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Series 65 > Chapter Two: Equity Securities > Flashcards

Chapter Two: Equity Securities Flashcards

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1
Q

Fundamentally, what is the securities industry all about?

A

It is two sides of the same coin, raising money and investing money

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2
Q

How can a company raise money?

A
  1. Equity Financing - sell stocks/shares (sell partial ownership)
  2. Debt Financing - Issue Debt Securities (bonds & notes)
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3
Q

What is Equity and Debt Financing?

A

Equity Financing is raising money by selling stocks and shares, what is left after debt, or ownership

Debt financing is raising money by issuing Debt Securities (bonds, notes)

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4
Q

Difference between a Treasury Bond & Municipal Bond?

A

Treasury Bond is Federal
Municipal Bond is City or County

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5
Q

Common Stock ; Pros and Cons

A
  1. Limited Liability - Can only lose what you put in
  2. Unlimited Potential Gain
  3. Lowest in Liquidation Priority
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6
Q

What are the 8 rights of common stock holders?

A
  1. Right to Inspect Records
    -Financial records and minutes of a
    shareholder meeting)
  2. Right to Vote on Relevant Matters
    • They can vote to elect the corporate board
      of directors and to approve corporate
      resolutions, such as mergers and acquisitions
      & changes of business direction. -
      -Shareholders are allowed one vote per share.
  3. Right to Receive Dividends
    • Payment of a portion of a company’s
      earnings to its shareholders (Quarterly)
  4. Right to a Residual Claim During Liquidation
  5. Right of Limited Liability
  6. Transfer Rights
  7. Preemptive Rights
  8. Right to Sue for Wrongful Acts
    • Imposing corrective changes in governance rather than by obtaining monetary damages
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7
Q

Dividends:
The date of the announcement is called the ________ date. The date of payment is called the _______ date. The date by which an investor must own the stock (that is, the investor must be the owner of record) to receive the dividend is called the _____ date.

A

Declaration, Payable, Record

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8
Q

What is the order of the Dividend dates?

A

DERP
Declaration Day
Ex-date Day
Record Day
Payable Day

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9
Q

Sharon is going to purchase 100 shares of AAPL. If the record date is on Tuesday, July 15, when must she purchase the shares by to receive the dividend?

A

Friday, July 11. Friday, July 11 is two business days before the record date. The ex-date is Monday, July 14. On or after the ex-date, she would no longer receive the dividend.

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10
Q

Jon uses cash to purchase 100 shares of MSFT on Thursday, July 3. The board of directors has declared a dividend. The record date is Monday, July 7. Will Jon receive the dividend?

A

No. Jon’s stock purchase will settle on July 8, which is one day past the record date. Remember to exclude July 4, which is a national holiday. Actually, Jon purchased the stock on the ex-date, July 3, so he does not receive the dividend. He would have had to purchase the stock by July 2 to have received the dividend.

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11
Q

Hot Box Lunches Corporation carries out a 1-for-5 split. Sheila has 1,000 shares. Before the split, each share was trading for $20 per share. How many shares does Sheila have after the split, and at what price will they trade?
A. 200 shares at $100 each
B. 5,000 shares at $4 each
C. 200 shares at $20 each
D. 5,000 shares at $20 each

A

Answer: A. A 1-for-5 split is called a reverse split, because each investor will receive one share for every five shares. After the split, Sheila will have 200 shares (1,000 / 5 = 200) at $100 each ($20 × 5 = $100). The value of her investment will stay the same at $20,000.

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12
Q

What is a Preemptive Right?

A

Anti-dilution protection ; If a corporation decides to issue additional common stock, current stockholders may have the right to maintain their share of ownership by purchasing a proportionate amount of the new issue before it is offered to the public.

This rights offering further entitles stockholders to buy these proportionate shares at a discount from the offering price.

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13
Q

What is a Derivative suit?

A

A lawsuit brought by a shareholder individually - or as a class action suit; mismanagement and fraud usually

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14
Q

Does Par Value matter for Common Stock

A

For common stock, the par value has little to no significance ; set arbitrarily and has no relation to market value

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15
Q

The Transfer Agent & Registar

A

Usually a Bank or Trust Company

Transfer Agent
-Transfers shares from one owner to another
-Loses a certificate? Will re-issue

Registar
-Records ownership
-Keeps track of # of shares

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16
Q

If an investor wants to be eligible for a dividend previously declared with a record date of Friday, June 13, by what date should she purchase the common stock, and what is the ex-dividend date?
A. Purchase by Monday, June 9; ex-date Tuesday, June 10
B. Purchase by Wednesday, June 11; ex-date Thursday, June 12
C. Purchase by Tuesday, June 10; ex-date Tuesday, June 10
D. Purchase by Tuesday, June 10; ex-date Wednesday, June 11

A

B. The record date is Friday, June 13. Count back one business day for the ex-date, Thursday, June 12. The purchase date is the day before the ex-date, Wednesday, June 11.

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17
Q

Preferred Stock; market fluctuates on what? Is it more or less risky than common stock? More or less riskier than a debt equity?

A
  1. Preferred Stock is a fixed payment
  2. The Preferred Stock market price fluctuates on interest and creditworthiness, not earnings and losses
  3. Preferred Stock is less risky than common stock, but less growth potential
  4. Riskier than debt bc can miss dividend payments without default
  5. NO VOTING RIGHTS
  6. Par Value for preferred stock = $100
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18
Q

What is the difference between a Preferred Stock and a floating-rate, or adjustable-rate, preferred stock?

A

The rate is reset quarterly, making the prices of adjustable-rate preferred stock less sensitive to interest rate changes

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19
Q

How do you calculate the annual dividend of a preferred stock?

A

The annual dividend =
par value x dividend rate

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20
Q

XYZ issues preferred stock with a 10% annual dividend. The par value on the preferred stock is $100 per share. The share price of the preferred stock is $110, and the share price of the common stock is $200. What is the quarterly per-share dividend on the preferred stock?

A

Answer: $2.50. The annual dividend would be par value times dividend rate ($100 × 0.10 = $10.00). The quarterly per-share dividend will be $2.50. The price of neither the preferred nor the common stock is relevant to calculating the dividend.

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21
Q

_____ represents the claim of the preferred shareholder against the value of the firm during liquidation. This means that if the company goes bankrupt, the ______ is the amount of money that the preferred shareholder can claim.

A

Par value

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22
Q

As with bonds, the market price of preferred stock generally ___ when interest rates fall, and ___ when interest rates rise.

A

rises, falls

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23
Q

What are the 4 classes of preferred stock?

A

Cumulative, participating, convertible, and callable preferred stock.

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24
Q

What is Cumulative Preferred Stock?

A

Allows dividends to accumulate
If a corp missed a dividend, it has to pay it next time before it pays common stock holders

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25
Q

Ruby Red Jewelry has issued both common stock and cumulative preferred stock. The cumulative preferred stock pays an 8% annual dividend on stock with a $100 par value. Ruby Red Jewelry has not paid a common or preferred dividend for two quarters. It has committed to pay a $2 per share dividend to its common stockholders. How much will it be required to pay its preferred shareholders per share?

