Unit 3 Flashcards

Customer Information, Risk and Suitability, Product Information

1
Q

Non-financial Investment Considerations

A
>Age
>Marital Status
>Number of ages of dependents
>Employment
>Employment of family members
>Current family educational/health needs
>Risk tolerance
>Attitude towards investing
>Tax status
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2
Q

Preservation of capital

A
Usually recommend:
Money market securities
Money market mutual funds
Certificates of Deposit (CD)
Government securities
Principal-protected funds
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3
Q

Dividend Dates

A

Declaration, Ex-Dividend, Record, Payable

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4
Q

Regular way settlment

A

T+2

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5
Q

Capital Growth

A

Refers to an increase in an investments value over time.

Growth oriented investments are EQUITY ORIENTED.

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6
Q

Tax advantaged products for Investors

A

IRAS and annuities allow interest to accumulate tax deferred.

Muni-bonds offer tax free interest income (not suitable for retirement accounts)

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7
Q

Liquid investments - keep in mind this means sell quickly at close to current market value

A

Securities on exchange or NASDAQ
Mutual funds
ETF
REIT

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8
Q

Illiquid investments

A
Annuities - when investor is under 59.5
Real estate
DPP
Hedge fund
Funds of hedge funds
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9
Q

Speculation investments

A

Higher risk / Higher return

>Options
>High-yield
>unlisted stocks or bonds
>sector funds
>precious metals
>special situation funds
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10
Q

Recommendations for Preservations of Capital

A
CD
MM Funds
Fixed Annuities
Govt Securities
Investment Grade Bonds
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11
Q

Recommendations for Growth

A
Common stock / common stock mutual funds
Blue chip stock
Tech stock
Sector stock
Defensive stock
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12
Q

Recommendations for Income

A
Bonds
REIT
CMO
Muni Bonds
Below investment grade bonds
Preferred stock
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13
Q

Recommendations for Liquidity

A

Securities on exchange
Bonds
Mutual funds
Public REITS

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14
Q

Recommendations for Diversification

A
Mutual funds
Equity porfolios 
Domestic portfolios
Bond portfolios 
Some foreign portfolios
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15
Q

Speculation

A
Options contracts
DPP
High yield bonds
Unlisted stocks
Sector funds
 Precious metals
Commodities
Futures
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16
Q

Capital risk

A

risk of losing all of your invested capital

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17
Q

Timing risk

A

buying or selling at wrong time

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18
Q

Interest rate risk

A

Sensitivity of investments price of value due to interest rates - usually associated with bonds. Shorter the tenor the less risky!!

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19
Q

Credit risk

A

Risk of default on bond

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20
Q

Investment grade bond

A

BBB or higher

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21
Q

Liquidity risk

A

not being able to convert investment into cash immediately at CMV

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22
Q

Advantages of Call feature to investor

A

> Refinance for lower interest rate
Reduce its debt at any time
Replace short term debt with long term
Force the conversion of convertibles

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23
Q

Asset allocation

A
the spreading of portfolio funds among different asset classes such as:
Stocks
Bonds
Cash
Can include RE and other asset classes
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24
Q

Strategic asset allocations

A

Refers to the proportion of various types of investments composing a long-term investment portfolio

