Chapters 6-10

Question 1

Stock Declaration Date, Record Date, Payment Date

Answer 1

Declaration Date: Board of Directors Declares Dividend
Record Date: Last Possible Date to own shares and be entitled to receive dividend
Payment Date: Dividend sent to shareholders
Board of Directors set all 3

Question 2

What is and who sets the ex-dividend rule

Answer 2

The market’s SRO (ex: Finra) sets it
Ex dividend date: the first date a stock begins to trade without its dividend

Usually ex dividend date = record date b/c if you buy on or after the record date it won’t settle by the record date (settlement is T+1) but market price for stock will adjust for it
ex: if a stock paying a 50 cent dividend closes at $20 per share on the day before the ex date, it will open at a price of $19.5 on the ex-dividend date

Question 3

Due Bills

Answer 3

Buyer is entitled to due bill for dividend if seller doesn’t deliver security in time (by record date)

Question 4

Using Cash (same day) settlement

Answer 4

The ex dividend date becomes the business day following the record date
ex: if the investor buys with cash on the record date, they are still entitled to the dividend

Question 5

Stock dividends

Answer 5

For example, an investor bought 100 shares of widget inc for $80 per share (original cost basis: $80) and the company declares a 10% stock dividend, the investor gets 10 shares but each 110 shares has a lower price per share (adjusted cost basis: $8000/110 shares=$72.72).

Does not increase company value
Stock distribution is not taxable

Question 6

Nominal Yield

Answer 6

coupon rate, regardless of price paid

Question 7

Current Yield (Dividend Yield)

Answer 7

=annualized dividend/ current market price

(not divided by original price aka not face value) so takes into account price paid, but fails to consider payment at maturity

Question 8

YTM yield to maturity

Answer 8

accounts for current price and payment at maturity

If purchased at a discount: YTM (you make the full discount immediately when you get payment at maturity)>Current yield>nominal yield

If purchased at a premium: nominal yield>current yield>YTM

Question 9

Basis Points

Answer 9

yield to maturity aka basis aka yield
1 basis point = 1% difference

1% difference in yield is 100 basis points –> usually corporate bonds have a 1-2% higher yield than treasuries (100-200 basis point spread)

If I buy bond B with a 4.95 basis, it provides a pick up yield of 40 basis points over Bond A

Question 10

YTC yield to call/ yield to worst

Answer 10

if issuer calls bond prior to maturity, yield to worst is the conservative estimate

If purchased at a discount: YTW>YTM b/c buyer is getting difference btwn face value and discount price faster

If purchased at a premium: YTM>YTW b/c buyer needs more time to make up for premium with interest payments

Question 11

Cost basis (capital gains and losses)

Answer 11

Original purchase price for tax purposes (including any commissions or fees paid to the broker)

For securities that make distributions that can be reinvested, investor’s total cost basis will increase since he’s required to pay tax on the distribution

By receiving the market value at the time of death, the trust’s beneficiary has a higher (stepped up) cost basis, which reduces his potential gain

capital gain: investment sold for greater value than its cost basis
capital loss: investment sold for less than its cost basis

Question 12

total return formula (total return in numerator, not percent change)

Answer 12

(ending value-beginning value)+investment income
/
beginning value

Question 13

Inflation adjusted rate of return formula

Answer 13

inflation adjusted return = actual return - rate of inflation

Question 14

Risk Free Return

Answer 14

Return on T bill (less than 1 yr) or 10 year treasury

Question 15

What are the Benchmark indexes

Answer 15

1. Dow Jones: Composite has 65 stocks (Industrial:30 stocks, transportation:20 stocks, Utility:15 stocks) – Dow Jones Industrial Average is quoted the most often (30 stocks)
2. S&P 500: 500 stocks, broader measure
3. NYSE composite index: all common stocks listed on NYSE
4. Wilshire 5000 index: all publicly traded companies
5. Major Market Index: 20 well known high cap stocks
6. Russel Index: 2000 small cap companies
7. The bond buyer municipal index

