Part 3 Flashcards
Common Stock
Is equity (ownership) in a corporation. Firm issues capital and investors buy stock become owner. Assets less liabilities belongs to owner.
-Preemptive rights
Preferred Stocks
Usually not the same voting rights or appreciation potential. Pays a fixed Q dividend a priority claim over common stock. Common stockholders cant receive a dividend until preferred are paid. bankruptcy, preferred have priority.
PF Stock
Fixed rate of return but is still ownership
Price fluctuates with interest rates like fx income (fixed dividend payment)
-Not the same voting rights
-Have priority after debtors
-Non voting
-generally no preemptive rights
Features of equity securities
-Growth (capital gains)
-Income (dividend though not an obligation on the firm)
-Stock dividend (additional shares given) or property dividend (share in a subsidiary.
-limited liability
-liquidity
Unrealized gains
Not taxed until realized. Most dividends and L capital gains are taxed around 15%.
Stock dividend
-Additional shares of stock given to save the cash.
Two things to know:
1. Prices of stock will drop (no new money for new share so overall value remain the same) Share increase but prices decrease value the same.
2. S D are not taxed when received. not taxed until sold and the effect of reducing the investor’s cost basis per share.
Stock certificate transfer agents
must be registered with SEC.
Types of P stock
-Straight (noncumulative): nothing special beyond dividend pmt. missed dividend not paid
-Cumulative: accrues payments due in the event divs. are reduced or suspended. when they decide to pay, pf receive current div and old div (arrears) before div paid to common stock
Callable Preferred
-right to call preferred stock. allows firm to replace fx div obligation like refinancing a mortgage
-Pays a premium for the call
-Client will have to re invest proceeds at a lower rate (reinvestment risk)
-Dividend rate is generally higher on these
Convertible preferred
Exchanged to a share of common stock
value pretty same as common so they fluctuate with common
lower price cuz of potential capital gains chance once converted
adjustable rate preferred
Adjustable rate dividends as often as every quarter
Benefits and risks of Preferred
- Fx income from div.
- Prior claim ahead of common
- Convertible low income but potential appreciation once converted.
- Similarities to debt securities but no maturity date so like a perpetual security.
Risks:
a. market risk (inability of firm to keep paying if market is bad)
b. possible loss of purchasing power
interest rate risk
business difficulties leading to reduction of divs. or losing the principle.
Stock Option strike price
Called grant or exercise price must be at least the market prices of the stock at the time the option is granted.
Hope is the mkt price will go up and the employees can exercise their options and the sell at the higher price.
Two kinds of stock options
- Non-qualified stock options
- Incentive stock options
Non-qualified stock options (NSOs)
Can be offered to board members or even suppliers.
-Difference bt current mkt price and strike price (profit, or bargain), will be reported as wages on tax returns. Subject to all taxes including social security
-Not as a capital gains, but as ordinary income
-Employer gets tax deduction as a salary expense (diff. of the mkt price and strike price)
Incentive Stock Options (ISOs)
Qualified
-IF the stock purchased through ISO is held for at least 2 years after date of grant, and 1 year after the date of exercise, Then profits are treated as long term gain. Otherwise, it is taxes as NSOs.
-Max 10year limit for exercise
ISOs
- No income recognized when option is granted
-No tax due when exercised
-Tax due when stock is sold
-Capital if held 1 year and sold two years after grant
-otherwise, taxed as income
Restricted Stock
-Restricted period and possible volume
COntrol Stock
Person who owns is a control person. Purchase and sell of control stock must be reported to SEC
-They always have volume limits
-No specification, but generally ownership of 10%+ is considered control
Those who wish to sell restricted or control stock
must file 144
Example; Husband 15% owner, Wife 5% wife wants to sell:
He is control but because wife is a spouse (immediate family), then she is considered control person too. Wife needs to file form 144 if selling
American Depository Recipts
Like shares of domestic companies but are shares of foreign sold in the US and in USD.
