S7 Flashcards
(214 cards)
1
Q
Who attests to the legality of a bond issue and issues a legal opinion on a proposed new municipal bond issue?
A
Bond counsel - The issuer hires a firm or an individual to act on its behalf as bond counsel
2
Q
If a customer buys a municipal bond at 110, maturing in eight years, but sells the bond six years later at 103½, the customer will have
A
a$10 per bond gain.
Municipal bonds that are purchased at a premium must be amortized. This bond has a premium of $100, which over eight years, amounts to $12.50 per year. The cost basis of the bond at the time of the sale is $1,100 − (6 × $12.50), or $1,025. If the bond is sold for $1,035, the customer has a gain of $10 per bond.
3
Q
From time to time, an investor’s situation arises where they may need to liquidate a portion of the portfolio. It could be a medical need, an emergency repair, or a joyous event such as a wedding. Getting the necessary cash would be most difficult from which of the following holdings?
A)A unit investment trust
DPP
A mutual fund
A listed option
A
When it comes to liquidity, at least for the exam, DPPs rank near the bottom of the list. Mutual funds and UITs are redeemable by the issuer, and closing a position in an option contract settles the next day.
4
Q
Which of the following best describes how a syndicate determines the amount to bid for a new municipal issue?
A
The average reoffering price minus the spread
A spread is analogous to the gross profit margin in other businesses. A syndicate’s bid is based on the average reoffering price (the price the public will pay) less the syndicate’s spread (the amount the syndicate will charge for bringing the issue to market).
5
Q
According to investment company rules, open-end investment companies may not distribute long-term capital gains to their shareholders more frequently than
A
Annually, Under the Investment Company Act of 1940, investment companies may not distribute long-term capital gains more frequently than once per year.
6
Q
There are several conditions found in the Securities Act of 1933 permitting the offering of control stock to the public without filing a Form 144. Included in that list are
A
5,000 shares or fewer are sold.
the dollar amount is $50,000 or less., de minimus
7
Q
When must a new options customer return a signed option agreement?
A
Within 15 days of the account approval
8
Q
Better Bond Sales (BBS) is participating in a firm underwriting of some GO municipal bonds. Their role is that of a syndicate member with a 10% commitment. Should BBS sell some of the bonds, its earnings would be
A
the total takedown.
The syndicate manager is the only participant who earns the spread when it makes the sale. Syndicate members earn the total takedown (all the spread other than the manager’s fee) when they sell the bonds. That includes the takedown plus the additional takedown. The selling group members earn the selling concession.
9
Q
ABC Corporation has an outstanding 8% convertible bond that is callable at 102. Currently, the bond is trading at 101. The conversion price is $40, and the common stock is currently trading at $39.50. ABC announces a call at 102. To realize the greatest profit, a bondholder should
A
tender the bonds.
The investor would realize the greatest sales proceeds by tendering the bond to the corporation for 102. Selling the bond at its current market value of 101 is not an attractive option. Converting the bond to common stock would result in 25 shares ($1,000 par converted at $40 = 25 shares) sold at $39.50 per share ($39.50 × 25 = $987.50). Once the call date passes, the issuer ceases interest payments making it unattractive to continue to hold the bonds.
10
Q
According to MSRB rules, a control relationship would exist between a municipal securities firm and an issuer when
A
an officer of the firm is in a position of authority over the issuer.
MSRB Rule G-22 deals with control relationships. Their interpretive letters indicate that it is only when the individual has the authority to exercise control that the disclosure rules apply. Here is how they put it: “For example, rule G-22 applies if the associated person is the chairman of an issuing authority and, in that capacity, actually makes the decision on behalf of the issuing authority to issue securities. The rule does not apply if the associated person as chairman does not make that decision and does not have the authority alone to make the decision, or if the decision is made by a governing body of which he is only one of several members.”
11
Q
Which of the following are part of the depreciable basis of a limited partner in a real estate direct participation program?
A
Buildings and A/C equipment
Only fixed plant (buildings) and equipment can be depreciated. Land, as well as any up-front costs charged to the limited partners, cannot be depreciated. Those nondepreciable costs, however, are part of the limited partner’s beginning basis but not part of the depreciable basis.
12
Q
Under what circumstances will a dilution of equity occur?
A
The conversion of convertible bonds into common stocks
Dilution of equity occurs when stockholders experience a reduction in their percentage ownership of the company. If bonds are converted, more common shares are issued, and the shareholder’s equity is diluted. A stock dividend or stock split does not change a stockholder’s percentage of ownership. Refunding debts has no effect on stockholders.
13
Q
A C corporation’s income statement renders the following information:
Earnings before taxes (EBT): $2 million
Interest paid on its outstanding debentures: $200,000
A footnote indicates that the corporation received $100,000 in dividends from preferred stock issued by other corporations.
Based on this information, this corporation will be taxed on income of
A
$1,950,000
The EBT of $2 million represents the bottom line after all expenses other than taxes have been paid. If the question referred to EBIT (earnings before interest and taxes), then the $200,000 of interest would be deducted, but EBT has already subtracted that expense. Part of the $2 million is the $100,000 of preferred stock dividends from other issuers. Remember the 50% dividend exclusion available to C corporations. That means only $50,000 of that $100,000 will be taxable, leaving the corporation obligated to pay taxes on $1,950,000.
14
Q
An investor opens the following options position: Buy 1 BOB Jan 60 call @4; Buy 1 BOB Jan 55 put @2½. What is the investor’s maximum gain, maximum loss, and breakeven point?
A
Maximum gain is unlimited; maximum loss = $650; breakeven points are $48.50 and $66.50.
The first step is to identify the position. This is a long combination—a long put and a long call with different terms. That means we are going to have two breakeven points. The maximum gain is unlimited because one of the positions is a long call. The maximum loss is the amount paid for the combination (the two premiums totaling $650). Breakeven follows the call-up and put-down rules. Add the premium to the strike of the call ($60 + $6½ = $66.50) and subtract the premium from the strike of the put ($55 ‒ $6½ = $48.50).
15
Q
An investor opens the following options position: Long 1 RAV Mar 50 put @5¾; short 1 RAV Mar 45 put @3. What is the investor’s maximum gain, maximum loss, and breakeven point?
A
Maximum gain is $225; maximum loss is $275; breakeven point is $47.25.
