Chapters 14/15/16

Question 1

Time of trade disclosures (MSRB Rule G-47)

Answer 1

A muni securities dealer MUST disclose to clients all material info that’s either known or reasonably accessible to the market AT or PRIOR TO THE TIME OF TRADE. These disclosures can be made verbally or in writing.

• THIS RULE IS NOT SATISFIED BY SIMPLY DIRECTING A CUSTOMER TO A GENERAL INDUSTRY SOURCE OR ADVERTISING.
• These rules apply regardless of whether the transaction was solicited or not, it was a primary or secondary offering, or it is a principal or agency transaction.
• Material info is defined as any info a reasonable investor would want.

Question 2

B/D capacities when executing customer trades

Answer 2

• Agency trade
• Dual agency cross
• Principal trade
• Riskless principal
• Net basis

Question 3

Broker/Agent trade

Answer 3

When a BD buys or sells securities on behalf of a customer and earns a comission.

• Commissions must be disclosed in the customer’s confirmation.

Question 4

Dual agency cross

Answer 4

When a BD matches a sale from one of its clients w/ a purchase from another one of its clients and charges both a comission.

• Commissions must be disclosed in the confirmations to each customer.

Question 5

Dealer/Principal trade

Answer 5

When a BD sells securities out of its own inventory or buys securities into its own inventory when executing a customer’s transaction. Transaction prices are based on the market price of the security. The firm charges the customer a markup above the market price of the security. When the customer sells, the dealer marks down the proceeds received by the customer.

Principals MUST disclose markups/markdowns

Question 6

Riskless principal

Answer 6

When a firm buys into inventory to fill preexisting customer orders. This is considered ONE trade.

Ex: Firm A receives a customer order to buy 1k shares of stock A. Firm A then buys 1k shares as a principal for their own inventory, and then resells the securities to the customer at the market price plus a markup. This allows Firm A to NOT be exposed to price risk.

Firms MUST disclose its capacity as a riskless principal AND the markup

• The profit earned is disclosed in the customer’s confirmation.

Question 7

Net basis

Answer 7

Similar to a riskless principal trade, however when reselling the securities to the customer they sell the securities at a higher price, rather than charging a markup. This is considered TWO trades. The markup is NOT disclosed w/ net basis trades.

FINRA requires disclosure and consent requrirements when executing these

• RETAIL CUSTOMERS MUST PROVIDE WRITTEN CONSENT. INSTITUTIONAL CUSTOMERS MAY PROVIDE WRITTEN OR ORAL CONSENT OR USE A BLANKET NEGATIVE CONSENT ORDER.
• The profit earned on a net basis trade is not disclosed in the customer’s confirmation. Instead, both legs are reported as principal since they occured at different prices.

Question 8

True or false: BDs never need an institutional customer’s consent when executing a net basis trade?

Answer 8

False, the customer must either provide oral consent before each trade, written consent before each trade, or blanket permission through a negative consent letter.

Question 9

What is required when performing a net basis trade w/ fiduciaries?

Answer 9

BDs must provide disclosure to the party that has trading authorization, obtain permission from that party, and follow the same disclosure requirements depending on whether the fiduciary is a retail customer or institutional customer.

Question 10

Soft-dollar arrangemens

Answer 10

Rebates that IAs get for channeling some/all of their trades through certain BDs.

Question 11

Conditions that must be met to use soft-dollar arrangements

Answer 11

1. The IA must be exercising discretion over the accounts of others.
2. The BD must provide the IA w/ services that assist the IA in making trade decisions (ex: equity research reports).
3. The IA must determine that value of the BD’s services is reasonable in relation to the commissions being paid.

The key is that the services received by the IA MUST benefit the client!

Question 12

Acceptable uses of soft-dollar arrangements

Answer 12

• Research reports
• Discussions w/ RAs
• Software for analyzing portfolios
• Certain types of trading software
• Market & economic data services
• Coverage of attendance fees for a conference/seminar.

