Ch 5. - Other Investment Vehicles

The exercise of an equity option requires that stock must be delivered

two business days after the exercise.

Someone who is short 1 August 35 put at 3 will breakeven at

32. For puts, the breakeven is found by subtracting the premium (3) from the strike price (35). Put sellers are bullish; therefore, the short put contract is profitable at or above the breakeven at expiration.

What are Limited Partners also referred to as?

(DPPs) Direct Participation Programs

A state sponsored investment pool designed for municipalities with short-term cash investment needs is called

A Local Government Investment Pool (LGIP)

What would be some advantages of a limited partner in a DPP?

An investment managed by others (GP) Limited Liability (can only lose the amount invested) Flow-through of income and certain expenses

When the Options Clearing Corporation (OCC) assigns exercise notices to a broker-dealer, the broker-dealer will in turn assign the exercise to customers with short positions using any of the following methods:

Any method considered fair & reasonable Random selection FIFO

What does it mean to have intrinsic value?

Be in the money.

What should be done in order to hedge against short stock?

Buy long calls.

Owner, holder, party who is long is the...

Buyer

Purchaser, holder, Pays premium, owns the right, is in control

Buyer

Which investors are bullish?

Buyers of calls and writers of puts are bullish investors

Which investors are bearish?

Buyers of puts and writers of calls are bearish investors.

What is considered bullish regarding puts & calls?

Buying calls and selling puts are bullish

What is considered bearish regarding puts & calls?

Buying puts and selling calls are bearish.

A customer recently approved to trade options buys a put contract for the account's initial transaction. If the customer fails to return the signed option agreement within 15 days of account approval, which of the following transactions is the customer permitted to make?

Closing sale. If a customer fails to return the signed option agreement within 15 calendar days of account approval, the customer is permitted to do closing transactions only.

What deductions reduce taxable income that are not actual costs/reduce cash flow?

Depreciation - Loss of value of a fixed asset as it ages. (buildings) Depletion -In natural resource programs, this is the loss of value from the resources as they are sued up. (lumber, oil, natural gas) Accelerated Depreciation - Some assets (computers are an example) lose value quickly and allow for greater depreciation deductions. Intangible drilling costs - These are the costs associated with drilling a well in gas and energy programs. These costs are lost completely if the well does not produce.

When adding options trading to a new account, which of the following steps are in the correct order?

Determine suitability, principal approval, first trade, signed option application

What doe shareholders receive from REITs?

Dividends from investment income or capital gains distributions. NOTE: REITs do not pass through losses like LPs and therefore are not considered DPPs. Taxation is under the conduit theory, similar to mutual funds.

Which securities do not have set maturity dates?

ETFs, VAs, and mutual funds. ETFs and Mutual funds may pay dividends, not interest.

An investor considering the differences between purchasing open-end investment company shares or ETFs with a similar objective should understand:

Each time an investor purchases and sells ETFs there is a commission. & It is possible that an investor liquidating ETF holdings will receive less than the NAV per share. Because ETFs usually track an index, the operating expense ratios are generally lower than that of open-end companies. That advantage can be canceled out by the commission charges when purchasing and selling an ETF. An open-end investment company must redeem shares at the NAV per share; ETFs pricing is based upon supply and demand making it possible to receive less than NAV. One cannot purchase open-end shares on margin.

What is an REIT?

Real Estate Investment Trust is a company that manages a portfolio of real estate, mortgages, or both to earn profits for SH.

A feature of direct participation programs is

Flow through of profits and losses of the partnership to the individual limited partners. Only DPPs allow flow through of losses.

What are some characteristics of hedge funds?

Hedge fund managers often employ highly speculative strategies and products associated with substantial risk. These might include using leverage (borrowing to purchase securities), selling securities short, (selling securities the portfolio does not own), investing in commodities or currencies, and utilizing derivative products such as options or futures.

What would NOT be associated with a hedge fund?

Investing in government debt securities as these are among the safest and risk-free investment.

What is true of a European option?

It may only be exercised on the last day of trading before expiration.

A client has established a long put position. The contract will have intrinsic value when the price of the underlying stock is

Less than the exercise price

What do put buyers want at expiration?