The first step is to identify the position. This is a debit put spread. It is a debit spread because the option purchased cost more than the one sold. The debit of $275 is the most the investor can lose. This is a bear put spread. We know that because the investor purchased the option with the higher strike price and sold the one with the lower strike price. The goal is for the stock’s price to decline to the point where both options are exercised. For example, if the market price of RAV should fall below 45, the owner of the 45 put will exercise, causing the seller to purchase the stock for $4,500. The seller can then exercise the long 50 put and deliver the stock purchased at 45 for 50. That is a profit of $500 less the cost of the options (the debit of $275). The breakeven point follows the put-down rule. Subtract the net premium (the $2.75 debit) from the higher strike price resulting in a breakeven point at $47.25.
16
Q
A municipal bond, issued with a covenant that states, “If revenue collections are not sufficient to meet debt service requirements, the issue will be backed by the full faith and credit of the municipality,” is known as
A
a double-barreled bond.
When a municipal bond is backed by both a source of revenue and the taxing ability of the issuer, this is referred to as a double-barreled bond.
17
Q
A corporation coming out of a bankruptcy proceeding would probably find it most attractive to issue
A
an income bond.
Income (or adjustment) bonds carry the unique characteristic of requiring payment of interest only when the issuer’s income is sufficient. They are used primarily for companies undergoing a financial restructuring, usually after a bankruptcy filing. Each of the other choices would require timely payment, and failure to do so could result in the company’s failure.
18
Q
Your customer wishes to invest in a security that will pay a specific level of dividends, but may also receive additional dividend amounts, should the underlying company have outstanding performance. Which of the following securities would best match this customer’s objectives?
A
Participating preferred stock
Participating preferred stock provides a stated dividend amount (as a percentage of par value) plus the opportunity to receive additional dividends, based on predetermined conditions, such as the profitability level of the underlying company. Although the convertible stock offers the possibility of capital appreciation due to its linkage to the common stock, that has no effect on the dividend.
19
Q
Accretion
A
Increase in value by means, represents the amount of “imputed interest
20
Q
Breakpoint
A
Occurs when an investor receives a reduced sales charge based on a quantity of investment
21
Q
Rights of reinstatement (ror)
A
A fund family may allow customers to redeem or sell shares in a fund and reinvest some or all of the proceeds without paying a sales charge or recoup some or all of a contingent deferred sales charge.
To be eligible for a ROR all just apply.
- Reinvestment must be made within a specified period of time. Example 90. But vary a reps find families
- The redemption and reinvestment must take place I. The same account.
- The redeemed shares must have been subject to a front end of deferred sales charge
- The redemption and reinvestment must comply with any other terms and conditions required by certain investment companies. (Reinvestments must be made in the same share class of the redeemed.
22
Q
Nav transfers.
A
Transfers within a family of funds without paying another sales charge.
23
Q
Short form registration
A
Limited size offering.
Tier 1. 20m
Tier 2. 75m
24
Q
Insider provision
A
An officer. Directory. Or principle stockholder (owns more than 10% of the outstanding shares) I.e. affiliated or control person.
25
Regulation crowdfunding (reg c)
The jobs act allows start-up companies to offer up to 5m worth of common shares with thin a 12 month period without being required to register with the SEC.
26
Good till canceled (GTC)
The order reminds in effect until it is executed or cancelled and is also called an open order.
27
Stop order
Memorandum order from a customer that becomes a market order if a trade takes place at or through the price stated in the memorandum. A stop order will protect a profit or limit losses on an existing position but cannot assure a specific price of execution.
28
A stop order can be used to protect a
Long position by using a sell stop order
Short position. By using a buy stop order
29
Sell stop order
A stop order. Also referred to as a stop-loss order is an order to but buy or sell a stock once the price of the stock reaches a specified price. Known as the stop price. When the stop price is reached, a stop order becomes a market order.
30
Buy stop order
Am instruction from an investor to a broker to buy a certain amount of a security. Buy orders may take various forms. For example l, an investor may instruct the broker to buy immediately at the best available price, or to wait until a certain price is reached.
31
Taping rules.
FINRA RULE 3170. To record conversations between clients and registered persons.
32
Spoofing
A form of market manipulation i which a trader places one or more highly visible orders but has no intention of keeping them.
33
Structured cds
Are tied to seers such as equities, commodities, currencies, and are held for 5-7 years. Usually held to maturity
34
Forex markets
The spot or cash price of each currency is used to determine the value or each currency being traded. The interbank market is a component of the broader forex market.
35
RMD
Must begin no later than April 1st following the Calendar year in which the owner reaches age 72. Late distributions are subject to a 50% penalty tax on insufficient distributions.
Traditional ira’s have an RMD
Roth IRA does not have an RMD
36
Reg d rule 504
Any trust or charitable organization. With total assets in excess of 5m is considered to be an accredited investor for purposes of private placements. (Changed to 10m)
37
Two types of voting for shareholders
Regular / statutory - receive one vote per share per director. Beneficial to large stockholders
Cumulative / block voting - shareholder receive or vote per share times the number of directors. Beneficial for smaller stockholders.
38
If a company goes into liquidation. Here is the order.
TSUPC
taxes / secured debt / unsecured debt / preferred stockholders / common stockholders
39
What type of stock has the best capital appreciation against inflation
Common stock
40
What is a normal round lot
100 shares of common stock.
41
What type of stock is callable
Preferred
42
How do you calculate outstanding stock.
Issued stock - treasury stock
43
Authorized stock
Max number of shares of stock that is slowed to be sold (issued) usually an ipo. You usually don’t sell (issue) more than is authorized
44
Issued stock.
Amount of stock taken from authorized stock that is sold or issued to the public in a primary distribution. Usually I’m a secondary market
45
Treasury stock
Repurchased stock from the company. Appears in the balance sheet as a deduction from issues stock basically buying its own shares back from the market.
Appears on the balance sheet as a deduction from issued stock.
The board of directors makes the decision to repurchase shares.
46
What are the reasons to buy back a stock into treasury
1. Increase earning per share
2. Finance future acquisitions
3. Provide stock for employee stock option plans
4. Fight a takeover attempt.
47
Treasury securities
Treasury notes and bonds.
Remember bnb
48
Long
Buys. Expects to go up.