A. $0
B. $2
C. $5
D. $6

A

Answer: D. Before Ruby Red Jewelry can pay its common stockholders a dividend, it must pay its cumulative preferred shareholders their dividend and all missed dividends. Ruby Red must pay $2 per share for each quarterly dividend (8% / 4 quarters × $100 = $2). It must pay two missed dividends and the current dividend, for a total of $6.

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26
Q

Participating Preferred Stock

A

Very rare! Allows extra dividends when company outperforms financial goals, also a greater claim in liquidation chain than simply non-participating preferred stock.

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27
Q

Convertible Preferred Stock

A

Can convert their preferred stock to common stock at a set ratio anytime.

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28
Q

Parity Value Equations; conversion ratio and parity value

A

Conversion Ratio: Face Value / Conversion
Parity Value: current market price of common stock x Ratio

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29
Q

A $100 convertible preferred stock certificate is issued in March 2017. The stock pays 4% in dividends and is convertible at $20. The price of the company’s common stock at issue was $10.27 per share. On the conversion date of March 15, 2018, the common stock is at $13.10 per share. What is the conversion parity price for the preferred share, if the shareholder converts on the conversion date?

A. $51.35
B. $20.00
C. $65.50
D. $100.00

A

Answer: C. The convertible price tells the shareholder how many shares of common stock she will get for one share of convertible preferred stock. To find the number of shares, divide the convertible price into the face value of the preferred stock. In this example, it is $100 / $20 = 5. Thus, the conversion ratio is 5; the shareholder will receive 5 shares of common stock upon conversion. The conversion parity price is the current market value of the preferred share if converted. It is calculated by multiplying the current market price by the conversion ratio ($13.10 × 5 = $65.50). If the convertible is trading at lower than $65.50, the investor will want to convert her shares. If the convertible preferred is trading at higher than $65.50, the investor will want to hang on to her shares.

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30
Q

Callable Preferred Stock

A

Issuer can call back stock

An issuer will usually choose to call in the stock if interest rates drop and the issuer can issue new preferred stock at a lower rate.

Callable preferred stock tends to pay higher dividends than non-callable stock to compensate

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31
Q

What is a Warrant?

A

an equity security that offers the owner the right to buy shares in the company at a set price (strike price) in the future

costs more than market price

usually thrown in as a sweetener in bond and preferred stock offering to make it more appealing

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32
Q

What is a Subscription Right and Subscription Price?

A

It’s similar to a warrant, but has a shorter life (few weeks)

Used when an exercising of the preemptive right occurs, during the rights offering, subscription right is offered to combat the shareholder dilution. The reduced price is called the subscription price.

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33
Q

What is the difference between a stock appreciation right and an employee stock option?

A

With stock appreciation rights, the employee receives the difference between the grant price and the market price without having to shell out any money.

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34
Q

American Depository Receipts (ADRs)

A

ADRs are receipts issued by a U.S. bank that represent shares of a foreign stock.

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35
Q

Global Depository Receipts (GDRs)

A

depository receipts are like ADRs, but they are created and sold in countries other than the United States.

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36
Q

Debt Securities: To be considered investment grade, a corporate bond must be rated ____ by S&P and Fitch, or ____ by Moody’s.

A

BBB- , Baa3

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37
Q

What is a bond below investment rate called?

A

high-yield bond, junk bond, speculative bond

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38
Q

What factors does a credit rating agency look at to determine a company’s credit rating?

A
  1. History and Corporate Philosophy
  2. Management Structure and
    Governance
  3. Financial Position, Debt Structure
    and Sources of Liquidity
  4. Economic, Political and Regulatory
    Environment
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39
Q

What is a bond indenture / trust indenture?

A

A form that has to be filed with the SEC when a bond is being issued. It specifies the scope and features of the bond, and holds the issuer to its terms.

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40
Q

The bond/trust indenture: third-party trustee

A

The issuer of the bond, must appoint a third-party trustee to protect the bondholder’s rights.

In charge of making sure issuer complies and authenticates it

It’s usually a bank or trust

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41
Q

Trust Indenture Act of 1939, what is it?

A

Bond indenture’s valued over $50 million, must be qualified and registered by the SEC

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42
Q

What is the difference between a term bond and a serial bond?

A

A term bond is paid off at the maturity date in a large sum, offered a single interest rate.

A serial bond can be paid over the time till the maturity date.

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43
Q

What is a Balloon Maturity?

A

Is a serial bond maturity with one large payment, usually at the end on top off other payments.

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44
Q

Bearer Bonds / Coupon Bonds

A

Old-school bonds, no name on them and coupon attached - anyone who possess it can get paid

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45
Q

Registered Bonds & Book-Entry Bonds

A

Have a name on the bond, but no coupon attached. The transfer agent is in charge of the sending the payments. They can be sold.

Registered bonds have largely been supplanted by book-entry bonds.

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46
Q

True or false. A ratings agency is hired by a potential investor, a transfer agent, or a broker-dealer to assess the creditworthiness of a bond issue.

A

False. A ratings agency is hired by an issuer to rate the bonds before issue.

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47
Q

True or false. Bearer bonds are registered to a specific owner—the bearer—making them undesirable to tax cheats.

A

False. Bearer bonds are not registered to a specific owner, which makes their income easy to hide and desirable to tax cheats.

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48
Q

What are the interest payments on an 8% bond?

A

Recall that corporate bonds have a par value of $1,000. For an 8% bond, the annual interest payment is 0.08 × $1,000 = $80. Because coupon payments are typically made twice a year, the investor will receive $40 every six months.

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49
Q

True or False. Coupon payments generally come in semi-annual installments, meaning the bondholder receives two coupon payments per year.

A

True

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50
Q

What is a Discount Bond and why buy it?

A

A bond that sells below its par value.
Buy it because you will get more than what you paid for when it reaches maturity.

Suppose you want to sell your 6% bond in the market, and similar bonds are being issued today at 8%. No one is likely to pay $1,000 to receive 6% ($60 per year) when they can lend the same amount at 8% and receive $80. Your bond will not attract potential investors unless you offer to sell the bond at a discount, that is, below its par value.

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51
Q

Premium Bond - What is it and why is it premium?

A

A bond that sells above its par value.
It has a high interest rate on the bond when interests rates have lowered, so it has good yields, would only give up for a good deal.

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52
Q

What is the current yield of a 6% bond purchased at discount for $960?

A

The annual coupon payment is 6% times its par value (0.06 × $1,000 = $60). The annual coupon payment, $60, divided by the purchase price of $960 is 0.0625. Thus, the current yield is 6.25%.

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53
Q

Current Yield

A

a snapshot approximation that represents the return an investor might expect to receive if she purchased a bond today and held it for a year. It is calculated by this formula:

annual coupon payment / current bond market price

Current Yield is measured in the ROI

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54
Q

True or False. For non-callable bonds, the YTM is equal to the internal rate of return (IRR) of the bond.

A

True

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55
Q

We often say that long-term bonds have a higher _____ than short-term bonds. _____ is a measure of a bond’s sensitivity to changes in interest rates.
______ measures the rate of interest rate volatility.