Question 13

Account statements

Answer 13

BDs MUST provide customers w/ account statements quarterly (however monthly is more common in practice) that contain:
* A description of all security positions
* All money balances
* All account activity since the last statement

Question 14

Can a BD hold a client’s mail if they’re away from their usual address?

Answer 14

Yes, as long as the firm:
* Receives written instructions which contains the time period to hold the mail. If longer than 3 consecutive months, the customer’s instructions must include a valid reason. Convenience is not a valid reason.
* Gives written disclosure to the customer regarding alternative methods of mail delivery (email, through the BD’s website, etc.)
* At reasonable intervals, verifies the customer’s instructions still apply.

Question 15

True or false: The SEC requires brokerages to provide a current B/S and/or IS to customers upon request?

Answer 15

False, just the B/S.

Question 16

True or false: When a customer’s accounts are transferred internally (ex: when a RR leaves and the customer is transferred to a new RR), the account records must be amended and that requires the re-approval of the customer, completion of the new account form, and the notification to the appropriate regulatory authority.

Answer 16

False, when a customer’s account is transferred internally, account records must be amended to but that does NOT require the re-approval of the customer, completion of the new account form, or the notification to the appropriate regulatory authority.

Question 17

Disclosures that MUST be made prior to execution:

Answer 17

• Risks associated w/ specific investments (ex: options, penny stocks, etc.)
• Conflicts of interest
• Investment limitations of the firm

Question 18

Disclosures of costs and fees

Answer 18

BDs must disclose to clients when these types of fees are involved w/ a transaction:
* Mutual funds (Must disclose what class the mutual fund shares are and what kind of load charges there are)
* Annuities (Surrender charges and mortality expenses)
* Non-discretionary fee based accounts (ex: IA fees)
* Soft-dollar arrangements

Question 19

Rule 10b-10

Answer 19

Requires that confirmations be given to customers AT or BEFORE the completion of any transaction that includes:
* The identity and price of the security
* The quantity being purchased/sold
* The date of the transaction and time of execution (or a statement that the time will be furnished on written request)
* The capacity in which the BD acted
* The price and yield on debt securities
* Whether a security is callable and a statement that more info can be provided on request
* The settlement date
* The name of the contraparty or a statement that it’ll be furnished upon request

Question 20

True or false: If an RR has discretion over a customer’s account, trade confirmations do NOT need to be sent to the client after every transaction?

Answer 20

False, they do. Trade confirms may be sent to an investment adviser or other third party, but only if the written consent of the customer is obtained.

Question 21

FINRA account updating requirement

Answer 21

If a customer provides a BD w/ an updated account, the BD MUST send a revised copy of the account record to the customer within 30 days after the BD received the notification.

Question 22

Things BDs should regularly check for when updating accounts

Answer 22

• Changes in address
• Changes in financial situations
• Changes in investment objectives

Question 23

SEC recordkeeping format requirements

Answer 23

Firms can keep records written or electronically. If the firm uses electronic, it must notify regulators prior to the beginning of its usage. Also, if the firm changes the form of electronic storage media being used, it must notify regulators 90 days before switching.

Question 24

SEC recordkeeping requirements for firms using electronic storage:

Answer 24

• Maintain records in non-editable and non-erasable formats
• Automatically confirm the quality and accuracy of the media recording process
• Maintain records in serial form w/ time and date info to show required retention period.
• Be able to download the indexes and records maintained to any medium that’s accepted by the SEC or other SRO of which the firm is a member.
• Allow SEC and SROs to immediately review files.

Question 25

Specified adult

Answer 25

Any adult that's 65 or older OR is 18+ w/ a mental or physical impairment. ## Footnote * Rule 2165 was created to protect specified adults.

Question 26

Trusted contact person

Answer 26

An adult who is 18+ who is responsible for overseeing specified adults. This person IS NOT given the authority to execute transactions or make account decisions. This type of authorization requires power of attorney. A trusted contract person's name and contact info SHOULD be obtained at account opening. Their contact info is not required but a firm should make a reasonable effort to obtain it. This doesn't apply to an institutional account.

