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SIE Exam > Unit 2 > Flashcards

Unit 2 Flashcards

Understanding Products and Their Risk

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1
Q

Equities

A

By Purchasing shares of a capital can participate in company’s prosperity

Capital Appreciation - Increase Stock Price

Distributed Profits - Dividends

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2
Q

Common Stock

A

Company issues stock to raise capital

investors buy stock also buy a share of ownership in the company’s net worth

each share of stock entitles its owner to a portion of the companies earnings and dividends and proportionate vote in major management decisions.

by electing board - stockholders have a say in company’s management

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3
Q

Benefits of Owning Common Stock

A

Common shareholders benefits including voting rights, opportunity for capital appreciation, and current income as well as limited liability

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4
Q

C/S Benefits - Rights of Common Stockholders

A

Have right to vote for corporate directors

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5
Q

C/S Benefits - Proxy

A

absentee ballot want vote but can’t attend

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6
Q

C/S Benefits - Growth (Capital Gains)

A

Increase in market price of securities is capital appreciation

hedge against inflation

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7
Q

C/S Benefits - Income

A

Many Pay dividends

dividends declared by BOD may increase overtime as profits increase

issuers may also pay stock dividends or property dividends

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8
Q

C/S Risk - Market Risk

A

chance that stock will decline in price is one risk of owning common stock

investors have no assurance able to recoup

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9
Q

C/S Risk - Decreased or No Dividend Income

A

a rise of stock ownership is the possibility of dividend income decreasing or ceasing entirely if company loses money.

decision to pay dividend rest with BOD

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10
Q

C/S Risk - Low Priority at dissolution

A

owners of bonds and preferred stock have priority over common stockholders.

debt and preferred shares are considered senior securities

C/S have residual rights to corporate assets upon dissolution

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11
Q

C/S - Owning Common Equity

A

in owning common equity, investor stands to lose current income through dividend reduction or suspension, as well as capital loss, should the market price decline.

in return shareholder has limited liability, liability is limited to the amount invested.

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12
Q

C/S - Bankruptcy

A

Reorganization - entity will likely be able to retain property and continue doing business.

Liquidation - keeping property or continuing business will not occur

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13
Q

C/S - Liquidation

A

Priority Claims on Assets Sold

  1. IRS taxes and employees (unpaid wages)
  2. Secured Debt (Bond and Mortgages)
  3. Unsecured Liability and general creditors (suppliers and utilities)
  4. subordinated debt (debt holders who agreed to be paid last)
  5. Common Stockholders
  6. Common Stockholders
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14
Q

Corporate Liquidation Priority - Common Shareholders

A

Common Shareholders are paid last of all bond and stockholders. Consider that only in cases where there are funds remaining after all other parties are paid do common stockholders receive anything

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15
Q

Preferred Stock

A

is an equity security because it represents class of ownership in corporation.

characteristic debt security

  • rate of return is fixed, C/S is variable
  • annual dividend represents fixed rate of return

No Voting Rights
No preemptive Rights

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16
Q

Common Vs. Preferred Stock

A

all corporations issue C/S, but not all incorporations issue P/S

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17
Q

Benefits of Owning Preferred Stock

A
  1. Dividend Preference - paid prior to common stock

2. Priority at Dissolution over Common Stock

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18
Q

Risk of Owning Preferred Stock

A
  1. Purchasing Powering Risk
    potential because inflation fixed income produced not purchase much in future
  2. Interest Rate Sensitivity
    Interest Rate Rise, Value of P/S Decline
    Interest Rate Decrease, Value Increase
  3. Decreased or no Dividend
    Dividend decreasing or Ceasing
  4. Priority at Dissolution
    Paid Before Common, behind creditors
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19
Q

Why Include P/S

A
  1. Fixed Income Dividends
  2. Prior Claim ahead of Common Stock
  3. Convertible preferred sacrifices income in exchange for potential appreciation
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20
Q

Preferred Stock - Straight (NonCumulative)

A

no special features beyond stated dividend payment

missed dividends are not paid

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21
Q

Preferred Stock - Cumulative

A

accrues payments due to shareholders in event dividends are reduced or suspended

receive current plus total accumulated

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22
Q

Preferred Stock - Callable Preferred

A

Company can buy back from investors at a stated price after specified date

allow replace high fixed dividend obligation with lower one when cost of money has gone down

dividend payment cease when called

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23
Q

Preferred Stock - Convertible Preferred

A

owner can exchange shares for fixed number of shares of common stock

issued with lower state dividend rate that nonconvertible given opportunity enjoy capital gain

because value of convertible preferred stock is linked to value of common stock, convertible preferred share price tends to fluctuate in line with common

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24
Q

Preferred Stock - Adjustable Rate Preferred

A

Adjustable dividend rates

dividends tied to rates of other interest rate benchmarks such as treasury bills and money markets rate

can adjust as often as quarterly

price of stock remains relatively stable

for investors looking for income through P/S this is least appropriate choice

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25
Q

Preferred Stock - Participating Preferred

A

Offers owner a share of corporate profits that remain after all dividends and interest due to other securities are paid.

6% preferred participating to 9%, company pays it holders up to 3% in additional dividends in profitable years

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26
Q

SEC Rule 144

A

regulates sales of control and restricted securities, stipulating period, quantity limitations, manner of sales, filing procedure

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27
Q

SEC Rule 144 - Control Securities

A

directors, officers, persons own 10% or more of issuers voting stock

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28
Q

SEC Rule 144 - Restricted Securities

A

acquired through means other than registered public offering.

may not be sold until held fully paid 6 months

after holding 6 months, may begin selling - volume restrictions

buyers of stock being sold subject to rule 144 are not subject to any restrictions if they choose to resell

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29
Q

Penny Stocks

A

is an unlisted security trading at less than $5 per share

highly speculative

risk disclosure document

monthly account statement

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30
Q

Penny Stock - Cold Calling Rules

A

Must disclose

  1. name of penny stock
  2. number shares to be purchased
  3. current quotation
  4. amount commission that firm and representative received.
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31
Q