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25
Re balancing porfolio
Adjusting investment decisions based on customer's needs. More fixed for older clientele.
26
Modern portfolio Theory
Scientific approach to measuring risk to choose investments. Involves calculating projected returns of various portfolio calculations to identify best performers. The concept is to minimize risk by combining volatile and price stable investments. Believes portfolio with lower volatility performs better than portfolio with higher volatility. DIVERSIFICATION REDUCES RISK
27
MPT Negative correlation
MPT looks for securities with a negative correlation. Perfect negative correlation is -1.0 which states that one security that goes up, the other will go down by the same amount.
28
Capital Asset Pricing Model
Used to calculate the return that an investment should achieve based upon risk.
29
Beta Coefficient
Measure of portfolios volatility in relation to the overall market. A security with a beta of 1 = more volatile than market Security with a beta of <1 = less volatile than market Securities with no market correlations would be 0
30
Stock with a Beta of 1
IF S&P rises about 10%, a stock with Beta of 1 rises or falls about 10% Same with 15% and 1.5.
31
Alpha
Extent to which an asset or portfolio return exceeds or falls short of expected returns. A Positive alpha (not negative) is desirable. If actual return is 10% and expected beta was 1.5, investor took more risk than was actually returned. Negative alpha. Conversely, if investment rose by 17% and expected beta was 1.5 - positive alpha.
32
Fundamental analysis
study of the business prospects of an individual company within the context of its industry and overall economy.
33
Capital structure - capitalization
Combined sum of long-term debt and equity securities.
34
Book Value Per Share
Tangible Assets - Liabilities - Par value of Preferred -------------------------------------------- Shares of common stock outstanding Note: Basically shows the liquidation value of firm
35
Earnings Per Share
Earnings available to common ------------------------------------ Number of shares outstanding
36
Earnings per share after dilution
assumes all convertible securities such as warrants and convertible bonds and preferred stock have converted into common
37
Current Yield
Annual dividends per common share ---------------------------- Market value per common share
38
Dividend payout ratio
annual dividends per common share ------------------------------------ earnings per share
39
Cash flow from operating activities
includes interest and dividends
40
Technical analysis
attempts to predict the direction of prices on the basis of historic price and trading volume patterns when laid out graphically
41
Fundamental analysts
Concentrate on broad based economic trends; current business conditions within industry and quality of particular corporations's business
42
Support level
bottom of the trading range
43
Resistance level
Top of the trading range
44
Bearish breakout
decline in the support level
45
Bullish breakout
rise in resistance level
46
Market breadth
The number of issues closing up or down on a specific day
47
Market trend - consolidation
When the tread line is horizontal and moves sideways and not up or down
48
Reversal
Indicates that an upward or downward tredline has haltered and the stock price is moving in the opposite direction Reversal of downtrend - saucer Reversal of uptrend - inverted saucer
49
Head and Shoulders top
Bearish - reversal in uptrend
50
Head and Shoulders bottom
Bullish - reversal in downtrend
51
Oversold Market
When market indexes are declining Number of declining stocks / number of advancing stocks is failing (fewer stocks declining) Usually means oversold market
52
Overbought market
Indexes are rising, but number of declining stocks / number of advancing stocks is rising (fewer stocks rising) Usually means overbought
53
Dow Theory
used to confirm the end of a major market trend. 3 types of changes in stock prices: ``` Primary Trends (1 year or more) Secondary trends (3-12 weeks) Short term fluctuations (hours/days) ```
54
Primary trend of bull market
series of higher highs and higher lows (dow theory)
55
Primary trend bear market
seriers of lower highs and lower lows (dow theory)
56
Odd lot theory
small invstors invariably buy and sell at wrong times. When odd lot buyers buy - odd lot analysts are bearish. When odd lot buyers sell - odd lot analysts are bullish. Odd lot is buying something less than 100 shares (100 is round lot)
57
Authorized stock
refers to a set number of shares the company has authorization to issue or sell. Laid out in company's original charter.
58
Issued stock
Stock that has been authorized and distributed to investors Usually occurs when: Raising new capital Paying stock dividends providing stock purchase plans for employees exchanging common stock for convertible bonds satisfying outstanding stock warrants
59
Treasury stock
stock the corporation has issued and repurchased from public. Can hold, reissue, or retire the stock. Does not carry rights of outstanding shares. Can be used to reissue to employees. Reasons for buying back: increase EPS Have an inventory to distribute use for future acquisitions
60
Voting rights of common shareholders
Common shareholders can vote on issues such as Issuance of convertible securities substantial change in business such as M&A activity declarations of stock splits
61
Calculation of number of votes
Statutory or Cumulative
62
Statutory voting
allows the stockholder to cast one vote per share FOR EACH ITEM ON BALLOT. Best for smaller shareholder.
63
Cumulative voting
allows stockholders to allocate their total votes in a manner they choose. Shareholder may allocate all shares into one direction.
64
Nonvoting common stock
Class A = voting rights | Class B = nonvoting
65
Preemptive rights
Allows shareholder to maintain proportionate share. Usually below market value Shareholder can: Exercise, sell, or let expire
66
Stockholder residual right to claim
Stockholder has claim to corporate assets after all debts and other security holders have been paid
67
Preferred stock
issued at fixed rate of return. Can be variable depending on current rates. Preferred prices move inversely to interest rates (if rates rise, people invest money elsewhere). No fixed maturity - unlike bond.
68
Convertible perferred
