Chapter 1

Comparative Safety of Debt Securities

1. Relationship of Rating to Yield Generally, higher a bond's rating = lower its yield. 2. Qualitative analysis In addition to financial statistics, qualitative factors such as an industry's stability, the issuer's management, and the regulatory climate are considered when bonds are rated.

Rights and Warrants

1. A company can issue right sot existing stockholders that allow the owner to buy stock at a favorable price for a short period of time. 2. A company can issue warrants, normally in conjunction with the issue of another security, that allow the holder to buy the stock at a set price (higher than at time of issue) for a long period of time, typically two to five years.

Stock Splits

1. A company will sometimes change the number of outstanding shares by means of a stock split. 2. The total value of the outstanding stock must be the same before and after the split. 3. Thus, if the XYZ corporation did a 2-for-1 stock split, an investor who owned 100 XYZ shares worth $20 per share before the split would own 200 shares worth $10 per share after the split. 4. In reverse, if it was a 1-for-2 split, an investor with 100 shares worth $20 per share before the split would own 50 shares worth $40 per share after the split. 5. The total of value remains the same. Shareholder approval is needed for stock splits. Take Note: Stock dividends, unlike cash dividends, are not taxed when received. There are no tax consequences incurred until the investor chooses to liquidate the shares and realize the gains or losses.

Categories of Preferred Stock - Convertible Preferred

1. A preferred stock is convertible if the owner can exchange each preferred share for shares of common stock. 2. The price at which the investor can convert is a preset amount and is noted on the stock certificate. Price fluctuates in line with the common. 3. Convertible preferred is often issued with a lower stated dividend rate than nonconvertible preferred because the investor may have the opportunity to convert to common shares and enjoy capital gains. 4. When the underlying common stock has the same value as the convertible preferred, it is said to be at its parity price. Example: XYZ Company's convertible preferred stock, with a par value of $100 and a conversion price of $20, can be exchanged for five shares of XYZ common stock ($100/$20 = 5). This is true, no matter what the current market value of either the preferred or the common stock. Thus, if an investor bought the preferred for $100 per share and the common stock rises in price eventually to more than $20 per share, the preferred stockholder could make a capital gain from converting.

Nasdaq (National Association of Securities Dealers Automated Quotation)

1. An electronic stock market originated in 1971. 2. An OTC, where unlisted securities trade. 3. No physical trading floor 4. Automated computerized information system that provides price and inventory for market makers of securities traded OTC. 5. Nasdaq stocks that don't meet the listing requirements of an exchange or choose not to trade OTC are unlisted securities. Most securities that trade are unlisted.

Cash Dividends

1. Are normally distributed by check if an investor holds the stock certificate or are automatically deposited to a brokerage account if the shares are held in street name - that is, held in a brokerage account in the firm's name to facilitate payments and delivery. 2. Dividends are usually paid quarterly and taxed as dividend income in the year they are received.

Characteristics of Bonds

1. As creditors, bondholders have preferential treatment over common and preferred stockholders - if a company files for bankruptcy. 2. Bonds are considered senior securities.

4 types of Common Stock

1. Authorized Stock 2. Issued Stock 3. Treasury Stock 4. Outstanding Stock

Financial Industry Regulatory Authority (FINRA)

1. Largest self-regulatory organization (SRO) 2. Regulates participants in the over-the-counter market (OTC) 3. As well as members of the New York Stock Exchange (NYSE)

Categories of Preferred Stock - Straight (Noncumulative)

1. No special features beyond the stated dividend payment 2. Missed dividends are not paid to the holder 3. Year's stated dividend must be paid on straight preferred if any dividend is to be paid to common shareholders. Take Note: Preferred stock with no special features is known as straight preferred.

Securities and Exchange Commission (SEC)

1. Regulates securities markets within the United States. 2. Created by the Securities Exchange Act of 1934. 3. Under SEC, exchanges regulate themselves.

Categories of Preferred Stock - Cumulative Preferred

1. Buyers of preferred stock expect fixed dividend payments. 2. Directors of a company in financial difficulty can reduce or suspend dividend payments to both common and preferred stockholders. 3. Any dividends in arrears must be paid prior to paying a common dividend. Take Note: Any special feature attached to preferred, such as cumulative feature, has a price. The cost for such a benefit is less dividend income. Cumulative preferred typically has a lower stated dividend than straight preferred (less risk equals less reward). 4. Dividends due to cumulative preferred shareholders accumulate on company's books until the corporation can pay them. 5. When resuming payment, stockholders receive their current dividends plus the total accumulated dividends - dividends in arrears - before any dividends may be distributed to common or other straight preferred stockholders. 6. Cumulative preferred stock is safer than straight preferred stock. Example: RST Corp. has both common stock and cumulative preferred stock outstanding. Its preferred stock has a stated dividend rate of 5% (par value $100). Because of financial difficulties, no dividend was paid on the preferred stock last year or the year before. If RST wishes to declare a common stock dividend this year, RST is required to first pay how much in dividends to the cumulative preferred shareholders? RST must pay missed dividends to cumulative preferred (as well as the current dividend) before dividends are paid on common stock. RST must pay $5 for the year before last, $5 for last year, and $5 for this year, for a total of $15. For noncumulative preferred stock outstanding, the answer would have been $5. Only the current year dividend would need payment before common because noncumulative preferred is not entitled to dividends in arrears.

Debt Securities

1. Can be issued not only by corporations, but by federal, state, or local governmental bodies as well. 2. Bonds are debt securities. As the borrower, the issuer promises to repay the debt on a specified date and to pay interest on the loan amount. 3. Fixed-income security. Usually have a par value of $1,000. Test Topic Alert: An investor who buys stock in a company is an owner or has equity in the company. An investor who buys bonds is owed money by the issuer. Bondholders are creditors of the issuer. Like any other borrower, the bond issuer pays interest for the use of the money to the bondholder.

Issuers

1. Corporate bonds are referred to as funded debt. 2. Funded debt is any long-term debt payable in five years or more. 3. Fed. Gov. is the largest borrower and most secure credit risk. Take Note: Generally, bonds issued by the fed. Gov. have the lowest default risk, followed by agency issues of the fed. gov. , municipal bonds, then corporate bonds. Because corporate bonds are the riskiest, they provide the highest potential income to investors.

Stock Certificate

1. Evidence of ownership for the shares of a corporation a person owns. 2. Majority of stock transactions are for round lot numbers of shares (share amounts evenly divisible by 100). 3. Odd lot transactions are share amounts of fewer than 100 shares, such as 4 or 99.

