Chapter 9/10/11 Flashcards

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1
Q

Exchange-traded-funds (ETFs)

A

ETFs issue shares that represent an interest in an underlying basket of securities which typically mirrors a specific index. Purchasers of ETFs do not pay sale charges but instead pay commission fees.

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2
Q

Difference between ETFs and mutual funds

A

ETFs trade on exchanges and are close-ended funds unlike mutual funds. Additionally, ETFs often have lower expenses than mutual funds and their shares may both be sold short and purchased on margin.

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3
Q

Inverse ETF

A

Designed to perform in a manner that’s the inverse of the index being tracked by short selling the investments within the fund. W/ an inverse ETF, for example, if the S&P falls 1.5% the inverse ETF should rise 1.5%.

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4
Q

Exchange-traded notes (ETNs)

A

A type of unsecured debt security that pays a return which is linked to an underlying market index or other benchmark. ETNs trade on exchanges and are available in both inverse and leveraged varieties. ETNs DO NOT MAKE INTEREST PAYMENTS. Instead, ETNs pay the holder an amount which is based on the performance of an underlying index or benchmark. The maturities of ETNs can range from 10 to 30 years. ETNs are issued by a financial intermediary and backed by their full faith and credit. The costs associated w/ ETNs are reocurring costs, including daily investor fees, and brokerage commissions involved w/ buying or selling ETNs.

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5
Q

Indicative value

A

The reference value of the benchmark minus the daily investor fee of an ETN.

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6
Q

Hedge funds

A

Not an investment company. Private investment pools not required to register w/ the SEC. Buyers of the fund are typically institutional or high net worth. Since hedge funds only deal w/ these types of investors, there relatively unregulated. Due to these exemptions, hedge funds may use strategies that are prohibited for more heavily regulated investment entities. Hedge funds are not required to disclose specific information regarding their holdings. Hedge funds often restrict their investors from redeeming for certain periods of time meaning there is little liquidity.

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7
Q

PE funds

A

PE and VC funds raise capital by offering investors limited partnership units that are sold as private placement.

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8
Q

REITs

A

Not an investment company. REITs are securities and require that prospectuses are sent to any investors who purchase shares that are offered to the public in the primary market. REITs create a portfolio of real estate investments from which investors may earn profits.

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9
Q

3 types of REITs:

A
  1. Mortgage REITs: borrow funds from investors and then invest the funds in mortgages and typically earn income based on the difference between these two rates of interest
  2. Equity REITs: own and operate income-producing real estate, such as apartment buildings, commercial property, shopping malls, vacation resorts, and other retail properties. Income is generated from rent.
  3. Hybrid REITs
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10
Q

3 varieties of REITs

A
  1. Sold as private placement and not registered w/ SEC.
  2. Registered w/ SEC and exchange-listed.
  3. Registered w/ SEC and not exchange-listed.
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11
Q

True or false: Dividends from REITs are taxed as ordinary income?

A

True, to avoid double taxation of dividends that are distributed to investors, a REIT must distribute a minimum of 90% of the income it generates from its portfolio

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12
Q

Direct participation programs (DPPs)

A

A type of investment in which the results of the business venture (cash flow, profits, and losses) directly flow through to the investors. Most DPPs are limited partnerships.

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13
Q

Limited partnerships

A

A type of DPP. A limited partnership requires a minimum of two partners—one general partner and at least one limited partner. The general partner (GP) is responsible for managing the program and must contribute at least 1% of the program’s capital. The limited partner (LP) is a passive investor who has no control over managerial decisions.