owner can exchange for common stock Since it is tied to common - price usually fluctates with common. Lower dividend rate - given feature.
69
Participating preferred
In addition to fixed dividends, participating allows shareholder to share in profits of corporate profits after all dividends and interest due are paid.
70
Callable preferred (redeemable)
company can buy back from investors at stated price on the call date or thereafter. Usually higher dividend rate
71
Subscription right
Certificate representing a short-term privilege to buy additional shares of corporation. One right issued for each common share outstanding.
72
How to find value of rights
Market price - subscription price ------------------------------ number of rights to purchase 1 share + 1 Example: ABC price per share is $41, subscription per share is $30. You need 10 rights to purchase 1 share of stock. So.... 41 - 30 11 ------- = --- = $1 is the value of one right. 10+1 11
73
Ex rights formula
Used to determine the value of the right after the ex-date. Market price - subscription price ------------------------------------------- Number of rights to purchase 1 share
74
Warrant
grating the owner right to purchase security at a specified price at a later date. Usually above market price.
75
American Depository Receipts
Foreign branches of large US banks issue ADRS. A custodian (bank of issuers country) holds shares of foreign stock that the ADR's represent. Currency risk....
76
Rights of ADR owners
Usually have same rights as common stockholders
77
Taxes on ADRs
Pertains to foreign income tax. Foreign income tax may be taken as a credit against any US income taxes.
78
Sponsored ADRs
Foreign company sponsors the issue to increase its ownership base. All exchange listed ADR's are sponsored. Non-sponsored are issued by banks without participation of issuer.
79
Penny stock disclosure requirements
Name of stock Number of shares purchase Current quote Amount of commission
80
Penny stock account statement frequency
Monthly
81
Established customers (penny stock)
Held account with BD at least a year OR Made at least three penny stock purchases of different issuers on different days
82
Speculative Bond
BB or lower
83
Unrated bond
Might not mean bad quality - could just be too small to justify expense of seeking rating
84
S&P vs Moody's
SP = AAA, AA, A etc | Moody's Aaa, Aa, A, Baa, etc
85
Secured bond
Issuer has identified specific assets to secure the note
86
Collateral trust bonds
issued by corporations that own other company's securities. May be backed by: Another company's stocks/bonds stock and bonds of partially/wholly owned subs company's prior lien long term bonds short term bonds Installment payments or other obligations of corporations clients
87
Collateral trust bonds
issued by corporations that own other company's securities. May be backed by: Another company's stocks/bonds stock and bonds of partially/wholly owned subs company's prior lien long term bonds short term bonds Installment payments or other obligations of corporations clients
88
Equitment trust certificates
Used by railroads, airlines, trucking companies, and oil companies to finance purchase of capial equipment. Secured by equipment - held in trust.
89
Debentures
Backed by general credit of issuing corporation. Below secured bonds and above sub debentures, preferred, and common stock
90
Guaranteed bonds
Backed by a company other than the issuer such as parent corp
91
Income bonds (adjustment bonds)
Usually during reorg. Pay interest only if corp has enough income to meet payments.
92
Zero coupon bond
issuers debt obligations that do no make regular payment. bought at discount, sold at face value. Advantage: Requires relatively small payment up front. No reinvestment risk Disadvantage: Since no cash interest, seroes a are mor volatile than traditional bonds. Prices fluctuate based on interest rates.
93
Taxes of Zero coupon
Investors who own zeroes woe income tax each year by the aomount that the investor would have received. Example: bought for $400 will received $600 in 10 years. $600/10 = $60 in interest each year, so $60 added to principal each year. $460, $520, $580, etc which is cost basis.
94
Advantages of convertible bonds (Issuer)
Sold at lower coupon Can eliminate fixed charges by removing debt No adverse effect on stock price, since it occurs over time Avoids immediate dilution to EPS Conversion price is higher than market price of common stock
95
Disadvantages of convertible bonds (issuer)
When converted, equity is diluted Common stockholders have voice in decisions Reducing corp debt = loss of leverage Less interest, which increases taxes
96
Market for convertible securities (advantage for investor)
Fixed rate of interest, redeemable for face value at maturity Convertible bondholders have priorty at liquidation over common shareholders Market price tends to move up with common stock Conversion has NO TAX LIABILITY Stable rates usually result in stable bond market
97
Conversion price
price at which convertible bond can be exchanged for shares of common stock
98
Conversion ratio
Bond with a price of $40 has a conversion ratio of 25:1. $1,000 / $40 = $25
99
Conversion parity
If bond is convertible at $50, conversion ratio is 20:1 If bond is selling for 104 ($1,040) is convertible into 20 shares, the common stock price would be $52. IMPORTANT: If common stock is selling below $52, the convertible bond is worth more than stock. If stock is selling above $52, the investor can make more money by buying bond, converting to common, and selling stock
100
Calculation of conversion parity
Market price of common x conversion ratio = parity price of convertible
101
Equity-linked notes
debt instruments where final payment at maturity is based on return of a single stocks, multiple stocks, or equity index. ELN's exchange rated or not, are considered non-conventional products and not suitable for most investors.
102
Collateralized Mortgage Obligation
Large pool of mortgages, usually singl-family homes. CMOS are issued by private secotor financeing corps and often backed by Ginnie Mae, Fannie Mae, and Freddie Mac. Pays principal and interest monthly, ONLY REPAYS ONE TRANCE AT A TIME Not backed by Government, Trade OTC
103
Payment of CMOs
Interest is paid on all tranches simultaneously. Principal pays one trance at a time.
104
Principal only CMO
