Chapters 14/15/16 Flashcards
Time of trade disclosures (MSRB Rule G-47)
A muni securities dealer MUST disclose to clients all material info that’s either known or reasonably accessible to the market AT or PRIOR TO THE TIME OF TRADE. These disclosures can be made verbally or in writing.
- THIS RULE IS NOT SATISFIED BY SIMPLY DIRECTING A CUSTOMER TO A GENERAL INDUSTRY SOURCE OR ADVERTISING.
- These rules apply regardless of whether the transaction was solicited or not, it was a primary or secondary offering, or it is a principal or agency transaction.
- Material info is defined as any info a reasonable investor would want.
B/D capacities when executing customer trades
- Agency trade
- Dual agency cross
- Principal trade
- Riskless principal
- Net basis
Broker/Agent trade
When a BD buys or sells securities on behalf of a customer and earns a comission.
- Commissions must be disclosed in the customer’s confirmation.
Dual agency cross
When a BD matches a sale from one of its clients w/ a purchase from another one of its clients and charges both a comission.
- Commissions must be disclosed in the confirmations to each customer.
Dealer/Principal trade
When a BD sells securities out of its own inventory or buys securities into its own inventory when executing a customer’s transaction. Transaction prices are based on the market price of the security. The firm charges the customer a markup above the market price of the security. When the customer sells, the dealer marks down the proceeds received by the customer.
Principals MUST disclose markups/markdowns
Riskless principal
When a firm buys into inventory to fill preexisting customer orders. This is considered ONE trade.
Ex: Firm A receives a customer order to buy 1k shares of stock A. Firm A then buys 1k shares as a principal for their own inventory, and then resells the securities to the customer at the market price plus a markup. This allows Firm A to NOT be exposed to price risk.
Firms MUST disclose its capacity as a riskless principal AND the markup
- The profit earned is disclosed in the customer’s confirmation.
Net basis
Similar to a riskless principal trade, however when reselling the securities to the customer they sell the securities at a higher price, rather than charging a markup. This is considered TWO trades. The markup is NOT disclosed w/ net basis trades.
FINRA requires disclosure and consent requrirements when executing these
- RETAIL CUSTOMERS MUST PROVIDE WRITTEN CONSENT. INSTITUTIONAL CUSTOMERS MAY PROVIDE WRITTEN OR ORAL CONSENT OR USE A BLANKET NEGATIVE CONSENT ORDER.
- The profit earned on a net basis trade is not disclosed in the customer’s confirmation. Instead, both legs are reported as principal since they occured at different prices.
True or false: BDs never need an institutional customer’s consent when executing a net basis trade?
False, the customer must either provide oral consent before each trade, written consent before each trade, or blanket permission through a negative consent letter.
What is required when performing a net basis trade w/ fiduciaries?
BDs must provide disclosure to the party that has trading authorization, obtain permission from that party, and follow the same disclosure requirements depending on whether the fiduciary is a retail customer or institutional customer.
Soft-dollar arrangemens
Rebates that IAs get for channeling some/all of their trades through certain BDs.
Conditions that must be met to use soft-dollar arrangements
- The IA must be exercising discretion over the accounts of others.
- The BD must provide the IA w/ services that assist the IA in making trade decisions (ex: equity research reports).
- The IA must dermine that value of the BD’s services is reasonable in relation to the commissions being paid.
The key is that the services received by the IA MUST benefit the client!
Acceptable uses of soft-dollar arrangements
- Research reports
- Discussions w/ RAs
- Software for analyzing portfolios
- Certain types of trading software
- Market & economic data services
- Coverage of attendance fees for a conference/seminar.
Account statements
BDs MUST provide customers w/ account statements quarterly (however monthly is more common in practice) that contain:
* A description of all security positions
* All money balances
* All account activity since the last statement
Can a BD hold a client’s mail if they’re away from their usual address?
Yes, as long as the firm:
* Receives written instructions which contains the time period to hold the mail. If longer than 3 consecutive months, the customer’s instructions must include a valid reason. Convenience is not a valid reason.
* Gives written disclosure to the customer regarding alternative methods of mail delivery (email, through the BD’s website, etc.)
* At reasonable intervals, verifies the customer’s instructions still apply.
