II. Understanding Products and Their Risks

Foreign currency options: C$50,000 Oct 75 call @ .60

50,000 = number of Canadian dollars covered by this one contract 75 = the strike price (quoted in terms of American cents; so "75" means that each Canadian dollar can be purchased at 0.75 USD, regardless of the actual exchange rate) .60 = "six-tenths of one penny"; so it has to be multiplied by the penny (0.01) to get 0.006 Since the contract covers 50,000 Canadian dollars, multiply that by 0.006 to get $300 ** $300 is what an investor would pay for this call Who would sell this option? If an investor were concerned that the Canadian dollar might skyrocket, chances are he's an importer who has to pay for a product in $C. This call would tell him the max cost of the contract and could also be used to profit, should his risk materialize

Current refunding

"A bond refunding (q.v.) in which new debt is issued, and the proceeds are used to call in the existing debt. Contrast with advance refunding (q.v.)." - Held in sinking fund Refunding a bond issue where the existing bonds are redeemed within 90 days

M&E fee

"Mortality and expenses risk fee" charged to annuitant to cover insurance company's risks

Settlement options for insurance policies

* Lump-sum method * Fixed-period settlement option == pays for a specific period of time; sum varies but period fixed * Fixed-amount settlement option == pays until principal and interest are gone; sum fixed but period varies *Life-income settlement option == proceeds are annuitized (i.e. beneficiary paid a guaranteed income for rest of life; takes age expectancy, etc. into account) * Interest-only settlement option == insurance company retains proceeds from policy and invests them, promising beneficiary minimum rate of interest. Here beneficiary can withdraw all principal or change settlement option

FNMA and FHLMC mortgage-backed securities

** Interest rates on mortgage securities from FNMA and FHLMC (Freddie Mac) higher than security and corporate bonds because of uncertainty of maturity and higher credit risk

Prepayment risk

**Common when interest rates drop The form of call risk inherent in owning a mortgage-backed security (e.g investor holding those issued and guaranteed by GNMA (Ginnie), FNMA (Fannie), FHLMC (Freddie) will take a hit if interest rates drop suddenly and all the principal is returned sooner than expected) - Similar to Call Risk, the risk that mortgages underlying a mortgage-backed security/pass-through will be paid off sooner than expected due to a drop in interest rates. Investors reinvest the principal at a lower rate going forward. Basically, homeowners refinance and suddenly return their principal all at once due to interest rate drop - Like bond issuers, homeowners with a mortgage typically take advantage of a drop in interest rates by refinancing (taking new loan w lower interest to repay old loan) REDUCING THIS RISK - Typically, the investor receiving principal sooner than expected will reinvest it into a similar mortgage-backed security and receive a lower rate of interest going forward, while the homeowners in the pool of mortgages will enjoy paying lower interest rates going forward [GNMA only has this risk (+ extension risk), but no credit/default risk; FNMA or FHLMC have these risks plus credit/default risk]

Extension risk

**Common when interest rates rise Homeowners are slower to return their principal due to interest rates rising The risk that when interest rates rise, fewer prepayments will occur because homeowners are reluctant to give up the benefits of a contractual interest rate that now looks low. As a result, the security becomes longer in maturity than anticipated at the time of purchase. *Most debt securities have stated maturities, while an investment in most mortgage-backed securities comes with an estimate only [GNMA pay only has this risk (+ prepayment risk), but no credit/default risk; FNMA or FHLMC have these risks plus credit/default risk]

Bond quote

- A bond quote refers to the last price at which a bond traded. - Bond quotes are expressed as a percentage of par (face value) and converted to a point scale. - The par value is traditionally set at 100, which represents 100% of a bond's $1,000 face value of $1,000. - May also be expressed as fraction *Above 100 = above par (premium *Below 100 = below par (discount) Example: XYZ 5.50s 2030 at 102 5.50s = coupon rate 2030 = maturity 102 = percentage of par value --> at premium

Ad valorem tax

- A tax levied on the assessed value of real and personal property * "ad valorem" means "according to value" - Local governments (e.g. cities, park districts, school districts) rely on property taxes for much of their revenue, and the property tax rises or falls "as to the value" of the property

DPP documents

- Certificate of limited partnership (provides basic info on partnership, GPs and registered agent) which GP signs and files with state where business is organized - Partnership agreement Signed by all partners and is the foundation for partnership (contains business purpose, effective date and term of ops, required capital for GP and LP, name of GP, principal place of business, allocation of profits, distribution of cash, transfer of interest, powers and limitations of GP's authority, withdrawal, removal of a partner) **DPPs (like corporations) are assumed to exist indefinitely unless partnership agreement specifies a date or triggering event for its dissolution. For ex, partnership dissolves when last townhouse has been sold or if GP dies

Four types of management companies (mutual funds)

- Diversified Open-End Fund (least risky) - Non-Diversified Open-End Fund - Diversified Closed-End Fund - Non-Diversified Closed-End Fund (riskiest type because uses leverage, so credit/default/bankruptcy risk, and diversification reduces investment risks)

Hedge funds

- Generally only open to accredited investors (have more than $1m in liquid net worth, or individual who makes more than $200k/yr / couple who makes > $300k. Primary residence not counted toward this minimum) - Use high-risk trading strategies including short selling, currency bets, and high levels of leverage, etc., so their investors must be able to afford losing their investments - Investors must meet minimum required investment (typically at least $1m) - Illiquid investment - meaning investor is not able to sell the investment over the short-term - Typically charges "two and twenty" = 2% of assets as management fee and extracts the first 20% of all capital gains - Typical arrangement for hedge fund is for limited num of investors to form a pvt investment partnership. Objective: rather than trying to beat an index, these funds generally seek to achieve "absolute positive investment performance" (~8%+), regardless of how overall market is doing. So designed to profit in any market environment

Diversification of mutual funds portfolios

- Industries (telecom, retail, healthcare, etc.) - Types of investment instruments (for bonds: debentures, zero-coupon, convertible, MBS, secured bonds, money market instruments) - Variety of securities issuers (e.g. Walmart, Michael's, Home Depot, Nordstrom) - Geographic areas (dif areas affected by economic slump, war, tropical storm)

Advantages of mutual funds

- Investment decisions made by professional portfolio manager - Ease of diversification ("undivided interest concept" - where $50 investor owns a piece of all securities in portfolio, just as $1mil investor would) - Ability to liquidate a portion of investment without losing diversification and usually can sell (redeem) shares without paying fees (vs directly investing in these stocks, which would require paying commission for each company's stock if investor wished to sell, or having less diversified portfolio if sold stock from one company) - Simplified tax information (issues one 1099-DIV, showing all income and capital gains distributions received over the tax year, versus needing to keep track of all dividends for each company stocks) - Simplified record keeping - Safekeeping of portfolio securities - Ease of account inquiry (shareholders receive one semi-annual report and one annual report from fund, versus receiving 10Qs and 10Ks for each company it directly invested in)

At minimum, offering materials for DPPs must disclose the following to potential investors

- Items of compensation (management, etc.) - Physical properties - Tax aspects - Financial stability and experience of sponsor - Program's conflict and risk factors - Appraisals of properties and other pertinent reports **Liquidity and marketability of the program must also be disclosed to investors (e.g. prior program where date or time period at which program might be liquidated was included, whether prior program in fact liquidated on or around that date/time period) Also, sponsor must be willing to provide investors in each AP the per-share estimated value of investment at current point (+ methodology for arriving at this estimated value and date of data used to calculate it)

Opening transaction

- Opening transaction, a term typically associated with derivative products, refers to the initial buying or selling that creates an active position. - An opening transaction can also refer to the first trade for a specific security on a given trading day. Basically the act of initiating a trade

Investment Company Act of 1940

- Provides a definition of "investment company" and regulates them - Grants SEC the authority to require companies to register securities offerings and provide full disclosure of their operations to investors in IPO and regularly afterwards - "Important to remember that the Act does not permit the SEC to directly supervise their investment decisions or activities, or judge the merits of their investments" Congressional legislation regulating companies that invest and reinvest in securities. The act requires an investment company engaged in interstate commerce to register with the SEC. - Defines a separate account - Defines "investment company" - Created and regulated mutual funds

Industrial Development Revenue (IDR) bonds

- RISKY; backed by a corporation - Municipality approves sale of bonds "on behalf" of a company (the ultimate responsibility for the payment of principal and interest rests with the corporation leasing the facility; therefore, the bonds carry the corporation's debt rating.) Issued by local municipal governments to build factories or other commercial properties. The plant or property is leased by the municipality to a corporation. Interest on bonds is paid from the lease rental payments made by the corporation. Potential risk of corporation bankruptcy here (so carry default risk), and issuer (i.e. municipality) will not bail out the bondholders

Subordinated debentures

- Unsecured bonds with a lower claim on assets than general creditors; in the case of liquidation, holders are paid off after the general creditors are paid - Bonds with a lower (subordinate) claim on the firm's assets than the claims of other debt instruments - Pay higher coupon than debentures or secured bonds

Disadvantages of mutual funds

- many fees: sales charge = fee investor gets charged when purchasing or selling shares (e.g. you invest 10k into a fund, but only 9.5k gets deposited in the fund) [most open-end funds don't have this, but some do] --> investor can go directly to the fund, instead of through a registered sales rep, but does not save money this way (fund would instead retain the entire fee, rather than sharing it with agent and its broker-dealer) operating expenses = management fee (paid to the investment advisor - usually largest annual expense associated with open or closed-end fund) + legal and accounting services + transfer agent fees + custodian charges + board of director salaries Expenses ratios = the percentage of a fund's assets that pay operating expenses (which means they represent the fund's administrative efficiency) Fees only associated with open-end funds: sales charge (rare); 12b-1 fee (common) **management fees (portfolio mngmnt) must be shown as separate line item from 12b-1 fee Fees associated with closed-end funds: - Brokerage commissions when investors buy or sell

Three methods for purchasing annuities

1. Single-payment deferred annuity (SPDA) 2. Periodic-payment deferred annuity 3. Single-payment immediate annuity

Types of money market mutual funds

1.) Government money market funds = at least 99.5% of portfolio is in Treasury securities 2.) Tax-exempt money market funds = hold municipal securities. Yields are low but still benefits investors in high marginal tax brackets 3.) Prime money market funds = hold corporate debt securities * Some for institutions and others for retail investors These funds are required to float their NAV down to their true fair market value **Good for investors wanting to preserve capital or want liquidity. However, annual expenses here are higher than many investors realize ** Except for government money market funds, both retail and institutional prime and tax exempt funds can now impose: - liquidity fees (up to 2% to discourage redemptions) - temporary halt to redemptions if situation is dire (up to 10 business days. Can only be done once within 90-day period)

T-Notes

2-10 maturities Pay interest every 6 months (semi-annually) Return principal with last interest payment Minimum denomination is $100 (for all Treasury debt instruments)

Special tax bond

A municipal revenue bond that is secured by a pledge of a specific, special tax. It is not a general obligation since it is limited to a specific tax source as revenue (rather than an ad valorem tax) Basically, any tax that is not considered a property or sales tax (includes excise taxes/sin taxes, taxes on gasoline, tobacco, hotel/motel, bottles water, alcohol, business licenses) For example, adding special tax on gasoline purchase throughout the county to pay for roads paved

Blend funds

A category of equity mutual funds with portfolios that are made up of a mix of value and growth stocks

Qualified Institutional Buyers (QIBs)

A company that manages at least $100 million of securities on a discretionary basis or is a registered broker-dealer investing at least $10 million in non-affiliate securities. **Under rule 144a, restricted stock can be sold to QIBs

Diversified company

A company that operates in two or more industries to find ways to increase long-run profitability As defined by Investment Company Act of 1940, - at least 75% of value of its total assets is represented by cash and cash items (incl receivables) - no more than 5% of assets are in any one company - does not own more than 10% of any company's outstanding shares ** Any fund not meeting those requirements must refer to itself as a non-diversified fund

Equipment leasing program

A direct participation program that leases equipment that companies do not want to own (e.g. computers, transport equipment, oil drilling, construction equip). Depreciation is a major tax-advantage of such a program.

Existing properties

A direct participation program that purchases operating real estate that already has an immediate cash flow. (similar to income programs for oil) Safer investment b/c investors can examine the financial statements and know what they're getting into (lower risk but also lower reward) Tax benefit: - Through depreciation of the buildings themselves and any maintenance equipment owned by partnership

HOLDRs (holding company depository receipts)

A financial product created by Merrill Lynch Traded daily on the American Stock Exchange (AMEX) and allows investors to buy or sell a basket of stocks in a sector, industry or other classification in a single transaction **vs ETFs, they do not track an underlying index but rather represent a narrow slice of an industry RISK: - These products are completely unmanaged and components almost never change - Consequently, if company is acquired and removed from a HOLDR, its stock is not replaced -- which can result in more concentration and added risk (vs ETFs which can change and are rebalanced with some regularity, and generally contain more components)

Investment company

A firm that invests the pooled money of a number of investors in return for a fee Also company where more than 40% of assets (outside government securities) are securities As per 1940 Investment Company Act, three types of investment companies: 1. Management companies (includes open-end and closed-end funds. Biggest focus for SIE exam) 2. Unit investment trusts 3. Face-amount certificate companies

Mortgage-backed security

A fixed income security whose interest and principal payments come from a pool of mortgages, e.g., GNMA, which is guaranteed by US Treasury; e.g. FNMA or FHLMC which is not guaranteed by US Treasury but will probably be bailed by them A debt security created by pooling together a group of mortgage loans whose periodic payments belong to the holders of the security **Has prepayment and extension risks

Banker's acceptance (BA)

A money market instrument used to finance int'l and domestic trade. A banker's acceptance is a check drawn on a bank by an importer or exporter of goods and represents the bank's conditional promise to pay the face amount of the note at maturity (normally less than three months). - Used extensively in foreign trade, a banker's acceptance is like a post-dated check and serves as a guarantee that an exporter can pay for the goods. - There is a secondary market for buying and selling banker's acceptances at a discount. - Secured by collateral (the goods being imported or exported), unlike other money market instruments e.g. a business might import $50mil worth of rice, but not pay for it upfront. Instead, bank issues letter of credit to seller of rice, informing it that the bank will guarantee payment (so this loan becomes a security purchased at a discount)

Limited tax bonds

A municipal bond which has a limit on the taxes that can be used to pay the debt service (perhaps property taxes can only be raised to a certain level to pay debt service on a GO (e.g. school districts can't raise too high), or perhaps only certain taxes can be used to pay debt service) Two distinguishing features: 1) First, as a general obligation bond, it is secured by all revenues the issuing municipality generates that are not otherwise secured. That is, unless a municipality's revenue specifically secures another bond, the municipality must theoretically use all of its other revenue to pay the bond. 2) Secondly, because it is a limited-tax bond, its provisions place a maximum possible tax increase that the municipality can levy if its other revenues come up short.

Revenue bonds

A municipal bond whose interest and principal payments are backed by the revenues generated from the project being built by the proceeds of the bonds (rather than being backed by the full faith and credit of the issuer behind it) Toll roads for example, are usually built with revenue bonds backed by the tolls collected (known as user fee). Sports stadiums revenue, for example, includes parking fees, concessions and ticket sales (known as user fees). Other examples include airports, convention centers, and golf courses ** If money problems arise for paying debt service, issuer does not raise taxes, but rather raises user fees. **If revenues decrease, the bonds' rating drops - Bond rating and yields fluctuate heavily since bond is revenue dependent - No need for voter approval since debt service not tied to bond Types of revenue bonds: special tax bond, special assessment bond, PHA/NHA bonds, IDR bonds, moral obligation bond

General Obligation Bonds (GOs)

A municipal debt issue backed by the full faith, credit, and taxing power of the issuer for payment of interest and principal (meaning that issuer can use sales taxes, income taxes, parking fees, fishing licenses, etc. to repay the debt. Can even raise taxes to pay debt service) - Requires voter approval (issuer is legally obligated to pay the debt service on bonds issued) Types of GOs: limited tax bonds; double-barreled bonds

Moral obligation bond

A municipal revenue bond secured by revenues that is additionally secured by a moral, but not legal pledge from the state (state legislature has authority but no legal obligation) to make up any deficiencies (i.e. can appropriate money in the event the issuer defaults). The state legislature would need to approve any makeup funds - A moral obligation bond not only gives investors the tax exemption benefits inherent in a municipal bond, but also provides an additional moral pledge of commitment against default. - The issuing body's commitment is supported by a reserve fund established to meet any debt service costs the government may be unable to make.

Money market mutual funds (MMMF)

A mutual fund that pools the funds of many small investors and purchases high-return, short-term marketable securities As SEC defines - Pay dividends that reflect prevailing short-term interest rates - Are redeemable on demand (liquidity) - Seek to maintain a stable NAV (principal stability) *Popular for retail and institutional investors Mission is to maintain a stable value. They are a holding place for cash that is not ready to be either invested long-term or spent by the customer. Money invested can be converted to the same amount with little or no risk. Investors earn low returns but can often write checks against these accounts. **Investors agree to pay operating expenses in exchange for benefits provided by investment product (so these investments aren't necessarily cheap) "When an investor says that they are currently "25% in cash", they probably mean that 1/4th of their account is currently in a money market mutual fund."

