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Series 6

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Preemptive Rights

1. A corporation that wishes to raise additional capital by selling common stock has the obligation to offer those shares to the existing shareholders first, under their "preemptive right". 2. The price per share is set at a discount to the market price, because there is no underwriter to be paid - the corporation is selling the shares directly to its existing shareholders. 3. Each share of stock gets 1 right. 4. Each right has a value, because it allows the stock to be purchased for less than market value. 5. The shareholder can either exercise the right, buying the additional shares at the discount price; or can sell the rights in the market for their value. 6. Rights offerings typically last for no more than 90 days.

dividends

1. Common stockholders have the right to dividends that the board of directors declares: Directors, not shareholders, declare dividends. Typically companies declare and pay cash dividends quarterly. Cash dividends are "paid" out of the company's retained earnings and thus reduce book value per share. Corporations generally pay a small portion of their earnings as dividends. 2. Dividends can be paid in the form of cash, additional shares (a stock dividend), or property (buy Starbucks stock - get a card good for so many free coffees at their stores). 3. Any cash dividends and property dividends are taxable (yup, the value of those cups of coffee is taxable!) however stock dividends are not taxable.

Corporate Actions Requiring Stockholder Vote:

1. Corporate actions that can materially affect the company's capital structure require a shareholder vote. These include: declaration of a merger divestiture acquisition of another company for stock issuance of convertible senior securities issuance of stock options to officers 2. On the other hand, dividend decisions are made by the Board of Directors and do not require shareholder vote. This is true for: cash dividends stock dividends property dividends (such as a corporation, say Starbuck's, giving its shareholders a card good for a limited number of free coffees at its stores)

Additional Rights - Continuity

1. Corporations are permanent a. They continue in existence indefinitely unless dissolved by owners or state. 2. If dissolved, shareholders get assets remaining after paying all creditors, bondholders, and preferred stockholders.

Regarding State rules for chartering a corporation, the corporation receives a certificate of incorporation which:

1. Grants authority to do business in the State. 2. Permits the corporation to enter contracts, to borrow money, and to hire employees. 3. Specifies the amount of stock that the corporation may issue (authorized stock).

outstanding stock

1. Outstanding stock is the number of common shares being held by the public. 2. Outstanding stock = issued stock - Treasury stock. 3. Outstanding shares are used as the basis for computing Earnings Per Share.

Owner's Equity

1. Owner's Equity or Common Stockholder's Equity is the net liquidation value or book value of each common share. 2. There are 2 ways to get to this figure from a corporation's balance sheet: All Assets - All Liabilities - Preferred Stockholders' Equity = Common Stockholder's Equity Common at Par + Capital in Excess of Par + Retained Earnings = Common Stockholder's Equity

par value

1. Par value per common share is an arbitrary value assigned to each share by the issuer when it incorporates in the State. 2. It is typically set very low because many States tax issuers annually based on their par value. 3. Any proceeds that the issuer receives when it sells its shares that is in excess of this arbitrary low value is called "capital in excess of par" or "capital surplus".

Voting Method

1. Shareholders do not have to be physically present at the annual meeting in order to vote their shares. 2. Rather, the shareholder completes a "proxy" or voting card with his or her votes and signs the card. 3. At the annual meeting, the votes of the proxies are tallied up, along with the votes of the stockholders that are physically present. 4. The items voted on at the annual meeting are seats up for election on the Board of Directors and corporate actions that are potentially dilutive that will result in the issuance of additional common shares such as the issuance of convertible securities, stock splits and stock dividends (but not cash dividends).

Voting Rights - Cumulative

1. Shareholders may accumulate votes for one candidate. 2. Owners of minority interests can combine votes to elect one or a few board members. 3. Shareholders still receive one vote per share, per director For example, a shareholder with 100 shares voting in an election of three directors would have 300 votes. The shareholders may combine their votes. This means that the shareholder could cast all 300 for one directorship; or could cast 200 votes for 1 directorship and 100 for another directorship; or could cast 100 votes for each of the 3 directorships.

Additional Rights - Limited Liability

1. Shareholders of a corporation have protection from the debts and obligations of the corporation. 2. They can only lose their investment, not their other assets. a. This differs from partnerships and proprietorships, where liability is not so limited b. For limited partnerships, however, the maximum loss again becomes the amount of the investment for the limited partners.

Voting Rights - Statutory

1. Statutory Voting requires votes to be spread over all candidates. Each share of common stock receives one vote for each seat on the board of directors Shareholders may not combine their votes Most corporations use this type of voting Minority shareholders typically cannot elect even one director 2. For example, a shareholder that owns 100 shares when there are 3 directorships up for election would get 100 votes for each directorship. There are 2 alternate candidates for each directorship, and the shareholder can cast 100 votes for each of the 3 directorships (300 votes total)

Additional Rights - Transferability

1. Stockholders may transfer ownership of their shares to anyone they want and at any time they choose. 2. They may buy and sell these shares repeatedly. 3. This transferability means the shares are negotiable securities. 4. Note the difference: a. Corporate shares are easy to transfer b. Partnership interest (including limited partnership interests) are more difficult to transfer because approval of the general partner is needed.

Authorized Stock

1. The State sets the rules for chartering a corporation. 2. On registration with the state, the corporation specifies the amount of stock that the corporation may issue (authorized stock). 3. The corporation then distributes all (or part) of the authorized stock to investors - this is issued stock. 4. If the corporation did not issue all authorized shares (called unissued stock), it may issue additional shares later without going back to the State to amend its charter.

issued stock

1. The corporate charter sets the limit on the number of shares that can be issued by the company - this is called the authorized shares. 2. The company may choose to issue (sell) part or all of its authorized share amount to investors - these are the issued shares. 3. Any portion of the authorized amount that has not been sold to investors are the unissued shares of the corporation.

market value

1. The market value of common stock is based on investor expectations for future earnings of that company. 2. It has no relation to par value or book value.

Additional Rights - Inspect Records

1. The shareholder may inspect the company books and records. 2. Most shareholders do not need to exercise this right because corporations must send audited financial statements annually. 3. Activist shareholders typically use this right to find the names and addresses of other shareholders. 4. For example, minority shareholders who have cumulative voting may use this right to locate other minority shareholders with whom to combine their votes in order to elect one or two directors favorable to them.

treasury stock

1. Treasury stock is stock that the corporation has issued and later repurchased from existing shareholders. 2. Corporations repurchase their shares for Treasury in order to reduce the number of shares outstanding. Then, when the corporation reports its earnings on a "per share" basis, the earnings are spread over fewer shares and "EPS" (Earnings Per Share) increases. 3. Corporate stock is typically valued as a multiple of EPS, so an increase in EPS typically results in an increased share price.

Voting Classes

1. Usually there is only 1 Class of common stock issued. 2. However, in rare cases, companies have issued multiple classes of common stock. 3.Usually companies issue multiple share classes to concentrate voting control in 1 share class and remove it from the other share class. 4.This is done by family-owned companies that wish to go public, yet wish to retain family control over the company - they get the concentrated shares. 5.It is also done by extremely successful companies that wish to seek additional investment capital without giving the new investors the same voting rights as the original owners. The new investors only accept lesser voting rights because the company is such a good investment - normally, they would not do so.

Capital in Excess of Par Value (Capital Surplus)

1. When a corporation issues common stock, it sets an arbitrary low par value on each share. 2. The actual sale price per share is well in excess of par value, and any amount received by the corporation in excess of par value is called "capital in excess of par" or "capital surplus". 3. For example, assume that a corporation receives $31 per common share and that par value is set at $1 per share. The capital surplus or capital in excess of par is $30 per share.

reverse stock split

1. When a corporation's stock price falls too low, it is in danger of being delisted from its exchange, which makes the stock very difficult to trade. 2. To preclude this from happening, the company will often "reverse split" its stock, which reduces the number of shares outstanding and increases the per share price proportionately. 3. Another way for a company to increase its share price is to initiate a stock buy-back program, again reducing the number of shares outstanding and thus increasing the per share market price.

Why corporations issue stock?

1. raise funds for future growth 2. can be used to develop and launch new products, buy other businesses, build manufacturing facilities, build store locations, etc. 3. funds are used for long term growth - they are not used to pay current liabilities

laws governing stock issuance: today

1. today a company can choose to incorporate in any state. each state 2. in addition, it must file in each state in which it operates. 3. there are no federal laws covering incorporation.

laws governing Stock issuance: back in the day

1. were established in the 1800s when there wasn't much interstate commerce. 2. each state had it own incorporation laws for businesses that operated within its borders.

Stock Dividends

1.Stock dividends are a distribution of additional shares of the companyÆs own stock. 2. A 10% stock dividend would give a stockholder 10% more shares than already owned (e.g. 100 shares, now has 110 shares). 3. The company typically issues new shares to "pay" for the stock dividend but may use Treasury Stock to pay this dividend. 4. The shareholder still has the same original investment, now divided by more shares, thus the price per share declines while the number of shares held increases.

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Bull & Bear Markets

A "bull" market is one that is rising rapidly. The generally accepted definition is an overall increase in stock prices of 20%. A "bear" market is one that is falling rapidly. The generally accepted definition is an overall decrease in stock prices of 20%. While there is no standard definition of the time frame within which these price changes must occur, some sources use a 2 month time window to measure price changes to see if the market is in a "bull" or "bear" phase.

Securities Markets and Analysis: Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Defensive Investing

A "defensive investment" is one which is generally unaffected by an economic downturn. During periods of strong economic growth, defensive investments will not do as well as more aggressive investments; but in periods of economic decline, they tend not to lose value. Thus, defensive investments preserve capital, produce some income, and minimize risk. Classic defensive investments are safe "bonds" such as Treasuries, Municipals, and AAA corporate bonds such as utility bonds. For stocks, defensive investments are blue chip companies in industries that are not subject to the economic cycle, such as pharmaceuticals, food, tobacco, and breweries. Defensive investors are long term investors that diversify their portfolio to reduce risk.

US Government, Municipal, Money Market Securities: Agency Issues: Collateralized Mortgage Obligations (CMOs) - Features

A CMO is a Collateralized Mortgage Obligation. These are created by broker-dealers who make bulk purchases of Fannie Mae, Ginnie Mae and Freddie Mac pass-through certificates (which are issued in $25,000 minimums) and place them into a trust. The trust is then dividend into $1,000 units that can be sold to investors. However, CMOs are a "derivative security," where by financial engineering, the cash flows from the underlying securities are cut into varying maturities and varying risk categories. In this manner, a $25,000 certificate can be refashioned into $1,000 selling units that can meet a variety of investor needs. The "risk" categories relate principally to the risk of the security being "prepaid" if market interest rates drop after issuance and the homeowners in the underlying mortgage pool prepay their mortgages to refinance at lower current market rates. Then the CMO holder is repaid principal at a faster rate, and these proceeds, if reinvested in new CMOs, will be reinvested at lower current market rates. This is called "prepayment risk." Note that this risk is much lower for CMOs than for actually owning the underlying mortgage-backed pass through certificates, since by dividing and sequencing the expected cash flows, each CMO "tranch" has a much better defined maturity that is less susceptible to prepayment risk as compared to the underlying MBS. Note that CMOs are rated "AAA" because they have virtually no default risk, since the underlying securities are government agency issues. CMOs make monthly payments to the certificate holders; and each payment is a combined payment of both interest and principal. The purchaser must continually reinvest these payments to maintain the overall rate of return on the investment - and if interest rates are dropping over this time frame, then the overall investment return will fall. This is reinvestment risk.

Securities Markets: Market Basics: Broker-Dealer Review

A broker-dealer can execute transactions for customers, either acting as an agent or as a principal in the transaction As a broker, the firm is an agent, finding the best market for the customer. For this the broker earns a commission As a dealer, the firm is a principal, buying the security from the customer directly into its inventory; or selling the security to the customer directly from the firm's inventory. For this, the dealer earns a mark-up or mark-down Broker-dealers cannot be both the broker and dealer in the same transaction - they cannot charge both a commission and a mark-up on the same transaction To summarize: Broker = Agent = Middleman = Intermediary = Commission Dealer = Principal = Direct = No Intermediary = Mark-Up or Mark-Down

Special Securities: Options - Calls

A call contract gives the holder the right to buy the underlying stock at the price, good for the life of the contract. The holder will only exercise if the market price of the stock rises above the strike price, so this is a bullish position The writer of the call contract is paid a premium for granting the contract to the holder, and is hoping that the market price falls below the strike price, so the contract expires and the writer keeps the premium. This is a bearish position. If the market price of the stock rises, the call will be exercised, obligating the writer to deliver the stock at the strike price.

Securities Quotes and Yields: Quotes: Stocks - Point Value

A change in value of 1 point for a share of either common or preferred stock represents a change in value of $1. Note, in contrast, that a change in value of 1 point for a bond represents a change in value of $10 (because each point equals 1% of $1,000 par for a bond).

Corporate Bonds: Pricing: Discount

A discount bond is one that is selling in the market for less than par value.

US Government, Municipal, Money Market Securities: Money Market Issues: Money vs. Capital Market

A money market instrument is a debt that will mature in 1 year or less. A security with a maturity of more than 1 year is termed a "capital market instrument." Issuers of money market instruments include the U.S. Government, corporations and banks.

Corporate Bonds: Pricing: Premium

A premium bond is one that is selling in the market for more than par value.

Special Securities: Options - Puts

A put contract gives the holder the right to sell the underlying stock at the price, good for the life of the contract. The holder will only exercise if the market price of the stock falls below the strike price, so this is a bearish position. The writer of the put contract is paid a premium for granting the contract to the holder, and is hoping that the market price rises above the strike price, so the contract expires and the writer keeps the premium. This is a bullish position. If the market price of the stock falls, the put will be exercised, obligating the writer to buy the stock at the strike price.