Self-regulatory Organization (SRO)

1. FINRA, largest 2. Municipal Securities Rulemaking Board (MSRB) 3. Chicago Board Options Exchange (CBOE) 4. SROs are not federal agencies, but are membership organizations that enforce federal securities laws on their members and are accountable to SEC.

American Depositary Receipts (ADRs) aka American Depositary Shares (ADSs)

1. Facilitate trading of foreign stocks in U.S. markets. 2. Typically issued by a bank that bought the foreign stock. 3. Negotiable security that represents a receipt for shares of stock in a non-U.S. corporation. 4. One ordinary share = one ADR Bought and sold in the U.S securities markets like stock. Take Note: ADRs allow domestic investors to buy foreign securities more easily. Many investors include foreign issues in their portfolios for diversification.

Par Value

1. For investors, a common stock's par value is meaningless. 2. Has no effect on the stock's market price. 3. If a stock has been assigned a par value for accounting purposes, such as $1 or $.01, it is usually printed on the face of the stock certificate.

Stock Dividends

1. If a company must use its cash for business purposes rather than to pay cash dividends, its BOD may declare a stock dividend. 2. This is typical of many growth companies that invest their cash resources in research and development 3. Under these circumstances, the company issues shares of its common stock as a dividend to its current stockholders. 4. A stock's market price per share declines after a stock dividend, but the company's total market value remains the same.

Categories of Preferred Stock - Participating Preferred

1. In addition to fixed dividends, participating preferred stock offers owners a share of corporate profits that remain after all dividends and interest due other securities are paid. 2. Before the participating dividend can be paid, a common dividend must be declared Example: If a preferred stock is described as "XYZ 6% preferred participating to 9%," the company could pay its holders up to 3% in additional dividends in profitable years, if the board so declares.

Dividends and Splits

1. Investors who buy stock are entitled to dividends only when the company's board of directors votes to make such distributions. 2. Stockholders are automatically sent any dividends to which their shares entitle them. Take Note: Dividends are never guaranteed to shareholders. This distribution of corporate profits is made only when declared by the BOD.

Book Value

1. Is a measure of how much a common stockholder could expect to receive for each share if the corporation were liquidated. 2. Book value per share is the difference between the historical value of a corporation's tangible assets and liabilities, divided by the number of shares outstanding. 3. The book value per share can (and usually does) differ substantially from a stock's market value.

Non-Nasdaq

1. Thousands of securities trade in the OTC market which are not Nasdaq. 2. These securities trade on the over-the-counter bulletin board (OTCBB) or the Pink Sheets and tend to be most speculative of all equity securities. Take Note: OTC Markets Group, Inc., formerly known as Pink OTC Markets, Inc., operates OTC Link, an electronic quotation system that displays quotes from broker-dealers for many OTC securities. These quotes at one time were printed on pink sheets of paper and distributed to broker-dealers. Though Pink Sheets don't exist today, the term is still referred to when discussing unlisted, non-Nasdaq securities.

Marketable Government Securities - Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities)

1. Type of zero coupon 2. Not issued or sold directly to investors 3. Can be purchased and held only through financial institutions and gov. Securities brokers and dealers.

Negotiable Certificates of Deposit (CDs)

Negotiable CDs (jumbo CDs) are time deposits banks offer.

Calling Bonds

A call feature allows the issuer to redeem a bond issue before its maturity date, either in whole or in part (in-whole or partial calls). Test Topic Alert: Under what economic circumstances do issuers call bonds? Bonds are typically called when interest rates are declining. Consider the issuer's side: would you want to pay more interest for the use of money than you need to? Investors who purchase callable bonds face what types of investment risk? Call risk is the risk that the bonds will be called and the investor will lose the stream of income from the bond. Remember that bonds don't pay interest after they have been called. The call feature also causes reinvestment risk. If interest rates are down when the call takes place, what likelihood does the investor have of reinvesting the principal received at a comparable rate? Both call risk and reinvestment risk apply to callable bonds. Which of the following would an investor prefer in a bond she is purchasing? A long call protection period when interest rates are high A long call protection period when interest rates are low A short call protection period when interest rates are high A short call protection period when interest rates are low Answer: A. Investors want to lock in the highest possible rate of interest for the longest period of time. During the call protection period the issuer may not call the bonds away.

Inflation

A general, continual increase in prices at the consumer level.

Gross Domestic Product (GDP)

A nation's annual economic output, all of the goods and services produced within it.

Preferred Stock - Fixed Rate of Return

A preferred stock's fixed dividend is a key attraction for income-oriented investors. A preferred stock with a par value of $100 that pays $6 in annual dividends is known as a 6% preferred The dividend payment causes the price of preferred stock to act like the price of a bond: prices and interest rates have an inverse relationship. Example: Consider a 6% preferred. If interest rates are at 8% and you want to sell your preferred, you will have to sell at a discounted price. Why would a buyer pay full value for an investment that is not paying a competitive market rate? But if interest rates fall to 5%, the 6% preferred will trade at a premium. Because it is offering a stream of income above the current market rate, it will command a higher price.

Tracking Equity Securities

A stock's market price is quoted in whole dollars, also known as points, plus fractions of a dollar expressed in cents. A round lot is 100 shares. Take Note: The exam may ask you to determine the cost of a round lot of stock in whole dollars from its quoted price. Example: If ABC corporation common stock is purchased at its trading day low, how much does an investor pay for a round lot? For the price of a round lot, multiply the trading day low price of $71 x 100 = $7,100 Take Note: Calculators are available at the test center, but do not expect a lot of math. Typically, the entire exam has fewer than five calculations.

Bond Certificates

All bond certificates contain basic information including the following: Name of issuer Interest rate and payment date Maturity date Call features Principal amount (par value) CUSIP number for identification Dated date - the date that interest starts accruing Reference to the bond indenture

General Obligation Bonds (GOs)

Also known as full faith and credit bonds because the interest and principal payments are backed by the full faith and credit of the issuer.

Preferred Stock - No Maturity Date or Set Maturity Value

Although it is a fixed-income investment, preferred stock, unlike bonds, has no preset date at which it matures and no scheduled redemption date or maturity value.

Preferred Stock

An equity security, because it represents ownership in the corporation. However, it does not normally offer the appreciation potential associated with common stock. Like a bond, it is issued with a fixed (stated) rate of return. It is a dividend rather than interest that is being paid. These securities are generally purchased for income. Dividend of most preferred stocks is fixed, some are issued with variable dividend payout known as adjustable rate preferred stock. Prices tend to move inversely with interest rates, similar to other fixed income assets such as bonds. Most preferred stock is nonvoting and maintains no preemptive rights. Although preferred stock does not typically have the same growth potential as common stock, preferred stockholders generally have two advantages over common stockholders. When the board of directors declares dividends, owners of preferred stock must receive their stated dividend in full before common stockholders may be paid a dividend. If a corporation goes bankrupt, preferred stockholders have a priority claim over common stockholders on the assets remaining after creditors have been paid. Take Note: Preferred stock has preference over common stock in payment of dividends and in claim to assets in the event the issuing corporation goes bankrupt.

