Products And Risks Flashcards
What benefits do common shareholders enjoy?
voting rights, the opportunity for capital appreciation, and current income as well as limited liability.
Why include common stock in a client’s portfolio?
■ Potential capital appreciation
■ Income from dividends
■ Hedge against inflation
What are the risks of owning common stock?
- Market risk—The chance that a stock will decline in price is one risk of owning com- mon stock. A stock’s price fluctuates daily as perceptions of the company’s business prospects change and influence the actions of buyers and sellers. Investors have no assurance whatsoever that they will be able to recoup the investment in a stock at any time. The price of a stock when an investor wishes to sell shares may be higher or lower than when the shares were ini- tially purchased.
- Decreased or no dividend income—A risk of stock ownership is the possibility of divi- dend income decreasing or ceasing entirely if the company loses money. The common stock- holders have the last claim on earnings, and there is no guarantee that dividends will be paid out. The decision to pay a dividend rests with the BOD, and it is not guaranteed.
- Low priority at dissolution—If a company enters bankruptcy, the holders of its bonds and preferred stock have priority over common stockholders. A company’s debt and preferred shares are considered senior securities. Common stockholders have residual rights to corporate assets upon dissolution. Once all debtholders and preferred shareholders are paid, residual funds would be paid out to the common stockholders. Common stockholders are the most junior class of investors in a company.
In the event a company liquidates, what is the priority of claims on the company’s assets that will be sold?
- IRS (taxes) and employees (unpaid wages)
- Secured debt (bonds and mortgages)
- Unsecured liabilities and general creditors (suppliers and utilities)
- Subordinated debt (debtholders who agreed to be paid back last of all debtholders in the event a liquidation ever needed to occur)
- Preferred stockholders
- Common stockholders
What are the benefits of owning preferred stock?
- Dividend preference—When the BOD declares dividends, owners of preferred shares must be paid before any payment to common shareholders.
- Priority at dissolution over common stock—If a corporation goes bankrupt, preferred stockholders have a priority claim over common stockholders on the assets remaining after creditors have been paid.
What are the risks of owning preferred stock?
- Purchasing power risk—This is the potential that, because of inflation, the fixed income produced will not purchase as much in the future as it does today.
- Interest rate sensitivity—Like a fixed-income security, when interest rates rise, the value of preferred shares declines. (This will be discussed in greater detail later in this unit.)
- Decreased or no dividend income—Like common stock ownership, there is the possibility of dividend income decreasing or ceasing entirely if the company loses money. The decision to pay a dividend rests with the BOD, and it is not guaranteed.
- Priority at dissolution—While preferred shareholders are paid before common shareholders if a company enters bankruptcy, they are paid behind all creditors.
What are the six types of preferred stock?
- Straight (noncumulative)—Straight preferred stock has no special features beyond the stated dividend payment. Missed dividends are not paid to the holder.
- Cumulative—Cumulative preferred stock accrues payments due its shareholders in the event dividends are reduced or suspended. Dividends due cumulative preferred stock accumulate on the company’s books until the corporation’s BOD decides to pay them. When the company resumes dividend payments, cumulative preferred stockholders receive current dividends plus the total accumulated dividends— dividends in arrears—before any dividends may be distributed to common stockholders.
- Callable preferred—Corporations often issue callable (or redeemable) preferred stock, which a company can buy back from investors at a stated price after a specified date. The right to call the stock allows the company to replace a relatively high fixed dividend obligation with a lower one when the cost of money has gone down. This is similar to refinancing a mortgage. When a corporation calls a preferred stock, dividend payments cease on the call date. In return for the call privilege, the corporation may pay a premium exceeding the stock’s par value at the call, such as $103 for a $100 par value stock.
- Convertible preferred—A preferred stock is convertible if the owner can exchange the shares for a fixed number of shares of the issuing corporation’s common stock.
Convertible preferred is generally issued with a lower stated dividend rate than nonconvertible preferred of the same quality because the investor may have the opportunity to convert to common shares and enjoy greater capital gain potential. - Adjustable-rate preferred—Some preferred stocks are issued with adjustable (or variable) dividend rates. Such dividends are usually tied to the rates of other interest rate benchmarks, such as Treasury bills and money market rates, and can be adjusted as often as quarterly. Because the payment adjusts to current interest rates, the price of the stock remains relatively stable.
