Session 1 - Equity

rates of money market instruments

London Interbank Offered Rate (LIBOR) is the rate of interest at which banks borrow short-term funds from each other in London

Test Prep Question: All of the following are appropriate reasons to purchase common stock except: I. It will provide a predictable income II. It is a possible hedge against inflation III. to diversify a portfolio against market risk IV. to diversify a portfolio against business risk a) I and III b) I and IV c) II and III d) II and IV

a) I and III

Benefits of Common stock ownership

a) capital growth - appreciation (primary motivation) i) hedge against inflation; historically high real returns b) income i)dividends if declared by board of directors 1) cash 2) stock (adjust cost basis, taxable upon sale) i) utility stocks - highest dividend payout ratio c) investor controls when to sell

types of municipal issues

a) general obligation bonds (GO) i) backed by full faith and credit (taxes) - considered safer 1) issuer's authority to tax b) revenue bonds i) backed by specific revenue source, tolls, other fees

characteristics of money market instruments

a) high quality debt a) short-term (1 year or less to maturity a) issued at a discount, except CDs

risks of municipal bonds

a) interest rate risk b) inflation risk c) possible exposure to the alternative minimum tax (AMT)

benefits of municipal bonds

a) low default risk b) tax-free income (attractive to those in high federal tax brackets)

risks of common stock ownership

a) market risk (systematic) i) risk of price fluctuations in the overall market ii) cannot protect through diversification - no b) business or financial risk (nonsystematic) i) risk of business decline of failure due to poor mgmt decisions or inability to meet debt obligations ii) can be limited through diversification

Test prep question: All of the following statements regarding government and agency securities are true EXCEPT a) they are always directly backed by the federal government b) they are considered safer than corporate securities c) interest paid is always subject to feral income tax d) they are authorized by congress

a) they are always directly backed by the federal government

issuers of money market instruments

all treated as ordinary income a) corporation - commercial paper (270 days or less) b) banks - negotiable (jumbo, 100k minimum) CDs i) no prepayment penalty ii) insured by FDIC (to $250,000) c) US government -- all T-bills as well as bonds and notes in the secondary market with one year or less remaining to maturity

test prep question: Corporate bonds are considered safer than common stock issued by the same company because: a) bonds and similar fixed-rate securities are guaranteed by SIPC b) bonds place the issuer under an obligation but stock does not c) the par value of bonds is generally higher than that of the stock d) if there is a shortage of cash, dividends are paid before interest

b) bond place the issuer under an obligation but stock does not

Test prep question: If a resident of NYC purchases an Albany, NY, general obligation bond that yields $600 of ingest in the course of the year, how is the interest taxed? a) it is subject to federal income tax at ordinary rates b) it is not subject to federal income tax c) it is subject to state income tax at ordinary rates d) taxation is deferred until the bond matures

b) it is not subject to federal income tax

Test prep question: if an investor has $20,000 to invest but requires $500 per month to pay for her mothers nursing home care, which of the following funds would you recommend? a) aggressive growth b) money market mutual fund c) biotechnology d) foreign stock

b) money market mutual fund

Test Prep Question: Which of the following investment strategies would be appropriate for an advisory client with a 20-year time horizon before retirement I. Holding more stock II. Holding less cash III. Holding fewer bonds a) I only b) II only c) II and III d) I, II, and III

d) I, II, and III

risks of preferred stock

fixed returns a) inflation risk b) interest rate risk c) dividends aren't guaranteed intrest rate movement, preferred acts like a bond

if any investor is subject to AMT, which muni bond do you stay away from?

industrial development revenue bond

if investor is subject to MT & do not receive tax exempt interest, what do yo want to stay away from

industrial development revenue bond

risks of agency issues include

interest rate risk inflation risk prepayment risk (pass-through certificates) reinvestment risk

Municipal bonds

issued by a form of government other than the federal government or agency of the federal government a) interset exempt from federal taxes b) exemption may also apply at state and local level (resident of co buying co bond) c) capital gains subject to taxation (taxable gains)

risks of government issues

lower yields interest rate risks inflation risk (except TIPS)

zero coupon bonds

most suitable to fund a kids education issued at a deep discount appropriate for "target" investments no reinvestment risk high volatility generates "phantom" income accretion turns into ordinary income, taxed annually (no capital gains, all ordinary income)

unsecured bonds

no collateral backed by full faith and credit of issuer riskier, higher return

US government securities Active secondary trading (negotiable)

not on exchange, OTC market a) t-bills b) t-notes c) t-bonds d) treasury inflation protection securities (TIPS)

risks of bonds

1. Default a) creditworthiness of issuer (high quality vs. low quality debt) 2. Interest rate risk--inverse relationship between price and yield a) long-term vs. short term (long-term debt more volatile (duration)) 3. call risk a) call protection 4. reinvestment risk a) interest payments and return of principal 5. inflation (purchasing power) risk a) fixed payment lose buying power

Government agency issues

1. Government National Mortgage Association (GNMA or Ginnie Mae) 2. Federal National Mortgage Corporation (FNMA or Fannie Mae) 3. Cash flow analysis on pass-through societies uses average maturities

benefits of bonds

1. predictable stream of income ( interest payment made semiannually) 2. repayment of principal at specified maturity date (bonds held to maturity have no interest rate risk as to principal) 3. Prior claims on issuers assets a) secured bonds have pledged assets b) debentures have priority over any equity

types of corporate bonds

1. secured 2. unsecured (subordianted debt) 3. high-yield bonds 4. zero-coupon bonds

t-bonds

10-30 year s

T-bills

4 weeks (1month) 13 weeks (3 months) 26 weeks (6 months) 52 weeks (1 year)

Characteristics of Preferred stock

Income not growth a) equity security with fixed (stated) dividend - decided by BOD b) purchased for income purposes

Characteristics of bonds

a) a security that represents an issuer's indebtedness b) purchased for income purposes (semi-annual interest payments) c) purchased for safety purposes

risks of money market securities

a) low yields b) not suitable for long term investors

Federal National Mortgage Corporation (FNMA or Fannie Mae)

a) pass-through certificate, semi-annual income b) interest taxed at all levels

Benefits of preferred stock ownership

a) preference over common i) dividends, ii) liquidation

benefits of money market securities

a) safety b) liquidity

test prep question: If a client wants his income to keep pace with inflation, what would you recommend? a) preferred stocks b) investment grade corporate bonds c) TIPs d) they are authorized by Congress

c) TIPs

Test prep question: The major risk of highly rated corporate bonds is a) stock market volatility b) liquidity c) interest rate changes d) tax law changes

c) interest rate changes

secured bonds

collateral lower coupon

Fixed income securities: issuers

corporations, municipalities, US government and agencies

high yield bone

new investment grade

TIPS

offer inflation protection semiannual adjustment to principal based on CPI

common stock tax rate

ordinary income 15% tax

Government National Mortgage Association (GNMA or Ginnie Mae)

safest agency security a) only agency issue backed by the full faith and credit of the US government b) pass-through certificate, monthly income c) interest taxed at all levels

benefits of government issues

safety liquidity best place to be when recession and deflation are predicted

t-notes

semiannual interest

US government securities

the largest issuer of debt in the US and the safest in terms of default risk. Interest tax-exempt at the state and local level

money market instruments

used to finance short-term cash requirements

Benefits of agency issues include

very high safety higher income than treasuries