Series 7 - Definitions, Regs and Rules Flashcards
What are the 5 agencies that congress authorizes to issue debt securities?
- Farm Credit Administration (FCS) - agency of fed gov’t.
- Gov’t National Mortgage Assoc. (GNMA / Ginnie Mae) - agency of fed gov’t.
Agency like but private corporations: - Federal Home Loan Mortgage Corp. (FHLMC / Freddie Mac)
- Federal National Mortgage Assoc. (FNMA / Fannie Mae).
- Student Loan Marketing Assoc. (SLMA / Sallie Mae).
What is the FCS?
FCS is the Farm Credit System. National network of lending institutions that provide agricultural financing and credit. System is privately owned but gov’t sponsored that raises loanable funds through the sale of Farm Credit securities. Funds made available through a national network of 8 banks and 225 Farm Credit lending institutions. The Farm Credit Administration, which is a gov’t agency, oversees the system. FCS issues notes, bonds and master notes that range from 1 day to 30 years. Interest is exempt from state and local taxes.
Describe a Special Situation Fund
Funds that buy securities of companies that may benefit from a change within the companies or the economy. Takeover candidates and turnaround situations are common investments. These funds are speculative (high risk).
Define inflation risk
The risk that fixed interest or dividend payments will be worth less over time in terms of purchasing power. As an example, the ability to convert preferred stock to common tends to offset as common tends to keep pace with inflation.
When a stock is inherited, what is the cost basis?
Cost basis is the price of the stock at the date of death.
Differentiate between technical analysis and fundamental analysis.
- Technical analysis attempts to predict the direction of prices on the basis of historic price and trading volume patterns when laid out graphically on charts.
- Fundamental analysis concentrates on broad-based economic trends; current business conditions within an industry; and the quality of a particular corporation’s business, finances and management.
What is a Rights Offering?
An offering of additional shares to existing shareholders.
What is a Tender Offer?
An offer to buy securities for cash or for cash plus securities. Used in context takeovers.
Describe an Inverse Fund.
Inverse Funds, sometimes called reverse or short funds, attempt to deliver returns that are the opposite of the benchmark index they are trading. Inverse funds can be leveraged funds (meaning attempting to deliver 2x or 3x the opposite of the index). Bought when an investor is bearish on the market as a whole or particular industry (e.g. transportation). Sold in ETFs for funds.
What is “paid-in surplus”?
Paid-in surplus is a balance sheet entry that accounts for money raised from the issuance of stock in excess of par value. When more stock is sold, paid in surplus will increase. Also called Capital in Excess of Par or additional paid-in capital.
What is Interest Rate Risk?
The danger that interest rates will rise and adversely affect (a bond’s) price. Risk is greatest for long-term bonds.
Full definition: The risk associated with investments relating to the sensitivity of price or value to fluctuation in the current level of interest rates; also, the risk that involves the competitive cost of money. Generally associated with bond prices, but applies to all investments. In bonds, prices carry interest risk because if bond prices rise, outstanding bonds will not remain competitive unless their yields and prices adjust to reflect the current market.
Describe a LOI in reference to received a breakpoint price on the purchase of mutual funds.
A person who plans to invest more money with the same mutual fund company may immediately decrease overall sales charge by signing a LOI.
-LOI states investor plans to reach the breakpoint within 13 months.
-One-sided contract binding only on the fund.
-Fund holds some of the shares in escrow.
-If customer makes required investment escrowed shares are released.
If not, given choice to pay sales difference or have underwriter liquidate enough escrowed shares to cover difference in cost.
-Appreciation and dividends do not count towards the LOI.
What are CMOs?
CMOs or Collateralized Mortgage Obligations are a type of asset-backed security. Asset-backed securities are ones whose value and income payments are derived or back by a specific pool of underlying assets. Pooling the assets allows them to be sold more easily (securitization). Pays principal and interest from the mortgage pool monthly; however repays principal to only one tranche at a time. Principal payments are made in $1,000 increments to randomly selected bonds within the tranche. Changes in interest rates affect the rate of mortgage payments and this in turn affects the flow of interest and principal payment to the investor. A CMOs yield and maturity are estimates based on historical data or projections from the Public Securities Association. Customers are required to sign a suitability statement before buying any CMO.