49
Short
Borrow, expects to go down. Bearish
50
How much is a point on a stock
$1
51
what is regular way settlement on a stock
the day in which a common stock is settled (t+2) two business day after trade date
52
what is reg T settlement
requires that payment for purchases of securities must be received by t+4 4th business day
53
what is a cyclical stock
auto manufactures steel companies, appliance manufactures, housing companies, paper companies, tool and die manufactures (moves with the economy)
54
counter cyclical stock
gold/silver mining companies, budget retailers, temp agencies
55
defensive / non-cyclical stock
no growth or increase. example coca cola, tobacco, companies, pharma
56
Utility Stock
not afraid of loosing customer base. companies that provide gas, water, electricity. offer high dividends but less capital appreciation (growth)
57
what type of stock dividends would be impacted by interest rates the most
utility stock dividends
58
what form is used to report dividends paid
US dollar form 1099b
59
what is the primary purpose of stock splits
increase marketability of the stock by reducing the market price
investors will receive new certificate for additional shares
par value decreases
*outstanding common shareholder must vote to approve stock split
when publicly traded company approves a stock split, the transfer agent maintains an accounting of the shareholders who are entitled and not entitled to the split
applies to options as well
60
what is a forward stock split
2:1 larger number in front / price of the share goes down
formula 2/1 (split ratio) x #of shares /1 = new shares
new price orig shares x price/ new amount of shares
61
reverse split
larger # in the back 2:3 / price of shares goes up
formula 2/3 (split ratio) x #of share / 1 = new shares
new price orig shares x price / new amounts of shares
62
warrants
long term
63
right
short term
64
debentures
bond not backed by any hard assets
65
rights formula
outstanding shares / new shares = # of rights needed to purchase each new share of stock
the if a client has x share, divide that by the # of rights needed
example.
1M shares outstanding, the company wants to issue 250k new shares
1m / 250k = 4 rights.
stock holder owns 1,000 share
1000 / 4 rights = 250 new shares
66
warrants
always a want to, no initial value,, warrants guarantee's to buy a common stock at a certain price usually for 10/20/30 years
example a company IPOs at $20 you buy warrants guaranteeing you can buy a share at $30 in the future. basically, the warrants hold no value, unless the stock price goes up in the future.
67
rights
always a have to- short term privaledge granted by a corporation to existing common shareholders which gives them the opportunity to subscribe to a proportionate number of newly issued shares. receive one right per share, max maturity of 90 days
68
equity options
a contract that entitles the buyer to either buy or sell shares of the underlying stock for a specific period of time at a set price
69
preferred stock
is a fixed income security, dividend is fixed. pays a set dividend stated as a % o par ($100) or in a fixed dollar amount
preferred stock has priority over common stock in receiving dividends and sharing assets if the corporation is dissolved.
no voting rights
less volatile than common
less appreciation
may be converted into common stock at the option of the stock holder
70
preferred stock call options
callable by the corporation that issued it. may be redeemed by the issuer at a set premium over the par value, after a specified date. most preferred stock is callable.
71
characteristics of preferred stock
cumulative
convertible
participating - dividends are fixed to a minimum but not a maximum amount
callable
72
how are dividends paid on common and preferred stock
cash
company owned stock
stock owned of other companies
treasury stock
products
73
dividend paying securities
common stock
preferred stock
mutual fund shares
ADR
not on warrants or bonds
interest payments on bonds ae a have to
74
DERP
declaration date - date the dividend is declared by the BOD. becomes a liability on the balance sheet of the issuer
ex-dividend date - must own the stock before the ex dividend date to claim dividend. if you own a stock after the ex dividend date, you will not claim the dividend
record date - date the corporation closes the updating of the stock book
payable date - date the dividend is actually paid out.
exception - the ex date for "cash" transactions is the business day after the record date.
75
dividend per share preferred stock formula
par value x dividend% = dividend per sahre
x # of shares
example
Mr. Jones owns 100 shares of 5% XYZ preferred stock, trading at $50 per share. Par value of the preferred stock is $100. How much will Mr. Jones receive in annual dividends from his stock position?
$100 par value x .05 = $5 per share
$5 per share x 100 shares = $500 annual dividend income
for stock dividend
An investor owns 200 shares of ABC common stock purchased at $50 per share. ABC decides to pay a 5% stock dividend. ( KEY WORD)
How many shares would the investor own after the dividend?
10 shares 200 x .05= 10 shares answer is 210 shares
What would be the new market price of the stock?
200 shares x 50 = $10,000
10,000/210 shares = $47.62 new market price
76
Current Yield on Common stock
Annual Dividend = Current yield %
Market Price
77
what is a REIT
Real Estate investment trust
invests in long term mortgages
own real property
make short term real estate construction and development loans
invest in others REITS
78
how does a REIT avoid double taxation
pays 90% of income to shareholders
75% of assets in real estate related activities
if satisfies, REIT don't pay corp taxes
considered to be an income equity security. seek income and capital appreciation.
79
how are REITS taxed
ordinary income tax, regulated under investment act of 1940
80
Direct Participation Programs DPP
DPP are investments which allows certain tax advantages.
limited partnership is the primary vehicle used for DPP
General Partners - manage the entity and have unlimited liability
Limited partners - limit their liability to the amount of their risk investment in the entity
Adjust cost basis - an investor cost of basis in a partnership interest is increased and decreased but certain items and is referred to as adjusted basis.
adjusted basis in important to a limited partner because limited partners can never write off more than the adjusted basis
81
Advantages / disadvaages of DPP
taxation
Single tax status
File federal tax return, but does not pay federal income taxes.( Limited Partnership)
No double taxation of profits.
Form K-1 are issued for tax purposes.
Limited liability- capital risk is normally limited to the investors initial cash investment
Depreciation- capital costs (building and machinery) can be depreciated
Flexibility- DPPs have flexibility concerning the types of investments available.
Diversification- financial risk and professional management.
82
Disadvantages of Dpps
Lack of liquidity- limited partners may not sell their interest in the partnership back without restriction(unlisted).( Investors who do not need liquidity)
Lack control- limited partners lack control over management( general management)
Tax code changes- possible changes in the tax code.
Loss of investment- loss of all or part of the investment.
Assessment- possible assessment of additional funds.
IRS scrutiny- additional IRS scrunty(abusive tax shelters)
AMT consequences- potential alternative minimum tax consequences.
Considerations-
possible loss of principal
general partner ability with potential conflicts of interest between partners
possible changes in the federal tax code
projected rate of return
The financial condition of other limited partners would not be a consideration in the customers evaluation of a DPP.
