so-called "12b-1 fees," which are fees paid by the fund out of fund assets to cover distribution expenses and sometimes shareholder service expenses. 12b-1 fees get their name from the SEC rule that authorizes a fund to pay them. The rule permits a fund to pay distribution fees out of fund assets only if the fund has adopted a plan (12b-1 plan) authorizing their payment. “Distribution fees" include fees paid for marketing and selling fund shares, such as compensating brokers and others who sell fund shares, and paying for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature. Some 12b-1 plans also authorize and include "shareholder service fees," which are fees paid to persons to respond to investor inquiries and provide investors with information about their investments. A fund may pay shareholder service fees without adopting a 12b-1 plan. If shareholder service fees are part of a fund’s 12b-1 plan, these fees will be included in this category of the fee table. If shareholder service fees are paid outside a 12b-1 plan, then they will be included in the "Other Expenses" category.

Answer 113

admin and management fees Annual Fund Operating Expenses - FROM SEC (https://www.sec.gov/files/ib\_mutualfundfees.pdf) 1. **Management Fees** 1. Management fees are fees that are paid out of fund assets to the fund’s investment adviser (or its affiliates) for managing the fund’s investment portfolio, and administrative fees payable to the investment adviser that are not included in the “Other Expenses” category (discussed below). 2. **Distribution and/or 12b-1 Fees** 1. This category identifies so-called “12b-1 fees,” which are fees paid by the fund out of fund assets to cover distribution expenses and sometimes shareholder service expenses. 1. “_Distribution fees_” include fees paid for marketing and selling fund shares, such as compensating brokers and others who sell fund shares, and paying for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature. Under FINRA rules, however, 12b-1 fees that are used to pay marketing and distribution expenses (as opposed to shareholder service expenses) cannot exceed 0.75% of a fund’s average net assets per year. 2. "_Shareholder Service Fees_" - A fund may pay shareholder service fees without adopting a 12b-1 plan. If shareholder service fees are part of a fund’s 12b-1 plan, these fees will be included in the “Shareholder Fees” category of the fee table. If shareholder service fees are paid outside a 12b-1 plan, then they will be included in the “Other Expenses” category, discussed below. FINRA imposes an annual 0.25% cap on shareholder service fees (regardless of whether these fees are authorized as part of a 12b-1 plan). 3. **Other Expenses** 1. Included in this category are expenses not included in the categories “Management Fees” or “Distribution [and/or Service] (12b-1) Fees.” Examples include: certain shareholder service expenses; custodial expenses; legal expenses; accounting expenses; transfer agent expenses; and other administrative expenses. 4. **Total Annual Fund Operating Expenses** 1. ****This line of the fee table represents the total of a fund’s annual fund operating expenses, expressed as a percentage of the fund’s average net assets.

Answer 114

Class A Shares

Answer 115

Class B Shares Mutual fund B shares do not require front-end sales charges, but carry a contingent deferred sales charge (CDSC) and have a higher 12b-1 fee (a 1% 12b-1 fee is common) than other mutual fund share classes. CDSCs are charges imposed on shareholders who sell their shares in the fund during the surrender period. These CDSCs are not paid to advisors, but to the fund company to cover various costs, including the upfront commissions the fund pays to advisors (often as high as 4%). Investors do not see these upfront commissions charged by funds that are paid to the advisors who offer the fund shares for purchase. Specific CDSCs are outlined in the mutual fund’s prospectus and the cost depends on how long the investor holds his/her shares. Many mutual fund B shares have a CDSC that is reduced to 0% by year six, while in year seven, the mutual fund Class B shares convert to Class A shares (which carry no surrender charges and have lower 12b-1 fees).