Question 27

Financial Exploitation

Answer 27

Wrongful taking, withholding, appropriation or usage of a specified adult's funds OR any act to obtain control through deception of the specified adult's assets OR any act to convert the specified adult's assets.

Question 28

True or false: Firms are allowed to place a temproary hold on the disbursement of the specified adult's assets or any transaction if there's reason to believe there's financial exploitation?

Answer 28

True, however the firm must allow disbursement if there's no reasonable belief of financial exploitation (ex: monthly bill paying). If a firm initiates a hold, an internal review MUST be initiated. ## Footnote * The temporary hold rule also applies to transfers of assets from one account to another at the same brokerage.

Question 29

Notification of temporary holds

Answer 29

Within 2 business days after the temporary hold is placed, the firm must provide written, electronic, or oral communications to all parties who can transact with the account (unless one of the parties is the suspect) AND to the trusted contact person (unless the trusted contact person is the suspect). ## Footnote * !! Once a temporary hold is initiated, the firm is permitted to terminate it only after contacting either the customer or the trusted contract person and discussing the situation !!

Question 30

Period for temporary holds

Answer 30

Temporary holds expire no later than 15 business days after the date it was first placed on the account, unless it's extended by a regulator. If the member firm's internal review supports the finding of financial exploitation, the temporary hold may be extended by 10 days (so 25 total business days after the temporary hold was first placed on the account). If the firm's internal review still supports the finding of financial exploitation, a temporary hold may be extended another 30 business days (so 55 total business days after the temporary hold was first placed on the account).

Question 31

Transfer initiation form

Answer 31

A written form that must be completed by the customer and given to the receiving firm when a customer wants to transfer an account between two firms. ACATS is a common registered clearing agency. The receiving firm must submit the transfer request to the carrying firm immediately at the time of receipt from the customer and, within one business day, the carrying firm must either validate the instructions or take exception to the transfer.

Question 32

Reasons the carrying party may take exception to the transfer of accounts between firms:

Answer 32

* Additional documentation is required * The account is flat and has no assets * Account # is invalid * SSN or account title doesn't match * There's an existing court order or tax lien * Written instructions to rescind the transfer are received from the client

Question 33

What is required of the carrying firm when validating the transfer?

Answer 33

The carrying firm must feeze the account, cancel all open orders, and within 3 business days of the validation, the carrying firm must complete the transfer of the account to the receiving party.

Question 34

Non-transferable assets

Answer 34

* A proprietary product of the carry firm * The asset is the product of a 3rd party and the receiving firm doesn't maintain the necessary relationship to receive the assets. * The asset is of a bankrupt issuer and the carrying firm doesn't have the proper denomination to complete the delivery. * The asset is a limited partnership interest. ## Footnote * If a non-transferable asset is liquidated, distributions must be made within five business days of the customer’s liquidation instructions

Question 35

Residual credits

Answer 35

Any cash or securities received by the carrying firm that were not included in the original account transfer request. The carrying firm is required to continue to transfer these residual credit balances for a period of six months from the processing of the original transfer request. These transfers must be made within 10 business days of any credit balance(s) accruing in the client’s account.

Question 36

True or false: FINRA allows member firms and employees to seek court orders to restrict the transfer of assets?

Answer 36

False

Question 37

Systematic risks (non-diversifiable)

Answer 37

* Market risk * IRR * Inflation risk * Event risk

Question 38

True or false: Bonds w/ lower interest rate are less sensitive to IRR than bonds w/ similar maturities and higher coupon rates?

Answer 38

False, more sensitive.

Question 39

Duration

Answer 39

A measure of the sensitivity of a bond or portfolio of bonds to a given change in int. rates. Ex: If duration is 10 years, a 1% increase in int. rates will cause a 10% decline in the bond's price.