Question 16

Open End Management Companies (Mutual Funds) Pros

Answer 16

Exchanges at Net Asset Value (NAV): shareholders may exchange the shares they own in one fund for shares of another fund at the net asset value if both funds are in the same fund family

prospectus delivery requirement

End of Day pricing (forward pricing): purchase price is not known until NAV is computed after the close of the business day

settlement is usually same day (unlike equities t+1)

ex-dividend date is determined by the fund or principal underwriter and is typically the business day after the record date

Question 17

Net asset value (NAV) definition and formula

Answer 17

bid or redemption price

NAV = total net assets/number of outstanding shares

total net assets = securities + cash - total liabilities

Question 18

Public Offering Price formula

Answer 18

NAV + sales load aka sales charge = POP

Question 19

Sales Charge % formula

Answer 19

POP-NAV
/
POP

Question 20

No load funds

Answer 20

to be marketed as a no load fund, this type of fund may not assess a front end load, a deferred sales load, or a 12b-1 fee that exceeds .25% (OR 25 Basis points) of the funds’ average annual net assets

Question 21

12b-1 fees

Answer 21

marketing fees for mutual funds
back end loads have higher 12b-1 fees
ex: service fees for maintaining shareholder accounts

Question 22

Back End Loads and Contingent Deferred Sales Charges (CDSC)

Answer 22

For class b and class c shares, sales charge only hits when investors redeem their shares

the longer the investor owns the shares, the greater the decrease will be in the back-end load (thus called CDSC). If investor holds shares long enough, there’s no sales charge

Question 23

Classes of Shares and their loads/fees

Answer 23

INSERT CHART ON PAGE 98

1. Class A: front end loads, small or non existent 12b-1 fees; breakpoints available; best for long term investors
2. Class B: no front end charges, higher 12b-1 fees; subject to contingent deferred sales charges (CDSCs) if redeemed before a certain time; best for 5-7 year redemptions
3. Class C: level load - ongoing fee (typically 1%) for as long as investors hold shares; best for short term investors (1-3 years)

Question 24

Breakpoints

Answer 24

breakpoints are the dollar levels at which the sales charge is reduced (mutual fund’s version of volume discount)
most mutual funds offer this for shares that are purchased with a front end load (class A shares)

Question 25

adjusted POP formula for a reduced load using breakpoints

Answer 25

POP = NAV/(100%- Sales charge%)
in other words,
POP = NAV/(100%-breakpoint sales charge%)

Question 26

Structure of a mutual fund (page 91) insert photo

Answer 26

board of directors: decide dividends and capital gain distro, appointing day to day fund’s principal officers, selecting custodian + transfer agent + principal underwriter, establishing investment objectives
investment adviser: manages fund’s portfolio according to board’s investment objectives
custodian bank: keeps assets safe like a custodian
transfer agent: recordkeeping functions
principal underwriter: sells shares to public, may use dealers to market their funds

Question 27

categories of mutual funds

Answer 27

1. aggressive growth funds: often participate in IPOs
2. growth funds: capital appreciation is main objective
3. specialized or sector funds
4. International and global funds
5. equity income funds
6. growth and income funds: hybrid fund. expected to show more growth than typical equity income stock and higher dividends but lower than most growth stocks.
7. bond funds
8. index funds
9. value funds: invest in “out of favor” companies, often in restructuring – better for long time horizons
10. balanced funds: diversified in stocks, bonds, and money market instruments (cash equivalents)
11. asset allocation funds: basically balanced funds
12. money market funds

Question 28

letter of intent (LOI)

Answer 28

• qualifies investor for a discount made available through breakpoints without initially depositing the entire amount required
• may be backdated 90 days
• non binding; however, if a person fails to invest the amount stated in the LOIU, the fund will retroactively collect the higher fee

Question 29

Rights of accumulation

Answer 29

investor is able to add up all the purchases made in the same fund complex. Once a breakpoint is reached, all future purchases are entitled to the reduced sales charge.

funds with the maximum allowable sales charge of 8.5% must offer investors both breakpoints and rights of accumulation

Question 30

Redemption Fees

Answer 30

range: .5% to approx 2% and are returned to fund portfolio
designed to discourage investors from redeeming shares too quickly; some funds waive them after a certain time duration

