Series 6 Exam - Securities Markets, Investment Securities, and Economic Factors

Broker

(1) A broker includes: an individual or a firm that charges a fee or commission for executing buy and sell orders submitted by another individual or firm; (2) the role of a brokerage firm when it acts as an agent for a customer and charges the customer a commission for its services; and (3) any person engaged in the business of effecting transactions in securities for the accounts of other that is not a bank.

Dealer

(1) A dealer includes: the role of a brokerage firm when it acts as a principal in a particular trade. A firm acts as a dealer when it buys or sells a security for its own account and at its own risk, then charges the customer a markup or markdown; and (2) any person engaged in the business of buying and selling securities for their own account, either directly or through a broker, that is not a bank.

Other SRO's within the industry

- Municipal Securities Rulemaking Board (MSRB) - Chicago Board Options Exchange (CBOE) *note that SRO's are not themselves federal agencies but are membership organizations that enforce federal securities laws on their members and are accountable to the SEC.

Four ways Common Stock is classified

-Authorized -Issued -Treasury -Outstanding

Ways that corporations can raise short-term funds in the money market

-Bankers acceptance (time drafts) -Commercial paper (prime paper) -Negotiable certificates of deposit -Federal fund loans -Loans to broker-dealers

A stockholder who owns rights may:

-Exercise the rights to buy stock 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 (rights certificates are negotiable securities) -Let the rights expire and lose their value

Relationship of Rating to Yield

-Generally, the higher a bond's rating, the lower the yield. Investors will accept lower returns on their investments if their principal and interest payments are safer. -Bonds with low ratings due to the issuer's financial condition pay higher rates because of the risks to principal and interest associated with such uncertainties

Advantages of a call to the issuer

-If general interest rates decline, the issuer can redeem bonds with a high interest rate and issue new bonds with a lower rate. -An issuer can call bonds to reduce its debt -The issuer can replace short-term debt issues with long-term issues, and vice versa. -The issuer can call bonds as a means of forcing the conversion of convertible corporate securities.

A corporation buys back stock for reasons that include:

-Increase earnings per share; -Have an inventory of stock available to distribute as stock options, fund an employee pension plan, etc. -use for future acquisitions.

GO bonds sources of funds

-Issued by states are backed by income taxes, license fees, and sales taxes. -Issued by towns, cities, and counties are backed by property taxes, license fees, fines, and other sources of funds to the municipality. -Schools and parks may issue muni bonds backed by property taxes. *Voter approval is required prior to use since they are backed by municipality's taxing power

Types of Corporate Bonds

-Secured -Unsecured

Money Market Securities issued by the U.S. Government and its agencies

-Treasury bills that trade in the secondary market -Treasury and agency securities with remaining maturities of one year or less. -Short-term discount notes issued by various smaller agencies. *Money-market portfolios that include municipal securities are considered tax-exempt money market instruments.

Advantages of Preferred Stock

-When the board of directors declares a 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. *Preferred stock appeals to investors seeking income and safety.

Order of Priority of Dividend Payments

1. Dividend payments in arrears paid to cumulative shares 2. Stated dividends paid to all preferred shares 3. Common dividend

Two primary factors affecting a bond's market price

1. Issuer's financial stability 2. Overall trends in interest rates *Bond quotes are commonly stated as percentages of par. A bid of 100 means 100% of par or $1000 or a bond quote of 98 1/8 means 98 1/8% (98.125%) of $1000 or $981.25

Basis Point

A basis point is 1/100 of 1%. 100 basis points equals 1%. Therefore 75 basis points is .75% * This may be used on your exam

Yield to Maturity (YTM)

A bond's YTM reflects the annualized return of the bond if held to maturity and is the most comprehensive measure for comparison of bond yields. -In calculating, the bondholder takes into account the difference between the price paid for a bond and par value. -if price is less than par, the discount amount increases return (if held to maturity). -If price is greater than par, the premium amount decreases the return (if held to maturity)

Nominal Yield

A bond's 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. Ex) A coupon of 6% indicates the bondholder is paid $60 in interest annually ($30 Semi annually) until the bond matures.

Bond Yields

A bond's yield expresses the cash interest payments in relation to the bond's value. -Yield is determined by the issuers credit quality, prevailing interest rates, time to maturity, and call features. -Bonds can be quoted and traded in terms of their yield as well as their price, expressed as a percentage of par dollar amount.

Stock Splits

A company will sometimes change the number of outstanding shares by means of a stock split. -The total value of the outstanding shares must be the same before and after the stock split. *Since they change the trading characteristics of a stock, shareholder approval must be obtained for stock splits.

Total Capitalization

A company's total capitalization is its net worth plus its long-term debt.

Authorized Stock

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 enough capital for its foreseeable needs. The company may sell the remaining authorized shares in the future or use them for other purposes.

Options Disclosure Document

A document that must be delivered to the investor prior to opening an options trading account. This document is mostly educational in nature and reviews basic options terminology, definitions, and risks. -The buyer is the owner of the contract and the seller is often referred to as the writer of the contract. *Because buying and selling options contracts can expose the investor to elevated and even unlimited financial risks, before an investor can open an options trading account, it must be determined to be suitable for the investor

Proxies

A form of absentee ballot for stockholders that cannot attend the annual stockholders' meeting. -Once returned to the company, a proxy is cancelled if the stockholder attends the meeting, authorizes a subsequent proxy, or dies

Trust Indenture

A legal contract between the bond issuer and a trustee representing bondholders. -The face of a bond mentions the trust indenture, but it is not automatically supplied to bondholders. The trust indenture specifies the issuer's obligation and the bondholders' rights and also identifies the trustee.

