Unit 3 Flashcards
Customer Information, Risk and Suitability, Product Information
Non-financial Investment Considerations
>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
Preservation of capital
Usually recommend: Money market securities Money market mutual funds Certificates of Deposit (CD) Government securities Principal-protected funds
Dividend Dates
Declaration, Ex-Dividend, Record, Payable
Regular way settlment
T+2
Capital Growth
Refers to an increase in an investments value over time.
Growth oriented investments are EQUITY ORIENTED.
Tax advantaged products for Investors
IRAS and annuities allow interest to accumulate tax deferred.
Muni-bonds offer tax free interest income (not suitable for retirement accounts)
Liquid investments - keep in mind this means sell quickly at close to current market value
Securities on exchange or NASDAQ
Mutual funds
ETF
REIT
Illiquid investments
Annuities - when investor is under 59.5 Real estate DPP Hedge fund Funds of hedge funds
Speculation investments
Higher risk / Higher return
>Options >High-yield >unlisted stocks or bonds >sector funds >precious metals >special situation funds
Recommendations for Preservations of Capital
CD MM Funds Fixed Annuities Govt Securities Investment Grade Bonds
Recommendations for Growth
Common stock / common stock mutual funds Blue chip stock Tech stock Sector stock Defensive stock
Recommendations for Income
Bonds REIT CMO Muni Bonds Below investment grade bonds Preferred stock
Recommendations for Liquidity
Securities on exchange
Bonds
Mutual funds
Public REITS
Recommendations for Diversification
Mutual funds Equity porfolios Domestic portfolios Bond portfolios Some foreign portfolios
Speculation
Options contracts DPP High yield bonds Unlisted stocks Sector funds Precious metals Commodities Futures
Capital risk
risk of losing all of your invested capital
Timing risk
buying or selling at wrong time
Interest rate risk
Sensitivity of investments price of value due to interest rates - usually associated with bonds. Shorter the tenor the less risky!!
Credit risk
Risk of default on bond
Investment grade bond
BBB or higher
Liquidity risk
not being able to convert investment into cash immediately at CMV
Advantages of Call feature to investor
> Refinance for lower interest rate
Reduce its debt at any time
Replace short term debt with long term
Force the conversion of convertibles
Asset allocation
the spreading of portfolio funds among different asset classes such as: Stocks Bonds Cash Can include RE and other asset classes
Strategic asset allocations
Refers to the proportion of various types of investments composing a long-term investment portfolio
Re balancing porfolio
Adjusting investment decisions based on customer’s needs. More fixed for older clientele.
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
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.
Capital Asset Pricing Model
Used to calculate the return that an investment should achieve based upon risk.
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
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.
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.
Fundamental analysis
study of the business prospects of an individual company within the context of its industry and overall economy.
Capital structure - capitalization
Combined sum of long-term debt and equity securities.
Book Value Per Share
Shares of common stock outstanding
Note: Basically shows the liquidation value of firm
Earnings Per Share
Number of shares outstanding
Earnings per share after dilution
assumes all convertible securities such as warrants and convertible bonds and preferred stock have converted into common
Current Yield
Market value per common share
Dividend payout ratio
earnings per share
Cash flow from operating activities
includes interest and dividends
Technical analysis
attempts to predict the direction of prices on the basis of historic price and trading volume patterns when laid out graphically
Fundamental analysts
Concentrate on broad based economic trends; current business conditions within industry and quality of particular corporations’s business
Support level
bottom of the trading range
Resistance level
Top of the trading range
Bearish breakout
decline in the support level
Bullish breakout
rise in resistance level
Market breadth
The number of issues closing up or down on a specific day
Market trend - consolidation
When the tread line is horizontal and moves sideways and not up or down
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
Head and Shoulders top
Bearish - reversal in uptrend
Head and Shoulders bottom
Bullish - reversal in downtrend
Oversold Market
When market indexes are declining
Number of declining stocks / number of advancing stocks is failing (fewer stocks declining)
Usually means oversold market
Overbought market
Indexes are rising, but number of declining stocks / number of advancing stocks is rising (fewer stocks rising)
Usually means overbought
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)
Primary trend of bull market
series of higher highs and higher lows (dow theory)
Primary trend bear market
seriers of lower highs and lower lows (dow theory)
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)
Authorized stock
refers to a set number of shares the company has authorization to issue or sell. Laid out in company’s original charter.