True or false: The SEC requires brokerages to provide a current B/S and/or IS to customers upon request?
False, just the B/S.
True or false: When a customer’s accounts are transferred internally (ex: when a RR leaves and the customer is transferred to a new RR) account records must be amended and that requires the re-approval of the customer, completion of the new account form, and the notification to the appropriate regulatory authority.
False, when a customer’s account is transferred internally, account records must be amended to but that does NOT require the re-approval of the customer, completion of the new account form, or the notification to the appropriate regulatory authority.
Disclosures that MUST be made prior to execution:
- Risks associated w/ specific investments (ex: options, penny stocks, etc.)
- Conflicts of interest
- Investment limitations of the firm
Disclosures of costs and fees
BDs must disclose to clients when these types of fees are involved w/ a transaction:
* Mutual funds (Must disclose what class the mutual fund shares are and what kind of load charges there are)
* Annuities (Surrender charges and mortality expenses)
* Non-discretionary fee based accounts (ex: IA fees)
* Soft-dollar arrangements
Rule 10b-10
Requires that confirmations be given to customers AT or BEFORE the completion of any transaction that includes:
* The identity and price of the security
* The quantity being purchased/sold
* The date of the transaction and time of execution (or a statement that the time will be furnished on written request)
* The capacity in which the BD acted
* The price and yield on debt securities
* Whether a security is callable and a statement that more info can be provided on request
* The settlement date
* The name of the contraparty or a statement that it’ll be furnished upon request
True or false: If an RR has discretion over a customer’s account, trade confirmations do NOT need to be sent to the client after every transaction?
False, they do. Trade confirms may be sent to an investment adviser or other third party, but only if the written consent of the customer is obtained.
FINRA account updating requirement
If a customer provides a BD w/ an updated account, the BD MUST send a revised copy of the account record to the customer within 30 days after the BD received the notification.
Things BDs should regularly check for when updating accounts
- Changes in address
- Changes in financial situations
- Changes in investment objectives
SEC recordkeeping format requirements
Firms can keep records written or electronically. If the firm uses electronic, it must notify regulators prior to the beginning of its usage. Also, if the firm changes the form of electronic storage media being used, it must notify regulators 90 days before switching.
SEC recordkeeping requirements for firms using electronic storage:
- Maintain records in non-editable and non-erasable formats
- Automatically confirm the quality and accuracy of the media recording process
- Maintain records in serial form w/ time and date info to show required retention period.
- Be able to download the indexes and records maintained to any medium that’s accepted by the SEC or other SRO of which the firm is a member.
- Allow SEC and SROs to immediately review files.
Specified adult
Any adult that’s 65 or older OR is 18+ w/ a mental or physical impairment.
- Rule 2165 was created to protect specified adults.
Trusted contact person
An adult who is 18+ who is responsible for overseeing specified adults. This person IS NOT given the authority to execute transactions or make account decisions. This type of authorization requires power of attorney.
A trusted contract person’s name and contact info SHOULD be obtained at account opening. Their contact info is not required but a firm should make a reasonable effort to obtain it. This doesn’t apply to an institutional account.
Financial Exploitation
Wrongful taking, withholding, appropriation or usage of a specified adult’s funds OR any act to obtain control through deception of the specified adult’s assets OR any act to convert the specified adult’s assets.
True or false: Firms are allowed to place a temproary hold on the disbursement of the specified adult’s assets or any transaction if there’s reason to believe there’s financial exploitation?
True, however the firm must allow disbursement if there’s no reasonable belief of financial exploitation (ex: monthly bill paying). If a firm initiates a hold, an internal review MUST be initiated.
- The temporary hold rule also applies to transfers of assets from one account to another at the same brokerage.
Notification of temporary holds
Within 2 business days after the temporary hold is placed, the firm must provide written, electronic, or oral communications to all parties who can transact with the account (unless one of the parties is the suspect) AND to the trusted contact person (unless the trusted contact person is the suspect).
- !! Once a temporary hold is initiated, the firm is permitted to terminate it only after contacting either the customer or the trusted contract person and discussing the situation !!
Period for temporary holds
Temporary holds expire no later than 15 business days after the date it was first placed on the account, unless it’s extended by a regulator.
