Passing Score - Series 7 Flashcards

Question

What is an institutional investor?

Answer 1

The following are considered institutional investors:Financial institutions such as banks, insurance companies, savings and loans, investment companies and registered investment advisersGovernment entitiesQualified retirement plans with at least 100 participantsBroker-dealers and registered representativesAn individual or entity with assets greater than $50 million * An agent acting on behalf of one of these institutional investors

Answer 2

Applies to private qualified retirement accounts. ERISA guidance requires portfolio management with professional expertise as well as funding and nondiscriminatory requirements. Plan assets must be used solely for the benefit of plan participants. Pension plans in the U.S. must comply with ERISA

Answer 3

Applies to the Municipal Securities Rulemaking Board (MSRB). The act established the MSRB as an SRO for firms that transact business in municipal securities. In 2010 the Dodd-Frank Act expanded the role of the MSRB to include regulation of advisors to municipal securities issuances

Answer 4

Applies to insider trading. Resulted from the abuses of the 1980s. Outlines specific civil and criminal penalties for various types of insider trading

Answer 5

Applies to insider trading. Resulted from the abuses of the 1980s. Permitted awards for whistle-blowers of up to 10%; of the penalty imposed and prescribed specific penalties for insider trading such as:Civil fines up to 3 times the amount of the profit gained or loss avoided from insider tradingCriminal fines up to $5 million for individuals and $25 million for corporations and other entities * Imprisonment up to 20 yearsAlso required broker-dealers to write, maintain, implement and enforce policies and procedures intended to prevent the misuse of material non-public information which must include:A system to monitor trading occurring in the broker-dealer's accounts and in employees' personal accountsMaintenance of a list of securities of which inside information exists and restricting or monitoring trading activity for those securities (e.g., restricted lists and watch lists)Protection of files containing inside information including:Information barriers: Establishment of adequate physical and procedural barriers to the unintentional transmission of confidential information * Employee training on insider trading

Answer 6

Prevents disclosure of information to certain individuals (e.g., securities professionals, institutional shareholders, etc.) without disclosing the same information to the general public. If the disclosure was intentional disclosure to the public must be simultaneous. If the disclosure was unintentional disclosure to the public must occur within 24 hours or, in the case of weekends and holidays, disclosure must occur at the opening of the next trading day for the NYSE and Nasdaq. Public disclosure may be through any means designed to broadly reach the public such as a press release, the Internet or filing Form 8-K with the SEC[Note: Requirements to disclose to the public does not apply for information in relationships where professional responsibility requires information to remain confidential (e.g., information disclosed to lawyers, accountants, etc.)]

Answer 7

Applies to telephone solicitations (aka cold calling or telemarketing) in which a call is made in order to profit from the call. Provides limitations on cold calling including:A do-not-call list must be maintained and entries on the do-not-call list must be maintained indefinitelyCalls must be made between 8:00 am and 9:00 pm (in the time zone of the person being called)Callers must provide their name, the name and contact address or telephone number of the individual or entity that the call is being made on behalf of and the caller's purpose in making the callUnsolicited facsimiles are prohibited * Autodialers and pre-recorded messages are prohibited unless an existing business relationship is in place or the caller is calling on behalf of a tax-exempt nonprofit organization

Answer 8

Intended to prevent abuse and ensure adequate information to the public for penny stocks. Penny stocks are OTC stocks with a relatively low price and market capitalization that are often highly speculative and are generally traded through the Pink Sheets and the OTCBB.These rules apply to all securities except:NYSE or Nasdaq securitiesInvestment company securitiesOCC-listed puts and callsSecurities trading above $5 per shareCompanies with average earnings for the last 3 years equal to $6 million or more; net tangible assets equal to $2 million or more for companies operational continuously for the last 3 years; or net tangible assets equal to $5 million or more for companies operational for less than 3 yearsSecurities transacted with an institutional accredited investorPrivately placed securitiesSecurities transacted with the issuer, officers, directors, general partners or owners with at least 5%; ownership * Securities transacted by a broker-dealer if compensation from penny stocks equal 5%; or less of total commissions and markupsRules include:Suitability based on investment objectives and financial situation must be confirmed and a written statement of suitability must be provided and signed by the customerA Risk Disclosure Document must be provided to the customer that contains all SEC-required informationPrior to purchasing penny stocks the customer's account must be approved to transact in penny stocksFor the first 3 penny stock transactions for an established customer (holding accounts with the broker-dealer for at least one year) a written agreement must be obtained from the customer with information regarding the name and quantity of securities to be purchasedFor each transaction the current quote, the compensation to the broker-dealer and the compensation for the registered rep must be disclosed * Statements for accounts with penny stocks must be provided monthly (versus the quarterly statement requirement) and must include the name and quantity of shares of each penny stock and the estimated market value as best possibly determined

Answer 9

FINRA is governed by the Federal Reserve Board of Governors which includes the CEO of FINRA and the CEO of NYSE Regulation. The U.S. is divided into districts headed by a District Committee who is an agent of the Board of Governors

Answer 10

Those eligible for FINRA membership include:Brokers: Any individual or entity that charges a fee or commission for filling securities transactions on behalf of an investor * Dealers: Any individual or entity that fills securities transactions for its own account as a regular business activityThose ineligible for FINRA membership include:Any individual or entity that fills securities for their own accounts that do not do so as a regular business activityBrokers or dealers suspended or expelled from a registered national securities association or exchangeBrokers or dealers suspended or barred from associating with members of a registered national securities association or exchange due to violations of fair and equitable practices * Brokers or dealers prohibited by court order from doing any related securities business activities with other brokers, dealers, investment advisors, underwriters, etc.

Answer 11

Business between a FINRA member and another FINRA member may be treated on a preferential basis (e.g., discounts, price concessions, etc.). Non-members must be treated the same as the public

Answer 12

The FINRA name may be used solely for identification and must be used together with the member firm's name but in smaller type than the firm's name. The FINRA name may be printed on:Trade directoriesConfirmations * Member firm's office door

Answer 13

A member firm that meets the following criteria must begin taping conversations between registered reps and clients for three years and follow special procedures on review and retention of the taped material. Once notified of the requirement by FINRA the member firm has 60 days to comply and beging recording the conversations as well as send a report to FINRA every quarterEmploys between five and nine registered reps when 40%; or more have been employed by a disciplined firm in the last three yearsEmploys between ten and nineteen registered reps when 4 or more have been employed by a disciplined firm in the last three years * Employs 20 or more registered reps when 20%; or more have been employed by a disciplined firm in the last three years

Answer 14

Uniform Practice Code - A uniform set of rules for dealer-to-dealer transactions for all non-exempt OTC securitiesConduct Rules - Concerned with transactions between FINRA members and the public ensuring the member's fair and equitable treatment of the publicCode of Procedure - A set of procedures for handling complaints and violationsCode of Arbitration - A set of rules for settling disputes among FINRA members and the public

Answer 15

A set of rules intended to establish uniform practices in dealer-to-dealer transactions for all non-exempt OTC securities (as defined by the Securities Exchange Act of 1934). Rules regarding transactions include:Delivery of securitiesConfirmations must be sent in written format the first business day following a regular-way transaction and on the same business day of a cash transaction * Customer confirmations must state that the firm acted as either a principal or an agent and must state the commission amount if acting as an agentBroker-dealer confirmations must contain adequate information on the security and transaction clarifying the terms of the transaction. If a disagreement concerning the transaction arises the broker-dealer that receives the confirmation may send a Don't Know (DK) noticeFidelity bonds must be posted (i.e., an insurance policy against the fraudulent acts of specified persons such as the member firm's employees). If the amount of insurance is inadequate the firm's assets are usedAn endorsement must be obtained on the certificate of a security that a customer is selling (typically the customer's signature on the back of the certificate)An assignment must be obtained for a security that a customer is transferring. The assignment must be guaranteed by a member firm or commercial bank (i.e., a signature guarantee) and must be exactly as the name appears on the certificateUnits of delivery must be in certain allowed multiples. If delivering units other than the allowed multiples delivery of the certificate may be rejectedStock transactions should be delivered in units of 100 shares or multiples of 100 shares with the following exceptions: * Certificates under 100 shares may be delivered if the total shares for the certificates add up to 100 shares (e.g., a certificate of 25 and another for 75 shares adds up to 100 shares total) * Odd lots. A single certificate under 100 shares may be delivered (e.g., three certificates of 100 shares each and one certificate for 25 shares is acceptable because only one single certificate is under 100 shares)

Answer 16

A set of rules regarding fraud and unreasonable profit, fair trade and business practices, standards of commercial honor and integrity, and general protection of the public in transactions with FINRA member firms. Excludes exempt securities (e.g., municipal securities, U.S. government securities). However, the SEC's antifraud provisions are always in force with no exemptionsRules and requirements regarding conduct include:Supervision of personnelSuitability of recommendations to customers * Communications with the public

Answer 17

A guide to assist member firms in adhering to the industry rule that sales to the public must be fair and reasonable in relation to current market conditions. Stipulates that commissions (charged when acting as an agent) and markups (charged when acting as a principal) should equal 5%; of the current market value of the securityThe 5%; Policy is only a guide and markups above or below 5%; may be appropriate under certain circumstances including:Type (e.g., stock, bond) - Securities that are more speculative may justify a higher markupAvailability - A relatively inactive stock incurs additional cost and effort and may justify a higher markupPrice/transaction amount - A security with a low market price or a transaction with a small total amount incurs a greater percentage of cost and may justify a higher markup * Exempt securities (e.g., securities sold under prospectus, new issues, mutual funds, etc.)The 5%; Policy generally applies to:Riskless or simultaneous transactions where an existing order from a customer is filledProceeds transactions where an order from a customer is filled with the proceeds from an existing order from that customer to sell a securityPurchase or sale of securities from inventory for a customerAgency transactions where a commission is charged * Third market transactions where securities are traded between broker-dealers and large institutional investors

Answer 18

The addition of a third party (e.g., an extra broker-dealer) on a trade typically as a means to provide the third party with commissions in exchange for referrals or other profit. Interpositioning is generally prohibited but may be permitted if proven that the intervention of a third party provided the customer with a better price

Answer 19

Principals include sole proprietors, partners, managers, directors, and officers of firms of supervisory jurisdiction or any person actively involved in the management of the firm's business

Answer 20

Registered representatives conduct business for their firm and include employees who solicit business, trade, underwrite, train, etc. They must initially work for a broker-dealer who sponsors them to take an exam through FINRA to qualify as a registered representative

Answer 21

Personnel of FINRA or MSRB member firms are required to be registeredGenerally, the requirements for registration of principals include:File a Form U4 * Pass the General Securities Principal Exam (Series 24)

Answer 22

Personnel of FINRA or MSRB member firms are required to be registeredGenerally, the requirements for registration of representatives include:File a Form U4 * Pass the General Securities Representative Exam (Series 7)

Answer 23

Personnel of FINRA or MSRB member firms are required to be registeredGenerally, the requirements for registration of representatives include:File a Form U4Pass either the General Securities Representative Exam (Series 7) or the Municipal Securities Representative Exam (Series 52) * Serve a 90 day apprenticeship during which no commissions or dealings with the public are allowed

Answer 24

The Central Registration Depository (CRD or Web CRD) is the central licensing and registration system for FINRA. It is used to process applications for registrations, employment history and disciplinary actions for broker-dealers and registered individuals

Answer 25

BrokerCheck is a free tool to help investors research the professional backgrounds of current and former FINRA-registered brokerage firms, brokers, adviser firms and representatives. The information is shared from CRD filings and includes licensing status and history, employment history, disputes, arbitration, written customer complaints of sales practices, criminal or regulatory investigations and other issues

Answer 26

This FINRA rule requires that member firms provide the following to customers in writing at least once a year: FINRA Public Disclosure Program hotline numberFINRA website address * Notification that a brochure with information about BrokerCheck is available

Answer 27

Generally, personnel that act in a solely administrative or clerical manner are not required to be registered. In addition, personnel selling non-securities (e.g., fixed insurance, commodities) are not required to be registered

Answer 28

Written proceduresDesignation of a partner, officer or manager in charge of carrying out procedures for every office of supervisory jurisdiction (OSJ) (i.e., an office that reviews certain activities such as customer orders, new accounts, advertising, etc.)Records for carrying out supervisory proceduresReview and endorsement, in writing, of all registered rep's correspondence and transactions relating to securities transactionsApproval of customer accounts and periodic review of accounts for abusesAt least once annually, an inspection of each office of supervisory jurisdiction (OSJ) * Examination of the qualifications, experience, reputation and character of potential registered representatives and continual monitoring of their good standing

Answer 29

Supervision rules for options are set by the Options Clearing Corporation and have been adopted by the options exchanges and by FINRAMember firms must have:Written procedures * Designation of a partner, officer, etc. as the Registered Options Principal (ROP)

Answer 30

The Regulatory Element: One year after the initial securities registration of a registered representative and every 3 years thereafter Regulatory Element training must be completed. Training includes compliance, regulatory, ethical and sales-practice standards. Representatives that do not complete training within the specified time frames may not perform any activity or receive any compensation that requires securities registrationThe Firm Element: Individual broker-dealers must create and enforce an annual Firm Element continuing education for all representatives

Answer 31

When a registered representative enters active military service their status changes in WebCRD to special inactive. All licensing requirements are delayed during active service which includes the two-year inactive status limitation for registration with a member firm and continuing education. The representative may continue to receive compensation but cannot contact clients or perform other securities functions during their military inactive status

Answer 32

Representatives, their spouses and minor children must disclose their association with a broker-dealer before opening any accounts. The opening firm must notify the broker-dealer in writing and await instructions before opening the account. For accounts with another member firm, prior written notification is required and approval of the employer may be required. For MSRB member firms duplicate confirmations must be sent to the broker-dealer only if requested. Mutual funds are exempted from disclosure requirements

Answer 33

Each member firm employee may not give or receive gifts exceeding $100 in material value per year to outside parties. Exemptions include occasional meals, tickets to sporting or cultural events, reminder advertising (e.g., writing instruments, key chains, etc.) and expenses related to legitimate business travel. Exemptions also exist for gifts to family members of an employee for a social event (e.g., wedding)For non-registered employees of another member firm, member firms may only compensate these employees if there is a written agreement stipulating the nature of the employment, the exact compensation to be paid and the written consent of the other member firm is given. All gifts and compensation given must be recorded by the member firmNon-registered persons may not receive any gift or compensation for referrals. However, the referred customer may receive benefit from the referral (e.g., discounted services) as long a the customer receives the benefit and not the referrer

Answer 34

The sharing of profits or losses in a customer's account is not allowed unless all of the following conditions are met:It is a joint account where the registered representative has obtained prior written consent from both the customer and their employerThe rep has made a financial contribution to the account * The profit and losses are shared in direct proportion to the financial contribution

Answer 35

Outside business activities only apply to activities in which the registered representative receives payPrior to participating in any business activities outside the scope of a registered representative's normal relationship with their firm the rep must provide written notice to their employing firm. The firm may prohibit the representative from engaging in any particular outside business activity

Answer 36

Private securities transactions are outside the scope of a registered representative's normal transactions with their employing firmPrior to engaging in private securities transactions the registered representative much obtain written approval from their employing firm. The firm may have specific procedures that must be followed in order to engage in the transaction. Transactions must be recorded in the firm's books if the rep receives compensation for the transaction

Answer 37

The Department of Enforcement must request authorization to issue a complaint from the Office of Disciplinary Affairs. The respondent (i.e., the member firm or person believed to be in violation) must file a response within 25 days. After 25 days the Department of Enforcement will issue a second notice. A non-response 14 days after the second notice can be treated as an admission to the violation charged in the complaintWhen filing a response the respondent may request a hearing. Not requesting a hearing waives the respondent's rights to a hearing. Hearings are held before a Hearing Panel which consists of a Hearing Officer and two panelists appointed by the Chief Hearing Officer

Answer 38

CensureFinesSuspension for either a specified period or until specified conditions are metExpulsion or cancellation of membership or registration[Note: This includes any type of association with a member firm including clerical or administrative activity]Suspension or barring from association with any member firmAny other fitting suspension[Note: This excludes imprisonment. Only a court of law may sentence imprisonment]

Answer 39

The respondent has 25 days to file an appeal with the National Adjudicatory Council (NAC). A decision on the complaint will not be made until the appeal process is complete. The NAC can affirm, reverse, modify, increase or reduce any sanction. The NAC can also impose an entirely different sanctionThe respondent may appeal a final sanction of FINRA to the SEC and may appeal the SEC's decision to a federal court

Answer 40

When a member firm or person (i.e., respondent) does not respond to a complaint issued by the Department of Enforcement, the Department of Enforcement may request the respondent to sign an AWCThe AWC describes the rules violated, the sanctions imposed and would waive the respondent's right to an appeal. If the respondent does not dispute the complaint and consents to the sanction sanctions may include a fine of not more than $2,500 and censure of the respondentThe respondent may reject the AWC in which case the disciplinary process would proceed as normal

Answer 41

The Code of Arbitration covers settlement of disputes through arbitration while the Code of Procedure covers discipline for violation of rules and regulations

Answer 42

Members against other members[Note: These disputes must be submitted to arbitration]Members and any clearing corporationMembers and public customers[Note: Public customers must give prior written consent in order to be brought to an arbitration and the majority of the arbitrators must consist of persons outside the securities industry]

Answer 43

The National Arbitration Committee is a panel that makes a final decision on disputes under the Code of Arbitration. The panel consists of three arbitrators. In cases where the amount in dispute does not exceed $50,000 the parties may choose simplified arbitration procedures in which only one arbitrator is required. The National Arbitration Committee's decisions are final unless the law directs otherwise

Answer 44

An attempt to resolve a dispute with the help of a third-party, the mediator, who facilitates a resolution. A mediator is initially suggested by FINRA, the parties, however, can select any mediator that they both agree on. The mediator fee is divided between the two parties. Meetings between each side and the mediator to help understand and resolve the issues are known as caucuses. Mediation will continue until either there is a written settlement, the mediator declares that no resolution can be reached or one of the parties withdraws in writing from the process. Mediation efforts can continue before or after arbitration proceedings have begun

Answer 45

Any written communication either on paper or electronically sent to 25 or less prospective or current clients during a 30-day period. Correspondence must be reviewed regularly and supervised but is not required to be preapproved by a principal or submitted to FINRA

Answer 46

Retail communication is paper or electronic distribution to more than 25 retail investors during a 30-day period. A distribution to 25 or less retail investors is considered correspondence. Any investor that does not meet the criteria of an institutional investor is considered a retail investor. Communications include:Material distributed to a wide audience such as though TV, web sites, magazines and radioA reprint of an article from a third-party sent to more than 25 retail investors during a 30-day period * Distribution through social media venues

Answer 47

A principal must approve retail communications before public release or the FINRA filing except in the following cases:The material has already been filed with FINRA by another firm and it has not been materially alteredThe material is from a social media website such as Twitter * The material does not recommend any investment, promote the products and services of the firm, is not considered a research report and does not provide financial advice (This includes normal contacts with customers and market letters)In most cases if the communication does not require preapproval than it does not need to be filed with FINRA

Answer 48

Filed with FINRA 10 days prior to use:All broadly disseminated communications within the first year as a FINRA memberA firm that has been disciplined may be required to have its communications approvedRetail communications regarding registered investment company comparisons and rankings that are created by the firm * Retail communications regarding security futuresFiled with FINRA within 10 days of use:Communications regarding the following:Mutual funds, ETFs, variable products, closed-end funds and unit investment trustsDerivativesCollateralized mortgage obligations * Publicly traded direct participation programs * Investment analysis tools and the resulting reports producedRoutine business communications such as recruitment ads, press releases and reprints of articles produced by third-parties do not have to be filed with FINRA

Answer 49

Ranking of investment companies can only be used in retail communications if they are created and published by a ranking entity or are based on the performance measurements of a ranking entity. A ranking entity is any organization that:Provides general information about investment companies to the publicIndependent from investment companies or their affiliates * Not hired or compensated by an investment company or its affiliates to provide a fund ranking

Answer 50

The name of the investment category being rankedThe number of investment companies compared within the categoryName of the entity issuing the rankingThe time period involved in determining the rankingCriteria used in determining the rankingStatement that past performance is not a guarantee of future resultsWhether the ranking takes into account front-end feesThe use of either total return or current SEC standardized yieldThe publisher of the ranking information * Explanation of any symbols, such as number of stars, used in the ranking

Answer 51

Bond volatility ratings cannot be used in public advertisements only in supplemental sales literatureA prospectus has been or will be sent to the clientThe volatility rating is not described as a risk ratingThe most recent available ratings are usedObjective and quantifiable factors are used to determine the ratingThe issuing entity provides a detailed disclosure on the rating methodology to investors on a website or toll-free numberThe name of the entity issuing the ratingMost current rating and the dateDescription of the rating including the methodology, whether the fund paid for the rating and the types of risks measuredStatement there is no standard method for determining the bond fund volatility rating * Statement that the portfolio may have changed since the date of the rating and there is no guarantee that it will stay the same

Answer 52

Criteria, methodology and main assumptions of the investment toolThe range of investments to be analyzed as well as the process of selecting securitiesDisclose that investment results may vary over timeAny securities which the firm makes a market in or is serving as an underwriterThe following disclosure:IMPORTANT: The projections or other information generated by (name of the investment tool) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

Answer 53

A public appearance is when a person representing a broker-dealer or fund sponsor speaks in an unscripted format on TV, radio, at a conference or seminar. Any similar engagement that is not considered retail communication is a public appearance and is not required to be preapproved by a principal or filed with FINRA

Answer 54

Any written communication on equity securities that contains adequate information to make investment decisions (e.g., rating, recommendation, price target). Prior to the use of a research report approval must be obtained by a Supervisor Analyst. Research reports must disclose:If the analyst or the analyst's immediate family is an officer, director or advisory board member of the companyOwnership information of the security if owned by the analyst or the analyst's immediate familyOwnership information if the firm owns 1%; or more common shares of the securityIf the firm is a market maker for the securityCompensation information if the issuer provided compensation for underwriting services to the firm within the last 12 months * Firms may not issue research reports if underwriting services for the security (i.e., as a manager or co-manager) were performed within the last 40 days for IPOs and within the last 10 days for secondary offeringsIn order to prevent conflict of interest a firm's research department must be separate from the investment banking department * Any material conflict of interest

Answer 55

For the first year broker-dealers must file all advertisements with FINRA at least 10 days prior to publicationFor established broker-dealers copies of all advertisements must be kept in an internal file for at least 3 yearsOtherwise, advertisements generally do not need to be filed with FINRA. Exceptions include advertisements for options, Collateralized Mortgage Obligations and investment companies

Answer 56

Three years. The first two years must be readily available during a FINRA audit

Answer 57

Approval by ROP prior to useAdvertisements and educational materials must be submitted to the SRO ten days prior to useAdvertisements must be general (i.e., cannot make specific recommendations)Advertisements cannot reference past or future performanceIf provided to customers not yet approved for options trading sales literature must be accompanied with the Characteristics and Risks of Standardized Options which discloses risks and outlines relevant information associated with options * If referencing past or future performance sales literature must either contain supporting documentation or contain notification that supporting documentation is available upon request

Answer 58

Name and address of residenceIf the customer is of legal ageSignature of registered representative opening the accountSignature of principal, officer or partner approving the account (approval must occur on or before the day the account is opened) * For accounts opened for businesses or organizations the names of the individuals authorized to transact business in the account must also be gatheredThere must also be a reasonable effort to obtain:Taxpayer ID number or Social Security NumberOccupation, employer, work addressIf the customer is associated with another broker-dealerIf associated with another member firm: * Written notice must be provided to the member firm of the intention to open an account * Copies of confirmations must be sent to the member firmIf the member firm provides any written instructions they must be followedInformation used to make recommendations such as risk tolerance, investment objectives, financial background, tax status, annual income, net worth, etc.[Note: Any information specifically withheld by the client should be documented] * If a discretionary account the customer must give written consent

Answer 59

A margin agreement must be signed by the customer stating that the customer must follow the requirements set by the Federal Reserve Board, the SRO and the brokerage firm. The margin agreement will typically contain:Credit agreement - Customer acknowledges the loan and accepts responsibility for interest and principal payments. All credit terms are outlinedHypothecation agreement - The customer agrees to hypothecate (i.e. pledge) securities in their account to the brokerage firm. In other words the securities in the account are used as collateral for the margin loan. The agreement also typically allows the brokerage firm to rehypothecate the securities at a bank for up to a value of 140%; of the debit balance. In this case the brokerage firm uses the securities as collateral to secure a margin loan with a bank. The maximum amount that may be used as collateral is 140%; of the balance that the customer owes (e.g., if the total value of the margin account is $20,000 and the customer deposits $10,000 in cash to meet the margin requirement then their debit balance is $10,000 and the maximum rehypothecation amount is $14,000)Loan consent agreement - Allows the brokerage firm to lend the customer's securities (typically for short sales for other clients). Current regulations do not require that the customer sign the loan consent agreement

Answer 60

The interest rate is variable and typically follows the broker call loan rate which is the interest rate charged to brokerage firms for loans from a bank. The margin interest rate will typically be the broker call loan rate plus an additional percentageInterest is charged daily and posts to the account monthly. Interest payments are typically tax-deductible against investment income