- Participating preferred—In addition to fixed dividends, participating preferred stock offers its owners a share of corporate profits that remain after all dividends and interest due other securities are paid. The percentage to which participating preferred stock participates is noted on the stock certificate.
What does SEC Rule 144 regulate?
the sale of control and restricted securities, stipulating the holding period, quantity limitations, manner of sale, and filing procedures. Selling shares under Rule 144 effectively registers the shares. In other words, buyers of stock being sold subject to Rule 144 are not subject to any restrictions if they choose to resell.
What are control securities?
Those owned by directors, officers, or persons who own or control 10% or more of the issuer’s voting stock.
What are restricted securities?
those acquired through some means other than a registered public offering. A security purchased in a private placement is a restricted security. Restricted securities may not be sold until they have been held fully paid for six months. According to Rule 144, after holding restricted stock fully paid for six months, an affiliate may begin selling shares but is subject to the volume restriction rules as enumerated in the following. In any 90-day period, an investor may sell the greater of: ■ 1% of the total outstanding shares of the same class at the time of sale; or ■ the average weekly trading volume in the stock over the past four weeks on all exchanges or as reported through Nasdaq. After the six-month holding period, affiliated persons are subject to the volume restrictions for as long as they are affiliates. For unaffiliated investors, the stock may be sold completely unrestricted after the six-month holding period has been satisfied.
What are Rule 144A Transactions Under the Act ‘33
exemption under the Securities Act of 1933 that is only available to certain large institutions, referred to as qualified institutional buyers (QIBs). A QIB owns and invests a minimum of $100 million in securities on a discretionary basis. If a QIB purchases securities under a 144A exemption, it is permitted to resell the securities with no volume restriction or holding period as long as the buyer is also a QIB.
What is an ADR?
American Depository Receipt. a type of equity security designed to simplify foreign investing for Americans. created when common shares are purchased in the foreign company’s home market. These shares are then deposited in a foreign branch of a U.S. bank, and a receipt (the ADR) is created. Each ADR may represent one or more shares of the foreign company’s shares held on deposit. The ADR provides U.S. investors with a convenient way to diversify their holdings beyond domestic companies.
What is a Penny Stock?
an unlisted (not listed on a U.S. stock exchange) security trading at less than $5 per share. Equity securities defined as penny stocks are considered highly speculative. In this light, SEC rules require that customers, before their initial transaction in a penny stock, be given a copy of a risk disclosure document. The member must receive a signed and dated acknowledgment from the customer that the document has been received. Not surprisingly, the penny stock disclosure document fully describes the risks associated with penny stock investments. Regardless of activity in the account, if the account holds penny stocks, broker-dealers (BDs) must provide a monthly account statement to the customer. This must indicate the market value and number of shares for each penny stock held in the account as well as the issuer’s name.
What are the SEC’s rules regarding cold-calling potential penny stock customers?
when a BD’s representative contacts a potential customer to purchase penny stocks (this is a solicitation to buy like those occurring during a cold call), the representative must first determine suitability on the basis of information about the buyer’s financial situation and objectives. The customer must sign and date this suitability statement before any initial penny stock trades may be placed. In addition, the BD must disclose:
■ the name of the penny stock;
■ the number of shares to be purchased;
■ a current quotation; and
■ the amount of commission that the firm and the representative received.
Established customers are exempt from the suitability statement requirement, but not from the disclosure requirements. An established customer is someone who:
■ has held an account with the BD for at least one year (and has made a deposit of funds or securities); or
■ has made at least three penny stock purchases of different issuers on different days.
What is a term bond?
structured so that the principal of the whole issue matures at once. Because the entire principal is repaid at one time, issuers may establish a sinking fund account to accumulate money to retire the bonds at maturity.
What is a serial bond?
schedules portions of the principal to mature at intervals over a period of years until the entire balance has been repaid.
What is a balloon bond?
When an issuer schedules its bond’s maturity using elements of both serial and term maturities. The issuer repays part of the bond’s principal before the final maturity date, as with a serial maturity, but pays off the major portion of the bond at maturity. This bond has a balloon, or serial and balloon, maturity.