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14
Q

Advantages of limited partnerships

A
  • No double taxation. All income is taxed on a personal level as ordinary income.
  • Limited partners are only liable for their investment.
  • Typically diversification of assets.
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15
Q

Disadvantages of limited partnerships

A
  • Lack of control for limited partners.
  • Iliquidity.
  • Tax issues: can complicate individual tax filings.
  • Positive capital call: investors in limited partnerships may be asked to contribute additional funds after their initial investment. Failure to make the additional contribution could result in the investors forfeiting their interest in a project.
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16
Q

DPP offering practices

A

To raise money, the general partner (also referred to as the program’s sponsor) may conduct either a public or private securities offering. In a public offering, the general partner will hire an underwriter to market the program to the public and will register the DPP’s interests with the SEC. An offering prospectus is provided to potential investors.

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17
Q

Tax treatment of individual partners in a DPP

A

Losses that are generated by passive activities may only be deducted against income from passive activities. If passive losses exceed passive income, the excess passive losses may be carried forward indefinitely to offset passive income in future years.

As an added benefit, when the ownership interest in a passive activity is sold, the investor can deduct all passive losses that are carried forward against any form of income—passive or non-passive.

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18
Q

How do limited partnerships invest in oil & gas?

A

Exploratory drilling, a.k.a. wildcatting, involves searching for oil and gas in unproven areas. Due to the uncertainty of success, these programs are considered high-risk ventures.

Development program: leases are acquired for the right to drill in proven areas. Lower risk. The lower risk is based on the belief that a productive exploratory well could be surrounded by equally productive drilling locations.

Balanced program: A combo of exploratory drilling and development programs.

Income program: Acquires interests in already producing wells.

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19
Q

What is an option?

A

A derivative security that gets its value from the value of underlying securities such as stocks, indexes, and ETFs.

An option is a contract between a buyer/owner/holder who is also considered the long. The buyer pays the option’s premium and gains the right to exercise the option. On the other hand, there’s the writer/seller of the option, who is considered the short. The seller receives the option’s premium and assumes an obligation if the contract is exercised in the future.

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20
Q

Call options

A

The buyer pays a premium and gains the right to call the underlying instrument at a set strike price. If the buyer doesn’t exercise, the premium paid represents the maximum loss. The seller receives the premium but must sell the instrument at the strike price if it’s called.

Ex: If there’s a cal option on a stock, the buyer of the call option is bullish and wants the stock to go up because they could still buy it at the strike price but the value would be greater. The seller would want to see it go down.

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21
Q

Put options

A

The buyer pays a premium and gains the right to sell an instrument at the strike price.

Ex: If you enter into a put option on a stock as the buyer, you are bearish and expecting the stock to go down so you can sell it for more than its worth in the future.

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22
Q

True or false: All options have expiration dates?

A

True, if an option has not been exercised or liquidated prior to its expiration, it expires.

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23
Q

What makes up the option premium?

A

The intrinsic value and time value. Intrinsic value is the amount by which an option is in-the-money, while time value is the portion of an option’s premium that exceeds its intrinsic value.

* An option will only have intrinsic value if it’s in the money.

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24
Q

How to determine intrinsic value of an option (if an option is in-the-money or out-the-money)

A

The relationship between the strike price of an option and the current market price of the underlying security determines whether an option is in-the-money or out-the-money. Calls are in-the-money if the market price > strike price. Puts are in-the-money if market price < strike price.

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25
Q

How to determine time value?

A

How to determine time value for an option that is in-the-money: Take current market price - strike price and the difference between this value and the premium is the time value.

How to determine time value for an option that is out-the-money: There is no intrinsic value for an option that is out-the-money, so any premium is comprised solely of time value.

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26
Q

Breakeven point of an option

A

For buyers of options, breakeven represents the amount they need the underlying stock to move in their favor to recapture the premium paid. For sellers of options, breakeven represents the amount they can afford the underlying stock to move against them because they received the premium.

Remember the phrase: Call UP and Put DOWN - for calls its strike price up (plus) the premium. for puts its stike price down (minus) the premium.

