Chapter 9/10/11

Question 1

Exchange-traded-funds (ETFs)

Answer 1

ETFs issue shares that represent an interest in an underlying basket of securities which typically mirrors a specific index. Purchasers of ETFs do not pay sale charges but instead pay commission fees.

Question 2

Difference between ETFs and mutual funds

Answer 2

ETFs trade on exchanges and are close-ended funds unlike mutual funds. Additionally, ETFs often have lower expenses than mutual funds and their shares may both be sold short and purchased on margin.

Question 3

Inverse ETF

Answer 3

Designed to perform in a manner that’s the inverse of the index being tracked by short selling the investments within the fund. W/ an inverse ETF, for example, if the S&P falls 1.5% the inverse ETF should rise 1.5%.

Question 4

Exchange-traded notes (ETNs)

Answer 4

A type of unsecured debt security that pays a return which is linked to an underlying market index or other benchmark. ETNs trade on exchanges and are available in both inverse and leveraged varieties. ETNs DO NOT MAKE INTEREST PAYMENTS. Instead, ETNs pay the holder an amount which is based on the performance of an underlying index or benchmark. The maturities of ETNs can range from 10 to 30 years. ETNs are issued by a financial intermediary and backed by their full faith and credit. The costs associated w/ ETNs are reocurring costs, including daily investor fees, and brokerage commissions involved w/ buying or selling ETNs.

Question 5

Indicative value

Answer 5

The reference value of the benchmark minus the daily investor fee of an ETN.

Question 6

Hedge funds

Answer 6

Not an investment company. Private investment pools not required to register w/ the SEC. Buyers of the fund are typically institutional or high net worth. Since hedge funds only deal w/ these types of investors, there relatively unregulated. Due to these exemptions, hedge funds may use strategies that are prohibited for more heavily regulated investment entities. Hedge funds are not required to disclose specific information regarding their holdings. Hedge funds often restrict their investors from redeeming for certain periods of time meaning there is little liquidity.

Question 7

PE funds

Answer 7

PE and VC funds raise capital by offering investors limited partnership units that are sold as private placement.

Question 8

REITs

Answer 8

Not an investment company. REITs are securities and require that prospectuses are sent to any investors who purchase shares that are offered to the public in the primary market. REITs create a portfolio of real estate investments from which investors may earn profits.

Question 9

3 types of REITs:

Answer 9

1. Mortgage REITs: borrow funds from investors and then invest the funds in mortgages and typically earn income based on the difference between these two rates of interest
2. Equity REITs: own and operate income-producing real estate, such as apartment buildings, commercial property, shopping malls, vacation resorts, and other retail properties. Income is generated from rent.
3. Hybrid REITs

Question 10

3 varieties of REITs

Answer 10

1. Sold as private placement and not registered w/ SEC.
2. Registered w/ SEC and exchange-listed.
3. Registered w/ SEC and not exchange-listed.

Question 11

True or false: Dividends from REITs are taxed as ordinary income?

Answer 11

True, to avoid double taxation of dividends that are distributed to investors, a REIT must distribute a minimum of 90% of the income it generates from its portfolio

Question 12

Direct participation programs (DPPs)

Answer 12

A type of investment in which the results of the business venture (cash flow, profits, and losses) directly flow through to the investors. Most DPPs are limited partnerships.

Question 13

Limited partnerships

Answer 13

A type of DPP. A limited partnership requires a minimum of two partners—one general partner and at least one limited partner. The general partner (GP) is responsible for managing the program and must contribute at least 1% of the program’s capital. The limited partner (LP) is a passive investor who has no control over managerial decisions.

Question 14

Advantages of limited partnerships

Answer 14

• No double taxation. All income is taxed on a personal level as ordinary income.
• Limited partners are only liable for their investment.
• Typically diversification of assets.

Question 15

Disadvantages of limited partnerships

Answer 15

• Lack of control for limited partners.
• Iliquidity.
• Tax issues: can complicate individual tax filings.
• Positive capital call: investors in limited partnerships may be asked to contribute additional funds after their initial investment. Failure to make the additional contribution could result in the investors forfeiting their interest in a project.