Income stream comes fully from principal payments of underlying mortgages. PO sells at a discount from par. Volatile to interest rates = as rates are higher people do not prepay as fast, as rates drop people pay off mortgages quicker and investor has better return
105
Interest only CMO
Sells at a discount and cash flow declines over time (similar to interest paid on mortgage). can be a hedge against interest rate risk, interest payments on mortgages rise as rates increase = more income for IO CMO
106
Planned Amortization class CMO PAC
PACs have targeted maturity dates, retired first and offer protection from prepayment or extension risk (payments are slower than expected). Reduced prepayment and extension risk
107
Targeted Amortization Class CMO (TAC)
Transfers prepayment risk only to a companion tranche and does not protect from extension risk. Investors accept extension risk and resulting greater price risk fro slightly higher interest rate. protected against prepayment risk, not extension.
108
Zero tranche CMO
No payment until preceding cmo tranches are retired (Most volatile).
109
CMO Charageristics
Rate of principal varies If interest rates fall and homeowner refinancings increase, principal is received sooner If interest rates rise and refinancing declines, the CMO investor may have to hold investment longer
110
CMOs yield
Usually pay investors interest and principal monthly. Made in $1,000 increments to investors for each tranche.
111
Liquidity
Active secondary market for CMOs. Market for CMOS with more complex characteristics may be limited or nonexistent.
112
Suitability
Customer is required to sign suitability statement before buying any CMO. Potential investors must understand that rate of return on CMOs
113
Collateralized Debt Obligations
Do not specialize in any single type of debt. usually consist of nonmortgage loans or bonds. Can be pool of bonds, loans or other assets such as leases.
114
Cautions of CDOs
Can be very complex - investors don't fully understand what they are investing in Sale of individual assets from originators of the loans - ie adverse selection...
115
Treasury securities (taxes)
Typically exempt from state but pay federal.
116
T Bills
Denominations of $100 to $5MM. 4,13,26 weeks are auctions weekly. No interest issued at discount.
117
T Notes
$100 to $MM. 2-10 years. quoted at 1/32.
118
T Bonds
Denominations of $100 to $5MM. 10-30 years.
119
Treasury receipts
BD buy treasury securities and place them in a trust at bank and sell receipts against principal and interest payments.
120
Seperate Trading of Registered Interest and Princial of Securities (STRIPS)
Securities of underlying treasury strips are in USD, major banks and dealers perform the actual separation of trading. Backed in full by US Government. Receipts ARE NOT.
121
Treasurty Inflation Protection Securities
Helps protect against purchasing power risk issued with fixed interest rate, pricnipal is adjusted to the change in Consumer Price Indext (measurement of inflation).
122
Money Market Instruments
Debt securities with short-term maturities, typically one year or less. Usually highly liquid and provide a high degree of safetey becasue most issues are highly rated.
123
US Govt MM securities
T Bills Treasury securities with <1 year maturity remaining Short term discount notes issued by smaller agencies Muni securities are considered tax-exmept MM securities
124
Money Market mutual funds
For retail investors are designed to have a stable NAV of $1 per share. Not guaranteed or protected by FDIC.
125
Banker's Acceptance
Corporations use BA as short term time draft for import/export business. Payment date of BA is normally between 1-270 days. Typically pays for goods and services in a foreign country
126
Commercial Paper
Unsecured. issued by corporation to raise cash to finance accounts receivable and seasonal inventory overages. Lower interest rates. Maturities typically 90 days, can be up to 270. . Primary buyers are money market funds, banks, pension funds, insurance companies, corporations
127
Negotiable CD's
Time deposits that banks offer. They have minimum face values of $100,000. Most are issued for $1MM or more. Mature in 1 year or less. Can be traded on secondary market.
128
Investment Company
corporation or trust that pools investors money together then invests the money on their behalf.
129
Unit Investment Trusts
UIT sets its portfolio, it remains the same for life of fund. Raises money by selling units (shares) to its investors. Typically one time offering. Many are publicly traded.
130
Exchange Traded Funds
Open-ended company. Issue shares in large blocks (creation units). Shares can be split later.
131
Ways to sell ETF Shares
Sell individual shares to other investors Can sell back to the ETF which they usually receive securities instead of cash. NOT MUTUAL FUND SHARES
132
Advantages of ETFS
Pricing and ease of trading - intraday trading Margin - can be bought and sold on margin Operating costs - lower than mutual funds Tax efficiency - no consequence until investors sell
133
Disadvantage to ETF
Commissions - each purchase or sale is commissionable Over trading - easy to do.
134
REIT
Not an investment company, but regulated by act of 1940. Pools money and forms a trust to invest into real estate
135
Equity REIT
When the trust owns their own property
136
Mortgage REIT
Own mortgages on property
137
Hybrid REIT
Combination of equity and mortgage REIT
138
REIT Advantages
Allows investor to invest in RE without incurring high liquidity risk Hedge price movements in other equity markets REITS provide reasonable expectation of income
139
REIT Disadvantages
No control over the portfolio Problematic loans can diminish returns Dividends paid by trust do not meet requirements of qualified dividends - taxable at ordinary income
140
REIT Distribution
Must distribute more than 90% of income to shareholders to avoid taxation as corporation
141
Open end company
Mutual funds. Only issues one class of security. No specific amount of shares. Mutual funds can purchase common stock, preferred stock and bonds for their portfolio. Investor buys common shares of mutual funds Not traded in secondary market
142
Diversified investment company (75-5-10)
75% Total assets invested in securities issued by companies other than the investment company itself OF WHICH: > no more than 5% funds total assets are invested in the securities of any one issuer > No more than 10% of outstanding voting securities of any one issue is owned by the 75% If capital appreciation causes allocation to pass 5% threshold - no action required
