Securities Products & Suitability Flashcards
This deck focuses on securities products including, debt, equities, investment company products, annuities, as well as investor suitability.
1
Q
What describes the number of common shares for which a convertible bond may be exchanged?
A
conversion ratio
The conversion ratio is the number of common shares for which a convertible bond may be exchanged.
2
Q
Which of the following statements about the risk characteristics of a convertible bond are true?
- A convertible bond is less risky than a similar straight bond
- A convertible bond is more risky than common stock
- A convertible bond is more risky than a straight bond but less risky than common stock
- A convertible bond is as risky as common shares
A
3 only
A convertible security provides more upside potential and risk than a straight bond, but less upside potential and less risk than the common stock.
3
Q
You are the owner of a $1,000 convertible bond that was issued at par. The conversion option allows you to exchange the bond for 10 shares of common stock. What is the bond’s conversion price?
A
$100
A convertible bond’s conversion price is calculated by dividing its issue price by the conversion ratio (number of shares for which it may be exchanged). In this case the issue price of $1,000 is divided by 10 to obtain the conversion price of $100.
4
Q
What is the purpose of a balance sheet?
A
- A one-time snapshot of the company’s assets and liabilities.
- The formula for the balance sheet is:
Assets - Liabilities = Net Worth
5
Q
What are assets or liabilities easily accessible or payable within one year called?
A
“Current” Assets and Liabilities
These assets include cash on hand, prepayments, and accounts receivable with terms less than one year. This also applies to short-term loans or accounts payable.
6
Q
What is the purpose of separating short-term assets and liabilities?
A
Evaluate a Company’s Liquidity
By separating short term assets and liabilities, we can create a set of ratios that give insight to the short term access to cash or the amount of upcoming liabilities that must be paid.
7
Q
Define:
Acid Test
A
- The acid test is an even more conservative analysis of the liquidity of a company. The formula is:
- Acid Test = (Current Assets - Inventory) / Current Liabilities
- The idea here is, inventory is considered a current asset but is not necessarily easily convertible into cash. By removing it from current assets, it gives a more conservative estimate of the cash available to pay liabilities.
8
Q
Define:
Secured Bonds
What are the three major types?
A
- Collateral Trust Bonds - secured by placing financial collateral with a trustee
- Mortgage Bonds - the bond is secured by property, such as real estate
- Equipment Trust Bonds - backed by equipment
9
Q
What is another name for a company’s unsecured debt?
A
Debentures
10
Q
How do zero coupon bonds differ from coupon bonds?
A
- They are issued at a deep discount and make no regular coupon payments.
- Their risk profile is also different: their market price is much more sensitive to rate changes than that of coupon bonds.
11
Q
Zero coupons pay no interest; how does the IRS capture taxes?
A
In a zero coupon bond, even though the investor does not receive any income until maturity, they are still required to pay taxes each year on the annual accretion.
12
Q
Why are zero coupon bond prices so volatile?
A
Because zero coupon bonds do not pay annual cash flows, they do not provide a buffer to changing rates and therefore are more volatile to changing rates.
13
Q
What is a suitable use of zero coupon bonds from an investor’s point of view?
A
Since zeros mature at par, they are suitable for long term planning purposes where the investor wants a known lump sum available in the future.
Example: A parent wants to have a $50,000 lump sum available in 20 years to pay for their child’s graduate education. It would be suitable for them to buy $50,000 zero bonds now at a deep discount, knowing they will mature at $50,000.
14
Q
What are EuroDollar bonds?
A
EuroDollar bonds are US dollar denominated bonds that are issued and/or traded outside of the US.
15
Q
How does the money market differ from the bond market?
A
Much Shorter Maturity
Although money markets have shorter maturities than the bond market, by defintion usually one year or less, they are just as important to funding the day-to-day operations of corporations and represent a very liquid, multi-billion dollar market.
16
Q
Who issues commercial paper?
A
Corporations
Commerical paper is issued by corporations as is used to raise short-term cash. These securities typically have a maximum maturity of nine months (270 days).
17
Q
For what purpose are bankers acceptance (BA) notes typically used?
A
To Finance International Trade
18
Q
What is a repo agreement and why do banks use them?
A
To Raise Short Term Cash
If a broker-dealer needs to raise cash, it can sell collateral to another party with an agreement to repurchase that same collateral at a defined price at some point in the future. The difference between the original sale price and the repurchase price is the interest charged for this loan.
19
Q
What are the specific tax benefits of U.S. government treasury bonds?
A
U.S. Treasuries are exempt from state and local taxes.
20
Q
For what return objective are T-Bills unsuitable for some investors?
A
T-Bills are very short term instruments sold at a discount and they provide no coupon payments. Because they have no cash flows, T-Bills, like zeroes, offer no current income. Investors seeking current income during a given period, such as retirement income, should avoid T-Bills.
21
Q
Describe the auction process of T-Bills.
A
T-Bills are offered weekly at auction, where primary dealers bid for the bills using their own capital and orders from customers. T-Bills are bought at discount in amounts of $1,000 to $1 million and mature in 13 and 26 weeks. The purchase price of T-Bills at auction is expressed as a percentage: a bid of 10 means that dealer is bidding that auction at a 10% discount to par.
22
Q
Describe how Treasury notes differ from T-Bills.
A
- Notes mature between 2 and 10 years versus T-Bills, which mature in one year or less
- Notes are issued with coupons and pay interest, unlike T-Bills, which are zeros
- T-Bills are quoted as a discount off of par, while T-Notes are quoted as a percentage of par in increments of 1/32
23
Q
Describe how Treasury bonds differ from T-Bills.
A
- Treasury bonds typically mature in 30 years whereas T-Bills have maturities of one year or less
- T-Bonds are issued with coupons and pay interest, unlike T-Bills, which are zeros
- T-Bills are quoted as a discount off of par, while T-Bonds are quoted as a percentage of par in increments of 1/32
24
Q
What are Treasury Receipts and how are they created?
A
Synthetic Zero Coupon Bonds
Treatury receipts are created by selling another security backed by the interest payments and principal of T-Bills and T-Notes. They are sold at a discount and pay no interim cash flows. Even though they are backed by treasuries, they do not carry any guarantee.
25
What are **STRIPS** and how are they created?
* Separate Trading of Registered Interest and Principal of Securities (**STRIPS**)
* STRIPS work almost exactly like treasury receipts. but are backed by the government. A simple bond is split into two parts, its interest payment and it's principal amount, and sold separately. The principal-only security works just like a zero coupon bond and is sold at a discount.
26
What are **TIPS**?
Treasury Inflation Protection Securities (**TIPS**)
## Footnote
TIPS are issued with a fixed coupon, but in order to protect against inflation, the notional is linked to the Consumer Price Index.
Although the coupon is fixed, the interest payment will change as the notional changes and can both increase or decrease with inflation or deflation.
27
What type of investor is suitable for TIPS?
Long-term investors
## Footnote
Investors who buy and hold TIPS usually are investing for things far into the future and are concerned about inflation eroding their purchasing power.
28
Where do TIPS trade relative to other Treasury securities?
TIPS trade at lower yields
## Footnote
Anytime a fixed income instrument has some feature that will benefit the investor, it will trade at a lower yield relative to a nearly identical asset without that feature. So two-year TIPS always will trade with a lower yield than the two-year Treasury note.
29
What types of government securities have no secondary market?
U.S. savings bonds
## Footnote
There is no secondary market for these bonds and to be sold must be redeemed with the U.S. Treasury.
30
What are the two government-sponsored enterprises (GSE)?
1. **Freddie Mac** - Federal Home Loan Mortgage Corporation (FHLMC)
2. **Fannie Mae** - -Federal National Mortgage Association (FNMA)
As GSEs, they are not formally backed by the government but are presumed to carry government backing – a presumption tested during the financial crisis.
31
How is Ginnie Mae (GNMA) different from Fannie and Freddie?
