Series 7 Ultimate Study Guide

Priority in Dissolutions

dissolution - A dissolution is the process of terminating a business entity such as a corporation, partnership, or limited liability company (LLC). priority order for dissolutions - The priority order for dissolutions is generally as follows: secured creditors, unsecured creditors, subordinated debt, preferred stockholders, and common stockholders.

Bond Yields

Nominal Yield (Coupon Rate) - Coupon = Face Value ($1,000) x Nominal Yield - this interest payment is the same every year Current Yield - the annual coupon payment of a bond divided by its current market price. - For example, current yield of a 6% bond trading for 80 ($800) is 60 / 800 = 7.5% - The DBL 10s of '39. DBL is the name of the issuer, 10s means the nominal yield is 10%, and '39 means that the bonds mature in 2039 - If an investor were to buy these bonds for more than $1,000 or less than $1,000, the return on the investment would not be 10%. For example, if these bonds had a current market value of $800, their CY would be 12.5% ($100 ÷ $800). Similarly, someone paying $1,200 for the bonds would receive a CY of 8.33% ($100 ÷ $1,200). Yield to Maturity (Basis) - an investor purchasing a bond at a discount knows that holding the bond until maturity date will result in a return of the par - Yield to maturity assumes that all coupon payments are reinvested at the same yield. value, an amount that will be more than her purchase price for the bond. That means a gain in addition to the interest. An investor purchasing a bond at a premium and holding it until the maturity date knows that the par value received will be less than her purchase price for the bond. That means that the total interest received is offset by a loss. We reflect this gain or loss that an investor will have at maturity by looking at another yield. This is the yield to maturity, or true yield. Yield to Call - A bond with a call feature may be redeemed before maturity at the issuer's option. - The call price may be at par or at a premium - When the bond is selling at a premium, this calculation generates a lower return than does the YTM. That is why call protection is so important when a callable bond is trading at a premium. - it is highly unlikely that an issuer would call in a bond that was available in the marketplace at a discount. After all, if the issuer could pay less than $1,000 to buy back the debt, why would they issue a call at par or higher? Zero Coupon Bonds - One bond that is always traded at a discount is the zero coupon bond. You would see them quoted as: BCD Zr 36 @ 6.45%. BCD is the issuer, Zr is the coupon (zero), 2036 is the maturity date, and the yield to maturity (basis) is 6.45%. How do changes in interest rates affect bond yields? - Bond yields and interest rates have an inverse relationship. - When interest rates rise, bond yields increase, and vice versa. This is because when interest rates rise, new bonds are issued with higher coupon rates, making older bonds with lower coupon rates less attractive to investors. As a result, their market price decreases, and their yield increases. - The current market price will fluctuate. - The current market price of a bond is determined by supply and demand. - Regardless of changes in the market value of the bond, the interest checks remain the same. Duration - it is basically a measurement of the time it takes for the cash flow (interest payments) to repay the invested principal. - The general rule is, the higher the coupon rate, the shorter the duration, and the lower the coupon, the longer the duration. - Long duration debt securities have greater interest rate risk than those with a short duration. - If the maturity dates are about the same (the difference between a 20-year maturity and a 22-year one is almost insignificant), then the bond paying the highest coupon rate will always have the shortest duration and that with the lowest coupon, the longest. - However, if the coupon rates are approximately the same, then the bond that will mature first will have the shortest duration, and the one that will mature last will have the longest duration. - Duration for a zero coupon bond is always equal to its maturity

REGISTRATION REQUIREMENTS

Securities Act of 1933 - to require issuers of new securities to file registration statements with the SEC to provide investors with complete and accurate information in the form of a prospectus when soliciting sales. - Think of the Securities Act of 1933 as the Paper Act because of the registration statement and prospectus. - New securities that are subject to the act's requirements are called nonexempt issues. Exempt securities are not subject to these requirements. - A purchaser of newly issued securities must receive a prospectus no later than by receipt of the purchase confirmation. - The prospectus is a legal document and may not be altered. - The prospectus will include an overview and history of the business, as well as any risks associated with it. Exempt Issuers and Securities - The U.S. government - U.S. municipalities and territories - Nonprofit religious, educational, and charitable organizations - Banks and savings and loans - Public utilities and common carriers whose activities are regulated as to rates and other items by a state or federal regulatory body - Commercial paper—maturity less than 270 days - Bankers' acceptances—maturity less than 270 days - Securities acquired in private placements—Regulation D Corporate bonds and variable annuities, however, are nonexempt securities and are subject to prospectus delivery requirements The Registration Process - split offering = This is a public offering of securities combining both a primary and a secondary offering. A portion of the issue is a primary offering, the proceeds of which go to the issuing corporation. The remainder of the issue is a secondary offering, the proceeds of which go to the selling stockholders. - After an issuer files a registration statement with the SEC, a 20-day cooling-off period begins. During the cooling-off period, the SEC reviews the security's registration statement and can issue a stop order if the statement does not contain all of the required information. Red Herring - The red herring (preliminary prospectus) is used to gauge investor reactions and gather indications of interest for corporate securities. - The final offering price and underwriting spread are not included in the red herring. Tombstone Advertisements - These announcements, typically published after the offering has been cleared for sale, offer information to investors. - Issuers are not required to publish tombstones, but they may appear either before or after the effective date of the sale. - Information found in a tombstone advertisement published on or after the effective date includes name of issuer, type of security, underwriter, price, and effective date of sale The Final Prospectus (Effective, Statutory Prospectus) - When the registration statement for corporate securities becomes effective, the issuer amends the preliminary prospectus and adds information, including the final offering price and the underwriting spread for the final prospectus. - Registered representatives may then take orders from those customers who indicated interest in buying during the cooling-off period. SEC - reviews the prospectus to ensure that it contains the necessary material facts, but it does not guarantee the disclosure's accuracy. - Furthermore, the SEC does not approve the issue but simply clears it for distribution. - If, at any time, the SEC believes that the registration statement is incomplete or has other problems, it may issue a stop order. Summary Prospectus—SEC Rule 498 - A mutual fund can provide a summary prospectus to investors that may include an application investors can use to buy the fund's shares. - Remember, customers can always request and receive a paper copy. If requested, the statutory prospectus must be sent within three business days of receipt of the written request. Statement of Additional Information (SAI) - Although a prospectus is always sufficient for the purpose of selling shares, some investors may wish to have additional information not found in the prospectus. - This additional information is not necessarily needed to make an informed investment decision but may be useful to the investor. - An SAI must be available to investors upon request without charge - If requested, a paper copy must be sent within three days of the request. Trust Indenture Act of 1939 - applies to corporate bonds (nonexempt) with the following characteristics: - Issue size of more than $50 million within 12 months - Maturity of nine months or more - Offered interstate

Types of Customer Orders

SLOBS (Sell Limit & Buy Stop) -------- BLISS (Buy Limit & Sell Stop) Market orders - A market order is an order to buy or sell a security at the current market price. - Market orders are executed immediately at the best available price. Limit orders - A limit order is an order to buy or sell a security at a specified price or better. - If a limit order to buy is placed below the current market price, or a limit order to sell is placed above the current market price, the order will only be executed if the market reaches the specified price. - They can be good for the day entered (day order), or good 'til canceled (GTC), sometimes referred to as an open order. Risks of Limit Orders - Sometimes limit orders are not executed, even if the stock trades at the limit price. - Limit orders on the DMM's book for the same price are arranged according to when they were received. If a limit order at a specific price was not filled, chances are another order at the same price took precedence—that is, there was stock ahead. Stop orders - A stop order is an order to buy or sell a security once the market price reaches a specified price, known as the stop price. - Once the stop price is reached, the order becomes a market order and is executed at the best available price. - There is no guarantee the executed price will be the stop price, unlike the price on a limit order. - A trade at the stop price triggers the order, which then becomes a market order. A stop order takes two trades to execute, which are as follows: 1) Trigger. The trigger transaction at or through the stop price activates the trade. 2) Execution. The stop order becomes a market order and is executed at the next price, completing the trade. Buy Stop Example Consider a buy stop at 52 entered when the market is 51. Based on the ticks below, at what price would this order be executed? 51.88 51.99 52.13 52.13 51.88 - Based on this example, this buy stop triggers at 52.13 and could execute at 52.13 Stop-limit orders - A stop-limit order is similar to a stop order, but it also includes a limit price. - Once the stop price is reached, the order becomes a limit order and will only be executed if the market reaches the limit price. EXAMPLE - UZEW is trading at 40.63. Your customer, who owns 100 shares of the stock, places an order to sell UZEW at 39.87 stop-limit. The tape subsequently reports the following trades: UZEW 40.63 40.75 40.05 39.83 39.80 39.93 - Your customer's order could first be executed at: 39.83 Reductions for Stock Splits EXAMPLE There is an open (GTC) order to sell 100 XYZ at 50 stop. If there is a 2:1 split, the order becomes sell 200 XYZ at 25 stop EXAMPLE There is an open order to buy 100 XYZ at 30. If there is a 20% stock dividend, the order becomes buy 100 XYZ at 25. Common sense says the order size should be 120 shares. However, only round lots are allowed on the order book. The additional 20 shares are in the customer's account but cannot be part of an open order When a stock goes ex-dividend, the price of the stock falls by the amount of the dividend Day Orders - Unless marked to the contrary, an open order (stop or limit) is assumed to be a day order, valid only until the close of trading on the day it is entered. - If the order has not been filled, it is canceled at the close of the day's trading Good Til Canceled (GTC) Orders - GTC orders are valid until executed or canceled. - However, all GTC orders are automatically canceled if unexecuted for the number of days (often 30 to 90) set by the individual brokerdealer. - If the customer wishes to have the order remain working beyond those specific days, the customer must reenter the order At-the-Open and Market-on-Close Orders - At-the-open orders are executed at the opening of the market - Market-on-close orders are executed at or as near as possible to the closing price in the OTC market. Not Held (NH) Orders - A market order coded NH (not held) indicates that the customer agrees not to hold the floor broker or broker-dealer to a particular time or price of execution. This provides the floor broker with the authority to decide the best time or price at which to execute the trade. All-or-none orders: - An all-or-none order is an order that must be executed in its entirety or not at all. - This type of order is commonly used when an investor wants to buy or sell a large number of shares at once. - AON orders can be day or GTC orders. - They differ from the FOKs in that they do not have to be filled immediately. Fill-or-kill orders - A fill-or-kill order is an order that must be executed immediately and in its entirety or cancelled. - This type of order is commonly used when an investor wants to buy or sell a large number of shares at a specific price. Immediate-or-Cancel (IOC) Orders - Immediate-or-cancel (IOC) orders are like FOK orders except that a partial execution is acceptable. - The portion not executed is canceled. - must be executed in one attempt.

Valuing a Variable Annuity

The pay-in period for a deferred annuity is known as the accumulation stage Annuity Units - When a variable annuity contract is annuitized, accumulation units are exchanged for annuity units. - determines the amount of each payment to the annuitant during the payout period - During the payout period, payments are based on a fixed number of annuity units established when the contract was annuitized. The value of an annuity unit varies from month to month according to the performance of the separate account, in comparison to the assumed interest rate.

Mutual Fund Features

- Many mutual funds allow initial investments of as low as $1,000. Dollar Cost Averaging - dollar cost averaging, where a person invests identical amounts at regular intervals. - This form of investing allows the individual to purchase more shares when prices are low, and fewer shares when prices are high. - In a fluctuating market and over time, the average cost per share is lower than the average price of the shares Withdrawal Plans - A customer may request the periodic withdrawal of a fixed-dollar amount. - Under a fixed-percentage or fixed-share withdrawal plan, either a fixed number of shares or a fixed percentage of the account is liquidated each period. - fixed-time withdrawal plan, customers liquidate their holdings over a fixed period Voluntary Accumulation Plans - allows a customer to deposit regular periodic investments on a voluntary basis (minimum amounts found in the prospectus). - If a customer misses a payment, there is no penalty because the plan is voluntary. Exchanges Within a Family of Funds - Exchange privileges allow an investor to convert an investment in one fund for an equal investment in another fund in the same family without incurring an additional sales charge. - A common example would be an investor who purchased the XYZ Growth Fund at age 40. Now, that investor is 62 and, as retirement approaches, needs something more conservative. The shares of the XYZ Growth Fund can be exchanged for shares of the XYZ Income Fund at no expense. Any gain or loss from the redemption of shares must be reported for tax purposes. Mutual Fund Dividend Distributions - Mutual fund dividends are typically paid from the mutual fund's net investment income, usually on a quarterly basis. - Qualified dividends are taxed at the lower long-term capital gains rate. - Nonqualified dividends are taxed as ordinary income. - NII = dividends + interest - expenses of the fund (D + I - E) The Conduit Theory - This means it is subject to tax only on the amount of NII the fund retains. - The portion of the NII distributed to shareholders escapes taxation at the mutual fund level. - To avoid taxation under Subchapter M, a fund must distribute at least 90% of its NII to shareholders. The fund then pays taxes only on the undistributed amount - Ex. If a fund distributes 89%, it must pay taxes on 100% of NII. - As a practical (and test relevant) matter, the fund will only distribute its long-term capital gains Mutual Fund Capital Gains Distributions - The appreciation or depreciation of portfolio securities is unrealized capital gain or loss if the fund does not sell the securities. Therefore, shareholders experience no tax consequences. - When the fund sells the securities, the gain or loss is realized. A realized gain is an actual profit made. Reinvestment of Distributions - a shareholder may elect to reinvest distributions in additional mutual fund shares. - The automatic reinvestment of distributions is similar to compounding interest. - The reinvested distributions purchase additional shares, which may earn dividends or gains distributions. - All mutual funds formed after April 1, 2000, must offer the reinvestment of dividends and capital gains back into the fund without a sales charge (at NAV). Taxation of Reinvested Distributions - Distributions are taxable to shareholders whether the distributions are received in cash or reinvested. - That means income, such as dividends, although not actually physically received by the taxpayer, is constructively received in the taxable year during which it is credited to his account or otherwise made available.

Asset Allocation and Modern Portfolio Theory

Asset Classes - Diversification = with its emphasis on variety, allows the spreading of assets around - Asset Allocation = spreading of portfolio funds among different asset classes with difference risk-and-return characteristics, based on the investment policy statement. Strategic Asset Allocation - refers to the proportion of various types of investments composing a long-term investment portfolio. - This is a passive strategy - EXAMPLE A standard asset allocation model suggests subtracting a person's age from 100 to determine the percentage of the portfolio to be invested in stocks. According to this method, a 30-year-old would be 70% invested in stocks and 30% in bonds and cash - Over time, the portfolio is rebalanced to bring the asset mix back to the target allocations Tactical Asset Allocation - Tactical asset allocation refers to short-term portfolio adjustments that adjust the portfolio mix between asset classes in consideration of current market conditions. - This is an active strategy. Modern Portfolio Theory (MPT) - employs a scientific approach to measuring risk and, by extension, to choosing investments. It involves calculating projected returns of various portfolio combinations to identify those that are likely to provide the best returns at different levels of risk. It is the concept of minimizing risk by combining volatile and price-stable investments in a single portfolio. - This theory holds that specific risks can be diversified by building portfolios of securities whose returns are not correlated. MPT seeks to reduce the risk in a portfolio while simultaneously increasing expected returns. - MPT wants securities in a portfolio to have negative correlation, not positive correlation Capital Asset Pricing Model (CAPM) - The capital asset pricing model (CAPM) is used to calculate the return that an investment should achieve based on the risk that is taken. - A portfolio's total risk is made up of nonsystematic (unsystematic) risk and systematic risk. Beta Coefficient - A stock or portfolio's beta is a measure of its volatility in relation to the overall market (systematic risk). - The overall market is typically based on the S&P 500. - A security that has a beta of one moves in line with the market - A security that does not move in relation to market movement would have a beta of zero. For example, a money market security or money market mutual fund would have a beta of close to zero. - If the S&P 500 rises or falls by 10%, a stock with a beta of one rises or falls by about 10%, a stock with a beta of 1.5 rises or falls by about 15%, and a stock with a beta of 0.75 rises or falls by about 7.5% Alpha - the extent to which an asset's or portfolio's return exceeds or falls short of its expected return. - A positive alpha would indicate a buy recommendation - EXAMPLE If an investment has a beta of 1.5, it is 50% more volatile than the market. Therefore, if the market goes up 10%, it is expected that the investment with a beta of 1.5 will go up 15%. However, if the investment only goes up 11%, the investor took a greater risk for less return on their money. So the return of 11% is less than the 15% expected return (negative alpha). EXAMPLE An aggressive investor buys ABC stock with a beta of 1.7. The S&P 500 has a 10% rate of return for the year, and ABC's return is 12%. What is the alpha for ABC? - With a beta of 1.7, an investor would expect ABC stock to be 70% more volatile than the general market as measured by the S&P 500. Remember, the beta of the market is 1.0. Therefore, we would expect to see the stock return 17% based on the S&P 500's 10% return. However, the actual return on ABC was only 12%. Alpha measures the difference in the actual return vs. the expected return. The difference between the expected return (sometimes referred to as the required return) of 17% and the actual return of 12% is a negative 5%. That represents an alpha of -5% for ABC stock.

Asset-Backed Securities

Asset-backed securities (ABS) - are financial securities that are backed by a pool of underlying assets, such as mortgages, auto loans, or credit card debt. - The assets that back ABS are referred to as collateral. The quality and characteristics of the collateral can have a significant impact on the performance of the ABS. - ABS are created through a process called securitization, in which the underlying assets are pooled together and transferred to a special-purpose vehicle (SPV), which issues the ABS CMOS, or collateralized mortgage obligations - are fixed-income securities that are backed by a pool of mortgage loans. - Are paid interest monthly - The underlying mortgage loans are pooled together and structured into different tranches, each with its own unique characteristics. - The tranches are typically structured based on their priority of payment, with the senior tranches receiving the first payments and the junior tranches receiving payments after the senior tranches. - One of the key risks associated with CMOS is prepayment risk, which is the risk that borrowers will pay off their mortgage loans earlier than expected, reducing the cash flows available to investors. - As rates fall, prices of the remaining tranches will rise. - Most CMOs offered to the public are backed by mortgages held by government-sponsored corporations like Fannie Mae, Ginnie Mae, Freddie Mac, et cetera. So, credit risk would be the lowest worry Collateralized Debt Obligations (CDOs) - CDOs do not specialize in any single type of debt - The assets backing the CDOs can be a pool of bonds, auto loans, or other assets such as leases, credit card debt, a company's receivables, or even derivative products of any of the assets listed - the assets comprising the CDO portfolio are small and individually not very liquid Classes of CMOs Principal Only CMOs (POs) - the income stream comes from principal payments on the underlying mortgages—both scheduled mortgage principal payments and prepayments. Interest-Only CMOs (IOs) - the income stream comes from interest payments - IOs increase in value when interest rates rise, and they decline in value when interest rates fall because the number of interest payments changes as prepayment rates change Planned Amortization Class CMOs (PACs) - they are retired first and offer protection from prepayment risk and extension risk (the chance that principal payments will be slower than anticipated) because changes in prepayments are transferred to companion tranches, also called support tranches. Targeted Amortization Class CMOs (TACs) - A TAC structure transfers prepayment risk only to a companion tranche and does not offer protection from extension risk - TAC investors accept the extension risk and the resulting greater price risk in exchange for a slightly higher interest rate. Zero-Tranche CMO (Z-Tranche) - A Z-tranche CMO receives no payment until all preceding CMO tranches are retired. These are the most volatile CMO tranches. CMO Characteristics - Because mortgages back CMOs, they are considered relatively safe - CMOs yield more than Treasury securities and normally pay investors interest and principal monthly. Principal repayments are made in $1,000 increments to investors in one tranche before any principal is repaid to the next tranche - Interest from CMOs is subject to federal, state, and local taxes. - There is an active secondary market for CMOs. Certain tranches of a given CMO may be riskier than others, and some CMOs in certain tranches carry the risk that repayment of principal may take longer than anticipated. - The customer must sign a suitability statement before buying any CMO. Potential investors must understand that the rate of return on CMOs may vary because of early repayment. Also note that the performance of CMOs may not be compared with any other investment vehicle. - CMOs yield more than U.S. Treasury securities

TRANSACTION PROCESSING RULES AND REGULATIONS

Assignment - Each stock and bond certificate must be assigned (endorsed by signature) by the owner(s) whose name is registered on the certificate's face. - Certificates registered in a joint name require all owners' signatures. Stock or Bond Power - a legal document—separate from a securities certificate—that investors can use to transfer or assign ownership to another person. - Instead of signing on the back of a certificate representing a security sold, the registered owner could sign on a separate paper - "Securities powers typically are used either: (1) as a matter of convenience when an owner cannot sign the actual certificates, or (2) for safety (such as sending unsigned certificates in one envelope and signed powers in another) - If an alteration or a correction has been made to an assignment, a full explanation of the change signed by the person or firm who executed the correction must be attached. Signature Guarantee - When customers hold securities in physical certificate form and want to transfer or sell them, they will need to sign the certificates or the securities powers mentioned earlier. - In most cases, the signature(s) will need to be guaranteed before a transfer agent will accept the transaction. Medallion Signature - Guarantee An investor can obtain a signature guarantee from a financial institution, such as a commercial bank, savings bank, credit union, or broker-dealer that participates in one of the Medallion signature guarantee programs. - financial institutions can guarantee customer signatures with the assurance that their guarantees will be immediately accepted for processing by transfer agent Signature Requirements - A customer's signature must match exactly the name registered on the security's certificate. - Regarding signature requirements for purposes of good delivery, the only two acceptable abbreviations within a signature are Co. for the word company, and & for the word and. No other abbreviations, such as Inc., or Corp., are permitted. Invalid Signatures - If a broker-dealer guarantees a forged signature, such as that of a deceased person, the firm becomes liable. The executor or administrator of the estate must endorse the certificate or furnish a stock power and transfer the securities to the name of the estate before they can be sold. Minors' signatures are invalid for securities registration purposes. Committee on Uniform Securities Identification Procedures (CUSIP) - a CUSIP number will aid in identifying and tracking a security throughout its life. - Securities traded ex-legal are in good delivery condition without the legal opinion. Fail-to-Deliver - A fail-to-deliver situation occurs when the broker-dealer on the sell side of a contract does not deliver the securities in good delivery form to the broker-dealer on the buy side on the settlement date. - As long as a fail-to-deliver exists, the seller will not receive payment. In a fail-to-deliver situation, the buying broker-dealer may buy-in the securities to close the contract and may charge the seller for any loss caused by changes in the market. - If a customer fails to deliver securities to satisfy a sale, the firm representing the seller must buy-in the securities after 10 business days from the settlement date. Reclamation - Reclamation occurs when a buying broker-dealer, after accepting securities as good delivery, later discovers that the certificates were not in good deliverable form (e.g., certificates are mutilated). - The securities can be sent back to the selling broker-dealer with a Uniform Reclamation Form attached within specific time frames, depending on the reason reclamation is being made - TEST TOPIC ALERT There are two types of bond deliveries that are never subject to reclamation: (1) bond certificates subject to an in-whole call and (2) bonds where the issuer goes into default after the trade date

DPPs and Their Investors

Direct Participation Program (DPP) - A DPP is a type of investment vehicle that allows investors to participate directly in the cash flow and tax benefits of a partnership or limited liability company (LLC). - DPPs are typically structured as pass-through entities, which means that their income and losses are passed through to investors, who report them on their individual tax returns. - DPPs are typically high-risk, illiquid investments - Member firms are required to maintain documentation regarding suitable net worth for investors - Analysts use both present value and internal rate of return to establish a DPP's rate of return - Passive losses can be used only to offset passive income, which is earned from direct participation programs and rental real estate. Taxable income for a partnership = Revenue - Expense - Interest - Depreciation Which two corporate characteristics are most likely to be avoided by a DPP? 1) Continuity of life and 2) freely transferable interests Issuing Limited Partnership Interests - Limited partnerships may be sold through private placements or public offerings. - private placements involve a small group of investors, each contributing a large sum of money. These investors must be accredited investors - The syndicator oversees the selling and promotion of the partnership. The syndicator is responsible for the preparation of any paperwork necessary for the registration of the partnership. - Syndication or finders fees are limited to 10% of the gross dollar amount of securities sold. Required Documentation 1) The certificate of limited partnership - It includes the partnership's name; the partnership's business; the principal place of business; the amount of time the partnership expects to be in business - The document attesting to the formation of a limited partnership, filed with designated authorities 2) The partnership agreement - It describes the roles of the GPs and LPs and guidelines for the partnership's operation. 3) The subscription agreement - All investors interested in becoming LPs (passive investors) must complete a subscription agreement. - The agreement appoints one or more GPs to act on behalf of the investors and is only effective when the GPs sign it. - the subscription agreement must include: the investor's net worth, the investor's annual income, a statement attesting that the investor understands the risk involved, and a power of attorney appointing the GP as the agent of the partnership. Recourse Loan = LP's may assume responsibility for the repayment of a portion of a loan made to the partnership - Recourse debt adds to basis as the partner is liable for this amount. - LPs are liable for their investments and any shares of recourse debt. They are not liable for nonrecourse debt Ex. A customer invests $20,000 in a direct participation program and signs a recourse note for $50,000. During the first year of operation, the customer receives a cash distribution of $15,000 from the partnership. At year's end, the customer receives a K-1 statement reporting his share of partnership losses of $75,000. How much of the loss may the customer deduct from passive income? - A limited partner can only deduct partnership losses to the extent of his basis. To determine basis, add the original investment ($20,000) to any recourse debt assumed by the investor ($50,000). Recourse debt adds to basis as the partner is liable for this amount. Cash distributions received reduce basis ($15,000). At year's end, the investor's basis and the amount he can deduct from passive income is $55,000. Nonrecourse Loan = the GPs have responsibility for repayment of nonrecourse loans (not the LPs). - For real estate limited partnerships, nonrecourse loans are included in the limited partner's cost basis. In this way, the loans increase the partner's original cost basis by the amount of the partner's debt liability for the loan. Dissolving a Limited Partnership - Secured lenders - Other creditors - LPs - GPs Investors in a Limited Partnership General Partners - Unlimited liability - Management responsibility - Morally and legally bound to use invested capital in the best interest of the investors - Buy and sell property for the partnership GPs can't: - Compete against the partnership for personal gain - Borrow from the partnership - Commingle partnership funds with personal assets or assets of other partnerships Limited Partners - Limited liability - No management responsibility: Provides capital for the business but may not participate in its management; known as a passive investor - Attempting to take part in a management role jeopardizes limited liability status - May sue the GP: Lawsuits may recover damages if the GP does not act in the best interest of the investors or uses assets improperly - Vote on changes to partnership investment objectives or the admission of a new GP - Vote on sale or refinancing of partnership property - Inspect books and records of the partnership LPs can't: - Act on behalf of the partnership or participate in its management - Knowingly sign a certificate containing false information - Have their names appear as part of the partnership's name

