Mutual Funds/Buying on Margin
Keep studying!
(I can't figure out how to delete a card)
Capital gain distribution
(can only come from a mutual fund) net gains that a fund realizes when it sells securities held in the fund's portfolio. The mutual fund doesn't actually sell the mutual fund. Mutual funds sell stocks in the mutual fund and have a gain, that gain has to be distributed.
What to consider when picking a fund?
*A fund's volatility - tendency to rise and fall *Long & Short term performance *Fund's size *Performance in up and down markets (bull/bear markets)
What are the exemptions to the 10% Early Withdrawal Penalty?
-Medical expenses/disabilities -First home buyer -Active military duty -College expenses -Unemployment
Golden rules of Investing in Mutual Funds
1. Invest only in no-load mutual funds that have a low expense ratio and do not assess a 12(b)1 fee. Debatable. 2.When choosing mutual funds, always match your investment philosophy and financial goals to mutual fund's objectives. A must. 3. When investing for long-term goals, definitely sign up for automatic reinvestment of your mutual fund dividends. Good because of opportunity costs of funds. 4. If you have a defined contribution retirement plan available at work, sign up for a payroll withholding to automatically forward a portion of each paycheck to a mutual fund. 5. Invest most of your serious money, to pay for retirement and college, into one or more low fee diversified index funds. 6. Don't jump in and out of the mutual fund market because of fees.
Four Ways to Take your Funds out of a Mutual Funds
1. Taking a set dollar amount each month 2. Cashing in a set number of shares each month 3. Taking current income as cash 4. Taking portion out of asset growth
How many companies does a typical mutual fund own?
100-200
What percentage of things can fund managers buy that is not part of their objective?
20%
What is the current NASD/NYSE maintenance requirement for stock purchased on margin?
25% of the current market value
Generally speaking, how much can brokerage customers borrow of marginable securities according to Reg T?
50% of the purchase price
How much do mutual funds have to distribute of dividends made from the stocks they are investing in?
98% has to go to mutual fund shareholders
What do mutual funds act like?
A checking account. Your account will sell enough shares to pay the amount you wrote on the check.
What lowers the amount of the margin loan?
A dividend or interest payment generated by the margin account.
What is a margin account?
A margin account is a collateralized loan account in which a customer increases his trading capital by borrowing money from a brokerage house.
What is a margin account?
A margin account is a form of a collateralized loan in which a customer increases his trading capital by borrowing from a brokerage house.
What is marking to the market?
A process where margin account balances are calculated each day. IF you gain more equity in your account that is required you can pull that money out as cash.
12b-1 Fee (or Distribution Fee)
Annual charge deducted by a fund company from fund's assets to pay for advertising, marketing, distribution, and promotion costs - Ongoing expenses that increase fund costs - Avoid funds with this charge - Fees are subtracted from the return. Found in the prospectus. - Fees are required to be disclosed.
Withdrawing Excess Equity in Cash (According to Daniel's notes)
Because no actual cash exists in a margin account, the customer that borrows money against his securities' increased value increases his/her loan value. When a customer withdrawals money from a margin account, he increases his margin loans debt balance.
Decile Ranking
Best ranking is 1/10 = Top 10 percentile
Objective Funds
Bond Funds - aim to earn current income without incurring undue risk and to pay ordinary income. Municipal Bond Fund -earns current tax-exempt income by investing solely in municipal bonds issued by cities, states, and political subdivisions. Mortgage Funds - invest in mortgage backed securities (Ginnie Maes)
Nominal owner
Brokerage firm (creditor)
What is buying on margin?
Buying securities with a down payment of less than the full market value (on credit).
How do brokerage homes make money?
By charging interest
Asset Bloat
Can be caused by an influx of new money into a mutual fund, often the result of a period of superior performance by the fund. The more mutual funds there are, the less one stock affects the return of the mutual fund. When you run out of things to buy then the portfolio managers just put more money into the stocks they already have.
What is the difference between open and closed end mutual funds?
Closed end mutual funds trade like a stock on the market while you buy and sell open end funds directly from the mutual fund company.
Expense Ratio
Combined percentage of the funds assets that are charged for fees (you want a lower expense ratio because you'll get a higher return)
Beneficial owner
Customer
Important thing to note (According to Daniel)
Declines in market value result in a dollar-for-dollar decrease in the investor's equity. The decline does not affect the debit balance of the loan. Remember: The House Never Loses.
What is it called when the equity in your margin account is above 50% of the market value?
Excess equity
True/False: Past performance determines future performance
False
True/False: The NYSE & NASD have higher margin maintenance requirements than most broker dealer houses.
False
True/False: You can use funds from custodial accounts/retirement accounts as marginable securities.
False
True/False: Broker-dealers can set house requirements lower than both the Reg T Initial Requirement, but never higher.