83
Dividends per share
Dividends paid to common shareholders / Outstanding common shares
84
Dividend Payout Ratio
measurement of what percentage of a company’s earning(not income) it pays out to its shareholders in the form of dividends.
dividends per share / earnings per share
85
Retained Earning
Retained Earning- net income minus dividends paid to shareholders. An increase in Retained Earning would result in an increase to shareholders equity on the company balance sheet.
net income - dividends paid = retained earnings
86
P/E ratio
The average price to earning ratio for the broad stock market is 20-25 times earning but this number fluctuates based on economic conditions.
Stock Splits- Par value decreases proportionately to the split- Forward split
Par value increases proportionately to the split- Reverse split
Warrants Key Facts- Exercising warrants causes dilution of the EPS
market price / Earnings per share = P/E ratio
87
what is the acronym BNB?
bills less than 1 years / never callable
notes 2-10 years / never callable
bonds 20-30 years / may be callable
88
key terms in bonds
Coupon Rate = Interest Rate= Nominal Yield
Par Value equals $1,000
Bond A Discount
Bond at a Premium
Bond at Par
Yield to Maturity( YTM)
Current Yield
Basis Points- equal to 1/100th of a point
One Point = $10
M= Roman Numeral for 1,000
89
what is the PAR value of a bond
issued in of $1000
90
Coupon Rate
interest rate of a bond is called the coupon rate and is a predetermined fixed rate that is a percentage of the par value bond. Interest is paid semi-annually.
Example- Coupon rate of 8%, therefore .08 x 1,000= $80 per year. And paid twice a year, which is $40 semi-annually.
91
what is one point on a bond
$10
92
corporate bond quoted at 98 1/2
98x10 = $980
1/2 x 10 = $5
bond price is $985
93
Maturity Date
the date the bond comes due for repayment to the investor. This means the investor receives interest payments for duration of the bond for example 20 years and at the end of the maturity date, the investor receives the par value or face amount of the bond.
94
how can bonds trade in the secondary market?
bonds can trade at a DISCOUNT, PAR VALUE or a PREMUIM.
Discount- < $1,000
Par Value - = $1,000
Premium- > $1,000
95
what is a series bond?
have a different issue date and usually have the same maturity date.
96
Term Bonds
An entire issue of bonds that all have the same maturity date.
97
Sinking Fund
represents money set aside to redeem the company’s bonds or debentures.
Basically, setting money to the side to repay bonds at the maturity date. Some bonds will have a provision in the contract. Can be used for preferred stock or bond issues.
98
Serial Bonds
bonds with one issue date and staggered maturity date. Interest costs will go down over the life of the bonds.
99
Balloon Maturity
bonds with a large amount of the issue that comes due at or near the final maturity date.
100
Funded Debt
corporate debt that is due more than one year from issue date, includes corporate bonds, notes, and bank loans.
NOT- preferred stock, government bonds and municipal bonds
101
Bonds Forms of Issuance
Registered – register in the investor name interest is paid directly to the investor. Principal is sent directly to the owner at maturity. If investor sells, they need to sign the back of the registered certificate. Currently issued as register.
Bearer- Not registered in investors name and have interest coupons attached. Interest is paid by attached coupons. NOT currently issued. Paper issued.
102
Investment clubs
cannot take advantage of breakpoints on mutual fund purchases.
are permitted to purchase new equity issues at the public offering price (POP).
Investment clubs are not considered restricted persons under the rules regarding sales of a new issue, and therefore, are eligible to purchase new equity issues. Note that if a registered representative (a restricted person) were a member of an investment club, the club would be prohibited from buying a new equity issue. Investment clubs are never permitted to take advantage of breakpoints available on mutual fund purchases.
103
A customer purchases $50,000 of bonds at a discount in the secondary market. The bonds mature in 10 years and are callable in five years at par. Under industry rules, the customer's confirmation will show
YTM
With callable bonds, the confirmation must show the lower of the yield to maturity (YTM) or yield to call (YTC). For a bond bought at a discount, the YTM is lower than YTC. On the exam, you will never encounter a call on a bond selling at a discount—it is less expensive to purchase the bond in the open market than pay the call price (which is always at least par).
104
In a new margin account, a customer sells short 1,000 shares of XYZ at $30 per share and deposits the required margin. If the stock subsequently falls to $25 per share, the equity in the account is
$20,000
When selling short, the initial credit balance is the sum of the proceeds of the sale ($30,000) plus the 50% Regulation T margin requirement ($15,000) or $45,000. The beginning equity is $15,000 (CR − SMV = EQ, or $45,000 − $30,000 = $15,000). If the market value falls to $25,000, equity is determined as $45,000 minus $25,000 equals $20,000.
105
Last week, your customer's margin account showed SMA of $6,000. As of the close of business yesterday, the margin account client had a long market value of $50,000 and a debit balance of $40,000. This client
When the equity in a long margin account falls below 25% of the market value, the customer receives a maintenance margin call for the amount necessary to bring the account back to 25%. A market value of $50,000 requires at least $12,500 in equity. The account currently has only $10,000 in equity ($50,000 minus $40,000). Therefore, a call will go out for a prompt deposit of an additional $2,500. SMA cannot be used to meet a maintenance call, only an initial margin call. Depositing fully paid marginable securities is another option. In our question, it would be enough securities to bring the LMV in the account up to 4/3 times the debit balance. $40,000 × 4/3 = $160,000 ÷ 3 = LMV of $53,333.33. With LMV of $50,000, the additional needed is $3,333.33
106
When an investor opens a new account at a member firm, FINRA rules require
the signature of the principal signifying that the account has been accepted.
107
Which of the following is the computation for the coverage ratio for a municipal revenue bond issue?
Net revenue divided by annual interest and principal expense
Debt service coverage measures the amount of money available for debt service compared to the annual debt service requirements. Annual debt service includes both interest and principal expense.
108
Nasdaq Level 1 service
displays the inside market: highest bid and lowest ask.
Level 1 service provides subscribers with the inside market. The inside market is the highest bid price anyone is displaying and the lowest ask price anyone is displaying, via the Nasdaq quotation system.
109
A registered representative would recommend a customer establish a short straddle on T-bonds when interest rates are expected to
Any straddle writer is always looking for a stable market. Volatility is the biggest enemy of the writer. Because this question is referring to debt options, their price movements are based upon changes in interest rates. No fluctuations in interest rates means no price changes.
