Characteristics, Uses And Taxation Of Investment Vehicles Flashcards
What are cash and cash equivalents investments
Treasury bills
Commercial paper
CDs
Money market deposit accounts
Repurchase Agreements (Repos)
Reverse Repurchase Agreements (Reverse Repo)
Bankers acceptance
What are the maturity weeks for treasury bills?
4, 13, 26, and 52 weeks
13 week T-Bills used as a proxy for the risk, free rate of return and various asset, pricing models and asset having the lowest level of risk among available assets
How is interest income taxed on treasury bills
Difference between face value paid at maturity, and purchase price
Taxed at ordinary federal income tax rates
Not subject to state or local income tax
Not taxable until maturity
What is commercial paper and how is it taxed?
Publicly traded short term, unsecured promissory notes, issued by companies to raise cash to finance accounts receivable and inventories. Maturity range from one to 270 days average 30 days
Interest income tax at ordinary income, tax rates in your earned
Gain is taxed or ordinary income (short term Capital loss)
Loss is short term Loss
How was the interest on CD taxed?
Ordinary income
What are Repurchase Agreements (Repos)?
Used by banks and security dealers to finance large inventory of marketable securities tax similar to CDs
What is a zero coupon bond? How are they taxed?
Do not pay periodic interest payments
Issued in trade at discount to par
Pay par value at maturity
Not subject to reinvestment rate risk
Duration equals time to maturity
Taxation - interest accrued taxable, issues with terms longer than one year are tax in the year earned even though the interest is not actually received until maturity, taxable zero-coupon bonds and tax deferred arrangements shld be in an IRA
What are the issue terms of treasury notes?
2, 3, 5, 7, and 10 years
What are the issue terms of treasury bonds?
30 years
What are the appropriate uses of treasury notes and treasury bonds?
High-quality investment is desired
Investor needs an investment that can be used as collateral for a loan
Certain of income is required
Investor designers a marketable investment
Portfolio diversification
How are treasury notes and treasury bonds taxed?
Interest payments - tax in the year received at ordinary rates for federal income tax purposes exempt from state and local income taxes
Sales proceeds - capital gain or loss for federal and state income tax holding period determines either short term or long-term.
What are Treasury Inflation - Protected Securities (TIPS)
Marketable securities, whose principle is adjusted by changes in the consumer price index (CPI)
Issued in terms of 5, 10, and 30 years.
Protest against purchasing power risk
How are Treasury Inflation Protected Securities (TIPS) Taxed?
Taxable income exempt from state and local income taxes
Principal increases tax at ordinary income tax rates in year occurred, increases tax basis
Principle decreases may be deducted against interest income for federal income tax purposes and reduces tax basis
Sales proceeds capital gain or loss for federal and state income holding period determines either short term or long-term.
What are Treasury STRIPS?
Separate Trading of Registered Interest and Principle
What type of US savings bonds are available?
Series EE
Series HH (No longer issued)
Series I
What are Series EE Bonds?
Low risk government back savings vehicle
Maybe used for funding, education cost, and gifting
Has a fixed interest rate
Must be held for at least 12 months three month interest penalty for bonds redeemed within five years of issue
How are series EE bonds Taxed?
Interest tax deferred until maturity or redemption, not subject to state income tax
Excluded from gross income when use for higher education cost
What are Series I Bonds and how are they taxed?
Low risk, inflation, index, savings vehicle
Semi annual inflation rate based on changes in the consumer price index for all urban consumers CPI-U
Taxation - similar to EE bonds
What are mortgage banked securities?
Ownership claim on a pool of mortgages commonly on residential property
What are the types of mortgage backed securities?
U.S. Government Agencies (Backed by the U.S. Government):
Ginnie Mae (GNMA) - no default risk
U.S. Govenment Sponsered:
Fannie Mae (FNMA), Freddie Mac (FHLMC), Sallie Mae (SLMA)
What are the three types of municipal bonds?
General obligation bonds - insure to finance community capital improvements
Revenue bonds - Finance specific projects revenue generated from the finance project is used to repay, riskier than general obligation bonds
Private activity bonds - example would be financing of a sports stadiums
How are taxes treated on municipal bonds?
Interest income is free from federal income tax
Interest income is free from state income tax for residence of the issuing state
What are some of the uses of corporate bonds?
Higher yields than government securities
Diversify equity concentrated portfolios
What is the taxation of corporate bonds?
