Series 65 w2 Flashcards

Question

What are 3 types of secured bonds?

Answer 1

1. Mortgage bonds - use real estate for collateral 2. Equipment trust certificates - backed by pledge of large equipment that corporation owns. 3. Collateral trust certificates - backed by pledge of either securities that issuer has purchased for investment purposes or backed by shares of wholly owned subsidiary (both stocks and bonds are acceptable forms of collateral as long as another issue has issued them.

Answer 2

An unsecured bond has no specific asset pledged as collateral for the loan; only backed by good faith and credit of the issuer. Known as debentures. Treated like a general creditor (in event of default).

Answer 3

1. Subordinated debentures - unsecured loan to the issuer that has a junior claim on the issuer in the event of default relative to the straight debenture. Should the issuer default, the holders of the debentures and other general creditors will be paid before the holders of the subordinate debentures will be paid anything. 2. Income/adjustment bonds - Corporations usually in severe financial difficulty, issue income or adjustment bonds. The bond is unsecured and the investor is only promised to be paid interest if the corporation has enough income to do so. Because of large risk, interest rate is very high and bonds are issued at a deep discount to par. An income bond is never appropriate recommendation for an investor seeking income or safety of principle. 3. Zero-coupon bonds - Bonds that pay no semiannual interest. Issued at deep discount from par value and appreciates up to par at maturity. This appreciation represents the investor's interest for purchasing the bond. Corporations, US government and municipalities all issue zero-coupon bonds to finance their activities. The annual appreciation of the bond is subject to federal income tax (which is known as phantom income).

Answer 4

Bond whose interest and principal payments are guaranteed by a third party such as a parent company. The higher the credit rating of the company who is guaranteeing the bonds, the better the guarantee.

Answer 5

Corporate bonds that may be converted or exchanged for common shares of the corporation at a predetermined price known as the conversion price. Because the bond is convertible, it usually will pay a lower rate of interest than nonconvertible bonds. An investor in this bond maintains senior position as creditor while enjoying the potential for capital appreciation.

Answer 6

Par value/conversion price = Number of shares | Ex: Bonds are convertible into XYZ stock at $25/share, how many shares upon conversion? $1000/$25 = 40 shares

Answer 7

Stock's parity price determines the value at which the stock must be priced in order for the value of the common stock to be equal to the value of the bond that the investor already owns. "Value of stock upon conversion must be equal, or at parity with, the value of the bond" Determining parity price - 2 steps 1. Determine number of shares (par value/conversion price) 2. Calculate price of each share at parity price (Parity price = Current market value of the convertible bond/Number of shares to be received Ex: conversion price $25/share and convertible bond quotes at 120 Parity price = $1200/40 = $30 (price stock needs to be in order to be equal.

Answer 8

Advantages: 1. Makes the issue more marketable 2. Can offer a lower interest rate 3. If the bonds are converted, the debt obligation is eliminated 4. The issuance of the convertible bonds does not immediately dilute ownership or earnings per share Disadvantages: 1. Reduced leverage upon conversion 2. Conversion causes the loss of tax-deductible interest payments 3. Conversion diluted shareholder's equity 4. Conversion by a large holder may shift control of the company

Answer 9

Conversion price of the bond will be adjusted accordingly. Trust indenture of a convertible bond will state the maximum number of shares that the corporation may issue while the bonds are outstanding, as well as the minimum price at which additional shares may be issued.

Answer 10

Trust indenture is a contract between issuer and the trustee. States that corporate bond issues in excess of $5M that are to be repaid during a term in excess of 1 year need to issue a trust indenture for the issue. This act only applies to corporate issuers, both federal and municipal issuers are exempt. Trustee acts on behalf of all the bondholders and ensures that issuer is in compliance with all of the promises and covenants made to the bond holders (Trustee is appointed by the corporation and is usually a bank or trust company).

Answer 11

Corporate bonds may be issued with either an open-end or closed-end indenture. Bonds issued with open end indenture - allow corporation to issue additional bonds secured by the same collateral and whose claim on the collateral is equal to the original price. Closed end indenture - does not allow additional bonds having equal claim on the collateral; if corporation wants to issue new bonds, their claim must be subordinate to claim of the original issue or secured by other collateral.

Answer 12

Rating agencies must look at many factors when assigning a rating to a debt issue: 1. Cash flow 2. Total amount and type of debt outstanding 3. Ability to meet interest and principal payments 4. Collateral 5. Industry and economic trends 6. Management S&P and Mood's are the two biggest rating agencies (in order to have debt rated, issuer must request it and pay for the service)

Answer 13

Debt securities that base a maturity payment in the performance of an underlying security or group of securities such as an index. These do not make coupon or interest payments. These may be purchased and sold at any time during the trading day and may be purchased on margin and sold short. Sometimes called equity-linked notes or index-linked notes. Risk factor: ETNs are unsecured and carry the credit risk of the issuing bank or broker dealer.