All About IRAs

Earned Income - Income derived from active participation in a trade or business, including wages, salary, tips, commissions, and bonuses passive investment - An interest in, for example, rental property, limited partnership, or other enterprise in which the individual is not actively involved. Passive income, therefore, does not include earnings from wages or active business participation, nor does it include income from dividends, interest, and capital gains unearned income - Income derived from investments and other sources not related to employment services. Examples of unearned income include interest from a savings account, bond interest, and dividends from stock. Compensation for IRA Purposes - Wages, salaries, and tips Commissions and bonuses Self-employment income Alimony1 Nontaxable combat pay Not Compensation for IRA Purposes - Capital gains Interest and dividend income Pension or annuity income Child support Passive income from DPPs Traditional IRA - Contributions are tax-deductible if the account holder meets income requirements and is not covered by an employer-sponsored retirement plan - Contributions grow tax-deferred - Withdrawals are taxed as ordinary income - Required minimum distributions (RMDs) must begin by age 72 - allows a maximum taxdeductible annual contribution of the lesser of $6,000 per individual or $12,000 per couple - withdrawals must begin by April 1 of the year following the year in which the account owner reaches age 72, and they must meet minimum Internal Revenue Code (IRC) distribution requirements or incur a 50% penalty on the amounts falling short of the RMD. RMD - RMDs must begin at age 72 but can be postponed as long as continuously employed by the same employer. Roth IRA - Contributions are made with after-tax dollars and are not tax-deductible - Distributions are tax-free if taken after age 59½ and a Roth account has been open for at least five years. - Contributions grow tax-free - Qualified withdrawals, including earnings, are tax-free and penalty-free - Contributions can be made at any age as long as there is earned income - If because of death, disability, or first-time home purchase, the distribution is qualified and not subject to tax or the 10% penalty. - No RMDs during the account holder's lifetime - Income limits apply for contributions SEP IRA (Simplified Employee Pension Individual Retirement Account) - Employer-funded plan for self-employed individuals and small business owners - Employer contributions are tax-deductible and grow tax-deferred - Withdrawals are taxed as ordinary income - Employee accounts are immediately 100% vested - Must cover all eligible employees and follow contribution limits - Has reached age 21 Has worked for the employer in at least 3 of the last 5 years - Has received at least $600 in compensation from the employer during the year Simple IRA - Savings Incentive Match Plan for Employees Individual Retirement Account - Employer-funded plan for small businesses with fewer than 100 employees - Employees can make pre-tax contributions and employer contributions are tax-deductible - Contributions grow tax-deferred Withdrawals are taxed as ordinary income - Employee accounts are immediately 100% vested - Must follow contribution limits and meet certain eligibility criteria Catch-Up Contributions - Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was the source of the legislation permitting certain individuals to make additional contributions - Individuals aged 50 and older - These catch-up payments can go either to a traditional IRA or to a Roth IRA. - Since 2006, that catch-up amount has been $1,000. Time for Contributions - IRA contributions for a specific taxable year may be made anytime from January 1 of that year through the required filing date of that year's return, (generally April 15 of the next year, unless the 15th falls on a holiday or weekend). - If the individual obtains a filing extension, the deadline is still April 15. Excess Contributions - Annual IRA contributions exceeding the maximum allowed are subject to a 6% penalty tax if the excess is not removed by the time the taxpayer files a tax including extensions IRA Investments - Funds in an IRA account may be used to buy stocks, bonds, mutual funds, unit investment trusts (UITs), limited partnerships, REITS, U.S. government securities - Tax-free municipal bonds, municipal bond funds, and municipal bond UITs are eligible, but generally considered inappropriate for an IRA (or any tax-qualified plan) because their yields are typically lower than those of other similar investments, and the income generated is taxable on withdrawal from the IRA - Covered call writing and buying puts and calls is allowed - Short sales, uncovered calls, and municipal bonds are all inappropriate for individual retirement accounts. Covered calls are allowed - An individual may contribute to both a traditional IRA and a Roth IRA. However, the maximum combined contribution is $6,000 (or $7,000, if 50 or older). Ineligible and Inappropriate Investments - Collectibles, including antiques, gems, rare coins, works of art, and stamps, are not acceptable IRA investments. Life insurance contracts (such as whole life and term) may not be purchased in an IRA. - No margin account trading, including short sales, is permitted in an IRA or any qualified retirement plan. The same is true for speculative options strategies such as uncovered (naked) puts and calls. 60-Day Rollovers - The account owner may do so only once per 12-month period, and the rollover must be completed within 60 calendar days of the funds' withdrawal from the original plan Education IRA (Coverdell ESAs) - Contribution limit is $2,000 per year per child until the child's 18th birthday - allow after-tax contributions for student beneficiaries. - Distributions are tax-free if they are taken before age 30 and used for eligible education expenses. - If the accumulated value in the account is not used by age 30, the funds must be distributed and subject to income tax and a 10% penalty on the earnings or rolled over into a different Coverdell ESA for another family member Transfer and Ship - the securities bought are transferred to the customer's name and are sent to the customer transfer and hold in safekeeping - the securities bought are transferred to the customer's name but are held by the broker-dealer.

Evaluating the DPP

Economic viability - means that there is potential for returns from cash distributions and capital gains. - Although tax benefits may be attractive, they should not be the first consideration in the purchase of an interest in a DPP - How is the economic soundness or viability measured? --> Two methods applied to the analysis of DPPs are cash flow analysis and internal rate of return.

Mutual Fund Share Classes

FINRA Rule 2341 prohibits its members who underwrite fund shares from assessing sales charges in excess of 8.5% of the POP on the purchase of open-end investment company shares. Breakpoints - The schedule of quantity purchase discounts a mutual fund offers is called the fund's breakpoints. - For a breakpoint qualification, person includes married couples, parents and their minor children, corporations, and certain other entities. - Investment clubs, Parents with adult children, or associations formed for the purpose of investing do not qualify for breakpoints. - Purchases made by the same investor in various accounts can be aggregated to qualify for a breakpoint discount. Eligible accounts include traditional brokerage, accounts held directly with a fund company, 401(k), IRA, and 529 college savings. Front-end loads (AKA Sales Load) (difference between POP and NAV)—Class A shares - Front-end sales loads are the charges included in a fund's POP. The charges are added to the NAV at the time an investor buys shares. Back-end loads (contingent deferred sales loads)—primarily Class B shares - they impose a contingent deferred sales charge (CDSC), also called a back-end load. - The CDSC normally declines and eventually is eliminated over time. Class C Shares (Level Load) - typically have a one-year 1% CDSC, a 0.75% 12b-1 fee (discussed shortly), and a 0.25% shareholder services fee - referred to as having a level load. - Class C shares are appropriate for investors who have short time horizons because they become quite expensive to own if investing for more than four years. 12b-1 fees - are used to cover the costs of marketing and distributing the fund to investors. - The maximum 12b-1 fee is 0.75% for distribution and promotion. FINRA does permit funds to charge an additional 0.25% as a service fee. That makes the total 1.0%, only 0.75% of which is the 12b-1 fee. No-Load Funds - the fund does not charge any type of sales load - a no-load fund is permitted to charge redemption fees = Those are usually charged when an investor is going in and out of the fund too frequently - Must have a 12b-1 charge that is less than .25%. Breakpoint Sale - FINRA prohibits registered representatives from making or seeking higher commissions by selling investment company shares in a dollar amount just below the point at which the sales charge is reduced Letter of Intent (LOI) - A person who plans to invest more money with the same mutual fund company may immediately decrease his overall sales charges by signing a letter of intent (LOI). - the investor informs the investment company that he intends to invest the additional funds necessary to reach the breakpoint within 13 months - The LOI may be backdated by up to 90 days to include prior purchases but may not cover more than 13 months in total. - If the LOI is not completed, the sales charge amount that applies is based on the total amount invested. Rights of Accumulation - allow an investor to qualify for reduced sales charges by reaching a breakpoint. - The major differences are that rights of accumulation allow the investor to use prior share appreciation and reinvestment to qualify for breakpoints and do not impose time limits - The customer may qualify for reduced charges when the total value of shares previously purchased plus the new purchase exceeds a breakpoint amount. - Ex. An investor deposits $5,000 (paying a 6.5% sales charge) in a mutual fund but does not sign an LOI. The $5,000 grows to $10,000 over time and the investor decides to invest another $15,000. If rights of accumulation exist, the new $15,000 pays a 5.5% sales charge, which is based on the new money plus the accumulated value in the account ($15,000 + $10,000 = $25,000). Combination Privilege - An investor seeking a reduced sales charge may be allowed to combine separate investments in two or more funds within the same family to reach a breakpoint. POP - NAV = sales charge dollar amount Sales Charge Percentage = Sales Dollar Amount / POP POP = NAV / (100% - Sales Charge Percentage) Expense Ratio - All mutual funds have expenses. It is important that you understand these expenses are not considered a cost of purchasing the fund. - A fund's expense ratio expresses the management fees and operating expenses as a percentage of the fund's net assets. - All mutual funds, load and no-load, have expense ratios

Different Types of Municipal Securities

GO Bonds - Bonds issued by municipalities that are backed by the full faith and credit of the issuer. known as full faith and credit issues. - Bonds issued by states are backed by income taxes, license fees, and sales taxes. Bonds issued by towns, cities, and counties are backed by property (ad valorem) taxes, license fees, fines, and all other sources of revenue to the municipality - Ad valorem is Latin for according to value. If you own a home, you are familiar with the property tax assessment - Statutory Debt Limits - Overlapping debt = Several taxing authorities that draw from the same taxpayers can issue debt. Bonds issued by different municipal authorities that tap the same taxpayer wallets are known as coterminous debt EXAMPLE Take the town of Smithville, located in Jones County. If Smithville issues GO debt, it will tax property in Smithville to service that debt. If Jones County issues GO debt, it will tax property in the county, which includes Smithville, to service its debt. As a result, there are two issuers taxing the same property. Revenue Bonds - Backed by user fees - Revenue Bonds - Bonds issued by municipalities that are backed by a specific revenue source, such as tolls, fees, or taxes on a particular product or service. - are not subject to statutory debt limits and do not require voter approval. - Revenue bonds are riskier than general obligation bonds, as the revenue stream can be affected by economic or other factors. - Debt service payments do not come from general or real estate taxes and are not backed by the municipality's full faith and credit Feasibility Study - Before issuing a revenue bond, an issuer will engage various consultants to prepare a report detailing the economic feasibility and the need for a particular project (e.g., a new bridge or airport). - The study will include estimates of revenues that will be generated and details of the operating, economic, and engineering aspects of the proposed project. bond resolution (Trust Indenture) - the document that authorizes the issuance of a municipal bond. - The resolution also describes the proposed issue's features and the issuer's responsibilities to its bondholders. Protective Covenants - Rate covenant = A promise to maintain rates sufficient to pay expenses and debt service. - Maintenance covenant = A promise to maintain the equipment and facility/facilities. - Insurance covenant = A promise to insure any facility built so bondholders can be paid off if the facility is destroyed or becomes inoperable - Catastrophe clause = A promise to use insurance proceeds to call bonds and repay bondholders if a facility is destroyed; a catastrophe call is also called a calamity call or an extraordinary mandatory call. Types of Revenue Bonds Industrial Development Revenue Bonds - to construct facilities or purchase equipment, which is then leased to a corporation. - The municipality uses the money from lease payments to pay the principal and interest on the bonds. - The ultimate responsibility for the payment of principal and interest rests with the corporation leasing the facility; therefore, the bonds carry the corporation's debt rating. - Some of these bonds are subject to the alternative minimum tax (AMT) collection ratio - measures taxes collected versus taxes assessed - a poor collection ratio might mean the municipality is likely to default on its revenue bonds. Lease-Rental Bonds - Under a typical lease-rental (or lease-back) bond arrangement, a municipality issues bonds to finance office construction for itself or its state or community. - Ex. A municipality might issue bonds to raise money to construct a school and lease the finished building to the school district. The lease payments provide backing for the bonds. Double-Barreled Bonds - Interest and principal are paid from a specified facility's earnings. However, the bonds are also backed by the taxing power of the state or municipality and therefore have the backing of two sources of revenue. - are rated and traded as GOs. - Double-barreled bonds are backed not only by a specified source of revenues, but also by the full faith and credit of a municipal issuer with authority to levy taxes. Special Tax Bonds - supported by sales, tobacco, alcohol, fuel, or business license taxes Special Assessment Bonds - issued to finance the construction of public improvements such as streets, sidewalks, or sewers. - The issuer assesses a tax only on the property that benefits from the improvement and uses the funds to pay principal and interest. New Housing Authority Bonds - to develop and improve low-income housing. - NHAs are backed by the full faith and credit of the U.S. government not the issuer - are sometimes called Public Housing Authority bonds (PHAs) or section 8 bonds - Because of their federal backing, they are considered the most secure of all municipal bonds. - PHAs are backed by the rental income from the housing - If the rental income is not sufficient to service the debt, the federal government makes up any shortfall. Essentially, these are revenue bonds backed by the U.S. government, and are therefore AAA rated. Moral Obligation Bonds - If revenues or tax collections backing the bond are not sufficient to pay the debt service, the state legislature has the authority to appropriate funds to make payments. - The potential backing by state revenues tends to make the bond more marketable, but the state's obligation is not established by law; it is a moral obligation only. - All moral obligation bonds are considered revenue bonds. Municipal anticipation notes - are short-term securities that generate funds for a municipality that expects other revenues soon. - tax anticipation notes (TANs) to finance current operations in anticipation of future tax receipts - Revenue anticipation notes (RANs) are offered periodically to finance current operations in anticipation of future revenues from revenue-producing projects or facilities. Variable Rate Municipal Securities Variable Rate Demand Obligations (VRDOs) - floating rate obligations that typically have a nominal long-term maturity of 20-30 years, but have an interest rate that is reset periodically. The reset can be daily, weekly, monthly, semiannually, or flexible - Used for a hedge against inflation - Interest rate changes every 6 months - One of the key features of this security is the ability of the investor to demand the issuer repurchase the bonds at par value. This can be done on any reset date. In essence, this is a put option where the investor "puts" the bond and receives the face amount plus any accrued interest. This feature is why VDROs are sometimes considered money market instruments Auction Rate Securities (ARS) - Auction rate securities (ARS) are debt securities that have interest rates that are periodically reset through - Dutch auctions, typically every 7, 14, 28, or 35 days A variable rate municipal security does not have a fixed coupon rate. The interest rate is tied to a market rate (e.g., T-bill yields) and is subject to change at regular intervals. Because the interest paid reflects changes in overall interest rates, the price of the bond remains relatively close to its par value.

Mutual Fund Suitability

Growth Funds - invest in stocks of companies whose businesses are growing rapidly. - Growth companies tend to reinvest all or most of their profits for research and development rather than pay dividends. - Growth funds are focused on generating capital gains rather than income. Aggressive Growth Funds (Performance Funds) - These funds are willing to take greater risk to maximize capital appreciation. - Some of these funds invest in newer companies with relatively small capitalization (less than $2 billion capitalization) and are called small-cap funds. - An aggressive portfolio contains securities of smaller companies that have the potential for significant capital appreciation Value Funds - focus on companies whose stocks are currently undervalued (earnings potential is not reflected in the stock price). - These undervalued companies are expected to perform better than the reports indicate, thus providing an opportunity to profit Equity Income Funds - An income fund primarily composed of stock, also known as an equity income fund, stresses current income over growth. - The fund's objective may be accomplished by investing in the stocks of companies with long histories of dividend payments, such as utility company stocks, blue-chip stocks, and preferred stocks. Option Income Funds - invest in securities on which call options can be sold (known as covered calls). - They earn premium income from writing (selling) the options. - They may also earn capital gains from trading options at a profit. Growth and Income Funds - (combination fund) may attempt to combine the objectives of growth and current income by diversifying its stock portfolio among companies showing long-term growth potential and companies paying high dividends Specialized (Sector) Funds - Many funds attempt to specialize in particular economic sectors or geographic areas. - These funds must have a minimum of 25% of their assets invested in their specialties - These funds are speculative in nature Special Situation Funds - Special situation funds buy securities of companies that may benefit from a change within the companies or in the economy - These funds are also speculative (high risk). Blend/Core Funds Blend/core funds - are stock funds with a portfolio comprising a number of different classes of stock. Index Funds - Index funds invest in securities that mirror a market index, such as the S&P 500 International Funds - International funds invest only in the securities of foreign companies Global Funds - Global funds and worldwide funds invest in the securities of both the United States and foreign countries. Balanced Funds - Balanced funds, also known as hybrid funds, invest in stocks for appreciation and bonds for income. Asset Allocation Funds - split investments between stocks for growth, bonds for income, and money market instruments or cash for stability. - Fund advisers switch the percentage of holdings in each asset category according to the performance (or expected performance) of that group. Target-Date Funds - sometimes called a lifecycle fund. - Target-date funds are designed to help manage investment risk. - This is done by selecting a fund with a target date in mind that is closest to the year an investor anticipates needing the money (i.e., retiring in 2030). For example, a 2030 fund gradually reduces risk by changing the investments within the fund to a more conservative mix as the target date approaches. Bond Funds - Bond funds have income as their main investment objective. U.S. Government Funds - U.S. government funds purchase securities issued by the U.S. Treasury or an agency of the U.S. government, such as Ginnie Mae. - Investors in these funds seek current income and maximum safety Principal-Protected Funds - Principal-protected mutual funds offer investors a guarantee of principal, adjusted for fund dividends and distributions, on a set future date (maturity) while providing opportunities for higher returns through investment in higher risk and higher expected return asset classes such as equities. - The basic guarantee is that the investor's return will never be less than the original investment, less any sales load. Money Market Funds - Money market funds are no-load, open-end investment companies (mutual funds) that serve as temporary holding accounts for investors' money. - Money market mutual funds are most suitable for investors whose financial goals require liquidity above all. - The NAV of money market funds is generally fixed at $1 per share. - They are not guaranteed, nor are they protected by FDIC insurance.

Convertible Debt

How does convertible debt work? - When an investor buys convertible debt, they have the option to convert their debt into equity at a specified price or ratio. If the stock price rises above the conversion price, the investor can choose to convert their debt into equity and benefit from the stock price appreciation. - These convertible securities are only issued by corporations - The conversion privilege is exercised at the discretion of the investor. What are the advantages of convertible debt for investors? - Investors in convertible debt have the potential to benefit from stock price appreciation if the company's stock price rises above the conversion price. - Additionally, if the company fails, the investor has a claim on the company's assets before common stockholders. Disadvantages of convertible debt for investors - One of the negative points about investing in convertible securities is their reduced income. Investors accept the lower income in exchange for the ability to profit from the conversion feature. The key point is, do not recommend convertible securities to those investors seeking to maximize current income. What action could a corporation take that would result in the forced conversion of an outstanding convertible debt security? - Exercise the call feature when the debt security's conversion value exceeds the call price conversion ratio - The conversion ratio is the number of shares of common stock that the convertible debt can be converted into. conversion price - The conversion price is the price at which the convertible debt can be converted into common stock. It is calculated by dividing the face value of the convertible debt by the conversion ratio. conversion premium - The conversion premium is the amount by which the conversion price exceeds the current market price of the common stock. A higher conversion premium means that the convertible debt is less likely to be converted into equity. Advantages of Convertible Securities to the Issuer - Convertibles can be sold with a lower coupon rate than nonconvertibles because of the conversion feature. - A company can eliminate a fixed interest charge as conversion takes place, thus reducing debt. Disadvantages of Convertible Securities to the Issuer - When bonds are converted, shareholders' equity is diluted; that is, more shares are outstanding, so each share now represents a smaller fraction of ownership in the company. - Common stockholders have a voice in the company's management, so a substantial conversion could cause a shift in the control of the company. - Reducing corporate debt through conversion means a loss of leverage. Anti-Dilutive Protection - One of the concerns of any holder of a convertible security (bond or preferred stock) is protection against the potential dilution resulting from a stock split or a stock dividend. - For example, if you owned a bond convertible into 20 shares and the issuer declared a 2:1 stock split, in order for you to have the same conversion benefit, you would need to be able to convert into 40 shares - Ex. ABC Corporation has issued $100 million of convertible debentures having a nondilutive covenant. Each debenture is convertible into 40 shares of ABC's common stock. If ABC declares a 2:1 stock split, When a debenture is convertible into 40 shares, the conversion price is $25 per share ($1,000 divided by 40 shares). After a 2:1 stock split, the conversion rate will now be twice as many shares (80). The split will make the conversion price half of what it initially was. Instead of $25 per share, it will be $12.50 ($1,000 divided by 80 shares). Corporate Bond Quotes - With a face value of $1,000, each percentage point of that face is equal to $10. That would mean a bond quoted at 99 is $990 and one quoted at 101 is $1,010. - These $10 "points" are further divided into eights. Each 1/8 has a value of $1.25 (divide $10.00 by 8 and it equals $1.25). - Ex. ABC Corporation's 4% bond is currently trading at 985/8. That would be price of $986.25. Parity - Ex. RST debenture is convertible to common at $50. If RST bond is currently trading for $1,200, what is the parity price of the common? Method One: Parity means equal. Solve for the conversion ratio as follows: Par value: $1,000 Conversion price: $50 Conversion ratio: 20 The parity stock price is found by dividing $1,200 by 20. The parity price of the common is $60.

Order Flow

Nasdaq Quotation Service Nasdaq Level 1 - displays the inside market only, the highest bids and the lowest asks for securities included in the system, and other basic information such as last sale and volume Nasdaq Level 2 - is available to approved subscribers only - The inside quote plus quotes from all market makers - provides the current quote and quote size available from each market maker in a security in the system Nasdaq Level 3 - allows registered market makers to input and update their quotes on any securities in which they make a market. - The inside quote, all other quotes, plus ability to enter or change your own quote Consolidated Audit Trail - allows regulators to efficiently and accurately track all activity, including options, throughout the U.S. markets in National Market System (NMS) securities. - The CAT requires broker-dealers, exchanges, and other market participants to report detailed data on orders, trades, and other market events in real time to a central database. The data includes information on the security traded, the time and price of the trade, the order type, and the identity of the market participant. Dark Pools of Liquidity - trading volume that occurs or liquidity that is not openly available to the public. - The bulk of this volume represents trades engaged in by institutional traders and trading desks away from the exchange markets Trade Reporting and Compliance Engine (TRACE) - the FINRA-approved trade reporting system for corporate and government agency bonds trading in the OTC secondary market. - TRACE is a trade reporting system only. It is not an execution system - Both sides of the transaction must report. - Trades must be reported as soon as practicable and no later than 15 minutes after execution. - Execution date, time of trade, quantity, price, yield, and if price reflects a commission charged are all reportable and displayed. Trade Reporting Facilities (TRFs) - a centralized electronic platform that is used to report trades that have been executed outside of a stock exchange (OTC) Role of the NYSE DMM - a person who represents a member firm of the NYSE. The DMM's primary role is to facilitate trading in certain stocks. - DMMs must make a market in the stock they trade by displaying their best bid and ask prices to the market during trading hours. - They also are required to maintain a fair and orderly market in the stocks they trade - They do this by stepping in with their own capital to help reduce market volatility when there is an imbalance of buy and sell orders Agent and Principal - DMMs are both agents and principals. On the NYSE floor, they can act in the following ways: - As agents, they execute all orders brokerage firms leave with them. They accept certain kinds of orders from members, such as limit and stop orders, and execute these as conditions permit. - As principals, or dealers, they buy and sell in their own accounts to make markets in assigned stocks. They are expected to maintain continuous, fair, and orderly markets— that is, markets with reasonable price variations Municipal Bond Reporting Electronic Municipal Market Access (EMMA) - a centralized online site used to locate key information about municipal securities. - is used to provide investors with access to information about municipal securities - The information on EMMA is presented for retail, nonprofessional investors. It is free of charge. - EMMA makes available official statements (OSs) (the municipal equivalent of a prospectus) for most new municipal bond offerings, 529 college savings plans, and other municipal securities. - Ratings information is also available. Real-Time Transaction Reporting System - a system used to report trades in the municipal bond market in real-time. - The data is captured and made available to the marketplace within 15 minutes of a trade. - It is used by dealers and brokers to report their trades and provide investors with real-time trade data, including trade price, yield, and volume. - The RTRS helps to increase transparency in the municipal bond market by providing timely and accurate trade data. - Municipal fund securities (i.e., Section 529 plans) are included in EMMA but not RTRS. Types of Markets Third Market - The third market is a trading market in which exchange-listed securities are traded in the OTC market - Broker-dealers registered as OTC market makers in listed securities can do transactions in the third market Fourth Market - The fourth market is a market for institutional investors in which large blocks of stock, both listed and unlisted, trade in transactions unassisted by broker-dealers. - These transactions take place through electronic communications networks (ECNs). - ECNs are open 24 hours a day and act solely as agents Grey Market -refers to a security not currently traded on any of the OTC quoting marketplaces (e.g., Pink Open Market) or quoted on any other U.S. quotation medium such as Nasdaq. - Broker-dealers are not willing or able to publicly quote OTC securities because of a lack of investor interest, company information availability, or regulatory compliance.The Uniform Practice Code (UPC) "The Uniform Practice Code (UPC) is a series of rules, interpretations and explanations designed to make uniform, where practicable, custom, practice, usage, and trading technique in the investment banking and securities business, particularly with regards to operational and settlement issues

