Representative Sample Draft Series 7 Cards Flashcards
On the Series 7 exam, questions about retirement plans will often focus on questions of Suitability. What types of accounts are some of the most commonly used for retirement planning?
- Roth IRA
- 401(k) and 403(b)
- SEP IRA plans
- Annuities
- Defined contribution / Defined Benefit plans.
What are the differences between qualified and non-qualified retirement plans?
- Qualified will always refer to income that has not been taxed yet.
- A non-qualified plan has contributions made with after-tax dollars - so the contributions grow tax free.
- If the employer is offering a non-qualified plan to employees, the employee contributions can be at risk in a bankruptcy.
- A non-qualified plan means it is not “IRS qualified” or ERISA eligible to accept qualified - pre tax - dollars as contributions to the plan.
What is the purpose of an IRA Account?
- IRA (Individual Retirement Accounts) were set up to encourage long-term savings for retirement.
- IRAs have contribution limits that other retirement plans, such as SEP IRAs, don’t have.
- Currently the cap on contributions is $5500 per year for those under age 50 and $6500 for those over 50
Up until what date may an IRA contribution be made for a given calendar year?
Individuals may make contributions to IRA plans until April 15th of the following year (i.e. April 15th, 2014 is the deadline for the 2013 calendar year.)
What is the penalty for excessive IRA contributions?
6%
Contributions above the limits are reduced by 6% of the contribution. Most plans won’t even allow contributions above the limits, so this is rarely used.
What is the key distinction between a ROTH IRA and a regular IRA?
Unlike a regular IRA, ROTH IRA contributions are not considered qualified dollars - they come from income that has already been taxed. The key benefit here is that the interest income on those contributions is tax free, which is a huge benefit over the long term.
What are the key features of munis?
- Interest is subject to State and local taxes only, not Federal - this is an important tax advantage for investors wanting to preserve income.
- Unlike stocks, munis have a legal opinion that confirms the issuer has the legal right to issue and the security is bona fide - remember the two types of legal opinions?
- Municipals usually issue serial debt (multiple maturities) and pay interest annually instead of quarterly.
For what types of projects do municipalities use general obligation 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 will be paid for via taxes- basic service projects like utilities, schools, etc.
Where are the convenants of a revenue bond listed?
The Trust Indenture
This will contain all the obligations of the issuer as well as outlining specific protections that protect the investor. The indenture will also specify a trustee who will ensure compliance with the indenture.
What are the characteristics of a negotiated muni offering?
This is the most common type of muni, and is carried out directly with a single institution of the issuers choice.
What is the importance of the dated date?
This is when the buyer begins to accrue interest, and it accrues up to the settlement date. The day of settle is the first day the buyer will receive 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 of $2.25 on a put option on the stock. 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.
Gamma value will be large and any requirements to hedge the position should be based on Gamma.
The value of Gamma is largest 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 of $2.25 on a put option on the stock. 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 derivative exchange:
Stock price: $90
Volatility: 29%
Short-term interest rates: 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?
14.16
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 wrong value of 6.65 + 90 - 85 = 11.65 is obtained.
Discounting the spot but not the strike, the wrong value of 6.65 + 87.34 - 85 = 8.99 rounded to 9.
Stock price: $60
Volatility: 23%
Short-term interest rates: 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 the issuer of call options hedge his position?
Buying Delta share 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 it, he will have to buy Delta stock for each option; this leads to a Delta-neutral position.