A

Duration

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56
Q

Zero Coupon Bonds

A
  • has the highest duration among bonds
    -pays no interest and only principle at maturity
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57
Q

Bond points are __% of par
Because corporate bonds have a par value of $1,000, how much is one bond point equal to?

A

1%, $10

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58
Q

Corporate bonds are typically quoted in 1/32 or 1/8th increments?

A

Corporate bonds are quoted in 1/8th increments
example: 97 1/8, is .97125 of par or $971.25

(.97125 x $1,000)

Treasury Bonds are sold in 1/32 increments

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59
Q

So when a bond’s yield to maturity increases from 4.25% to 4.79%, the bond yield is said to have increased by __ basis points

A

54

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60
Q

Basis Point is how much of par?

A

One hundred basis points is 1%; 25 basis points is 0.25%

So when a bond’s yield to maturity increases from 4.25% to 4.79%, the bond yield is said to have increased by 54 basis points

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61
Q

5M is how much?

A

In finance “M” is often used to represent $1,000

Answer: 5,000

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62
Q

What is a bid-ask spread?

A

The maximum a dealer is willing to bid and pay.

The difference is the profit and it indicates the liquidity of the bond.

Example: 99 1/8 – 99 7/8

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63
Q

If the bid-ask spread of a corporate bond is 98 3/8 to 99 7/8, what is the spread in dollars?

A

Answer: $15.00. Recall that the face value of a corporate bond is $1,000. The bid price in dollars on a corporate bond is therefore 98 3/8 = 0.98375 × $1,000 = $983.75. The ask price is 99 7/8 = 0.99875 × $1,000 = $998.75. The spread is the difference between bid and ask, $998.75 – $983.75 = $15.00

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64
Q

Secured Bonds: Mortgage Bonds

A

Bonds that offer a first lien on a corporate property. If the company fails, the trustee can sell the property to pay the bondholders

  • pay interest semi-annually
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65
Q

Secured Bonds: Equipment Trust Certificates (ETCs)

A

Secured bonds that are commonly issued by transportation companies. When an airline buys a fleet of new planes, it may decide to use an ETC to finance the purchase.They are bonds in which a trustee sells the issue to investors and delivers the proceeds to the buyer (the airline). The trustee holds legal title to the mortgaged equipment (the fleet of new airplanes), which it leases to the airline until the bond is paid off. The trustee collects rent from the airline, which it uses to send the interest payments to the bondholders.

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66
Q

Secured Bonds: Collateral Trust Bonds aka Collateral Trust Certificates (CTCs)

A

Collateral trust bonds are secured by financial assets, such as stocks and bonds.

The bond indenture usually requires that the market value of the collateral securities always be greater than the face value of the bonds by a specified margin.

Example: Required collateral is 120%, value of the bond drops to 115%, they must provide an addition 5%

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67
Q

True or False. The majority of bonds are secured.

A

False - majority are unsecured, and only secured by a promise

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68
Q

What is a Debenture?

A

An unsecured corporate bond - they range is riskiness

Semi-annual interest payments + Par Value at Maturity

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69
Q

Debenture: Liquidation Preference

A
  1. Secured Creditors / Claims
  2. Debentures
  3. Subordinate Debenture
  4. Preferred Stock
  5. Common Stock

These are debentures that will be repaid only after other corporate debts, including regular debentures, have been satisfied.

They have a high credit risk and thus pay out higher yields.

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70
Q

Junk Bond / High Yield-Bonds; Short-term or Long-Term? What do they perform like? When happens to them when interest rates fall?

A
  • Not Investment Grade
    -Performs more like stock; bc low credit standing makes them sensitive to market conditions and issuer’s financial performance
    -Short-term, so Higher Yields

Falling interest rates will increase the market price of bonds in general, but the drop in corporate earnings dampens that impact on junk bonds and tends to drive their prices down.

After recessionary periods, junk bonds have the potential for strong price appreciation as the economy begins to expand and corporate earnings improve, possibly leading rating agencies to upgrade junk bonds’ ratings

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71
Q

What do bonds normally do when interest raise fall? What about Junk Bonds and why?

A

Falling interest rates will increase the market price of bonds in general, but the drop in corporate earnings dampens that impact on junk bonds and tends to drive their prices down.

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72
Q

True or False. The price of a convertible bond will never vary far from its conversion parity because if it did, many investors would try to profit from the difference between a bond’s conversion value and its selling price.

A

True

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73
Q

Arbitrage

A

This investing strategy of profiting from differences in prices across markets

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74
Q

What is a sinking fund?

A

A fund set aside to pay off bonds

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75
Q

What are the maturity schedules for the following bonds: Term Bonds, Serial Bonds and Series Bonds

A

Term Bonds - ONCE
a company issues a large number of bonds and they all mature at the same date

Serial Bonds -CONSECUTIVE
Bonds that are issues at consecutive years

Series Bonds- INTERVALS
Bonds set to mature in regular internals - used to fund projects that need steady income

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76
Q

Name the 2 types of unsecured bonds

A
  1. Debenture
  2. Income Bonds
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77
Q

A customer purchased a 6% XYZ convertible debenture at par for $1,000. The conversion price is $20. If the bond’s market price increases by 10%, what is the conversion ratio?

A

Answer: 50. Find the conversion ratio by dividing the conversion price into the par value: $1,000 / $20 = 50 shares of common stock for 1 bond. The conversion ratio is not influenced by a rise in the market price of the bond

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78
Q

A convertible bond has a conversion ratio of 50 and the issuer’s stock is currently selling at $24. What is the bonds conversion value?

A

The bond’s conversion value is $1,200 (50 shares × $24/share). If the bond is selling at $1,200, it is said to be at conversion parity.

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79
Q

A customer purchases a 6% XYZ convertible debenture at par for $1,000. The bond is convertible at $25. If the stock is selling at $30 per share and the bond is sold at parity, what will it be sold at

A

Answer: $1,200. First, find the conversion ratio by dividing the conversion price into the par value: $1,000 / $25 = 40 shares of common stock for 1 bond. Then multiply 40 shares times $30 to find the parity value (40 × $30 = $1,200).

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80
Q

Income Bond

A

High Risk!
- Coupon payments for income bonds are not guaranteed
- Typically, a company will offer income bonds to existing creditors prior to going into default

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81
Q

Zero Bond

A

It’s a zero coupon bond offered at a big discount
thus considered a discount bond
Interest Rate locked in for life of bond

Example: A 20-year bond that has a par value of $5,000 may have a $1,000 issue price.

P.S. IRS treats discount as interest and needs to pay taxes

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82
Q

What is the highest risk to bondholders?

A

Default Risk and Credit Risk
-Interest Rate Risk, Purchasing Power Risk (inflation), Call Risk, Reinvestment Risk

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83
Q

What are some safeguards for callable bonds?

A

Call Premium
- When a call price is set at a higher value than the face value of the bond, the difference is the call premium. For instance, a $1,000 bond with a call price of $1,100 has a $100 call premium payable to the investor if the bond is called.

Call Protection
- Prohibits redemption during the first few years of the bond’s life. The earliest date on which a bond is callable is known as the first call date

Sinking fund redemption

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84
Q

Refunding of Bonds

A
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85
Q

Once a bond is issued and starts to trade in the market, its coupon rate and par value do not change.