What does the coupon of a bond represent?
the interest rate the issuer has agreed to pay the investor. At one time, bonds were issued with interest coupons attached that the investor would detach and turn in to receive the interest payments. While bonds are no longer issued with physical coupons attached, the interest rate the bond pays is still called the coupon rate. It is also referred to as the stated yield or nominal yield. It is calculated from the bond’s par value, usually stated as a percentage of par. Par value, also known as face value for a bond, is normally $1,000 per bond, meaning that each bond will be redeemed for $1,000 when it matures. Therefore, a bond with a 6% coupon is paying $60 in interest per year (6% × $1,000 par value = $60).
What is a nominal yield of a bond?
Also called Coupon or stated yield is set at the time of issue. Remember that the coupon is a fixed percentage of the bond’s par value.
What is a bond’s current yield?
CY measures a bond’s annual coupon payment (interest) relative to its market price, as shown in the following equation:
annual coupon payment ÷ market price = CY
What is a bond’s yield to maturity
A bond’s YTM reflects the annualized return of the bond if held to maturity. In calculating YTM, the bondholder takes into account the difference between the price that was paid for a bond and par value received when the bond matures. If the bond is purchased at a discount, the investor makes money at maturity (i.e., the discount amount increases the return). If the bond is purchased at a premium, the investor loses money at maturity (i.e., the premium amount decreases the return).
What is a bond’s yield to call?
Some bonds are issued with what is known as a call feature. A bond with a call feature may be redeemed before maturity at the issuer’s option. Essentially, when a callable bond is called in by the issuer, the investor receives the principal back sooner than anticipated (before maturity). YTC calculations reflect the early redemption date and consequent acceleration of the discount gain if the bond was originally purchased at a discount, or the accelerated premium loss if the bond was originally purchased at a premium.
What is a bond with a call feature?
allows an issuer to call in a bond before maturity. Issuers will generally do this when interest rates are falling. From the issuer’s perspective, why pay 6% interest to investors on an existing bond if current interest rates have fallen to 4%? It is better to call in the 6% bond and simply issue a new bond paying the lower current interest rate. This feature benefits the issuer.
What is a put feature of a bond?
the opposite of a call feature. Instead of the issuer calling in a bond before it matures, with a put feature the investor can put the bond back to the issuer before it matures. Investors will generally do this when interest rates are rising. From the investor’s perspective, why accept 6% interest on a bond one owns if current interest rates have risen to 8%? It is better to put the 6% bond back to the issuer, take the principal returned, and invest it in a new bond paying the current interest rate of 8%. This feature benefits the bondholder. If called, the (former) bondholder now has the dilemma of finding a similar rate of return in a low interest rate environment.
What is a convertible bond?
issued by corporate issuers, allowing the investor to convert the bond into shares of common stock. Giving the investor the opportunity to exchange a debt instrument for one that gives the investor ownership rights (shares of common stock) is generally considered a benefit for the investor.
What are treasury bills?
T-bills are direct short-term debt obligations of the U.S. government. They are issued weekly with maturities of 4 weeks, 13 weeks, 26 weeks, and at times, 52 weeks. Though the maximum maturity for T-bills is subject to change, they are always short-term instruments— that is, one year or less.
T-bills pay no interest in the way other bonds do; rather, they are issued at a discount from par value and redeemed at par. For example, an investor might purchase a $10,000, 26-week T-bill at a price of $9,800. She would receive no regular interest check, but, at maturity, the Treasury would send her a check for $10,000. The difference between the $9,800 she paid and the $10,000 she received would be considered her interest income, though she never received a separate interest check.
What are four key points to remember regarding T-bills?
■ T-bills are the only Treasury security issued at a discount;
■ T-bills are the only Treasury security issued without a stated interest rate;
■ T-bills are highly liquid; and
■ the 13-week (a.k.a. 90-day) T-bills are used in market analysis as the stereotypical risk-free investment.
What are Treasury notes?
Direct debt obligations of the U.S. government. They pay semiannual interest as a percentage of the stated par value, and they mature at par value. T-notes have intermediate maturities (2–10 years).