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27
Q

Liquidating an option

A

An alternative to exercising an option. To liquidate an option, an investor (either the buyer or seller) executes an opposite transaction on the same option contract. The buyer of an option creates the position with an opening purchase and could subsequently liquidate the position through a closing sale. The seller of an option creates the position with an opening sale and could subsequently liquidate the position through a closing purchase.

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28
Q

Two styles of exercising an option:

A
  1. American style exercise: Options may be exercised at any time up to the day on which they expire.
  2. European style exercise: Options may only be exercised at a specified point in time, usually on the day of expiration.

  • All equity options use American style.
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29
Q

What is the process of exercising an option?

A
  1. Notify the broker-dealer
  2. The broker-dealer will notify the options clearing corporation (OCC)
  3. The OCC will randomly issue the exercise notice to a broker-dealer whose account shows a short option position that’s identical to the long option position being exercised.
  4. The broker-dealer that receives the exercise notice, must select a client to whom the notice will be assigned. There are three methods by which this assignment may be accomplished—(1) using random selection, (2) using first-in, first-out (FIFO), or (3) using any other method that’s deemed to be fair and equitable.
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30
Q

True or false: W/ options, the third friday of the expiration month is the final day to exercise and a brokerage must be notified by 5:30pmEST?

A

True, additionally, at 4pmEST on that Friday options stop trading.

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31
Q

Options disclosure document/Characteristics and Risks of Standardized Options

A

A brochure created by the OCC that offers investors with a description of the options market and info about options.

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32
Q

Index options

A

a financial derivative that gives the holder the right (but not the obligation) to buy or sell the value of an underlying index. When settled, the buyer recieves cash.

W/ an equity option, the buyer would receive the underlying stock.

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33
Q

Long hedge

A

If an investor is long stock and fears that the stock will decline, buying a put on the stock creates a long hedge

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34
Q

Short hedge

A

If an investor is short stock and fears that the stock will rise, buying a call on the stock creates a short hedge.

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35
Q

Covered vs uncovered options

A

Covered options: Essentially just means that the seller owns the stock and is obligated to sell if the buyer exercises. The seller anticipates that the stock will drop so that the seller will receive the premium on the option and the dividend from the stock.

Uncovered options: If an invester writes an option and doesn’t own the stock. An uncovered call writer has an unlimited maximum potential loss since there’s no limit as to how high the price of the security may rise.

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36
Q

```

~~~

Covered put

A

The seller of a put is obligated to buy the underlying stock if the buyer of the put exercised the contract. Therefore, for the put to be covered, the seller must either be short the underlying stock or deposit cash equal to the strike price. If an investor sells an XYZ put and doesn’t deposit sufficient cash, the position is considered an uncovered put.

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37
Q

Which option position has the potential for an unlimited gain?

A

Long call

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38
Q

Pros and cons of public offerings

A

Pros: Unlimited # of potential investors

Cons: Regulatory costs

39
Q

Private placements

A

An alternative to public offerings. This is where institutional investors provide capital to firms.

40
Q

Pros and cons of private placements

A

Pros: faster and less costly than a public offering.

Cons: Limited # of potential investors

41
Q

Follow-on offering

A

A stock offering after an IPO. This is still considered a primary distribution.

42
Q

Primary distribution

A

An offering in which the proceeds of the deal are paid to the issuer.

43
Q

Combined offering/split offering

A

An offering where some of the shares are issued by the firm (primary offering) while some are sold by existing shareholders (secondary offering).

44
Q

Firm-commitment underwriting

A

When an underwriter/syndicate of underwriters agrees to purchase the entire offering from the issuer and absorb any securities that remain unsold

45
Q

Best-efforts underwriting

A

The syndicate agrees to sell as much of the new offering as they’re able. Best-efforts underwriters are acting in the capacity of an agent by finding purchasers for the issuer, rather than as a principal for their own accounts. Any unsold portion of the offering is returned to the issuer.