Penny Stock - Provisions

A

provision of penny stock rules apply only to solicited transactions like those that might occur during cold call. unsolicited transactions are exempt

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32
Q

Penny Stock - Established Customer Exemption

A

established customer are exempt

  1. has held account with broker dealer for at least one year
  2. has made at least three penny stock purchases on different days
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33
Q

Bonds

A

money borrowed by corporations, federal government or local governments (municipalities) from investors.

load is evidenced by bond which is certificate representing the borrowers indebtedness to investor

when investor buys a bond investor is lending the borrowing entity money for a set period of time at fixed annual interest rate

acquires no ownership in entity unlike purchasing stock

investor becomes creditor

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34
Q

Bond Characteristics - Maturities

A

Term Bond - principal and whole issue mature at once

Serial Bond - portion of principal at intervals until entire balance is repaid

Ballon - elements of both serial and term. repay part before maturity, and major portion at maturity

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35
Q

Bond Characteristics - Coupons

A

represent interest rate issuer agreed to pay investor

interest rate bond pays is called coupon rate

interest is generally paid on semiannual basis -
bond with 6% coupon is paying $60 .

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36
Q

Bond Characteristics - Pricing

A

once trading in second market they can trade at a price of par, premium, or discount to par

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37
Q

Bond Characteristics - Market Forces

A

sensitivity to market interest rates

bond prices have inverse relationship to interest rates
Interest rates increase, bond price decrease
interest rates decrease, bond price increase

though price of bond will react to market forces and supply / demand, coupon is always the same.

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38
Q

Bond Characteristics - Yields

A

Bonds Yield expresses cash interest payments in relation to bonds value.

Yield is determined by issuers credit, prevailing interest rates, time to maturity, and bond features.

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39
Q

Bond Characteristics - Yield - Nominal Yield

A

coupon, nominal, or stated yield

set at time of issue

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40
Q

Bond Characteristics - Yield - Current Yield

A

measures bonds annual coupon payment

annual coupon payment / market price = current yield

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41
Q

Bond Characteristics - Yield - Yield to Maturity

A

reflects annualized return of bond if held to maturity
Discount - investor makes money, discount amount increases the turn

Premium - Investor loses money at maturity, the premium amount decreases the return

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42
Q

Bond Characteristics - Yield - Yield to Call

A

redeemed before maturity at issuers option.

investor received principal back sooner than anticipated.

YTC reflect acceleration of discount gain if bond at discount and accelerated premium loss if purchased at premium

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43
Q

Bond Features - Call Features

A

a call feature allows an issuer to call bond before maturity.

issuers generally do this when interest rates are falling

benefits issuer

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44
Q

Bond Features - Put Feature

A

opposite of call feature

investor can put the bond back to the issuer before matures

investors will do this when interest rates are rising

benefits bondholder

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45
Q

Bond Features - Convertible

A

allow investor to convert bond into shares of common stock

opportunity to exchange debt instrument for one that gives investor ownership right

benefit investor

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46
Q

Bond Features

A

when bonds are issued with features that benefit issue - call feature, issuer generally will need to pay slightly higher coupon rate of interest to make bond attractive to new investors

when bonds are issued with features that benefit the bondholder, put or conversion features, the issuer can usually pay slightly lower coupon rate of interest as the feature will compensate for lower return

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47
Q

Treasury Securities

A

US Treasury department - determines type of government securities it must issue to meet federal budget needs.

Marketplace - determines interest rates securities will pay

are backed by full faith and credit, based on power to tax

all are issued in book form

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48
Q

Treasury Securities - Treasury Bills

A

T-Bills
direct short term debt obligations of US Government

Maturity: 4,13,26,52 weeks

Pay no interest,
Issued at discount

  • Treasury bills are only issued at discount
  • treasury bills are only issued without stated interest rate
  • treasury bills are highly liquid
  • 13 week are used in market as risk free investment
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49
Q

Treasury Securities - Treasury Notes

A

T-Notes:
pay semi annual interest as percentage of stated par value and mature at par value

2-10 years

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50
Q

Treasury Securities - T Bonds

A

Pay semiannual interest as % of states par value and mature at par value

10 years to 30 years

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51
Q

Treasury Securities - Treasury Receipts

A

brokerage firms create

broker dealers buy treasury securities, place them in trust at bank sell separate receipts against the principal and coupon payments.

not backed by full faith and credit of US government

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52
Q

Treasury Securities - Treasury STRIPS

A

treasury department own version of receipts.

certain issues are suitable for stripping into interest and principal components

banks and broker dealers perform actual separation of interest

backed by US Government

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53
Q

Treasury Securities - Alert

A

treasury STRIPs are backed by full faith of US government.

Treasury Receipts are not

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54
Q

US Government Agency Issues

A

the settlement of agency issues securities occurs regular way -
T+2
known as asset backed or mortgage backed securities

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55
Q

Farm Credit System (FCS)

A

national network of lending institutions that provide agricultural financing and credit

privately owned, government sponsored

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56
Q

Government National Mortgage Association (GNMA)

A

is government owned corporation that supports department housing.

Ginnie Mae are only agency securities backed by full faith and credit of federal government

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57
Q

Freddie Mac

A

public corporation

promote development of nationwide secondary market in mortgages by buying residential mortgages from financing institutions and packaging them into mortgage backed securities for sale to investors

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58
Q

Fannie Mae

A

Publicly Held Corporation
provides mortgage capital

FNMA purchases conventional and insured mortgages from FHA and VA

securities created are backed by FNMA general credit

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59
Q

Corporate Bonds

A

Secured - backed by various assets

Unsecured - backed by reputation, credit record, financial stability. backed by corporations full faith and credit

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60
Q

Corporate Bonds - Mortgage Bonds

A

corporation borrow money backed by real estate and physical assets of corporation.

real estate assets pledged as collateral - sold

purchaser of montage bond in position safety

secured loan

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61
Q

Corporate Bonds - Equipment Trust Certificates

A

finance acquisition of capital equipment used in course of their business.

equipment held in trust, usually by bank acting as trustee, until certificates paid in full.

