CFP COURSE 3: INVESTMENT PLANNING NOTES

DOWNSIDE OF HAVING TOO MUCH CASH IN RETIREMENT

All individuals need some cash and cash equivalents, if for no other reason than to pay for current expenses. However, some individuals tend to have too much cash, which leads them to incur a great deal of purchasing power risk. One of the financial mistakes that retirees make is to position too much of their investment portfolios in cash and cash equivalents, only to find a few years later that their ability to buy life's necessities has been eroded by inflation. Indeed, the financial planner should remember that one of the biggest risks to a senior's income is not the loss of an investment's principal but, rather, the loss of an investment's purchasing power.

EXAMPLES OF "LIQUID" & "MARKETABLE"

For example, a money market deposit account is liquid but not marketable. Rather, such an account is only REDEEMABLE—that is, there is no market beyond the issuer of the obligation, which is the bank in this case. Alternatively, a U.S. Treasury bill is BOTH LIQUID and MARKETABLE. Accordingly, whenever cash and cash equivalents (and investments generally) are discussed in the financial planning process, the financial planner should understand the difference between liquidity and marketability and that one does NOT necessarily lead to the other.

PROFESSOR'S NOTE: DIVIDENDS

For our discussion, we are referring to cash dividends from stocks, not dividends distributed in stock, which are generally not taxable for federal income tax purposes, or additional shares.

TEST TIP: PRIVATE PLACEMENTS

Frequent investors in private placements include INSURANCE COMPANIES and PENSION FUNDS.

Secondary or Seasoned Offering.

If a company has already issued shares but wants to raise additional capital through the sale of more stock, it does so by what is called.

T-BILL: PRE-MATURE SALE

If an investor sells a T-bill before it reaches maturity, the difference between the sales price and the investor's original purchase price is taxable. Investors may use T-bills to diversify their portfolios and to participate in a secure, short-term investment.

Short Selling & Dividends

If the company pays a dividend before the short sale is covered, the short seller is required to make a cash payment in lieu of the dividend to the investor whose stock was borrowed. Investors have no particular time period to cover the short sale.

MARGIN CALL

If the equity in an investor's position drops below the maintenance margin percentage, then the investor will receive a margin call (i.e., a demand by the broker to add cash to the margin account). If the investor does not add cash promptly, a portion of the investor's position will be sold by the broker to cover the margin call.

Public Float

Indicates the number of shares that are available for trading by investors; the remaining shares of those outstanding generally are held by insiders and often have restrictions on disposition.

"MARKETABILITY" DEFINITION

Liquidity may be compared with marketability, which is the ability to sell an investment quickly in a readily identifiable market (i.e., no consideration of whether a corresponding loss of principal occurs at the time of sale). Cash and cash equivalents are generally characterized by both their relative liquidity and marketability; however, just because a cash equivalent is liquid does not necessarily mean it is marketable. **For example, a money market deposit account is LIQUID but NOT MARKETABLE.**

MUTUAL FUND SELECTION:

MUTMUTUAL FUND SELECTION:UAL FUND SELECTION:

"CALL LOAN RATE" ("CALL MONEY RATE")

Margin accounts (or marginable securities) may be used as collateral by the broker-dealer for its own borrowing from a bank. If this is done, the bank will charge interest to the broker-dealer on the loan using a predetermined rate known as the call loan rate (also known as the call money rate).

Individual common stock may be directly owned in two ways:

An investor is issued a certificate (CERTIFICATE FORM) of ownership by the corporation indicating the number of shares owned. Investors may use a brokerage firm to hold stock in a brokerage account on their behalf (STREET NAME). **Most often, investors will leave their securities with a brokerage firm rather than taking physical delivery of a stock certificate. A possible disadvantage to securities being held in street name is a possible loss if the brokerage firm fails. Most of the time, though, securities are covered by the Securities Investor Protection Corporation (SIPC), and this should not be an issue.**

Odd Lot

An odd lot would be less than 100 shares.

T-BILL: CASH MANAGEMENT BILLS

Another type of T-bill, the cash management bill, is issued in variable terms, usually of only a matter of days. Cash management bills are not auctioned on a regular schedule.