143
Sector Fund
Must have at least 25% of assets invested in a particular economy or geographic area Can still be diversified if it meets 75-5-10 rule
144
Types of mutual funds
Stock funds - stocks Bond funds - bonds Balance funds - stock and bonds Money market funds - short term funds (cash equivalents)
145
Performance disclosure
Law requires disclosure of annual returns for 1, 5, and 10 year periods. If fund is less than 10 years old then must disclose since inception.
146
Fund Costs of mutual funds
Funds typically charge front loads of up to 8.5% to compensate salseforce.
147
Expense Ratio of mutual funds
Funds expenses --------------------------- Average net assets A ratio of 1% means the fund charges $1 for every $100 invested. Aggressive funds have higher ratios. DOES NOT INCLUDE LOAD CHARGES
148
Taxation of mutual fund
Mutual fund investors pay taxes on any dividends or cap gains fund distributes. Taxed in year earned.
149
Portfolio Turnover of mutual fund
Costs of buying and selling securities including markups or markdowns are reflected in portfolio turnover. Not uncommon for aggressive growth fund to reflect annual turnover of 100% or more. 100% turnover means fund replaces portfolio annually. 25% turnover rate - turns over every 4 years.
150
Mutual fund services
``` Retirement account custodianship Investment plans Check-writing privileges Telephone transfers Conversion privileges Withdrawal plans ```
151
Stock funds
Uses stock to meet stated objectives. Historically have outpaced inflation for most 10 year horizons
152
Growth funds
Invests in stocks of companies who are growing rapidly. reinvest all or most of profits for R&D rather than paying dividends. Focused on cap gains. Higher level of risk
153
Blue chip funds
invest in more recognized companies - less risk | Companies with large market cap
154
Large cap funds
Companies with market cap of >$10Bn
155
Aggressive growth funds (performance funds)
willing to take on more risk. Invest in newer/smaller cap companies
156
Mid cap fund
Somewhat aggressive Targets $2bn - $10bn in market cap
157
Value funds
Focus on companies whose stock are undervalued (earnings not shown in price) *Higher dividend yields than growth* More conservative than growth
158
Income funds (Equity fund)
Stresses current income over growth Investing in companies that pay dividends. Target value not growth. Lower risk. PAY MONTHLY DIVIDENDS
159
Option Income Fund
investes in securities on which call options can be sold (covered calls) Eqarn premium income from writing options. Earn capital gains from trading options for profit.
160
Growth and income funds
Combined objectives of both.
161
Special situation funds
buy securities of companies that may benefit from a change within the company or economy
162
Blend/Core funds
Portfolio comprising of a number of different classes of stock. Includes blue chip and high risk.
163
Index Funds
Invests in securities that mirror market index such as S&P. Low turnover low cost
164
Foreign Stock fund
Invest only in companies that have a principal interest outside of US Objective is long term capital appreciation
165
Global funds
Invests in securities in both US and foreign companies. Huge amount of currency and political risk.
166
Balanced funds (hybrid)
Invests in stocks for appreciation and bonds for income. Might be 60% stock. 40% income.
167
Asset allocation funds
Split investments between stocks for growth, bonds for income, and MM instruments for stability. Usually target a specific goal such as retirement. Similar to balanced fund
168
Target date funds (life cycle or interval)
Offered by most benefit plans. Designed to help manage risk with a SPECIFIC TARGET DATE IN MIND.
169
Bond Funds
Funds invest solely in investment grade funds. Do pay dividends if BOD declares such
170
Tax Free Bond Funds
Municipal bond funds invest in muni bonds/notes **Appropriate to investors which high tax bracket seeking income
171
US Government Funds
Purchase securities issued by UST or agency of USG (GNMA) Investor seeking maximum safety
172
Agency Funds
1. Bonds issued or guaranteed by US Fed Government 2. Bonds issued by government sponsored enterprises Bonds issued by GSE's inclue GNMA(USG bakced), FNMA, FHLM
173
Principal protected fund
Offers investor a guarantee of principal adjusted for dividends and distributions on set future date (maturity) Provides opportunities for higher risk investements such as equityes Protection can be insued by 3rd party
174
Features of Principal Protected Fund
Guarantee principal - guarantee initial investment minus front end charges even if markets fall Lock up period - typically 5-10 year period. If you withdraw you can lose guarantee (if below market) Hold a mixture of bonds stocks - mostly invested in zero coupon bonds when rates or low and markets are volatile. Provides less exposure to volatility if it exists
175
Index tracking funds - differences from mutual funds
Intra day trading Margin availability Short selling
176
Leveraged funds
Funds attempt to deliver multiple on the return of the benchmark index they are tracking Most of the funds use derivative products such as options, futures, swaps to enable them to reach goal Not suitable for all investors. No leverage limitations
177
Inverse funds
attempt to deliver returns taht are opposite of benchmark index. Can also be leveraged fund.
178
Hedge fund
investments are pooled and professionally manged, they have more flexibility and more aggressive on investment objectives. Unregulated - usually private partnerships Not liquid - investments can have minimum timeline Most investors must be sophisticated
179
Hedge fund strategies
``` Highly leveraged portfolios use of short positions Utilizing derivative products Currency speculations Commodity speculations Investing in unstable markets ```
180
Hedge Fund lockup provisions
Period where investor cannot withdraw dollars. Generally associated with new funds. Dependent on investment strategy
181
Blank check hedge fund
Special Purpose Acquisition Companies (SPACS) Blank check - Companies without business operations that raise money through IPO with sole purpose of finding a business or combination of businesses
182
Blind Pool fund
usually provide an indication of general industry but not much other detail. Similar to blank check
183
Mutual fund Dividends