not paid - repossessed as collateral

secured loan

obligation to pay investor is secured by the equipment

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62
Q

Corporate Bonds - Collateral Trust Bonds

A

Deposits debt securities it owns into a trust to serve as collateral for lender

can be securities in other corporations or those partially or fully owned as long as securities are marketable - liquidated

secured by securities deposited, better quality securities, better quality of certificate

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63
Q

Corporate Bonds - Debentures

A

debt obligation of corporate backed only by its word and creditworthiness

written promise,

are not secured by any pledge of property

sold on general good faith and credit of company

unsecured

although debentures are unsecured - issuers whose credit standing is so good that debentures might be considered safer than unsecured bonds of less creditworthy companies

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64
Q

Corporate Bonds - Guaranteed Bonds

A

backed by company other than issuing company such as parent company

value of guarantee is only as good as faith of company making guarantee

unsecured - never be fooled by guarantee as it relates to guaranteed bonds

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65
Q

Corporate Bonds - Income Bonds

A

adjustment bonds

pay interest only if have enough income to meet interest

unsecured

income bonds are true oxymoron, if investor is seeking income, an income bond is likely not a suitable recommendation

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66
Q

Senior of Subordinated Debt

A
  1. Secured Creditors Debt Instruments
    (Mortgage Bonds, Equipment Trust Certificates, Collateral Trust Bonds, Mortgages)
  2. Unsecured Creditors Debt Instruments
    (General Creditors, debenture holders, guaranteed bonds, income bonds)
  3. Subordinated debt
    (debt holders agreed to be paid back last)
  4. Preferred Stock
  5. Common Stockholders
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67
Q

Municipal Securities

A

considered second in safety of principal only to US government and US government agencies

Municipal Bonds - issued either by state or local government

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68
Q

Municipal Securities - General Obligations Bonds

A

Municipal Bonds issued for capital improvements

interest must be paid by taxes collected from municipal issuer

known as good faith and credit issues - backed by municipality’s taxing power

back by income taxes, license fees, sales tax

ad valorem

can be limited to protect from excessive taxing

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69
Q

Municipal Securities - Revenue Bonds

A

used to finance any municipality that generates sufficient income.

principal and interest are made from revenues generated
utilities - housing - transportation - education - health - industrial - sport

not supporting by issuers authority to tax

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70
Q

Municipal Securities - Anticipation Notes

A

ST securities generate funds, less than 12 month maturity but can range from 3mo - 3yr

repaid when municipality receives funds

TAN - finance current operations in anticipation taxes
RAN - finance current from future revenues
TRANS - combination of above
BANs- interim financing be converted to long term through sale of bonds

Tax Exempt Commercial paper 270 days
CLN - construction
variable rate notes - fluctuating interest, put option
GANS - expectation receiving grant

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71
Q

Municipal Securities - Taxable Municipals

A

Build America Bonds

Bondholder pay tax on interest received

Tax Credit BABS - federal income tax credit equal to 35% of interest paid on each bond each year. excess credit carried forward

Direct Payment BABs: no credit to bondholder, provide municipal issuer with payments from UST equal to 35% of interest paid to issuer

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72
Q

Municipal Securities - Section 529 Plans

A
  1. Overall contributions levels can vary
  2. assets remain in donors control until student becomes legal age
  3. no income limitation
  4. monthly payments if desired
  5. unused may be transferred
  6. rollover are permitted

up to 10,000 per year

official statement or offering circular

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73
Q

Municipal Securities - LGIP

A

provide other government entities cities, counties, school,

short term investment vehicle to invest funds.

generally formed as a trust which municipalities can purchase shares or units in LGIP investment portfolio.

Not Money market Fund
Not required to register with SEC or subject o regulations

No prospectus

do have disclosure documents

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74
Q

Municipal Securities - ABLE

A

tax advantage savings accounts for individuals with disabilities and their families

must have before 26

only one able account per customer

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75
Q

Money Market Instruments

A

Capital and Money Market

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76
Q

Money Market Instruments - Capital Markets

A

source of intermediate term and long term financing

equity or debt securities with maturities of more than one year

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77
Q

Money Market Instruments - Money Market

A

provides short term funds to corporations, banks, broker dealers, government municipalities, and US Federal Government.

Fixed Income (debt) securities with short term maturities, less than year

Consider to be highly liquid, little time to default.

high degree safety

investors purchase generally do not receive interest but issued at discount or par and mature at face value.

return = difference between purchase price and face value

Why Include:

  1. highly liquid
  2. very safe
  3. good place investment money needed short term

Risk:

  1. rate of return low
  2. due to ST, principal potentially reinvested at different rate each time, fluctuate each new instrument purchased
78
Q

Money Market Instruments - Certificate of Deposits

A

banks issue and guarantee

fixed interest rates and minimum face value of 100k

jumbo - face value of 1m or more and most common

most mature in less than one year

some can be traded in secondary market = negotiable CD - these are consider money market

negotiable CD - banks version of unsecured promissory note, backed only by good faith and credit

79
Q

Money Market Instruments - Bankers Acceptance

A

short term time draft with specified payment date.

BA is postdate check

payment date 1 to 270 days

corporation use extensively to finance international trade

typically pays for goods and services in foreign country

80
Q

Money Market Instruments - Commercial paper

A

corporations issue short term, unsecured paper known as promissory notes.

raise cash to finance accounts receivable and inventory

maturity - 1 to 270 days, most mature 90 days

excellent credit

81
Q

Money Market Instruments - US Treasury Bills

A

Direct short term debt obligations of US government
issued with maturities
4,13,26,52

thought T Notes and T Bonds are issued with longer maturities than T Bills, once notes and bonds have only a year left to maturity they are considered to be money market instruments

82
Q

Money Market Instruments - Repurchase Agreement

A

financial institution, bank or broker dealer raise cash by temporarily selling securities hold with agreement to buy back securities at later date at higher price.

agreement to conduct transaction, reverse transaction in future.

contract - repurchase price, and maturity date

Reverse Repo
dealer agrees to sell securities to lender and buy back at higher price,

reverse dealer agrees to buy securities form investor and sell back at higher price

