CFP Section 3 : Investments
Venture Capital Seed Capital
"high risk high returns" Stages: seed capital : start up capital
Yield Curve (positive vs negative)
positive=what you would normally asume. With long duration, higher rates (less interest rate risk), (good economy) expectation theory and liquidity theory support this expectation theory (expect interest rates go up=normal yield curve, same with inflation) liquidity theory (w longer duration bonds, theyre holding your money longer so you should be compensated for this , longer term yield higher)) ONLY EXPLAINS NORMAL YIELD CURVE negative (bad economy) (long term rates lower than short term) expectation theory supports this also (expect rates to go lower=inverted yield curve, same with inflation) market segmentation theory (based on supply/demand) and unbiased expectation theory can be used to explain any type of yield curve if yield curve is reletively flat, short term and long term rates are =, this is a sign of a negative economy
Advantages of Convertible Preferred Stock
preferred div> common div if firm is profitable, the can share in profits by converting shares into common stock conversion bcomes more valuable when common stock prices increase have less risk often used to finance risky venture capital/private equity firms
Treausry Inflation Protected Securities (TIPS)
principal value adjusted by CPI to find semi annual interest pmts, multiply inflation adjusted principal value by 1/2 fixed rate interest & increases in principal will be taxed annualy as ordinary income (fed level only), tax basis adjusted upward as principal is indexed ex) 4.5% coupon rate, CPI=4% to solve for inflation adjusted principal for 100k TIPS at the end of 6 m: 100k*1.02=102k......1.02 comes from taking 1+(4%/2 for semiannual) to solve for semiannual interest pmt for a period 4.5%/2)*102k = 2295
Promissory note
promise tp pay sum (treat like bonds, accept loan between individuals) interest taxable as ordinary income
Stop Order
protects investors from large losses limit losses in connection with short sales when trigger is hit and the market price reaches certain point, stop order turns to market order guarentees execution but not price
Mezzanine Financing
provided for expansion and new product
Federal National Mortgage Association (Fannie Mae) (FNMA)
publicly held corp conventional mortgages repacked into mortgage backed securities securities backed by FNMAs general credit
Gov National Mortgage Association (GNMA_ GinnMae)
purchase pools mortgage pass through securities 25k min quoted yields based on 12 yr prepayment trade OTC directly backed by US Gov
Growth Stocks
sales/earnings growth rates exceed industry avg typically dont pay dividends funnel profits into research and development
Secured Bonds
secured by asstes of company lower interest rate, less risky
Repurchase Agreements (Repos)
securities sold and bought back at agreed price, fixed yield (repo rate) gov security dealers short term liquidity needs short maturity, low risk reverse risk, buy gov securities sell them back at future date
Bond Swaps
sell one debt security and replace with another possible goals: increase portfolio YTM save income tax reduce interest rate risk ex substitution swap-swap bonds with identical characteristics but diff selling price intermarket spread swap-exchange one type bond with another type, capitalize on YTM disparity across bond markets rate anticipation swap-take advantage of expected interest rate changes (exchange lt bonds for short term bc short term far less impacted by rising rates) (interest down then stack up on long term) pure yield pickup swap -swap lower yield for higher yield tax swap- if losing in specific bond, sell to harvest loss and buy another bond to take its place.
Treasury STRIPS
seperate trading of registered interest and principal securities means for gov dealers & securities to take 1 US treasury and turn it into several seperate bonds (each a 0 coupon bond) seperate coupon and principal payments of us tnote/bond and sell them seperately sell each one of them at a discount highly sensitive to interest rate changes not callable little liquidity risk/default risk accrued interest is taxable
Serial Obligation
series of maturity dates
Bond Bullets
several bonds mature at same time minimize interest rate risk because we are holding bonds until maturity ex) buy 2 bonds today mature in 10 yrs buy 2 bonds in 2 years mature in 8 yrs buy 2 bonds in 4 yrs mature in 6 years
Bankers Acceptances
short term drafts used to finance imports and exports negotiable, unsecured line of credit ordinary income taxed Us/Korean company hasnt done business together Us wants widgets Korean company has and korea company wants to explore new markets and sell. Since they havent done business and Us uneasy, want to ensure what they order is what they wanted and quality is good. Korean company wants to get paid. Bank creates post dated check. Us company could always send products back and end the deal drafts given to foreign company dont have to be held by foreign company.