Answer 116

higher The 12b-1 fee is divvied up into two distinct charges: 1. a distribution/marketing fee (capped at 0.75%) 2. a service fee (capped at 0.25%) 12b-1 fees are capped at 1% annually, with distribution/marketing fees and service fees limited to 0.75% and 0.25%, respectively. NOTE - **different than Front End Load Fee**. A Shares * “A share” mutual fund investors pay a separate upfront sales and marketing commission, so they are typically only face the service fee portion of the 12b-1 fee. * Class A shares tend to have lower 12b-1 fees (marketing and distribution fees included in the fund's expense ratio), so if you plan on holding these shares for several years, a front-end load might be beneficial in the long run. * Class A shares, which usually charge a front-end load but no back-end load, may come with a reduced 12b-1 expense but normally don't come with the maximum 1% fee. C Shares * “C share” mutual fund investors pay both the distribution/marketing fee and the service fee to compensate their fund managers. * The presence of a 12b-1 fee frequently pushes the overall expense ratio on a fund to above 2%.

Answer 117

Class C Shares Class C shares are a type of level-load fund, which charges an annual fee. This class works well for individuals who will be redeeming shares in the short term. **Pros** 1. _No Front-End Fees_ – Your entire initial investment contribution earns interest income. 2. _Small Back-End Load_ – The back-end load is typically only 1%. 3. _Opportunity to Avoid Back-End Load_ – The back-end load is normally removed after the shares have been held for one year. **Cons** 1. _Back-End Load_ – A back-end load – although small – is typically charged if funds are withdrawn within the first year. 2. _Higher Expense Ratios_ – Although the expense ratios of Class C shares are lower than those of Class B shares, they are higher than those for Class A shares. 3. _No Conversion_ – Unlike Class B shares, Class C shares cannot be converted into Class A shares, removing the opportunity for lower expense ratios. _As such, if you have a long time horizon, Class C shares are not optimal for you as the high management fees are continuous_. That is, your investment returns will be reduced the longer you stay invested because the fees will add up considerably over time. 4. _No Discounts_ – Class C shares do not offer discounts on expenses when the account reaches certain levels.

Answer 118

style drift

Answer 119

his adjusted basis = ($10k + 200 + 500 + 700 + 300) = $11,700 his capital gain from sale = $20k - $11,700 = $8,300

Answer 120

hedge funds

Answer 121

leverage short selling riskier investment options lack of transparency (don't disclose a lot of info)

Answer 122

true Hedge fund fees are often higher than those of mutual funds and they frequently involve both a management fee and a performance fee. A commonly-quoted hedge fund fee is “**_two and twenty_**”—an annual two percent of assets fee plus 20 percent of the gains over some base return or “hurdle rate.” **_High water marks_** refer to performance fee policies that specify that the fund manager will only be paid a percentage of the profits if the net value of the fund exceeds the previous highest value achieved by the fund. A fund must actually make up losses before it can charge an incentive. **In other words, if a $1,000,000 investment loses 50% in the first year (leaving $500,000), then earns 100% the following year, it cannot charge an incentive fee the second year because the investment is only back to where it began**. Some investors feel the high-water mark can lead to the manager taking on more risk, if he is in a position where he has to play catch-up. Others would not invest without it. **_Hurdle rates_**, also referred to as minimum acceptable rates of return, are also used as a determining factor for hedge fund performance fees, by measuring fund performance against an external benchmark. Where hurdle rates are applied, performance fee percentages are not paid to the fund manager unless the rate of return on the fund meets or exceeds that benchmark rate. The rates used for comparison may be a pre-determined percentage, or some other financial industry measure such as the rate of return on US treasury bills, or other rates of return in the financial industry. Guaranteeing that performance fees will not be levied helps to reassure investors that they will be compensated somewhat if the return fails to exceed that of other investment options.

Answer 123

hedge fund managers usually makes use of derivatives, leveraging, short selling

Answer 124

derivative

Answer 125

financial futures

Answer 126

agricultural futures Futures are often used to trade agricultural commodities. Such commodities are divided into several groups: 1. grains and oilseeds, 2. Livestock, 3. dairy, 4. lumber, 5. softs, 6. biofuels. The CME Group is used as the main supplier of market data for agricultural commodity futures on TradingView. It operates the biggest futures exchange in the world. Even though this market segment is often perceived as a whole, each product behaves differently. You may sort the futures using various metrics that will help you understand the product, its volatility and price dynamics.