83
Q

Federal Funds

A

FRB mandates money supply

excess deposits of required amount know as federal funds

can be loaded to member bank to meet reserve requirement

loans are short term, occur overnight

84
Q

Options

A

derivative securities -

derive value from that of an underlying instrument such

  • stock
  • stock index
  • interest rate
  • foreign currency

offer investor to hedge, or protect investment value or speculate price movement of

  • individual securities
  • foreign currencies
  • other instruments

two parties involved in contract - right to exercise, other obligated to fulfill

Contract Premium
amount paid for contract when purchased, or received for contract when it is sold

85
Q

Options - The Buyer

A

Pays premium for contract

referred to as owner, holder, or party

long the contract

right to exercise contract

  1. purchaser
  2. long
  3. pays premium
  4. owns right
  5. in control
86
Q

Options - The Seller

A

receives premium

writer, party

short the contract

obligated to perform if buyer chooses to exercise contract

87
Q

Options - Transaction Types

A

Buy Calls

Sell Calls

Buy Puts

Sell Puts

88
Q

Options - Calls - Long Call(Purchase)

A
  • Call buyer
  • Owns Rights to buy at specified stock at expiration
  • exercise before expiration
  • bullish investor
  • anticipates price of underlying security will rise

Long 1 XYZ Jan 60 Call at 3

  • Buyers of Calls want the underlying stock to rise in value.
  • hopes market price above 60
  • pays $300 premium
89
Q

Options - Calls - Short Call (Sales)

A
  • Call Writer (Seller)
  • obligation to sell specified stock at specified price if buyer exercises contract
  • bearish investor
  • anticipates price of underlying security will fall

Short 1 XYZ Jan 60 Call at 3

  • want price to stay at or below 60
  • if unexercised receives $300 premium
90
Q

Options - Puts - Long Put (Purchase)

A
  • Put Buyer
  • Owns rights to sell specified stock at specified price
  • bearish investor
  • wants price to fall

Long XYZ Jan 60 Put at 3

  • market price to fall to 40, sell at 60
  • investor pays $300 premium to buy put
91
Q

Options - Puts - Short Put (Sale)

A
  • Put writer (seller)
  • obligation to buy at specified price
  • bullish investor
  • price to rise or remain unchanged
  • received premium

Short 1 XYZ Jan 60 Put at 3

92
Q

Options - Calls - Call Buyer

A
  • Bullish Investor
  • Wants market to rise
  • call is exercised only if market price rises
93
Q

Options - Calls - Call Writer

A
  • Bearish Investor
  • want market fall or remain unchanged
  • contract not exercise if market price is below strike price
94
Q

Options - Puts - Put Buyer

A
  • bearish investor
  • wants market to fall
  • exercise only if market price falls below strike price
95
Q

Options - Puts - Put Writer

A
  • bullish investor
  • market rise or remain unchanged
  • contract not exercised if market price above strike price
96
Q

Options - Calls - In the Money

A

Price of Stock EXCEEDS strike price of call

  • buyer will exercise calls that are in the money
  • buyer wants options to be in the money
  • seller NOT wants in the money
97
Q

Options - Calls - At the Money

A

Price of Stock EQUALS strike price of call

  • buyer will not exercise
  • seller want at the money
  • buyers do not
  • seller keeps premium without obligation
98
Q

Options - Calls - Out of the Money

A

Price of Stock Lower than Strike Price of Call

  • buyer will not exercise
  • sellers want
  • seller keeps premium
99
Q

Options - Calls - Intrinsic Value

A

amount a contract is in the money
Has Intrinsic value - price of stock above strike price

options

  • never negative
  • always positive
  • At the Money or In the money have IV
  • Buyer like to have intrinsic value
  • sellers do not

call that has intrinsic value will be exercised by buyer
call no intrinsic value will not be exercised

during lifetime
buyer - contract to move in the money
sellers - contract to move out of the money

100
Q

Options - Calls - Parity

A

premium equals intrinsic value

Example
ABC Stock is at 62
ABC June 60 Call trading at 2

Trading @ 62
intrinsic value = 62-60 = 2
premium = 2

given contract is trading at premium of 2, it is known to be trading at parity

101
Q

Options - Puts - in the money

A

Price of stock LOWER than strike price of put

  • buyer exercise put in the money
  • buyer want in the money
  • sellers do not
102
Q

Options - Puts - at the money

A

price of stock EQUALS strike price of put

  • buyer will not exercise
  • seller want
  • buyer do not
103
Q

Options - Puts - out of the money

A

price of stock HIGHER than strike price of put

  • buyer will not exercise
  • sellers want
  • buyers do not
104
Q

Options - Puts - intrinsic value

A

same as in the money

put has intrinsic value

  • stock price below strike price of put
  • buyers like options with IV
  • put with IV will be exercised
105
Q

Options - Puts - Parity

A

premium equals intrinsic value

ABC stock is at 58
ABC June 60 Put trading at 2
Strike price - stock price = 2
trading at premium of 2 trading at parity

106
Q

Long Call - BE, MG, ML

A

Call Buyers are bullish, profit from increase stocks price
For Calls
BE = Strike Price + Premium, Profit above BE
MG = Unlimited
ML = premium paid

Long 1 July 40 Call at 3 
BE = 40+3 
MG = Unlimited 
ML = 300 
above 43 call buyer is profitable
107
Q

Short Call - BE, MG, ML

A

call writers are bearish, investor profit from stock price fall
For Short call
BE = Strike Price + Premium, Profit below BE
MG = Premium Received
ML = Unlimited

Short 1 July 40 Call at 3 
BE = 40+3 = 43 
MG = 300 
ML = unlimited 
at or below 43 call writer is profitable
108
Q

Long Put - BG, MG, ML

A

Put Buyers are Bearish, investor profit from decrease in price
BE = Strike Price - Premium, profitable below BE
MG = Strike Price - Premium, no lower than 0
ML = Premium Paid

Long 1 July 40 Put at 3 
BE = 40-3 = 37 
MG = from BE to zero, same as BE = 3,700 
ML = 300 
below 37 put buyer is profitable
109
Q