Member

A member of FINRA is any individual, partnership, corporation, or legal entity admitted to membership in FINRA

Convertible Preferred Stock

A preferred stock is convertible if the owner can exchange each preferred share for shares of common stock. -The price at which an investor can convert is a preset amount and is noted on the stock certificate. Because the value of convertible preferred is linked to the value of the issuer's common stock, the convertible preferred's price fluctuates in line with the common. -Often issued with a lower stated dividend rate than nonconvertible because the investor may have the opportunity to convert to common shares and enjoy capital gains. -In addition, the conversion of pref. stock into shares of common increases the total number of common shares outstanding, which decreases earnings per common share and may decrease the common stock's market value.

Preferred Stock's fixed dividend or fixed rate of return

A preferred stocks fixed dividend is a key attraction for income-oriented investors. -Normally a preferred stock is identified by its annual dividend payment stated as a percentage of its par value, which is usually $100 on the Series 6 Exam. *A preferred stock's par value is meaningful to the investor, unlike that of common stock. **The stated rate of dividend payment causes the price of preferred stock to act like the price of a bond: prices and interest rates have an inverse relationship.

Book Value

A stock's book value per share is a measure of how much a common stockholder could expect to receive for each share if the corporation were liquidated. -is the difference between the historical value of a corporations tangible assets and liabilities, divided by the number of shares outstanding

Subscription Right Certificate

A subscription right is a certificate representing a short term (typically 30 to 45 days) privilege to buy additional shares of a corporation. -One right is issued for each common stock share held by the investor.

Warrants

A warrant is a certificate granting its 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 usually a long-term instrument, giving the investor the choice of buying shares at a later date at the exercise price.

Bank-grade (investment grade) bonds:

AAA/Aaa, AA/Aa, A/A, BBB/Baa

American Depository Receipts (ADRs) also Known as American Depository Shares (ADSs)

ADRs or ADSs facilitate the trading of foreign stocks in the U.S. markets. -An ADR, typically issued by a bank that has bought the foreign stock, is a negotiable security that represents a receipt for shares of stock in a non-U.S. corporation (one ordinary share=one ADR) -Bought and sold in the U.S. securities markets like stock

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 or par value -CUSIP number for identification -Dated date - the date that interest starts accruing =Reference to the bond indenture

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.

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 combing all their shares on a single seat.

Statutory Voting

Allows stockholders to cast one vote per share owned for each item on the ballot, such as seats on the board of directors. A board candidate needs a simple majority to be elected.

Rights Offering

Allows stockholders to purchase common stock below the current market price. -The rights are valued separately from the stock and trade in the secondary market during the subscription period

General Obligation Bonds (GO's)

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. -Used to raise funds for municipal capital improvements that benefit the entire community - public schools, a library, a jail, a bridge, a courthouse. These facilities typically do not produce revenues.

Asset-backed securities (ABS)

An ABS is essentially the same thing as a MBS 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 mortgages.

CMO Liquidity

An active secondary market exists for CMOs but the market for CMOs with more complex characteristics may be limited or nonexistent. -Certain tranches of a given CMO may be riskier than others, and some CMOs or certain tranches carry the risk that repayment of principal may take longer than anticipated (extension risk)

Associate Person (AP) of a Member

An associated person is any employee, manager, director, officer, or partner of a member broker-dealer or another entity (issuer, bank, etc.) or any person controlling, controlled by, or in common control with that member.

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, although it is a dividend rather than interest being paid.

Capital Appreciation

An increase in the market price of shares

Security

An investment of money, in a common enterprise, with the expectation of profits to be derived primarily from the efforts of a person other than the investor.

Total Return (individual securities)

An investments 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.

Decreased or No Income

Another risk of stock ownership is the possibility of dividend income decreasing or ceasing entirely if the company has business reverses.

Customer

Any individual, person, partnership, corporation, or legal entity that is not a broker, dealer, or municipal securities dealer- that is, the public.

Par Value

Arbitrary value the company gives the stock in its articles of incorporation, and it has no effect on the stock's market price. -Meaningless for investors -for accounting purposes, it is assigned a par value, such as $1. -when the corporation sells the stock, the money received exceeding par value is recorded on the corporate balance sheet as capital in excess of par, a.k.a paid-in surplus, capital surplus, or paid-in capital

Liquidity

Liquidity is the ease with which a bond or any other security can be sold. 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)

Treasury Bonds (T-Bonds)

Are long-term securities that pay interest every six months. -Treasury bonds are issued and mature in more than 10 years -T-bonds are quoted exactly like T-notes. -Some T-bonds have optional call dates, ranging from three to five years before maturity. *The treasury department must give bondholders four months notice before calling bonds

Series HH Bonds

Are no longer issued as of September 1, 2004; however, billions of dollars of them are still outstanding. HH bonds are considered current-income securities and pay a fixed rate of interest every six months until maturity or redemption, whichever comes first. -Maturity is 10 years with an additional 10-year extension during which interest continues to be paid. *Interest is reportable for tax purposes in the year it is earned.

Collateralized Mortgage Obligations (CMO's)

Are securities created from pools of mortgages. -This type of MBS was developed to provide investors with a greater range of timeframes and a greater cash-flow certainty than previously offered by MBS pass-through securities.