Question 16

DPP offering practices

Answer 16

To raise money, the general partner (also referred to as the program’s sponsor) may conduct either a public or private securities offering. In a public offering, the general partner will hire an underwriter to market the program to the public and will register the DPP’s interests with the SEC. An offering prospectus is provided to potential investors.

Question 17

Tax treatment of individual partners in a DPP

Answer 17

Losses that are generated by passive activities may only be deducted against income from passive activities. If passive losses exceed passive income, the excess passive losses may be carried forward indefinitely to offset passive income in future years.

As an added benefit, when the ownership interest in a passive activity is sold, the investor can deduct all passive losses that are carried forward against any form of income—passive or non-passive.

Question 18

How do limited partnerships invest in oil & gas?

Answer 18

Exploratory drilling, a.k.a. wildcatting, involves searching for oil and gas in unproven areas. Due to the uncertainty of success, these programs are considered high-risk ventures.

Development program: leases are acquired for the right to drill in proven areas. Lower risk. The lower risk is based on the belief that a productive exploratory well could be surrounded by equally productive drilling locations.

Balanced program: A combo of exploratory drilling and development programs.

Income program: Acquires interests in already producing wells.

Question 19

What is an option?

Answer 19

A derivative security that gets its value from the value of underlying securities such as stocks, indexes, and ETFs.

An option is a contract between a buyer/owner/holder who is also considered the long. The buyer pays the option’s premium and gains the right to exercise the option. On the other hand, there’s the writer/seller of the option, who is considered the short. The seller receives the option’s premium and assumes an obligation if the contract is exercised in the future.

Question 20

Call options

Answer 20

The buyer pays a premium and gains the right to call the underlying instrument at a set strike price. If the buyer doesn’t exercise, the premium paid represents the maximum loss. The seller receives the premium but must sell the instrument at the strike price if it’s called.

Ex: If there’s a cal option on a stock, the buyer of the call option is bullish and wants the stock to go up because they could still buy it at the strike price but the value would be greater. The seller would want to see it go down.

Question 21

Put options

Answer 21

The buyer pays a premium and gains the right to sell an instrument at the strike price.

Ex: If you enter into a put option on a stock as the buyer, you are bearish and expecting the stock to go down so you can sell it for more than its worth in the future.

Question 22

True or false: All options have expiration dates?

Answer 22

True, if an option has not been exercised or liquidated prior to its expiration, it expires.

Question 23

What makes up the option premium?

Answer 23

The intrinsic value and time value. Intrinsic value is the amount by which an option is in-the-money, while time value is the portion of an option’s premium that exceeds its intrinsic value.

* An option will only have intrinsic value if it’s in the money.

Question 24

How to determine intrinsic value of an option (if an option is in-the-money or out-the-money)

Answer 24

The relationship between the strike price of an option and the current market price of the underlying security determines whether an option is in-the-money or out-the-money. Calls are in-the-money if the market price > strike price. Puts are in-the-money if market price < strike price.

Question 25

How to determine time value?

Answer 25

How to determine time value for an option that is in-the-money: Take current market price - strike price and the difference between this value and the premium is the time value. How to determine time value for an option that is out-the-money: There is no intrinsic value for an option that is out-the-money, so any premium is comprised solely of time value.

Question 26

Breakeven point of an option

Answer 26

For buyers of options, breakeven represents the amount they need the underlying stock to move in their favor to recapture the premium paid. For sellers of options, breakeven represents the amount they can afford the underlying stock to move against them because they received the premium. Remember the phrase: Call UP and Put DOWN - for calls its strike price up (plus) the premium. for puts its stike price down (minus) the premium.

Question 27

Liquidating an option

Answer 27

An alternative to exercising an option. To liquidate an option, an investor (either the buyer or seller) executes an opposite transaction on the same option contract. The buyer of an option creates the position with an opening purchase and could subsequently liquidate the position through a closing sale. The seller of an option creates the position with an opening sale and could subsequently liquidate the position through a closing purchase.