  • Bond prices fluctuate depending on the rise and fall of interest rates.
  • Interest rates and bond prices have an inverse relationship for most bonds, but this relationship does not hold for junk bonds.
  • When interest rates fall, callable bonds are likely to be called.
  • When interest rates rise, putable bonds are likely to be redeemed.
A
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86
Q

A convertible bond has a [higher/lower] level of volatility than the underlying common stock.

A

Lower

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87
Q

Convertible bondholders have a [higher/lower] claim on a company’s assets than non-convertible debtholders.

A

Lower

88
Q

Bonds with sinking fund provisions are redeemed at [par value/a premium].

A

Par Value

89
Q

A current refunding occurs within _____ of issuance of the refunding bonds

A

90 days

90
Q

A refunded bond is considered to be _____, which means it is removed from the issuer’s balance sheet.

A

Defeased

91
Q

US Treasury Securities: Primary Dealer

A

Is a bank or broker-dealer that buys Treasury securities at auction from the U.S. Treasury and resells them to investors.

92
Q

Are interest on treasury securities taxable on a state and local level?

A

No. Interest on all Treasury securities is taxable at the federal level, but it is exempt from state and local taxes.

93
Q

True or False. Treasury bills are issued at a discount to par and offer no interest

A

True!
For example, an investor who buys $1 million in one-year T-bills at a 5% yield will pay $950,000, and in return this T-bill investor will receive $1 million at maturity.

94
Q

What’s the maturity of a Treasury Bill (T-Bill)?

A

Max 1 year ;
Their yield is considered to be a risk-free return, and T-bills are the common measure for a riskless rate of return.

95
Q

Bank Discount Yield

A
96
Q

Rank the order of maturity: Treasury Notes, Treasury Bonds, Treasury Bills

A

Treasury Bills (T-Bills) - 1 year or less
Treasury Notes (T-Notes) 2 to 10 years
Treasury Bonds (T-Bond) - 10 to 30 years

97
Q

Are Treasury Notes (T-Notes) callable?

A

No. They are not

98
Q

What is a STRIP/ Treasury Receipts?

A

A long-term zero coupon bonds consisting of U.S. Treasury securities created by PRIVATE issuers - not the treasury

99
Q

Treasury Inflation-Protected Securities (TIPS)

A

Inflation-adjusted securities issued by the U.S. Treasury. With TIPS, the principal is adjusted according to the Consumer Price Index (CPI), and at maturity, the investor receives the inflation-adjusted principal or the original principal, whichever is greater.

Provides Inflation and Deflation protection

100
Q

US Saving Bonds: I Bonds and EE Bonds

A

I Bonds : Pay a guaranteed interest rate that may be adjusted upward when inflation rises

EE Bonds : Pay a fixed rate

-They are non-callable, nontransferable, and nonnegotiable. They cannot be sold in the secondary market

-With both, interest payments accrue over the life of the bond and are paid out with the principal at maturity. In other words, the investor receives no interest until the bonds are redeemed.

101
Q

Asset-backed securities (ABS)

A

bonds that are backed by the cashflow of other kinds of debt

102
Q

Securitization

A

The financial practice of combining illiquid debt obligations into a pool of assets that can be packaged into tradable securities

103
Q

A mortgage-backed security (MBS) is a bond backed by what?

A

A pool of mortgages.

104
Q

What risks are MBS owners subject to?

A
  1. Prepayment risk (the risk that they will get their money back sooner than expected, which may happen when interest rates fall)
  2. Extension risk (the risk that they will get their money back slower than expected, which may happen when interest rates rise)
105
Q

Government-Sponsored Enterprises (GSEs)

A

Privately owned but chartered by the federal government

  • NO SEC OVERSIGHT
    -no state or local tax by entity but obv yes to investors
    -credit line of 2b+

Fannie Mae & Freddie Mac
Both entities are privately owned, publicly traded companies that purchase mortgages on the secondary market and pool them to create mortgage-backed securities

106
Q

Name the 3 agency securities

A

Fannie Mae, Freddy Mac and Ginnie Mae

107
Q

What is unique about Collateralized mortgage obligations (CMOs) ?

A

CMO offers a range of coupon rates and maturity dates for investors to choose from.
the CMO investor’s principal is returned over the life of the security rather than repaid in a single lump sum at maturity, which occurs with other types of debt securities.
CMOs typically pay investors interest and principal on a monthly basis, except for during the lockout period,

108
Q

All of the following conditions make a mortgage-backed security a potentially risky investment except:
A. The investor may receive the principal back sooner than anticipated.
B. The investor may have to hold on to his investment longer than anticipated.
C. The rate of principal repayment may vary.
D. Interest rates move up and down with the stock market.

A

D. With mortgage-backed securities, mortgages in the pool can be paid off at any time, making resulting funds unpredictable. Investors never know when the principal on their MBS will be paid off. Prepayment risk is associated with falling interest rates resulting from refinancing. Extension risk is associated with lower than expected interest payments that might occur when homeowners are late in paying off their mortgages. This possibility makes the the rate of principal repayment unpredictable. Interest rates do not move up and down with the stock market.

109
Q

Which two of the following are true of CMOs?

I. CMOs are backed by pools of mortgage payments.
II. CMOs are backed by credit card receivables.
III. CMOs are structured into tranches.
IV. CMOs are tax-exempt at the local, state, and federal levels.

A. I and III
B. I and IV
C. II and III
D. II and IV

A

A. I and III

110
Q

What is the difference between Ginnie Mae and Fannie Mae?
A. Ginnie Mae is a government agency, while Fannie Mae is privately owned but chartered by the federal government.

B. Fannie Mae is a government agency, while Ginnie Mae is privately owned but chartered by the federal government.
C. Both are government agencies, but each serves a different purpose.
D. Both are privately held organizations, but Fannie Mae has a history of corruption.

A

A. Ginnie Mae stands for Government National Mortgage Association, and it is a government agency that guarantees mortgage-backed securities. Fannie Mae, or the Federal National Mortgage Association, issues mortgage-backed securities, and it is privately owned but chartered by the federal government. Fannie Mae and other Government-Sponsored Enterprises (GSEs) are publicly traded companies created by the federal government to serve a public purpose. Of the securities issued in the mortgage-backed security industry, only Ginnie Mae securities are guaranteed by the full faith and credit of the federal government.

111
Q

Money Market Securities

A

debt securities that mature in one year or sooner
- HIGHLY Liquid
-Considered very safe
-Big Purchasing Power Risk bc they offer such low-yield that can’t keep up with inflation
-not required to register w/ SEC but subject to anti-fraud laws

112
Q

Money Market Security: Commercial Paper

A

-Unsecured, but considered safe bc short-term and high credit rated issuers

113
Q

Money Market Security: Banker’s Acceptance

A
  • usually in the international market
  • Banker’s acceptances are usually issued at a discount to face value
114
Q

Money Market Security: Repurchasing Agreement/ Repo

A

At its simplest, a repo is a form of short-term borrowing.