Types of Corporate Bonds

What are corporate bonds? - Corporate bonds are debt securities issued by corporations to raise funds. These bonds pay interest to investors at a fixed rate over a specific period of time, and the principal is repaid at the bond's maturity date. "5s" is short for "fives", which is short for "bonds paying a five percent coupon rate"; "7s" is short for "sevens", which is short for "bonds paying a seven percent coupon rate". Secured debt securities - are backed by various kinds of assets of the issuing corporation. Unsecured debt securities - are backed only by the reputation, credit record, and financial stability of the corporation Mortgage Bonds - a corporation will borrow money backed by real estate of the corporation - For example, the real estate could be the factories or office buildings the company owns - There may be a situation where foreclosing on the property results in a sale below the outstanding mortgage balance. In that case, the mortgage holder becomes a general creditor for the unsatisfied balance. Equipment Trust Certificates - Corporations, particularly railroads and airline companies, finance the acquisition of their rolling stock, locomotives, or airplanes by issuing an equipment trust certificate. Collateral Trust Bonds - Sometimes a corporation wants to borrow money and has neither real estate (for a mortgage) nor equipment (for an equipment trust) to use as collateral. Instead, it deposits securities it owns into a trust to serve as collateral for the lenders - the better the quality of the securities deposited as collateral, the better the quality and rating of the bond. Debentures - a debt obligation of the corporation backed only by its word and general creditworthiness - are not secured by any pledge of property. They are sold on the general credit of the company - The quality depends on the overall assets and earnings of the corporation. Guaranteed Bonds - a bond that is guaranteed as to payment of interest, or both principal and interest, by a corporate entity other than the issuer. - The value of the guarantee is only as good as the strength of the company making that guarantee Senior - describes the relative priority of claim of a security. Every preferred stock has a senior claim to common stock. - Every debt security has senior claim to preferred stock. - Secured bonds have a senior claim to unsecured debt, such as debentures. Subordinated - The term subordinated means "belonging to a lower or inferior class or rank; secondary1 ." It is usually describing a debenture. - A subordinated debenture has a claim that is behind (junior to) that of any other creditor. - However, no matter how subordinated the debenture, it is still senior to any stockholder. Income Bonds (Adjustment Bonds) -used when a company is reorganizing and coming out of bankruptcy. - Income bonds pay interest only if the corporation has enough income to meet the interest payment and if the board of directors declares a payment - Buyer doesn't need to pay accrued interest Zero Coupon Bond - debt obligations that do not make any interest payments. - Instead, zeroes are issued, or trade, at a deep discount and mature at par ($1,000). - The major attraction of this type of investment is that it allows an investor to lock in a yield (or rate of return) for a predetermined, investor-selected time with no reinvestment risk (covered in Lesson 14.1). That is why these are often used to fund future education or retirement needs - Buyer doesn't need to pay accrued interest

Types of Risk

three primary systematic risks are: market, interest rate, and inflation or purchasing power. five primary unsystematic risks: Business, Financial, Liquidity, Political, Regulatory Credit risk: The risk that a borrower will default on a debt obligation, leading to a loss for the lender or investor. Inflation risk: The risk that the value of an investment will be eroded over time due to inflation, leading to a decline in purchasing power. - Fixed-income securities are the most vulnerable to this risk; equity securities are historically the least susceptible Sovereign risk ratings - capture the risk of a country defaulting on its commercial debt obligations Liquidity risk: The risk that an investor may not be able to buy or sell an investment at a desired price or time, potentially leading to a loss. - The Treasury bill market is a highly liquid market because investors can sell a Treasury bill within seconds at the quoted prices. Currency risk: The risk that changes in exchange rates between currencies will impact the value of an investment. Interest rate risk - It is the risk that a security's value will decline because of an increase in market interest rates. - Rising interest rates can be bearish for some common stock prices as well, particularly those of highly leveraged companies such as public utilities - TEST TOPIC ALERT: There are even some common stock investments with interest rate risk. For exam purposes, it is the common shares of public utility companies. There are two reason for those stocks being interest-rate sensitive: 1) Public utility stocks are known for their liberal dividend policies. When a stock's price is largely determined by its dividend yield (the case with most utilities), as interest rates go up, their stock prices go down. This is true of public utility stocks more than any other common stock. 2) Public utility companies are highly leveraged. That is, they are regularly borrowing money. As interest rates go up, so does the utility's borrowing cost. That will have the effect of lowering the income and possibly a reduction to the dividend. Method of Reducing Interest Rate Risk - A popular way of reducing interest rate risk is by laddering a bond or CD portfolio - In a laddered strategy, the bonds are all purchased at the same time but mature at different times (like the steps on the ladder). - As the shorter maturities come due, they are reinvested and now become the long-term ones. Political risk: The risk that changes in government policies or instability in a country's political environment will impact the value of investments in that country. Reinvestment Risk - An investor receiving a periodic cash flow from an investment—such as interest on a debt security—may be unable to reinvest the income at the same rate as the security itself is paying. For example, if an investor purchased a bond with a 10% coupon and several years later comparable securities were only paying 7%, the investor would not be able to compound the investment at the original rate. - This risk also occurs at maturity. If the fixed-income investor was enjoying a 10% return on the earlier bond, when it matured, the investor was only able to reinvest the principal in a 7% security. That is one of the advantages of purchasing bonds with a longer term to maturity— you're assured the fixed return for that length Systematic risk (Market Risk) - the risk that affects the entire market or a particular segment of the market, such as interest rate fluctuations, economic recessions, or political instability. - It is also known as market risk and cannot be diversified away since it affects the entire market. - It is generally caused by factors that affect all businesses, such as war, global security threats, or inflation - Market risk cannot be diversified away Non-systematic risk, on the other hand, is risk that is specific to a particular company or industry, such as changes in management, supply chain disruptions, or product recalls. - Non-systematic risk can be diversified away through proper asset allocation and diversification of a portfolio Business Risk - an operating risk, generally caused by poor management decisions

Customer No Financial Profile

- A nonfinancial investment consideration is one that cannot be expressed as a sum of money or a numerical cash flow (risk tolerance, or tax bracket, for example). - Ex. Age Marital status Number and ages of dependents Employment Employment of family members - If a customer contacts a registered representative and wants to purchase securities that the rep feels are not suitable for the client, the registered representative has a responsibility to tell the customer that she feels the trade is not suitable. If the customer insists on the purchase, the registered representative should place the order and mark the trade unsolicited. - When the customer refuses to supply the necessary suitability information, the account may be opened, but trading must be limited to unsolicited orders

Variable Products of Insurance Companies

- Annuities aren't insured by the FDIC, but are covered by state guarantee associations - A corporation can't be an annuitant because it has perpetual existence - On the exam, unless stated to the contrary, every annuity is nonqualified. One of the benefits of nonqualified annuities is that there is no age at withdrawals must commence Fixed Annuities - are not securities - Guarantees a fixed rate of return much like a CD - When the individual elects to begin receiving income, the payout is determined by the account's value and the annuitant's life expectancy based on mortality tables. - A fixed annuity payout remains fixed throughout the annuitant's life. - a fixed annuity risks loss of purchasing power because of inflation. - Payments made with after-tax dollars - Insurer assumes investment risk Variable products - are insurance products that allow policyholders to invest in various securities such as mutual funds, stocks, and bonds variable annuity - A variable annuity is a contract between an insurance company and an individual that allows the individual to invest in a variety of investment options, with the value of the investment fluctuating based on market performance. - Variable annuities have two phases: the accumulation phase, during which the investor contributes funds and the value of the investment fluctuates based on market performance, and the annuitization phase, during which the investor begins to receive regular payments from the annuity contract. - Most variable annuities offer an option stating that if the investor dies during the accumulation period, the beneficiary will receive the greater of the current value of the account or the amount invested. Therefore, the estate is assured of getting back at least the original investment. - Variable annuities may be suitable for investors who are looking for tax-deferred growth, a guaranteed death benefit for their beneficiaries, and the potential for higher returns than traditional fixed annuities. - It is important for investors to carefully review the prospectus for a variable annuity, which provides detailed information about the investment options, fees, and risks associated with the product. - has a better chance of keeping pace with inflation than fixed-income investments. - Payments made with after-tax dollars - Annuitant assumes investment risk variable life insurance policy - A variable life insurance policy is a type of life insurance policy that allows policyholders to invest the policy's cash value in a variety of investment options. - the premiums paid are split; part of the premium is placed in the general assets of the insurance company. These general assets are used to guarantee a minimum death benefit. - The balance of the premium is placed in the separate account and represents the cash value of the policy. Because the cash value is invested in the separate account, which fluctuates in value, its cash value is not guaranteed. - The policy's death benefit may increase above the minimum guaranteed amount as a result of investment results, but may never fall below the minimum (as long as premiums are paid). Assumed Interest Rate (AIR) - the minimum rate of return necessary to provide the level death benefit - It is simply a target, not a projection. - If the separate account returns are greater than the AIR, these extra earnings are reflected in an increase in death benefit and cash value. If the separate account returns equal the AIR, actual earnings meet estimated expenses, resulting in no change in the death benefit. Should the separate account returns be less than the AIR, the contract's death benefit will decrease.

Customer Financial Profile

- Financial investment considerations can be expressed as a sum of money (Ex. What are the values of securities you currently own?, What is the cash value of your life insurance?, How large is your credit card debt?) - An individual's net worth is the difference between the individual's assets and the individual's liabilities. Recommendation - Regulation BI uses the phrase "a call to action" to describe the essence of a recommendation - Account recommendations include recommendations of securities account types generally (e.g., to open an IRA or margin account), as well as recommendations to roll over or transfer assets from one type of account to another (e.g., a workplace retirement plan account to an IRA).

RULES AND REGULATIONS OF THE OPTIONS MARKET

- Once the new account form is completed, a ROP or branch office manager must review and approve the account in writing at or before the initial trade. - The ODD of the OCC must be given to the customer no later than at the time the account is approved for options trading. Verification by the Customer - Within 15 days of account approval, the firm must obtain from the customer a signed written agreement (customer option agreement) that the account will be handled under the rules of the OCC and the CBOE and that the customer will not violate position or exercise limits. TEST TOPIC ALERT - If the signed option agreement is not returned within 15 days of account approval, the firm can permit closing transactions only. TAKE NOTE - In the event that the OCC should revise the ODD, all existing options account holders must receive the revised ODD no later than by the date the customer's next option transaction confirmation is delivered. Even Split - even stock splits occur, additional options contracts are created. - An even split ends in 1—such as a 2:1, 3:1, or 4:1 split. Uneven Split - uneven split, also known as a fractional split, such as a 3:2 or 5:4, does not create additional options contracts EXAMPLE - Note that stock dividends are treated as uneven splits; the number of contracts remains the same, strike price is adjusted, and the contract now covers more shares. After a 20% stock dividend, 1 LFA 60 call will be represented by 1 LFA 50 call with 120 shares in the contract. How did we do the math? A 20% stock dividend is an additional 20 shares. Dividing the original exercise value of $6,000 by the new number of shares (120) results in a strike price of $50 per share. Original contract: 100 × 60 = $6,000 New contract when closed or exercised: 120 × 50 = $6,000 It is important to note that whatever the adjustment, monetary value remains the same. The Functioning of the Listed Options Market - Options trade on several U.S. exchanges and OTC. - Exchange-traded options are listed options and have standardized exercise prices and expiration dates. - The most likely tested locations for trading listed options are: The CBOE The NYSE The Nasdaq Stock Market The PHLX (the Philadelphia Stock Exchange TAKE NOTE If a security is subject to a trading halt on its trading market, options on that security stop trading as well Standard Features of Options Trading and Settlement Trading Times - Listed stock options trade from 9:30 am to 4:00 pm ET (3:00 pm CT) Exercise - The latest time for turning in an exercise notice is 5:30 pm ET Expiration - Listed stock options expire on the third Friday of the month at 11:59 pm ET. The final time for trading an option is 4:00 pm ET on the final day of trading (expiration) Settlement Listed - options transactions settle on the next business day. Stock delivered as a result of exercise is settled on a regular way basis (two business days). Automatic Exercise - Contracts that are in the money by at least 0.01 at expiration are automatically exercised as a service to the customer unless other instructions have been given American- or European-Style Contracts - A for American means anytime. - E for European means expiration date

Types of Communications with the Public

- Options communications generally need review or approval from an ROP (Series 4). Correspondence: Any written or electronic communication made available to 25 or fewer retail investors within any 30 calendar-day period. - FINRA means this to include current and prospective customers. - Procedures may allow for either pre- or post-review of correspondence by a principal. When pre-review is not required, the firm must include a provision for the education and training of associated persons as to the firm's procedures governing correspondence Institutional Communications: any written communication that is distributed or made available only to institutional accounts but does not include a member firm's internal communications. - "institutional account" shall mean the account of any: Bank, Savings and loan association, Insurance company, Registered investment company, Registered investment adviser (SEC or state-registered), Any entity with $50 million or more of total assets, including natural persons - If a member has reason to believe that a communication or excerpt of the communication intended for institutional investors will be forwarded to or made available to a person who is not an institutional investor, the communication must be treated as a retail communication until the member reasonably concludes the improper practice has ceased. Retail Communications: Any written or electronic communication distributed or made available to more than 25 retail investors within any 30 calendar-day period. - What would commonly be thought of as advertisements and sales literature generally fall under this definition - an appropriately qualified registered principal of the member must approve each retail communication before the earlier of its use or filing with FINRA's Advertising Regulation Department. - The requirement of prior principal approval generally will not apply with regard to any retail communication that does not make any financial or investment recommendation or otherwise promote a product or service of the member. - The requirement to have a principal approve retail communication does not apply if, at the time that a member intends to distribute it: - another member has filed it with FINRA's advertising department and has received a letter from the department stating that it appears to be consistent with applicable standards, - the member using it in reliance upon the letter has not materially altered it and will use it in a manner that is consistent with the conditions of the department's letter, - if it is a post to an interactive electronic forum. Sales Literature: Any written or electronic communication that promotes the sale of a security and includes a prospectus, brochure, or advertisement. Other Communications Public Appearance - A public appearance is participation in a seminar, webinar, radio or television interview, or other public appearance or public-speaking activity. - To qualify, it must be an activity that is unscripted and could not be classified as correspondence, retail, or institutional communication. - preapproval of a principal may be required but is not mandated - To be a public appearance, it must be unscripted and for the public, not a group of registered representatives - Any scripts, slides, handouts, or other written (including electronic) materials used in connection with public appearances are considered communications for purposes of this rule, and members must comply with all applicable provisions of this rule based on those communications' audience, content, and use. If the material will be seen by more than 25 investors in a 30-day period, it is considered retail communication. In that case, it must have preapproval from a principal unless meeting one of the exceptions mentioned previously - If an associated person recommends a security in a public appearance, the associated person must have a reasonable basis for the recommendation. The associated person also must disclose any conflicts of interest that may exist, such as a financial interest in any security being recommended. - If past performance of a mutual fund or variable contract is shown, it must be for no less than the previous 12 months. Independently Prepared Reprint - An IPR consists of any article reprint that meets certain standards designed to ensure that the reprint was issued by an independent publisher and was not materially altered by the member. - consists of any article reprint that meets certain standards. A key requirement is that the reprint was prepared by an independent publisher and was not materially altered by the member. A member may alter the contents of an IPR only to make it consistent with applicable regulatory standards or to correct factual errors. - IPRs must be preapproved by a principal and are exempted from the FINRA filing requirements. Research Reports - A research report is a document prepared by an analyst or strategist, typically as a part of a research team for an investment adviser or broker-dealer. - The report may focus on an individual stock or sector of the economy and generally, but not always, will recommend buying, selling, or holding an investment. - A broker-dealer is prohibited from presenting to a client research reports, analysis, or recommendations prepared by other persons or firms without disclosing that they were prepared by a third party. Electronic Communications With the Public - Websites, whether sponsored by the company itself or set up by an individual registered representative, are considered retail communications and are subject to applicable filing and recordkeeping rules. They must be reviewed and approved by a principal before first use and must contain no exaggerated claims or misleading information, and if materially altered since the last filing, must be reapproved and refiled. There must also be nothing in the website that suggests business affiliation with or approval by FINRA. Individual emails to customers fall under the definition of correspondence and are subject to the appropriate standards of conduct and supervision. Instant messaging could qualify as retail communication or correspondence, depending on the size of the audience. SEC Advertising Rules 1) Generic Advertising SEC Rule 135A - Generic advertising promotes securities as an investment medium, but does not refer to any specific security - often includes information about: - the securities investments that companies offer, - the nature of investment companies, - services offered in connection with the described securities, - explanations of the various types of investment companies, - descriptions of exchange and reinvestment privileges, and - where the public can write or call for further information. 2) Rule 156 - Under federal law, it is unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, to use sales literature which is materially misleading in connection with the offer or sale of securities issued by an investment company - sales literature is materially misleading if it (1) contains an untrue statement of a material fact or (2) omits to state a material fact necessary to make a statement made, in the light of the circumstances of its use, not misleading - In any sales literature for an investment company, other than a money market fund, that contains performance data, average annual total return (after taxes on distributions, as well as after taxes on distributions and redemption) for one-, five-, and 10-year periods must be shown. If the fund has been in operation for a shorter period, the life of the fund must be used. Longer periods may be shown in five-year increments up to the life of the fund. Names Rule - The name rule requires a registered investment company with a name suggesting that the company focuses on a particular type of investment (e.g., an investment company that calls itself the ABC Stock Fund, the XYZ Bond Fund, or the QRS U.S. Government Fund) to invest at least 80% of its assets in the type of investment suggested by its name.

Short Sales

- Selling a security one does not own is known as being short or having a short position in the securities - Because there is theoretically no limit on how high a security's price can go, the short seller has unlimited loss potential Regulation SHO - Regulation SHO mandates a locate requirement. That means that before the short sale of any equity security, firms must locate the securities for borrowing to ensure that delivery will be made on the settlement date. The regulators refer to this as affirmative determination. Not doing so is known as naked short selling and is not permitted. TAKE NOTE When a customer is both long and short shares of the same stock simultaneously, the positions must be netted out to determine if the customer is net long or net short. For example, if a customer is long 500 shares of XYZ and short 200 shares of XYZ, the net position is long 300 shares. In this case, if the customer wished to sell 400 shares of XYZ, the sell order ticket must read "SELL 300 shares long and 100 shares short," because the customer is only long 300 shares (net). Mark to Market - Mark to market, sometimes called marking to the market, is simply making daily adjustments to the customer's margin account as the price of the underlying security changes. In a short position where the stock's price increases, the equity in the account goes down. Of course, when the price of the short security drops, the effect on the account's equity is positive. TEST TOPIC ALERT You may be required to know that short selling municipal bonds is almost never done. A buyer has no idea that shares purchased were sold short, but the order ticket prepared by the brokerage firm representing the seller must indicate that the sale is short. Short sales may be executed at any time during the trading day, including the opening and closing.

Account Changes

- Under FINRA rules, no change in any account name(s) can be made unless the change has been authorized by a qualified registered principal designated by the member. - This principal must, before giving her approval of the account designation change, be personally informed of the essential facts relative thereto and indicate her approval of such change in writing Negative Response Letter - generally informs the recipient of the letter of an impending action, and requires the recipient to respond or act within a specified time frame if the recipient objects to the action. - If the recipient does not respond, he is deemed to have consented to the action. - The negative response feature will not be activated until at least 30 days after the letter was mailed.

Employer-Sponsored Retirement Plans

401(k) Plan - Employer-sponsored retirement plan - Allows employees to make pre-tax contributions from their paycheck - Contributions grow tax-deferred - Employer may offer a matching contribution up to a certain percentage - Withdrawals are taxed as ordinary income - Required minimum distributions (RMDs) must begin by age 72 403(b) Plan - Employer-sponsored retirement plan for certain non-profit organizations (religious organizations), schools, and hospitals - are eligible to participate if they are at least 21 years old and have completed one year of service. - plan is only available to employees - it is estimated that more than 85% of all 403(b) money is invested in either fixed or variable annuities. - Allows employees to make pre-tax contributions from their paycheck - Contributions grow tax-deferred - Employer may offer a matching contribution up to a certain percentage - Withdrawals are taxed as ordinary income - Required minimum distributions (RMDs) must begin by age 72 457 Plan - Employer-sponsored retirement plan for certain state and local government employees Allows employees to make pre-tax contributions from their paycheck Contributions grow tax-deferred Employer may offer a matching contribution up to a certain percentage Withdrawals are taxed as ordinary income No penalty for early withdrawals if the employee separates from service Defined Benefit Plan - Employer-sponsored retirement plan Provides a guaranteed retirement benefit to employees based on a formula that takes into account salary, years of service, and age Employer is responsible for funding the plan Employee contributions are not required Typically only offered by larger companies and government entities Profit Sharing Plan - Employer-sponsored retirement plan Employer makes contributions to the plan based on a percentage of profits or a predetermined formula Contributions grow tax-deferred - Profit-sharing plans are popular because they offer employers the greatest amount of contribution flexibility. The ability to skip contributions during years of low profits appeals to corporations with unpredictable cash flows. - a profit-sharing plan must have substantial and recurring contributions, according to the IRC. Keogh Plan - are retirement plans for self-employed people

Municipal Fund Securities

529 Plans - Tax-advantaged savings plans that are used to save for qualified education expenses. - Earnings on contributions grow tax-free, and withdrawals are tax-free as long as they are used for qualified expenses. - funded with after-tax dollars - Section 529 plans, used primary for saving for college, are legally considered municipal fund securities. - Prepaid tuition plans allow donors to lock in future tuition rates at today's prices, thus offering inflation protection. - The education savings plan allows the donor to invest a lump sum or make periodic payments. The money is typically invested into target-date funds. Achieving a Better Life Experience (ABLE) Accounts - The beneficiary of the account is the account owner and income earned by the account is not taxed. - One could be over the age of 26, but as long as the onset of the disability occurred before age 26, the person is eligible to establish an ABLE account. - Contributions must be made using after-tax dollars and is not tax deductible for purposes of federal income taxes. Local Government Investment Pools (LGIPs) - provide other government entities—such as cities, counties, school districts, or other state agencies—with a shortterm investment vehicle to invest funds. - an LGIP may be permitted to maintain a fixed $1 net asset value (NAV). Maintaining a stable NAV, similar to a money market mutual fund, facilitates liquidity and minimum price volatility

Taxation of Variable Annuities

Annuity Accumulation Stage - All growth in the value of an accumulation unit is deferred until withdrawal - For example, a grandparent gives a newborn grandchild $10,000. That money is used for a single premium deferred annuity. If the account earned 7%, when that child turned 70, it would be worth over $1.1 million. During those 70 years, not a penny of tax would be due Annuity Payout Stage - There are three different taxable scenarios and we will consider them one at a time. - On withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income When the contract is annuitized, the annuitant is credited with a fixed number of annuity units. Once annuitized, the number of annuity units does not vary. The value of accumulation and annuity units varies with the investment performance of the separate account. Random Withdrawals - Random withdrawals from annuity contracts are taxed under the last in, first out (LIFO) method. - Earnings are presumed by the IRS to be the last monies to hit the account. - The earnings are considered to be withdrawn first from the annuity and are taxable as ordinary income. - If an investor receives a lump-sum withdrawal before age 59½, the earnings portion withdrawn is taxed as ordinary income and is subject to an additional 10% tax penalty under most circumstances. - The penalty does not apply if the funds withdrawn before age 59½ are withdrawn because of death or disability, or are part of a life income option plan with fixed payouts TEST TOPIC ALERT - Even when the distribution is from a nonqualified annuity, if it is made before the age of 59½, it is subject to the 10% additional tax (unless it meets one of the exceptions listed previously). - Assume an annuity is nonqualified unless a question specifically states otherwise. When contributions are made with after-tax dollars, these already taxed dollars are considered the investor's cost basis and are not taxed when withdrawn. The earnings in excess of the cost basis are taxed as ordinary income when withdrawn. - Any answer choice that mentions capital gains taxation on annuities or retirement plans is wrong. There is only ordinary income tax on distributions from annuities. Annuitization - Annuitized payouts are typically made monthly and are taxed according to an exclusion ratio. Each monthly payment consists of principal plus earnings. The portion representing principal is a return of the cost basis. That is not subject to taxes—it is simply getting your original investment back. The balance of the payment is the deferred earnings and that is what will be taxed. The exclusion ratio expresses the percentage of each monthly payment that is taxable. - EXAMPLE An investor purchased a single premium deferred annuity with $50,000. At the time the investor annuitized, the accumulated value was $100,000. The exclusion ratio would hold that 50% of each payment will be treated as ordinary income and the other 50% of each payment will be treated (for tax purposes) as nontaxable return of basis. If the value at annuitization was $125,000, then 60% (75,000 divided by 125,000) would be taxed as ordinary income and the balance as a nontaxable return of cost basis. 1035 Exchange - A 1035 exchange is a tax-free exchange between like contracts - This 1035 exchange provision applies to transfers of cash values from annuity to annuity, life to life, and life to annuity. It cannot be used for transfers from an annuity to a life insurance policy.

Qualifying the Customer

Accredited Investor - a net worth of at least $1 million (excluding net equity in a primary residence), or has had annual income of at least $200,000 ($300,000 joint return) in the past two years - FINRA believes that each member should take reasonable steps to verify that status where applicable. Here are some of the recommended steps: - Tax returns or W-2s for the previous two years Obtaining a written representation from the purchaser that he has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year - If the purchaser is an accredited investor on the basis of the $1 million net worth, reviewing one or more of the following types of documentation dated within the prior three months: - Bank or brokerage account statements - A credit report from at least one of the nationwide consumer reporting agencies

FUNDAMENTAL ANALYSIS WITH FINANCIAL STATEMENTS

Balance Sheet - The balance sheet provides a snapshot of a company's financial position at a specific point in time - Net Worth = Assets - Liabilities Income Statement - The income statement, sometimes called the profit and loss or P&L statement, summarizes a company's revenues (sales) and expenses for a fiscal period, usually quarterly, year to date, or the full year - Revenue (or sales), COGS, and pretax income are the three primary components of an income statement. Capital Stock at Par - Capital stock includes preferred and common stock, listed at par value. Capital in Excess of Par - Capital in excess of par, often called additional paid-in capital or paid-in surplus, is the amount of money over par value that a company received for issuing the stock in a primary offering. Retained Earnings - Retained earnings, sometimes called earned surplus or accumulated earnings, are profits that have not been paid out in dividends. - Retained earnings represent the total of all earnings held since the corporation was formed, less dividends paid to stockholders. - Retained earnings represent the accumulated total of all earnings that have been retained in the company since its inception. - are undistributed profits since its inception. Liquidity Calculations Working Capital - Working capital is a measure of a firm's liquidity, which is its ability to quickly turn assets into cash to meet its short-term obligations. - current assets - current liabilities = working capital Current Assets = include all cash and other items expected to be converted into cash within the next 12 months - Cash - Accounts Receivable - Inventory Fixed Assets - Fixed assets are property, plant, and equipment. - have limited useful lives because wear and tear eventually reduce their value. For this reason, their cost can be depreciated over time or deducted from taxable income in annual installments to compensate for loss in value. Current Ratio - Current Ratio = Current Assets / Current Liabilities Quick Asset Ratio (Acid-Test Ratio) - Sometimes it is important for the analyst to use an even stricter test of a company's ability to meet its short-term obligations (such as, "pass the acid test") - = (Current Assets - Inventory) / Current Liabilities Leverage Financial - leverage is a company's ability to use long-term debt to increase its return on equity. A company with a high ratio of long-term debt-to-equity is said to be highly leveraged. - In general, industrial companies with debt-to-equity ratios of 50% or higher are considered highly leveraged. However, utilities, with their relatively stable earnings and cash flows, can be more highly leveraged without subjecting stockholders to undue risk. If a company is highly leveraged, it is also affected more by changes in interest rates. Income Statement Computations - EPS = earnings available to common / Number of Shares outstanding - Dividend Payout Ratio = Annual Dividend / EPS - Price-to-Earnings Ratio = current market price of a common share / EPS - EPS = Current Market Price of Stock / PE Ratio

Investment Company Rules and Regulations

Board of Directors (BOD) - Another way of stating that no more than 60% of the directors in a mutual fund may be interested persons is to say that at least 40% must be noninterested, that is, "outside" directors. - These are individuals who have no connection to the fund other than a position on the board (and maybe owning some shares of the fund as would any investor). Prohibited Activities Mutual funds may not: - purchase any security on margin - sell any security short - acquire more than 3% of the outstanding voting securities of another investment company Size of Investment Companies - No registered investment company is permitted to make a public offering of securities unless it has a net worth of at least $100,000. Periodic and Other Reports - All investment companies must file annual financial reports with the SEC - In addition, shareholders must be sent financial information semiannually. In keeping with current technology, these reports may be delivered electronically Selling Dividends - Selling dividends is the prohibited practice of inducing customers to buy mutual fund shares by implying that an upcoming distribution will benefit them The Gifts Rule - it prohibits any member or person associated with a member, directly or indirectly, from giving anything of value in excess of $100 per year to any person where such payment is in relation to the business of the recipient's employer

The Ratings Game

Bond Rating - an assessment of the creditworthiness of a bond issuer by a rating agency. It is a measure of the issuer's ability to pay interest and principal on the bond. Investment-Grade Debt - bonds rated in the top four categories (BBB or Baa and higher) High-Yield Bonds - Lower-grade bonds, known in the industry as junk bonds, are now more commonly called high-yield bonds. - (BB or Ba or lower) S&P 500 Ratings: AAA → AA → A → BBB → BB → B → CCC → C → D Moody's: Aaa → Aa → A → Baa → Ba → B → Caa → Ca → C Notice the 3 → 2 → 1 → 3 → 2 → 1 Moody's Investment Grade (MIG) short-term municipal note ratings are from MIG 1 (best quality) through MIG 4 (adequate quality).