Answer 61

Each long margin position (i.e., a position owned by the customer in the hopes that it will increase in value) has a:Long market value (LMV):No. of Shares× Current Market PriceDebit Balance (DR): Amount owed to the brokerage firmEquity is determined by subtracting the debit balance from the long market valueEquity = LMV - DR

Answer 62

If the initial equity in the account is at 50%; of the long market value (in order to meet Regulation T's 50%; initial requirement), and then the long market value increases there will be equity in excess of the 50%; requirementFor example, if the long market value of a customer's account has increased to $50,000 and their debit balance is $20,000 the equity in their account is now $30,000 ($50,000 - $20,000). The 50%; requirement is $25,000 ($50,000 x 50%;). Therefore, their excess equity is $5,000 ($30,000 - $25,000)Excess Equity:Current Account Equity− (Long Market Value × 50%;)

Answer 63

SMA is a line of credit with a brokerage firm that is generated by notating an eligible amount (such as cash additions to the account). These cash additions are used to pay down the debit balance which increases excess equity in the account. The customer may withdraw cash from their margin account up to the total of the notated amounts (aka the SMA) at which point the equity in their account will once again be at the 50%; margin requirement. Items that generate SMA include:Excess equityCash dividendsBond interestProceeds from the sale of securities * Voluntary customer cash deposits

Answer 64

The amount of money available for securities purchases. For cash accounts buying power is equal to the cash in the accountFor margin accounts buying power is equal to the cash in the account plus the SMA divided by 50%; (the margin requirement):Cash + SMA50%;For example if a customer had $1,000 in cash and $5,000 in SMA or excess equity they would be able to purchase $12,000 in securities ([$1,000 + $5,000] / 50%;)

Answer 65

Federal Reserve Board Regulation T governs margin accounts. However, industry requirements are permitted so long as they are more stringent than Regulation T. They include:Initial margin requirement - The minimum customer deposit is the lesser of $2,000 or 100%; of the purchase price. In other words, for purchases of less than $2,000, the customer must deposit 100%; of the purchase price rather than Regulation T's 50%; initial requirement. For purchases of $2,000-$4,000 the customer must deposit $2,000 which is higher than Regulation T's 50%; requirementMaintenance margin requirement - Equity in the margin account must not fall below 25%; of the current market value of the account. If equity falls below 25%; the customer will receive a maintenance call to make an additional deposit or to liquidate securities in order to make the maintenance requirement. The result is that if the current market value falls below 4/3 of the debit balance the account would be below the 25%; maintenance requirement. Regulation T does not have a maintenance requirement:LMV × 4/3

Answer 66

A margin account becomes restricted when the equity in the account falls below Registration T's 50%; initial margin requirement. For restricted accounts:Margin purchases may still be made as long as the new purchase meets the 50%; margin requirementProceeds from any sales are used to reduce the debit balance and only 50%; of the proceeds of the sale is added to the SMA balance[Note: Cash may only be withdrawn from the SMA when the account is no longer restricted]Same-day substitutions occur when a purchase and a sale of securities is made on the same day * For same-day substitutions of equal sale and purchase amounts no additional deposit is required * For same-day substitutions where the purchase is greater than the sale amount the 50%; requirement is only required for the difference between the purchase and sale amount. For example, for a purchase of $10,000 and a sale of $5,000 on the same day a deposit of $2,500 ([$10,000 - $5,000] x 50%;) is required * For same-day substitutions where the purchase is less than the sale amount SMA is credited 50%; of the difference between the purchase and sale amount. For example, for a purchase of $10,000 and a sale of $20,000 on the same day SMA would be credited an additional $5,000 ([$20,000 - $10,000] x 50%;)

Answer 67

Each short margin position (i.e., a position borrowed by the customer in the hopes that it will decrease in value) has a:Short market value (SMV):No. of Shares× Current Market PriceCredit Balance (CR):Short Sale Proceeds+ Reg T Initial Margin Req for Short PositionsEquity is determined by subtracting the short market value from the credit balance:Equity = CR - SMV

Answer 68

The equity of an account with long and short positions is equal to the equity of all long positions plus the equity of all short positionsLong market value (LMV):Shares of Long Positions× Current Market PriceDebit Balance (DR): Amount owed to the brokerage firm for long positionsShort market value (SMV):Shares of Short Positions× Current Market PriceCredit Balance (CR):Short Sale Proceeds+ Reg T Initial Margin Req for Short PositionsEquity is determined by subtracting the debit balance and the short market value from the long market value and the credit balance:Equity:LMV + CR - DR - SMV

Answer 69

If the initial equity in the account is at 50%; of the short market value (in order to meet Regulation T's 50%; initial requirement) and then the short market value decreases there will be equity in excess of the 50%; requirementFor example, if the short market value of a customer's account has decreased from $60,000 to $50,000 and their credit balance is $90,000 the equity in their account is now $40,000 ($90,000 - $50,000). The 50%; requirement is $25,000 ($50,000 x 50%;). Therefore, their excess equity is $15,000 ($40,000 - $25,000)Excess Equity:Current Account Equity− (Short Market Value × 50%;)

Answer 70

Federal Reserve Board Regulation T governs margin accounts. However, industry requirements are permitted so long as they are more stringent than Regulation T. They include:Initial margin requirement - The minimum customer deposit is the greater of $2,000 or Regulation T's initial margin requirement. For short sales of less than $4,000 the customer must deposit $2,000 which is higher than Regulation T's 50%; requirementMaintenance margin requirement - Equity in the margin account must not fall below 30%; of the equity in the account. If equity falls below 30%; the customer will receive a maintenance call to make the maintenance requirement. If the current market value falls below 10/13 of the credit balance the account would be below the 30%; maintenance requirement:SMV × 10/13Margin requirements for securities with a low market price: * If less than $5 per share: Equity must be the greater of the current short market value or $2.50 per share * If more than $5 per share: Equity must be the greater of $5 per share or 30%; of the current short market value

Answer 71

Re-evaluating a security to assess its current market value. For securities in a margin account used to meet margin requirements marking to market may occur to adjust the value of the securities and, if the marked to market securities fall under the margin maintenance requirements, the customer may experience a margin call to deposit additional assets

Answer 72

Exempt securities are not subject to Regulation T but are subject to SRO requirements. They include:U.S. Government Securities - 1%; to 6%; of the current market value depending on the amount of time remaining until maturity. The initial and maintenance margin requirements are the sameMunicipal Securities - 7%; of the current market value. The initial and maintenance margin requirements are the sameNonconvertible Corporate Bonds - 10%; of current market value for investment grade bonds. The greater of 20%; of market value or 7%; of the principal amount for noninvestment grade bonds. The initial and maintenance margin requirements are the sameConvertible Corporate Bonds - 50%; of the current market valueArbitrage - If a client has a long position that is convertible into an equal number of shares in a short position of the same security the maintenance margin requirement is 10%; of the current market value of the long positionShort against the Box - If a client has a long position and an equal number of shares in a short position of the same security the maintenance margin requirement is 5%; of the current market value of the long positionOptions - The initial margin requirement is 100%;

Answer 73

Member firms must have set procedures for approving accounts for options trading due to the risky nature of options. Required procedures are as follows:Registered reps must obtain financial and background information that shows the customer's knowledge and experience and ability to understand the nature of options trading and the associated risksAn Options Account Agreement is completed by the registered rep stating the customer's background informationThe member firm must send the agreement to the customer in order to verify the information. The customer's lack of response or completion or correction of information in the agreement is considered verification of the agreement. Any refusal by the customer to provide information must be noted on the agreementThe agreement is also given to the ROP for review. After the ROP approves the agreement the account may execute options transactionsOn or before the approval date, the Characteristics and Risks of Standardized Options booklet that discloses risks and provides relevant information associated with options must be provided to the customerThe customer has 15 days from account approval date to sign and return the Options Account Agreement. Signing the agreement verifies the customer information and shows that the customer has agreed to abide by regulations, exercise and position limitsIf the signed Options Account Agreement is not returned the account is restricted to closing transactions only. No other types of options transactions may be made * If a discretionary account the ROP must approve discretionary status of the account and maintain a written record of the approval. The customer must also provide written authorization of discretion for options trading prior to any discretionary options activity

Answer 74

Investment objectives are the primary goals that a client wishes to accomplish with a particular investment or investment account. They include:Current income - The primary goal is to provide a steady and stable stream of cash. For example, bonds and annuitiesGrowth - The primary goal is capital appreciation. For example, common stocks.[Note: For investments that may be considered speculative Registered Reps must ensure that the client understands and is able to bear the risks involved]Preservation of Capital - The client would like a return on their investment but does not want to put their principal at risk. For example, Treasury and money-market securitiesTax Relief - The primary goal is tax relief, especially for clients subject to higher taxes. For example, tax-exempt or tax-deferred investments

Answer 75

Risk tolerance is the level of comfort with risk in losing one's principal investment in return for higher potential gainsInvestment objectives are the primary goals that a client wishes to accomplish with a particular investment or investment accountRisk tolerance and investment objectives do not necessarily coincide

Answer 76

Time horizon is the length of time an investment is made or projected to be held before it is liquidated. Investments with shorter time horizons are typically less volatile while investments with longer time horizons have more flexibility in volatility

Answer 77

Individual - Opened by and for one person. A third party may be authorized on the account through express written authorization by the account ownerJoint - Two owners or more. Generally any joint owner may initiate account activity. However, the account may specify that all owners must jointly initiate and sign off on all activityCorporate - The customer is the corporation. The corporate resolution specifies persons authorized for the account and a copy of the resolution should be kept on filePartnership - Information and signatures for all partners should be obtained. The partnership agreement specifies persons authorized for the account and a copy of the agreement should be kept on fileFiduciary - The customer is acting on behalf of another and their investment decisions should be conducted in what would be deemed a prudent manner. Documentation of authority should be kept on file (e.g., Will, Trust)Incompetents - A fiduciary is appointed by a court for persons unable to competently act on their own behalf. Additional documentation may be necessary to grant authorityMinors - Minors are not allowed to open accounts

Answer 78

Joint Tenants with Right of Survivorship (JTWROS) - Both tenants own the property jointly and the account passes to the remaining owner in the event of deathTenants in Common (TIC) - Ownership is typically proportional to each owner's contribution to the account and is passed to the deceased owner's estate in the event of death rather than passing to each other

Answer 79

Uniform Gifts to Minors (UGMA) - An adult gives an irrevocable gift to a minor (only one minor per account) and appoints a custodian for the account (only one custodian per account). There is no maximum limit to the gift, however, the gift may be subject to the gift tax. Custodians must act in a manner deemed prudent. The account is opened under the minor's social security number but is registered in the name of the custodian as custodian for the minor. Taxation of any income generated from the account is the minor's responsibility. The custodial relationship ends when the minor reaches the age of majority and assets should then be transferred out of the UGMA. If the custodian dies before the minor reaches the age of majority and has not appointed a successor the court will appoint a successor. If the minor dies the assets become a part of the minor's estateUniform Transfers to Minors Act (UTMA) - A new version of UGMA that has been passed by most states. UTMA is similar to UGMA

Answer 80

A trading authorization is a power of attorney that allows a third party to trade in an account. A limited trading authorization allows the placement of buy and sell orders. A full trading authorization also allows withdrawals of cash and securities from the account. A written trading authorization with the date authority will be granted and signed by all account owners should be obtained prior to exercising trading authorityFiduciaries and persons not considered to be legal persons (e.g., minors, incompetents, decedents) may not grant trading authorizations to a third party

Answer 81

Generally an account where a registered representative is the third party authorized to trade in an account. Discretionary accounts must be approved by the customer and the principal prior to granting of the trading authorization. Each discretionary order must be approved promptly and reviewed frequently by the principal and must be identified as discretionary on tickets and confirmationsExceptions - A registered rep may trade in an account without it being considered discretionary if the customer requests: * A specific number of shares * A specific security * Whether to buy or sellIf the customer specifies all of these things, leaving discretion only as to time and/or price, written authorization is not necessary. For verbal orders (versus written orders) the time and price discretion is limited to the trading day that the client placed the order. This information should be notated on the order ticket

Answer 82

CashMargin | * Option

Answer 83

Eligible to anyone that receives income from working (e.g., wages, salaries, commissions, etc., however, interest income, dividends and capital gains are excluded). The annual contribution limit for the years 2008 to 2012 is the lesser of $5,000 or $5,500 in 2013 or 100%; of annual compensation. If aged 50 years old or more an additional $1,000 catch-up contribution is permitted. Further limits may be imposed if an individual's income is above a specified levelThe contribution deadline is the date the individual's tax return is due, typically on April 15th (e.g., the deadline for a 2012 IRA contribution is April 15, 2013, when the 2012 tax return is due). Contributions must be made in cashIRAs provide certain tax incentives. However, if an individual contributes more than the maximum allowable amount the excess contribution amount is penalized at 6%;. The excess contribution amount is also not eligible for tax incentive benefits[Note: Enrollment in qualified retirement plans does not affect eligibility for IRAs]

Answer 84

A married couple may open two separate IRAs if both spouses receive working compensation. If only one spouse is working the working spouse may open a Spousal IRA for the non-working spouse. IRAs for married couples are subject to the same contribution limits as individuals (i.e., $5,500 for each IRA in 2013)

Answer 85

Allowable investments for IRA include stocks, bonds, mutual funds, annuities, real estate and other financial assets. Life insurance policies, art and antiques are not allowable investments. The custodian bank may also have their own limitations on what investments they will allow

Answer 86

The bank or brokerage firm acts as a custodian or trustee of the account only. They may also assist in setting up the account and may service the account. The customer makes investment decisions in the account