If the member firm’s internal review supports the finding of financial exploitation, the temporary hold may be extended by 10 days (so 25 total business days after the temporary hold was first placed on the account).
If the firm’s internal review still supports the finding of financial exploitation, a temporary hold may be extended another 30 business days (so 55 total business days after the temporary hold was first placed on the account).
Transfer initiation form
A written form that must be completed by the customer and given to the receiving firm when a customer wants to transfer an account between two firms. ACATS is a common registered clearing agency.
The receiving firm must submit the transfer request to the carrying firm immediately at the time of receipt from the customer and, within one business day, the carrying firm must either validate the instructions or take exception to the transfer.
Reasons the carrying party may take exception to the transfer of accounts between firms:
- Additional documentation is required
- The account is flat and has no assets
- Account # is invalid
- SSN or account title doesn’t match
- There’s an existing court order or tax lien
- Written instructions to rescind the transfer are received from the client
What is required of the carrying firm when validating the transfer?
The carrying firm must feeze the account, cancel all open orders, and within 3 business days of the validation, the carrying firm must complete the transfer of the account to the receiving party.
Non-transferable assets
- A proprietary product of the carry firm
- The asset is the product of a 3rd party and the receiving firm doesn’t maintain the necessary relationship to receive the assets.
- The asset is of a bankrupt issuer and the carrying firm doesn’t have the proper denomination to complete the delivery.
- The asset is a limited partnership interest.
- If a non-transferable asset is liquidated, distributions must be made within five business days of the customer’s liquidation instructions
Residual credits
Any cash or securities received by the carrying firm that were not included in the original account transfer request. The carrying firm is required to continue to transfer these residual credit balances for a period of six
months from the processing of the original transfer request. These transfers must be made within 10 business days of any credit balance(s) accruing in the client’s account.
True or false: FINRA allows member firms and employees to seek court orders to restrict the transfer of assets?
False
Systematic risks (non-diversifiable)
- Market risk
- IRR
- Inflation risk
- Event risk
True or false: Bonds w/ lower interest rate are less sensitive to IRR than bonds w/ similar maturities and higher coupon rates?
False, more sensitive.
Duration
A measure of the sensitivity of a bond or portfolio of bonds to a given change in int. rates.
Ex: If duration is 10 years, a 1% increase in int. rates will cause a 10% decline in the bond’s price.
Unsystematic (diversifiable risk)
- Business risk
- Regulatory risk
- Legislative risk
- Political risk
- Liquidity risk
- Opportunity cost risk
- Currency risk/Exchange rate risk
- Capital risk
- Credit risk
- Call risk
- Prepayment risk
- Capital risk is especially prevelent to options investors.
Current yield on a stock
Annual dividend ÷ current market price
Cost basis
The total amount that an investor paid to purchase a security. This includes any commissions or other fees paid to the brokerage. If securities make capital distributions, this increases the cost basis.
True or false: Any capital gain recognized on a short sale is taxed as a LT gain?
False, ST gain.
Return of capital (ROC)
When a company gives a portion of the investor’s original investment back. An ROC is NOT a taxable event.
Cost basis of inherited securities
When securities are inherited, the cost basis to the recipient is equal to the MV of the securities at the time of the deceased’s death. Regardless of the deceased’s actual holding period, the recipient’s holding period will be
considered long-term.
Cost basis of gifted securities
When securities are received as a gift, the cost basis to the recipient is the lesser of the security’s MV OR the donor’s cost to purchase the securities. The holding period of the recipient will be the same as the holding period of the giver.
A 35-year-old small business owner, who is single and appears to be doing well financially, informs an RR that he wants to day-trade. Fearing identity theft, the client refuses to provide the RR with background information beyond what’s required under AML rules (e.g., name, Social Security number, date of birth). What should the RR recommend for this client?
A. A collection of small cap equities and a long option
B. Nothing
B.
If a client refuses to provide certain information, an RR may not make assumptions about the client’s finances. An RR may only make recommendations that are based on the information that has been disclosed by the client. In some cases, a firm may decide not to open an account due to a client’s unwillingness to provide sufficient background information
True or false: Mutual fund shares can be bought on margin?
False. ETFs can though
True or false: Growth investors seek low p/e multiples?