Fannie and Freddie are both government sponsored enterprised that have an implied but not explicit backing of the US government. Ginnae Mae is a government agency, which has an explicit backing of the US government and thus would be considered safer.
32
What are the general yield characteristics of government sponsored enterprise debt relative to treasury or corporate debt?
Higher than treasuries - lower than corporates
## Footnote
Because the debt is not a direct obligation of the government, investors demand a higher yield for that small risk. Because GSE's debt is significantly safer than corporate debt, they will carry a lower yield.
33
What are the characteristics of GNMA debt?
Higher yield than treasuries
## Footnote
Even though backed by the U.S. Government, GNMA debt trades with a higher yield than do treasuries.
As mortgages that make up GNMA debt pay down, the principal notional of the bond is reduced every month and GNMA debt also pays interest every month.
The reason for the higher yield is the uncertainty of maturity.
34
What is a significant risk characteristic of GNMA pass-through securities?
Re-investment risk when rates fall
## Footnote
GNMA pass-through securities are comprised of bundles of individual mortgages. In a falling rate environment, more home owners re-finance and that means more of the bonds' notional is returned to investors, who are then forced to invest that money in the new lower-rate environment.
35
What was the stated purpose of Freddie Mac?
Create a secondary mortgage market
## Footnote
In the past, there was no secondary market within which to sell the mortgages that local and community banks created. This limited the credit available for the housing market. FHLMC buys individual mortgages from these community banks, bundles them, and creates mortgage-backed securities from them.
36
Describe the basic structure of a Collateralized Mortgage Obligation (CMO).
CMOS are mortgage backed securities that have been structured by broker-dealers and cut up into different pieces called tranches. The various tranches will all vary in credit quality, expected maturity, and exposure to pre-payments.
37
What was the primary motivation of creating the CMO security?
Pre-payment risk management
## Footnote
Other pass through securities simply "pass through" interest and principal payments every month. This makes them very sensitive to interest rates as well as to shortened **duration** of the securities as more and more mortgages fare pre-payed via re-financing.
By creating tranches by credit risk and expected maturity, investors would have more certainty about what they actually were buying.
38
How does a CMO control the expected maturity of a particular tranche?
Re-distributing cash flows
## Footnote
When principal payments are made by a mortgage holder, the CMO trustee will distribute those payments toward the retirement of the first tranche. By estimating the payments, it is possible to control the expected time when that tranche will be paid off. Once each tranche is paid off, the cash flow is directed toward paying off the next tranche.
Note: only the principal payments are re-directed. Normal interest payments are distributed to all the tranches.
39
What type of CMO is the least **extension risk**?
Planned Amortization Class (PAC)
## Footnote
This type of CMO was created to fill the need for more specific maturity dates even in the event of mortgage prepayments. This prepaid cash is sent to other tranches referred to as a support tranche and the PAC is paid off on a defined schedule.
40
Income taxes are assessed on **which types of income**?
The IRS taxes all income from **wages and salaries**, also called "ordinary income". Investment income - **capital gains, interest income, and dividends** - are also taxable.
41
How are **cash dividends** from stock taxed?
If an investor holds the stock for greater than 60 days during the 121 day period surrounding the ex-dividend date, the dividend will be classified as a qualified cash dividend and taxed at a preferential rate. If the investor does not meet that holding period, it will be defined as an ordinary cash dividend and taxed at the investor's ordinary income rate.
42
What **types of capital gains** are there?
There are **short-term** capital gains and **long-term** capital gains.
43
How are **short-term capital gains** defined and taxed?
A short-term capital gain is one for which the asset was **held 12 months or less.** It is taxed as ordinary income, which is the same rate as an investor's salary.
44
How are **long-term capital gains** defined and taxed?
Long-term capital gains are assessed on assets **held over 12 months.** Long-term capital gains are taxed at a preferential rate, meaning a lower rate than what investors pay on their salary.
45
What is the **cost basis** of a stock?
The cost basis is the effective price for the purpose of calculating taxes. Commissions will increase the cost basis of a stock. The taxable income will be the sale price minus the cost basis.
46
What law governs how investment companies are regulated?
The Investment Company Act of 1940
47
A **Unit Investment Trust (UIT)** is defined and regulated by the Investment Company Act of 1940. What is a UIT's typical investment strategy?
A **UIT** will purchase a defined and fixed portfolio from a broad range of securities (often including stocks, bonds and munis) and has no restrictions on what kind of securities it can buy. Importantly, once the portfolio is created, it is fixed, meaning whatever is in the portfolio stays there. It is not actively managed.
48
What are the fees that investors pay when they purchase UITs?
Similar to mutual funds, because UITs offer redeemable shares, investors pay sales charges when they purchase the units. They do not pay commissions as UITs are not exchange traded products.
49
What is the termination date of a UIT?
The termination date of a UIT is the date when the trust ends and investors receive their proportionate share of the UITs net assets. For a bond UIT, the termination date often coincides with the maturity date of the bonds. For an equity UIT, the termination date is established when the UIT is created.
50
If a UIT is a fixed portfolio of securities but consists of callable bonds, how does the portfolio change if that bond is called away?
The called bond is not replaced by another and will simply be taken out of the basket by the call. In this event, the investor will receive a cash distribution of proceeds. This is also the case as bonds mature. The trust can make any kind of interest payment: monthly, quarterly, or semi-annual.
51
On what exchange can an investor sell their UIT?
None. There are no exchanges for UITs, they must be redeemed with the issuer.
52
What types of **management fees** are UITs allowed to charge?
UITs are not allowed to charge any **management fees** since the UIT is fixed and there is no active buying and selling of securities.
53
What are the benefits of a management investment company for investors?
In a management investment company, the investors' funds are actively managed to acheive an investment objective. This means that the management company hires an investment adviser that will actively trade the portfolio to meet the fund's goals.
54
There are two types of management companies. What are they?
**Open-end funds (aka mutual funds)** and **closed-end funds**
55
A closed-end fund trades most like what security?
Common stock. Similar to shares of a corporation, a closed-end fund have a one time initial public offering for shares that are actively traded on an exchange. Because the shares of a closed-end fund are exchange-traded, similar to common stock, the price of each share is based on supply and demand.
56
An investor that is looking to buy an actively managed investment company security that trades throughout the day would most likely purchase which type of shares?
Closed-end funds would be most appropriate for investors as they combine active management with exchange-trading. Mutual funds also provide active management, but do not issue exchange-traded shares. Instead, the shares are only redeemable with the issuing investment company.
57
What are the two key characteristics of a mutual fund?
Mutual funds, also referrred to as open-end funds, register a continuous offering of redeemable shares. This means that there is no secondary market for mutual funds, the shares are redeemable, meaning bought and sold directly with the mutual fund itself. Also, importantly, mutual funds are actively managed
58
On what **exchange** do open-ended funds trade?
Mutual funds **do not trade on a secondary market**. Instead, the shares are reedeemed by the investor with the fund.
59
What defines a **diversified investment company**?
For an investment company to qualify as diversified, the following **75-5-10 test** must be met:
* At least 75% of the fund's total assets must be invested in securities issued by companies other than the investment company itself
* Of that 75%,
* No more than 5% of the fund's total assets can be investment in the securities of any one issuer, and
* No more than 10% of the outstanding voting securities of any one issuer can be owned.
60
One of the benefits of open-end investment companies is professional management. Who hires the manager?
Fund managers are generally hired by the board of directors of the investment company.
61
# Define:
**advance/decline trend**
The difference in up and down days of a security - used in technical analysis as a market movement indicator. When declines outnumber advances by a large amount, that is typically a bearish indicator and when advances outnumber declines by a large amount, that is typically a bullish indicator.
62
The top of a stock's normal trading range
Resistance
63
The bottom of a stock's normal trading range
Support
64
Price-weighted index of 30 "blue chip" U.S. stocks of industrial companies
Dow Jones Industrial Average
65
Capitalization-weighted index of 500 stocks, regarded as the standard for measuring large-cap U.S. stock market performance
S&P 500
66
Defines and regulates investment companies, including mutual funds
Investment Company Act of 1940
67
Share value of OTC, non-NASDAQ stock subject to the Penny Stock Cold Calling Rules
Less than $5 per share
68
Under penny stock rules, an established customer is
1) Someone who has made at least three penny stock purchases of different issuers on different days or 2) someone who has held an account with the broker-dealer for at least one year.