Money Market Deposit Accounts (MMDAs)

Some banks and savings and loans offer money market deposit accounts (MMDAs). These accounts should not be confused with money market mutual funds, which are offered by open-end investment companies and are not federally insured. Rather, MMDAs are bank obligations and ARE FEDERALLY INSURED, subject to the $250,000 per ownership category LIMIT. As a result, MMDAs are very safe and highly liquid. In addition, although MMDAs require a minimum balance to be maintained, they offer limited check-writing privileges. Typically, SIX TRANSFERS or withdrawals are permitted from the MMDA EACH MONTH. Investors may use MMDAs as a temporary place to store money for future investments.

IPO'S and Investment Banks

Specifically, the owners engage an investment banking firm to underwrite the stock offering—that is, purchase all the public shares at a pre-established price and then resell them to the public (presumably at a significant profit). The day before the actual sale of the company's shares to the actual public, the underwriter typically prices the issue.

The three major categories of money market mutual funds are as follows:

Taxable money market funds. Tax-exempt money market funds—national. Tax-exempt money market funds—state.

PROFESSOR'S NOTE: SIPC COVERAGE

The SIPC oversees the liquidation of brokerage firms and insures investors' accounts up to a maximum value of $500,000 ($250,000 for cash balances) in the case of bankruptcy of a brokerage firm the SIPC insures brokerage accounts in the event of a brokerage firm's financial difficulties, it does not cover market losses suffered while waiting to get securities from a bankrupt brokerage firm.

U.S. Treasury Bills: ISSUANCE

The U.S. Treasury regularly issues, by way of weekly auction (52-week T-bills are auctioned every 4 weeks), 4-, 13-, 26-, and 52-week T-bills in $100 increments with a $100 minimum purchase. T-bills are PURCHASED AT A DISCOUNT, which means they are sold at a price less than their par or face value. However, because T-bills have a maturity date of no more than one year, they are not subject to the original issue discount taxation rules that apply to other bonds.

The secondary market consists of four distinct markets: 1st Market

The first market is the exchange (auction) market where listed securities trade and includes the New York Stock Exchange (NYSE) and the over-the-counter (OTC) market.

Holding Period Return With Use of Margin

The holding period return (HPR) computation may also be used in conjunction with the use of borrowed money by the investor. Intuitively, if an investor has borrowed money to make an investment, he has less of his own money at risk and, accordingly, his HPR should increase.

Terms involved in the issuance of securities: Managing underwriter, lead underwriter, or originating house.

The investment banker that takes the lead role in an underwriting group.

Terms involved in the issuance of securities: Syndicate.

The investment banking companies that participate with the managing underwriter to assist in the distribution of the new issue.

Terms involved in the issuance of securities: Prospectus.

The offering document for the sale of securities.

REVERSE REPURCHASE AGREEMENT (AKA "REVERSE REPO")

The opposite of the repo is the reverse repurchase agreement, or reverse repo. In a reverse repo, the dealer buys government securities from another dealer and then sells them back later at a higher price. Many central banks use repos and reverse repos in government debt as part of their open-market operations.

Terms involved in the issuance of securities: Registration.

The process of filing the prospectus with the SEC.

Terms involved in the issuance of securities: Green shoes.

The right to increase the size of an offering.

PROFESSOR'S NOTE: RISK-FREE RATE OF RETURN

The risk-free rate is used as a benchmark to measure the return of other assets and represents the lowest level of return an investor expects to receive.

The secondary market consists of four distinct markets: 2nd Market

The second market provides a method of trading unlisted securities (OTC and Nasdaq).

Professor's Note: Stop Order

The stop order is used to protect investors from large losses. Likewise, this order is used to limit losses in connection with short sales.

Define: Brokers

brokers (agents of sellers of securities who receive a commission for executing a transaction)

Advantages for limited partners include:

business venture participation with limited liability; start-up financing shared with other partners, whereby one individual is not responsible for all the start-up costs; and receipt of periodic income payments.

Define: Dealers

dealers (principals who buy and sell securities for their own accounts).

The following formula is used to determine when a margin call will occur:

margin call = Debit Balance / 1 - maintenance margin Sometimes, this formula is also written as follows: margin call = 1 - initial margin percentage / 1 - maintenance margin × purchase price of stock

The disadvantages of limited partnerships include:

that they are generally riskier investments than bonds or exchange-traded equities; they are usually illiquid; limited partners cannot participate in the management of the partnership; and the sale of partnership interest may be restricted.