Question 40

Unsystematic (diversifiable risk)

Answer 40

* Business risk * Regulatory risk * Legislative risk * Political risk * Liquidity risk * Opportunity cost risk * Currency risk/Exchange rate risk * Capital risk * Credit risk * Call risk * Prepayment risk ## Footnote * Capital risk is especially prevelent to options investors.

Question 41

Current yield on a stock

Answer 41

Annual dividend ÷ current market price

Question 42

Cost basis

Answer 42

The total amount that an investor paid to purchase a security. This includes any commissions or other fees paid to the brokerage. If securities make capital distributions, this increases the cost basis.

Question 43

True or false: Any capital gain recognized on a short sale is taxed as a LT gain?

Answer 43

False, ST gain.

Question 44

Return of capital (ROC)

Answer 44

When a company gives a portion of the investor's original investment back. An ROC is NOT a taxable event.

Question 45

Cost basis of inherited securities

Answer 45

When securities are inherited, the cost basis to the recipient is equal to the MV of the securities at the time of the deceased's death. Regardless of the deceased’s actual holding period, the recipient’s holding period will be considered long-term.

Question 46

Cost basis of gifted securities

Answer 46

When securities are received as a gift, the cost basis to the recipient is the lesser of the security's MV OR the donor's cost to purchase the securities. The holding period of the recipient will be the same as the holding period of the giver.

Question 47

A 35-year-old small business owner, who is single and appears to be doing well financially, informs an RR that he wants to day-trade. Fearing identity theft, the client refuses to provide the RR with background information beyond what’s required under AML rules (e.g., name, Social Security number, date of birth). What should the RR recommend for this client? A. A collection of small cap equities and a long option B. Nothing

Answer 47

B. If a client refuses to provide certain information, an RR may not make assumptions about the client’s finances. An RR may only make recommendations that are based on the information that has been disclosed by the client. In some cases, a firm may decide not to open an account due to a client’s unwillingness to provide sufficient background information

Question 48

True or false: Mutual fund shares can be bought on margin?

Answer 48

False. ETFs can though

Question 49

True or false: Growth investors seek low p/e multiples?

Answer 49

False, high p/e multiples. Value investors look for low p/e multiples.

Question 50

Indexing

Answer 50

Passive investing

Question 51

Modern portfolio theory (MPT)

Answer 51

Assumes that investors are risk-averse and that there are many different ways to achieve an *optimal portfolio* that provides the max. amount of return for a certain level of risk. MPT looks for asset classes with negative correlations- essentiallly, diversification is key.

Question 52

Capital asset pricing model (CAPM)

Answer 52

A financial model that calculates the expected rate of return for an asset.

Question 53

Beta

Answer 53

How CAPM measures systematic risk. It measures how an asset reacts to a change in the market. Ex: If Investment A has a β of 1.5, this suggests that it’s 50% more volatile than the market as a whole. Therefore, if the market rises by 10%, Investment A is expected to rise by 15% (10% x 1.5). Conversely, if the market declines by 10%, Investment A is expected to decline by 15% (10% x 1.5).

Question 54

The Bond Buyer

Answer 54

An online newsletter that contains news that's pertinent to both the muni market and the financial community in general. The newsletter includes a variety of statistics that relate to the municipal bond market.

Question 55

Visible supply

Answer 55

Sums together the total $ value of all muni securities being underwritten on a competitive and negotiated basis which are expected to reach the markets over the next 30 days.

Question 56

The Bond Buyer Placement Ratio

Answer 56

The $ amount of bonds that were sold by underwriting syndicates over the week as a % of the amount of bonds that were issued that week. Compiled on a weekly basis. | Gives an indication of muni demand

Question 57

Bond Buyer Indexes

Answer 57

Compiles info regarding different indexes that are widely watched in the muni industry. These indexes provide an indication of the avg. weekly yields for both GO and revenue bonds.

Question 58

20 Bond Index

Answer 58

The avg. yield on 20 GO bonds w/ 20-year maturities and have an avg. rating that’s equivalent to Aa2 for Moody’s and AA for S&P.