List 5 common CMOs.
- Principal Only (POs): sells at a discount from par. Market value tends to be volatile. Affected by fluctuations in prepayment rates. Value rises as interest rates drop and vice-versa.
- Interest Only: by-product of POs. Sells at a discount and cash flow decreases over time. IOs increase in value when interest rates rise and decline when rates fall. Can be used to hedge against a portfolio against interest rate risk.
- Planned Amortization Class: Targeted maturity dates, and retired first and offer protection from prepayment risk and extension risk.
- Targeted Amortization Class: Pays slightly higher interest in return for investors accepting greater extension risk.
- Zero-tranche CMO: Receives no payment until all preceding tranches are repaid. Most volatile.
How are Capital Losses treated from a tax perspective?
Capital losses are deducted from ordinary income and, therefore, reduce tax liability. The maximum that individuals or married couples can deduct is $3,000 annually. If the long-term capital loss exceeds the maximum, the excess is carried forward to future years until the loss is exhausted. Under current IRS regulations, $1 in losses results in $1 in deductions
What is A.M. Best?
A.M. Best historically has specialized exclusively in rating debt instruments for the insurance marketplace. They issue financial strength ratings measuring insurance companies’ ability to pay claims and rate financial instruments issued by insurance companies, such as bonds and notes. They can issue debt and financial strength ratings for other sectors as well, under the Credit Rating Agency Reform Act.
What are position limits as it relates to Options.
250,000 contracts on the “same side of the market” within a 5 business day period. Limit is subject to frequent adjustment. LEAPS are added to traditional options to determine if a violation has occurred. Same side is Long calls / short puts (bull) and long puts / short calls (bear).
What is Regulation D?
Regulation D: Private Placements
Private placement exempt transaction
Up to 35 non-accredited investors
The SEC does not require registration of an offering if it is privately placed with
Accredited investors that do not need SEC protection
a maximum of 35 (non-accredited investors)
An accredited investor is defined as one who: has net with of $1M (not including primary residence), annual income in excess of $200K in each of 2 most recent years ($300K jointly with spouse) and reasonable expectations income will continue, an insider of the issuer such as officer or director, institutions such as pension plan.
In order to solicit or advertise a private placement, the business must take reasonable steps to verify that all purchasers are accredited.
A private placement investor must sign a letter stating that they intend to hold the stock for investment purposes only. Private placement stock is called lettered stock due to this investment letter. Also called legend stock in that it cannot be transferred without registration or exemption.
While a business may sell to up to 35 non-accredited investors, in order to solicit or advertise, all purchasers must be accredited.
Rule 147
Under Rule 147, offerings that take place entirely in one state are exempt from registration when:
-issue has its principal office and 80% of income is in state
-80% of assets in the state
-at least 80% of assets are used within the state
-majority of employees are based in state
-all purchasers are residents of the state.
(only need one of the 80% qualificaitons)
Purchasers of an intrastate issue may not resell the stock to any resident of another state for at least 6 months.
Under the provisions of Rule 144, what percentage of outstanding stock may a control person sell every 90 days?
Rule 144 (sale of restricted or control stock) allows for the sale of 1% of the outstanding shares or the weekly average of the last 4 weeks’ trading volume (whichever is greater), every 90 days.
What are the 3 types of oil and gas DPPs?
exploratory
developmental
income
List the following for an Exploratory (wildcatting) Oil and Gas DPP: objective advantages disadvantages tax features risk
objective: locate undiscovered reserves
advantages: high rewards for discovery of new reserves
disadvantages: few new wells actually produce
tax features: High IDCs (intangible drilling costs) for immediate tax sheltering
risk: High - most risky
Institutional communication:
Any written communication that is distributed or made available only to institutional investors but does not include a member firm’s internal communication.
Retail Communication
defined in FINRA rule 2110 as “any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar day period.” Ads and sales literature fall under Retail Communication.
