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2024 planning studies. > Securities Markets and Money Market Instruments > Flashcards

Securities Markets and Money Market Instruments Flashcards

1
Q

What are investment banks?

A

Financial institutions that assist corporations and municipal governments in raising capital

They do this by underwriting new securities and acting as the issuer’s agent in the issuance of securities.

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2
Q

Fill in the blank: Investment banks help corporations and municipal governments raise capital by _______.

A

[underwriting new securities and acting as the issuer’s agent]

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3
Q

True or False: Investment banks only focus on mergers and acquisitions.

A

False.

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4
Q

Fill in the blank: Investment banks assist companies in _____ by providing expert financial advice.

A

strategic planning.

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5
Q

Which of the following is NOT a function of an investment bank?
A) Underwriting securities
B) Providing personal loans
C) Advising on mergers

A

B) Providing personal loans.

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6
Q

What is meant by ‘best efforts’ in underwriting?

A

The underwriter will make every effort to sell all the shares, but the company does not receive any money for unsold shares.

In this arrangement, the investment banker acts as a broker rather than buying the securities.

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7
Q

How does a banker operate under a ‘best efforts’ agreement?

A

The banker does not underwrite the securities at all and only acts as a broker to sell whatever stock it can at the stipulated price.

This means the banker does not purchase any securities.

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8
Q

What do investment bankers guarantee to a company during a firm commitment?

A

That the entire issue will be purchased

This means that investment bankers take on the risk of selling the issue to investors.

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9
Q

What happens if investment bankers fail to sell the entire issue to investors?

A

They absorb the loss

This indicates the level of risk that investment bankers take in a firm commitment.

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10
Q

What is dilution in the context of stock issuance?

A

Dilution refers to the reduction in the value of existing shares due to the issuance of additional shares.

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11
Q

Why are companies reluctant to issue more stock?

A

Companies are reluctant to issue more stock because it increases the supply of stock outstanding, which decreases the value of each existing share.

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12
Q

What happens to earnings per share when a company issues more stock?

A

Earnings per share decrease when a company issues more stock.

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13
Q

A sale of securities to the public by insiders or other affiliated persons.

A

Secondary offering.

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14
Q

The investment banking companies that participate with the managing underwriter to assist in the distribution of the new issue.

A

Syndicate.

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15
Q

Brokerage firms that help distribute securities in an offering but that are not members of the syndicate.

A

Selling group.

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16
Q

After a new issue comes to market, typically there is a lockup period, often ___ days, during which early investors and employees may not sell their shares.

A

180 days

The purpose of these lock-up periods is to prevent a sudden influx of shares into the market, which could depress the stock price.

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17
Q

What is a broker-dealer?

A

A firm that acts as both a broker and a dealer in securities

Brokers are agents for sellers who receive commissions, while dealers buy and sell for their own accounts.

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18
Q

What role does a broker play in securities transactions?

A

Acts as an agent for sellers of securities who receive a commission for executing a transaction

The broker facilitates the sale of securities on behalf of clients.

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19
Q

What role does a dealer play in securities transactions?

A

Acts as a principal who buys and sells securities for their own accounts

Dealers take on the risk of holding securities in their inventory.

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20
Q

Fill in the blank: A broker-dealer acts as both a _______ and a _______ in securities transactions.

A

broker, dealer

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21
Q

is the point where the amount supplied equals the amount demanded. At this price, the market is balanced, and there is neither a surplus (too much supply) nor a shortage (too much demand).

A

Equilibrium price.

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22
Q

This is for new companies without any products and provides them cash for product development and market research.

A

Seed capital.

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23
Q

Cash is provided for manufacturing and sales activities.

This is in relation to venture capital.

A

First stage financing.

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24
Q

Cash is provided for working capital.

In relation to venture capital.

A

Second stage financing.

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25
Q

Cash is provided for expansion and new products.

In relation to venture capital.

A

Mezzanine financing.

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26
Q

phase during which capital is provided for an expected IPO of a venture capital company.

A

Bridge financing.

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27
Q

What is a Leveraged Buyout (LBO)?