Answer 14

Guarantee return of investor principal if note is held until maturity, these carry guarantee that is only as good as issuer's credit rating and therefore are never 100% guaranteed (type of ETN).

Answer 15

Eurobond = bond issued in domestic currency of the issuer but sold outside of the issuer's country Eurodollar = bond issued by a foreign issuer denominated in US dollars and sold to investors outside of the US and outside of issuer's country Yankee bond = similar to Eurodollar bond except these are dollar denominated bonds issued by a foreign issuer and sold to US investors

Answer 16

1. Auction rate securities - long term securities that are traded as short-term securities; interest rate paid wil be reset at regularly scheduled auctions for the securities every 7, 28, or 35 days 2. Variable Rate Demand Obligations (VRDO) - have interest rate reset at set intervals daily, weekly, or monthly. Interest rate is set by dealer to rate that will allow instruments to be priced at par; investors may elect to put securities back to issuer on reset date.

Answer 17

Debt securities or as preferred stock offerings

Answer 18

Retiring corporate bonds: 1. Redemption - bonds are redeemed upon maturity and principal amount is repaid to investors (also receive last semi-annual interest payment) 2. Re-funding - Many times corporations will use sale of new bonds to pay off the principal of outstanding bonds (known as refunding corporate debt 3. Prerefunding - Proceeds from the new issue of bonds are placed in an escrow account and invested in government securities. Interest generated in escrow account is used to pay the debt service of the outstanding or prerefunded issue. One the issue has been prerefunded, the issuer's obligation under the indenture are terminated (this is known as defeasance) 4. Exercise of a call feature by the company - call feature gives corporation ability to manage the amount of debt outstanding as well as take advantage of favorable interest rate environments. Most bonds are not callable in the first several years after issuance (call protection. 5. Exercise of a put feature by the investor - under a put option, holder of the bonds may tender the bonds to the company for redemption. Some put features will allow bond holders to put he bonds to the company for redemption if their rating falls too low or if interest rates rise significantly. 6. Tender offering - company may make a tender offer in effort to reduce its outstanding debt or to take advantage of low interest rates; companies usually will off a premium for the bonds in order to make the offer attractive to bond holders 7. Open market purchase - in effort to reduce amount of outstanding debt, may simply repurchase bonds in the marketplace

Answer 19

State and local governments will issue municipal bonds in order to help local governments meet their financial needs. Most municipal bonds are considered to be almost as safe as treasury securities by the federal gvmt. However, unlike the federal gvmt, from time to time an issuer of municipal security does default. Degree of safety varies from state to state and from municipality to municipality.

Answer 20

1. States 2. Territorial possessions of the US, such as Puerto Rico 3. Legally constituted taxing authorities and their agencies 4. Public authorities that supervise ports and mass transit.

Answer 21

1. General obligation bond (GOs) 2. Revenue bonds 3. Industrial development bonds/Industrial revenue bonds 4. Lease rental bonds 5. Special tax bonds 6. Special assessment bonds 7. Double-barreled bonds 8. Moral obligation bonds 9. New housing authority/Public housing authority (NHA/PHA) 10. Short term municipal financing

Answer 22

Bonds that are backed by full faith and credit of the issuer and by their ability to raise and levy taxes. Also called full faith and credit bonds. In essence, tax revenues back the bonds. Usually fund projects that benefit entire community. GO bonds that have been issued by state are backed by income and sales tax while GOs that have been issued by local governments or municipalities by property tax.

Answer 23

Voter approval - GO bonds are a drain on tax revenue of state or municipality that issues them; amount of GO bonds that may be issued must be within certain debt limits and requires voter approval. The maximum amount of GO debt that may be issued is known as statutory debt limit.

Answer 24

Based on the assessed value of the property, not on its actual market value; homeowner will have to pay assessment rate at certain percentage determined by town (Ex: 75% assessment rate of $100K is $75K).

Answer 25

Overlapping debt is when taxpayers are subject ot the taxing authority of various municipal authorities that draws revenue from same base of taxpayers. Also called coterminous debt.

Answer 26

A revenue bond is a municipal bond that has been issued to finance a revenue-producing project such as a toll bridge. Proceeds from issuance of the bond will construct or repair the facility and the debt payments will be supported by revenue generated by the facility. Municipal revenue bonds are exempt from the Trust Indenture Act of 1939, but all revenue bonds must have indenture that spells out 1. Rate covenant 2. Maintenance covenant 3. Additional bond test 4. Catastrophe clause 5. Call or put features 6. Flow of funds 7. Outside audit 8. Insurance covenant 9. Sinking fund

Answer 27

Municipal bonds issued for benefit of a private corporation - proceeds will go toward purchasing equipment of building a facility for the corporation. The facility or equipment then will be leased to corporation and lease payments will support debt service of the bonds. Interest earned may be subject to investor's alternative minimum tax. States are limited to the amount of industrial revenue bonds that may be issued based on population of the state.