Series EE bonds

Are sold at face value starting at a minimum of $25, in increments as small as a penny. An investor could purchase a $40.54 EE bond. -EE bonds earn a fixed rate of interest, credited monthly and paid at redemption. -The maximum amount an investor can purchase in one calendar year is $10000 -The tax on accrued interest can be paid annually or deferred until the bonds mature. If an investor redeems EE Bonds in the first five years, he will forfeit the three most recent months interest. If an investor redeems them after the first five years, she won't be penalized

Characteristics of Bonds

As creditors, bondholders receive preferential treatment over common and preferred stockholders if a corporation files for bankruptcy. Because creditor claims are settled before the claims of stockholders, bonds are considered senior securities. -Therefore, stockholders interests are subordinate to those of bondholders

Unissued stock

Authorized but unissued stock does not carry the rights and privileges of issued shares (such as voting rights and the right to receive dividends) and is not considered in determining a company's total capitalization.

T-note

Maturity: -Two to 10 years; intermediate-term Pricing: -Priced at percentage of par Form: -Book entry

Registered bonds

May be issued as fully registered or registered as to principal only

Speculative (noninvestment grade) bonds:

BB/Ba, B/B, C/Caa, D/D *Speculative (noninvestment grade) bonds are commonly referred to as high-yield or junk bonds. -They must offer a higher yield to compensate investors for the elevated risk that the bond may default.

Liquidity and safety of Money Market Instruments

Because they are short term instruments, money market securities are highly liquid. Money market securities also provide a relatively high degree of safety because most issuers have high credit ratings.

Inverse Relationship Affects all Debt Securities

Bond prices are inversely affected by interest rates. As interest rates fall, bond prices rise; as interest rates rise, bond prices fall.

Call Protection

Bonds are called when general interest rates are lower than they were when the bonds were issued. -Investors, therefore, are faced with having to replace a relatively high fixed-income investment with one that pays less; this is known as call risk. -A newly issued bond typically has a call protection period of five or 10 years to provide some safety to investors. - When the call protection period expires, the issuer may call any or all of the bonds, usually at a premium. *This feature is an advantage to bondholders in periods of declining interest rates. **Generally have slightly higher coupons than comparable noncallable bonds because of the increased risk to investors.

Calling Bonds

Bonds are often issued with a call feature or provision. -This allows the issuer to redeem a bond issue before its maturity date, either in whole or in part. The issuer does this by notifying the bondholder that it will redeem the bonds at a particular price on a certain date.

Registration of Bonds

Bonds are registered to record ownership should a certificate be lost or stolen. Tracking a bond's ownership through its registration has been common in the United States only since the early 1970's

Fully Registered Bonds

Bonds registered as to both principal and interest, the transfer agent maintains a list of bondholders and updates this list as bond ownership changes. -Interest payments are automatically sent to the bondholder of record. -The transfer agent transfers a registered bond whenever a bond is sold by cancelling the seller's certificate and issuing a new one in the buyer's name. *Today if a bond is issued with a certificate, it will be fully registered.

Interest

Both the interest rate an issuer pays its bondholders and the timing of payments are set when the bond is issued. The interest rate, or coupon, is calculated from the bond's par value. -Par Value or Face Value is normally $1000 per bond, meaning it will be redeemed for $1000 when it matures.

Market Makers

Broker-dealers regulated by FINRA that maintain inventories of OTC securities and sell to other broker-dealers out of their inventory for their asked or offering price, or they buy from other broker-dealers for their inventory at their bid price.

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. Common stock is the most junior security because it is at the bottom of the liquidation priority list.

CMO Yields

CMOs Yield more than Treasury securities and normally pay investors interest and principal monthly. Principal repayments are made in $1000 increments to investors in one tranche before any principal is repaid to the next tranche.

There are two basic types of option contracts

Call and Puts

Callable Preferred Stock

Callable, or redeemable, preferred stock, which a company can buy back from investors at a stated price after a specified date. The right to call the stock allows the company to replace a relatively high fixed dividend obligation with a lower one. -When a corporation calls a preferred stock, dividend payments and conversion rights cease on the call date, however in return the company usually pays a premium exceeding the stock's par value at the call. *Because of the call risk, callable preferred has a higher state dividend rate 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 rate for money.

Debt Securities

Can be issued not only by corporations, but by federal, state, or local government bodies as well. Corporate debt instruments can be secured and unsecured. Secured bonds are backed by some form of collateral -A debt instrument issued by a state or local government takes on the form of a municipal bond or note. -A debt instrument issued by the federal Treasury takes the form of a Treasury bill, note, or bond. -A debt instrument issued to fund a government-sponsored enterprise takes the form of an agency issue.

Revenue Bonds

Can be used to finance any municipal facility that generates enough income to support its operations and debt service. A feasibility study will be completed to ensure the facility can generate the money needed. *Voter approval is not required for these because it is not levied to a specified group of tax payers

Cash Dividends

Cash dividends 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. Dividends are usually paid quarterly and taxed as dividend income in the year they are received.

Federal Home Loan Mortgage Corporation (FHLMC or Freddie MAC)

Chartered by congress in 1970 to provide liquidity, stability, and affordability to the nations housing market. -Freddie MAC is backed by its own issuing authority. -As a pass-through certificate, Freddie MAC distributes principal and interest payments semiannually.