Test Taking Tips

Calculations - Always divide first number by second number DERP (Secondary trading) 1) Declared Date 2) Ex-Dividend Date - "Ex" = Without - One business day before record date - Date not declared by BOD; every other date is determined by BOD 3) Record Date 4) Payable Date DREP (Primary Trading Ex. Mutual Funds) - All dates determined by the BOD 1) Declared Date 2) Record Date 3) Ex-Dividend Date - One business day after record date 4) Payable date Cannot sell dividends Yield See Saw Y (Current Yield) --> M (Yield to Maturity) --> C (Yield to Call) Subchapter M (Conduit Theory) D + I - E 90 - Have to pass through 90% of Net Investment Income DPP PIGS = Passive Income Generator PALS = Passive Activity Losses - Want to match PIGS and PALS - If an investor has a lot of passive income, one should suggest a DPP SLOBS (Sell Limit & Buy Stops) -------- BLISS (Buy Limit & Sell Stop) BAAC (Brokers Act as Agents for Commission) DAAP (Dealers Act as Principals for Profit) Breakevens for Spread CAL (Call Add Lower) - Add net premium to lower strike price PSH (Put Subtract Higher) - Subtract net premium from higher strike price BULLS (Because U "R" Long Lower Strike) = Bullish Debit & Credit Spread DEW = Debit Exercise Widen CEN = Credit Expire Narrow Straddles SILO = Short Inside Long Outside EPIC = Exporters buy Puts, Importers buy Calls

Types of Customer Accounts

Cash Account - Customer pays for securities in full at the time of purchase - No borrowing of funds or securities - No minimum balance requirement - May earn interest on uninvested cash Margin Account - Customer borrows funds from a broker-dealer to purchase securities - Customer must deposit an initial margin requirement and maintain a minimum equity level - Interest is charged on the borrowed funds - Securities purchased on margin serve as collateral for the loan Prime Brokerage Account - one in which a customer, generally an institution, selects one member firm (the prime broker) to provide custody and other services, while other firms, called executing brokers, handle most of the trades placed by the customer. Delivery vs. Payment (DVP); Receipt vs. Payment (RVP) - DVP is a settlement method in which the delivery of securities is only made to the buyer once payment has been made - RVP, on the other hand, is a settlement method in which the payment for securities is only made to the seller once the securities have been received - Both are used to ensure that both parties in a financial transaction fulfill their respective obligations. pattern day trader - someone who executes four or more day trades in a five-business-day period - The minimum equity requirement for pattern day traders is $25,000. Joint tenants with rights of survivorship (JTWROS) - ownership stipulates that a deceased tenant's interest in the account passes to the surviving tenant(s) - Ownership is equal - Only one tax identification number (Social Security number) is placed on the account. Tenants in common (TIC) - ownership provides that a deceased tenant's fractional share in the account goes to that tenant's estate - ownership can be unequal. Transfer on death (TOD) - a type of account registration that allows the owner of the account to pass all or a portion of it, upon death, to a single or multiple beneficiaries - Avoids probate - reducing estate taxes isn't a benefit A custodial account - a type of brokerage account that is created by an adult on behalf of a minor, who is the account beneficiary. The adult, known as the custodian, manages the account until the minor reaches the age of majority. - Custodial accounts can hold a wide range of investments, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other securities. - custodial accounts can be used to pay for educational expenses, but withdrawals are subject to taxes and penalties if they are not used for qualified education expenses.

Analysis of Municipal Debt Securities

Characteristics of the Issuer - quantitative analysis focuses on objective information regarding a municipality's population, property values, and per capita income. - A qualitative analysis focuses on subjective factors that affect a municipality's securities. - Ex. The community's attitude toward debt and taxation, population trends, property value trends, and plans and projects being undertaken in the area are all relevant considerations. Debt Limits - To protect taxpayers from excessive taxes, statutory debt limits may be placed on the overall amount of debt a municipality can have. Ad Valorem Taxes - Ex. A couple's home has an assessed valuation of $40,000 and a market value of $100,000. What will the tax be if a rate of 5 mills is used? A short-cut method: take the assessed value, remove the last three 0s, and multiply by the number of mills of tax ($40 × 5 mills = $200). - Ex. A taxpayer's home is currently valued at $400,000. The tax is based on a 50% assessment of market value. If the annual tax rate is 7 mills, what is the taxpayer's property tax liability? We solve as follows: 50% of the market value is $200,000. That is multiplied by the millage rate (0.007). The result is a tax of $1,400. municipal bonds provide a form of prospectus, (disclosure document), known as an official statement (OS). Flow of Funds - The issuer pledges to pay expenses in a specific order, called the flow of funds. - Net Revenue Pledge = Issuer pays operations and maintenance expenses then debt service - Gross Revenue = debt service is paid first then operations and maintenance Debt Coverage Ratio = Available Revenues / Debt Service Requirements

FINRA's Complaint Resolution Methods and Rules

Code of Arbitration Procedure - Code of Arbitration Procedure was originally established to arbitrate unresolved industry disputes. It was mandatory in controversies involving: - a member against another member or registered clearing agency, - a member against an associated person, and - an associated person against another associated person. - Today, virtually all new account forms contain a predispute arbitration clause that must be signed by customers before account opening. If a customer requests to see the predispute arbitration agreement she has signed, a member firm must supply her with a copy within 10 business days of the request - a member cannot force a customer to arbitration. - In addition, claims alleging employment discrimination brought against a member firm by its own employees, including sexual harassment claims, are not required to be arbitrated unless the parties agree. - The advantages of arbitration over suits in state or federal courts are savings of time, money, and the fact that all decisions are final and binding; no appeals are allowed Initiation of Proceedings - The respondent then has 45 calendar days to respond to both the director and the claimant. The answer must specify all available defenses and any related counterclaim the respondent may have against the claimant. A respondent who fails to answer within 45 days may, at the sole discretion of the director, be barred from presenting any matter, arguments, or defenses at the hearing. Mediation - An alternate dispute resolution process and a reasonable, inexpensive first step is mediation - If both parties agree, before the opening of hearings, a meeting may be held in an attempt to work out a settlement. - A mediator is selected to preside over the discussions and to assist the parties, if possible, in reaching their own solution - A mediator is prohibited from serving on an arbitration panel regarding any matter in which that person served as mediator. - Once mediation begins, either party may withdraw at any time without the consent of the mediator or the other party Selection of Arbitrators 1) Nonpublic arbitrators are as follows: Any persons who worked in the financial industry for any duration during their careers, including persons associated with a mutual fund or a hedge fund, and persons associated with an investment adviser - Also Any financial industry professional who regularly represents or provides services to investor parties in disputes concerning investment accounts or transactions including attorneys, accountants, or other professionals whose firms earned significant revenue from representing individual and/or institutional investors relating to securities matters are classified as nonpublic arbitrators. 2) Public arbitrators are as follows: Any persons who do not meet the definition of a nonpublic arbitrator may serve as a public arbitrator. Arbitration Thresholds and Simplified Arbitration - $50,000 or less—one arbitrator - $50,000-$100,000—one arbitrator unless both parties agree to three - Greater than $100,000—three arbitrators unless both parties agree to one Simplified Arbitration - Any dispute involving a dollar amount of $50,000 or less is eligible for simplified arbitration. - In this instance, a single arbitrator reviews all of the evidence and renders a binding decision within 30 business days. Awards - All monetary awards must be paid within 30 days of the decision date. Statute of Limitations - No claim is eligible for submission to arbitration if six years or more have elapsed from the time of the event giving rise to the claim. The Code of Procedure (COP) - there has been a violation of the rules—someone has broken the law Sanctions - Sanctions against a member or associated person found in violation of securities laws and rules are included with the written decision. - Under FINRA Rule 8300, sanctions could include one or more of the following: Censure, Fine, Suspension of the membership of a member or suspension of the registration of an associated person for up to two years, Expulsion, Barring a member - If an associated person is suspended, that person cannot remain associated with the member in any capacity, including a clerical or administrative capacity (during the suspension period, that person cannot remain on the member's premises). The member is prohibited from paying a salary, commission, or other remuneration that the person might have earned during the suspension period. Appeals - If either side is displeased with the decision, an appeal may be made to the National Adjudicatory Council (NAC). - Any appeal must be made within 25 days of the decision date; otherwise, the decision is final. - Please note that decisions under the Code of Procedure (disciplinary actions) may be appealed. It is only arbitration cases for which there is no appeal - If no satisfaction is received from the NAC, the appealing party may take the case to the SEC. Again, if turned down, the appealing party has the right to continue the appeal process by taking its case to the federal court system Clearly Erroneous Transactions - Nasdaq has the authority to declare any interdealer trade null and void or adjust the terms of any interdealer trade if the terms of the trade are clearly in error (e.g., obvious error in price, number of shares). - If a member wants to have a trade nullified or adjusted, it must notify Nasdaq Market Operations within 30 minutes of the execution and provide all the details surrounding the trade

Municipal Bond Math

Computing Accrued Interest - Accrued interest increases the bond cost to the buyer and the proceeds to the seller. - Accrued interest is calculated from the last interest payment date up to but not including the settlement date (two business days after the trade date). - The buyer owns the bond on the settlement date, which means that the interest starting from that day belongs to the buyer and the previous six months interest is credited to the seller. The Calculation - Corporate, agencies, and municipals: use 30-day months (360-day year) - U.S. Treasury securities: use actual day months (365-day year) When counting days: - Go back and include the last interest payment date. - Go up to but not including the settlement date. EXAMPLE If an F&A municipal bond is traded regular way on Monday, March 5, the number of days of accrued interest is calculated as follows: February 30 days March 5 trade 6 days (settles T+2 regular way March 7) Days of accrued interest 36 days If the interest dates are: The bonds are known as: - January 1 and July 1 = J&J bonds - February 15 and August 15 = F&A 15 bonds - March 1 and September 1 = M&S bonds - April 1 and October 1 = A&O bonds - May 15 and November 15 = M&N 15 bonds - June 15 and December 15 = J&D 15 bonds Accrued Interest and the Dated Date - For a new bond issue, the date from which interest accrual begins is called the dated date. - For example, if the bond's dated date is April 1 and the interest payment dates are June 1 and December 1, the first interest payment will be on December 1 and will be for eight months of interest. This first payment is called a long coupon. Trading Flat - When a debt security is trading flat, it means no accrued interest is included in the transaction. - In most cases, this occurs when the issuer is in default of interest payments. - Of course, this is also the case with zero coupon bonds because there is no interest being paid Amortization - reduces cost basis and - reduces reported interest income. Accretion - increases cost basis and - increases reported interest income.

Disclosure of Risks

Control Relationships - A control relationship exists when a broker-dealer is owned by, is under common ownership with, or owns an entity that issues securities. It could be thought of as being part of the same family. - When it comes to a recommendation, one would have a natural bias toward that entity. - unless a customer gives her express authorization, the broker-dealer cannot effect transactions to the customer's account for securities in which it has a control relationship with the securities' issuer. Regulation Full Disclosure (FD) - an SEC rule dealing with issuers disclosing information that can affect the price of the stock. - Almost all Regulation FD disclosures are for unintentional leaks. When that happens, the issuer must make prompt disclosure (defined as before the next trading day). - "Promptly" means as soon as practical—more specifically, no later than 24 hours after known by a senior officer, or the start of the next day's trading on the New York Stock Exchange, whichever is later Tender Offers - "an active and widespread solicitation by a company or third party (often called the bidder or offeror) to purchase a substantial percentage of the company's securities. - Usually, the tender offer is at a premium to the most recent trade so it can be a good deal for the client - The tender offer, unless withdrawn, under Regulation 14E, must remain open for at least 20 business days from the date the offer is first announced. - If the terms of the offer are changed, the revised offer must remain open for at least 20 business days from the commencement and 10 business days from the date the terms are changed. - The target company, within 10 business days of the announcement, must provide its shareholders with a statement: - accepting or rejecting the offer, - expressing no opinion on the offer, or - that it is unable to take a position on the offer. - Shareholders of the target company are permitted to tender shares only to the extent of their net long position. That means shareholders cannot sell shares back to the company that they do not own. - EXAMPLE A customer is long 400 shares of ABCD in a cash account and short 100 shares of the stock in a margin account. If ABCD becomes the target of a tender offer, the customer would be permitted to tender 300 shares, the net long position

BASIC OPTION STRATEGIES

Covered vs. Uncovered Call Writers - When a call option is covered, it means the investor owns the number of shares "covered" by the option contract. For example, if the writer is selling 3 contracts, 300 shares of the stock is in the writer's account - A call option is uncovered when an investor writes a call option without owning the underlying stock or other related assets that would enable the investor to deliver the stock should the option be exercised. You may also see this referred to as a naked write. TEST TOPIC ALERT - Naked call writers face unlimited potential risk of loss Ratio Call Writing - Ratio call writing involves selling more calls than the long stock position covers. This strategy generates additional premium income for the investor, but also entails unlimited risk because of the short uncovered calls. - EXAMPLE An investor who is long 100 shares of HIJ common stock writes 2 HIJ OCT 45 calls. This is a 2:1 ratio write because the ratio of total calls to covered calls is 2:1. The 100 shares in the account is enough to cover one of the calls. The other call is uncovered and that means the potential loss is unlimited. Put-Call Ratio - put-call ratio reflects the current open interest in the trading of put options to call options. - The ratio can be used as a gauge of investor sentiment (bullish or bearish) and can be calculated to measure broad sectors of the market across many underlying securities or indexes, or it can be used to gauge investor sentiment for just one underlying security. - The ratio is calculated by dividing the number of traded put options by the number of traded call options. - The higher the ratio, the more bearish investors have been up to that point in time.

Account Opening Requirements

Customer Identification Program (CIP) - Program established by the USA PATRIOT Act to verify the identity of customers opening new accounts - Requires financial institutions to obtain and verify customer identification information, such as name, address, date of birth, and identification number, Social Security number for an individual or Tax ID number for a business entity Office of Foreign Assets Control (OFAC) - list of known or suspected terrorists or terrorist organizations. - prohibit transactions with certain persons and organizations listed on the OFAC website as Terrorists and Specially Designated Nationals and Blocked Persons Know Your Customer (KYC) - Process of obtaining information about a customer to assess their risk and ensure they are using the financial institution for legitimate purposes - Includes identifying the customer's source of funds, intended account activity, and risk profile KYC procedures help prevent money laundering, terrorist financing, and other illegal activities New Account Form - Document used to collect information about a customer opening a new account - Customer's name and residence address - Whether the customer is of legal age - The customer's tax identification or Social Security number - The occupation of customer and name and address of employer - Whether the customer is an associated person of another member - The customer's signature is not required on the new account form. The only signature required to open an account is a partner, officer, or manager (a principal) signifying that the account has been accepted in accordance with the member's policies and procedures for acceptance of accounts - requires delivery of a copy of the account information within 30 days of opening (and every 36 months thereafter) Opening Accounts for Other Members' Employees - FINRA rule requires that a person associated with a member, before opening an account or placing an initial securities order with another member, notify the employer and the executing member (where the new account is to be maintained), in writing, of her association with the other member. - Before the account can be opened, the employing FINRA member firm must grant written permission. Regulation S-P (Privacy Notices) - This regulation was enacted by the SEC to protect the privacy of customer information. - the notice must provide customers a reasonable means to opt out of this disclosure. Reasonable opt out means include providing customers with a form with checkoff boxes along with a prepaid return envelope, providing an electronic means to opt out for customers who have agreed to the electronic delivery of information, and providing a toll-free telephone number - A broker-dealer must give a customer 30 days to implement any opt-out provision in the privacy notice. Full Power of Attorney - May deposit or withdraw cash or securities and make investment decisions for the account owner. Limited POA - allows entering of buy and sell orders but not the withdrawal of funds.

DPP Regulation

DPP Compensation Restrictions - Specifically, if the organization and offering expenses exceed 15% of the gross proceeds, FINRA considers that too high. A subset of those expenses is the compensation to the member firm. That cannot exceed 10% of the gross proceeds. Included in the 10% is any compensation to wholesalers - The maximum compensation to a member firm involved in the sale of a DPP is 10% of the gross proceeds. The rule permits an additional 5% for administrative, organization, and offering expenses. That brings the total maximum to 15%. Ex. An investor places $100,000 into an oil and gas limited partnership program. To comply with FINRA rules, what is the minimum amount of the investment that must be received by the business? - Under FINRA Rule 2310, the maximum in total offering expenses is 15% - The 15% limitation is the maximum percentage of the gross proceeds of a DPP that may be used for the organization and offering expenses Ex. A customer of a member firm has just invested $100,000 into an equipment leasing DPP. Under FINRA rules, the maximum compensation allowable to the firm is - FINRA Rule 2310 limits compensation on the sale of a DPP to 10% of the offering price DPP Roll-Up - A roll-up is a transaction involving the combination or reorganization of one or more limited partnerships into securities of a successor corporation. - this involves DPPs that have not been successful. - The attraction to investors is the possibility of turning an illiquid DPP into a security with greater liquidity. - In connection with a DPP rollup, member firms may not solicit votes from limited partners unless the compensation is 2% or less

What is a Debt Security

Debt Securities - Debt securities represent a loan made by an investor to an issuer in exchange for regular interest payments and repayment of principal at maturity - Debt securities can be issued by corporations, municipalities, and the federal government - Common types of debt securities include bonds, notes, and debentures Indenture - The terms of the loan are expressed in a document known as the bond's indenture. - The indenture, sometimes also referred to as the deed of trust, states the issuer's obligation to pay back a specific amount of money on a specific date. - The indenture also states the issuer's obligation to pay the investor a specific rate of interest for the use of the funds as well as any collateral pledged as security for the loan and all other pertinent details Bonds - Bonds are a type of debt security that represent a loan made by an investor to an issuer in exchange for regular interest payments and repayment of principal at maturity - Bonds can be issued by corporations, municipalities, and the federal government - Bonds typically have a fixed interest rate, maturity date, and par value - Bonds may be callable, convertible, or have other features that affect their value and risk Types of Risk: Credit Risk - Credit risk is the risk that an issuer of a debt security will default on its payment obligations Credit risk is typically assessed by credit rating agencies, which assign a rating to the issuer based on its creditworthiness and ability to repay the debt Higher-rated issuers are considered to have lower credit risk, while lower-rated issuers are considered to have higher credit risk The credit rating of a debt security can affect its yield, price, and marketability Interest Rate Risk - Interest rate risk is the risk that the value of a debt security will decline due to changes in interest rates - When interest rates rise, the value of existing debt securities decreases, as investors demand higher yields to compensate for the increased risk of holding these securities - Conversely, when interest rates fall, the value of existing debt securities increases, as investors are willing to accept lower yields in a low-interest-rate environment - Longer-term debt securities are typically more sensitive to changes in interest rates than shorter-term securities

RULES OF THE SECURITIES MARKETPLACES

Designated Market Maker (DMM) - facilitate trading in specific stocks, and their chief function is to maintain a fair and orderly market in those stocks. In fulfilling this function, they act as both brokers and dealers. They act as dealers when they execute trades for their own accounts and as brokers when they execute orders other members leave with them Auction Market - Exchange securities are bought and sold in an auction market. Exchange markets are also sometimes called double-auction markets because both buyers and sellers call out their best bids and offers in an attempt to transact business at the best possible price. - To establish the best bid, a buying broker-dealer must initiate a bid at least $0.01 higher than the current best bid. The best offer by a selling broker-dealer must be at least $0.01 lower than the current best offer. Priority, Precedence, and Parity - When more than one broker enters the same bid or offer, the specialist (DMM) awards the trade in the following order: 1. Priority—first order in 2. Precedence—largest order of those submitted 3. Parity—spin the parity wheel (random) Volatile Market Conditions Rule 80B - Rules known as the market-wide circuit breaker rules protect against rapid, uncontrolled drops in the market. A market-wide trading halt will be triggered if the S&P 500 Index declines in price by specified percentages from the prior day's closing price of that index Level 1 halt = 7% decline in S&P 500 - Before 3:25 pm—15 minutes; - At or after 3:25 pm—trading may continue, unless there is a Level 3 halt Level 2 halt = 13% decline in S&P 500 - Before 3:25 pm—15 minutes; - At or after 3:25 pm—trading may continue, unless there is a Level 3 halt Level 3 halt = 20% decline in S&P 500 At any time—trading will halt and not resume for the rest of the day

INVESTMENT COSTS, FEES, AND TAX CONSIDERATIONS

Donor Taxes - When a person dies, tax is due on the estate. This tax is payable by the estate, not by heirs who inherit the estate (although certain other taxes may apply to heirs). Likewise, if a person gives a gift, tax is due on the gift. Gift tax is payable by the donor, not the recipient Annual Gift Tax Exclusion - Individuals may give gifts up to $16,000 per year to any number of individuals without incurring gift tax. The amount of the exclusion is subject to change depending on inflation. Gifts between spouses, no matter the size, are not subject to tax. Corporate Dividend Exclusion - There is a special tax break available to C corporations. When a C corporation owns stock in another corporation, 50% of the dividends received from that other corporation are excluded from the corporation's income. - When a dividend of one corporation is paid to another - That is, if ABC Corporation receives $10,000 in dividends on stock it owns in XYZ Corporation, only $5,000 of that dividend is included in ABC's taxable income Progressive Tax = income and estate taxes the percentage amount increases as the taxable amount increases. Regressive = Sales and cigarette taxes everyone pays the same percentage tax regardless of their income. Determining Which Shares to Sell - An investor holding identical securities, each with a different acquisition date and cost basis, may determine which shares to sell by electing one of three accounting methods: FIFO, share identification, or average cost basis. - If the investor fails to choose, the IRS assumes the investor liquidates shares on a FIFO basis FIFO basis - When FIFO shares are sold, the cost of the shares held the longest is used to calculate the gain or loss. - In a rising market, this method normally creates adverse tax consequences because there is a larger capital gain Share Identification - When using the share identification accounting method, the investor keeps track of the cost of each share purchased and uses this information to liquidate the shares that would provide the lowest capital gain - The investor keeps track of the cost of each share purchased and specifies which shares to sell on the basis of that investor's specific tax needs. Average Cost Basis - A shareholder may elect to use an average cost basis when redeeming mutual fund shares (but not shares of specific stocks). - The investor would calculate average basis by dividing the total cost of all shares owned by the total number of shares.

ERISA

ERISA (Employee Retirement Income Security Act) - was established to prevent abuse and misuse of pension funds. ERISA guidelines apply to private-sector (corporate) retirement plans and certain union plans—not public plans like those for government workers. - ERISA applies to private-sector plans (corporate) only. It does not apply to plans for federal or state government workers (public sector plans), nor is it applicable to nonqualified plans. Testable ERISA Provisions Participation - This identifies eligibility rules for employees. All employees must be covered if they are 21 years or older and have performed one year of full-time service, which ERISA defines as 1,000 hours or more or 500 hours per year for three consecutive years for the company Vesting - Vesting defines when an employer contribution to a plan becomes the employee's money, such as an employer-matching contribution to a 401(k) plan Communication - The plan document must be in writing, and employees must be given annual statements of account and updates of plan benefits. Nondiscrimination - All eligible employees must be treated impartially through a uniformly applied formula. Beneficiaries - Beneficiaries must be named to receive an employee's benefits at death. Health Savings Plan - In order to be eligible for a health savings plan, an individual must be enrolled in a high deductible health plan (HDHP). - Health savings accounts (HSAs) offer several benefits to participants. Among them is distributions to cover qualified medical expenses are generally tax-free.

Foreign Debt Securities

Eurobond - is any long-term debt instrument issued and sold outside the country of the currency in which it is denominated. - For example, if a Swiss company issued bonds denominated in British pounds, it is a Eurobond. Eurodollar Bond - A U.S. dollar-denominated Eurobond, or Eurodollar bond, is a bond issued by a corporation (or government), sold outside the United States and the issuer's country, but for which the principal and interest are stated and paid in U.S. dollars. - The U.S. government does not issue Eurodollar bonds. - For example, if an Indian bank held dollar-denominated bonds issued by a Korean company, the term Eurodollar bond would still apply.