False, high p/e multiples. Value investors look for low p/e multiples.
Indexing
Passive investing
Modern portfolio theory (MPT)
Assumes that investors are risk-averse and that there are many different ways to achieve an optimal portfolio that provides the max. amount of return for a certain level of risk. MPT looks for asset classes with negative correlations- essentiallly, diversification is key.
Capital asset pricing model (CAPM)
A financial model that calculates the expected rate of return for an asset.
Beta
How CAPM measures systematic risk. It measures how an asset reacts to a change in the market.
Ex: If Investment A has a β of 1.5, this suggests that it’s 50% more
volatile than the market as a whole. Therefore, if the market rises by 10%,
Investment A is expected to rise by 15% (10% x 1.5). Conversely, if the market declines by 10%, Investment A is expected to decline by 15% (10% x 1.5).
The Bond Buyer
An online newsletter that contains news that’s pertinent to both the muni market and the financial community in general. The newsletter includes a variety of statistics that relate to the municipal bond market.
Visible supply
Sums together the total $ value of all muni securities being underwritten on a competitive and negotiated basis which are expected to reach the markets over the next 30 days.
The Bond Buyer Placement Ratio
The $ amount of bonds that were sold by underwriting syndicates over the week as a % of the amount of bonds that were issued that week. Compiled on a weekly basis.
Gives an indication of muni demand
Bond Buyer Indexes
Compiles info regarding different indexes that are widely watched in the muni industry. These indexes provide an indication of the avg. weekly
yields for both GO and revenue bonds.
20 Bond Index
The avg. yield on 20 GO bonds w/ 20-year maturities and have an avg. rating that’s equivalent to Aa2 for Moody’s and AA for S&P.
11 Bond Index
The avg. yield on 11 of the 20 bonds that are in the 20 Bond Index and has an avg. rating that’s equivalent to Aa1 for Moody’s and AA+ for S&P.
Revenue Bond Index
The avg. yield on 25 revenue bonds w/ 30-year maturities and has an avg. rating that’s equivalent to A1 for Moody’s and A+ for S&P.
Bond Buyer Muni Index
The avg. prices of 40 recently issued and actively traded munis.
SIFMA Index
A 7 day market index of VRDOs w/ >= $10mm outstanding.
Municipal market data (MMD) curve
The yield curve of AAA munis published by Reuters.
Short Interest Theory
A bullish theory that follows the amount of common stock that’s been sold short but has not yet been covered (closed out). The theory is bullish because the short sellers must purchase the stocks to close out their positions- a short squeeze.
Put/Call Ratio
A technical indicator. The ratio of the volume of all put transactions divided by all call transactions.
- Although a high ratio indicates that the mood of investors is bearish, from an analyst’s point of view it reflects an oversold market and a higher probability that the market will reverse course and turn bullish. The opposite is true for a low put/call ratio, which is
viewed as a bearish indicator.
Odd-lotters
Small public investors whose purchases are usually <= 100 shares.
The Odd-Lot Theory
A technical indicator that suggests that odd-lotters usually time the market wrong: buy when the price is too high and sell when it’s too low. This indicator advises analysts to do the opposite of what odd-lotters are doing.
Advance-Decline Theory
A technical indicator that measures the # of stocks that have increased in a trading session compared to the # of stocks that have decreased. Shows the direction of the market.
- It’s bullish if the Advance-decline average is up.
- It’s bearish if the indexes are up but the advance-decline average is down.
The Dow Theory
A technical indicator that says the market is in an upward trend if one of the Dow averages advances above a previous important high and is accompanied or followed by a similar advance in another average.
Ex: If the DJIA climbs to an intermediate high, an investor might watch the Dow Jones Transportation Average (DJTA) climb to confirm an upward trend.
Support level
When a market is oversold and the price of a stock/index falls below the normal range of prices. At this point, buying pressures will kick in and bring the price up.
Resistance level
When a market is overbought and the price of a stock/index climbs to the top of the normal range of prices. At this point, selling pressures will kick in and bring the price down.
Consolidation phase
When a stock/index is trading in between the support and resistance levels at its normal price range.
Breakout
When a stock’s price increases above the resistance level or falls below the support level. When this happens, analysts believe that the stock will continue on its course.
