Knopman: SIE Class Summary

Reverse Stock Split

In a reverse stock split, the number of outstanding shares is reduced, and the share price is increased proportionally. Generally, a reverse split is used by a company to inflate their stock price and avoid falling below the minimum price required for the exchange listing. For example, after a 1 for 10 split an investor owning 100 shares of stock at $1 per share will now own 10 shares at $10 per share. Both before and after the split, the value of the investor's position remains $100.

Stock Dividend Taxation

Stock dividends are not taxed when received by a shareholder. However, the basis of the investor's tax position is adjusted downward to reflect the new number of shares. Example: Assume an investor holds 100 shares of stock valued at $50 per share and received as 10% stock dividend. The $5,000 value ($50 x 100 shares) of the total position does not change, so the investor now has 110 shares with an adjusted basis of $45.45 (calculated as $5,000 total value / 110 shares).

Blue Chip versus Penny Stocks

Stocks of well-established, stable companies with a long history of steady earnings and dividends are known as blue-chip stocks. Blue chip stocks typically trade on the major exchanges such as the NYSE or NASDAQ. Penny stocks are riskier, more volatile, and less liquid than blue chip stocks.

Summary Prospectus

The SEC allows a mutual fund to deliver a summary prospectus to shareholders, which is a compilation of highlights from the longer prospectus. A summary prospectus includes the fund's investment objectives, fee structure, and other pertinent information. It must be provided to investors prior to or at the time of sale. Not all investment companies are required - just mutual funds.

Non-Marketable US Government Securities

The US government issues both marketable and non-marketable debt securities. Marketable securities can be freely traded by investors and include US Treasury securities, such as Treasury bills, Treasury notes, and Treasury bonds. Non-marketable securities, for example, US savings bonds, cannot be resold by investors, and therefore have no secondary market.

Current Yield

The current yield of a bond is calculated as the annual interest divided by the market price. If the semiannual coupon is provided, make sure to multiply by two to annualize. Example: A bond is trading at $960 and pays a $15 semiannual coupon. Current yield is calculated as the annual interest of $30 ($15 x 2) divided by the market price of $960. Therefore, current yield is 3.1%.

Dated Date

The dated date is the date when interest begins to accrue on fixed income securities. The dated date is only relevant for new issuances and once regular semi-annual coupon payments begin, it is no longer relevant.

Ex-Dividend Date

The ex-date is the first day purchasers of the stock will not receive a dividend. This is because the trade will not settle on or before the record date. For a regular way trade, which settles at T+2 (two business days after trade date), the ex-date is the business day before the record date.

Taxation of Treasury Securities

The interest income from Treasury bonds is taxed at the federal level, but not at the state or local levels.

Official Statement

The official statement is the primary disclosure document used in connection with a municipal security offering. It includes all relevant information for investors, such as the risks of the bonds.

Bond Pricing

The price of a bond is most affected by interest rates. Factors like credit rating, market demand, and earnings potential of the company are not as impactful.

REIT Investment Objective

The primary investment objective for a REIT investor is current income in the form of dividends. This is bc REITs are required to pay at out at least 90% of income in the form of dividends.

Reinvestment Rate Risk

The risk that as interest rates fall, that the semi-annual coupon payments that an investor receives will be reinvested back into the market at a lower rate of return. Note that zero coupon bonds do not have reinvestment rate risk as there are no cash flows to reinvest.

Interest Rate Risk

The risk that if interest rates increase, the price of outstanding bonds will fall. Long-term, low-coupon bonds (including zero-coupon bonds) have the greatest interest rate risk, meaning that they are most sensitive to changing rates. Although a Treasury bond has no credit risk, as they are guaranteed by the full faith and credit of the US govt, they still are susceptible to interest rate risk given their long-term maturity.

Convertible Bond Pricing

The value of a convertible bond is based on the value of the underlying common stock, since the investor can exchange the bond for the shares. The parity price is the value at which the investor is mathematically indifferent between owning the bond or converting into the underlying shares.

