Characteristics, uses, and taxation of investment vehicles Flashcards
Common stocks
- ownership in a corporation
- entitled to vote
- may receive dividends
- most junior, last to receive income if corporation is liquidated
Capitalization
market value of a compnay
- large cap: 10 B < x
- mid cap: 2B < x > 10 B
- small cap: 2 B > x
- micro cap: 300 M > x
Corporate Report - Annual report
written by corporate management for its shareholders
- explains previous year results
- provides financial data and report by independent auditors
Corporate Report - 10Q
quarterly reports from corporate management to SEC
Corporate Report - 10K
annual reports from corporate management to SEC
Preferred Stock
- hybrid security: both equity and debt
- typically issued at $25 par or $100 par with stated dividend rate
- pays fixed dividend rate (different than common)
- perpetual: infinite duration, more sensitive to interest rate changes
- cumulative or noncumulative
Cumulative vs noncumulative stock
when dividend payments are missed….
cumulative: pay all dividends in full before any payment to common stockholders is allowed
noncumulative: missed dividends do not have to be made up
Preferred stock investors
typical buyer is corp with excess funds on hand
- interest is taxable with bonds, with preferred usually 50% is tax free
Preferred stock dividends
- for annual dividend to be qualified: must own for 90 days in 181 day period that begins 90 days before ex-dividend date
American Depositary Receipts (ADRs)
buy foreign shares in the US
- instead of buying foreign companies overseas
- ADR: receipt for shares of foreign corp held in US
- entitled to dividends (paid in dollars)
- prices quoted in US dollars
- dividends declared in country of origin but paid in dollars
Exchange Traded Funds (ETFs)
- basket or index of stocks
- open ended: UIT, investment company or closed ended
- traded on exchange
- broadbased track large groups of stock
- more tax efficient than mutual funds
Unit Investment Trusts (UITs)
- no day to day portfolio management
- unmanaged portfolio created by sponsor and handled by trustee
- passive investment of frozen assets not traded
- no new securities purchased and rarely sold
- trust collects income and repayment of principal
- self liquidating : as funds are received, they are not reinvested, distributed to unit holders
- buy and sell used units, traded NAV
Mutual Funds
- open ended
- cap always changing as people buy and sell
- NAV computed at end of day = total market value / number of shares
- possible sales change to compensate professionals
- redeemable not tradeable
Closed-end investment companies
- funds issued once then books are closed
-no new shares issued - shares trade on exchange
-can hold illiquid securities
Types of funds
aggressive growth: maximum capital appreciation
balanced: both stocks and bonds (not necessarily 50/50)
growth: securities potentially offering rising share price. dividends are least important
growth and income: equity securities and seeks dividend income
global equity: securities worldwide, including US
international: securities only outside US
corporate bond: US based companies
GNMA: mortgage backed securities
high yield: non-investment grade corporate bonds
municipal bond: issued by states and municipalities
specialty: particular sectors
Index funds
- invest in stocks/bonds that are components of various indexes
- emphasize tax efficiency through minimal portfolio turnover
Hedge funds
- aggressively managed investment portfolio using advanced strategies (leveraging, long, derivative)
- goal to generate high returns in down and up markets
- open to limited number of investors with large minimum deposit
-illiquid, must keep in for 1 year - less regulated
- accredited investors
- 100M or more must register with SEC
Limited partnerships
- real estate, oil, gas
-blind pool
Guaranteed Investment Contracts (GICs)
- similar to CDs
- issued by insurance companies
- 2-5 years
- guaranteed interest rate
- value does not fluctuate with interest rates
- value depends on financial strength of issuer
- popular for DB plans
Real estate
- hedge against inflation
- low correlation with US common stocks
- diversification potential
Unimproved vs improved land
Unimproved: passive, no income or depreciation, return is price appreciation, possible negative cash flow for upkeep
Improved: generates income from rentals, NOI used for intrinsic value
Net Operating Income (NOI)
Gross rental receipts
+ non-rental income
= potential gross income (PGI)
- vacancy and collection losses
= effective gross income
- operating expenses
= Net operating income NOI
vacancy= PGI * %
operating expense = excludes interest and depreciation, only actual cash expense
Property’s intrinsic value
NOI / Capitalization rate
Real Estate Investment Trust (REIT)
- invests in real estate, construction, mortgages
- diversification and marketability
- exchange or OTC
- nonpublic REITs and limited partnerships are not liquid or marketable
- at least 75% of income must come from real estate
- 90% of income gets distributed, only taxed on undistributed amount
- if fails to distribute 90% then all of it is taxed
- shareholders can deduct 20% pass through income
Equity REITs
- invest in income producing properties
- use leverage to finance property purchases
Mortgage REITs
- make loans to develop property
- purchasing power risk
Real estate limited partnership (RELPs)
-non publicly traded relatively illiquid
- 10-20 years or until liquidated
REIT vs RELP
- REIT: portfolio investment, subject to taxation, actively traded, managed by BOD
