Investment Planning Flashcards
(85 cards)
What are the risks for corporate and muni bonds?
HINT: is it DRIP, RIP, or IP?
DRIP
D-Default Risk
R- Reinvestment Risk
I- Interest Rate Risk
P- Purchasing Power
What are the risks for government bonds?
HINT: Is it DRIP, RIP, or IP?
RIP
R- Reinvestment Risk
I- Interest Rate Risk
P- Purchasing Power
(there’s no default risk, as it’s guaranteed by the gov’t)
What are the risks for CDs?
HINT: is it DRIP, RIP, or IP?
R- Reinvestment Risk
P- Purchasing Power
What are brokered CDs, and what are the risks for them (DRIP, RIP, or IP)?
CD’s sold through brokerage firm (vs. savings institution); risks include…
R- Reinvestment Risk
I- Interest Rate Risk
P- Purchasing Power
What are OID Bonds, and how are they taxed?
Original Issue Discount Bonds
-Discounted from par value at the time of purchase.
-Each year, the portion of the discount that has been earned is included as taxable interest income (PHANTOM INCOME), and the bond’s basis is increased.
What are STRIPS, how are they taxed, and who usually purchases them?
STRIPS are zero-coupon bonds issued by the US Treasury (thus they are a direct obligation of the US government); the discount on STRIPS is treated as taxable
(PHANTOM) income, earned annually.
NOTE: they are not subject to reinvestment risk since there is no coupon.
They are usually purchased by tax-deferred entities (pensions, IRAs, annuities).
Treasury Bills, Notes, Bonds
Bills: mature in 3-12 months; quoted in terms of discounted yield
Notes: intermediate debt (1-10 years)
Bonds: long-term debt (10-30 years)
What are TIPS, and how are they taxed?
TIPS are marketable with a face value adjusted semi-annually based on inflation (using CPI as a gauge). The higher the inflation, the higher the face value and semi-annual interest payment.
TIPS are taxed annually on the interest payment plus appreciation in face value (but only federal tax applies).
All about EE Bonds
EE Bonds
-Nonmarketable, non-transferable, non-negotiable.
-Issued at face value and in electronic form only.
-Earn fixed interest rates (for 30 yr period)
-Treasury guarantees that the bond’s value will double after 20 years.
-Interest is not subject to federal tax until bonds are redeemed or reach final maturity. NOTE: the owner may have interest taxed each year.
-No state or local taxes.
EEs in UTMA custodial account
vs
EE Educational Bonds
EEs in UTMA: owned by child; taxed as ordinary income at redemption.
EE Education Bonds: owned by adult (usu. parent); tax-free if parent’s AGI is less than phaseout at redemption.
EE and I bonds and use for educational expenses
Both can be used for education expenses and tax exempt, but only if…
-EE are educational bonds owned by parents (and parents’ AGI is below phaseout); thus, must be held outside of an UGMA/UTMA account
-Certain requirements are met for I bonds.
HH Bonds
-What’s unique?
-How often do they pay interest?
HH bonds are no longer issued. You could previously exchange EE bonds for HH bonds. Taxable gain is paid when the bonds are cashed in.
Recommending HH bonds should be a wrong answer on the test.
HH bonds pay interest semi-annually.
I Bonds (aka II Bonds)
-Nonmarketable, non-transferable, non-negotiable, cannot be pledged as collateral.
-Issued at face value.
-Interest is compounded every 6 months.
-Provide no guaranteed rate of earnings.
-Interest is composed of fixed base rate plus inflation adjustment (based on CPI).
-Taxed the same as EE bonds.
Which muni has less risk: general obligation or revenue bonds?
General obligation (GO)- backed by full faith, credit, and taxing power of issuer (whereas revenue depends on revenue source, which is not pledged).
Collateralized Mortgage Obligations (CMOs) and Real Estate Mortgage Investment Conduit (REMIC) are synonymous for the exam!
They do not pass through payments in exactly the same (uneven) form as received.
They create separate classes of securities (tranches) from A to Z, where A is fast pay, M is medium pay, Y is slow pay, and Z is a no-coupon tranche (like a zero) that receives cash flow from the collateral remaining after the other tranches are satisfied.
What is a GNMA?
Government National Mortgage Association
(Ginnie Mae)
-Direct guarantee of US gov’t
-Risks: RI (reinvestment and interest rate)
-Purchase a pool of FHA/VA guaranteed mortgages.
-Each payment represents both interest and return of principal.
FNMA and FHLMC
FNMA: Fannie Mae
FHLMC: Freddie Mac
Neither are guaranteed; they have been taken over by the fed government and are in conservatorship
How to Calculate a Security’s Intrinsic Value
PV of its expected cash flows
Call Premium
Represents the amount over par paid to the bondholder whose bond is called.
In the event a corporation is liquidated, what is the order of precedence in who will get their claims paid?
Secured and unsecured creditors and owners of bonds and preferred stock all take precedence over claims from common stockholders.
What are some of the unique attributes of preferred stock?
-Hybrid security (resembles both equity and debt)
-Pays a fixed dividend rate
-Is often perpetual
-Typically purchased by a corporate treasurer with excess funds (note: in most instances, 50% of the dividends received are excluded from taxation)
-Can be callable (like bonds)
What’s unique about Unit Investment Trusts?
-passive investment
-no day-to-day portfolio performance
-self-liquidating
-can trade on the secondary market
-payments can be income and/or return of principal
-most commonly used for muni bond portfolios
NOTE: there’s no continuous trading or redemption; think of them as shares that can be sold back to a sponsor
Think of UITs as the “grandfather of mutual funds” (with no captain).
Which of the following does not apply to mutual fund shares?
a) nonnegotiable
b) redeemable
c) tradeable
d) continuously issued
(b) Tradeable
(shares are redeemable but not tradeable)
The Investment Company Act of 1940 defines the following as investment companies…
Mutual Funds
Open-end funds
Closed-end funds
UIT companies
Variable annuity companies