110
ABC Corporation has issued a convertible preferred stock with a par value of $100. The stock is convertible at $40. The current market price of the preferred stock is $80. It would be correct to state that the conversion ratio is
2.5:1
When a $100 par preferred has a conversion price of $40, the stockholder can convert into 2.5 shares. That is a 2.5:1 ratio. The current market price of the stock is only relevant if the question asks about the parity price (which is $32). As a refresher, the parity price is that market price where the value of the shares received on conversion is equal to (at parity with) the market price of the convertible security. With the preferred stock selling at $80 per share and being convertible into 2.5 common shares, when the market price of the common is $32 ($80 ÷ 2.5) we have parity because 2.5 times $32 = $80.
111
Which of the following orders are reduced on the ex-dividend date for a cash dividend?
Buy 100 XYZ 60 DNR
Sell 100 XYZ 70
Sell 100 XYZ 60 STOP
Buy 100 XYZ 70 STOP
III only
Orders placed below the market (buy limits and sell stops) are automatically reduced on the ex-date. The exception to this rule is for orders marked DNR (do not reduce).
112
A DMF convertible bond (convertible into 25 shares) has increased 20% above par in market value. Which of the following would you expect the price of the DMF's common stock to be?
$1,000 (par) + 20% = $1,200 / 25 shares = $48. Alternatively, it is ordinarily the 20% increase in the value of the common stock that has caused the bond to increase 20% in value. $1,000 divided by 25 shares equals $40 plus 20% equals $48.
113
Consider a fund that randomly selects 30 stocks from the S&P 500 list of companies. The fund creates a portfolio of the 30 stocks, such that the portfolio beta equals 1.0 relative to the S&P 500. Assume there was unexpectedly bad news about two stocks held in the fund such that the fund's return was 8%, whereas the S&P 500 return was 8.5%. Which of the following statements regarding the fund's alpha is correct?
The fund generated negative alpha.
The alpha measures how well a portfolio performed compared to its risk-adjusted benchmark over a specific period. In this question, the fund's strategy is to match the S&P 500. The beta of the fund is constrained to equal 1.0, so we should expect its performance to match that of the S&P 500. The fund's realized return (8%) was less than its required return (8.5%) by 50 basis points. Therefore, the alpha was negative. Beta is not something that is generated by a portfolio. It is a measurement that reflects the expected volatility of a security or portfolio compared to its benchmark.
114
Use the following information to answer the question that follows:
Number of shares outstanding: 10,000,000
Trading volume:
Week ending Feb 4 - 90,000
Week ending Feb 11 - 80,000
Week ending Feb 18 - 125,000
Week ending Feb 25 - 135,000
Week ending Mar 4 - 100,000
Based on this information, a control person holding unrestricted stock is complying with Rule 144 when selling a maximum of
110,000 shares.
Unrestricted stock does not have a holding period. Compliance with Rule 144 relies on a volume limit. A control person may sell the greater of 1% of the outstanding shares or the average of the four weeks of trading volume. In this example, the last four weeks are the weeks ending February 11 through March 4, not February 4 through February 25. The average of the relevant four weeks is 110,000 and that is greater than 1% of the outstanding shares (100,000).
115
Which of the following explains that including noncorrelated assets in a portfolio can reduce certain risks?
Modern portfolio theory (MPT)
Instead of emphasizing particular stocks, MPT focuses on the relationships among all the investments in a portfolio. This theory holds that specific risk can be diversified away by building portfolios of assets whose returns are not correlated.
116
Which of the following is the FINRA-approved trade reporting system for corporate bonds trading in the over-the-counter (OTC) secondary market?
TRACE (Trade Reporting and Compliance Engine) is the FINRA-approved trade reporting system for corporate bonds trading in the OTC secondary market. TRACE's purpose is to add market transparency by disseminating trade details immediately to the investing public.
117
An investor purchases an original issue discount municipal bond on the offering at 80. The bond matures in 25 years. Eight years later, the investor sells the bond for 84. The tax consequence of this transaction is
long-term capital loss of $24
The 20 point ($200) discount accretes over the 25-year life of the bond. That makes the annual accretion $8 per year ($200 divided by 25 years). After 8 years, there has been $64 of accretion ($8 times 8 years). That means the cost basis of the bond is $864. The sale at $840 represents a loss of $24 and has a long-term holding period.
118
An investor purchased a 2x leveraged inverse ETF for $10,000. The ETF was linked to the performance of the S&P 500. During the first period, the S&P 500 rose by 8%, while during the next period, the index fell by 7%. What is the investment's value at the end of the second period?
9576
The investment's value at the end of the second period would be $9,576. In 2× leveraged inverse ETF, the value of the shares would move in an opposite direction to an index by twice the amount of movement of the index. When the S&P 500 rose by 8%, the leveraged inverse ETF would have fallen by 16%. The investment value would have declined to $8,400 ($10,000 × 16% = $1,600; $10,000 - $1,600 = $8,400). When the S&P 500 fell by 7%, the leveraged inverse ETF would have increased by 14% from $8,400 to $9,576 ($8,400 × 14% = $1,176). $8,400 + $1,176 = $9,576.
119
BNB
Treasury Bills- less than 1 year( never callable)
Treasury Notes- 2 year to 10 year( never callable)
Treasury Bonds- 20 year to 30 year(may be callable)
120
what is the par value of a bond
1000
121
how much is one point on a bond
$10
122
Roman Numeral M
1,000
123
coupon rate
interest rate on a bond is called coupon rate
and is a predetermined fixed rate that is a percentage of the par value bond. Interest is paid semi-annually.
Example- Coupon rate of 8%, therefore .08 x 1,000= $80 per year. And paid twice a year, which is $40 semi-annually.
124
corporate bond is quoted 98 ½
98 x10= 980
½ x10 = $5
$985
125
Maturity Date
the date the bond comes due for repayment to the investor. This means the investor receives interest payments for duration of the bond for example 20 years and at the end of the maturity date, the investor receives the par value or face amount of the bond.
126
Series Bonds
have a different issue date and usually have the same maturity date.
127
Term Bonds
An entire issue of bonds that all have the same maturity date.
128
Sinking Fund
represents money set aside to redeem the company’s bonds or debentures.
Basically, setting money to the side to repay bonds at the maturity date. Some bonds will have a provision in the contract. Can be used for preferred stock or bond issues.