Answer 127

mineral futures Despite using it every day, not many people know the differences between crude oil and gasoline. It is the raw material that is refined to produce gasoline, heating oil, diesel, jet fuel and many other petrochemicals. The fundamentals are different since it is a raw product. Light Sweet Crude Oil is traded on the New York Mercantile Exchange (NYMEX). "Light Sweet" is the most popular grade of crude oil being traded. Another grade of oil is Brent Crude, which is primarily traded in London, and is seeing increased interest. Russia, Saudi Arabia, and the United States are the world’s three largest oil producers as of 2018. When crude oil is refined or processed, it takes about three barrels of oil to produce two barrels of unleaded gas and one barrel of heating oil. This helps to put into perspective the production needs of crude, and why production/supply levels are watched so closely.

Answer 128

New York Mercantile Exchange Chicago Mercantile Exchange Chicago Board of Trade The New York Mercantile Exchange (NYMEX) is the world's largest physical commodity futures exchange. Today, NYMEX is part of the Chicago Mercantile Exchange Group (CME Group). The CME Group is the world’s leading and most diverse derivatives marketplace, made up of four exchanges, 1. **CME** 1. The CME trades futures, and in most cases options, in the sectors of agriculture, energy, stock indices, foreign exchange, interest rates, metals, real estate, and even weather. 2. By 2010, the CME purchased a 90% interest in the Dow Jones stock and financial indexes. The CME grew again in 2012 with the purchase of the Kansas City Board of Trade, the dominant player in hard red winter wheat. And in late 2017, the Chicago Mercantile Exchange began trading in Bitcoin futures. 2. **Chicago Board of Trade (CBOT)** 1. The CBOT originally traded only agricultural commodities such as wheat, corn and soybeans. Now, the CBOT offers options and futures contracts on a wide range of products including gold, silver, U.S. Treasury bonds and energy 3. **NYMEX** 1. ****Futures and options on energy and precious metals have become great tools when companies try to manage risk by hedging their positions. The ease with which these instruments are traded is vital to hedging activities and gauging futures prices, making NYMEX a vital part of the trading and hedging worlds. Daily exchange volume of the CME Group is around 30 million contracts with NYMEX making up about 10% of that amount because of the physical commodities that are traded on that exchange. 4. **Commodity Exchange, Inc. (COMEX)** 1. ****COMEX is the primary futures and options market for trading metals such as gold, silver, copper and aluminum. Formerly known as the Commodity Exchange Inc., COMEX merged with the New York Mercantile Exchange (NYMEX) in 1994 and became the division responsible for metals trading.

Answer 129

true In the world of futures contracts, the margin rate is much lower. In a typical futures contract, the margin rate varies between 5 and 15% of the total contract value. **For example** 1. the buyer of a contract of wheat futures might only have to post $1,700 in margin. 2. Assuming a total contract of $32,500 ($6.50 x 5,000 bushels) the futures margin would amount to around 5% of the contract value. 3. **Initial Futures Margin** is the amount of money that is required to open a buy or sell position on a futures contract. Initial margin is original margin, the amount posted when the original trade takes place.

Answer 130

initial deposit

Answer 131

spot rate As an **_example_** of how spot contract works, say it's the month of August and a wholesaler needs to make delivery of bananas, she will pay the spot price to the seller and have bananas delivered within 2 days. However, if the wholesaler needs the bananas to be available at its stores in late December, but believes the commodity will be more expensive during this winter period due to a higher demand and lower overall supply, she cannot make a spot purchase for this commodity since the risk of spoilage is high. Since the commodity wouldn't be needed until December, a forward contract is a better fit for the banana investment.

Answer 132

daily limit It is often used in the derivatives market, especially for option or futures contracts, to harness the excessive volatility that can ensue in one trading session. Daily trading limits are imposed by securities exchanges to protect investors from extreme price movements and discourage potential manipulation within the markets. Here’s a hypothetical example: suppose the daily trading limit for a particular commodity was $0.50 per bushel and the previous day’s settlement was $5.00. In this case, traders cannot sell for less than $4.50 or buy for more than $5.50 per bushel during the current session. If either of the daily trading limits were to be reached then this commodity would be deemed to be a 'locked' market. It would also be described as having gone 'limit up' or 'limit down' based on whether the upside or downside limit was reached.