CMO Characteristics

Considered relatively safe because they are backed by mortgages. However, they are susceptible to interest rate movements and the resulting change in the mortgage repayment rate. Several risk factors: -The rate of principal repayment varies. -If interest rates fall and homeowner refinancing increases, principal is received sooner than anticipated, and fewer interest payments are made. This is known as prepayment risk. -if interest rates rise and refinancing declines, the CMO investor may have to hold his investment longer than anticipated, although he does not receive more interest payments. This is known as extension risk.

Common Stock Voting Rights

Consist of voting on: -issuance of convertible securities or additional common stock -substantial changes in the corporation's business, such as mergers and acquisitions; and election of board of directors *shareholders do not vote on anything that has to do with dividends. They do vote on stock splits, membership on the BOD, and issuance of additional securities like common stock and convertible bonds

Corporate Debt

Corporate debt securities cover the spectrum from very safe AAA to very risk Junk bonds (also known as speculative or high-yield) -Corporate bonds are backed in varying degrees by the issuing corporation. Usually ranked from safe to risky as follows: 1. Secured bonds 2. Debentures 3. Subordinate debentures 4. Income (adjustment) bonds *income adjustment bonds are issued by corporations emerging from bankruptcy. Interest will only be paid if the issuer has the money (as determined by the BOD). On your exam, never recommend an income bond to an investor that is seeking income

Issuers

Corporations issue bonds to raise working capital or funds for capital expenditures such as plant construction or equipment and other major purchases. Corporate bonds are commonly referred to as funded debt. -Funded debt is any long-term debt payable in five years or more. -The federal government is the nation's largest borrower and the most secure credit risk.

Municipal Issues

Generally, the next level of safety is in securities issued by municipalities. -General Obligation bonds (GOs), backed by the taxing power of the issuer, are usually safer than revenue bonds. -Revenue bonds are backed by revenues from the facility financed by the bond issue.

Bonds

Debt securities issued by corporations, municipalities, the U.S. government, or its agencies. -As the borrower, the issuer promises to repay the debt on a specified date and to pay interest on the loan amount. -Because the interest rate the investor receives is set when the bond is issued, it is a fixed-income security. Individual bonds usually have a par (principal or face) value of $1000.

Dividend Yield or Current Yield

Dividend yield or sometimes referred to as current yield, is the annual dividend (four times the quarterly dividend) divided by the current market price of the stock.

Strike Price

Each stock option contract covers 100 shares (a round lot) of stock which may be exercised (bought in the case of a call, and sold in the case of a put), at a specified price, called the strike price, before a specified date, called the expiration date. -In general the maximum life of an option is nine months. This makes them longer term than stock rights but shorter than warrants.

Federal National Mortgage Association (FNMA or Fannie Mae)

Fannie Mae was founded in 1938 during the Great Depression as part of the New Deal -It provides mortgage capital, allowing lenders to reinvest their assets into more lending and, in effect, increasing the number of lenders in the mortgage market by reducing reliance on savings and loan associations. Fannie Mae distributes principal and interest payments semiannually.

Exemptions

Federal and municipal governments are exempt from the Trust Indenture Act provisions, although municipal revenue bonds are typically issued with a trust indenture to make them more marketable.

FINRA

Financial Industry Regulatory Authority. It is a registered securities association and is the successor to the NASD; it is the SRO that regulates participants in the over-the-counter (OTC) in securities, as well as members of the NYSE.

Maloney Act of 1938

Gave the SEC authority to establish other self-regulatory organizations (SRO's).

Government National Mortgage Association (GNMA, or commonly known as Ginnie Mae)

Ginnie Mae is a government owned corporation within the Department of Housing and Urban Development. -Ginnie Maes are guaranteed by the full faith and credit of the U.S. Government -Ginnie Mae buys Federal Housing Administration (FHA) and Veterans Administration (VA) mortgages and auctions them to private lenders, who pool the mortgages to create pass-through certificates for sale to investors. *Thus, monthly interest and principal payments from the pool of mortgages pass through to investors.

Preemptive Right

Give stockholders the right to buy enough newly issued shares to maintain their proportionate ownership in the company.

Call option

Gives the buyer the right to call (buy) a security away from someone. You can buy that right for yourself, or you can sell that right to someone else, and thus take on an obligation to sell the stock, if the call option is exercised.

Put option

Gives the buyer the right to put (sell) a security to someone. You can buy that right for yourself, or you can sell that right to someone else, and thus take on an obligation to buy the stock, if the put option is exercised.

Agency-like organizations

Government-Sponsored enterprises (GSEs) such as Freddie Mac, or Fannie Mae), are chartered by acts of Congress but owned by Stock-holders. The U.S. Government does not officially back these; however many investors understand they carry an implied government backing.

Nonmarketable government securities

Have no secondary market and, therefore, are only redeemable through the federal government. Include: -Savings bonds -Series EE, HH, and I Bonds *Can only be redeemed by the U.S. Treasury. Savings bonds interest is exempt from state and local taxation but is subject to federal taxation

Registered as to Principal Only Bonds

Have the owner's name printed on the certificate, but the coupons are in bearer form. *Like Bearer bonds, these bonds are no longer issued.

Treasury Inflation Protection Securities (TIPS)

Helps protect investors against purchasing power risk. -They are issued with a fixed interest rate, but the principal amount is adjusted semiannually by an amount equal to the change in the Consumer Price Index (CPI) the standard measurement of inflation. -These issues are sold at lower interest rates than conventional fixed-rate Treasury securities because of their adjustable nature. *TIPS are also purchased in minimum increments of $100. Interest on TIPS, like other U.S. government issues, is exempt from state and local income taxes but is subject to federal taxation.