Securities Markets: Market Basics: Confirmation

A trade confirmation details the security traded, amount and price, plus any commission, mark-up or mark-down. Trade confirmations must be sent to customers no later than the business day after trade date, for regular way trades.

Securities Markets: New Issue Market: All or None Underwriting

A variation on a best efforts underwriting is an "all-or-none" deal. In an "all-or-none" underwriting, either the entire issue is sold or the deal is canceled. All-or-none underwritings are used for "start-up" companies that need the full funding otherwise they would fail. Subscribers to the issue have the monies held in escrow. If the entire issue is not sold, the subscribers are returned their funds held in escrow.

Securities Markets: New Issue Market: Due Diligence

All parties that sign the registration statement filed with the SEC are liable for any "omissions or misstatements of material fact" in either the registration filing or the prospectus delivered to purchasers. The registration statement is signed by the officers of the issuer; the attorneys that prepare the registration statement and prospectus; the accountants that certify the financial statements included in the prospectus; and the underwriters for the issue. All of the parties get together towards the end of the 20-day cooling off period to review the registration filing and the copy of the proposed prospectus to perform "due diligence." At the "due diligence" meeting, the documents are reviewed to insure accurate and complete disclosure of all relevant facts about the offering.

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Aggressive Investing

An "aggressive investment" is one which outperforms the market when stock prices are generally rising due to strong economic conditions; but which will fall faster than the market when economic conditions are weak. Aggressive investments generate capital gains due to increasing stock prices, with little or no current income, and with a greater loss of capital if market conditions deteriorate. Classic aggressive investments are growth stocks such as high technology and biotech stocks, and junk bonds. Aggressive investors accept greater risk for a potentially higher return. They can leverage their return by borrowing money to buy investments on margin; or by using options strategies. Aggressive investors tend to concentrate their holdings in one business area, assuming a greater level of business risk. Rather than taking a "buy and hold" approach, they will rapidly trade in and out of positions as conditions change.

Corporate Bonds: Features: Redemption Prior To Maturity Or Call Date

An issuer that wishes to redeem its bonds prior to a maturity date can do so by either: Calling them under the provisions of the bond contract Buying them back in the open market Call provisions can take the form of: In Whole Call: The whole bond issue can be called at pre-set dates and prices (usually with a call premium) established in the bond contract Sinking Fund Call: Part of the issue is called at par using extra money accumulated in a sinking fund. The call is by random selection at pre-set dates established in the bond contract. Instead of calling the bonds at par, if market prices have fallen, the trustee can retire the bonds by buying them in the market.

Corporate Bonds: Features: Maturity Date

An issuing corporation must pay the loan principal when the bond matures The bond specifies the date when its face value becomes payable - this is the maturity date At maturity, if the issuer sells new bonds to raise the funds to pay off the old bonds, then the bond issued is being "refunded" Note that equity securities do not have a maturity; only debt has a maturity

Securities Markets: New Issue Market: Primary Offerings

An offering of securities made by an issuer where the proceeds go to the issuer is made in the "Primary Market." Once shares have been issued, they are either listed on an exchange or trade OTC. In this case, the proceeds of the sale go to the selling shareholder. Trading of issued securities occurs in the "Secondary Market."

Securities Quotes and Yields: Yields: Current Yield, Common Stock

Any yield computation is computed on an annualized basis. Since common dividends are paid quarterly, to get annual dividend income, the 4 payments must be totaled. The formula for Current Yield is: Annual Dividends Received / Current Market Price.

Securities Markets: New Issue Market: Stabilization

As of the effective date, the underwriters commence selling the issue to customers at the POP - Public Offering Price - as stated in the prospectus. For an IPO, once the underwriters complete the sale, the "books are closed" and the issue begins to trade in the aftermarket. The worry of the syndicate is that the price might fall steeply in the aftermarket, which would make all of the syndicate's customers who bought the offering at POP very unhappy. To stop this from happening, the manager of the syndicate is permitted to "stabilize" the price of the issue by buying it back in the aftermarket from anyone who wants to sell. This is the only legal form of market manipulation and only the manager is permitted to stabilize under very tight SEC rules. To do so, a Notice of Stabilization must be included in the prospectus.

Securities Markets: Exchange Markets: Specialist's Pricing

As the "Designated Market Maker" on the NYSE floor, the Specialist must make a continuous market in the stock. The specialist maintains a bid-ask quote in the stock. The specialist is always willing to buy at the bid; and is always willing to sell at the ask. The specialist's profit is the spread (difference between bid and ask). The specialist will work for narrow spreads on actively traded issues; and demands wider spreads for inactively traded issues.

Securities Markets: New Issue Market: Effective Date

At the end of the 20-day cooling off period, if the SEC has not made a request for additional information, then registration is effective. The effective date is the first day that the issue can be sold, offered and recommended. Any offer, recommendation, or sale of the issue must be accompanied with, or preceded by, delivery of the final prospectus.

US Government, Municipal, Money Market Securities: Money Market Issues: Bankers' Acceptances

Bankers' Acceptances are an almost obsolete money market instrument that is used to finance imports and exports, mainly from 3rd world countries. For example, an importer of Nigerian cocoa must give the seller a check for the goods when the seller delivers them to the shipping dock in Nigeria, but the buyer does not want the check "cashed" until the goods arrive in the U.S. and are inspected. This takes about 90 days, so the check is post-dated to the expected date of delivery to the U.S. However, the seller wants to get his money immediately. The seller can take the post-dated check to a local branch of a U.S. multinational bank and have it "accepted." The bank is now guaranteeing payment by issuing a letter of credit against the draft. The exporter can now sell the check in the "money market" at a discount to face.

US Government, Municipal, Money Market Securities: Money Market Issues: Negotiable CDs

Banks issue Negotiable CDs, meaning that they can be traded prior to maturity The buyer and seller negotiate the rates and term. These are issued in $100,000 minimums and do not get FDIC insurance

Securities Quotes and Yields: Yields: Basis Quotes

Basis points are the basic measure of yield change. 1 basis point equals .01%; 100 basis points equals 1%.

Securities Quotes and Yields: Yields: Tax-Free Equivalent Yield

Because municipal yields are free from federal income tax, while corporate yields are taxable, the customer can earn less on a municipal bond and have the same "after-tax" yield. The formula to find the tax-free equivalent yield is: Taxable Yield (100% - Tax Bracket %)

Securities Markets: New Issue Market: Best Efforts Underwriting

Best Efforts Underwriting Investment banker (Underwriter) is a selling agent only Underwriter does not buy any shares Underwriter simply attempts to sell shares to the public Underwriter may or may not sell all issued shares AllûorûNone Underwriting Investment banker (Underwriter) is selling agent only Underwriter does not buy any shares Underwriter attempts to sell shares to the public Underwriter must inform investors of the ôallûorûnoneö nature of this offer and that this may cause cancellation of the offer If underwriter fails to sell ALL shares, The issuer cancels the issue Underwriter must void all sales

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Beta

Beta is a measure of price volatility relative to the market as a whole. A portfolio that has a "beta" of 1 moves at the same rate as the general market, as measured by the Standard and Poor's 500 Index. For example, if the S & P 500 Index moves up by 10%, then a portfolio with a "beta" of 1 will also move up by 10%. A portfolio with a "beta" greater than 1 moves faster than the overall market. For example, if the S & P 500 Index moves up by 10%, then a portfolio with a "beta" of 1.5 will move up by 15% (1.5 times the market movement). A portfolio with a "beta" lower than 1 moves slower than the overall market. For example, if the S & P 500 Index moves up by 10%, then a portfolio with a "beta" of .5 will move up by 5% (1/2 the market movement). Examples of high beta stocks are technology and emerging markets issues. Examples of low beta stocks are utilities and food companies.

Securities Markets: Market Basics: Bid & Ask

Bid is the price at which a specialist or market maker will buy a particular security from a customer Ask (or offer) is the price at which a specialist or market maker will sell a particular security to a customer Spread is the difference between bid and ask, and is the dealer's profit when each "round turn" trade (a buy and sell) is completed by the dealer Spreads are narrower for actively traded stocks, since the dealer can rely on a large trading volume to generate a profit Spreads are wider for thinly traded stocks, since the dealer cannot rely on a large trading volume to generate a profit

Corporate Bonds: Features: Debt

Bonds are debt Investors who buy corporate bonds are loaning money to the corporation. Bondholders are not owners of the corporation; rather they are creditors. The principal (loan) amount owed on a corporate bond is a liability of the corporation issuing the bond.

Corporate Bonds: Pricing: Reasons For Trading At A Discount Or Premium

Bonds are issued at par, with a coupon rate set to the prevailing market rate. If market interest rates rise after issuance, or the bond's credit quality deteriorates, then the bond's price will fall and it will trade at a discount If market interest rates fall after issuance, or the bond's credit quality improves, then the bond's price will rise and it will trade at a premium

Analysis of Investment Risk: Types of Investment Risk: Business Risk

Analysis of Investment Risk: Types of Investment Risk: Business Risk - Application

Business risk is the risk that a company's future operating earnings (the net earnings of the company before paying bond interest and dividends) decline due to adverse business factors, such as declining demand for the company's products. If the company's earnings decline precipitously, it could "go out of business," hence the term business risk. Government, agency and municipal bonds do not have business risk, since these securities are generally backed by tax collections - not by business operations.

Corporate Bonds: Summary: Corporate Capitalization

Capitalization is the total amount of money invested in a business The sources of a company's long term capital are: Common Stockholders Preferred Stockholders Bondholders Common stockholder's equity is the most complex portion of the firm's capital base because it has 3 components Capital at Par Capital in Excess of Par Retained Earnings Preferred Stockholder's equity is the amount of funds raised by selling preferred shares to the public. Debt Capital, in the form of either secured or unsecured bonds, is the amount of funds raised by selling bonds to the public.

US Government, Municipal, Money Market Securities: Negotiable Treasury Issues: T-Notes and T-Bonds

Characteristics of both T-Notes and T-Bonds Highly liquid and marketable Little risk of default T-Notes are issued with 2-10 year maturities at par and pay interest semi-annual based on the issue's fixed coupon rate T-Bonds are issued with 30 year maturities at par and pay interest semi-annual based on the issue's fixed coupon rate

Corporate Bonds: Types: Collateral Trust Certificates

Collateral Trust Certificates are issued by corporations that own stock in other companies, usually wholly-owned subsidiaries. The stock of the subsidiary is put up as collateral for the bond issue By giving the bondholders a lien against these assets, the issuer gets a lower interest rate If the issuer defaults, the bondholders claim these assets for themselves and no one else has a right to these assets

US Government, Municipal, Money Market Securities: Agency Issues: Collateralized Mortgage Obligations (CMOs) - Overview

Collateralized Mortgage Obligations (CMOs) are a derivative security, whose value is derived from an underlying instrument To create a CMO, mortgage backed pass-through certificates are placed into trust, and the monthly mortgage payments are reallocated into "synthetic" securities The cash flows are allocated into so-called "tranches", each with a different maturity and yield From the underlying mortgage backed pass-through certificates, the monthly mortgage payments are allocated pro-rata to all tranches for the interest payments; but are allocated sequentially to the tranches for the principal repayments All tranches receive a monthly interest payment; but the tranches are retired sequentially, creating a sequence of maturities

US Government, Municipal, Money Market Securities: Money Market Issues: Commercial Paper

Commercial paper is a short term IOU that is unsecured, with a maximum maturity of 9 months. It is used to finance short term capital requirements - it is not a source of long term funding. Commercial paper is only marketable by the highest credit quality corporate issuers because it is unsecured. Buyers of commercial paper are institutions with excess funds to invest and money market funds. It is not bought by individual investors because the purchase minimum is typically $100,000.

Stockholder Rights

Common stockholders have the following 6 major rights: 1.Right to vote 2.Right to dividends if declared by Board of Directors 3.Preemptive right 4.Right to remaining assets upon dissolution of the company 5.Right to transfer Shares 6.Right to inspect company books and records.

Corporate Bonds: Types: Convertible Bonds (Dilution)

Conversion of bonds into common stock dilutes stockholders equity Company earnings are divided among more outstanding shares so earnings per share will be reduced. This will dilute earnings per share and hence the stock's market price Because of the potential dilutive effect, common shareholders must approve of the corporation issuing convertible bonds

Corporate Bonds: Types: Convertible Bond Calculations

Convertible bonds can be converted into a fixed number of common shares at the option of the bondholder At issuance, there is a set conversion price. For example, if the conversion price is set at $25, this means that each $1,000 par preferred share can be converted into $1,000/$25 = 40 common shares If the market price of the common stock rises above $25, the convertible will trade at "parity" with the common. For example, if the common stock rises to $30, the bond will trade at $30 x 4 (the conversion ratio) = $1,200, since each bond must be worth the equivalent of 40 common shares.

Preferred Stock: Features: Conversion Calculations

Convertible preferred can be converted into a fixed number of common shares at the option of the preferred stockholder. At issuance, there is a set conversion price. For example, if the conversion price is set at $25, this means that each $100 par preferred share can be converted into $100/$25 = 4 common shares. This is the conversion ratio. If the market price of the common stock rises above $25, the convertible will trade at "parity" with the common. For example, if the common stock rises to $30, the preferred will trade at $30 x 4 (the conversion ratio) = $120, since each preferred share must be worth the equivalent of 4 common shares.

Preferred Stock: Features: Convertible Preferred

Convertible preferred gives the stockholder the right to exchange the preferred stock for common stock at a specified price. The specified price for conversion is above the current market price for the common stock when the company issues the convertible preferred stock. For example, a company issues $100 par convertible preferred stock that is convertible at $10 per share, when the market price of the common stock is $6. The preferred stockholder would not convert unless the market price of the common rises above the $10 conversion price. Convertibility is attractive to preferred stock shareholders and for the issuing company. With a conversion feature, the issuing company can issue the preferred stock with a lower stated dividend rate as compared to non-convertible preferred (a benefit for the issuing company) because of the potential for price appreciation of the common stock (which is a potential benefit for the shareholder).