A short-term contract to sell an asset, such as a Treasury bond, and simultaneously buy it back in the future at an agreed-upon price (typically a higher price)

often done overnight

115
Q

Money Markey Security: Municipal Notes

A

The primary purpose of municipal notes is to meet an agency’s cash flow needs in anticipation of the taxes, fees, or other sources of revenue that fund its ongoing commitments.

Zero Coupon

Notes are issued by different names, depending on where the anticipated receipts are coming from

116
Q

Are bank CD’s a money market security?

A

Nope - Certificates of deposit (CDs) are not considered securities, but are still considered part of the money market

Bank CDs typically offer low yields and, therefore, do not protect against purchasing power (inflation) risk.

117
Q

Money Market Securities: Demand Deposits

A

Accounts where funds can be withdrawn at any time. In other words, the funds are payable on demand.

Both checking and savings accounts are considered demand deposits.

118
Q

Foreign Bonds: Eurobonds

A
  • denominated in currency other than where it is issued (sold)
    -Underwritten by foreign banks

Example: bonds may be issued and sold in Britain by a Kuwaiti company and denominated in the pound

The currency in which the Eurobond is based will also be the currency in which the principal and interest are paid.

Issuers often choose Eurobonds because they can pay better interest rates in the chosen denomination.

An issuer may choose to issue the bond in a country with the fewest regulatory constraints

119
Q

Foreign Bonds: Eurodollar Bonds

A

Eurodollar Bonds denominated in U.S. dollars but will be sold outside of the US

Not offered in US or to US investors, so no taxes or SEC Regulations required

120
Q

Foreign Bonds: Sovereign Bonds

A

They are issued by foreign governments

Currency Risk

Sovereign bonds tend to be less risky than other types of foreign bonds because governments can raise taxes or lower spending to make their interest payments

Politically stable governments typically issue debt securities with lower coupon rates than less stable governments

121
Q

Jon Pierre lives in France and wishes to buy a bond that was issued by a Japanese company, is sold in France, and has its interest and principal paid in U.S. dollars. What type of bond would be appropriate?

A. Eurobond
B. Eurodollar bond
C. Yankee bond
D. Sovereign bond

A

Answer: B. Eurodollar bonds are Eurobonds denominated in U.S. dollars, meaning that the interest and principal will be paid in U.S. dollars, but the bonds will be sold outside the U.S.

122
Q

Foreign Bonds: Brady Bonds

A

Principal and sometimes interest was collateralized with U.S. Treasury bonds held in escrow by the U.S. Federal Reserve

Attractive to investors because investors can invest in emerging market debt with improved liquidity and transparency

Bradies are denominated in U.S. dollars, they allow investors to invest in sovereign debt without currency risk.
Many Brady bonds were callable and were retired by the issuing countries.

123
Q

Brady bonds allow U.S. investors to assume what risk and avoid what risk?
A. Sovereign, currency
B. Currency, liquidity
C. Interest rate, sovereign
D. Liquidity, interest rate

A

Answer: A. A Brady bond is a sovereign debt security issued in U.S. dollars by Latin American and other developing countries. Brady bonds offer U.S. investors the opportunity to assume the risk associated with investing in a foreign government (sovereign risk) without the risk of being paid in a currency that might lose value relative to the dollar (currency risk).

124
Q

Why are Municipal Bonds issued and who issues them?

A

To raise capital for day-to-day operations

issued by states, cities, and counties

125
Q

True or False. Municipal Bonds are exempt from SEC registration, and issuers do not have to publish a prospectus.

A

True

126
Q

True or False. Municipal bond investors are exempt from paying federal taxes on the bonds. In addition, municipal bonds are often tax-free at the state and local level as long as the bondholder lives within the municipality in which the bond was issued.

A

True

127
Q

What are the two types of Municipal Bonds?

A
  1. General Obligation (GO) Bonds (LESS RISKY)
    -unsecured bonds backed by the full faith and credit of
    the municipality and paid for by taxpayers
  2. Revenue Bonds
    • secured bonds used to finance specific projects and
      are funded by the revenue stream generated by the
      project.
128
Q

[GO/Revenue] Bonds finance airports, mass transit systems, roads and bridges, libraries, and hospitals. Income from concessions, tolls, or user fees is put into a [GO/Revenue] fund

A

Revenue, Revenue

129
Q

[GO/Revenue] bonds may be issued when voter approval for [GO/Revenue] bonds cannot be attained

A

Revenue, GO

130
Q

The value of bonds with shorter maturities will stay [farther/closer] to par throughout their lives, while the value of longer-term bonds will vary more from par during their lives. Additionally, as a bond gets [farther/closer] to maturity, its value gets closer to its par value. This is called price convergence.

A

Closer, Closer

131
Q

If interest rates go down, the issuer is likely to [not call /call] a bond, and thus the bond’s value will move toward its call price as the call date approaches. If interest rates rise, the issuer will probably [not call/call] the bond, and thus an approaching call date will not affect the bond’s price.

A

call, not call

132
Q

As a bond’s YTM and YTC increase, the value of the bond decreases, and as the YTM or YTC of the bond decreases, the value increases.

A
133
Q

If a rating organization downgrades a bond’s rating, the value of the bond will [increase/decline]. If a rating organization raises the bond’s rating, the value of the bond will [increase/decline].

A

Decline, Increase

134
Q

The value of bonds with higher durations vary more with changing ______ than the value of bonds with lower durations.

A

interest rates

135
Q

Suppose that a discounted cash flow analysis using the rates of comparable bonds reveals that a bond is valued less than its par value. What does this probably tell us?

I. The interest rates have declined.
II. The interest rates have risen.
III. The bond buyer should be only willing to purchase the bond at a discount.
IV. The bond buyer should be only willing to purchase the bond at a premium.

A. I and IV
B. II and III
C. I and III
D. II and IV

A

Answer: B. When bonds are valued less than their par value using a discounted cash flow analysis, this generally means that interest rates have risen, and the bond buyer should be only willing to purchase the bond at a discount.

136
Q

Payments in Perpetuity Formula

A

Annual Payment / Annual Rate of Return

137
Q

An investor wants to know how much she would need to set aside as a nest egg if she wants to receive $10,000 per year in income off that nest egg. If she believes that she can consistently earn 5% on her nest egg

A

Annual Payment / Annual Rate of Return

She would divide $10,000 by 0.05 (the rate of return expressed as a decimal), which would yield $200,000. In other words, $200,000 earning 5% should provide an investor with $10,000 per year indefinitely.

138
Q

Calculate the amount needed to provide a perpetuity of $500 per month using a 6% annual rate of return

A

If the exam gets tricky and asks you to calculate the monthly or quarterly payment amount, it’s important that you remember to divide the annual rate of return by the payment period referenced in the question. For example, if the exam asks you to calculate the amount needed to provide a perpetuity of $500 per month using a 6% annual rate of return, you’d first need to convert the 6% into monthly terms. You’d do this by dividing 6% by 12 (the number of regular periodic payments the investor desires). In this case, it would yield a monthly rate of return of 0.005. You would then divide the desired monthly payment by this amount, not the original 6%. In this problem, that would mean the investor needs a nest egg of $100,000 to pay a perpetuity of $500 per month.

