Section II.A. Investment Vehicles Flashcards
1
Q
Exchange Traded Product (ETP)
A
- A derivative security that trades on a national securities exchange on an intra-day basis
- The underlying asset is often a commodity, currency, equity share price, or interest rate
- ETPs may be indexed or actively managed
- Examples included in exchange traded funds and notes
2
Q
Exchange Traded Fund (ETF)
A
- A security that trades on an exchange
- Usually a passive strategy that tracks an index or benchmark
- May be bought or sold throughout the day (as opposed to mutual funds)
- Investors may buy, short, or leverage ETFs
- Gives smaller investors an opportunity to access professional money managers
- Usually lower annual fees and expenses (vs. mutual funds)
- Potential advantages:
1.) Trade continuously like stocks
2.) Can be sold short or purchased on margin
3.) Lower costs
4.) Tax efficient - Potential disadvantages:
1.) Prices can depart by small amounts from NAV
2.) Must be purchased from a broker
3
Q
Exchange Traded Note (ETN)
A
- ETNs are traded on a major exchange
- Unsecured debt securities
- Can be sold short or purchased on margin
- No coupon payments
- ETNs have a maturity date
- Taxation:
1.) Typically, more efficient than mutual funds and ETFs
2.) Typically, no internal taxation generated for shareholders
3.) Shareholders typically only pay taxes if/when recognizing a gain upon sale of their shares
4
Q
Mutual fund
A
- Investment vehicles that allow pooled funds to be managed professionally
- Investments within these structures are often made in stocks, bonds, and money market securities
- Mutual funds give smaller investors and opportunity to access professional money managers
- Purchases and redemptions are done at the end of the day
- Mutual fund units are offered for purchase based on a fund’s net asset value (NAV); a.k.a. “open-end fund”
5
Q
Open-end fund
A
- Fund issues new shares when investors buy in and redeems shares when investors cash out
- Priced at Net Asset Value (NAV)
6
Q
Closed-End Fund (CEF)
A
- An investment pool managed by an advisor that is actively priced and traded on a stock exchange
- Capital is raised through an initial public offering (IPO)
- CEFs differ from exchange traded funds (ETFs) and open-ended mutual funds in that CEFs may not raise new funds (contributions)
- No change in shares outstanding; old investors cash out by selling to new investors
- Priced at premium or discount to NAV
- Strategies usually include sector, industry, or geographic focus or specialization
7
Q
Separately Managed Account (SMA)
A
- SMAs are individually segregated accounts that are actively managed by professional money managers
- An investment advisor usually oversees the account
- Unlike mutual funds, SMAs offer investors the benefit of individual cost basis and customization
- Usually recommended/sold through traditional brokerage houses
- SMAs can invest in REITs
- Less popular now given new products available and the rise of the independent advisor
8
Q
Unit Investment Trust (UIT)
A
- An investment vehicle that offers a fixed, unmanageable portfolio of stocks and/or bonds
- Usually issued in increments of $1,000
- Can be traded on a secondary OTC market and every trust has an expiration date
- May be a registered investment corporation (RIC) where investors are joint owners, or a grantor trust offering proportional ownership
- Redeemable units offered for a specific period of time
- More popular with retirees seeking income
- More susceptible to inflation as interest is fixed for the life of the security
- Allows concentrated positions
- Bond UITs more popular than stock UITs
9
Q
Real Estate Investment Trust (REIT)
A
- An actively managed portfolio of real estate holdings (either commercial or residential)
- Pooled investment structure allowing smaller investors access to professional management
- Traded on a stock exchange if a public REIT or it may be privately held
- Is a “flow through” entity in which at least 90% of the income must be paid out to shareholders
- Types include equity, mortgage, and hybrid REITs
- Distributions taxes to unit holders, not the entity, if requirements are met
- Divided distributions are taxed to unit holder as capital gains if considered “qualified”
- Considered a form of UIT
- Offers diversification, professional management, higher yields, tax advantages, liquidity
- Receives special tax treatment
REIT taxation on entity:
1.) Rental income is treated as business income to REITs (applies to expenses)
2.) Income distributions to shareholders is not taxed to the REIT (tax liability is passed through)
3.) Exempt from tax at the trust level if they meet requirements including 90% distribution rule
4.) REITs still face corporate tax on retained earnings and income
REIT taxation to unitholders:
1.) Dividends paid are taxed as ordinary income unless considered “qualified dividends” which are taxed as capital gains
2.) Dividends may be considered “return of capital” in which case they reduce cost basis and are not considered taxable income
10
Q
Master Limited Partnership (MLP)
A
- A limited partnership ownership structure that is publicly traded
- Limited partners provide most of the capital and general partners are responsible for managing MLP activities
- Must receive approximately 90% of its cash flows from investments in real estate, commodities, or natural resources
- Gains are taxed to the unitholders (partners) when distributed
- Offers liquidity
11
Q
Bond
A
- A debt obligation, which is a legal commitment to repay an amount borrowed and any promised interest over a defined period of time
12
Q
Common stock
A
- Ownership interest in a corporation represented by shares of stock
- Common stock shareholders receive the right to elect a board of directors and vote on corporate policy
- Common stock shareholders are last in the order of those receiving assets upon corporate liquidation
- Higher risk of owning common shares leads these shares to outperform corporate bonds and preferred stock of the same company
- Secondary rights to dividends
- Also known as “ordinary shares”
13
Q
Preferred stock
A
- The ownership interests in a corporation that has a superior (hence, “preferred”) claim on income and assets vis-à-vis common stock owners
14
Q
Fixed annuity
A
- Guarantees a stream of payments over a specified period of time
- Investment risk borne by insurance company
15
Q
Variable annuity
A
- Offer tax-deferred growth to investors with option of different investments (through sub-accounts)
- Offers some degree of asset protection
- Taxation of variable annuities:
1.) Growth is tax deferred
2.) Withdrawals before age 59.5 incur 10% penalty
3.) Gains distributions are taxed as ordinary income
4.) Installment payments typically create a scenario in which a portion of the payment is considered return of principal (not taxed if contribution was made with after-tax money) and another portion of each payment is considered taxable gain
5.) Immediate or other (non-installment) payments may create tax liability on all payments until gains are paid out (i.e., taxable gain payments are considered made first with non-taxable return of principal payments considered made second)