129
Serial Bonds
bonds with one issue date and staggered maturity date. Interest costs will go down over the life of the bonds.
130
Balloon Maturity
bonds with a large amount of the issue that comes due at or near the final maturity date.
131
Funded Debt
corporate debt that is due more than one year from issue date, includes corporate bonds, notes, and bank loans.
NOT- preferred stock, government bonds and municipal bonds
132
Registered bond issuance
register in the investor name interest is paid directly to the investor. Principal is sent directly to the owner at maturity. If investor sells, they need to sign the back of the registered certificate. Currently issued as register.
133
Bearer bond issuance
Not registered in investors name and have interest coupons attached. Interest is paid by attached coupons. NOT currently issued. Paper issued.
“ AS TO PRINCIPAL ONLY”- Registered in investors name with interest coupons
134
Book Entry Form
ownership is electronically.
135
Bond Ratings
AAA / AA / A / BBB
136
137
how are corporate bonds quoted, taxed, and accrued interest calculated
1/8
federal, state, local
30 day month / 360 day year
138
how are treasuries quoted, taxed, and accrued interest calculated
1/32
federal / taxable
state and local / exempt
365
139
how are munis quoted, taxed, and accrued interest calculated
1/8
federal exempt, usually state and local exempt
30 day month / 360 day year
140
what is a debenture
not back by hard assets
141
YTM (or basis)
The long-term yield on a bond that is expressed as an annual rate. Takes into account the purchase price, redemption value, coupon rate and time to maturity.
142
YTM
annual interest + annual accretion or- annual amortization
divided by
(market price+ par value)2
143
Nominal Yield
the coupon rate or interest rate of the bond
144
Current Yield on bonds
the actual income that an investor will receive. annual interest / market price
145
Basis point on a bond equal
1/100th of point
Change in 1% in yield equal to 100 basis points
Or .01% of the par value
DO NOT CONFUSE Basis Point and POINTS.
146
Maturity of a bond
Short-term bonds react quicker to interest rate changes. (MARKET PRICE) ex. 1 year (safer) more stable
Long-Term Bonds react greatest to interest rate changes. (More Risk)
147
M in bond trading
roman numeral for 1,000
example, 5M bonds = $5,000 worth of bonds not qty. 5,000
148
points on stock and bonds
1 point on stock = $1
1 point on a bond = $10
149
When an investor purchases a bond, they pay
Market Price + Accrued Interest
1. Calculated on a 30 day month/360 day year / for corp and muni
2. Paid up too but not including settlement date
Settlement date is 2 business days after the trade date.
150
if a corp bond is traded june 10th, and the last day interest was paid is march 15th. how many days of interest will the cleint owe
87 days
16 Days for March
30 Days for April
30 Days for May
11 Days for June (add one more day after the trade date)
87 days
note if the trade date is on a Friday, include the weekend. (2 days)
151
Assume an investor buys a Treasury Bond Regular way on Tuesday June 29 and interest was paid January 15th of the same year. How many days accrued interest is the seller entitles to
Jan. =17
Feb. = 28
Mar. =31
Apr. =30
May =31
June. = 29
166 days
note, do not add one day like in corp
152
how are most bonds traded
OTC
153
Trust Indenture Act of 1939
(corporate debt)- federal act that requires that all corporate bonds and debentures be issued under an indenture (legal contract) or deed of trust. The bond indenture specifies the rights and duties of the issuer, underwriter, and investor.
Under the Act- the issuer is required to appoint a trustee who will represent and protect the bondholders and their interests.
Does not regulate: Federal Government Issues
Municipals Issues…… Private placements…… and Unit investments (UITS)
154
Secured Bonds
types of bonds that are more conservative investments that are secured by a guarantee or collateral.
155
Mortgage Bond
Secured by a mortgage on the real property owned by the issuing corporation. Mortgage bonds are the largest type of secured securities issued by corporations.
156
Close-end mortgage bond
property CANNOT be used as collateral for future loans, unless subsequent loans are in lesser claim. First on the list to get paid.
157
Open-End Mortgage Bonds
Property can be used to secure subsequent loans and all debts hold equal claims against the assets. More risk associated therefore a higher yield.
158
General Mortgage Bonds
pledges all mortgageable properties of a corporation as collateral but does not name any specific lots. No specific lots, building named in the bond.
159
Equipment Trust Certificate
Purchase new equipment- issued by transportation companies to purchase new equipment. ( Not callable)
Secured- the bonds are secured by the new equipment.
Trustees- hold the title to the equipment until bonds are completely paid
Default- in the event of a default on the bonds, bondholders have first rights to the titles of equipment.
160
Collateral Trust Certificate
uses securities(stocks) of other corporations.
161
Guaranteed Bonds
Guaranteed by a company other than the issuing company.
Parent company guarantees debt of a subsidiary company.
162
Parity Bond
bonds issued that have equal claims or rights as other bonds which were previously issued.
163
Debentures and Subordinated Debentures
bonds not secured by collateral or other types of assets. Still can be safe, but considered less safe in comparison to secured bonds due to lack of guarantee or collateral.
Not secured by assets
Debenture- we promise to pay back without assets or collateral.
Backed by good faith and credit
Subordinated Debenture- holds lesser claim, paid only after higher level debenture claims have been satisfied
164
Income or Adjustment Bonds
riskiest type of corporate bond- issued by companies in financial difficulty trying to avoid bankruptcy. Promise to pay interest only with sufficient earning and if the board declares that interest will be paid.
Principal due at maturity
Trade flat
Called adjustment bonds due to when a company reorganization.
Considered risky.
165
Zero-Coupon
bonds sold deep discounts and pay no interest while the bonds are outstanding. Basically you are getting a bond at a discounted price with no interest payments. Example you pay for a discount coupon bond of $600 with a par value of $1000. You will not receive any interest payments due to the face that you bought the bond at a deep discounted price and will only receive payment at maturity of the face value of the bond.
Does not pay semi-annual payments, no accrued interest. Issued at a discount.
Increase in value by accretion. Paid in one lump sum
166
Accretion (imputed interest)
you will use Purchase date, purchase price, dated date and maturity date. Not market price.
P Purchase date
P Purchase Price
D Dated date- in which interest starts accruing
M Maturity Date
167
‘Phantom Income”-
bondholders are taxed annually based on the increased value of the security even though they have received no actual income. In the first year, I don’t receive any interest but you still are taxed on yet… with zero coupon bonds.