-Can be exchanged to foreign shares anytime
-Subject to exchange rate risk and Market risk (traded like stocks)
-They are good hedge against inflation because they are stocks. There is little to no liquidity risk
Div. Discount Model
- current value of stocks equal to all future dividends.
-discount dividends to PV.. to get the price of security
Div. growth model
-Predicts a higher stock price as dividends grow
-Not used with preferred stocks because their div. pmt is fixed
Support level for stock
- Price where the stock price bottoms
Resistance level
-Price where the stock’s price reaches a high enough level where there are now more sellers than buyers and the stock no longer rises in price.
Break out
When the price movement penetrates the support or the resistance.
-Once this is seen, there will be a rapid movement in that direction until a new support or resistance is seen.
Technical theories
-Short interest theory (bull, since many sold short, there will be demand to actually buy it and will create a new support.
-Odd-lot theory:fewer than 100 shares. ODL sell, then analyst think it is bullish. Since these traders buy or sell at the wrong time.
-Advance/decline theory:
Regulated by securities act of 1934
Broker dealers and transfer agents
Volume sentiment
A price increase on heavy volume relative to the stock’s normal trading volume is interpreted as an indication of bullish activity.
bond indenture
The term of the loan of a bond
Long term debt
More than 5 years
-Issuers include US gov, Corporations, and State (cities towns called municipal bonds)
T. Bills
-Shrt term debt obligation of US
-4 weeks, 8, 13, 26, and 52 (only issued once every 4 weeks)
-No interest, but bought at a discount. So, at maturity, you get the principle + difference between bought and sold price
-Always a discount
-Only treasury security with no interest
-Highly liquid
-13-week deemed risk free rate
T. Notes
-Pays semi-annual interest
-intermediate maturities
-matures at par value
-noncallable
T. Bonds
Semi annual interest
-Long term maturities
-mature at par value
Treasury Inflation protection securities (TIPS)
-fixed interest rate but adjustable principle rate
-Inflation rises, payment increases. Inflation falls, payment falls.
-lower interst rates
-Exempt from state but not federal tax. When principle is adjusted, increase is considered reportable income for that year even though you don’t receive it until the note matures.
GNMA Securities
-Gov. national mortgage association
-Pass through certificate (mortgage pmts in a pool, then passed through to investors)
-diff on pmt received
1. Pmt are received monthly cuz of the underlying mortgage is monthly
2. Each monthly pmt consists partly interest and partly income.
Interest portion is subject to taxes
-min denomination of $25K and then $1000 increments
Government sponsored enterprises bonds (GSEs)
second only to gov securities in terms of safety. Issue debts or back debts and can issue mortgage backed securities
Federa National mortgage association
Also mortgage backed securities. The major risk associated is pre-payment (form of re-investment risk). Most mortgages are paid out early cuz someone sells the home or refinances. So, investor gets the principle early and can no reinvest back in the same rate. So, it will be a risk of reinvestment.
MBS pros and cons
-Higher rate of return
-complicated instruments difficult to understand
-Prepayment risk due to loan being refinanced
-default risk if the mortgage is subprime
-reinvestment risk
-liquidity risk
Tennessee valley authority
-Largest public power provider and gov corporation
-Bonds are not backed by us gov, but by revenues generated from the projects.
-Credit ratings see a implicit government guarantee
Bond Pricing
Corporate and municiple bonds
Quoted as a percentage of par: 100% equals 1000
Each point is 10$. So, 1/8 is like 1/8 divided by 10 = 1.25
90 1/4 equls 902.50
Government bonds also percentage of par but 0.1 represents 1/32 of 10. 0.3125.
Secured debt Vs. Unsecured debt
-Secured debt backed by various assets of the corporation
-unsecured is just backed by reputation, credit, ec. The interest on debt is always paid first before div on common and preferred stock
-Mortgage Bonds:
-Equipment Trust Certificates: backed by equipment
-Collateral trust bond: When no assets or equipment is available so security is used as collateral.
