Chapters 6-10 Flashcards
Memorize
Stock Declaration Date, Record Date, Payment Date
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
What is and who sets the ex-dividend rule
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
Due Bills
Buyer is entitled to due bill for dividend if seller doesn’t deliver security in time (by record date)
Using Cash (same day) settlement
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
Stock dividends
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
Nominal Yield
coupon rate, regardless of price paid
Current Yield (Dividend Yield)
=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
YTM yield to maturity
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
Basis Points
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
YTC yield to call/ yield to worst
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
Cost basis (capital gains and losses)
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
total return formula (total return in numerator, not percent change)
(ending value-beginning value)+investment income
/
beginning value
Inflation adjusted rate of return formula
inflation adjusted return = actual return - rate of inflation
Risk Free Return
Return on T bill (less than 1 yr) or 10 year treasury
What are the Benchmark indexes
- 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)
- S&P 500: 500 stocks, broader measure
- NYSE composite index: all common stocks listed on NYSE
- Wilshire 5000 index: all publicly traded companies
- Major Market Index: 20 well known high cap stocks
- Russel Index: 2000 small cap companies
- The bond buyer municipal index
Open End Management Companies (Mutual Funds) Pros
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
Net asset value (NAV) definition and formula
bid or redemption price
NAV = total net assets/number of outstanding shares
total net assets = securities + cash - total liabilities
Public Offering Price formula
NAV + sales load aka sales charge = POP
Sales Charge % formula
POP-NAV
/
POP
No load funds
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
12b-1 fees
marketing fees for mutual funds
back end loads have higher 12b-1 fees
ex: service fees for maintaining shareholder accounts
Back End Loads and Contingent Deferred Sales Charges (CDSC)
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
Classes of Shares and their loads/fees
INSERT CHART ON PAGE 98
- Class A: front end loads, small or non existent 12b-1 fees; breakpoints available; best for long term investors
- 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
- Class C: level load - ongoing fee (typically 1%) for as long as investors hold shares; best for short term investors (1-3 years)
Breakpoints
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)
adjusted POP formula for a reduced load using breakpoints
POP = NAV/(100%- Sales charge%)
in other words,
POP = NAV/(100%-breakpoint sales charge%)
Structure of a mutual fund (page 91) insert photo
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
categories of mutual funds
- aggressive growth funds: often participate in IPOs
- growth funds: capital appreciation is main objective
- specialized or sector funds
- International and global funds
- equity income funds
- 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.
- bond funds
- index funds
- value funds: invest in “out of favor” companies, often in restructuring – better for long time horizons
- balanced funds: diversified in stocks, bonds, and money market instruments (cash equivalents)
- asset allocation funds: basically balanced funds
- money market funds
letter of intent (LOI)
- 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
Rights of accumulation
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
Redemption Fees
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
3 types of systematic withdrawal plans
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
Prohibited Sales Practices for RRs by Finra
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
Difference between open end funds and Closed End Management Companies/ funds
Table on page 103
Face Amount Certificate Company
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”
Unit investment Trusts (UITs)
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
Annuity
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
fixed annuities
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
Variable annuities
- 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.
Variable annuity expenses
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
Qualified annuity
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
Equity Indexed Contracts (EICs) – long term investments
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%)
Municipal Fund Securities
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
Inverse ETF (short term investment prod)
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
Leveraged ETFs (short term investment prod)
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
ETN (Exchange traded notes)
instead of making interest payments, ETNs pay returns based on the underlying index. maturities: 10-30 yearsl
unsecured debt payments – very similar to bonds
Hedge funds
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
REITs
- 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%
- Mortgage REITs: borrowing investor funds to buy mortgages, earn spread, interest rate sensitive
- Equity REITs: own & operate income producing real estate like commercial, retail. shopping malls, vacation resorts
- Hybrid REITs:
Direct Participation Programs (DPPs)/ Limited partnerships
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.
bond priority in liquidation
- secured creditor
- general creditor
- limited partner
- general partner
DPP offering practices
IPO will involve GP hiring underwriter (aka syndicator)
Comparison of alternative investments (ETF, ETN, Hedge Fund, PE fund, REITs, DPPs)
pg 127
real estate limited partnerships
for capital appreciation: raw land, new construction
for immediate cash flows: existing properties
for tax credits: government assisted housing
Types of oil and gas limited partnerships
- Exploratory program: aka wildcatting, involves searching for oil and gas in unproven areas. high risk ventures
- Developmental program: leases are acquired for the right to drill in proven areas. lower potential return
- Balanced program: a hybrid of exploratory and developmental programs
- Income program: acquires interests in already producing wells. safest. best for risk averse
Options
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
Options Buyers and sellers (synonyms)
buyers: holder, long
sellers: writer, short
types of options
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
option premium formula
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”
“in the money”, “at the money”, “out of the money” for calls and puts
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)
Breakeven:
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
speculation vs hedging
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.
liquidating to close out of an options position
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
exercising to close out an options position
- american style:
- european style:
The options clearing corporation’s role in options trading
issues and guarantees listed option contracts (by doing so, they eliminate counterparty risk.)
exercising an equity option process flow
person who wants to long»_space; broker dealer»OCC»(using random selection) broker dealer» (using random, FIFO first come first serve, or a fair and equitable method)»_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.
Index options
unlike equity options: these options are cash settled
covered vs uncovered options
FOR SELLERS
covered call: when you own the stock and sell calls
uncovered call: when you don’t own the stock and sell calls