Stock Certificates

Identify the company's name, number of shares, and investor's name, as well as the security's CUSIP number (an identification or tracking number) - It is evidence of ownership for the shares a person owns of a corporation - The vast majority of stock transactions are for round lot number of shares (share amounts evenly divisible by 100) - Odd lot transactions are share amounts of fewer than 100 shares. *Individual stock certificates must be issued for any number of shares.

Low Priority at Dissolution

If a company declares bankruptcy, holders of its bonds and preferred stock have priority over common stockholders. A company's debt and preferred shares are senior securities.

Stock Dividends

If a company must use its cash for business purposes rather than to pay cash dividends, its board of directors may declare a stock dividend. -A stock's market price per share declines as a result of a stock dividend, but the company's total market value remains the same. *This type of issue is typical of many growth companies that invest their cash resources in R&D or CapEx **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 gains or losses.

Standby Underwriting

If the current stockholders do not subscribe to all the additional stock, the issuer may offer unsold shares to a broker-dealer in a standby underwriting -A standby underwriting is 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

Points

In Financial Sections of daily newspapers and in other financial publications, A stock markets price quote in dollars, a.k.a. points, plus fractions of a dollar expressed in cents.

Difference between a CMO and a traditional pass-through

In a CMO structure many different securities are created from pools of mortgages by redirecting the cash flow of principal and interest. The issuer collateralizes a pool of various class mortgage loans and creates a tranche. -A tranche segregates portions of the cash flows from the CMO in order to redirect its principal and interest payments to other tranches based on a predetermined distribution schedule established when the CMO was created. -One CMO may be entitled to receive a certain amount of principal before all the others. *CMO's are issued by the private sector financing corporations and are often backed by GNMA, FNMA and FHLMC pass-through securities.

Qualitative analysis rating bonds

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.

Participating Preferred Stock

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. The percentage to which participating preferred stock participates is noted on the stock certificate. Before the participating dividend can be paid, a common dividend must be declared.

Calculating tax benefits

In comparing a corporate with a municipal bond, the tax-equivalent yield gives the equivalent yield of a corporate bond to that of a municipal bond; the tax-free equivalent yield gives the equivalent yield of a municipal bond to that of a corporate bond. -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

Exchange-Listed Stocks

In order to trade on an exchange, a security must meet the listing requirements of the exchange such as maintaining a certain price and trading activity. *The model exchange for your exam is the NYSE -listed securities may also trade OTC

Call Premium

In return for early redemption, an issuer that calls a bond before its maturity date usually pays bondholders a premium -Various municipal bonds, corporate bonds, and preferred stocks are callable at some point over their terms.

Liquidation Priority (*will definitely see this on the exam)

In the event a company goes bankrupt, the hierarchy of claims on the company's assets are as follows: 1. Unpaid wages 2. IRS, state, and county (taxes) 3. Secured debt (bonds and mortgages) 4. Unsecured bonds (debentures) and general creditors of the issuer 5. Subordinate debt 6. Preferred stockholders 7. Common stockholders *Bonds are often called senior securities because of their priority in this hierarchy.

CMO taxation

Interest from CMOs is subject to federal, state, and local taxes.

Option

Is a contract that gives the buyer a right to do something with an underlying security over time, usually nine months. -The right will be to buy or sell the underlying security at a stated price; the seller of the contract is obligated to fulfill the terms of the contract if it is exercised. *an option is also a type of derivative because the value of the contract is primarily based on the value of the underlying security.

Options Clearing Corporation (OCC)

Listed option contracts are issued in standardized formats by the OCC and traded on the Chicago Board Options Exchange (CBOE) or another exchange. -Options are easily tradable because the CBOE and other exchanges provide forums to trade, and the OCC stands behind options contracts in the event of a firm's failure.

Which positions have rights?

Long call, long put

Which options positions are bullish?

Long call, short put

Which positions buy stock at exercise?

Long call, short put

Which options positions are bearish?

Long put, short call

Which positions sell stock at exercise?

Long put, short call

Interest Rate Risk

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

Series I bonds

Low risk, liquid savings product designed to protect investors from inflation risk. I bonds may be purchased electronically or paper I bonds may be purchased via an Investors IRS tax refund -Electronic I bonds are sold at face value starting at a minimum of $25, to the penny. The maximum purchase in one calendar year is $10000 -Paper I bonds are sold at face value in denominations of $50, $75, $100, $200, $500, $1000, and $5,000 with $5,000 being the maximum purchase in on calendar year *have an annual interest rate that reflects the combined effects of a fixed rate and a semi-annual inflation rate. Interest is added to the bond monthly and is paid when the bond is redeemed. **The tax on accrued interest can be paid annually or deferred until the bonds mature.

Income

Many Corporations pay regularly quarterly cash dividends to stockholders based upon the company's earnings. A company's dividend typically increases over time as earnings and profitability increase.

Coupon (Bearer) Bonds

Many years ago, most bonds were issued in coupon, or bearer, form. Issuers kept no record of purchasers, and securities were issued without an investor's name printed on the certificate. *Bearer bonds have not been issued in the United States since 1982, however, the term coupon is still used to describe interest payments received by bondholders.