  • Oftentimes in this type of arrangement, the underwriters have minimum amounts for the offerings
46
Q

Best-efforts-all-or-none underwriting

A

the underwriters act as agents for the issuer and attempt to sell as much of the offering as possible. However, if the entire offering is not sold, all sales that were made must be cancelled and the money must be returned to the subscribers.

47
Q

Mini-max underwriting

A

With this form, there’s a minimum threshold of sales that must be met for the offering to avoid being cancelled. However, once that minimum is met, additional sales may be made up to a specified maximum amount.

48
Q

Standby offering

A

A syndicate agrees to buy any shares not purchased by existing stockholders in a rights offering.

49
Q

Market-out clause

A

A clause that allows the syndicate to cancel the agreement. The justification for cancelling the commitment is based on certain events occurring that make marketing the issue difficult or impossible.

50
Q

Shelf registration

A

A filing with the SEC to register a public offering, usually where there is no present intention to immediately sell all the securities being registered. This allows firms to sell additional securities on either a delayed or continuous basis. Securities may be sold three years after the initial registration.

Advantages of shelf registration: the issuer can complete all the necessary paperwork in advance and be prepared to market the shares to the public when conditions are the most favorable.

51
Q

Syndicate letter/agreement among underwriters

A

A written agreement between the lead underwriter and syndicate members that specifies each firm’s rights and obligations.

  • This also happens in a competitive sale for munis
52
Q

Selling group members

A

When outside broker dealers assist a syndicate in a distribution of securities. Selling group members DO NOT ASSUME LIABILITY. Any shares that are not sold by the selling group are retained by the syndicate since the syndicate members remain financially liable for any unsold shares.

53
Q

Distribution participants

A

The term for the underwriters and selling group

54
Q

True or false: In a secondary offering, underwriters typically price the issue at a small discount to the current market price?

A

True

55
Q

Underwriting spread

A

The syndicate’s gross profit. It’s the difference between the amount paid by the investing public and the amount received by the issuing corporation. The spread consists of the manager’s fee (lead underwriter), the member’s/underwriter’s fee, and the concession (the portion that is paid to the underwriter issuing/selling the shares).

56
Q

Total takedown

A

the amount that’s paid to a syndicate member when it sells shares of the offering. It’s the underwriter’s fee plus the concession

57
Q

Syndicate compensation example:

A

Firm A is issuing stock to the public at $10 per share, with a total spread of $.80 per share. Of the $.80 spread per share, $.10 is allocated to the manager, $.20 is allocated to the firm that assumes liability for the shares, and $.50 is allocated to each underwriter that sells the shares. That leaves $9.20 for firm A.

58
Q

FINRA rules for member firms accpeting compensation from issuing firms:

A

A member firm MAY NOT receive compensation from an issuer for:
* Publishing a quote
* Acting as a market maker
* Submitting an application in connection with market-making activity

59
Q

Registration statement

A

a public document that issuers file with the SEC in effort to prevent fraud in the sale of new issues. Shoudld contain info about the business, owners, and financial condition.

60
Q

Security issue registration process:

A
  1. Pre-registration period: Prepare the registration statement. Underwriters CANNOT discuss w/ customers yet. Issuer files w/ the SEC. The date this period ends is called the filing date.
  2. Cooling-off period: This is a 20 day waiting period. SEC reviews the registration statement. Propsectus is created. Blue-Sky laws apply. The date this period ends is called the effective date.
  3. Post-registration period: Underwriters can contact buyers and deliver the red herring and final prospectus is delivered. Underwritters cannot accept payment or sell the issuer during this period.
61
Q

True or false: The SEC guarentess that info within the registration statement is true?

A

False

62
Q

Deficiency letter

A

A letter that’s issued after the pre-registration period if the SEC believes the registration statement is incomplete or misleading.

63
Q

Red herring

A

A condensed form of the registration statement delivered to customers. Does not contain the final price per share but instead lists a range of prices.