False. Broker-dealers can also set house requirements higher than both the Reg T Initial Requirement, but never lower.
True/False: Equity in a margin account represents cash balance.
False. Equity in a margin account represents the portion of the securities in the account that the customer fully owns.
True/False: If the stock in a margin account declines in value, the equity in the account rises dollar for dollar with the stock's market value.
False. If the stock in a margin account declines in value, the equity in the account falls dollar for dollar with the stock's market value
True/False: Redemption fee is a back-end load.
False. Redemption fee is not a back-end load.
True/False: Loads can never by law exceed 10% of net asset value in a year
False; Loads cannot exceed 8.5%
Reg T requires all margin customers to meet initial margin deposits no later than the _________ business day after a trade.
Fifth
How much are you investing in Front end vs. back end loads?
Front-end: You're investing less. Back-end: You're investing everything.
Difference between global funds and international funds?
Global - includes the US International - doesn't include the US
Rule of 72
How long it will take to double $
Rule of 115
How long it will take to triple $
What is cost basis?
How much you originally invested
Prospectus
It has all the objectives of the mutual fund. Best source of information for a mutual fund. Required by law before you buy shares. Fees, historical return, expenses, major account holdings.
Why are annual 12b-1 charges very costly over the long run?
It increases the expense ratio
Another name for target date funds
Life-cycle fund
Long term? Short term?
Long term more than 1 year, short term less than 1 year
Which funds are better over a 5-year period?
Lower cost funds (funds with no 12b-1 and index funds because they have a lower expense ratio since they are passively managed) always deliver better returns than those offered by higher-cost funds
Positive Leverage
Make a higher rate of return than you paid. Negative is the opposite; it occurs when the cost of borrowing money is greater than the return a party makes on any equity investment
What are the advantages of a broker?
Margin account loans generate interest income for the firm. With borrowed capital added to the customer's own capital, margin customers usually trade in bigger positions, resulting in increased commission revenue for the firm.
If your securities decline to the point where they no longer meet the minimum equity requirements from your margin loan, you will receive a...
Margin maitnence call
What is it called when the equity in your account is 50% below market value?
Margin maitnence call
Initial margin account balance
Money you put into a margin account.
What are some advantages on a margin account?
More buying power and leverage (buying on margin magnifies the gain/loss)
What are some more advantages of margin accounts?
More securities can be purchased with a lower initial cash outlay, and the customer can leverage the investment.
Marking the Market (According to Daniel's notes)
Once an account balance is marked to the market, a customer's equity is compared to the securities' current market value. When equity is above 50% of the market value, the customer has Excess Equity; if the equity falls below 50% of the market value, the account becomes Restricted. Margin accounts are marked to the market each day in order to determine the investor's equity and buying power.
What does a 50% portfolio turnover rate mean?
Out of 100 mutual funds the mutual fund company buys each year, they sell 50 of them.
Social Responsibility includes:
Protecting the environment, human rights, and public safety. Investors may buy or not buy certain companies based on that. EX: not investing in a tobacco company
Which type of fund is used to time the market?
Sector Funds
NAV
Share price
Up-front load charges are costly to what type of investors?
Short term investors (less than 5 years)
Regulation T
The Fed sets the minimum amount a customer must deposit when purchasing on margin. The Initial margin requirement, is currently 50% of the market value of the marginable securities and 100% of the market value for non-marginable securities. Reg T also determines which stocks are eligible to be bought on margin. Stocks quoted on the NASDAQ are eligible, but options on a margin account and mutual funds are not eligible. The 50% requirement is the minimum amount a customer must deposit.
What is margin trading regulated by?
The Federal Reserve Board
Regulation T (According to Daniel's notes)
The Federal Reserve sets the minimum amount a customer must deposit when purchasing on margin. This amount is called the Reg T Call or Initial Margin Requirement. It is currently 50% of the market value for the marginable securities. The 50% is the minimum amount a customer must deposit; he/she can always pay a larger percentage of the purchase price.
What is the risk to the broker-dealer?
The customer could default, causing the Broker-Dealer to lose money if the securities securing the loan decline in value.
What happens to the debit balance dollar amount of the loan when the stocks in your margin account decrease in market value?
The debit balance dollar amount of the loan does not change. When the Current Market Value falls, the debit balance of the loan becomes a larger % of the CMV.
What price are mutual funds bought/sold at?
The forward price at the close. (End of the day price)
What is a "street name"?
The name of a brokerage firm, bank, or dealer in which stock is held on behalf of a purchaser (because when you have a security on margin you don't actually own it)
What is the primary risk of a margin account for a broker?
The securities securing a loan might decline in value to the point where the loan (customer's debt balance) is no longer fully collateralized.