Question 28

Two styles of exercising an option:

Answer 28

1. American style exercise: Options may be exercised at any time up to the day on which they expire. 2. European style exercise: Options may only be exercised at a specified point in time, usually on the day of expiration. ## Footnote * All equity options use American style.

Question 29

What is the process of exercising an option?

Answer 29

1. Notify the broker-dealer 2. The broker-dealer will notify the options clearing corporation (OCC) 3. The OCC will randomly issue the exercise notice to a broker-dealer whose account shows a short option position that’s identical to the long option position being exercised. 4. The broker-dealer that receives the exercise notice, must select a client to whom the notice will be assigned. There are three methods by which this assignment may be accomplished—(1) using random selection, (2) using first-in, first-out (FIFO), or (3) using any other method that’s deemed to be fair and equitable.

Question 30

True or false: W/ options, the third friday of the expiration month is the final day to exercise and a brokerage must be notified by 5:30pmEST?

Answer 30

True, additionally, at 4pmEST on that Friday options stop trading.

Question 31

Options disclosure document/Characteristics and Risks of Standardized Options

Answer 31

A brochure created by the OCC that offers investors with a description of the options market and info about options.

Question 32

Index options

Answer 32

a financial derivative that gives the holder the right (but not the obligation) to buy or sell the value of an underlying index. When settled, the buyer recieves cash. | W/ an equity option, the buyer would receive the underlying stock.

Question 33

Long hedge

Answer 33

If an investor is long stock and fears that the stock will decline, buying a put on the stock creates a long hedge

Question 34

Short hedge

Answer 34

If an investor is short stock and fears that the stock will rise, buying a call on the stock creates a short hedge.

Question 35

Covered vs uncovered options

Answer 35

Covered options: Essentially just means that the seller owns the stock and is obligated to sell if the buyer exercises. The seller anticipates that the stock will drop so that the seller will receive the premium on the option and the dividend from the stock. Uncovered options: If an invester writes an option and doesn't own the stock. An uncovered call writer has an unlimited maximum potential loss since there’s no limit as to how high the price of the security may rise.

Question 36

# ``` ``` Covered put

Answer 36

The seller of a put is obligated to buy the underlying stock if the buyer of the put exercised the contract. Therefore, for the put to be covered, the seller must either be short the underlying stock or deposit cash equal to the strike price. If an investor sells an XYZ put and doesn’t deposit sufficient cash, the position is considered an uncovered put.

Question 37

Which option position has the potential for an unlimited gain?

Answer 37

Long call

Question 38

Pros and cons of public offerings

Answer 38

Pros: Unlimited # of potential investors Cons: Regulatory costs

Question 39

Private placements

Answer 39

An alternative to public offerings. This is where institutional investors provide capital to firms.

Question 40

Pros and cons of private placements

Answer 40

Pros: faster and less costly than a public offering. Cons: Limited # of potential investors

Question 41

Follow-on offering

Answer 41

A stock offering after an IPO. This is still considered a primary distribution.

Question 42

Primary distribution

Answer 42

An offering in which the proceeds of the deal are paid to the issuer.

Question 43

Combined offering/split offering

Answer 43

An offering where some of the shares are issued by the firm (primary offering) while some are sold by existing shareholders (secondary offering).

Question 44

Firm-commitment underwriting

Answer 44

When an underwriter/syndicate of underwriters agrees to purchase the entire offering from the issuer and absorb any securities that remain unsold

Question 45

Best-efforts underwriting

Answer 45

The syndicate agrees to sell as much of the new offering as they’re able. Best-efforts underwriters are acting in the capacity of an agent by finding purchasers for the issuer, rather than as a principal for their own accounts. Any unsold portion of the offering is returned to the issuer. ## Footnote * Oftentimes in this type of arrangement, the underwriters have minimum amounts for the offerings

Question 46

Best-efforts-all-or-none underwriting

Answer 46

the underwriters act as agents for the issuer and attempt to sell as much of the offering as possible. However, if the entire offering is not sold, all sales that were made must be cancelled and the money must be returned to the subscribers.