64
Q

3 methods of state securities registration:

A
  1. Notification/filing: This method is not allowed in all states. Simply an application.
  2. Coordination: This form is completed simultaneously with a federal registration.
  3. Qualification: This method involves meeting the specific requirements of one state and becomes effective at the discretion of the state Administrator.
65
Q

Post-effective period

A

The period where the POP is set and underwriters can sell the issue. Purchasers must be provided w/ a final prospectus.

66
Q

True or false: delivering a prospectus is typically the inital requirement in a securities offering?

A

True

67
Q

After-market prospectus delivery

A

Unlisted IPO = 90 days
Unlisted follow-on= 45 days
IPO listed on NYSE or NASDAQ = 25 days
Follow-on listed on NYSE or NASDAQ = no requirement

68
Q

Types of prospectuses

A

A prospectus is any kind of notice that offers a security for sale.
1. Statutory prospectus: a condensed form of the registration statement
2. Preliminary prospectus/red herring
3. Mutual fund summary prospectus: often only 3-4 pages
4. Free writing prospectus: any communication that doesn’t meet the standards of a statutory prospectus.

69
Q

True or false: A private placement requires a prosepctus and registration statement?

A

False, the issuer provides the potential buyer w/ an offering memorandum or private placement memorandum

70
Q

Securities exempt from SEC registration

A
  • Treasury & Agency securities
  • Munis
  • Commercial paper
  • Securities issued by domestic banks and trust companies
  • Securities issed by small business investment firms

  • These securities still remain subject to anti-fraud provisions.
71
Q

Reg D

A

Says that a security can be exempt from registration if the issuer believes the buyer is a sophisticated investor, the buyer has access to the same info in a prospectus, the potential investor doesn’t plan to make a quick sale, and the securities are sold to no more than 35 non-accredited investors.

For private placements there’s no limit on the # of accredited investors

72
Q

Accredited investor

A
  • Financial institution
  • Directors, executive officers, or general partners of the issuer
  • Individuals who have a net worth of at least $1MM (not including primary residence) OR have gross income of at least $200,000 (or $300,000 combined with a spouse) for each of the past two years with the anticipation that this level of income will continue
73
Q

Restrictive legend

A

Shares that are acquired through a private placement carry a restrictive legend that’s printed across the face of the certificate. The legend indicates that the securities have not been registered with the SEC and are not eligible for resale unless the legend is removed. In many cases, the removal of the legend is accomplished under SEC Rule 144.

74
Q

Rule 144

A

Regulated the sale of restricted (i.e. unregistered) stock or control stock (restricted stock that is acquired by a control person in the secondary market). Under Rule 144, an investor who intends to sell either restricted or control stock must notify the SEC. If the securities are not sold within 90 days of the date that the notice was filed with the SEC, an amended notice must be filed. However, SEC notification is not required if the amount of the sale doesn’t exceed 5,000 shares or the dollar amount doesn’t exceed $50,000.

Rule 144 imposes certain holding periods on investors. For restricted stock, the purchaser must hold the stock for a specific period before he may dispose of it. If the issuer is a reporting company, the holding period is six months; however, if the issuer is a non-reporting company, the holding period is one year. For control stock, there’s no mandatory holding period.

75
Q

Rule 144 Volume limitation

A

Rule 144 sets a limitation on the amount of stock that an affiliate may sell over any 90-day filing period. For NYSE- and Nasdaq-listed stock, the maax that may be sold is the > of 1% of the total shares outstanding or the stock’s average weekly trading volume of the past four weeks. For restricted (private placement) stock, there’s no volume restriction for non-affiliates of the issuer. Non-affiliates are persons who are not associated with the issuer. However, volume restrictions continue to apply to insiders and affiliates.

76
Q

Private investment in PE (PIPE)

A

the buying of shares of publicly traded stock at a price below the current MV per share. Often PIPE investors hold the restricted securities for a short period and, upon registration, will then quickly resell them in the public marketplace.