Treasury Receipts

Treasury receipts are zero-coupon bonds that are structured by broker-dealers but backed by cash flows from Treasury securities.

Risk of Treasury Securities

Treasury securities do not have credit risk but are subject to interest rate risk and purchasing power risk.

Treasury Stock

Treasury stock is authorized stock that was previously sold to the public but was repurchased by the issuer. Because it is no longer outstanding, the company's share count will fall, and the shares no longer receive dividends or have voting rights. Treasury shares may be held by the company, reissued to the public, or cancelled.

Unsecured Corporate Debt

Unsecured corporate debt is not backed by collateral or a specific asset of the corporation. Instead, it is backed by the good faith and credit quality of the company. It is also referred to as a debenture bond.

Commercial Paper

Unsecured promissory note, issued by corporations at a discount. Typically has a max maturity of 270 days.

Statutory versus Cumulative Voting

Voting by common stockholders can be carried out by one of two methods. Statutory Voting: Allows a shareholder to vote one time per share for each seat on the board of directors. For example, if an investor owns 100 shares of common stock and there are three board seats to be filled, they can cast up to 100 votes for each of the three seats. Cumulative Voting: Allows the shareholder to pool their votes together and allocate them as desired. For example, the shareholder above can aggregate all of their votes - 300 total (100 votes x 3 seats) and allocate them however they choose.

Warrants as Equity Securities

Warrants are considered as equity securities (not debt securities) because if the warrant is exercised, the investor will receive shares in the underlying company. Importantly, warrants do not make interest payments to investors.

Issuance Price of Warrants

Warrants are generally not issued with intrinsic value, meaning they are issued with an exercise price above the current market value of the stock. For example, if the current stock price is $50, the exercise price given to the warrants might be $80. For the warrant to be exercised by an investor, the price would have to increase to above the exercise price.

Withholding Taxes

When a foreign corporation pays a dividend, a bank will take the foreign dividend payment and convert it into US dollars for the ADR holder. It is possible that the ADR holder might receive a lower dividend than was actually declared because the foreign government might withhold a percentage of the dividend for taxes.

Dissolution of Limited Partnership

When a limited partnership is dissolved, the priority of claims against the partnership is: 1. Secured lenders 2. General creditors 3. Limited partners 4. General partners

Forward Pricing

When an investor purchases shares of a mutual fund, the price they pay is based on the next NAV calculation after the order is received. The NAV is calculated daily based on the closing price of the market. This is referred to as forward pricing. For example, if on a Monday a customer places an order to buy shares at 5:00 PM which is after market close, the price they would pay for the shares is based on Tuesday's closing price. The share price is no calculated based on the prior day's closing price or the next day's opening price.

Call Price

When an issuer calls bonds, it must pay the investor par value, any call premium (if applicable), and the interest accrued to that date. Investors receive no interest after the bond is called.

Mutual Fund Suitability

When deciding on a mutual fund investment, the investor's investment objectives are the primary consideration. Fees are of secondary importance. Note that the size of the fund is typically the least important factor.

Discount versus Premium Bond

When the market value of a bond is greater than par value, the bond is trading at a premium. If the market value of the bond is below par value, the bond is trading at a discount.

12b-1 Fee

12b-1 fees are annual fees paid by mutual fund shareholders to cover the marketing and administrative expenses of the fund. 12b-1 fees do not cover management expenses or trading funds.

Letter of Intent (LOI)

An LOI allows a mutual fund shareholder to invest in installments and receive breakpoints, which are discounts off of the sales charges. An LOI can be used for up to 13 months and can be backdated for 90 days.

Serial Bonds

In a serial bond issue, the outstanding bonds mature at different intervals with a portion of the issues maturing each year.

Prohibited Mutual Fund Strategies

Mutual funds cannot sell stock short or borrow money.

No-Load Fund

No-load funds are mutual funds that do not charge a sales charge. They are purchased by investors at the NAV.