Exchange-Traded Funds (ETFs)

Exchange-Traded Funds (ETFs) - are investment funds that are traded on an exchange like stocks. ETFs can hold a variety of assets, such as stocks, bonds, and commodities. - Aren't actively traded - ETFs trade on an exchange like stocks and their price is determined by supply and demand. The market price of an ETF may trade at a premium or discount to its NAV. - ETFs are generally more liquid than mutual funds because they trade on an exchange like stocks. Investors can buy and sell ETF shares throughout the trading day. - ETFs can be actively or passively managed, with some ETFs designed to track a specific index or benchmark. - ETFs generally have lower fees than mutual funds because they are passively managed and have lower expenses associated with administering the fund. - ETFs can be bought and sold throughout the trading day, unlike mutual funds, which are only priced once a day. Leveraged ETF - These funds attempt to deliver a multiple of the return of the benchmark index they are designated to track. - For instance, a 2x leveraged fund would try to deliver two times the return of whatever index it is tracking. - it is always a double-edged sword; volatility is magnified. Therefore, the risk to be recognized regarding this fund strategy is that if the benchmark index is falling, then the fund's returns will be—in theory—the designated leverage amount (perhaps two or three) times the loss. Inverse (Reverse) Funds - attempt to deliver returns that are the opposite of the benchmark index they are tracking. - For example, if the benchmark is down 2%, the fund's goal is to be up 2%

FINRA FILING RULES INCLUDING VARIABLE LIFE

Exclusions From the Filing Requirement - Retail communications that previously have been filed with FINRA and that are to be used without material change - Retail communications that do not make any financial or investment recommendation or otherwise promote a product or service of the member - Retail communications that do no more than identify a national securities exchange symbol of the member or identify a security for which the member is a registered market maker - Retail communications that do no more than identify the member - Correspondence - Institutional communications - Communications that refer to types of investments solely as part of a listing of products or services offered by the member - Retail communications that are posted on an online interactive electronic forum Communications Regarding Variable Contracts Product Communications - All communications must clearly describe the product as either variable life or a variable annuity, as applicable. Liquidity - Because variable life insurance and variable annuities frequently involve substantial charges and/or tax penalties for early withdrawal, there may be no representation or implication that these are short-term, liquid investments Guarantees - There may be no representation or implication that a guarantee applies to the investment return or principal value of the separate account. Also, it may not be represented or implied that an insurance company's financial ratings apply to the separate account. Single Premium Variable Life - When a life insurance policy is funded with too much money within a seven-year period, it is defined as a modified endowment contract (MEC). Hypothetical Illustrations of Rates of Return in Variable Life Insurance - Hypothetical illustrations may not be used to project or predict investment results. - Illustrations may use any combination of assumed investment returns up to and including a gross rate of 12%, provided that one of the returns is a 0% gross rate - In general, variable life product performance may not be compared with other investment products. However, comparison of variable life with a term insurance product is permitted to demonstrate the concept of tax-deferred growth resulting from investment in the variable product.

SEC AND FINRA RULES ON NEW ISSUES

Exempt Transactions Regulation A: Small and medium corporate offerings - provides two offering tiers for small- and medium-sized companies that will allow the companies to raise capital - Tier 1. Securities offerings up to $20 million in a 12-month period will be allowed - Tier 2. Securities offerings up to $75 million in a 12-month period will be allowed. - Tier 2 investors must be qualified investors, and there are two ways to qualify: Be an accredited investor as defined in Rule 501 of Regulation D or Limit the investment to a maximum of the greater of 10% of the investor's net worth or 10% of the investor's net income per offering. - In a Regulation A offering, the issuer files an abbreviated notice of sale, or offering circular, with the regional SEC office. Investors are provided with this offering circular rather than a full prospectus. - Individuals buying securities in a Regulation A offering must receive a final offering circular at least 48 hours before confirmation of sale. Regulation D: Private placements - Under Rule 506, a company can raise an unlimited amount of money from an unlimited number of accredited investors, and up to 35 non-accredited investors who meet certain financial suitability requirements. - Under Rule 503 of Regulation D, an issuer that is issuing securities in reliance on Regulation D must file Form D electronically with the SEC no later than 15 days after the first sale of securities in the offering. Rule 147: Securities offered and sold exclusively intrastate - offerings that take place entirely in one state are exempt from registration when: - the issuer has its principal office and receives at least 80% of its income in the state, or - at least 80% of the issuer's assets are located within the state, or - at least 80% of the offering proceeds are used within the state, or - a majority of the issuers' employees are based within the state, and - all purchasers are residents of the state. - Purchasers of an intrastate issue may not resell the stock to any resident of another state for at least six months after the purchase. Regulation S: Offers and sales made outside the United States by U.S. issuers - Offers and sales made outside the United States by both U.S. and foreign issuers are excluded from the registration provisions of the Securities Act of 1933 - Regulation S applies to United States issuers. Foreign issuers are not subject to this regulation if certain requirements are me - To be an offshore transaction, offers and sales cannot be made to any person or entity in the United States. However, U.S. citizens residing outside the United States could purchase these securities. All sales made under Regulation S must be reported to the SEC on Form 8-K Other exempt transactions, including Rule 144, Rule 144A, and Rule 145 Shelf Registration (Rule 415) - Shelf registration is a process by which a company can register a large block of securities with the SEC, and then sell them in one or more offerings over a period of time. - The advantage of shelf registration is that it allows a company to have securities registered and ready for sale when market conditions are favorable, without having to wait for SEC approval each time a sale is made. - The shelf life of a shelf registration is typically three years, after which time the registration will expire unless it is renewed. - No, securities cannot be sold immediately after a shelf registration is filed. A waiting period of at least 20 days is required before any sales can be made. Rule 144 (1+4+4=9(0) days) (1% or average of last 4 trading weeks whatever is greater to sell shares with a Form 144 4 times a year) - control securities are those owned by directors, officers, or persons who own or control at least 10% of the issuer's voting stock. These are commonly referred to as insiders. - If an unaffiliated individual owns 7% of the voting stock of XYZ, that person is not a control person. However, if that person's spouse owns 4% of the voting stock, then both would be considered control persons. In other words, if there is a 10% or more interest held by immediate family members, then all those family members owning voting stock might be control persons - Restricted securities are those acquired through some means other than a registered public offering. A security purchased in a private placement is a restricted security. Restricted securities may not be sold until they have been held fully paid for six months - According to Rule 144, after holding restricted stock fully paid for six months, an affiliate may begin selling shares by submitting Form 144 but is subject to the volume restriction rules as enumerated as follows. In any 90-day period, an investor may sell the greater of: - 1% of the total outstanding shares of the same class at the time of sale or - the average weekly trading volume in the stock over the past four weeks on all exchanges or as reported through Nasdaq. - Form 144 need not be filed if 5,000 or fewer shares are sold or the dollar amount is $50,000 or less. The de minimis rule applies to sales in any 90-day period. Short-Swing Profit - This rule states that any insider of a publicly traded corporation (the CFO would certainly be included in the definition of insider or affiliate) is prohibited from profiting from any purchase or sale (or sale and purchase) of the company's equity securities within a period of less than six months Only restricted stock has a holding period. Control stock, unless it is restricted, can be sold immediately, but volume limits always apply Protecting the Public and Restricted Persons Prohibitions - The rule prohibits member firms from selling a new issue to any account where restricted persons are beneficial owners. Restricted persons are defined as follows: - Member firms - Employees of member firms - Finders and fiduciaries acting on behalf of the managing underwriter, including attorneys, accountants, financial consultants, and so forth - Portfolio managers, including any person who has the authority to buy or sell securities for a bank, savings and loan association, insurance company, or investment company - Any person owning 10% or more of a member firm - Furthermore, any immediate family member of any person in bullet points two through five is also restricted. Immediate family includes parents, in-laws, spouses, siblings, children, or any other individual to whom the person provides material support - Officers of the managing underwriter are restricted.

Options Taxation

Expiration, Close, or Exercise - There are three ways to handle an existing (open) option position. An open positon can expire, be closed in the open market, or be exercised by the party who is long (owner). Expiration - At the expiration of an options contract, the buyer loses the premium; the seller profits from the premium. The buyer reports a capital loss equal to the premium amount; the seller reports a capital gain equal to the premium amount. Closing Out - Closing sales or purchases generate a capital gain or loss equal to any price difference. This gain or loss must be reported on the basis of the date of the closing transaction

FINRA Rule 2111

FINRA Rule 2111 - FINRA Rule 2111, also known as the Suitability Rule, requires broker-dealers to make recommendations that are suitable for their customers' financial situation, investment objectives, and other factors The rule applies to recommendations involving securities transactions, investment strategies, and account types Broker-dealers must have a reasonable basis to believe that their recommendations are suitable based on the information provided by the customer When it comes to suitability, use the 100 Rule - Take 100 subtract age of investor. Use this amount towards equity securities and the other towards bonds Reasonable-Basis Suitability - It requires broker-dealers to have a reasonable basis for believing that a recommendation is suitable for at least some investors, based on the security's investment characteristics - Broker-dealers must conduct due diligence to ensure that the recommendation is suitable for at least some investors, and must disclose any material risks or limitations of the investment - You must recognize the potential risks and rewards associated with the recommended security or strategy. - If you can't explain the risks when recommending a security or strategy, you are violating the suitability rule. Customer-Specific Suitability - It requires broker-dealers to have a reasonable basis for believing that a recommendation is suitable for a particular customer, based on the customer's investment objectives, financial situation, and other factors - The recommendation would be based on that customer's investment profile. Quantitative Suitability - It requires broker-dealers to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive or unsuitable for the customer when taken together - Broker-dealers must consider factors such as the frequency and size of transactions, and the customer's investment objectives and financial situation when assessing quantitative suitability

Regulation of Variable Insurance Products

FINRA Rule 2320—Variable Contracts of an Insurance Company - deals with a member's responsibility in the sale of certain insurance company-based products. Specifically the concern is with deferred variable annuities - One key difference between the rules for funds and those for VAs is that FINRA Rule 2320 does not place a maximum sales charge on variable annuities. 36-Month Rule - One of the factors in determining if the exchange is suitable is taking into consideration whether the customer has had another deferred variable annuity exchange within the preceding 36 months. Investment Company Act of 1940 Rules for Variable Life Insurance Policy Loans - a variable life insurance contract allows the insured to borrow against the cash value that has accumulated in the contract. - The minimum percentage that must be made available is 75% after the policy has been in force for three years. - The insurer is never required to loan 100% of the cash value. Full cash value is obtained by surrendering the policy to the insurer. - If the insured dies with a loan outstanding, the death benefit is reduced by the amount of the loan. Variable Life Insurance Contract Exchange - During the early stage of ownership, you have the right to exchange a variable life insurance contract for a form of permanent insurance issued by the company with comparable benefits (usually whole life). - The length of time this exchange privilege is in effect varies from company to company, but under no circumstances may the period be less than 24 months (federal law). - No medical underwriting (evidence of insurability) is required for the exchange. - The new policy is issued as if everything were retroactive. That is, the age of the insured as of the original date is the age used for premium calculations for the new policy Sales Charges - The sales charges on a fixed-premium variable life contract may not exceed 9% of the payments to be made over the life of the contract. - The contract's life, for purposes of this charge, is a maximum of 20 years. Refund Provisions - The insurer must extend a free-look period to the policyowner for 45 days from the execution of the application, or for 10 days from the time the owner receives the policy, whichever is longer. - After a variable life policy has been in effect for two years, the surrender value of the policy is the cash value; there is no sales charge refund.

Reporting Disciplinary Incidents and Handling Customer Complaints

Form U4 - name, address, and any aliases used; - five-year residency history; - 10-year employment history (verify the past three years); and - disclosure of an charge or conviction for any felony or any securities-related misdemeanor - Any changes to this information require filing an amended form with the Central Registration Depository no later than 30 days after the member becomes aware of these changes. - It is not necessary to update Form U4 to note educational achievements or changes to marital status Customer Complaint Procedures - Customer complaint records shall be preserved for a period of at least four years. - a complaint is only a complaint if it is in writing When Complaints are Received - If the complaint is received by the registered representative, it must be immediately brought to the attention of the person designated in the member's written procedures manual. That could be the branch manager or perhaps someone in the firm's legal department - If a complaint about a registered representative is received by the broker-dealer, the most common procedure is to discuss it with the rep first before contacting the customer. Efforts are made to solve the complaint without taking it through FINRA's formal procedures. If that can't be done, mediation or arbitration is usually the next step.

Fundamentals of Common Stock

Fundamentals of Common Stock - Common stock represents ownership in a corporation and gives shareholders the right to vote on important corporate decisions, such as electing the board of directors or approving mergers and acquisitions - Common stockholders also have the right to receive dividends, although the payment of dividends is not guaranteed - Common stockholders are the last in line to receive payment in the event of a company's liquidation or bankruptcy Dividends - Dividends on common stock are paid at the discretion of the corporation's board of directors. - a corporation can pay a dividend even when there are no earnings. - However, no dividend on common stock can ever be paid before payment of the dividends due on preferred stock Classes of Common Stock: 1) Authorized - The corporate charter specifies the number of shares the company is authorized to issue. - It is a decision made by the founders of the business. 2) Issued - authorized stock that has been sold to investors. 3) Outstanding - any shares that a company has issued and are in the hands of investors. - issued stock - treasury stock = outstanding stock 4) Treasury - stock a corporation has issued and subsequently reacquired - No voting rights and the right to receive dividends. Characteristics of Common Stock - Limited Liability - Residual Claim to Assets = The common stockholder has the last claim (if there is anything left) - Transferability - Stock Split - forward stock split = increases the number of shares. - reverse split = investors own fewer shares worth more per share - the value of the investment does not change Voting Rights Statutory voting - Statutory voting allows a stockholder to cast one vote per share owned for each item on a ballot, Cumulative voting - Cumulative voting allows stockholders to allocate their total votes in any manner they choose. - Minority stockholders are more likely to be able to elect representatives to the board of directors through cumulative voting. - Ex. With 300 shares and three seats, the shareholder has 900 shares to be invested in any manner desired preemptive right - allows owner to purchase enough newly issued shares to maintain their proportionate ownership in the corporation.

U.S. Government Agency Securities

Government National Mortgage Association (GNMA or Ginnie Mae) - A government-owned corporation that guarantees mortgage-backed securities (MBS) that are backed by federally insured or guaranteed loans, such as FHA or VA loans. - taxable at all levels. - are quoted in 32nds like T-notes and bonds - Payments are monthly (will pay back both principal and interest monthly) - Eliminate credit risk (the U.S. government can't default) - interest is computed on a 30-day month/360-day year basis - Interest earned on GNMA, FHLMC, and FNMA certificates is taxable at the federal, state, and local levels Federal National Mortgage Association (FNMA or Fannie Mae) - a publicly held corporation that provides mortgage capital. FNMA purchases conventional and insured mortgages from agencies such as the FHA and the VA - Taxable at all levels - FNMA pass-through certificates are not guaranteed by the U.S. government. Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) - was created to promote the development of a nationwide secondary market in mortgages by buying residential mortgages from financial institutions and packaging them into MBS for sale to investors. - sells two types of securities: mortgage participation certificates (PCs) and guaranteed mortgage certificates (GMCs). PCs make principal and interest payments once a month; GMCs make interest payments twice a year and principal payments once a year. Student Loan Marketing Association (SLMA or Sallie Mae) - A government-sponsored enterprise that provides funding for student loans by purchasing and securitizing student loans from banks and other lenders. Farm Credit System (FCS) - A network of lending institutions that provide credit to farmers, ranchers, and other agricultural borrowers. FCS securities are issued through the Federal Farm Credit Banks Funding Corporation. prepayment risk - the risk that the underlying mortgages will be paid off earlier than anticipated. - This will occur if interest rates fall, causing homeowners to refinance their mortgages at lower rates. extended maturity risk - the risk that the underlying mortgages will remain outstanding longer than anticipated. - This will occur if interest rates rise, virtually eliminating any refinancings. This is also called extension risk. Pass Through Security - pass-through refers to the mechanism of passing homebuyers' interest and principal payments from the mortgage holder to the investors. Taxation of Treasury Securities Interest Income - The interest earned on any security issued by the U.S. Treasury is taxable on the federal level. - The interest on any security issued by the U.S. Treasury is exempt from state and local taxation. Taxation of Agency Securities Interest Income - The one constant about taxation of agency securities is that the interest is always subject to federal income tax. - Interest earned on GNMA, FHLMC, and FNMA certificates is taxable at the federal, state, and local levels - Interest paid on Farm Credit System and Federal Home Loan Banks securities is taxable at the federal level and is exempt from state and local taxation in most states. The interest income from most U.S. government and agency securities is exempt from state and local—but not federal—taxes. Mortgage-backed securities (such as FNMA and GNMA obligations) are subject to federal, state, and local taxes. The interest on municipal issues (like the Minneapolis Housing Authority bonds) is exempt from federal taxes and, because this investor is a Minnesota resident, state taxes as well.

Hedge Funds

Hedge Funds - are private investment partnerships that use a range of strategies, such as leverage, derivatives, and short selling, to generate returns for their investors. - Hedge fund structures are a form of fund generally organized as a limited partnership with no more than 100 investors. That keeps the fund from having to register with the SEC. - Most hedge funds are organized as limited partnerships with the portfolio managers investing, along with the investors. - Almost all hedge funds charge performance-based fees. The typical fee structure is known by the vernacular 2 & 20—most funds take a 2% management fee and 20% of any profits. - the initial investment minimums are typically well over $100,000. - Lock Up Provision = The period when the investor cannot withdraw investment dollars - Hedge funds are typically sold only to accredited investors, who are individuals or entities that meet certain net worth or income requirements. This is because hedge funds are considered to be high-risk investments that are not suitable for all investors. - Hedge funds use a variety of investment strategies, including long-short equity, global macro, event-driven, and quantitative strategies, among others. - Hedge funds are often structured as private placements, which means that they are not required to offer the same level of liquidity as publicly traded securities. Investors may not be able to withdraw their money from the fund at will. - Hedge funds are considered to be high-risk investments, and investors may face a variety of risks, including market risk, credit risk, and liquidity risk, among others - Which of the following characteristics do hedge funds share with mutual funds? --> A pooled investment with other investors Funds of Hedge Funds - are registered mutual funds available to all investors that invest primarily in unregistered hedge funds Blank-Check or Blind-Pool Hedge Fund - are companies without business operations that raise money through IPOs in order to have their shares publicly traded for the sole purpose of seeking out a business or combination of businesses. - When a business is located, they will present proposals to holders of their shares for approval.

Nonequity Options

Index Options - Options on indexes allow investors to profit from the movements of markets or market segments and hedge against these market swings 1) Broad-based indexes - reflect movement of the entire market and include the S&P 100 (OEX), S&P 500, (SPX) and the Major Market Index (MMI) that mimics the Dow Jones 30 Industrial Average. 2) Narrow-based indexes - track the movement of market segments in a specific industry, such as technology or pharmaceuticals. The Volatility Market Index (VIX) - This index is a measure of the implied volatility of the S&P 500 Index options traded on the CBOE. - VIX options, also traded on the CBOE, are designed to reflect investor expectations of market volatility over the next 30 days. - It is often referred to as the fear gauge or index - is considered to be the most accurate indicator of anticipated market volatility. - High readings are not bullish, nor are they bearish, but instead are a measure of the expectation (fear) that the market will be volatile - The VIX rises when put option buying increases and falls when more calls than puts are being bought. Put buying is bearish, so when the "bears" are more active, market participants get scared. On the other hand, call buying is bullish, so when the "bulls" are in command, anxiety levels decrease. TEST TOPIC ALERT - With regard to settlement, there are two major differences between index options and equity options. The exercise of an index option settles the next business day, whereas the exercise of an equity option settles the regular way (two business days). With regard to trading (i.e., buying or selling), settlement is the next business day for both. The other difference is that index options settle in cash rather than physical delivery. Interest Rate (Yield-Based) Options - Interest rate options are yield-based (i.e., they have a direct relationship to movements in interest rates). These options are based on yields of T-bills, T-notes, and T-bonds. A yieldbased option with a strike price of 35 reflects a yield of 3.5%. Assume an investor believes that rates on T-notes—currently at 3.5%—will rise in the near term. The investor could purchase a call option with a 35 strike price (at the money). If rates rise to 4.5%, the investor could exercise and receive cash equal to the intrinsic value of the option. Foreign Currency Options (FCOs) - Currency options allow investors to speculate on the performance of currencies other than the U.S. dollar or to protect against fluctuating currency exchange rates against the U.S. dollar. - Currency options are available for trading on U.S.-listed exchanges on the Australian dollar British pound, Canadian dollar, Swiss francs, Japanese yen, and Euro. Importers and exporters frequently use currency options to hedge currency risk. - TEST TOPIC ALERT You should know that the only FCO with a contract size other than 10,000 units is the Japanese yen.

Taxation of Corporate Debt

Interest - the interest paid by corporations on their debt securities is treated as ordinary income. Unlike dividends on stock, there is no category of "qualified" interest with a reduced tax rate. - In addition to federal income tax, this interest is taxable on a state and local level as well. - Although zeroes pay no regular interest income, investors in zeroes owe income tax each year on the amount by which the bonds have accreted, just as if the investor had received it in cash. Accretion - If a new issue municipal bond is bought at a discount in the primary market, the discount must be accreted - Each year, the annual accretion is taxable to the holder. - In addition, the customer may adjust the cost basis of the zero upward by the amount of the annual accretion. - Ex. An investor purchases a zero coupon bond at a price of 64. The bond matures in nine years. Five years later, the investor sells the bond at a price of 80. This would result in This question deals with accretion of the discount. The discount here is $360 (the difference between the $640 paid and the $1,000 maturity value). With nine years until maturity, the annual accretion is $360 divided by nine, or $40 per year. After five years, the bond's basis has increased by $200 ($40 times 5 years) to $840. The sale at $800 represents a long-term loss of $40. Amortization - Ex. Paying a premium of $10 per bond, Tracey bought 10 municipal bonds with 20 years to maturity. Ten years later, she sold the bonds for 103. For tax purposes, she has The cost per bond is $1,010. The amortization amount each year is 10/20 years, which equals $0.50 per year. $0.50 per year × 10 years = $5 per bond. After 10 years, the adjusted cost basis is $1,005 per bond. She sells the bonds for $1,030 per bond. $1,030 − $1,005 = $25 per bond 25 × 10 = $250 gain Capital Gains and Capital Losses - when a bond is sold for a price higher than its cost, there is a capital gain. - When sold below cost, there is a capital loss. - If the holding period is 12 months or less, any gain or loss is short-term. If the holding period is longer than 12 months, it is longterm

Municipal Bond Tax Calculations

Interest Payments - the interest on a municipal security is exempt from federal income tax. - if the investor resides in the issuer's state, it is generally free of state income tax as well. tax-equivalent yield = municipal bond coupon divided by (100% - investor's tax bracket). - Ex. Therefore, if the coupon rate (nominal yield) of the municipal bond is 4.2% and the investor is in the 40% tax bracket, you would divide 4.2% by (100% - 40%) or 4.2% by 60% and arrive at a tax-equivalent yield of 7%. That is, to receive the same after-tax benefit, this investor would have to purchase a taxable bond (corporate or government) with a coupon of 7%. For exam purposes, you never recommend municipal bonds to investors unless they are in the higher tax brackets. Any question dealing with a low tax bracket client will never have a municipal bond as a suitable recommendation. AMT Bonds - Under the Tax Reform Act of 1986, the interest on these nonpublic purpose bonds (or private purpose bonds) may be taxable because the act reserves tax exemption for public purposes. - Because these bonds are used for a nonpublic purpose, the interest income may be subject to the alternative minimum tax (AMT). Taxable Municipal Bonds - There are municipal bonds where the interest is not tax-exempt. The most notable case is the Build America Bonds (BABs). BAB - BABs were created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing costs to issuing municipalities and stimulating the economy - There are two types of BABs issued: tax credit BABs and direct payment BABs. 1) Tax Credit BABs = These types of BABs provide the bondholder with a federal income tax credit equal to 35% of the interest paid on the bond in each tax year. 2) Direct Payment = BABs Direct payment BABs provide no credit to the bondholder but instead provide the municipal issuer with payments from the U.S. Treasury equal to 35% of the interest paid by the issuer.

Valuing Options

Intrinsic value - is the same as the amount a contract is in the money. - A call has intrinsic value when the market price of the stock is above the strike price of the call. - Options never have negative intrinsic value; intrinsic value is always a positive amount or zero At the Money - A call or a put is at the money when the market price of the underlying asset equals the strike price of the option. - EXAMPLE An ABC 50 call is at the money when the price of ABC stock is 50. Out of the Money - A call option is out of the money when the market price of the underlying asset is less than the strike price of the option. - A buyer will not exercise calls that are out of the money at expiration. Out of the money contracts are advantageous to sellers. - The options expire and sellers keep the premium without obligations to perform. - EXAMPLE An ABC 50 call is out of the money by 4 points when the price of ABC stock is 46 Time Value - The second component in valuing an option is its time value. - Quite simply, time value is a function of the time remaining before the option expires. - On the expiration date, the time value is zero—there isn't any more time left. - An option expiring in nine months has more time value than one expiring in six months - How do you compute time value? That will likely be a question on your exam. An option has time value anytime the option's premium exceeds its intrinsic value. PIT. Premium minus intrinsic value equals time value Trading at Parity - An option is trading at parity when the premium equals the intrinsic value of the contract (e.g., a May 35 call is at parity when the market price is 40 and the premium is 5.

Quotations

Introduction - In many cases, before customers place an order, they want to know the approximate price they will be paying or receiving. - The information is relayed to the client by furnishing a quotation or quote. Bids, Offers, and Quotes - Quotations are available for both listed and unlisted securities. In the case of stocks traded on the NYSE, the quotes come from the DMM. These are available electronically, even to retail investors. In the case of the OTC market, the quotations originate with the market makers. - The current bid is the highest price at which the market maker will pay to buy, and the current offer is the lowest price at which the market maker will accept to sell - When a customer of a FINRA member firm enters an order to buy a stock, the firm has two ways of acting. If the firm acts as a principal (the dealer part of broker-dealer), it buys the stock from the market maker at the asking or offering price. Then, following the FINRA 5% policy (covered in Lesson 13.5), it adds a markup to its cost. Alternatively, it can act as an agent (the broker part of broker-dealer), and charge the customer the same price it paid plus a commission. - If the customer enters a sell order, things work in reverse. The firm, acting as a principal, buys from the customer and sells to the market maker at the bid price. The price paid to the customer by the member firm is less than what it receives from the market maker. That difference is the markdown. The broker-dealer can also act in an agency capacity by crediting the customer with the market maker's bid price, less a commission. TEST TOPIC ALERT - A broker-dealer can never charge a markup (or markdown) and a commission on the same trade. One or the other, but never both. Types of Quotes Firm Quote - A firm quotation is the price at which a market maker stands ready to buy or sell at least one trading unit—100 shares of stock or five bonds—at the quoted price with other member firms. - Examples would be, "it is 40 -41," or "we are quoting 40 - 41." - EXAMPLE A market maker in ABCD common stock is quoting 52.15 - 52-27, 4 × 6 That means the bid is $52.15 and the ask is $52.27. At those prices, the dealer is willing to buy as many as 400 shares and sell as many as 600 shares. If a member calls to sell 100 on behalf of its customer, the market maker will buy 100 at 52.15 and revise the quote to 52.15 - 52.27, 3 × 6 to reflect the fact that it has already purchased 100 shares. Backing Away - A market maker can revise a firm quote in response to market conditions and trading activity, but a market maker who refuses to do business at the price(s) quoted is backing away from the quote. - Backing away is a violation of trading rules. If you see this on the exam, remember, it is a bad thing to back away from a firm quote. Subject Quote - One could think of a subject quote as being the opposite of a firm quote. - Whereas the firm quote represents the prices the dealer will honor, a subject quote requires further confirmation - when a customer calls her registered representative and asks, "How is ABCD doing today?" The representative could respond, "Last time I looked, it was 38 to a half," or "I think it is about 38-38.50." The statement is clear that the prices might have changed workout quote - is an approximate figure used to provide the buyer or the seller with an indication of price, not a firm quote. - is usually reserved for situations where a market maker knows that special handling will be required to accommodate a particular trade nominal quote - is someone's assessment of where a security might trade in an active market. - Nominal quotes may be used to give customers an idea of the market value of an inactively traded security, but they are not firm quotes. - Nominal quotes in print must be clearly labeled as such. - These are common with municipal bonds (see Lesson 6.1) because the market for so many of them is very thin. TEST TOPIC ALERT A phrase worth remembering is, "The more active a security, the narrower the spread." The reverse would be true as well. Interpositioning - is a term used in the financial industry to describe a practice where a broker places themselves in between the client and the actual market for a security. - This can result in the client paying a higher price for the security than they would have if the broker had simply executed the trade directly on the market. - Interpositioning is generally considered unethical and can be illegal under certain circumstances.