Short Put - BE, MG, ML

A

Put sellers are bullish, profit if stock price rises
BE = Strike Price - Premium, profitable above BE
MG = Premium Paid
ML = same as BE

Short 1 July 40 Put at 3 
BE = 40-3 = 37 
MG = 300 
ML = 37 
at or above 37, put writer is profitable
110
Q

Options Clearing Corporations

A

OCC is clearing agent for listed options,
standardize, guarantee, issue
determines when new should be offered
designates strike price and expiration for new

Trading Times - 930am - 4pm et

Settlement - T+1

Expiration - third Friday of expiration month

Exercise - by owner until expire. BD notifies OCC

Automatic Exercise - In the money .01 exercised

Assignment - short broker dealer, OCC assigns on random, FIFO

options contracts are traded without certificate. an investors proof of ownership is the trade confirmation

111
Q

OCC - Contract Specifications

A

only owners of option contracts, those who are long the contracts, have the right to exercise them.

writers of contracts, those who are short contracts, will be assigned to fulfill their obligation to perform, either sell, if short call, buy if short put

112
Q

Exercise and Assignment - Owner of Call

A

party long contract

right to buy stock at strike price

must exercise call

113
Q

Exercise and Assignment - Writer of Call

A

assigned

obligation to sell stock at strike price

114
Q

Exercise and Assignment - Owner of Put

A

Party Long the contract

right to sell stock at strike price

exercise put

115
Q

Exercise and Assignment - Writer of Put

A

assigned

obligation to buy stock at strike price

116
Q

Exercise and Assignment - American Style

A

call or put buyers can exercise contract any time before expiration

117
Q

Exercise and Assignment - European Style

A

call or put buyers can only exercise contract on expiration date only

118
Q

Exercise and Assignment - Foreign Currency

A

may be either American or European style

119
Q

Underlying Security and Cash Settlement

A

Settled - equity option is exercised shares of stock must be delivered

Cash Settle - index and foreign currency options are cash settled. cash must be delivered by party (short the contract)

settling in cash (US dollars) facilities exercise and assignment process

120
Q

Options Account Diagram

A

Customer open option account

  • provided ODD
  • approved by BOM before trading
  • Options agreement - 15 days

note chronological conundrum

  • options must be approved before trading
  • account approve - trades occurred
  • having 15 days after approval, has not returned signed options agreement
  1. customer wishes trade options
  2. RR determines suitability
  3. OCC disclosure document provided before account approval
  4. Options account approved by ROP
  5. first trade may take place immediately following approval
  6. options contact bought and sold (T+1) premiums paid
  7. signed option agreement returned within 15 days
  8. closing transaction only if option agreement not returned or late
121
Q

Options - Covered

A

if contract is covered, writer already owns underlying security.

ensures writers ability to perform (deliver) should the owner exercised the contact

have security - or cash to settle

Long 100 shares xyz at 40
short 1 xyz july 45 call

if owner exercise call, writer will need to deliver stock at strike price 45.
already owning stock at 40, no risk

122
Q

Options - Uncovered (Naked)

A

if contract is uncovered, writer does not own underlying security

contract exercised by owner, writer will need to purchase underlying security at current market price in order to deliver it

uncovered (naked) contracts entail much more risk due to the uncertainty in price regarding purchase of security in the current marketplace if the contact is exercised.

writers of naked calls are willing to accept risk in return for the premium when selling short (writing) the call.

Long 100 shares xyz at 40
short 1 xyz july 45

if owner exercises call, writer need to deliver stock at strike price of 45.

not owning- need to purchase in open market in order to deliver it.

123
Q

Investment Companies

A

is a corporation or trust that pools investors money and then invest money in securities on their behalf.

investors able to pool and have investment company invest based on clearly defined objective such as growth or income

investing single large account, jointly owned by ever investor, able to invest in many different securities reducing overall risk

investment companies raise capital by selling shares to public

same registration and prospectus required imposed by securities act of 1933

subject to regulations shares sold

regulated by investment company act of 1940

124
Q

Types of Investment Companies

A

investment company act o 1940

classified into three broad categories

  1. Face Amount Certificate Companies (FACS)
  2. Unit Investment Trust (UITs)
  3. Management Investment Companies

variable annuities have subaccounts that are defined as either UITs or open end management investment companies

FAC and UITs are not managed, once portfolios are composed they do not change

FAC and UIT do not trade in secondary market, they are redeemable only through the issuer

125
Q

Investment Companies - Face Amount Certificates (FAC)

A

contract between investor and issuer

issuer guarantees payment of stated (face amount) sum to investors at some set date

investor agrees to pay issuer set amount money, lump sum or periodic installment

lump sum - fully paid face amount certificate

issues of these investment group face amount certificate companies

few exist today

126
Q

Investment Companies - unit Investment Trust (UITs)

A

organized under trust indenture

do not have board of directors

have trustees

portfolio and debt or equity securities designed to meet company objective

sell redeemable interest = units = shares of beneficial interest

each share undivided interest to entire underlying portfolio

127
Q

Fixed UIT

A

purchases a portfolio of bonds and terminates when bonds in portfolio mature

equity fixed UIT purchases portfolio of stock an terminates at a pre-determined date

128
Q

non fixed UIT

A

Purchases shares of underlying mutual fund

129
Q

Managed Investment Companies

A

actively manages a securities portfolio to achieved a stated investment objective

is either closed end or open end.

both sell shares in IPO

Closed End - initial shares limited
Open End - perpetually offering new shares to public

130
Q

Closed End Investment companies

A

Initial Shares Limited

raise capital for its portfolio by conducing common stock offering.

