Representative Draft Series 7 Content Flashcards
Series 7 retirement plan questions often focus on product suitability. What types of accounts are most commonly used for retirment planning?
- Roth IRA
- 401(k) and 403(b)
- SEP IRA
- Annuities
- Defined contribution / Defined benefit plans
What are some of the characteristics of qualified and non-qualified retirement plans?
- Qualified plans always refer to income that has not yet been taxed.
- Non-qualified plan contributions are made with after-tax dollars - so the contributions grow tax-free.
- Non-qualified plan employee contributions may be at risk in a bankruptcy.
- Non-qualified plans are not IRS qualified or ERISA eligible to accept qualified pre-tax dollars as contributions to the plan.
What are some characteristics of IRA accounts?
- IRAs encourage long term savings for retirement.
- IRAs have contribution limits that other retirement plans, such as SEP IRAs, do not have.
- Currently, the cap on contributions is $5,500 per year for participants under age 50, and $6,500 for those over 50.
Up until what date may a prior-year contribution be made to an IRA?
Individuals may make prior-year IRA plan contributions until April 15th of the current year.
What is the penalty for above-limit IRA contributions?
Contributions above the limits are assessed a penalty of 6% of the excess contribution; most plans do not even allow contributions above the limits, so this penalty is rarely invoked.
What is the key distinction between ROTH IRAs and regular IRAs?
Unlike in regular IRAs, ROTH IRA contributions are not considered qualified dollars - they come from income that has already been taxed. The key benefit is that these tax dollars grow tax free, which is a significant benefit over long time-horizons.
What are the key features of munis?
- Interest subject only to state and local taxes - this is an important tax advantage for investors seeking to preserve income.
- Unlike stocks, munis carry a legal opinion that confirms the issuer has the legal right to issue and that the security is bona fide - remember the two types of legal opinions?
- Munis usually issue serial debt (multiple maturities) and pay interest annually instead of quarterly.
For what types of projects do municipalities use general obligation (GO) bonds?
Non-Revenue Projects
GOs are supported by the taxing authority of the municipality issuing the bond. They are used for projects that produce no revenue and that will be paid for via taxes - basic service projects like utilities and schools.
Where are the convenants of a revenue bond listed?
The Trust Indenture
The trust indenture lists all the obligations of the issuer as well as outlining specific protections that protect the investor. The trust indenture also specifies a trustee who will ensure compliance with the indenture.
What are the characteristics of a negotiated muni offering?
This type of offering is carried out directly with a single institution of the issuer’s choice and is the most common type of offering.
What is the importance of the dated date?
The dated date is the date on which the buyer begins to accrue interest, which accrues up to the settlement date. The date of settlement is the first day the buyer receives interest accruals.
You would like to reduce a client’s exposure to WJT stock, currently trading at $15.00. Your client is the ex-CEO of the company and currently has $50mm in the company’s stock.
The trading desk provides you with a quote on a put option on the stock of $2.25. The put option has a strike price of $14.00 in one year’s time, at which point a large portion of your client’s stock will vest.
At expiration, the put option on WJT stock is at-the-money. Describe the relative magnitude of Delta and Gamma?
The Gamma value will be high and thus any requirement to hedge the position should be based on Gamma.
The value of Gamma is highest when an option is at-the-money and near expiration. This can lead to large swings in the price of the option for which Delta hedging is not well suited. Thus, it is best to manage an option position that is near expiry and at-the-money by Gamma-hedging the position.
You would like to reduce a client’s exposure to WJT stock, currently trading at $15.00. Your client is the ex-CEO of the company and currently has $50mm in the company’s stock.
The trading desk provides you with a quote on a put option on the stock of $2.25. The put option has a strike price of $14.00 in one year’s time, at which point a large portion of your client’s stock will vest.
Given the price of the put option quoted by the desk, and a risk-free rate of 5%, calculate the value of a call option on WJT stock.
Using put-call parity:
Call - Put = Stock - Strike / (1 + Rf)T
Call = Stock - Strike / (1 + Rf)T + Put
= $15.00 - $14.00 / (1 + 5%)1 + $2.25
= $15.00 - ($14.00 / 1.05) + $2.25
= $15.00 - $13.33 + $2.25
= $3.92
The following options are quoted on a derivatives exchange:
Stock price: $90
Volatility: 29%
Short-term interest rate: 3%
Dividend: none
Expiration: 1 year
Prices of European style options:
85 strike put, price: $6.65
What is the expected price of a call with an $85 strike price?
Based on the put-call parity relationship, the value of the call = Put + Spot - Strike × exp(-Rate × Time)
= 6.65 + 90 - 85 × exp(-0.03 × 1)
= 14.16.
Not discounting the strike, the incorrect value of 6.65 + 90 - 85 = 11.65 is obtained.
Discounting the spot but not the strike, the incorrect value of 6.65 + 87.34 - 85 = 8.99 rounded to 9 is obtained.
Stock price: $60
Volatility: 23%
Short-term interest rate: 2.5%
Dividend: $0.06 after 3 months
Expiration: 4 months
Ask prices of American style call options:
55 strike, price: $0.95
60 strike, price: $2.90
65 strike, price: $6.25
How would an issuer of call options hedge his position?
Buying Delta stock for each option
The issuer is short (not long) call options, which is equivalent to a Delta short position in the stock. In order to hedge the position, the issuer will have to buy Delta stock for each option. This leads to a Delta-neutral position