-Debentures: sold on the general credit of the company
-
Priority
- Secured creditors (mortgage bonds, equipment trust cert., collateral trust bonds)
- Unsecured creditors (general creditors including debenture holders)
- subordinated debt holders
Preferred stockholders
common stockholders
2 types of municipal bonds
- General obligation bonds
- Revenue bonds
Tax equivalent yield
- Interest on corporate bonds are taxable at state and federal level
- Treasury bills income is only taxable at the federal level
- Municipal bonds: Free from federal taxes and also free from state tax if you live in the same state as the issuer.
Two ways to work with a tax equivalent yield (TEY);
1. Coupon on a municiple bond divided by (100-tax bracket) to determine what a taxable security needs to pay to give the same after-tax return
2. taxable security coupon
taxable yield is 8% and you are in 30% tax bracket. So, you pay 30% of the 8% or 2.4% in taxes. So, effectively the after tax yield is 8%-2.4% = 5.6%. So a municipal bond needs to pay about 5.6% to be TEY
Foreign Bonds
Pros:
Potentially higher returns
Diversification
Hedging against a drop in value of USD
Cons:
Currency risk (currency falls against US)
Potentially higher risk of default
Less liquidity
higher trading costs
Euro bonds:
Issued and sold outside of the country of the currency in which it is denominated.
Advantages;
1. Cuz they are USD denominated, no currency risk
2. Rated by US rating agencies so the risk is clear
3. May offer higher yield than domestic bonds
Disadvantages:
-Because they r not registered with sec, there may be a lack of transparency
-Political and country risk
-less liquidity than domestic issues
-Currency risk if denominated in a currency other than home
Parity price
Method 1:
Par 1k
Conversion price 50
Conversion ratio: 1000/50=20.
Then you divide 1200 by 20 = 60. That is the parity price.
If asked for debuture prices while giving the common stock p, multiply the ratio by common stock price
Method 2:
So, 1200 is basically 20% more than par value. So, make 50 plus 20% equals 60
I
Convertible security
Opportunity for ownership and growth
Coupon rate will be lower cuz of potential growth
Stability of a debt security with upside potential of an equity
Generally sell above the parity price
Bond yields
Interest paid.
So, 10% yield equals 100$
If you pay 1200$ for it, then 100/1200 is only 8% return. If you pay 800, then 100/800 is 12.5% return. So regardless, you get a 100 since this company always pays on the interest agreed.
Bond at a discount and bond at premium
YTM always lower than Nominal Yield and Current Yield
If bought at a premium. If bought at a discount, YTM will be higher.
CY
6% bond trading at 800. 60/800 equals 7.5%. This bond is trading at a discount, When prices fall, yield rise. CY is greater than nominal when bonds are trading at a discount
6% bond trading at 1200
60/1200 equats 5%. premium price up equals yield down. CY is less than the nominal yield when bonds trade at premium
Chart ranking yield
Duration
Time it takes for cash flow (int pmt) to repay the invested principle. The higher the coupon rate, the shorter the duration. The shorter the duration, the lower coupon rate. or the longer the duration.
Since zero coupon don’t pay anything, then duration is alway equal to maturity.
DCF
The higher, the more valuable an investment.
Money Market Instruments
Money Market: (Short tem date 6 m to 1 y) mrkt for trading short term loanable funds in the form of securities and loans. Do no tpay interest but are issued at a discount.
Pros:
1. Highly liquid
2. Very Safe
3. Best place to store money when needed soon
Risks:
1. Return low not suitable for long term invst.
2. Fluctuating income; principle reinvested at a different rate
Negotiable certificate of deposit
CDs unsecured time deposits and the money is being loaned to bank for a specific period. Bank will redeem the CD at face value plus interest on maturity date. The only instruments that pay interest. CdS must have 100k in face value to be considered cd.
CDs are called Jumbo CDs (negotiable CDs)
Pay interest semi - annually
Commercial papaer
Short term. unsecured. Exempt from regis. on both federal and state if maturity less than 270 days.
Euro Dollar
Deposit held in home currency outside of home. Lending used LIBOR rate.
LIBOR
World’s common benchmark rate for short term interest rate.