What are treasury bonds?
direct debt obligations of the U.S. government. They pay semiannual interest as a percentage of the stated par value and mature at par value. These government obligations have long-term maturities, greater than 10 years and up to 30 years.
What are treasury receipts?
Created by brokerage firms from U.S. Treasury notes and bonds. BDs buy Treasury securities, place them in trust at a bank, and sell separate receipts against the principal and coupon payments. This separating of the coupon interest payments from the principal creates new securities and provides investors with several maturities to choose from. This stripping process also yields more profit for the BD versus selling the original Treasury securities outright.
Although the Treasury securities held in trust collateralize the Treasury receipts, the receipts (unlike Treasury securities) are not backed by the full faith and credit of the U.S. government.
What are Treasury STRIPS?
The Treasury Department’s version of receipts known as Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities). The Treasury Department designates certain issues as suitable for stripping into interest and principal components. Banks and BDs perform the actual separation of interest coupon and principal and trading of the STRIPS.
What federal government agencies are authorized by U.S. congress to issue debt securities?
■ Farm Credit Administration
■ Government National Mortgage Association (GNMA, or Ginnie Mae)
Other agency-like organizations operated by private corporations include the following:
■ Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac)
■ Federal National Mortgage Association (FNMA, or Fannie Mae)
■ Student Loan Marketing Association (SLMA, or Sallie Mae)
What is the Farm Credit System (FCS)?
a national network of lending institutions that provides agricultural financing and credit. The system is a privately owned, government-sponsored enterprise that raises loanable funds through the sale of Farm Credit Debt Securities to investors. These funds are made available to farmers through a nationwide network of banks and Farm Credit lending institutions. The Farm Credit Administration (FCA), a government agency, oversees the system.
What is the government national mortgage association (GNMA) or ginnie Mae?
a government-owned corporation that supports the Department of Housing and Urban Development. The only agency securities backed by the full faith and credit of the federal government. Although many of these securities have a stated 30-year life, GNMA’s are typically sold based on an average life expectancy since the issues are backed by mortgages, which are often retired early. When a mortgage is paid off before its stated maturity, the GNMA investor will receive back all outstanding principal of that loan at par. This early payout is referred to as prepayment risk.
Occasionally, GNMA securities are purchased by BDs that use the underlying assets to create hybrid securities called collateralized mortgage obligations (CMOs). These hybrid securities separate principal and interest payments into various investment choices called tranches. CMO customers typically receive payments monthly. CMOs are considered to be corporate securities and must be registered under the Securities Act of 1933.
What is the Federal Home Loan Mortgage Corporation (FHLMC) or Freddie Mac?
a public corporation. It was created to promote the development of a nationwide secondary market in mortgages by buying residential mortgages from financial institutions and packaging them into mortgage-backed securities for sale to investors.
What is the Federal National Mortgage Assocation (FNMA) or Fannie Mae?
a publicly held corporation that provides mortgage capital. FNMA purchases conventional and insured mortgages from agencies such as the FHA and the VA. The securities it creates are backed by FNMA’s general credit.
What is a mortgage bond?
Just as the owner of a home pledges a real asset (the home and land) as collateral for a loan (the mortgage), a corporation will borrow money backed by real estate and physical assets of the corporation. Just as a home ordinarily would have a market value greater than the principal amount of its mortgage, the value of the real assets pledged by the corporation will be in excess of the amount borrowed under that bond issue. If the corporation develops financial problems and is unable to pay the interest on the bonds, those real assets pledged as collateral are generally sold to pay off the mortgage bondholders. Having the real assets as collateral for the loan puts the purchaser of a mortgage bond in a position of safety. This is a secured loan.
What are equipment trust certificates?
Corporations, particularly railroads and other transportation companies, finance the acquisition of capital equipment used in the course of their business. For example, railroads will issue equipment trust certificates to purchase their rolling stock and locomotives. Title to the newly acquired equipment is held in trust, usually by a bank acting as a trustee, until the certificates have been paid in full. When the railroad has finished paying off the loan, it receives clear title to its equipment from the trustee. If the railroad does not make the payments, the lender repossesses the collateral and sells it for his benefit. Again, this is in an example of secured loan; the obligation to pay the investor is secured by the equipment.