Answer 133

open interest

Answer 134

futures price

Answer 135

maintenance margin Securities margin is the money you borrow as a partial down payment, up to 50% of the purchase price, to buy and own a stock, bond, or ETF. This practice is often referred to as buying on margin. Futures margin is the amount of money that you must deposit and keep on hand with your broker when you open a futures position. It is not a down payment and you do not own the underlying commodity. Futures margin generally represents a smaller percentage of the notional value of the contract, typically 3-12% per futures contract as opposed to up to 50% of the face value of securities purchased on margin. **_Initial margin_** is the amount of funds required by CME Clearing to initiate a futures position. While CME Clearing sets the margin amount, your broker may be required to collect additional funds for deposit. Maintenance margin is the minimum amount that must be maintained at any given time in your account. If the funds in your account drop below the maintenance margin level, a few things can happen: You may receive a margin call where you will be required to add more funds immediately to bring the account **back up to the initial margin level** (DIFFERENT THAN SECURITIES MARGIN). If you do not or can not meet the margin call, you may be able to reduce your position in accordance with the amount of funds remaining in your account. Your position may be liquidated automatically once it drops below the maintenance margin level.

Answer 136

to reduce risk associated with fluctuating commodity prices Most people would think that hedgers would initiate a hedge as soon as possible to make sure they don’t have any risk that prices could make a detrimental move before they have to buy or deliver a commodity. However, that is often far from the normal case. Some companies don’t hedge or they rarely hedge. **A good example of this is when the major airlines were caught sleeping when the price of oil climbed from $30 to nearly $150 a barrel**. Many airlines suffered huge losses and some went bankrupt due to the high fuel costs. If they had been hedging properly, a large portion of the losses could have been avoided. They still would have had to pay the higher fuel costs, but they would have made a substantial amount of profits on the futures positions. Most airlines are now very diligent about using a strict hedging program. Farmers, for example, sometimes don’t hedge until the last minute. Grain prices often move higher in the June - July timeframe on weather threats. During this time, farmers watch prices move higher and higher, often getting greedy. Sometimes they wait too long to lock in the high prices and prices tumble. In essence, these hedgers turn into speculators.

Answer 137

farmer is long in wheat, he could go short in a wheat futures contract If a company knows that it will be selling a certain item, it should take a short position in a futures contract to hedge its position. As an example, Company X must fulfill a contract in six months that requires it to sell 20,000 ounces of silver. Assume the spot price for silver is $12/ounce and the futures price is $11/ounce. Company X would short futures contracts on silver and close out the futures position in six months. In this case, the company has reduced its risk by ensuring that it will receive $11 for each ounce of silver it sells. If the price declines to $5, Company X will sell the silver for $5 but will recoup the difference

Answer 138

the farmer is locked into his $3.10 price so he will lose $0.90 per bushel

Answer 139

60% long term and 40% short term regardless of holding period Bob will recognize a $6000 capital gain on his 2015 tax return. This $6000 will be taxed on the 60/40 rate. Futures traders benefit from a more favorable tax treatment than equity traders under Section 1256 of the Internal Revenue Code (IRC). 1256 states that any futures contract traded on a US exchange, foreign currency contract, dealer equities option, dealer securities futures contract, or index futures contract are taxed long-term capital gains rates of 60 percent and short-term capital gains rates of 40 percent—**regardless of how long the trade was opened for**. Carry Back & Carry Forward 1. Should a futures trader wish to carry back any losses under Section 1256, they are allowed to do so for up to three years, under the condition that the losses being carried back do not exceed the net gains of that previous year, nor can it increase an operating loss from that year. 2. The loss is carried back to the earliest year first, and any remaining amounts are carried to the next two years. 3. As usual, the 60/40 rule applies. Conversely, if any unabsorbed losses still remain after the carry-back, these losses can be carried forward.

Answer 140

call option

Answer 141

covered call option

Answer 142

naked call option

Answer 143

put option

Answer 144

portfolio insurance

Answer 145

index option

Answer 146

equity option * A company issues a bond and attaches a warrant to the bond to make it more attractive to investors. If the issuer's stock increases in price above the warrant's stated price, the investor can redeem the warrant and buy the shares at the lower price. * **_For example_**, if the warrant has a strike price of $20 per share and the market price of the stock rises to $25 per share, the investor can redeem the warrant and buy the shares for $20 per share. * If the stock never rises above the strike price, the warrant expires, so it becomes worthless. There are complicated formulas for determining the value of warrants based on the strike price, the current market price, the time until expiration, and other factors.