Question 47

Mini-max underwriting

Answer 47

With this form, there’s a minimum threshold of sales that must be met for the offering to avoid being cancelled. However, once that minimum is met, additional sales may be made up to a specified maximum amount.

Question 48

Standby offering

Answer 48

A syndicate agrees to buy any shares not purchased by existing stockholders in a rights offering.

Question 49

Market-out clause

Answer 49

A clause that allows the syndicate to cancel the agreement. The justification for cancelling the commitment is based on certain events occurring that make marketing the issue difficult or impossible.

Question 50

Shelf registration

Answer 50

A filing with the SEC to register a public offering, usually where there is no present intention to immediately sell all the securities being registered. This allows firms to sell additional securities on either a delayed or continuous basis. Securities may be sold three years after the initial registration. Advantages of shelf registration: the issuer can complete all the necessary paperwork in advance and be prepared to market the shares to the public when conditions are the most favorable.

Question 51

Syndicate letter/agreement among underwriters

Answer 51

A written agreement between the lead underwriter and syndicate members that specifies each firm’s rights and obligations. ## Footnote * This also happens in a competitive sale for munis

Question 52

Selling group members

Answer 52

When outside broker dealers assist a syndicate in a distribution of securities. Selling group members DO NOT ASSUME LIABILITY. Any shares that are not sold by the selling group are retained by the syndicate since the syndicate members remain financially liable for any unsold shares.

Question 53

Distribution participants

Answer 53

The term for the underwriters and selling group

Question 54

True or false: In a secondary offering, underwriters typically price the issue at a small discount to the current market price?

Answer 54

True

Question 55

Underwriting spread

Answer 55

The syndicate's gross profit. It's the difference between the amount paid by the investing public and the amount received by the issuing corporation. The spread consists of the manager's fee (lead underwriter), the member's/underwriter's fee, and the concession (the portion that is paid to the underwriter issuing/selling the shares).

Question 56

Total takedown

Answer 56

the amount that’s paid to a syndicate member when it sells shares of the offering. It's the underwriter’s fee plus the concession

Question 57

Syndicate compensation example:

Answer 57

Firm A is issuing stock to the public at $10 per share, with a total spread of $.80 per share. Of the $.80 spread per share, $.10 is allocated to the manager, $.20 is allocated to the firm that assumes liability for the shares, and $.50 is allocated to each underwriter that sells the shares. That leaves $9.20 for firm A.

Question 58

FINRA rules for member firms accpeting compensation from issuing firms:

Answer 58

A member firm MAY NOT receive compensation from an issuer for: * Publishing a quote * Acting as a market maker * Submitting an application in connection with market-making activity

Question 59

Registration statement

Answer 59

a public document that issuers file with the SEC in effort to prevent fraud in the sale of new issues. Shoudld contain info about the business, owners, and financial condition.

Question 60

Security issue registration process:

Answer 60

1. Pre-registration period: Prepare the registration statement. Underwriters CANNOT discuss w/ customers yet. Issuer files w/ the SEC. The date this period ends is called the filing date. 2. Cooling-off period: This is a 20 day waiting period. SEC reviews the registration statement. Propsectus is created. Blue-Sky laws apply. The date this period ends is called the effective date. 3. Post-registration period: Underwriters can contact buyers and deliver the red herring and final prospectus is delivered. Underwritters cannot accept payment or sell the issuer during this period.

Question 61

True or false: The SEC guarentess that info within the registration statement is true?

Answer 61

False

Question 62

Deficiency letter

Answer 62

A letter that's issued after the pre-registration period if the SEC believes the registration statement is incomplete or misleading.

Question 63

Red herring

Answer 63

A condensed form of the registration statement delivered to customers. Does not contain the final price per share but instead lists a range of prices.