Like call buyers, they want the contracts to have intrinsic value/be in the money.

What do put writers want at expiration?

Like call writers, they want the contracts to be either at or out of the money and have no intrinsic value.

What are the 3 main potential risks for private, nontraded REITs?

Liquidity Reliability of valuations Transparency Nontraded REITs are taxed the same way as public (traded) REITs

When do listed option transactions settle?

Listed options transaction settle on the next business day. Commonly referred to as T + 1 business day or simply T + 1.

A call buyer owns the right to buy shares of a specified stock at the strike price before the expiration if he chooses to exercise the contract.

Long Call

Which contracts are in the money if the strike price is 30 and the market price is 40?

Long Call & Short Call All calls are in the money when the market price is above the strike price.

Do ETFs need to deliver a prospectus to customers following a transaction?

No. Publicly traded closed-end funds are not obligated to deliver a prospectus when traded in the secondary market place.

What is the disclosure document for a 529 college savings plan?

Official statement Municipal securities are sold by official statement, a document similar to a prospectus used in the sale of municipal securities. 529 plans are state sponsored.

Deductions for depletion would most likely apply to which of the following direct participation programs (DPP)?

Oil and gas income program. With income programs, the wells have been drilled and are already producing and, therefore, being depleted. By contrast, exploratory programs have a low expectation of success and it is therefore more likely that there will not be anything found to deplete.

Cost per share of a contract is the

Premium

What are some characteristics of an REIT?

REIT shares can trade on exchanges or OTC. Owners of these shares may receive dividend distributions and have capital gains pass through to them for tax purposes. REITs, organized as trusts, are not investment companies (open or closed-end). Shares in REITs are equity securities.

What are the most common types of direct participation programs?

Real Estate Oil and Gas Leasing Programs

Which of the following are the two basic types of Section 529 plans, which are products used for funding higher education?

Savings Plans & Prepaid Tuition Plans The savings plan allows the investor to accumulate money for use later in funding someone's education. The prepaid tuition plan allows the purchaser to pay the tuition for a particular K-12 or higher education institution at current rates, either in a lump sum or by periodic payments. The beneficiary of the plan then attends the institution, perhaps many years later, tuition-free. Note that Education Savings Accounts (ESAs) are not a type of 529 plan.

Writer, Short, Receives premium, takes on obligation

Seller

A call writer has the obligation to sell shares of a specific stock at the strike price if the buyer exercises the contract.

Short Call

Which positions have limited gains?

Short stock & long put

Which of the following statements regarding real estate investment trusts (REITs) are true?

Some REITs hold no real property but hold mortgages on commercial property instead. REITs can pay dividends to shareholders and make capital gains distributions. Equity REITs typically hold commercial property rather than residential property. Mortgage REITs hold mortgages on commercial property, and hybrid REITs do both. Dividend disbursements, as well as capital gains distributions, can be made to shareholders.

What is true regarding an Achieving a Better Life Experience (ABLE) account?

That the onset of the disability must have occurred before the owner turns 26. That the account owner and beneficiary must be disabled. That the income is tax-free

What is an ETF classified as?

The SEC has classified them as a type of open-end fund, and they have operating costs and expenses that are lower than most mutual funds, but not a mutual fund. ETFs traditionally have operating costs and expenses that are lower than most mutual funds because they do not have to purchase and sell holdings within the portfolio to accommodate investors purchasing shares or redeeming shares, as is the case with mutual funds.

What is time value?

The amount an investor pays for an option above its intrinsic value. It reflects the amount of time left until expiration. The amount is calculated by subtracting the intrinsic value from the premium paid.

Which of the following option positions would offer a full hedge to a long stock position?

The best way to hedge a long stock position is with a long put.

When speaking to a customer about exchange-traded funds (ETFs), a registered representative could make which of the following correct statements?

The potential tax consequences of owning an ETF can be different than those experienced when owning mutual funds. While an ETF can make a capital gains distribution, they generally do not—unlike a mutual fund, which generally would make such distributions on an annual basis. ETFs can be traded like other exchange products using traditional stock-trading techniques and order types and are priced by supply and demand. Customers pay commissions, not sales charges.