US T Bill Taxation?
short term gov security that is a zero coupon bond issued at discount that matures at full par value 4,13,26,52 week maturities (13 week proxy for RFR return) sold in $100 increments w $100 mins no default risk, highly marketable (wont ever default bc we have ability to tax population) not subject to OID (original issued discount rules) for ex) a zero coupon bond is issued at 800 and matures at par at $1k, this makes the OID $200 (1k-800). if it is a 5 yr note. divide OIA by 5 to tell us that each year, $40 would be income (phantom income). this is taxable, however if it is a T bill, it is not subject to this, but if sold before maturity the diff between purchase and sales price IS taxable
Preferred Stock who wants these?
similar to bonds in that: pays % of par value of stock in dividends on reg basis 100 par value similar to stock in that: shareholders not guarenteed dividends no maturity date (perpetuity) for equity investors corporations (have allowed deductions of 70% of the amount received as dividends from a domestic corp
Stop Limit Order
similar to stop order, turns into limit order when triggered guarantees price but no execution
Bond Ladders
staggering maturities -establishes schedule for reinvesting bonds proceeds as they mature advantages: combo of long term and short term bonds provides higher yield -allows you to have available cash
Conversion Ratio
# of shares into whcih a bond may be converted (once set, cant be changed) par value/conversion price
Public float
# shares available for trading by investors any remaining shares of those outstanding held by insiders and typically have restrictions on them
private placement
(company is still private) primary offerings in which shares are sold directly to a small group of institutional or wealthy investors "accredited investors"-bank insruance company, bus development company, small bus invest company, indv with 200+ income in proceeding yr, net worth over 1 million, couple 300+ income, networth 1 mil+
NYSE How to be on exchange?
400 round lot holders (lot of 100 shares) 1.1 mill public shares outstanding
Current Yield
Annual coupon/current FMV of the bond
Module 3
Equity Investments and Managed Assets
Gov Agency -directly backed Private Corp - indirectly back
GinnieMae FreddieMac Fannie Mae Sallie Mae (student loan)
calculate the additional capital that the investor must provide to cover a margin call.
MV*MM)-(MV-loan amount)
Investment Grade Bond vs High Yield (Junk) Bond
S&P Investment Grade BBB- or higher S&P Junk BB+ or lower (double B=BAD BOND) Moodys Investment Grade Baa+ Moodys junk): Ba and lower (think Bad Asset)
Wash Sale (see on demand module 1 part 3 doc for example)
Selling a security at a loss for tax purposes and, within 30 days before or after, purchasing the same or a substantially identical security. The IRS disallows the claimed loss. the disallowed loss would be added to cost basis
Savings Bonds
Seroes EE: purchased electronically, held 12 m, denominations 25-10k interest not taxable til maturity unless proceeds used for qualified higher education Series HH: no longer issued, obtained by exchanging E/EE Bonds, pay semiannual interest up to 20 yrs Series I (Inflation Indexed) combines 2 rated fixed for life and semiannual inflation rate based on CPI last 6 months
Red Herring
a preliminary prospectus distributed to prospective investors in a new issue of securities statement printed in red ink
Standard and Poor
all uppercase
Margin (ownership/equity) (how much do i need to own in this position)
allows you to increase borrowing power
Premium Bond
bond value greater than 1k CR>CY>YTM>YTC created by interest rates going down, value is going up
Muni Bonds: General Obligation Bonds
finance non revenue producing capiutal improvements backed by municipalities taxing power full faith and credit bc of this taxpayer vote debt amount limited by law
Muni Bonds: Revenue Bonds
finanice muni facilities generate income that pays back bond riskier than GOs (higher yields, similar maturities) categories: industrial development rev bonds special assessment bonds special tax bonds new housing authority (Sec 8) bonds
CDs interest rate marketability users other features
fixed for specified period yes, redeemed - early withdrawal period indv/sm bus laddering
Instructors email
[email protected] cfp student in subject line of email