Question 64

3 methods of state securities registration:

Answer 64

1. Notification/filing: This method is not allowed in all states. Simply an application. 2. Coordination: This form is completed simultaneously with a federal registration. 3. Qualification: This method involves meeting the specific requirements of one state and becomes effective at the discretion of the state Administrator.

Question 65

Post-effective period

Answer 65

The period where the POP is set and underwriters can sell the issue. Purchasers must be provided w/ a final prospectus.

Question 66

True or false: delivering a prospectus is typically the inital requirement in a securities offering?

Answer 66

True

Question 67

After-market prospectus delivery

Answer 67

Unlisted IPO = 90 days Unlisted follow-on= 45 days IPO listed on NYSE or NASDAQ = 25 days Follow-on listed on NYSE or NASDAQ = no requirement

Question 68

Types of prospectuses

Answer 68

A prospectus is any kind of notice that offers a security for sale. 1. Statutory prospectus: a condensed form of the registration statement 2. Preliminary prospectus/red herring 3. Mutual fund summary prospectus: often only 3-4 pages 4. Free writing prospectus: any communication that doesn’t meet the standards of a statutory prospectus.

Question 69

True or false: A private placement requires a prosepctus and registration statement?

Answer 69

False, the issuer provides the potential buyer w/ an offering memorandum or private placement memorandum

Question 70

Securities exempt from SEC registration

Answer 70

* Treasury & Agency securities * Munis * Commercial paper * Securities issued by domestic banks and trust companies * Securities issed by small business investment firms ## Footnote * These securities still remain subject to anti-fraud provisions.

Question 71

Reg D

Answer 71

Says that a security can be exempt from registration if the issuer believes the buyer is a sophisticated investor, the buyer has access to the same info in a prospectus, the potential investor doesn't plan to make a quick sale, and the securities are sold to no more than 35 non-accredited investors. | For private placements there's no limit on the # of accredited investors

Question 72

Accredited investor

Answer 72

* Financial institution * Directors, executive officers, or general partners of the issuer * Individuals who have a net worth of at least $1MM (not including primary residence) OR have gross income of at least $200,000 (or $300,000 combined with a spouse) for each of the past two years with the anticipation that this level of income will continue

Question 73

Restrictive legend

Answer 73

Shares that are acquired through a private placement carry a restrictive legend that’s printed across the face of the certificate. The legend indicates that the securities have not been registered with the SEC and are not eligible for resale unless the legend is removed. In many cases, the removal of the legend is accomplished under SEC Rule 144.

Question 74

Rule 144

Answer 74

Regulated the sale of restricted (i.e. unregistered) stock or control stock (restricted stock that is acquired by a control person in the secondary market). Under Rule 144, an investor who intends to sell either restricted or control stock must notify the SEC. If the securities are not sold within 90 days of the date that the notice was filed with the SEC, an amended notice must be filed. However, SEC notification is not required if the amount of the sale doesn’t exceed 5,000 shares or the dollar amount doesn’t exceed $50,000. Rule 144 imposes certain holding periods on investors. For restricted stock, the purchaser must hold the stock for a specific period before he may dispose of it. If the issuer is a reporting company, the holding period is six months; however, if the issuer is a non-reporting company, the holding period is one year. For control stock, there’s no mandatory holding period.

Question 75

Rule 144 Volume limitation

Answer 75

Rule 144 sets a limitation on the amount of stock that an affiliate may sell over any 90-day filing period. For NYSE- and Nasdaq-listed stock, the maax that may be sold is the > of 1% of the total shares outstanding or the stock’s average weekly trading volume of the past four weeks. For restricted (private placement) stock, there’s no volume restriction for non-affiliates of the issuer. Non-affiliates are persons who are not associated with the issuer. However, volume restrictions continue to apply to insiders and affiliates.

Question 76

Private investment in PE (PIPE)

Answer 76

the buying of shares of publicly traded stock at a price below the current MV per share. Often PIPE investors hold the restricted securities for a short period and, upon registration, will then quickly resell them in the public marketplace.

