Module 3: Equity Investments and Managed Assets Flashcards
Equity Investing Risks
- Market Risk
- Interest Rate Risk
- Financial Risk
- Business Risk
Rights
Sometimes referred to as subscription rights, are given by the corporation who plans to raise more money via stock issues. This gives the owner the right to buy more shares of the company before someone else does, so it doesn’t dilute their equity holdings in the company. Rights are valued separately and actually trade in their own secondary market during the “subscription period”.
Warrents
Long-Term, customized call options that allows the owner to buy shares of the company at a specified price.
Differences Between Warrants and Call Options (4)
- Warrents are not sold in round lots like a call option. aka 1 call option equals x amnt of shares.
- Warrants are created by the corporation, call options created by an individual.
- A warrant is customized to fit the needs of the corporation, whereas the options is required to follow the OCC guidelines.
- A warrant may not expire for years, whereas the Call Option expires within 9 months on average.
Specific Idenitification Method
When the shares werre bought for cost basis, which is different from the FIFO method.
Difference between Dividend and Interest from a bond
Interest from a bond is a guaranteed payment from a corporation, a dividend is declared by the board of directors
Shareholder of Record
The person who receives the dividend because they are the owner who is listed as such on the record date To be listed as the shareholder of record, the investor must purchase stock before the ex-dividend date
Record Date
is the first dividend date after the ex-dividend date.
Ex-Dividend Date
The first dat eon which a security is traded that a buyer is not entitled to receive a previously declared dividend.
Dividend Reinvest Plans (DRIPS)
The opportunity for shareholders to purchase more stock using the dividends they’ve received.
Reinvested Dividends Taxes
They are streated the same for income tax purposes as those that you receive in the form of cash, however, the amount reinvested in dividends dds to the investors tax basis.
Taxation of Cash Dividends
Qualifying Dividends may be trated at favorable long-term cap gains rates (0%, 15%, 20%) if it meets the following criteria:
- The dividend received is from a domestic corporation or a qualified foreign corporation
- The stock must be held for more than 60 days during the 121 day period beginning 60 days before the ex-dividend date
Non-qualified dividends are taxed at ordinary income tax rate.
Which Dividends are Considered Qualifying?
Most dividends declared by the corporate board of directors of a domestic corporation are considered qualifying dividends and are permitted preferential tax treatment.
- qualified foreign companies
- Corporations, who stock of American depository receipts trades readily on an United States securities market
Stock Dividends
Dividends paid to shareholders of record in the form of additional shares of company stock rather than in cash.
Stock dividends taxation
- Unless they have the option to receive a cash dividend (which would create a constructive receipt), the stock dividend is usually not federally taxable, although it does decrease the basis in the overall holding to reflect the received stock.
Forward Pricing
The purchase or redemption of a mutual fund share is determined at the next NAV calculation after an order is entered
NAV Calculation
assets(cash+value of securities) - liabilities
Mutual Fund Operating Expenses
- Management Fee
- 12b-1 Fees
- Other Expenses
Mutual Fund Management Fees
The fee paid by a mutual fund to the investment advisor for its services related to managing the fund
12b-1 Fees
Fees used to compensate investment advisors on an ongoing basis for selling the funds
Mutual Fund other expenses
Administrative or outside services, such as shareholder recordkeeping, auditing, custodial services, legal services, proxy solicitations, annual meeting costs, directors fees, and state and local taxes
Types of Mutual Funds
Bond Funds equity funds hybrid funds precious metal funds commodity funds
Taxable Bonds Funds
- Primary Objective is to provide current income to shareholders.
Bond Funds vs. Individual Bonds
- Interest Income Changes, it’s not fixed
- Maturity is not fixed
- Yield is calculated differently, a bond funds yield is based on current income relative to its NAV
- Monthly interest distributions
GNMA Funds
These funds hold at least 80% of their portfolios in mortgage-backed securities guaranteed by Ginnie Mae.
Multisector Bond Funds
“Strategic Income Bond Funds” - typically purchase 3 types of bonds: US Government Bonds, high-yield corporate bonds, and foreign bonds (up to 25% of the fund’s portfolio).
Foreign World Bond Fund Risks
Investors should be aware of the potential change in the value of the foreign currency relative to the U.S dollar because some funds won’t gedge currency risk.
Municipal Bond Fund Considerations
- Determining if the interest from them is subject to the alternative minimum tax, and if so, to what extent.
Small Market Capitalization
$2b or lower
Mid Market Capitalization
$2b to $10b
Large-Cap Capitalization
$10b+
Sector Funds
- Invest in specific sectors, must have a minimum of 25% of their assets invested in their specialties.
Index Fund Optimization
If an index contains a large number of stocks or the fund has limited assets, the fund will buy a representative sample of the index’s stocks OR it will use index options or futures contracts to follow an index.
International Funds Correlations with US Funds
- Large Cap International: higher correlation
- Emerging markets: lower correlation
- Frontier markets: lowest correlation
Frontier Markets
- markets less developed than those classified as emerging markets. Exmaples: Ecuador, Kenya, Romania, Panama, and Ukraine
Developed Countries
France, Germany, Great Britain, and Japan
Emerging Market Countries
Brazil, Mexico, Malaysia, China and India
Flexible Portfolio Funds
Give money managers the greatest flexibility in anticipating or responding to economic changes.
Types of Flexible Portfolio Funds
- Lifestyle Funds
- Lifecycle Funds
Lifestyle Funds
Most of these are funds of funds, usually offering three portfolios with different risk levels such as conservative, moderate and growth.
Lifecycle Fund
More commonly referred to as a target-retirement fund or a target date at which the investor will retire.