Interest in income tax at ordinary income
Interest payments are tax deductible by the issuing corporation
Sales proceeds are short term or long-term
Market discount bond (bond purchased below par) - Amount attributed to a market discount generally is not included in the income until sale or disposition that is treated as interest income
Market premium bond - bond purchased above par, at ordinary income tax rates as bond interest is paid. They have to wait until they dispose of the bond to recover the premium.
How do you figure the tax equivalent yield used to compare the advisability of investing in a municipal bond versus a corporate taxable bond?
Tax equivalent yield = r / (1-t)
r = nominal, tax-free rate of term (Municipal bonds return)
t = Marginal tax rate as a decimal (.35, .10, etc)
- note this shows you what an equivalent corporate bond would be to that rate…so anything above that rate wld be better than the municipal rate.
What are the four dividend dates and what do they mean?
- Declaration Date:
Date the board of directors approves, and declares that a dividend will be paid
- Ex-Dividend Date:
Date stock begins trading without the dividend investors who purchased the stock on the day before receive the dividend
- Record date:
Date by which stock trades must be settled for shareholders to receive the dividend one business day after ex dividend date
- Payable date: the company actually pays the dividend.
What is a Preferred stock?
Hybrid security with features of both equity and debt securities
What are some of the differences between preferred stock and common stock?
Preferred dividends must be satisfied before paying dividends on common stock
Preferential right over common stockholders to assets of the corporation upon liquidation
What are the types of preferred stock?
- Cumulative:
Dividends from prior years are paid before dividends are paid on common stock
- Straight noncumulative:
Not paid missed dividends
- Participating:
Receive regular fix dividend plus an additional dividend if common stock dividend exceeds a specific amount
- Convertible:
Issued with the right to convert the preferred shares into a specified number of common shares
- Callable: company may re-purchase preferred shares from investors at a stated call price after a specified date.
What is the taxation on preferred stock dividends if the dividends received are a corporation or the individual investor?
Corporation:
Taxable as ordinary income , allowed as a deduction and amount equal to 70% of the amount received as dividends from a domestic corporation
Individual investors:
Taxable as ordinary income, unless considered a qualified dividend
Suitability
Investors interested in growth should invest in what?
Stock funds
Suitability
Investors interested in income should invest in?
Bond funds
Suitability
Investors interested in immediate liquidity should invest in?
Money market funds
Suitability
Investors interested in tax relief should invest in?
Municipal bond funds
Suitability
Investors interested in maximizing current income should invest in?
Corporate bond funds
What are the two types of partners in a limited partnership and what do they do?
General partner: controls business activities, determines when distributions are made, and has unlimited liability
Limited partners: do not participate in management limited liability
Pass-through income reporting for tax purposes, partners pay tax on partnership income
What are the two types of limited partnerships?
Publicly traded and private limited partnership
What are the advantages and disadvantages for limited partners in a limited partnership?
Advantages: limited liability, startup financing shared, receipt of periodic income
Disadvantages: risky investments, ill liquid, cannot participate in management, sale of interest may be restricted
Rental property provides what to an investor?
Positive cash flow from rents
Little taxable income in early years due to depreciation deduction
Returns from positive cash flow and appreciation
What are some of the basics of owning undeveloped land to an investor who cannot rent it?
Negative cash flows, no rent, property taxes, insurance, maintenance
Returns are from appreciation
Riskier than investing in developed land
What are some forms of indirect real estate ownership?
Real estate limited partnerships (RELPs)
Real estate investment trust (REITS)
Real estate mortgage investment conduits (REMICs)
What are some of the Characteristics of real estate Limited partnerships (RELPs)?
Limited liability
Capital growth through appreciation of property
May distribute income
Passive activity rules apply
How are taxes treated on real estate investment trust (REITs)?
Dividend generally treated as ordinary income, unless classified as qualified dividends
Distributions are classified as long-term capital gains, regardless of shareholders holding period
What are the benefits of international investments?
Diversification, local correlation with domestic securities
Potential higher returns
What are some of the risks with international investments?
Exchange rate or currency risk
Country risk
What are a couple of reasons to invest in precious metals?
Local correlation with equities
Provided a hedge against a declining stock, market and high inflation
What is a key difference between a mutual fund and separately managed account?
Money managers purchasing the securities in the portfolio on behalf of the investor, not on behalf of the fund
And a separately managed account investor directly owns the underlying securities eliminates built-in gains
Mutual fund investor owns shares of fund, not the underlying securities, buy into the existing gains in the fund