Question 31

3 types of systematic withdrawal plans

Answer 31

fixed dollar, fixed percentage (a % of NAV of that day), fixed time (fixed payout plan so their holdings are completely liquidated by a specific date)

fund calculates NAV at least daily for investors who want to redeem or withdraw funds systematically

investment company act of 1940 requires mutual funds to pay the redemption proceeds to their investors within 7 calendar days

Question 32

Prohibited Sales Practices for RRs by Finra

Answer 32

Breakpoint sales: telling clients to purchase shares at a level just below the breakpoint or into several different fund families

Telling clients to buy class B shares when they intend to place a large order. Rats should direct client to class A shares so they can take advantage of breakpoints

Pressuring clients to immediately buy mutual fund shares to capture an impending dividend because client has no economic benefit; once the dividend is paid, the NAV will fall and client must pay taxes on the distribution.

Switching shares. Recommending they sell existing mutual fund shares and invest proceeds into another fund family. Client must pay new sales charges.

Exchanging shares (in the same fund family): must pay taxes on the gain or loss of the sold shares

Question 33

Difference between open end funds and Closed End Management Companies/ funds

Answer 33

Table on page 103

Question 34

Face Amount Certificate Company

Answer 34

Company that issues debt certificates that pay a predetermined rate of interest. Super rare today. If you redeem early, you receive a lesser “surrender value”

Question 35

Unit investment Trusts (UITs)

Answer 35

Formed under a legal indenture (document)
Have trustees rather than a board of directors
Invests in fixed portfolio (cannot be adjusted) income producing securities like bonds and preferred stock
No management fees because only supervised by investment companies

Question 36

Annuity

Answer 36

an agreement with a contract owner (the annuitant) and an insurance company
- growth is tax deferred (aka non-qualified)
- long holding periods with high surrender charges if you withdraw too early

Question 37

fixed annuities

Answer 37

investor receives a fixed rate of interest and investment risk is assumed by the insurance company
- governed under state insurance law only
- not considered securities

Question 38

Variable annuities

Answer 38

• provides investors with greater protection against inflation than fixed annuities
• issued by insurance companies, but not considered a form of life insurance
• contract owner can control how contributions are invested
• long term investments

Accumulation period: when person first directs her contributions to the insurance company. Annuitant may cancel/surrender their variable annuities at any time.

Loan: you can borrow (take a loan) out against the value of your annuity contracts

Annuity Period (pay out period) options:
1. straight life annuity: monthly payments for as long as you live + highest monthly payments, but no designated beneficiary
2. life annuity with period certain: monthly or other periodic payments for life. If client dies prior to end of contract, payments will be made in lump sum or in installments to a designated beneficiary, but if after period, beneficiary gets nothing
3. unit refund life annuity: periodic payments for life. If annuitant dies before an amount equal to the value of the annuity units is paid out, remaining units go to beneficiary
4. joint and last survivor life annuity: payments are made to 2 or more people. If one dies, survivor continues to receive only her payments. after death of both, payments ceast

Annuity period: total net assets/ total units issued

NAV per unit (aka per subaccount): total net assets/ total units issued

forward pricing: the actual price that annuitants will pay for their units is the next calculated NAV

death: person will receive the greater of
1. the sum of all of contract owner’s payments into the annuity
2. the value of the annuity on the day of the annuitant’s death

FINRA rules: specify a maximum sales charge of 8.5% for mutual fund sales, there’s no statutory maximum sales charge on variable products.

if annuitant withdraws funds prior to reaching the age of 59.5, he’s required to pay taxes on any increases in the value of his annuity + a 10% tax penalty.

Question 39

Variable annuity expenses

Answer 39

management fees, expense risk charges, administrative expenses, mortality guarantee (insurer will make payments for the rest of their life, insurer will return a certain amount of money to beneficiary if contract owner dies during the annuity’s accumulation phase

Question 40

Qualified annuity

Answer 40

for non profits or public schools for their employees

tax deferred and amount contributed is excluded from their taxable income (like 401k, not roth)

employers may contribute to it

Question 41

Equity Indexed Contracts (EICs) – long term investments

Answer 41

do not have to be SEC registered as securities

tax deferred growth

hybrid of Fixed (minimum guaranteed rate of return or floor) and Variable annuities (upside potential with link to equity index)

Ex: an EIC has a participation rate of 80% and the associated index’s return is 10%. Investor’s return is capped at 8% (10% x 80%)

Question 42

Municipal Fund Securities

Answer 42

Municipal bonds are typically sold in minimum increments of $5,000, pay interest on a semi-annual basis, and have maturities that range from less than one year to 30 years.