Total Return (Individual Securities)

An investment's total return is a combination of the dividend income (for equity investments) or interest paid (for debt investments) and price appreciation or decline over a given period of time. The net gain is the total return on investment divided by the purchased price. Example: A common stock purchased for $20 with an annual dividend of $1 is sold after one year for $24. The total return on the investment is $5, $1 in dividends plus $4 in capital appreciation. The total return, then, is 25% ($5/$20 = 25%).

Options

An option is a contract that gives the buyer a right to do something with an underlying security over time, usually nine months. 1. It is also a type of derivative because the value of the contract is primarily based on the value of the underlying security. 2. An options disclosure document must be delivered prior to opening the account. 3. The buyer is the owner of the contract and the seller is often referred to as the writer.

Exercise Prices

An option's exercise or strike price is the price at which the option owner is entitled to buy or sell the underlying security and the price at which the option seller has agreed to sell or buy the security.

Preemptive Rights

Antidilution provision is when a corporation raises capital through the sale of additional common stock, it may be required by law or its corporate charter to offer the securities to its common stockholders before the general public. Stockholders then have a preemptive right to buy enough newly issued shares to maintain their proportionate ownership in the corporation. Take Note: Preemptive rights give investors the right to maintain a proportionate interest in a company's stock. Example: ABC, Inc., has 1 million shares of common stock outstanding. Shareholder X owns 100,000 shares of ABC common stock, or 10%. If ABC issues an additional 500,000 shares, Shareholder X will have the opportunity to buy 50,000 of those shares before the shares are offered to the public, and often at a discount.

Convertible Bonds

Are corporate bonds that may be exchanged for a fixed number of shares of the issuing company's common stock. Test Topic Alert: On your exam, if an investor's main objective is income, don't recommend a convertible bond!

Corporate Bonds

Are issued to raise working capital or capital for expenditures such as plant construction and equipment purchases.

Marketable Government Securities - Treasury Bonds (T-Bonds)

Are long-term securities that pay interest every six months. Maturities. T-Bonds are issued and mature in more than 10 years. Pricing. T-bonds are quoted exactly like T-Notes. Callable. Some T-Bonds have optional call dates, ranging from three to five years before maturity.

Nonmarketable Government Securities

Are savings bonds which include: Series EE, HH, and I Bonds These bonds are nonmarketable (nonnegotiable) Take Note: As of Jan. 1, 2012, paper savings bonds are no longer sold at financial institutions. This action supports the Treasury's goal to increase the number of electronic transactions with citizens and businesses. In other words, savings bonds may only be purchased directly through the Treasury, specifically the Treasury's Website www.TreasuryDirect.gov

Collateralized Mortgage Obligations (CMOs)

Are securities created from pools of mortgages. Take Note: You could see the term asset-backed security (ABS) on your exam. An ABS is essentially the same thing as a mortgage-backed security, except that the securities backing it are assets such as leases, loans, receivables, credit card debt, royalties and so forth. In other words, an ABS is not backed by mortgage-based securities.

Authorized Stock

As part of its original charter, a corporation receives authorization from the state to issue or sell, a specific number of shares of stock. Often, a company sells only a portion of the authorized shares, raising capital for its foreseeable needs. The company may sell the remaining authorized shares in the future or use them for other purposes.

Net Worth

Assets - Liabilities = Net Worth or Assets = Liabilities + Net Worth

International Monetary Factors

Balance of Payments Flow of money between the United States and other countries. When debits exceed credits, a deficit in the balance of payments occurs; when credits exceed debits, a surplus exists. Currency Exchange Rates Take Note: Importers like their own currency to be strong (or, similarly, foreign currencies to be weak). Exporters like their own currency to be weak (or, similarly, foreign currencies to be strong).

FRB - Discount Rate

Banks can also borrow money directly from the Fed at its discount rate, the interest rate the Fed charges its members for short-term loans.

Tracking Corporate Bonds

Bonds are listed in newspapers and other financial publications such as Barron's and The Wall Street Journal. Example: See example on page 60. Test Topic Alert: You might be asked to determine the price of a bond from a bond quote; 1 bond point = $10. If the bond's quote is 105, its price is $1050. If a bond is quoted at 97⅝, find its price in three steps: 97 x 10 = $970 ⅝ = .625 x 10 = $6.25 $970 + $6.25 = $976.25

Registration of Bonds

Bonds are registered to record ownership should a certificate be lost or stolen. Coupon (Bearer) Bonds bonds use to be issue in coupon or bearer form. Registered Bonds 1. Fully registered 2. Registered as to principal only: have the owner's name printed on the certificate, but the coupons are in bearer form. Book-Entry Bonds Owners do not receive certificates. Transfer agent maintains the security's ownership records. Test Topic Alert: Bonds issued today must be fully registered or book-entry, not bearer or registered as to principal only bonds - the issuer must have the name of the investor entitled to both principal and interest payments on its ownership list.

Market Makers; Ask and Bid Price

Broker-dealers called market makers maintain inventories of OTC securities. 1. They sell to other broker-dealers out of their inventory for their asked or offering price. 2. Or they buy from other broker-dealers for their inventory at their bid price. 3. Market makers buy and customers sell at the bid price. 4. Market makers sell and customers buy at the ask price. 5. Competition among market makers ensures the customer of the lowest ask price available if the customer is buying or the highest bid price available if the customer is selling.

Bullish and Bearish Stock Positions

Buy low now, sell high later An investor who buys shares is considered long the stock, and is bullish- that is, expects the stock to increase in price. Long is the act of buying. Sell high now, buy back low later Such a transaction, known as a short sale, involves borrowing shares to sell that the investor must eventually replace. An investor who sells borrows shares is short the stock until he buys and returns the shares to the lender, and is bearish - expects the stock to go down in price. Short is the act of selling.

Advantages of a Call to the Issuer

Callable bonds can benefit issuers in several ways. 1. If general interest rates decline, the issuer can redeem bonds with a high interest rate and issue new bonds with a lower rate. 2. An issuer can call bonds to reduce its debt. 3. The issuer can replace short-term debt issues with long-term issues, and vice versa. 4. The issuer can call bonds as a means of forcing the conversion of convertible corporate securities. If a bond issue's trust indenture does not include a call provision, the issuer can buy bonds in the open market, a practice known as tendering, to retire a portion of its debt.

Revenue Bonds

Can be used to finance any municipal facility that generates enough income to support its operations and debt service.