Answer 87

``` Traditional IRA (often referred to as an IRA)Roth IRASimple IRA * SEP IRA ```

Answer 88

After-tax contributions are not taxable. Pre-tax contributions and capital gains are tax-deferred (i.e., pre-tax contributions and gains are not subject to federal and state income taxation until withdrawal)Withdrawals may not occur until the individual reaches the age of 59 1/2 without a penalty. Early withdrawals are subject to a 10%; penalty unless the following applies: * Death * Disability or mental incompetence * Withdrawals are used for certain medical expenses * Withdrawals are used for qualified higher education expenses * Withdrawals are used for certain expenses related to the purchase of a first-time homeWithdrawals of after-tax contributions are not taxed. Withdrawals of pre-tax contributions and gains are taxed as ordinary income in the tax year in which the withdrawal is madeAnnual withdrawals of tax-deferred contributions and earnings are mandatory beginning April 1st after the individual reaches the age of 70 1/2. The annual Required Minimum Distribution (RMD) is calculated by the IRS based on the individual's life expectancy. Any RMD amounts not withdrawn are subject to a 50%; tax penalty

Answer 89

Retirement assets may move from one retirement account to another without tax penaltyA trustee-to-trustee transfer is a transfer where assets are sent directly from one trustee to another trustee (i.e., the individual never receives the assets). The transfer may be electronic or may be a check sent directly to the receiving trustee and made payable to the receiving trustee. The number of allowable trustee-to-trustee transfers is unlimited.A rollover is a transfer where the assets of the transferring account are distributed in the form of a check sent directly to the individual. Rollover checks must be deposited into the receiving account within 60 days of receipt. Rollovers are limited to once every 12 months. Rollover distributions may be subject to 20%; backup withholding (where the IRS requires that the trustee withhold 20%; of the distribution amount)

Answer 90

A Roth IRA is an IRA where contributions to the account are not tax-deferred. The individual must pay any required taxes on contributions. Qualified distributions of Roth IRA (contributions and capital gains), however, are not subject to taxationRoth IRA do not have a Required Minimum Distribution. Withdrawals once the individual reaches the age of 70 1/2 are not mandatoryContributions may be made at any age. Unlike Traditional IRA, contributions are not required to stop after the age of 70 1/2Eligibility to contribute to Roth IRA are phased out at the following adjusted gross income (AGI) limits for 2012:Single tax filing status:$110,000 - $125,000Joint tax filing status:$173,000 - $183,000Eligibility to contribute to Roth IRA are phased out at the following adjusted gross income (AGI) limits for 2013:Single tax filing status:$112,000 - $127,000Joint tax filing status:$178,000 - $188,000

Answer 91

Health Savings Accounts are tax-advantaged individual accounts to pay for qualified medical expenses. Pretax contributions are made into an account and invested with all withdrawals also tax-free as long as they are used to pay for qualified medical expenses. Any withdrawals made for other purposes are subject to a 20%; tax penalty. Any withdrawals made after the age of 65 are not subject to the penalty

Answer 92

A plan that meets the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and therefore qualifies for certain tax benefits which include: * Employer deducts contributions to the plan from employee income * The retirement fund is exempt from taxesQualified retirement plans have an early withdrawal penalty of 10%; if distributions are made before the age of 59 1/2

Answer 93

The plan must be either a defined contribution plan or a defined benefit plan. Defined contribution plans, also known as money purchase plans, are plans where the employer must contribute an amount into the plan on behalf of the employee based on the employee's annual compensation. Defined benefit plans promise benefit payments each year to the employee when the employee retires typically based on age, compensation history and years of service. Employers must deposit an amount into the plan each year, determined by actuarial calculations, in order to meet the promised retirement benefitsThe plan must have an IRS-approved vesting schedule (e.g., full vesting after three years of service). Vesting is the amount an employee may retain if withdrawing from the planThe plan must have eligibility requirements such as 21 years of age or older, one full year of service or more, 1,000 hours worked per year or more, etc. Eligibility requirements must not be discriminatory (i.e., must be established for the benefit of all employees)Plans must be in writing. At inception and through annual updates plan provisions must be communicated to employeesThe trustee of the plan must be a fiduciary under the prudent man standard (i.e., in the best interest of participants). Generally, the plan should be diversified, have liquidity and have reasonable returns given benefit payment schedules * Contributions into the plan are not included in the employee's income until distributed from the plan. Contributions and gains are tax-deferred

Answer 94

Corporate:401(k) * Profit-Sharing * Employee Stock Ownership Plan (ESOP)Self-Employed/Employer * Keogh (HR-10) * Simplified Employee Pension (SEP)Government/Non-Profit * 457 * 403(b), Tax-deferred annuity, tax-sheltered annuity, or qualified annuity

Answer 95

A qualified defined contribution plan. Employee contributions on a pre-tax basis, deducted from their salary, are a maximum of $17,500 for 2013 and $17,000 per year for 2012 ($16,500 for 2009 to 2011). Individuals over 50 years old may contribute an additional catch-up contribution of $5,500 in 2012 and 2013. Employers may choose to match employee contributions with a limit between both contributions of $51,000 in 2013 or $50,000 in 2012 ($49,000 for 2009 to 2011). The employee contribution portion is always fully vested. Employer contributions may be subject to a vesting schedule. Investments are selected from a list of options

Answer 96

A qualified defined contribution plan. Employees share in the profits made by the company. Contributions into the plan are made by the employer and vary at the employer's discretion. Contributions cannot exceed 25% of covered compensation and they do not have to come from income or retained earnings, but must be substantial and recurring

Answer 97

A qualified defined contribution plan. Contributions into the plan are made by the employer and varies at the employer's discretion. Contributions are invested into the stock of the company. Benefits of this type of contribution include employer tax deductions based on the market value of the stock and not having to use cash. Disadvantages include the risk of a decline in the value of the stock. ESOPs are also used in the hope that the plan will motivate employees to improve company performance and therefore increase the value of their plans

Answer 98

For self-employed individuals and their eligible employees. May be set up as a defined contribution plan or a defined benefit plan. The 2013 maximum contribution is the lesser of $51,000 (2012 was $50,000) or 20%; of pre-tax self-employment income. Employee limit is $17,500 and the employer may contribute up to $33,500 for a total limit of $51,000. Contribution rates must be the same for both the employer and employeesKeogh plans must be opened prior to the end of the tax year and contributions must be made by the date the individual's tax return is due (e.g., a 2012 contribution must be made in Keogh plan established by December 31, 2012 and the contribution must be deposited by April 15, 2013)Contributions are deducted on the individual's tax return. Contributions and gains are tax-deferred. Keogh plans have Required Minimum Distributions. Early withdrawals before the age of 59 1/2 are subject to a 10%; penalty[Note: Enrollment as an employee in an employer-sponsored retirement plan does not affect eligibility for a Keogh plan]

Answer 99

For employers and self-employed individuals and their eligible employees. The maximum contribution is the lesser of $50,000 in 2012, $51,000 in 2013 or 25%; of the employee's salary. Contributions are immediately 100%; vested and are placed into the employee's individual SEP IRA. All employees aged 21 and over must be included in the plan if they have worked for the employer in three of the last five years earning at least $550. Self-employed individuals have a limit determined by calculations of their net profit

Answer 100

A qualified defined contribution plan. Only for tax-exempt, non-profit organizations qualified under section 501(c)(3) (e.g., churches, public schools, etc.). Also known as tax-deferred annuities (TDA), tax-sheltered annuities (TSA), or qualified annuities. Similar to 401(k) plans. Typical investments include annuities or mutual funds

Answer 101

A qualified defined contribution plan. Only for certain non-profit or government organizations (e.g., public universities, school districts, etc.). Similar to 401(k) plans, except:The contribution limit is independent of 401(k) and 403(b) plans that the individual participates in. The combined contribution limit for all 401(k) and 403(b) plans is $17,500 for 2013. Individuals may contribute up to an additional $17,500 in a 457 plan even if they have reached the maximum combined contribution amount for their 401(k) and 403(b) plansEarly withdrawals are not subject to a 10%; penaltyNon-governmental plans are limited to higher compensated employeesNon-governmental 457 plans cannot be rolled over into other qualified retirement plans but may be rolled over into other non-governmental 457 plans * Any contributions that are not vested are the property of the employer

Answer 102

Payroll deduction planDeferred compensation plan | * Nonqualified annuity

Answer 103

A voluntary retirement plan. All contributions are after-tax. Payroll deductions may be used to pay for insurance premiums, investment accounts, etc. Employers may match employee contributions

Answer 104

Employees enter into a contractual agreement to defer compensation until termination, retirement, disability or death. May be used so that income will be earned in a year where the individual anticipates their tax bracket will be lower. Employers determine eligibility. Contributions are after-tax. The employee has no rights to the contributions. The employee does not pay tax on contributions until they receive the money in either installments or a lump sum

Answer 105

An annuity purchased by an individual with after-tax dollars

Answer 106

A Coverdell Education Savings Account or education IRA is a tax-advantaged savings account created to pay for future education expenses. After-tax funds can be invested in a tax deferred account until needed for qualified education expenses. These can include tuition, books and other related materials for primary through university level education. Contributions can be made to the account until the beneficiary turns 18 unless they are a special needs beneficiary. Qualified withdrawals can be made until the beneficiary is 30 years old after which the account can be changed to another member of the family under 30 with qualified education expenses. Withdrawals made for nonqualified uses are subject to a 10%; penalty and taxed as ordinary income

Answer 107

A Section 529 plan is a savings plan designed for higher education expenses for a designated beneficiary. Prepaid plans allow the purchase of tuition at current prices to be used in the future. The investment then grows at the same rate as tuition inflation and are administered by states or higher education institutions. Contributions exceeding $13,000 per year increasing to $14,000 in 2013 may be subject to the gift tax, unless it is the initial contribution which has a limit of $65,000 increasing to $70,000 in 2013 (initial gifts are treated as if the gift was made over a 5-year period). There are no income limits for 529 plans. Contributions are made with after-tax dollars but withdrawals are tax-free for qualified education expenses. Qualified expenses include tuition, books, supplies as well as room and board at accredited colleges, universities or vocational schools. Each state determines plan rules such as tax-deductibility of state taxes, investment options, etc. Rollovers for 529 plans from one state to another are limited to once every 12 months. Rollovers between 529 plans and Coverdell ESAs are not allowed

Answer 108

Recommendations to customers must be suitable. Recommendations that are profitable but unsuitable to the customer's financial situation and needs would still violate the fair dealings standardUnsuitable recommendations include: * Purchases beyond the customer's ability to pay * Excessive account activity * Mutual fund shares which by their nature are not suitable as trading vehicles * Any fraudulent activities[Note: Registered reps may execute unsolicited orders that are unsuitable. Prior to execution the rep must provide an explanation of why they believe the trade is unsuitable to the client. Solicited orders and trades in discretionary accounts, however, must always be suitable]

Answer 109

Borrowing and lending between a registered representative and a client can only occur if the firm has implemented specific written procedures and under one of the following conditions:Registered rep and the client are immediate family membersThe client is a financial institution in the business of providing credit or loansBoth parties are registered with the same firmThere is a personal relationship between the two parties on which the loan is based * There is a business relationship between the two parties apart from the client-member firm relationship

Answer 110

Where securities are transferred into the customer's name but held in a firm's vault in segregation

Answer 111

Where securities are transferred into the customer's name and delivered to the customer

Answer 112

Where securities are registered under the name of the brokerage firm as nominee. They may be held in the firm's vault, safekeeping area or a centralized depository (e.g., the Depository Trust Company or DTC) and are transferred on a book-entry basis

Answer 113

Where the securities of a broker-dealer are mixed with the securities of a customer. Commingling is a violation of the Securities Act of 1934. All customer securities held in a firm vault must be segregated and the customer must be identified as the owner

Answer 114

DVP - Delivery Versus Payment is a system that ensure the securities are delivered to the buyers custodial account at the same time that payment is made from their custodian bank. The broker-dealer delivers the purchased securities and receives payment for them at the same time * RVP - Receive Versus Payment is the same process when a security is sold from an institutional account. The dealer receives the securities from the custodian bank at the same time payment is madeThese are both known as COD or cash on delivery systems whose primary purpose is to reduce the risk of payments or securities being delivered with no offsetting transaction

Answer 115

Profit or loss sharing (unless approved by a principal and the gains and losses are shared in proportion to ownership of assets)Lending securities that have been fully paid by the client (unless written approval is obtained identifying the security name and amount) * Informing clients that securities are guaranteed against loss

Answer 116

* Address changes * Financial situation * Investment objectives

Answer 117

Mark the customer's account "deceased."Cancel all open ordersFreeze all assets in the account until receiving the necessary legal documents from the executor or administer of the customer's estate. These generally include: * Copy of death certificate * Letters testamentary (gives authority to act on estate's behalf, e.g., will or court appointment) * State inheritance tax waiverAffidavit of domicile (certifies deceased customer's place of residence at time of death)Close account and transfer assets to an estate account so that the executor or administrator may transact business in the estate account[Note: Any existing power of attorney is automatically cancelled upon death of the customer]

Answer 118

A transfer on death provision allows the accountholder to specify a beneficiary on the account in case of death. This process is in place in most states through the Uniform Transfer on Death Security Registration Act which simplifies the transfer by avoiding probate but estate taxes will still apply

Answer 119

A regular power of attorney is no longer effective once the grantor becomes incapacitated due to physical or mental issues. A durable power of attorney specifies that in these cases the power of attorney should continue to be in effect. The power of attorney will continue until the death of the grantor

Answer 120

Broker-dealers must send account statements quarterly for inactive accounts and typically monthly for active accounts. Accounts statements should show all activity for the statement period, account balances, all current long and short positions and debits and credits

Answer 121

Clients may have their mail delivered to either a physical address or PO BOX. A physical address is required, however, when the account is opened. A client may leave written instructions to hold mail for up to two months if traveling domestically or three months if travelng internationally

Answer 122

Account records must be amended. Does not require customer approval, new account forms or notification to any regulatory authority

Answer 123

The carrying firm is the firm that currently holds the customer account and the receiving firm is the firm that will hold the customer account upon transferReceiving firm must receive written instructions from customerReceiving firm must immediately submit transfer request to carrying firmWithin one business day carrying firm must either validate instructions or take exception. For non-transferable assets the carrying firm must inform customer and request instructions (e.g., liquidation of non-transferable assets or retention by carrying firm or a third party) * Within three business days of validation carrying firm must complete transfer of account

Answer 124

The Automated Customer Account Transfer Service (ACATS) is a system to standardize and automate account transfers when both firms are members of the system. ACATS is part of the National Securities Clearing Corporation (NSCC) but other clearing agencies have similar systems

Answer 125

The firm does not have any record of the accountThe transfer instructions are not complete * The instructions do not have a valid signature

Answer 126

Proprietary funds of the carrying firmThe receiving firm does not have the required selling or distribution agreements to hold the asset such as a mutual fund * Private investment interests

Answer 127

The broker-dealer must provide a confirmation to the customer at or before completion of a transaction, usually the settlement date. Confirmations must include:Name of the securityWhether the security was bought or soldPriceNumber of shares, units or the principal amountAny remunerations received (e.g., commissions)[Note: Markups must be disclosed in riskless principal transactions where the broker-dealer does not purchase the security until it receives the order from the customer in principal transactions in Nasdaq stocks, and in principal transactions in NYSE or Amex stocks traded over the counter (OTC)]Date of transactionTime of executionSettlement dateCapacity in which the broker-dealer acted (e.g., agent for customer, third party or as principal for its own account)For debt securities: * Dollar price * Yield * Par value * Name if issuer * Maturity * Type of bond * Coupon rate if applicable * Amount of accrued interest, principal and transaction total if applicableCall features if applicable * Whether the security is callable

Answer 128

A commission is the charge for executing a trade on behalf of the customerA markup is the difference in price of a principal transaction that is charged to the customer and the prevailing price charged between broker-dealers

Answer 129

Commissions, markups and markdowns must be fair and reasonable. Factors that determine the amount may include:Current market price of the securityTransaction-related expenses * The firm's right to earn profits

Answer 130

All errors made by a registered rep must be recorded and an error account must be maintained by the broker-dealer[Note: Transactions made with an incorrect account number may be corrected with the permission of a registered principal by transferring the transaction to the correct account number]

Answer 131

Whenever a broker-dealer uses any means of interstate commerce (e.g., calling or mailing to another state). In practical terms this requires that almost all broker-dealers become a member of SIPC

Answer 132

If a broker-dealer becomes insolvent SIPC coverage provides up to $500,000 for each customer of which up to $250,000 may be for cash losses. These are not trading losses but failure of the brokerage firm to be able to cover cash and securities held for its clients. Any losses incurred above the maximum amount can still be claimed in the resulting bankruptcy proceedings. The customer would become a general creditor for the excess amount not covered by SIPC and would receive the same priority as the failed broker-dealer's other general creditors[Note: SIPC coverage only applies to public customers. It does not apply to securities held by other broker-dealers]

Answer 133

Requires all SEC-registered members to reasonably protect customer privacy (i.e., confidential information) and to provide to the customer a privacy notice at the initiation of an ongoing relationship and annually thereafter. Additionally, a privacy notice must be provided to any new consumer prior to disclosure of any nonpublic personal information to a nonaffiliated third partyPrivacy notices must include:Type of personal information collectedCategories of affiliated and non-affiliated third parties that may receive the personal information * Notification of client's right to opt out of disclosure to non-affiliated third parties

Answer 134

A consumer is someone who has provided information for a potential transaction with the firmA customer has an ongoing relationship with the firm

Answer 135

CTRs must be filed whenever a customer's cash transactions during one business day (the aggregate total of all transactions) exceeds $10,000.CMIRs must be filed whenever a customer transports an aggregate total of $10,000 into or out of the United States

Answer 136

Whenever a transaction or group of transactions equals $5,000 or more and the firm suspects that any of the following might apply:Violation of federal criminal lawsThe transaction(s) involve funds related to illegal activitiesThe transaction(s) are designed to evade reporting requirements * After examining all available facts and circumstances regarding the transaction(s), it does not appear to have a legitimate purpose or reasonable explanation

Answer 137

Anti Money-Laundering (AML) Compliance Programs are mandatory. They must be in writing and must be approved by a member of senior management. They must also include:Policies and procedures reasonably designed to detect and report suspicious transactionsA compliance officer designated to be responsible for the firm's AML programAn ongoing employee training program * An independent audit program established to ensure that the AML program is effectivePenalties for violation of AML laws may be incurred for both direct participation and lack of due diligence and include:Jail sentences of up to 20 years * Fines up to the larger of $500,000 or twice the money involved

Answer 138

A list maintained by the Treasury Department's OFAC of known and suspected terrorists and other criminals. Firms must not transact business with persons on the OFAC list

Answer 139

A requirement for a firm's AML Compliance Program. The CIP must be written.The information that must be obtained for clients that are U.S. Citizens are: * Name * Date of birth * Address * Taxpayer identification numberFor non-U.S. citizens, at least one of the following must additionally be obtained: * Taxpayer identification number * Passport number and country of issuance * Government issued document with photograph that provides evidence of nationality

Answer 140

A bond is a contract between an issuer (e.g., government entity, private business, etc.) and an investor. The investor lends money to the issuer, making the investor a creditor and the issuer the debtor. The issuer promises to pay interest on the loan and to pay back the principal amount when the bond matures. Bonds are debt securities

Answer 141

No longer issued in the U.S., bearer bonds do not have a record of the owner listed on the actual bond or on the books of the issuer. The bond contains interest coupons that the bondholder detaches and deposits at a bank when an interest payment is due. When the bond matures the bondholder redeems the bond by presenting the bond certificate

Answer 142

Registered bonds have a record of the owner's name and address both on the bond and on the books of the issuerBonds may be registered in the following ways:Registered as to principal only - Bondholder of record receives written notices and payment of principal amount at maturity. Interest payments are received by detaching interest coupons when interest payments are due and depositing them at a bankFully registered - Bondholder of record receives written notices, payment of principal amount at maturity and interest payments (via a check from the issuer every 6 months)Book entry form - No physical bond is issued. Digital entry of owner's name and address in a computer system is the only evidence of ownership

Answer 143

The principal or face amount of a bond. This is the amount paid back at the maturity of the bond often set at $1,000 each

Answer 144

The price investors are willing to pay (i.e., market price) for a bond may be much higher or lower than its principal amount (i.e., par value)Bonds selling for less than par value are sold at a discountBonds selling for more than par value are sold at a premiumThe market price of a bond is typically stated as a percentage of its par value where each 1%; increment in price is known as a point. For example:A market price of 95 is discounted 5 points and equals 95%; of the par value of bond

Answer 145

Purchase Amount:= Bond Price × Par Value= $98 × $1,000=$980

Answer 146

Serial bond issue. When bonds mature serially (e.g., $1M in bonds matures Jan 2010, another $1M Jan 2011, another $1M Jan 2012)Term bond issue. All bonds mature on the same dateBalloon bond issue. A portion of bonds mature serially but the majority of bonds mature in one specific year

Answer 147

Also known as the nominal yield. Coupon rate is the amount of interest that a bondholder receives until the bond matures, typically every 6 months. The amount received is the interest rate multiplied by the bond's par value. If coupon rate is 5%; the bondholder will receive $50 annually (5%; x $1,000 par value). Each semi-annual payment will be $25 ($50/2)

Answer 148

You will receive the principal amount (par value) and the last semi-annual interest paymentPrincipal Amount = $1,000Semi-Annual Interest Payment:= Annual Interest Payment2= Coupon Rate × Par Value2=5%; × $1,0002= $502=$25Last Payment:= Principal Amount+ Semi-Annual Interest Payment= $1,000 + $25=$1,025You will receive $1,025 when the bond matures

Answer 149

Zero-coupon bonds have no coupons and do not pay interest at regular intervals. They are offered at a deep discount from their par value, usually discounted further the longer the period until the bond matures. The difference between the discounted price and the par value is interest which is paid as a lump sum when the bond matures. Yields on zero-coupon bonds are typically higher than interest-bearing bonds. The prices of zero-coupon bonds are typically more volatile than interest-bearing bonds

Answer 150

Nominal Yield. The stated interest rate that the issuer promises to the bondholder. The rate does not change over the life of the bond. Typically paid every 6 monthsCurrent Yield. The interest rate relative to the bond's current market priceCurrent Yield =Total Annual DividendCurrent Market PriceYield to Maturity. The overall rate of return of a bond purchased at today's market price and held until the maturity, assuming that interest is reinvested and compounded. Generally calculated with specialized tools. One basis point is equal to 1/100 of 1%; (e.g., 5.75%; is 75 basis points higher than 5.00%;). Stated as yield or basis interchangeably (e.g., 5.25%; yield to maturity, 5.25%; yield, or 5.25%; basis)Yield to Call. Similar to yield to maturity, however, rather than using the maturity date it reflects the bond's interest rates until it is called

Answer 151

The nominal yield is always the same as the coupon rate. The nominal yield is 5%;

Answer 152

Current Yield:= Total Annual DividendCurrent Market Price= Coupon Rate × Par ValueCurrent Market Price=4.5%; × $1,00090%; × $1,000= $45$900=0.05The current yield is 5%;

Answer 153

The coupon or interest rate of a bond does not change over the life of the bond. However, as interest rates in the market change, new bonds will be issued with a coupon rate higher or lower than existing bonds. As interest rates increase the market price of existing bonds decrease. As interest rates decrease the market price of existing bonds increase. The market price of bonds has an inverse relationship to yields

Answer 154

The coupon or interest rate of a bond does not change over the life of the bond. However, as interest rates in the market change new bonds will be issued with a coupon rate higher or lower than existing bonds. If interest rates increase after a bond is purchased the bond must be sold at a discount to be more attractive than newer bonds at a higher coupon rate. This is known as interest-rate risk.Longer term bonds and bonds with lower coupon rates are more susceptible to interest-rate risk

Answer 155

For par bonds:The nominal yield is always fixed for the life of the bondThe current yield is the same as the nominal yieldThe yield to maturity is also the same because the bond was purchased at par and will be redeemed at par when the bond matures.For discount bonds:The nominal yield is always fixed for the life of the bondThe current yield is higher than the nominal yield because the bond is sold at a discountThe yield to maturity is higher than the current yield because the bond was sold at a discount but will be redeemed at the full value when the bond maturesFor premium bonds:The nominal yield is always fixed for the life of the bondThe current yield is lower than the nominal yield because the bond is sold at a premiumThe yield to maturity is less than the current yield because the bond was sold at a premium but will be redeemed for the original value when the bond matures

Answer 156

Longer term bonds have higher interest rates. When interest rates fluctuate longer term bonds will increase or decrease in value more dramatically than shorter term bonds. Investors receive a higher interest rate for the extra risk they incur with longer term bondsThe coupon rates for shorter term bonds change more quickly than longer term bonds. When interest rates fluctuate the change is reflected more quickly for shorter term bonds being newly offered than for longer term bonds being newly offered

Answer 157

A yield curve is a graph of the yields of bonds at differing maturities. They are typically used to infer the direction that interest rates are heading. The different yield curves are:Normal Yield Curve. Positively sloped, where yields increase as maturities lengthen. Exists under most market conditions. Also known as: normal, positive, ascending, upward slopingInverted Yield Curve. Negatively sloped, where yields decrease as maturities lengthen. Relatively rare. Also known as: negative, descending, downward slopingFlat Yield Curve. No slope, where yields are similar across all maturities. Occurs when there is a similar demand and supply for money

Answer 158

The real interest rate is the interest rate a bondholder receives after inflation is taken into account.Real Interest Rate =Interest Yield− Inflation Rate

Answer 159

The risk that the inflation rate will be higher than the interest rate that a bondholder receives over the life of the bondFor example, if a bondholder purchases a bond earning a 3%; coupon rate for $1,000 that matures in one year and the inflation rate that year is 4%;, the purchasing power of the bond plus interest after one year will be lower than the purchasing power of the bond when it was originally purchased

Answer 160

The risk that future distributions of interest and principal will have to be reinvested at a lower rate of returnFor example, if a bondholder purchases a bond earning a 5%; coupon rate that matures in one year and bond coupon rates are lower after one year, the bondholder will receive the interest and principal at the maturity date and will have to reinvest the proceeds at a lower interest rate

Answer 161

The risk that an issuer of a bond may default and not be able to pay interest and principal to bondholders

Answer 162

Bond ratings measure the credit risk of an issuer or the risk that the issuer may default and not pay interest and principal to bondholdersU.S. government issued bonds are considered to have no credit risk because they are backed by the government's virtually unlimited ability to tax and print moneyCredit risk is relatively difficult to measure. Therefore, the responsibility of bond ratings are generally entrusted to rating services such as Moody's, Standard & Poor's and Fitch Investors Service. The bond issuer must pay for the analysis which is periodically reviewed and updated by the rating service

Answer 163

A provision in a bond that allows the issuer to redeem the bonds before the maturity date by paying the principal in full plus any accrued interest. No interest payments are made after the bond is redeemedBonds are typically called when interest rates have declined. If an issuer calls all of its outstanding bonds and issues new bonds at a lower interest rate, it is known as refundingSome calls may only be exercised on specific dates after the first call date, others may be exercised at any time after the first call date and are referred to as continuous call

Answer 164

Call risk is the risk that a callable bond will be called when interest rates are falling and the bondholder will not be able to reinvest their money at the same rate of returnCall protection is a restriction on how soon the call feature on a callable bond can be exercised, typically 5-10 years from the issue dateCall premium is amount above par value that the issuer pays the bondholders to compensate them for the call risk

Answer 165

Payment Amount:= Par Value× Call Premium= $1,000 × 110%;= $1,100

Answer 166

Applies to callable bonds. Prefunding is when an issuer decides to lock in a lower interest rate prior to a scheduled call date by creating a new issue or refunding issue. The proceeds from the new issue or prefunded bonds are typically invested in government securities and deposited at a bank after signing an escrow agreement that guarantees that the securities on deposit plus any earnings will be used to pay interest and principal (i.e., refunded) on the original issue. After the original issue is secured by escrow securities the issuer is no longer responsible for payment of interest or principal and the bondholders no longer have the original rights and liens under the original indenture (i.e., bond agreement). The original issue is said to be defeased and the elimination of the issuer's responsibilities and the bondholder's rights is known as defeasanceThe market value of the refunded issue typically increases because it is secured by U.S. government securities and poses no credit risk. Trading of the refunded bonds is based on yield to call

Answer 167

A special fund used by issuers to deposit the money needed to redeem their bonds. Generally used to gradually redeem a portion of the issue beginning a few years prior to the maturity date

Answer 168

The bond agreement of a bond issue. It is the contract which details the legal obligations and rights of the bond issuer and bondholders. A trustee is assigned in the indenture to represent the rights of bondholders

Answer 169

A provision in a bond that allows the bondholder to redeem the bonds at a specified date or dates before the maturity date. The bondholder typically receives the par value of the bond, but may also redeem the bond at a discount or a premiumThe put feature allows bondholders to redeem the bonds when interest rates have risen and therefore invest their money at a higher interest rateBonds with a put feature typically have a lower yield due to the extra protection from interest rate risk that the put feature affords

Answer 170

When the broker-dealer controls the issuer or any person with responsibilities regarding the debt service on the securitiesWhen a broker-dealer sells debt securities in which a control relationship exists the broker-dealer must:Prior to execution disclose to the customer that the control relationship exists. The disclosure may be verbal, however, verbal disclosures must also be disclosed in writing by the settlement date * Prior to execution obtain written authorization if a discretionary account

Answer 171

The pricing of bonds refers to the calculation of the dollar price of a bond sold at a yield or the calculation of the yield of a bond sold at a dollar price. The calculation will be different depending on whether the bond is priced to the maturity date or to the call date. The MSRB requires that the lower of the two calculations be used and has stipulated the following general rules:Bonds selling at a discount should be priced to maturityBonds callable at par that are selling at a premium should be priced to the call * Bonds callable at a premium that are selling at a premium should be priced at the lower of the price to maturity or the price to the call

Answer 172

The dated date is the date at which interest begins to accrue on a fixed-income security which may be the date of issuance, in which case the dated date would be the same date as the issue date

Answer 173

Corporate bonds are sometimes referred to as senior securities because corporations generally must pay interest on bonds before paying dividends on stocks and, in the event of a bankruptcy, must pay bondholders and other creditors before stockholders

Answer 174

A closed-end indenture provides the greatest protection to bondholders because it does not permit the corporation to issue additional bonds secured by the same claim on the same assets as the original issueAn open-end indenture does permit the issuance of additional bonds secured by the same claim on the same assets. Because this dilutes the original bondholder's protection an earnings test or additional bonds test is typically stipulated in the indenture that requires that the corporation achieves a specific level of earnings before issuing additional bonds

Answer 175

Unsecured and secured corporate bonds are backed by the full faith and credit of the issuing corporation.Secured corporate bonds are additionally backed by specific corporate assets

Answer 176

Unsecured corporate bonds (i.e., backed only by the full faith and credit of the issuing corporation)

Answer 177

A type of unsecured corporate bond where bondholders' claims are subordinate to the other bondholders (e.g., unsecured bondholders, secured bondholders, etc.)

Answer 178

Unsecured BondsHigh-Yield (Junk) Bonds - Non-investment grade bonds (i.e., higher than normal credit risk) compensated by higher coupon rates. Suitable for speculative investorsGuaranteed Bonds - Additionally secured by a guarantee of another corporation to pay interest and principal (e.g., a parent company guaranteeing bonds issued by one of its subsidiary companies)Secured BondsMortgage Bonds - Additionally secured by a first or second mortgage on real property providing bondholders with a lien on the property. New issues are typically backed by the same property once the previous issue has been repaidEquipment Trust Certificates - Additionally secured by a specific piece of equipment owned and currently in use by the corporation (e.g., railroads, airplanes, ships, etc.), granting the trustee legal title to the equipment. Typically used to purchase new equipmentCollateral Trust Bonds - Additionally secured by third-party securities (e.g., stocks and bonds) owned by the corporation which are placed in escrow as collateral for the bonds

Answer 179

A convertible bond is a corporate bond that allows the bondholder to later convert the bonds into shares of the corporation's common stock at a predetermined conversion ratio. The conversion price is set when the bond is issued and is used to derive the conversion ratio. The conversion value is the value of the stocks received based on the conversion ratioConversion Ratio:= Par Value of BondConversion Price= X shares for each bondConversion Value:Conversion Ratio× Current Market Price of StockWhen bonds convert to stocks it increases the number of outstanding shares which in turn dilutes the stockholder's equity (because earnings are divided by the larger number of stockholders). The fully diluted earnings per share (EPS) is a figure that shows the EPS if all conversions are madeConvertible bonds allow corporations to borrow money at a lower coupon rate because investors accept the lower coupon rate in exchange for the ability to convert their bonds. In turn, investors have the potential for capital appreciation if the stock appreciates but a higher degree of safety if the stock falls

Answer 180

A stock split proportionately decreases the conversion price and proportionately increases the conversion ratio. In other words if a stock splits 2-for-1, the conversion price would halve and the conversion ratio would double. If a stock splits 3-for-1 the conversion price would be divided by three and the conversion ratio would tripleNew Conversion Price =Current Conversion PriceStock Split RatioNew Conversion Ratio =Current Conversion Ratio× Stock Split Ratio

Answer 181

A stock dividend increases the conversion ratio by the percentage of additional stock given. The conversion price proportionately decreases to the new conversion ratioNew Conversion Ratio =Current Conversion Ratio× Stock Dividend RateNew Conversion Price =Par ValueNew Conversion Ratio

Answer 182

A convertible bond is at parity when the conversion value is equal to the current market price of the bondBonds may trade at a premium to parity (when the current market price of the bond is higher than the market value of the stock that would be received upon conversion) or at a discount to parity (when the current market price is lower than the market value of the stock received upon conversion)

Answer 183

When the current market price of the bond is higher than the market value of the stock that would be received upon conversion, the bond is trading at a premium to parity. The difference between the current market price of the bond and the value of stock received at conversion is the conversion premiumConversion Premium =Market Price− (Conversion Price × Conversion Ratio)

Answer 184

When a convertible bond is called the bondholder must either accept the redemption price of the bond (which may be higher or lower than the current conversion value) or is forced to convert the bonds immediately (i.e., forced conversion)

Answer 185

Arbitrage is a technique used to profit from price differentials in the same or similar security. If a convertible bond is trading at a discount to parity the bond may be purchased and then immediately converted to a market value that is higher than the purchase price of the bonds

Answer 186

Also referred to as adjustment bonds. An income bond is where the corporation promises to repay principal but only promises to pay interest if it has sufficient earnings. Income bonds are typically issued by companies in bankruptcy, trade flat (i.e., without accrued interest) and sell at a deep discount (i.e., far below par). They are considered to be speculative investments

Answer 187

Eurodollar bonds are issued outside the U.S. (generally corporations, foreign governments and international agencies in Europe) and pay principal and interest in U.S. dollars. Because they are not registered with the SEC they may not be sold in the U.S. until 40-90 days after issuance. Generally purchased by foreign investors

Answer 188

Yankee bonds are issued within the U.S. by foreign banks and corporations and pay principal and interest in U.S. dollars. They must be registered with the SEC and allow foreign entities to borrow money in the U.S.

Answer 189

Eurobonds are issued in one country but are denominated in the currency of another country. The country of the issuer, the country in which the bond is sold and the currency are not necessarily the same. For example, a British corporation may sell bonds in France denominated in U.S. dollars

Answer 190

A bond's value may be stated at a dollar price (i.e., percentage of par) and be shown in points or eighths of a point. A bond's value may also be stated as a dollar cost. The following examples show the same bond with a par value of $1,000 stated in various ways:Dollar Price:$95 1/8$95.125Percentage of Par: 95.125%;Dollar Cost:$951.25

Answer 191

Published weekly (printed on yellow paper) by the National Quotation Bureau. The Yellow Sheets list bid and asked quotations for corporate bonds traded in the over-the-counter market. Also listed are the name and telephone number of brokerages which make a market in those bonds

Answer 192

Accrued interest is the interest accrued since the last interest payment on the bond. The seller of the bond is entitled to the accrued interest and is paid the accrued interest by the buyer of the bondInterest on corporate bonds accrue based on a 360-day year (30 days for each month of the year). The accrual period is from the last interest payment to (but not including) the settlement date[Note: The settlement date is typically three business days after the sell date and interest payments on bonds typically occur every six months on the day of the maturity day and six months after the maturity day (e.g. a bond maturing on March 1, 2020 would have interest payments each March 1st and September 1st)]

Answer 193

Accrued interest is paid based on the settlement date which is 3 business days after the trade date for corporate bonds. If the trade date is Thursday, September 7th the settlement date is Tuesday, September 12thThe interest payments are on the day of the maturity date and six months after the maturity day. Therefore, interest payments are made each year on January 1st and July 1st. Your last interest payment was July 1st. You have accrued interest for July (30 days based on a 360-day year) and August (30 days based on a 360-day year) and 12 days of September:= 30 + 30 + 12= 72 days of accrued interestAccrued Interest based on a 360-day year:= Par Value× Coupon Rate×No. of Days of Accrued Interest÷360= $1,000 × 5%; × (72/360)= $10

Answer 194

Interest is taxed as ordinary income subject to federal, state and local taxation (i.e., taxed in the year received at the bondholder's tax bracket)[Note: If the bond is sold the seller must include accrued interest as ordinary income and the buyer would subtract from ordinary income the amount of accrued interest the buyer paid to the seller)]

Answer 195

Both are used to finance U.S. government operationsMarketable securities are negotiable, meaning they may be resold to other investors. They are also known as Treasuries.Nonmarketable securities are nonnegotiable, meaning they may not be resold to other investors and may only be redeemed by the U.S. government. They are also known as savings bonds

Answer 196

Treasury bonds - Maturities of 10+ yearsTreasury notes - Maturities of 2-10 yearsTreasury bills - Maturities of 1 year or less, non-interest bearing, sold at a discount from face valueTreasury STRIPS (Separate Trading of Registered Interest and Principal Securities) - Treasury notes and bonds that are stripped of interest payments, repackaged as interest and final principal payments then resold by a broker-dealer as a zero coupon bond that is sold at a discount from face valueTreasury TIPS (Treasury Inflation-Protected Securities) - Interest rate always fixed, however, the principal value is adjusted based on the Consumer Price IndexTreasury CMBs (Cash Management Bills) - Unscheduled, short-term (with maturities as short as one day), sold at a discount from face value, maturing at the face amount

Answer 197

A bond's value may be stated at a dollar price (i.e., percentage of par) and be shown in points or thirty-seconds of a point. A bond's value may also be stated as a dollar cost. The following examples show the same bond with a par value of $1,000 stated in various ways:Dollar Price:$95 16/32$95.16Percentage of Par: 95.5%;Dollar Cost:$955.00