Index fund

A mutual fund that tries to match the performance of a particular index by investing in the companies included in that index. This fund tracks an index as opposed to specific stocks, in an attempt to outperform the market ** Management fees are low here since virtually no trading occurs

Index option

A non-equity option representing the right to receive in cash the difference between the underlying value of a market index and the strike price of the option. The investor speculates on the direction, degree, and timing of the change in the numerical value of the index. Related item(s): capped index option. Key points on index options are: 1. Exercise involves delivery of cash, not stock 2. Index is valued at the end of the trading day 3. Multiplier is $100 **When investors buy or write calls on the SPX (S&P 500 index), they are betting on the point value of the index, which is figured every trading day - The buyer says the point value of SPX is going up - The seller says the point value of the index is not **Exercise involves the delivery of cash rather than stock. When the buyer exercises the call, the seller pays the buyer cash. Amount depends on the intrinsic value or the "in-the-money" amount **Index is valued as of the end of the trading day, so would be dangerous to exercise an index option in the morning (often, S&P and other indexes go up for part of the day before finishing in negative territory) - If an investor exercises an option before the index has been officially totaled up for the day and that option ends up going out-of-the-money, the buyer would have to pay the seller the amount that the option is out-of-the-money **Index options are frequently used to hedge stock portfolios (e.g. investors heavily weighted in a particular sector would find a narrow-based index that matches his portfolio; same for investors exposed to the broad market --- typically S&P 500 or DJIA) EXAMPLE Call has a strike price of 500. If the holder exercises the call when the index is at 520, the call would be in-the-money 20 points, so the seller would have to send the buyer 20 points' worth of cash by next business day How much is a point worth? multiply by $100 (so in example above, would be $2,000 that seller would deliver to the buyer) Premium is also multiplied by $100 So long 1 SPX Jun 500 call @ 8 = strike price of $50,000 and premium of $800 - To break even, the SPX option would have to go in-the-market by 8 points (508)

Free-look period

A period of time given to annuitant where they can change their mind about investing in annuity/life insurance and receive full refund Variable annuities = 10 days Fixed annuities = depends on what state mandates for insurance policies

Universal Life Insurance

A permanent life insurance with an investment savings element and low premiums like term life insurance "flexible premiums" BENEFIT = flexibility, savings element, insurance ** A universal life insurance option provides more flexibility than whole life insurance. Policyholders have the flexibility to adjust their premiums and death benefits. - Client can adjust the death benefit --> the premiums are then increased to buy more coverage or decreased to back off on coverage and so save money - The excess of premium payments above the current cost of insurance is credited to the cash value of the policy, which is credited each month with interest. ** If cash value is sufficient, client can cease paying premiums and begin to be covered by the policy's cash value ** Cash value then continues to grow at a minimum, guaranteed rate ** If general account does well, cash value increases from there [Traditional insurance policy where insurance companies bear all investment risk, through general account]

Fixed-Percentage Periodic Payments (Fixed-Percentage Plan)

A systematic withdrawal plan where investor receives a set percentage of account's value each month (e.g. 2% sent each quarter) **The amount received each month and the amount of time the funds will last is unknown

Systematic withdrawal plan

A plan offered by mutual funds that allows shareholders to be paid specified amounts of money each period To do this: - Investor must have minimum account value (usually ~5k) - Should stop putting money into the fund once the plan begins - Payments made first from dividends, then from capital gains. If dividends and capital gains do not cover amount investor wants to withdraw, fund begins to redeem the investor's shares Withdrawal options: 1. Fixed-Dollar Period Payments (Fixed-Dollar Plan) 2. Fixed-Percentage Periodic Payments (Fixed-Percentage Plan) 3. Fixed-Shares Periodic Payments (Fixed-Share Plan) 4. Fixed Time

Mutual funds

A pool of money used by a company to purchase a variety of stocks, bonds or money market instruments. Provides diversification and professional management for investors. - Managed by an investment adviser - Investors buy shares of the portfolio, and advisor uses this money to invest in stocks and bonds that meet the fund's objectives and hence creates the mutual fund's portfolio Good option for retail investors: - Because the portfolio is typically diversified, it is less susceptible to the volatility involved with holding just a few stocks or bond issues (much less risky than holding just a few positions of common stock). - Gives access to professional investment advisors, who typically require large amounts to manage the accounts of individual ** When an investor deposits money into the fund, the portfolio increases in size, but the addition of the new investor also increases the number of shares outstanding. The only way for shares to increase in value is for the portfolio to become more valuable (which only rise when securities in the portfolio increase in market value or when they pay income to the portfolio) NAV = Net Asset Value (amount of assets - liabilities). Whether open- or closed-end, this is the value of one share of the fund - Floating the NAV means no longer artificially pricing each share in fund, but instead letting it float to its true fair market value Board of Directors oversee operations and establish policies (non-interested means not affiliated with distributor or advisor)

Direct participation programs (DPPs)

A program which provides flow-through tax consequences, regardless of the structure of the legal entity or vehicle for distribution (open to engage in many different types of projects) *Only open to sophisticated investors * Basically non-traded pooled investments Here, the business's owners take a share of the business entity's net income or net loss on their own personal income taxes (versus typical way where corporations are taxed as business entities and owners are then taxed on any dividend income they distribute to themselves from the business's profits) *Typically structured as partnerships (limited partnerships) Tax advantage: - tax shelters - depletion (primary tax advantage) -> when oil or natural gas is sold, partnership assumes charge against its revenue (basically for depleting its assets). - If the business entity owns the drilling equipment, depreciation charges can provide tax shelter to the partners - although many partnerships lease equipment **However, they provide tax benefits only to those who can actually use them (some have no tax shelters, e.g. raw land) Risk: - They are long-term and illiquid. Should investor wish to sell, no buyers may be standing ready. As with hedge funds, investors may be able to redeem their investment, but only on certain dates established by the program 1. Business venture might fail or underperform 2. IRS determines partnership to be abusing tax shelter

Fixed Time

A systematic withdrawal plan where investor's account is liquidated/withdrawn over a set amount of time (e.g. over three years, fund will calculate the amount to redeem each month to exhaust account by the specified date)

Raw land program

A real estate direct participation program that aims to provide capital appreciation by investing in undeveloped land. - riskiest type of real estate DPP b/c purely speculative (hoping the piece of land you buy will be near to an airport or industrial park to be built in next few years). If investor is right, the investment will appreciate in value. Otherwise, it does not. In the meantime, receives no income or tax benefits from owning the raw land **Here, there is nothing to deplete, and land does not depreciate, the way apartment buildings and oil rigs do

New construction program

A real estate direct participation program that aims to provide capital appreciation from building new property. - They are aggressive programs, but once completed, the projects (townhouses or condominiums) can be sold for capital gains - Safer investment than raw land programs but provide a lower reward potential and involve more costs (b/c someone needs to finance the new construction) - For a construction program lasting several years, LPs are likely to receive a share of a net loss at the beginning, as partnership sinks capital into building a townhouse community on the front end, hoping to sell enough units on the back end to turn a profit

Chapter 11 Bankruptcy

A reorganization form of bankruptcy for businesses that allows them to continue operating under court supervision as they repay their restructured debts. - Company can convince creditors to either write off some of debt or extend terms of debt - Company can be completely re-organized, where former creditors typically become shareholders of the newly reorganized entity (company now a "debtor in possession" but functions same as best as possible) U.S. Trustee - Requires debtor in possession to file regular reports on operations of business to US trustee - Appoints a creditors' committee (usually made up of unsecured creditors who hold 7 largest unsecured claims against debtor) to consult with debtor on administration, investigate debtor's conduct and management, and assists with plan to reorganize business

Unsystematic risk

A risk that affects at most a small number of assets. Also, unique or asset-specific risk E.g. if EPA increases regulations on the automobile industry, only a few issuers and industries will be affected, not system-wide **Diversification reduces these risks (e.g. portfolio holding securities in Microsoft, Toyota, Starbucks and Wells Fargo is diversified, since the issuers operate in unrelated industries --> versus portfolio holding positions in Starbucks, McDonald's, Cheesecake Factory and Dunkin') **Bond portfolios are less volatile than stock portfolios, but to diversify, bond investors buy bonds from dif issuers operated in unrelated industries to avoid excessive default risk Types: - Business risk - Legislative, or regulatory risk - Credit/default risk - Liquidity risk - Opportunity cost

Market / Systematic risks

A risk that influences a large number of assets, affects securities system-wide (versus unsystematic risk, which only affects certain market sectors or companies) **Diversification does not help in this case; if overall market is going down, does not matter how many dif stocks an investor owns, because they're all going down Types: - Market risk (betas) - Interest rate risk (bond ladder can reduce) - Purchasing power risk /inflation risk - Call risk (one-time risk; callable at stated price in indenture) - Prepayment and extension risk (mortgage-backed securities) - Reinvestment risk (bond ladders or zero-coupon bonds can reduce; ongoing risk) - Political risk (some foreign markets) - Currency, foreign exchange risk (all foreign markets)

Restricted stock

A special type of stock that is not transferable from the current holder to others until specific conditions are satisfied Indicated as restricted in the legend of the security's certificate Subject to holding period: - If issuer is a reporting company and abiding by reporting requirements, purchasers must hold security for a minimum of 6 months before selling - If issuer not a reporting company, the minimum holding period is 1 year Once holding period is met: - Non-affiliate can sell shares as soon as holding period expires (and legend removed by transfer agent) - Affiliates must file a Form 144 if the sale is more than 5,000 shares and $50k

Flow of funds statement

A statement connected to a revenue bond showing how revenues are to be allocated in terms of operations and maintenance reserve account deposits debt service etc. -*included in the Protective Covenant in indentures -establishes the priority of payments made from a facility's revenues Typically flows in following order: - Revenue fund - Operations and maintenance fund - Debt service fund - Debt service reserve fund (in case of shortfalls in revenue) - Reserve maintenance fund (to cover unexpected maintenance expenses) - Replacement and renewal fund (to cover new equipment and repairs, based on engineering report) - Sinking fund (used to retire bonds early through refunding or advance refunding) - Surplus fund (extra money for emergencies)

Bond ladder

A strategy where investors invests in a fixed-income portfolio with maturities spread evenly among short-term, intermediate-term and long-term bonds (so they divide their investment dollars among bonds that mature at regular intervals in order to balance risk and return) **In this way, when the one-year note matures, its proceeds go toward a 10- or 30-year maturity (Common way to reduce interest rate risk)

Collateralized debt obligation (CDO)

A structured financial product that bundles (or pools) together cash flow-generating assets and repackages this pool into discrete tranches that can be sold to investors. They are also divided into tranches (senior tranches are safer than junior tranches since have first claim on collateral in case of default, and have higher claim on interest payments. So senior tranches have higher credit ratings and lower yields. Most junior tranches, "equity tranche" receives only residual cash flows after more senior tranches have been paid) ** While a CMO focuses on mortgages, this type of security repackages individual fixed-income assets into a product that can be divided up and sold in pieces on the secondary market. The assets packaged (mortgages, corporate bonds, corporate loans, automobile loans, credit card debt) serve as collateral for investors

Fixed-Dollar Period Payments (Fixed-Dollar Plan)

A systematic withdrawal plan where investor periodically receives a fixed-dollar payment (e.g. if investor wants to receive $300 per month, the fund will send investor this amount until investments is exhausted) Here, the amount is fixed, not the period (i.e. the time)

Fixed-Shares Periodic Payments (Fixed-Share Plan)

A systematic withdrawal plan where investor receives a set number of shares periodically (e.g. ten shares per month) ** Amount received is unknown, depends on amount that those shares will be worth at the time

Closing purchase transaction

A transaction in which the purchaser's intention is to reduce or eliminate a short position in a stock, or in a given series of options. Typically associated with derivatives

Obsolescence

A type of business risk where a company's offerings suddenly become a thing of the past, obsolete E.g. investing in a bookstore chain or newspaper company presents more risk than investing in manufacturing underwear or bleach

Capped index option

A type of index option issued with a capped price at a set interval above the strike price (for a call) or below the strike price (for a put). The option is automatically exercised once the underlying index reaches the capped price. Related item(s): index option. **Hypothetically, there is no limit to how high an index can rise, and that is what makes selling calls on an index so risky. therefore, capped index options are available. - If we set up the cap interval at 30 points, as soon as the buyer's option goes up that high, it is automatically exercised. In this way, seller knows what maximum losses are, and buyer knows maximum gain - Foreign currency options - Commodities trading - If it an SPX Aug 400 call, it would be automatically exercised as soon as the S&P 500 hit 430 or higher, assuming cap interval is 30 - If it is an OEX (S&P 100) Aug 400 put, it would be automatically exercised if the S&P 100 hit 370 or lower

Face-Amount Certificate Company

A type of investment company that issues debt securities to investors, where an investor makes periodic payments in either installments or one lump sum, and then later, on some future date, receives a certificate for the face amount, which is greater than what the investor contributed to the program Charges: - Sales charges (cover cost of marketing and selling the shares) - Management fees (cover cost of managing the investment to pay out more than they have taken in)

Variable Universal Life Insurance (VUL)

A type of permanent life insurance policy that allows for the cash component to be invested to produce greater returns These policies are built on traditional universal life policies but have a separate sub-account that invests the cash piece in the market. ** allows the policyholder to make fund choices for the investment component ** but has no guaranteed cash value and no guaranteed interest rate. - Client assumes risk - "Flexible premiums" (meaning client may or may not pay the premium) --> universal feature - Death benefit and cash value tied to separate account - Client must maintain enough cash value and death benefit to keep VUL policy in force ** Because death benefit dependent on subaccount returns, some VULs come with minimum guaranteed death benefit

Asset allocation funds

A type of specialized mutual fund where funding is allocated to match investors' goals E.g. can maintain a balanced mix of large cap value stocks (20%), small cap growth stocks (20%), high-yield bonds (40%), short-term Treasuries (20%) Appropriate for conservative investors

ETN (Exchange Traded Note)

A type of unsecured debt security issued by a FI, e.g. Barclays Capital (has characteristics of both a bond and an ETF) *They differ from other types of bonds and notes because their returns are based on the performance of an underlying benchmark minus fees (benchmark e.g. market index, foreign currency or commodities) **No coupon payments are distributed during investor's holding period and no principal protections exist - Here, issuer borrows investor's money for a certain period, hopefully paying it all bank with interest at maturity (rate of interest dependent on the benchmark's performance) *At maturity, issuer pays investor a sum based on performance on benchmark, investor fees, and calculation explained in the prospectus During holding period, value of the note fluctuates depending on performance of benchmark and creditworthiness of issuer (if credit worthiness drops, so does value of security -- like with bonds) *Can be traded on secondary market (but market price varies) **Generally not as liquid as stocks, bonds and money market securities RISKS: - Market risk - Credit risk - Liquidity risk Although they track an underlying benchmark, they do not own the index (ETFs and ETNs are included in the category of exchange-traded products, or ETPs)

Barbara Bean purchases 100 shares of QSTX for $50 a share. Barbara is bullish on QSTX for the long-term but is afraid it may trade sideways in the short-term. To hedge her risk and increase income, which of the following strategies would you recommend? A. sell a call B. buy a call C. sell a put D. buy a put

A. Sell a call Buying options does not increase income. In this case, Barbara must sell an option to bring money into her account. Call sellers are bearish-neutral. If the stock drops below - or stays right at - the strike price, she will at least get the premium. If the market price rises above the strike price, the stock will be called away. This is because she is a seller of covered calls. Barabara, the investor, has underlying shares in her account when she takes on the obligation to sell them for the strike price. If the stock gets called away, her broker-dealer simply delivers her shares to the other side, and she receives 100 times the strike price for them. (so risk is limited here, versus investors selling naked call position, where risk is unlimited). After establishing a covered all the investor's risk is not that the stock will be called away; in fact, this is the best-case scenario. Typically, investor bought the stock for less than she is now willing to sell is (strike price), so probably would still make a profit if it is called away. And no matter what, she gets the premium when writing the call. Let's say she writes one QSTX Mar 55 call @2. If so, her max gain is only $7 per-share. Why? If stock price rises above $55, it will be called away. When she logs into her account, she will find the stock position is gone, but $5,500 of cash is now in the account. She also made $200 when she sold the call. In the T-chart: Money-out column: $50 per share (or $5 total) Money-in column: $200 for the premiums collected and $5,500 representing what she sells stock for (even if it is actually worth $60 or $70 per-share at the time the option is exercised) Her breakeven is at $48, meaning that $2 premium provides that much of a cushion per-share. After that, she can lose all the way down to zero. (so maximum loss is $4,800). **This means she has about the same downside as an investor holding just the stock, yet her upside is capped, unlike the stock investor whose upside is always unlimited

Option (derivative instrument) - class

All calls and all puts on a particular security represent a class of options (so all MSFT calls are a class)