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
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
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
Calculation of number of votes
Statutory or Cumulative
Statutory voting
allows the stockholder to cast one vote per share FOR EACH ITEM ON BALLOT. Best for smaller shareholder.
Cumulative voting
allows stockholders to allocate their total votes in a manner they choose.
Shareholder may allocate all shares into one direction.
Nonvoting common stock
Class A = voting rights
Class B = nonvoting
Preemptive rights
Allows shareholder to maintain proportionate share. Usually below market value
Shareholder can:
Exercise, sell, or let expire
Stockholder residual right to claim
Stockholder has claim to corporate assets after all debts and other security holders have been paid
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.
Convertible perferred
owner can exchange for common stock
Since it is tied to common - price usually fluctates with common.
Lower dividend rate - given feature.
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.
Callable preferred (redeemable)
company can buy back from investors at stated price on the call date or thereafter. Usually higher dividend rate
Subscription right
Certificate representing a short-term privilege to buy additional shares of corporation. One right issued for each common share outstanding.
How to find value of rights
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
Ex rights formula
Used to determine the value of the right after the ex-date.
Number of rights to purchase 1 share
Warrant
grating the owner right to purchase security at a specified price at a later date. Usually above market price.
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….
Rights of ADR owners
Usually have same rights as common stockholders
Taxes on ADRs
Pertains to foreign income tax. Foreign income tax may be taken as a credit against any US income taxes.
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.
Penny stock disclosure requirements
Name of stock
Number of shares purchase
Current quote
Amount of commission
Penny stock account statement frequency
Monthly
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
Speculative Bond
BB or lower
Unrated bond
Might not mean bad quality - could just be too small to justify expense of seeking rating
S&P vs Moody’s
SP = AAA, AA, A etc
Moody’s Aaa, Aa, A, Baa, etc
Secured bond
Issuer has identified specific assets to secure the note
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
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
Equitment trust certificates
Used by railroads, airlines, trucking companies, and oil companies to finance purchase of capial equipment.
Secured by equipment - held in trust.
Debentures
Backed by general credit of issuing corporation. Below secured bonds and above sub debentures, preferred, and common stock
Guaranteed bonds
Backed by a company other than the issuer such as parent corp
Income bonds (adjustment bonds)
Usually during reorg. Pay interest only if corp has enough income to meet payments.
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.
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.
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
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
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
Conversion price
price at which convertible bond can be exchanged for shares of common stock
Conversion ratio
Bond with a price of $40 has a conversion ratio of 25:1.
$1,000 / $40 = $25
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
Calculation of conversion parity
Market price of common x conversion ratio = parity price of convertible
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.
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
Payment of CMOs
Interest is paid on all tranches simultaneously. Principal pays one trance at a time.
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
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
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
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.
Zero tranche CMO
No payment until preceding cmo tranches are retired (Most volatile).
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
CMOs yield
Usually pay investors interest and principal monthly. Made in $1,000 increments to investors for each tranche.
Liquidity
Active secondary market for CMOs. Market for CMOS with more complex characteristics may be limited or nonexistent.
Suitability
Customer is required to sign suitability statement before buying any CMO. Potential investors must understand that rate of return on CMOs
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.
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…
Treasury securities (taxes)
Typically exempt from state but pay federal.
T Bills
Denominations of $100 to $5MM. 4,13,26 weeks are auctions weekly. No interest issued at discount.
T Notes
$100 to $MM. 2-10 years. quoted at 1/32.
T Bonds
Denominations of $100 to $5MM. 10-30 years.
Treasury receipts
BD buy treasury securities and place them in a trust at bank and sell receipts against principal and interest payments.
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.
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).
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.
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
Money Market mutual funds
For retail investors are designed to have a stable NAV of $1 per share. Not guaranteed or protected by FDIC.