Venture capital is provided in the following specific stages: Leveraged buyout (LBO) financing.

Capital is provided to allow management to buy all or part of a business; it is often used when a public company divests a division that it feels is no longer part of its long-term plans.

Venture capital is provided in the following specific stages: Acquisition financing.

Capital, including high-yield bonds, is provided to acquire other companies.

Venture capital is provided in the following specific stages: Mezzanine financing.

Cash is provided for expansion and new products.

Venture capital is provided in the following specific stages: Start-up capital.

Cash is provided for initial marketing activities but not for sales activities.

Venture capital is provided in the following specific stages: First-stage financing.

Cash is provided for manufacturing and sales activities.

Venture capital is provided in the following specific stages: Second-stage financing.

Cash is provided for working capital.

An investment bank's functions may include the following:

Advising corporations on the best ways to raise long-term capital Raising capital for issuers by distributing new securities Buying securities from issuers and reselling them to the public Distributing large blocks of stock to the public and to institutions Helping issuers comply with securities laws

Selling a stock short involves four steps, as follows:

1. The investor uses a stockbroker to borrow stock from another investor's account. This requires the short seller to make a deposit—equal to the margin requirement (currently 50%) times the fair market value of the stock—to the broker. As an outgrowth of this requirement, the investor must also establish a margin account with the broker-dealer. This type of account allows the investor to borrow money from the brokerage firm. 2. The investor sells the borrowed stock in the open market. 3. The investor repurchases the stock in the open market. 4. Finally, the investor replaces, or covers, the borrowed stock.

After a new issue comes to market, typically there is a lockup period during which early investors and employees may not sell their shares. How long is the typical lockup period?

180 Days

For listing on the NYSE, there must be at least:

400 round-lot holders and 1.1 million public shares outstanding (and other financial standards for listing, such as certain earnings or valuation/revenue tests, that must be met)

CERTIFICATES OF DEPOSITS (AKA "TIME DEPOSITS")

Certificates of deposit (CDs), also known as time deposits, are deposits made with a bank or savings and loan for a specified period, commonly one month to five years. CDs have traditionally been used to provide an income stream to retirees. Interest is subject to ordinary income tax in the year earned.

Defining Characteristics of a "ACCREDITED INVESTOR"

A bank, insurance company, registered investment company, business development company, or small business investment company An employee benefit plan, within the meaning of the Employee Retirement Income Security Act of 1974 (ERISA), if a bank, insurance company, or registered investment advisor makes the investment decisions or if the plan has total assets in excess of $5 million A charitable organization, corporation, or partnership with assets exceeding $5 million A director, executive officer, or general partner of the company selling the securities A business in which all the equity owners are accredited investors A natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase (does not include the value of a person's primary residence) A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchase a sophisticated person makes

When will a Company typically Issue New Shares

A company typically issues new shares only if its capital structure of debt and equity needs rebalancing to comply with debt covenants.

Terms involved in the issuance of securities: Initial public offering (IPO).

A company's first public offering of securities.

Round Lot

A round lot is considered the general unit of trading, which is usually 100 shares.

Terms involved in the issuance of securities: Secondary offering.

A sale of securities to the public by insiders or other affiliated persons.

BANKER'S ACCEPTANCES

Banker's acceptances are SHORT-TERM DRAFTS drawn by a private company on a major bank used to finance imports and exports. They are typically traded at a DISCOUNT from their face value in the SECONDARY market. **Companies that are too small to issue commercial paper sometimes use banker's acceptances to finance their short-term debt needs.**

BANER'S ACCEPTANCE: EXPOUNDED

Banker's acceptances are analogous to a personal line of credit issued to a borrower by a financial institution. However, in the case of banker's acceptances, an unsecured line of credit is provided to a corporate or small-business customer. They are taxable as ORDINARY INCOME for federal and state income tax purposes

PROFESSOR'S NOTE: DIVIDEND TAXATION

Be careful with the term dividends—there are several types and they are not all the same! Dividends that receive PREFERENTIAL capital gains treatment (called QUALIFYING DIVIDENDS) are those ISSUED by C CORPORATIONS (the net income is taxed on the corporate level first, and then the dividend is distributed to the shareholder). Dividends paid by an S CORP or a Real Estate Investment Trust (REIT) are not taxed at the corporate level prior to being distributed, so they DO NOT QUALIFY for preferential capital gains treatment.

