Characteristics, uses, and taxation of investment vehicles Flashcards
1
Q
Cash and Cash Equivalents
A
the hallmark of cash and cash equivalents is their liquidity. Liquidity is the ability to sell or redeem an investment quickly at a known price, without incurring a significant loss of principal.
2
Q
Certificate of Deposit (CD)
A
- deposits made with a bank or savings or loan for a specified period of time, usually no more than a year.
- negotiable CD’s are deposits of $100,000 or more placed with commercial banks. They may be bought and sold on the open market
3
Q
Money Market Funds
A
- invest in high quality short-term instruments, such as negotiable CD’s, commercial paper, and T-bills.
- Are not insured by FDIC.
4
Q
Treasury Bills
A
- maturities ranging from 4 to 26 weeks
- considered to be default risk free and is often used as a proxy for the risk free rate of return when determining an investors required rate of return.
- sold at a discount
5
Q
Commercial Paper
A
- unsecured private sector promissory note
- maturities are 270 days or less
- slightly higher yield than T-bills
6
Q
Bankers Acceptances
A
- securities that serve as a line of credit issued from a bank to finance imports and exports.
- companies too small to use commercial paper will use bankers acceptances to fund short-term debt needs.
- Trade at a discount from their face value on the secondary market.
7
Q
Eurodollars
A
- U.S. dollar denominated deposits at banks located outside of the united states.
- has a maturity of less than 6 months.
- they are bank loans to very credit-worthy foreign companies that are taxed like a domestic CD.
8
Q
Registered and bearer bonds
A
- registered bonds are registered with the corporation or organization and any payments will be paid to the individual of record.
- bearer bonds can be transferred like cash and the debtor will pay the person who holds the bearer bond
9
Q
Yield to Maturity (YTM)
A
- the internal rate of return for cash flow associated with the bond, including the purchase price, coupon payments, and maturity value.
- market rate > YTM = discount bond
- market rate < YTM = premium bond
10
Q
Doctrine of reciprocity
A
-interest payable on US Treasury notes and bonds are free of income taxes at both the state and local levels.
11
Q
Treasury STRIPs
A
- the Federal Reserve assists in separating the interest and principle components of the bonds.
- Issued at a deep discount to par
- it is purchased through financial institutions and government securities brokers and dealers
- it may not be purchased directly from the U.S Treasury
12
Q
Treasury Inflation-Protected Securities (TIPS)
A
- the principle value of the bond is adjusted for changes in the CPI, and the semi-annual interest payments received by the investor are determined by multiplying the inflation-adjusted principle value by one-half of the stated coupon payment.
- the coupon RATE remains the same for the life of the security, but the coupon PAYMENT changes based on the value of the inflation-adjusted principle of the securities.
13
Q
Series EE bonds
A
- interest rate is fixed for the life of the bond.
- the value of the bond is guaranteed to double after 20 years
- may be purchased for an amount that is equal to 50% of its face value and for a minimum amount as lows as $25.
- Interest is not taxable until the bonds are redeemed or reach maturity
- interest may be completely excluded from gross income if the bond proceeds are used to pay for qualified higher education expenses.
14
Q
Series HH Bonds
A
-Existing series HH bondholders pay taxes on the interest accrued semi-annually.
15
Q
Series I Bonds
A
- Like EE bonds, interest accrues over time, with the feature of income tax deferral
- Unlike EE bonds, they are sold at face value.
- interest rate earned is a combination of two separate rates: 1) a fixed rate of return that remains the same and 2) a semi-annual inflation rate based on the changes in the CPI during the previous 6 month period.
- interest may be excluded from gross income if used for qualified higher education expenses.
16
Q
Mortgage-Backed Securities
A
- GNMA ‘ginnie mae” is backed by the full faith and credit of the united states govt
- FNMA “fannie mae” and FHLMC “freddie mac” have only implied or indirect backing by the govt through federal subsidies.
- All agency issues are taxable at both the state and local levels.
17
Q
Zero-Coupon Bonds
A
- Eliminate reinvestment risk because no payments are made until the bond matures
- require taxes to be paid currently on the accrued interest each year.
18
Q
Term or Serial Payments
A
- principle on term bonds is repaid in full upon maturity
- serial bonds require the municipality retire a certain sum of the bonds issued each year.
- most municipals are issued with serial payment provisions.
19
Q
Debenture
A
- applies to any unsecured long-term corporate bond
- viewed as being more risky than a secured bond and therefore has a higher yield.
20
Q
Summary of Common Stock “BIG CID”
A
- Blue chip stocks
- Income stocks
- Growth stocks
- Cyclical stocks
- Interest-sensitive stocks
- Defensive sensitive stocks
21
Q
Cyclical Stocks
A
- automobiles
- cement
- paper
- airlines
- railroads
- machinery
- steel
22
Q
Defensive Stocks
A
- utilities
- soft drinks
- groceries
- candy
- drug/pharmaceuticals
- tobacco
23
Q
Street Name
A
-when brokers hold stock for investors (such as in a brokerage account)
24
Q
Date of declaration
A
-the date the board of directors approves and declares that a dividend will be paid.
25
Ex-dividend Date
- the date that the market price adjusts for the dividend
| - normally two business days before the date of record
26
Date of record
- the date at which the company will determine who owns stock in the company and is therefore, entitled to the dividend.
- shareholders who purchase the stock between the date of record and the date of payment are not entitled to the dividend.
27
Date of Payment
-the date that the company pays the dividend to the shareholders.
28
American Depository Receipts
- represent ownership interest in foreign securities denominated in U.S. dollars and are issued by banks in foreign countries.
- eliminate the exchange risk that otherwise occurs when a direct purchase of foreign securities is made.
- dividends declared are first declared in the local currency
29
Unit Investment Trusts (UITs)
- a fixed pool of securities, usually municipal bonds, with each unit representing a proportionate ownership in that pool.
- hold passive investments
30
Closed-end Investment Companies
- only has a fixed number of shares available and trade between investors on the secondary market at whatever price supply and demand dictate.
- may trade at either a premium or discount to their NAV
31
Guaranteed Investment Contracts
- also called "stable value funds"
- securities sold by insurance companies primarily to pension plans.
- the rate of return is guaranteed for a fixed period of time.
- returns are relatively low because little risk is involved
32
Put Bonds
- the owner of the bond can choose to hold onto the bond if its coupon rate is higher than comparable market yields.
- the bond can be "put" or sold at an agreed time should the coupon be lower than market rates.
- the bond principal is then reinvested at current market yields.
33
Term Structure of Interest Rates
-refers to the relationship between the rates of interest on securities that have similar characteristics but different terms of maturities, as illustrated in a yield curve relating interest rates to maturities.
34
Market Segmentation Theory
-the more distant the maturities of two different securities are from each other, the lower the probability that the two securities will be substitutes for each other.
-the interest rates for short-term securities is determined by the supply of and the demand for short-term funds. Same holds true for long term funds
-
35
Unbiased (rational) expectations theory
- the shape of the yield curve is a function of expectations concerning future interest rate movements.
- an upward sloping yield curve will prevail if short-term rates are expected to increase in the future.
- the yield curve will be downward sloping if short-term rates are expected to fall in the future.
36
Liquidity Preference Theory
-holds that there is more uncertainty over the long-term than the near term, so investors will demand a premium for giving up liquidity for a longer period. Therefore, the yield curve will usually be rising.