• do not have stated par values or maturity dates and cannot be priced on yield or dollar price
• valued based on investment performance of an underlying peel of assets with an aggregate value that changes day to day

Types of Municipal Fund Securities:
1. local government investment pools (LGIPs): governments use surplus cash to buy interests in a trust which invests in large portfolio of securities, according to state goals and trust’s investment objectives, to take advantage of economies of scale (pooling money together)
2. 529 College Savings Plans:
- prepaid college tuition plans: NOT a municipal fund security b/c plan locks in today’s tuition costs, tax deferred, transferable to a sibling
- college savings plans: like a mutual fund where stocks will be exchanged for bonds when person gets closer to college age, can use 10k for private school for K-12 or 10k for withdrawal for student loan repayment or apprenticeship, contribution limits are 18k frontloaded with 90k (treated as if put in over the course of 5 years)
3. 529A (529 ABLE) Plans: state savings accounts for the disabled; max contribution is 500k (per yr 18k); account will not impact medicare or social security payments unless current account value > 100k

Question 43

Inverse ETF (short term investment prod)

Answer 43

Goal: provides a return that is equal to short selling the stocks in the index. For example, if the S&P 500 falls by 1.5% on a given day, the inverse ETF should rise by approximately 1.5%. Used by investors with long positions as a hedge against a bear market.

price movements are calculated on a percentage basis for that day only. the next day, the process will restart so only short term instrument

Question 44

Leveraged ETFs (short term investment prod)

Answer 44

use debt instruments or financial derivatives such as swaps, futures, and options to amplify the returns of a specific index

price movements are calculated on a percentage basis for that day only. the next day, the process will restart so only short term instrument

Question 45

ETN (Exchange traded notes)

Answer 45

instead of making interest payments, ETNs pay returns based on the underlying index. maturities: 10-30 yearsl

unsecured debt payments – very similar to bonds

Question 46

Hedge funds

Answer 46

only for accredited investors so not required to register with the SEC via the investment company act of 1940
illiquid: not required to publish NAV daily
sales charge<8.5% of fund offerings
no active trading volume

Question 47

REITs

Answer 47

• create a pool of real estate investors to buy residential and commercial income producing real estate
  categorized under securities act of 1933

2018 tax reforms:
- only taxed once at the dividend level, not the annual profits level like corporates
- 20% of the income that’s distributed by REITs is deductible (excluded from tax)
- max tax rate on ordinary income is lowered to 37% from 39.6%

1. Mortgage REITs: borrowing investor funds to buy mortgages, earn spread, interest rate sensitive
2. Equity REITs: own & operate income producing real estate like commercial, retail. shopping malls, vacation resorts
3. Hybrid REITs:

Question 48

Direct Participation Programs (DPPs)/ Limited partnerships

Answer 48

GP (manages program and must contribute at least 1% of the program’s capital) and LP (passive)

general partnerships, joint ventures, limited liability companies, and subchapter S corporations

PROS
1. tax benefits: 20% of the income that’s passed through by partnerships is deductible
- max tax rate on ordinary income is lowered to 37% from 39.6%
2. limited liability
3. Diversification

CONS
1. limited control as a limited partner
2. illiquidity
3. tax issues
4. possible capital call: additional contribution requests
5.