Precious metals funds

Allow investors to speculate on price of precious metals like gold, silver, platinum, and palladium ** Typically holds stock in mining companies as opposed to holding precious metals themselves (which would involve storing the metals in vaults)

Conversion/exchange privilege (mutual funds)

Allows investors to sell shares of one fund for another at the NAV (e.g. sell shares of their L&H Growth Fund, to buy shares of their L&H Income Fund at the NAV, rather than the higher POP) **The IRS considers the sale a taxable event

Alphas (measuring investment performance/risk)

Alpha, one of the most commonly quoted indicators of investment performance, is defined as the excess return on an investment relative to the return on a benchmark index. For example, if you invest in a stock, and it returns 20% while the S&P 500 earned 5%, the alpha is 15. An alpha of -15 would indicate that the investment underperformed by 20%. **Basically if investment performed better or worse than its beta predicts

Preemptive rights

Also known as "first right of refusal" Stockholders' right to maintain their proportionate equity in a corporation by purchasing any additional shares issued. Here, company can issue more shares to the public, but must first give existing shareholders the right to buy their proportion of new shares (otherwise, equity of current shareholders would be diluted or diminished) **Under this, investors receive what is known as subscription rights (can purchase new stock below market price)

Separate Account (SMAs)

An investment pool funded by contributions to variable contracts, including variable annuities and variable life insurance. These assets are kept separate from the insurance company's general account - When purchase payments are invested in this account, the individual's payments are vulnerable to investment risk (versus general account which is guaranteed by company) - This offers more customization in investment strategy, approach and management style than mutual funds do, and also provide direct ownership of securities and tax advantages over mutual funds [Defined by Investment Company Act of 1940)

Call provision

An agreement between the issuer and the bondholders (or preferred stockholders) that gives the issuer the ability to repurchase the bonds (or preferred stock) on a specified date or dates before maturity **Call provisions can be referred to as in-whole redemptions or partial redemptions (since issuers may call the entire issue or only part of it) An optional redemption gives the issuer the option to refinance/refund their debt as of a certain date at a stated price, or over a series of prices and associated call dates. Some bonds are issued with mandatory call provisions requiring the issuer to call a certain amount of the issue based on a schedule or on having enough money to do so in the sinking fund

Deferred annuity

An annuity that starts sometime in the future (usually younger investors) - Investor has option to surrender contract for its surrender value (if doing this during surrender period, means incurring a very steep surrender charge) Versus an immediate annuity (usually older investors), immediate fixed annuities much more common than variable Investor must be 59 1/2 years old to avoid paying 10% tax penalties on withdrawals, which is why deferred makes sense for younger investors

Bond counsel

An attorney retained by a municipal issuer to give an opinion concerning the legality and tax-exempt status of a municipal new issue.

Growth and income funds

An equity mutual fund whose investment goal is to earn returns from both dividends and capital gains. Invests in companies that are expected to grow their profits and pay dependable dividends - Less volatility than growth funds because of income component

Income funds

An equity mutual fund whose main objective is income from equities. The fund invests in the common and preferred stock of companies that pay dependable dividends - Lower risk than equity growth funds

Rule 144a

An exemption to the holding period and volume restrictions of Rule 144 (restricted stock) for qualified institutional buyers (QIBs) - An issuer of restricted stock can sell to QIBs, under this rule

Unit Investment Trust (UIT)

An investment company that sells redeemable shares in a professionally selected portfolio of securities. It is organized under a trust indenture, not a corporate charter (they are pooled investments) **Like any other trust, this type is an entity holding title to assets and receiving income from those assets (if its a portfolio of bonds, the bonds are allowed to mature) Not actively managed portfolios, so they DO NOT charge a management fee Units are redeemable (they can be cashed in for their current value) - Like open-ended mutual funds, UITs are bought and sold directly from the company that issues them, although sometimes they can be bought on the secondary market; - Like closed-end funds, UITs are issued via an initial public offering (IPO). - Unlike mutual funds, UITs have a stated expiration date based on what investments are held in its portfolio; when the portfolio terminates, investors get their cut of the UIT's net assets.

Hedging instrument

An investment made to reduce the risk of adverse price movements in a security or future transaction by taking an offsetting position in a related security such as an option or a short sale *Term based on the way people grow hedges to establish the boundaries around their property (in this case, property is stock; - with a hedge, owner can establish the boundaries in terms of what they're willing to lose *This is an instrument meant to limit investor's potential loss on the related stock position. It involves betting the other way with the options position - If the stock position is bullish (call), the investor hedges by establishing a bearish (put) position; and vice versa For hedgers, selling an option offsets the potential loss by the amount of premium collected

European-style option (derivative)

An option that can be traded throughout each trading day, but can only be exercised on the expiration date **Non-equity options can be this style or American style (non-equity options are based on underlying instruments such as foreign currencies and stock indexes)

Sell stop order

An order for a brokerage firm to sell a stock when the price falls to a specified level ** A client who owns stock is exposed to 100% loss of invested principal, unless the client engages in one of a number of strategies designed to mitigate/reduce the risk of loss. One such strategy is the sell stop order, in which the client picks a price at which he or she will exit/liquidate their stock position if the stock falls to that price level, 'stopping' the loss from getting any worse.

Debenture

An unsecured debt (not backed by collateral), usually with a maturity of 10 years or more Backed by the "full faith and credit" of the issuer. Higher right, so pay a higher coupon/nominal yield than secured bonds - Debenture holders are general creditors (these holders have less claim in cases of liquidation than do those of secured bonds)

Current yield (CY) of a bond

Annual Interest / Current Market Price Same formula used for dividend yield *As interests rise, bond prices drop Long-term bond prices react more to changes in interest rate than prices for short-term bonds; but w/ respect to interest rates, short-term rates fluctuate to a greater extent and more frequently than long-term rates Current yield represents the return an investor would expect to earn, if the owner purchased the bond and held it for a year. However, current yield is not the actual return an investor receives if he holds a bond until maturity.

12b-1 fees (level load)

Annual fees charged by a mutual fund to pay for marketing and distribution costs, based on a customer's account value **Both A- and B-shares charge a 12b-1 fee, but the B-shares' fee is typically .75% higher **These fees are only used to cover selling/distribution expenses as compensation to sales representatives, advertising and mailing out prospectuses to those who request them. They are not used to cover portfolio management, transfer agent fees, etc. Under SEC Rule 12b-1, an open-end fund can distribute its own shares directly to the public, and covers distribution costs through these ongoing, asset-based "12b-1" sales fees To approve and renew this fee, there must be a majority vote of Board of Directors (including majority vote of non-interested board members). However, discontinuing the 12b-1 fee requires only a majority vote of the outstanding shares and a majority vote of non-interested

Period-certain settlement option (Unit refund life annuity)

Annuitant guaranteed certain number of payments, regardless of whether alive or not So if annuitant dies, beneficiary receives the balance of the remaining payments If annuitant older, this option typically leads to lower monthly payments

Life-only or straight-life settlement option

Annuitant receives largest monthly payout of the options available, but only required while annuitant is alive

Intrinsic value of a call option (derivative instrument)

Another way of stating how much higher the underlying stock market price is compared to the call's strike price If the underlying stock is trading at $75/share, the MSFT Aug 70 calls are in-the-money by $5; therefore, the calls have an intrinsic value of $5/share --> meaning that an investor could save $5/share by owning the call and using it to buy the underlying stock (when it's in-the-money) **All options have a time value, but not all options have an intrinsic value If the MSFT Aug 70 is trading at $65/share (below the strike price, so out-of-the-money), then the Aug 70 call has no intrinsic value - The premium represents the fact that there is still time for things to improve, as when the MSFT trades at the strike price of $70 (referred to as being at-the-money) **In either case, if the option does not expire for another three months, speculators might decide the stock could rise over that period. If so, the market attaches time value to the call

Derivatives

Any financial asset whose value is derived from the value of some other "underlying" instrument or asset One side wins and the other loses --> zero-sum game **if a speculator buys options and wins $3,000, it is because the option's seller has lost $3,000) *They include warrants, options, futures and forwards *The underlying instrument whose value drives the derivatives' value could be common stock or stock indexes, interest rates or agricultural commodities

In-the-money

Any time the market price is higher than the exercise price *Still can incur loss if the in-the-money amount is not above the price + premium paid If in-the-money, the option has intrinsic value

CMOs (Collateralized Mortgage Obligations)

Are securities created from pools of mortgages or pool of mortgage-backed securities Provides investors with greater range of time frames and cash flow. Tranches created (e.g. dif classes of bonds) These securities are "highly sensitive to changes in interest rates and any resulting change in the rate at which homeowners sell their properties, refinance or otherwise pre-pay their loans. Investors in these securities may not only be subject to this prepayment risk, but also exposed to significant market and liquidity risks." - Two CMOs having the same underlying collateral may have very different prepayment and interest-rate risks Because of these risks, PACs and TACs created Communication to investors must state that prepayment may significantly affect yield and avg life. Broker-dealer must offer customers educational materials describing their features & risks (as with options) Used interchangeably with REMIC (Real Estate Mortgage Investment Circuit)

Call risk

As interest rates fall, an issuer is more likely to call its bonds and refinance at a lower rate. Here, the issuer can borrow new money at today's lower rate and use it to pay off current bondholders sooner than expected Most municipal and corporate bonds are callable, meaning that the issuer can retire the bonds before the maturity date by buying them back at a price stated in the indenture or the literature supporting details of bond issue - Callable bonds offer higher yields to investors in exchange for this flexibility to the issuer to refinance debt at a better price Bondholders face two risks: 1) Bond's price stops rising in secondary market, since investors know the call price to be received 2) They take the proceeds from a bond that was paying, say, 5% and turn it into a 3% payment (e.g. for a bond with $1 mln principal, the $50k in interest income per year could become $30k per year) *Home mortgages are "callable", but this is referred to as refinancing - Here, if interest rates drop, homeowners currently paying 9% on their mortgage debt will borrow new money at, say, 6%. So here, the homeowner pays off the old loan with a new one at a lower interest rate

Convertible preferred stock

As with a convertible bond, this type of preferred stock allows an investor to exchange one share of preferred stock for a certain number of common stock shares Difference w other types of preferred stock: - This is a growth-and-income investment, versus all other types of preferred stock which are income investments only - Less interest-rate sensitive, since value also depends on other factors (i.e. market price of common stock) Trade at parity, above parity, below parity E.g. if ratio is 10:1 and common stock went up to $15 a share, the convertible preferred would be worth 10 x $15 = $150

If a short seller wants to hedge his bet while also increasing his income, what does he do? A. buy a put B. sell a put C. sell a call D. buy a call

B. sell a put * If he starts out bearish, he hedges with a bullish position. In that case, to increase income, he will sell an option, and the only bullish position he can sell is a put. So, he sells the stock short and also sells a put on that underlying stock. If the stock ends up being put to him, he will use those shares to cover his short stock position. If he sells the stock at $50 and sells a Jun 40 put @3, where would he break even? Short sellers want the stock to go down. However, since he took in $3, he can watch his stock position work against him by $3 and still be even. This investor breaks even at $53. Maximum loss is unlimited though, as is usual for a short seller. He doesn't have the right to buy back the stock at a particular price. Like a covered call writer, this investor has also capped his maximum gain. His upside is downward. When the stock goes down to zero, does he get to buy it back at zero? Not after writing the put option. **An investor who bought a Jun 40 put is going to make the writer buy the stock for $40 if the stock drops below that price. In this scenario, the investor realizes his maximum gain. He sold the stock at $50 and bought it back at $40, for a gain of $10. He also took in $3 for writing the put, so max gain is $13

Benefits and risks for annuitants

BENEFITS FOR INVESTOR - Has free-look period - Mortality guarantee (meaning will receive monthly payments for reminder of annuitant's life) - Death benefit (will pay beneficiary at least amount annuitant invested into it during lifetime) - Tax-deferred growth RISKS FOR INVESTOR - purchasing power if fixed - stock market risks if variable

Breakeven, Max Gain, Max Loss for PUTS (derivative option)

BUYERS - Max Gain = BE is zero - Max Loss = premium - BE = Strike price - premium SELLER - Max Loss = BE is zero - Max Gain = premium - BE = Strike Price - Premium **Unlike writer of a naked call, the writer of a put does not face an unlimited loss (because a stock can only drop to zero, so although loss can be huge, it is not unlimited) - So if seller collects $2 a share as premium, granting buyers the right to sell him stock at $70, the max he could lose (if stock's market price goes to 0), is $68/share

Underwriters/Distributors/Wholesalers (open-end funds)

Bear the costs of distributing the fund up front and are then compensated by the sales charge that they either earn entirely themselves or split with the broker-dealers who make the sales **If an open-end fund covers these costs itself, usually covers it through a 12b-1 fee. The fund can call itself "no load" provided the 12b-1 fee does not exceed .25% of the fund's net assets

Real estate assets (other assets)

Benefits - Provide a hedge to a securities portfolio b/c real estate market not highly correlated with stock and bond markets Disadvantages - Liquidity risk (difficult to liquidate quickly or at an attractive price) - Ownership may require a management company or a major time commitment by owner - Often involves repairs, upgrades, insurance and other expenses (unlike investment in common stocks)

Precious metals (other assets)

Benefits: - Fixed-income investors can face inflation risks associated with bond investments by investing in gold, silver and other precious metals (e.g. coins, jewelry, industrial applications) - During periods of inflation or financial uncertainty, investors often bid up the price of such metals Four major precious metals: gold, silver, platinum and palladium How to invest in precious metals - Buy bullion (bars of gold, silver, platinum, etc.) or buying coins made of those metals - Buying metal mutual funds that hold shares in mining companies - ETFs that hold bullion in each of the four major precious metals Disadvantages: - Require storage, security and insurance

Calls (derivative option)

Betting on company price. Basically, buyer ("bullish") says market price of a stock will rise above a strike price, the seller ("bearish") disagrees. **In exchange for a PREMIUM, the buyer of one call option receives the right to buy (e.g. 100 shares) of the underlying stock for a set price (STRIKE PRICE) within a stated time frame (EXPIRATION DATE) Risk is unlimited for the seller, as there is no upper limit to the price he will pay to get the stock if the seller loses the bet (who knows what the current market price will be if option is exercised) Risk for buyer is losing premium (premium is expressed as the amount per share to be paid) **With options, the buyers receive the right to do something, while the sellers take on the obligation to let them do it **One problem with buying options is that we might pay, say $5/share, and even though the call does go up by $3/share, still lose the difference of $2/share (so market price needs to be in-the-money relative to strike or exercise price) EXAMPLE 1 A "MSFT Aug 70" call gives the call buyer the right to buy MSFT common stock for $70 at any time up to the expiration date of the call in August. If stock goes up to $90/share or $190/share before expiration, the owner of the call could buy the stock for $70 EXAMPLE 2 Someone bets that Coca Cola stock won't go above $25/share before end of year, everyone betting against him paid him $300 for 100 shares ($3/share). As the writer of that call option, he granted any buyer willing to pay $300 the right to buy 100 shares of Coca Cola common stock from him for $25/share. Anyone holding that option would want to exercise it if the stock for Coca Cola rises above $28/share ($25 + $3 they paid). In either case, the guy who wrote the call receives the money that those betting gave him (so if stock price for Coca Cola does not rise above $25/share, he does nothing beyond keeping premiums paid to him). If option expires, the seller realizes his maximum gain, while buyers realize their maximum loss

Futures (derivative instrument)

Binding agreements between two parties to buy or sell at a specific date in the future at a price specified today In the world of commodities, today's cash price = spot price (spot market is the current market) *Those who use it to lock in purchase or sale prices to their businesses are called hedgers *Those who use it to bet on the near-term price movement of a commodity are called speculators These contracts are standardized by the exchange on which they trade, meaning that the quantity, quality and delivery are all standard terms **Most contracts don't lead to delivery (usually trades are offset before expiration to avoid having to provide or accept delivery of the actual commodity itself; maybe 1% of all contracts actually lead to the delivery of the underlying commodity) **Not just used for commodities; also for stock indexes, interest rates, currencies, emissions credits, weather, etc. Futures give traders leverage, putting them at risk without having to put down much of their money initially - Futures exchange requires both parties to put up an initial amount of cash, called either a margin or a good faith deposit (usually ~5-15% of contract value) (versus options which are paid in full) Marking to market: - Then, since the futures price will change daily, the dif in strike price and daily futures price is settled daily also. In this case, exchange pulls money out of one party's margin account and puts it into the other's (versus options, where daily market prices won't lead to any actual loss, only "paper loss", until expiration or redemption). - If margin account drops below certain value, a margin call is made, and account owner must deposit more margin to keep the game going - Speculators continue to lose as price of commodity drops (versus options, buyer only loses what they pay) **Buyer only pays the contract price (and seller receive) upon delivery

Discount bond

Bond trading below the par value This means that on paper, the initial investor is now losing, a situation resulting in a lower price or a higher yield on the bond These have the highest yield to call, since a call pays out the gain sooner than the maturity date The yield to maturity is indicated on the trade confirmation delivered to these customers, which indicates the best possible outcome