Precious Metal Funds
- These funds seek an increase i the value of their investments by investing at least 80% of their portfolios in securities associated with gold, silver, and other precious metals.
Gold Fund Uses
Tend to do well in period of political and economic uncertainty, when real interest rates are low, and when inflation rates increase. A weak dollar also encourages investors to buy gold as a way to preserve purchasing power
Silver Fund uses
More closely tied to economic activity. The market for silver is also smaller which makes it more volatile.
Commodity Funds
Generally regarded as inflation hedges because of the direct impact that increased commodity prices can have on measures of inflation. Very volatile funds
Mutual Fund Tax Considerations
Mutual Fund Taxable Events:
- Ordinary Taxable Dividends
- Exempt interest dividends
- Capital gain distributions
You can also receive a tax-free return of capital from the sale of shares; these are considered nontaxable distributions.
If an investor sells shares of a mutual fund, there is a tax owed on any gain.
Mutual Fund Tax Laws
- required that cash from the year’s net gains - those left after taking offsetting losses - must be distributed by December 31st.
Investors Capital Gains Calculation after Selling Shares of a Mutual Fund
Net Sales Price received for the shares (after deducting any expense of sale) less the investor’s basis (or adjusted basis) in the shares.
Three Methods to Calculate Mutual Fund Basis
- Specific Identification Method
- Average Cost Method
- First in, first out (FIFO)
** The specific identification method will generally be the most favorable for the investor, but it requires the investor to keep detailed records and identify to the IRA the exact shares sold.
Closed-End Investment Companies
A company whose shares trade in the same manner that publicly traded stocks trade int he secondary market on a stock exchange or over the counter.
Unit Investment Trusts (UITs)
A type of investment company whose units are sold in the secondary market but not on the major exchanges. Generally known as unmanaged or passively managed, funds because professional managers initially select the securities to be included in the portfolio and then hold those unti lthey mature.
Taxation of UIT
During the term of the trust, the unit holders are taxed like shareholders of a mutual fund, with capital gains, interest and dividends earned by the trust passed through and taxed to the unit holders.
Separately Managed Accounts
An account comprising a diversified portfolio of individual securities managed by a professional money manager.
Advantages of SMA’s
The professional money manager purchases the securities in the portfolio on behalf of the investor, not on behalf of the fund. Also it gives the investor the ability to maintain an individual cost basis in the securities within the portfolio, thereby making it easier for prudent income tax management.
ETF “In-Kind Redemption”
Occurs when the investor redeems some of th shres in the fund for a distribution of some of the fund’s underlying stock. So they are not taxed on the distribution.
Two types of ETF Replication
- Replicate Index-based ETF
- Sample index-based etf
Indexing
The purpose of an indexed portfolio is not to beat the targeted index but merely to match its long-term performance, less any management fees and admin costs.
Hedge Funds
Generally unregistered, privately offered, managed pool of capital for wealthy, financially sophisticated investors.
Hedge Fund Structure
A partnership, with the general partner acting as the investment manager and investors consituting the limited partners.
Hedge Fund Risks (4)
- leverage
- short selling
- higher risk investments
- lack of transparency
Fund of Funds
Hedge fund that consists of several, usually 10 to 30, hedge funds.
Fund of Fund Fees/Values
The FOF has extra fees for the value that it adds in:
- Strategic Allocations
- Tactical Allocations
- Manager Selection
Guaranteed Investment Contracts
Similar to CD’s but are issued by insurance companies , not commercial banks. They are not federally insured.
Participating vs. Nonparticipating GIC’s
Participating = variable return
DCA Does Not Guarentee
A profit for investors. This is especially true if the asset continue to decline in price over the long term and does not rebound.
Value Averaging
Periodic investments designed to ease the investor into the market on a regular basis. This is not equal dollar investments; instead it aims to have hte market value in th eaccount increase by a definite dollar amount at regular and periodic time intervals.
Share Averaging
An equal number of shares of a stock or fund are purchased each period.
DCA, Value or Share Averaging?
It comes down to the amount of time you have to allocate to said strategy and the investor profile
Mutual Fund Selection Factors
- Investment Objective
- Investment Strategy
- Investment Holdings
- Securities Permitted
- Manager Flexibility
- Risk Exposures
- Fund Performance
- Management Continuity
- Fees and Expenses
- Fund Size
- Portfolio Turnover
- Fund Age
- Tax Efficiency
What investment Strategies should be given attention?
- As a general rule, anythign that involves more than 5% of assets is considered material by the SEC.
- leveraging through borrowing
- short-selling
- the lending of securities
- Lack of diversification
- Manager Flexibility
- Investment Style
Manager Flexibility
- Consideration should be given to the degree of flexibility that is given to the fund portfolio manager
Fund Performance
- Consistency of Performance
- Comparing Apples to Apples
- Risk Adjusted Performance
Fund Company Evaluation
- Low Expenses
- Closing Funds
- Bringing out “hot” Funds
- Advertising Short-Term Performance
- Depth and Clarity of Shareholder Communication
- Investment Policies and Restrictions (Redemption Fees, which go back into the fund, not the firm)
- Management ownership of their own funds
- Investment personnel turnover
- Large Bonuses to it’s Executives
Potential Mutual Fund Investing Pitfalls
- New Funds with Great Records
- Top-Ranked Funds
- Fund Performance, Loads and Fees
- Tax Liabilities
- Disappearing Underachievers
- Misleading long-term performance
Mutual Fund Tax Liability Timing
- A purchase of a fund with a large realized gain immediately before a distribution is essentially buying a tax liability because the tax must be paid on those distributions regardless of the amount of time the purchaser has owned the shares.
- Short-Term realized gains are taxed at ordinary income rates.