Impact of Dividends on NAV

The NAV of a mutual fund share will decrease by the amount fo the dividend on the ex-date. This is because the fund is paying out cash so the fund's assets will fall.

Wilshire 5000

The Wilshire 5000 is an index which measures the value of US companies with actively traded stock.

Warrants

Warrants are typically issued by a company in conjunction with another security to make that other security more attractive to investors. For example, a company might use a warrant as a sweetner for investors as part of a debt deal. Unlike pre-emptive rights, warrants do not prevent dilution.

Risk of ADRs

ADRs help to facilitate the trading of a foreign corporation's stock in the US. Investors in ADRs face political risk, which is the risk that political instability and uncertainty in that foreign country might negatively impact their investment. Importantly, because ADRs are common stock and not debt securities, they do not have call risk or interest rate risk.

Accrued Interest

Accrued interest is the interest paid by the buyer of the bond to the seller of the bond when the bond is trading between coupon dates. A bond that trades with accrued interest is said to trade, and or with interest. The accrued interest is taxable for the recipient as ordinary income, though it does not impact the cost basis of the bond. A bond that trades without accrued interest (bond in default, or zero coupon instrument) is said to trade flat.

Ginnie Mae

Along with Fannie Mae and Freddie Mac, Ginnie Mae is an issuer of MBS. However, Ginnie is the only one of the three that is backed by the full faith and credit of the US government. Because Fannie and Freddie are GSEs, they only have an implied, but not an explicit backing of the US govt.

Nominal Yield

Also referred to as the coupon, the nominal yield is the annual interest rate paid to the investor. Unlike other bond yields, the nominal yield is fixed and does not change over the life of the bond. For example, a bond that pays 5% coupon, pays the same 5% of $1,000 (par value) or $50 of interest per year throughout the life of the bond.

S-Corp versus C-Corp

An S-Corp is a type of DPP. Shareholders receive a pass-through of income and losses, and the S-corp entity is not taxed. A C-Corp is a taxable entity and shareholders receive dividends that were taxed at the entity level and will be taxed again at the shareholder level. Double taxation applies to dividends from C-corps.

Interest in a Limited Partnership

An interest in a limited partnership is an equity security as it indicates the partner owns a piece of the partnership.

Company Repurchases

A company that believes its stock is undervalued may repurchase shares in the open market (creating treasury stock).

Banker's Acceptance

A money market instrument that is used to finance and facilitate international trade.

Municipal Bond Funds

A municipal bond fund, also referred to as a tax-exempt bond fund, is a mutual fund consisting of tax-free municipal bonds. These bonds are most appropriate for high-net-worth investors in high tax brackets who will most benefit from the tax-free nature of the interest income. When the fund pays out its net investment income to investors, the dividends are tax-free bc they represent the tax-free interest income, though any capital gains distributions are taxable.

ETF versus Mutual Fund Expenses

Because mutual funds are actively managed, they typically have higher fees for investors than ETFs.

Cash Dividend Taxation

Cash dividends on stock received by the an investor are taxable as ordinary income and do not increase the investor's cost basis.

Depletion

Depletion is a tax deduction that compensates a limited partnership as they use up a natural resource such as oil or gas. Because real estate is not a natural resource, it cannot be depleted.

REITs

A Real Estate Investment Company (REIT) is a company that owns or operates income-producing real estate or real-estate related assets. It is not an investment company or DPP. REITS are not subject to corporate tax (they pass through gains, though not losses), if they meet all three of the following criteria: 1. At least 75% of assets must be invested in real estate 2. At least 75% of the REIT's income must be derived from real estate 3. 90% of the gains must be passed through to investors

Series I Bond

A Series I Bond is a non-marketable US Treasury savings bond. It pays a combination of fixed and variable interest (linked to the rate of inflation).