Asset-backed securities (ABS)

Bonds or notes that represent groups of loans of similar types, duration and interest rates, backed by financial assets typically consisting of receivables other than mortgage loans, such as credit card receivables, auto loans, home-equity loans, manufactured-housing contracts (e.g. CDOs) Some are backed by amortizing loans (with scheduled principal payments), and others are backed by non-amortizing loans (with no scheduled principal payments). Most are AAA/Aaa rated, because they are secured by collateral and come with credit enhancements ** Safe investments that yield more than Treasury securities (similar yields to corporate bonds and mortgage-backed securities with similar maturity and credit quality)

Simple versus compound interest

Bonds pay simple interest (constant rate of interest according to par value of bond) CDs typically pay compound interest (interest is added to the principal, so that larger principal is multiplied by the stated rate of return each time interest is to be paid until the CD matures) e.g. a 10K cd paying 3% interest the 1st year then pays 3% interest on the amount after first year (so 3% interest on $13K, etc)

Sinking fund bonds

Bonds that require the issuer to make deposits to a separate account; bondholders are repaid at maturity from that account. This also helps protect bond rating

Breakeven, Max Gain, Max Loss for CALLS (derivative options)

Breakeven (BE) = strike price + premium (for both buyer and seller, known as "tie") Buyers ("bullish") - Maximum loss is premium - Maximum gain is unlimited, b/c premium and strike price are fixed - BE is strike price + premium Sellers ("bearish") - Maximum gain is premiums received - Maximum loss is unlimited (depends on whether naked call or covered call) - BE is strike price + premium **The seller of a naked call option is subject to unlimited loss, but he can also choose to buy back the option to avoid exercise anytime up to expiration. Still, no way to predict how large such a loss would be whether he buys back the calls for much more than he sold them or is forced to buy the underlying stock and sell it for much lower exercise price of the option

Exercising derivative options

Buyer exercises the right to sell or buy the underlying stock at the strike price CALLS: - When call goes in-the-money, investor can choose to exercise it, meaning he buys stock at the current price and sells it immediately at the current market price - To do this, the holder of the option completes an exercise notice with his broker-dealer, after which broker-dealer sends an ASSIGNMENT NOTICE to a broker-dealer with at least one customer who wrote that series of option, and the broker-dealer receiving the notice assigns it to any of its customers who wrote that series (either randomly or based on writing order through FIFO - first-in-first-out) PUTS: - Holder completes an exercise notice with his broker-dealer, when in-the-money (can sell for more than its current market price) - Broker-dealer delivers the shares to the other side, and whichever customer receives assignment delivers cash in the amount of 100 times the strike price per contract (e.g. if owner of 5 MSFT Apr 80 puts exercises the contracts, he must deliver 500 shares with the seller who receives assignment delivering $40k) **Buyers and sellers are not directly linked. When contract is exercised, it goes to any seller of that series of option. So any seller of that series is subject by any buyer of that series up through expiration

Income programs (for oil and gas) (DPPs)

Buys existing production - Safest type of DPP b/c provides an immediate cash flow, but have the lowest potential reward Safe because they are DPP, but still risky given that prices for O&G are volatile, making income and investment's value difficult to estimate

Purchasing in open-end mutual fund

Bypassing a registered sales representative does not bypass any costs; instead, investor's sales charge would go directly to the open-end fund and would not be shared with the sales agent or their broker-dealer **Once account is opened through registered sales rep, customer can purchase additional shares by - Contacting registered representative - Mailing payment to the fund's customer service dep't (transfer agent) - Telephoning fund company - Purchasing online - Wire transfer *Automatic payment plan can be set up (this way shares are also not bought at just one price at one go) **Investor is given option of receiving dividends and capital gains in the form of a check or additional shares. Both taxed. Advantage of additional shares is that they are then bought at NAV and avoid sales charge (so money will grow faster this way, b/c money will go directly to fund instead of distributor) ----If investor is in a retirement plan, will automatically reinvest b/c there are penalties for withdrawals

An investor buys 1 SPX Mar 600 call when the index is @590 for a premium of 9. What is the investor's gain or loss if he exercises the option when the SPX closes at 612? A. $100 loss B. $300 loss C. $300 gain D. $100 gain

C. $300 gain Out-money (debit) = $9 In-money (credit) = $12 So $3 x 100 = $300 gain

American style option (derivative)

Can be traded throughout each trading day and even exercised before the contract expires **All equity options (ones based on common stock) are this style Example: You hold a MSFT May 30 call, you can exercise it in April, March, February, etc., if the common stock were to rise above $30 per-share

Brokered CDs

Certificates of deposit offered by selling agents and paying competitive yields among a larger universe of banks (not limited by yield offered by that specific bank). - Liquid (can be withdrawn before maturity or resold on secondary market) - Investor pays fees here (like brokered mortgages) - Not necessarily FDIC insured. Assuming it is FDIC-insured (up to $250k), investors can place several brokered CD accounts and receive insurance on each up to $250k as opposed to opening several accounts at dif banks to avoid FDIC coverage)

Hybrid REITs

Combine Equity REITs and Mortgage REITs

Combination privilege

Combining purchases in dif funds within a family of funds to achieve a breakpoint in sales charges Many fund families (Fidelity, Vanguard, American Funds, etc.) let investors combine a purchase of their Income Fund (20k) with, for ex. their Bond or Growth Fund (30k) in figuring a breakpoint = combined would be 50k

Combination annuities

Combo offers features of fixed and variable contracts -Fixed portion offers guaranteed rate -Variable portion tries to achieve higher rate of return -$ in fixed portion goes to general account for conservative investment -$ in variable portion goes to separate account for stocks, bond, mutual funds -Reps must have securities and insurance licenses

Life with Period Certain settlement option

Company makes payments for either the annuitant's life or for a certain period, whichever of these is longer

Debt Service Coverage Ratio (DSCR)

Compares the projected revenues to the projected expenses of the facility

529 College Savings Plan

Considered a municipal fund securities (similar to a mutual fund) and NOT a fixed income security The money invested in these qualify for a deduction from state (but not federal) income taxes, and any account earnings end up being tax free at both the state and federal level if employed for qualified education expenses Contributions are generally used to acquire shares or units in a state trust (considered municipal fund securities), with trust assets invested in a manner consistent with the trust's stated investment objectives MSRB makes mandatory to communicate to investors the state tax or other benefits offered according to investor's or designated beneficiary's home state laws Sometimes have characteristics of money market funds. If so, must be communicated to investor (if not FDIC insured, must be aware. If value could be lost, must be informed)

Double-barreled bonds

Considered to be a GO but has revenue bond characteristics. Interest and principal are paid from a specified facility's earnings, backed by full faith and credit of issuer, but bonds are also backed by taxing power of the state or municipality. e.g. public hospital as issuer

Convertible bonds

Corporate bonds that can be converted into common stock at the bondholder's decision. ** Pay lower nominal yields than others - Issuance of these bonds usually comes with a conversion price (e.g 25:1 --> meaning 25 stocks per 1 bond). This makes market price less sensitive to interest rates On second market, the prices of stocks and bonds for this company are supposed to be at "parity", meaning the value of shares will affect the value of these bonds (because they are tied to the conversion price set by issuer). If they are same ratio, then one is trading "above parity" or "below parity" **Accrued interest on corporate and municipal bonds is calculated on a 360-day year and assumes 30-day months

Secured bonds

Corporate bonds that have specific assets of the issuer pledged as collateral. These bonds offer lower interest rates **Accrued interest on corporate and municipal bonds is calculated on a 360-day year and assumes 30-day months

Assessed Value of Property

County Assessor's determination of a percentage of the true and fair market value of the property. (e.g. municipality assess property at 50% of its market value, which means home with market value of $400K would have assessed value of $200K, and homeowner takes assessed value of their home and multiplies it by a rate known as the millage rate to find tax bill)

Chapter 7 Bankruptcy

Court appoints trustee to liquidate assets and paid out according to priority claims A filing has been done, and a cease letter is sent to each employee about three weeks before the close of the company. Next somebody can buy your company and then no Bankruptcy will happen. If no buyer happens, the bank or some other entity, will take a look at all the assets and then try and sell the assets. Typically, only 1/3rd of employees are kept to finish the loose ends of the company.

Viatical or life settlement

Created when someone with life insurance policy wants to receive most benefits from policy now, while alive - If policy has $1 million death benefit, the viatical settlement would involve investor purchasing policy for more than its cash surrender value, but at a discount to the $1 million death benefit - Third party buyer then becomes policy's owner and pays any premiums due When insured dies, the investor collects the full death benefit of $1 million (so the sooner the insured dies, the higher the investor's yield). Until insurer dies, investor pays premiums and does not receive payment **Life settlements are sometimes pooled into "death bonds", where investors buy shares of a diversified pool of life insurance policies (as with individual life settlement, investor's profit depends on how long premiums must be paid on the policies versus how soon the death benefits in the pool are paid out to investors) RISK / downside - Not liquid (no secondary market exists for these alternative investments) - No annual return is offered (unlike bond investment) - Unpredictable because no one can accurately predict when someone will die ADVANTAGE - Provides diversification - Not taxable (so gain made upon payout is tax-free, b/c death benefits are not taxable)

An investor sells short 100 shares of ABC at $50. To protect against an increase in price, which of the following strategies would you recommend? A. buy a put B. sell a put C. sell a call D. buy a call

D. Buy a call Word protection means the investor has to buy an option. If he is concerned about his purchase price, he buys a call, which gives him the right to purchase the stock at a strike price. Maybe he is wiling to risk having to repurchase the stock at $55 but not a penny higher. Therefore, he buys a Sep 55 call for $2 If using a T-chart, Credit column (in-money) = $50 per share Debit column (out-money) = $2 per share Break even = market price of $48. Why? We see $50 in the credit column, and $2 in the debit column. Therefore, SP - Premium would equal $48. Is he breaks even, is his gain unlimited? No. Short sellers never have unlimited gain, as the stock can drop no further than zero. His maximum gain is from his breakeven down to zero (meaning $48 per-share, or $4,800 total) **Short sellers face unlimited loss, but this investor bought a call for protection. He has the right to buy the stock price for the strike price of $55 per-share, even if it rises to $100. If he exercises his call, his T-chart would show that $50 came in when he sold short, while $57 went out (when he bought the stock at $55 after buying the call at $2). That is a loss, but only a loss of $7

Jimmy Joe purchases 100 shares of QSTX for $50/share. Mr. Joe is bullish on QSTX for the long-term but is nervous about a possible downturn after next week's earnings announcement. To hedge his risk and get the best protection, which of the following strategies would you recommend? A. sell a call B. buy a call C. sell a put D. buy a put

D. Buys a put There are two bearish positions he could take to bet the other way. He could sell a call, but if the question wanted you to recommend that strategy, it would have said something about "increasing income" or "increasing yield". Because question asked to "get the best protection", he buys a put (has the right to sell his stock for a minimum price no matter what happens on the secondary market) The investor bought the stock for $50. Let's say he buys a QSTX Mar 45 put @2. That means he has the right to sell the stock at $45, even if it drops well below that price. If that happens, he realizes his maximum loss of $7 per-share, of $700 total (in the T-chart, we would put $50 and $2 in the money-out column, and $45 in the money-in column). His maximum gain is still unlimited. And his breakeven is $52 b/c after buying protection for $2/share, the stock will have to make that up before he is even

Money market instruments

Debt obligations of large corporations and governments with an original maturity of one year or less (T-Bills and bank CDs are these types of financial instruments) Appropriate for investors with short time horizon (e.g. investor planning on buying a house in next 6-9 months) E.g. anticipation notes, commercial papers

Debt Statement (GOs)

Debt statement gives the amount of general obligation debt that the issuer is fully responsible for and the debt it is partially responsible for (net overall debt = direct debt + overlapping debt) This is also used in the analysis of GO debt and it includes the estimated full valuation of taxable property, the estimated assessed value of property, and the assessment percentage. To evaluate the municipality's debt structure, an analyst calculates "total debt", the sum of all bonds issued by the municipality, and subtracts "self-supporting debt" from this figure. Although revenue bond debt is included in total debt, it is backed by revenues from the facility it financed and is not a burden on the municipality's taxpayers. The result is the municipality's "net direct debt", which includes GOs and short-term notes issued in anticipation of taxes or for interim financing. To net direct debt, the analyst adds "overlapping debt".

LEAPS (long term equity anticipation securities)

Derivative options with expiration dates longer than one year (up to 3 year maturities currently; 12-39 months) [Ordinary options expire in nine months or less] **Because of the extra time on the contacts, premiums here are much higher than those on similar ordinary options "So, if predicting where common stock will close a week from next Friday is hard, imagine buying this contract that involves predicting where it will close thirty-eight months from next Friday?"

Leveraged inverse ETFs ("ultra-short fund")

Designed to bet against an index, and most funds do so at 2 or 3X multiplier by using derivatives This means that a leveraged inverse ETF moves in the opposite direction of the index by a factor of 2 or 3 (e.g a 2X leveraged inverse fund is designed to rise 10% if the index drops 5%)

Subscription rights

Determine how many shares an existing stockholder can buy and at what price in the case of a new stock issue Works like a coupon, allowing current shareholders to purchase new stock below market price. Company's investors can use these rights, sell them or let them expire (so a security) For instance, if the stock is trading at $20/share, existing shareholders can perhaps take one right plus $18 to buy a new share (the rights give current shareholders two dollars off the market price)

Difference between CMO and REMICs

Difference is that REMICs offer mortgage pools separated into different risk classes not just different maturity classes

Mutual Fund Prospectus

Discloses: - investment objectives (e.g. does it only invest in companies with outstanding stock > $5 bil or below? - does it employ fundamental analysis and look at balance sheet? or rely on technical analysis (trends, charts, etc.)? - investment policies (can it invest in assets outside the U.S., can it invest in companies not included in the S&P 500, can it invest in low-rated/unrated securities) - advisor/manager bios (typically includes manager tenure) - total return over one, five and ten years - Results after taxes have been figured in (any figures shown must clearly specify whether taxes or expenses have been factored into the figures displayed)

Zero-coupon bonds

Do not pay periodic interest; Sold at a discount and pay par value at maturity (the dif b/t par and discount equals the interest income) ** B/c no cash flow, their market prices are more sensitive to interest rates than income-paying bonds w same maturity Even though interest not received until end, it is still taxed annually (pay federal income taxed on accretion even though not received yet) - This tax liability, payable before money is received, can be called "phantom tax exposure"

Bond's nominal yield (coupon rate/interest rate/stated rate)

Does not change. Indicates the amount per thousand that the bondholder will receive as income Amount of interest rate depends on: - Solid credit history and solid cash flow of the issuer - Length of maturity (issuing company pays more to borrow for 10 yrs than for 3 mo) - If collateral is pledged (just like mortgages are offered at lower rates than unsecured borrowing through credit cards) ** Interest rates change with the economy, but for fixed-income securities, the rates don't change once the security is issued

Stock indexes

Dow Jones - Most famous is the Dow Jones Industrial Average (DJIA) - price-weighted, meaning that stock price itself determines weight a specific stock receives within index (so stock trading at $100/share has much higher weight than stock trading at $11/share) - lists 30 stocks (very exclusive) - Dow Composite = DJIA + Dow Jones Transportation Average and Dow Jones Utility Average ----> provides what is called a "blue-chip microcosm of the US stock market" S&P 500 - Like most indexes, it is market cap weighted (meaning value of the outstanding shares as of the close of trading). So price/share does not matter here for weight of stock compared to others in index - B/c S&P 500 contains such a large % of the major stocks trading on secondary market, its movement is considered representative of overall stock market - Lists all 30 stocks contained in Dow Neither Dow nor S&P 500 care if stock trades on NYSE or NASDAQ NASDAQ 100 - Represents 100 largest non-financial company stocks trading on NASDAQ (includes Facebook, Google, Microsoft, Amazon) Russell 2000 - Well-known small cap index * Bond indices also exist for bond investors who want to pay low management fees and engage in passive investing

GO credit analysis

Effects on rating - Because needs voter approval (conservative voters less likely to approve tax GO bond referendums) - Population trends (residents moving in or out, taking tax dollars with them?) - Economic growth (jobs coming in and out?) - Economic base (is economy dependent on one industry?) - Demographic (are residents affluent?) - ad valorem tax rates, etc. Analysts check - collection ratio (dividing taxes collected by taxes assessed) - debt statement (direct debt + overlapping debt = net overall debt) - debt limit ratio (+ debt per capita) - unfunded pension liabilities (amount that municipality has to pay its workers, etc. If very high, low credit rating because less likely to pay outstanding balance on bond) Any factor the reduces Debt/Value Ratio - Good Any factor that increases Debt/Value Ratio - Bad

Value funds

Equity fund investing in value stocks, which trade for less than the portfolio management team determines they are worth For ex, if they foresee turnaround, or feel investors are overstating company's short-term problems. - Any 10Q or disappointing headline can push market price of growth stocks down substantially, even if company is still profitable - Typically less volatile than growth funds because bad news is already priced into the stocks held in the portfolio - Capital gains = primary driver (over income/dividend)

Growth funds

Equity funds that focus on stocks that have potential for above-average growth compared to their competitors and/or overall stock market - Typically cost a lot compared to the profits they might or might not earn (so market price compared to earnings is high) - More aggressive than value - Capital gains = primary driver (over income/dividend)

Eurodollar Deposit

Eurodollars are dollar-denominated deposits held in foreign banks and thus not subject to Federal Reserve regulations. Very large deposits of eurodollars are held in banks in the Cayman Islands and the Bahamas. Money market funds, foreign banks, and large corporations invest in them because they pay a slightly higher interest rate than U.S. government debt.