T-BILL: AS A RISK-FREE INVESTMENT

Because of their lack of default risk and high degree of marketability, T-bills are often used as the proxy for a risk-free investment (an asset having the lowest level of risk among all available assets) in modern portfolio management theory. Specifically, the 13-week (90-day) T-bill is cited as the risk-free rate (rf) in various asset-pricing models and performance measures because it is not sensitive to interest rates and inflation changes.

Terms involved in the issuance of securities: Selling group.

Brokerage firms that help distribute securities in an offering but that are not members of the syndicate.

FDIC INSURANCE OF CDs

CDs are FDIC insured up to $250,000 per ownership category, which is often a reason for investors' interest in purchasing CDs.

Venture capital is provided in the following specific stages: Bridge financing.

Capital is provided for an expected IPO

COMMERICAL PAPER

Commercial paper is a negotiable, short-term, unsecured promissory note issued by a large corporation to finance accounts receivable and inventories. This type of debt is usually issued in denominations of $100,000 or more and is a substitute for short-term bank financing. Money market mutual funds are the primary purchasers of commercial paper. Commercial paper is normally SOLD AT A DISCOUNT and is rated by a rating service (such as Standard & Poor's) as to quality. The term to MATURITY is NO MORE than 270 days and is often backed by lines of credit from banks. Compared to T-bills, commercial paper is slightly less liquid and has a HIGHER risk of default; therefore, it has a nominally HIGHER yield. Commercial paper is taxed in a fashion similar to that used for other money market securities. The income is taxed to the investor at ORDINARY INCOME rates when earned.

NASDAQ: Listing Option

Companies that do not qualify for listing on exchanges or that decide not to list their securities on an exchange may have their securities listed on the National Association of Securities Dealers Automated Quotation system (Nasdaq).

TAX OBLIGATIONS: DIVIDEND INCOME

DIVIDEND INCOME from stocks is called dividend income. All dividend income is taxable to individuals on both federal and state income tax returns. CORPORATIONS receive a DIVIDEND EXCLUSION when they receive dividend income from stocks of other corporations, resulting in a LOWER effective TAX RATE rate on their DIVIDEND INCOME. Some dividends are not taxed because they are an actual return of principal, which serves to reduce the tax basis of the security. These dividends are tax-free because returns of capital dividends are simply a return of the investor's own money

EXAMPLE: HPR using margin

Darrin bought 100 shares of XYZ stock at $100 per share on margin (a 50% initial margin percentage). The margin interest was 8% annually. After one year, Darrin sold all of his shares for $130 per share. XYZ stock paid no dividends during the one-year period. What was Darrin's HPR using margin? The answer is 52%, in the following manner: 1. Ending value = 100 shares × $130 per share = $13,000 2. Beginning value = 100 shares × $100 per share = $10,000 3. Cash flows: - Positive? No (no dividends) - Negative? Yes (margin interest = 8% × 50% × $10,000 = $400) 4. Darrin's investment = 50% × $10,000 = $5,000 Therefore, his HPR can be calculated as follows: HPR = $13,000 - $10,000 - $400 / $5,000 = $2,600 / $5,000 = 0.52 × 100 = 52% In contrast, the HPR would have been only 30%, rather than 52%, if Darrin had not purchased this stock on margin: HPR = $13,000 - $10,000 / $10,000 = $3,000 / $10,000 = 0.30 × 100 = 30% Therefore, Darrin has indeed leveraged, or increased, his percentage HPR through the use of margin. However, what if the value of XYZ stock had declined over the course of the year? In that case, the use of margin would have also increased the potential percentage loss or downside risk that Darrin experienced.