pay dividends to each shareholder similar to any other company. Requires written statement Qualified dividends - taxed at long term rate Non-qualified dividends - ordinary income
184
Net investment income
Dividends + interest - expenses of fund D+I-E= NII
185
Avoiding Triple Taxation
Avoided by mutual fund qualifying as a subchapter M company if the fund acts as a conduit for distribtuions it may qualify as a regulated investment company only subject to retained income. To be subchapter M fund must distribute at lease 90% of its net investment. Only pays taxes on remaining income (so if distributes 95%, taxed on 5%)
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Triple Taxation
1 Mutual fund taxed on income, 2 GEM pays tax on dividend received, and 3 finally investor pays income tax on distribution from fund
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Capital gains example
Investor purchases shares of a mutual fund 3 months later fund has a long-term cap gains distribution, this is taxed to the investor as... Long term capital gain - makes no difference how long the investor has held shares, the investment is a long-term and will be taxed such.
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Reinvestment of distributions
In mutual fund investor can elect to reinvest distributions which will be without sales charge
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1099 DIV
Allows shareholder to report realized distribution capital gains for the year
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Cost basis of inherited shares
Either stepped up or down at the date of decedents death. Subject to more favorable long-term tax rates no matter the duration
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Inherited shares example
Grandpa bought $10K of stock 20 years ago; current value is $50K at death. Grandaughter's cost basis is $10K.
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Donor taxes
When a person dies, tax is due on their estate. Payable by the estate not heirs. Gift tax is payable by the donor NOT recipient
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Gift tax exemption
Individuals are allowed to give up to a certain $ amount per year without incurring gift tax. Inter spousal gifts are not subject to tax.
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Progressive taxes vs. Regressive taxes
Progressive: increase with the size of the estate or gift (example is income tax) Regressive: flat taxes impact lower income individuals for a higher degree
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Wash sales
Capital losses used to offet gains or income investor sells security at a loss and purchases the same or substantially idential within 30 days Substantially refers to other security with same investment performance (securities convertible into the one being sold, warrants to purchase same security)
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Wash rule timeline
30 days before and 30 days after and wash day 61 days total
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Valuing fund shares Mutual fund (liquidation)
cost base of mutual fund share includes shares' total cost including sales charges + reinvested dividendand cap gains distributions
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Liquidating shares FIFO
cost of the shares held the longest is used to calculate gain or loss
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Share Identification (Liquidation)
investor keeps track of the cost of each share and uses information to decide which shares to liquidate
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Average basis
Use the average cost basis when redeeming the shares.
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Price of mutual fund shares
Total assets - liabilities = net assets Based off of NAV
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NAV does not change
Manager buys or sells securities, fund issues shares, fund redeems shares
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Purchasing Mututal fund shares
Forward pricing. Always have to wait until NEXT AVAILABLE no matter if they are being redeemed or purchased
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Class A shares Mutual fund
Front end loads. Load charges are taken out of investment amount.
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Breakpoints
Keep in mind that if they sign an LOI then they will have benefit of full purchase amount ,not individual transaction
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Backdating letter - breakpoints
allows LOI to be back dated up to 90 days but may not cover more than 13 months total Customer who backdates 60 days has 11 months to complete
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Rights of accumulation
allow investor to qualify for reduced sales charge Difference from Breakpoint: Available for subsequent investment and do not apply to initial transactions Allow investor to use prior share appreciation Do not impose limits Allows addition and accumulation over time
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Combination privilege
with mutual funds managers may allow investor to combine investments to reach a breakpoints
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Exchanges with family mutual funds
May be purchased at NAV under a no-load privilege when: Purchase may not exceed proceeds generation by redemption of other fund redemption may not involve a refund of sales charges sales personnel and dealers must receive no compensation gains or losses from redemption must be reported
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Computing sales charge - always based off POP NOT NAV
PoP - NAV = sales charge amount Sales Charge Amount -------------------------------- = sales charge percentage POP
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Mutual fund prospectus must contain a formula that explains how the fund computes NAV
Sales charge is always based on POP NOT NAV
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Class B Shares
No front-end sales charge Have 12b-1 fee (75bps) Convert to class A shares over time
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Class C Shares
Level load Typiucally have one year 1% CDSC, 75bps 12b-1 fee and a 25bps shareholder services fee Higher fees, shorter horizons
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12b-1 fees