Securities Quotes and Yields: Quotes: Corporate Bonds - Point Value

Corporate bonds are quoted on a percentage of $1,000 par basis, in minimum price increments of 1/8ths. 1 Point on a corporate bond = 1% of $1,000 par = $10 1/8th Point (the minimum price increment) on a corporate bond = .125% of $1,000 par = $1.25.

Securities Quotes and Yields: Quotes: Corporate Bonds - Quotes

Corporate bonds are quoted on a percentage of $1,000 par basis, in minimum price increments of 1/8ths. Note that this is very different than stock quotes, which are quoted in dollars and cents per share. 1 Point on a corporate bond = 1% of $1,000 par = $10 1/8th Point (the minimum price increment) on a corporate bond = .125% of $1,000 par = $1.25.

Preferred Stock: Features: Tax Issues

Corporations with excess funds to invest are principal purchasers of preferred stock, because they are given a major tax incentive that is not available to individuals Corporate investors can exclude 70% of the dividends they receive from investments in other companies from tax; if they own 20% or more of the stock of the company, then 80% of dividends can be excluded from their taxable income This so-called "dividend exclusion" is not given to individual purchasers of stock; only to corporate purchasers and applies to both common and preferred dividends received

Corporate Bonds: Features: Form

Coupon Bonds (bearer bonds) These bonds have an interest coupon attached to the certificate for each interest payment required. No owner's name or address is printed on the bond or on its coupons. Whoever comes in "bearing" the coupon on its due date receives the interest payment Whoever comes in "bearing" the bond on its maturity date receives the principal payment Bearer bonds are obsolete and have not been issued since the early 1980s Registered Bonds For these bonds, a Transfer Agent maintains a record of the ownerÆs name and address, and the issuer prints them on the bond certificate. The Transfer Agent automatically sends the interest payments to the owner of record as the payments come due. Registering helps to discourage theft and income tax avoidance. Since the 1990s, registered bonds have been obsolete Book Entry Bonds For these bonds, there are no certificates. The bondholder's name and address are kept in an electronic "book." The Transfer Agent maintains the only record of ownership. As with Registered Bonds, the Transfer Agent automatically sends interest payments to the owner of record as the payments come due. Virtually all new issue bonds are now book-entry because it saves the issuer time and money.

Analysis of Investment Risk: Types of Investment Risk: Credit Risk - Corporate Examples

Credit risk is the risk of default (meaning that issuer fails to pay either interest or required principal repayments as due). Secured bonds have a lower credit risk than unsecured bonds. The secured corporate bonds, ranked from lowest risk to highest risk, are: Mortgage bonds, where real estate is the collateral Equipment trust certificates, where expensive equipment like airplanes is the collateral Collateral trust certificates, where stock of an operating subsidiary of the company is collateral. The unsecured corporate bonds are: Debentures, which are backed by the company's faith and credit Income Bonds, which only pay if the company has sufficient income.

Analysis of Investment Risk: Types of Investment Risk: Credit Risk

Credit risk only applies to companies that have issued bonds. The issuance of bonds is called "leverage." By using "leverage" in its capital base, a company can "leverage" (meaning magnify) its earnings for shareholders as operating earnings increase, because the company's interest payment is fixed. Once this amount is covered, any incremental net earnings accrue to the shareholders. This is the good side of leverage. The bad side of leverage is that if the company does not have enough operating earnings to cover its fixed bond interest cost, then the company might default. If there is a default, then the bondholders can compel the company to liquidate to get their principal back - and usually they only get a portion of this back in a bankruptcy. Credit risk is also known as default risk.

Analysis of Investment Risk: Types of Investment Risk: Exchange Rate Risk

Currency exchange risk is the risk that the currency of the country of the issuer will decline against the currency of the investors country. For example, assume that a U.S. customer makes an investment in a foreign security denominated in Euros. If the Euro weakens, then when the value of the investment is converted from Euros to U.S. dollars, each Euro will "buy" fewer U.S. dollars, and the investment's value in terms of U.S. dollars will decrease.

Securities Quotes and Yields: Yields: Current Yield, Bonds

Current Yield = Annual Income / Market Price If the bond is trading at par, Current Yield will be the same as the bond's Nominal Yield If the bond is trading at a discount, Current Yield will be higher than the bond's Nominal Yield If the bond is trading at a premium, Current Yield will be lower than the bond's Nominal Yield

Corporate Bonds: Types: Debentures

Debentures are an unsecured corporate debt that is simply backed by the corporation's promise to pay Debentures carry a higher interest rate than secured debt because there is no pledge of assets backing the issue

Corporate Bonds: Types: Comparison - Secured / Unsecured Bonds

Debentures are unsecured bonds so they are not backed by any collateral Backing is owners promise to pay Similar to promissory note Debentures are typically issued with long-term maturities Subordinated Debentures are unsecured bonds that are issued after a corporation has already sold its first debenture issue. The new debentures cannot have the same claim as the first debentures, so they are made subordinate to the first debentures. Subordinated debentures will carry a higher interest rate because of this.

US Government, Municipal, Money Market Securities: Agency Issues: Characteristics

Debt issued by the "Federal" agencies is not directly backed by the U.S. Government - there is only an "implicit" backing that if they were to default, the U.S. Government would come to the rescue - but there is no guarantee of this In contrast, Treasury debt and GNMA debt is directly government guaranteed - the safest in the world, and hence, these can be sold at low yields. Agency debt yields more than Government debt because of its slightly higher risk. Agencies can be either wholly government owned, such as FHLB (Federal Home Loan Banks), or can be stockholder owned, such as Fannie Mae or Freddie Mac.

Corporate Bonds: Features: Term

Debt may be short, intermediate, or long term Short term debt matures or is due for repayment within one year Intermediate term debt is due between one and five years Long term debt reaches maturity or is due in more than five years Funded debt is a commonly used term for long term corporate debt (five years or longer)

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Diversification Effect

Diversification of assets in a portfolio will result in the superior performance of some investments being offset by the poor performance of other investments Business risk is the risk that a specific company will perform poorly in the future due to adverse changes in business conditions. Studies have shown that if a portfolio is diversified by investing in about 20 companies in different industries, the non-systematic risk (business risk) component has been diversified away, and the portfolio will perform as well as the overall market. Note that such portfolio diversification does not reduce systematic (market) risk. It only reduces non-systematic risk. Timing risk is the risk that a specific investment will be made at the wrong time in the market - that is, when the market price is at a peak. This can be minimized by making periodic investments over a long-term time frame in the specific security.

Special Securities: Rights - Mechanics

Each share of stock gets 1 right. Note that under the terms of the offer, more than 1 right is usually needed to exercise. For example, if a company has 100 million shares outstanding, it will issue 100 million rights. If it wishes to issue 10 million additional shares, the 100 million rights / 10 million additional shares = 10 rights needed to subscribe to each new share.

Analysis of Investment Risk: Types of Investment Risk: Duration (Bonds)

Duration measures the sensitivity of the value of a fixed income security to changes in market interest rates - essentially it is a measure of interest rate risk. Duration is a tool for comparing the interest rate risk of bonds with different coupon rates and different times to maturity. A high duration number means that the bond's price moves a large amount in response to changes in market interest rates. A low duration number means that the bond's price does not move much as market interest rates move. Bonds with low coupons and/or long maturities have high durations - that is, they are more volatile in their price movements as market interest rates move. Bonds with high coupons and/or short maturities have low durations -- that is, they are less volatile in their price movements as market interest rates move. The duration number is always less than length of time to maturity, except for zero coupon bonds where it equals the length of time to maturity.

Economic Factors: Economic Basics: Inflation & Deflation

During periods of inflation, prices of goods and services are rising. This reduces peoples' purchasing power, if their incomes do not keep up with rising prices. There are various theories for why inflation occurs. These are: Demand-Pull Inflation: There is so much excess demand for a specific item that the price can be pushed up without demand lessening. For example, if you drive 30 miles back and forth to work, and gas prices triple, you still must buy the same amount of gasoline to get back and forth to work. Your demand for gasoline to get back and forth to work will not fall (unless you change jobs or get a more fuel efficient vehicle - both of which take time) Cost-Push Inflation: As manufacturers see their material and labor costs rise, they keep increasing their product prices to match. As consumers see product prices rise, they demand wage increases to match, which leads to more product price increases, etc. In inflationary periods, market interest rates rise because bond investors demand to be compensated for their increased purchasing power risk. Stock prices fall because corporate profits erode as companies cannot increase prices fast enough to cover their increasing costs. The only assets that do well in an inflationary environment are hard assets such as real estate and commodities such as gold. Deflation is a period when prices of goods and services are falling. This increases purchasing power. Deflationary periods rarely happen (in not-so- recent U.S. history, the last deflationary period was during the depression of the 1930s).

Securities Markets: New Issue Market: 20-Day Cooling Off Period - Permitted Activities

During the "quiet period," the only permitted activities are the distribution of a preliminary prospectus and the acceptance of non-binding indications of interest. The issue cannot be sold, recommended or advertised during this period.

Securities Markets: Over-The-Counter Market: Fourth Market

ECNs are Electronic Communications Networks - these are electronic order matching books that are the cheapest way for institutions to trade with each other (if they can get a match) The 2 major ECNs are Instinet and Archipelago. ECNs were capturing an ever-increasing share of trading of both NYSE and NASDAQ listed issues. To deal with the loss of potential trading volume, the NYSE bought the Archipelago ECN; and NASDAQ bought the Instinet ECN. Both Instinet and Archipelago are run as separate operating subsidiaries of the parent markets.

Economic Factors: Economic Basics: Business Cycle

Economists measure changes in real GDP to assess the health of the economy. If real GDP is growing, then the economy is in a period of "expansion." After a sustained period of expansion, growth slows and can even become negative. This is called the "peak" or prosperity. From a peak, the economy can start to contract, and real GDP declines. If there are 2 consecutive quarters of GDP decline, this is a "recession." The decline in real GDP starts to slow and then the economy turns around and growth starts to slowly resume. This is called the "trough" or recovery. From the trough, economic growth starts again, with another period of expansion. This progression is called the economic cycle. The normal order of the cycle is: Expansion Peak or Prosperity Recession Trough or Recovery Also note that if there is a sustained period of GDP decline of 18 months, this is now a depression instead of a recession.

Corporate Bonds: Types: Equipment Trust Certificates

Equipment Trust Certificates are issued by railroads, airlines and long-distance trucking companies, where the trains, planes and trucks are collateral, securing the issue By giving the bondholders a lien against these assets, the issuer gets a lower interest rate If the issuer defaults, the bondholders claim these assets for themselves and no one else has a right to these assets

Securities Quotes and Yields: Quotes: Stocks - Quotes

Exchange stock listings show current day's closing price (last reported sale) and with the change in price from the preceding day's close If the change is a "+", then the stock closed higher in price than the preceding day. Thus, the preceding day's closing price was lower. If the change is a "-", then the stock closed lower in price than the preceding day. Thus, the preceding day's closing price was higher.

Economic Factors: Monetary Policy: Easy Money and Tight Money

Federal Reserve monetary policy actions are often simplified into terminology that describes what the Fed is doing as either an "Easy Money" Policy or a "Tight Money" Policy. When economic growth is weak, the Fed will pursue an "Easy Money Policy" to stimulate the economy. It will engage in repos with the government bank dealers to give them cash to lend out. It could lower reserve requirements and the discount rate. And it could lower margins on securities. The effect of all this is to lower interest rates and increase credit availability. When economic growth is too strong (which can lead to inflation), the Fed will pursue a "Tight Money Policy" to slow down the economy. It will engage in reverse repos with the government bank dealers to drain them of cash, so these banks will reduce their lending. In addition, the Fed could raise reserve requirements and the discount rate; and it could raise margins on securities. The effect of all this is to increase interest rates and decrease credit availability.

Economic Factors: Fiscal Policy: Responsibility

Fiscal policy is set by the executive (President) and legislative (Congress) branches of the federal government. Fiscal policy determines how the government will spend the monies from tax collections and federal borrowing - for example, how much will be spent on defense, on social security, on education programs, on Medicare, etc.

US Government, Municipal, Money Market Securities: State and Municipal Issues: General Obligation Bonds

General obligation bonds are backed by the faith, credit and unlimited taxing power of the issuer. The sources of taxing power backing State G.O. bond issues are income taxes, sales taxes and excise taxes. The source of taxing power backing political subdivision G.O. bond issues is property taxes. Because these bonds are backed by taxes paid by citizens, and people don't like their taxes to go too high, there are legal limits on the dollar amount of G.O. bonds that can be issued.

Economic Factors: Economic Basics: Gross Domestic Product

Gross Domestic Product (GDP) is the economic measure of all goods and services produced in the U.S. in a year. It consists of total consumer, investment and government spending plus exports and minus imports. Economic output (GDP) is measured in "real" terms. This means that any effect of inflation is taken out of the calculation.

Special Securities: Hedge Funds

Hedge funds are private investment funds that pursue aggressive investment strategies. They require large minimum investments (typically at least $500,000) and are only suitable for sophisticated or institutional investors. Hedge funds are set up as private placements that are not SEC registered. The securities are restricted and illiquid.