Answer 147

exercise price

Answer 148

intrinsic value Intrinsic value is the value any given option would have if it were exercised today. Basically, the intrinsic value is the amount by which the strike price of an option is in the money. It is the portion of an option's price not lost due to the passage of time. The time value of options is the amount by which the price of an option exceeds the intrinsic value. It is directly related to how much time an option has until it expires, as well as the volatility of the stock. The formula for calculating the time value of an option is: Time Value = Option Price -- Intrinsic Value The actual derivation of the time value of an option is a fairly complex equation. As a general rule, an option will lose one-third of its value during the first half of its life and two-thirds during the second half of its life. This is an important concept for securities investors because the closer you get to expiration, the more of a move in the underlying security is needed to impact the price of the option. Time value is often referred to as extrinsic value.

Answer 149

intrinsic value

Answer 150

greater of the market price minus the exercise price or zero

Answer 151

greater of the exercise price minus the market price or zero For example, 1. let's say General Electric (GE) stock is selling at $34.80. 2. The GE 30 call option would have an intrinsic value of $4.80 ($34.80 – $30 = $4.80) because the option holder can exercise his option to buy GE shares at $30, then turn around and automatically sell them in the market for $34.80—a profit of $4.80. 3. the GE 35 call option would have an intrinsic value of zero ($34.80 – $35 = -$0.20) because the intrinsic value cannot be negative. In a different example, 1. Intrinsic value also works the same way for a put option. 2. For example, a GE 30 put option would have an intrinsic value of zero ($30 – $34.80 = -$4.80) because the intrinsic value cannot be negative. On the other hand, a GE 35 put option would have an intrinsic value of $0.20 ($35 – $34.80 = $0.20).

Answer 152

$5 (premium - intrinsic value)

Answer 153

$3 (premium - intrinsic value)

Answer 154

premium - intrinsic value For example, if Alphabet Inc. (GOOG) stock is priced at $1,044 per share and the Alphabet Inc. $950 call option is trading at $97, then the option has an intrinsic value of $94 ($1,044 - $950) and a time value of $3 ($97 - $94).

Answer 155

Options Clearing Corporation

Answer 156

open interest

Answer 157

american options An American option is a version of an options contract that allows holders to exercise the option rights at any time before and including the day of expiration. Another version or style of option execution is the European option that allows execution only on the day of expiration.

Answer 158

european options

Answer 159

when the exercise price is less than the market price

Answer 160

when the exercise price is greater than the market price

Answer 161

at the money

Answer 162

when the exercise price is greater than the market price

Answer 163

when the exercise price is less than the market price

Answer 164

exercise price minus the premium paid

Answer 165

the premium received

Answer 166

the premium received

Answer 167

the premium paid

Answer 168

the premium paid

Answer 169

unlimited (naked)

Answer 170

exercise price minus the premium received

Answer 171

binomial option pricing

Answer 172

binomial option pricing

Answer 173

black-scholes option valuation method

Answer 174

black-scholes option valuation method We'll discuss the limitations of the Black-Scholes model, which is one of the most popular models for options pricing. Some of the standard limitations of the Black-Scholes model are: 1. Assumes _constant values for risk-free rate of return_ and _volatility_ over the option duration—none of those may remain constant in the real world 2. Assumes continuous and costless trading—ignoring liquidity risk and brokerage charges 3. **Assumes stock prices to follow lognormal pattern, i.e., a random walk (or geometric Brownian motion pattern)—ignoring large price swings that are observed more frequently in the real world** 4. Assumes no dividend payout—ignoring its impact on the change in valuations 5. Assumes no early exercise (i.e., fits only European options)—the model is unsuitable for American options 6. Other assumptions, which are operational issues, include assuming no penalty or margin requirements for short sales, no arbitrage opportunities and no taxes—in reality, all these do not hold true; either additional capital is needed or realistic profit potential is decreased

Answer 175

zero cost collar

Answer 176

zero cost collar A zero cost collar is a form of options collar strategy to protect a trader's losses by purchasing call and put options that cancel each other out. The downside of this strategy is that profits are capped, if the underlying asset's price increases. A zero cost collar strategy involves the outlay of money on one half of the strategy offsetting the cost incurred by the other half. It is a protective options strategy that is implemented after a long position in a stock that has experienced substantial gains. The investor buys a protective put and sells a covered call. Other names for this strategy include zero cost options, equity risk reversals, and hedge wrappers.