REPURCHASE AGREEMENTS (AKA "REPOs")

Dealers in government securities use repurchase agreements or "REPOs". TO SATISFY SHORT-TERM LIQUIDITY NEEDS, dealers will sell some of those securities to another dealer with an agreement to BUY THEM BACK AT A LATER DATE at an agreed-upon price. The buyer of the repo then receives the equivalent of a fixed yield or return on the investment. Although it is legally a sale and subsequent purchase of securities, a repo is ESSENTIALLY A COLLATERALIZED LOAN, where the difference between the sale and repurchase prices is the INTEREST ON THE LOAN. The rate of interest on the repo is called the "REPO RATE". Similar to commercial paper, repos are frequently found in money market mutual funds because they have an EXTREMELY SHORT MATURITY and VERY LOW RISK.

EURODOLLARS

Eurodollars are U.S. dollar-denominated deposits at banks OUTSIDE OF THE UNITED STATES used to settle INTERNATIONAL TRANSACTIONS. The average deposit is VERY LARGE (in the millions) and has a MATURITY of LESS than SIX MONTHS. Interest income is TAXABLE to the owner as ORDINARY INCOME when earned. A variation on the Eurodollar TIME DEPOSIT is the Eurodollar CD (Euro CD).

DEBIT BALANCE (MARGIN)

Finally, the amount owed to the broker-dealer is known as the debit balance and includes the original amount borrowed by the investor plus any accrued interest. The amount of equity that the investor has in the account is the current fair market value of the security purchased with the use of margin less the debit balance.

The secondary market consists of four distinct markets: 4th Market

Finally, the fourth market is generally used by institutions (e.g., pension funds) that trade in very large volumes among themselves without the help of brokers (INSTINET)

Private Placements

Instead of incurring the time and expense of an IPO, some businesses choose to sell their securities privately in order to meet their capital formation needs. Companies may use private placements to sell an issue—most commonly bonds—to a small group of institutions or sophisticated individual investors. Private placements avoid the SEC registration requirements of an IPO, and the company's information is not accessible by the general public. In addition, the selling costs associated with a public offering are eliminated, and the issue can be tailored to meet both the issuer's and investor's needs. ***Private placements are limited to 35 unaccredited investors but are available to an unlimited number of accredited investors.***

TAX OBLIGATIONS: INTEREST INCOME

Interest Income from deposit accounts—CDs, money market instruments, and bonds—is referred to as interest income. All interest income from these sources is TAXABLE as ORDINARY INCOME on both federal and state tax returns, with some exceptions. Income from U.S. government obligations is not taxable on state income tax returns. Income from state and local municipal bonds is not taxable on federal income tax returns (with certain limited exceptions); it is taxable on state income tax returns, but only when the income is from bonds of states other than the state of residence. Bonds issued in a particular state are generally exempt in that state. Thus, some municipal bonds are said to be double tax exempt. For example, a municipal bond issued in Colorado may be exempt from both federal income taxes and state income taxes for Colorado residents

T-BILL: TAXATION

Interest income from the bill, which is not taxable until the bill matures, is taxed at ordinary federal income tax rates but is not subject to state or local income tax. An investor holding the bill as of the date of maturity includes the amount of the discount as ordinary income.

TYPES OF UNDERWRITING AGREEEMENTS: BEST EFFORTS

Investment bankers guarantee company that entire issue will be purchased; investment bankers absorb loss if they fail to sell entire issue to investor

TYPES OF UNDERWRITING AGREEEMENTS: FIRM COMMITMENT

Investment bankers guarantee company that entire issue will be purchased; investment bankers absorb loss if they fail to sell entire issue to investor

Investment Bankers and Dealers

Investment banks or bankers are financial institutions that assist corporations and municipal governments in raising capital by underwriting new securities and/or acting as the issuer's agent in the issuance of securities

DIVIDEND TAXATION: HOLDING PERIODS

Investors should take special note of the holding period requirement for a stock in order for the dividend to qualify for the preferential rates. The stock must be held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. The extra "1" day includes the day of the transaction.

"LEVERAGE" DEFINED

Leverage is defined as the financial advantage of an investment that controls property of greater value than the cash invested.

PROFESSOR'S NOTE: Limited Partnerships

Limited partnership investments tend to be relatively risky and generally unsuitable for the average investor. Mutual funds or exchange-traded funds (ETFs) offer investors many of the same advantages of limited partnerships, including diversification and professional management, but without as much marketability or liquidity risk.