Answer 198

The interest rate of Treasury TIPS always remains fixed. However, the principal value is adjusted based on the CPI by multiplying the initial face amount by 1 + CPI increase (e.g., a 1%; CPI increase since the last semi-annual interest payment would increase a $1,000 TIPS to $1,000 x 1.01%; = $1,010 paid at maturity). The total inflation adjusted principal is paid at maturity. Note: TIPS will never pay less than the initial face amount at maturity regardless of CPI decreasesIn addition to interest paid the annual inflation adjustment is taxed as ordinary income each year an adjustment is made

Answer 199

Interest is taxed as ordinary income subject to federal taxation (i.e., taxed in the year received at the bondholder's tax bracket). All treasury securities are exempt from state and local taxes. Note: If an interest-bearing bond is sold the seller must include accrued interest as ordinary income and the buyer would subtract from ordinary income the amount of accrued interest the buyer paid to the seller)Taxation for different types of Treasury securities is as follows: Series EE and Series I Bonds - Tax on interest may be deferred until maturity or redemption of the bondT-bills - Interest taxed in the year of maturityNotes and Bonds - Interest taxed the year interest is receivedSTRIPS - Interest taxed each year

Answer 200

Treasury bills (aka T-bills) are sold at a discount from face value. A higher yield on a T-bill would indicate a larger discount and therefore a lower price. For this reason the bid price will appear to be higher than the asked price. The Ask Yield shown in T-bill quotations is the bond or coupon equivalent yield which compares the yield of the T-bill to yields of notes, bonds and other interest-bearing securities. The bond equivalent yield accounts for the fact that interest is earned on the discount price versus the face value. For this reason the bond equivalent yield is always greater than the discount yield

Answer 201

Accrued interest is the interest accrued since the last interest payment on the bond. The seller of the bond is entitled to the accrued interest and is paid the accrued interest by the buyer of the bondInterest on U.S. government bonds accrues based on the actual number of days (e.g., 31 days for January, 28 days for February) rather than the 360-day basis for corporate bonds (i.e., 30 days for all months). The accrual period is from the last interest payment to (but not including) the settlement date[Note: The settlement date for a regular-way settlement is typically the next business day after the sell date and interest payments on bonds typically occur every six months on the day of the maturity day and six months after the maturity day (e.g. a bond maturing on March 1, 2020 would have interest payments each March 1st and September 1st)]

Answer 202

Accrued interest is paid based on the settlement date which is the next business day after the trade date for U.S. government bonds. If the trade date is Thursday, September 7th, the settlement date is Friday, September 8thThe interest payments are on the day of the maturity date and six months after the maturity day. Therefore, interest payments are made each year on January 1st and July 1st. Your last interest payment was July 1st. You have accrued interest for July (31 days) and August (31 days) and 8 days of September:= 31 + 31 + 8= 70 days of accrued interestAccrued Interest based on a 365-day year:= Par Value× Coupon Rate×No. of Days of Accrued Interest÷365= $1,000 × 5%; × (70/365)= $9.59

Answer 203

SafetyLiquidity | * Interest exempt from state and local taxes

Answer 204

Savings bonds are nonmarketable and include: Series EE Bonds - 30-year bonds issued in $50-$10,000 denominations, non-interest-bearing, purchased at a 50%; discount from face value. If issued between May 1, 1997 and May 1, 2005, the interest rate is equivalent to 90%; of the average yield on 5-year Treasury bonds. If issued after May 1, 2005 the interest rate is fixed and is reset twice a year. May be cashed after 12 months. If cashed before 5 years a 3-month interest penalty is incurredSeries HH Bonds - 20-year bonds issued in $500-$10,000 denominations, interest paid semiannually, not sold directly to the public as of August 2004 but may be acquired by exchanging EE bonds 6 months and older that did not mature more than one year agoSeries I Bonds - Indexed for inflation, 30-year bonds issued in $50-$10,000 denominations, sold at face value, interest reset twice a year depending on inflation. May be cashed after 12 months. If cashed before 5 years a 3-month interest penalty is incurred

Answer 205

Federal Reserve auctions are the means by which the U.S. government sells Treasuries. They are held on a regular basis and currently include:Mondays: 3-month and 6-month Treasury bills. Issued ThursdayTuesdays: 4-week and 1-year Treasury bills. Issued ThursdayMonthly: 2-year and 3-year Treasury notes. Issued at the end of the monthQuarterly (typically February, May, August, November): 5-year and 10-year Treasury notes. Issued on the 15th of the month * Semi-annually (typically February and August): 30-year Treasury bonds. Issued on the 15th of the month

Answer 206

They may be submitted through competitive tenders or non-competitive tendersCompetitive tenders are submitted by large institutional investors and indicate a price and yield. The highest bids receive the securitiesNon-competitive tenders are submitted by small investors who must accept the yield and price determined through a dutch auction process. The price that all non-competitive bidders receive is the average bid price for all competitive bids. Non-competitive bids are accepted before competitive bids are accepted thereby guaranteeing that non-competitive bidders will receive securities but the yield and price is determined after all competitive tenders are accepted

Answer 207

Agency securities are not direct obligations of the U.S. government. However, they can be assumed to be AAA due to the prevailing presumption that the federal government would not allow entities that it has created to default on their obligations. Yields are somewhat higher than Treasury securities

Answer 208

Federal Agencies - Direct arms of the U.S. government and therefore backed by the full faith and credit of the U.S. governmentGovernment-Sponsored Enterprises (GSEs) - Publicly chartered and privately owned. Created to provide low cost homes to population segments such as students, farmers, homeowners. Issues securities through a selling group of dealers where proceeds are lent to a bank that in turn lends to the qualified individual. Not directly backed by the full faith and credit of the U.S. government

Answer 209

A Government-Sponsored Enterprise that provides funds for:Banks for CooperativesIntermediate Credit Banks * Federal Land BanksThe Federal Farm Credit Consolidated System-wide Banks issue short-term discount notes, short-term interest-bearing bonds and long-term interest-bearing bonds. Interest is subject to federal taxation and exempt from state and local taxation

Answer 210

A Government-Sponsored Enterprise that helps to provide liquidity for savings and loan institutions that have seasonal demands for money. It consists of 12 FHLBs and issues discount notes with maturities of one year or less and consolidated bonds with maturities of one year or more. Not backed by the U.S. government but the Treasury may buy up to $4 billion of FHLB issues. Interest is subject to federal taxation and exempt from state and local taxation

Answer 211

A Government-Sponsored Enterprise that provides liquidity for student loan makers and financing for state student loan agencies and lends directly to educational institutions. Also known as Sallie Mae, it is authorized to deal in uninsured student loans and loans insured in the federal Guaranteed Student Loan Program (GSLP). Sallie Mae-issued securities trade on the NYSE. Not backed by the U.S. government but maintains a direct line of credit with the U.S. government. Interest is subject to federal taxation and state and local taxation varies by state

Answer 212

The most common type of security issued by government agencies, a mortgage-backed pass-through certificate is created by the purchase of a pool of mortgages. An undivided interest in the pool is sold to investors as a pass-through certificate which entitles the investor to a share in the cash flow generated by the pooled mortgages. The cash flow includes monthly mortgage payments that homeowners make less administrative charges. The monthly mortgage payments including interest and principal are passed through to the investors each month

Answer 213

Also known as Freddie Mac. Provides liquidity to federally insured savings institutions in order to finance new housing by purchasing residential mortgages from the savings institutions. Freddie Mac issues pass-through certificates and guaranteed mortgage-backed certificates. Freddie Mac notes, bonds and stocks trades on the NYSE. Not backed by the U.S. government but backed by other agencies and by the mortgages purchased by Freddie Mac. Interest is subject to federal, state and local taxation

Answer 214

Also known as Fannie Mae. Raises money to buy insured Federal Housing Administration (FHA), Veteran's Administration (VA) and conventional residential mortgages from lenders (e.g., banks, savings and loan associations). Not backed by the U.S. government but backed by its authority to borrow from the Treasury. Fannie Mae notes, bonds and stocks trade on an exchange. Interest is subject to federal, state and local taxation

Answer 215

Also known as Ginnie Mae. Provides financing for residential housing. Issues mortgage-backed securities, participation certificates and modified pass-through certificates. Modified pass-through certificates are pass-through certificates backed by a pool of Federal Housing Administration (FHA) and/or Veteran's Administration (VA) residential mortgages. The mortgages in the pool have maturities of 25-30 years but the average life of the pool is typically 12-14 years due to refinancings, foreclosures and prepayments. As a part of the Department of Housing and Urban Development it is a true government agency backed by the U.S. government. Monthly payments are guaranteed to the certificate owner regardless of the payment history of the homeowners. Interest is subject to federal, state and local taxation

Answer 216

When interest rates have declined homeowners have an incentive to refinance and pay off their existing mortgage. This prepayment is passed through to the mortgage-backed security owner who must reinvest this large amount of principal at a time when interest rates are lower. The risk of prepayment makes cash flow from mortgage-backed securities unpredictablePrepayment rate is the rate at which mortgages in the pool are paid offAverage life is the average number of years that each dollar of principal is expected to remain outstanding

Answer 217

When interest rates rise homeowners have an incentive to extend their existing mortgage. The mortgage-backed security owner then receives less principal and therefore has less money to reinvest at a time when interest rates are high. The risk of extension makes cash flow from mortgage-backed securities unpredictable

Answer 218

A Collateralized Debt Obligation or CDO is an asset-backed security that uses a pool of bonds, loans and other securities. The CDO is broken down into priority of payments called tranches. Investors seeking higher risk buy lower priority tranches while those seeking lower risk purchase senior tranches. CDOs are normally appropriate for institutional or more sophisticated investors due to their complexity

Answer 219

A CMO is a mortgage-backed security that takes the principal and interest payments from a pool of mortgages and creates different classes of bonds called tranches. Each tranche has a different interest rate, repayment schedule and level of priority. CMOs help alleviate prepayment risk by spreading the risk over the different tranches. Typically, the higher the risk the higher the yield of each tranche. CMOs are issued in $1,000 denominations. Interest is typically paid monthly and is subject to federal, state and local taxation. Principal payments are considered return of capital and therefore are not taxable

Answer 220

The average life of a CMO measures the average life of each tranche and compares it to other types of fixed-income securities. It is the average number of years that each dollar of principal is expected to remain outstanding assuming a certain prepayment rate assumption. Changes in the prepayment rate affect the average life

Answer 221

PSA or the Public Securities Association is a standard measure of mortgage prepayments known as the PSA Standard Benchmark. This standard increases monthly prepayment amount by 0.2%; for the first 30 months of the mortgage pool until reaching 6%; at which it remains constant going forward. Assumptions of prepayment speeds are then stated as some multiple or proportion of this model. 100 PSA will prepay at exactly the rate given above while 250 PSA would be 2.5 times the rate of the base model and 75 PSA would be at 0.75 times the rate of the model

Answer 222

Plain Vanilla or Sequential PayPlanned Amortization Class (PAC)Targeted Amortization Class (TAC)Companion or Support BondsZ-TranchesPrincipal Only (PO) SecuritiesInterest Only (IO) Securities * Floating-Rate Tranches

Answer 223

A CMO where each tranche receives interest payments. However, only the first tranche receives principal payments until the first tranche is completely repaid then only the second tranche receives principal payments and so on until all tranches are repaid

Answer 224

A CMO that provides a predetermined principal repayment schedule so that the PAC tranche has top priority but only receives principal payments up to a specified amount. Additional principal payments are then paid to a companion or support tranche which has a lower priority

Answer 225

A CMO that is similar to PACs except that TACs only protect against prepayment risk and not extension risk. Provides a predetermined principal repayment schedule and any prepayments are amortized to maintain the schedule

Answer 226

A CMO that is the companion or support tranche to PAC or TAC tranches which have priority for principal payments. Because they do not receive principal payments until the PAC or TAC tranches have met their payment schedule, companion or support bonds have a more volatile cash flow and average life but typically have a higher yield to compensate for the greater risk

Answer 227

A CMO that is a deferred-interest bond. Initially has no cash flow but instead interest compounds (similar to zero-coupon bonds). Once all other tranches have been repaid interest and principal payments are made to the Z-tranche. Has the longest average life of all the tranches and has the highest risk

Answer 228

A CMO that is created by stripping interest from the underlying mortgage and then sold at a deep discount to face value. A faster prepayment rate results in faster return of principal and therefore a higher yield

Answer 229

A CMO that receives all or a portion of interest and no principal. As principal is repaid interest rates decrease because the interest is based on a lower principal amount. IOs decrease with high prepayment rates and increase with low prepayment rates

Answer 230

A CMO that fluctuates with an interest index (e.g., LIBOR) and is reset periodically to a margin above the index subject to a cap (maximum) and a floor (minimum). A super floater resets the interest rate by more than the index changes. An inverse floater moves in the opposite direction to the index

Answer 231

Applies to all communication with the public (e.g., advertisements, sales literature, correspondence, etc.)The term collateralized mortgage obligation must appear in the name of the productIf applicable, a disclosure must appear stating that government agency backing only applies to the face value of the product (not any premium paid)Any claims made must be accurate and may not be misleading (e.g., guarantees, safety, predictability, product simplicity)No comparison may be made with other types of investmentsAdvertisements must be filed with FINRA 10+ days in advance of use * Any changes required by FINRA must be made prior to use * Disapproved material must be re-filed and approved prior to useBroker-dealers must offer to customers educational materials regarding CMOs * Advertisements using FINRA's standardized CMO print advertisement must still be submitted to FINRAAdvertisements not using FINRA's standardized CMO print advertisement (including non-print ads) must contain the same information as the standardized adAdvertisements must be approved by a principal of the firm prior to useAdvertisements must contain a standardized description of the product and the underlying collateralAdvertisements must contain the following disclosure:The yield and average life shown above consider prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Please contact your representative for information on CMOs and how they react to different market conditions

Answer 232

Must discuss the characteristics and risks of CMOs including: * how prepayment rates and the average life is affected by changing interest rates * credit risk * liquidity * transaction costs * minimum investmentstaxation informationMust discuss the structure of CMOs, including: * different types of structures (e.g., tranches and risks associated with each structure)that CMOs with the same structure may still have different risks (e.g., prepayment risks)Must discuss the relationship between mortgage loans and mortgage-backed securities * Must contain a glossary of terms relating to mortgage-backed securities

Answer 233

Used by state and local governments to finance their capital expenditures. Exempt from filing and registration requirements (but not the antifraud provisions) of the Securities Act of 1933. Do not need to provide a prospectus to investors but do need to provide an official statement which contains disclosures about the bonds and the financial condition of the issuer and also contains the legal opinion verifying that the municipality has the legal authority to issue the bonds. Exempt from federal and most state and local taxation, especially if the bondholder lives in the state the bond was issued. Bonds issued by U.S. territories or possessions are triple tax-exempt and are not subject to federal, state or local taxes. Because of this special tax treatment municipal bonds typically offer lower coupon rates than U.S. Treasury securities. However, unlike U.S. Treasury securities, municipal securities carry default risk

Answer 234

General obligation bonds - Secured by the full faith, credit and taxing power of the issuer. Typically requires voter approvalRevenue bonds - Used to finance projects or enterprises and secured by the revenue generated by the projects

Answer 235

A municipal bond secured by the full faith, credit and taxing power (e.g., income, sales, excise, property, ad valorem, school taxes) of the issuer. Can only be issued by entities authorized to levy and collect taxes. Used to fund projects that benefit the public and therefore are paid for by taxation of everyone subject to the governmental entity issuing the bond. Nontax revenue may also be used (e.g., parking fees, licensing fees, park and recreational fees). Typically requires voter approval. Most municipalities have self-imposed debt limits but may borrow in amounts exceeding the debt limits with voter approval

Answer 236

A general obligation bond issued by a municipality with a legal limit on the tax rate they may levy

Answer 237

A general obligation bond issued by a municipality with no legal limits on the tax rate they may levy

Answer 238

The total interest and principal owed to bondholdersLevel debt service occurs when the debt service for each year is equal

Answer 239

Overall economic health * Changes in real estate valuation * Largest employers * Average incomeDemographics * Population trends * Employment trends * Diversification of economic activity * Property value trends * Tax collection rate trendsGeographyTax collection recordTax burdenSource of tax paymentsFinancial conditionFiscal responsibilityExisting debtDebt trendsBudget structureFuture financing (i.e., borrowing in the present to finance future growth) * Unfunded pension liabilities (i.e., where money available to pay pensions is less than projected pension amounts)

Answer 240

Direct debt - All debt issuedNet direct debt - All direct debt less any self-supporting debt (i.e., debt that pays for itself such as revenue and note issues)Overlapping debt - Debt of a political entity where the tax base overlaps with the tax base of another political entity (e.g., a city within a state) Coterminous cities and school districts (i.e., where the city and school district lie within the same boundaries) always have overlapping debt

Answer 241

Debt with maturities of more than one year. The same meaning as long-term debt

Answer 242

Used to encourage banks to invest in municipal securities. Allows banks to deduct 80%; of the interest cost paid to depositors on the funds used to purchase the bonds. Qualification is limited to a maximum of $10 million of municipal bonds annually per issuer

Answer 243

A municipal bond used to finance projects or enterprises and secured by the revenue generated by the projects (e.g., airports, bridges, tunnels, hospitals, water and sewer systems, etc.). May be issued by state or local governments, an authority (e.g., Port Authority) or an agency created to issue bonds and build and operate the project

Answer 244

A GO is secured by the full faith, credit and taxing power while a revenue bond is only secured by the revenue generated from the project financed by the bonds. For that reason GOs are considered safer and generally have a lower yield than revenue bondsGOs generally require voter approval while revenue bonds do not. Revenue bonds may be used in some cases when voter approval for GOs cannot be obtainedGOs are subject to the legal debt limits that limit the amount of debt a municipality may incur while revenue bonds are not. Revenue bonds may also be used when a municipality has reached its debt limit

Answer 245

Industrial Development Revenue (IDR) and Pollution Control RevenueSpecial taxSpecial assessmentDouble-barreledMoral obligationParity municipalTaxable municipalPublic Housing Authority (PHA) or New Housing Authority (NHA)Advance refunded municipal and escrowed to maturity (aka prefunded or defeased) * Private activity or alternative minimum tax (AMT)

Answer 246

For building a facility for a private company. Issued by municipalities, secured by a lease agreement with a corporation to lease the new facility. May not be exempt from federal taxation if the IDR holder is a substantial user of the facility

Answer 247

Payable only from a special tax (e.g., gasoline tax) but may also be backed by full faith and credit of issuer

Answer 248

Payable only from an assessment on those directly benefiting from the project (e.g., a sidewalk or sewer project would only benefit inhabitants of the project area)

Answer 249

Payable from two sources of revenue, typically taxation and revenue from the project. Secured by revenue but also by the full faith and credit of the issuing municipality

Answer 250

Payable from revenue from the project and, if necessary, the state or state agency is morally obligated to provide the required funds. Requires legislative approval by the state government

Answer 251

Payable from revenue from the project. However, bonds already outstanding are payable from the same revenue from the project

Answer 252

Municipal bonds that are taxable. Generally issued because the Tax Reform Act of 1986, in certain circumstances, limits the issuance of tax-exempt bonds to the greater of $150 million or $50 per capital

Answer 253

No longer issued but still traded in the secondary market. Previously issued and secured by local housing authorities and backed by the full faith and credit of the U.S. government through the Department of Housing and Urban Development. Used for construction of low-income housing

Answer 254

Outstanding obligations that have been collateralized by the U.S. government. Refunded bonds will usually be paid off on their next call date. Escrowed to maturity bonds do not have a call feature and remain outstanding until maturity

Answer 255

When 10%; or more of bond proceeds is used by a private entity and when 10%; or more of bond proceeds is secured by property used by the private entity's business. Subject to the AMT, therefore subject to federal taxation if the bondholder is subject to the AMT. May have higher yields

Answer 256

The debt service coverage ratio is the ratio of net revenue (gross revenue less operating and maintenance costs) to debt service. Because net revenue from a project is the primary source of payments to bondholders, the most important factor influencing the risk and safety of revenue bonds is the amount of money available compared to the debt serviceAnnual Gross Revenue− Annual Operating Costs− Annual Maintenance CostsAnnual Debt ServiceThe feasibility study is a report required from the issuer where hired consultants analyze the ability of the project to produce the necessary revenue and will include an engineering report by a consultant engineer. The trust indenture or bond resolution contains provisions and covenants (e.g., rate covenant, maintenance covenant, financial reports and audit, catastrophe call, etc.) that protect bondholdersThe flow of funds states the priority for disbursing revenue from the project into certain funds or accounts (e.g., operation and maintenance fund, debt service fund, reserve maintenance fund, replacement and renewal fund, etc.). Revenue is disbursed into the first fund up to a certain amount and then flows in the subsequent funds

Answer 257

The covenants and provisions are pledges by the issuer to uphold specified items. They provide protection to bondholders and may include: Rate covenant - Rates will be maintained at a level sufficient to cover operation costs, maintenance costs, debt service, and certain reserve fundsMaintenance covenant - The project will be maintained to be in good working orderInsurance covenant - Insurance will be carried on the propertyNondiscrimination covenant - Special rates will not be granted to any person or groupIssuance of additional bonds - Closed-end indentures disallow the issuance of additional bonds. Open-end indentures allow the issuance of additional bonds against the same security generally for future expansions of the projectFinancial reports and audit - Proper records will be kept and a qualified accounting firm will be retained for outside audits (to prevent the misuse of funds)Catastrophe call - In the event of an uncontrollable event (e.g., fire, flood, earthquake, condemnation, etc.), the issuer may call an entire issue

Answer 258

When revenue is received by a project the flow of funds dictates the priority in which the funds flow into several specific accounts. These accounts may include in the typical order of priority:Revenue fund - The account that receives and records all receipts and gross revenuesOperation and maintenance fund - The account that maintains a prorated amount to meet the costs needed to operate and maintain the projectDebt service fund - The account maintains an amount sufficient to pay semi-annual interest and principal as it matures. For gross revenue issues the debt service fund will have priority over the operation and maintenance fund because gross revenues are used to pay debt service. For net revenue issues operation and maintenance costs are paid first and the net revenue (gross revenue less operation and maintenance costs) are used to pay debt serviceDebt service reserve fund - After the debt service fund contains the amount required to maintain annual debt service, funds flow into this account to be used only if the debt service fund is insufficient to meet annual paymentsReserve maintenance fund - Contains funds to be used for unexpected maintenance costsReplacement and renewal fund - Contains funds to be used for repair costs and new equipment (based on the engineer's reports)Sinking fund - Contains funds to be used to retire bonds prior to the maturity date. For bonds with a mandatory sinking fund provision the sinking fund receives priority over the replacement and renewal fundSurplus fund - The account receives any excess funds to be used in case of emergencies

Answer 259

Municipal notes are short-term and are generally issued at par with interest paid at maturity. Municipal notes may also be issued at a discount and are paid at par at maturity. They are typically used as financing for projects or as assistance to management of cash flowThey include:Tax anticipation Notes (TANs) - Typically GOs. Funds are used for current municipal operations in anticipation of future funds from taxes (e.g., property taxes)Revenue Anticipation Notes (RANs) - Typically GOs. Funds are used for current municipal operations in anticipation of future funds from revenues or general taxes (e.g., federal/state subsidies)Bond Anticipation Notes (BANs) - Funds are obtained in anticipation of future funds from a long-term bond issueGrant Anticipation Notes (GANs) - Funds are obtained in anticipation of future funds from federal grantsConstruction Loan Notes (CLNs). Funds are used for construction projects in anticipation of future funds from a long-term bond issue

Answer 260

Moody's:MIG 1: Best qualityMIG 2: High qualityMIG 3: Favorable qualityMIG 4: Adequate qualityStandard & Poor's:SP-1: StrongSP-2: Satisfactory * SP-3: Speculative

Answer 261

A long-term debt security (typically a municipal bond) marketed as short-term with a variable interest or dividend rate. Also known as Money Market Preferred Securities, Variable Rate Preferred Securities and Periodic Auction Rate Securities.The interest or dividend rate is reset periodically at set intervals, generally 7, 28 or 35 days based on a single price or "Dutch Auction" process where the shares available in the auction are based on the number of existing bondholders who either wish to sell their bonds or will only hold their bonds if the yield is above a rate that they specify. The total number of shares available is also called exposed for sale. Investors interested in purchasing the bonds indicate the number of shares they wish to purchase and the lowest interest rate they will accept. All bids are ranked in order from lowest to highest bid and the lowest bid rate at which all shares can be sold at par becomes the clearing rate. The entire issue is reset to this clearing rate. All investors that indicated a bid rate above this clearing rate will not receive bonds, all investors that indicated a bid rate at or below the clearing rate will receive bonds at the clearing rate. If, however, the number of bids is insufficient to purchase all available shares, the auction is deemed to have failed. In a failed auction, no shares are sold and the interest or dividend rate is reset to the maximum rate defined by the issuer[Note: Registered representatives must disclose to the client any specific features of the auction rate securities, that a failed auction could result in inaccessibility of funds and that the client must have liquid investments if these products are recommended]

Answer 262

The offering documents of an Auction Rate Security specifies auction procedures and typically permit the following types of auction orders:Hold - Also known as a roll order. Hold existing shares regardless of the new interest rate (also known as the clearing rate). The auction procedures typically indicate that if an existing bondholder does not place an order it will be deemed that the bondholder elected to place a hold orderHold-at-rate - Also known as a roll-at-rate order. Hold existing shares only if the new interest rate is above a specified rate. If the new interest rate is above the specified rate the investor receives the same number of shares at the clearing rate. If the new interest rate is below the specified rate all shares are soldBuy - Where investors wishing to purchase the Auction Rate Securities submit a bid to buy shares at a specified interest rateSell - Where an existing bondholder wishes to sell shares regardless of the new interest rate

Answer 263

A long-term security (typically a municipal bond) marketed as short-term with an interest rate that is reset periodically at set intervals, generally daily, weekly or monthly, by the dealer at a rate that would allow the VRDO to be sold at par value. VRDOs typically have a put feature that allows the bondholder to sell back their shares (for par value plus accrued interest) to the issuer or to a third party on the date that the interest rate is reset

Answer 264

When an insurance company or group insures a new issue of municipal bonds by agreeing to pay all interest and principal in the event that the issuer fails to make those payments. The issuer pays a fee to the insurer. However, in exchange for paying the fee the issuer will typically be able to pay a lower coupon rateThe largest insurers include: the American Municipal Bond Assurance Corporation (AMBAC), the Municipal Bond Investors Assurance Corporation (MBIA), the Financial Guaranty Insurance Company (FGIC), the Financial Security Assurance Inc. (FSA)

Answer 265

A municipal bond is typically quoted on a yield basis. However, dollar bonds are typically quoted at a dollar price (i.e., percentage of par) and may be shown in points. The following example shows a municipal bond from New York State offered at $100,000 face value with a 6%; interest rate, maturing December 1, 2014 at a 9.5 basis (less a quarter point dealer concession deducted), that is callable on December 1, 2012 at 100:100m New York State 6.00i12-1-14 @ 9.5 - 1/4 C12 @ 100

Answer 266

Accrued interest is the interest accrued since the last interest payment on the bond. The seller of the bond is entitled to the accrued interest and is paid the accrued interest by the buyer of the bondInterest on municipal bonds accrues based on a 360-day year (30 days for each month of the year). The accrual period is from the last interest payment to (but not including) the settlement date. Note: The settlement date for regular-way settlements is typically three business days after the sell dateFor accrued interest before the first interest payment has been made on a new issue the accrued interest is from the dated date (i.e., the date at which interest begins to accrue; typically the issue date) to the settlement date. The first interest payment is often not 6 months from the dated date and may be a long coupon (more than 6 months) or a short coupon (less than six months)

Answer 267

Because municipal bonds are often triple-tax-exempt (exempt from federal, state and local taxation) they are more suitable for investors in higher tax brackets. For investors who receive special tax treatment (e.g. receiving tax-deferred income such as pensions) municipal bonds are not a suitable investment. To determine the suitability of municipal bonds as an investment the taxable equivalent yield (the yield that a taxable investment would need to be in order to be equivalent to the yield of a tax-exempt investment) and the net yield (the yield a tax-exempt investment would need to be in order to be equivalent to a taxable investment) may be used.Taxable Equivalent Yield =Municipal Yield100%; − Tax BracketNet Yield =Taxable Yield× (100%; − Tax Bracket)

Answer 268

Taxable Equivalent Yield:= Municipal Yield100%; − Tax Bracket= 7%;100%; − 30%;= 7%;70%;= 0.10The taxable equivalent yield is 10%;. A taxable investment would need to have a yield of 10%; in order to be equivalent to the 7%; yield that you would receive from the tax-exempt NY bond

Answer 269

Net Yield:= Taxable Yield× (100%; − Tax Bracket)= 5%; × (100%; - 30%;)= 5%; × 70%;= 0.035The net yield is 3.5%;. A tax-exempt investment would need to have a yield of 3.5%; in order to be equivalent to the 5%; yield that you would receive from the taxable corporate bond

Answer 270

Municipal securities traded OTC are not traded on an exchange or other similar centralized system. Broker-dealers have therefore created mediums for trading municipal securities which include:A broker's broker - Transacts business strictly with banks and with other brokerage firms. Broker's brokers will typically provide a wire service for quotes. Subscribers to the wire service must contact the broker's broker to enter a bid or offer. At the end of the day the broker's broker notifies the highest bidder and charges a fee to the seller for the transaction. These transactions are anonymousThe Bond Buyer - A newspaper published daily about the municipal market and other financial news including a new issue calendar, notices of sale, call notices, legal notices, bankruptcy notices, name changes, etc.Munifacts - A wire service providing current offerings, information from the Daily Bond Buyer and news about the municipal market and other financial news periodically throughout the day

Answer 271

The Bond Buyer publishes the following indicators:30-day visible supply - The total volume, in dollars, of all bonds with maturities of at least 13 months that should reach the market in the next 30 days. Compiled dailyThe Bond Buyer Placement Ratio - An indicator of the overall demand for municipal issues (a higher placement ratio indicates higher demand). Compiled weekly20 Bond Index - An indicator of levels of yield based on the average yield of 20 general obligation bonds with maturities of 20 years. The average rating is equivalent to an AA rating11 Bond Index - An indicator of levels of yield based on the average yield of 11 of the 20 bond from the 20 Bond Index. The average rating is equivalent to an AA+ ratingRevenue Bond Index - An indicator of levels of yield based on the average yield on 25 revenue bonds with maturities of 30 years. The average rating is equivalent to an A+ rating

Answer 272

Official StatementThe underwriting spreadAny fees that the broker-dealer received as an agent for the issuerThe initial reoffering price for all maturity dates of the issueIf the broker-dealer participated in the underwriting for the issue and had a financial advisory relationship where the broker-dealer received compensation for providing advice to the broker-dealer

Answer 273

Settlement dates are same-day for cash transactions and three business days for regular-way transactionsSecurities are delivered on the settlement date and typically will: * Have the certificate in good physical condition (if any essential information is missing from the certificate, the bond must be authenticated by the agent or by the issuer) * Include all unpaid coupons if it is a bearer bond * Include a legal opinion * Be in denominations of multiples of $1,000 or $5,000 * Be a bond that has not been called * Include a proper assignment if it is a registered security[Note: If delivery of securities is not good, they may be subject to rejection. If the securities have already been accepted for delivery but are not in an acceptable condition, they are subject to reclamation]

Answer 274

Yes, MSRB rules allow it if permission to use the ownership information is obtained from the issuer of that security

Answer 275

No, MSRB rules prohibit compensation in the form of giving away business. This is to prevent abuses because the account of a bond fund is potentially very lucrative for a firm due to the volume of transactions necessary to manage the bond fund

Answer 276

Municipal securities are not subject to the registration and prospectus requirements of the Securities Act of 1933. However, it is subject to the antifraud provisions of the Act and to the MSRB requirements for municipal underwritingIn exchange for the underwriting spread (i.e., commission), the underwriter assists in the process of issuance of securities by assisting the issuer including: * Pricing the securities * Providing an intermediary between the issuer and the public * Potentially structuring the financingBy underwriting the issue underwriters make an implied recommendation of the issue and must have a reasonable basis for this recommendation in order to avoid violation of the antifraud provision of the Securities Act of 1933. Therefore, underwriters are required to review any disclosure documents for accuracy, truthfulness and completeness

Answer 277

Negotiated sales and competitive sales are two types of relationships between an issuer and an underwriterA competitive sale is typically used for general obligation municipal bonds where the issuer has a notice of sale published that advertises the issuer's need for an underwriter. All underwriters interested in underwriting the securities submit a bid to the issuer that must meet all terms specified by the issuer in the notice of sale. The issuer awards the underwriting contract to the best bid (typically the bid with the lowest interest costs over the life of the issue) and the underwriter is committed to the specified interest cost which may only be changed at the underwriter's risk[Note: A syndicate may be formed, generally through an underwriting agreement]A negotiated sale is typically used for revenue municipal bonds where the issuer selects an underwriter at a specified interest cost which may be changed at any time if advisable[Note: A syndicate may be formed generally through a syndicate letter]

Answer 278

A notice of sale is an advertisement by an issuer for a competitive sale where any underwriters interested in underwriting the new issue submit bids and the best bid is selected by the issuer. The notice of sale must state the issue's dated date (i.e., the date at which interest begins to accrue) and must outline the bidding requirements for the issue. The notice of sale will typically state that the issuer has the right to reject any and all bids if necessary to protect its best interest. The notice of sale also contains information necessary for underwriters to submit bids such as:Amount of issuePurpose of issueStructure of issue (e.g., serial, term, or balloon)Interest payment datesMethods of interest paymentsRegistration provisionsLegal opinion (verifies that the municipality has the legal authority to issue the bonds)Where and when bids will be accepted * Amount of good-faith deposit

Answer 279

The legal opinion verifies that the municipality has the legal authority to issue bonds and is required for all municipal issues. A recognized bond counsel writes the legal opinion and validates the following:The issuer has legal authority to issue the bondsThe issuer has followed all legal procedures in issuing the bondsIf interest is exempt from federal, state or local taxation * What sources are used to make interest and principal paymentsAn unqualified legal opinion is unconditional. A qualified legal opinion is conditional and may be issued by the bond counsel if the legality of the issue is questioned

Answer 280

A tombstone advertisement may be issued by the winning underwriter in a competitive sale for municipal securities, so called because of its black border and heavy black print. It contains basic information about the new issue which may include:Amount of issuePurpose of issueThe dated date (i.e., date at which interest begins to accrue)Interest payment datesName of bond counsel * Coupon rate and yield to maturity

Answer 281

A bid must be submitted on an issuer-provided bid form and submitted at the designated place and time along with a check for the good-faith deposit. The bid may include: Total interest costs to the issuer either as net interest cost (NIC) or true interest cost (TIC)Reoffering yields or future yields that will be received by bondholders (e.g., for serial bonds that will be offered at an established frequency)Complete reoffering scale, listing the coupon rate, yield and selling profit for each maturity. Also used to calculate interest cost * Reoffering yield or yield to customer

Answer 282

The underwriting spread is the compensation that the syndicate receives for taking a new issue public. It is the difference per bond between the amount received from the investing public and the amount paid to the issuer. Part of the underwriting spread will be used to pay for the syndicate manager's fee and for syndicate expenses. The takedown or total takedown is the underwriting spread less the manager's fee and expenses. The total takedown consists of the concession which is paid to a non-syndicate member broker-dealer selling the bond and the additional takedown which is paid to the syndicate

Answer 283

It is the order of priority for bond orders intended to maximally benefit the entire syndicate rather than benefiting one particular member. The allocation is stipulated in the syndicate letter (between syndicate members, setting obligations, etc.) and must also be disclosed to customers by request. The typical priority of orders is:Presale orders - Orders placed before the syndicate received the issueGroup net orders - Orders where the syndicate retains all profitsDesignated orders - Orders where a non-syndicate member broker-dealer receives profitMember orders - Orders where only one syndicate member receives the total takedown

Answer 284

The MSRB is an independent self-regulatory organization (SRO), supervised by the SEC, that was created by the Securities Acts Amendments of 1975 and creates the rules and policies for all brokers and dealers involved in the sale of municipal securities.[Note: These rules do not apply to issuers of municipal securities]The MSRB does not have powers of enforcement. Other regulatory entities are responsible for enforcement and include:For broker-dealers (e.g., FINRA members): the SEC and FINRAFor national-charter banks: the Comptroller of the CurrencyFor non-national banks with membership in the FRB System: Federal Reserve Board * For non-national banks without membership in the FRB system: FDIC

Answer 285

The Real-Time Transaction Reporting System or RTRS is an MSRB system to record all municipal securities transactions within 15 minutes of the trade. If a transaction is done after regular business hours then it must be reported within 15 minutes of the start of the next business day

Answer 286

The Electronic Municipal Market Access or EMMA is a system created by the MSRB to gather primary market documents from issuers and underwriters. Access to the information is made public and also includes continuing disclosure requirements

Answer 287

Disputes are settled through arbitration. All decisions made through arbitration are final and binding for all parties involved. Arbitration may be used unilaterally for:Broker-dealer against another broker-dealer * An individual (non-broker-dealer) against a broker-dealerSimplified arbitration may be used for disputes of $2,500 or less

Answer 288

Any person communicating with the public regarding municipal securities must be a qualified municipal securities representative unless they are a municipal securities principal or sales principal or they act in a wholly clerical or administrative capacity. Both of the following requirements must be met to be qualified as a municipal securities representative:Passing of either the Series 52 exam (municipal securities representative exam) or the Series 7 exam (general securities representative exam)Completion of a 90-day apprenticeship with a broker-dealer. An apprentice may act as a representative except: they may not receive compensation on a transaction basis and may not have contact with a public customer (including effecting transactions)[Note: The apprenticeship may be extended to an 180-day apprenticeship if the exam requirement is not met within the first 90 days. If the exam is not passed after the extended 180-day apprenticeship the individual loses apprentice status until passing the exam]

Answer 289

The syndicate manager is required to:Provide a report to all members of all allocations of securities given priority over member orders within two business days of the date the sale was madeDistribute profits from an order within 30 days of the delivery of securities to a customerProvide the final settlement of the syndicate within 60 days of settlement with the issuer including distribution of any profits, an itemized report of expenses and a report of any group orders filled and the identity of related portfolios * In a competitive sale, if the syndicate was not awarded the issue the good-faith deposit must be distributed within two business days of receiving the deposit back from the issuerEach syndicate member is required to:Disclose the identity for any persons that the member has fulfilled a group order for * Disclose any orders which involve completing the order on behalf of the member's dealer account, related portfolio, accumulation account or for a municipal unit investment trust that the member underwrites. Disclosure must occur at the time the order is entered

Answer 290

