Chapter 5 Customer Accounts
if margin maintenance call unmet
B/D liquidates securities to bring back equity to maintenance level
client refuses to disclose suitability information
FOR BROKERAGE: may open account but any rec limited to information given accept only unsolicited orders FOR IA: may not open due to fiduciary responsibility
There are many different legal ways to structure a new business entity. One of these is the general partnership. Among the benefits of using this structure would be: A) taxation at a lower rate than a corporation. B) limited liability. C) substantial capital can be raised with little effort and low cost. D) ease of formation. Your answer, taxation at a lower rate than a corporation., was incorrect. The correct answer was: ease of formation. Compared to a corporation, it is generally easier to form (and dissolve) a partnership. General partners have full liability and there is no tax - it is passed on to the partners, to be taxed at a rate that might exceed the corporate tax rate. Corporations are the entity for raising a lot of capital. Reference: 6.1.5.2 in the License Exam Manual.
General partnership easy to form and dissolve no tax--passed to partners corporations can raise a lot of capital
margin call example
Regulation T at 50% purchase of $12000 of stock = margin call of $6000 B/D lends client the other $6000 debit balance in account results equity in account is 50%
maintenance
Self Regulatory Organizations (SRO) eg: Finra and NYSE not Reg T est min levels of equity
account records
all customer accounts all securities customer name address telephone number type of account and account number customer investment objective list of all securities deposited with the firm list of all transactions
A deceased client's trust account has over 90% of its value invested in a single common stock whose recent performance has been outstanding, resulting in a very large unrealized capital gain. Under the Uniform Prudent Investors Act, the investment adviser handling the account would be acting with proper fiduciary responsibility by A) continuing to hold that stock position if it is felt that it meets the objectives of the trust B) liquidating a portion of that stock to take advantage of the tax savings offered by the stepped-up basis at death C) exchanging a portion of that stock for a suitable security held in the adviser's trading account D) selling all of that stock in order to rebalance the trust's assets Your answer, continuing to hold that stock position if it is felt that it meets the objectives of the trust, was incorrect. The correct answer was: liquidating a portion of that stock to take advantage of the tax savings offered by the stepped-up basis at death Under current tax law, a beneficiary inherits assets at their fair market value as of the time of death. This is known as a stepped-up basis (probably because these assets are generally at a higher price than when originally purchased). In this question, we are told that there is a large unrealized gain. Therefore, with a portfolio that is over-concentrated in one security, it would make sense to diversify while, at the same time, avoiding or minimizing capital gains taxes. It would be against the provisions of the UPIA for a fiduciary to ever engage in trading from his own account. Reference: 6.5.3.7 in the License Exam Manual.
at death, liquidate stock to take advantage of step up basis
If a client wanted an investment that would eliminate interest risk as to principal, you would recommend A) TIPS B) a 90-day Treasury bill C) a bank insured certificate of deposit D) preferred stock Your answer, a 90-day Treasury bill, was incorrect. The correct answer was: a bank insured certificate of deposit Because bank insured CDs are non-negotiable (we're not discussing the $100k minimum jumbos), there is no market fluctuation caused by changes in interest rates as with marketable securities. If you invest $10,000, you will always get back that $10,000 whenever you cash in the CD, regardless of current interest rates. This is true even when cashing in early. There may be a prepayment penalty, but that is considered separate from interest rate risk. TIPS offer inflation protection and preferred stock is interest rate sensitive in the same manner as a bond. The 90-day T-bill doesn't have much interest rate risk, but, if an investor was to attempt to liquidate the holding prior to maturity and interest rates increased, there could be a loss. Reference: 6.3.1.1 in the License Exam Manual.
bank insured CDs eliminate interest risk
net equity
calculate equity from both long and short positions
A feature of which of the following business entities is limited liability but no flow-through of earnings or losses? A) LLC. B) Corporation. C) Sole proprietorship. D) Limited partnership. Your answer, LLC., was incorrect. The correct answer was: Corporation. The corporation (always assume C corp unless it says different on the test) offers limited liability to its shareholders, but there is no flow-through of income or loss. LLCs and limited partnerships offer both and the sole proprietorship has unlimited liability. Reference: 6.1.5 in the License Exam Manual.
careless mistake corporation has limited liability and no flow through of earnings or losses
B/D customer account
cash and securities repository + record of investment activity
One of your clients has been following a dollar cost averaging plan for the past five months. During that time, she has invested $200 each month on the 12th of the month. If the 12th was a non-business day, she invested the funds on the next available business day. Her monthly purchases were 30 shares, 22.5 shares, 25 shares, 20 shares and 18.1 shares. If she were to sell today at $10 per share, her cost basis is approximately: A) $23.12. B) $8.65. C) $4.62. D) $8.91. Your answer, $8.91., was incorrect. The correct answer was: $8.65. The investor's cost basis is her average price per share. This is computed by taking the total investment for the 5 months ($1,000) and dividing it by the total number of shares acquired (115.6). $1,000/115.6 = $8.65.