69
An unsecured corporate bond
Debenture
70
Security with the most junior claim in a corporate liquidation
Common stock
71
Agency debt that is backed in full by the U.S. government
Ginnie Mae
72
Considered the safest form of debt issued in the U.S.
U.S. Government bonds, notes and bills
73
Taxable at the federal level; may be exempt from taxation at the state level
U.S. Government bonds and notes
74
Of long-term and short-term bonds, which generally pays a higher interest amount?
Long-term bonds
75
Of long-term and short-term bonds, which generally has lower price volatility?
Short-term bonds
76
The degree of risk associated with an issuer's ability to repay the principal
Credit or default risk
77
A bond that is rated BBB or above by Standard and Poor's
Investment Grade
78
Risk that a bond may be called prior to maturity
Call risk
79
Specific time period from date of issue when a bond cannot be called
Call Protection Period
80
Type of bond issue that is not typically callable
U.S. Government bonds (Treasury bonds)
81
Risk that proceeds from a called bond cannot be invested as favorably
Reinvestment risk
82
Bonds backed only by the good faith of the issuing corporation
Unsecured bonds or debentures
83
Typically backed by real estate holding of a corporation
Mortgage bond
84
Typically secured by other securities owned by the corporation
Collateral Trust bond
85
Secured by physical assets owned by the company
Equipment trust certificates
86
Allow for the exchange of debt for equity issued by the same corporation
Convertible debt
87
The stated number of common shares a bondholder receives upon conversion
Conversion ratio
88
The point at which there is neither profit or loss in a conversion
Conversion parity
89
Purchased at a deep discount; pays no interest during the life of the bond
Zero-coupon bond
90
The amount of interest paid prior to maturity on a Treasury Bill
None, T-Bills are zero coupon securities
91
U.S. Government instrument that matures in 1 year or less
Treasury Bill
92
U.S. Government instrument sold through weekly auctions
Treasury Bill
93
U.S. Government instrument that is quoted on an annualized discounted yield basis
Treasury Bill
94
U.S. Government instruments that matures within 2 -10 years
Treasury Note
95
U.S. Government instruments that typically mature in 20 - 30 years
Treasury Bonds
96
U.S. government instruments that are quoted in 32nds
Treasury Notes and Treasury Bonds
97
Inflation-indexed bonds issued by the U.S. Treasury
TIPS
98
U.S. government zero-coupon bond instrument that has no reinvestment risk
STRIP
99
Three government entities that issue mortgage-backed securities
Ginnie Mae, Fannie Mae and Freddie Mac
100
Agency that provides student loans
Sallie Mae
101
Investment risk most associated with mortgage-backed securities
Prepayment risk
102
Investment risk that coincides with early payment of a mortgage-backed securities
Reinvestment risk
103
Distinct maturity categories of CMOs
Tranches
104
Frequency of interest payments on mortgage-backed securities
Monthly
105
Mortgage-backed securities with the implied backing of the U.S. government
Fannie Mae and Freddie Mac
106
Debt securities that provide immediate term financing
Money market securities
107
Denomination of CMOs
$1,000
108
Protects convertible bondholders from a reduction in ownership percentage
Anti-dilution covenant
109
The relationship of the coupon rate of a corporation's convertible debt to its non-convertible debt
Lower
110
The type of risk rated by Moody's, Standard & Poor's and Fitch
Default or Credit Risk
111
The risk that the issuer will not be able to pay the principal and interest owed on outstanding debt securities
Default or Credit Risk
112
A bond which can be sold at face value back to the issuer prior to maturity at pre-determined times
Puttable bond
113
Corporate secured bonds that have the highest priority claim
Mortgage bonds
114
Type of corporate security that is backed by the title to newly acquired equipment
Equipment trust certificate
115
Two companies that rate bond issues
Moody's and Standard and Poor's (also Fitch)
116
Type of bonds often issued by corporations emerging from bankruptcy that pay interest only if income is available
Income bond
117
The stock price at which a convertible bond can be exchanged for shares of common stock
Conversion price
118
Zero coupon securities created from U.S. Treasury notes and bonds by brokerage firms
Treasury receipts
119
Percentage of net investment income that a REIT must distribute to avoid corporate taxation
90%
120
For a REIT, the minimum percentage of investment assets that must be invested in real estate
75%
121
The minimum percentage of gross income that a REIT must derive from rents or mortgage interest
75%
122
Where REIT shares or certificates of beneficial interest can be purchased
OTC or on a stock exchange
123
Type of investment that passes through real estate income but not losses
REIT
124
Permit after-tax contributions of up to $2,000 per student for children under age 18 for educational purposes
Coverdell Education Account (Education Savings Account)
125
Age at which funds from Coverdell accounts must be distributed or rolled into an ESA for another family member
30
126
Federal tax status of contributions made to Section 529 plan
After-tax
127
Tax advantage available for 529 plan contributions in many states to state residents
Contributions to 529 plan sponsored by that state are tax deductible on state tax returns
128
Tax rate increases as income increases
Progressive tax
129
Taxes that are levied equally regardless of income
Regressive taxes
130
An example of a regressive taxes
Sales taxes
131
Two examples of progressive taxes
Income, estate
132
Three types of income subject to taxation
Earned, passive, portfolio
133
Three taxable forms of portfolio income
Interest, dividends and capital gains
134
Minimum holding period for lower long-term capital gains tax rate
1 year and 1 day
135
Short-term holding period for capital gains tax computation
1 year or less
136
Maximum amount of capital loss that can be used to offset current income each year
$3,000
137
Period of time for which capital losses can be carried forward
Indefinitely
138
Transaction which disqualifies capital loss because substantially similar securities are repurchased within 30 days
Wash sale
139
Number of days before or after a sale for a loss for which a purchase of substantially similar securities must be avoided
Thirty days
140
Under the wash sale rule, purchases of any of these four securities of the same issuer are considered substantially identical to purchases of the issuer's stock
Long calls, rights, warrants and convertible bonds
141
Three accounting methods available for determining which shares to liquidate
FIFO, share identification, average basis
142
Method of share identification assigned by the IRS if no other method is chosen
FIFO
143
How are qualified cash dividends taxed?