What is Modern Portfolio Theory?
MPT employs a scientific approach to measuring risk and by extension choosing investments. It’s a mathematical approach that is designed to reduce risk and increase performance of an investment portfolio by using different classes of securities that don’t always move in the same direction at the same time.
What is Capital Asset Pricing Model?
CAMP states that the only risk that can be defined is systematic risk because that cannot be eliminated by diversification.
Alpha
Alpha is the extent to which an asset’s or a portfolio’s actual return exceeds or falls short of its expected return. A positive Alpha = buy.
Balance Sheet equation
Assets = liabilities + shareholder’s equity or assets - liabilities = shareholder’s equity
Long-term liabilities
financial obligations due for payment after 12 months.
Capital Stock
includes both common and preferred and issued at par value which is an arbitrary value with no relationship to market price.
Retained Earnings
Earned surplus or accumulated earnings are profits that have not been paid out as dividends. Retained earnings represent the total of all earnings held since the corporation was formed, less dividends paid to stockholders. Operating losses in any year reduce the retained earnings from prior years.
working capital
current assets - current liabilities
current ratio
current assets divided by current liabilities. Higher the ratio the more liquid.
Quick Asset Ratio
Acid test ratio. uses quick assets instead of current assets. Quick assets are current assets minus inventory.
debt to equity ratio
debt to total capital. How much of the capital is debit
book value per share
tangible assets - liabilities - par value of preferred
_____________________________= book value per share
shares of common stock outstanding
fundamental analyst
one who focuses on company’s books
EPS
Earnings per share = earnings available to common / number of shares outstanding
current yield
CY = annual dividends per common / market value per common
dividend payout ratio
= annual dividends per common / EPS
EBIT
Earnings before Interest and Taxes. Allows fundamental analyst to focus on operating profitability.
P/E Ratio
Price to earnings = current market price of common / earnings per share.
Head and shoulders top
indicates the beginning of a bearish trend, reversal of an upward trend
Head and shoulders bottom
indicates the beginning of a bullish trend, reversal of a downtrend.
odd lot theory
when odd-lot traders buy, odd-lot analysts are bearish and when odd-lot traders sell, odd-lot analysts are bullish
short-interest theory
short interest refers to number of shares that have been sold short. short interest reflects mandatory demand which creates support levels. High short interest is a bullish indicator and low short interest is a bearish indicator.
authorized stock
specific number of shares a company has authorization to sell.
statutory voting
allows a stockholder to cast one vote per share owned for each item on the ballot.
cumulative voting
allows stockholder to allocate their total votes in any manner they choose.
bid / ask
buyer will pay the ask seller will receive the bid
What is the intrinsic value of an option at the money?
zero. and there is no such thing as negative intrinsic value.
Closing purchase (options)
an options transaction in which the seller buys back an option in the same series; the two transactions effectively cancel each other out, and the position is liquidated
Closing sale (options)
an options transaction in which the buyer sells an option in the same series; the two transactions effectively cancel each other out, and the position is liquidated.
Hedging
using an option to protect the position of an underlying security.
ratio call writing
selling more calls than the long stock position covers.
collar
protecting the downside risk on a long position of stock for no out-of-pocket cash. Involves buying a put and selling a call so that the net gain is zero. This protects downside risk but also limits the upside as well.
spread
simultaneous purchase of one option and sale of another of the same class. e.g long call and short call or long put and short put.
price spread
also now as a vertical spread - one that has different SPs but the same expiration date.
Time Spread
also known as a calendar spread or horizontal spread includes option contracts with different expiration dates but same SPs.
diagonal spread
one in which the options differ in both time and price.
Debit call spread
Used by investors to reduce the cost of a long option position. Potential reward is also reduced. Investor is bullish.
Breakeven on a call spread
NP + lower XP (CAL)
breakeven on a put spread
Higher XP - net premium (PSH)
credit call spread
used by investors to reduce the risk of a short option position. potential reward is reduced. investor is bearish.
debit put spread
used by investors to reduce the cost of a long put position. Investor is bearish.
credit put position
created to reduce the risk of a short put position.