Strike Price

The price that will be paid for the shares if the option is exercised

CDC Pharmaceutical stock is currently trading at $50 a share. The CDC Nov 55 put is trading at $7. Which of the following is true?

The time value is $2. The intrinsic value is $5.

What is an Exchange Traded Product (ETP)?

The value of an ETP is derived and priced from other investment instruments, such as a commodity, a currency, a share price or an interest rate. They trade on a national securities exchange. They are marginable and may be sold short.

T/F: REITS may or may not be registered (public or private) w/ the SEC.

True

T/F: REITs are not investment companies (open or closed)

True

How are REITs organized?

Trusts in which investors buy shares or certificates of beneficial interest, either in stock exchanges or in the OTC market.

What are Mutual Funds usually prohibited to do that hedge funds CAN do?

Under most conditions, mutual funds are prohibited from purchasing securities on margin (i.e., using leverage—borrowed money) and from selling short. However, both of those strategies are commonly employed by hedge funds.

A REIT can avoid being taxed as a corporation would by

Under the guidelines set by the Internal Revenue Code, a REIT can avoid being taxed as a corporation by receiving 75% or more of its income from real estate and distributing 90% or more of its net investment income to its shareholders.

The writers of calls want what?

Want the market price of the underlying stock to fall or stay the same. This way, if the contract is never exercised by expiration, the writer keeps the premium w/o further obligation.

Buyers of calls want what?

Want the market price of the underlying stock to rise (bullish). Ex: if the MP rises above 60, he then has the right to buy the stock at the strike price of 60 even if its then at 80.

What are some characteristics of 529 savings plans?

Withdrawals are tax free if used for qualified education expenses. Contributions grow tax deferred. Contributions may be state deductible Plan is not federally tax deductible

For a 529 plan, can one person be both the beneficiary and owner?

Yes. The plan assets belong to the account owner, not the beneficiary.

Last year Brownstone Properties, LP distributed $200 per unit to investors and reported a $500 business loss per unit on the K-1. For tax purposes the investors received

a $500 per unit passive loss. Income and losses in an LP are always treated as passive and are reported to the investor via the K-1. The tax results for the year are included in that document.

Who may approve option trading for an account?

a Registered Options Principal (ROP) of the firm

In a leasing partnership program, loans are taken to purchase equipment that is then leased to companies in return for the lease payments. This process

allows for the loan interest and equipment depreciation to be taken as deductions that will shelter the income from the lease payments received.

A REIT that owns and operates an office building in the Dallas Metroplex is an example of

an Equity REIT A real estate investment trust that owns properties but does not hold mortgages is an equity REIT. One that holds mortgages but not the property is a mortgage REIT. Both would be a hybrid. There is no such thing as a leasing REIT.

The options disclosure document (ODD) must be provided

at or before the time of account approval. The ODD explains options strategies, risks, and rewards and is designed to provide full and fair disclosure to customers before they begin options trading. It must be provided at or before the time the account is approved.

What do REITs normally own?

commercial property (equity) mortgages on commercial property (mortgage REITS) OR BOTH

Regarding oil and gas DPPs, tangible drilling costs are associated with items that:

have some salvage value at the end of the program & can be depreciated Costs for items that will have some salvage value at the end of the program are considered tangible drilling costs. These items, such as equipment, can be depreciated and written off over the life of the program.

ABC Corporation's stock is trading at $35. A client has purchased a $50 strike call. The option's premium is made up of

intrinsic value plus time value. In this case, the option has no intrinsic value because an investor could acquire stock at $35 in the market place, while the option provides the opportunity to purchase shares at $50. The option is out of the money, which means its total premium is made up of time value and intrinsic value, but the intrinsic value is zero.

The breakeven

is the price point of the underlying security where an investor has neither a gain nor a loss.

An August 15 call is written at 4. The call expires without being exercised by the owner. The writer of the call

keeps the $400 (premium) received when the call was written.

A March 25 put purchased at 1.5 has expired without being exercised. The owner of the put

loses the $150 premium paid.

What are the 3 types of Direct Participation Real Estate Programs?

raw land, new construction, existing properties

A hedge fund portfolio has been characterized as being highly leveraged. This means that

there is substantial borrowing or purchasing on margin.