They are taxed at a preferential rate (meaning lower rate) than the investors ordinary income
144
Cash dividends that are eligible for taxation at the same rate as long-term capital gains
Qualified
145
Minimum holding period of stock for dividends to be classified as qualified
Sixty-one days during the 121-day period surrounding the ex-dividend date
146
Tax implication of stock splits and stock dividends
Reduction to cost basis; no current taxation
147
The amount of investment in property; used to determine the gain or loss at time of sale
Cost basis
148
The accounting method that allows an investor to select which shares to liquidate for tax purposes
Share identification
149
Shares that would be liquidated first to result in the lowest possible capital gain
Shares with highest cost basis
150
The date which determines the amount of the tax deduction for charitable donations of appreciated property
Date the donation is made
151
The amount of tax deduction available for gifts of securities made to family members or others
None, as only charitable donations receive a tax deduction
152
The recipient's cost basis for gifts of securities from family members or others
Original cost basis of the donor
153
The cost basis of securities that are left to an heir
Market value of the securities on the date of the death of the owner
154
The current annual gift tax exclusion amount
$17,000
155
The tax provision that allows married persons to transfer their entire estate to the surviving spouse at death without taxation
Unlimited marital deduction
156
The person responsible for payment of gift taxes due
Donor
157
Interest on bonds of these two issuers is taxable at the federal, state and certain local levels
Corporations and agencies
158
Interest on bonds of this issuer is taxable at the federal level but exempt from taxation at the state and local level
U.S. Government
159
Amount of gift tax that applies on gifts between spouses
No gift tax regardless of amount
160
Tax treatment of withdrawals from Section 529 Plans
Tax free withdrawals (after-tax contributions)
161
Tax nature of contributions to Section 529 Plans
After tax contributions
162
Annual contribution to a Coverdell ESA is
$2,000 per beneficiary (non-deductible)
163
Investment requirement and pass-through requirement for REITs to qualify for favorable tax treatment
75% of assets invested in real estate and 90% of income passed through to investors
164
Two types of Investment Companies defined by the Investment Company Act of 1940
Unit Investment Trust and Management Company
165
Management company shares that may trade at a price more or less than their net asset value
Closed-ended Investment companies
166
Three types of securities that closed-end companies can issue
Common shares, preferred shares and bonds
167
An investment company that meets the 75-5-10 test
Diversified
168
Type of management company that can issue shares continuously
Open-end
169
Type of management company that issues a fixed number of shares in a single offering
Closed-end
170
Type of management company that can issue only equity shares
Open-end
171
Type of management company that can issue both equity and debt
Closed-end
172
Type of management company shares that are redeemed by the issuer
Open-end
173
Type of management company shares that trade in the secondary market
Closed-end
174
The difference between the Public Offering Price and Net Asset Value
Sales load
175
Type of management company shares that are priced by formula
Open-end
176
Type of management company shares that are priced by supply and demand
Closed-end
177
An investment company which issues redeemable securities and is not actively managed
Unit investment trust
178
The price at which an investor purchases closed-end company shares
Ask price
179
Type of management company that offers shares through a continuous primary offering
Open-end
180
The only type of securities that mutual funds can issue
Common shares
181
Form that mutual funds send shareholders annually to report taxability of distributions
1099
182
Section of the Investment Company Act of 1940 that permits funds to charge ongoing fees for marketing and distribution
Section 12b-1
183
Securities legislation that defines management companies and registration requirements
Investment Company Act of 1940
184
Maximum sales charge for mutual funds permitted by FINRA rules
8.5% of POP
185
Maximum annual 12b-1 fee permitted by the Investment Company Act of 1940
.75% of average annual net assets
186
Quantity purchase discounts that apply to individuals who purchase funds within the same fund family
Breakpoints
187
Document that allows an investor to receive a discounted sales charge on current and future funds invested within the same fund family
Letter of Intent
188
Maximum duration of a Letter of Intent
13 months
189
The maximum time allowed to backdate a Letter of Intent
90 days
190
Allows for reduction of sales charges on subsequent purchases based on combining additional purchases with prior share appreciation
Rights of accumulation
191
Maximum time limit for Rights of Accumulation
There are no time limits imposed on Rights of Accumulation
192
FINRA violation which involves encouraging a customer to purchase shares at a point below an available sales charge reduction
Breakpoint sale
193
Mutual fund share class with a front end sales load
Class A shares
194
Mutual fund share class with a back-end load and 12b-1 fees
Class B shares
195
Mutual fund share class with 12b-1 fees charged quarterly
Class C shares
196
The pricing concept that defines the purchase and redemption of mutual fund shares at the next calculated price
Forward pricing
197
Life insurance company contract designed to provide a stream of guaranteed income payments for life
Annuity
198
The insurance company account in which variable annuity payments are invested
Separate account
199
A directly managed variable annuity's category of registration under the Investment Company Act of 1940
Open-end management company
200
The two phases of a variable annuity contract
Accumulation phase and Annuity phase
201
The benchmark rate used during annuitization for determining the amount of income paid from month to month
Assumed Interest Rate
202
The impact on the monthly payment from a variable annuity, as compared to the previous month, if the separate account performance is greater than the AIR
Increase
203
The transition from the accumulation to the payout phase of a variable annuity
Annuitization
204
The penalty that applies if funds are withdrawn from an annuity before age 59 1/2.
10% penalty on earnings
205
Price at which open-end company shares are purchased
Public Offering Price (POP)
206
Price at which open-end company shares are redeemed
Net Asset Value (NAV)
207
An investment company fund with assets concentrated in a single industry
Specialized or sector fund
208
A management investment company with no provision for redeeming outstanding shares
Closed-end
209
Performs customer service functions on behalf of the mutual fund
Transfer agent
210
Responsible for the safekeeping and segregation of a mutual fund's securities
Custodian
211
Implements the investment strategy and invests on behalf of the mutual fund
Investment adviser
212
Defines the fund's investment objectives and oversees the direction of the fund
Board of Directors
213
Board Members who are independent or not connected with the mutual fund's key functions
Noninterested Parties
214
The amount of mutual fund Board members that must be noninterested
Majority (\*note that for funds that do not charge a 12b-1 fee, the board must only be made up of 40% noninterested persons)
215
Also known as the sponsor or distributor, and is responsible for selling and marketing funds shares
Underwriter
216
Compensated by a percentage of a mutual fund's assets
Investment adviser
217
Paid a fee by a mutual fund to perform their functions
Custodian and transfer agent
218
Paid from sales charges to perform its function
Underwriter
219
The type of interest an investor owns in a mutual fund portfolio
Undivided
220
Type of security typically held by mutual funds with growth objectives
Common stock
221
Three types of securities that are held by mutual funds with income objectives
Bonds, preferred stock, blue chip common stock
222
Type of mutual fund that is focused on generating capital gains, and tends to reinvest most earnings
Growth fund
223
Type of mutual fund with low portfolio turnover and low expenses that tracks market performance
Index fund
224
Type of mutual fund that invests in stock for appreciation and bonds for income
Balanced
225
Type of mutual fund that authorizes the fund adviser to rebalance the percentage of holdings between cash and different investment categories
Asset allocation fund
226
Usually sold with no sales or liquidation fees
Money market funds
227
NAV of a single share of a money market fund
$1
228
Mutual fund that offers tax-exempt income to shareholders
Municipal bond fund
229
Type of mutual fund that is best suited to an investor seeking maximum safety
U.S. government bond fund
230
Maximum remaining maturity of funds held within a money market portfolio according to SEC rules
13 months
231
Fund expenses/average net assets
Expense ratio
232
Expresses the rate at which a fund replaces the securities held in its portfolio
Portfolio turnover ratio
233
Type of fund that is likely to have a high expense and portfolio turnover ratio
Aggressive growth fund
234
The maximum amount of 12b-1 fee a no-load fund can charge
0.25%
235
Fund's NAV/Number of Shares Outstanding
NAV per share
236
The impact on NAV per share when portfolio securities increase in value
Increase in NAV
237
The impact on NAV per share when shares are sold or redeemed
No impact
238
NAV + Sales Charge
POP
239
Another name for a back-end load
Contingent deferred sales charge
240
Equation to calculate a mutual fund share's POP
NAV/(100% - sales charge %)
241
Objective is to purchase mutual fund shares at a lower average cost per share than average price per share
Dollar cost averaging
242
Three types of mutual fund systematic withdrawal plans
Fixed share, fixed percentage and fixed time withdrawal plans
243
A risk associated with the loss of buying power from a fixed annuity's payment
Purchasing power risk
244
The annuity payout option the provides the largest monthly income amount
Life income (also called life only or straight life)
245
The annuity payout option that guarantees that income will be paid for the lives of two individuals
Joint life with last survivor
246
An annuity which begins paying income within 60 days of purchase
Immediate annuity
247
An annuity in which purchase payments are deposited according to a premium payment schedule until payments are started
Periodic payment deferred annuity
248
An annuity that provides both fixed and variable annuity benefits
Combination annuity
249
The insurance company account in which fixed annuity payments are invested
General account
250
A risk assumed by the owner of a variable annuity
Investment risk
251
Type of annuity that guarantees the rate of return that will be earned on the investment
Fixed annuity
252
The fee charged by an insurance company for guaranteeing annuity income for life
Mortality fee
253
Disclosure document that must be provided to investors when variable annuities or mutual funds are sold
Prospectus
254
An accounting measure used to determine the owner's interest in the separate account when purchasing a variable annuity
Accumulation unit
255
Letters of intent for mutual funds can be backdated for
90 days
256
The most suitable mutual fund share class for a substantial fund investor with a long term perspective
Class A
257
To levy maximum sales charge, fund must offer both
breakpoints and rights of accumulation
258
Distributions from 403(b) plans are
100% taxable
259
The four phases of the economic cycle
Expansion, peak, trough and contraction
260
Measures the general rate of increase or decrease in prices paid for certain standard goods
Consumer Price Index (CPI)
261
What is considered the most volatile interest rate
Federal funds rate
262
Uses charts and historic trading patterns to determine when to move in to and out of the markets
Technical analysis
263
Bases investment decisions on broad-based market trends, and analysis of financial firm financial reports