FRB - Reserve Requirements

Commercial banks must deposit a certain percentage of their depositors' money with the Federal Reserve. When a small change in reserve requirements has an exaggerated result in terms of the money supply, it is known as a multiplier effect.

Voting rights

Common stockholders exercise control of a corporation by electing a board of directors and by voting at annual meetings on important corporate policy matters, such as: 1. Issuance of convertible securities or additional common stock 2. Substantial changes in the corporation's business, such as mergers or acquisitions 3. Election of board of directors Shareholders do not vote on: 1. Dividends 2. Stock splits 3. Membership on the Board of Directors 4. And issuance of additional securities like common stock and convertible bonds

Commercial Paper

Corporations issue short-term, unsecured commercial paper, or promissory notes, to raise cash to finance accounts receivable and seasonal inventory coverages.

Categories of Preferred Stock - Callable Preferred

Corporations often issue callable, or redeemable, prefered, which a company can buy back from investors at a stated price after a specified date. Take Note: Callable preferred stock is unique because of the risk that the issuer may buy it back and end dividend payments. Because of this risk, callable preferred has a higher stated rate of dividend payment than straight, noncallable preferred. Issuers are likely to call securities when interest rates are falling. Like anyone, an issuer would prefer to pay a lower securities that have lower fixed rate obligations.

Over-the-counter (OTC)

OTC securities are priced by negotiations because there are no centralized trading locations.

Categories of Preferred Stock - Adjustable-Rate Preferred

Dividends are usually tied to the rates of other interest rate benchmarks, such as Treasury bill and money market rates, and can be adjusted as often as semiannually. Test Topic Alert: Which of the following types of preferred stock typically has the highest stated rate of dividend (all other factors being equal)? A. Participating B. Straight C. Cumulative D. Callable Answer: D. When the stock is called, dividend payments are no longer made. To compensate for that possibility, the issuer must pay a higher dividend. Which of the following would you expect to have the higher stated rate? A. Straight B. Cumulative Answer: A. Cumulative preferred is safer, and there is always a risk-reward trade-off. Because straight preferred has no special features, it will pay a higher stated rate of dividend.

Price Levels

Economists adjust GDP figures to constant dollars rather than compare actual dollars.

Interest

Example: A bond with a coupon of 6% pays $60 of interest every year on a semiannual basis (6% x $1,000). Therefore, the bond pays $30 of interest every six months (no matter what the bond's current market value is).

Preferred Stock - Limited Ownership Privileges

Except for rare instances, preferred stock does not have voting or preemptive rights. Test Topic Alert: Preferred stock represents ownership in a company like common stock, but its price is sensitive to interest rates - just like the price of a bond.

Transferability of Ownership

Exchange of money and ownership requires little or no additional action on the investor's part. Few or no restrictions when it comes to giving, transfering, assigning, or selling shares.

Call protection period

Five or ten years that provides some safety to investors for newly issued bonds. During this period, issuer may not call any of its bonds.

Antidilution Provision

Gives the owner of convertible securities such as a convertible preferred stock or bond, the right of the owner to maintain the same conversion ratio in the event of a stock split or stock dividend.

Agency Issues

Gov. National Mortgage Association (GNMA or Ginnie Mae) Take Note: Unlike a traditional bond that pays interest every six months and returns an investor's principal in one lump sum at maturity, Ginnie Maes pay interest and return a portion of principal to investors each month. Test Topic Alert: Of agency securities, GNMAs are the most testable. Important points to remember: 1. Ginnie Maes are the only agency security backed in full by the U.S. gov. 2. Ginnie Mae issues pass-through certificates Investors receive interest and principal on a monthly basis; investors buy Ginnie Maes to satisfy income objectives 3. Yield on Ginnie Maes are slightly higher than on Treasuries 4. Ginnie Maes are subject to interest rate and prepayment risk

Warrants

Grants the owner the right to buy securities from the issuer at a specified price, normally higher than the market price when issued. Unlike a right, a warrant is a long-term instrument, giving the investor the choice of buying shares at a later date at the exercise price.

Benefits of Common Stock Ownership: Growth

Growth: An increase in the market price of shares is called capital appreciation. Take Note: When an investor sells a security for more than it was purchased for, the profit is defined as a capital gain; if money is lost on the sale, the loss is defined as a capital loss. If the investor does not sell the stock, the investor has an unrealized gain (or loss). Capital gains are taxable only when they are realized.

Residual Claims to Assets

If a corporation is liquidated, the common stockholder, as owner, has a residual right to claim corporate assets after all debts and holders of more senior securities have been satisfied. The common stockholder is at the bottom of the liquidation priority list. This makes common stock the most junior security.

Liquidation Priority

In the event a company goes bankrupt, the hierarchy of claims on the company's assets are as follows. Unpaid wages IRS, state, and county (taxes) Secured debt (bonds and mortgages) Unsecured bonds (debentures) and general creditors of the issuer Subordinated debt Preferred stockholders Common stockholders Test Topic Alert: Be ready for a question on liquidation priority. Secured debt is safest, followed by unsecured bonds, then subordinated debt. Common stock is always last in line. Bonds are frequently called senior securities because of their priority in this hierarchy.

Outstanding Stock

Includes any shares that a company has issued by has not repurchased - that is, investor-owned stock. Test Topic Alert: On the exam, you might see a question like this: ABC company has authorized 1 million shares of common stock. It issued 800,000 shares one year ago. It then purchased 200,000 shares for its treasury. How many shares of ABC stock are outstanding? The solution requires you to know a basic formula: Issued stock (800,000) - Treasury stock (200,000) = Outstanding stock (600,000) ABC company has 600,000 shares of common stock outstanding. This question illustrates another point about FINRA exams. The question gives the number of shares of authorized stock, but this information is unnecessary. Many questions give more information than you need. The Series 6 exam requires you to know concepts well enough that you can determine both what is and what is not essential to solving a problem.

Benefits of Common Stock Ownership: Income

Income: Many corporations pay regular quarterly cash dividends to stockholders based upon the company's earnings. Take Note: A company that earns $1 per share may elect to pay a portion of those earnings to shareholders in dividends. As earnings increase over time, the company may increase its dividend as well. Investors who receive dividends must generally pay 15% dividend tax. (Until recently, investors paid ordinary income taxes on dividend income.) The IRS makes no exceptions for individuals, but corporations receive a 70% exclusion on dividend income. Example: Ten years ago, an investor bought 100 shares of ABC Corp. for $20 per share, for a total investment of $2,000. At the time, the company's business was profitable, earning $3 per share of which it paid $1 per share in dividends to shareholders and reinvested the rest in growing the business. Ten years later, after moderate but consistent growth, the company earns $12 per share and pays $4 in dividends per share. The stock price has consistently increased with the earnings growth and now sells for $80 per share ($8,000 total value for our investor's 100 shares). The investor has had to pay income taxes each of the past 10 years on the dividend income he received but will only have to pay capital gain taxes if he sells the stock. If he sold the stock now, his taxable capital gain would be $60 per share ($80 current value - $20 original cost = $60 capital gain).