Green shoes Green shoe offering
gives the right to increase the size of an offering'
Market Order
guarantee execution, do not guarantee price most popular, highest priority
Regulation T
how much investor must come in with/how much they can borrow from brokerage firm set by fed, typically 50%
Purchasing on Margin
initial margin deposited by investor (50% based on reg T from fed reserve) other half/portion borrowed from BD there are maintenance requirements (usually 35%) on margin call if you have gone below 35% (maintenance requirement) debit balance is og amt + any accrued interest equity= current FMV - debit balance
Muni Bonds
interest not taxable fed but is on state
Portfolio Immunization
interest rate risk offset by reinvestment rate risk rising interest rates=decrease in value=increase in reinvestment activity passive strategy bond duration
US Treasury Notes/Bonds tax characteristics
interest taxable on fed but not state\ longer maturities then t-bills notes 1yr-10 yr bonds 2-30 yr notes/bonds same but maturities different issued at par "default risk free" Do pay coupon unlike tbills. taxed at ordinary income (fed level only) trade in 2nd market good for portfolio diversification issued at discount, investor paid less then face value, soo the investor will have to include each yr a share of OID and the basis will be increased by the OId amount that is included in income each year. if sold b4 maturity
Primary, Secondary, Third, Fourth
intital sale of investors to issuing company largest market. provide buyers/sellers way of buying previously issued securities, typically on exchanges & OTC market (New York Stock Exchange) stocks traded on organized and otc market used by institutions (usually pension funds) that trade in large volume
Income Stocks
issued by companies consistently paying dividends
Cyclical Stocks
issued by companies that prosper in growing economies and suffer economic declines (auto companies)
Passbook Savings Accounts interest rate marketability users other features
low fixed rate if any yes, redeemed no penalty indv/sm bus no min balance
REgistration
process of filing prospectus with SEC
Term Bond
single maturity
Blue Chip Stocks
stocks of oldest companies with long history of paying regular dividends
Indenture
the contract between an issuer of bonds and the bondholder
Conversion value
the conversion ratio * market price of common stock aka par val/conversion price)*market price
Debenture
unsecured bonds higher interest rate, more risky
Moody
upper and lower case (moody, up and down)
Eurodollars
us $ denominated deposits at foreign banks avg deposit less then 1 mili maturities less 6 months interest income taxable as ordinary income eurodollar cd
Yield to Maturity
use calculator FV:1k PV:FMV N:period PMT:use coupon rate solve for i
MM Deposit Accounts (MMDA) interest rate marketability users other features
variable redeemed-no penalty indv/sm bus 6 transfer/withdraw / month insured by FDIC insurance bc it is a bank account
Prospectus
offering doc for sale of securities
Bond
debt security periodic interest (coupon payments) repays principal upon maturity issued in registered (somebody actually gets certificate), bearer bonds (no longer a things since 1986) or book entry forms (bonds held electronically at broker house)
Foreign Bonds
ones that are payable in US $s have no exchange/currency risk yankee bond (registered w SEC eurodollar bonds (not registered w SEC)
Bond issued at par what is par value
par value is $1k
Bond Risk (DRIP)
default: issuer not be able to pay period coupon pmts or pay back principal at maturity Reinvestment: risk that as pmts being made, if interest rates go down, bond holders not going to be able to reinvest pmts at similar rates (not applied to zero coupon bond because they dont make pmts interest rate risk: rates ^ value bond down purchasing power (inflation) risk: return doesnt supercede rate of inflation
Limited Partnership Limiited Partners
do not participate in management limited liability have share in income, gains, losses, deduction, tax credits may have difficulties selling their interests
Yield to Call
does not hold 100% of the time so dont count on the relationship like the others
Negotiable CDs interest rate marketability users other features
CDs 100+$ fixed for specified period traded in 2nd market institutions deposits>100k
If interest rates dont change on a bond at par...