Unit Investment Trust (UIT)

A UIT is an investment company security that combines redeemable shares with a fixed portfolio. Specifically, the portfolio is assembled by a sponsor, who does not actively trade the portfolio. UITs hold a fixed portfolio - sell redeemable shares or units to investors, typically in a one time IPO. Passively managed - fixed for bonds, or tracks an index. Distributes portfolio income to investors, and on the trust's maturity date, any remaining securities are liquidated and distributed to investors. NO SECONDARY MARKET.

Mutual Fund Custodian

A bank or trust company acts as a custodian for mutual funds and is responsible for the holding and safekeeping of the fund's securities and cash.

Breakpoint Sale

A breakpoint sale is a violation where the registered rep suggests that an investor purchases a mutual fund just below the point at which they would receive a discounted sales charge. For example, if there is a breakpoint of $250,000, suggesting that the customer only invest $249,000 is a violation.

Stock Splits

A stock split is an artificial adjustment in the issuer's outstanding share count and stock price. Importantly, because the number of shares and price change in proportion with one another, the overall value of the company as well as the investor's ownership position in the company remain unchanged. For example, if an investor owned $1,000 of stock before a stock split, there will still own $1,000 of stock after.

Transfer Agent versus Custodian

A transfer agent of an issuer is responsible for issuing and cancelling certificates and processing investor mailings. A custodian, on the other hand, is responsible for holding investor assets or securities for protections. A custodian may also maintain certain investor records.

Value of Warrants

A warrant provides an investor the ability to purchase a company's stock at a specified exercise price for a set time period. For example, the investor is given the right to purchase the stock at $100 per share. The investor would want to exercise this right if the price increases above the exercise price (investor wants to pay $100 for stock worth $150 not for stock only worth $50) and therefore the market value of a warrant is tied to the value of the underlying stock.

Credit Ratings

Bond rating services publish credit ratings to inform investors of a bond's credit quality. A bonds credit rating may change periodically while it is outstanding. Credit ratings are typically a big factor in the liquidity of bonds (even more so than coupon or maturity).

Adjusting Premium Bonds by Amortization

Bonds purchased at a premium (>$1,000 per par), must be amortized over the life of the bond. Amortization means that the cost basis will be adjusted downwards each year so that at maturity an investor's cost basis is $1,000 par. What will amortization affect? Amortization effects a bond's cost basis (downwards) and should the investor sell the bond prior to maturity, the profit or loss on the transaction. Amortization does not affect sale proceeds (what a purchaser is willing to pay). Example: When an investor purchases a bond at a premium, the cost basis will be adjusted downwards towards par on a straight-line basis. This is referred to as amortization, for example, a 10-year bond bought at 110 would be adjusted by one point each year calculated as: 10-point premium / 10 years to maturity = 1 point per year.

Forward Stock Split

In a forward stock split, the number of outstanding shares increases, and the share price is reduced proportionally. For example, after a 2 for 1 split, an investor owning 100 shares of stock at $30 per share, will now own 200 shares at $15 per share. Both before and after the split, the value of the investor's position remains $3,000.

Convertible Bonds

Convertible bonds are a type of corporate bond where the investor has the right to convert the bond into the company's underlying stock. Because of this conversion benefit for the investor, convertible bonds pay a lower rate of interest compared to similar non-convertible bonds. Conversion Ratio = Par Value / Conversion Price

Cost Basis

Cost basis is the original value of an asset for tax purposes. If the asset is later sold for a profit, the difference between the cost basis and sales proceeds reflects the investor's taxable capital gains. Importantly, any dividends reinvested by an investor would increase their costs basis as the investor will have already paid tax on that income. For example, if an investor's original cost basis in a mutual fund is $1,000 and the investor receives $200 in dividends which they reinvest into the fund, their cost basis would be adjusted upwards to $1,200.

Cumulative Preferred Stock

Cumulative preferred stock allows investors to receive dividends in arrears. This means that of a dividend is skipped for cumulative preferred shareholders, they must receive both current and skipped dividend payments before any dividend payment can be made to common shareholders. This is a benefit for the investor as it entitles them to receive missed dividend payments.