Definitions Under the Investment Company Act of 1940

Investment Company - a corporation or a trust through which investors may acquire an interest in large, diversified portfolios of securities by pooling their funds with other investors' funds and buying shares or units of the fund. - People often invest in investment companies because they believe a professional money manager should be able to outperform the average investor in the market. Face-Amount Certificate (FAC) Companies - a contract between an investor and an issuer in which the issuer guarantees payment of a stated (or fixed) sum to the investor at some set date in the future. Unit Investment Trusts (UITs) - an unmanaged investment company organized under a trust indenture. - UITs do not: have boards of directors, employ an investment adviser, and actively manage their own portfolios (trade securities). - issues only redeemable securities, known as units or shares of beneficial interest, each of which represents an undivided interest in a portfolio of specified securities - UITs are sold by prospectus - If it is a bond portfolio → trust will remain in effect until the last bonds mature or are called - If it is a stock portfolio → Specified termination date Management Companies - which actively manages a securities portfolio to achieve a stated investment objective. - A management investment company is either closed-end or open-end Open-end and closed-end investment companies have far more similarities than differences. One of these is the term, net asset value per share, generally shown as NAV. This value is the result of the fund valuing all of its assets (the largest of which is the portfolio), subtracting its liabilities, and then dividing that by the number of shares outstanding. Diversified Management Company - The 75% must be invested in such a way that - no more than 5% of the fund's total assets are invested in the securities of any one issuer and - no more than 10% of the outstanding voting securities of any one issuer is owned (by the 75%). - There are no restrictions of the remaining 25% → this is totally unrestricted

Investment Objectives vs. Investment Constraints

Investment Goals - A goal is where you want to be (the "end game") - Some commonly specified goals include: planning for college education; retirement; saving for a future purchase, such as a home; philanthropy; capital to start a business; and leaving a legacy Investment Objectives - Investment objectives refer to the financial goals an investor wants to achieve through their investments - Common investment objectives include capital preservation (stability), income generation, and capital appreciation Investment Constraints - Investment constraints refer to factors that can limit an investor's investment choices or strategies - Common investment constraints include liquidity needs, tax considerations, legal or regulatory restrictions, and Unique circumstances and/or preferences

HANDLING CUSTOMER ACCOUNTS INCLUDING RECORD RETENTION REQUIREMENTS

Lifetime Records - Stock Certificate Book - Partnership Agreement or Articles of Incorporation - Minutes of Board or Partnership Meetings Six-Year Records - Blotters - Ledgers - Customer Account Records - Designated Principals 4 Year Record - Customer Complaints Three-Year Records - Forms U4 & U5 - Fingerprint Cards - Order Ticket - Confirmation of Trades Death of an Account Holder - once a firm becomes aware of the death of the account owner, the firm must cancel all open orders, mark the account deceased, and freeze the assets in the account until receiving instructions and the necessary documentation from the executor of the decedent's estate. - Depending on the type of account, the documents necessary to release the assets of a decedent are: a certified copy of the death certificate, inheritance tax waivers, and letters testamentary If one party in a joint tenants with rights of survivorship (JTWROS) account dies, the account cannot be transferred to the name of the new owner (the other party) until a certified copy of the death certificate is presented to the member firm. Holding Customers' Mail - Statements and confirmations may be sent to someone who holds power of attorney for the customer if the customer requests it in writing and if duplicate confirms are also sent to the customer. - One of your clients has asked for the requirements for having duplicate confirmations and statements for his account be sent to his CPA. To accomplish this, the client must complete and sign the duplicate statement/confirm request form - the member firm receives written instructions that include the time period the request is being made for up to three months (requests may be granted for periods longer than three months for an acceptable reason such as safety or security concerns but not merely for the sake of convenience) - While holding mail is a courtesy that firms may extend to customers, the rule does not require them to. Approval and Documentation of Changes in Account Name or Designation - No change in such account name(s) (including related accounts) or designation(s) shall be made unless the change has been authorized by a registered principal." Anti-Money Laundering (AML) Compliance - The firm's anti-money laundering (AML) program must be approved in writing by a member of senior management. If the approving senior manager leaves the member firm, the AML program should be reapproved by the new manager. - the rules would require member firms to: provide ongoing training for appropriate personnel, designate to FINRA an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program Currency Transaction Report (CTR) - requires broker-dealers to report on FinCEN Form 112 any currency deposited or received in excess of $10,000 on a single day. - This requirement applies to cash transactions used to pay off loans, the electronic transfer of funds, or the purchase of certificates of deposit, stocks, bonds, mutual funds, or other investments. - The act also requires the reporting of wire transfers of $3,000 or more. - The record retention requirements for Form 112 are five years - Form 112 must be E-filed within 15 days of receipt of the currency

MSRB Rules

MSRB - Rules and regulations applicable to all firms and individuals having to do with municipal securities are written by the Municipal Securities Rulemaking Board (MSRB) - governs the issuance and trading of municipal securities - The rules are enforced by other regulatory bodies depending on who the bond dealer making the trade is. If it was completed by a community bank, the FDIC is the enforcement body. If it is done by a member bank of the Federal Reserve, the regulator is the Federal Reserve Board (FRB). If the trade is made through a FINRA member firm, then FINRA is the enforcer. The SEC has regulatory authority over the MSRB and all other self-regulatory organizations (SROs) not the IRS. - does not regulate issuers. Rule Enforcement - The MSRB has no authority to enforce the rules it makes - the MSRB rules concerning broker-dealers (e.g., FINRA member firms) are specifically enforced by FINRA with SEC oversight. Recordkeeping for Municipal Securities Firms Records kept for the lifetime of the firm - Articles of incorporation - Minutes of board or partnership meetings - Records of stock certificates Records kept for six years - Blotters - ledgers - Customer account records (six years after the account is closed) - Customer complaints (only written complaints are considered and email is written) Records kept for four years - (all those not specifically designated as lifetime or six-year records) - Advertisements (A municipal securities principal or general securities principal of the dealer must approve all advertising before use) MSRB Rule G-15 - We know that calling a premium bond invariably results in a lower yield to the investor than holding the bond to maturity. Therefore, this rule states that in computing yield and dollar price, - the lower of yield to call or yield to maturity when a transaction in a debt security is done on a yield or dollar basis EXAMPLE A customer buys a 20-year, 7% bond on a 7.35 basis. The bond is callable in six years at 103, in eight years at 102, in 10 years at 101, and at par beginning in the 12th year. The customer's confirmation will show yield to - The confirmation of a bond trade must disclose the lower of yield to call or yield to maturity. This bond is being bought at a discount because the basis is higher than the coupon. Because the yield to maturity on a discount bond is lower than the yield to call, this is the yield that will be shown on the confirmation. - the yield or dollar price computed and shown shall be computed to the lower of call or nominal maturity date; and - for purposes of computing yield to call or dollar price to call, only those "in whole calls" are included. municipal financial professional (MFP) - The MSRB defines an associated person of a broker-dealer who is primarily engaged in municipal securities activities other than retail sales to individuals A municipal securities firm that has a control relationship with respect to a municipal security is subject to additional disclosure requirements Rule G-37 Political Contributions - prohibits municipal firms from engaging in municipal securities business with an issuer for two years after any political contribution is made to an official of that issuer. - De minimis contributions of up to $250 per election are permitted by MFPs Conflicts of Interest - Potential conflicts of interest arise if a firm acts as both a member of the underwriting syndicate and financial advisor for the same issue. - if a broker-dealer is acting as a financial advisor to the issuer, generally, the broker-dealer may not participate in underwriting the bonds of the issuing municipality.

Extension of Credit in the Securities Industry

Margin accounts: The most common form of credit extension in the securities industry is through margin accounts. A margin account is a type of brokerage account that allows investors to borrow money from their broker to buy securities. The amount that can be borrowed is typically based on the value of the securities in the account. Regulation T: The Federal Reserve Board's Regulation T governs margin requirements for securities transactions. Regulation T requires that investors put up at least 50% of the purchase price of securities in cash or securities. This means that they can borrow up to 50% of the purchase price from their broker. Margin calls: If the value of securities in a margin account drops below a certain level, the broker may issue a margin call, which requires the investor to deposit more money into the account or sell some of the securities to bring the account back into compliance with the margin requirements. Long Margin Account = LMV - DR = EQ - The buying power of SMA is 2:1 EXAMPLE The SMA of $20,000, when used as the margin requirement, allows the customer to purchase $40,000 of stock Short Margin Account = CR - SMV = EQ - The credit balance (CR) is the stock sales proceeds plus the equity deposited (SMV + EQ) - For every $1 decrease in market value in a short account, $1.50 of SMA is created Long Maintenance Call - Min maintenance = 25% of LMV - Debit Balance / 0.75 EXAMPLE A customer has a long margin account with a market value of $12,000 and a debit balance of $10,000. The customer would receive a maintenance call for - The equity in the account is $2,000, which is approximately 16% of the market value, ($2,000 divided by $12,000). To bring the account back to the minimum, which is $3,000 (25% × $12,000), the customer will receive a maintenance call for $1,000. After meeting the call, the account will look like this: LMV $12,000; DR $9,000; EQ $3,000. Short Maintenance Call - Min Maintenance = 30% - CR / 1.30 Excess equity (EE) - in a margin account is the amount of equity exceeding the Regulation T requirement. - EE creates SMA, or buying power, in the account. Combined Account LMV + CR - DR - SMV = EQ TAKE NOTE Shorting stock that is below $5 per share requires an initial deposit of $2,000 or $2.50 per share, whichever is greater Hypothecation Agreement - gives permission to the broker-dealer to pledge customer margin securities as collateral - All customer securities must be held in street name (registered in the name of the firm) to facilitate this process. When customer securities are held in street name, the broker-dealer is known as the nominal, or named, owner. The customer is the beneficial owner, because he retains all rights of ownership. Credit Agreement - The credit agreement discloses the terms of the credit extended by the broker-dealer, including the method of interest computation and situations under which interest rates may change. Loan Consent Form - If signed, the loan consent form gives permission to the firm to lend out customer margin securities to other customers or broker-dealers, usually for short sales. - Only the credit and hypothecation agreement must be signed. The loan consent agreement is optional and there is no signature on the margin disclosure statement. - Broker-dealers are limited to pledging 140% of a customer's debit balance as collateral. Any customer securities in excess of this amount must be physically segregated. The firm cannot commingle customer securities with securities owned by the firm May be purchased on margin and used as collateral: ■ Exchange-listed stocks, bonds ■ Nasdaq stocks ■ Non-Nasdaq OTC issues approved by the Federal Reserve Board ■ Warrants Cannot be purchased on margin and cannot be used as collateral: ■ Put and call options ■ Rights ■ Non-Nasdaq OTC issues not approved by the Federal Reserve Board ■ Insurance contracts Cannot be bought on margin but can be used as collateral after 30 days: ■ Mutual funds ■ New issues Risk Disclosure - Before or at the time of opening a margin account, a member firm must provide customers with a margin disclosure statement. This information must also be provided to margin customers on an annual basis. The document discusses the risks associated with margin trading Dividends - Cash dividends and interest are considered nonrequired deposits to a margin account and are credited in full to SMA - When an investor sells stock short on the ex-dividend date, the dividend belongs to: The key here is that the sale is taking place on the ex-dividend date. That means that the buyer is not entitled to the dividend. Rather, it belongs to the seller. However, in this question, the seller does not own the stock because this is a short sale. Who is the owner of the stock? Whose name will be on the records? That would be the lender of the stock, and that is who will receive the dividend Deadlines for Meeting Margin Calls - As previously discussed, Regulation T requires margin account customers to meet initial margin deposit requirements no more than two business days after the settlement date. The deposit may be made in cash or in fully paid marginable securities valued at twice (200%) the amount of the Regulation T cash call. Freeriding - Freeriding is a term used when securities are purchased and then sold without making payment for the purchase on settlement date. - Freeriding is generally prohibited in both cash and margin accounts. - As a penalty, the account will be frozen for 90 days and no new transactions can occur unless there is cash or marginable securities in the account before the purchase is made if the customer's first purchase in a margin account is less than $2,000, deposit 100% of the purchase price. If the first purchase is between $2,000 and $4,000, deposit $2,000. If the first purchase is greater than $4,000, deposit 50%. Marking to the Market - The practice of recalculation to check the status of the equity in the account - It is typically done every business day on the basis of the closing price of the stock. - This concept applies to both long and short margin accounts, which will be discussed separately. Restricted Account Rules If an account is restricted, the following rules apply. - To purchase additional securities, put up 50%. - To withdraw securities from the account, the customer must deposit cash equal to 50% of the value of the securities to be withdrawn. Retention Requirement - If securities are sold in a restricted account, at least half the proceeds must be retained in the account to reduce the debit balance. This is called the retention requirement. Also, 50% of the proceeds are credited to SMA. House Minimum - A firm can impose a maintenance level higher than the FINRA minimum maintenance rule levels. This is a house minimum. Many firms today impose 30%-35% minimum maintenance requirements. Options and Margin - options are not marginable securities. When buying options, customers must deposit 100% of the premium. When buying a stock on margin and then writing a covered call, there is no Regulation T requirement for the call option. All the customer must do is have 50% of the purchase price of the stock in the account EXAMPLE - If a customer buys stock and receives a premium by writing a call, the premium received for the call reduces the margin deposit that would be required. Question: A customer purchases 100 ABC at 62 and simultaneously writes an ABC 65 call at 3 in her margin account. What is the margin deposit? Answer: The Regulation T requirement for establishing the long stock position is $3,100 (50% × $6,200). The margin deposit is $2,800, which is the Regulation T requirement reduced by the premium received. Because options trades settle T+1, the $300 from the sale will be in the account ahead of the settlement date (T+2) for the stock purchase. With $300 already in the account, the investor need only deposit $2,800 to meet the Regulation T requirement of $3,100.

Municipal Bond Marketability

Marketability Factors - the higher the rating, the more marketable the bond - the shorter the time until maturity, the more marketable the bond. - the higher the coupon, the more marketable the bond. - Trades in smaller amounts are not as marketable. - noncallable bonds are the most marketable. - bonds with a lower dollar price are more marketable Refunding - When interest rates fall, the municipality issues a new bond (at lower rates). Then they use the proceeds from the new bond to pay off the old, higher interest debt. - There are two types of refunding 1) Advance Refunding (Prerefunding) = This is refinancing an existing municipal bond issue before its maturity or call date by using money from the sale of a new bond issue 2) Current Refunding = This differs from advance refunding in that the old bonds will be redeemed within 90 days or less from the date of issuance of the refunding bonds. Municipal Bond Insurance - Municipal bond issuers can insure their securities' principal and interest payments by buying insurance from a number of insurers. - This will generally improve the marketability of the bond. - Among those specializing in insuring municipal issues are National Public Finance Guarantee Corp. (formerly the Municipal Bond Investors Assurance Corporation—MBIA), Financial Guaranty Insurance Company, Assured Guaranty Corporation, and AMBAC Indemnity Corporation - Both interest and principal will be paid as scheduled, over time through the life of the bond. It is not paid out as a lump sum. An investor won't even notice the difference because the interest checks will come the same way they always did. Broker's Broker - There are certain firms in the municipal securities business that do not position trade (keep an inventory of) bonds. - Rather, they exist to assist other firms find buyers or sellers of municipal bonds. They perform this duty in both primary and secondary market transactions. - They will also represent institutions, but never have any dealings with public customers. - A major reason these firms exist is because the market for most municipal bonds is quite thin. That means not a lot of trading going on. - a municipal broker's broker deals with other dealers and institutions, not with the general public.

The Money Market

Money Market Securities - Money market securities are short-term debt securities issued by corporations, municipalities, and the federal government - Money market securities typically have a maturity of less than one year and are considered to be low-risk investments - most (but not all) money market instruments share is that they are issued at a discount - Common types of money market securities include Treasury bills, commercial paper, certificates of deposit (CDs), and repurchase agreements (repos) - They are offered without a sales load or charge. - The principal objective of the fund is to maintain a stable NAV ($1 per share). - The yield of the money market fund will change, but the price is fixed at $1 per share. - Beta is a measure of volatility; money market funds have low betas. Treasury Bills (T-bills) - Treasury bills are short-term debt securities issued by the U.S. Treasury T-bills have a maturity of one year or less and are sold at a discount to their face value T-bills are considered to be one of the safest investments in the world, as they are backed by the full faith and credit of the U.S. government T-bills are issued in denominations of $1,000 or more and are highly liquid Negotiable CD - the minimum size is $100,000. The most common size is $1 million, and they can be more than that. - These CDs are unsecured time deposits (no asset of the bank is pledged as collateral), and the money is being loaned to the bank for a specified period - CDs are the only money market instrument issued at face value (not a discount) and that pays periodic interest, usually semiannually - Jumbo CDs are insured (up to the FDIC limit of $250,000), but they are not secured by any bank asset. Commercial Paper - Commercial paper is a short-term unsecured debt security issued by corporations to raise capital - Commercial paper typically has a maturity of less than 270 days and is sold at a discount to its face value - Commercial paper is considered to be a low-risk investment, as it is issued by highly rated corporations with strong creditworthiness - Commercial paper is often used to fund short-term working capital needs, such as payroll or inventory financing - These are always issued at a discount from the face value. - The minimum denomination is usually $100,000, making them unsuitable for small investors. Certificates of Deposit (CDs) - Certificates of deposit are short-term debt securities issued by banks and other financial institutions CDs typically have a maturity of less than one year and offer a fixed rate of interest CDs are considered to be a low-risk investment, as they are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank CDs may have penalties for early withdrawal and are generally less liquid than other money market securities Broker's Acceptance (BA) - The payment date of a BA is normally between one and 180 days and never more than 270 days. - Certain corporations in the import-export business will often use bankers' acceptances (BAs) as a short-term time draft with a specified payment date drawn on a bank Repurchase Agreements (Repos) - Repurchase agreements, or repos, are short-term loans between a dealer or bank and an investor - In a repo, the investor buys a security (usually a Treasury security) from the dealer or bank and agrees to sell it back at a higher price at a later date - Repos are typically overnight transactions, but can also be longer-term - Repos are considered to be low-risk investments, as they are collateralized by the underlying security and are often used for short-term cash management by institutional investors

MUNICIPAL BOND DOCUMENTATION

Official Statement - The full and fair disclosure document for municipal securities is called the official statement (OS) (there is no prospectus). There is no preliminary prospectus either for municipal securities, but there is a preliminary official statement. Just as with the red herring for an equity issue, underwriters use a preliminary OS to determine investors' and dealers' interest in the issue. - the OS identifies the issue's purpose, the source from which the interest and principal will be repaid, and the issuer's and community's financial and economic backgrounds. The OS also has information relating to the issue's creditworthiness. - MSRB rules require that a copy of the OS must accompany or precede the delivery of the bonds. Official Notice of Sale - The official notice of sale to solicit bids for the bonds is usually published in The Bond Buyer and local newspapers - How do the potential underwriters know about the new issue? Through an official notice of sale.

Comparing Open-end and Closed-end Management Investment Companies

Open-Ended Funds (Mutual Funds) - issue and redeem shares on demand at their net asset value (NAV) - Open-end funds are priced at the end of each trading day based on their NAV, which is calculated by dividing the total value of the fund's assets by the number of shares outstanding - Open-end funds are generally more liquid because investors can redeem their shares on demand - Open-end funds may have higher fees than closed-end funds because of the ongoing expenses associated with managing and administering the fund. - Open-end funds may charge sales loads, which are fees paid to brokers or other intermediaries for selling the fund's shares. - SEC rules require that open-end management companies distribute dividends to their investors from the firm's net investment income. - Most funds provide a combination privilege, allowing investors to aggregate purchases made in different funds in the same family to qualify for a breakpoint. The income yield of a mutual fund includes dividends only. A group of friends is not eligible for a breakpoint - The Investment Company Act of 1940 requires that mutual funds provide their shareholders with reports twice per year (biannually). - The Investment Company Act of 1940 prohibits mutual funds from engaging in short selling. - In most cases (all on the exam), a mutual fund will allow investors to get a breakpoint discount by combining their fund purchases with those of their spouse and minor children. They are also able to credit mutual fund transactions in retirement accounts, educational savings accounts, or even in accounts at other brokerage firms. Two unrelated adults may not combine transactions to receive a breakpoint. - are priced at their NAV at the end of each trading day. - Price determination for purchases and sales is based upon the forward pricing principle. That is, whenever an order, whether to purchase or redeem shares, is received, the price is based upon the next computed NAV per share. For example, any order received (and time stamped) before 4:00 pm ET will be executed at the price computed as of that day's market close. If the order is received at 4:00 pm (or later), it will be executed based upon the NAV computed as of 4:00 pm the next business day. - The NAV per share will rise or fall relative to the value of the underlying portfolio. If dividends are distributed to shareholders, the fund's assets decrease, and their per-share value will decline accordingly. Appreciation of the portfolio and dividends received will increase the value. Redemption of shares will have no impact on the NAV per share, as the money paid out is offset by a reduced number of shares outstanding. Closed-End Funds - issue a fixed number of shares that are traded on an exchange like stocks. - Closed-end funds are priced based on supply and demand, and can trade at a premium or discount to their NAV. - are less liquid because they trade on an exchange and may not have a ready market. - may trade at a premium or discount to their NAV based on market demand - trade in the secondary markets just like any common stock. Therefore, there is generally a commission charged when purchasing and when selling. Also trade in primary market Business Development Company (BDC) - The purpose was to create a new vehicle to aid in the promotion and development of small businesses. - A business development company (BDC) is a closed-end investment company regulated under the Investment Company Act of 1940.

Opening Special Accounts

Option Accounts - There is a special options account agreement. It describes the risks of options trading and the rules the customer must follow. - This agreement must be signed and returned to the member within 15 days after the account has been approved - The steps in opening an options account occur in the following order: obtain essential facts about the customer, give the customer an options disclosure document (ODD), have the manager approve the account, enter the initial order, and have the customer sign and return the options agreement within 15 days. Margin Accounts 1) credit agreement (mandatory) - discloses the terms of the credit extended by the broker-dealer. These include the method of interest computation and situations under which interest rates may change. 2) hypothecation agreement (mandatory) - gives the broker-dealer a lien on the customer's margin securities 3) loan consent (optional). - gives permission to the firm to loan customer margin securities to other customers or broker-dealers Risk Disclosure - Before opening a margin account, a broker-dealer must provide customers with a risk disclosure document. - This information must also be provided to margin customers on an annual basis. - The document discusses the risks associated with margin trading Discretionary Accounts - the customer has authorized the broker-dealer or registered representative to make the investment decisions in the account. - Must sign a Trading Authorization Form - Action, Asset, Amount → If a RR chooses any of these three, it is a discretionary trade - There is an exception to the requirement that applies to the exercise of time or price discretion. This is discretion orally granted by the customer to purchase or sell a specific amount of a particular security (e.g., "Buy 100 shares of ABCD and get the best price you can"). - Registered representatives may choose the price or timing of an order without having discretionary authority. - No documentation is required for an individual to open an UGMA or UTMA account. Documentation for Corporate Accounts - The charter is proof that the corporation does exist, and the resolution authorizes both the opening of the account and the officers designated to enter orders. Documentation for Partnership Accounts - partnership must complete a partnership agreement stating which of the partners can make transactions for the account - An amended partnership agreement must be obtained each year if changes have been made. Sole Proprietorship - This is the simplest form of business organization and is opened like an individual account

The Order Ticket

Order Memorandum (Ticket) - After the representative prepares the order ticket, it is sent to the wire room or trading desk, where the order is routed to the proper market for execution - A registered principal must approve the order promptly after execution. FINRA's interpretation of the term promptly after execution is no later than the end of the trading day. - The information required on the order ticket includes: customer account number; registered representative identification number; whether the order is solicited or unsolicited; description of the security (symbol); number of shares or bonds to be traded; action (buy, sell long, or sell short); options (buy, write, covered, uncovered, opening, or closing); order restrictions and price qualifications (e.g., market, GTC, or day order); type of account (cash or margin); and the time the order was received, the time of entry, and the price at which it was executed. - Two items that would not be on an order ticket are the current market price of the security and the client's name or address. - If a mistake is made (e.g., a wrong account number), no change to the order can be made without the approval of a principal or the branch manager Report of Execution (Execution Report) - The registered representative receives a report after a trade is executed. - He first checks the execution report against the order ticket to make sure that everything was done as the customer requested. - If everything is in order, he reports the execution to the customer. - If an error exists, the representative must report it to the branch office manager or principal immediately. Incorrect Trade Reports - Even when the reporting mistake was made by the firm, the actual trade is binding on the customer. However, if execution takes place outside the customer's instructions, the trade is not binding. For example, if the customer order was for 200 shares and the trade was reported as 300 shares, the customer is not obligated for the extra 100 shares. Reporting an Error - FINRA rules require that a record of any errors be reported to the person designated to receive such error reports by the firm. At a broker-dealer, that individual would always be a manager or someone who holds a principal's license. - All such reports should be made immediately in writing and retained for three years under the general record retention rules.