A deeper look at the term "Restricted" (margin accounts)
The term restricted is somewhat misleading because, when used in conjunction with a margin account, restricted means that the percentage equity in the account is less than the Reg T initial requirement. Current Reg T requirements do not mandate that a margin account be kept at 50% equity. Reg T requirements also do not require an additional cash deposit by the investor. If fact, the investor can continue to undertake many of the same transactions in a restricted account as he could in an unrestricted account, as long as he has 50% equity. In other words, the investor is not closed out of trading when he/she has a restricted account.
When are front-end loads paid?
They are paid up front before the shares are purchased.
No Load
They don't charge anything up front, but they have higher fees
True/False: Each firm can define, within certain guidelines, which stocks, bonds and mutual funds are marginable. The list usually includes securities traded on the major U.S. stock exchanges that sell for at least $5 per share; in other words, no Penny Stocks.
True
True/False: If a company has more management, the expense ratio will be higher.
True
True/False: Redemption fees on no loads is worse than a back end load
True
True/False: Small caps have the highest rate of return, than large caps, the corporate bonds, then government bonds, then treasury bills
True
True/False: People who are conservative do not get ahead financially over the long term because taxes and inflation offset most of their interest earnings
True - Low return plus inflation equals even lower return
When is interest paid by the margin trader?
WHen the loan to the brokerage house is outstanding.
When does a margin account become restricted?
When it has less than 50% of the deposit from the initial purchase.
Open Ended Mutual Fund
When you sell the shares back to the company.
Are there taxes on capital gains or capital losses?
Yes, there are taxes on both.
Is moving within the same fund family taxable?
Yes. So it moving within a different family.
Can short sales be sold in a margin account?
Yes. The customer profits with a decline in value from short sales.
What is instant liquidity?
You can buy or sell any time you want.
Back-end load (Deferred Contingent load)
You pay the load when you sell the investment. The longer you hold the load, the lower the load amount. This is called a sliding scale. If you hold it long enough, you won't have to pay the load.
Mutual Funds are ....
a derivative security
Exchange Fee
a small charge, typically $5 or $10 per transaction, on transfers from one fund to another
Dollar Cost Averaging
a systematic program of investing equal sums of money at regular intervals regardless of the price of the investment (automatically investing). It reduces share prices! EX: You can get a mutual fund for as little as $25-50 per month
Management Fee
annual assessment to pay advisors who operate the mutual fund
Withdrawal Plans (or Systematic Withdrawal Plans)
available to shareholders who want a periodic income from their mutual fund investments
Different types of open ended mutual funds
balanced (includes a mixture of bonds, preferred stocks, and blue-chip common stocks - usually 60% stocks and 40% bonds), value (stock price is down, but a very good company), blend, income, index (tracks an index), growth, and target date
Active Investor
carefully studies economy, market trends, and investment alternatives (individual stocks, covered and naked, calls and puts)
Investment Company
corporation, trust, or partnership in which investors with similar financial goals pool their money to: Utilize professional management and Diversify their investments
Passive Investor
doesn't actively engage in trading securities or spend large amounts of time monitoring investments (mutual funds)
Forward Price
end of the day price of a mutual fund
Investment Plan
explanation of how your funds will be invested for the purpose of reaching a specific goal
Standardized Expense Table
illustrates in an identical manner the effects of a mutual fund's fees and other expenses
Return
income an investment generates from current income and capital gains
Interest Rate Risk
interest rates up, bond prices down
Speculative Risk
involves potential for either gain or loss
Current Income
money received while you own an investment (i.e. interest and dividends)
Switching Privilege (or Exchange Privilege)
permits mutual fund shareholders to easily swap shares on a dollar-for-dollar basis for shares in another mutual fund within a mutual fund family
Net Asset Value (NAV)
price of mutual fund everyday; per share value of a mutual fund = Value of Fund/ Number of Shares
Risk Premium
the difference between a riskier investment's return and the totally safe return on the T-bill
Modern Portfolio Theory
the goal is to identify investor's acceptable risk tolerance and find an optimal portfolio of assets that will have the highest expected returns for that level of risk.
Investment Risk
the uncertainty that the yield on an investment will deviate from what is expected
Market Timers
time the market just right, you have to catch market highs and lows. Not a good idea; it's better to stay in the market and ride out the ups and downs.
Weighted Average Rate of Return
total return based on how money is allocated
Bear Market
when securities prices have decreased 20% or more over time
Bull Market
when securities prices have risen 20% or more overtime
Mutual Fund Family
when the same management company operates a variety of mutual funds, each with its own investment objectives. Pick good mutual fund companies with lots of options, that way you'll have no charges or fees Larger fund families are good so you have more choices!
What does it mean when you hace mutual funds held in a tax deferred account?
you don't have to pay taxes on the earnings right now