Limited Partnerships

Limited partnerships are characterized by a partnership entity that consists of a general partner and limited partners. The general partner controls the business activities of the partnership, determines when distributions are made to the limited partners, and has unlimited liability. The limited partners do not participate in the management of the partnership and have limited liability. These programs offer investors a share in the income, gains, losses, deductions, and tax credits of the business entity. Investors should purchase limited partnerships that are economically viable and offer the potential of cash distributions and capital gains.

"LIQUIDITY" DEFINITION

Liquidity is the ability to sell or redeem an investment quickly and at a known price without a significant loss of principal.

The basic order types are as follows:

Market order. This is an order to buy or sell at the current price. The order would be executed at the best price available at that time. Limit order. This is an order to buy or sell at a specific price. The price acts as a ceiling for purchases and a floor for sales. For example, an order to buy at $50 per share means that the buyer does not want to pay more than $50 per share for the stock. Note that "or better" is inferred with limit orders, meaning the order may be executed at a better price if available. For example, with an order to buy at $50, if shares are available at $49.90, the order may be executed at this lower (better) price. Day order. This is an order that is good just for the day and expires at the end of the day (if not executed). Good-til-canceled (GTC) order. This is an order that will remain in effect until either it is executed or canceled. Sometimes broker-dealers will put a time limit on GTC orders, such as 90 days, after which they will automatically be canceled. Stop order. This is an order to buy or sell if the price of the stock trades at or through the stop price. A buy stop would be placed higher than the current market price of the stock, and a sell stop would be placed lower than the current market price of the stock. If the stock trades at or through the stock price, the order then becomes a market order. Stop-limit order. This is similar to a stop order, with the difference being that if the stock trades at or through the stop price, it then becomes a limit order rather than a market order.

TEST TIP: MONEY MARKET MUTUAL FUNDS

Money market mutual funds are used by investors as part of their emergency fund because the funds are extremely liquid. In addition, such funds serve as a short-term depository for investors in a managed (wrap) account who are waiting for a more appropriate time to invest in other securities.

TAX TREATMENT OF DIVIDENDS

Most dividends are taxed at rates of 0%, 15%, or 20%. The rate applicable to the long-term capital gains is determined by the taxpayer's taxable income, which includes the dividend income. For married couples filing jointly, the 0% rate ends at $83,350 of taxable income. Thus, any dividends comprising part of that $83,350 of taxable income will escape taxation entirely. For dividends falling between the $83,351 breakpoint and $517,200 of taxable income (again, for married couples filing jointly), the rate is 15%. For dividends falling into the taxable income above $517,201 (MFJ), the rate is 20%.

Investors who purchase only_________may not have any direct involvement in the primary or secondary markets.

Mutual Funds

NEGOTIABLE CDs

Negotiable CDs are deposits of $100,000 or more placed with commercial banks at a specified interest rate for a term of up to one year. Because of their large denominations, negotiable CDs are bought most often by institutional investors, including money market mutual funds. Unlike regular CDs, which are redeemable by the issuing bank, negotiable CDs are bought and sold in the secondary market at a market-determined price (i.e., an amount that is potentially different from the original principal invested).

MAINTENANCE MARGIN

Once a margin account position has been established, the investor must maintain a maintenance margin, which is usually set at 35%. The maintenance margin is set by the broker-dealer, not the Federal Reserve, but Rule 431(b) of the NYSE requires a minimum maintenance requirement of at least 25%. This is a minimum percentage of cash equity in the position. The maintenance margin percentage is less than the initial margin percentage.

Money Market Mutual Funds

Open-end investment companies offer both taxable and tax-exempt money market mutual funds. These funds typically invest in high-quality, short-term investments, such as U.S. Treasury bills, commercial paper, and negotiable CDs. The investments within the fund usually mature within one year and have an overall weighted average maturity of less than 60 days. The typical minimum investment is $1,000, and funds may be withdrawn from the account at any time without penalty by writing a check on the account (usually for a minimum amount). The rate of return on the fund is highly sensitive to changes in short-term interest rates, particularly the federal funds rate or the overnight lending rate between banks that are members of the Federal Reserve System.

PROFESSOR'S NOTE: LEVERAGING

PROFESSORS NOTE Leveraging is the use of borrowed money to achieve an individual's investment objectives.