DPP Taxation

Pass-through taxation: Most DPPs are structured as pass-through entities, which means that their income and losses are passed through to the investors. The investors report the income and losses on their individual tax returns. Real Estate Program Taxation - When a corporation loses money, there is no tax benefit to the shareholders. When a DPP shows a loss, that loss can be used to offset passive income and save on taxes - In the case of a real estate program, expenses creating the losses are: mortgage interest expense, depreciation allowances for the "wearing out of the building," and expenses for improvement to the property. In addition, there are two other benefits unique to real estate programs: - Nonrecourse debt adds to the investor's cost basis. We will get to this shortly. - Tax credits are offered for government-assisted housing and historic rehabilitation projects. The advantage of a tax credit is that is reduces tax liability dollar-for-dollar Oil and Gas Program Taxation - Write-offs for the expenses of drilling are usually 100% deductible in the first year of operation. These include costs associated with drilling such as wages, supplies, fuel costs, and insurance. Intangible drilling costs (IDCs) can be defined as any cost that, after being incurred, has no salvage value. - Tangible drilling costs are those costs incurred that have salvage value (e.g., storage tanks and wellhead equipment). These costs are not immediately deductible; rather, they are deducted (depreciated) over several years. - The IRS allows allowances in the form of tax deductions that compensate the partnership for the decreasing supply of oil or gas (or any other resource or mineral). Depletion - Depletion is only allowed for natural resource programs (Ex. Mining & Timber) - Depletion allowances may be taken only once the oil or gas is sold - Not applicable to real estate If a partner's basis is $25,000 at year-end and the investor has losses of $35,000, only $25,000 of the losses may be used to deduct against passive income. The remaining $10,000 may be carried forward.

General Characteristics of Municipal Bonds

Paying a premium of $10 per bond = The cost per bond is $1,010 Municipal Debt - securities issued either by a state or local government or by U.S. territories. They can also be issued by municipal authorities and special districts. - Investors who buy these securities are loaning money to the issuers for the purpose of public works and construction projects (e.g., roads, hospitals, civic centers, sewer systems, and airports). - Municipal securities are considered second in safety of principal only to U.S. government and U.S. government agency securities. - The safety of a particular issue is based on the issuing municipality's financial stability. Municipal Bond Price or Basis Quotations - Municipal bonds are usually priced and offered for sale on a yield to maturity (YTM) basis rather than a dollar price. This is called a basis quote. In this case, the bond's basis is its YTM. If the bond is quoted at a 3.78 basis, it means the yield to maturity is 3.78%. - Each basis point is 1/100 of 1 percent. That is, if the yield on the previous bond quoted at a 3.78 basis should fall to a yield of 3.65%, we would say the yield has dropped by 13 basis points. - Ex. A basis quote may be listed as 7s 35 at 7.5. This is a 7% coupon for a bond maturing in 2035 with a YTM of 7.5% - Ex. If a question mentions a 6% bond quoted on a 6.5 basis, you should be able to determine that the coupon of the bond is 6% and its YTM is 6.5%. Because the YTM is higher than the coupon, the bond is trading at a discount. Municipal Bond Quote Rules - Municipal bonds are bought and sold in the OTC market. They are not listed on the stock exchanges - the MSRB was created to regulate securities professionals in the municipal securities field. Bona Fide (Firm) Quotes - the dealer must be prepared to trade the security at the price specified in the quote and under the conditions and restrictions (if any) accompanying the quote - quote given by municipal dealer Other Types of Quotations - workable indication = reflects a bid price at which a dealer will purchase securities from another dealer. - nominal, or subject, quotation = indicates a dealer's estimate of a security's market value. - Holding a quote = A municipal securities dealer may quote a bond price that is firm for a certain time. This is called an out-firm with recall quote. Generally, these quotes are Municipal Bonds firm for an hour (or half hour) with a five-minute recall period Municipal Bond Maturities - Term Maturity = All principal matures at a single date in the future. - Serial Maturity Bonds = within an issue mature on different dates according to a predetermined schedule - most municipal bonds are issued serially. - Balloon Maturity = An issuer pays part of a bond's maturity before the final maturity date, but the largest portion is paid off at maturity Sinking Fund - can be used to call bonds, redeem bonds at maturity, or buy back bonds in the open market. Legal Opinion - written and signed by the bond counsel - The legal opinion states that the issue is legally binding on the issuer and conforms to applicable laws. - Issuer is responsible for delivering the legal opinion - qualified opinion = is one where the bond counsel to the municipality places certain legal restrictions (qualifications) on the issue that must be disclosed to purchasers. - unqualified opinion has no restrictions. - Issuers desire an unqualified legal opinion - The ex-legal designation allows a bond to meet good delivery requirements without an attached legal opinion.

Rules Applying to the Sale of Equity Securities

Penny Stock - If the stock trades for less than $5 per share and is not listed on a major exchange such as the NYSE or the Nasdaq Stock Market - are highly speculative securities. - are thinly traded securities (Ex. A penny stock broker-dealer may publish a quote on a penny stock as $0.54 bid, $0.65 ask. This means you can buy the stock at 65 cents or sell it at 54 cents. That 11-cent difference, called the spread, means you are immediately at a loss if you have to sell) - Some have little or no operating history Penny Stock Rules - requires that customers, before their initial transaction in a penny stock, be given a copy of the Risk Disclosure Document - The member firm must receive a signed and dated acknowledgment from the customer that the document has been received. - In addition to obtaining the client's signature, the SEC requires the firm to wait at least two business days after sending the statement before executing the first trade. - provide penny stock purchasers with monthly statements Fair Prices and Commissions (FINRA Rule 2121) - was adopted to ensure that the investing public receives fair treatment and is charged reasonable rates for brokerage services. - It is considered a guideline—not a firm rule. - It does not apply to prospectus offerings - The 5% policy applies to both principal (dealer) and agency (broker) transactions. It applies to markups, markdowns, and commissions, but not to securities sold by prospectus.

Annuity Purchase and Settlement Options

Periodic Payment DeferredAnnuity: These are the most common type of variable annuity, in which the investor contributes funds over time and the value of the investment fluctuates based on market performance. Immediate variable annuities: With an immediate variable annuity, the investor typically makes a lump-sum payment to the insurance company, which then begins making regular payments to the investor immediately. - purchased with a lump sum, and the payout of benefits usually commences within 60 days. Bonus Annuities - It is not uncommon for variable annuities to offer a bonus on top of the investor's initial contribution. - For example, investing $60,000 into a single premium annuity with a 5% bonus would result in an account balance of $63,000. Payout Options Life/Straight Annuity When you die, the check stops No beneficiary The biggest check that you can get for the rest of your life Payout = $$$$ Life with period certain If you live beyond X amount of years, you still get a check for the rest of your life If die before your period certain (Ex. 5, 10, 15, or 20 years), your beneficiary gets paid for the remaining amount of years Payout = $$$ Joint with last survivor - Check stops at the last death - Usually for spouse Payout = $$ - Joint and last survivor option, the annuity payment is made jointly to both parties while both are alive. When the first party dies, the annuity payment is made to the survivor. When the second party dies, all payments cease. Unit (Cash) Refund - Only option that guarantees that if you invested $500k that $500k will be paid out - Once you annuitize, the insurance company guarantees that at least $500k must be distributes → could be more but can't be less Payout = $

Other Equity Securities

Preferred Stock - Preferred stock is a type of equity security that typically pays a fixed dividend and has priority over common stock in the event of a company's liquidation or bankruptcy - Preferred stock is generally less volatile than common stock, but also typically offers lower potential returns - One important point about these dividends is that, just as with common stock, there is no obligation for them to be paid - Call premium = the term used to describe that excess over par that the issuer pays when calling in the preferred stock (or callable bond). Types of Preferred Stock Cumulative preferred stock - requires that any missed dividend payments must be made up before common stockholders can receive dividends - The dividend rate on cumulative preferred stock is fixed. It is never more than the stated rate. Non-cumulative preferred stock - does not have this requirement, so missed dividends are not owed to shareholders in the future Participating preferred stock - allows shareholders to receive additional dividends if the company's profits exceed a certain level - Ex. A preferred stock is described as "XYZ 6% preferred participating to 50%." In addition to the fixed dividend, the company could pay holders of this stock up to 50% of the common dividend Convertible preferred stock - can be converted into a fixed number of shares of common stock at a predetermined ratio, giving investors the potential for capital appreciation Callable Preferred - company can buy back the stock from investors at a stated price on the call date or any date thereafter. - The call feature would most likely be used when interest rates decline - they tend to have higher dividend rates because of call feature - the call price is at a premium over the par value. An example could be $103 for a $100 par value stock. Adjustable Rate Preferred - Have variable dividend rates - The interest rate on U.S. government Treasury bills is one frequently used. - When interest rates go up, so does the dividend. Risks of Preferred Stock - Interest rate risk is a concern for fixed-rate preferred stock, as rising interest rates can cause the value of these securities to decline - Credit risk is a concern for all types of preferred stock, as the issuer's financial health and creditworthiness can affect the likelihood of receiving dividends and principal payments - Liquidity risk is a concern for less actively traded preferred stock, as it may be difficult to buy or sell shares at a fair price Rights and Warrants Rights - are a type of equity security that gives existing shareholders the right to purchase additional shares of common stock at a discounted price - Have no voting privilege Warrants - are similar to rights, but are typically sold separately from other securities and have a longer expiration date - purchase price is always higher than the current market price on the date of issue of the warrant. - Warrants are usually offered to the public as sweeteners, or inducements, in connection with an offering of other securities, such as bonds or preferred stock - Can't pay dividends - Have no voting privilege Subscription Right - subscription right is a certificate representing the privilege to buy additional shares of a corporation. - Expire within 30-45 days of issue, rarely more than 60 cum rights (before the ex-rights date), the formula is M ‒ S / N + 1 ex-rights (without the rights), the formula does not include the "+1." The formula is (M - S) / N. "Ex" = Without ADR - a receipt for shares of a foreign stock deposited with a custodian. - ADRs are in English and trade in U.S. dollars. - right to receive dividends when declared. - Most important, those dividends are in U.S. dollars. - Generally, ADRs do not have voting rights - ADR investors are subject to currency risk.

Qualified vs Non Qualified Retirement Plans

Qualified Retirement Plan - Meets the requirements of the Internal Revenue Code (IRC) and is eligible for favorable tax treatment - Contributions are tax-deductible for the employer - Contributions grow tax-deferred - Withdrawals are taxed as ordinary income - Must meet certain criteria, such as nondiscrimination testing and limits on contributions and benefits - Examples include 401(k), 403(b), and pension plans Non-Qualified Retirement Plan - Does not meet the requirements of the IRC and is not eligible for favorable tax treatment - Contributions are not tax-deductible for the employer - Contributions grow tax-deferred - Withdrawals are taxed as ordinary income, but may also be subject to additional taxes or penalties - May be offered only to select employees or executives - No nondiscrimination testing or contribution/benefit limits (May be discriminatory) - Examples include deferred compensation and executive bonus plans

Real Estate Investment Trusts (REITS)

REIT - A REIT is a real estate investment trust, which is a company that owns, operates, or finances income-producing real estate properties. - are a way to have an ownership interest in real estate without having to manage properties or worry about collecting rents. - There are three main types of REITs: equity REITs, mortgage REITs, and hybrid REITs. Equity REITs = Own commercial property. - They take an ownership position in the properties. They receive rental income and possible capital gains upon a future sale of the properties mortgage REITs = Own mortgages on commercial property - They make real estate loans (mortgages). Their earnings come from the interest payments on those loans. hybrid REITs = Own commercial property and own mortgages on commercial property. - have the liquidity of listed stocks because they trade on exchanges and OTC - Losses do not pass through - REITs do compute a NAV per unit. As you can imagine, the valuation of real estate is not as exact as the price of publicly traded stock. Therefore, the NAV is only an approximation. - Because REITs are not redeemed by the issuer, the prices are based on supply and demand - the price an investor pays can be more, less, or the same as the NAV. - REITs are not DPPs (losses do not flow through). - Dividends from REITs are not qualified; they are taxed as ordinary income - Aren't redeemed by the issuer REIT Taxation - A REIT shareholder generally is taxed only on dividends paid by the REIT and on gains upon the disposition of REIT shares. - A REIT is a corporation for U.S. tax purposes. - The REIT is generally not subject to corporate tax if it distributes to its shareholders substantially all of its taxable income for each year - Under the guidelines of Subchapter M of the IRC, a REIT can avoid being taxed as a corporation by receiving 75% or more of its income from real estate and distributing 90% or more of its taxable income to its shareholders.

Types of DPPs

Real Estate Programs: These DPPs invest in real estate properties, such as commercial or residential buildings, and provide investors with an opportunity to earn income through rent and appreciation of property value. Raw Land - Purchase undeveloped land for its appreciation potential - Most speculative real estate partnership New Construction - Build new property for potential appreciation - Depreciation and expense deductions after construction is completed and income is generated - Less risky than new land; more risky than existing property Existing Property - Generate an income stream from existing structures - Immediate cash flow; known history of income and expenses - Relatively low risk Government-Assisted Housing Programs - Develop low-income and retirement housing - Relatively low risk Historic Rehabilitation - Develop historic sites for commercial use - Tax credits for preserving historic structure - Similar to risk of new construction Oil and Gas Programs: These DPPs invest in oil and gas exploration and production projects, and provide investors with an opportunity to earn income through oil and gas production. Exploratory (Wildcatting) - Locate undiscovered reserves of oil and/or gas - High; most risky oil and gas program Developmental - Drill near existing fields to discover new reserves (called step-out wells) - Medium to high risk Income - Provide immediate income from sale of existing oil - Low risk Equipment Leasing Programs - created when DPPs purchase equipment leased to other businesses. - Investors receive income from lease payments and also a proportional share of write-offs from operating expenses, interest expenses, and depreciation

REVIEW, APPROVAL, AND FILING OF COMMUNICATIONS

Required Approvals of Public Communications - Institutional—No preapproval of a principal is required. When such procedures do not require review of all institutional communications before first use or distribution, they must include provision for the education and training of associated persons as to the firm's procedures governing institutional communications. - Retail—Preapproval of a principal is required (before use). - Correspondence—Pre- or post-review of a principal is required (reviewed before or after use). - Public appearance—Preapproval of a principal may be required but is not mandated. - Independently prepared reprints—These must be preapproved by a principal if the communication meets the definition of a retail communication. - Research reports—Approval requirements are based on how they are defined (e.g., institutional, retail). Research reports must be preapproved by a principal if the communication meets the definition of a retail communication. Electronic communications - Website preapproval of a principal is required. - Electronic bulletin boards—Use of an online interactive forum by a registered representative must be approved by a principal, although each post does not require principal approval. Emails and instant messaging—Approval requirements are based on how they are defined (institutional, retail, or correspondence). - Generic advertising—Preapproval of a principal is required. Filing Requirements - There is a special filing requirement for new members of FINRA. For a period of one year beginning on the date reflected in the Central Registration Depository (CRD®) system as the date that FINRA membership became effective, the new member must file any retail communication with FINRA at least 10 business days before first use. This is called prefiling - After the first year of registration, a member firm is now established. From this point, the firm may file retail communications within 10 business days of first use (postfiling). Retail communications must be kept on file for three years from last use

Compliance with the Senior Exploitation Rules

Senior exploitation rules, also known as elder abuse rules, are a set of regulations that aim to protect senior citizens from financial exploitation. - If this rule is violated, account may be placed on temporary hold for 55 business days

EXCHANGE, BROKER-DEALER COMMISSIONS, AND BROKERAGE AND RESEARCH SERVICES

Soft dollar compensation - a term used in the securities industry to describe a type of payment made by a brokerage firm to a money manager or investment advisor in exchange for certain services. - Soft dollars are payments made by a broker-dealer to a money manager or investment advisor to compensate them for research or other services provided to the broker-dealer. For example, a broker-dealer may provide a money manager with access to research reports, software, or other services that help the manager make investment decisions. - Soft dollar compensation is regulated by the SEC under its "soft dollar" rules, which require broker-dealers to disclose the amount and nature of the soft dollar compensation paid to money managers and investment advisors. The rules also require broker-dealers to ensure that any services paid for with soft dollars are "eligible," meaning that they are related to the investment decision-making process and benefit the money manager's clients. Here are some of the items that, if received as soft dollar compensation, would likely fall under Section 28(e)'s safe harbor provisions: - Research reports analyzing the performance of a particular company or stock - Financial newsletters and trade journals could be eligible research if they relate with appropriate specificity - Quantitative analytical software - Seminars or conferences with appropriate content - Effecting and clearing securities trades On the other hand, likely to fall out of the safe harbor would be the following: - Telephone lines - Office furniture, including computer hardware - Travel expenses associated with attending seminars - Rent - Any software that does not relate directly to analysis of securities - Payment for training courses for this exam - Internet service

Business Accounts

Sole Proprietorship - Business owned and operated by one individual Owner is personally liable for all debts and obligations of the business Business income and expenses are reported on the owner's personal tax return Simplest form of business organization Partnership - Business owned and operated by two or more individuals - Partners share profits and losses based on their ownership percentage - Partners are personally liable for all debts and obligations of the business - Business income and expenses are reported on each partner's personal tax return - General partners have management responsibilities and unlimited liability, while limited partners have limited liability and no management responsibilities Limited Liability Company (LLC) - Business organization that combines the liability protection of a corporation with the tax benefits of a partnership - Owners are called members and have limited liability for the debts and obligations of the business - Members report their share of business income and expenses on their personal tax return - Can be taxed as a partnership or a corporation C Corporation - Business organization that is a separate legal entity from its owners - Owners are called shareholders and have limited liability for the debts and obligations of the business - Income is taxed at the corporate level, and dividends paid to shareholders are taxed at the individual level - Can issue multiple classes of stock and has no limit on the number of shareholders S Corporation - Business organization that combines the liability protection of a corporation with the tax benefits of a partnership - Owners are called shareholders and have limited liability for the debts and obligations of the business - Income is taxed at the individual level, and losses can be passed through to shareholders - Must have no more than 100 shareholders and can only issue one class of stock - Can only have individual shareholders or certain types of trusts as shareholders Limited Partnership - Business organization that combines general partners with limited partners - General partners have management responsibilities and unlimited liability for the debts and obligations of the business - Limited partners have limited liability and no management responsibilities - Income and losses are allocated based on ownership percentage - Limited partnerships are often used in real estate and other investment ventures Partnerships, limited or general, and S corporations do not pay income tax. Any income earned by the business flows through to the owners

Advanced Options Strategies

Spread - the simultaneous purchase of one option and sale of another option of the same class: A call spread is a long call and a short call. A put spread is a long put and a short put. - Think of a bid-ask example --> You are buying (long) & selling (short) - Net Debit = Max Loss - Net Credit = Max Gain - Max Gain or Loss = Difference in strike price - Max Gain or Loss - Call Spread = Add Net Premium to lower strike price - Put Spreads = Subtract Net Premium from Higher Strike Price Types of Spreads Price or Vertical Spread - A price spread or vertical spread is one that has different strike prices but the same expiration date. EXAMPLE - Example of a price or vertical spread: Long RST Nov 50 call for 7 Short RST Nov 60 call for 3 - This is a price or vertical spread because the difference in the two options is the 50 and 60 strike prices (not the premiums). Time or Calendar Spread - A time spread or calendar spread, also known as a horizontal spread, includes option contracts with different expiration dates but the same strike prices - Investors who establish these do not expect great stock price volatility - EXAMPLE Example of a time or calendar spread: Long RST Nov 60 call for 3 Short RST Jan 60 call for 5 - This is a time or horizontal spread because the difference in the two options is the Nov and Jan expiration dates (time). Diagonal Spread - A diagonal spread is one in which the options differ in both time and price EXAMPLE - Example of a diagonal spread: Long RST Jan 55 call for 6 Short RST Nov 60 call for 3 - This is a diagonal spread because both the strike prices and expiration dates are different. Bull and Bear Spreads - a bull spread is created when the investor buys the option with the low strike price and sells the option with the high strike. - a bear spread is buying high and selling low. Debit and Credit Spreads - a debit spread if the long option has a higher premium than the short option - a spread is a credit spread if the short option has a higher premium than the long option - debit spreads are profitable if the difference between the premiums widens or if the options are exercised - credit spreads are profitable if the difference between the premiums narrow or the options expire - It is a debit if the investor purchased the one with the higher strike price (higher premium). - It is a credit if the investor sold the one with the higher strike price (higher premium). Straddle - composed of a call and a put with the same exercise (strike) price and expiration month - SILO Short Inside - Straddle is profitable inside the strike prices Long outside - Staddle is profitable outside the strike prices Long Straddles - An investor who uses a long straddle expects substantial volatility in the stock's price but is uncertain of the direction the price will move. To be ready for either occurrence, the investor purchases both a call and a put. - Profit is stock is above or below a limit - EXAMPLE An investor establishes a long straddle position by going long 1 ABC JAN 50 call at 3 and going long 1 ABC JAN 50 put at 4 - Max Gain = Unlimited - Max Loss = Combined Premiums Short Straddle - An investor who writes a short straddle expects that the stock's price will not change or will change very little. The investor collects two premiums for selling a straddle. - Profit if stock is between two limits - EXAMPLE An investor establishes a short straddle position by going short 1 XYZ FEB 45 call at 4 and 1 XYZ FEB 45 put at 3. - Max Gain = Combined Premiums - Max Loss = Unlimited Combinations - A combination is composed of a call and a put with different strike prices, expiration months, or both. - EXAMPLE An investor could establish a long combination by buying an XYZ Jan 40 call and buying an XYZ Jan 45 put. Collars - A collar is an option strategy generally used to protect an unrealized gain on a long stock position.

Options Math

Spreads 1. Net Premiums - Net Debit = Max Loss - Net Credit = Max Gain 2. Net Strike Prices 3. Net Strike Price - Net Premium 4. To find Breakeven - Calls = Add net premium to low strike - Puts = Subtract net premium from high strike Long Straddle - Max Gain = Unlimited - Max Loss = Both premiums - Breakeven = Add the sum of both premiums to the call strike price and subtract the sum from the put strike price Short Straddles - Max Loss = Both premiums - Max Loss = Unlimited - Breakeven = Add the sum of both premiums to the call strike price and subtract the sum from the put strike price Covered Call - Breakeven = Stock cost - Premium In-the-money - Doesn't include premium

Taxation of Equity Securities

Taxation of Equity Securities - Equity securities are subject to capital gains taxes when they are sold for a profit, and capital losses can be used to offset capital gains - Short-term capital gains are taxed at the investor's ordinary income tax rate, while long-term capital gains are taxed at a lower rate - Dividends received from equity securities are subject to either ordinary income tax rates or lower qualified dividend tax rates, depending on various factors - Equity securities held in tax-deferred retirement accounts such as IRAs are not subject to capital gains or dividend taxes until the funds are withdrawn Wash Sale Rule - The wash sale rule prohibits investors from deducting losses on the sale of securities if they purchase substantially identical securities within 30 days before or after the sale - The purpose of the rule is to prevent investors from artificially creating tax losses without changing their investment position - If an investor violates the wash sale rule, the disallowed loss is added to the basis of the new securities, which could reduce future capital gains or increase future losses EXAMPLE Jennifer bought 500 shares of Wolfe Industries common stock on October 1, 2019, at $50 per share. On October 24, 2019, she sold all the stock at $40 per share. On November 12, 2019, she buys 200 shares of Wolfe Industries common stock at $42. How much of a loss will Jennifer be able to claim for 2019? - By repurchasing 200 shares of Wolfe Industries common stock less than 30 days after the sale at a loss, Jennifer has run afoul of the wash sale rule. Because she only purchased 200 rather than the full 500 she sold, those are the only shares affected by the rule. Therefore, of the $5,000 total loss (500 shares × $10 per share as the stock fell from $50 to $40), $2,000 (200 shares × $10) is "washed" but the other $3,000 is allowable. Cost Basis - Cost basis is the original purchase price of a security, including any transaction fees or commissions - Cost basis can be adjusted for various factors, such as stock splits, mergers, and reinvested dividends, to determine the actual basis for tax purposes - The cost basis is used to calculate the capital gains or losses on a security when it is sold - Investors can use different methods to determine the cost basis, such as first-in, first-out (FIFO), specific identification, or average cost

TECHNICAL ANALYSIS

Technical Analysis - Technical analysis attempts to predict the direction of prices on the basis of historic price and trading volume patterns when laid out graphically on charts. - A decline through the support level is called a bearish breakout; a rise through the resistance level is called a bullish breakout. Consolidations - Consolidations If a stock's price stays within a narrow range, it is said to be consolidating. When viewed on a graph, the trendline is horizontal and moves sideways, neither up nor down. Reversals - A reversal indicates that an upward or a downward trendline has halted, and the stock's price is moving in the opposite direction - The head-and-shoulders top pattern indicates the beginning of a bearish trend in the stock. - When reversed, this pattern is called a head-and-shoulders bottom, or an inverted headand-shoulders, and indicates a bullish reversal. Dow Theory - Analysts use the Dow theory to confirm the end of a major market trend. - According to the theory, the three types of changes in stock prices are primary trends (one year or more), secondary trends (3-12 weeks), and short-term fluctuations (hours or days). Odd-Lot Theory - Followers of the odd-lot theory believe that these small investors invariably buy and sell at the wrong times. - When odd-lot traders buy, odd-lot analysts are bearish. When odd-lot traders sell, odd-lot analysts are bullish TEST TOPIC ALERT - The standard trading unit for equity securities is a round lot. A round lot is 100 shares. An odd-lot is something less than 100 shares. If a trade is made for 550 shares of common stock, the trade was for five round lots (500 shares) and one odd-lot (50 shares). Short-Interest Theory - Short interest refers to the number of shares that have been sold short - High short interest is a bullish indicator, and low short interest is a bearish indicator.

ANALYZING MUNICIPAL SECURITIES

The Bond Buyer - The Bond Buyer is published every business day and serves as an authoritative source of information on primary market municipal bonds. - The Bond Buyer publishes the 30-day visible supply (the total dollar volume of municipal offerings—not including short-term notes—expected to reach the market in the next 30 days) and the placement, or acceptance, placement ratio indexes (the percentage of the total dollar value of new issues sold versus the total dollar value of new issues offered for sale the prior week). The Bond Buyer 20 bond index measures secondary market yields of GO bonds. It consists of 20 GO bonds, A-rated or better, and each with approximately 20 years to maturity. The index is updated each week. Placement Ratio - Number of Sold Bonds / Number of Offered Bonds - For example, if $1 billion of bonds were offered during the week, and $700 million were placed (sold), that is a 70% placement ratio. Revdex 25 Weekly index of 25 revenue bonds with 30 years to maturity, rated A or better. Thomson Muni Market Monitor - provides the most up-to-the-minute information relevant to the secondary municipal bond market - Current news items pertaining to the secondary municipals market appear in these wire services throughout the day along with current municipal offerings. Comparatively, these wire services should be considered a source for bonds already trading in the municipal secondary markets, while The Bond Buyer is a source for new issue municipal bonds (primary market).