cover costs of marketing. Deducted quarterly - reflected annually RULES: Maximum fee is 75 bps Fee must anticipated level of distribution services
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If designated as no-load fund
May not charge more than 25bps on avg net assets for 12b-1 fee.
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No load fund
permitted to charge purchase fees, account fees, exchange fees, and redemption fees (none considered sales load)
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Voluntary accumulation plan (mutual fund)
Allows customer to deposit regular periodic investments on a voluntary basis Designed to help customer for regular investment habits
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Dollar cost averaging
Form of investing that allows individual to purchase more shares when prices are low and fewer shares when prices are high Does not guarantee profits in declining markets because prices may continue to decline
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Fix dollar withdrawal
Liquidates enough shares each period for that set sum
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Fixed percentage or fixed share withdrawal
either a fixed number of shares or percentage of the account is liquidated
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Fixed time withdrawal
customer liquidates their holdings over a fixed period. Funds require a customers account to be worth a minium amount before this may begin
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Withdrawal plan discloser
Withdrawal plans are never guaranteed Registered rep MUST: Never promise guaranteed rate of return stress to investor that it is possible to exhaust account by overdraw State during down market that account will be exhausted even if withdraw is small Never used charts or tables unless permitted
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Withdrawal plan discloser
Withdrawal plans are never guaranteed Registered rep MUST: Never promise guaranteed rate of return stress to investor that it is possible to exhaust account by overdraw State during down market that account will be exhausted even if withdraw is small Never used charts or tables unless permitted
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Annuity
Insurance contract designed to provide retirement income. Refers to a stream of payments guaranteed for some period of time - for life, certain age, or number of years Amount paid out may not be guaranteed but the stream of payments are Annuitant makes an after tax lump sum or periodic payments to insurance company which invests the money into an account, grows tax referred
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Annuity pauyout
Can be either lump sum or periodic payments, typically for life Withdrawals before 59.5 have 10% penalty in addition to full income tax.
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Fixed annuity
Investor payz premium the insurance company is obligated to pay in a guaranteed amount of payout (monthly) to annuitant based on original paid in. Insurer guarantees rate of return and bears investment risk Purchasing power risk present
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Index annuity
Way to overcome purchasing power risk Popular amongst investors seeking market participation but with a guarantee against loss Performance is based on specific index such as SP 500 Annuitant is credited with a % of growth (typically 80-90%). Total growth payout can be capped at 12%.
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Variable annuities
Designed to keep place with inflation Investor assumes investment risk. Considered a security Must be sold with prospectus Premium payments are invested into a separate account of issuer. The separate account is comprised of various sub-accounts which act like mutual funds with different objectives. Monthly income either increases or decreases based upon performance of separate account.
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Combination annuity
Investors received advantages of both the fixed and variable annuities. Contribute to both plans
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Purchasing annuities
Usually no load to purchase, but if surrendered there are significant penalties Payments to insurance company can be lump, monthly, quarterly or annual
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Single premium deferred annuity
purchased with lump sum, payments of benefits is delayed
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Periodic public payment deferred annuity
allows investments over time. Benefit payments are always deferred until later date
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Immediate annuity
purchased with a lump sum and payout benefits commence within 60 days
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Bonus annuities
Financial benefits offered with with annuities Benefits include enhancement to the buyer's premium with the insurance company contributing an additional 3-5% to the premium. Comes with a cost, higher fees, longer surrender periods (7-10 years)
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Annuity Sales charge
No maximum sales charge - must adhere to FINRA fair and reasonable rules
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Accumulation phase
Growth phase, payout phase is the annuity phase
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Payout phase
When payments commence, money will be distributed per the payout option chosen accumulation units purchased over time are converted into annuity units
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Distributions from annuities
Monthly payments dependent on the following: ``` Amount in contract Age Sex (females live longer - smaller check) Paout option Investment return ```
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Assumed Interest Rate
AIR is the conservative projection of the performance of the separate account of the estimated life of the contract
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AIR effect on payout
If separate account performance is > than AIR, next month payment is more than this month If separate account performance is = to AIR then payment stays the same If separate account performance is less than the AIR, next months payment is less than this month AIR Payment Month 1 4% $ 1,000 Month 2 6% $ 1,100 Month 3 4% $ 1,100 Month 4 3% $ 1,000 Month 5 3% $ 950