Question 59

11 Bond Index

Answer 59

The avg. yield on 11 of the 20 bonds that are in the 20 Bond Index and has an avg. rating that’s equivalent to Aa1 for Moody’s and AA+ for S&P.

Question 60

Revenue Bond Index

Answer 60

The avg. yield on 25 revenue bonds w/ 30-year maturities and has an avg. rating that’s equivalent to A1 for Moody’s and A+ for S&P.

Question 61

Bond Buyer Muni Index

Answer 61

The avg. prices of 40 recently issued and actively traded munis.

Question 62

SIFMA Index

Answer 62

A 7 day market index of VRDOs w/ >= $10mm outstanding.

Question 63

Municipal market data (MMD) curve

Answer 63

The yield curve of AAA munis published by Reuters.

Question 64

Short Interest Theory

Answer 64

A bullish theory that follows the amount of common stock that's been sold short but has not yet been covered (closed out). The theory is bullish because the short sellers must purchase the stocks to close out their positions- a short squeeze.

Question 65

Put/Call Ratio

Answer 65

A technical indicator. The ratio of the volume of all put transactions divided by all call transactions. ## Footnote * Although a high ratio indicates that the mood of investors is bearish, from an analyst's point of view it reflects an oversold market and a higher probability that the market will reverse course and turn bullish. The opposite is true for a low put/call ratio, which is viewed as a bearish indicator.

Question 66

Odd-lotters

Answer 66

Small public investors whose purchases are usually <= 100 shares.

Question 67

The Odd-Lot Theory

Answer 67

A technical indicator that suggests that odd-lotters usually time the market wrong: buy when the price is too high and sell when it's too low. This indicator advises analysts to do the opposite of what odd-lotters are doing.

Question 68

Advance-Decline Theory

Answer 68

A technical indicator that measures the # of stocks that have increased in a trading session compared to the # of stocks that have decreased. Shows the direction of the market. ## Footnote * It's bullish if the Advance-decline average is up. * It's bearish if the indexes are up but the advance-decline average is down.

Question 69

The Dow Theory

Answer 69

A technical indicator that says the market is in an upward trend if one of the Dow averages advances above a previous important high and is accompanied or followed by a similar advance in another average. Ex: If the DJIA climbs to an intermediate high, an investor might watch the Dow Jones Transportation Average (DJTA) climb to confirm an upward trend.

Question 70

Support level

Answer 70

When a market is oversold and the price of a stock/index falls below the normal range of prices. At this point, buying pressures will kick in and bring the price up.

Question 71

Resistance level

Answer 71

When a market is overbought and the price of a stock/index climbs to the top of the normal range of prices. At this point, selling pressures will kick in and bring the price down.

Question 72

Consolidation phase

Answer 72

When a stock/index is trading in between the support and resistance levels at its normal price range.

Question 73

Breakout

Answer 73

When a stock's price increases above the resistance level or falls below the support level. When this happens, analysts believe that the stock will continue on its course.

Question 74

Saucer pattern

Answer 74

A technical indicator that suggests that a stock has bottomed and is ready to rise.

Question 75

Inverse saucer pattern

Answer 75

A technical indicator that suggests that a stock has peaked and is ready to fall.

Question 76

Random Walk Theory

Answer 76

A theory that believes that technical nor fundamental analysis allows investors to consistently predict market movements.

Question 77

3 basic categories of assets:

Answer 77

* Current assets: Assets that can be converted into cash within one operating cycle or a year: whichever is shorter. (ex: marketable securities, cash, inventories). * Fixed assets: Assets that CANNOT be converted into cash within one operating cycle or a year. * Intangible assets: Assets that cannot physically be touched.

Question 78

2 basic ways to value inventories

Answer 78

* FIFO * LIFO ## Footnote * LIFO will result in lower EBIT because the cost basis for the units being sold will be higher. * LIFO also results in lower taxes during an inflationary period.

Question 79

True or false: The IRS allows companies to deduct D&A from income?