Initial Offering, registers fixed number of shares with SEC

offers to public with prospectus for limited time through underwriters.

once all shares sold, fund closed

elects closed end because of sector

may also issue bonds and preferred stock

often called publicly traded -
anyone an by OTC in secondary market

supply and demand determine bid price and ask price
trade at premium to NAV

NAV per share is funds NAV divided by number of outstanding shares

    • closed end investment companies are the only investment company security that trades in secondary market
    • closed end companies may issue common stock, preferred stock and debt securities
131
Q

Open End Investment Companies (Mutual Funds)

A

only issues one class of security

only issue common stock

does not issue preferred shares or bonds.

when registers and has open offering does not disclose exact number of shares

mutual funds conduct continuous primary offering of common stock

can raise unlimited amount of investment capital by continuously issue new shares

investors wanting to sell their holding, fund itself redeems shares.

mutual funds are like FAC and UIT do not trade in secondary market

investor sell shares back to fund, fund sends investor money for proportionate share

mutual fund capital shrinks when investors redeem shares, do does outstanding share,

value of each share does not fall as result of redemption

** while mutual funds only issue common shares to shareholders, funds themselves can purchase common stock, preferred stock, and bonds for investment portfolio.

** each fund has stated investment objective, types of securities purchases has largely to do with fulfilling their objective

132
Q

Variable contracts / Annuities

A

insurance contract designed to provide retirement income.

stream of payments guaranteed for period of time

actual amount paid may not be guaranteed but stream payment itself is

can provide rest of life - mortality guarantee

insurance companies introduced as way to keep pace with inflation

investors assumes investment risk

considered security

Separate Account - premium payments - various subaccounts

returns of account not guaranteed

Directly Managed

  • Investment Act 1940
  • Open end Management Investment Company

Indirectly Managed

  • passes responsibility
  • UIT
    • a fixed annuity differs from variable annuity. though both are insurance company products and guarantee stream of income, fixed annuity promises a state rate of return, insurance company is at risk
    • fixed are not considered security
133
Q

Mutual Fund (Open End) Characteristics

A

MF is pool of investors money invested various securities.

offer guaranteed marketability - mutual fund ready to buy back

redeemable security - do not trade in secondary market

all investors are mutual participants

  1. professional investment adviser manages portfolio
  2. diversification
  3. allow minimum investment 500
  4. may all investments at reduces sales charge based on amount of investment
  5. investors retain voting rights,
  6. must offer reinvestment of dividends and capital gains at NAV
  7. liquidate without disturbing
  8. provided 1099
  9. reinstatement provision, reinvest within 30 days with no new sales charge, in prospectus, available one time
134
Q

Mutual Fund - Share Class

A

Investors can purchase the same underlying mutual fund shares in several way.

sales charges in way the distribution services fund underwriters provides.

135
Q

Class A (Front End Load) Shares

A

Front end Sales charge (loads)
sales charge are paid at time investor buys shares and sales charge is taken from total amount invested

Most common

10,000 @ 2%
purchase with 9,800

136
Q

Class B (Back End Load) Shares

A

back end sales charge

contingent deferred charge (CDSC)

paid at time investor sell shares.

declining percentage reduced annually

structured, drops to zero and converted to A shares and no sales charge applied.

with class b - full investment amount is available to purchase shares no sales charge is applied at purchase but instead deferred to time of redemption

shares grow in value - sales charge can be greater than amount initially invested if not held long enough

137
Q

Class C( Level Load) Shares

A

typically one year
1% CDSC
.75% 12b-1
.25% shareholder fee

fees never go away, considered to have level load,

good for investors with short time horizon

bad or investors long time

138
Q

No load Shares

A

market directly to public eliminating need for underwriters and thus sales charges used to compensate them.

fund does not charge any type of sales charge

can charge fees - purchase, account, exchange, redemption

redemption fee deducted like deferred sales load, often fixed amount vs. percentage of redemption

139
Q

Mutual Fund - Market Timing

A

Short term buying and selling of mutual fund shares to take advantage of inefficiencies in mutual fund pricing.

Can harm long term shares, dilute value

prohibited by vast majority of mutual funds

not intended for day trading

140
Q

Mutual Fund - NAV

A

trade in secondary market

Total Assets - Total Liability = TNAV

net Asset value of fund / shares outstanding = nav per share

purchase price = POP

Front End = NAv + SC = POP

NAV changes daily because market

See page 88

141
Q

Mutual Fund Prospectus

A 
Full and fair disclosure 
fund objective 
sales charge 
management expense 
service charge 
five and 10 year performance or performance over life

if fund has been in existence for 8 years, show performance for five and 8

if existence for 4, show one and 4

delivery type of any sales literature is considered solicitation and must be accompanied by delivery of prospectus

Purpose: sale document
Contains: full and fair disclosure
Presented: prior to or with solicitation, if summary used no later than confirmation of sale

142
Q

Mutual Fund - Summary Prospectus

A

Standardized summary of key information

investor purchases using summary must have access to full no later than confirmation date

  1. fund name and class of shares
  2. fund ticker or ETF
  3. legend -summary of nature, full stat. prospectus, investment strategy, risk, holding, shareholder information

Purpose: rule 498, short form
Contains: summary of key information in prospectus
Presented: prior to or with solicitation

143
Q

Mutual Fund - SAI

A

both open and closed required to have

funds history and policies

must contain consolidated financial information 
balance sheet 
statement of operations 
income statement 
portfolio list

Purpose: more data for investor
Contains: additional details not found in prospectus
Presented: 3 days of customer request

144
Q

Mutual Fund - Disclosure

A

SEC requires

  1. discussion of factors
  2. graph performance to market index
  3. names, title, responsible day to day management
145
Q

Mutual Fund - Financial Reports

A

investment company act 1940 requires investors received financial reports at least semiannual. Must be audited

  1. investment company balance sheet
  2. valuation of securities (portfolio list)
  3. income statement
  4. complete statement compensation to board and advisory
  5. total dollar amount securities purchased and sold

** an investment company must send copy of balance sheet to any shareholders who request one in writing between semiannual reports

146
Q

Mutual fund - Fund Cost and Fees

A

services may include retirement, custodianship, investment plans, check writing privileges, transfer by phone, withdrawal plans,

investor should always weigh the cost of services provided

sales load, management fees, operating expense reduce returns because they are reduced from money available for the funds to invest

147
Q

Mutual Fund - Sales Load

A

fund can charge front end, back end, level load

permitted to charge up to 8.5% for money invested in a shares.

percentage sale charge compensate sale force, broker dealers, underwriters, market and sell shares to public.