Corporate Bonds: Pricing: Discount Bond Yields

If a bond is trading at a discount, its price has fallen below par. There is no effect on the bond's Nominal Yield, which is: Annual Income / Par The bond's Current Yield increases because of the fall in market price. The formula for Current Yield is: Annual Income / Market Price The bond's Yield to Maturity increases even more than Current Yield because it reflects the annual earning of the discount. The formula for Yield to Maturity is: Annual Income + Annual Gain / Averaged Market Price For a discount bond, the yields arranged from lowest to highest are: Nominal Yield Current Yield Yield To Maturity

Corporate Bonds: Pricing: Premium Bond Yields

If a bond is trading at a premium, its price has risen above par. There is no effect on the bond's Nominal Yield, which is: Annual Income / Par The bond's Current Yield decreases because of the rise in market price. The formula for Current Yield is: Annual Income / Market Price The bond's Yield to Maturity decreases even more than Current Yield, because it reflects the annual loss of premium as the bond is held. The formula for Yield to Maturity is: Annual Income - Annual Loss / Averaged Market Price For a premium bond, the yields arranged from lowest to highest are: Yield to Maturity Current Yield Nominal Yield

Corporate Bonds: Pricing: Yield Relationship - Premium Bond

Analysis of Investment Risk: Types of Investment Risk: Purchasing Power Risk - Application

If an investor's portfolio value increases in value and this increase: is less than the rate of inflation, the investor loses "purchasing power;" keeps pace with inflation, the investor maintains the same "purchasing power;" exceeds the rate of inflation, the investor gains "purchasing power." If an investor's portfolio value decreases in value and this decrease: is less than the rate of inflation, the investor gains "purchasing power;" keeps pace with inflation, the investor maintains the same "purchasing power;" exceeds the rate of inflation, the investor loses "purchasing power."

Corporate Bonds: Pricing: Bond Volatility

If market interest rates move up, bond prices will fall - but all bond prices do not fall at the same rate. Conversely, if market interest rates move down, bond prices will rise - but all bond prices to not rise at the same rate. The basic truths about bond price volatility are: The lower the coupon rate, the more volatile the bond's price movements as market interest rates move The longer the maturity, the more volatile the bond's price movements as market interest rates move. Thus, the most volatile bonds are low coupon, long term issues. These are bonds trading at deep discounts. The least volatile bonds are high coupon, short term issues. These are bonds trading at premiums.

Analysis of Investment Risk: Types of Investment Risk: Interest Rate Risk

If market interest rates rise, then prices of outstanding bonds must fall. This will increase the yields of outstanding bonds to make them competitive with new issues that are coming out with new higher market interest rates. As market interest rates rise, this means that corporations will have to pay more in interest expense to borrow. The result will be that corporate earnings will decrease and this puts downwards pressure on stock prices.

Preferred Stock: Features: Non-Cumulative Preferred vs. Cumulative Preferred

If the corporate directors omit a preferred stock dividend, straight (non-cumulative) preferred stockholders have no right to catch up on dividends in arrears (the missed dividends) When the stock is cumulative preferred, any unpaid dividends will accumulate, and must be paid, along with the current year's preferred dividend, before a common dividend can be paid. Almost all preferred stock is cumulative - there are very few non-cumulative issues in the market

Securities Markets: New Issue Market: Firm Commitment Underwriting

In a firm commitment underwriting, the underwriter buys the issue outright from the issuer at a negotiated price and then resells it to the public. The underwriter takes full financial liability for any unsold shares. The underwriter is a principal in the relationship with the issuer.

Securities Markets: New Issue Market: Stand By Underwriting

In a rights offering, the issuer attempts to sell additional shares directly to its existing shareholders without using an underwriter. If all of the shareholders do not exercise their rights, then the issuer will not raise all of the needed funding. To insure that the issuer will raise the entire amount needed, the issuer will have an underwriter "stand-by" to pick up any unsubscribed shares in the rights offering on a firm commitment basis. The underwriter then resells these shares to the public for more than the subscription price. Because the issuer already has registered shares outstanding, stand-by underwritings are not IPOs - rather they are called "add-on" offerings because the issuer is adding more registered shares to its existing number of outstanding shares.

Corporate Bonds: Types: Income Bonds

Income Bonds are issued by companies in financial difficulty that are likely to default on their existing bonds They offer the existing bondholders new bonds with new terms The backing on the new bonds is the earnings of the corporation - these bonds only pay if the company has enough "income." There is no legal obligation to pay interest The issuer adjusts up the interest rate and the principal amount to get the bondholders to exchange their bonds, so these are also called "adjustment bonds" Bondholders accept the offer because they would rather try to preserve the company than force bankruptcy Income bonds have high credit risk or high risk of default

US Government, Municipal, Money Market Securities: State and Municipal Issues: Industrial Revenue Bonds

Industrial Revenue Bonds (also called Industrial Development Bonds) are a type of revenue bond used to finance a facility that the issuer will lease to a corporate user. IDBs are used to finance the building of manufacturing plants, convention centers, ball stadiums, parking garages, etc. The tax code deems these to be "non-essential private purposes" and because of this, the interest income from IDBs is federally taxable.

Securities Quotes and Yields: Yields: Taxable Equivalent Yield

Interest income from municipal bonds is exempt from Federal income tax. Because of this, municipal bonds offer a lower yield than taxable investments. A customer might wonder why the municipal yield appears to be low. It is lower because the customer keeps all of the yield; whereas he or she only keeps part of the yield earned on a taxable investment. For example, a customer in the 30% tax bracket that earns 10% on a corporate bond keeps 7% of the return and pays 3% of the return as tax. If the customer were to invest in a 7% municipal bond, all of the return is kept after tax, so these are "equivalent." To find the equivalent taxable yield, the formula is: tax free yield/ 100%-tax bracket= Equivalent Taxable Yield

US Government, Municipal, Money Market Securities: Agency Issues: Taxation

Interest income received from Fannie, Freddie, and Ginnie mortgage-backed certificates (and CMOs created from those certificates) is taxable at both the Federal and State levels (since the homeowner is able to deduct the interest at both levels). In contrast, the interest income from U.S. Government and other agency obligations is subject to Federal income tax, but is exempt from State and local income taxes (since State government cannot tax Federal obligations and vice-versa).

US Government, Municipal, Money Market Securities: Negotiable Treasury Issues: Taxation

Interest income received from Treasury obligations is subject to Federal income tax, but is exempt from State and local income taxes.

US Government, Municipal, Money Market Securities: State and Municipal Issues: Taxation

Interest income received from a municipal bond is exempt from Federal income tax, but is subject to State and local tax. However, if a municipal bond is purchased by a State resident, then that State (usually) exempts the issue from taxation as well Thus, for "in-State" purchasers, municipal interest income is exempt from Federal, State and local income taxes. In contrast, corporate bond interest income is taxable at all levels; and U.S. Government bond interest income is taxable at the Federal level, but exempt from State and local tax. Because of this major tax advantage, municipal bonds can be sold in the market at lower yields than either corporate or U.S. Government bonds.

Analysis of Investment Risk: Types of Investment Risk: Interest Rate Risk - Examples

Interest rate risk for fixed income securities is the risk that market interest rates increase. If this occurs, then the market price of outstanding issues must decline, so that their yields will rise to the new market rate. Interest rate risk is greater for fixed income securities with: Longer maturities Lower coupons Interest rate risk is lower for fixed income securities with: Shorter maturities Higher coupons

Securities Markets: New Issue Market: Investment Banker Functions

Investment bankers are FINRA member firms that specialize in handling securities offerings for issuers. When an issuer wishes to raise additional funds, it retains an investment banker (the underwriter) to: evaluate the current market to determine whether securities can successfully be issued determine the best type of security for the issuer to sell set the price on the offering and negotiate the underwriter's compensation for completing the offering market the issue to the public. The underwriter's compensation for selling the issue is embedded in the Public Offering Price (POP) and is called the spread. Any purchaser buys at POP. There are no commissions paid by purchasers of new issues.

Special Securities: Options - Call / Put Comparison

Investors buy calls when they are bullish and expect the market price to rise. They have the right to buy the stock at a fixed price and have unlimited gain potential. If the market falls, they lose the premium paid. Investors sell calls when they are bearish and expect the market price to fall. They collect a premium for selling the contract and if the market falls, the contract expires worthless and the gain is the collected premium. If the market rises, call writers are exercised and must deliver the stock that they do not own. They have unlimited risk potential. Investors buy puts when they are bearish and expect the market price to fall. They have the right to sell the stock at a fixed price and have increasing gain potential as the market falls. If the market rises, they lose the premium paid. Investors sell puts when they are bullish and expect the market price to rise. They collect a premium for selling the contract and if the market rises, the contract expires worthless and the gain is the collected premium. If the market falls, put writers are exercised and must buy the stock that they do not want. Their risk is being forced to pay the strike exercise price for worthless stock.

Special Securities: Options - Uses

Corporate Bonds: Types: Convertible Bonds

Issuer can sell convertible bonds with lower coupon rates compared to non-convertible issues, saving the issuer money Investors can convert the bonds into common stock at a predetermined price if the common stock price appreciates (this is why investors accept the lower coupon rate) If the common stock price appreciates, then the bond price will appreciate in tandem. For example, a $1,000 par 10% bond is convertible at $50. The bondholder can convert the bond into $1,000 / $50 = 20 shares of common stock at any time. If the common appreciates to $60 per share, the bond will be worth $1,200 (20 x $60) since it is equivalent to 20 common shares. Thus, the bond's market price movements parallel those of the common stock. If the stock price depreciates below the conversion price, the conversion feature has no value and the bond trades based on the value of its interest stream. Thus, it trades like a bond.

Analysis of Investment Risk: Types of Investment Risk: Legislative/Taxability Risk

Legislative risk is the risk of Congress changing the tax laws, adversely affecting the value of an investment. This is also called taxability risk. Investments that are given favored tax status are susceptible to this risk. Interest income received from municipal bond investments is exempt from Federal income tax. If the Federal government were to change the tax laws and tax municipal interest income, then municipal bond prices would plummet.

Analysis of Investment Risk: Types of Investment Risk: Liquidity Risk

Analysis of Investment Risk: Types of Investment Risk: Liquidity Risk - Application

Liquidity risk is the risk that, in order to liquidate a position (sell it), the seller might have to incur high transaction costs or reduce the price in order to attract a buyer. Liquidity risk is a risk associated with "illiquid" securities, hence the name. Actively traded securities such as U.S. Governments, agencies and "blue chip" stocks have very little liquidity risk. Inactively traded securities such as small cap stocks, "penny" stocks, hedge fund partnership investments, and "junk" bonds have high liquidity risk.

US Government, Municipal, Money Market Securities: Negotiable Treasury Issues: Treasury Receipts/STRIPS

Long-term zero coupon Treasury obligations are an investment that is very attractive to pension fund managers because of their safety and the fact that the manager does not have to worry about receiving semi-annual interest payments that must be reinvested to maintain the portfolio's overall rate of return Before the Treasury issued zero-coupon bonds directly to these investors, broker-dealers would buy conventional Treasury Notes and Bonds, "strip" them of their coupons and sell them to pension fund investors as long term zero-coupon bonds. The first issue was named "CATS" - Certificates of Accrual on Treasury Securities - but the generic name for these securities is Treasury Receipts In the mid-1980s, the Treasury decided to cut out the middleman and started selling zero-coupon Treasuries directly to investors under the name "STRIPS" - Separate Trading of Registered Interest and Principal Security.

Analysis of Investment Risk: Types of Investment Risk: Market Risk

Market risk for common stocks is the risk of a general market decline, taking all stocks down with it (both good and bad). Another name for market risk for common stocks is "economic risk." Do not confuse market risk for common stocks with market risk for bonds. Market risk for bonds is called "interest rate risk" and is the risk of an increase in market interest rates that will cause outstanding bond prices to drop. Do not confuse market risk with marketability risk. Marketability risk is the ease with which a security can be sold in the market. For example, exchange listed stocks have low marketability risk; stocks included in the OTC Pink Sheets are infrequently traded and have high marketability risk.

Analysis of Investment Risk: Types of Investment Risk: Marketability Risk

Marketability risk is the risk that when an investor wishes to sell, there is no "market" for that security - meaning that there is no one to take the other side of the trade. Marketability risk is a non-issue for government securities, because the Treasury market is the largest, most active trading market in the world. It is a minor issue for securities listed on exchanges, because the specialist (DMM - Designated Market Maker) will always make a market. Marketability risk is much more of an issue for thinly traded OTC issues included in the OTCBB (Over-the-Counter Bulletin Board) or Pink Sheets. For these, it may be impossible to find a buyer. Marketability risk is also an issue for corporate bonds and municipal bonds, which are not actively traded. The least marketable security is a partnership unit, which typically requires general partner approval to sell.

US Government, Municipal, Money Market Securities: Money Market Issues: Treasury Bills

Money market instruments that are issued by the U.S. Government include are any Treasury Bill (maximum 12 month maturity) and outstanding Treasury Notes and Bonds that will mature within 1 year.

US Government, Municipal, Money Market Securities: Agency Issues: MBS/CMO Suitability

Mortgage backed pass through certificates are issued in $25,000 minimums, so they are not suitable for the small investor. Because interest and principal is paid monthly, they provide monthly income, but also saddle the holder with "reinvestment risk" - this is the risk that over the life of the security, market interest rates are falling, and payments received are reinvested at lower and lower market rates, reducing the overall rate of return. Ginnies have no credit risk because they are backed by the U.S. Government. Fannies and Freddies are not directly government backed, so their credit risk is slightly higher. Because the source of the income from mortgage backed securities are mortgage payments, where the homeowner is able to deduct the interest expense from both Federal and State tax returns; the recipient of those interest payments must include them on his or her Federal and State tax returns. So interest income received from MBSs and CMOs is taxable at both the Federal and State level as compared to other Government obligations, where the interest is subject to Federal income tax, but is exempt from State and local tax.

Corporate Bonds: Types: Mortgage Bonds

Mortgage bonds are a secured debt, where the issuer pledges its property, plant and generating equipment as the backing for a bond issue. Granting a mortgage on these assets secures the bonds and allows the issuer to obtain a lower interest rate. Utilities are large issuers of mortgage bonds. If the issuer defaults, the bondholders claim these assets for themselves and no one else has a right to these assets.