Answer 79

True

Question 80

True or false: Fixed assets are usually shown on the b/s at MV?

Answer 80

False, usually at carrying value: original price minus D&A.

Question 81

Capital surplus/Paid-in capital

Answer 81

The amount of premium above the par value that’s paid by shareholders for the shares that are sold to the public by the corporation. This is found in equity. Ex: Firm A IPOs for $15/share when the par value is $10/share. $5 is listed as paid-in capital.

Question 82

Bond coverage ratio

Answer 82

EBIT ÷ int. expense

Question 83

True or false: EBITDA represents cash earnings?

Answer 83

False, EBITDA is an effective metric to evaluate profitability, but not cash flow, since it ignores the capital expenditures (ex: R&D) that're necessary to maintain and grow a business.

Question 84

Liquidity ratios

Answer 84

* Net working capital: CA - CL * Current ratio: CA ÷ CL * Quck ratio/Acid Test Ratio: (CA - inventories) ÷ CL * Cash flow: NI + D&A ## Footnote * A low current ratio suggests an issue w/ working capital. * Many analysts believe that a 2-1 current ratio represents sufficient liquidity. However, since inventories is the least liquid asset, firms w/ small amounts of inventories may be able to run w/ less. * Many analysts believe that a 1-1 quick ratio represents sufficient liquidity.

Question 85

Inventory turnover ratio

Answer 85

Indicates how often a firm sells its goods that it produces and implies a time frame for processing its goods. Inventory turnover = COGS ÷ Avg. Inventory ## Footnote * In some cases, sales is used in the numerator.

Question 86

LT Capital

Answer 86

LT Liabilities + Equity

Question 87

Bond Ratio

Answer 87

Par value of bonds ÷ LT capital

Question 88

Book value per common share (BVPS)

Answer 88

A metric commonly used to find the bankruptcy value of a company. (TA - TL - Intangibles - Preferred stock) ÷ # of common shares outstanding ## Footnote * While book value is an estimate of the liquidating value of a company, it should not be treated as an exact measurement. The actual liquidating value of a company is dependent on the market value a company receives for selling its assets based on supply and demand.

Question 89

Return on Equity

Answer 89

(NI - Preferred dividends) ÷ (Common stock at par + paid-in capital + RE) | Does NOT include Preferred Equity

Question 90

True or false: Companies w/ high P/E ratios tend to be large dividends?

Answer 90

False, these are growth companies that tend to pay little in dividends.

Question 91

True or false: To calculate the dividend payout ratio use annualized dividends?

Answer 91

True

Question 92

Current yield

Answer 92

ANNUAL dividend per share ÷ market price

Question 93

Effects of declaring a cash dividend

Answer 93

When the company announces its cash dividend. When a dividend is declared, RE is reduced and dividends payable (part of CLs) increases. Thus, working capital decreases since CA is unchanged but CL increases.

Question 94

Effects of paying a cash dividend

Answer 94

When the company actually pays the dividend to its shareholders. During this stage, cash and dividends payable are both reduced by equal amounts. Thus, there is no change to working capital.

Question 95

Effects of buying machinery/equipment

Answer 95

Cash is reduced to buy the equipment and fixed assets rise. Working capital decreases.

Question 96

Effects of issuing debt

Answer 96

Cash increases and so does LT debt. Working capital increases.

Question 97

Effects of calling bonds

Answer 97

Cash decreases to call the bonds and then LT debt decreases as the bonds are retired. Working capital decreases.

Question 98

Effects of issuing stock

Answer 98

Cash increases and common stock increases. Working capital thus increases.

Question 99

Effects of repurchasing stock

Answer 99

Cash is reduced to buy back the shares. Common stock decreases as the shares are retired. Working capital decreases. EPS increases.

Question 100

Efficient frontier

Answer 100

A set of optimal portfolios that provide the highest possible expected return for a given risk level, or the lowest risk for a desired expected return.

Question 101

Capitalization

Answer 101

How many stocks and bonds an issuer has issued.