Investment Vehicles Flashcards
What is an Issuer?
An organization that distributes and sells securities to investors, or a group of people that raises capital by offering securities to investors
Example: Coca-Cola is the issuer of Coca-Cola stock.
What type of security is common stock?
Common stock is referred to as an equity security.
What does it mean to be ‘Long’ or ‘Go Long’?
Long is finance jargon for owning a security
Example: the investor is long (owns) 100 shares of GE stock.
Going long is finance jargon for purchasing ownership in a security
Example: the investor goes long (buys) 100 shares of GE stock.
What is a security?
A legal term for a specific type of investment
Examples: common stocks, bonds, mutual funds, ETFs, options
What are Retained Earnings?
Profits retained by a company - these are often used to expand and reinforce business operations
These earnings are not paid to investors by dividend
Stock prices are driven by supply and demand
Retained earnings: Profits retained by the company
Stockholder rights
Right to pro-rate share of dividends
Right to vote for Board of Directors
Right to inspect books and records
Right to maintain proportionate ownership
Right to assets upon dissolution
Right to transfer ownership
Dilutive actions:
Reduce proportionate ownership
May be required to be approved by stockholders
Rights offerings avoid dilution
Corporate liquidation priority
Unpaid wages
Unpaid taxes
Secured creditors
Unsecured creditors
Junior unsecured creditors
Preferred stockholders
Common stockholders
What are two types of redeemable securities?
Mutual Funds (Open-ended management companies)
Unit investment trusts
What is another term for mutual funds?
Open-ended management companies
What is the definition of Settlement? What is the standard timeline for the most common type of settlement?
Settlement refers to the day the stock is “officially” in the buyer’s possession.
Most trades execute through regular-way settlement, which occurs on the second business day after the transaction (known as T+2 - trade date plus two business days).
NOTE: Weekends and holidays do not count towards settlement time frames
Negotiable securities
Trade in the secondary market between investors
Common stock is negotiable
Most securities are negotiable
Redeemable securities
May only be bought and sold with the issuer
Primary market
Where issuers offer securities to investors
IPOs are a type of primary market transaction
Secondary market
Where investors trade securities with other investors
Issuer transaction
Sale of securities where the issuer keeps proceeds
Takes place in the primary market
Common example: IPOs
Non-issuer transaction
Sale of securities where a party other than the issuer keeps proceeds
Takes place in the secondary market
Where securities trade after their initial sale
American depositary receipts (ADRs)
US-registered receipts for foreign investments
Created by domestic financial firms with foreign branches
Trade in US dollars in US markets
Subject to currency exchange risk
No voting or pre-emptive rights
Foreign government tax withholding creates a US tax credit
Foreign investing
Adds diversification to portfolios
Subject to currency exchange risk
Currency exchange risk
Currency conversion negatively affects investment
Weak domestic currency
Unfavorable converting into foreign currency
Favorable converting out of foreign currency
Strong domestic currency
Favorable converting into foreign currency
Unfavorable converting out of foreign currency
Emerging markets
Traditionally smaller economies
Increasing economic growth
High risk & return potential
What is the definition of Yield?
Yield is a term to describe the overall rate of return on an income-producing investment.