Saucer pattern
A technical indicator that suggests that a stock has bottomed and is ready to rise.
Inverse saucer pattern
A technical indicator that suggests that a stock has peaked and is ready to fall.
Random Walk Theory
A theory that believes that technical nor fundamental analysis allows investors to consistently predict market movements.
3 basic categories of assets:
- Current assets: Assets that can be converted into cash within one operating cycle or a year: whichever is shorter. (ex: marketable securities, cash, inventories).
- Fixed assets: Assets that CANNOT be converted into cash within one operating cycle or a year.
- Intangible assets: Assets that cannot physically be touched.
2 basic ways to value inventories
- FIFO
- LIFO
- LIFO will result in lower EBIT because the cost basis for the units being sold will be higher.
- LIFO also results in lower taxes during an inflationary period.
True or false: The IRS allows companies to deduct D&A from income?
True
True or false: Fixed assets are usually shown on the b/s at MV?
False, usually at carrying value: original price minus D&A.
Capital surplus/Paid-in capital
The amount of premium above the par value that’s paid by shareholders
for the shares that are sold to the public by the corporation. This is found in equity.
Ex: Firm A IPOs for $15/share when the par value is $10/share. $5 is listed as paid-in capital.
Bond coverage ratio
EBIT ÷ int. expense
True or false: EBITDA represents cash earnings?
False, EBITDA is an effective metric to evaluate profitability, but not cash flow, since it ignores the capital expenditures (ex: R&D) that’re necessary to maintain and grow a business.
Liquidity ratios
- Net working capital: CA - CL
- Current ratio: CA ÷ CL
- Quck ratio/Acid Test Ratio: (CA - inventories) ÷ CL
- Cash flow: NI + D&A
- A low current ratio suggests an issue w/ working capital.
- Many analysts believe that a 2-1 current ratio represents sufficient liquidity. However, since inventories is the least liquid asset, firms w/ small amounts of inventories may be able to run w/ less.
- Many analysts believe that a 1-1 quick ratio represents sufficient liquidity.
Inventory turnover ratio
Indicates how often a firm sells its goods that it produces and implies a time frame for processing its goods.
Inventory turnover = COGS ÷ Avg. Inventory
- In some cases, sales is used in the numerator.
LT Capital
LT Liabilities + Equity
Bond Ratio
Par value of bonds ÷ LT capital
Book value per common share (BVPS)
A metric commonly used to find the bankruptcy value of a company.
(TA - TL - Intangibles - Preferred stock) ÷ # of common shares outstanding
- While book value is an estimate of the liquidating value of a company, it should not be treated as an exact measurement. The actual liquidating value of a company is dependent on the market value a company receives for selling its assets based on supply and demand.
Return on Equity
(NI - Preferred dividends) ÷ (Common stock at par + paid-in capital + RE)
Does NOT include Preferred Equity
True or false: Companies w/ high P/E ratios tend to be large dividends?
False, these are growth companies that tend to pay little in dividends.
True or false: To calculate the dividend payout ratio use annualized dividends?
True
Current yield
ANNUAL dividend per share ÷ market price
Effects of declaring a cash dividend
When the company announces its cash dividend. When a dividend is declared, RE is reduced and dividends payable (part of CLs) increases. Thus, working capital decreases since CA is unchanged but CL increases.
Effects of paying a cash dividend
When the company actually pays the dividend to its shareholders. During this stage, cash and dividends payable are both reduced by equal amounts. Thus, there is no change to working capital.
Effects of buying machinery/equipment
Cash is reduced to buy the equipment and fixed assets rise. Working capital decreases.
Effects of issuing debt
Cash increases and so does LT debt. Working capital increases.
Effects of calling bonds
Cash decreases to call the bonds and then LT debt decreases as the bonds are retired. Working capital decreases.
Effects of issuing stock
Cash increases and common stock increases. Working capital thus increases.
Effects of repurchasing stock
Cash is reduced to buy back the shares. Common stock decreases as the shares are retired. Working capital decreases. EPS increases.
Efficient frontier
A set of optimal portfolios that provide the highest possible expected return for a given risk level, or the lowest risk for a desired expected return.
Capitalization
How many stocks and bonds an issuer has issued.
Common stock ratio