77
Q

Rule 144A

A

Permits sales of restricted securities to sophisticated investors without being subject to the conditions that are imposed by Rule 144. The securities being offered under Rule 144A may be equity or debt securities and they may be offered by either a domestic or foreign issuer. After the issuance, the securities may be immediately resold to qualified institutional buyers.

78
Q

Rule 145

A

Under Rule 145 of the Securities Act of 1933, certain types of securities reclassifications are considered to be sales and are subject to the registration and prospectus requirements of the Act. This includes:
* An issuer that substitutes one security for another
* A merger or consolidation in which the securities of one corporation are exchanged for the securities of another corporation
* A transfer of assets from one corporation to another

Stock splits, reverse stock splits, & changes in par are not subject

79
Q

Rule 147

A

Mandates that securities sold within a state do not have to be registered w/ the SEC. This rule has 4 conditions:
1. At least 80% of its consolidated gross revenues from the firm selling securities is produced within the state.
2. At least 80% of its consolidated assets are located within the state or territory at the end of its most recent semi-annual fiscal period
3. At least 80% of the net proceeds from the offering are intended to be used by the issuer
4. A majority of the issuer’s employees are based in the state or territory

  • There are 2 provisions that state the issuer must make a best faith effort to identify the purchaser’s primary residence and that the securities under Rule 147 cannot be resold outside of the state for 6 months after the sale.
80
Q

True or false: A federal registration exemption is available for securities that are sold within the borders of one state, provided the instruments of interstate commerce are not used to sell the securities?

A

True

81
Q

True or false: The leader underwriter (manager) of a syndicate typically makes the largest underwriting commitment?

A

True

82
Q

Notice of sale

A

When an issuer intends to sell bonds through a competitive sale, it will advertise through a Notice of Sale. This contains essential info.

83
Q

Legal opinion

A

Written by a recognized bond counsel that’s hired by the issuer to attest to the validity and tax-exempt status of the bond issue. Essentially, the legal opinion assures investors that the issuer has the legal right to issue the bonds. Every muni issue MUST have a legal opinion.

84
Q

Official statement

A

The primary client disclosure document that’s used in competitive AND negotiated municipal offerings. It’s essentially a prospectus but since it’s for munis the official statement is not required to be filed w/ the SEC. Contains detailed information about both the issuer and the offering/

Not considered advertising

85
Q

Rule G-32 - Electronic Municipal Market Access (EMMA)

A

The rule requires that disclosure documents be filed with the MSRB and provided to customers. EMMA is the data pool where issuers file documentation. EMMA is free for the public to use.

86
Q

True or false: Each customer who purchases a new issuance of municipal bonds must be provided with a final confirmation and a copy of the official statement by no later than the settlement date?

A

True

87
Q

The final prospectus for new issues of common stock must be delivered to the client by no later than when?

A

The confirmatino of the sale

88
Q

What does it mean when a registration statement becomes effective?

A

The SEC allows the securities to be sold.

89
Q

An individual owns more than 10% of a company’s outstanding shares. What rule determines the amount of this stock that the individual is able to sell at any given time?

A

Rule 144

90
Q

Example:
An annuitant has been receiving payments from a variable annuity for six years and, at the time of his death, his beneficiary receives a lump-sum payment. The annuity payout option is:

A

Unit refund life annuity

91
Q

Example:

A customer purchases 10 M Dade Co. Florida 7.50% G.O. bonds at a 9.50 basis. How much interest will she collect each year?

A

10M = $10,000 par value
$10,000 * 0.075 = $750

92
Q

What is the best hedge for a long stock option?

A

Buying a put option

93
Q

True or false: If YTM < coupon rate, the bond is selling at a discount?

A

False, a premium

94
Q

True or false: If an investor’s initial margin purchase is less than $4,000 of stock, his initial deposit requirement is $2,000, rather than 50%.

A

True, if initial purchase > $4,000. the initial deposit requirement= 50%