Bid Price

Market makers buy and customers sell through their broker-dealers

Ask Price

Market makers sell and customers buy

T-bond

Maturity: -More than 10 years Pricing: -Priced at percentage of par Form: -Book entry

T-bill

Maturity: -4 to 52 weeks; short term Pricing: -Issued at a discount; priced on discount basis Form: -Book entry

Current Yield (CY)

Measures a bond's annual interest relative to its market price, as shown in the following equation: - Annual interest/Market Price=Current Yield *Bond prices and yields are inversely related When a bond trades at a discount, its current yield increases; when it trades at a premium, its current yield decreases. **Refer to the inverse bond/yield relationship chart on pg. 41

Unlisted Securities

Nasdaq stocks that don't meet the listing requirements of an exchange or choose not to trade OTC are unlisted. *Most securities that trade are unlisted.

NADAQ

National Association of Securities Dealers Automated Quotation system. -electronic stock market originated in 1971 and does not have a physical trading floor that brings buyers and sellers together. -Automated computerized system that provides price and inventory information for market makers of securities traded OTC

Negotiable Certificates of Deposit (CD's)

Negotiable CDs (jumbo CDs) are time deposits banks offer. -Minimum face values of $100,000 but most are issued for $1 million or more. -Mature in one year or less -Unsecured: any amount issued that is more than FDIC insurance ($250,000) -Interest bearing -They can trade in the secondary market before their maturity.

Net Worth

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

Important points to remember about GNMA's

Of agency securities, Ginnie Mae's are the most testable for the exam. Things to remember: -Ginnie Maes are the only agency security backed in full by the U.S. Government -Ginnie Mae issues pass-through certificates -Investors receive interest and principal on a monthly basis; investors buy Ginnie Maes to satisfy income objectives -Yields on Ginnie Maes are slightly higher than on Treasuries -Ginnie Maes are subject to interest rate and prepayment risk.

Maturities

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 3-year range.

Pricing

Once issued, bonds are bought and sold in the secondary market at prices determined by market conditions.

T-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. -quoted on a yield basis and sold at a discount from par. They are zero-coupon securities. The bid reflects the yield the buyer wants to receive, the ask represents the yield the sellers are willing to accept. *the exam will not require you to calculate the bid and ask prices **because they are quoted in yield, a T-bill quote has a bid higher than its ask, which is revers of bid-ask relationships for other instruments.

Bond price changes are quoted in newspapers in points

One point is 1% of $1000 (or $10), and 1/4 point $2.50. The minimum variation for most corporate bond quotes is 1/8 or (.125%, or $1.25) Ex) Bid Ask 98 3/4 98 7/8

Leverage or Income (with options)

Option contracts provide purchasers with leverage: a relatively small cash outlay allows an investor to control an investment that would otherwise require a much larger sum. As the seller of an option contract, there is one main objective: Income. -The writer sells the contract, collects the premium, and hopes the contract expires so they can keep the premium.

Book-entry Bond

Owners do not receive certificates. Rather, the transfer agent maintains a security's ownership records. -The names of buyers of both registered and book-entry bonds are recorded (registered), but the book-entry bond owner does not receive a certificate - the registered bond holder does. -The trade confirmation serves as evidence of book-entry bond ownership. *All U.S. government and municipal bonds are available only in book-entry form.

Par, Premium, and Discount

Par: -represents the dollar amount of the investor's loan to the issuer, and it is the amount repaid when the bond matures. Discount: -In the secondary market when a bond sells below par value Premium: -In the secondary market when a bond sells above par value

Auction Market

Physical locations of exchanges where there is a trading floor and buyers & sellers compete for trades.

Straight (noncumulative) Preferred Stock

Preferred stock with no special features beyond the stated dividend payment. -Missed dividends are not paid to the holder.

Limited Liability

Protects stockholders from having to pay a corporations debts in bankruptcy. *Stockholders cannot lose more than the amount they have paid for a corporation's stock. **Another way to refer to this 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.

Money Market Instruments

Provide businesses, financial institutions, and governments a means to finance their 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- the issuer's ability to pay interest and principal as they come due.

Rights vs. Warrants

Rights: -Short-term instruments, exercise price is below the market price; issued to current shareholders only, who may exercise them, sell them on 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.

Negotiability

Shares of stock are negotiable; that is, a stockholder can give, transfer, assign, or sell shares the stockholder owns with few or no restrictions.

Which positions have obligations?

Short call, short put

Treasury Bills (T-bills)

Short-term obligations and, unlike most other debt securities, are issued at a discount from par (or face amount). -Rather than making regular cash payments, the return on a T-bill is the difference between the price the investor pays and the par value received when the bill matures. *T-bills are issued and mature in 4,13,26, or 52 weeks

Adjustable-Rate Preferred Stock

Some preferred stocks are issued with adjustable, or variable, dividend rates. Such dividends are usually tied to the rates of other interest rates benchmarks, such as Treasury bill and money market rates, and can be adjusted as often as semiannually.

CMO Suitability

Some varieties of CMOs may be particularly unsuitable for small or unsophisticated investors because of their complexity and risks. Customers may be required to sign a suitability statement before buying high-risk classes.

Municipal Bond issuers

States, counties, townships, villages, school districts, and transportation authorities. -Generally considered to be very safe in terms of default risk. -Pay interest semiannually. The interest payment schedule is set when the bonds are issued.

Treasury Stock

Stock a corporation has issued and subsequently repurchased from the public. The corporation can hold this stock to perpetuity or can reissue or retire it. Could reissue its treasury stock to fund employee bonus plans, distribute it to stockholders as a stock dividend or, under certain circumstances, redistribute it to the public in an additional offering. Does not carry rights such as voting rights and the right to receive dividends.