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
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
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.
Investment Company
corporation or trust that pools investors money together then invests the money on their behalf.
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.
Exchange Traded Funds
Open-ended company. Issue shares in large blocks (creation units). Shares can be split later.
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
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
Disadvantage to ETF
Commissions - each purchase or sale is commissionable
Over trading - easy to do.
REIT
Not an investment company, but regulated by act of 1940.
Pools money and forms a trust to invest into real estate
Equity REIT
When the trust owns their own property
Mortgage REIT
Own mortgages on property
Hybrid REIT
Combination of equity and mortgage REIT
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
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
REIT Distribution
Must distribute more than 90% of income to shareholders to avoid taxation as corporation
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
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
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
Types of mutual funds
Stock funds - stocks
Bond funds - bonds
Balance funds - stock and bonds
Money market funds - short term funds (cash equivalents)
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.
Fund Costs of mutual funds
Funds typically charge front loads of up to 8.5% to compensate salseforce.
Expense Ratio of mutual funds
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
Taxation of mutual fund
Mutual fund investors pay taxes on any dividends or cap gains fund distributes. Taxed in year earned.
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.
Mutual fund services
Retirement account custodianship Investment plans Check-writing privileges Telephone transfers Conversion privileges Withdrawal plans
Stock funds
Uses stock to meet stated objectives.
Historically have outpaced inflation for most 10 year horizons
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
Blue chip funds
invest in more recognized companies - less risk
Companies with large market cap
Large cap funds
Companies with market cap of >$10Bn
Aggressive growth funds (performance funds)
willing to take on more risk. Invest in newer/smaller cap companies
Mid cap fund
Somewhat aggressive
Targets $2bn - $10bn in market cap
Value funds
Focus on companies whose stock are undervalued (earnings not shown in price)
Higher dividend yields than growth
More conservative than growth
Income funds (Equity fund)
Stresses current income over growth
Investing in companies that pay dividends.
Target value not growth. Lower risk.
PAY MONTHLY DIVIDENDS
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.
Growth and income funds
Combined objectives of both.
Special situation funds
buy securities of companies that may benefit from a change within the company or economy
Blend/Core funds
Portfolio comprising of a number of different classes of stock.
Includes blue chip and high risk.
Index Funds
Invests in securities that mirror market index such as S&P.
Low turnover low cost
Foreign Stock fund
Invest only in companies that have a principal interest outside of US
Objective is long term capital appreciation
Global funds
Invests in securities in both US and foreign companies.
Huge amount of currency and political risk.
Balanced funds (hybrid)
Invests in stocks for appreciation and bonds for income.
Might be 60% stock. 40% income.
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
Target date funds (life cycle or interval)
Offered by most benefit plans.
Designed to help manage risk with a SPECIFIC TARGET DATE IN MIND.
Bond Funds
Funds invest solely in investment grade funds. Do pay dividends if BOD declares such
Tax Free Bond Funds
Municipal bond funds invest in muni bonds/notes
**Appropriate to investors which high tax bracket seeking income
US Government Funds
Purchase securities issued by UST or agency of USG (GNMA)
Investor seeking maximum safety
Agency Funds
- Bonds issued or guaranteed by US Fed Government
- Bonds issued by government sponsored enterprises
Bonds issued by GSE’s inclue GNMA(USG bakced), FNMA, FHLM
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
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
Index tracking funds - differences from mutual funds
Intra day trading
Margin availability
Short selling
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
Inverse funds
attempt to deliver returns taht are opposite of benchmark index.
Can also be leveraged fund.
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
Hedge fund strategies
Highly leveraged portfolios use of short positions Utilizing derivative products Currency speculations Commodity speculations Investing in unstable markets
Hedge Fund lockup provisions
Period where investor cannot withdraw dollars. Generally associated with new funds. Dependent on investment strategy
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
Blind Pool fund
usually provide an indication of general industry but not much other detail.
Similar to blank check
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
Net investment income
Dividends + interest - expenses of fund
D+I-E= NII
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%)
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
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.