A

A financial strategy where an entity acquires another company primarily using borrowed funds.

The assets of the acquired company often serve as collateral for the loans.

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28
Q

Who typically conducts a Leveraged Buyout?

A

A private equity firm or a group of investors.

These entities aim to purchase a target company.

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29
Q

What is the financing mix in an LBO?

A

A combination of debt and equity.

Debt often constitutes 60% to 90% of the purchase price.

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30
Q

What happens during the valuation and negotiation phase of an LBO?

A

The target company is evaluated, and a purchase price is negotiated.

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31
Q

What is involved in the financing arrangement of an LBO?

A

Securing financing primarily through debt instruments using the target company’s assets as collateral.

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32
Q

What is the purpose of post-acquisition management in an LBO?

A

To implement strategies to improve the company’s profitability and cash flow.

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33
Q

What is the final step in the LBO process?

A

Debt repayment and exit strategy execution.

This may include selling the company or taking it public.

34
Q

What is the primary motivation for using an LBO?

A

To achieve high returns on investment by leveraging borrowed funds.

35
Q

What is the significance of cash flows in the LBO process?

Leveraged Buyout

A

They are used to repay the debt over time.

LBOs use a high degree of debt financing. The acquired company’s cash flows must be sufficient to cover interest payments and principal repayment on this debt.

36
Q

What does the term ‘equity’ refer to in the context of an LBO?

A

Investor’s own funds used to finance the acquisition.

37
Q

are limited to 35 unaccredited investors but are available to an unlimited number of accredited investors.

A

Private placements.

38
Q

Frequent investors in private placements include

A

insurance companies and pension funds.

39
Q
A

C

The answer is I, II, and III. Only statement IV is incorrect. Venture capital investments exhibit a lack of liquidity.

40
Q
A

D

The answer is I, III, IIII, and IV. All of these are considerations for an investor when deciding on the purchase of a private placement.

41
Q
A

B

The answer is tax-free income is provided by the partnership to Kim. The income from limited partnerships is not tax exempt. An investor, however, may use a tax loss from a partnership to offset the income from another passive investment.

42
Q

indicates the number of shares that are available for trading by investors; the remaining shares of those outstanding generally are held by insiders and often have restrictions on disposition.

A

Public float.

43
Q

What is a round lot in trading?

A

A round lot is considered the general unit of trading, which is usually 100 shares.

Round lots are standard trading units and typically offer better liquidity and pricing.

44
Q

What is an odd lot in trading?

A

An odd lot is less than 100 shares.

Odd lots may incur different fees and may have less favorable pricing compared to round lots.

45
Q

PROFESSOR’S NOTE

A

The SIPC oversees the liquidation of brokerage firms and insures investors’ accounts up to a maximum value of $500,000 ($250,000 for cash balances) in the case of bankruptcy of a brokerage firm. While the SIPC insures brokerage accounts in the event of a brokerage firm’s financial difficulties, it does not cover market losses suffered while waiting to get securities from a bankrupt brokerage firm.

46
Q

Once a margin account position has been established, the investor must maintain a ________, which is usually set at 35%. The ___________ is set by the broker-dealer, not the Federal Reserve, but Rule 431(b) of the NYSE requires a minimum maintenance requirement of at least 25%. This is a minimum percentage of cash equity in the position.

A

Once a margin account position has been established, the investor must maintain a maintenance margin, which is usually set at 35%. The maintenance margin is set by the broker-dealer, not the Federal Reserve, but Rule 431(b) of the NYSE requires a minimum maintenance requirement of at least 25%. This is a minimum percentage of cash equity in the position.

47
Q

True or false?

The maintenance margin percentage is less than the initial margin percentage.

A

True.

The initial margin requirement is typically 50%

48
Q

If the equity in an investor’s position drops below the maintenance margin percentage, then the investor will receive a

A

Margin call.

49
Q

includes the original amount borrowed by the investor plus any accrued interest.

Specifically, in a margin account.

A

Debt balance.

50
Q

the current fair market value of the security purchased with the use of margin less the debit balance.

A

Margin equity.