- RELP: subject to passive loss rules, not marketable, managed by general partner
Real estate mortgage investment conduit (REMICs)
- limited life, self liquidating entity
- invests exclusively in real estate mortgages or in securities backed by real mortgages
- more flexible than CMO, may end up replacing them
- can separate mortgage pools into different maturity and risk classes
Derivitives
value is based on underlying asset or group of assets
- one option invloves rights or obligations relative to 100 shares
Options - Intrinsic value
minimum price an option will command
EP-MP (put)
MP-EP (call)
Options - Time premium
amount the MP of an option exceeds IV
1. premium paid - IV
Options - Exercise price
strike price
price at which the stock can be purchased or sold on exercise of the option
agreed price
Options - Premium
MP (cost) of option
how much it costs to buy an option
as option approaches its expiration date, the market price of the option approaches its intrinsic value
Put Options
- I buy a put option, it gives me the right to sell shares at specific set price for given time period before it expires
- I hope the stock will go down (bearish) because then I can buy it at the lower price and sell it to the writer at the higher exercise price
- writers (sellers of options) want the price to increase, so I can never exercise my option. they still get premium income
- EP(agreed price)-MP(what I buy it for) =IV
- If IV is positive i am in the money, if its 0 i am out of the money. (cant be negative)
Call option
- I buy a call option, I have the right to buy shares at a specific price for a period of time
- I am bullish, i think the shares will increase in value. Writer is bullish and thinks the stock wont rise
- If they are right they keep premium income and stock (if covered)
- If I am right then I buy the stock from them at a lower price than is currently trading
- If IV is positive then MP> EP. IF IV is 0 then EP>MP
Covered call
call written on a stock that is already owned by writer.
call premium can help offset decline in stock when exercise price isnt met
Naked call
selling call option without owning the stock
Options: time to expiration vs volatility
MP = EP (at the money, no IV)
greater volatility, greater price of option
if it has a long expiration, premium is probably due to time value. if it has a short expiration probably due to volatility (speculative)
Call option taxation - 9 mo or less
- at purchase, premium is nondeductible expenditure
- when exercised, premium is included in basis of stock
taxation for writer
- option lapses: premium is ST gain
- option exercised (covered call): premium added to sale price (LT or ST)
taxation for holder
- not exercised: option considered sold, ST loss
Long term equity anticipation securities (LEAPs)
option with maturities 2 years and beyond
for investors to assume long term market movements
Futures contracts
agreement between buyer and seller, through commodity exchange for future delivery of commodity at specified date and price
- very risky, due to leveraged margin requirements
- business may use to hedge (protect) against certain business risks
Futures - spot price
current market price of a commodity in the cash market
Futures - open interest
number of futures contracts trading for a particular commodity on any given day
Futures - daily limit
maximum permissible price increase or decrease relative to the settlement price on the previous day
3 types of futures contracts
- commodity
- financial
- foreign currency
Margin of futures contracts
initial deposit is the good faith amount
if market moves against investor and the value of the contract drops by more than initial margin - maintenance margin, there will be a margin call. that will require investor to deposit additional cash to restore initial margin
Futures - 2 ways to settle
delivery: settlement, delivery of good
offset: buyer sells position, seller buy position prior to delivery, cancel each other out
Futures - long vs short
long position - wants to buy commodity (bullish)
short position - wants to sell commodity (bearish)
Warrants
similar to call option - option to buy in specified time for stated number of shares.
Differences from call
- warrants issued by corporations, not individuals
- warrants have maturities lasting several years, not 9 mo
- warrants terms are not standardized like calls
- warrants are issued with no intrinsic value
Tangible Assets - Collectibles
rare objects
- coins
- stamps
- rugs
- antiques
typically rise in value during inflationary times
difficult to do because of limited number of buyers and sellers
little regulation
- negative correlation to market, diversifier
LTCG rate is 28%, different than others
Tangible Assets - Natural resources
- diversification
-negative correlation to stock market - elastic = sensitive to price changes
Tangible Assets - precious metals
inflation hedge, 28% tax rate
- bullion
- gold mining stocks
- futures
-coins
- gold mutual funds
Private placement - Regulation D
not public offering
- exempt from formal registration, full disclosure still needed
- max 35 non accredited investors (must be sophisticated), unlimited accredited
Accredited investor
-individual with NW 1M (excluding primary residence)
- annual income 200k - individual
- annual income 300k - couple
- 1 2 3 test
Qualified purchaser
- non accredited investors who cannot evaluate issue on their own need services of purchaser representative (lawyer, accountant) to help them evaluate and sign letter
- qualified purchase: 5 M in investments