Preferred stock characteristics
Form of ownership (equity)
Market prices are influenced by interest rates
Considered a fixed income security
Preferred stock settlement
Regular way: T+2
Cash: same day if prior to 2:30pm ET
Preferred stock dividends
Must be approved by the BOD
Typically paid on a semi-annual basis
Preferred stock par value
Also known as face value
Typically $100 for preferred stock
Could also be $25 or $50
Never fluctuates
Dividend rate based on par
Yield
Represents overall rate of return
Based on market price and dividend rate
Continually fluctuates
Yield and market price are inverses
Low market price = high yield
High market price = low yield
Current yield formula
CY=
market price
annual income
Fixed income market prices
Discount = trading below par
Premium = trading above par
Rising interest rates
Fixed income market prices decline
Falling interest rates
Fixed income market prices increase
Cumulative preferred stock
Issuer must eventually pay skipped dividends
Beneficial feature for investors
Lower rates of return (vs. straight)
Straight (non-cumulative) preferred stock
Issuer does not pay skipped payments
Beneficial feature for the issuer
Higher rates of return (vs. cumulative)
Participating preferred stock
Eligible to receive more than the stated dividend rate
Issuers pay more in profitable years
Beneficial feature for the investor
Lower dividend rates (vs. non-participating shares)
Trades at higher prices and lower yields
Call features
Allows issuer to end an investment by paying back its par value
Calls typically occur when interest rates fall
Beneficial for the issuer
Sold with higher dividend rates (vs. non-callable)
Lower prices & higher yields
Used by issuers to refinance
Call protection
Number of years before security can be called
Call premium
Amount above par required to call shares
Convertible preferred stock
Convertible into common stock of the same issuer
Beneficial feature for investors
Sold with lower dividend rates (vs. non-convertible)
Higher prices & lower yields
Conversion ratio
CR=
conversion price
Par
Conversion price
CP=
conversion ratio
Par
Common stock parity price
Price paid per common share based on convertible security market price
PPoCS=
Conversion ratio
Preferred stock market price
Preferred stock parity price
Value of preferred stock based only on the conversion feature
PPoPS=common stock market price x conversion ratio
Bond parity price
Value of bond based on its conversion feature
BPP=stock price x conv. ratio
Anti-dilution covenant
Prevents issuer from performing dilution actions without adjusting the conversion feature
Involved when stock splits occur
Conversion ratio goes up
Conversion price goes down
Rule 144
Rule covering restricted and control stock
Restricted stock
Stock not registered with the SEC
Subject to a 6 month holding period
Control stock
Stock owned by an affiliate (insider)
Subject to volume limitations
Affiliate
Officer, director, or 10% shareholder
Security sales subject to volume limitations
Form 144
Filed if control or restricted stock intended to be traded in the next 90 days
Only must be filed if more than
5,000 shares, or
$50,000 total value sold
Form 4
Filed if an affiliate trades control stock
Must be filed within 2 business days of trade
EDGAR
Electronic filing system for SEC forms
Form 144 and Form 4 are filed on this system
QIB (qualified institutional buyer)
$100 million or more of investable assets
Rule 144A
QIBs are not subject to rule 144
QIBs avoid holding periods and volume limitations
Cash dividends
Taxable income received from common or preferred stock
Tax rates:
Qualified = 15% or 20%
Non-qualified = up to 37%
Reported on tax form 1099-DIV
Progressive tax systems
Higher taxes if more money involved
Examples:
Income taxes
Estate taxes
Gift taxes
Regressive tax systems
Flat tax rates
Examples:
Sales taxes
Excise taxes
Capital gain
Securities sold for more than the basis
Reported on tax form 1099-B
Share selection methods for sales
FIFO
LIFO
Specific share identification
Is the best method to reduce taxation
Capital loss
Securities sold for less than the basis
Reported on tax form 1099-B
Long-term capital gain
Gain on security held more than 1 year
Tax rate: 15% or 20%
Short-term capital gain
Gain on security held for 1 year or less
Tax rate: up to 37% (income tax bracket)
Fundamental analysis
Inspection of a company’s finances
Balance sheet
Compares company assets and liabilities
Indicates a company’s net worth
Net worth
Determines overall value of company or person
NW=assets - liabilities
Income (cash flow) statement
Displays company income and expenses
Footnotes
Provides additional context for information in financial statements
10-K annual report
Audited financial report
10-Q quarterly report
Unaudited financial report
Current assets
Assets able to be converted into cash within one year
Current liabilities
Liabilities owed now or will be within one year
Measures ability to pay short term obligations
Net working capital
NWC=current assets - current liabilities
Determines liquid cash and marketable assets on hand
Quick assets
QA=current assets - inventory
Quick ratio
Also known as the acid test ratio
QR=
current liabilities
current assets - inventory
Used to determine a company’s liquidity
PE ratio
PE=
earnings per share
market price
High PE ratios
May indicate an overpriced investment
Typical of growth companies
Low PE ratios
May indicate an underpriced investment
Typical of value companies
What’s another name for the quick ratio? What does it measure?
Acid test ratio.
It measures a corporation’s liquidity.
What is the corporate dividend tax exclusion rule?
Corporations avoid paying taxes on dividends
They get a 50% exemption if owning less than 20% issuer’s common stock
They get a 65% exemption if owning 20% or more of the issuer’s common stock
What’s the equation for Net Worth?
Net Worth = Total Assets - Total Liabilities
What’s the equation for the Quick Ratio?
QR = (Current Assets - Inventory) / Current Liabilities
True/False: Does preferred stock have a higher tax rate than Bonds?
NO: Preferred stock has a LOWER tax rate than bonds
What’s the equation for Current Ratio?
CR = Current Assets / Current Liabilities
What’s the equation for Net Working Capital?
Net Working Capital = Current Assets - Current Liabilities