Basic Options Including the Role of the OCC

The Options Contract Option - is a two-party contract that conveys a right to the buyer and an obligation to the seller. - The terms of option contracts are standardized by the Options Clearing Corporation (OCC). This standardization allows options to be traded easily on an exchange such as the Chicago Board Options Exchange (CBOE). - Options are called derivative securities because their value is derived from the value of the underlying instrument, such as stock, an index, or a foreign currency. when an option is bought or sold, that option trade settles T+1. If an equity option is exercised, what happens? Stock is either bought (call) or sold (put) and that is treated as any other equity transaction. That means T+2 settlement date. Two Parties Are Involved in an Options Contract Buyer = Long = Holder = Owner - Pays premium (the cost of the contract) to seller. There is a debit to the account of the buyer when the premium is paid - Has the right to exercise (buy or sell stock). Seller = Short = Writer - Receives premium from buyer. There is a credit to the account of the seller when the premium is received. - Has the obligation when contract is exercised. The writer will be assigned (must buy or sell as required by contract). EXAMPLE An option contract might look like this: ABC 40 NOV Call. That means the underlying asset is 100 shares of ABC common stock. The strike (exercise) price is $40 per share. The option expires in November Calls - Long call. A call buyer owns the right to buy 100 shares of a specific stock at the exercise (strike) price before the expiration if he chooses to exercise - Short call. A call writer (seller) has the obligation to sell 100 shares of a specific stock at the strike price if the buyer exercises the contract. Puts - Long put. A put buyer owns the right to sell 100 shares of a specific stock at the exercise (strike) price if she chooses to exercise - Short put. A put writer (seller) has the obligation to buy 100 shares of a specific stock at the strike price if the buyer exercises the contract. TAKE NOTE Buyers of options call the shots; they are in control. They choose to exercise or not to exercise. That is why buyers pay premiums. The writer is at the mercy of the buyer's decision. Options are exercised against the writer when the buyer makes that decision. Writers do not have the opportunity to choose to exercise. Opening and Closing Positions - Opening Purchase --> Closing Sale - Opening Sale --> Closing Purchase Settlement Dates - When options are bought and sold, the settlement is the next business day. We refer to that as T+1 in the industry. - Unlike stocks and bonds, there are no certificates for options. That makes settlement much quicker. Role of the OCC - an SRO, is the issuer of listed options contracts - Its primary functions are to standardize, guarantee the performance of, and issue option contracts. The OCC determines when new option contracts will be offered to the market. - It designates the strike prices and expiration months for new contracts within market standards to maintain uniformity and liquidity. - Supply and demand in the trading markets determines the premium for the contracts. - One of the important guarantees of the OCC is the exercise of options contracts. That means, if for some reason a seller is unable to perform, the OCC does. If a holder of an option wishes to exercise, her broker-dealer notifies the OCC. The OCC then assigns exercise notice against a broker-dealer with a customer who has written that option. The broker-dealer then assigns that exercise noted to a customer with a short position Assignment of Exercise Notices - When the OCC is notified by a broker-dealer that one of its customers wants to exercise, the OCC randomly selects a firm with a short position in that option to which it assigns the exercise. - The OCC assigns exercise notices on a random basis. Then, it is up to the assigned broker-dealer to determine which of its clients is going to be obligated - Broker-dealers have three ways to allocate exercise assignments. They may allocate to customers on: - a random basis; - a first in, first out (FIFO) method; or - any other method that is fair and reasonable. - One method that is not considered fair and reasonable (and is often tested) is selecting based on the size of the writer's position. Although those who have written 100 contracts are more likely to be selected randomly than a client who is short one contract, the firm cannot deliberately choose the client with the largest short position. TEST TOPIC ALERT - The exam will try to trick you with settlement dates. The settlement date for equity options is the next business day. That is, when an option is bought or sold, that option trade settles T+1. If an equity option is exercised, what happens? Stock is either bought (call) or sold (put) and that is treated as any other equity transaction. That means T+2 settlement date.

Marketing New Issues

The Primary Market - describes the sale of securities to the investing public in what are known as issuer transactions. - The most common example is the initial public (or primary) offering (IPO). Those shares represent the first time any shares have been issued to raise new capital for the issuer - " If the funds wind up in the coffers of the issuer, it is a primary offering or a primary distribution. TEST TOPIC ALERT - There is one case where the issuer receives the proceeds and it is not a primary offering. When a company resells treasury stock, it receives the proceeds. Because those shares were previously owned, it cannot be called a primary offering. The Secondary Market - once a new issue has been distributed, all further buying and selling takes place in the secondary market. - As pointed out much earlier, these are the exchanges, Nasdaq, and the OTC market - the proceeds of the sale do not go to the issuer; they go to the selling shareholder (or bondholder). Participants in a New Issue The Issuer - the issuer (the entity), selling the securities to raise money, must file a registration statement with the SEC. This document requires that the issuer supply sufficient information about the security and the corporation and its officers to allow an investor to make a sound investment decision - When the SEC reviews this document, during what is known as the 20-day cooling-off period, it looks for sufficiency of investment information rather than accuracy, though upon completion of the review, it does not guarantee adequacy of the prospectus. - Near the end of the cooling-off period, the underwriter holds a due diligence meeting. The preliminary studies, investigations, research, meetings, and compilation of information about a corporation and a proposed new issue that go on during an underwriting are known collectively as due diligence. Underwriter - a broker-dealer specializing in investment banking—the process of underwriting new issues - The investment banker who negotiates with the issuer is known as the underwriting manager or syndicate manager. The underwriting manager directs the entire underwriting process, including signing the underwriting agreement with the issuer and directing the due diligence meeting and distribution process Forming a Syndicate - a group of underwriters formed to purchase (underwrite) a new issue of municipal securities from the issuer and offer it for resale to the general public. The syndicate is organized for the purposes of sharing the risks of underwriting the issue, obtaining sufficient capital to purchase an issue and broadening the distribution channels of the issue to the investing public." - A syndicate's bid is based on the average reoffering price (the price the public will pay) less the syndicate's spread (the amount the syndicate will charge for bringing the issue to market). - In a firm commitment offering, all syndicate members commit to purchase from the issuer and then distribute an agreed-on amount of the issue (their participation or bracket). - Syndicate members sign a syndicate agreement, or syndicate letter, that describes the participants' responsibilities and allocation of syndicate profits, if any - Syndicate members take on financial liability and act in a principal capacity - In a negotiated underwriting, the issuer and the investment banker negotiate the offering terms, including the amount of securities to be offered, offering price or yield, and underwriting fees. - In a competitive bid, a state or municipal government invites investment bankers to bid for a new issue of bonds. The issuer awards the securities to the underwriter(s) whose bid results in the lowest net interest cost to the issuer. Syndicate Letter - is sent by a municipal dealer to prospective members inviting them to join the syndicate and setting forth the conditions of the syndicate. - Such conditions include who the manager will be, the percentage participation (each member's share), and the amount of good faith deposit required. Selling Group Formation - Although the members of an underwriting syndicate agree to underwrite an entire offering, they frequently enlist other firms to help distribute the securities as members of the selling group. Selling group members act as agents with no commitment to buy securities. - Selling group members sign a selling group agreement with the underwriters - Selling group members have no financial liability and act as agents because they have no commitment to buy securities from the issuer. Types of Underwriting Agreements Firm Commitment - The firm commitment is the most commonly used type of underwriting contract. Under its terms, the underwriter(s) [investment bank(s)] commit to buy the securities from the issuer and resell them to the public. - The underwriters assume the financial risk of incurring losses in the event they are unable to distribute all the shares to the public - A firm commitment underwriting can be either a negotiated underwriting contract or a competitive bid arrangement. Negotiated underwriting contracts are used in most corporate issues. The issuer selects an underwriter and negotiates the conditions of the underwriting contract. A competitive bid arrangement is the standard for new issue offering in the municipal securities market. Standby - Standby is a form of firm commitment unique to corporate rights offerings. When a company's current stockholders do not exercise their preemptive rights in an additional offering, a corporation has an underwriter standing by to purchase whatever shares remain unsold as a result of rights expiring. Best Efforts - the underwriter acts as an agent for the issuing corporation. - In a best efforts underwriting, the underwriter sells as much as possible, without financial liability for what remains unsold. - The underwriter is acting in an agency capacity with no financial risk. All-or-None - In an all-or-none (AON) underwriting, the issuing corporation has determined that it wants an agreement outlining that the underwriter must either sell all of the shares or cancel the underwriting Mini-Max - A mini-max offering is a best efforts underwriting setting a floor or minimum, which is the least amount the issuer needs to raise to move forward with the underwriting, and a ceiling or maximum on the dollar amount of securities the issuer is willing to sell. The underwriter must locate enough interested buyers to support the minimum (floor) issuance requirement. Once the minimum is met, the underwriter can expand the offering up to the maximum (ceiling) amount of shares the issuer specified. Underwriting Municipal Securities - One significant difference between corporate and municipal underwritings to note is the need for a legal opinion - Participants formalize their relationship by signing a syndicate letter, or syndicate agreement, in a competitive bid or a syndicate contract, or agreement among underwriters, in a negotiated underwriting - Syndicate letters are not legally binding until the syndicate's submission of the bid. Firms may drop from the group until this point. Types of Syndicate Accounts Western account - is a divided account. Each underwriter is responsible only for its own underwriting allocation. Eastern Account - an undivided account. Each underwriter is allocated a portion of the issue. EXAMPLE A syndicate is underwriting a $5 million municipal bond issue. There are five syndicate members, each with equal participation, including your firm. Your firm sells its entire allocation, but bonds worth $1 million remain unsold by the other syndicate members. If this is a Western account, what is your firm's liability? In a Western account, your firm would have no remaining liability because its entire share was sold. However, if your firm had sold only $700,000 of its $1 million allocation, it would have to purchase the remaining $300,000 for its own inventory. If this is an Eastern account, what is your firm's liability? In an Eastern account, the unsold amount is divided among all syndicate members based on their initial participation. In this example, your firm would be allocated 20% of the remaining amount, or $200,000. The responsibility for any unsold bonds continues until the entire bond issue is sold. Syndicate Account - Settlement of syndicate accounts is 30 calendar days after the issuer delivers the securities to the syndicate. Therefore, the maximum length of time for the syndicate to exist is 30 calendar days from the time the issuer delivers the securities to the syndicate. Breakdown of the Spread - The price at which the bonds are sold to the public is known as the reoffering price (or reoffering yield). The syndicate's compensation for underwriting the new issue is the spread, or the difference between the price the syndicate pays the issuer and the reoffering price. Each participant in the syndicate is entitled to a portion of the spread, depending on the role each member plays in the underwriting. EXAMPLE A corporation issues stock to the public at $20 per share. It is done through a firm commitment and the syndicate manager's fee is $0.25 per share. The underwriting fee is $0.40 per share and the selling concession is $0.50 per share. The issuer will receive - The proceeds to the issuer are the offering price less the spread. The spread consists of all of these pieces ($0.25 + $0.40 + $0.50) and is a total of $1.15. The $20 offering price less the $1.15 spread results in the issuer receiving $18.85 per share. - Just as with mutual funds, the offering price, or public offering price, is the price paid by investors and includes the spread. That is, using the above example, the investors do not pay the $20 per share plus something else. Everything is included Syndicate Management Fee - Syndicate managers receive a per-bond fee for their work in bringing the new issue to market. - The manager might receive 1/8 point ($1.25) as a management fee from a total spread of 1 point ($10). Total Takedown - The portion of the spread that remains after subtracting the management fee is called the total takedown. - In the following example, for a 1-point spread with a management fee of 1/8 point, the takedown is 7/8 point ($8.75) - A syndicate member that has purchased bonds at the takedown can sell its bonds either to customers at the offering price or to a dealer in the selling group below the offering price. Selling Concession and Additional Takedown - A syndicate member can buy bonds from the manager for $991.25, sell them to the public for $1,000, and earn the takedown of 7/8 point ($8.75). If the firm chooses instead to sell bonds to a member of the selling group, it does so at a price less than $1,000, or, $995 in the following example. The discount the selling group receives from the syndicate member is called the selling concession. This $5 is equal to 1/2 point. - Selling group members buy bonds from syndicate members at the concession. The syndicate member keeps the remainder of the total takedown, called the additional takedown. The additional takedown in this example is 3/8 point ($3.75). Management Fee --> Additional Takedown --> Concession The syndicate manager may notify other firms that are not syndicate or selling group members of the new issue through The Bond Buyer. Interested firms may buy the bonds from the syndicate at a small discount from the reoffer price. This discount is termed a reallowance, which is generally half of the concession amount.

Good Delivery Under FINRA's Uniform Practice Code (UPC)

The Uniform Practice Code (UPC) - "The Uniform Practice Code (UPC) is a series of rules, interpretations and explanations designed to make uniform, where practicable, custom, practice, usage, and trading technique in the investment banking and securities business, particularly with regards to operational and settlement issues Good Delivery - Good delivery is a delivery where everything is in good order such that a transaction settles satisfactorily. There are a number of requirements, such as the proper time, size, and documentation. Time for Delivery - The settlement date is the date on which ownership changes between buyer and seller. It is the date on which broker-dealers are required to exchange the securities and funds involved in a transaction and customers are requested to pay for securities bought and to deliver securities sold. - Corporate securities, municipals, and government agency securities settle T+2. - U.S. government T-bills, T-notes, T-bonds, and options settle next business day—T+1. - Money market securities transactions settle the same day. - In trades between dealers, if the seller delivers before the settlement date, the buyer may either accept the security or refuse it without prejudice. Cash Settlement - Settlement = Same Day - Cash trade settlement occurs no later than 2:30 pm ET if the trade is executed before 2:00 pm. If the trade occurs after 2:00 pm, settlement is due within 30 minutes. Seller's Option - Contracts Seller's option contracts are a form of settlement that are available to customers who want to sell securities but know they cannot deliver the physical securities in time for regular way settlement. - A seller's option contract lets a customer lock in a selling price for securities without having to make delivery on the second business day. Instead, the seller can settle the trade as specified in the contract When-Issued Trades - new municipal bond issues are sold to investors before the bonds are issued and available for delivery. - An investor receives a when-issued confirmation describing the bonds. - What isn't included on a When-Issued Trade (SAT) = Settlement Date, Accrued Interest, Total Dollar Amount - The confirmation does not include a total dollar amount or settlement date because, until the settlement date is known, the accrued interest cannot be calculated to determine the total dollar amount. - Once the bonds are issued, the investor receives a new confirmation stating the purchase price and settlement date. - A when-issued transaction confirmation must include: a description of the security; the purchase price (dollar bond) or yield (serial bond); and the trade date. - Because the settlement date is unknown, a when-issued confirmation for bonds cannot include accrued interest. That means it will not show the total dollar amount due. - The buyer's broker-dealer is responsible for verifying that the securities delivered meet the requirements for good delivery, which may include factors such as the number of shares, the certificate number or CUSIP number, and other details. - If a question asks when customer confirmations must be sent, the answer is no later than the settlement date. However, if the question asks when broker-to-broker confirmations must be sent, the answer is no later than the business day following the trade date (T+1). Don't Know (DK) Notice - DKs are used in interdealer trades for which one party to the transaction does not recognize the trade or, if it does, disagrees with the terms of the trade as submitted by the other party Due Bills - If one of your customers buys a stock before the ex-dividend date, the customer is entitled to the dividend. However, if the trade is somehow mishandled and does not settle until after the record date, the seller will receive the dividend in error. In this case, your firm should send a due bill to the seller's firm stating, "Our customer is due the dividend—kindly remit." Good Deliverable Form - Every issue has a transfer agent. The transfer agent is the final arbiter of whether a security meets the requirements of good delivery. Overdelivery and Underdelivery EXAMPLE - Overdelivery: A customer sells 300 shares and brings in one certificate for 325 shares. - Underdelivery: A customer sells 100 shares and brings in one certificate for 80 shares Partial Delivery - A member-to-member partial delivery is acceptable under Uniform Practice Rules if the amount remaining to be delivered does not include an odd-lot. - EXAMPLE Delivering 200 shares to satisfy a 300-share sale would be good delivery (the amount remaining is a round lot). However, delivering 250 shares in the same scenario would not be good delivery, because it would be a mix of two round lots and an odd-lot. Good Delivery Clearing Rule (100-Share Uniform Units) - Please pay attention to the good delivery clearing rule because is it highly tested. - When one broker-dealer delivers stock certificates to another broker-dealer, the firm separate round lots and odd lots. - Round lot certificates are good delivery as long as they are in 100s or multiple of 100s. In simple terms, as long as the certificate ends in 00 (e.g., 400, 1,200, 8,500), it meets the conditions of the UPC. - When it comes to odd lots, members can make round lot deliveries of them if the odd lots add up to a single round lot. Good Delivery for Bonds Missing Coupons - If coupons are missing from a bond, it is not good delivery. If an issuer is in default on a coupon bond, all of the unpaid coupons must be attached for it to be good delivery.

Customer Confirmations and Account Records

Trade Confirmation - a document that confirms a trade of a security. - It applies if the customer is buying or selling a security. - On the face of the confirmation is the amount of money due from or owed to the customer. - It will also include the date the money changes hands. That is the settlement date. - rules require the confirmation to contain: - whether the member acted as agent or principal (capacity) - the lower of yield to call or yield to maturity when a transaction in a debt security is done on a yield or dollar basis - the markup or markdown charged retail customers when acting in a principal capacity - whether a control relationship exists between the issuer and member - the identity of the shares or units as well as the price and number of shares - if the member is a market maker in the security - The current yield (annual interest / current market price) is not included on confirmations. - There is no requirement to provide identifying information for the registered representative. Confirmation Delivery - For each transaction, the customer must be sent or given a written confirmation of the trade at or before the completion of the transaction (settlement date). Copies of customer confirmations must be retained for three years. When-Issued Trades - Typically, new municipal bond issues are sold to investors before the bonds are issued and available for delivery - The confirmation does not include a total dollar amount or settlement date because, until the settlement date is known, the accrued interest cannot be calculated to determine the total dollar amount. Once the bonds are issued, the investor receives a new confirmation stating the purchase price and settlement date. - A when-issued transaction confirmation must include: a description of the security; the purchase price (dollar bond) or yield (serial bond); and the trade date - Because the settlement date is unknown, a when-issued confirmation for bonds cannot include accrued interest. That means it will not show the total dollar amount due Customer Account Statements - Members are required to send statements to customers at least quarterly. - Must be retained for 6 years With respect to joint accounts, the statement is sent to the person whose Social Security number is on the account. Customer account statements must include a statement advising customers to promptly report any discrepancy or inaccuracy to the brokerage firm and, if applicable, the clearing firm

Types of Treasury Securities and Their Pricing

Treasury Securities - Treasury securities are debt obligations issued by the U.S. Department of the Treasury to finance government operations and pay for the national debt - Because Treasury securities are backed by the full faith and credit of the U.S. government, they are considered to have a low risk of default. - the interest that government securities pay is exempt from state and municipal taxation but subject to federal taxation. - Treasury securities are considered to be highly liquid, meaning they can be easily bought and sold in the market. - No treasury securities have credit risk - Treasury securities have only been available in book-entry form. Book-entry means that the record of ownership is kept on the "books" of the Treasury - Are goofy because they settle T + 1 and use actual calendar days Treasury Bills (T-Bills) - Short-term securities that mature in one year or less. - T-Bills are issued at a discount to their face value and pay no interest until maturity. - the 13-week T-bill is commonly used in quantitative analysis as the risk-free investment. - Don't have interest rate risk - Because T-bills are quoted in yield, a T-bill quote has a bid higher than its ask price - the interest from those Treasury bills is treated as ordinary income subject to federal income tax. Treasury Notes (T-Notes) - Intermediate-term securities that mature in two to ten years. - T-Notes pay interest every six months and are issued in denominations of $1,000 or more. - They are considered intermediate length securities with maturities of 2, 3, 5, 7, or 10 years. - traded as a percentage of par in 1/32% - Interest on T-notes is computed on an actual-day basis - Have interest rate risk Treasury Bonds (T-Bonds) - Long-term securities that mature in ten to thirty years. T-Bonds pay interest every six months and are issued in denominations of $1,000 or more. - traded as a percentage of par in 1/32% - The interest on U.S. government securities (such as Treasury bonds) is exempt from state and local income taxes but not federal income taxes - Have interest rate bonds Interest on Treasury bills, notes, and bonds is taxable as ordinary income at the federal level. It is exempt from state and local taxation Municipal securities issued by which of the following are triple tax exempt? Answer: U.S. territories Treasury Inflation-Protected Securities (TIPS) - Securities that are designed to protect investors from inflation. - These bonds are issued with a fixed interest rate, but the principal amount is adjusted semiannually by an amount equal to the change in the Consumer Price Index (CPI), the standard measurement of inflation. - The interest payment the investor receives every six months is equal to the fixed interest rate times the newly adjusted principal. - In times of inflation, the interest payments increase, while in times of deflation, the interest payments fall. - Like other Treasury securities, TIPS are exempt from state and local income taxes on the interest income generated, but they are subject to federal taxation STRIPS - Separate Trading of Registered Interest and Principal of Securities. - Treasury Department's version of the zero coupon bond - is long-term, no-interim income security and has a locked-in yield because it is purchased at a discount from par. - As zero coupon bonds, they have minimal reinvestment risk. Treasury Receipts - Brokerage firms can create a type of zero coupon bond from U.S. Treasury notes and bonds. - Treasury receipts are not backed by the full faith and credit of the U.S. government.

Investing in Alternative Debt Securities

Types of Alternative Debt Financing - now generally referred to as Alts - These included, among other products, ETNs, leveraged ETFs, and new, highly sophisticated financial derivatives - are considered structured products. Equity-Linked Notes (ELNs) or ETN - debt instruments where the final payment at maturity is based on the return of a single stock, a basket of stocks, or an equity index - In the instances where the securities are traded on an exchange (most still are not), they are generally referred to as exchange-traded notes (ETNs). Special Considerations - Lack of regulation Low transparency Low liquidity High fees Lack of historical data - In most cases, the investors are institutions or highly sophisticated (and wealthy) individuals. They are willing to take the risk for the higher potential rewards. Private Placement Debt - this money is loaned on a private basis. - These securities are not registered with any regulatory body, such as the SEC. - Because of the private nature, there are no ratings to guide investors - mezzanine debt = this is money that is borrowed at an intermediate point in the company's development

CUSTOMER RECORDS INCLUDING ACCOUNT TRANSFERS

Updating Customer Account Information - each retail customer who opens a new account must, within 30 days of the opening of the account, be furnished with a copy of the account record. - For updating purposes, the member firm must send a copy of the account record to customers at least every 36 months thereafter. - If the customer should notify the firm of any changes to the account record, such as change in name, address, or investment objectives, the firm must send a copy of the updated account record within 30 days of receiving notice of the change. - A broker-dealer must retain records of all of the identification information obtained from the customer under the CIP for five years after the account is closed. - By contrast, records made about the CIP information verifying a customer's identity have to be retained for only five years after the record is made. Automated Customer Account Transfer Service (ACATS) - When a customer whose securities account is carried by a member (the carrying member) wants to transfer the account to another member (the receiving member), the customer must sign an account transfer form - The TIF is sent immediately to ACATS by the receiving firm. - one business day to validate the securities listed on the TIF or take exception to the transfer instructions - If there are no exceptions, within three business days following validation, the carrying firm must complete the transfer of the account. Following a Registered Representative From One Member Firm to Another - requires that educational material be provided to customers about potential conflicts of interest, the transferability of assets, differences in products and services, and potential costs of the transfer. - Customers do not need to have their identity revalidated by a receiving firm, because the carrying firm has already complied with anti-money-laundering requirements.

PRODUCT SPECIFIC COMMUNICATIONS

Use of Investment Company Rankings in Retail Communications - Members may not use investment company rankings in any retail communication other than: - rankings created and published by Ranking Entities or - rankings created by an investment company or an investment company affiliate but based on standard performance measurements. Required Disclosures of Investment Company - A headline or other prominent statement must not state or imply that an investment company or investment company family is the best performer in a category unless it is ranked first in the category CMO Suitability - FINRA Rule 2216 states that before a member can sell a CMO to a retail customer (anyone other than an institutional investor), the firm must be sure the representative is trained and must offer the customer educational material that includes information and a discussion on: - the characteristics and risks of CMOs, including prepayment rates and average lives; - the interest rates, including their effect on value and prepayment rates; - tax considerations; - transaction costs and liquidity - etc. - Any retail communication concerning CMOs: - may not compare CMOs to any other investment vehicle, including bank CDs;

Trading Places

primary market - is the market in which the proceeds of sales go to the issuer of the securities sold. - Securities Act of 1933 regulates activity in the primary market secondary market - is where previously issued securities are bought and sold - The Securities Exchange Act of 1934 regulates the activity in the secondary market. Stock Exchanges - major exchanges include the New York Stock Exchange (NYSE), NYSE American LLC (formerly known as the American Stock Exchange (AMEX)), the Chicago Board Options Exchange (CBOE), and the Nasdaq Stock Market - Where listed securities are traded - auction markets. - The designated market maker, (DMM), formerly called the specialist, conducts the auction. - Many of the stocks listed on the NYSE are considered "blue-chips." The term refers to the common stock of well-known companies with a history of growth and dividend payments. OTC Market - an interdealer market in which unlisted securities—that is, securities not listed on any exchange—trade. - refers to a decentralized market where financial instruments such as stocks, bonds, currencies, and derivatives are traded directly between two parties, without the involvement of a formal exchange. In other words, it's a market where trades are conducted directly between buyers and sellers rather than through an organized exchange. - has no central marketplace. Trading takes place over the phone, over computer networks, and in trading rooms across the country - has market makers. A market maker chooses to "deal" in selected OTC stocks. market makers compete to post the best prices at which they are ready to buy or sell those stocks - a negotiated market. Electronic Communications Network (ECN) - Broker-dealers can send an order through an ECN instead of going through a market maker. - An ECN is an electronic trading system that automatically matches buy and sell orders at specified prices. - ECNs are SEC-sanctioned alternative trading systems (ATS). - They are open 24 hours a day - ECN matches buy and sell orders as agents, not as principals. Dark Pools - trading volume that occurs that is not openly available to the public. - The bulk of this volume represents large trades engaged in by institutional traders - they do not reveal their investment strategy