``` An asset class that consists of short-term debt securities (of one year or less) that facilitate the borrowing and lending of excess funds over a short period. Known as cash equivalents because they are of such high quality and safety as to be as good as cash. Because their returns are relatively uncorrelated with bonds they are considered a separate asset class from debt instrumentsExamples of cash equivalents include:Money-market fundsNegotiable certificates of depositCommercial paperBankers' acceptancesFederal funds * Repurchase agreements ```

Answer 291

A cash equivalent. Issuers include the U.S. government, government agencies, banks and corporations. Participants include banks, corporations, securities dealers and the Federal Reserve Board. Typically invested over short periods (i.e., overnight, a few months, up to one year)

Answer 292

A cash equivalent issued by banks and savings and loans with a fixed interest rate and maturities at a specified period of time. CD holders are penalized for redeeming the CD before the maturity date. The minimum maturity is 7 days with no maximum maturity, though CDs generally mature in one year or less. CDs are guaranteed up to $100,000 by the Federal Deposit Insurance Corporation (FDIC)Negotiable CDs or jumbo CDs have minimum denominations of $100,000, though they generally have a denomination of $1 million or more. They are normally not FDIC-insured because they exceed $100,000. An active secondary market exists for negotiable CDsLong-term CDs or brokered CDs typically have maturities of 2-20 years (and therefore are not considered money market securities). They are issued by banks but sold by broker-dealers. FDIC insurance coverage applies if the issuing bank declares bankruptcy and SIPC coverage would apply if the broker-dealer selling the brokered CD declares bankruptcy. Long-term CDs may carry additional risks that may include: * Limited or no liquidity * Loss of principal if sold prior to maturity * Call features that limit capital appreciation or increase reinvestment risk * Unique features (e.g., variable rates, step-ups, step-downs, etc.) * FDIC insurance may not applyBroker-dealers must explain the differences between brokered CDs and traditional CDs to customers

Answer 293

At its sole discretion the issuer may call the CD prior to maturity (therefore the client does not have the right to the CD prior to maturity)If called before maturity the client may not be able to reinvest the funds at a comparable rate of interestIf called before maturity the CD may yield a return less than its yield to maturity * The CD may not be called, therefore the client may be required to hold the CD until maturity

Answer 294

A cash equivalent that is short-term, unsecured corporate debt with maturities generally 270 days or less. If 270 days or less it is exempt from the prospectus requirements of the Securities Act of 1933. Typically issued at a discount from face value but may also be interest-bearing. Typically issued by corporations with high credit ratings but may be issued by corporations with lower credit ratingsDirectly placed commercial paper is commercial paper sold directly to the public using the corporation's own sales forceDealer-placed commercial paper is commercial paper sold to large dealers and subsequently resold to the public

Answer 295

A cash equivalent used to facilitate foreign trade. For example, if an American company wished to buy foreign goods from a foreign company and pay after delivery of the goods they could issue a time draft (i.e., a check that is good after a future date) that is secured by a letter of credit from a U.S. bank. The secured time draft would be used as payment for the goods. The foreign company would then either cash the draft at the specified due date or they may cash the draft immediately at a discount. When the draft is cashed at a discount and held at a bank it is known as a banker's acceptance which the bank may hold until the due date or may sell in the market. Because bankers' acceptances are secured by both the issuing bank and by the goods purchased they are considered quite safe

Answer 296

A cash equivalent where money is borrowed overnight on a bank-to-bank basis. Typically used to meet the Federal Reserve's reserve requirement. The bank with extra reserves earns interest on otherwise dormant funds and the bank in need of reserves meets their reserve requirementThe fed funds rate is the rate charged on these loans and fluctuates daily. The fed funds rate is a leading indicator of interest rate trends because it reflects the availability of funds in the bank system. Other short-term interest rates also tend to follow the fed funds rate. The Federal Reserve does not set the fed funds rate but attempts to influence the rate via purchases and sales of government securities in the secondary market

Answer 297

A cash equivalent where a dealer sells securities (typically T-bills) to another dealer and agrees to repurchase the securities at a specified date and price. The repurchasing dealer would then receive cash for the securities over a short period (typically overnight) and the lending dealer would receive the difference between the purchase price and the repurchase price in exchange for making the loanA reverse repo or matched sale occurs when the dealer purchases securities from another dealer and agrees to resell the securities at a specified date and price. A reverse repo is the other side of the repo transaction and is used to borrow short-term amounts rather than invest

Answer 298

The primary market - Also known as the new issues market (NIM). Where the issuer (e.g., corporations) sells securities in the form of stocks or bonds directly to the investor. Underwriting groups facilitate the primary market by pricing securities and overseeing the sale of securities to the publicThe secondary market - Where financial instruments are traded between investors and dealers rather than issuers. The secondary market includes the over-the-counter market and the exchanges (e.g., NYSE, Nasdaq)

Answer 299

Exchange-listed securities traded over-the-counter generally between broker-dealers and large institutional investors

Answer 300

Exchange-listed securities traded over-the-counter between large institutional investors without the assistance of a broker-dealer. These trades are not subject to reporting requirements

Answer 301

A dark pool or dark liquidity is the ability to allow trades that do not get publicly disclosed. This can be facilitated by brokers who cross trades between clients or exchanges that offer crossing networks. The investor can remain anonymous and avoid the price impact of large trades. Other traders can be disadvantaged and the markets become less transparent which makes the practice controversial

Answer 302

Bid - An offer to buy a security that includes the highest price the buyer is willing to pay and the quantity they wish to purchaseAsk - The ask price is also known as the offering price and is the lowest price the seller is willing to accept and generally includes the quantity they will sellSpread - The difference between the bid price and the ask price

Answer 303

Firm quote - Guarantees a specified price. When a firm quote is offered, but the transaction is not made, the failure to make the transaction is known as backing away and is a firm quote violation. All quotes are considered firm unless otherwise specifiedOut-firm quote - Guarantees a specified price for a specific period of time (e.g., good for one hour). May contain a recall provision permitting the dealer to shorten the period of time with notification to the customerSubject quote - Price is subject to confirmation by the dealer or market maker. For example, "15 to 15.25 subject" is a subject quote where the actual price must be confirmed and accepted before the transaction is filledWorkout quote - Where a dealer receives an inquiry for a particular security after receiving a prior inquiry on the same security. A workout quote is subject to confirmation that the prior inquiry still has interest in the securityBid wanted - When a dealer requests a suggested price from a prospective buyer for securities the dealer wishes to sellOffer wanted - When a dealer requests a suggested price from a prospective seller for securities the dealer wishes to buy

Answer 304

OATS allows FINRA to record order and quote information for trades on NASDAQ and over the counter stocks. FINRA uses OATS to monitor activity and enforce regulations

Answer 305

The Trade Reporting and Compliance Engine or TRACE was implemented in 2002 to allow greater transparency in the corporate bond market. FINRA distributes information on corporate bond and secondary OTC fixed-income transactions that are reported by brokers per SEC rules

Answer 306

Provides quotes of stocks for exchange-listed securities and OTC securities, including all common stocks, preferred stocks, warrants, rights, etc. CQS money makers must be FINRA members and are permitted to enter orders into CQS

Answer 307

Provides quotes of stocks for exchange-listed securities and Nasdaq securities. Orders may be entered anonymously, during and after hours. A fee is charged to use the system. ECNs act strictly in an agent capacity

Answer 308

Provides quotes of OTC securities that do not meet Nasdaq requirements. The OTCBB does not have any listing requirements

Answer 309

Provides subject quotes of OTC securities that do not meet Nasdaq requirements. The Pink Sheets do not have any listing requirements

Answer 310

Requires all market makers to report trades within 90 seconds. Most trades are reported through the TRF which satisfies FINRA's reporting rules

Answer 311

The settlement date is the date that an executed security trade is cleared that is, when the buyer must pay for the securities and the seller delivers the securities. Settlement typically occurs (i.e., regular-way transactions):3 business days from the trade date for stocks and bondsThe next business day for U.S. government securities and options * Same day for cash transactionsExceptions include:Seller's option contract. The seller is permitted to deliver securities outside of the typical 3 business day period for regular-way transactionsWhen-issued. The securities for when-issued (WI) transactions are authorized for trading but have not yet been issued and will settle shortly after the securities are availableSpecial settlement procedures may be requested for U.S. government securities traded over-the-counter. * Skip-day settlements are the second business day from the trade date. * Corporate settlements are the third business day from the date date

Answer 312

A principal (also known as a dealer) takes ownership of assets in a transaction at its own inventory risk. The dealer then resells the securities to customers from its own account and earns a profit by marking up the market price of the securitiesAn agent (also known as a broker) facilitates the trading of securities on behalf of the customer and charges a commission

Answer 313

A short sale is the sale of borrowed securities typically in anticipation of a decline in market price. The investor receives the borrowed proceeds from the sale at the current market price and must purchase an equal number of shares at a future date in order to replace the borrowed shares (at a potentially lower market price)

Answer 314

Also known as the Big Board or the Exchange, it is the largest stock exchange in the world based on the aggregate market capitalization of its listed securities. The NYSE is based in New York and was founded in 1792. Stocks listed on the NYSE must meet the following criteria:A minimum market valueA minimum number of shareholdersA minimum average monthly trading volumeA minimum pretax earningsNational interest in the company * The company must solicit proxies

Answer 315

Approval of the application to delist must be granted by the issuer's board of directors and audit committeeA press release containing an announcement of the proposed delisting must be issued by the issuer * A written notice must be sent to 35 or more of the largest shareholders of the stock notifying them of the proposed delisting

Answer 316

The NYSE has a set of rules specific to the exchange and they include:A member firm may not make a series of orders at incrementally higher or lower prices if the orders are designed to influence market price or create a false impression of activity on the securityRumors designed to influence market price are prohibitedNYSE Rule 80B: A halt on trading will be imposed if the DJIA falls a significant level during a single trading day. The level at which trading is halted is updated quarterly but generally a 10%; decline will halt trading for 1 hour, a 20%; decline will halt trading for 2 hours and a 30%; decline will halt trading until the next trading dayThe price of an executed order is binding even if the broker-dealer reports an erroneous price to the customer. The broker-dealer is required to notify the error to the customer and the customer is required to pay the executed price[Note: This does not apply to the number of shares. If the broker-dealer executed an order for a certain number of shares and reports to the customer an erroneous number of shares the customer is not required to honor the erroneous shares]