Issued Stock

Stock to be distributed to investors. When a corporation issues fewer shares than the total number authorized, it normally reserves the unissued shares for future needs, including: -raising new capital for expansion -paying stock dividends -providing stock purchase plans for employees or stock options for corporate officers -Investors converting convertible bonds or convertible preferred stock to common stock; or -Satisfying the exercise of outstanding stock purchase warrants.

Calculating the number of votes for shareholders

Stockholders can cast one vote for each share of stock owned for each item on the ballot.

Inspection of Corporate Books

Stockholders have the right to receive annual financial statements and to obtain lists of stockholders.

T-note pricing

T-notes are issued, quoted, and traded in 1/32 of a percentage of par. A quote of 98.24 can be expressed as 98-24 or 98:24. On a $1,000 note, this means that the note is selling for 98 24/32% of its $1000 par value. A quote of 98.24 equals 98.75% of $1000 or $987.50

Term Bonds an d Serial Bonds

Term Bonds: All mature on the same date, are generally called by random drawing Serial Bonds: issued with a sequence of maturities, are usually called in reverse order of their maturities, because longer maturities tend to have higher interest rates. *calling the longer term maturities lowers the issuer's interest expense by the largest amount.

Rights of ADR Owners

The ADR holder has no preemptive rights and generally, no voting rights but does have the right to exchange the ADRs for the actual foreign share certificates -ADR holders not only face the normal business risks associated with stock ownership, but also face currency risks as well, should the foreign currency decline in value. Dividends are initially paid by the foreign company in that currency then simply exchanged for dollars before being passed on to the ADR holder.

Approval for an additional stock issue

The BOD must approve decisions to issue additional stock through a rights offering -If the additional shares would increase the stock outstanding beyond the amount authorized in the company charter, the stockholders must vote to amend the charter. -A rights offering can give shareholders an incentive to vote their approval for the additional stock

Treasury STRIPS

The Treasury Department designates certain Treasury issues as suitable for stripping. These securities are known as STRIPS (Separate Trading of Registered Interest and Principal of Securities) -STRIPS are a type of zero coupon created from U.S. Treasury notes and bonds when the Treasury sells separate receipts against the principal and coupon payments. -The securities underlying Treasury STRIPS are the U.S. government's direct obligation. *STRIPS are not issued or sold directly to investors. STRIPS can be purchased and held only through financial institutions and government securities brokers and dealers. **The minimum face amount needed to strip a fixed-principal note or bond is $100 and any par amount to be stripped about $100 must be in a multiple of $100

The Trustee

The Trust Indenture Act of 1939 requires a corporation to appoint a trustee- usually a commercial bank or trust company-for its bonds. -The trustee ensures compliance with the covenants of the indenture and acts on behalf of the bondholders if the issuer defaults.

The Trust Indenture Act of 1939

The Trust Indenture Act requires corporate bonds of $50 million or more and greater than 270 days to maturity to be issued under a trust indenture.

U.S. Government and Agency Securities Issuing

The U.S. Treasury determines the quantity and types of government securities it must issue to meet federal budget needs. -The marketplace determines the interest rates those securities will pay. *In general, the interest that government securities pay is exempt from stat and municipal taxation but is subject to federal taxation. **The federal government is the nations largest borrower as well as the best credit risk. Interest and principal is backed in full faith and credit, which is based on its power to tax ***Government securities are issued in book entry form

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.

Option Premium

The cost of an option is called the premium. -Premiums are quoted in dollars per share.

Municipal Securities

The debt obligations of state and local governments and their agencies. Most are issued to raise capital to finance public works or construction projects that benefit the general public.

Cumulative Preferred Stock

The directors of a company in financial difficulty can reduce or suspend dividend payments to both common and preferred stockholders. -With Cumulative preferred, any dividends in arrears must be paid prior to paying a common dividend. *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) **All dividends due to cumulative preferred shareholders accumulate on the company's books until the corporation can pay them.

Municipal Bonds Tax Benefits

The federal government, with some exceptions, does not tax the interest from debt obligations of municipalities, but any capital gains from municipal transactions are taxable. *This tax-advantaged status of municipal bonds allows municipalities to pay lower interest rates on their bond issues. **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.

National Association of Securities Dealers (NASD)

The first SRO established by the SEC that was a membership, like the exchanges, and comprised the broker-dealer firms that engage in the securities business and whose function was to regulate the securities industry within assigned jurisdictions.

U.S. Government and Agency Securities

The highest degree of safety is in securities backed by the full faith and credit of the U.S. Government -U.S. Treasury Bills, notes, and bonds, and Series EE, HH, and I bonds -New Housing Authority bonds (NHAs) -Securities of the Government National Mortgage Association (GNMA or Ginnie Mae)

Sources of Revenue for Revenue bonds

The interest and principal payments of revenue bonds are payable to bondholders only from the specific earnings and net lease payments of revenue-producing facilities such as: -Utilities (water, sewer, electric) -housing -transportation (airports, toll roads) -education (college dorms, student loans) -health (hospitals, retirement centers) -industrial (industrial development, pollution control) *debt service repayments do not come from general or real estate taxes and are not backed by the full faith and credit of the municipality

Tendering

The issuer can buy bonds in the open market if a bond issue's trust indenture does not include call provisions to retire a portion of its debt

Business Risk

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.