Reinvestment of distributions
In mutual fund investor can elect to reinvest distributions which will be without sales charge
1099 DIV
Allows shareholder to report realized distribution capital gains for the year
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
Inherited shares example
Grandpa bought $10K of stock 20 years ago; current value is $50K at death. Grandaughter’s cost basis is $10K.
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
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.
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
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)
Wash rule timeline
30 days before and 30 days after and wash day
61 days total
Valuing fund shares Mutual fund (liquidation)
cost base of mutual fund share includes shares’ total cost including sales charges + reinvested dividendand cap gains distributions
Liquidating shares FIFO
cost of the shares held the longest is used to calculate gain or loss
Share Identification (Liquidation)
investor keeps track of the cost of each share and uses information to decide which shares to liquidate
Average basis
Use the average cost basis when redeeming the shares.
Price of mutual fund shares
Total assets - liabilities = net assets
Based off of NAV
NAV does not change
Manager buys or sells securities, fund issues shares, fund redeems shares
Purchasing Mututal fund shares
Forward pricing. Always have to wait until NEXT AVAILABLE no matter if they are being redeemed or purchased
Class A shares Mutual fund
Front end loads. Load charges are taken out of investment amount.
Breakpoints
Keep in mind that if they sign an LOI then they will have benefit of full purchase amount ,not individual transaction
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
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
Combination privilege
with mutual funds managers may allow investor to combine investments to reach a breakpoints
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
Computing sales charge - always based off POP NOT NAV
PoP - NAV = sales charge amount
Sales Charge Amount
——————————– = sales charge percentage
POP
Mutual fund prospectus must contain a formula that explains how the fund computes NAV
Sales charge is always based on POP NOT NAV
Class B Shares
No front-end sales charge
Have 12b-1 fee (75bps)
Convert to class A shares over time
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
12b-1 fees
cover costs of marketing.
Deducted quarterly - reflected annually
RULES:
Maximum fee is 75 bps
Fee must anticipated level of distribution services
If designated as no-load fund
May not charge more than 25bps on avg net assets for 12b-1 fee.
No load fund
permitted to charge purchase fees, account fees, exchange fees, and redemption fees (none considered sales load)
Voluntary accumulation plan (mutual fund)
Allows customer to deposit regular periodic investments on a voluntary basis
Designed to help customer for regular investment habits
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
Fix dollar withdrawal
Liquidates enough shares each period for that set sum
Fixed percentage or fixed share withdrawal
either a fixed number of shares or percentage of the account is liquidated
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
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
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
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
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.
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
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%.
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.
Combination annuity
Investors received advantages of both the fixed and variable annuities. Contribute to both plans
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
Single premium deferred annuity
purchased with lump sum, payments of benefits is delayed
Periodic public payment deferred annuity
allows investments over time. Benefit payments are always deferred until later date
Immediate annuity
purchased with a lump sum and payout benefits commence within 60 days
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)
Annuity Sales charge
No maximum sales charge - must adhere to FINRA fair and reasonable rules
Accumulation phase
Growth phase, payout phase is the annuity phase
Payout phase
When payments commence, money will be distributed per the payout option chosen
accumulation units purchased over time are converted into annuity units
Distributions from annuities
Monthly payments dependent on the following:
Amount in contract Age Sex (females live longer - smaller check) Paout option Investment return
Assumed Interest Rate
AIR is the conservative projection of the performance of the separate account of the estimated life of the contract
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
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
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
Annuitization payment options
Life annuity (straight life)_
Life annuity for certain period
joint life with last survivor
unit refund
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
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
Unit Refund Option
Minimum number of payments are made upon retirement. Value remains in the account after death to annuitant and payable to beneficiary.
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.
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
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
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
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.
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.
Variable life prospectus delivery
Considered a security, prospectus is required
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
Loans on VL contract
Not considered to be constructive receipt of income and are received tax free.
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
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
VL sales charges
may not exceed 9% of the payments made over the life of contract
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
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
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
Prepaid tuition plans
Allow donors to lock in future tuition rates at today’s prices
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
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.