Answer 317

Membership on the NYSE is required to transact business on the floor of the Exchange. Members must be approved by the exchange and members must pay for a trading license annually to maintain membershipMembers generally fall into the following categories:Commission house broker or floor broker - Executes orders on the exchange floor for the firm at which they are employee generally either on behalf of a client of the firm or for the firm's proprietary accountsTwo-dollar broker or independent broker - Executes orders on the exchange floor for other brokers who have too many orders to be able to execute. So called because they were historically paid $2.00 (although now commissions are negotiated)Competitive trader or floor trader - Executes orders for their own accounts. May on rare occasions execute orders on behalf of clients (in which case the clients' orders must have priority over the trader's own orders)Specialist - Executes orders out of their own inventory in order to facilitate trading and ensure a fair and orderly market for a specific security. Each stock in the exchange will typically have one specialist designated

Answer 318

A trading post is the designated area that each security of the NYSE is traded. Each security is assigned to one trading post and anyone who wishes to trade that security must go to the assigned trading post. The trading crowd is the group of persons trading the security at its assigned trading post

Answer 319

A specialist is responsible for facilitating trading and ensuring a fair and orderly market for a specific security. Each security on the exchange will generally have one designated specialist and the specialist may be assigned one or more securities from the same trading post. The specialist's responsibilities for the securities that they are assigned to include:Act as an agent to facilitate trading - When a commission house broker or two-dollar broker cannot immediately execute an order the specialist will enter these orders in the specialist's book (which is typically electronic). The specialist acts as an agent and charges a commission on any of these orders that are executedAct as a principal to ensure a fair and orderly market - Specialists hold their own inventory of their assigned stock(s) and if there is a significant shift in demand or supply of the stock the specialist will sell from their inventory if there are no offerors at the trading post and will buy for their inventory if there are no bidders at the trading post. This helps to reduce the spread between the bid and ask on the specialist's assigned security(ies)[Note: The specialist may not compete with public orders. Specialists may only buy or sell for their own inventory for the purpose of maintaining a fair and orderly market]Stop stock - Specialists may stop an order which guarantees that an order placed by a broker will be executed by the specialist at a specified price. If a better price is available the order may be executed at the better price[Note: Stopping stock is only permitted for public orders and is prohibited for orders for a member firm's own account]

Answer 320

An order ticket is a written record of a customer's instructions for executing an order and how the order was handled. The order ticket includes:Buy or sellIf the sale is long (seller owns the security) or short (seller does not own the security and will instead borrow the security)Security name or ticker symbolTerms and conditions (e.g., market, stop, limit, good-til-canceled, etc.)If the order was solicited or unsolicitedIf the order was discretionary (for discretionary accounts) * Account type

Answer 321

Order tickets follow the following process:Initially filled out by a registered representative with a customer's instructionsSubmitted to the wire room or order department where orders are transmitted to the appropriate exchange or product area for executionThe purchase and sales department records the transaction after it is completed and reconciles all transactions for any trade discrepanciesA record is maintained for each customer's account, including all trading activity, by the margin department to ensure that payment and delivery is made according to customer account rulesFunds and securities are distributed and received by the cashiering departmentAt each step in the execution process the order ticket is filled out with additional information. Orders may be executed, may expire or may be cancelled[Note: The SEC requires that either a copy of all order tickets must be retained or a record of the data on all order tickets must be kept]

Answer 322

Market - To be executed immediately at the price available at execution. The execution price is not specifiedLimit - To be executed at a specified price. If a better price is available at execution the order may be executed at the better price (i.e., a lower price for a buy order or a higher price for a sell order). If the order cannot be executed at the specified price or better the order will not be executedStop - To be executed after the security reaches a specified price known as the stop price. When the stop price is reached the order is activated and the customer will receive whatever price is available at execution. The stop price is always below the current market price for sell stop orders and above the current market price for buy stop orders. Stop orders are generally used to limit loss or protect profit (for example, for sell stop orders if a stock price goes too far below the current market price and reaches the stop price the stock is sold before the price goes potentially even lower)Stop-limit - Activated after the security reaches a specified price known as the stop price at which point the order becomes a limit order and will be executed only at a specified price

Answer 323

Order qualifiers specify when or how an order should be executed. They include:Day - Cancelled if not executed by the end of the trading day[Note: All orders are considered day orders unless otherwise specified]Good-til-canceled - Remains active on the specialist's book until cancelled or until executedAt-the-opening - Cancelled if not executed at the openingAt-the-closing - Cancelled if not executed at the closingImmediate-or-cancel - To be executed immediately. If only a portion of the order is executed immediately the rest of the order is cancelledNot-held - To be executed at the discretion of the broker as to the time and price of the order. The broker is not liable if the order is not executed or if the best price was not obtained

Answer 324

Multiple orders for a particular security at its trading post may accumulate before execution. The execution priority is:The highest bid and lowest offerThe order submitted first (if all prices bid and offered are equal) * The largest order (if all prices are equal and all orders are submitted simultaneously)

Answer 325

An electronic system that provides a continuous report of the sales volume and price for all trades in an exchange. Network A of the consolidated tape lists all NYSE trades and Network B lists all American Stock Exchange and regional exchange tradesTrades may be listed with the following codes:SLD: When a trade is reported out of sequenceOPD: When the initial transaction on a security is delayedPr: Preferred stockWt: Warrant * Rt: Right

Answer 326

Each exchange has an automated routing system that may be used for market and limit orders. For example, the NYSE uses SuperDOT which allows orders to be entered at the branch (as opposed to on the floor). These orders are transmitted directly to the specialist and are reported directly back to the branch

Answer 327

An SEC registered securities exchange that provides quotes on OTC securities that are registered and that meet Nasdaq qualifications including:A minimum amount of issuer assetsA minimum number of shareholdersA minimum number of outstanding sharesA minimum of three market makersTo be a Nasdaq market maker the following criteria must be met:A minimum amount of capitalRegularly make bids and offersAble to trade a normal unit of trading (100 shares) at quoted bids and offers * Report transactions within 90 seconds of execution

Answer 328

The Nasdaq provides quotes for certain OTC securities which may be accessed through terminals at three different levels:Level I - Provides real-time quotes. Does not list market makers. Only lists highest bids and lowest offers for each Nasdaq securityLevel II - Provides real-time quotes for all market makers for each Nasdaq securityLevel III - Provides real-time quotes for all market makers for each Nasdaq security and also provides the ability to enter bids and offers, execute orders and send information. Level III is restricted to registered Nasdaq market makers

Answer 329

The Nasdaq is a negotiated market and each over-the-counter security typically has multiple market makers quoting the security at different negotiated prices. The inside market is the lowest offer price and the highest bid price among all of the market makers' quotes for that security. The difference between the lowest offer and highest bid is the spread

Answer 330

Provides more comprehensive quotes and information than the Nasdaq on OTC securities that meet NGM qualifications which are more stringent than Nasdaq qualifications. Generally, NGM listed securities have more trading volume, are more nationally known and have more market makers than Nasdaq securities

Answer 331

Provides quotes on OTC securities that meet Nasdaq Capital Market qualifications which are less stringent than Nasdaq qualifications. Generally, Nasdaq Capital Market securities are smaller than Nasdaq securities

Answer 332

Previously known as SuperMontage, it is an automatic execution system for the Nasdaq, NGM and Nasdaq Capital Market, used to enter orders and access quotes of Nasdaq market makers. Firms entering orders in the system are known as order-entry firms. Orders must be either market orders or limit orders that are priced to be immediately executable

Answer 333

Preferred stock is typically issued after common stock has been issued and is for investors interested in income over capital appreciation. Preferred stock always carries a specified dividend (e.g., a 3%; preferred stock has a 3%; annual dividend). The dividend rate is the maximum dividend. However, under certain circumstances (e.g., poor earnings) the board of directors may decide to pay less than the dividend rate. Preferred stock has a preference over common stockholders when a corporation pays dividends and when it liquidates assets. Preferred stockholders generally do not have voting rights. Not all corporations will issue preferred stockCommon stock is the first type of stock a corporation issues. Common stockholders have voting rights and a higher potential for capital appreciation than preferred stockholders

Answer 334

WagesTaxesSecured creditors including secured bondholdersGeneral creditors including debenturesSubordinated creditors including subordinated debenturesPreferred stockholders * Common stockholders

Answer 335

Right to receive a stock certificate (i.e., physical proof of ownership which shows the name of the corporation, owner's name, number of shares owned and signature of an authorized corporate officer)Right of transfer of shares * Right of inspection of certain books and records of the corporation

Answer 336

Authorized shares are the total number of shares that a corporation is authorized to issue. The amount of authorized shares is specified in the corporation's charter which may be changed by a majority vote of stockholders

Answer 337

The number of shares actually sold or granted and held by stockholders. A subset of the total authorized shares

Answer 338

Treasury stock are shares that have previously been issued (i.e., sold) and have been reacquired by the corporation. Stocks that remain in the treasury do not have voting rights nor receive dividends

Answer 339

Outstanding stock is equal to all shares that have been sold (i.e., issued shares) less shares that have been reacquired by the corporation (i.e., treasury stock). Outstanding stock has voting rights and receive dividendsOutstanding Stock =Issued Stock− Treasury Stock

Answer 340

Outstanding Stock:= Issued Stock− Treasury Stock= 200,000 − 50,000= 150,000 outstanding shares

Answer 341

Cash dividends are the amount that a corporation pays to common and preferred shareholders per each share owned. Dividends are paid from the company's earnings. The board of directors determines the dividend amount (if any)The date the dividend is authorized is the declaration date.The payment date is the date the dividend is paidThe record date is the last date that shares can be acquired and still receive the next scheduled dividend paymentEx-dividend stocks are shares that have been traded after it is possible to receive the next dividend payment. The ex-dividend date is set by the SROs (e.g., FINRA) and is typically the second business day prior to the record dateDividends reduce company assets, therefore, the stock price of each share is reduced by the per-share dividend amount on the ex-dividend date

Answer 342

Stock dividends are dividends paid in additional shares of stocks rather than as cash and are therefore not taxable until the shares are sold. The stock dividend is a percentage of the number of shares owned (e.g., a 3%; stock dividend on 100 shares currently owned would amount to an additional 3 shares)The stock price of each share is reduced proportionately by the amount of the stock dividend. Stock dividends do not reduce company assets

Answer 343

Stock dividends are paid in additional shares of stocks. You will receive 10%; more shares:Stock Dividend:= Stock Dividend %;× No. of Shares= 10%; × 100 shares= 10 additional shares

Answer 344

Stock splits typically occur to reduce the price of a company's stock to make it more marketable. The total value of shares will remain the same, however, more shares are issued at a specified ratio to the existing stockFor example, if the split ratio is 2-for-1, the total number of shares will double and the price per share will halve:100 shares owned will become 200 shares after a 2-for-1 stock splitA $50 stock price will become $25 per share after a 2-for-1 stock splitThe total value of 100 shares at $50 per share equals $5,000 which is the same value as $200 shares at $25 per share

Answer 345

No. of New Shares:= Current No. of Shares× Split= 100 Shares × 3/2= 150 SharesYour number of shares have increased from 100 shares to 150 sharesNew Share Price:= Current Share Price× Inverse of Split= $60 × 2/3= $40 per ShareThe share price has decreased from $60 to $40 per shareNote: The value of your shares has remained the same:100 sh × $60 = $6,000150 sh × $40 = $6,000

Answer 346

Reverse stock splits typically occur to increase the price of a company's stock to make it more marketable or to prevent the company from being delisted from an exchange. The total value of shares will remain the same, however, the number of shares are reduced at a specified ratio to the existing stockFor example, if the split ratio is 1-for-2 the total number of shares will halve and the price per share will double:100 shares owned will become 50 shares after a 1-for-2 reverse stock splitA $5 stock price will become $10 per share after a 1-for-2 reverse stock splitThe total value of 100 shares at $5 per share equals $500 which is the same value as $50 shares at $10 per share

Answer 347

No. of New Shares:= Current No. of Shares× Split= 100 Shares × 1/2= 50 SharesYour number of shares have decreased from 100 shares to 50 shares.New Share Price:= Current Share Price× Inverse of Split= $60 × 2/1= $120 per ShareThe share price has increased from $60 to $120 per shareNote: The value of your shares has remained the same:100 sh × $60 = $6,00050 sh × $120 = $6,000

Answer 348

For each share owned a stockholder will receive the right to one vote. [For 1,000 shares owned the stockholder will receive 1,000 votes] Stockholders may vote in person or by proxy. Voting topics include stock splits and elections to the board of directors but do not include dividends. The stockholder may also attend annual shareholder meetings[Note: Voting rights are only available to common stockholders]

Answer 349

Statutory and cumulative voting are two methods a company may use for the election of the board of directorsFor statutory voting the stockholder may cast all or part of their available votes for each director position open. If the stockholder owns 1,000 shares and 3 director positions were open, the stockholder could place up to 1,000 votes for each of the 3 director positions open. For cumulative voting the stockholder's votes are multiplied by the number of director positions open and the stockholder may place the total of these votes with any or all of the director positions open. If the stockholder owns 1,000 shares and there were 3 director positions open the stockholder would have 3,000 shares that they may place with one, some or all director positions open

Answer 350

Maximum No. of Votes:= No. of Shares× No. of Positions= 1,000 Shares× 5 Positions= 5,000 Maximum VotesYou may cast all 5,000 votes for one candidate or you may distribute the 5,000 votes as you wish between the other candidates

Answer 351

Preemptive rights are the rights to purchase newly issued shares before the additional shares are offered to the public. An existing stockholder receives one right per share. Preemptive rights allow stockholders to preserve their proportionate ownership interest in the companyWhen preemptive rights are offered it is called a rights offering. The number of rights required to purchase one share may vary in addition to the purchase price offered and the period of time available for exercising the rights. The purchase price offered is typically lower than the current market value of the stock and is called the subscription price. Preemptive rights during a rights offering are completely transferable[Note: Preemptive rights are generally only available to common stockholders]

Answer 352

Warrants are a type of equity security that gives the purchaser the option of buying common stock in the future at a specified price (i.e., subscription price). The subscription price is generally higher than the current market value of the stock. Warrants typically expire after a number years but may also be perpetual. They are typically issued in conjunction with a stock or bond offering in order to provide additional incentives to investors to purchase the issuesIf the market price rises above the subscription price before the expiration of the warrant, the warrant has intrinsic value. If the market price is $55 and the subscription price is $50, the warrant has an intrinsic value of $5

Answer 353

Cumulative Preferred StockIf a preferred stockholder does not receive the maximum dividend in any given year, each year under the maximum amount is accumulated to be paid in arrears. The preferred stockholder receives all of these past accumulated dividends before the common stockholder can receive anythingNoncumulative Preferred StockPreferred stockholders receive up to their maximum dividend for the current year before the common stockholder can receive anythingParticipating Preferred StockRelatively rare. Carries a higher participating dividend rate in addition to the preferred dividend rate. The stockholder will receive up to their maximum preferred dividend rate. However, if the common stock dividends reach a specified level the participating preferred stockholder will receive up to their maximum participating dividend rateCallable Preferred StockWhere the company has a right to repurchase (i.e., call back) the stock at a specified price at some point in the future. The call price is generally higher than the current market value of the stock as an incentive for investors to purchase the stockConvertible Preferred StockWhere stockholders may exchange their preferred shares for common shares at a specified price (i.e., the conversion price). The conversion ratio is the number of shares of common stock received for each share of preferred stock based on the current market value of preferred shares and the conversion priceConversion Ratio:= Par ValueConversion Price= No. of common shares the investor receives per each share of convertible preferred share owned upon conversionConvertible preferred stock is generally for investors who are interested in income but are willing to trade a lower dividend rate for a higher potential for capital appreciation when converting to common stock

Answer 354

Conversion Ratio:= Par ValueConversion Price= $100 ÷ $25= 4-for-1The conversion ratio is 4-for-1. 4 shares of common stock are received for every convertible preferred stock share owned upon conversion

Answer 355

Conversion Price:= Par ValueConversion Ratio= $100 ÷ (2/1)= $50The conversion price is $50

Answer 356

The current yield measures the annual income received from an investment compared to the current market priceCurrent Yield =Annual DividendCurrent Market Price

Answer 357

Current Yield:= Annual DividendCurrent Market Price= ($500/100 Shares)$50= $5 Annual Dividend per Share$50= 0.1The current yield is 10%;

Answer 358

Stocks are typically classified based on type of company, expected return, assumed risk or correlation to business cycle. Common classes include:Blue Chip - Large, well-established, mature companies with stable earnings and dividend payments and no extensive liabilitiesGrowth - Companies with sales, earnings, and market share growing faster than the industry average and general economy. Usually retains earnings for company growth rather than paying dividendsIncome - Pays higher than average dividends. Dividends are high relative to market priceDefensive - Resistant to recession, usually because they produce essentials or necessary servicesCyclical - Earnings fluctuate with the business cycleAmerican Depositary Receipt (ADR) - Represents a claim to foreign securities but held by U.S. banks abroad. Traded in U.S. markets with dividends paid in U.S. dollars. Used to facilitate the trading of foreign securities in the U.S.

Answer 359

In order to raise capital a corporation may issue securities. The first issuance of securities for public sale is called a new issue, primary offering or primary distributionWhen the new issue is the corporation's first offering of stock for public sale it is the initial public offering (IPO). If the corporation is already public and is issuing additional securities it is called the additional public offering or subsequent public offering (SPO)All new issues must be registered with the SEC

Answer 360

Investment banks help arrange new offerings of stocks or bonds for corporations or municipalities on terms that are advantageous for the issuer in order to raise capital

Answer 361

Also known as the purchase contract. It is the agreement between the underwriters (i.e., investment bankers) and the corporation issuing new securities. The agreement specifies the public offering price, the underwriting spread, the net proceeds to the issuer and the settlement date

Answer 362

Firm-commitment - Where the underwriters act in a principal capacity and purchase the entire issue and must absorb any shares that they are unable to sellBest-efforts - Where the underwriters act in an agency capacity and make a bona fide effort to sell all shares. Any unsold shares are returned to the issuer without penaltyBest-efforts all-or-none - Where the underwriters act in an agency capacity and make a bona fide effort to sell all shares. If the entire issue is not sold the entire issue is cancelled and all money is returnedBest-efforts mini-maxi - Where the underwriters act in an agency capacity and make a bona fide effort to sell all shares. If a specified percentage of shares are sold the offering becomes effective. If the specified percentage is not met the entire issue is cancelled and all money is returnedStandby - Where the corporation has a preemptive rights offering (where current shareholders are given the opportunity to purchase shares before offering the shares to the public) and the underwriters agree to purchase any shares not sold, if necessary

Answer 363

A group of investment bankers (aka underwriters) working together to take a new issue public. One investment banker or a group of investment bankers will typically act as manager or co-managers. The agreement among underwriters indicates the terms of compensation and liabilities of each member of the syndicate

Answer 364

The underwriting spread is the compensation that the syndicate receives for taking a new issue public. It is the difference per share between the amount received from the investing public and the amount paid to the issuer. For example, for a syndicate that consists of a broker dealer, underwriter and syndicate manager, the broker-dealer selling the securities may receive a concession per share (typically the largest amount) and there may be an underwriting fee per share and a manager's fee (typically the smallest amount) per share. The total of the concession, underwriting fee and manager's fee would equal the underwriting spread

Answer 365

An agreement between the syndicate manager, acting as an agent for the underwriters, and the selling group. The selling group is a group of broker-dealers appointed by the syndicate manager to market and sell the securities to the public. The selling group agreement establishes the selling concession (i.e., commission) and outlines responsibilities and liabilities

Answer 366

Western account or divided account - Each member of the selling group is responsible only for their specified portion of the issue. Once they have sold their portion their liability in the offering is completedEastern account or undivided account - Each member of the selling group is responsible for their specified portion of the issue. However, if there is an unsold balance for the selling group as a whole each member is responsible for their specified percentage of the unsold balance

Answer 367

FINRA member firms must make a bona fide effort to offer new issues to the public and not withhold shares for restricted persons (e.g., the broker-dealer, employees of the broker-dealer, other industry insiders)[Note: Personnel of limited broker-dealers are exempt from this rule]A firm must meet preconditions for sale before they may sell a new issue to an account. Preconditions include obtaining representation that the account may purchase new issues in accordance with the New Issue Rule from an authorized person of the account (e.g., an affirmative statement declaring eligibility of the account to purchase new issues). If the account is held by a conduit (e.g., a bank, broker-dealer, investment advisor, etc.), representation must additionally be obtained that all purchasers of the new issues are in compliance with Rule 2790. Representation must be written, must be verified every 12 months and all records relating to obtaining representation must be retained for at least 3 yearsSales of new issues are prohibited to any account where a restricted person would have a beneficial interestRestricted persons are prohibited from purchasing new issues unless an exemption exists. Restricted persons include:Member firms and any associated personsImmediate family members of employees of a member firm (i.e., spouse, children, parents, siblings, in-laws, any persons materially supported by the employee) that meet any one of the following: * Employee is currently employed by the member firm that is selling the new issues * Employee can control the allocation of the new issueEmployee provides or receives material support for the immediate family member (i.e., lives in the same household or is responsible for over 25%; of income)Owners of a broker-dealer (generally 10%; or more ownership)Portfolio managers and their immediate family (i.e., persons who can control the purchase and sale of securities for institutional investors and therefore have influence over the future business to the firm) * Finders and fiduciaries and their immediate family (e.g., attorneys, accountants, persons assisting in the new issue offering)

Answer 368

New issues under the new issue rule include all equity security IPOs under a registration statement or offering circular Securities that are exempt include:All debt offeringsSecondary offeringsPrivate offeringsPreferred stock and rights offeringsInvestment company offeringsReal Estate Investment Trusts (REITs)Direct Participation Programs (DPPs) * Any exempt securities outlined in the Securities Act of 1933

Answer 369

The New Issue Rule prohibits sales of new issues to restricted persons. However, there are several exemptions to this restriction. New issues may be sold to:Investment firms registered under the Investment Company Act of 1940An insurance company if it is a general or separate accountA common trust fundIf the beneficial interest of all restricted persons combined is less than 10%; (known as the de minimis exemption)Publicly traded entities (excluding broker-dealers or broker-dealer affiliates that offer new issues to the public)Foreign investment firmsTax exempt plans under IRS Code 501(c)(3) (e.g., state benefit plans, ERISA accounts, etc.)If the new issue offering is undersubscribed the broker-dealer may purchase new shares in its own accountIf a restricted person has been an existing shareholder for at least one year prior to the new issues offering they may purchase shares to prevent the dilution of their ownership in the company. If purchased to preserve their equity interest in the company new shares may not be resold until at least 3 monthsIf an entity is under control or is controlled by the issuer (e.g., subsidiary, employees and their immediate family, parent company) they may purchase new shares if the issuer provides specific instructions for them to do soIf an issue is oversubscribed the underwriters have the option to request a green shoe clause so that they may purchase additional shares up to 15%; and sell those sharesIf the new issue lacks investor interest the managing underwriter may purchase shares in order to stabilize the securities (i.e., prevent a price drop). Bids for the shares must be at or below the public offering price. Stabilization purchasing may be stopped at any time but may not continue after all shares of the new issue are sold[Note: The prospectus must contain a disclosure of stabilization and once enacted must be reported to the SEC]

Answer 370

The no approval clause is a statement on the front page of any prospectus that the SEC does not guarantee the adequacy or accuracy of information in the prospectus. Any statement to the contrary is a criminal offense

Answer 371

A registration statement for new issues must be filed with the SEC and must contain the following:Description of issuer's businessIssuer's capitalizationSpecific uses of funds received from the issueBiographical data for directors and officers of the issuing companyShareholdings of officers, directors and underwriters of the issuing company * List of any persons with 10%; or more ownership of the issuing company's securities

Answer 372

A registration statement for new issues must be filed with the SEC. During the pre-registration period the issuer prepares the registration statement typically with the assistance of underwriters. The new issue may not be discussed with customers during this time. The filing date is the date that the SEC receives the registration statementThe waiting or cooling-off period is the 20 days following the filing date. During the cooling-off period the SEC reviews the registration statement. The SEC may issue a deficiency letter that delays the effective date if their review shows that the registration statement misrepresents or omits information, contains errors or otherwise is materially deficient. The SEC may also issue a stop order that prohibits sale of the new issue. During the cooling-off period the issuer must blue sky (i.e., register) the issue in any states where the new issue is intended to be sold. During the cooling-off period the issuer must also prepare a red herring (i.e., preliminary prospectus which does not yet contain an effective date or offer price, so called because it must have a red border on the cover page to indicate that it is only a preliminary draft of the prospectus). Solicitation of the new issues where money is accepted is strictly prohibited prior to the effective date of the new issue. However, the red herring may be used to obtain indications of interest from investors. Any indication of interest does not constitute an order and must be contacted again after the new issue becomes effectiveAfter approval but prior to the official issuance of the final prospectus, a due diligence meeting is held by the underwriters and associated persons of the new issue to review the underwriting and to ensure that due diligence was exercised in following all required regulationsIf the new securities will be listed on a national exchange or on Nasdaq the final prospectus must be delivered to any customer for 25 days from the effective date. If the new issues are over the counter and ineligible to be listed on Nasdaq the final prospectus must be delivered for 40 days or, if this is the corporation's first issuance of stock to the public, the requirement is 90 days

Answer 373

A tombstone advertisement is the only advertising allowed for a new issue, so called because of its black border and heavy black print. It contains basic information about the new issue and lists the underwriters in order of importance. Tombstone advertisements will generally direct prospective investors to the prospectus with the standardized clause that the advertisement is "not an offer to sell, or a solicitation of an offer to buy. The offering is made only by a prospectus"

Answer 374

Issuers are required to blue sky (i.e., register) a new issue in any states where the issue is intended to be sold. The three types of state registration allowed are:Filing - Submission of an application to request approval to offer the new issue with the State AdministratorQualification - Meeting criteria required by the state where approval to offer the new issue is at the discretion of the State AdministratorCoordination - State and SEC registration are submitted simultaneously and approval to offer the new issue occurs at the same time

Answer 375

Certain types of securities are exempt from the registration and prospectus requirements of the Securities Act of 1933. This exemption does not exclude the securities from any antifraud requirements. Exempt securities include:U.S. government securitiesU.S. government agency securitiesAny non-profit issued securitiesCorporate debt securities with maturities of 270 days or lessAny U.S. bank or trust issued securities * Any small business investment company issued securities

Answer 376

An investor that is financially sophisticated and therefore has a reduced need for the protection that certain government filings are intended to provide (and would therefore qualify under SEC Regulation D). An accredited investor is defined as one of the following:Financial institution (e.g., bank, insurance company)A charity, corporation or partnership with assets exceeding $5 million * Private business development companyor an accredited investor may also be an individual that meets the following criteria:Earns a gross income of $200,000 or a gross joint income of $300,000 for each of the past two years with the expectation of continuing at the same income levelHas a net worth of $1,000,000 or more excluding value of primary residence (individually or jointly) * Is one or more of the following: a general partner, executive officer, or director of the issuer

Answer 377

Known as the intrastate offering exemption. Provides an exemption from the registration requirements of the Securities Act of 1933 when a new issue is sold within only one state and not through interstate commerce. The following criteria must be met:At least 80%; of gross revenue is generated from in-state activitiesAt least 80%; of the issuers assets are located within the stateAt least 80%; of funds received from the new issue are used for facilities located within the state * 100%; of investors purchasing the new issue are principal residents of the state

Answer 378

Provides an exemption from the registration requirements of the Securities Act of 1933 when a new issue is sold over a 12-month period and is valued at $5,000,000 or less. However, instead of registering with the SEC, the issuer is required to file an offering statement and to provide an offering circular to prospective investors

Answer 379

Provides an exemption from the registration requirements of the Securities Act of 1933 when a new issue is privately placed if the following criteria is met:The issuer must have reason to believe the investor has the investing experience to be able to evaluate the securities and any risksThe issuer must provide an offering memorandum in order to provide the investor with the information that a prospectus would typically containThe issuer must be assured that the investor does not intend to immediately sell the securities, typically through an investment letter * The issuer must not sell the issue to more than 35 nonaccredited investors (i.e., an institution or an investor qualified to be financially sophisticated and therefore would have a reduced need for the protection of the registration requirement)

Answer 380

Regulation S covers securities issued by U.S. firms but sold outside of the country. Because only non-U.S. investors can buy these securities upon issuance they do not need to be registered under the Securities Act of 1933. The holding period for debt securities is 40 days and 1 year for equities before they can be resold in the U.S.