What are collateral trust bonds?
Sometimes, a corporation wants to borrow money and has neither real estate (to back a mortgage bond) nor equipment (to back an equipment trust) to use as collateral. Instead, it deposits securities it owns into a trust to serve as collateral for the lenders. The securities the corporation deposits as collateral for a trust bond can be securities issued by the corporation itself or by stocks and/or bonds of other issuers. Regardless of the issuer, all deposited collateral securities must be marketable (readily able to be liquidated). Collateral trust certificates are secured by the securities deposited—and obviously, the better the quality of the securities, the better the quality of the certificate.
What is a debenture?
a debt obligation of the corporation backed only by its word and general creditworthiness. Written promises of the corporation to pay the principal at its due date and interest on a regular basis. Although this promise is as binding as a promise for a secured bond such as a mortgage bond, debentures are not secured by any pledge of property. They are sold on the general good faith and credit of the company, unsecured.
What is a guaranteed bond?
backed by a company other than the issuing corporation, such as a parent company. The value of the guarantee is only as good as the strength of the company making that guarantee. This is an unsecured debt security.
What are income bonds?
also known as adjustment bonds, are used when a company is reorganizing and coming out of bankruptcy. Pay interest only if the corporation has enough income to meet interest on debt obligations and if the BOD declares that the interest payment be made. Obviously, income or adjustment bonds fall under the heading of unsecured debt securities.
What are municipal bonds?
Securities issued either by state or local governments or by U.S. territories, authorities, and special districts. Investors who buy such bonds are lending money to the issuers for the purpose of public works and construction projects (e.g., roads, hospitals, civic centers, sewer systems, and airports). Municipal securities are considered second in safety of principal only to U.S. government and U.S. government agency securities, but the safety of any particular issue is based on the issuing municipality’s financial stability.
Interest on most municipal bonds is tax free on a federal level and tax free on a state level if the investor lives in the state of issuance. (Please note that capital gains or trading profits on these securities would still be taxable.) Municipal securities settle T+2 and pay accrued interest based on a 30-day month/360-day year.
Two categories of municipal securities exist: general obligation bonds and revenue bonds.
What are general obligation bonds?
municipal bonds issued for capital improvements that benefit the entire community. Typically, these projects do not produce revenues, so principal and interest must be paid by taxes collected by the municipal issuer. Because of this backing, GO bonds are known as full faith and credit issues and are backed by the municipality’s taxing power. Bonds issued by states are backed by income taxes, license fees, and sales taxes. Bonds issued by towns, cities, and counties are backed by property (ad valorem) taxes, license fees, fines, and all other sources of direct income to the municipality. School, road, and park districts may also issue municipal bonds backed by property taxes.
Finally, the amount of debt that a municipal government may incur can be limited by state or local statutes to protect taxpayers from excessive taxes. Debt limits can also make a bond safer for investors. The lower the debt limit, the less risk of excessive borrowing and default by the municipality. If an issuer wishes to issue GO bonds that would put it above its statutory debt limit, a public referendum is required. In this light, GO bonds are often associated with requiring voter approval.
What are revenue bonds?
type of municipal bond that can be used to finance any municipal facility that generates sufficient income. These municipal bonds are considered to be self-supporting debt because principal and interest payments are made exclusively from revenues generated by the project or facility for which the debt was issued, such as:
■ utilities (water, sewer, and electric);
■ housing (public housing projects);
■ transportation (airports, bridges, tunnels, and toll roads);
■ education (college dorms and student loans);
■ health (hospitals and retirement centers);
■ industrial (industrial development and pollution control); and
■ sports (stadium facilities).
Sometimes issued by authorities, which are quasi-governmental entities often tasked with building roads, tunnels, bridges, and other infrastructure. In many cases, a transit authority might own several bridges or tunnels. Bondholders must be aware that each bond may only be backed by a specific portion (not all) of the authority’s overall revenues that is earmarked for that bond issue.
Keeping in mind that these bonds are not supported by the issuers’ authority to tax, they are not subject to statutory debt limits and therefore do not require voter approval.
What are short term municipal obligations (anticipation notes)?
short-term securities that generate funds for a municipality that expects other revenues soon. Usually, municipal notes have less than 12-month maturities, although maturities may range from 3 months to 3 years. They are repaid when the municipality receives the anticipated funds. Municipal notes fall into several categories.