Fundamental analysis
264
# Defensive, Cyclical or Growth Industry?
Food
Defensive
265
# Defensive, Cyclical or Growth Industry?
Utilities
Defensive
266
# Defensive, Cyclical or Growth Industry?
Steel
Cyclical
267
# Defensive, Cyclical or Growth Industry?
Automobile
Cyclical
268
# Defensive, Cyclical or Growth Industry?
Technology
Growth
269
Basic balance sheet equation
Assets - Liabilities = Net Worth
270
Financial statement that summarizes revenues and expenses
Income statement
271
Features charting and market timing
Technical analysis
272
Predicts company performance based on financial statements and overall economic health
Fundamental analysis
273
Characterized by falling stock markets, rising inventories, declining GDP
Contraction
274
Characterized by low unemployment , increased business activities
Expansion
275
In a liquidation, where do bondholders stand relative to equity holders?
In the event of a liquidation, bondholders have senior status and they are in line for assetsahead of both common and preferred stockholders.
276
What is the meaning of call protection?
This is a period of time defined in the bond's indenture during which the bond cannot be called, no matter what happens to interest rates.
277
What risk does an investor face if their bond is called?
The investor will face reinvestment rate risk as they will need to take the proceeds from their bond and reinvest them back into the market at a time when interest rates are falling.
278
How can a lower rating impact bond trading?
Lower prices and potential greater volatility
279
How are Treasury bonds quoted?
Treasuries are quoted in 32nd of a point. So, a Treasury bond trading at 98-16, is trading at 98-16/32. This bond would have a dollar value of $985.
280
What distinguishes the return profile of a convertible bond from a common debt issue?
* A convertible bond has a mixed return profile, with elements of equity returns as well as some of the security of a fixed-income instrument.
* A convertible bond is "convertible" into common equity at some defined ratio. So, as stock returns rise, the implied option to convert the bond into stock drives appreciation of the underlying bond.
281
# Define:
Convertible Bond Parity
At parity, an investor is indifferent between holding the convertible bond or converting into the underlying shares of stock because either way they have the same total value.
282
If a bond is trading at $950 and has a conversion price at $50, how many shares is the bond convertible into?
To determine the number of shares the investor can convert into, you must calculate the conversion rate, which is the par value of the bond divided by the conversion price. Be careful to use par rather than the market price of the bond for this calculation.
$1,000/$50 = **20 shares**
283
If a bond is convertible into 25 shares and is trading at $980, what is the parity price?
To calculate the parity price of the stock, take the market value of the bond dividend by the conversion ratio**.**
$980/25 = **$39.20**
284
If the convertible bond is trading at $960 and is convertible into 15 shares, what is the parity price?
To calculate the parity price of the stock, take the market value of the bond dividend by the conversion ratio.
$960/15 = **$64**
285
The duration of a bond is equal to:
Duration is a measure of sensitivity to interest rate changes. Therefore, duration is the percentage change in price that corresponds to a given change in interest rates. For exam purposes, they will not make you calculate duration, though it is important to understand that bonds with a longer duration are more volatile to changing interest rates.
286
The **main difference** between a fund with a global style and a fund with an international style is that a(n):
**global fund makes both foreign and domestic investments**
## Footnote
Global funds invest in both domestic and international securities, whereas international funds invest in international securities only.
287
What is the payout ratio of a common stock?
**Payout ratio** measures the percentage of a company's earnings that are paid to stockholders as a dividend. It is calculated as annual dividends per share/ earnings per share.
High-growth companies that reinvest earnings into the company may declare no divdend and therefore not have a payout ratio. Other companies, such as utility companies, that traditionally have offered higher dividends will have higher payout ratios.
288
How do investment companies report taxable income to investors?
The investment company will send the investor a **Form** **1099**.
289
What are two factors that impact bond price volatility?
coupon; maturity
## Footnote
Long-term, low coupon bonds (including zeros) will be most impacted by a change in interest rates.
290
The risk that a bond will be called prior to maturity is known as
Call Risk
## Footnote
Call risk is the risk that a debt security will be called prior to maturity. This will occur in an environment when interest rates are falling.
291
Collateral trust bonds are backed by:
the issuer's securities portfolio (e.g. stocks and bonds it owns)
292
What type of corporate debt is backed by legal a claim on some specified property of the issuer in the event of default?
Secured
## Footnote
Secured bonds are backed by collateral, to provide protection against issuer default.
293
For a given change in yield, bonds with higher coupons undergo:
Smaller price changes than those on bonds with lower coupons
## Footnote
This relationship shows that bond price volatility is inversely related to coupon size.
294
All else equal, the longer the maturity of a bond:
The greater the price volatility
## Footnote
The longer the maturity of a bond, the greater the price volatility resulting from a change in market yields.
295
How does a sinking fund impact credit risk?
A sinking fund reduces default risk because it requires the issuer to set aside cash each year to have enough to redeem the bonds at maturity.
296
Treasury bills, notes, and bonds are first sold:
In auction
297
A portfolio manager wishes to construct a portfolio of bonds that will exhibit very little market value sensitivity to changes in interest rates.
**Which of the following strategies would be consistent with this desire?**
A. The portfolio manager should purchase as many zero coupon bonds as possible.
B. The portfolio manager should purchase bonds with relatively long maturities.
C. The portfolio manager should purchase high coupon bonds with short maturities.
D. The portfolio manager should purchase a wide variety of bonds with exposure to as many maturities as possible. It would also help to obtain a good mix of both high coupon bonds and equal weighting in low and zero coupon bonds.
C
## Footnote
When all other factors are constant, bonds with short maturities and relatively high coupons will be less sensitive to changes in interest rates.
298
T-bills have a maturity of:
One year or less
299
How is interest income from mortgage-backed securities issued by government agencies treated for tax purposes?
The interest income is taxable at all levels
300
The presence of a sinking fund provision will have what impact on the yield of an issue?
Reduces the yield on a bond issue
## Footnote
The presence of a sinking fund provision is preferred by the bondholder because it reduces the level of risk on the bond as the issuer will be setting aside capital each year to retire the bond. Because of this reduce risk, the issuer can pay investors a lower yield.
301
The presence of a call provision has what impact on a bond's yield?
Increases the yield on a bond issue
## Footnote
A call provision is exercised when market interest rates have fallen far enough below the bond yield to make exercise profitable for the issuer. This would be to the disadvantage of the bondholder, because the bondholder would then have to give up the high rates previously received. Investors charge the issuer for including call provisions via a higher yield.
302
Are T-Bills issued with fixed coupons?
No
## Footnote
T-bills are sold at a discount from their par value. This discount provides the yield on the obligations. Unlike other U.S. government obligations, there are no coupon payments on T-bills.
303
The interest income from U.S. government securities is subject to which level of taxation?
Federal income tax
## Footnote
The interest income from U.S. government securities is exempt from state and local taxes, but is subject to federal income tax.
304
Treasury and agency bonds are traded in increments of:
1/32 of one percent of par value
## Footnote
Treasury and agency bond prices are quoted as percentages of par value. The smallest increment of change in the quoted price is 1/32 of one percent. For example, the smallest possible change on a bond last traded at 98% of par value is a change to 98 1/32% or 97 31/32% of par value.