51
Q
A
52
Q

Your client purchased 100 shares of FAQ stock at $60 per share with a 50% initial margin percentage and a 35% maintenance margin requirement. If the stock drops to $40 per share, how much money does your client need to deposit to meet the required equity amount in the margin account?

A. $400
B. $600
C. $615
D. $800

A

A

The answer is $400

Calculate as follows:
Value: $40 x 100 shares = $4,000
Loan amount: $6,000 x 0.50 = ($3,000)
Actual equity: $1,000
Required equity: $4,000 x 0.35 = ($1,400)
Cash deposit needed: $400

53
Q

Abigail uses her margin account to purchase 300 shares of Monroe stock at $85 per share. The initial margin is 50% and the maintenance margin is 35%. Abigail’s margin account charges 6% annual interest. Monroe stock pays the following dividends at the end of the first two years: $2.50 (Year 1) and $3.60 (Year 2). At the end of Year 2, Abigail sells all of her stock for $100 per share. What is Abigail’s holding period return?

A. 18.83%
B. 24.85%
C. 37-65%
D. 49.67%

A
54
Q

True or false?

Money market deposit accounts at a bank offer federal insurance, whereas a money market mutual fund do not.

A

True.

Though a money market deposit account at a bank may also limit the amount of transfers and check writing within a certain period of time.

55
Q

These funds typically invest in high-quality, short-term investments, such as U.S. Treasury bills, commercial paper, and negotiable CDs.

  • The investments within the fund usually mature within one year and have an overall weighted average maturity of less than 60 days.
  • rate of return on the fund is highly sensitive to changes in short-term interest rates, particularly the federal funds rate or the overnight lending rate between banks that are members of the Federal Reserve System.
A

Money market mutual funds.

56
Q

a negotiable, short-term, unsecured promissory note issued by a large corporation to finance accounts receivable and inventories. This type of debt is usually issued in denominations of $100,000 or more and is a substitute for short-term bank financing.

  • Primarily purchased by money market mutual funds.
A

Commercial paper.

57
Q

term to maturity is no more than 270 days and is often backed by lines of credit from banks.

  • rated by a rating service (such as Standard & Poor’s) as to quality.
  • taxed to the investor at ordinary income rates when earned.
A

Commercial paper.

58
Q

typically traded at a discount from their face value in the secondary market.

  • short-term drafts drawn by a private company on a major bank used to finance imports and exports.
  • bank usually acts as an intermediary between the American company and the foreign company (i.e., the company furnishing or receiving the goods).
A

Banker’s acceptances.

For example

an American importer may request acceptance financing from its bank when the foreign company will not provide credit. As a result, the importer’s bank agrees to pay the foreign supplier on behalf of the importer. The importer is then contractually obligated to repay the bank within three to six months. In turn, the importer’s bank may sell the obligation at a discount to obtain immediate cash.

59
Q

Characteristics of Money Market Instruments

A
60
Q

Which of the following statements best describes money market mutual funds?

A. They allow up to six withdrawals per month and are insured by the FDIC.
B. They are an asset that provides a modest rate of return, diversification, and liquidity.
C. They are used primarily to finance imports and exports.
D. The average maturity date of the investments within these types of funds is 270 days.

A

B

The answer is they are an asset that provides a modest rate of return, diversification, and liquidity. Unlike an MMDA, the fund is not insured by the FDIC. The average maturity date of the investments in the fund is usually less than 60 days. Banker’s acceptances are used primarily to finance imports and exports.

61
Q

In a repurchase agreement, the percentage difference between the repurchase price and the amount borrowed is most accurately described as

A. the haircut.
B. the repo rate.
C. the repo margin.
D. the federal funds rate.

A

B.) the repo rate

62
Q

Corporations receive a dividend exclusion when they

A

Received dividend income from stocks of other corporations.

63
Q

a type of dividend payment where shareholders receive additional shares of the company’s stock instead of cash.

A

Stock dividend.

Stock dividends are generally not taxable at the time they are received for federal income tax purposes, provided they don’t offer a choice between cash or stock. Instead, the tax basis of your shares is adjusted.