AIR (assumed interest rate)

Expectation of performance in a variable annuity unit, which the annuitant chooses (e.g. if this rate is 5%, the subaccount investments are expected to grow at 5%) Combined with other factors such as the annuitant's age upon annuitization, spousal coverage options and the type of annuity coverage chosen, the AIR determines the monthly payment the annuitant will receive. Monthly worth of a variable annuity unit depends on the investment performance of the subaccounts compared to the expectation of performance (known as this rate): 1). If the returns are higher than the assumed rate, the units increase in value. 2). If returns are as expected, the unit value remains the same 3). If account returns are lower than expected, the unit value drops than what it was in previous month

Rights of Accumulation (ROA) (breakpoints in mutual funds)

Features of many mutual funds whereby a rise in account value is counted the same as new money invested for purposes of achieving a breakpoint ** If account value drops, only the amount invested is counted ** Has nothing to do with a letter of intent

Tax-exempt money market funds

Funds that limit their investments to tax-exempt municipal securities with maturities of 60 days or less

Venture capital (VC) firms

Goal = uncover the next game-changing company Typically focus on providing investments in early-stage companies (vs pvt equity), only open to accredited or institutional investors - Instead of using leverage (pvt equity), VC firms typically employ cash in exchange for shares of company's common or preferred stock - They usually make smaller investments in several companies, taking only minority ownership of stock (vs pvt equity which typically buy a company outright) - These investors know that most of their investments will be losses. So their return is made on only a handful of performers that do survive and thrive. - Their approach is much more hands-off than PGE Versus hedge fund, "which is more a portfolio of securities than a fund providing private investment capital to companies at various stages of their development"

Expiration of derivative options

Here, all options are either in-the-money or they expire worthless Most frequently, they expire worthless (representing maximum loss to the buyer and maximum gain to the seller) [Expiration for options based on common stock (equity options) is typically the third Friday of the month]

1035 exchange

IRS allows tax-free transfer of cash values between 2 LIKE policies (i.e. Life to Life, Annuity to Annuity, or Life to Annuity).

Letter of intent (breakpoints in mutual funds)

If investor does not have certain amount in fund to receive certain % breakpoint, investor could sign a letter of intent to indicate intention to invest X amount in fund over X amount of months (normally valid for up to 13 months) With this letter, the fund is charging the breakpoint % even though the amount deposited is not the cutoff amount yet **Until the intended amount has been deposited, the extra shares purchased are held in escrow (because every time a certain amount is deposited, it pays more shares than it would have if the breakpoint rate had not been applied). These extra shares held in escrow will be retained by the fund if the investor does not reach the intended investment amount *Can be backdated up to 90 calendar days to cover a previous purchase

Opportunity cost

If we pass up an investment opportunity to make 5%, our opportunity cost is 5%, and we need to do better than 5% with the opportunity we choose instead If we could have made 5% and end up making 7% with another investment, we made 2% better than our opportunity cost

Breakpoint sale

In mutual funds the dollar investment required to make the investor eligible for a lower sales charge (e.g. < $25k = 5.5% sales charge; $25k-49k = 5.0%; $100k+ = 3.0%; etc.) *Rights of accumulation apply *Mother and minor child in custodial account are seen as a combined investment in terms of achieving a breakpoint *Investment clubs do not qualify for breakpoints BREAKPOINT SELLING is a violation of FINRA rules (when agents encourage investor to invest a lower amount of money to prevent the lower sales charge offered at the next breakpoint). Also violation not to inform an investor that they are about to reach a breakpoint Taken into account: - $ invested - letter of intent - rights of accumulation - combination privilege

Option (derivative instrument) - series

Includes the important details of the contract (underlying security, strike price, expiration date) MSFT May 20 calls represent one kind MSFT May 25 calls represent another kind **But the class and the type are the same

Passive Income

Income from rental property, limited partnerships and enterprises in which an individual is not actively involved **This does not include income from securities or earned income from salaries, wages, bonuses, tips, etc.

To calculate first payment for a variable annuity in the pay-out stage

Insurance company uses following factors: - Account value (cost basis) - Age of annuitant (the older you are, the bigger the payment) - Gender of annuitant (women tend to outlive men) - Settlement option (e.g. life-only, period-certain, joint) Health is not factored into this, as its not life insurance policy

Variable Life Insurance (VLI)

Insurance contract that provides financial compensation to the insured's named beneficiary if the insured dies while the policy is in force. The insurance company guarantees a minimum death benefit as long as premiums are paid. The cash value of the policy is determined by the performance of separate accounts and is not guaranteed. - Involves "scheduled premium" (VERSUS flexible premiums of VUL) - Pay out the cash value/surrender if policyholder cashes in the policy, but value at the time of surrender will be unknown (if subaccount performed well, cash value may be higher than expected. But if dropped in value, cash value will have decreased) - Minimum or fixed death benefit is guaranteed (minimum referred to as the "floor"), no matter how market does (covered by insurance company's general account), but death benefit could increase depending on AIR vs subaccount performance - If premiums not paid or loans taken out against policy, then the benefit could be reduced or depleted Same fees for variable annuities apply: - M&E fee - investment management fees

Indexed annuity

Insurance product offering a minimum guaranteed rate of return (even if index decreases) and some participation rate in an underlying index (usually the S&P 500) Participation rate of 70% means that only 70% of the increase in index's value gets added to the rate of return (e.g. 10% increase in index means 7% increase in the investor annuity value) ** This does not count for dividends paid by companies in the index ** Usually have a cap (maximum amount that contract value can increase in one year) --> has purchasing power risk if cap is not up to pace with inflation rate **Insurance company bears the investment risk Less risky than investing directly in an index Goes into general account

Fixed annuity

Insurance product that promises a minimum rate of return to investor, in exchange for one large payment into contract or several periodic ones ** "Guaranteed" rate of return (i.e. backed by claims-paying ability of insurance company's investment accountS BENEFITS FOR INVESTOR - Insurance company bears all the investment risk * that's why it's important to check company's A.M. Best rating and history of claim payments before investing - Safe investment that promises to make dependable payments for remainder of investor's life (or as long as the agreement is for) RISK FOR INVESTOR - Does not offer high rate of return and has purchasing power risks Purchase payment = money collected from investor (has deductible fees) General account = where purchase payment gets placed

International funds versus global funds

International funds == invest strictly in foreign securities Global funds == invests in companies located and doing business anywhere in the world, including US Moving away from US investments increases political risk and currency exchange risk. - Political risk lower for developed markets (e.g. Japan, Singapore) and higher for developing markets (e.g. Brazil) - Currency exchange risk present across any non-US market (developed or developing) for US investors

Feasibility study

Investigation that gauges the probability of success of a proposed project and provides a rough assessment of the project's feasibility Includes an engineering report that focuses on design and construction of the facility, predicts how many people will use facility and projected user fee versus operating expenses

Capital risk

Investing in stocks, bonds, and mutual funds puts investors' invested capital at risk of loss. This is the risk of losing some or all of the invested capital Examples - When we buy U.S. Treasury bonds, we eliminate this risk - When we buy corporate bonds or common stock, we face this risk. - Investing in common stock presents significantly higher risk of this than investing in corporate bonds (but also higher potential return) Therefore, before investors assume capital risk, they typically establish a layer of financial protection

Variable annuity

Investor (i.e. annuitant) bears the investment risk, in exchange for potential higher returns [Versus indexed annuity -> no participation rate or cap So account has all ups and downs from stock market investment] **Goes into separate account (has investment options called subaccounts, which determine value of the contract) ** So purchase payment gets placed in one of more of the various subaccounts available to annuitant, and investment fees deducted from these subaccounts + M&E fee (e.g. 20% can be allocated to conservative income subaccount, 20% to growth subaccount, 60% to high-yield subaccount) During accumulation period, positive returns from subaccount investments are associated w increase value of accumulation units (but no rate of return is assumed during this period) --> these units get converted into annuity units when annuity phase commences ***Value of annuity units fluctuates, but number of annuity units is fixed **A.M. Best rating not key here Free-look period is 10 days Annuitants of variable annuities are permitted to vote their units on imp decisions - electing board of managers - changing investment objectives, policies - ratifying auditor/accountant

ADR (American Depository Receipts)

Investors can purchase stock in a foreign company in USD and through American stock exchanges (e.g. Toyota listed on NYSE in USD) Register with SEC and trades on markets in the U.S. as any stock would trade *These holders have the option to exchange it to the actual foreign currency they represent ** Present risks that any stock investment presents Additional risk: - Currency exchange risk (risk of investment loss due to fluctuation in currency values). A weak USD is better for the investor, but if yen weakens relative to the dollar (or dollar strengthens relative to the foreign currency), then investor is losing money [The bank that created this receipt typically retains stock's voting rights, but not always.]

Transfer agent (open-end fund)

Issues new shares to buyers and cancels the shares that sellers redeem Most are in the form of electronic files While the custodian receives dividends and interest payments from the portfolio's securities, the transfer agent distributes income dividends to the fund's investors - Often takes care of the reporting - Investors can purchase directly through them or through their registered representatives

Advance refunding

Issuing new bonds and depositing part of the proceeds of the refunding issue in an escrow account to cover debt service on the outstanding issue, more than 90 days ahead of the first legal call date on the existing bond issue. ** Here, an independent CPA issues a "verification report" to verify that the yield on the escrow deposit will be sufficient to pay off the outstanding or refunded bond issue - Held in sinking fund In a "crossover refunding" the promised revenue stream backing the prior issue continues to be used to meet debt service until the bonds are called with proceeds from the escrow account

Term Life Insurance

Life insurance that pays a death benefit if the policyholder dies within a specific time period but has no remaining cash value at the end of this time. - Individual pays premiums in exchange for a guaranteed death benefit payable to beneficiary(s) during specified term (after term, policy expires) - Policyholder can renew insurance, but usually means higher premiums since older and costlier to insure, but benefits will stay the same This type of insurance is cheaper than other policies, but does not build cash value and typically must be renewed at higher and higher rates [Traditional insurance policy where insurance companies bear all investment risk, through general account]

Open-end funds (known generally as mutual funds)

Like closed-ended mutual funds, these are collections of securities managed by a professional investment advisor. Unlike closed-ended, the trades of shares are done only through the open-end fund, and NOT with other investors throughout the day Mutual funds which will continually add to the number of shareholders in the mutual fund by issuing new shares. If you purchase shares in a fund, they will take your money and add to the fund's portfolio of assets. Sometimes open-ended funds stop selling shares to new investors when they grow too large to be managed effectively. **Industry typically refers to these as mutual funds, and other type usually referred to as "closed-end funds" specifically **Money invested by putting in a set amount of money, and not know exactly how many shares that amount would purchase until after purchase is done. In either case, investor here usually receives "full and fractional shares" rather than full shares (you can have 12.5 shares, which is half of a share) **DO NOT issue senior securities (which include preferred stock and bonds) Continuously marketed to investors (projections not allowed in sales pitches, websites, or print ads as per FINRA reg) Liability include short-term borrowing for purchasing securities or paying investors who have sold their shares Declaring dividends --> record date comes first chronologically, followed by the ex-dividend date, and then, finally, the payable date. These occur on three successive days Methods of distribution for open-end mutual fund shares are as follows: - Fund/to underwriter/to dealer/to investor - Fund/to underwriter/to investor - Fund/to investor

Forwards (derivative instrument)

Like futures, this is a derivative that specifies a price for a security for delivery at a specified future date Versus forwards: - They are not traded on an exchange - They are not standardized (given exchange standardizes this for futures and options) - They are side deals between two parties (i.e. don't have clearing houses to guarantee performance of every contract, such as margin requirements, settlement dates, etc.) --> therefore, "counterparty risk" to both players Advantages in trading these: - Flexibility to both sides of the contract (expiration date, size of contract, terms of contract, etc. are up to both parties as opposed to the standardized contracts available to derivatives on exchanges) **Some companies have a specific need for a type of derivative that may not be offered on the options or futures exchanges. In this case, they may structure a private derivate contract with another party, called a "forward"

Closed-end funds

Like open-ended mutual funds, these are collections of securities managed by a professional investment advisor. Unlike open-end mutual funds, their shares are traded on a stock exchange like ordinary stocks. Shares trade among investors on the secondary market Liabilities include senior securities they typically issue **Way money is invested is by buying a specific number of shares (he wants 100 shares, would pay whatever that cost) **These funds can issue bonds to investors, and can issue preferred stock and even common stock with > or < voting rights They use leverage by issuing preferred stock and, even, bonds. That means the owners of common stock rank below other investors when it comes time to pay the stated dividends and interest payments (Other way to say this is they use leverage by issuing senior securities). **Open-end continually issues new shares, but NOT here. Stocks here work like those of public companies (like Starbucks or Microsoft). To issue new shares, they conduct an IPO -- at which point a fixed number of shares exist. These stocks trade the same way any other share of common stock would (so market sensitive, market makers involved). - These shares can trade at a discount to their NAV or at a premium, depending on the supply and demand. Because market is not always liquid, discounts and premiums to NAV are more the rule than the exception - Can be purchased on margin (credit) and sell them short (which involves borrowing shares from a broker-dealer and selling them, with obligation to buy back or replace at some later date) -- if price drops, the investor buys them low after selling them first, and if price rises, the investor suffers a loss - NAV is calculated once a day after close of trading - Investor owns entire share, NOT "full and fractional" like open-end fund investors **These funds have board of directors, investment advisers, transfer agents and custodians but NO distributor - These stocks trade (usually on NYSE or NASDAQ) - Transfer agents here don't issue new shares or redeem them, but instead record changes in ownership of the fixed number of outstanding shares (the way they do for public companies)

Variable insurance products

Like variable annuities, variable insurance products do not guarantee contract cash values, and it is the policyowner who assumes the investment risk (placed in subaccounts selected by investor) By placing their policy values into separate accounts, policyowners can participate directly in the account's investment performance, which will earn a variable (as opposed to a fixed) return "The advantages of a variable life insurance over whole life insurance include the ability to invest some of the premiums in the stock market, which has historically enjoyed relatively high average returns and beaten inflation." ** A policy's cash value is tied to account performance, BUT death benefit is tied to actual performance versus AIR (just like with annuity units in a variable annuity). So if separate account grew, the amount by which it grew does not matter So if AIR is 6% and the account has 4% return, the cash value will increase due to positive return, but death benefit will decrease since the return rate is less than AIR - Variable policies make 75% of the cash value available to the policy owner as a loan after three years (and charge interest on that loan). Failure to repay that loan reduces cash value and death benefit - If loan taken out and subaccount value drops a lot, client may need to place money back in to keep policy in force Policyholder has minimum two years to switch to traditional whole life policy (original issue date retained) Variable insurance products are considered securities contracts as well as insurance contracts. Therefore, they fall under the regulatory arm of both state offices of insurance regulation and the Securities and Exchange Commission (SEC). To sell variable insurance products, an individual must hold a life insurance license and a Financial Industry Regulatory Authority (FINRA) registered representative's license [Investor can choose to invest some of the premium in fixed account to play it safe, and can switch among subaccounts]

Variable Rate Demand Notes (VRDN)

Long-term municipal bond which is offered to investors through money market funds. The notes allow a municipal government to borrow money for long periods of time while paying short-term interest rates to investors. As VRDNs are issued in a minimum of $100,000 denominations, smaller investors can only invest in VRDOs indirectly through money market funds. Because money market interest rates, such as the bank prime rate, are variable over time, the interest rate applicable to a variable rate demand note is variable as well. - Every time the prevailing money market rate changes, a variable rate demand note's interest rate is adjusted accordingly. Typically, the interest rate on VRDN is adjusted daily, weekly, or monthly to reflect the current interest rate environment. As the name implies, variable rate demand notes are payable on demand as they have an embedded put option. This means that the investor or lender of the funds can request a repayment of the entire debt amount at his or her discretion, and the funds must be repaid once the demand has been made. Depending on the demand feature affixed to these debt instruments, the investor may be required to provide a one-day or seven-day notification to tender the securities to a financial intermediary, such as a trustee or re-marketing agent. Because of the demand feature, the maturity date of a VRDN is considered to be the next put date rather than its final maturity date. - VRDN issuers employ credit enhancements through letters of credit (LOCs) from a highly rated financial institution, which serves as the liquidity provider of last resort, committed to supporting the timely payment of interest and repayment of principal on tendered securities. As long as the financial institution providing the letter of credit is solvent, the investor will receive payment.