US Government, Municipal, Money Market Securities: Agency Issues: Mortgage Backed Securities (MBSs)

Mortgage-backed pass through certificates "pass through" the monthly mortgage payments to the certificate holders. The certificates are issued by Fannie, Freddie and Ginnie in $25,000 minimums. Since each monthly mortgage payment is a combined payment of interest and principal, these are "self-amortizing" - the principal amount is paid down monthly. Because homeowners can prepay their mortgages when interest rates drop (they can refinance at lower current rates) they might pay off their old mortgages early. If this occurs, the prepayments are passed through to the certificate holders and the certificate might be repaid much earlier than anticipated. This is called "prepayment risk."

US Government, Municipal, Money Market Securities: State and Municipal Issues: Issuers

Municipal issues are either backed by a pledge of taxing power (general obligation bonds) or a pledge of revenues from an enterprise activity (revenue bonds). General obligation bonds can be issued by States and political subdivisions such as counties, cities, townships, etc. Revenue bonds are issued by non-profit "authorities" such as a bridge and tunnel authority, airport authority, turnpike authority, hospital authority, etc.

Securities Quotes and Yields: Quotes: Corporate Bonds - Financial Listings

Newspaper listings for corporate bonds give the following information Bond Name of the issuing company, the nominal yield, and the maturity year Thus AAA Intl 9+ 11 is a 9+% bond that AAA Int issued and which matures in 2015 The rate and maturity year are important to identify specific bonds in cases where a company may have several outstanding bond issues Current Yield is the nominal yield ($92.50) divided by the current price If this yield is LOWER than the nominal yield, the price must be at a PREMIUM If this yield is HIGHER than the nominal yield, the price must be at a DISCOUNT Vol ù the number of bonds traded today High/Low ù the high and low prices for which the bond traded today Close ù the last price for which the bond traded today Net Chg ù the difference between todayÆs last price and yesterdayÆs last price ù a net change of +1 is a change of $10 CV ù this indicator tells us that the bond is convertible

Securities Quotes and Yields: Yields: Nominal Yield

Nominal yield applies to bonds and preferred stock Nominal is the ônamedö yield stated on the bond or preferred stock certificate. This yield can be called the nominal yield, stated yield, or coupon rate. The nominal yield is set to the market conditions at the time of issuance to price the security at par ($1000 for a bond; $100 for preferred stock). Once the bond is issued, the nominal yield does not change.

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Non-Systematic Risk

Non-Systematic risk is "stock-specific" risk. Investing in just one or a few stocks generally produces a portfolio that will have more volatility than one that is fully diversified. Such a portfolio is said to have "non-systematic" risk (stock specific risk) in addition to "systematic" risk (market risk).

Securities Markets: Market Basics: Principal Dealer

OTC firms are called broker-dealers because they can act either as a broker or as a dealer in a transaction When a firm acts as a dealer, it is a principal buying the security into inventory (at the dealer's bid price) or selling the security out of inventory (at the dealer's ask price). The profit to the dealer for being a market maker or dealer is the spread, which is the difference between the bid and ask price that is earned for each round-turn trade performed by the dealer (a buy and a sell) Some dealers are wholesalers that only trade with other brokerage firms; other dealers are large brokerage firms that have their own dealer subsidiary. When a dealer receives a buy order from another broker, it sells to that broker at the ask. The broker then charges its customer a commission for executing that trade. Thus, the customer pays the ask price + a commission in this transaction When a dealer receives a sell order from another broker, it buys from that broker at the bid. The broker then charges its customer a commission for executing that trade. Thus, the customer receives the bid price - a commission in this transaction When a large brokerage firm that owns a dealer receives a buy order from one of its customers, it sells to the customer directly out of inventory and charges the customer a mark-up on the transaction. Thus, the customer pays the ask price + a mark-up in this transaction. When a large brokerage firm that owns a dealer receives a sell order from one of its customers, it buys from the customer directly into its inventory and charges the customer a mark-down on the transaction. Thus, the customer receives the bid price - a mark-down in this transaction.

Securities Markets: Market Basics: Agency-Broker

OTC firms are known as broker-dealers because they can act either as a broker in a transaction or they can act as a dealer in a transaction A broker is an agent for the customer, finding the best market to execute the customer transaction A broker matches a customer that wishes to buy to the seller with the best (lowest) price; a broker matches a customer that wishes to sell to the buyer with the best (highest) price For matching buyer and seller, the broker earns a commission Note that brokers do not maintain a securities inventory, and thus do not earn spreads

Securities Markets: Market Basics: Good Delivery

On settlement date, the securities that are delivered must be in "good" form, called a "good delivery" For registered securities (registered in customer name) to be a good delivery, they must be assigned by the customer. This means that the customer signs the back of the certificates, authorizing their transfer to someone else. The transfer agent will not accept a signature unless it is guaranteed. Only members of the Medallion Signature Guarantee Program can guarantee signatures. They are large financial institutions, mainly commercial banks and the larger FINRA member firms. Note that a signature guarantee is very different than a notarized signature. With a signature guarantee, the guarantor assumes the risk of loss if the signature is that of an imposter. All that a notarized signature shows is that the signer presented a proof of identity - there is no assumption of potential risk.

US Government, Municipal, Money Market Securities: Negotiable Treasury Issues: Taxation - Zero-Coupon Obligations

On zero-coupon Treasury issues, tax is due on the imputed interest earned each year. This is true for Treasury Bills, Treasury STRIPS and Treasury Receipts However, Series EE Bonds are given a tax benefit that the other zero-coupon Treasury issues do not have - tax on the imputed interest earned is not due until the Series EE Bond is redeemed.

Securities Markets: New Issue Market: Prospectus Delivery

Once registration is effective, the issue can be sold, offered and recommended. The final prospectus must be delivered to any purchaser of a registered offering, at or prior to, confirmation of sale. The final prospectus must be delivered to any prospective purchaser at the time that the security is offered or recommended to the customer.

Economic Factors: Monetary Policy: Open Market Operations - Repos & Reverse Repos

Open market operations are conducted daily and immediately affect interest rate levels as measured by the Fed Funds Rate (overnight loans of reserves from member bank to member bank) To loosen credit, the Fed will buy securities from a member bank with an agreement to sell them back the next day. For that 1 day, the bank has excess cash that it can lend out. This is known as a Repurchase Agreement (Repo). To tighten credit, the Fed will sell securities to a member bank with an agreement to buy them back the next day. For that 1 day, the bank has been drained of cash, so it must reduce its lending. This is exactly the reverse of a "repo" and so is called a "Reverse Repo."

Corporate Bonds: Features: Par Value

Par value for bonds is typically $1,000 and is the "face value" of the bond Par value is the amount the corporation owes on each bond The interest rate is stated as a percentage of par - it is not a percentage of the market price. The interest rate is the coupon rate on the bond. For example, an 8% bond pays 8% x $1,000 par or $80 per year in annual interest. Since interest payments are made 2 times a year, each payment will be $40.

Corporate Bonds: Types: Comparison - Bonds vs. Preferred Stock

Preferred stock and Bonds both: are senior securities, with prior claim over common stock can be callable and can be convertible; are fixed income securities whose price movements are interest rate sensitive. Preferred stock and Bonds differ in that: preferred stock is equity and bonds are debt; preferred stock has no fixed maturity and bonds do have a fixed maturity; preferred stock only receives a dividend if the board of directors so declares, while bonds have a legal claim to interest payments.

Preferred Stock: Features: Voting Rights

Preferred stock generally has no voting rights. Preferred shareholders do not vote for the board of directors. This is the tradeoff for the preference in corporate liquidation, dissolution, and bankruptcy. Preferred stock typically has no preemptive rights because the issuance of additional common shares does not affect the fixed dividend rate promised to the preferred stockholders.

Preferred Stock: Features: Summary

Preferred stock is equity (ownership) in a corporation; it is not a debt of the corporation. Preferred stock has a fixed dividend rate; there is no fixed dividend rate for common stock. Preferred stock dividends are only paid if the Board of Directors declares them. Preferred stock price movements are directly interest rate sensitive and move inversely to market interest rates. Preferred stock can be callable (the issuer has the right to call away the stock from the holder at a pre-set price), convertible, or participating.

Securities Markets: New Issue Market: Registration Statement Filing

Prior to filing a registration statement (S-1) with the SEC, the issuer and underwriter(s) are prohibited from offering or promoting the new issue. The issuer and underwriter can determine what type of security to offer and can estimate the size of the issue and price of the issue. Once the registration statement is filed with the SEC, the issue enters into the 20-day cooling off period. During this period, a preliminary prospectus can be sent to interested customers and a list of potential purchasers can be created. Once the registration is effective (at the end of the 20-day cooling off period) the issue can be offered and sold to potential purchasers via prospectus.

Analysis of Investment Risk: Types of Investment Risk: Purchasing Power (Inflation) Risk

Purchasing power risk is the risk of inflation. During inflationary periods, market interest rates rise, hence bond prices will drop. Furthermore, if the inflation rate is increasing, the value of fixed interest payments received from bond investments keeps on declining over the bond's investment time horizon. Also, the final principal repayment is declining in "real" dollars. This is purchasing power risk. Any long term fixed income security is susceptible to inflation risk. To avoid this risk, either buy a money market instrument with an extremely short maturity; or buy a variable rate security; or make investments that tend to grow with inflation, such as real estate investments.

Special Securities: Restricted/Letter Stock

Restricted securities are an issue of stock which the issuer has not registered with the SEC because it has been sold in a private placement under Regulation D. The SEC requires that a restriction legend be placed on the shares, since the securities are not registered and cannot be traded in the public markets. In addition, resale privately is typically restricted for at least 6 months. Investors typically purchase this stock by means of an ôinvestment letterö (hence the term, letter stock). Restricted securities are usually only purchased by sophisticated wealthy or institutional investors.

US Government, Municipal, Money Market Securities: State and Municipal Issues: Revenue Bonds

Revenue bonds are backed by a pledge of revenues from an enterprise activity. Revenue bonds are issued by "authorities" and are used to build toll roads, toll bridges and tunnels, convention centers, water and sewer facilities, ball stadiums - any project that can generate revenues. Because each project "pays its own way," there are no debt limits on revenue bonds (as compared to G.O. bonds). There is no voter approval required for revenue bond issuance, as is the case for G.O. bond issuance.

Special Securities: Rights/Warrants Comparison

Rights are short term (usually 90 day maximum) issuer granted options to buy stock at a discount to the market price, granted by issuers to their existing stockholders. The stockholder can either exercise, or sell them in the market for value, since they are "in the money" when issued. Warrants are long term (usually 5 years) issuer granted options to buy stock at a premium to the current market price. They are attached to preferred stock and bond offerings that the issuer is having a hard time selling, to make them more attractive to investors. The stockholder would only exercise the warrant if the market price of the stock rises - at issuance, the warrant's exercise price is much higher than the current market price of the stock. The warrant trades alongside the common stock.

Securities Markets: Market Basics: Cash Settlement

Securities trades can either be settled for "Cash" or "Regular Way" Cash settlement is same day settlement; Regular Way settlement is 3 business days after trade date Almost all trades settle regular way; very few trades settle for cash because it is more expensive to find a counter-party willing to settle the same day

Securities Markets: New Issue Market: Selling Group

Selling group members are signed by the syndicate manager to act as agents for the syndicate, finding customers. They take no liability and earn a selling concession for each security that they sell.

US Government, Municipal, Money Market Securities: Non-Negotiable Treasury Issues: Series EE

Series EE Bonds replaced the older Series E Bonds Investors purchase EE Bonds at a discount $25 buys a $50 bond (the smallest face amount) The interest rate is based on the 10-year Treasury Note rate and is added monthly to the value of the bond. Series EE bonds are redeemable with the government (through a bank) but are not marketable or transferable to other investors and cannot be used as collateral for a loan. When redeemed, the interest on EE Bonds is subject to federal income taxation

US Government, Municipal, Money Market Securities: Non-Negotiable Treasury Issues: Series HH

Series HH Bonds replace the older Series H bonds $500 is the smallest face amount Investors purchase HH bonds at face They receive interest semi-annually This interest does not accumulate It is reportable each year for federal income tax as received The bonds mature after 10 years Since 2004 investors may not redeem EE bonds for HH bonds

Special Securities: American Depositary Receipts

Shares of foreign companies are rarely listed directly in the U.S. because then the foreign company would have to comply with U.S. accounting and disclosure rules. The "foreign" shares trading in the U.S. are actually ADRs - American Depositary Receipts. A U.S. bank branch in a foreign country will buy up shares of a foreign company, place them in trust, and then issue receipts against those shares which it lists in the U.S. markets. Thus, the issuer does not have to deal with U.S. securities and accounting disclosure rules - the depositary bank deals with this. The depositary bank retains voting and pre-emptive rights. Any dividends received by the bank are converted to U.S. dollars and remitted to the receipt holders, net of foreign taxes due. ADR holders are subject to exchange rate risk, because the U.S. receipt price is based on the value of the foreign shares.

Securities Quotes and Yields: Quotes: Treasury Note/Bond Quotes

Similar to corporate bonds, government notes and bonds are quoted as a percentage of par value However, because the government bond market is more active, dealers are willing to trade in smaller increments than 1/8ths - for governments, dealers trade in 1/32nds. Dealer quotes are in terms of bid and ask. The bid price is the price at which the dealer will buy from a customer. The ask price is the price at which the dealer will sell to a customer. The difference between the bid and ask is the dealer's "spread." Customers buy at the dealer's ask; and sell at the dealer's bid.