64
Q

PROFESSOR’S NOTE

A

Be careful with the term dividends—there are several types and they are not all the same! Dividends that receive preferential capital gains treatment (called qualifying dividends) are those issued by C corporations (the net income is taxed on the corporate level first, and then the dividend is distributed to the shareholder). Dividends paid by an S corporation or a real estate investment trust (REIT) are not taxed at the corporate level prior to being distributed, so they do not qualify for preferential capital gains treatment.

65
Q

What is the maximum tax rate for collectibles?

A

28%

Collectibles include works of art, metals, gems, antiques, coins, and stamps.

66
Q

List some examples of collectibles.

A
  • Works of art
  • Metals
  • Gems
  • Antiques
  • Coins
  • Stamps

These items are taxed at a maximum rate of 28%.

67
Q

How are gold and silver exchange-traded funds (ETFs) taxed?

A

As collectibles, not securities

This means they are subject to the maximum 28% long-term capital gains tax rate.

68
Q

What is the maximum tax rate applicable to the gain created by depreciation on real estate?

A

25%

This rate applies specifically to gains resulting from depreciation.

69
Q

True or False: Long-term capital gains on collectibles are taxed at preferential lower rates.

A

False

Long-term capital gains on collectibles are taxed at the maximum 28% rate.

70
Q

Fill in the blank: Collectibles are taxed at a maximum _______ rate.

A

28%

This is the highest tax rate for collectibles.

71
Q

TEST TIP P

Net capital losses are deductible against earned income to a maximum of $3,000 per year. Any capital losses not deducted in a taxable year may be carried forward indefinitely to be used in future years.

A
72
Q

What is the Net Investment Income Tax (NIIT)?

A

A 3.8% tax on investment income for individuals with modified adjusted gross income (MAGI) over certain thresholds

Commonly referred to as the ‘Medicare surtax’.

73
Q

What are the MAGI thresholds for NIIT for single filers?

A

$200,000

This threshold is used to determine liability for the tax.

74
Q

What are the MAGI thresholds for NIIT for married filing jointly?

A

$250,000

This threshold is used to determine liability for the tax.

75
Q

NIIT applies to the lesser of which two amounts?

A

Your net investment income or the amount by which your MAGI exceeds the threshold

This determines the taxable amount under NIIT.

76
Q

What types of income are subject to the Net Investment Income Tax?

A
  • Interest
  • Dividends
  • Capital gains
  • Rental and royalty income
  • Income from passive business activities

These are categorized as investment income.

77
Q

Which types of income are excluded from NIIT?

A
  • Wages
  • Self-employment income
  • Distributions from certain qualified retirement plans

These forms of income do not count towards the NIIT calculation.

78
Q

True or False: The NIIT is a flat tax rate applied to all income.

A

False

NIIT specifically targets investment income above certain MAGI thresholds.

79
Q

Fill in the blank: The NIIT tax rate is _______.

A

3.8%

This is the rate applied to applicable investment income.

80
Q

EXAMPLE: Medicare contribution tax

aka NIIT tax

Example 1

Paul and Tina are married taxpayers filing a joint tax return. In 2019, their AGI is $350,000, and their net investment income (included in the AGI) is $80,000. They will pay the 3.8% Medicare contribution tax on $80,000. This is the lesser of the net investment income ($80,000) or the AGI in excess of the threshold amount ($350,000 — $250,000, or $100,000). In this situation, all $80,000 of the net investment income is subject to the Medicare contribution tax. Paul and Tina will pay a $3,040 Medicare contribution tax (3.8% on $80,000).

A

Example 2

Tim and Jennifer are married taxpayers filing a joint tax return. In 2019, their AGI is $275,000, and their net investment income is $80,000. They will pay the 3.8% Medicare contribution tax on $25,000. This is the lesser of the net investment income ($80,000) or the AGI in excess of the threshold amount ($275,000 — $250,000, or $25,000). In this situation, only $25,000 of the investment income is subject to the Medicare contribution tax. Tim and Jennifer will pay a $950 Medicare contribution tax (3.8% on $25,000).

2024 planning studies. (6 decks)

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