139
Q

Daredevil Dave, a famous skydiver, is your client. “Double D,” as he is known, comes to you and tells you that in 18 months he is planning to attempt his most dangerous dive yet: a free fall from an orbiting space station. Double D says that he doesn’t have life insurance, and in case he doesn’t survive this space dive, he wants to make sure he provides his family with income. In fact, he wants them to receive a monthly payment of $5,000 in perpetuity. He asks you how much money he will need to pay now in order to achieve this goal. Assuming a 2% rate of return and assuming this is going to be Double D’s last dive, you tell him that he will need to contribute:

A. $3 million
B. $6 million
C. $9 million
D. $12 million

A

Answer: A. A perpetuity is an annuity or stream of payments without end. To calculate the present value of a perpetuity, divide the periodic payment by the rate of return (also known as interest rate or yield). In this case there are two ways to reach the answer: (1) divide the 2% rate of return by 12 to get the monthly rate of return (0.001667), then divide the monthly payment by the monthly rate of return ($5,000 / 0.001667 = $2,999,400), or (2) multiply $5,000 times 12 months to get a $60,000 annualized payment to the family and then divide that by the 2% yield, or $60,000 / 0.02 = $3 million.

140
Q

Do the current ratio and quick ratio suggest that the company can meet its short-term obligations?

A

Numbers below one are worrisome.

141
Q

Does the debt-to-equity ratio seem reasonable?

A

Companies with high debt-to- equity ratios are usually businesses that require a lot of capital but have steady cash flow, which enables them to meet high debt service payments.

142
Q

Structure of Mutual Funds: Board of Directors, At least ____% of the members of the board of directors must be non-interested persons.

A

40%

143
Q

Structure of Mutual Funds: Who manages the fund’s investment portfolio by implementing the officers’ and board’s objectives and policies?

A

Investment Advisor aka Portfolio Manager

144
Q

Structure of Mutual Funds: Investment Advisor aka Portfolio Manager

A
  • Is usually a company, not an indv
  • Needs to be registered under the Investment Advisers Act of 1940
  • Paid percentage of Fund’s value
  • Manages the portfolio’s day-to-day trading
  • Identifies the tax status of distributions made to shareholders
145
Q

Structure of Mutual Funds: Custodian

A
  • Usually a bank or stock exchange member broker-dealer, holds the mutual fund’s shares and monetary funds
  • Responsible for performing the accounts receivable and accounts payable functions
  • Maintains records of dividends and interest received from the company’s investments
  • Keeps the company’s assets physically segregated and restricts access to certain officers and employees
146
Q

Structure of Mutual Funds: Transfer Agent

A
  • aka customer service agent
    -sends out shareholder reports
  • The custodian may also serve as its transfer agent, but custodial functions should be independent of transfer agent functions.
  • issues new shares to buyers and cancels any shares redeemed by shareholders
147
Q

Structure of Mutual Funds: Underwriters / Sponsors

A
  • Sponsor Mutual Funds, aka market and sell shares to the public - either directly or through broker-dealers
148
Q

The ____ fee is an annual marketing or distribution fee on a mutual fund and cannot exceed 0.25% of net assets if the company wishes to call itself a “no-load” fund.

A

12b-1 ; Mutual fund companies that choose to market and sell their own shares may call themselves “no-load” funds. In this case, the distribution cost generally is recovered through the 12b-1 fee (named after a section in the Investment Company Act of 1940). The 12b-1 fee is an annual marketing or distribution fee on a mutual fund and cannot exceed 0.25% of net assets if the company wishes to call itself a “no-load” fund.

149
Q

Members of the board of directors:

I. Can include employees of the custodian firm
II. Must include at least 40% non-interested persons
III. Assist with day-to-day portfolio management
IV. Vote on a change of investment adviser

A. II and IV
B. I and III
C. II and III
D. I and II

A

D. The board of directors can include persons other than non-interested persons, but at least 40% must be non-interested. Shareholders vote on a change in investment adviser.

150
Q

Which of the following statements about the sale of mutual fund shares is not true?

A. The underwriter prepares sales literature.
B. The mutual fund company sells shares to the transfer agent at the NAV.
C. The transfer agent receives the investor’s payment and issues new shares to buyers.
D. The custodian safeguards the proceeds of the sale.

A

B. The mutual fund company sells shares to the underwriter, not the transfer agent, at the NAV.

151
Q

Which of the following is not true of the role of mutual fund shareholders?

A. They vote to select board members.
B. They vote on changes in fees.
C. They vote to decide what percentage of the profits should be retained.
D. They vote to approve an independent auditor.

A

C. Shareholders do not get a say in what percentage of the profits should be retained or what percentage should be paid out in dividends.

152
Q

Which of the following entities identifies the tax status of distributions made to shareholders?

A. Investment adviser
B. Transfer agent
C. Custodian
D. Underwriter

A

A. In addition to managing the portfolio’s day-to-day trading, the investment adviser identifies the tax status of distributions made to shareholders.

153
Q

Equity Funds

A

are used to invest in equity securities aka common stock

154
Q

Equity Funds: Growth Funds

A
  • expensive, high price-to-earnings ratio
  • contains stocks of growing companies ; they reinvest their earnings into expansion, acquisitions, and research and development, and therefore pay low or no dividends
155
Q

Types of Mutual Funds; What are the three ways they are catagorized?

A
  1. Equity (Stock) FUNDS
  2. Fixed-Income (Bonds) FUNDS
  3. Money Market FUNDS
155
Q

Types of Mutual Funds; What are the three ways they are catagorized?

A
  1. Equity (Stock) FUNDS
  2. Fixed-Income (Bonds) FUNDS
  3. Money Market FUNDS
156
Q

TYPES OF MUTUAL FUNDS: Equity Funds - Growth Funds contains what kinds of stocks? Are they expensive, and if so, why? Do they pay dividends? Long-term or short-term investment?

A

-Contains stocks of growing companies (investing in R&D, expansion, acquisition)
-No Dividends, why above reasons
-Yes, expensive because potential future earnings high, long-term investment, need to wait to hit it big

Goal/Bet = Capital appreciation

157
Q

Growth fund is the [opposite/similar] to an Income Fund

A

Opposite
Growth is growing companies (R&D, Acquisition, Expansion) and Income is well-established, nice dividends

158
Q

TYPES OF MUTUAL FUNDS: Equity Funds- Income Funds contains what kind of stocks?

A

Well-established companies that produce nice dividends

  • has an investment horizon longer than a year
159
Q

TYPES OF MUTUAL FUNDS: Equity Funds- Value Funds contains what kind of stocks? What is generally thought of them? High or Low Dividends and why? Safer or Riskier than Growth Funds?

A

-Stocks trading less than they are worth (according to the portfolio manager)
-Generally thought of being out of favor, perceived boring and low to no growth potential
- High Dividends bc of low price to earnings ratio
-Considered safer (conservative) bc bullet point above

Goal/Bet: depressed price will rise

160
Q

TYPES OF MUTUAL FUNDS: Equity Funds - What two types are funds are in a Blend Fund? And what kind of investors does it appeal to?