Preferred Stock: Features: Dividend Preference

Since it is stock, preferred stock is an equity security Preferred stock has preference over common stock for (1) Dividends and (2) Liquidation Dividend preference Only the board of directors can declare dividends, including preferred dividends Directors may omit both preferred and common stock dividends If the company declares a dividend, it must pay preferred stockholders the full amount of their dividend before it can pay any dividends to common stockholders

Preferred Stock: Features: Participating Preferred Stock

Some companies offer a version of preferred stock known as participating preferred. This means that, after preferred stockholders receive their stated dividends, the participating preferred stockholders may share with the common stockholders in additional dividends - if the board of directors declares an "extra" dividend. If the preferred stock is both cumulative and participating preferred, the participating part is not cumulative; only the regular preferred dividend component is cumulative.

Securities Markets: Exchange Markets: Specialist

Specialists are market makers on stock exchanges, now renamed DMMs - Designated Market Makers Specialists (DMMs) ensure an orderly and continuous market by buying and selling for their own account. Specialists (DMMs) buy for their own account when there is an excess of sell orders on the floor of the exchange. Specialists (DMMs) sell from their own account when there is an excess of buy orders on the floor of the exchange. Specialists (DMMs) cannot buy when customer orders to buy are unfilled or sell when customer orders to sell are unfilled.

Securities Markets: Market Basics: Good Delivery Units

Stock certificates must be delivered, dealer to dealer, in units that add to amounts of 100 (a round lot) or in certificates that are multiples of 100

Securities Quotes and Yields: Quotes: Stocks - P/E Ratio

Stock listings include a stock's "P/E" Ratio - the Price/Earnings Ratio. This is a value measure called the "multiple" - stocks that are expected to grow rapidly in price have high P/E ratios, while stocks that are expected to grow slowly have low P/E ratios. Because stock listings give both the closing price of the stock and the P/E ratio, we can find the company's actual EPS (Earnings per Share) by dividing the Closing Price by the P/E Ratio.

Stock Splits

Stock splits mean shareholders receive additional shares based on their existing holdings A 3 for 1 split means the shareholders get two new shares for each current share making a total of 3 shares where they had one A reverse stock split will mean a reduction in the number of shares owned where the shareholders had 100 shares, they may now have 50 The price of the shares adjusts on the stock split or reverse stock split Thus, the total value of the shares is the same after the split as it was before the split This also means the total par value of the stock remains the same as before the split Why do corporations split (reverse split) stock? Stock split: to make stock more affordable to investors - The lower price makes the stock more attractive to more investors Reverse split: to make a stock whose price has fallen too low more attractive to investors by increasing the price There is no income tax liability at the time of the split. The changed cost basis is the price from which the IRS determines gain (or loss) on later sale of the stock

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Systematic Risk

Systematic risk is the risk of the "market" and it is the risk that cannot be diversified away in a portfolio.

Securities Markets: Over-The-Counter Market: NASDAQ Levels

The "old" version of NASDAQ was divided into 3 Levels of service, which may still be tested. These levels have been incorporated into the new NASDAQ "SingleBook" system. NASDAQ Level I - shows the best bid and ask (highest bid and lowest ask). Since a customer buys at the ask price, it is best to buy at the lowest ask; since the customer sells at the bid price, it is best to sell at the highest bid. These are incorporated into SingleBook as the "NBBO" - National Best Bid and Offer. NASDAQ Level II - shows the quotes of all market makers with their size (how many shares the quote is good for). This is still called Level II in SingleBook NASDAQ Level III - was the level where a market maker could change its own quote. This level is now obsolete with SingleBook.

Securities Markets: New Issue Market: 20-Day Cooling Off Period - Prohibited Activities

The 20-Day Cooling Off Period is called the "Quiet Period" because anyone involved in the offering must be "quiet" about it. The issue cannot be advertised, cannot be recommended, and cannot be sold. Because the final offering price is not set until the very end of the cooling off period, the worry of the SEC is that the underwriters might attempt to aggressively promote the offering in an attempt to raise the final price. The only permitted action during the cooling off period is the distribution of a preliminary prospectus, known as a "red herring." This can be distributed by underwriters and the underwriters can then accept non-binding indications of interest from potential customers that have received the red herring. The issue cannot be sold or recommended until the effective date. As of that date, any purchaser must get the final prospectus, at or prior to, confirmation of sale.

Securities Markets: Exchange Markets: Network A Tape (NYSE)

The Consolidated Network A Tape reports trades of NYSE listed issues, regardless of where the trade took place (it might take place on an exchange floor; it might take place in the Third Market, it might take place in the Fourth Market, etc.) The Consolidated Network B Tape reports trades of AMEX listed issues, regardless of where the trade took place The Consolidated Network C Tape reports trades of NASDAQ listed issues, regardless of where the trade took place

Securities Markets: Over-The-Counter Market: Network C Tape (NASDAQ)

Securities Markets: Over-The-Counter Market: Third Market

The Third Market is trading of listed stocks OTC Third Market Makers stay open 24 hours a day and do much of their trading when the exchange is closed The Third Market accounts for about 30% of trading in NYSE-listed issues Third Market Makers also specialize in block trades of NYSE-listed issues for institutions, because if such a large block were sent to the exchange and announced, it might cause a major price move in the stock.

Economic Factors: Economic Basics: CPI vs. PPI

The Consumer Price Index (CPI) measures price inflation for consumers. It is based on typical market basket of goods and services, measured in cities around the country. The Producer Price Index (PPI) measures price inflation for producers. It is based on materials sold by producers such as farm products sold to food companies and supermarket chains and industrial goods sold to manufacturers. It includes no services. Increases in PPI generally precede (leading indicator) increases in CPI because the increased prices are first felt by producers making their products who, in turn, raise prices to consumers (CPI increases) to cover their rising costs.

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Market Indices

The Dow Jones Industrial Average consists of 30 large capitalization stocks that are representative of the current make-up of the U.S. economy. The Dow Jones "Averages," also called the "Composite" index, is the total of the 3 Indexes prepared by Dow Jones and Company. It consists of the Dow Jones Industrial Average (30 stocks); Dow Jones Transportations Average (20 stocks) and the Dow Jones Utilities Average (15 stocks); for a total of 65 stocks in the Dow Jones Averages. The Standard and Poor's 500 Index consists of the 500 largest companies headquartered in the U.S., as measured by market capitalization. The Russell 2000 Index consists of 2,000 small capitalization stocks. The Wilshire "5000" Index contains all of the stocks listed on the NYSE, AMEX and NASDAQ. When it was started in the 1970s, it contained about 5,000 issues, hence the name. Today, it consists of roughly 2800 NYSE issues; 600 AMEX issues and 3200 NASDAQ issues, for a total of 6,600 issues.

Economic Factors: Monetary Policy: Open Market Operations

The FOMC - Federal Open Market Committee oversees the Fed's Open Market Operations The Fed buys and sells government securities with the major bank dealers in the open market to influence the money supply Open market operations are conducted daily and immediately affect interest rate levels as measured by the Fed Funds Rate (overnight loans of reserves from member bank to member bank) To loosen credit, the Fed will buy securities from the member bank with an agreement to sell them back the next day. For that 1 day, the bank has excess cash that it can lend out. This is known as a Repurchase Agreement (Repo). To tighten credit, the Fed will sell securities to the member bank with an agreement to buy them back the next day. For that 1 day, the bank has been drained of cash, so it must reduce its lending. This is exactly the reverse of a "repo" and so is called a "Reverse Repo."

US Government, Municipal, Money Market Securities: Money Market Issues: Money Market Rates

The Fed Funds rate is the interest rate banks pay each other to borrow the funds they need to make this deposit These loans are usually very short term (often overnight) The Fed influences this rate every day through its open market operations This is the base lending rate and, as it moves, all other interest rates will move as will The Call Money rate is the interest rate that banks charge broker dealers who borrow using their customers margin securities as collateral. This rate is higher than Federal funds. The Prime rate is the interest rate that banks charge their best commercial customers for unsecured loans. It is the highest of the money market rates.

Economic Factors: Monetary Policy: Four Fed Policy Tools

The Fed has 4 tools to control money supply levels and credit availability in the economy. They are "DORM." D - Discount Rate: The Fed sets the rate at which member banks can borrow from the Federal Reserve's "discount window." To loosen credit, the Fed can lower the discount rate; to tighten credit, the Fed can increase the discount rate. O - Open Market Operations: The New York Fed is a trading partner with the major commercial banks. Every day, it trades with these banks in the "open market." To loosen credit, the Fed buys securities from the banks, giving them cash to lend out. To tighten credit, the Fed sells securities to the banks, draining them of cash, so they must reduce their lending. R - Reserve Requirements: Every bank must keep a portion of money deposited on reserve and the bank can lend out the balance. To loosen credit, the Fed can lower the reserve requirement. To tighten credit, the Fed can increase the reserve requirement. M - Margin on Securities: The Federal Reserve has the power to set margin percentages on securities trades. Margin is the portion of the transaction that must be deposited by the customer, with the balance being lent to the customer. Regulation T of the FRB controls credit on securities from broker to customer. Regulation U of the FRB controls credit on securities from bank to customer. To tighten credit, the Fed can raise margins. To loosen credit, the Fed can lower margins.

Economic Factors: Monetary Policy: Other Fed Policy Tools

The Fed has 4 tools to control money supply levels and credit availability in the economy. They are "DORM." D - Discount Rate: The Fed sets the rate at which member banks can borrow from the Federal Reserve's "discount window." To loosen credit, the Fed can lower the discount rate; to tighten credit, the Fed can increase the discount rate. O - Open Market Operations: The New York Fed is a trading partner with the major commercial banks. Every day, it trades with these banks in the "open market." To loosen credit, the Fed buys securities from the banks, giving then cash to lend out. To tighten credit, the Fed sells securities to the banks, draining them of cash, so they must reduce their lending. R - Reserve Requirements: Every bank must keep a portion of money deposited on reserve and the bank can lend out the balance. To loosen credit, the Fed can lower the reserve requirement. To tighten credit, the Fed can increase the reserve requirement. M - Margin on Securities: The Federal Reserve has the power to set margin percentages on securities trades. Margin is the portion of the transaction that must be deposited by the customer, with the balance being lent to the customer. Regulation T of the FRB controls credit on securities from broker to customer. Regulation U of the FRB controls credit on securities from bank to customer. To tighten credit, the Fed can raise margins. To loosen credit, the Fed can lower margins.

Economic Factors: Monetary Policy: Federal Reserve Functions

The Federal Reserve System ù known as the "Fed," consists of 12 district banks in major cities around the country, with the "lead" bank being the New York Fed. The system is overseen by the Board of Governors of the Fed (FRB) in Washington, D.C. The FOMC - Federal Open Market Committee - meets every 6 weeks and looks at economic growth in each region. If the FOMC believes that the economy is growing too slowly, it will take action to increase credit availability to stimulate the economy. If the FOMC believes that the economy is growing too rapidly, it will take action to decrease credit availability to slow down the economy. Thus, the Fed is controlling "monetary policy." The Fed has 4 tools to do this, which you can memorize by the acronym "DORM." D - Discount Rate: The Fed sets the rate at which member banks can borrow from the Federal Reserve's "discount window." To loosen credit, the Fed can lower the discount rate; to tighten credit, the Fed can increase the discount rate. O - Open Market Operations: The New York Fed is a trading partner with the major commercial banks. Every day, it trades with these banks in the "open market." To loosen credit, the Fed buys securities from the banks, giving them cash to lend out. To tighten credit, the Fed sells securities to the banks, draining them of cash, so they must reduce their lending. R - Reserve Requirements: Every bank must keep a portion of money deposited on reserve and the bank can lend out the balance. To loosen credit, the Fed can lower the reserve requirement. To tighten credit, the Fed can increase the reserve requirement. M - Margin on Securities: The Federal Reserve has the power to set margin percentages on securities trades. Regulation T of the FRB controls credit on securities from brokers to customers. Regulation U of the FRB controls credit on securities from banks to customers.

US Government, Municipal, Money Market Securities: Money Market Issues: Repos / Reverse Repos

The Federal Reserve is a big player in the "money market" that trades every day with the large commercial banks. The Federal Reserve engages in open market operations with the large commercial banks to control short term credit availability. To loosen credit, the Fed engages in Repurchase Agreements with the commercial banks, buying U.S. Government securities from the bank with an agreement to sell them back the next day. This gives the banks extra cash to lend out and loosens credit. To tighten credit, the Fed engages in Reverse Repurchase Agreements with the commercial banks, selling U.S. Government securities to the bank with an agreement to buy them back the next day. This drains the bank of cash to lend out and tightens credit. Note that in addition to Fed-Dealer Repos and Reverse-Repos, commercial banks can enter into Repos with each other (when one bank dealer has excess funds and another bank dealer is short of funds).

Securities Markets: Over-The-Counter Market: NASDAQ Stock Market

The NASDAQ Stock Market is a decentralized electronic linked market that trades about 3200 issues, including such stocks as Dell, Microsoft, Apple and Google. The market allows for direct electronic trading and for electronic negotiation of trading terms. The NASDAQ Market actually has more listings and greater trading volume than the NYSE. Do not confuse the NASDAQ Market, which has listing standards, with the OTCBB or Pink Sheets, which have no listing standards. The OTCBB (Over-The-Counter Bulletin Board) and the Sheets are where "speculative" stocks are quoted. The OTCBB and Pink Sheets give electronic quotes, but trades are conducted over the telephone.

Securities Markets: Over-The-Counter Market: Types Of Securities

The OTC Market is bigger than you might think! All new issue offerings (IPOs - Initial Public Offerings) occur in the OTC market. Once the offering is completed, the shares are either listed on an exchange or trade OTC. All mutual funds are offered in the OTC market. These are redeemable securities and there is no trading of these shares. Once issued, they can only be redeemed with the sponsor. Almost all bonds trade only in the OTC market. Stocks, including closed-end fund shares and ADRs, trade either on exchange floors or OTC. If a security is "listed," this generally means listed on an exchange.