■ Municipalities issue tax anticipation notes (TANs) to finance current operations in anticipation of future tax receipts. This helps municipalities to even out cash flow between tax collection periods.
■ Revenue anticipation notes (RANs) are offered periodically to finance current operations in anticipation of future revenues from revenue producing projects or facilities.
■ Tax and revenue anticipation notes (TRANs) are a combination of the characteristics of both TANs and RANs.
■ Bond anticipation notes (BANs) are sold as interim financing that will eventually be converted to long-term funding through a sale of bonds.
■ Tax-exempt commercial paper is often used in place of BANs and TANs for up to 270 days, though maturities are most often 30, 60, and 90 days.
■ Construction loan notes (CLNs) are issued to provide interim financing for the construction of housing projects.
■ Variable rate demand notes have a fluctuating interest rate and are usually issued with a put option. This means the investor could periodically (e.g., weekly, monthly) return the security to the issuer for its stated value.
■ Grant anticipation notes (GANs) are issued with the expectation of receiving grant money from the federal government.
What are Build America Bonds (BABs)?
created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing costs to issuing municipalities and stimulating the economy. While bonds to fund municipal projects have traditionally been sold in the tax-exempt arena, BABs are taxable obligations. Bondholders pay tax on interest received from BABs, but tax credits are provided in lieu of the tax-exempt status usually afforded the interest on municipal securities. These bonds attracted investors who would normally not buy tax-exempt municipal bonds, and expanded the pool of investors to include those in lower-income tax brackets, investors funding retirement accounts where tax-free securities would normally not be suitable, public pension funds, and foreign investors. Two types of BABs are issued: tax credit BABs and direct payment BABs.
■ Tax credit BABs provide the bondholder with a federal income tax credit equal to 35% of the interest paid on the bond in each tax year. If the bondholder lacks sufficient tax liability to fully use that year’s credit, the excess credit may be carried forward.
■ Direct payment BABs provide no credit to the bondholder, but instead provide the municipal issuer with payments from the U.S. Treasury equal to 35% of the interest paid by the issuer.
What is a Section 529 Plan?
a specific type of education savings account available to investors. The plans allow money saved to be used for qualified expenses for K-12 and post-secondary education. Qualified expenses include tuition at an elementary or secondary public, private, or religious school for up to $10,000 per year. Because they are state sponsored, they are defined as a municipal fund security. As such, the sale of these plans must be accompanied or preceded by an official statement or offering circular (similar to a prospectus) in the same way other municipal securities sales would be.
There are two basic types of 529 plans: prepaid tuition plans for state residents and savings plans for residents and nonresidents. Prepaid plans allow resident donors to lock in current tuition rates by paying now for future education costs. The more popular option is the savings plan, which allows donors to save money to be used later for education expenses.
Any adult can open a 529 plan for a future college student. The donor does not have to be related to the student. (An adult student may also contribute to her own 529 plan.) With a 529 plan, the donor can invest a lump sum or make periodic payments. When the student is ready for college, the donor withdraws the amount needed to pay for qualified education expenses (e.g., tuition, room and board, and books).
Contributions, which are considered gifts under federal tax law, are made with after-tax dollars, and earnings accumulate on a tax-deferred basis. Withdrawals are tax free at the federal level if they are used for qualified education expenses. Most states permit tax-free withdrawals as long as the donor has opened an in-state plan. In addition, many states allow contributions into in-state plans to be tax deductible. Therefore, if one of your customers wishes to open an out-of-state plan, you must advise the customer that certain tax advantages, such as the one just noted, may not be available to out-of-state donors.
If a beneficiary does not need the funds for school, there are no tax consequences if the donor changes the designated beneficiary to another member of the family. For example, if one child gets a full scholarship, a parental donor can roll funds from that child’s 529 plan into a sibling’s plan without penalty.
Other relevant points regarding Section 529 plans are as follows.
■ Overall contribution levels can vary from state to state.
■ Assets in the account remain under the donor’s control, even after the student becomes of legal age.
■ There are no income limitations on making contributions to a 529 plan.