Question 77

Rule 144A

Answer 77

Permits sales of restricted securities to sophisticated investors without being subject to the conditions that are imposed by Rule 144. The securities being offered under Rule 144A may be equity or debt securities and they may be offered by either a domestic or foreign issuer. After the issuance, the securities may be immediately resold to qualified institutional buyers.

Question 78

Rule 145

Answer 78

Under Rule 145 of the Securities Act of 1933, certain types of securities reclassifications are considered to be sales and are subject to the registration and prospectus requirements of the Act. This includes: * An issuer that substitutes one security for another * A merger or consolidation in which the securities of one corporation are exchanged for the securities of another corporation * A transfer of assets from one corporation to another | Stock splits, reverse stock splits, & changes in par are not subject

Question 79

Rule 147

Answer 79

Mandates that securities sold within a state do not have to be registered w/ the SEC. This rule has 4 conditions: 1. At least 80% of its consolidated gross revenues from the firm selling securities is produced within the state. 2. At least 80% of its consolidated assets are located within the state or territory at the end of its most recent semi-annual fiscal period 3. At least 80% of the net proceeds from the offering are intended to be used by the issuer 4. A majority of the issuer’s employees are based in the state or territory ## Footnote * There are 2 provisions that state the issuer must make a best faith effort to identify the purchaser's primary residence and that the securities under Rule 147 cannot be resold outside of the state for 6 months after the sale.

Question 80

True or false: A federal registration exemption is available for securities that are sold within the borders of one state, provided the instruments of interstate commerce are not used to sell the securities?

Answer 80

True

Question 81

True or false: The leader underwriter (manager) of a syndicate typically makes the largest underwriting commitment?

Answer 81

True

Question 82

Notice of sale

Answer 82

When an issuer intends to sell bonds through a competitive sale, it will advertise through a Notice of Sale. This contains essential info.

Question 83

Legal opinion

Answer 83

Written by a recognized bond counsel that’s hired by the issuer to attest to the validity and tax-exempt status of the bond issue. Essentially, the legal opinion assures investors that the issuer has the legal right to issue the bonds. Every muni issue MUST have a legal opinion.

Question 84

Official statement

Answer 84

The primary client disclosure document that’s used in competitive AND negotiated municipal offerings. It's essentially a prospectus but since it's for munis the official statement is not required to be filed w/ the SEC. Contains detailed information about both the issuer and the offering/ | Not considered advertising

Question 85

Rule G-32 - Electronic Municipal Market Access (EMMA)

Answer 85

The rule requires that disclosure documents be filed with the MSRB and provided to customers. EMMA is the data pool where issuers file documentation. EMMA is free for the public to use.

Question 86

True or false: Each customer who purchases a new issuance of municipal bonds must be provided with a final confirmation and a copy of the official statement by no later than the settlement date?

Answer 86

True

Question 87

The final prospectus for new issues of common stock must be delivered to the client by no later than when?

Answer 87

The confirmatino of the sale

Question 88

What does it mean when a registration statement becomes effective?

Answer 88

The SEC allows the securities to be sold.

Question 89

An individual owns more than 10% of a company's outstanding shares. What rule determines the amount of this stock that the individual is able to sell at any given time?

Answer 89

Rule 144

Question 90

Example: An annuitant has been receiving payments from a variable annuity for six years and, at the time of his death, his beneficiary receives a lump-sum payment. The annuity payout option is:

Answer 90

Unit refund life annuity

Question 91

Example: A customer purchases 10 M Dade Co. Florida 7.50% G.O. bonds at a 9.50 basis. How much interest will she collect each year?

Answer 91

10M = $10,000 par value $10,000 * 0.075 = $750

Question 92

What is the best hedge for a long stock option?

Answer 92

Buying a put option

Question 93

True or false: If YTM < coupon rate, the bond is selling at a discount?

Answer 93

False, a premium

Question 94

True or false: If an investor's initial margin purchase is less than $4,000 of stock, his initial deposit requirement is $2,000, rather than 50%.

Answer 94

True, if initial purchase > $4,000. the initial deposit requirement= 50%