148
Q

Mutual Fund - Expenses

A

incur operating and management fee

149
Q

Mutual Fund - Operating Expenses

A

salary and administrative fees

150
Q

Mutual Fund - Fund Portfolio Management Fee

A

paid to those hired to manage investments in fund portfolio calculated as % of assets under management

** the management fee is every funds greatest expense. charged annually this fee is a percentage of total assets under management

151
Q

Mutual Fund - 12b-1

A

investment company act 1940 permits mutual fund to collect fee for promoting, selling, undertaking activity in connection with distribution sales.

determined annually by flat dollar amount or as % of NAV charged quarterly.

associated with no load fund,

if fee is greater than .25%, front may not use no load term

expense ratio compares management fees and operating expense against net assets
expenses / assets

an expense ratio of 1..72% means that the fund charges $1.72 per year for every 100 invested

Stock Equity expense ratio 1 and 1.5%

bond debt funds between .5 and 1%

152
Q

Non US Market Securities

A

most are structured for long term.

investors need to be sensitive to different risk political, currency, and liquidity

153
Q

Direct Participation Programs (DPPS)

A

unique forms of business that raise money to invest in real estate, oil and gas, equipment leasing, and other similar business ventures.

Not taxed directly - income or losses are passed directly to owners of partnership/ investors.

investors are individually responsible for satisfying tax consequences.

considered high illiquid

154
Q

Real Estate Programs

A

Invest in raw land, new construction, existing property

  1. Capital Growth Potential - appreciation of property
  2. Cash flow - collected rom rents
  3. tax deductions - mortgage interest expense, depreciation allowances for wear, capital improvements
  4. tax credits - government assisted housing, historical rehabilitation, reduce tax liability
155
Q

Oil and Gas Programs

A

speculative or exploratory
riskiest development
producing wells - least risky

Intangible Drilling cost
cost associated with drilling, wages, supplies, fuel, insurance, no salvage value when program ends.
Written off in fully amount first year

drilling equipment - deductible over several years as deprecation,

depletion allowance
tax deductions compensate program for decreasing supply of oil or gas

156
Q

Leasing Programs

A

created when DPP purchase equipment leased to other businesses.

investor receive income form lease payments and proportional share of write offs from operating expense, interest expense, and depreciation of actual equipment

primary investment objective is tax sheltered income, income being sheltered by write offs.

157
Q

Limited Partnership

A

Most common type of DPP

permits economic consequences of business to flow or pass through to investors.

business not tax paying

investors (partners) have responsibility to report individually to IRS

greatest disadvantage is lack of liquidity

secondary market is extremely limited

158
Q

Investors in Limited Partnership

A

involves GP and LP

property held in TIC provides limited liability and no management responsibility to LP

159
Q

General Partners

A

Unlimited liability - personally liable for business losses and debts

manage all aspects and have fiduciary responsibility.

may not compete personally with business, borrow money from, or commingle with own personal assets

160
Q

LP

A

limited liability can’t lose more than they invest
no business management responsibility
rights to vote, receive distributions, inspect all books, right to sue GP

  1. investment managed by others (GP
  2. limited liability
  3. flow through of income and certain expenses

may be sold private or public placement

private - small groups of limited partners each contributing large sums of money - accredited investor

sold by prospectus for disclosure in public offering

LP are liquidated on predetermine date specified in partnership agreement

dissolution - GP settle accounts

  1. secured lenders
  2. other creditors
  3. limited partners for claims profit / contribute capital
  4. GP
161
Q

Real Estate Investment Trust

A

company that manages portfolio of real estate, mortgages, or both to earn profits.

pools capital similar to investment company but are NOT investment companies, open or closed

shareholders receive dividends from investment income or capital distributions

  • own commercial property (equity REIT)
  • mortgage and commercial (Mortgage REIT)
  • do both ( hybrid)

organized as trust - buy shares or certificates of interest on stock exchange or OTC

Subchapter M - avoid being taxed - 75% of income from real estate, distribute 90% or more to shareholders

  1. owners of REIT hold undivided interest in a pool of real estate investments
  2. REIT may or may not be registered with SEC
  3. REITS may or may not be listed on exchanges
  4. REITS are not investment companies (open or closed)
  5. REITS offer dividends and gains to investors but do not pass through losses like partnership, NOT considered DPP
162
Q

Registered REIT

A

Registered with SEC

Subject to all disclosure requirements

163
Q

Nonregistered REIT

A

Not Registered

not subject to same disclosure requirements as public and subject to greater risk

164
Q

Listed REIT

A

Traded on Stock Exchange,

165
Q

non listed REIT

A

not listed on exchange and trade OTC market

unique risk exist

not be exchange trade difficult to price and possibly illiquid

166
Q

Hedge Funds

A

Private Investment Companies

Not classified

hedge funds are considered unregulated as they currently do not have to be registered with SEC

167
Q

Hedge Fund Structure and Characteristics

A

Similar to mutual funds

investments are pooled, fund has more flexibility in investment strategies

limit risk, higher returns, shoulder substantial risk

suitable sophisticated investors

while hedge funds are unregulated, US laws required that investors meet sophisticated investor. Considered accredited, minimum annual income.

  1. highly leverage portfolios (borrowing to purchase)
  2. use of short positions (selling does not own)
  3. utilization of derivatives such as options and futures
  4. currency speculation
  5. commodity speculation
  6. investment politically unstable

private investment partnership, limit investors, minimum length
Lock Up Provisions

not unusual for hedge fund organizers to be investors themselves

168
Q

Exchange Traded Products

A

Securities that trade intra day on national securities exchange

priced so value of product derived from other investment instruments
commodity, currency, share price, interest rate

benchmarked to stocks, commodities, indices,

can be actively or passively managed

169
Q

ETPS - ETF

A

Equity security, invest in specific group of stocks and mimic particular index.

similar to mutual fund that track index

trades like stock on floor of an exchange

registered as open end or UIT

investors can take advantage of intraday price change due to normal market forces.

can be purchased on margin or sold short

expenses lower than mutual funds, management fee is low as well.