168
zr
implies zero coupon bond
169
Call protection
fixed time period where bonds may not be called by the issuer. Bondholders want interest rates to decline during this time and bondholders want bond prices to rise during this time period.
170
Coupon Rate
the higher the coupon rate on the bond, the greater the chance that the bond will be called.
171
When bonds are “called”
Bondholder receives “call premium” plus accrued interest.
Company credit improves(Less debt)
Debt-to-net-worth ratio improves
172
“Notice to call”
Prior to calling bonds the issuer must give investors the “notice to call”. During this time investors may:
state date when bonds when they will be called back.
They can COVERT the bonds( to equity)
SELL the bonds
WAIT for redemption date
173
Convertible Bonds
convert to shares of common stock at the option of the bondholder.
174
Coupon Rate
is normally lower compared to non-convertible bonds
Investor has choice to convert.
175
Conversion feature
allows bondholder to choose to participate in the growth of the corresponding equity security.
176
Calculating parity Price
Calculate conversion Ratio:
Par Value / Conversion Price = Common shares produced
$100 for convertible preferred stock
$1000 for convertible bonds
STEP 2
Market Price of bond or preferred stock / Common Shares Produced = Parity price of Common Stock
OR
177
A convertible bond is quoted at 80 and has a conversion price of $50. What is the parity price of the common stock?
Step 1.
Par $1,000 / 50 = 20 shares produced
Step 2. $800 / 20= 40 parity price of common stock
178
A convertible preferred stock is selling for $120 per share with a conversion price of $20. What is the parity price of the common stock?
Step 1.
Par 100 / 20= 5 shares of common stock
Step 2.
120 / 5 = $24 parity price of common stock
179
A convertible bond has a conversion price of $25. The common stock is currently trading at $23. What is the parity price of the bond?
Step 1. $1,000 / 25 = 40 shares produced
Step 2. 40 shares x $23 Mkt price = $920 parity price of the bond
180
An investor owns a callable convertible preferred stock which is convertible into common stock at $25 per share. The current market price of the common stock is $30 and the preferred stock is called at $165. What should the investor do?
Step 1.
Par $100 / $25= 4 shares produced
Step 2 Stock $30 x 4 shares = $120 parity
Step 3; The investor could
Convert for $120
Or
Tender for $165. Best Option
181
Interest on CMO is paid
at a fixed coupon rate over the life of the CMO
Principal of the CMO is paid in varying amounts over the life of the CMO depending on the various tranches and varying maturity factors.
182
CMOs are considered
derivative securities because the cash flow of the CMO is dependent on the performance of a pool of mortgages.
183
Issuers of CMOs
Ginnie Mae(GNMA), Fannie Mae(FNMA) or Freddie Mac(FHLMC). Also called Agency CMOs. FHA Mortgage Loans and Conventional/ Private Mortgage Issuers. Government sponsored corporations that provide financing for the housing market.
184
Ginnie Mae
pass-through securities are comprised of FHA and VA mortgages that are guaranteed against default. ggg
185
CMO tranches generally pay investors
monthly.
Interest payments are subject to federal, state and local income tax.
186
Z-bond
The final tranche of a CMO, also called an accrual bond or accretion bond.
Holders of Z bonds receive no cash until earlier tranches are paid in full.
187
Variable Interest Rate
CMO
London Interbank Offered Rates(LIBOR).
188
Credit Risk
Historically little or no credit risk due to most CMOs are guaranteed by US government sponsored enterprises or agencies and have carried AAA rating.
189
Interest Rate and Market Risk cmo
If rates decline, CMO prices will increase, mortgages will be refinanced and prepayment will occur.
If rates rise, mortgages typically are held through maturity and lower-rate CMOs may be less desirable than newer, higher-rate CMOs.
Implied Call risk- the risk that principal will be returned sooner than originally anticipated.
This may occur due to sharp interest rate declines and increases in refinancing activities. It may pay their loans ahead of schedule.
Extension risk- the risk that the maturity on the CMOs may be extended or end up longer than expected.
Some pre-payment of mortgages is anticipated in estimating various tranches.
If there is no pre-payment, the maturity of the CMO may be extended beyond the time frame.
190
Collateralized Debt Obligations(CDO)
A structured debt security backed by a pool of assets (ABS-Asset Backed Security) including mortgages, auto loans, corporate debt and credit card debt)
These debts are packaged and sold to investors
CDO is divided into different tranches much like a CMO, generally based on risk.
191
Treasury Bills
Treasury Bills are short term debt obligations of the federal government. Up to ONE year maturity. Highly marketable and low risk.
Sold at Discount at competitive bid auctions and redeemed at par on maturity.
Marketable, nit not redeemable until maturity.
Available in 1,2-,3-4,6-, and 12-month maturities. Never issued with a maturity of more than a year. Can be listed in weeks as well.
Treasury Bills are extremely liquid.
Return exemption are exempted from state and local taxes but not Federal Income tax.
Minimum issued with a $100 denomination
Not callable prior to maturity
Rate of Interest does not carry a fixed rate of interest.
Discounts
Taxed as interest income and NOT as a Capital gain
T-bills are quoted on a yield basis (discount from par)
Characteristics
Issued in minimum denominations of $100(formerly $1,000)
Subject to Federal Tax
Regular Way settlement- T+1 in the secondary Market
Regular Way settlement is T+3 in Primary Auction Market
192
Treasury Notes
Maturities of 2 to 10 years and are not issued as callable
193
Treasury Bonds
matures of 20 to 30 years and may be issued as callable.
A point on a Treasury Note or Treasury Bond is equal to $10.00 and fractions of point are quotes in 32nds.
Example-
Treasury Bond @97.16
97 x10= $970.00
16/32x 10= $5.00
$975.00
194
TIPS- Treasury Inflation-Protected Securities
TIPS are Treasury notes and bonds whose interest and redemption payments are “indexed “to the current inflation rate based on the Consumer Price Index(CPI).
Interest – paid semi-annually. Fixed rate is applied to the inflation-adjusted principal value of the bond, not par of $1,000.
Subject to Federal Tax
Adjusted to CPI semi-annually.
Final payment cannot be less than what the investor originally paid.
Appreciation
Appreciation on the principal value of the TIP must be reported annually and is subject to federal income tax at the time reported (phantom income). Income we did not receive in that year, but need to pay taxes on due to increase value.