Smaller, Regional Exchanges include:

Philadelphia, Chicago, and Pacific exchanges. *These exchanges typically list smaller, local companies. These companies often have what is called dual listing, which means that they also trade on another exchange, such as the NYSE.

Terms involved in the issuance of securities: Red herring

Preliminary prospectus; it is called a red herring because of the statement printed in red ink on the front of the prospectus that states, "A Registration Statement relating to these securities has been filed with the Securities and Exchange Commission but has not yet become effective. Information contained herein is subject to completion or amendment. These securities may not be sold nor may offers to buy be accepted prior to the time the Registration Statement becomes effective."

The term ACCREDITED INVESTOR is defined in Rule___of Regulation D 501

The term accredited investor is defined in Rule 501 of Regulation D and includes the following: 1.) A bank, insurance company, registered investment company, business development company, or small business investment company 2.) An employee benefit plan, within the meaning of the Employee Retirement Income Security Act of 1974 (ERISA), if a bank, insurance company, or registered investment advisor makes the investment decisions or if the plan has total assets in excess of $5 million 3.) A charitable organization, corporation, or partnership with assets exceeding $5 million 4.) A director, executive officer, or general partner of the company selling the securities 5.) A business in which all the equity owners are accredited investors 6.) A natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase (does not include the value of a person's primary residence) 7.) A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year 8.) A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchase a sophisticated person makes

The secondary market consists of four distinct markets: 3rd Market

The third market consists of stocks traded both on the organized exchanges and on the OTC market.

Money Market Mutual Funds: Tax-exempt money market funds—state.

These funds also offer tax-exempt income and are normally purchased by residents of the state so that any income is also free from state income taxes. As with the national tax-exempt funds, AMT may be an issue.

Money Market Mutual Funds: Tax-exempt money market funds—national.

These funds invest in municipal securities from around the country, and the income is free from federal income tax. If some of the income comes from the individual's home state, then that portion can also be free from state income taxes. If private activity bonds are in the fund, then the income from these bonds would be subject to AMT (alternative minimum tax).

Money Market Mutual Funds: Taxable money market funds.

These funds seek to maintain a stable net asset value and usually limit their average dollar weighted maturity to 90 DAYS OR LESS. For additional security, an individual could invest in a fund that just invests in U.S. Treasuries.

Characteristics of Venture Capital

These investments are characterized by high risk, high return, lack of liquidity, and a low correlation with equities. Their interest is in seeing each company grow so that they can cash out within about 5-10 years, preferably through a public offering of the company's stock.

Venture capital is provided in the following specific stages: Seed capital.

This is for new companies without any products and provides them cash for product development and market research.

Eurodollar CD (Euro CD)

This type of CD shares the same characteristics as its domestic counterpart EXCEPT that the obligation is the liability of a NON-U.S. bank. Accordingly, Euro CDs are LESS LIQUID and, therefore, offer a slightly HIGHER YIELD than domestic CDs. Generally, ONLY THE LARGEST financial institutions invest in the Eurodollar market. Individual investors may participate in the Eurodollar market indirectly using money market mutual funds.

LIQUIDATING CDs PREMATURELY

Usually, an investor who wants to redeem (i.e., liquidate) the CD before its stated maturity date must pay a penalty in the form of either a one-time fee or a lower overall interest rate.

Define: Venture Capital

Venture capital is financing for privately held companies (e.g., start-ups) typically in the form of convertible preferred stock and is characterized by high risk with the potential for high return

MARGIN PURCHASES

When an investment is purchased on margin, 50% of the funds are deposited by the investor (known as the initial margin percentage, as established by Federal Reserve Regulation T), and the 50% may be borrowed from the broker-dealer. However, some broker-dealers may require a higher initial margin percentage.

BANKER'S ACCEPTANCE: BANK'S ROLE

When using a banker's acceptance, the bank usually acts as an intermediary between the American company and the foreign company (i.e., the company furnishing or receiving the goods). For example, an American importer may request acceptance financing from its bank when the foreign company will not provide credit. As a result, the importer's bank agrees to pay the foreign supplier on behalf of the importer. The importer is then contractually obligated to repay the bank within three to six months. In turn, the importer's bank may sell the obligation at a discount to obtain immediate cash.