Answer 381

Sets the conditions for the sale of restricted stock (i.e., not registered with the SEC, typically private placement stock), unregistered stock and control stock (i.e., registered stock purchased by a control person such as a director or officer). To sell these types of securities the following criteria must be met:The holding period must be met * For restricted stock the holding period is 6 months from the time the stock was purchased by the original investorFor control stock there is no holding periodAnyone selling these securities must file notice with the SEC at the time the order is placed with a broker unless the total number of shares is 5,000 or less and the total dollar amount is $50,000 or less[Note: An amended notice must be filed if the securities are not sold within 90 days of the previous notice]Adequate public information must be available regarding the issuerFor exchange and Nasdaq listed securities the trading volume over any 90-day period is limited to the greater of 1%; of total shares outstanding or the average of the weekly trading volume for the previous four weeksFor over-the-counter securities that are not Nasdaq listed, the trading volume over any 90-day period is limited to 1%; of total shares outstandingFor private placement stock that is held two years or more trading volume is not restrictedAll trading requirements that normally apply to any trade must be metThese securities may be sold through a brokers' transaction that are on an agency basis only where the broker-dealer may sell the securities but may not solicit orders unless: * An unsolicited indication of interest from a prospective investor was made within the last 10 business days * An indication of interest from another broker has been made within the last 60 days

Answer 382

Exempts qualified financial institutions (i.e., a Qualified Institutional Buyer has $100 million or more invested in securities that are not issued by affiliates of the institution) from the requirements of SEC Rule 144 when buying and selling directly amongst themselves. There is no holding period and securities may be foreign or domestic and debt or equity

Answer 383

Shelf registration is used when the sale of the new issue is delayed or continuous for up to three years. Shelf registration allows the issuer to fulfill all registration requirements, wait for market conditions to improve and then quickly issue a public offering

Answer 384

Stipulates that certain types of reclassifications must fulfill the registration and prospectus requirements of the Securities Act of 1933 and include:When securities are reclassified so that one security is substituted for another securityWhen a corporation experiences a merger or consolidation so that one corporation's securities are substituted for another corporation's securities * When the assets of one corporation are transferred to another corporation[Note: Stock splits, reverse splits and changes in par value are not subject to Rule 145]

Answer 385

A derivative is a contract between two or more parties. The value of a derivative is determined by (is derived from) an underlying asset such as stocks, bonds, interest rates, etc. Options, futures and swaps are the most commonly used

Answer 386

An option is a contract between the buyer (also known as the owner or holder) of the option and the seller (aka the writer) of the option where the buyer has the option, but not the obligation, to either buy (a call) or sell (a put) a specific security or asset at the specified strike price during a specified time period or date. In an option the buyer is long and the seller is short. An option is composed of:Underlying securityStrike price (or exercise price)Expiration period or dateType of option (put or call) * Premium (the amount the buyer pays to the seller in exchange for the option to buy or sell)

Answer 387

Call option - The buyer has the option to buy (a call) at the specified strike price. The seller is obligated to sell at the strike price if the buyer exercises the option. If the market price increases the buyer will be able to buy at the lower strike pricePut option - The buyer has the option to sell (a put) at the specified strike price. The seller is obligated to buy at the strike price if the buyer exercises the option. If the market price decreases the buyer will be able to sell at the higher strike price

Answer 388

The premium is the amount that the buyer pays to the seller in exchange for the option to buy or sell. The premium fluctuates and is determined by the market, depending on factors such as: Current market price relative to the strike priceThe amount of time until the option expiresPayments from the underlying security (e.g., dividends)Volatility of the underlying security * Rates of return that may be made on other investments (e.g., current interest rates)The premium is comprised of the intrinsic value of the option (the difference between the current market price and the strike price) and the time value of the option (calculated by subtraction the intrinsic value from the premium)Option Premium =Intrinsic Value+ Time ValueIf the current market price is the same or better than the strike price the option has no intrinsic value and only derives its value from the time value. Premiums are usually paid in roundlots of 100 sharesExample:For a call option the current market price is $20, the strike price is $15, the premium is $6.The premium for one option contract is 100 shares x $6 = $600The intrinsic value is $20 - $15 = $5The time value is $6 - $5 = $1

Answer 389

An option is in-the-money when the strike price of the underlying security is better than the value of the underlying security at the current market price. A higher underlying security market price is more valuable with a call while a lower market price is more valuable for the buyer of a put. An option is out-of-the-money when the opposite is true. If the strike price and the current market price is the same the option is at-the-money

Answer 390

Options are only valid until the expiration date and may be closed at expiration, by liquidation or exercisingLiquidation - Options may be liquidated or traded in the secondary market. When the option is sold the profit is the difference between the price paid for the option and the price received for selling the optionExercising - The owner of the option may exercise their option to buy or sell. If the current market price on a call option is higher than the strike price the owner could buy the security at the lower strike price and immediately sell the security at the higher market price. If the current market price on a put option is lower than the strike price the owner could buy the security at the lower market price and then sell those securities at the higher strike price. When the owner exercises their option the seller is then assigned the exercise. The seller is obligated to fulfill the optionExpiration - If the current market price of the underlying security is a better price than the strike price at the time of expiration the option owner has no incentive to exercise the option and will not be able to sell the option because the option is worthless and has no time remaining until expiration. Because the option writer was not assigned the exercise, the profit the writer receives is the premium paid when the option was initially sold

Answer 391

The following example illustrates the difference between purchasing a stock outright and a call option for that stock:The premium for a call option is 5%;, the strike price is $38, and the current market price of the underlying stock is $40The cost to purchase a roundlot of 100 shares of the security is 100 shares x $40 = $4,000The cost to purchase one option contract of 100 shares x $5 = $500Options allow the buyer to leverage and require a smaller amount of money for the right to purchase the same number of sharesThe market price increases to $50100 shares of the security are now $5,000. Therefore, the value of the shares has increased $5,000 - $4,000 = $1,000, or a 20%; profitThe option is now in-the-money by 10 points and is therefore worth 100 shares x $10 = $1,000. This represents an increase of $1,000 - $500 = $500, or a 100%; profit.Options have a potential for higher profits. For every dollar the market price increases, the intrinsic value of the option increases by one dollar. Therefore, their maximum gain is theoretically unlimitedThe market price remains at $40The value of the stock remains at $4,000. The investor has no profit or loss.The value of the option is zero. The investor has lost $500, the premium amount initially paid for the option.Options lose their relatively small initial investment if the market price of the stock remains the same.The market price decreases to $25100 shares of the security is now $2,500. Therefore, the value of the shares has decreased $4,000 - $2,500 = $1,500.The value of the option is zero. The investor has lost $500, the premium amount initially paid for the option. The maximum loss of an option is the premium amount.Options cannot lose more than the relatively small initial investment amount.The expiration date has arrivedThe investor may hold onto the stock and will profit from any future increases in value.The option owner must either sell their option to another buyer, exercise the option or allow the option to expire. If the market price is not higher than the strike price, the owner has no time remaining to wait for the market price to rise and will lose the premium they paid.Options are limited in time. Market prices must move in a profitable direction within the specified time frame for the option to be profitable

Answer 392

Buying a long call option is when an investor pays a premium in order to purchase the option to buy a security at a specified strike priceThe point at which an option owner breaks even is when the premium initially paid for the option is recouped. The maximum potential gain is the maximum amount of profit the owner may potentially receive for the option. The maximum potential loss is the maximum amount the owner may potentially loseBreakeven: When the market price is higher than the strike price by the amount of the premium (e.g., If the strike price is $10 and the premium is $1, the option breaks even when the market price is $11)Maximum potential gain: Unlimited (the higher the market price goes, the higher the profits) * Maximum potential loss: The premium amount

Answer 393

Selling a long call option is when an investor receives a premium in exchange for agreeing to sell a security at a specified strike priceThe point at which an option seller breaks even is when the seller has neither a profit or a loss. The maximum potential gain is the maximum amount of profit the seller may potentially receive from the option. The maximum potential loss is the maximum amount the seller may potentially loseBreakeven: When the market price is higher than the strike price by the amount of the premium (e.g., If the strike price is $10 and the premium is $1, the option breaks even when the market price is $11) if the call is uncovered or naked (i.e., the seller does not own the underlying stock). The seller will then have to purchase the securities at the higher market price and sell the securities to the option owner at the lower strike price. If the difference in the market price and strike price is the amount of the premium, the seller will lose the premium they were initially paid and will have no profit or lossMaximum potential gain: The premium amount received * Maximum potential loss: Unlimited if the call is uncovered or naked. The seller has agreed to sell the securities at the strike price. If the seller does not own the securities the option seller must first purchase the securities at the current market price no matter how high the price may have risen

Answer 394

You received $2 for the call option. In order to break even you could endure a $2 loss. Therefore, if the buyer of your option purchases the underlying security at $50, and you must purchase the security at the current market price in order to sell the shares to the buyer at $50, you would break even if you sold the shares at a $2 loss

Answer 395

Buying a put option is when an investor pays a premium in order to purchase the option to sell a security at a specified strike price. If the market price declines the option owner can buy securities at the lower price and sell them at the strike priceThe point at which an option owner breaks even is when the premium initially paid for the option is recouped. The maximum potential gain is the maximum amount of profit the owner may potentially receive for the option. The maximum potential loss is the maximum amount the owner may potentially loseBreakeven: When the market price is lower than the strike price by the amount of the premium (e.g., If the strike price is $10 and the premium is $1, the option breaks even when the market price is $9)Maximum potential gain would occur if the shares fell to zero:(Strike Price − Premium)× 100 Shares * Maximum potential loss: The premium amount

Answer 396

You paid $2 to purchase the put option. In order to break even and make your initial $2 investment back you would have to purchase shares of the underlying security at the current market price and then exercise your option to sell the underlying security at $50 per share for a $2 profit.Therefore the breakeven point is:= Strike Price− Premium= $50 − $2= $48You will make a $2 profit when the current market price reaches $48, therefore the put option breaks even when the market price is $48.The maximum potential gain for a put option is limited to the amount you would receive for exercising your option to sell 100 shares at the strike price less the premium you had initially paid. If the current market price drops to zero you may purchase 100 shares and then exercise your option to sell those shares at the $50 strike priceTherefore the maximum potential

Answer 397

Selling a put option is when an investor receives a premium in exchange for agreeing to buy a security at a specified strike price during a specified time period. If the market price declines the writer is obligated to purchase the security at the higher strike priceThe point at which an option seller breaks even is when the seller has neither a profit nor a loss. The maximum potential gain is the maximum amount of profit the seller may potentially receive from the option. The maximum potential loss is the maximum amount the seller may potentially loseBreakeven: When the market price is lower than the strike price by the amount of the premium (e.g., If the strike price is $10 and the premium is $1, the option breaks even when the market price is $9). The seller will then have to purchase the securities at the higher strike price. If the difference in the market price and strike price is the amount of the premium, the seller will lose the premium they were initially paid and will have no profit or lossMaximum potential gain: The premium amountMaximum potential loss for one contract: (Strike Price − Premium)× 100 Shares

Answer 398

You received $2 for the put option. In order to break even you could endure a $2 loss. Therefore, if the buyer of your option sells the underlying security at $50 and you must purchase the shares at $50, you would break even if you sold the shares you now own at the current market price at a $2 lossTherefore, the breakeven point is:= Strike Price− Premium= $50 − $2= $48You will lose the $2 premium you received for selling the option when the current market price is $48, therefore the call option breaks even when the market price is $48.The maximum potential gain for selling a put option is limited to the premium paid. If the current market price of the underlying security rises above the strike price, the buyer of your option will not to exercise their option to sell the underlying security. In this case, you will retain the premium amount you had initially received. Therefore, the maximum potential gain is $2 per shareThe maximum potential loss for selling a put option is limited to the amount the buyer would receive for exercising their option to purchase 100 shares at the strike price less the premium you received. The buyer of the option may sell the underlying security at $50. If the current market price drops to zero, you will have to purchase the security at the $50 strike price but would not be able to resell the shares you were obligated to purchaseTherefore the maximum potential loss is:= (Strike Price − Premium) × 100 Shares = ($50 − $2)× 100 Shares= $48 × 100 Shares= $4,800

Answer 399

Buyers of call options realize profits when the market price increasesSellers of call options realize profits when the market price decreasesBuyers of put options realize profits when the market price decreasesSellers of put options realize profits when the market price increasesBuyers and sellers break even at the same pointThe buyer's maximum gain is the seller's maximum loss * The seller's maximum gain is the buyer's maximum loss

Answer 400

Long call - Buying a call option (paying a premium for the right to purchase securities at the strike price hoping that the market price will increase). If the market price increases the buyer may purchase the securities at the lower strike priceShort call - Selling a call option (receiving a premium for the obligation to sell securities at the strike price hoping that the market price will decrease). If the market price increases the seller will be obligated to sell the securities at a lower strike priceLong put - Buying a put option (paying a premium for the right to sell securities at the strike price hoping that the market price will decrease). If the market price decreases the buyer will be able to sell the securities at the higher strike priceShort put - Selling a put option (receiving a premium for the obligation to purchase securities at the strike price hoping that the market price will increase). If the market price decreases the seller will be obligated to purchase securities at a higher strike price

Answer 401

A hedge is an investment made for the purpose of offsetting the risk of another asset or investment. The goal is usually to lower the risk to a certain degree since it is difficult and more expensive to completely eliminate a given risk. Securities that move in the opposite direction as the hedged asset work as effective hedgesOptions may be used to hedge long or short positions:Long positions may be hedged with a short call or a long put * Short positions may be hedged with a long call or a short put

Answer 402

Also known as covered call writing. The investor writes a call (i.e. sells a call option) which obligates the seller to sell the underlying security if the option is exercised. The seller receives a premium for selling the option. The call is covered because the seller already owns a long position in the underlying securityBreakeven:Strike Price− Call Premium(e.g., If the strike price is $10 and the premium is $1 the covered call breaks even when the market price is $9). If the market price declines by the amount of the premium the seller will lose the premium they were initially paid and will have no profit or lossMaximum potential gain:Market Value of Long Position at Strike Price− Original Investment in Long Position+ Call PremiumIf the market price increases above the strike price the call will be exercised and the investor will be forced to sell their long position at the strike price. Their profit will be the difference between the market value of the security at the strike price and their original investment amount plus the premium they received for selling the call optionMaximum potential loss:Original Investment in Long Position− Call PremiumA covered call is only a partial hedge because, if the stock price declined to zero the investor would lose their entire investment except for the premium they received for selling the call option

Answer 403

Also known as a protective put or synthetic call. The investor buys a put option by paying a premium for the right to sell the underlying security at a specified strike price. The investor owns a long position in the underlying security hoping the market price will increase, but purchases the option to sell the security at the strike price to receive protection from a market price decline. Used to hedge risk for a long stock positionBreakeven:Strike Price+ Put Premium(e.g., If the strike price is $10 and the premium is $1, the protective put breaks even when the market price is $11). If the market price increases by the amount of the premium the buyer will have recouped the premium paid for the put optionMaximum potential gain: Unlimited. If the market price increases the value of the investor's long position will increaseMaximum potential loss:+ Original Investment in Long Position− Market Value at Strike Price+ Put PremiumThe investor will be able to sell the long position at the strike price no matter how low the market price is. The maximum loss is the difference between the original investment amount and the market value of the security at the strike price plus the premium paid to buy the put option[Note: The investor will no longer have the protection of a put option when the put expires. To continue receiving protection the investor will need to purchase another put]

Answer 404

Also known as a protective call or synthetic put. The investor buys a call option by paying a premium for the right to buy the underlying security at a specified strike price. The investor currently has a short position in the underlying security and has borrowed the security hoping that the market price will decrease at which point the investor may purchase the securities at a lower market price so that they may return the borrowed securities. If however, the market price increases the investor may exercise their put option and purchase the securities at the strike price. Used to hedge risk for a short stock positionBreakeven:Stock price at Start of Position− Call Premium(e.g., If the stock price is $10 and the premium is $1, the protective call breaks even when the market price is $9). If the market price decreases by the amount of the premium the investor will be able to purchase the securities at the lower market price and return the borrowed securities which were sold at a higher price. The profit from the short sale is equal to the premium amount paid for the call option. The investor will have recouped the premium amount and made no profit or lossMaximum potential gain:Proceeds from Short Position− Call PremiumIf the market price decreases to zero the investor pays nothing to purchase the securities and receives the entire amount that they initially received for the short position less the premium paid for the call optionMaximum potential loss:+ Market Value at Strike Price− Proceeds from Short Position+ Call PremiumIf the market price rises above the strike price the investor will exercise the call and purchase the securities at the strike price. The investor will lose the difference between the amount they paid to purchase the securities at the strike price and the amount they originally received for selling the borrowed securities. The investor will also lose the premium amount paid for the call option[Note: The investor will no longer have the protection of a call option when the call expires. To continue receiving protection the investor will need to purchase another call]

Answer 405

Also known as covered put writing. The investor writes a put (i.e. sells a put option) which obligates the seller to buy the underlying security if the option is exercised. The seller receives a premium for selling the option. The put is covered because the investor already has a short position in the underlying security in which the seller sold borrowed securities and received proceeds from the sale, but must purchase the securities at a later date to repay the short loan. Used to increase gains from a short position and provide a partial hedgeBreakeven:Short Sale Price+ Put Premium(e.g., If the short sale price is $10 and the premium is $1 the covered put breaks even when the market price is $11). If the market price increases by the amount of the premium the seller must purchase the securities at the higher market price. The difference between the amount the seller paid to purchase the securities and the short sale proceeds is the amount of the premium. The seller's profits from the premium are wiped out and the seller will have made no profit or lossMaximum potential gain:+ Short Sale Proceeds− Market Value at Strike Price+ Put PremiumIf the market price decreases below the strike price the call will be exercised and the investor will be forced to buy the securities at the strike price. Their profit will be the difference between their original short sale proceeds and the market value of the security at the strike price plus the premium they received for selling the put option * Maximum potential loss: Unlimited. If the market price increases the investor will be forced to purchase the securities at the higher price regardless of how high the market price increases

Answer 406

When an investor buys both a call and a put (long straddle), or when an investor sells both a call and a put (short straddle) with the same underlying security, strike price and expiration dateA long straddle will profit from the market price of the underlying security moving significantly in either direction (a significantly higher or lower market price). A short straddle will profit from the market price remaining stable

Answer 407

A long straddle is when an investor buys both a call and a put with the same underlying security, strike price and expiration date. A long straddle will profit if the market price is volatile and is an appropriate investment if the investor believes the market price will move significantly but is unsure in which directionIn a long straddle, the investor has the option to purchase or sell the securities at the strike price. If the market price increases the investor can exercise the call option to purchase securities at the lower strike price and would allow the put option to expire. If the market price decreases the investor can sell the securities at the higher strike price and would allow the call option to expireBreakeven:Strike Price+ Total Premiums- OR -Strike Price− Total Premiums(e.g., If the strike price is $10 and each premium is $1 the long straddle breaks even when the market price is either $12 or $8). When the market price increases or decreases by the total premium amount the investor will recoup the premium amounts they initially paid for the call and the putMaximum potential gain: Unlimited if the market price increases. If the market price decreases:(Strike Price × 100 Shares)− Total Premiums * Maximum potential loss: Total of premiums paid. If the market price remains stable the call option and the put option would both be worthless. The investor would allow both options to expire and would lose the premium amounts paid for the call and the put

Answer 408

A short straddle is when an investor sells both a call and a put with the same underlying security, strike price and expiration date. A short straddle will profit if the market price is stable and is an appropriate investment if the investor believes the market price will remain stable and would like to earn income from both the call and the put premiumsIn a short straddle, the investor is obligated to purchase or sell the securities at the strike price if the option is exercised. If changes in the market price do not exceed the premium amounts, the options will not be exercised and the investor will keep the premium amounts they received. If the market price increases above the premium amount, the call will be exercised and the investor will be forced to sell the securities at the lower strike price and will lose money. If the market price decreases below the premium amount, the put will be exercised and the investor will be forced to buy the securities at the higher strike price and will lose moneyBreakeven:Strike Price+ Total Premiums- OR -Strike Price− Total Premiums(e.g., If the strike price is $10 and the premiums are $1 each, the long straddle breaks even when the market price is either $12 or $8). When the market price increases or decreases by the premiums the investor will lose exactly the premium amount they initially received for the call and the putMaximum potential gain: Total Premiums. If the market price remains stable the call option and the put option will not be exercised. The investor would then be able to keep the premiums they received from the call option and the put option that they soldMaximum potential loss: Unlimited if the market price increases. If the market price decreases:(Strike Price × 100 Shares)− Total Premiums

Answer 409

When an investor buys both a call and a put (long combination), or when an investor sells both a call and a put (short combination) on the same underlying securityCombinations differ from straddles because the strike price and/or the expiration date are different. The calculation for breakeven point, maximum potential gains and maximum potential losses are the same for long combinations and long straddles and for short combinations and short straddles

Answer 410

When an investor simultaneously buys a call option and sells a call option with the same underlying security but with different strike prices and/or expiration dates

Answer 411

When an investor simultaneously buys a put option and sells a put option with the same underlying security but with different strike prices and/or expiration dates

Answer 412

Also known as a vertical spread. A price spread may be a call or a put spread where both options have the same expiration date but have different strike prices

Answer 413

Also known as a horizontal spread, time spread or calendar spread. A time spread may be a call or a put spread where both options have the same strike price but have different expiration dates

Answer 414

A diagonal spread may be a call or a put spread where both the strike prices and the expirations dates are different

Answer 415

A spread is when an investor simultaneously buys and sells either a call option or a put option. The investor pays a premium for purchasing the option but also receives a premium for selling the optionA net credit spread is when the premium received is higher than the premium paidA net debit spread is when the premium paid is higher than the premium received