Risks of Common Stock Ownership: Business Risk

Investors have no assurances that they will receive the returns they expect from their investments. Business Risk Or the level of risk of the specific business, includes the speculative nature of the business, the management of the business, the philosophy of the business, and so on. Relates to the activities of the company.

Risks of Common Stock Ownership: Low Priority at Dissolution

Investors have no assurances that they will receive the returns they expect from their investments. Low Priority at Dissolution If company declares bankruptcy, holders of its bonds and preferred stock have priority over common stockholders.

Risks of Common Stock Ownership: Market Risk

Investors have no assurances that they will receive the returns they expect from their investments. Market Risk The tendency for securities to move with the market is market risk. Long investor's losses are limited to his total investment in a stock. Short seller's losses are theoretically unlimited because there is no limit to how high a stock's price may climb.

Nominal Yield

Is set at issuance and printed on the face of the bond. Nominal yield is a fixed percentage of the bond's par value and is also known as the coupon or stated yield. Example: A coupon of 6% indicates the bondholder is paid $60 in interest annually ($30 every six months) until the bond matures. 6% x $1,000 (par) = $60 Take Note: Recognize that different names exist for a bond's nominal yield. It can be called the coupon rate, the fixed rate, or the stated rate of the bond. The nominal rate of interest will always be paid to the bondholder, regardless of whether the bond's price changes.

Liquidity

Is the ease with which a bond or any other security can be sold at current market value. Many factors determine a bond's liquidity, including: Quality Rating Maturity Call features Coupon rate and current market value Issuer Existence of a sinking fund (an account to insure payment of principal) Take Note: The terms liquidity and marketability are synonymous. Know that either term refers to how quickly a security can be converted into cash.

Leverage or Income

Leverage: a relatively small cash outlay allows an investor to control an investment that would otherwise require a much larger sum. Income: main objective for a seller of an option contract. Writer: Sells contract, collects premium, hopes contract expires so they can keep the premium. Take Note: In a call: the buyer of the call has the right to buy; the seller of the call has the obligation to sell. In a put: the buyer of the put has the right to sell; the seller of the put has the obligation to buy.

Calls and Puts

Listed option contracts are issued in standardized formats by the Options Clearing Corporation (OCC) and traded on the Chicago Board Options Exchange (CBOE) or another exchange. There are two basic types of option contracts: calls and puts: Call option: buyer can buy security at strike price, a bullish position. If selling a call contract, the seller becomes obligated to sell the stock at the strike price if the call option is exercised, a bearish position. Put Option: buyer can sell security at strike price, a bearish position. If selling a put contract, the seller becomes obligated to buy the stock at the strike price if the put option is exercised, a bullish position. Example: A premium of $3 means $3 for each share x 100 shares, or $300. Take Note: In a call: the buyer of the call has the right to buy; the seller of the call has the obligation to sell. In a put: the buyer of the put has the right to sell; the seller of the put has the obligation to buy. Test Topic Alert: The exam will have very few questions about options. You should be well prepared if you know the information in the following table. Be prepared to answer the following questions: Which options positions are bearish? Long put, short call Which options positions are bullish? Long call, short put Which positions buy stock at exercise? Long call, short put Which positions sell stock at exercise? Long put, short call Which positions have rights? Long call, long put Which positions have obligations? Short call, short put

Exchange-Listed Stocks

Listed securities will trade on the exchange. Must meet listing requirements of the exchange, such as maintaining a certain price and trading activity. Exchanges have physical locations and are considered an auction market; there is a trading floor where buyers and sellers compete for trades. In addition to trading on exchanges, listed securities may also trade over-the-counter (OTC).

Economic Policy and the Stock Market

Lower tax rates = stimulate spending Higher tax rates = less spending

U.S. Government and Agency Securities

Marketable gov. Securities trade in the secondary market (OTC). Nonmarketable government securities have no secondary market and, therefore, are only redeemable through the federal gov.

Current Yield

Measures a bond's annual interest relative to its market price, as shown in this equation: Annual interest / market price = current yield Bond prices and yields move in opposite directions: as a bond's price rises, its yield declines, and vice versa. When a bond trades at a discount, its current yield increases; when it trades at a premium, its current yield decreases. Example: What is the current yield of a 6% bond trading for $800 Current yield = annual interest / current market price Find the solution as follows: $60 / $800 = 7.5%. Note that this bond is trading at a discount. When prices fall, yields rise. The current yield (7.5%) is greater than the nominal yield (6%) when bonds are trading at a discount. Example: What is the current yield of a 6% bond trading for $1,200? Find the solution as follows: $60 / $1,200 = 5%. This bond is trading at a premium. Price is up, so the yield is down. The current yield (5%) is less than the nominal yield (6%) when bonds are trading at a premium.

Consumer Price Index (CPI)

Most prominent measure of general price changes is CPI. Measures rate of increase or decrease in a range of consumer prices.

Proxies

Most stockholders find it difficult to attend the annual stockholders' meeting and so vote on company matters by means of a proxy, a form of absentee ballot. Once returned to the company, a proxy is cancelled if the stockholder attends the meeting, authorized a subsequent proxy, or dies.

Municipal Bonds

Municipal bond issuers include states, counties, cities, townships, villages, school districts, and transportation authorities.

Tax Benefits

Municipal securities are more appropriate for investors in high tax brackets than those in low tax brackets because the amount of tax savings for high tax-bracket investors is larger. Calculating tax Benefits Tax-equivalent Yield: (Municipal yield) / (1 - investor tax rate %) = Equivalent corporate yield Tax-free Equivalent Yield: (Corporate yield) x (1 - investor tax rate %) = Equivalent municipal yield Example: Two investors 1. One in a 15% tax bracket and 2. One in a 30% tax bracket, consider purchasing a new municipal bond with a 7% coupon at par. Comparable corporate bonds are currently being issued at 8.5%. The investor in the 15% tax bracket would receive a tax-equivalent yield of 8.2%. 1. To calculate this, divide 7% by (100% minus his tax rate of 15%), or 2. 7% divided by 85% (.85), which equals 8.2%. 3. The municipal bond would not be a good choice for this investor because he could get a higher rate of return by investing in corporates. 4. If the investor chooses a corporate bond paying $85 a year, he would pay taxes of $12.75 per bond ($85 x 15%), leaving him with $72.25 after taxes, which is more than the $70.00 he would get from the municipal bond. The investor in the 30% tax bracket would receive a tax-equivalent yield of 10% (7% divided by 100% minus his 30% tax rate, or 1. 7% divided by 70% = 10%). He would receive a higher after-tax yield from the municipal bond. 2. If the investor chooses a corporate bond paying $85 a year, he would pay taxes of $25.50 ($85 x 30%), leaving him with $59.50 after taxes, which is less than $70.00 tax free. Test Topic Alert: The most important point about municipal debt is that interest earned on these securities is exempt from federal taxation. They are most suitable for high tax-bracket investors and generally unsuitable for investors in low tax brackets or within retirement plans. Note that interest may also be a tax-exempt at the state and local level if the bond holder is a resident of the state in which the bond is issued.