cost basis for dollar cost averaging total investment $1000/ shares acquired 115.6 = 8.65$
two negative numbers
cost to repurchase stock we're short debit balance ADD Two +s and subtract Two --s = net equity
short account equity
credit balance -- current market value of short stock = short equity Credit balance - CMV short = Short equity
customer investment objectives, trading authority
determine account type
trading authorization/power of attorney
discretionary power signed copy must be on file
loan consent agreement
firm can loan out money on customer margin securities
loan consent (optional)
firm has permission to lend securities held in margin account to other brokers for short sales not mandatory for customers to sign loan consent agreement
TIC
fractional interest at death passes to estate not other tenant interest may be unequal if one dies, all pending orders and transactions canceled can be more than 2 tenants checks payable in acct name, endorsed by all parties
new account information
full name date of birth addresses and phone numbers (home/off) soc sec or tax (1st 4 items reqd by USA PATRIOT ACT 2001) (below reqd by regulators) occupation/employer, type of business citizenship estimated income and net worth investment objectives bank and brokerage services whether the customer is an officer, director o control person name + occupation of each person with trade authority signature of partner, officer or manager, registered principal account signatory accepted in accordance with member's policies for acceptance of accounts. CUSTOMER SIGNATURE IS NOT REQUIRED FOR NEW ACCOUNT periodic update for changing situation
hypothecation agreement
gives firm permission to pledge securities held on margin mandatory
suitability information
income net worth tax status number of dependents current financial situation present holdings risk tolerance needs investment objectives
account ownership types
individual joint partnership corporate fiduciary/custodial
margin call
initial call for funds when making margin transaction
join account
joint account agreement must be signed designated tenants in common TIC (can have unequal shares) or JTWROS joint tenants with right of survivorship equal shares checks payable to the names registered on account endorse for deposit by all tenants mail sent to one address
margin maintenance call
level bellow which a call issued for addl funds
opening margin account: financial leverage increase potential for gain can result in loss greater than original investment
may borrow part from B/D control investments for less $ margin= min amt of cash or marginable securities customer must deposit to buy securities Margin = potential source of cash FRB Federal Reserve Board sets limit own borrowed cash relative to cash and securities deposited Customer meets min. suitability requirement then: buy securities on margin, pay interest on borrowed funds.
insider trading monitor
new account form identifies: customer is director officer shareholder or control person owning more than 10%
TOD Transfer on death accounts applies to individual and JTWROS
no probate on death does not avoid estate taxes available for all paper assets: accounts in banks, credit unions, CDs, stocks, bonds, etc. owner while alive is sole upon death, proper transfers to beneficiaries owner changes beneficiaries anytime TOD does not control distribution: will does
earned degrees
not included on new account form
signature cards
not legally required protection and conveninece allows written orders to signature verified
individual accounts
one beneficial owner controls investment in account request distributions of cash or securities
account approval
partner or principal must approve
opening cash account
pay full purchase price securities by transaction settlement date basic investment account all eligible may open (no minors/incompetents) corporate retirement accounts custodial accounts UGMA: uniform gift to minors act account
Account opened
registered in 1 or more names account owners sole access to account competent person of majority can open fiduciary or custodial acct for incompetents/minors
positive margins
returns are higher than cost of borrowed $ to fund positions
negative margins
returns are lower etc
good delivery form
securities sold from joint account signed by both tenants
mailing instructions
sent to power of attorney duplicate confirmations
mixed margin account
short sale: investor borrows stock from b//d and sells in anticipation of market decline If correct=investor buys back stock at lower price; profit by difference between purchase price and sale price short sale must occur in margin acc if acc has long and short positions=mixed margin acc
documentation margin account
sign margin agreement credit agreement hypothecation agreement optional loan consent NASAA unethical to execute transaction w/o margin agreement written PROMPTLY AFTER initial transaction
two positive numbers
stock we own credit balance
house maintenance
stricter limits imposed by B/Ds themselves SRO = 25% B/D may require 35% or higher
credit agreement
terms of credit SEC Rule 10b-16 discloses method of computing interest how int rates charged firm sends assurance that int rate charge statement sent monthly or quarterly
JTWROS joint tenant with rights of survivorship
test will always mean this when referring to joint tenants deceased tenant inters passes to surviving tenants right of succession occurs, other party becomes sole owner of account checks made payable in account name, endorsed by all parties
partnership account
unincorporated 2 or more individuals partnership agreement to open disclose investment liabilities who has trading authority margin trading only allowed if stated in partnership agreement
long account equity
what is owned -- what is owed = long equity current market value -- debit balance = long equity CMV long - Debt balance = Long equity
IA counsel clients
whose securities transactions made at B/Ds