Answer 416

A net credit spread is when an investor simultaneously buys and sells either a call option or a put option and receives a higher premium for selling the option than they paid to buy the optionIf the investor bought and sold a call premium, they have the option of purchasing the securities at the strike price, but are also obligated to sell the securities at a lower strike price. If the investor bought or sold a put option, they have the option of selling the securities at the strike price, but are also obligated to buy the securities at a higher strike price The investor profits when the spread between the strike price and the market price narrowsBreakeven: For call spreads:Lower Strike Price+ Net Premium AmountFor put spreads:Higher Strike Price− Net Premium Amount(e.g., If the lower strike price is $10 and the net premium is $1 the net credit call spread breaks even when the market price is $11; if the higher strike price is $15 and the net premium amount is $1 the net credit put spread breaks even when the market price is $14). When the market price increases or decreases by the premium amount the investor will lose exactly the premium amount they initially received for the call and the putMaximum potential gain: Net Premium Amount. For a call spread, if the market price remains below the strike price for the long call but below the strike price for the short call, neither call will be exercised. For a put spread, if the market price remains below the strike price for the short put and above the strike price for the long put, neither put will be exercised and the investor would then be able to keep the net premium amount they receivedMaximum potential loss:Higher Strike Price− Lower Strike Price− Net Premium AmountIf both options are exercised, the investor would lose the difference between the two strike prices but would still retain the net premium amount initially received

Answer 417

A net debit spread is when an investor simultaneously buys and sells either a call option or a put option and pays a higher premium for buying the option than they received for selling the optionIf the investor bought and sold a call premium, they have the option of purchasing the securities at the strike price but are also obligated to sell the securities at a higher strike price. If the investor bought or sold a put option, they have the option of selling the securities at the strike price, but are also obligated to buy the securities at a lower strike price. The investor profits when the spread between the strike price and the market price widensBreakeven: For call spreads:Lower Strike Price+ Net Premium AmountFor put spreads:Higher Strike Price− Net Premium Amount (e.g., If the lower strike price is $10 and the net premium is $1, the net credit call spread breaks even when the market price is $11; if the higher strike price is $15 and the net premium amount is $1, the net credit put spread breaks even when the market price is $14). When the market price increases or decreases by the premium amount, the investor will lose exactly the premium amount they initially received for the call and the putMaximum potential gain:Higher Strike Price− Lower Strike Price− Net Premium AmountIf both options are exercised, the investor would gain the difference between the two strike prices but would still have lost the net premium amount initially paid * Maximum potential loss: Net Premium Amount. For a call spread, if the market price remains below the strike price for the long call but below the strike price for the short call, neither call will be exercised. For a put spread, if the market price remains below the strike price for the short put and above the strike price for the long put, neither put will be exercised and the investor would have lost the net premium the paid for both options

Answer 418

An equity option is an option where the underlying instrument is a single stockA non-equity option is an option where the underlying instrument is anything other than a single stock such as:Debt securitiesStock indexesForeign currencies * Interest rates

Answer 419

American exercise permits the option owner to exercise the option at any point up to one business day before the expiration date. All equity options are under American exerciseEuropean exercise permits the option owner to exercise the option only during a specified time period, usually one business day before the expiration date. Certain non-equity options use a European exercise

Answer 420

Interest rate options which are based on the price of the underlying debt security which may be U.S. government securities such as Treasury bills, notes and bonds * Yield-based options which are based on the yield of the underlying debt security which may be 13-week Treasury bills, 5-year Treasury notes, 10-year Treasury notes or 30-year Treasury bonds

Answer 421

Treasury bill option - The underlying debt security is a 13-week Treasury bill with a $1,000,000 face value. Traded on the American Stock Exchange * Strike Price = Par - Discount Yield where Par = 100.Premiums are quoted in whole number percentages and in basis points where one basis point equals one hundredth of a percent or $25. Therefore, a premium that is quoted in basis points = Premium in Basis Points x 100 x $25Treasury note option - The underlying debt security is a Treasury note with a $100,000 face value * Strike Price = Par - Discount Yield where Par = 100.Premiums are quoted as a percentage of par in 32nds of a point (e.g., a premium of $5.12 is equal to 5 and 12/32 basis points), where one basis point equals $1,000. Therefore, a premium that is quoted in basis points = Premium as Basis Points x $1,000 (e.g. 5 and 12/32 x $1,000)Treasury bond option - The underlying debt security is a Treasury bond with a $100,000 face value. The strike price and premium is calculated in the same way as Treasury note options

Answer 422

A debt call option where the buyer of the option pays a premium in exchange for the option to purchase the underlying debt security at the strike price prior to the expiration date. The seller is obligated to sell at the strike price if the buyer exercises the option. If the bond price increases the buyer will be able to buy at the lower strike price[Note: Bond prices usually increase when interest rates decline assuming credit rating and other characteristics remain the same. Therefore the call option will be in-the-money when interest rates decline]

Answer 423

A debt put option is where the buyer of the option pays a premium in exchange for the option to sell the underlying debt security at the strike price prior to the expiration date. The seller is obligated to buy at the strike price if the buyer exercises the option. If the bond price decreases the buyer will be able to sell at the higher strike price[Note: Bond prices usually decrease when interest rates rise assuming credit rating and other characteristics remain the same. Therefore, the put option will be in-the-money when interest rates rise]

Answer 424

Yield = Strike Price10

Answer 425

Yield-based options are settled on a cash basis (i.e., no physical Treasury securities are exchanged) and may only be exercised at a specified period prior to the expiration date (European style)Settlement Amount for Calls =(Current Yield × 10)− (Strike Price × 10)× 100Settlement Amount for Puts =(Strike Price × 10)− (Current Yield × 10)× 100

Answer 426

A yield-based call option grants the buyer the option to close out of the option when the underlying debt security is at the buyer's desired yield. No securities are exchanged when the option is exercised. Instead, the yield reported by the Federal Reserve Bank of New York is used and the option writer is obligated to pay to the owner the settlement amount:(Current Yield × 10)− (Strike Price × 10)× 100If interest rates increase the buyer will be able to exercise the option at the lower strike price

Answer 427

A yield-based put option grants the buyer the option to close out of the option when the underlying debt security is at the buyer's desired yield. No securities are exchanged when the option is exercised. Instead, the yield reported by the Federal Reserve Bank of New York is used and the option writer is obligated to pay to the owner the settlement amount:(Strike Price × 10)− (Current Yield × 10)× 100If interest rates decrease the buyer will be able to exercise the option at the higher strike price

Answer 428

An option where the underlying instrument is a stock index. Index options may lower risk because they are based on an entire stock index rather than a single stock. The two types of index options are:Broad-based: Based on the performance of the entire market (e.g., DJIA, S&P 500, Nasdaq 100, Russell 2000, etc.)Narrow-based: Based on the performance of an industry or market segment (e.g., biotechnology, etc.)The value of index options are equal to the index value multiplied by 100 (similar to equity options which are sold in roundlots of 100 shares)An index option grants the buyer the option to close out of the option when the underlying index is at the buyer's desired value. No securities are exchanged when the option is exercised. Instead, the value of the index is taken at the close of market and the option writer is obligated to pay to the owner the settlement amount:(Index Value − Strike Price)× 100[Note: The value of the index is taken at the close of market not when the option is exercised. If the option is exercised earlier in the day the value at closing may fluctuate significantly. If the index value declines below the strike price the day the option is exercised the option owner is required to pay the writer the negative value of the option]

Answer 429

The VIX or Volatility Market Index is traded on the Chicago Board Options Exchange (CBOE) and reflects the market expectation for volatility in the next 30 days. It is based on the implied volatility of the S&P 500 index and generally moves in the opposite direction as the index. The VIX is also known as the fear index since it reflects investor apprehensions or complacency

Answer 430

Also known as caps. A capped index option is an index option that is automatically exercised at a specified index value (the capped price). They may only be exercised either automatically at the capped price or optionally at expiration. Capped index options typically have lower premiums and transactions costs, simplified execution and may lower risk by avoiding exercise of the option when the market fluctuates drastically)The strike price is the price at which the option is at-the-money. The capped interval is the difference between the strike price and the capped price, typically 30 points

Answer 431

The price at which one country's currency can be exchanged for another country's currency. The exchange rate for most developed countries is floating where the rate is not fixed but changes relative to other currenciesFactors that may affect the exchange rate include:Demand for goods or raw materialsBalance of paymentsAffluence of the populationAmount of foreign investmentMonetary and fiscal policyDirect government interventionPolitical atmospherePolitical stability * Trade embargoes

Answer 432

Foreign exchange rates are the price at which one country's currency can be exchanged for another's. They may be quoted in U.S. terms, which express how much of a foreign currency is required to purchase one U.S. dollar. Or they may be quoted in European terms which express how many U.S. dollars are required to purchase one unit of foreign currencyFor example, if it takes 0.80 Euros to purchase one dollar, the foreign exchange rate in U.S. terms is 0.80 (0.80 Euros divided by 1.00 U.S. dollar). The foreign exchange rate in European terms is 1.25 (1.00 U.S. dollar divided by 0.80 Euros)

Answer 433

Foreign currencies are traded between commercial banks in the Interbank Market where exchange rates are subsequently established. Trading is generally for the banks' own accounts but may also be for other banks or commercial customersInterbank Market transactions are most commonly either spot transactions or forward transactions. The rate for these transactions is established upon agreement between the buyer and the seller on the trade date.Spot Transactions - Settle two business days after the trade date. Most transactions are spot transactionsForward Transactions - Settlement more than two business days after the trade date, typically stated in months. The settlement date is established upon agreement by the buyer and seller. The settlement date for forward transactions are in 1, 3, 6, 9, or 12 month intervals

Answer 434

PHLX World Currency Options are traded on the Philadelphia Stock Exchange (PHLX) and are traded in the following six currencies:Australian dollarBritish poundCanadian dollarEuroJapanese yen * Swiss francPHLX World Currency Options are quoted in European terms and are settled in U.S. dollars in order to avoid delivery or receipt of a foreign currency. Options are under European exercise (i.e., may only be exercised during specific periods)Hours of trading are between 9:00 AM and 4:00 PM Eastern Time

Answer 435

Foreign currency options expire in cycles. At any given time, there will be options with expiration dates in March, June, September and December. At the beginning of the month following each of these months (i.e., April, July, October and January), three additional option contracts are introduced with one-month, two-month and three-month expirations. In this way there will always be options expiring in the current month, the following month and the month after (1, 2 and 3 month expirations) and there will always be options expiring in March, June, September and December)Option contracts expire 11:59 PM Eastern Time on the Saturday following the third Friday of the expiration month

Answer 436

The following currencies are:Australian dollar (XDA): 10,000 units/contractBritish pound (XDB): 10,000 units/contractCanadian dollar (XDC): 10,000 units/contractEuro (XDE): 10,000 units/contractJapanese yen (XDN): 1,000,000 units/contract * Swiss franc (XDS): 10,000 units/contractThe strike price of all currencies are quoted in cents per unit, except the Japanese yen which is quoted in hundredths of cents per unit. Therefore, the calculations for strike price and premiums for XDA March 150 call @ $2.50 are as follows:At 10,000 units/contract where each contract point is equal to $100 * Strike Price = 150 x .01 = $1.50 USD/Australian dollar * Premium = $2.50 x 100 = $250 USDAggregate Exercise Price = 10,000 units x $1.50 = $15,000 USDThe calculations for strike price and premiums for XDN March 150 call @ $2.50 are as follows:At 1,000,000 units/contract where each contract point is equal to $100 * Strike Price = 150 x .0001 = $0.0150 USD/Japanese yen * Premium = $2.50 x 100 = $250Aggregate Exercise Price = 1,000,000 units x $.0150 = $15,000

Answer 437

A foreign currency call option is where the buyer of the option pays a premium in exchange for the option to purchase a U.S. dollar equivalent of the underlying foreign currency at the strike price at a specified period before the expiration date. The seller is obligated to sell at the strike price if the buyer exercises the option. If the currency increases the buyer will be able to buy at the lower strike priceMaximum potential gain: Unlimited * Maximum potential loss: Premium

Answer 438

A foreign currency put option is where the buyer of the option pays a premium in exchange for the option to sell a U.S. dollar equivalent of the underlying foreign currency at the strike price at a specified period before the expiration date. The seller is obligated to buy at the strike price if the buyer exercises the option. If the currency decreases the buyer will be able to sell at the higher strike priceMaximum potential gain:Strike Price× No. of Units of Foreign Currency * Maximum potential loss: Premium

Answer 439

Foreign currency options may be used to reduce the risk of currency movements. For example, if an investor wishes to buy a foreign currency in the future, they may purchase a foreign currency call option to lock in the current cost in U.S. dollars for the foreign currency. The call option reduces the risk of increased costs due to an increase in the currency. If an investor wishes to sell a foreign currency in the future, they could purchase a put option to lock in their cost. The put option reduces the risk of decreased value due to a decrease in the currencyForeign currency options are also used for speculating in the movement of exchange rates. Options have the potential of large profits but losses would be limited to the premiums initially paid for the options

Answer 440

Options may be purchased over-the-counter or on the following exchanges:Chicago Board Options Exchange (CBOE)American Stock Exchange (AMEX)Philadelphia Stock Exchange (PHLX)Pacific Coast Exchange (PCSE) * International Securities Exchange (ISE)

Answer 441

Options that are listed on an exchange. Listed options have standardized contract terms

Answer 442

The OCC issues and guarantees all listed options and acts as the counterparty in all transactions. Rather than transacting directly with each other broker-dealers are required to settle listed options transactions directly with the OCC within one business day and the OCC will credit the other broker-dealer the following business day. The OCC is owned by the exchanges that list options and is regulated by the SEC

Answer 443

Options have strike prices above and below the current market price. New option contracts are created when the current market price fluctuates at the following fixed intervals:2.50-point intervals for securities with a market price of below $25 or below5-point intervals for securities with a market price between $25 and $20010-point intervals for securities with a market price above $200 * Variable intervals if required to increase liquidity

Answer 444

The expiration date is the date that the option expires. However, the exercise cut-off is the date that the exercise must be initiated in order to be able to exercise the option. Trading of the option may end before the exercise cut-offTrading cut-off: 4:00 PM Eastern Time (ET) on the business day prior to the expiration dateExercise cut-off: 5:30 PM ET on the business day prior to the expiration date * Expiration date: 11:59PM ET on the Saturday following the third Friday of the expiration month

Answer 445

The expiration date is the date that the option expires. However, the exercise cut-off is the date that the exercise must be initiated in order to be able to exercise the option. Trading of the option may end before the exercise cut-off * Trading cut-off: 4:00 PM ET for narrow-based index options and 4:15 PM ET for broad-based index options on the business day prior to the expiration date. * Exercise cut-off: 5:30 PM ET on the business day prior to the expiration date * Expiration date: 11:59PM ET on the Saturday following the third Friday of the expiration month

Answer 446

The expiration date is the date that the option expires. However, the exercise cut-off is the date that the exercise must be initiated in order to be able to exercise the option. Trading of the option may end before the exercise cut-offTrading cut-off: 4:00 PM ET on the business day prior to the expiration dateExercise cut-off: 5:30 PM ET on the business day prior to the expiration date * Expiration date: 11:59PM ET on the Saturday following the third Friday of the expiration month

Answer 447

The expiration date is the date that the option expires. However, the exercise cut-off is the date that the exercise must be initiated in order to be able to exercise the option. Trading of the option may end before the exercise cut-offDebt Options * Trading cut-off: 1 business day prior to the expiration date * Exercise cut-off: 1 business day prior to the expiration dateExpiration date: 11:59PM ET on the Saturday following the third Friday of the expiration month * T-bill options expire March, June, September and December

Answer 448

Option owners of listed options are required to notify the member firm of their intention to exercise the contract by certain cut-off times (generally, 5:30 PM ET on the business day prior to the expiration date). Exceptions are only granted due to errors or extraordinary situations where the customer was unable to communicate with the member firm in a timely mannerAfter receiving exercise notification from the customer the member firm must then relay the exercise notice to the OCC and may do so up until expiration

Answer 449

Equity options with longer expirations of up to 39 months. Underlying securities examples include Microsoft and General Electric. Advantages of a LEAP include:Time value is not lost as quickly as options with shorter expirationsLonger term protection * Longer time to speculate on price movementsContract terms:Each option is sold in round lots of 100 sharesAmerican style exerciseSettlement the next business dayExpires in January, on the Saturday following the third Friday of the monthNew options are created once per year, one with a strike price at the market price, one with a strike price above the market price, and another with a strike price below the market price * Premiums are quoted in full points and decimals

Answer 450

The CBOE uses the market maker systemMarket makers act as principals and buy and sell options for their own accounts. Each underlying security has several market makersBoard brokers act as agents for other brokers for a specific class of options. The board broker executes orders for other members and keeps a written record of all orders that they receive. Order Book Officials (OBO) who are employees of the exchange may sometimes assist board brokers with the public customer limit order book by executing and maintaining written records of these ordersFloor brokers bring orders to the appropriate trading post and act as an agent for other members and for the public

Answer 451

At the member firm's office orders are submitted electronically or via telephone to the exchange floorThe order is then executed. The highest bid price and lowest offer price have the highest order priority. If trading for the underlying security is halted trading for all options with that security is also haltedOnce the trade is executed the order is submitted to the OCCThe trade must be settled with the OCC by 10:00 AM ET on the business day following the execution date * The OCC will credit the other party the next business day

Answer 452

An order ticket is a written record of the instructions for executing an order and how the order was handled. The order ticket must include:Buy or sellIf the order is a call or a putIf the order is to open or close the transactionThe purpose of the order such as * To create or increase a long position (when opening a purchase) * To create or increase a short position (when opening a sale) * To terminate or decrease a short position (when closing a purchase)To terminate or decrease a long position (when closing a sale)Number of option contractsName of the underlying securityExpiration dateStrike price * Terms and conditions (e.g., market, stop, limit)

Answer 453

The customer must notify the member firm of their intention to exercise the option by the cut-off time (5:30 PM ET the business day prior to the expiration date)[Note: Options that are in-the-money by at least one cent will automatically be exercised by the OCC]The member firm may relay the exercise notice to the OCC up until expirationThe OCC randomly assigns the exercise notice to a member firm with a corresponding short optionThe member firm determines which client should receive the exercise notice in a fair and equitable way such as by random or on a first-in/first-out basisThe member firm notifies the client * If a stock is purchased or sold as a result of the exercise, settlement occurs three business days following the execution date

Answer 454

Even Stock Split:Number of shares of underlying stock increases => Number of option contracts increases by the same amount[Example: A 2 for 1 split would increase 1 contract to 2 contracts.]Market price of underlying stock decreases => Strike price decreases by the same amount[Example: A $20 strike price would decrease to $10.]Even Reverse Stock Split:Number of shares of underlying stock decreases => Number of option contracts decrease by the same amountMarket price of underlying stock increases => Strike price increases by the same amount

Answer 455

Odd Stock Split:Number of shares of underlying stock increases => Number of shares per contract increases by the same amount[Example: A 3 for 2 split would increase 100 roundlot shares per contract to 150 shares per contract (100 x 3/2).]Market price of underlying stock decreases => Strike price decreases by the same amount[Example: A $20 strike price would decrease to $13.33 ($20 x 2/3).]Reverse stock split:Number of shares of underlying stock decreases => Number of shares per contract decreases by the same amountMarket price of underlying stock increases => Strike price increases by the same amount

Answer 456

Stock Dividend:Number of shares of underlying stock increases by the stock dividend rate => Number of shares per option contract increases by the same rate[Example: A 10%; stock dividend would increase the shares per contract from 100 roundlot shares to 110 shares per contract]Market price of underlying stock decreases => Strike price decreases by the same amount (Aggregate Strike Price / Adjusted # of Option Contracts)[Example: If the strike price is $20, the new strike price = 100 roundlot shares x $20 / 110 contracts = $18.18]

Answer 457

Cash dividends belong to the owner of the stock. If a call option is exercised before the ex-dividend date, the owner of the call will have exercised their right to purchase the underlying security and will therefore receive the dividend. If a put option is exercised after the ex-dividend date the owner of the put will have sold the underlying security after the ex-dividend date. Since they retained ownership of the underlying security they will receive the dividendThe number of contracts and the strike price do not change when there is a cash dividend

Answer 458

A large portfolio of several individual investment positions that is professionally managed. Allows investors to purchase a single product that provides a mix of several individual positions. Many packaged products are in the form of investment companies and are regulated by The Investment Company Act of 1940May be used to diversify investments with a small initial investment amount or to purchase a small amount of securities that are only available in large volume. Also used by small investors who would benefit from professional management of their holdings but cannot afford a personal investment manager. Investment companies may also provide beneficial services to investors such as monthly automatic investing from a checking account, regular performance reports, annual tax reports, etc.

Answer 459

Management Company * Mutual FundsClosed-end fundsUnit Investment Trust (UIT) * Face-Amount Certificate Company

Answer 460

Issues shares of a professionally managed portfolio of individual investment positions. Management companies may be:Open-end (Mutual Funds) - Issues continuous primary offerings. All shares issued are new shares, purchased at the public offering price (POP) and all shares redeemed are destroyed. No secondary market exists for the shares. Shares are continuously redeemable and may be redeemed at any point for the net asset value (NAV) of the underlying positions. Shares may only be common sharesClosed-end - Issues a one-time public offering of non-redeemable shares. The number of shares is fixed. Shares are purchased and sold in the secondary market by paying a commission, markup or markdown. The value of the shares are determined by the market. Shares may be common, preferred or bonds

Answer 461

Issues securities that represent partial ownership of a fixed, unmanaged portfolio of individual investment positions. Investors receive their partial share of net income received from underlying positions. UITs are generally used as dividend income and/or capital appreciationEach "unit" is sold by a broker-dealer at an offering price of $1,000. The $1,000 includes a sales charge (e.g., a 5%; sales charge would be 5%; x $1,000 = $50, and the net investment would be $950). The units are redeemable at a specific maturity date. The redemption value is based on the net asset value (NAV) of the underlying securitiesThe portfolio is usually fixed for the duration of the UIT. No management fees are assessed for UITs

Answer 462

Issues debt certificates purchased in either periodic installments or lump-sum payments. Interest rates are predetermined. Certificates may be redeemed at the maturity date for a specific amount or prior to the maturity date for the surrender valueFace-amount certificate companies are relatively rare

Answer 463

Management companies may be diversified or non-diversified. Diversified management companies must meet the following qualifications at the inception of the portfolio as stipulated by the Investment Company Act of 1940:75%; or more of assets must be invested5%; or less of invested assets may be invested in one company * 10%; or less of voting stock for one company may be owned by the investment companyThe investment company will retain diversified status even if it no longer meets these qualifications due to subsequent changes in the market

Answer 464

Growth - Common stocks * Conservative - Large-cap stocksAggressive - Small/Mid-cap stocksGrowth & Income - StocksEquity Income - Common/preferred stocksBond funds - Fixed-income securities * U.S. government funds - Treasury securities * Municipal bond funds - Municipal securities * Mortgage-backed funds - Mortgage-backed securities * Corporate bond funds - Investment-grade corporate bondsHigh-yield funds - Junk bondsBalanced funds - Part stocks, part bonds, and part cash equivalentsAsset allocation funds - Stocks, bonds, and/or cash equivalentsIndex funds - Mirrors a specific indexSpecialized/Sector funds - Securities of one region or industryInternational funds - Foreign securitiesEmerging market funds - Securities of emerging market nations * Money-market funds - Cash equivalents

Answer 465

Objective: Capital appreciationRisk profile: Higher risk, higher returns potentialTime horizon: Long-term * Investments: Common stocks (blue-chips, large-cap, etc.)

Answer 466

Objective: Capital appreciationRisk profile: Very high risk, very high return potentialTime horizon: Long-term * Investments: Common stocks (mid-cap, small-cap, IPOs, etc.)

Answer 467

Objective: Capital appreciation and current incomeRisk profile: Moderate risk, moderate returns potential, moderate dividendsTime horizon: Medium-term * Investments: Stocks (potential growth and dividends that are in between growth funds and equity income funds)

Answer 468

* Objective: Current income * Risk profile: Lower risk, lower returns potential, high dividends * Time horizon: Medium-term * Investments: Common and preferred stocks (lower risk mature companies with limited growth potential and high dividends)

Answer 469

Objective: Current income and preservation of capitalRisk profile: Low risk, low returns potential, interest incomeTime horizon: Varies * Investments: Debt securities (Treasury securities, municipal bonds, mortgage-backed securities, corporate bonds, etc.)

Answer 470

Objective: Mirrors the investment objective of the specified indexRisk profile: Mirrors the risk profile of the specified indexTime horizon: Mirrors the time horizon of the specified index * Investments: Mirrors the specified index (S&P 500 index, DJIA index, Russell 2000 index, etc.)Because index funds are passively managed they have lower fees than funds that are actively managed

Answer 471

Objective: A balance of objectivesRisk profile: A balance between risk, return, and incomeTime horizon: Medium-term * Investments: A balance of common/preferred stocks, bonds, and cash equivalents (at least some of each)

Answer 472

Objective: VariesRisk profile: VariesTime horizon: Varies * Investments: Common stocks, bonds, and cash equivalents (a mix of some or none of each depending on market conditions, typically determined by computer models)

Answer 473

Objective: SpeculationRisk profile: Very high risk, very high returns potentialTime horizon: Varies * Investments: Securities of one region or industry (biotechnology, etc.)

Answer 474

Objective: VariesRisk profile: Higher risk, higher returns potentialTime horizon: Varies * Investments: Non-U.S. securities (Latin America, Europe, Japan, etc.)

Answer 475

Objective: Capital appreciationRisk profile: Very high risk, very high returns potentialTime horizon: Varies * Investments: Securities of less developed countries

Answer 476

Objective: Liquidity and preservation of capitalRisk profile: Low risk, low returns potential, interest incomeTime horizon: Short-term * Investments: Cash equivalents