Maturities of Bonds (Maturity)

On the maturity date, the loan principal is repaid to the investor. Each bond has its own maturity date. The most common maturities fall in the five to 30-year range. The longer the term to maturity, the greater the risk to bondholders. Bonds with longer terms to maturity experience greater fluctuation in price, or volatility, than short-term bonds.

Issued Stock

Once authorized, issued stock can be distributed to investors. When selling fewer shares than the total number authorized, it normally reserves unissued shares for future needs, including: 1. Raising new capital for expansion 2. Paying stock dividends 3. Providing stock purchase plans for employees or stock options for corporate officers 4. Investors converting convertible bonds or convertible preferred stock to common stock 5. Satisfying the exercise of outstanding stock purchase warrants

Pricing of Bonds

Once issued, bonds are bought and sold in the secondary market at prices determined by market conditions. Par, Premium, and Discount 1. Premium: Above par 2. Discount: Below par 3. Bond quotes are commonly stated as percentages of par. A bid of 100 means 100% of par, or $1000. A bond quote of 98 and ⅛ means 98 and ⅛% (98.125%) of $1,000, or $981.25. Example: Bid - 98 ¾ Ask - 98 ⅞ The term basis point may be used on your exam. A basis point is 1/100 of 1%. 100 basis points equals 1%. Therefore 75 basis points is .75%, 50 basis points is .50% and so on. Test Topic Alert: It is important to remember that one bond point is equal to $10 and one stock point is equal to $1. For example, when a bond is selling at a 2% premium, it is selling at 102% of par, or $1020 (2 points over par). Take Note: Just like preferred stock, bond prices are inversely affected by interest rates. As interest rates fall, bond prices rise; as interest rates rise, bond prices fall. This inverse relationship affects all debt securities. Long-term bond prices fluctuate more than short-term bond prices because the longer length of time to maturity magnifies price movement. The risk of rising interest rates reducing the value of fixed income investments such as preferred stock or bonds is called interest rate risk. However, it is important to know that a bond that is held to maturity has no interest rate risk because, at maturity, the bondholder receives the par value, or face amount of the bond. Bond Price/Yield Relationship Price decreases = Yield increases

Primary Offering (aka Primary market) and Secondary Market

Once issues in a primary offering, securities typically trade between investors in what are known as secondary market transactions. Trades take place on: 1. Stock Exchanges 2. Over-the-counter (OTC) 3. Or, in case of some securities - both.

Calculating Conversion Parity

Parity is the state of a convertible bond (or preferred stock) when its price is equal to the market price of the underlying stock. Following calculate the parity prices of convertible securities and their underlying common shares: Market price of the bond / conversion ratio (# of shares) = Parity price of common stock, or Market price of common x conversion ratio = parity price of convertible bond Example: RST convertible bond has a conversion price of $50. If the bond has a current market value of $1,200, what is the parity price of the underlying common stock? Par value: $1,000 Conversion price: $50 Current market value (CMV) of the bond: $1,200 Calculate parity price of the common stock. Step one: calculate the conversion ratio: $1,000 / $50 = 20 shares of common stock Step two: Divide the CMV by the conversion ratio to determine the parity value of the common stock: $1,200 / 20 = $60 If the stock is trading at $60, the value of the equity position (20 x $60 = $1,200) is equal to the CMV of the bond ($1,200). Parity exists. Example: RST convertible bond has a conversion price of $50. If the current market value of the underlying common stock is $40, what is the parity price of the bond? Par value: $1,000 Conversion price: $50 Current market value (CMV) of common stock: $40 Calculate the parity price of the bond. Calculate the conversion ratio: $1,000 / $50 = 20 shares of common stock. Multiply the CMV of common stock by the conversion ratio to determine parity of the bond: $40 x 20 = $800 If the stock is trading at $40, the value of the equity position ($40 x 20 = $800) is equal to the CMV of the bond ($800). Parity exists.

Business Cycles

Periods of economic expansion are historically followed by periods of economic contraction in a pattern called the business cycle. Four stages: Expansion Peak Contraction (decline) Trough (and then the cycle repeats) Test Topic Alert: Know the order of the four phases of the business cycle: expansion, peak, contraction, trough. Take Note: Inflation causes purchasing power risk. Today's dollars can buy fewer goods tomorrow. A constant dollar adjustment must be made to compare dollars from year to year that have been affected by inflation.

Refunding Bonds

Practice of raising money to call a bond. Take Note: Refunding can be thought of as issuer refinancing. Homeowners are familiar with this: when interest rates drop, it makes sense to replace a high-interest mortgage with a new mortgage at a more competitive rate. An issuer can accomplish the same thing by refunding.

Money Market Instruments

Provide businesses, financial institutions, and governments a means to finance their short-term cash requirements. Liquidity and Safety Because money market instruments are short-term, they are highly liquid

The Money Market

Take Note: The money market is the source for short-term financing, while the capital market is the course for medium - to long-term financing. Money market funds are short-term, liquid debt obligations.

Rating and Analyzing Bonds

Rating services, such as Standard & Poor's and Moody's, evaluate the credit quality of bond issues and publish their ratings - rate both corporate and municipal bonds and base their bond ratings primarily on an issuer's creditworthiness. Take Note: Speculative (noninvestment-grade) bonds are commonly referred to as high-yield bonds or junk bonds, they must offer high yields to compensate investors for the elevated risk that the bond may default. Test Topic Alert: You might be asked to choose the bond with the highest rating. Ratings are like report cards - the more As up front, the better. Example: Which of the following bonds is considered to be safest: A rated mortgage bond Baa rated equipment trust certificate AA rated unsecured debenture B rated funded debt Answer: C. The safest of the bonds listed is the AA rated unsecured debenture. You don't need to be concerned with the type of bond; the rating takes into account all features of the security when rating the credit risk.