Auctioned on JULY, OCTOBER AND JANUARY.
Preserve Capital- due to the inflation indexing feature, TIPS preserve an investors capital best among all treasury securities.
195
STRIPS- Separate Trading of Registered Interest and Principal Securities
Several brokerage firms offer investors the ability to purchase certificates which represent a portion of a trust with treasury bonds as the underlying security. The trust buys a large quantity of Treasury bonds, strips the coupons and then offers certificates or receipts with varied maturities investors.
Also known as
Treasury Receipts- stripped coupon Treasury Bonds, trade at deep discounts which are accreted and taxed annually and are very volatile.
Interest is paid at maturity.
Rate of Return- able to lock in a rate of return for a predetermined period.
196
Zero-Coupon Treasury Bonds
Example- a STRIPS rate of return
You have a 20 year U.S. Treasury Bond which means you have 40 semi-annual interest payments with one principal payment, so you will have 41 separate Zero-Coupon Treasury Receipts
Interest and principal payments are guaranteed by the U.S. Treasury and therefore are of the highest quality. Collateral is US TREASURY BONDS, not expected to default.
Interest Taxation- interest on Treasury Receipts is taxable annually on though the investor receives only one payment at maturity.
All of the Interest is PAID at maturity.
Reason for purchase
Individuals normally purchase Treasury Receipts for retirement plans such as IRA’s and Keogh’s that have no current tax liability.
Regular Way Settlement
For U.S. securities in the secondary Market is the business day after trade date. T+ 1
Payment is normally required in federal funds. Federal Reserve bank to another one.
197
Series EE Saving Bonds
Series EE Saving Bonds- Non-marketable Federal Government Debt. Meaning cannot trade them from investor to investor.
Issue at face value and earn. Interest
Interest received and taxed when the bonds are redeemed
Offered in denominations of $25 to $10,000(max per calendar year limit).
Registration- Electronically register in the investors name
Must be redeemed back to the government
Not subject to market fluctuations
Redemption- redeemable prior to maturity(after 1 year)
No Loan collateral- not eligible to be used as collateral for a loan due to they are not marketable.
198
Municipal Bonds
( TAX FREE)
Bonds issued by state and local government entities such as cities, counties, school districts, authorities and the state.
Interest is exempt from federal income tax
May also be exempt from state and local income taxes.
199
General Obligations Bonds
Aka- full faith credit bonds
State- county, city, school and district
Payment of Principal and interest- is not limited to the revenues derived from any one specific project.
Secured by taxes- principal and interest payments of these bonds are secured by/ from taxes collected by the municipality. Derived from sales and property taxes
Voter Approval required
200
Revenue Bonds
(toll road)
bonds for which the payment of the bond interest and principal depends on revenues generated from a particular facility, such as a toll road or bridge, rather than from the taxing powers of a city or town.
DO NOT require a vote of the citizens
DO NOT count towards any constitutional or statutory limit on the amount of debt a municipality may incur.
Not payable from taxes and will not contribute toward any possible future increase of taxes.
AKA Industrial Revenue Bonds- municipality approves the sale of bonds “on behalf of a corporation to construct or purchase facilities that are then purchased by or leased to a private user.
Enables company to borrow at tax free rates.
Principal and interest are paid solely by the company.
Debt responsibility- companies for whom the bonds were issued. More risky
Substantial users- may be taxed on interest if they buy the bonds.
201
Municipal Yield to Corporate Yield
Municipal Yield = Corporate Equivalent Yield /( 100% - Investors Tax rate)
202
Corporate Yield to Municipal Yield
Corporate Yield x (100% - investors tax rate)= Municipal Equivalent Yield
MC Hammer
203
Tax Anticipation Notes (TAN)
used to raise monies which will be paid off with tax receipts in the near future.
204
Revenue Anticipation Notes( RAN)
raise monies which will be paid off when certain revenues are realized or received.
205
Tax and Revenue Anticipation Notes(TRAN)
combination of a tax and revenue note.
206
Bond Anticipation Notes(BAN)
used to raise money which will be paid off from the sale of bonds in the future. It will issue notes to carry it through until the long term bond revenues are received.
207
Grant Anticipation Notes(GAN)
grants received by municipalities from the federal government generally from the federal transit authority program for the purchase of buses, trains, ferries, vans, and support equipment.
208
Construction Loans Notes(CLN)
notes typically issued to fund housing projects.
Demand Notes- used for short-term financing that are callable on “demand”
Tax-exempt commercial paper- paper is short term( max of 270 days) issued to:
Raise working capital
Cover extraordinary expenses
Cover construction or maintenance costs
Note :not issued to refund outstanding bonds.
209
Build America Bonds(BABs)
Taxable municipal bonds issued for infrastructure rebuilding.
Cannot be used to refinance outstanding debt.
Fully taxable- interest payment are fully taxable to investors.
Subsidized interest paid- by the federal government paying back the municipality 35% of the interest paid out.
OR
Bondholders may take a federal tax credit equal to 35% of the interest expense.
210
Municipal Fund Securities
Include local government investment pools(LGIPs), ABLE programs and 529 plans.
211
MSRB G-37
The MSRB governs political contributions made by municipal finance professionals(MFP), Municipals Dealers or Political Action Committees(PAC) controlled by the broker-dealer or MFP, to officials of an issuer.
Example of a violation – contribute more than $250 /2yr penalty
212
Other Debt instruments
Money market instruments – high quality, short term(mature in 12 months or less) debt instruments.
Treasury Bills- most liquid of all money market instruments.
Negotiable Certificates of Deposit(CDs) :
Time deposits Issued and guaranteed by banks( Commercial Banks)
$100,000 minimum… fixed maturities of 1 year or less.
Usually trade “plus interest” and are in registered form.
Penalties may be incurred if cashed in prior to maturity.
Eurodollar CD’s are short term instruments issued by banks outside the US, interest and principal is paid in US dollars.
213
Commercial Paper-
unsecured promissory note issued at a discount by corporations, generally used to finance daily operation( not international trade).
Commercial paper is repaid from accounts receivable.
Issued for a specific amount and has a set maturity date with a maximum maturity of 270 days.
Not guaranteed by FDIC
214
Banker’s Acceptances
finance foreign trade and are similar to a letter of credit
Exchange risk- associated with foreign and sovereign debt(bond) issues, NOT U.S or domestic debt (bond) issues.