Question 49

bond priority in liquidation

Answer 49

1. secured creditor
2. general creditor
3. limited partner
4. general partner

Question 50

DPP offering practices

Answer 50

IPO will involve GP hiring underwriter (aka syndicator)

Question 51

Comparison of alternative investments (ETF, ETN, Hedge Fund, PE fund, REITs, DPPs)

Answer 51

pg 127

Question 52

real estate limited partnerships

Answer 52

for capital appreciation: raw land, new construction

for immediate cash flows: existing properties

for tax credits: government assisted housing

Question 53

Types of oil and gas limited partnerships

Answer 53

1. Exploratory program: aka wildcatting, involves searching for oil and gas in unproven areas. high risk ventures
2. Developmental program: leases are acquired for the right to drill in proven areas. lower potential return
3. Balanced program: a hybrid of exploratory and developmental programs
4. Income program: acquires interests in already producing wells. safest. best for risk averse

Question 54

Options

Answer 54

contract whose value is derived from the movement of an underlying stock, index, currency, or other asset
buyer pays the premium and receives the right/option to exercise
(to buy or sell the contract at a specific time and date). Other party is required to fulfill the contract if buyer exercises it

however if option expires, premium = buyer’s loss

Question 55

Options Buyers and sellers (synonyms)

Answer 55

buyers: holder, long
sellers: writer, short

Question 56

types of options

Answer 56

Call: right to buy
- buyer: bullish (want underlying asset to rise)
- sellers: bearish (want asset to fall)

Put: right to sell
- buyer (bearish): want asset to fall
- seller (bullish): want asset to rise

Question 57

option premium formula

Answer 57

PRICE of an option

option premium = intrinsic value + time value

time value: portion of an option’s premium that exceeds its intrinsic value (an index for time before option expires)
Intrinsic value: option will only have intrinsic value if it is “in-the-money”

Question 58

“in the money”, “at the money”, “out of the money” for calls and puts

Answer 58

Call:
- in the money: stock’s market price is above the strike price (cheaper to buy option than stock)
- at the money: stock’s market price is the same as strike price (intrinsic value is 0)
- out of the money: stock’s market price is lower than strike price (intrinsic value is 0)

Put:
- in the money: stock’s market price is lower than strike price (you can sell option for more than the stock)
- at the money: stock’s market price is the same as strike price (intrinsic value is 0)
- out of the money: stock’s market price is above the strike price (intrinsic value is 0)

Question 59

Breakeven:

Answer 59

price at which a stock must be trading so that an investor will neither lose nor make money

breakeven point = strike price + premium

Call UP (stock rises), put DOWN (stock falls) to find breakeven for both buyers and sellers

Question 60

speculation vs hedging

Answer 60

speculation: generating a profit based on an anticipated price change. Ex: buying a call in anticipation of stock rising or a put in anticipation of stock fall. Sellers anticipate that contracts will expire useless.

hedging: purchasing options to protect against risk. Ex: buying a put locks in the price they’re able to sell for (strike price) if the underlying stock falls in value.

Question 61

liquidating to close out of an options position

Answer 61

if you bought, sell. If you sold, buy.

difference between what the investor pays and what he sells is the profit lost or made.

May 30 –> 30 is the exercise price.

Math: for example an investor bought an XYZ May 30 call at 3. Later, XYZ stock increased to $40 and the investor liquidates the position for its adjusted premium of 11 (10 points of intrinsic value and 1 point of remaining time value). Since the investor originally paid $300, but later sold the call for 1100, his gain is $800.

work: intrinsic value (40-30 = 10
premium = 10+1=11
price bought: premium x number of shares= 3 x 100 = 300

Question 62

exercising to close out an options position

Answer 62

1. american style:
2. european style:

Question 63

The options clearing corporation’s role in options trading

Answer 63

issues and guarantees listed option contracts (by doing so, they eliminate counterparty risk.)

Question 64

exercising an equity option process flow

Answer 64

person who wants to long&raquo_space; broker dealer»OCC»(using random selection) broker dealer» (using random, FIFO first come first serve, or a fair and equitable method)&raquo_space; ppl who want to short

settles between broker dealers in 1 business day

important options dates/times: most expire the first friday of expiration month at 11:59 pm but buyer must notify brokerage of intent to exercise option by 5:30 pm. At 4 pm options stop trading.

Question 65

Index options

Answer 65

unlike equity options: these options are cash settled

Question 66

covered vs uncovered options

FOR SELLERS

Answer 66

covered call: when you own the stock and sell calls

uncovered call: when you don’t own the stock and sell calls