305
As a portfolio manager, you have a significant portion of your bond portfolio maturing in the next few weeks. You are concerned that rates have dropped since you purchased these bonds and that the yields that you will get by reinvesting the proceeds will be smaller than what you now are receiving. This type of risk associated with investing in debt securities is known as
Reinvestment rate risk
306
An investor has several mortgage-backed securities in their portfolio. If interest rates fall significantly, they would be most concerned with
Prepayment risk
307
Which tranche pays interest only until all preceding CMO tranches are repaid?
Z-tranche
308
Unlike other fixed income securities, mortgage-backed securities do not have a fixed maturity date. This is because
the borrower has the option to prepay the mortgage at any time
309
What is the role of a support tranche in a CMO structure?
To provide prepayment protection to PAC tranches.
310
An increase in the average life of a mortgage-backed security is referred to as?
Extension risk
## Footnote
Extension risk occurs when interest rates rise and homeowners do not prepay their mortgages as quickly as initially expected.
311
What is extension risk?
It is the risk that when interest rates rise, mortgage prepayments fall and therefore the time horizon of the mortgage-backed securities will increase.
312
Rising rates tend to slow the prepayments on mortgage-backed securities. This risk is referred to as
extension risk
313
Which CMO tranche protects investors against both prepayment and extension risk?
Planned amortization class (PAC) CMOs
314
What type of CMO class protects against prepayment, but not extension risk?
Targeted Amortization Class (TACs) CMOs
315
Which pays a higher yield, a TAC bond or a PAC bond?
A PAC bond (Planned Amortization Class CMO) aims to protect against both prepayment and extension risk. A TAC bond (Targeted Amortization Class CMO) protects only against prepayment risk. Because a TAC bond offers less protection, it offers a higher yield to investors.
316
You hear an investor say:
"PAC bondholders have priority over principal payments in a CMO. As such, the cash flows to PACs are more stable and their exposure to extension risk is greatly reduced at the expense of increased prepayment risk."
Is this correct?
This is incorrect as the cash flow structure of a Planned Amortization Class CMO provides protection against both extension and prepayment risk
317
As interest rates fall, homeowners will often refinance their outstanding mortgages. The risk this creates for investors in mortgage-backed securities is
prepayment risk
318
Principal-Only CMOs will increase in value when
interest rates fall and prepayment accelerate.
319
Interest-Only CMOs will increase in value when
interest rates rise and prepayments fall as this will extend the number of interest payments that the investor will receive.
320
When compared to agency CMOs, private label CMOs have greater
credit risk
## Footnote
Non-agency securities do not carry the support or guarantee of the federal government as do agency securities. Therefore, they have greater default risk and pay higher yields to investors.
321
When comparing agency versus private label CMOs, which typically has a higher credit quality and lower yield?
**Agency** **CMOs** are backed by Ginnie, Fannie, and Freddie MBS. Therefore, because the underlying MBS have the explicit or implied backing of the US Government, these securities will be safe than private label CMOs which are backed by MBS issued by private institutions.
322
The analysis of a company based on its financial statements and business prospects is referred to as
fundamental analysis
323
What type of mutual fund invests in both U.S. and foreign stocks?
Global funds
## Footnote
Global funds contrast with nternational mutual funds which nvest wholly outside the United States.
324
If a US investor wants to be liquid shares of a foreign company, they can purchase
American Depository Receipts (ADRs)
325
Which type of bonds have the most senior position in a company's corporate structure?
secured debt
## Footnote
Secured bonds are the most senior bonds in a firm's capital structure and have the lowest risk of distress or default.
326
What type of bonds only pay interest if the company is profitable?
income bonds
## Footnote
Income bonds are issued by company's emerging from bankruptcy. They only pay interest if the company is profitable and therefore are not actually appropriate for investors that are seeking income.
327
Convertible bonds generally pay lower interest rates than non-convertible debentures of comparable risk because:
Investors are given the benefit to convert their shares into the company's underlying equity
328
Which of the following is/are true about debentures?
1. Debentures are not backed by any specific collateral.
2. If the issuer does not make interest and principal payments, debenture holders can declare the firm bankrupt and claim any unpledged assets to pay off the debentures
3. Debentures have a higher yield than comparable secured bonds,
I, II, and III
## Footnote
Debentures are unsecured corporate debt. Because debentures are not backed by any collateral, they have higher yields than comparable secured bonds.
329
ADRs pay dividends in what currency?
US Dollars
## Footnote
When a foreign company declares a dividend, a bank will convert that foreign dividend payment into US dollars for the ADR holder.
330
What type of mutual fund is most appropriate for an investor looking to add short-term liquidity to their portfolio?
money market fund
331
Corporate bonds can contain a variety of features and forms. Which of the following descriptions of these features is inaccurate?
* A sinking fund allows an issuer, at its discretion, to set aside cash each year to redeem the bonds at maturity
* Call provisions specify when a firm can issue a call for the bond before maturity, thus redeeming a portion of its outstanding debt
* Debentures promise interest and principal payments, but do not pledge specific assets (collateral) to back their promise
* Income bonds have payment schedules but only are payable if the company earns the income required to make the payments
A sinking fund is a required deposit each year, not at the company's discretion
332
An individual wants to invest in a foreign stock, but is considered about having to select individual companies to invest in. What type of security can she invest in?
International mutual funds
## Footnote
ADR's, American Shares, and Direct purchase can be inconvenient and/or relatively illiquid. International mutual funds provide a convenient way to achieve the benefits of international diversification on a small scale.
333
How are REIT dividends taxed for investors?
All REIT dividends are taxed as **ordinary income**. There is no preferential rate for REIT dividends.
334
In order for REITs to pass through gains to investors and avoid corporate taxes, which three qualifications must be met?
* At least 75% of the income must be derived from real estate
* At least 75% of all the assets must be invested in real estate
* At least 90% of net investment income must be distributed to shareholders
335
Do REITs pass through gains and losses to investors?
**REITs only pass through gains and not losses to shareholders.** Losses are reflected by the value of the shares declining.
336
# Define:
**Real Estate Investment Trust**
An actively managed pool of capital that invests in real estate or real-estate-related assets (i.e., mortgages). These investments combine professional management, diversification, exchange-trading, and tax benefits, since gains (but not losses) are passed through to investors.
337
# Define:
**Equity REIT**
A type of REIT that owns income-producing real estate. Equity REITs’ revenues typically come from rent on the property they own and from sales of the properties they hold.
338
# Define:
**Mortgage REIT**
A type of REIT that invests in mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest they earn on the mortgages they hold as well as the sales of these mortgages to other investors.
339
Can an individual make tax-deductible contributions to a 529 Plan?
No, all contributions to a 529 Plan must be made with after-tax dollars.
340
What are the three different types of **annuity payout options**?
1. Life annuity
2. Life annuity with period certain
3. Joint and last survivor
341
# Define:
**Life annuity**
An annuity payout structure that makes monthly payments for the **life of the owner of the annuity**. When the owner dies, all payments cease.
342
# Define:
**Joint and Last Survivor Annuity**
An annuity payour structure that makes montly payments over the life span of two individuals (e.g. a husband and then once the husband dies their wife until she dies).
343
When recommending an exchange of annuities, a registered representative should consider whether the investor has replaced another annuity in the past
36 months
344
What are the tax-consequences of a 1035 exchange?
A 1035 exchange allows an investor to transfer funds from one annuity provider to another without any tax consequences. Importantly, although this is a tax-free exchange, other fees, such as surrender chargers, may apply.
345
The primary purpose of the statement of cash flows is to
provide information about a company's sources and used of cash during the accounting period.
346
# Define:
**Quick Ratio**
(Current Assets - Inventory) / Current Liabilities
347
If a company's stock has a beta of greater than 1, how does the stock's systemic risk compare to the overall market?
higher
## Footnote
If the beta for an asset is 1, it has the same systematic risk as the market. If beta is greater than 1, it has higher systematic risk than the market , which means that it is more volatile than the overall market.