Fiscal Policy

Refers to legislative decisions of Congress and the President, which basically involves the ability to tax and spend and can include increases or decreases in: Federal spending Money raised through taxation Federal budget deficits or surpluses

Yield to Maturity (YTM)

Reflects the annualized return of the bond if held to maturity and is the most comprehensive measure for comparison of bond yields. Take Note: When a bond is trading at a premium, its YTM is less than its current yield. The point of intersection on the YTM line is below the current yield on the line that represents premium. Use the chart to keep these important relationships in mind. When you take the Series 6 exam, draw this chart for reference on a piece of scratch paper. Bond at premium = YTM is less than current yield.

Call Premium

Right to call bonds for early redemption gives issuers flexibility in their financial management. When calls for bond before maturity - issuer pays bondholders a call premium.

Rights

Rights Preemptive rights allow existing stockholders to maintain their proportionate ownership in a company by buying newly issued shares before the company offers them to the general public. Rights offering allows stockholders to purchase common stock below the current market price. Stockholder who owns rights may: Exercise the rights to buy stocks by sending the rights certificates and a check for the required amount to the rights agent Sell the rights and profit from their market value (negotiable securities) Let the rights expire and lose their value Approval for an Additional Stock Issue BOD must approve decisions to issue additional stock through a rights offering. Characteristic of Rights Subscription Rights Certificate: Short-term (30-45 days) privilege to buy additional shares of a corporation. Terms of the Offering: Terms describe how many new shares a stockholder may buy, price, the date new stock will be issued, and a final date for exercising the rights. Standby Underwriting: Done on a firm commitment basis, meaning the broker-dealer or underwriter buys all unsold shares from the issuer and then resells them to the general public.

Rights of ADR Owners

Share certificates of foreign companies are held by a U.S. depository bank. U.S. bank issues the receipts for the shares. Investor purchases the ADR with U.S. dollars, receives dividends through the bank in U.S. dollars, and may sell the ADR on the open market for U.S. dollars. Remember that stock represented by the ADR is originally traded in a foreign currency, and that dividends are initially paid by the foreign company in that currency. ADR holders face normal business risks and currency risks, if foreign currency declines in value. ADR holder has no preemptive rights and generally, no voting rights but does have the right to exchange the ADRs for actual foreign certificates. Test Topic Alert: The following question identifies nearly all the testable points on ADRs: Which of the following statements about ADRs is TRUE? Owners of ADRs have preemptive rights. ADRs allow foreign investors to buy domestic issues of stock. Owners of ADRs receive dividends in foreign currency. ADR owners are subject to currency risk. Answer: D. Owners of ADRs face currency risk. The exchange rate between the foreign currency of the ADR issuer and the U.S dollar causes the dividend payment to rise and fall in dollar value. Owners of ADRs have no preemptive rights. ADRs allow domestic investors to purchase foreign issues, not the reverse. ADR owners receive dividends in dollars.

Monetary vs. Fiscal Policy

Test Topic Alert: Monetary Policy: Policy of the Federal Reserve Board (FRB) Discount rate Reserve requirement (multiplier effect) Open market operations (most frequently used) Fiscal Policy: Actions of Congress and the President Government spending and Taxation

Banker's Acceptance (BA)

Short-term time draft with a specified payment date drawn on a bank - essentially a postdated check or line of credit.

Statutory vs. Cumulative Votes

Stockholder has one vote for each share of stock owned for each item on the ballot. Depending on a company's bylaws and applicable state laws, a stockholder may have: Statutory voting: Allows a stockholder to cast one vote per share owned for each item on a ballot, such as seats on the board of directors. A board candidate needs a simple majority to be elected. Cumulative voting: Allows stockholders to allocate their votes in any manner they choose. Cumulative voting may be advantageous for small shareholders by giving them a greater opportunity to offset the votes of large shareholders by combining all their shares on a single seat. Example: An investor owns 100 shares of stock in the ABC Company. An election of the board of directors is coming up, and several candidates are running to fill three seats. The investor thus has a total of 300 cotes - 100 for each seat. Under statutory voting, he would allocate 100 votes to each of the three candidates he prefers. Under cumulative voting, he could, if he wished, allocate all 300 of his votes to a single candidate for just one of the seats.

Limited Liability

Stockholders cannot lose more than the amount they have paid for a corporation's stock. Limited liability protects stockholders from having to pay a corporation's debts in bankruptcy. Test Topic Alert: Limited liability means a shareholder of common stock cannot lose more than what was invested - a shareholder can lose the original value of his stock only. Another way to refer to limited liability is to state that common stock is non-assessable. You may see the term assessable common stock on your exam; there is no such thing as assessable common stock in today's marketplace.

Inspection of Corporate Books

Stockholders have the right to receive annual financial statements and obtain lists of stockholders. Inspection rights do not include the right to examine detailed financial records or the minutes of directors' meetings.

Economic Factors

Supply and demand.

Marketable Government Securities - Treasury Bills (T-Bills)

T-bills are short-term obligations and, unlike most other debt securities, are issued at a discount from par (or face amount). Example: An investor buys a T-bill for 975 ($975) and receives $1,000 when the bill matures in six months. The $25 difference ($1,000 - $975) is the investor's return. Maturities. Treasury bills are issued and mature in 4, 13, 26, or 52 weeks. Test Topic Alert: Treasury bill maturities are expressed in weeks, or one year in the case of the 52-week bill. Pricing. Once they are issued, T-bill bid and ask quotes in the secondary market are stated in terms of the annualized interest rates that the discount from par value will yield. Example: Note the following quote: U.S Treasury Bills Maturity Date - 12/15 Bid - 5.00 Ask - 4.90 T-bills are quoted on a yield basis and sold at a discount from par. They are zero-coupon securities. The bid reflects the yield buyers want to receive. The ask reflect the yield sellers are willing to accept. The exam will not require you to calculate the bid and ask prices of T-bills. Because T-bills are quoted in yield, a T-bill quote has a higher than its ask, which is the reverse of bid-ask relationships for other instruments.

Marketable Government Securities - Treasury Inflation Protection Securities (TIPS)

TIPS, helps protect investors against purchasing power risk.

Agency-Like Organizations

Take Note: The creation of a pass-through security begins with a pool of mortgages. This pool is packaged together and a single security is created. The important distinction between a pass-through and any other mortgage backed security (MBS) such as collateralized mortgage obligations (discussed next) is that the pass-through is the only security created from the pool of mortgages. Other types of mortgage-backed securities could start with the same mortgages but create numerous different securities. Take Note: Ginnie Mae is the only agency that is backed by the U.S gov. Freddie Mac, Fannie Mae, and other agencies are backed by their own issuing authority and are considered moral obligations of the U.S. gov. On Sept. 7, 2018, the Federal Housing Finance Agency (FHFA) established a conservatorship for Fannie Mae and Freddie Mac. As the conservator, the FHFA has taken over the assets and assumed all the powers of shareholders, directors, and officers. It may take any necessary action to restore the firms to a sound and solvent condition. The conservatorship will end when the FHFA finds that a safe and solvent condition has been restored. For test purposes, you should consider agency issues (in general) to be second only to issues of the U.S. gov. In terms of safety from default.