■ Plans allow for monthly payments if desired by the account owner.
■ Account balances left unused may be transferred to a related beneficiary.
■ Rollovers are permitted from one state’s plan to another state’s plan, but no more than once every 12 months.
What is a local government investment pool (LGIP)?
Established by states to provide other government entities, such as cities, counties, school districts, or other state agencies, with a short-term investment vehicle to invest funds.
Generally formed as a trust in which municipalities can purchase shares or units in the LGIP’s investment portfolio.
While not a money market fund, most LGIPs operate similar to one. For instance, an LGIP may be permitted to maintain a fixed $1 net asset value (NAV). Maintaining a stable NAV, similar to a money market mutual fund, facilitates liquidity and minimum price volatility.
Not required to register with the SEC and are not subject to the SEC’s regulatory requirements, given that LGIPs fall within the governmental exemption, just as municipal securities do. Therefore, investment guidelines and oversight for LGIPs can vary from state to state.
With no SEC registration required, there is no prospectus. However, LGIP programs do have disclosure documents, which generally include information statements, investment policy, and operating procedures. The information statement typically details the management fees associated with participation in the LGIP.
What are Achieving a Better Life Experience (ABLE) accounts?
tax-advantaged savings accounts for individuals with disabilities and their families. They were created as a result of the passage of the ABLE Act of 2014. The beneficiary of the account is the account owner, and income earned by the accounts is not taxed.
The ABLE Act limits eligibility to individuals with significant disabilities where the age of onset of the disability occurred before turning age 26. In this light, remember that one need not be under the age of 26 to be eligible to establish an ABLE account. One could be over the age of 26, but as long as the onset of the disability occurred before age 26, one is eligible to establish an ABLE account.
If an individual meets the age/onset criteria and is also receiving benefits either through Social Security insurance (SSI) and/or Social Security disability insurance (SSDI), he is automatically eligible to establish an ABLE account. Only one ABLE account per person is allowed.
Contributions to these accounts, which can be made by any person including the account beneficiary themselves, as well as family and friends, must be made using after-tax dollars and is not tax deductible for purposes of federal income taxes. Some states, however, do allow income tax deductions for contributions made to an ABLE account. Contributions by all participating individuals are limited to a specified dollar amount per year, which may be adjusted periodically to account for inflation.
What is the difference between the capital market and the money market?
The capital market serves as a source of intermediate-term to long-term financing, usually in the form of equity or debt securities with maturities of more than one year.
The money market, on the other hand, provides very short-term funds to corporations, banks, BDs, government municipalities, and the U.S. federal government.
Money market instruments are fixed-income (debt) securities with short-term maturities, typically one year or less. Because of their short-term maturities, they are considered to be highly liquid. These securities also provide a relatively high degree of safety. Consider that because they are short term, they have little time to default. In return for the safety, investors forgo a higher return for the lower returns generally associated with money market securities.
Finally, investors who purchase money market securities generally do not receive interest payments; instead, these securities are typically issued at a discount and mature at face value. The return is the difference between the discounted purchase price and the face value received at maturity.
What is a certificate of deposit (CD)?
Banks issue and guarantee these with fixed interest rates and minimum face values of $100,000 (jumbo CDs), although face values of $1 million or more are common. Most mature in one year or less. Some that can be traded in the secondary market are known as negotiable CDs. Only these negotiable CDs are considered to be money market instruments.
A negotiable CD is a bank’s version of an unsecured promissory note in the same way commercial paper is for corporations. In other words, it is a bank’s promise to pay principal and interest—secured by no physical asset and backed only by the bank’s good faith and credit.
What is a banker’s acceptance (BA)?
a short-term time draft with a specified payment date drawn on a bank. Essentially, it is a postdated check or line of credit. The payment date of is normally between 1 and 270 days (nine months). Corporations use these extensively to finance international trade; that is, a BA typically pays for goods and services in a foreign country.
What is a commercial paper?
Also known as a prime paper or promissory note. Corporations issue short-term, unsecured promissory notes, to raise cash to finance accounts receivable and seasonal inventory gluts. Maturities range from 1 to 270 days, although most mature within 90 days. Typically, companies with excellent credit ratings issue commercial paper.