General versus Limited Partner

In a limited partnership, the general partner is the active partner in the business, managing the day to day, whereas the limited partner contributes capital and from that point has a passive involvement in the business. The general partner has unlimited personal liability, whereas the limited partners have limited liability.

Passive Gains and Losses

DPPs pass through gains and losses to investors, which means that there is no corporate taxation, instead only the investors in the program pay taxes. If there is a passive loss, it can only be used to offset passive gains.

Accretion of Discount Bonds

Discount bonds will be accreted, which is similar to amortization, but the cost basis is adjusted upwards (towards par) each year.

REIT Dividends

Dividends paid by a REIT are always taxes as ordinary income, regardless of the holding period. This contrasts with the dividends paid by traditional corporations, which are taxed at a lower rate as long as the investor holds the stock for greater than 60 days.

Duration

Duration is a measure of a bond's sensitivity to changing interest rates. Bonds with a longer duration are more sensitive to changing rates.

ETFs

ETFs are investment company securities that are designed to track a specific index or benchmark. Like closed-end funds, ETFs are exchange-traded and thus investors pay commissions when purchasing the shares.

Equity REITs

Equity REITs own and operate income-producing real estate. They are professionally managed to generate income from rent received as well as sales from the properties they hold.

Eurodollar Bonds

Eurodollar bonds are bonds issued outside the US but denominated in US dollars. Par is $1,000 USD, these are issues and trade outside the US and are not registered with the SEC. Issuers use Eurodollar bonds to make their securities more marketable.

Eurodollar Deposit

Eurodollars are US dollars held in a depository (bank) abroad. Ex: A Swiss bank account denominated in US dollars would hold Eurodollar deposits. These are used by foreign corporations (or individuals) who have US currency abroad.

Expense Ratio

Every mutual fund has an expense ratio, which is the percentage of the fund's total assets that will be used to cover the expenses of the fund. It is calculated as (management fees plus operating expenses) divided by the average annual net assets of the fund. The fund's expense ratio would increase if the operating expenses of the fund were rising faster than the value of the fund's investments.

General Obligation Bonds

GO bonds are municipal securities used to finance non-revenue facilities, such as public parks, public schools, and public libraries. The interest and principal is backed by the full taxing power of the issuing municipality.

Voting Rights

Holders of common stock have voting rights, which allow them to exercise control by electing the board of directors and voting on corporate policy. This contrasts with holders of preferred stock, who typically do not have voting rights.

Call Feature

If a bond is callable, the issuer has the right to buy it back from the investor prior to maturity. Typically, the issuer will redeem a bond if interest rates decline, allowing the company to issue new bonds at a lower interest rate. A call feature benefits the issuer, not the investor.

Default

If an interest payment is missed on an outstanding debt obligation, the bond will default.

Index Fund Reconstitution

Index funds are mutual funds that seek to track the performance of a specific index - S&P 500. Because they simply track an index and are not actively managed, they have lower fees and expenses than other types of mutual funds. Generally, the only time the portfolio changes in when a company is added or subtracted from the index. For example, when FB was added to the S&P 500, all of the index funds that tracked the S&P 500 purchased FB stock. The process of updating the portfolio to continue to mirror the underlying index is referred to as reconstitution.

Industrial Development Revenue Bonds

Industrial Development Revenue Bonds are a type of taxable municipal security that is issued by a municipality on behalf of a corporation. Specifically, the municipality will issue debt to build a facility on behalf of a corporation and then lease the facility to the corporation. Because the bonds are backed by lease payments made by the corporation, the debt is the responsibility and credit quality of the corporation.

Call Protection

Issuers can call callable bonds at any time unless the bond has a call protection period. If there is call protection, the issuer must wait until the period expires. Callable bonds with call protection are safer for investors. Example: A 20 year bond with a 10 year call protection period could be called any time after year 10 through maturity.