Securities Markets: Over-The-Counter Market: Market Characteristics

The OTC market is a negotiated market, as compared to an exchange floor which is an auction market The OTC market has a greater number of issues traded and greater trading volume than exchanges. The equities portion of the OTC market consists of the OTCBB and the Pink Sheets. All new issue offerings, including mutual fund offerings, are made OTC. In addition, almost all bonds trade OTC.

US Government, Municipal, Money Market Securities: Agency Issues: Issuers

The agencies that issue mortgage backed certificates are: GNMA - "Ginnie Mae" (Government National Mortgage Association) FNMA - "Fannie Mae" (Federal National Mortgage Association) FHLMC - "Freddie Mac" (Federal Home Loan Mortgage Corporation) All 3 agencies buy mortgages from originating lenders, assemble them into mortgage pools, and then sell "mortgage backed pass-through certificates" that represent an ownership interest in the pool The mortgage backed pass through certificates "pass through" the monthly mortgage payments to the certificate holders. These securities are often called "MBSs" - Mortgage-Backed Securities. The major difference is that "Ginnie" is owned and directly backed by the U.S. Government, while "Fannie" and "Freddie" have been "spun off" by the government and are now for-profit stock companies that were listed on the NYSE. Fannie and Freddie went "bust" in 2008 because they purchased too many "sub prime mortgages" that defaulted and have been placed in government conservatorship. Their shares were delisted from the NYSE and now trade in the Pink Sheets. Other agencies, such as Federal Land Banks, Federal Home Loan Banks, Federal Intermediate Credit Banks, do not issue MBSs.

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Micro Cap / Small Cap / Mid-Cap / Large Cap Funds

The categories of companies by the size of their market capitalization are: Micro Cap: Any company whose market cap is less than $300 million; Small Cap: Any company whose market cap is between $300 million and $1 billion; Mid Cap: Any company whose market cap is between $1 billion and $5 billion; and Large Cap: Any company whose market cap is over $5 billion.

Corporate Bonds: Features: Payment Claim

The commitment to pay interest on bonds is a legal obligation. The board of directors has no discretion in making interest payments Failure to pay interest means default, which can result in forced liquidation of the corporation.

Securities Markets: New Issue Market: Investment Banker Compensation

The compensation to the investment banker (underwriter) for selling a new issue to the public is called the spread. The spread is the difference between the POP and the proceeds of the offering that go to the issuer. For example, if the POP is set at $50 and the issuer will get proceeds of $47 per share, the underwriter will earn a spread of $3 for each share sold to the public. Any purchaser pays POP net for the new issue. There are no additional charges or commissions to the purchaser, since the underwriter's compensation is already embedded in the POP.

Securities Markets: Exchange Markets: Ex Date - Summary

The ex-date is set at 2 business days prior to record date, because any purchaser in a regular way trade will now settle after record and will not receive the dividend. On the ex-date, the price of the stock is reduced by the dividend amount by the exchange or market maker (for OTC stocks). There is no advantage to "rush" and buy the stock prior to the ex-date to capture the dividend. If the stock is bought on the ex-date or after, the price is reduced for the dividend that will no longer be received by the purchaser.

Securities Markets: Exchange Markets: Market Characteristics

The first securities markets in the U.S. were exchange floors, so any stock exchange floor is known as a First Market Do not confuse the First Market with the Primary Market. The Primary Market is the name for the new issue market - these are sold OTC. Once the shares are sold, they might be listed on an exchange and trade in the First Market; or they might trade OTC in the Second market. Exchange floors are auction markets; in contrast, the OTC market is a negotiated market.

Corporate Bonds: Pricing: Bond Ratings

The issuers credit rating affects the price of the bonds it issues Lower credit rating means higher risk of default on payment of interest and principal In economic downturns, higher quality bonds maintain value better than lower quality bonds. Rating services rate bonds according to level of risk of default The more As the higher the rating and the lower the risk of default Bonds rated below Baa or BBB are junk bonds These are speculative grade They are NOT suitable for investors who cannot accept the risk that the bonds may default and not make interest payments (e.g., older investors in accounts providing retirement income) They ARE suitable for investors who can accept this risk (e.g., younger investors who want to maximize their income)

Corporate Bonds: Features: Call Date

The issuing corporation may make its bonds ôcallableö The corporation can buy back the bonds from the bondholders prior to maturity at pre-set dates established in the bond contract When the corporation ôcallsö the bonds, interest ceases to accrue When calling its bonds, a corporation may have to pay a call premium This is an additional payment for calling the bonds early and is established in the bond contract This premium decreases as the bond approaches maturity Example: A $1,000 par bond with 30 years to maturity may be callable at 105 ($1050) staring in year 10. If the bond is called in year 10 or later, the extra $50 is the call premium Corporations will exercise the call option when interest rates decline Corporations can issue new bonds at the new lower rates When will corporations issue callable bonds? Corporations issue callable bonds when they think interest rates are now high and will decline in the future When they think rates are now low and will rise in the future, corporations will issue uncallable bonds

US Government, Municipal, Money Market Securities: Money Market Issues: Summary

The major money market instruments are: Treasury Bills issued by the U.S. Government with a maximum 12 month maturity Repurchase agreements entered into between the Federal Reserve and Bank Dealers (or between Bank Dealer and Bank Dealer), typically having an overnight maturity Commercial Paper issued by corporations with a maximum 9 month maturity Bankers' Acceptances issued by banks, used to finance imports and exports Negotiable CDs issued by banks in $100,000 minimum units.

Securities Markets: New Issue Market: Syndicate - Potential Liability

The manager forms a syndicate to spread the capital requirements needed to do the underwriting, which also reduces the risk of each syndicate member. The manager typically retains the largest portion of the offer, with the syndicate members taking smaller portions. The selling group members act as agents for the syndicate. Their function is to find customers, but they assume no liability.

Securities Markets: New Issue Market: Syndicate - Reason For Formation

The manager forms a syndicate to spread the capital requirements of the underwriting among other firms, especially when a very large issue is being underwritten. This reduces the potential risk for each firm in the syndicate, but also reduces the potential profit that each syndicate member can earn. By including syndicate members that are geographically diverse, this means that the issuer can be assured that the security buyers will be spread across the country. This is attractive to issuers that want a "national presence" and a broad investor base.

Analysis of Investment Risk: Portfolio Risk, Return and Valuation: Company Capitalization Components

The market capitalization of a company is the aggregate value of common shares outstanding. For example, if the price of a company's common stock is $20 per share and the company has 10,000,000 shares outstanding, the market capitalization of the company is $200,000,000.

US Government, Municipal, Money Market Securities: Non-Negotiable Treasury Issues: Marketable Debt Securities

The market for Treasury securities is the largest and most liquid in the world The Treasury issues both negotiable (marketable) and non-negotiable (non-marketable) debt. The negotiable debt issued by the Treasury includes Treasury Bills, Treasury Notes and Treasury Bonds The non-negotiable debt issued by the Treasury includes Series HH and Series EE bonds (these are savings bonds).

Corporate Bonds: Summary: Liquidation Preference

The other major preference of preferred stock is its preference in event of corporate liquidation, dissolution, or bankruptcy. In this event, the business terminates and sells its assets for cash. The terminated corporation then distributes the cash in the following order (federal bankruptcy laws set this order) Secured bondholders Unpaid wages and taxes General creditors and unsecured bondholders Preferred stockholders Common stockholders In event of a bankruptcy, the company often does not have enough cash to pay all of these liabilities so it pays what it can and stops when it runs out of cash. This means that some of those on the list do not receive any payment at all. Note that the preferred stockholders receive ALL of their stated dividends (plus arrears, if cumulative) and their full par value before common stockholders can receive any payment at all. Bonds and Preferred Stock are senior securities because their claim is senior to or ahead of common stock. Note, however, that common stock receives ALL that remains after those ahead of it receive their full payment There is no limit on how much the common stockholders can receive. To receive this benefit, they stand last in line and take the greatest risk of not receiving any payment.

Preferred Stock: Features: Fixed Dividend

The preferred stock dividend is a percentage of its par value. Par value for preferred stock is typically $100 per share, though $50 par and $25 par preferred has been issued The dividend rate is stated as a fixed percentage of par value (this is true for bonds as well) For example, a 6% dividend means the preferred stock will pay 6% of $100 par = $6 in annual dividends Preferred dividends are either paid quarterly (like common) or semi-annually (like bonds) If a corporation has a 6% annual preferred dividend rate on its $100 par preferred, and pays dividends semi-annually, then the stockholder will get a $3 per share dividend per payment

Economic Factors: Fiscal Policy: Purpose

The purpose of fiscal policy is to foster controllable economic growth with little or no inflation. Fiscal policy is set by Congress and the President and determines the level of taxes and government spending on defense, homeland security, social security, Medicare and other government programs and services.

Securities Quotes and Yields: Yields: Yield to Maturity

The relationship between yield measures for a DISCOUNT bond is (from lowest to highest): Nominal Yield (lowest) Current Yield Yield To Maturity (highest) This the case because Nominal Yield is based on par value; Current Yield is based on buying the bond for less than par; and Yield To Maturity factors in both buying the bond for less than par and the fact that the discount will be "earned" over the life of the bond. The relationship between yield measures for a PREMIUM bond is (from lowest to highest): Yield To Maturity (lowest) Current Yield Nominal Yield (highest) Yield To Maturity factors in both buying the bond for more than par and the fact that the premium will be "lost" over the life of the bond. Current Yield factors in the fact that the bond is purchased for more than par. Nominal Yield is based on buying the bond at par.

Securities Markets: Market Basics: Market Definition - Fourth Market

The securities market is categorized into the New Issue Market, called the Primary Market, and the Trading Market, called the Secondary Market The Secondary Market is trading of issued securities. This market is sub-categorized into the First Market Second Market Third Market Fourth Market. The names come from how trading of securities has evolved over time. First Market: Trading of listed securities on an exchange floor. Before the telephone was invented, traders had to physically meet to trade. Exchange floors have been around in the U.S. since the 1780s. NASDAQ is an exchange market, too. Second Market: Trading of unlisted securities that take place OTC - Over-The-Counter. The OTC market developed in the early 1900s once the telephone was invented. For equities, it includes the OTCBB (Over-The-Counter Bulletin Board) and the Pink Sheets. Third Market: Trading of listed securities that takes place OTC between so-called Third Market Makers. These are OTC Market Makers that compete with the exchanges. This market started in the 1960s, trades 24 hours a day, is mainly an institutional market, and now accounts for about 30% of trading in listed stocks. Fourth Market: Trading of both listed and unlisted stocks that takes place directly between institutions on so-called ECNs- Electronic Communications Networks. Some of these systems are Instinet and Archipelago. The advantage is very fast, cheap trading. These systems started in the 1970s, but came into their own when fast cheap computer networks became available in the 1990s.

Securities Markets: Market Basics: Market Definition - Third Market

The securities market is categorized into the New Issue Market, called the Primary Market, and the Trading Market, called the Secondary Market The Secondary Market is trading of issued securities. This market is sub-categorized into the First Market Second Market Third Market Fourth Market. The names come from how trading of securities has evolved over time. First Market: Trading of listed securities on an exchange floor; and on the NASDAQ System. Before the telephone was invented, traders had to physically meet to trade. Exchange floors have been around in the U.S. since the 1780s. Second Market: Trading of unlisted securities that take place OTC - Over-The-Counter. The OTC market developed in the early 1900s once the telephone was invented. For equities, the OTCBB (Over-The-Counter Bulletin Board) and the Pink Sheets. Third Market: Trading of listed securities that takes place OTC between so-called Third Market Makers. These are OTC Market Makers that compete with the exchanges. This market started in the 1960s, trades 24 hours a day, is mainly an institutional market, and now accounts for about 30% of trading in listed stocks. Fourth Market: Trading of both listed and unlisted stocks that takes place directly between institutions on so-called ECNs- Electronic Communications Networks. Some of these systems are Instinet and Archipelago. The advantage is very fast, cheap trading. These systems started in the 1970s, but came into their own when fast cheap computer networks became available in the 1990s.

Securities Markets: Market Basics: Market Definition - First Market

The securities market is categorized into the New Issue Market, called the Primary Market, and the Trading Market, called the Secondary Market The Secondary Market is trading of issued securities. This market is sub-categorized into the: First Market Second Market Third Market Fourth Market The names come from how trading of securities has evolved over time. First Market: Trading of listed securities on an exchange floor. Before the telephone was invented, traders had to physically meet to trade. Exchange floors have been around in the U.S. since the 1780s. Second Market: Trading of unlisted securities that take place OTC - Over-The-Counter. The OTC market developed in the early 1900s once the telephone was invented. For equities, it includes NASDAQ, the OTCBB (Over-The-Counter Bulletin Board) and the Pink Sheets. Third Market: Trading of listed securities that takes place OTC between so-called Third Market Makers. These are OTC Market Makers that compete with the exchanges. This market started in the 1960s, trades 24 hours a day, is mainly an institutional market, and now accounts for about 30% of trading in listed stocks. Fourth Market: Trading of both listed and unlisted stocks that takes place directly between institutions on so-called ECNs- Electronic Communications Networks. Some of these systems are Instinet and Archipelago. The advantage is very fast, cheap trading. These systems started in the 1970s, but came into their own when fast cheap computer networks became available in the 1990s.