A

Growth and Value Funds

Appeals to Investors Who Seek: future capital appreciation + dividends and SUBSTANSTIAL diversification

161
Q

TYPES OF MUTUAL FUNDS: Equity Funds- Income and Growth funds, what kind of investors does it appeal to?

A

Investors who want future growth and need current decent dividends

162
Q

TYPES OF MUTUAL FUNDS: Equity Funds -International Mutual Funds/ Foreign Stock Funds invest in what kind of funds? focus on short-term or long-term capital appreciation?

A

-Stock that invests outside of the investors country of residence
- Long-term Capital Appreciation
(although SOME produce current income)

163
Q

TYPES OF MUTUAL FUNDS: EQUITY FUNDS - Sector Mutual Funds invest in what kind of funds? Is it a higher or lower risk and why?

A
  • Invest in a specific sector
  • Higher Risk - no diversification, it’s volatile

Goal/Bet - Appreciation potential when increased demand for product or service sector provides (EX: Masks)

164
Q

TYPES OF MUTUAL FUNDS: EQUITY FUNDS - What’s the difference between a blended fund and a growth and income fund? (price to earnings ratio)

A

A growth and income fund has a MODERATE price to earnings ratio (income is MODERATE, growth is HIGH)

A blended (value and growth) fund has a LOW price to earnings ratio (value is LOW, growth is HIGH)

165
Q

TYPES OF MUTUAL FUNDS: Balanced Funds, contain what two types of funds, the percentage of each and why does it exist?

A

Contains stocks and bonds - Equity Funds for appreciation and Bond Funds for Income

Any percentage of stocks vs bonds, check prospectus on philosophy

Why - Goal/Objective: Lower volatility than an equity funds, but higher returns than a bond fund

166
Q

TYPES OF MUTUAL FUNDS: Balanced Funds - Lifecycle/ Age-based funds, what is it and why? Do they vary?

A

a fund that adjusts to become more conservative as the target-date approaches, common retirement fund

yes, they vary based on how they are structured, maintained and the fees

167
Q

TYPES OF MUTUAL FUNDS: Bond Funds aka fixed-income funds, do the yield and risk vary?

A

Yield and risk vary, ex: Treasury Bonds = safe, Corporate Bonds = no as safe

168
Q

TYPES OF MUTUAL FUNDS: Bond funds do not mature like individual bonds—shares can be sold any time without considering ______. Both the _____ and ____should be considered when choosing a bond fund.

A

bond maturity dates, share price and yield

169
Q

TYPES OF MUTUAL FUNDS- Money Market Funds invest in what? How liquid are they? What kind of investor does it appeal to?

A
  • invest in high-quality, short-term debt instruments
  • MUST BE high liquidity, high quality (law)
  • nearly as safe & liquid as bank accts but w higher yield
  • Perfect for investors who need high liquidity but want a higher interest rate than bank acct
170
Q

TYPES OF MUTUAL FUNDS- Money Market Funds maintain a stable what per share? Pay dividends based on what?

A
  • NAV $1 per share

The debt instruments they invest does not produce capital gains or losses - very rare the “buck is broken”

-Pay dividends based on short-term interest

171
Q

TYPES OF MUTUAL FUNDS - Index Funds, are used to track what?

A

Mutual Funds that are set-up to track certain market segments. Will hold the same proportion of securities (stocks and bonds) that it is tracking

  • adviser is mimicking, not analyzing stocks

examples:
S&P500 (500 large capitalization stocks)
DOW Industrial Average (30 large-cap, blue-chip stocks)

172
Q

Studies show that over time index mutual funds [underperform/outperform] most actively managed mutual funds.

A

outperform

173
Q

What is the difference between a balanced fund and a blended fund?

A

A balanced fund is stocks and bonds, a type of mutual fund

A blended bund is value and growth funds is a type of equity fund

174
Q

Name the Fund
1. General type of fund that invests in common stock
2. A fund that contains stocks that pay good dividends
3. A fund that contains stocks that paw low dividends with high P/E ratio
4. A fund that is made up of stocks and bonds
5. A very safe fund that invest in short-term debt instruments

A
  1. Equity Fund
  2. Income Fund
  3. Growth Fund
  4. Balanced Fund
  5. Money-Market Fund
175
Q

Public Offering Price (POP) = ___ + ____
what is it for a load and no-load fund?

A

Load Fund: POP = Nav + Sales Charge
No-Load Fund: POP = NAV

176
Q

The price of the mutual fund is determined by what? and how often is it calculated?

A

The NAV (Net Asset Value) aka Book Value of the fund

Calculated erry day

177
Q

The price of a share in a mutual fund is driven by supply and demand or by the performance of the securities?

A

The price is based on the performance of the securities in the fund. The NAV can change daily because the market value of a fund’s securities portfolio fluctuates, as does the number of outstanding shares.

178
Q

How do you calculate the NAV of a mutual fund?

A

Market Value + Assets - liabilities
divided by number of shares

179
Q

What is the difference between a sales charge that is front-end and back-end?

A

Front-end, included in the investment PURCHASE of shares
Back-end, charged at the investment SALE of shares

180
Q

What is the contingent deferred sales charges contingent on?

A

It’s a back-end charge and is dependent on when the shares are sold, it gets lower the longer they hold and can be zero once sold

181
Q

Mutual Funds: What is a breakpoint?

A

It’s a discount on a front-end sales charge, when you invest a lot of money. The exact dollar amount is the breakpoint.

Example: MegaFund charges a 5% sales charge on investments under $25,000 and 4.25% on investments at or above $25,000. The breakpoint in this case would be $25,000.

182
Q

What is the breakpoint?
MegaFund charges a 5% sales charge on investments under $25,000 and 4.25% on investments at or above $25,000.

A

The breakpoint in this case would be $25,000.

183
Q

What is the right of accumulation (ROA) and the right of letter of intent (LOI)?

A

ROA: Adding more money to your fund accumulates your initial purchase of shares and therefore let’s you reach different breaking points for a lower front-end sales charge when you purchase more

LOI: If you know you’re buying more in the future, can write a LOI and get the lower front-end sales load for current purchases until then

Example: Using the previous example breakpoint schedule, an investor has $10,000 in her fund account and plans to invest $15,000 more in the next 13 months. She could write a letter of intent to her broker, who would charge her the 4.25% sales load on any new shares purchased in the next 13 months.

184
Q

Who do you send the LOI to and can it be backdated?

A

Sent to your broker and yes, up to 90 days

185
Q

Mutual Fund (B) Shares:
POP, Sales Charge, 12b-1 Fee, Appropriate for?

A

POP = NAV

Sales Charge = Back-end, can be $0 if held for long enough

12b-1 Fee = Higher than (A), may convert to (A) if held long enough

Appropriate for: Smaller accts with investors who intend to hold for a longer time

186
Q

Mutual Fund (A) Shares:
POP, Sales Charge, 12b-1 Fee, Appropriate for?

A

POP = NAV + front-end sales charge

Sales Charge= Can be reduced through Breakpoints

12b-1 Fee = Lower than (B) & (C)

Appropriate for: Accts large enough to benefit from breakpoints

187
Q

Mutual Fund (C) Shares:
POP, Sales Charge, 12b-1 Fee, Appropriate for?