Order of Dividend Process

Make sure to know the order of dates in the dividend payment process. Declaration Date, Ex-Dividend Date, Record Date, and Payment Date.

T-Bills

Maturity of up to one year, no semiannual interest, and quoted as annualized discount percentage.

Money Market Fund

Money market funds are mutual funds consisting of money market securities, which are debt securities with maturities of one year or less. Because of the nature of the securities they invest in, money market funds are extremely safe and highly liquid. These funds generally attempt to maintain a stable NAV of $1.00 per share, though the price can fluctuate above or below that amount.

Money Market Instruments

Money market securities are short-term debt instruments with maturities of one-year or less. Because of their short-term nature, they tend to be relatively liquid and low risk compared to longer-term bonds, Examples inlcude T-bills, commercial paper, negotiable CDs, and banker's acceptances. Additionally, once a Treasury bond has only one year or less remaining until maturity, it can trade in the money market.

Mutual Fund Dividends

Mutual fund cash dividends are taxable for investors regardless of whether they are taken in cash or reinvested back into the fund.

ETFs versus Mutual Funds

Mutual fund shares are redeemable, which means they can only be bought from and sold back to the mutual fund. There is no secondary market for mutual funds, in contrast, ETFs are exchange and can be bought and sold between investors throughout the day. Because ETFs have a secondary market, they are considered more liquid than mutual funds.

Mutual Fund Shareholder Reports

Mutual funds are required to send financial reports to shareholders which include financial statements and detail the holdings of the fund's portfolio. These reports must be sent semiannually.

Fund Share Classes

Mutual funds can have different share classes. Class A shares have an upfront sales charge. Class B shares have a back-end sales load (aka contingent deferred sales charge of CDSCs, which investors pay when they redeem their shares. Class C shares have level loads. All share classes have 12b-1 fees, but Class B and C 12b-1 fees are usually higher than Class A shares. Class A shares are the only share class that can benefit from breakpoints.

Mutual Fund Investment Strategies

Mutual funds can invest in equities, corporate bonds, and other registered securities.

Net Investment Income

Net investment income is the total profits that an individual earns from their investments. For mutual fund investments, this would include any dividends plus interest income plus net capital gains (capital gains minus capital losses).

Business Risk

Non-systematic risk is business risk, which is the risk that a specific company may not be profitable.

T-Notes & Bonds

Pay semiannual coupon, quoted as a percentage of par in 32nds of a point (1/32) Quote of 95:16 - aka 95 16/32 - 95.5 - 955.

Penny Stock

Penny stocks are defined as OTC equity securities (aka unlisted), and worth less than $5.00 per share.

Pre-emptive Rights

Pre-emptive rights allow a current shareholder to maintain their proportionate ownership interest and avoid dilution when a company issues additional shares.

10-K

Public companies must file annual financial reports (which include financial statements) called 10-ks with the SEC within 90 days of year-end.

Raw Land Limited Partnership

Raw land LPs invest in a piece of land hoping that it increases in value over time and that it can eventually be sold for a profit. Because the land is not developed, there is no income or depreciation from the ownership interest.

STRIPS

STRIPS are zero coupon bonds that are issued and backed by the US government. They are issued at a discount and mature at face value.

Agency Securities

Securities issued by Ginnie, Fannie, and Freddie - sometimes collectively referred to as "Agency Securities" are taxable at the federal, state, and local levels.

Short Sale

Selling short is when an investor, believing the price of the security will decline, sells borrowed shares in the market, hoping to repurchase and replace the shares at a lower price than what they were initially sold for. Theoretically, because the prices of the shares can rise indefinitely (rather than fall as the investor wants), short sellers have unlimited risk potential.

Closed-End Fund Pricing

Similar to mutual funds, closed-end funds have a NAV, which is the total assets of the fund minus the total liabilities. However, bc closed-end funds are exchange-traded, they can trade at a price either above or below their NAV based on the supply and demand of the shares.