Securities Markets: Market Basics: Market Definition - Second Market

The securities market is categorized into the New Issue Market, called the Primary Market, and the Trading Market, called the Secondary Market The Secondary Market is trading of issued securities. This market is sub-categorized into the: First Market Second Market Third Market Fourth Market. The names come from how trading of securities has evolved over time. First Market: Trading of listed securities on an exchange floor. Before the telephone was invented, traders had to physically meet to trade. Exchange floors have been around in the U.S. since the 1780s. Second Market: Trading of unlisted securities that take place OTC - Over-The-Counter. The OTC market developed in the early 1900s once the telephone was invented. For equities, it includes NASDAQ, the OTCBB (Over-The-Counter Bulletin Board) and the Pink Sheets. Third Market: Trading of listed securities that takes place OTC between so-called Third Market Makers. These are OTC Market Makers that compete with the exchanges. This market started in the 1960s, trades 24 hours a day, is mainly an institutional market, and now accounts for about 30% of trading in listed stocks. Fourth Market: Trading of both listed and unlisted stocks that takes place directly between institutions on so-called ECNs- Electronic Communications Networks. Some of these systems are Instinet and Archipelago. The advantage is very fast, cheap trading. These systems started in the 1970s, but came into their own when fast cheap computer networks became available in the 1990s.

Securities Markets: Market Basics: Spread

The spread is the difference between a dealer's bid and ask quote For example, if the dealer's bid is $25.50 and the dealer's ask is $25.75, this means that the spread is $.25 This is the profit that the dealer will earn on each round-turn (buy and sell) trade Active trading markets are characterized by narrow dealer spreads Inactive trading markets are characterized by wide dealer spreads

Special Securities: Options - Basic Features

There are 2 parties to an option contract The buyer of the option is called the holder, and is said to be "long" the contract. The holder has the right to either buy or sell the underlying stock at the exercise price. The seller of the option is called the writer, and is said to be "short" the contract. The writer, if exercised, is obligated to either deliver the stock (to the holder) or buy the stock (from the holder) at the exercise price.

Analysis of Investment Risk: Types of Investment Risk: Political Risk

There are 2 risks that are unique to foreign investments: Political risk Currency exchange risk Political risk is the risk that the foreign government changes its laws; or that the government is changed (i.e. overthrown) and the foreign holders of that country's securities find that the new government expropriates those assets or renounces its debt. Political risk is mainly an issue with "Third World" countries that have weak governments. Currency exchange risk is the risk that the foreign currency loses value against the U.S. dollar; thus the value of the foreign investment falls in terms of the U.S. dollar.

Economic Factors: Monetary Policy: Money Supply Definitions

There are 4 measures of the money supply - M1, M2, M3, and L. M1 = Currency in circulation and checking accounts M2 = M1 + savings accounts and money market accounts M3 = M2 + time deposits over $100,000 and repurchase agreements longer than 1 day L = M3 + all money market instruments maturing within 1 year.

Securities Markets: Exchange Markets: Ex Date

To be an owner of record, the stock must be purchased in a regular way trade at least 3 business days prior to the Record Date If the stock is purchased 2 business days or less prior to Record Date in a regular way trade, then the trade will settle after the Record Date and the purchaser will not be on the shareholder list to receive the dividend Thus, 2 business days prior to the Record Date is the "Ex-Date." As of the market opening on the "Ex" date, the Specialist (DMM - Designated Market Maker) reduces the price of the stock for the cash dividend that any purchaser will no longer receive. This stops speculators from engaging in short term trading just to capture the dividend.

Analysis of Investment Risk: Types of Investment Risk: Reinvestment Risk

To maintain an investment's rate of return, any interest or dividend payments must be reinvested in securities that give the same rate of return. If market interest rates are declining over an investment's time horizon, then interest or dividend payments received will be reinvested at lower and lower rates, averaging down the investment's rate of return. This is reinvestment risk. Zero-coupon bonds have no reinvestment risk because they do not make periodic payments.

Securities Markets: Market Basics: Regular Way Settlement

Trade Date is the day on which the customer actually buys or sells the security. Settlement Date is the day on which the securities are delivered and payment is made. Regular Way settlement of securities trades occurs 3 business days after Trade Date. For example, a regular way trade of ABCD stock that takes place on Monday, April 2nd, will settle on Thursday, April 5th For example, a regular way trade of DEFF stock that takes place on Friday, May 15th will settle on Wednesday May 20th

Securities Markets: Exchange Markets: Ticker Tape

Trades of NYSE listed stocks are reported through the Consolidated Network "A" Tape. Trades of AMEX listed stocks are reported through the Consolidated Network B Tape. Only round lot trades are reported. If a trade is reported with just a price, it is a trade of 1 round lot of 100 shares. If a trade is reported with the designation "s", from "2s" up to "99s", this means that round lots were traded at the price. For example, 2s means 2 round lots = 200 shares; 50s means 50 round lots = 5,000 shares; 99s means 99 round lots = 9900 shares. When 10,000 or more shares trade, this is a block trade and the full amount of the trade prints; but the "s" is not dropped. Therefore 10,000s = 10,000 shares traded; 15,000s = 15,000 shares traded, etc.

US Government, Municipal, Money Market Securities: Negotiable Treasury Issues: Summary - Comparison

Treasury securities that are issued at par and pay semi-annual interest at a stated rate of interest are Treasury Notes, Treasury Bonds and Series HH bonds Treasury securities that are issued at a discount from par and that mature at par, with the difference being the interest earned are Treasury Bills, Treasury STRIPs (or Treasury Receipts) and Series EE bonds. Series EE and Series HH bonds are non-negotiable; all other Treasury issues are negotiable

Treasury Stock - Rights

Treasury stock, unlike outstanding common shares, has no voting rights, no preemptive rights and no dividend rights.

US Government, Municipal, Money Market Securities: State and Municipal Issues: Summary

Types of municipal issues include: general obligation bonds backed by tax collections at the state and local level; revenue bonds issued by "municipal authorities" to build toll road, bridges, etc., where the revenues from the facility pay off the bonds; and industrial development bonds, which are issued by "municipal authorities" to build manufacturing facilities that will be leased to corporations to bring jobs to a depressed area. Convertible bonds are corporate issues, since they can be converted at a fixed price into common stock of that company. Series EE bonds are savings bonds issued by the U.S. Government.

US Government, Municipal, Money Market Securities: Negotiable Treasury Issues: T-Bills

U.S. Treasury securities are T-Bills, T-Notes, T-Bonds T-Bill Characteristics Highly liquid and marketable They are short term (1, 3, 6, or 12 months) Little risk of default T-Bills sell at a weekly auction at a discount to par They earn the discount over the life of the T-Bill They carry no stated interest rate

Special Securities: Restricted Stock - Accredited Investors

Under Regulation D, private placements can only be sold to a maximum of 35 "non-accredited" investors and to an unlimited number of accredited investors. Accredited investors are generally wealthy. They include: Individual with annual income of $200,000 or couple with annual income of $300,000 Individual with $1,000,000 net worth Institution with at least $5,000,000 of assets for investment Officer or Director of the issuer

Preferred Stock: Features: Pricing

Unlike common stock, where the market price is based on expectations for future earnings and growth, pricing for both preferred stock and bonds is totally different. Both preferred stock and bonds are called "fixed income" securities because they either have a fixed dividend rate or fixed interest rate, expressed as a percentage of par value. The market for interest rates is dynamic - it is not static. As market interest rates move, the pricing of these securities adjusts to make their yield competitive with the current market For example, assume that a company issues 10% $100 par preferred when market rates are at 10%. This issue gives a return that is competitive with the market and will be priced at $100 par. Any purchaser will get $10 of annual dividends / $100 purchase price = 10% dividend yield (which equals the current market rate) If market interest rates double to 20%, then any new preferred stock issue will have a dividend rate of 20%. For this "old" 10% issue to be competitive with the market, its price must fall to $50 in the market. Any purchaser will receive 10% of $100 par = $10 of annual dividends / $50 purchase price = 20% dividend yield (which equals the current market rate). If market interest rates fall by half to 5%, then any new preferred stock issue will have a dividend rate of 5%. For this "old" 10% issue to be competitive with the market, its price will rise to $200 in the market. Any purchaser will receive 10% of $100 par = $10 of annual dividends / $200 purchase price = 5% dividend yield (which equals the current market rate). To summarize: Any fixed income security's market price is directly interest rate sensitive. The price will move inversely to market interest rate movements. If market rates move up, the price of fixed income securities fall (to make their yields competitive with the market). If market rates move down, the price of fixed income securities rise (to make their yields competitive with the market).

Special Securities: Warrants

Warrants are created by issuers to be attached to bond or preferred stock offerings that the issuer is having a hard time selling. They are a "sweetener" that gives the purchaser of the bond or preferred stock a long term option (usually up to 5 years) to buy the stock at a pre-set price. At issuance, the warrants have no value. For example, if you buy the corporation's $1,000 par bond, you might get a warrant attached to buy 1 new share at $30. At the time of issuance, the stock is trading at $10. For the warrant to have any value, the stock's price must rise above $30 over the next 5 years. Warrants trade alongside the stock.

Securities Markets: New Issue Market: Primary Offerings - Effect on Issuer's Books

When a corporation issues new shares, the payment for the shares increases the issuer's cash position, and the additional issued shares are recorded as an increase in stockholder's equity, increasing net worth. Due to the issuance of the shares, the company will have more shares outstanding. Its earnings will now be spread across a greater number of shares, decreasing reported EPS (Earnings Per Share).

Securities Markets: Exchange Markets: Record Date To Receive Dividend

When a corporation makes a dividend announcement, that date is called the Declaration Date In the announcement, the corporation sets both the Record Date and the Payable Date. On the evening of the Record Date, the corporation takes the list of shareholders to receive the dividend To be an owner of Record, the stock must be purchased and the trade settled no later than the Record Date This means that anyone who purchases the stock in a Regular Way trade at least 3 business days in advance of the Record Date will be on the shareholder list to receive the dividend Anyone who buys the stock in a Regular Way trade 2 business days or less prior to Record Date will not receive the dividend. Thus, the "Ex-Dividend" date is set at 2 business days prior to Record Date. On this date, any purchaser will no longer get the cash dividend and the stock price is reduced at the market opening to reflect this. The Payable Date is the date that the checks are mailed to the stockholders - typically 1 month after the Record Date.

Securities Quotes and Yields: Yields: Yield Comparison - Govt/Corp/Muni Bonds

When comparing yields of the 3 major classes of bonds, the yields are, from highest to lowest: Corporate bonds U.S. Government bonds Municipal bonds. This ranking assumes that the bonds of similar maturity and credit quality. Corporate bonds give the highest yield because the interest income is taxable at both the Federal and State levels. U.S. Government bonds can be sold at a lower yield than corporates because the interest income is exempt from State income tax. Note that the interest income is Federally taxable. Municipal bonds can be sold at the lowest yield because the interest income is exempt from Federal income tax; and if the purchaser is a resident of the State that issued the bond, that State exempts the issue from taxation as well.

US Government, Municipal, Money Market Securities: State and Municipal Issues: Taxation of Private Purpose Revenue Bonds

While the general rule is that municipal interest income is exempt from Federal income tax, any revenue bonds that are "private activity" issues such as Industrial Development Bonds, are subject to a form of Federal income tax called the "AMT" - Alternative Minimum Tax. The idea behind the AMT is that "creative" taxpayers with high incomes can take advantage of "tax preferences" included in the tax code to reduce their taxable income, often to almost nothing. The AMT tax takes these "tax preferences" and adds them back to that person's reported taxable income and then taxes the whole amount at a flat rate of 26-28%. Congress felt that municipal bonds that are not benefitting the public should be taxable; but they included their interest as an "AMT" tax preference item. Thus, the interest becomes taxable only to high-income taxpayers that use tax preferences to reduce taxable income and thus, that become subject to AMT.

Corporate Bonds: Types: Zero Coupon Bonds

Zero Coupon Bonds have no stated rate of interest, because investors do not receive annual interest payments û there is no "coupon." An investor buys a zero coupon bond at a steep discount, for example a 30 year, $1,000 par bond zero coupon bond is purchased for $200. At maturity 30 years later, the investor receives $1,000 par, for a gain of $800 earned over 30 years. Long-term investors like these bonds because they receive a fixed rate of return and they do not have to reinvest semi-annual interest payments Issuers like to offer these bonds and are less likely to call them for redemption because no interest payments are required until maturity. Even though the aggregate amount of interest is not received until maturity, the IRS requires that the annual "accretion" of interest be reported each year and this is taxable yearly. To avoid current taxation on income not actually received until maturity, zero coupon bonds are most often purchased in tax-deferred retirement accounts.

common stock is an (blank) security, as is preferred stock.

equity

owners of common stock have an:

equity position in the corporation.

Corporate Bonds: Pricing: Yield Relationship - Discount Bond

f a bond is trading at a discount, its price has fallen below par. There is no effect on the bond's Nominal Yield, which is: Annual Income / Par The bond's Current Yield increases because the fall in market price. The formula for Current Yield is: Annual Income / Market Price The bond's Yield to Maturity increases even more than Current Yield, because it reflects the annual earning of the bond discount. The formula for Yield to Maturity is: Annual Income + Annual Gain / Averaged Market Price For a discount bond, the yields arranged from lowest to highest are: Nominal Yield Current Yield Yield To Maturity

Special Securities: Rights - Overview

stock rights are also called preemptive rights - if a company wishes to issue additional shares, the existing shareholders have the "right" to maintain proportionate ownership The mechanics of a rights offering works as follows: The company issues 1 right per outstanding share of stock A shareholder may be required to use more than one right to obtain a share of the new issue of stock. Example: A company with 80 million shares outstanding wishes to issue 10 million new shares. Each shareholder receives 1 right per share, so 80 million rights are issued. Since the company is only issuing 10 million additional shares, it will require 80 million rights / 10 million new shares = 8 rights to subscribe to each new share, plus payment for that new share. If existing shareholders do not subscribe to all of the new stock, an underwriter or broker-dealer will buy the stock in a standby underwriting and resell it to the public. An investor who does not want to subscribe for the new shares can sell the stock rights for their intrinsic value. Rights have a short life - typically less than 90 days. The recipient should either exercise, since the rights allow the stock to be purchased at a discount, or should sell the rights for their value in the market.

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