CR CY and YTM will all be the same
Limit Order
guarantee price, do not guarantee exectution sell get your price or higher buying get your price or lower no necessarily executed because if there are not anymore available it will not be executed
Discount bond
bond valued at less then 1k CR less then CY and CY less then YTM CR<CY<YTM<YTC created by interest rates gone up, value of bond goes down
Short Sale
borrow shares from another investor, selling them, buiying them back and returning to original person you borrowed from must sign hypothecation agreement that lets stock be lended out covering short sale is when you are returning the stock any dividends must be given back to owner of stock
Selling Group
brokerage firms help distribute the securities in offering but not members of syndacite
Bond Barbells
buying short term and long term bond issues long term end locks in attractive long term interest rate short term end have access to cash as they mature more frequently, gives opportunity to invest in other things requires active management
Convertible Bonds
ca n be exchanged for fixed # common stock shares (stated in bond indenture) will sell for no less than the greater of its straight value or its conversion value (straight value is the price a convertible security would sell for without the convertible option)
Zero Coupon Bonds
can be issued by: US treasury corps OR munis no pmt til maturity aka no reinvestment risk volatile OID bonds -issued at DEEP discount -accrued interest taxable appropriate for tax deferred account
After Tax Yield
compare yield of corporate taxable issues to muni tax exempt issues after tax yield= pretax return*(1-marg tax rate) 8% corp bond, .28 tax bracket = 5.76 would need muni bond paying 5.76
*** Taxable Equivalent Yield (TEY) on formula sheet for test
compare yields of muni tax exempt ossues to corporate taxable issues =tax exempt yield/(1-marginal tax rate) example: muni bond pay 6%, someone in 25% tax bracket 6/(1-.25)=8 soooo to be equal you would need an 8% or higher return taxable corporate bond the higher the tax bracket, the more appealing a muni bond would be
Limited Partnership General Partners
control bus activies within partnership unlimited liability
Fed Home Loan Mortgage Corp (FHLMC) Freddit Mac
conventional mortgages repacked into mortgage backed securities pass through certificates reinvestment rate risk (prepayment of mortgages)
Value Stocks
currently trading below value based on historical earnings and asset values
Margin Call=
debit balance/(1-maintenance margin) debit balance = (BV*(1-initial margin) or ((initial margin %)/(1-mainenance margin))*purchase price of stock SIMPLIFY: Loan amount per share/(1-maintanence margin (typically 35%)) ex) say you have a stock selling for $40... to find margin call : $20 (because you know that you must have 50% required by fed) / 1-.35(because maintanence margin is typically 35%) = 30.77
Muni Bonds
debt obligations of states, counties, parishes, cities, towns interest free from fed income tax -state tax exemption if resident purchases muni bond from their state (some states work together to do this gains from sale subject to taxation
Corporate Bonds
debt securities -debentures (paid first) -subordinated debentures have higher coupons because greater risk callable bonds -cant be called for specific # yrs -less attractive -higher coupon than non callable tax: market discount -amt attributable to market discount not includable in taxes until sale of bond, treated as interest income can elect to include market discount as it accrues on sale gain in access of accrued market discount is capital gain income market premium ordinary income tax paid on interest as paid may elect to amortize premium, if elected you can apply part of premium attributable to a given year to reduce the basis
Firm Commitment vs Best Efforts
if dont sell them, investment banker will buy them (absorb the loss) no guarentee they will sell them all
Call Provision
issuer can call prior to maturity. after certain period they can call it if interest rates go down, they can call bond and reissue new bonds at lower interest rate think about a homeowner refinancing their house most callable bonds called at premium to par (this is usually how issuers compensate callable bonds)
Syndacite
lead underwriter will bring on other investment bankers to help them sell the shares to public for the first time
Holding Period Return (HPR) with the use of margin
less money at risk Holding period return should increase HPR= ending value of investment- beg value investment +- any cash value / beg value investment EV-BV+-CF)/BV with margin is similar but divide by initial investment instead of beg value (typically 50% of beg value because of Reg T) same example last time except investment grew to 60$, no CF, for HPR, and HPR w margin 60-40/40 60-40/20 if they make interest, EV-BV - (BV* margin requirement)*margin interest rate))/(bv*margin requirement) margin requirement is typically .5 but can be different
Flat yield curves
long term rates could rise to bring about a more rational relationship between return and risk long term rates could also rise as a consequence of an increase in rates over the entire yield curve
Money Market Mutual Funds
made available by mutual funds (open ended investment companies) taxable or tax exempt high quality short term investments fund investments typically mature within 1 yr avg weighted maturity less than 60 days 1k min invest funds withdrawn no penalty interest rate sensitive higher interest rate then money market depost fund use for: emergency fund short term depository
Short Term vs Long Term Gain Taxation
marginal tax rate 20%, 15%, 0% based on income
Downside risk of a convertible bond is...
market value-investment value
Short term bonds intermediate long term
maturoty 1-3 3-10 10+
Muni Bond: Private Activity Bond
more than 10% used for private bus use (think football stadium)
Muni Bond: Qualified Private Activity Bond
more than 95% net bond proceeds used for 1 of several qualified purposes
Commercial Paper
negotiable unsecured corporate debt $100k+ denominations maturity less then or = 270 days backed by bank lines of credit income taxable as ordinary income commercial paper is a short-term, unsecured promissory note issued by large firms and offers a nominally higher yield than T-bills.
Coupon Rate
nominal rate(yield) of bond at issue (% of par) do get annual coupon take rate *par value for payment take this number and divide it by amount of payments (bonds typically pay out semiannually