Answer 177

a long stock position a long put position a short call option To better understand all of this information, let’s look at an example of a zero cost collar. * Assume an investor owns 100 shares of stock XYZ that he bought at a price of $90. Currently, the stock is trading at $85. To protect against further downside risk, the investor sets up a zero cost collar by purchasing a put option with a strike price of $83 and selling a call option with a strike price of $92. * Assume the call options were sold at a premium price of $2 per share. Assume the put options were bought at a premium price of $2 per share. Therefore, the investor enters the trade with zero costs. * If the stock expires at $92 or above, then the investor will achieve the **_maximum profit of $200_**, or 100 shares x (92 – 90). * If the stock expires at $83 or below, then the investor will experience his **_maximum loss of $700_**, 100 shares per contract x (90 – 83). * From this example, an investor can see how a protective position can be established at zero cost. This is an effective strategy to use when an investor wants to protect his stock position from further downside risk.

Answer 178

max profit = $30 - $29 max loss = $29 - $27.50 +0 = $1.50 breakeven = $29 + $0 = $29

Answer 179

LEAPS long term equity anticipation securities Premiums are a nonrefundable cost to trade in the options market. The premiums for LEAPS are higher than those for standard options in the same stock. The further out expiration date gives the underlying asset more time to make a substantial move and for the investor to make a healthy profit. Known as the time value option marketplaces use this lengthy timeframe and the intrinsic value of the contract to determine the value of the option. As mentioned earlier, the option contract has a basis of 100 shares of the asset. So, if the premium for Facebook (FB) is $6.25 the option buyer will pay $625 total premium ($6.25 x 100 = $625).

Answer 180

warrants A major difference between stock warrants and stock options is how they originate. Stock options are listed on exchanges, whereas stock warrants are issued by the company itself. When a stock warrant is exercised, the shares of the stock are received not from another investor, but from the company itself. Stock warrants exist for long terms that can last up to 15 years. Stock options usually exist for a month, with some lasting at most two to three years.

Answer 181

profit = (gain on stock - cost of warrant) x # of shares profit= ($4 - $1) x 50 =$150

Answer 182

true Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends.

Answer 183

general partner

Answer 184

general partner

Answer 185

limited partner

Answer 186

above (Well above) Warrants are a derivative that give the right, but not the obligation, to buy or sell a security—most commonly an equity—at a certain price before expiration. The price at which the underlying security can be bought or sold is referred to as the exercise price or strike price. An American warrant can be exercised at any time on or before the expiration date, while European warrants can only be exercised on the expiration date. Warrants that give the right to buy a security are known as call warrants; those that give the right to sell a security are known as put warrants.

Answer 187

Real Estate Investment Trust (REIT)

Answer 188

equity trusts

Answer 189

mortgage trusts

Answer 190

hybrid trusts

Answer 191

real estate mortgage investment conduits (REMICs) 1. A real estate mortgage investment conduit (REMIC) is a special purpose vehicle that is used to pool mortgage loans and issue mortgage-backed securities (MBS). Real estate mortgage investment conduits hold commercial and residential mortgages in trust and issue interests in these mortgages to investors. 2. Fannie Mae and Freddie Mac are some of the more prominent issuers of REMICS

Answer 192

venture capitalists

Answer 193

seed financing

Answer 194

start-up financing

Answer 195

first-stage financing

Answer 196

second-stage financing

Answer 197

third-stage financing

Answer 198

mezzanine or bridge financing

Answer 199

separately managed accounts

Answer 200

with a separately managed account the money manager is purchasing securities for the investor not the fund