A

POP= NAV

Sales Charge= No front-end, no back-end

12b-1 Fee= Higher than (A) or (B)

Appropriate for? Smaller investors who won’t hold for a long time

188
Q

All 12b-1 fees must be reapproved ____ and reviewed ____ by the board of directors. FINRA imposes an annual ____ cap on 12b-1 fees for funds that are identified as “no load.” If a firm does not charge a 12b-1 fee, it can charge a maximum front-end sales charge of ____ of the public offering price.

A

annually, quarterly, 0.25%, 8.5%

189
Q

Mutual Funds: Automatic Reinvestment, is it taxed? What is the sales charge?

A
  • Dividends & Capital Gains reinvested into the fund (no sales charge)
  • still subject to taxation
    -usually retirement accounts bc high withdrawal penalities
190
Q

Mutual Funds: Dollar Cost Average - What is the strategy and why do it?

A

An investment strategy; buying the same security at the same price periodically despite price being high and low

Why? lowers the average cost per share of the investment over time

191
Q

Mutual Funds: Conversion Privilege - What is it any why do it?

A

A way to save money on a sales charge

Allows the investor to sell shares of one type of fund and buy shares of a different fund within the family at the NAV rather than the POP

IRS say’s TAX IT - it’s taxable, all gains and losses

192
Q

Mutual Funds: Market-timing

A

It’s Naughty, short-term gains strategy

Profits from the differences between daily closing NAV and next day’s NAV

There’s a penalty called a Redemption Fee to discourage bc could end up costing fund more $$ in admin fees

193
Q

What are the three different methods Equity-Indexed Annuities (EIAs) are calculated?

A
  1. Point-to-point - the difference (of the index) between beginning point of the contract and end point of the contract
  2. High-water method - the difference between the highest point and the starting term
  3. Annual Reset Indexing Method -Locks in “gain” each year, this gain credited each year instead of at the end of the contract
194
Q

Who bears the risk in Variable Annuities?

A

The investor, not the issuer, bc they pick accts that work like mutual funds and get their gains depending on the performance of chosen accts

195
Q

What are the two phases of a variable annuity and explain

A

Accumulation Phase - person puts money into account, grows and shrinks depending on investments chose

Payout Phase - When they being to receive payments either fixed amounts or variable, whatever they choose

196
Q

What happens if a person dies during the accumulation phase of an annuity? and what if the annuity lost money?

A

It will go to the beneficiary - it’s called a death benefit, they will receive based on the total invested

If the annuity lost money- they will receive the total invested money

197
Q

Explain the purchase and payout of the following:
Single Premium Deferred Annuity
Periodic Payment Annuity
Immediate Annuity

A
  1. Purchase with a lump sum and deferred payment
  2. Purchase Periodically (weekly/monthly/annually) Scheduled, deferred payment
  3. Purchase lump sum, Payout begins in 30 days
198
Q

Explain surrender time, fee and value

A

Surrender time is the time you cannot touch the money in an annuity, the fee is if you want to touch it and the value is the value of the acct after the surrender fee is subtracted

199
Q

Pros and Cons of a Bonus Annuity and who is it ideally not for?

A

Pro: Free additional money, usually 3-5% more of what you choose to contribute

Con: have long surrender time and if you don’t wait, get hit with a surrender fee

Not great for older people who can’t wait the surrender time and lose free money in paying the fee

200
Q

Explain 1035 exchange

A

IRS allows exchanges of annuity contracts without being taxed, however not usually in best interest of client, usually new surrender time so not good for oldies

201
Q

What are the three ways you can receive payments through an annuity?

A
  1. Random Withdrawal - requests sums at random times
  2. Fixed-Payments
  3. Lump Sum
202
Q

Annuity Settlements, which check is bigger and why: Life Income, Life with period Certain or Joint life with last survivor?

A

Life income is bigger, shortest time span so bigger check

203
Q

Variable Annuity Regulations, explain each: Free-look period, prompt payment and early redemption

A
  1. Can undo everything within 10 days
  2. Broker must submit everything to insurance company quickly
  3. Early Redemption - If annuity is redeemed within 7 days, rep has to return sales commission
204
Q

With [annuity, life insurance] the beneficiary receives the face value of the policy, which may be significantly larger than the original investment.
A/n [annuity, life insurance] may be purchased to insure another person.

A

life insurance, life insurance

205
Q

What is term-life insurance and why would someone get it?

A

It’s temp life insurance, for ex. insured until age of 40.
why? can’t afford life insurance, gets more expensive at tend of initial policy bc your older and stuff.

ALSO NO CASH VALUE (what you pay you don’t get back)

206
Q

A variable life insurance policy owner has the right to exchange her policy for a traditional policy (typically whole life) with comparable features. Federal law requires the insurance company to make the exchange option available for at least the first____years of the policy. The new policy must offer comparable benefits, and the health of the insured [can/cannot] be reevaluated.

A

Two, cannot

207
Q

Variable life policyholders get one vote per ____ of cash value. This is different from variable annuity and mutual fund owners, who get one vote per ____.

A

$100, share

208
Q

Sales charges must be reasonable in terms of the services rendered. Under federal law, a sales load must not exceed___ of the sum of the annual premiums that the insured would be expected to pay during the lesser of (1) her anticipated life expectancy or (2) 20 years

A

9%

209
Q

The policyholder may elect to return the contract within ___ days of its execution or within __days of receiving the issued contract, whichever is later, and receive a full refund of all payments made.

A

45, 10

210
Q

A. Variable Life Insurance
B. Whole Life Insurance
C. Term Life Insurance
D. Universal Life Insurance

  1. _____ Policyholder only receives life insurance for a specified period of time.
  2. _____ Death benefit and cash value fluctuate depending on performance of separate accounts.
  3. _____ Policyholder is guaranteed a minimum cash value and a death benefit.
  4. _____ Death benefit and premiums can be adjusted by the policyholder.
A

Answers: 1. C; 2. A; 3. B; 4. D

211
Q

For variable life insurance, the insurance company has to make at least ____ of the cash value of the policy available for loans. The policy owner can get ___ of the account value if he is willing to surrender the policy

A

75%, 100%

212
Q

What are the four settlement options for insurance policies?

A
  1. Lump Sum - all of it
  2. Fixed-Period - $ put into interest account for the fixed period, gets until period over
  3. Fixed-Amount - $ put into interest acct and gets a fixed amount till $ runs out
  4. Life Income - certain amount till death
213
Q

The IRS treats withdrawals from life insurance products on a [FIFO/LIFO] basis, but it treats withdrawals from annuities on a [FIFLO,LIFO] basis.

A

FIFO, LIFO

214
Q

LNTR Jul 25 call @ 3
Suppose the price rises to $28. You exercise the call and buy a security for $25 that has a market value of $28. What is your profit?

A

Zero

215
Q

The expiration day is always the ______ month

A

third Friday of the month

216
Q

What is the breakeven point?
SLML Oct 20 put @ 1.50

A

Series 65 (6 decks)

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