Certificates of deposit (CDs)

Longer term deposits that pay a higher rate than a savings account Basically, a savings accounts that guarantee a depositor a set interest rate over a specified interval as long as the funds are not withdrawn before the end of the period—six months or one year for example - Cannot be resold - Typically pay compound interest There are long term CDs (20 yrs), but has significant risk if cashed in before maturity because you forfeit interest payments (so limited to no liquidity). Interest payment calculations here very complex

CBOE Rule 9.2

No member organization shall be approved to transact options business with the public until those persons associated with it who are designated as Options Principals have been approved and registered by Exchange. Persons engaged in management of the member org business are designated as Options Principals.

General partners (GPs)

Manage the program and must contribute at least 1% of capital. Unlimited liability (consequently, GPs are often a corporation, to provide individual controlling business protection of personal assets). - Involved in day-to-day management (b/c of this, they can also be compensated for their managerial efforts through a salary) - Has authority to acquire and sell property on behalf of business and sign documents on behalf of business (if they are required to carry out its management) - Must keep accurate books and records and must provide annual financial statements to the LPs - Is fiduciary to the LPs (so must maintain loyalty and good faith to investor). Interest of partnership must come before own, cannot charge a "non compete" payment, can't compete with partnership through some other venture, any conflict of interest must be disclosed to LPs (e.g. if he provides a loan to business, must inform LPs) - Can admit new LPs to partnership at their discretion - Responsible for filing the certificate of limited partnership with state where entity is organized

T-Bills

Mature in one year or less (most investors purchase 3- and 6- month maturities) Auctioned weekly They pay the face amount and investors try to buy them for the biggest discount possible As interest rates rise, their price falls, vice versa Minimum denomination is $100 (for all Treasury debt instruments) Downside **Interest rate risk Benefit **No Default risk/credit risk In a low interest-rate environment, the price we pay would be close to the face amount received in three or six months

T-Bonds

Maturities up to 30 years Pay interest every 6 months (semi-annually) Return principal with last interest payment Minimum denomination is $100 (for all Treasury debt instruments) Auctioned on scheduled dates throughout the year

Position limit

Maximum number of options contracts that a trader can have on the same side of the market (Bull/bear) and/or may exercise over a five-day period ** this applies "per class" (e.g.. all MSFT calls or puts) [Not all MSFT Oct 30 calls) Example: Having a standardized option with a position limit of 25,000 means that an investor cannot have more than 25,000 bull or bear positions in that option. If he buys 20,000 calls, he could write 5,000 puts

Purchase payments in annuities

Money collected by insurance company from investor, contributed to the annuity contract Usually the following are deducted: - sales charge - admin fee - state premium tax The purchase payments represent the investor's cost basis when calculating payment

Whole life insurance

Most common type of permanent insurance, guarantees death benefit Premiums (which remain level) are higher than in temporary/term insurance, but insurance company here guarantees minimum cash value with whole life insurance, even if policyholder stops paying into policy (versus term life, which is cheaper but after a few years has no cash value) --> so here, policy can also be used as a savings vehicle Policy holder can take out more of the cash value for loans than variable insurance policies (75% max) Has purchasing power risks due to inflation [Traditional insurance policy where insurance companies bear all investment risk, through general account]

Equity funds

Mutual fund that invest primarily in common stocks Includes: - Growth funds (most volatile) - Value funds - Blend fund - Equity income fund (least volatile) - Growth and income fund (medium volatile)

Bond funds

Mutual funds that invest primarily in bonds (fixed-income) - Maturity dates will depend on investor's time horizon. - Bond type will depend on risk tolerance (US Treasury funds or high-yield corporate bonds) *For investors not in high tax bracket or investing in an IRA, 401(k) etc., agents recommend taxable bond funds *For investor in taxable account wanting to earn federal tax-exempt interest, the agent might put her into a tax-exempt bond fund, which purchases municipal bonds *For investor in high-tax state, agent can sell tax-exempt bond fund specifically for residents of her state *Type of issuer here will depend on risk tolerance (low risk, probably focus on issuers with high credit ratings; high risk, probably focus on high-yield tax-exempt fund)

Specialized funds

Mutual funds that specialize in a particular industry, geographic region, etc. E.g. investors can buy Latin America, Canada, or the Pacific Basin fund - Risk that region may suffer from economic slump or natural disaster - Because this is non-diversified, higher volatility Other examples: - Sector fund - Asset allocation fund - Balanced fund - Target funds - Global fund - International fund - Precious metals fund - Index fund

Trading derivative options

Often buyers trade contracts, or seller buy them back **To avoid exercise, seller of an option can close/trade the position for its intrinsic value (to calculate intrinsic value, compare higher market price to the strike price) To close an option --> if he sold the option, he buys it back to close; if he bought the position, he sells it back to close If a seller of a MSFT May 90 call closes the position when MSFT common stock trades for $92 at expiration, he pays the intrinsic value of $2/share to close each contract (so same thing to say seller does this "at expiration" or "for the option's intrinsic value") At expiration, there is no time value on any option, as there is no time left. So same as saying a call seller closed the contract "for the option's intrinsic value"

Government-sponsored enterprises (GSEs)

Organizations created by the federal government to help increase loan opportunities to specific sectors of the American economy - privately owned but publicly chartered organizations - created by Congress but not guaranteed by US Gov't. GSEs (e.g. Fannie Mae and Freddie Mac) - not direct obligations from government e.g. Farm Credit System (FCS) created in 1916

Par value of a bond

Original value of a bond when it was first issued - Amount the bond issuer agrees to pay at maturity (or redemption) and the amount on which cash interest payments are based; also called face amount or face value of a bond. Par value is also called face value, and that is its literal meaning. The entity that issues a financial instrument assigns a par value to it. When shares of stocks and bonds were printed on paper, their par values were printed on the faces of the shares. (versus market value, which depends on supply and demand, interest rates, bond's credit status, etc.)

REITs (Real estate investment trusts)

Owns a portfolio of properties and sells shares/publicly trades this portfolio to investors (can own apartment buildings, office buildings, shopping centers, hotels, etc.) - Open to retail investors Equity REIT - Losses not passed onto investors (only for real estate partnerships) - Investor does not need to be wealthy - Liquid since investor does not own physical property - Typically pay very high dividend yields (but taxed at ordinary income rates versus lower rates on qualified dividends)

POP (mutual funds)

POP = NAV + Sales Charge To calculate the sales charge as a percentage of the POP, use this formula: (POP - NAV) / POP **Note - sales charge is expressed as a percentage of the POP, not the NAV (so "gross amount invested" as opposed to "net amount invested)

Government-assisted housing programs

Partnership that builds, acquires or rehabs a government-assisted housing project - Benefits from tax credits and possibly subsidies from gov "Alternatively, a local government might provide tax credits to a partnership that does historic rehab or repurposing of former train stations or water-pumping stations into shopping or restaurant districts, for example" Benefit is the tax credits TAX CREDIT BETTER THAN TAX DEDUCTION OF AN EQUAL DOLLAR AMOUNT

Limited Partners (LPs)

Passive investors with no say in managerial decision and contribute a large amount of capital. Limited liability (only their investment is liable) - Creditors cannot generally come after LP's personal assets if business goes bankrupt (but all types of lawsuits can be filed against them, just personal assets aren't at risk) - No duty to refrain from owning businesses that compete with partnership - Partnership democracy gives them voting rights on major decisions - They can extend loans to the partnership (some of the capital LPs provide the partnership can be through debt securities)

PAC

Planned amortization class Associated with a plan, so offers more protection to CMO securities in this class against prepayment and extension risk "Support class" created to protect prepayment risk

Fund of funds

Portfolio comprised of several of a fund family's mutual funds - Associated with higher fees

Balanced fund

Portfolio is always balanced between stocks and bonds, generally diversified among the differing types of each Similar to asset allocation fund

Cumulative preferred stock

Preferred stock on which undeclared dividends accumulate until paid; common stockholders cannot receive dividends until cumulative dividends are paid. E.g. if company missed 6% dividend per share one year, must pay 12%/share the next year to these investors before company can pay dividends to its common stock owners

Short-swing profits

Profits made by corporate insiders (affiliates) during a period of less than six months between purchase and sale. If this is done, profit must be surrendered to the company with the gain taxed via the IRS

Mortgage REIT

Provide financing for real estate projects as opposed to just buying up and managing properties - Provide financing as well as buying up mortgages and mortgage-backed securities

Joint-with-last-survivor settlement option

Provides the smallest monthly payout because company obligated to make payments, provided the annuitant or its beneficiaries are still alive Expensive for insurance company because has mortality risks for more than one person

Negotiable CDs ("jumbos")

Purchased in denominations ranging from $250k to several mils - Negotiable because investors can sell them - Not fully insured by FDIC (so higher yields)

Covenants in an indenture

Rate covenant = raising user fees if needed to service the debt Maintenance covenant, insurance covenant = Properly maintaining and insuring the facility Financial reports and audit covenant = Subjecting the project's finances to an outside audit Nondiscrimination covenant = promises that everyone, including local politicians and their guests, must pay user fees Catastrophe call = in case of external events like hurricane, bond issue will be called, assuming the facility is insured

Income Bonds (Adjustment Bonds) - bankruptcy

Repay principal but pay no interest unless the issuing company is profitable ** This bond type is usually issued by a company coming out of bankruptcy and usually offers high coupon to compensate for uncertainty

Revenue bond analysis

Revenue bond analysts look at whether facility will be able to generate enough revenue to maintain its operations and pay back bondholders their interest and principal (debt service) Variables analysts look at - Feasibility study - Debt service coverage ratio (depends on whether net revenue pledge or gross revenue pledge)

Special assessment bonds

Revenue bonds where debt service is payable from the assessment on the benefited property (users of sewer, lighting, electricity districts) e.g. wealthy neighborhood - homeowners want sidewalks fixed, so they pay a special assessment on their properly to finance the improvement

Tranches

Risk maturity dates into which a COLLATERALIZED MORTGAGE OBLIGATION (CMO) are split. For example, the typical CMO has A, B, C, and Z tranches, representing fast pay, medium pay, and slow pay bonds plus a tranche that bears no coupon but receives the cash flow from the collateral remaining after the other tranches are satisfied. Tranche A receives principal first (so has highest prepayment risk of all tranches) Z-tranche behaves like a zero-coupon bond inside a CMO: returns principal (& accrued interest) only after tranches A-C are paid off/retired Basically, bonds that offer different rates of interest, repayment schedules and levels of priority for principal repayment (here, investors can choose the yield, maturity structure, and risk level that best suits them)

RISKS FOR INSURANCE COMPANY

Risk of rising expenses --> charge an expense fee - For life insurance, investor dies soon afterward - For annuity, mortality risk (annuitant lives v long life) --> charge mortality risk fee to cover this risk Charges: - They charge M&E fee - For variable annuities, charge investment fees - Charge contract fees (can add as much as 1% to contract's annual expenses)

Natural event risk

Risk that an external event could have a negative effect on securities or securities markets, because it would have an effect on a country's economy or possibly the economy of an entire region E.g. tsunami, earthquake, hurricane, pandemic (none of these risks would concern the quality of product /service or management skills of the company, but would nonetheless affect the price) ** Does not fit neatly under either systematic or unsystematic risks - While a tsunami would have a negative impact on markets overall, many weather-related events hit certain sectors or issuers only, an example of unsystematic risk (e.g. some weather conditions would affect certain crops, for example Florida frost primarily impacts orange juice) - Also, some industries do better after natural disasters (e.g. mold remediation, construction, disaster recovery do better after a flood or hurricane)

Currency, Foreign Exchange Risk

Risk that changes in the relative value of certain currencies will reduce the value of investments dominated in a foreign currency - Therefore, value of USD relative to foreign currencies is a risk to both int'l and emerging-markets investors **America investors are typically harmed when the value of the dollar strengthens relative to foreign currency in whatever country they currently invest Risk that comes with investing in foreign markets, emerging or otherwise, or ADRs

Interest rate risk

Risk that interest rates will rise, pushing down the market prices of bonds and other fixed-income securities FOR BONDS: - When rates go up, all bond prices fall, but long-term bonds suffer the most - When rates go down, all bond prices rise, but long-term bonds increase the most, regardless of issuer **Therefore, a 30-year gov bond has no default (credit) risk, but carries more interest rate risk than a 10-year corporate bond - Believe it or not, investors could lose money even on guaranteed US Treasury Bonds if they were to sell after interest rates had risen (so although Treasury Bonds and bank accounts are both guaranteed by the fed government, T-Bonds have fluctuating market values due to interest-rate sensitivity, while the bank accounts are just "money in the bank" and instead have purchasing power risk/inflation risk) - The reason investors invest in short-term or intermediate-term bond funds is because they want to reduce interest rate risk (in addition to maybe having a shorter time horizon, which would mean they cannot risk a drop in market value due to a sudden rise in interest rates) - Here, they sacrifice the higher yields of longer-term bonds, but can sleep better knowing that possible rise in interest rates will not be as damaging to their invested capital FOR PREFERRED STOCK - Especially if it is perpetual - This is even more sensitive to a rise in interest rates than many bonds, because bonds approach maturity more closely every day REDUCING THIS RISK - Common way is to build a bond ladder (A security sensitive to this type of risk is referred to as interest-rate sensitive)

Exploratory programs (for oil and gas) (DPPs)

Riskiest types of DPPs but also have the highest potential ROI The act of exploring for oil is something called "wild-catting", which provides a hint of the risk/reward nature ** This generates intangible drilling costs (IDCs) -> these are paid out (versus capitalized costs sunk into the oil rig and other equipment), leaving no tangible assets such as oil rigs to show for them - IDCs include labor costs, expenses of geological survey (to indicate potential oil or gas below) - Provides most effective tax shelter (b/c IDCs are so high in first few years) -> this means that net losses received from program can be used to offset certain income he would otherwise be taxed on for the year ** Take depreciation expenses on tangible costs (like drilling equipment owned), which may also provide tax shelter to owners

Exercise limits

Same numbers used for position limits are used here. For ex, if the option is subject to a 25,000 exercise limit, this represents the maximum num of open bull or bear positions a trader can have at one time on a class of options and the maximum number of contracts he can exercise over five consecutive business days

Agency bonds

Securities issued by various agencies and organizations of the Federal government; Most aren't guaranteed by US Government explicitly, but it is implicit; - Federally related institutions that are owned by the US Government and are exempt from SEC rules and are guaranteed by US Gov't; E.g. Ginnie Mae, Small Business Administration (SBA) and Federal Housing Administration (FHA) are guaranteed against default like Treasury securities - Government sponsored enterprises (GSE) are privately owned but publicly chartered organizations and were created by Congress but not guaranteed by US Gov't. GSEs (e.g. Fannie Mae and Freddie Mac) are not direct obligations from government

Fixed-income securities

Securities such as bonds, notes, and preferred stocks that offer purchasers fixed periodic income. Anyone receiving a fixed income recognizes that the market will re-price their investment whenever interest rates move. The risk is that, when interest rates rise, the market price of this security will drop.

Leveraged ETFs

Seek to deliver multiples of the performance of the index or benchmark they track. Uses derivatives to increase a fund's exposure to its underlying index Some funds are called "2X" (or exposed to the index in a way that doubles gains or losses) Some are even called "3X" (triple the exposure to the index, so triple gains (or losses) to investors) **Leveraged funds are only suitable for short-term investment (2X and 3X returns are re-set each day, so they capture the return trends only for one day) **These products are designed only for institutional or otherwise sophisticated investors due to complexity and amplified exposure to stock, bond or commodities markets

SEC Rule 144

Sets requirements for selling restricted and control securities 1.) Issuer must have been a reporting company (subject to 10Qs and 10Ks) under Securities Act of 1934 for at least 90 days before sale 2.) Issuer cannot have missed filing of any of the reports it was required to file during 12 months preceding sale Affiliates: - Regardless of whether stock is restricted or controlled, affiliates must file a Form 144 with the SEC no later than the actual time of sale. Filing good for ninety days (unless transaction is less than 5,000 shares and $50k, which means sale can be made without filing a Form 144) - If its an exchange-traded security, affiliate can sell the stock as long as it is no more than the greater of 1% of the outstanding shares or the avg weekly trading volume over the 4 most recent weeks. If stock is traded on OTCBB or Pink Quote, only 1% of outstanding shares can be traded - Sale must be handled as routine trading transactions, and brokers may not receive more than a normal commission (neither seller or broker can solicit orders) - Can never bet against the company's stock by selling it short

Commercial paper (corporate)

Short-term unsecured debt issued by large corporations a short-term corporate IOU with a typical maximum maturity of 270 days (sold at discount, instead of paying interest)

Shareholder voting (open-end mutual fund)

Shareholders vote on the following: - changes in investment policies - approval of investment advisor contract - approval of changes in fees - approval and discontinuation of 12b-1 fees - election of board members - ratification of independent auditors Funds forbidden to do the following without obtaining majority vote of outstanding shares: - change from open-end to closed-end fund, vice versa - change from diversified to non-diversified, vice versa

Selling in open-end mutual fund (known as REDEMPTION)

Shares are not traded, but rather sold back to fund in a process called "redemption". When doing this: A-share == investor receives NAV B-share == investor receives NAV minus back-end load (i.e. sales charge) Shareholders can redeem shares through any of the following: - Contacting registered rep - Writing to the fund company - Telephoning or faxing fund company - Via fund company's website **Systematic withdrawal plans can be set up **Some open-end funds charge a redemption fee during first year to encourage holding investment long term (this fee not a back-end sales charge but rather a penalty) **Fund company reserves the right to receive "signature guarantee" on any redemption (i.e. official stamp that officers of a bank can put on the required paperwork, and is a common requirement when stock is being transferred or sold)

Age-based portfolio

Shift allocation from mostly-equity to mostly-fixed income (more conservative) gradually as investor nears retirement goal Also can be - Lifecycle funds - Target funds (e.g. educational savings funds (like a 529 Plan), where investing is much more aggressive when they're children and becomes more conservative for students aged 18+). ** target funds could be an investor in mid-40s saving for retirement, choosing the Target 2045 Fund (more stocks than bonds). If investor is in 60s, would most likely choose instead the Target 2025 Fund (more bonds than stocks).