Refunding

The practice of raising money to call a bond. Specifically, the issuer sells a new bond issue (with a lower rate) to buy back an old bond issue (with a higher rate). -Refunding, like a call, can occur in full or in part. Generally, an entire issue is refunded at once. *Refunding is common for bonds approaching maturity because an issuer may not have enough cash to pay off the entire issue. Or, it may choose to use its cash for other needs. **Can be thought of as issuer refinancing

Exercise or strike price

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

Market Value or Current Market Value (CMV)

The price investors must pay to buy the stock. -Market value is influenced by a company's business prospects and the consequent effect on supply (the number of shares available) and demand (the number of shares investors want to buy)

Default risk

The risk that the issuer cannot make the obligated interest payments. *Generally bonds issued by the federal government have the lowest default risk, followed by agency issues of the federal government, municipal bonds, then corporate bonds. -Because corporate bonds are the riskiest, they provide the highest potential income to investors

Debt Service

The schedule of interest and principal payments due on a bond issue

Issues of Agency-like Organizations

The second highest degree of safety is in securities issued by government-sponsored corporations, although the U.S. Government does not back the securities. -Federal Farm Credit Banks (FFCBs) -Federal Home Loan Mortgage Corporation (Freddie Mac) -Federal National Mortgage Association (FNMA or Fannie Mae)

Market Risk

The tendency for securities to move with the market. -When the market risk is rising, stocks have a tendency to increase in value. -Conversely, most stocks tend to fall in periods of market decline.

Sale and Offer to sell

The term "sale" or "sell" shall include the disposition of a security or interest in a security for value. The term "offer to sell", "offer for sale" or "offer" shall include every attempt or offer to dispose of, or offer to buy, a security or interest in a security, for value.

Terms of Offering

The terms of a rights offering are stipulated on the subscription right certificates mailed to stockholders. -The 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. *The stock is often offered to rights holders at a discount

Non-Nasdaq Securities

Thousands of securities trade in the OTC market that are not part of Nasdaq. These are termed non-nasdaq securities and trade on the over-the-counter bulletin board (OTCBB) or the pink sheets and tend to be the most speculative of all equity securities

Sinking Fund

To facilitate the retirement of its bonds, a corporate or municipal issuer sometimes establishes a sinking fund operated by the bonds trustee. -The trust indenture often requires a sinking fund, which can be used to call bonds, redeem bonds at maturity, or buy back bonds in the open market. -To establish a sinking fund, the issuer deposits cash in an account with the trustee. -Makes money available for redeeming bonds, and it can aid price stability of the bond

Marketable government securities

Trade in the secondary market (OTC). Include: -Bills, notes, bonds, and TIPS

Federal Government Securities

Treasury bills (maturities of 52 weeks or less), notes (2 to 10-year maturities), and bonds (greater than 10-year maturities) are backed by the full faith and credit of the government and its unlimited taxing powers.

Treasury Notes (T-notes)

Unlike T-bills, T-notes pay interest every six months -T-notes are intermediate term bonds maturing in 2 to 10 years. T-notes mature at par (face amount), or they can be refunded (called). -if a T-note is refunded, the government offers the investor a new security with a new interest rate and maturity date as an alternative to cash payment for the maturing note. Bondholders may always request their principal in cash.

Mortgage Backed Securities

Use pools of mortgages as collateral for the issuance of securities. They represent an ownership interest in mortgage loans made by financial institutions finance the purchasers of homes or other real estate. -As the homeowners pay off the mortgages, investors receive interest and principal payments. *Agency and agency like securities have higher yields than direct obligations of the federal government buy lower yields than corporate debt securities. **They are considered very safe when it comes to default risk and are actively traded in the secondary market. **Interest on these issues is taxed at the federal, state and local level.

Origination of Warrants

Warrants are usually offered to the public as sweeteners in connection with other securities, such as debentures or preferred stock, to make the securities more attractive, such offerings ay be bundled as units. -Warrants may be detachable or nondetachable from other securities. If detachable, they trade in the secondary market in line with the common stock's price. -First issued well above the stock's market price. If the stock's current market price increases, the owner can exercise the warrant and buy the stock at the exercise price or sell the warrant in the market.

Redemption

When a bond's principal is repaid, the bond is redeemed. Redemption usually occurs on the maturity date. When redeemed at maturity, the redemption equals the last semi-annual interest payment plus the principal of the bond.

Capital Gain/Loss

When an investor sells a security for more than it was purchased for, the profit is defined as a capital gain. Similarly, 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 capital gain or loss. *Capital Gains are taxable only when they are realized.

Parity Price

When the underlying common stock has the same value as the convertible preferred stock, it is said to be at its parity price.

Outstanding stock

includes any shares that a company has issued but has not repurchased-that is, investor owned stock.

Round Lot

is 100 shares. *exam may ask you to determine the cost of a round lot of stock in whole dollars from its quoted price.

Bankers Acceptance (BA)

short-term time draft with a specific payment date drawn on a bank - essentially a postdated check or line of credit. -Maximum maturity of 270 days *Corporations use extensively to finance international trade - typically goods and services in a foreign country. They are issued at a discount and mature at par

Commercial Paper or Promissory notes

short-term unsecured commercial paper is used by corporations to raise cash to finance accounts receivable and seasonal inventory overages. *Commercial Paper interest rates are lower than bank loan rates. *typically issued by companies with excellent credit ratings. -Maximum maturity of 270 days

Antidilution provision

when a corporation is required by law to offer the securities to its common stockholders before the general public when raising capital through the sale of additional common stock.