BA vs. Commercial Paper vs. CDs

Test Topic Alert: Know the features of each money market instrument listed below: Banker's Aceptance (BA): Time draft or letter of credit for foreign trade Max maturity of 270 days Commercial Paper: Issued by corporations Unsecured promissory note Max maturity of 270 days Negotiable CDs: Issued by banks Min. face value of $100,000 Mature in one year or less Unsecured Interest bearing

Rights vs. Warrants

Test Topic Alert: Rights: Short-term instruments, exercise price is below market price; issued to current shareholder only, who may exercise them, sell them on the open market, or let them expire. Warrants: Long-term instruments, exercise price is above market price at time of issue; used as sweeteners with issues of more speculative corporate bonds; also, owners of warrants are not entitled to dividends, though they may sell the warrant on the open market.

Market, Book, and Par Value

Test Topic Alert: Three methods of common stock valuation do not result in the same amount. 1. Market value = supply and demand price (most familiar to investors) 2. Book value = current hypothetical liquidation value of a share. 3. Par value = an arbitrary accounting value.

Treasury Stock

Test Topic Alert: 1. Was outstanding stock before it was repurchased by the issuer 2. Has no voting rights 3. Does not receive dividends 4. Can be reissued or retired A corporation buys back its stock for reasons that include: 1. Increase earnings per share 2. Have an inventory of stock available to distribute as stock options, fund an employee pension plan, etc. 3. Use it for future acquisitions

Open-Market Operations

The Federal Open Market Committee (FOMC) was created to direct the FRB's open market operations. Test Topic Alert: When it comes to monetary policy, moving reserve requirements is the least used tool and Federal Open Market Committee Operations is the most frequently used tool.

Monetary Policy

The Federal Reserve Board (FRB) affects the money supply through its use of three policy tools: Changes in reserve requirements Changes in the discount rate (on loans to member banks) Open-market operations (buying and selling Treasury securities)

Economic Policy

The Federal Reserve Board (FRB, the Fed) conducts monetary policy by influencing the money supply, which in turn affects interest rates and the economy.

The Trust Indenture Act (TIA) of 1939

The act requires corporate bonds of $50 million or more and greater than 270 days to maturity to be issued under a trust indenture, a legal contract between the bond issuer and a trustee representing bondholders. Trustee TIA requires a corp. To appoint a trustee - usually a commercial bank or a trust company - for it's bonds. Exemptions Fed. and municipal governments are exempt from TIA, although municipal revenue bonds are typically issued with a trust indenture to make them more marketable.

Debt Retirement

The schedule of interest and principal payments due on a bond issue is known as the debt service.

Interest Rates

The cost of doing business is closely linked to the cost of money; the cost of money is reflected in interest rates. Major U.S. interest rates include the following: 1. Federal funds rate - most volatile, changes every day 2. Prime rate - changes when banks react to changes in FRB policy. 3. Discount rate - charge on loans to depository institutions 4. Broker call loan rate - charge on loans to broker-dealers with stock as collateral

Calculating Yield/Current Yield

The dividend yield is the annual dividend (four times the quarterly dividend) divided by the current price of the stock. A stock's dividend yield may also be referred to as its current yield. Test Topic Alert: You might be asked to calculate dividend yield on the exam. Formula: Annual dividend/Current market value of the stock = dividend yield, or current yield Example: RST stock has a current market value of $50. Total dividends paid during the year were $5. What is the dividend yield? The solution is found by dividing $5 by $50. The yield is 10%. Be alert for a slightly tricky approach to this question. The question might state that RST has a current market value of $50. The most recent quarterly dividend paid was $1.25. What is the dividend yield. The solution is found by annualizing the quarterly dividend (multiplying by 4) first. $1.25 x 4 = $5. $5/50 = a 10% dividend yield - remember to use annual dividends in calculating yield. Test Topic Alert: You may see a question that asks about the priority of dividend payments made by a corporation. The order of payment is as follows: Dividends in arrears paid to cumulative shares Stated dividends paid to all preferred shares Common dividend

Market Price or Current Market Value (CMV)

The most familiar measure of a stock's value is its market price, or current market value (CMV). 1. The number of shares available to investors 2. The number of shares investors want to buy

Duration

Tool in bond calculations; it is a measure of the amount of time a bond will take to pay for itself. Fo the Series 6, remember that duration is often used to assess the sensitivity of a bond in response to interest rate changes - the longer the duration, the greater the sensitivity, and thus greater interest rate risk in an environment of changing interest rates.

Types of Corporate Bonds

Two primary types of corporate bonds are secured and unsecured. Take Note: Holders of secured bonds do not have a specific claim on any of the other assets of the corporation in a liquidation. Guaranteed Bonds Income Bonds Zero-Coupon Bonds Take Note: When a bond doesn't pay interest, it is said to trade flat. Zero-Coupon bonds, income (adjustment) bonds, and any bond in default is considered trade flat. Test Topic Alert: If asked which security has no reinvestment risk, look for a zero. This is because there are no semiannual interest payments to reinvest. Also, buying a zero is the only way to lock in a rate of return. When the exam asks you to select an investment that provides for a certain dollar amount in the future, zeros are a good choice because investors know they will receive the face amount at maturity. Example: A suitability question asks what you would recommend to a couple who wishes to have $100,000 available in a college education fund in 10 years. Choose a zero coupon.

Marketable Government Securities - Treasury Notes (T-Notes)

Unlike T-bills, T-notes pay interest every six months. Maturities - T-notes are intermediate-term bonds maturing in 2 to 10 years. Pricing - T-Notes are issued, quoted, and traded in 1/32 of a percentage of par.

Sinking Fund

Used to call bonds, redeem bonds at maturity, or buy back bonds in the open market.

Redemption

When a bond's principal is repaid, the bond is redeemed. Example: The redemption amount for a 6%, $1,000 par corporate bond equals the last semi-annual interest payment of $30, plus the principal of $1,000, for a total amount due of $1,030.

Call Risk

When investors face with having to replace a relatively high fixed-income investment with one that pays less.

Bond Yields

Yield is determined by the issuer's credit quality, prevailing interest rates, time to maturity, and call features.

Comparing Yields

You can look at a bond's yield in several ways.