Anticipation notes (municipal)

Short-term debt obligations of a municipality held primarily by tax-exempt money market mutual funds - Cities and school districts borrowing over the short term employ "anticipation notes". By issuing this, a city that will collect taxes in a few months can receive and use those funds immediately instead of waiting those few months Types: TANs = tax anticipation notes BANs = bond anticipation notes RANs = revenue anticipation notes TRANs = tax and revenue anticipation notes

Repurchase agreements (repo)

Short-term loans (usually have a maturity of less than 2 weeks) for which Treasury Bills serve as collateral. The repo, or repurchase agreement, is part of the overnight lending money market. - Treasury bills or other government securities are sold to another party with an agreement to repurchase them at a set price on a set date. **A dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price.

Annuity

Sold by insurance companies, part of individual's retirement plans A fixed sum of money paid to someone each year, typically for rest of life - Promises minimum rate of return; or - Allows investor to allocate payments to various investment accounts Annuitant buying options: "single premium" (single payment) or "periodic payment" - Annuities exist first in an accumulation phase, whereby investors fund the product with either a lump-sum or periodic payments. - Once the annuitization phase has been reached, the product begins paying out to the annuitant for either a fixed period or for the annuitant's remaining lifetime. - Annuities can be structured into different kinds of instruments - fixed, variable, immediate, deferred income, that give investors flexibility. - Illiquid (during surrender period there's a fee to withdraw) Very expensive products: - Has many fees (M&E fee, investment fee, contract fees). For this reason, more expensive than investing in mutual funds - Annuities are ideal for those who have maxed our their IRA and company-sponsored 401(k) BENEFIT - Tax-deferred growth ** investor must be 59 1/2 years old to avoid paying 10% tax penalties on withdrawals, which is why deferred makes sense for younger investors

CBOE VIX

Sometimes called "investor fear gauge", "fear index", "fear gauge" or "volatility index" A trading instrument related to the market's expectation fo future volatility A key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices **Considered to be the world's premier barometer of investor sentiment and market volatility So the S&P 500 and the VIX move opposite one another, although not a perfect one-to-one relationship (~80% of the time, one moves up when the other drops, vice versa) **A high value of the VIX is not necessarily a bearish indicator for the stock market, b/c expected market volatility over the next 30 days could be pointed in either a bullish or a bearish director -The highest VIX readings occur when investors overall anticipate large price moves in either direction - A low VIX value would imply that investors expect little movement in the overall stock market [Proper name is Chicago Board Options Exchange Market Volatility Index]

Pooled Investment Vehicles

Sometimes called "packaged product" or "mutual fund" Investment companies that pool capital of many investors together for common portfolio management. Include mutual funds, depositories, and hedge funds. The investor's ownership interests are referred to as shares, units, depository receipts, or limited partnership interests. - Mutual Funds - Exchange-traded funds (EFTs) & Exchange-traded notes (ETNs) - Asset-backed Securities - Hedge Funds

PHA (Public Housing Authority) and NHA (New Housing Authority) bonds

Sometimes referred to as "Section 8" bonds Municipal revenue bonds issued to raise money for housing projects. Debt service is backed by rental payments, which are in turn backed by federal government because falls under HUD **Considered the safest municipal revenue bond type because guaranteed by federal gov Not backed by issuer's full faith and credit

Structured products

Specialized financial instruments that are customized for specific investors, created and sold by financial intermediaries with terms that are mutually agreed upon by both parties

Control stock

Stock acquired by an affiliated person such as an officer or director Basically, stock held by an investor who can control the issuer or could harm the market price by selling large amount of stock - Not subject to a holding period, but affiliate cannot take a profit on its company's stock that it held for less than 6 months If selling more than 5,000 shares and $50k worth of control stock, affiliate must file a Form 144

Stock rights

Stock rights are instruments issued by companies to provide current shareholders with the opportunity to preserve their fraction of corporate ownership. A single right is issued for each share of stock, and each right can typically purchase a fraction of a share, so that multiple rights are required to purchase a single share. The underlying stock will trade with the right attached immediately after the right is issued, which is referred to as "rights on." Then the right will detach from the stock and trade separately, and the stock then trades "rights off" until the rights expire. Rights are short-term instruments that expire quickly, usually within 30-60 days of issuance. The exercise price of rights is always set below the current market price, and no commission is charged for their redemption.

Participating preferred stock

Stock that allows the preferred stockholder to participate in the profits of the corporation along with the common stockholders. "A type of preferred stock whose dividend rate is fixed as to the minimum, but not as to the maximum"

Private equity (PGE)

Structured as a partnership, open only to sophisticated investors, invests in securities that are not publicly traded After appointing their own managers and board members, they improve the acquired company's profits, possibly generate some positive media buzz and then perhaps approach investment bankers to conduct an IPO so they can cash in - These funds are typically set up for a fixed period (perhaps 10 years?). After that, investors receive their money back in addition to - they hope - a profit - Leverage associated with private equity groups (whose acquisitions are often referred to as leveraged buyouts) Versus hedge funds, which trade a portfolio of securities, private equity funds typically purchase companies, improve them, and sell them to larger investors for a profit Versus VC firms: - Less risk of failure - Direct management: pvt equity plan to install new management and run the company for a while

Suitability requirements for DPPs

Suitability standards must be created by program for participants and fully disclosed in prospectus Broker-dealers cannot recommend DPP unless: - participant has financial position to realize significant extent the benefits in prospectus (including tax shelter) - Participant has fair market net worth to sustain risks (like loss of investment or lack of liquidity) **If the DPP can trade among investors, these rules are somewhat relaxed

TAC

Targeted amortization class For CMO security investors - offers some protection against prepayment risk but not against extension risk "Support class" created to protect prepayment risk

Partnership democracy

Term referring to a limited partner's right to vote in certain matters of major importance.

Cash value

The amount of money saved in a whole life policy that the policyholder can take by either borrowing against or cashing in the policy For whole life insurance, policyholder may withdraw/borrow part of cash value == termed as partial surrender ** This reduces contract value, which involves interest charges (interest is either repaid, or it reduces the death benefit and cash value of contract)

Intrinsic value of a put option

The amount of money that a put's strike price is above the stock's market price E.g. an October 40 put has how much intrinsic value when the underlying stock trades at $30? Answer: $10

Death benefit

The amount payable to the beneficiary upon the death of the insured minus any unpaid premiums or loan balances

Net revenue pledge

The more common method used by the issuer of a revenue bond in which the operations and maintenance are covered before debt service (vs gross pledge)

Record date

The date when the company determines ownership of outstanding shares for dividend purposes Shareholders who properly registered their ownership on or before the record date (or "date of record") will receive the dividend. Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date.

Ex-date (ex-dividend date)

The day on which all shares bought and sold no longer come attached with the right to be paid the most recently declared dividend ** Prior to this date, the stock is said to be cum dividend ("with dividend")

The payable date

The day when the dividend checks will actually be mailed to the shareholders of a company or credited to brokerage accounts. three or four weeks after the record date, the dividend disbursing agent sends dividend checks to all stockholders whose names appear on the books as of the record date

Millage rate

The dollars of tax per $1,000 of property value. For example, a millage rate of 20 means that a person owning a property having an assessed value of $100,000 would pay 20 × 100, or 100,000 x 0.02 = $2,000 in tax. For example, a millage rate of "9 mills" means assessed value of $200,000 is multiplied by .009 to get tax bill of $1,800. The tax goes to support many dif overlapping municipalities (e.g. water district, park district, school district, library and museums)

Liquidity

The ease with which an asset can be converted into cash

Bearer form

The form of bond issue in which the bond is issued without record of the owner's name; payment is made to whomever holds the bond certificate "A bearer form security is an investment that is not registered in the issuing corporation's books and is payable to the person possessing the stock or bond certificate."

Betas (measuring investment risks)

The higher the beta of a stock, the greater the market risk faced by an investor in that security Beta = the measure of relative volatility Examples: - A beta of 1.3 = stock is 1.3x more volatile than the S&P 500 -- which is already volatile - A beta of .8 means the stock is less volatile than S&P 500 -- only 80% as volatile **Investors following modern portfolio theory and its related tenets believe this is the only type of risk an investor should expect to be compensated for taking. Why? Because this type of risk is "non-diversifiable", so the more of this risk it takes, the higher the potential return (versus unsystematic risks can be diversified and thereby reduced)

Puts (derivative option)

The holder/owner/buyer ("bearish") has the right to sell this underlying stock at strike price, regardless of what it's worth in the open market, before expiration An investor who thinks a stock is about to drop in price purchases this derivative option. The value of the option rises as the underlying stock's market price drops below the strike price Example -> owner of 100 shares IXR Oct 40 - Means the owner can sell 100 IXR stock at $40/share any time before expiration, even if its worth only $2/share on open market EXAMPLE SELLER Someone bets Pepsi is such a great stock, it could not possibly fall below $70/share in the next nine months. He is so confident of this, that he will take a bet with anyone who says the stock is a loser. Those betting against him have to pay $200, but gives them the right to sell him 100 shares of Pepsi for $80, no matter how low it goes in the next nine months. So even if the stock goes to zero, you can sell him 100 shares for $70 each. If those betting against him lose, then they lose part or all of their premium

Political risk

The likelihood that political forces or instability will cause drastic changes in a country's business environment that will adversely affect the profit and other goals of a particular business enterprise. REDUCING THIS RISK - Only way would be to limit an investor's exposure to emerging markets BENEFIT - Although high risk, could protect US investors against a down year in the domestic stock market (even if the S&P 500 drops, companies in Brazil or China may do well and take their related stock markets up with them) Emerging markets are countries or regions with immature and unpredictable financial markets Example - Risk of investing in China, for ex, can be that Chinese gov decides to remove capitalism and seize the companies whose shares investors used to own --> which would constitute a total loss - Risk that transition from communism to capitalism in a country does not go well, which can cause whole country to shut down with riots in streets and gov tanks rolling in --> also could be total loss

Common stock

The most basic form of ownership - Do not receive interest payments, but are rather part-owners of a company (ROI depends on profitability of company) Represents ownership of a percentage of company's profits (as profits grow, so does investment). If profits large enough, some of it may be paid as dividends Advantages for investors: - Limited liability (shareholders lose no more than they invested; assets not attached to company, for ex in case of bankruptcy; lawsuit against company is not an action against shareholders) - Shares can be sold or transferred - Access to info - Voting rights on major issues (statutory or cumulative). Some companies issue non-voting common stock -- here, owners have equal footing in terms of dividends received. Rare because this is not preferred by institutional investors and many exchanges refuse to list company stock if they don't allow voting - Preemptive rights (shareholder rights to buy additional stocks of company at a discounted price)

Cost basis

The original value of a purchased asset, usually the purchase price Basically, the total amount originally invested, plus commissions/fees involved This is used for tax purposes because tax is due based on the gain in value of an asset. EXAMPLE If a person buys a rock for $20, and sells the same rock for $20, there is no tax, since there is no profit. If, however, that person buys a rock for $20 and then sells the same rock for $25, then there is a capital gain on the rock of $5, which is thus taxable. The purchase price of $20 is analogous to cost of sales.

Annuity phase (annuity period)

The payout period of an annuity during which the annuitant receives periodic income payments. - This is a new phase after the accumulation period ends - In this phase, payment period begins in what is known as "annuitizing" the contract

Strike price (exercise price)

The price at which an option (derivative type) holder buys or sells a share of stock (underlying asset) when the option is exercised, dependent on whether market price goes above the strike price If underlying stock trades above the strike price of the call, the call is IN-THE-MONEY Example: A MSFT Aug 70 is in-the-money as soon as it trades above $70/share. If its trading at $73/share, an Aug 70 call is in-the-market by $3

The time value of a call option

The price the buyer of an option pays to the seller that is in excess of the value of the option if it were immediately exercised The difference between an option's price (or premium) and its intrinsic value. **If the call is in-the-money, the time value attached to the call = Premium - intrinsic value **Whenever a call is at- or out-of-the-money, the premium represents time value only **Time value exists because an option could become more valuable given the amount of time left before expiration Because time value decays, only having this value favors the seller of the option. Sellers love to collect a lot of time value, knowing that time works against the buyer of the contract - especially as the expiration date nears

Yield to Call (YTC)

The rate of return earned on a bond when it is called before its maturity date (its the amount that the bondholders receive, based on the issuer's stated price of its bond and how quickly it is received by the bondholders) **This factors in the coupon payments plus or minus the amount gained or lost between the current time and the first call date Background on call: **In a call or early redemption of a bond, the bond issue could be retired early by the issuer

Legislative or regulatory risk

The risk that changes to industry regulations or the tax code could negatively effect the value of an investment - Not all industries are harmed by increased regulations (e.g. some regulations can lead to higher demand for certain industry, like consultants specialized in health care regulations; when tax code becomes more complex, demand for CPAs will increase) E.g. announcement by the fed gov that all large SUVs and pickup trucks must get 35 mpg by the following year, which would probably depress the value of certain stocks and bonds issued by automotive companies (e.g. Ford, GM) E.g. If tax-exempt municipal bonds are no longer tax-exempt, investors could rush to sell these bonds and drive down their market price

Credit/default risk

The risk that a company will be unable to pay the bond's face amount or interest payments as it becomes due. ** Defaults are rare events - US Treasuries have little or no default risk, but some municipal securities and most corporate bonds carry at least some of this risk - Even if an issuer never misses a payment, if S&P and Moody's downgrade its credit score, the market value of its bonds will also drop REDUCING THIS RISK (tradeoff is receiving lower yields) - Limit exposure to junk bonds - Invest exclusively in US Treasuries

Liquidity risk

The risk that an asset cannot be sold on short notice without incurring a loss, due to a lack of buying interest or otherwise (thinly traded securities have these risks; whereas securities with more active secondary markets are liquid) Liquidity is the ability to quickly turn an investment into cash without having to sell at a loss - Government securities more liquid than municipal securities - Listed stocks are more liquid than those trading on non-Nasdaq OTC - Homes not very liquid (if on market for long time before being sold, prices drop; if market is active, homeowners often receive more than their asking price) *Securities markets are not as slow as real estate, but within each industry some investments are harder to liquidate than others *Partnerships and hedge fund investments are illiquid *Insurance companies invest their net premiums in liquid, investment-grade bonds because they must often liquidate their portfolios to pay claims after, say, a hurricane or flood. If they had to find buyers for illiquid junk bonds or real estate holdings, they would likely end up selling at unfavorable prices

Purchasing power risk (also known as inflation risk or constant dollar risk)

The risk that an investor's purchasing power will decrease over time due to overall increases in consumer prices - Or money (or capital) saved can't keep pace with rising consumer prices If inflation erodes the purchasing power of money, an investor's fixed return cannot buy what it is used to (e.g a 10-yr bond pays the same interest income each year, but as time goes on, that fixed payment will typically lose some, or even a lot, of its purchasing power) Fixed-income investments typically present this risk, so investors can try to beat inflation by investing in common stock (the ride might be a wild one, but the reward is that an investors' portfolio could grow faster than the rate of inflation) Retirees more susceptible to this, since salaries for people in the workforce tend to rise with inflation - But due to shorter time horizon and high needs for liquidity, common stock often too volatile. Solution is to put most of capital into short-term bonds and money market instruments, with a small % in large-cap stock, equity income, or growth and income funds - In this way, fixed income can cover living expenses, while smaller percentage in conservative stock investments can provide some protection of purchasing power (example can be blue-chip stocks since they provide safe dividends which tend to increase over time)

Reinvestment risk

The risk that interest rates will drop, forcing bondholders to reinvest at lower rates - This risk applies to bondholders who use their fixed income to reinvest into new bonds (typically those who are not near retirement) **While a call happens in this way, this is a one-time event. This type of risk is ongoing (every six months, bondholders could be reinvesting interest payments at lower rates than they are receiving on the bonds they hold) REDUCING THIS RISK - Bond ladders (here, he is investing just part of his portfolio at varying interest rates; not all at once) - Zero-coupon bonds (more drastic approach to hedge this risk) --> as opposed to making regular interest payments, these bonds pay higher principal at maturity, thereby eliminating the risk to reinvest coupon payments every six months

Business risk

The risk that the business we invest in becomes less profitable, or even unprofitable due to many dif circumstances - In other words, the stock we own is only as solid as the business that issued it Examples can include poor management, better competitors, labor strikes, release of inferior products, obsolescence

Counterparty risk

The risk that the other party to an agreement will default. Question then: "is the party on the other side of the contract financially sound enough to honor it?" This risk is present in forwards (a derivative) due to lack of clearinghouse to act as buffer as is the case for all options and futures on exchanges

Blue chip stock

The stock of a large, well-established and financially sound company that has operated for many years. So a safe investment that generally attracts conservative investors

Leverage

The use of borrowed money to supplement existing funds for purposes of investment **More generally refers to an investment promising higher returns on a percentage basis due to increased exposure to risk (multiplying gains or losses) (Companies issuing bonds to raise capital are employing this term, the use of borrowed funds to earn higher returns) Leveraged companies are more susceptible to rises in interest rates than those who issue only common stock, as rising rates make financing and refinancing their operations more difficult For example, a margin account's investor assumes the risk of borrowing money at a specific rate of interest, hoping to receive twice the returns he would have made on a percentage basis by being twice as exposed to marketplace risks

Yield to Maturity (YTM)

The yield an investor would receive in the form of all the interest payments plus (or minus) the difference between the amount he paid for the bond and the par value he would receive at maturity

Treasury strips

These are zero-coupon bonds - Sold at a significant discount to face value, but don't offer interest payments, due to the fact that they mature at par Also subject to "phantom tax exposure" Good for investors who want to avoid credit risk and reinvestment risk - Backed by the U.S. government, Treasury STRIPS, were introduced in 1985, in an effort to offer minimal risk and some tax benefits in certain states. [It's an acronym for Separate Trading of Registered Interest and Principal of Securities]

Hedging: If investor holds a stock that looks like it's about to drop, what can they do?