securities unlikely to change

greater tax efficiency for investor

every time purchase or sell, commission, can add up

registered as open end funds,

170
Q

ETN

A

senior, unsecured debt securities issued by bank or financial institutions.

backed only by good faith and credit of issuer

note track performance of particular market index

do not represent ownership in a pool of securities the way ownership of fund does

ETNs are bond like instruments

  • stated maturity date
  • do not pay interest
  • do not offer principal protection

ETN investors
receive cash payment linked to performance of underlying index minus management fees when note matures

ETN risk
if credit of underwriter falter, note might lose value like senior debt of issuer would,

ETN Trade
might trade at premium could be subject to loss later depending on value

171
Q

Investment Risk

A

greater risk , greater reward

172
Q

Systematic Risk

A

risk that changes in overall economy will have adverse effect on individual securities regardless of company circumstance
War, global security threats, inflation
cannot diversify

** no matter how diversified a portfolio of investment is, it will be subject to systematic risk

173
Q

Systematic Risk - Market Risk

A

risk that overall market declines, so too will any portfolio of securities is comprised of.

DJIA plummet, so too would portfolio of common stock. could not escape large fall in market without being affected

174
Q

Systematic Risk - Interest Rate Risk

A

if FRB push interest rates up, market price of bonds affected

interest rates rise, market price of bonds fall

market risk for bonds

175
Q

Systematic Risk - Reinvestment Risk

A

variation of interest rate risk

interest rates decline, difficult to reinvest proceeds from redemption

securities with call risk, reinvestment distributions and maintain same level of income without increasing credit or market risk

176
Q

Systematic Risk - Inflation Risk

A

Purchasing Power Risk

effect of continually rising prices on investment returns

investment yield lower than inflation, purchasing power diminish over time

investor purchased 30 year bond, 5% inflation above 5% , interest payment no longer sufficient to purchase good and services initially had

177
Q

Nonsystematic Risk

A

risk can be reduced through diversification

unique, specific to industry, business, investment type e

178
Q

Nonsystematic Risk - Capital Risk

A

potential for investor to lose some or all of his money, under circumstances non- related to issuers financial strength.

capital risk is minimal to none when investing in securities backed by federal government such as T bills but could be far greater when investing in derivative products such as options or DPP

179
Q

Nonsystematic Risk - Business Risk

A

operating risk caused by poor management decisions

at best - earning lower

worst - companies go out of business and lose investment

introducing new product turns out to have narrow market, and poor business decisions

180
Q

Nonsystematic Risk - Financial Risk

A

companies that use debt financing (leverage)

inability to meet interest and principal payment on those debt obligations lead to bankruptcy

sometimes called credit risk or default risk

181
Q

Nonsystematic Risk - Call Risk

A

bond might be called before maturity and investor unable to reinvest principal at a comparable rate of return.

can lead to reinvestment risk.

interest rates falling - bond with higher coupon rates more likely to be called.

concerned about call risk - call protection - period bond cannot be called.

most corporate and municipal securities provide some year of call protection

investor holds callable bond yielding 5%, interest rates fall to 3%, bond call and investor receives principle, now left to reinvest at 3 when at 5

182
Q

Nonsystematic Risk - Prepayment Risk

A

risk that a borrower will repay principal on loan or debt instrument (bond) before maturity

deprive lender of future interest payments

associated with call risk

183
Q

Nonsystematic Risk - Currency Risk

A

possibility of an investment in one currency could decline if value of decline in exchange rate.

important consideration when investing in foreign

184
Q

Nonsystematic Risk - Liquidity Risk

A

investor not able to sell investment quickly at fair market value

marketability risk

marketability of RR consistent with client liquidity needs

while common stock and money market instruments are considered fairly liquid for potential buyer and market to sell them is readily available, investments in fixed assets like real estate, fine art, collectibles are not

185
Q

Nonsystematic Risk - Regulatory Risk

A

comes from change in regulations
government, state, federal, pass regulations

changes in rules a business must comply with

EPA / FD

upset business model and profitability

pharmaceutical drug companies biggest drug is pulled by FDA - left decision either sell at depressed or hold for correction

186
Q

Nonsystematic Risk - Legislative Risk

A

changes in law
most common is tax law

implementation of luxury tax on higher priced items such as automobiles severely impact industries

187
Q

Nonsystematic Risk - Political Risk

A

interrelated with legislative risk

potential instability in the political underpinnings of the country

particular true in emerging, can happened in highly developed

188
Q

Nonsystematic Risk - Sovereign Risk

A

risk of country defaulting on its commercial debt obligations.

when country is at risk, impact is felt worldwide

189
Q

Open Vs. Closed Comparison

A

Capitalization
Open - unlimited, continuous offering
Closed - fixed, single offering

Issues
Open - Common stock only, no debt, can borrow
Closed - common, preferred, debt securities

Shares
Open- full or fractional
Closed - Full Only

Offerings and Trade
Open - sold and redeemed by fund only, continuous primary offering, must redeem shares

Closed - IPO, secondary trading, OTC, does not redeem shares

Pricing
Open - NAV + sales charge, selling price by formula in prospectus

Closed - CMV + commission, price determined by supply and demand

Shareholders Rights
Open - dividends when declared, voting
Closed - dividends, voting, preemptive

Ex Date
Open - Set by BOD
Closed - Set by exchange or FINRA

190
Q

Advantages of ETF

A
  1. pricing and ease of trading - traded on exchange can be bought and sold anytime at price currently trade
  2. margin - ETF can be bought and sold short on margin like other exchange products. MF cannot
  3. Operating Cost - lower than mutual funds
  4. Capital Gains - sometime distribute gain, rare, none until sell, greatest advantage associated
191
Q

Disadvantages of ETF

A
  1. commission - commissions paid can erode the low expense advantage, greatest impact while trading small sums of money
  2. overtrading - ability to trade, excessive trading can eliminate advantage of diversified portfolio + commission eroding expense and operating cost advantages
  3. market influence on price - trade on exchange, share prices an be influenced by market forces like supply and demand. investors might receive less than book value per share when selling corporate share of stock, investor might receive less than NAV when selling ETF

SIE Exam (9 decks)

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