348
What is the definition of the current ratio?
current assets / current liabilities
349
# Define:
**403(b) plan**
Also referred to as a tax-sheltered annuity, this plan is a qualified retirement plan offered by nonprofit organizations and education institutions. Other than the fact that these are offered by public entities rather than private corporations, they work similar to 401(k)s in that they allow eligible employees to make tax-deductible contributions.
350
# Define:
**fixed annuity**
An annuity contract that guarantees the owner a fixed rate of return over the life of the contract. To generate this fixed return, all premiums are invested in the insurance company’s general account. Because investors are guaranteed a return, fixed annuities are not considered a security.
351
# Define:
**general account**
The account of an insurance company in which customer premiums are invested
into conservative options that deliver a guaranteed fixed rate of return. All premiums for a fixed annuity are invested into this account.
352
# Define:
**immediate annuity**
A type of annuity in which payments for life begin shortly after the contract is issued and contributions are made by the annuitant.
353
# Define:
**minimum death benefit**
An insurance-like feature in an annuity contract that states that if the owner dies during the accumulation phase, which is the period in which she is making contributions to the plan, her beneficiary will receive the greater of the current value of the contract or the amount contributed.
354
# Define:
**single-premium deferred annuity**
A type of annuity where the annuitant contributes a lump sum that accumulates earnings until a future date decided by the contract owner. On this date, payments for life begin for the annuitant.
355
# Define:
**mortality guarantee**
The guarantee in an annuity contract that says the holder will receive payments as long as they live, no matter how long that may be.
356
# Define:
**earned income**
Income earned by an individual through their job, including salary, wages, and bonus.
357
# Define:
**estate tax**
The federal tax on the transfer of assets after a person's death.
358
# Define:
**First In, First Out (FIFO)**
The method used by the IRS to determine which shares the investor is selling against if they do not identify their position. Under FIFO, the IRS will use the cost basis of the shares held the longest to calculate the taxable gain or loss.
359
# Define:
**long-term capital gains**
Capital gains generated from securities that were held for one year and one day or more. Taxed at a preferential rate, which is a lower rate than what one would pay on their salary (i.e lower than ordinary income).
360
# Define:
**short-term capital gains**
Capital gains generated from securities that were held for one year or less. Taxed as ordinary income, which is the rate the investor pays on their salary.
361
# Define:
**capital loss deduction**
If an investor has any remaining capital losses after offsetting their capital gains, they can use up to $3,000 in capital losses to reduce their taxable ordinary income. Any excess losses can be carried forward to be used in future years.
362
# Define:
**wash sale rule**
States that if an investor sells a security for a loss, they cannot go into the market and repurchase the same or substantially the same security within 30 days of the sale. If an investor violates the wash sale rule, the loss is disallowed for tax purposes (e.g. they cannot use it to offset capital gains or reduce their ordinary income).
363
# Define:
**beta**
A measure of the volatility of a stock or portfolio compared to the overall market. A security that has a beta of 1.0 will track the market, a beta of more than 1.0 indicates the price will be more volatile than the market, and a beta of between 0 and 1.0 indicates that the security will be less volatile than the market.
364
# Define:
**odd lot**
An order for less than 1 round lot (100 shares).
365
# Define:
**odd lot theory**
A technical analysis theory that assumes that smaller investors are always buying or selling at the wrong time. Therefore, someone should take the opposite direction in the market as odd-lot traders who are buying and selling in small volumes.
366
# Define:
**diluted earnings per share**
Calculated as a company's net income divided by its diluted outstanding shares. A company's diluted share count includes employee stock options, warrants, and convertible bonds that, if exercised or converted, would increase the number of oustanding shares and thus dilute the existing shareholders of the company.
367
# Define:
**earnings per share**
Calculated as a company's net income divided by its reported outstanding shares.
368
# Define:
**working capital**
A measure of a company's liquidity, which is calculated as current assets minus current liabilities.
369
# Define:
**dividend payout ratio**
Measures the percentage of earnings that a company pays to its shareholders. It is calculated as dividends per share dividend by earnings per share.
370
# Define:
**529 Plan**
A type of municipal fund security that offers individuals a tax-advantaged means to savefor education, such as high school, college, or graduate school. Specifically, these accounts allow for after-tax contributions, which grow tax-free. Distributions for qualified education expenses, such as tuition, books, and supplies, are completely tax-free.
371
# Define:
**callable preferred stock**
A type of preferred stock that can be repurchased by the company at its discretion. The company is most likely to exercise this call feature when interest rates are falling in order to issue new stock with a lower dividend. Because of the call risk faced by the investor, callable preferred generally pays a higher dividend than non-callable preferred stock from the same issuer.
372
# Define:
**cumulative preferred stock**
A type of preferred stock that requires the company to pay any previously skipped dividend payments to these investors before any dividends can be paid to a common stockholder.
373
# Define:
**participating preferred stock**
A type of preferred stock that allows holders to receive an additional dividend on top of the stated rate if some predetermined event occurs.
374
# Define:
**purchasing power risk**
The risk that as inflation increases, the purchasing power of an investor’s fixed coupon will decrease—essentially, that the fixed coupon payment will not go as far for the investor as the price of goods and services rises.
375
# Define:
**non-systematic risk**
The risk that one specific company’s value will lower, be it due to poor management decisions or product recalls. An investor can protect against this risk by owning a diversified portfolio.
376
# Define:
**mortgage backed securities**
Pools of mortgages that have been securitized and turned into bonds, typically by Ginnie, Fannie, and Freddie. These securities pay monthly interest to investors (similar to mortgages) and help to enhance the liquidity of the mortgage market.
377
# Define:
**planned amortization tranche**
A CMO tranche that protects against both prepayment and extension risk.
378
# Define:
**plain-vanilla CMO tranche**
A type of CMO that pays interest on all tranches simultaneously, but only pays principal to one tranche at a time. Once that tranche is retired, subsequent principal payments are made to the next tranche in line.
379
# Define:
**tranche**
The unique classes of a CMO, each consisting of different credit qualities, expected maturities, and exposures to prepayments.
380
# Define:
**aggressive growth fund**
An equity mutual fund that invests in stocks of riskier companies that are expected to appreciate at a much faster rate than the market average. Stocks of these companies rarely pay dividends; instead earnings are reinvested further for research and development.
381
# Define:
**rights of accumulation**
Offer investors an opportunity to receive breakpoints on new mutual fund purchases based on the current value of those customers’ invested funds.
382
# Define:
**breakpoint sale**
A prohibited sales practice in which a registered representative tries to earn a higher commission by encouraging the sale of mutual fund shares at an amount just below the point where the sales charge is reduced.
383
# Define:
**selling dividends**
A prohibited practice in which a registered representative sells a mutual fund to an investor right before the fund pays out a dividend. This is a violation because the dividend distribution creates a tax liability for the investor, as the investor must immediately pay taxes on the distribution.
384
# Define:
**net investment income**
Net investment income is the total profits that an individual earns from their investments. For mutual fund investments, this would include any dividends plus interest income plus net capital gains (capital gains minus capital losses).
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# Define:
**preferred stock fund**
A mutual fund that invests in preferred stock in order to generate dividend income for investors.
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# Define:
**voluntary accumulation plan**
A benefit offered by a mutual fund that allows existing shareholders the right to purchase more shares at regular intervals with no additional sales charge.
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# Define:
**back-end load**
A back-end sales charge that investors pay when they redeem their mutual fund shares within a certain number of years. Generally, this fee will decrease each year the investor holds the shares.
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# Define:
**Class A share**
A type of mutual fund share that has a front-end sales charge, which investors pay when they buy into the fund. This share class tends to be the most economical for investors, as it offers breakpoints and has lower 12b-1 fees than other classes of shares.
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# Define:
**Class B share**
A type of mutual fund share that has a back-end sales charge which investors pay if they redeem their shares within a specified number of years. This share class typically has higher 12b-1 fees than class A shares and does not offer breakpoints.