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Surrender of annuity
annuitant may simply cash in annuity. Cost basis is total amount invested. Liable for income tax plus 10% fee if before 59.5
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Death of annuitant
If dies during accumulation period, death benefit takes effect Beneficiary is guaranteed either the total value of the annuity or amount invested. Whatever is greater Still liable for income tax on growth
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Annuitization payment options
Life annuity (straight life)_ Life annuity for certain period joint life with last survivor unit refund
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Life annuity (straight life)
Guarantees a minimum of certain year period. Annuitant is still guaranteed monthly income for life, if death occurs within the period the beneficiary receives payments
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Joint life wit hlast survivor annuity
Agrees to payments over two lives Often used for spouses. Insurance company is obligated to pay a check over two lifetimes and is considered to be smaller than a life with a certain option. Survivor receives deceased's payments
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Unit Refund Option
Minimum number of payments are made upon retirement. Value remains in the account after death to annuitant and payable to beneficiary.
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Taxation of annuities
All contributions are made with after tax dollars unless part of employer sponsored retirement plan Taxed as ordinary income when withdrawn on gains.
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Variable annuity suitability
Most suitable for someone who can fund contract with cash. Refinancing home is not suitable Not suitable for who might need lump sum with anticipation of needing for an upcoming expense Investing using funds from a tax deferred account such as IRA is not smart - provides no additional savings Maximum contributions to all other retirement savings vehicles should be made beforehand
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1035 exchange
Is a tax-free exchange between like contracts IRS allows annuity and life policyholders to exchange their policies without tax liability Cannot be used for transfers from an annuity to life insurance policy
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Possible abuses with 1035 exchange
Possible surrender charges on old policy New surrender charge period on new policy Possible loss of a higher death benefit that existed on old policy
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Life Insurance
Permanent life is designed to last until at least age 100 or the death of insured. Policies accrue cash value that may be borrowed for living needs.
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Variable life insurance
Fixed schedule premium bu differs from whole life in that the premiums paid are split Part of the premium is placed in the general assets of insurance company - used to guarantee minimum death benefit balance of premium is placed in separate account - represents value of the policy. Fluctuates and not guaranteed.
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Variable life prospectus delivery
Considered a security, prospectus is required
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AIR Variable death benefit
Does have AIR and is dictated by performance. Benefits of VL is that death benefit may adjust upward and keep pace with inflation
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Loans on VL contract
Not considered to be constructive receipt of income and are received tax free.
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Loans on VL contract restrictions
Minimum % that must be available is 75% after being in force for 3 years No scheduled repayment of loan, but if death benefit becomes payable then loan amount is deducted first If outstanding loan reduces cash value to negative amount, insured has 31 days to deposit funds
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VL contract exchange
For a WL contract Length of time privilege is in effect varies by insurer but can never be less than 24 months Exchange is allowed without evidence of insurability
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VL sales charges
may not exceed 9% of the payments made over the life of contract
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Refund providsions VL
45 days from execution or for 10 days from the time the owner receives the policy (whichever is longer) Refund provisions extend for 2 years but refund is the cash value
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Suitability of Variable life insurance
There must be a need for life insurance Must be comfortable with separate account Applicant must understand the variable death benefit Prospectus must be delivered at time of solicitation
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Section 529 Plan
Defined as Muni securities. Funded with after tax dollars earnings grow tax deferred. State sponsored Withdrawals taken for qualified expenses are tax free (10% penalty for non qualified) Pentalty is not charged if you terminate because beneficiary has died Any person can open account for future student- does not have to be related
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Prepaid tuition plans
Allow donors to lock in future tuition rates at today's prices
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College savings plan
Donor invests a lump sum or preiodic payments Typically invested in target dat funds Up to 10,000 per year can be used for K-12 education purposes College plans may be set up in more than one state No age limitations for contributions no income limitations Can be contributed via periodic payments - limited to $15,000 per year per donor If beneficiary is predesignated they must be a close family member of first
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Coverdell Education Savings Account
Not muni security. Funded with traditional types of securities. After tax contributions of up to 42,000 per student per year until 18th birthday. Contributions can be made by any person and are NOT tax deductible. Distributions are tax free if taken before 30 for education expenses.