They could sell the stock, but that is a drastic measure because if the stock rallies, the investor can miss out on this opportunity Instead of this drastic measure, investor could buy an option that names a selling price for the stock (ie. buying a put option, allows investor to sell stock at a stated price, regardless of how low it goes on the open market) - Can be thought similar to a homeowner's insurance policy. Does not mean they hope the house burns down, but if disaster strikes, they'll be glad to have paid the premium for the protection. * so buying puts against stock owned is a form of protection, like insurance. It costs money, but allows investor to hold a large position without taking excessive risk

ETFs (exchange-traded fund)

They trade among investors throughout the day, known as intra-day trading (versus open-end funds which shareholders redeem for the NAV next calculated, known as forward pricing) *Typically is an index fund - to track the S&P 500, for ex, investor can buy the "Spider" (named this way because its a SPDR - Standard & Poor Depository Receipt) - Leveraged ETFs (e.g. 2X and 3X), use derivatives - Inverse ETFs (bet against an index, most at 2 or 3X multiplier through use of derivatives) *They can be bought on margin and sold short for those willing to pursue high-risk investment strategies -- They trade alongside shares or any other public company, thereby allowing investors to hedge their market risk by betting against the overall market with a percentage of their portfolio. For ex, a trader thinking that the S&P 500 will drop today can sell an ETF tracking the index short. If he is right, he will make money, which will offset whatever he loses on his stock portfolio *Investor can find ones that track a wide variety of dif indexes (small cap, value, growth, blue chip, long-term bonds, etc.). An investor wanting to be 80% long-term bonds and 20% small cap stock can achieve it by just investing in two low-cost ETFs Benefits: - They offer diversification - Make asset allocation strategies easy

SPDA (Single Premium Deferred Annuity)

This is purchased with a lump sum, but payment of benefits not paid until after one year or more has lapsed Basically - an annuity established with a single payment featuring investment growth solely during the accumulation phase Has the benefit of tax-deferred interest accumulation during the Pay-In (accumulation) period It is up to you when you want to start receiving your funds (plus interest) from the insurance company

General account

This typically holds safe investments and backs up any promises or guarantees made by the insurance company - When purchase payments are investment in this account, investor is guaranteed a specific rate of return **Corporate bonds and other conservative investments are found in such accounts

New World Currency Option contracts (WCOs)

To eliminate risk of settling foreign currency options associated with physical delivery of foreign currency (which must be stored, could be lost or destroyed), this type of contract was created for retail investors. - Makes contracts smaller and has them settled in USD

Limited Partnerships (type of DPPs)

Type of DPP where a general partner manages the business, while one or more limited partners provide most of the investment capital. - The partnership is not taxed; rather, they are taxed on their share of the net income or net loss that flows directly through the business to them - Partnership still files tax forms - However, partners take their share of the net loss or net income for the tax year

Foreign currency options (non-equity options)

Type of capped index option If one currency goes up, the other goes down, vice versa. **This is really useful for importers/exporters to hedge their foreign currency risks, because paying for imported goods in foreign currency depends on exchange rate, which fluctuates. Risk that foreign currency value will skyrocket relative to the USD EPIC (American Exporters buy Puts. American Importers buy Calls) - exporter puts; importer calls Importing example --> American company imports hard drives from Canadian company, and they insist on being paid in 1 million Canadian dollars within sixty days of issuing order. Risk? That Canadian dollar shoots up in value against weak dollar **To hedge risk, a call gives importers the right to buy, for ex, Canadian dollars at a strike price, even if the underlying C$ goes up in value. That is why "Importer buy Calls" Exporting example --> American company's assembled computers get exported to a retailer in Japan, who pays 100 million yen for X computers in sixty days Risk? USD strengthens relative to their weakened yen **To hedge risk, a put on the yen (or at least selling a call) could offset the loss on this exchange rate

Fund of hedge funds

Type of mutual fund for non-accredited investors to invest indirectly in a hedge fund - investments here held in several different hedge funds - Investor cannot redeem their investment during initial lock-up period, because of illiquidity - These investments usually have high expenses (since, in addition to typical mutual fund fees, they also incur high expenses from hedge funds)

Sector fund

Type of specialized mutual fund that focuses on industry sections E.g. Communications Fund, Financial Services Fund, the Healthcare Fund Very aggressive investment strategy

Option (derivative investment) - types

Types = call or put * Call --> gives owner the right to buy the stock at the strike price * Put --> gives the owner the right to sell stock at the strike price

Development programs (for oil and gas) (DPPs)

Types of DPPs that drill for oil and gas in an area where these natural resources are already being extracted with engineering studies in place to confirm Sometimes called "step-out" programs - Less risky than exploratory programs but have lower return potential - Intangible drilling cost can provide a tax shelter

Market risk

Uncertainty about an asset's future value because of potential changes in the market for that type of investment (all securities present this risk) No one can predict wars, terrorist attacks, banking crisis, etc., but when these events occur, they can have devastating effects on overall market (when investors panic, and for example, they all try to sell the securities they hold at the same time, the sudden selling interest depresses the value of whatever they are selling, meaning the securities' market prices across the board drop) **Diversification does not help in this case; if overall market is going down, does not matter how many dif stocks an investor owns, because they're all going down REDUCING THIS RISK - To protect against this risk, an investor would have to bet against (short) the overall market (e.g. can use options, future and ETFs based on S&P 500, which is usually used to represent overall stock market) This risk is measured by betas **The only way to avoid market risk is to stay out of the market and exclusively invest in insurance and banking products [a type of systematic risk]

Preferred stock

Unlike common stock, this pays a fixed income to the investors who own it (less reliable than bond interest though). Therefore, they are interest-rate sensitive These types of stock owners do not receive a share of the issuer's profitability should it increase ** Should the company be liquidated to pay creditors, these stock owners receive preferred treatment over common stock owners + dividend paid to them before anything can go to common stockholders An issue of preferred stock is named according to its rate of return (e.g. 4% preferred stock, 5.5% preferred stock). The rate is on par value, so does not change if market price goes up or down (rate is more a max than a min; vs. participating preferred stock) - Here, if Board votes to not declare dividends, these stockholders get paid nothing. So to these stockholders, concerns similar to the bondholders (interest rates and credit quality)

C-shares (open-end mutual funds) - no-load funds

Usually do not charge an upfront load (i.e. sales charge), but typically carry a high 12b-1 fee (or "asset-based sales charge") of up to .25% of net assets These shares are purchased at the real NAV - The fund can call itself a "no-load" fund provided the 12b-1 fee does not exceed .25% of the fund's net assets - Nicknamed level load because of this 12b-1 fee - Do not convert to A-shares (while B-shares do) ** therefore, they are suitable for shorter holding periods only, for investors with <$500,000 to invest

Refunding Municipal Bonds

Usually using new bonds to substitute for old bonds. The refunding of bonds can be referred to as being issued to "defease" the prior issue of outstanding bonds Bonds issued to retire bonds already outstanding. The refunding bonds may be sold for cash and outstanding bonds redeemed in cash, or the refunding bonds may be exchanged with holders of outstanding bonds. Done either through current refunding or an advance refunding Because of the certainty surrounding a refunded bond issue, these bonds are typically rated AAA and are among the safest of all municipal bonds on the market. Because of their inherent safety, refunded bonds are also liquid or easy to sell at a good price Refunding bonds are NOT tax-exempt

Warrants (derivatives)

Warrants are long-term instruments that also allow shareholders to purchase additional shares of stock at a discounted price, but they are typically issued with an exercise price above the current market price. A waiting period of perhaps six months to a year is thus assigned to warrants, which gives the stock price time to raise enough to exceed the exercise price and provide intrinsic value. A derivative security that gives the holder the right to buy the issuer's common stock for a set, or exercise, price regardless of how high the stock price rises on the secondary market Issued by the company itself (versus equity options (call or put option, for ex) which are offered by options exchanges, based on the price of various public company stocks, with the company's permission but not with its participation E.g. if a warrant lets an investor buy XYZ for $30 per share as of some future date, the investor will benefit is the stock price rises above $30 Good for a long time period (~2-10 yrs) Often included in a bond offering. Corporations pay interest to borrow money through bonds. Including warrants can "Sweeten the deal" by offering investors potential upside on the company's common stock and also allows them to offer a lower interest payment **Like convertible bonds or convertible preferred stock, investor pay be willing to accept lower income payment in exchange for a potential gain on issuer's stock

Premium bond

When a current yield is lower than the nominal yield/coupon rate These have the lowest yield to call, since it returns the loss sooner than the maturity date When a bond is purchased at this rate, the "yield to worst" (or soonest possible call date) is shown on the trade confirmation to the customer

Naked call position

When investor sells a call without first owning the stock (so maximum loss is unlimited) **Whatever the buyer can win, that is what the seller will lose in this position As opposed to a "covered call," wherein the writer already owns all shares he would be required to deliver upon exercise

Cumulative Voting Rights

[Rarer method, vs. statutory] Shareholders can abstain on voting for some candidates and can give those unused votes to just one or two candidates Minority shareholders prefer this (because pro-minority-shareholder candidate has higher chance of being elected if small shareholders can be persuaded to cast all votes for that person)

Statutory Voting Rights

[More common method, vs cumulative] Each stockholder gets to vote one per share held for each of the directors to be elected. but the shares must be voted as a block vote. ex: a stockholder owns 100 shares, 3 directors are being elected but 5 are running. The stockholder can vote 100 votes for 3 of the people (cannot abstain votes on other candidates and count all votes towards one member, though) Large shareholders prefer this

Total return

a calculation that includes the annual dividend as well as any increase or decrease in the original purchase price of the investment the sum of a stock's dividend yield and its capital gain rate (i.e. the income received by the investor and the increase/decrease in market value on the investment) [Whereas yield is always positive, this figure can be + or -]

Eurodollar bonds

any issuer except the US Payable in US currency, no currency risk for US investors A Eurodollar bond is a U.S.-dollar denominated bond issued by an overseas company and held in a foreign institution outside both the U.S. and the issuer's home country. Don't register with SEC

B-shares (open-end mutual funds)

charge back-end load when the investor sells (REDEEMS) them Here, investor pays the real NAV of shares when they buy them, but leaves a percentage behind when they sell them. This percentage usually starts to decline in the second year, and after several years (6-8 yrs), the back-end load goes to zero as the B-shares convert to A-shares **Associated with contingent deferred sales charges Much higher annual expenses than A-shares; so while investor waits for the contingent deferred sales charges to disappear, the account is being depleted to a greater extent than are those holding the A-shares --> due to a 12b-1 fee **Most suitable for intermediate or long-term investors with a small amount to invest

A-shares (open-end mutual funds)

charge front-end load when the investor acquires them B-shares convert to these over time ** These shares are most suitable for long-term investors with >$50,000 to invest To calculate what investor pays for A-shares of open-end fund, meaning having a front-end sales charge/load: POP = NAV / (100% - sales charge) **Open-end funds with sales charges offer quantity discounts on these charges depending on amount invested, called BREAKPOINTS

marking to market

in the futures market, a daily settlement in which the exchange transfers funds from a buyer's account to a seller's account or vice versa, depending on changes in the price of the contract

Narrow-based index

index focusing on a particular industry, geographic region, e.g., a transportation index An index that is designed to reflect the movement of a market segment, such as a group of stocks in one industry or a specific type of investment. Examples include the Technology Index, the Gold/ Silver Index, the Dow Jones Utilities Index or the Dow Jones Transportation Index. **So if an investor is heavily weighted in a particular sector, he needs to hedge his risk with the associated narrow-based index options. So if an investor is over weighted in pharmaceutical stocks, he needs to find a pharmaceutical index that mirrors his own portfolio (same is the case for an investor exposed to the broad market -- he would hedge with broad-based index options such as S&P 500)

GNMA mortgage-backed securities

minimum $25K investment Backed by full faith and credit of US Gov the yields are typically higher than a Treasury security of a similar term due to prepayment and extension risk (although has no credit risk)

Municipal bonds

tax-exempt bonds issued by state and local governments (bond counsel determines legal and tax-exempt status. Refunded bonds are not tax exempt for example) (investors of these bonds escape income tax on the interest paid, so issuer pays lower interest than taxable bonds) Two types 1. General obligation bonds (safer than the other, because backed by municipality's ability to raise and collect taxes from various sources) 2. Revenue bonds (only as safe as the revenue source tied to bonds) ** Many of these bonds come with a credit enhancement from an insurance company to insure against default (makes bond more marketable and keep interest payments as low as possible) These bonds do carry default risk (versus US Treasury bonds which have no default risk) **Accrued interest on corporate and municipal bonds is calculated on a 360-day year and assumes 30-day months

Custodian of a mutual fund is

the bank that has the legal responsibility for holding and keeping records of all the cash and securities owned by the mutual fund They receive the dividends and interest payments made by the stocks and bonds comprising the fund portfolio; releases the funds for investment advisors to buy and sell securities

Debt limit

the maximum amount of gross or net debt that is legally permitted (protects residents from excessive taxes, municipalities typically improve a maximum on how much general obligation debt they can have outstanding at one time) If municipality is close to the limit, an analyst might not like to see another bond issue going out at this time Debt per capita = debt divided by the population (a high debt per capita means lower credit rating)

Gross revenue pledge

the rarer method where debt service is given first priority, followed by the funding of operations and maintenance (vs net pledge)

Collection ratio

the total amount collected divided by the total amount charged.

NAV (net asset value)

the value per share of a mutual fund; found by dividing the total value of all the holdings of the fund (assets) by the number of shares outstanding Both for open- and closed-end funds This amount rises and falls every day the markets are open, and calculated when markets close ** Closed-end shares trade throughout the day, but b/c this figure is only calculated at end of day, the price for closed-end fund shares is often above or below the real amount ** Open-end fund shares don't trade. Rather investors buy or sell to fund based on the NAV next determined (e.g. if order is placed by customer at 10.30 AM, they will not know at which price the order is filled until markets close and fund recalculates the NAV) -- known as FORWARD PRICING The opposite, LATE TRADING or LATE-DAY TRADING is a violation of SEC rules

Indenture

the written agreement between the corporation or municipality (if revenue bond) and the lender detailing the terms of the debt issue Its a contract enforced by a trustee in which the issuer promises to protect the interests of the bondholders Typically includes protective covenants that commit the issuer to various actions to protect bondholders' interest. In revenue bond, this includes: - Rate covenant - Maintenance covenant, insurance covenant - Financial reports and audit covenant - Nondiscrimination covenant - Catastrophe call - Flow of funds statement - Bond counsel's legal opinion and description of maturity features of bond [Municipal bonds are not covered by the Trust Indenture Act of 1939, but typically revenue bonds are sold with an indenture]