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# Define:
**Class C share**
A type of mutual fund share that has a level-load sales charge. These shares typically have relatively high 12b-1 fees and do not offer breakpoints.
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# Define:
**closed-end fund**
A type of management investment company that issues a fixed number of exchange-traded shares. Similar to mutual funds, these types of investment companies are actively managed and have a net asset value. However, because an active secondary market exists for these, share prices are based on supply and demand.
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# Define:
**contingent deferred sales charge**
A back-end sales charge that investors pay when they redeem their mutual fund shares within a certain number of years. Generally, this fee will decrease each year the investor holds the shares.
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# Define:
**expense ratio**
A calculation of a mutual fund’s expenses, including management fees and operating expenses, divided by the fund’s average annual net assets.
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# Define:
**Investment Advisers Act of 1940**
A federal legislation that defines and regulates investment advisers.
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# Define:
**letter of intent (LOI)**
A contract offered by a mutual fund that allows a purchaser to invest in installments and receive breakpoints. An LOI is good for up to 13 months and can be backdated 90 days. If the customer fails to meet the terms, the otherwise applicable sales charges will apply.
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# Define:
**load**
Also referred to as the sales charge, it is the fee an investor pays when buying a mutual fund share. To calculate the public offering price, the sales load is added to the NAV.
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# Define:
**management fee**
The fee paid to the investment advisor who is responsible for actively managing the portfolio of a management investment company, such as a mutual fund or closed-end fund. It is typically the greatest expense of any management company.
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# Define:
**management company**
A type of investment company that actively manages a portfolio of securities to achieve a stated investment objective for investors. This is the most common type of investment company and includes both closed-end funds as well as mutual funds.
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# Define:
**money market fund**
A mutual fund that consists of money market securities, which are short-term debt instruments with maturities of one year or less. These funds are considered extremely safe and liquid.
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# Define:
**open-end management company**
Also known as a mutual fund, it is a management investment company that makes a continuous offering of redeemable shares. The portfolio of the fund is actively managed to achieve a clearly defined investment objective. However, because the shares are redeemable, there is no secondary market trading; instead the shares can only be bought from and sold back to the fund.
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# Define:
Reinvestment Privilege
Allow mutual fund investors to reinvest distributions into the fund at the NAV without having to pay any sales charges on these new purchases. Investors must still pay taxes on these distributions, however.
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# Define:
**12b-1 fee**
Annual fees paid by investors to cover a mutual fund’s marketing and distribution expenses. The maximum 12b-1 fee that a fund can charge is 1% of the fund’s average net assets, though if a fund wants to advertise itself as being no-load (not having a sales charge), then it cannot charge 12b-1 fees of more than 0.25% of the average net assets.
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# Define:
**unit investment trust (UIT)**
An investment company that issues redeemable securities representing an undivided interest in a trust. As with mutual funds, no secondary market exists for these. However, unlike management companies, there is a fixed portfolio with no active management.
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# Define:
**balanced fund**
A mutual fund that combines invests in stocks for growth and bonds for income.
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# Define:
**dollar cost averaging**
A method of purchasing shares in a mutual fund where the investor invests a fixed dollar amount at regular intervals. Over long periods of time, this will typically allow investors to have an average cost per share lower than the average price per share as they will buy more shares when prices are low and fewer when prices are high.
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# Define:
**non-diversified management company**
An investment company that does not meet the 75-5-10 diversification requirements set forth under the Investment Company Act of 1940.
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# Define:
**ETF**
An exchange-traded investment company security that is designed to closely track the performance of a specific sector, benchmark, or index. The fund is not actively managed and typically only changes when the underlying benchmark it tracks changes.
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# Define:
**Growth Fund**
An equity mutual fund that invests in stocks of companies that are expected to appreciate at a faster rate than the market average. Stocks of these companies rarely pay dividends; instead earnings are reinvested further for research and development.
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# Define:
**Income Fund**
An equity mutual fund that invests in dividend-paying companies including utility stocks, blue chip stocks, and preferred stocks.
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# Define:
**Growth and Income Fund**
Also referred to as a growth and income fund, it is an equity mutual fund that includes some stock for growth and others that pay high dividends.
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# Define:
**mutual fund**
Also known as an open-end fund, it is a management investment company that makes a continuous offering of redeemable shares. The portfolio of the fund is actively managed to achieve a clearly defined investment objective. However, because the shares are redeemable, there is no secondary market trading; instead the shares can only be bought from and sold back to the fund.
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The tax that a mutual fund shareholder pays on capital gains distributions from the fund are based on
the holding period of the fund
## Footnote
As long as the mutual fund held the security in its portfolio for greater than one year, any capital gains that are realized are long-term capital gains for the fund investors regardless of how long they have held the shares of the fund.
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A mutual fund investors decides to automatically reinvest dividends rather than take a cash distribution. Is this a taxable event?
Yes, mutual fund dividends are taxed when declared by the fund regardless if they are taken in cash or reinvested back into the fund.
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Systematic withdrawal plan
A mutual fund redemption option which allows investors to withdraw a fixed amount (e.g. fixed dollar amount, fixed percentage of the account, or fixed number of shares) in regular intervals.
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What investor type is best suited for municipal bond funds?
High income investors who will most benefit from the tax-free interest income provided by municipal bonds
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What is the **maximum amount** a mutual fund can charge as sales charge?
A mutual fund can charge no more than 8.5% of the offering price.
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Who determines the **ex-dividend** date for a mutual fund?
The **board of directors** of a mutual fund will set the ex-dividend date. In order to receive the dividend, an investor must purchase shares prior to the ex-dividend date.
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**Breakpoint**
Discounts off the sales charge based on the amount of money invested within a mutual fund.
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What are mutual expenses not covered in a 12b-1 fee?
Management expenses and trading fees
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An investment company that pursues a **sector investment strategy** focuses on:
a specific industry
## Footnote
A sector focus strategy generally looks for securities from a particular sector or industry such as financial services, telecommunications, technology, etc.
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Which types of investment companies are redeemable?
Mutual funds and unit investment trusts
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What is not a benefit of investing in a fund of funds hedge fund?
lower fees
## Footnote
Fund of funds hedge funds typically charge much higher fees than a direct investment in a hedge fund because the manager in charge of the fund of funds adds its fee on top of the fees charged by the funds that comprise the fund of funds.
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# Define:
**Net Asset Value**
The value of a mutual fund, calculated as the total assets of the fund divided by its total liabilities. When a customer purchases a share, he pays the public offering price, which includes the NAV plus a sales charge. When a customer sells his shares back to the fund, he receives the NAV.
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What is an **expense ratio** of a mutual fund?
* The expense ratio is the **total annual expenses divided by the total net assets of the fund**.
* This expresses how much of the fund's return is actually being used to pay expenses and management of the fund. The higher the expense ratio -- the less efficient mutual fund.
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What is the formula for calculating the percentage sales charge of a mutual fund?
(POP - NAV)/POP
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What percentage of net investment income must a mutual fund distribute to shareholders to avoid taxation?
90%
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What are two major differences between mutual funds and ETFs?
Mutual funds are actively managed and redeemable (meaning there is no secondary market). ETFs, on the other hand, are not actively managed and are exchange-traded.
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A mutual fund has an NAV of $18 and charges a sales charge of 3%, calculate the POP.
$18.56
| POP = NAV/(100% - SC)
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How does the portfolio turnover rate for ETFs compare to mutual funds?
Lower
## Footnote
Because ETFs are not actively managed, there is very little turnover of securities within the pool.
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Because they are passively managed, the capital gains that ETFs generate are typically
minimized
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**Describe the pricing of closed-ended funds**
**Because they are exchange-traded, closed-end funds may trade at a premium of discount to the NAV based on the supply and demand of the shares**
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Under the penny stock cold-calling rules, what must a registered rep disclose to a client when soliciting a penny stock trade?
* The name of the stock
* The number of shares that they are soliciting
* The current quote
* The commission to be received