Answer 28

Lease back arrangement is created when a municipality issues a municipal bond to build a facility for an authority of agency such as a school district.

Answer 29

A bond issued to meet a specific goal; bond's debt service is paid only by revenue generated from specific taxes. These are revenue bonds, not general obligation bonds; most supported by "sin" taxes such as taxes on alcohol, tobacco, etc.

Answer 30

These will be issued in order to finance a project that benefits a specific geographic area or portion of a municipality (Ex. Sidewalks and reservoirs). Homeowners in the area that benefit will be subject to a special tax assessment, the assessment will be then used to support the debt service of the bonds.

Answer 31

Issued to build or maintain a revenue-producing facility such as a park that charges an entrance fee. If revenue generated is insufficient, state legislature may vote to allocate tax revenue to cover the shortfall. It doesn't require that state cover shortfall, but gives option to. Reasons why a state may cover shortfall: 1. Keep a high credit rating on all municipal issues 2. Ensure that interest rates on their municipal issues do not rise

Answer 32

Bonds issued to build low income housing. Government will cover any shortfall. Because guaranteed by the federal gvmt, these are considered safest type of municipal bond. Not considered double-barreled bonds because any shortfall will be covered by the federal gvmt, not the state or municipal gvmt.

Answer 33

Bonds that have been issued to build or maintain a revenue-producing facility such as a bridge or a roadway. Initial debt service is supported by use fees generated by facility, however if revenue is not enough, payments will be supported by general tax revenue of state or municipality. Rated and traded like GO bonds

Answer 34

1. Sell short term notes and tax exempt commercial paper. Short term notes are sold in anticipation of receiving other revenue and are issued an MIG rating (1-4) by Moody's investor service. The types of short term notes a state of municipality may issue are: 1. Tax anticipation notes (TANs) 2. Revenue anticipation notes (RANs) 3. Bond anticipation notes (BANs) 4. Tax and revenue anticipation notes (TRANs) Municipal tax-exempt commercial paper matures in 270 days or less and will usually be backed by a line of credit at a bank.

Answer 35

(100%-investor's tax bracket)

Answer 36

The rate at which a corporate bond yield makes more financial sense than a bond offering a tax break Tax equivalent yield = Rate/Tax free yield Ex: 7% coupon rate and 30% tax bracket 7%/(100-30%) = 7%/.7 = 10% (corporate bond yield should be >10% otherwise municipal bond has better return)

Answer 37

Municipal bonds that have been issued by a territory such as Puerto Rico or Guam are given tax-free status for interest payments from federal, state and local income taxes.

Answer 38

Purchasers in OID bonds as well as those that have been purchased in the secondary market are required to accrete the discount over the number of years remaining to maturity. That is to say the investor must step up their cost by the annualized discount each year. Annualized discount = Total discount/No. of years to maturity (Ex: $100/10 years = $10 year; Investor who bought $900 with 10 years remaining that sold the bond at year 3 at $925 would have a loss of $5 because cost base would be $930) If sold as profit, capital gain is taxable as ordinary income for the investor.

Answer 39

Investors who purchase municipal bonds at a premium are required to amortize the premium over the number of years remaining to maturity. Annualized premium = Total premium/No. of years to maturity (Ex: $100/10 years = $10/year; Investor who buys $1100 with 10 years and in year 3 sold bond at $1075 would have again of $5 because cost base is $1070)

Answer 40

If an investor wishes to sell a bond at a loss for tax purposes, loss will be realized when bond is sold, but can't repurchase bond that is the same for 30 days after sale is made. New bond must have new issuer, coupon, or maturity which creates a bond swap and not a wash sale. Wash sale would result in loss being disallowed by IRS whereas bond swap is OK.

Answer 41

It varies from issuer to issuer, investors need to be able to mine the risk of particular issuer or particular bond.

Answer 42

Quality of GO bond is largely determined by financial health of issuing state or municipality. Since it is supported through tax revenue received by issuer, therefore risk depends on ability of issuer to levy and collect tax revenue which varies from state to state and municipality to municipality. Should read a state or municipality report before purchasing these bonds.

Answer 43

In normal interest rate environments, longer term bonds will pay investors a higher interest rate than short term bonds of equal quality. Bond's duration (stated in years) is a measure of the bond's price sensitivity to a small change in interest rates.

Answer 44

Longer term bonds with low coupons will generally have higher duration than shorter term or higher yielding bonds (the higher the bond's duration, the greater the bond's interset rate risk and greater its volatility).

Answer 45

Modified duration - assumes a change in interest rate will not affect bond's expected cash flow Effective or Call-adjusted duration - change in interest rates may affect the bond's cash flow if the bonds are callable or have other options for early retirement - this is always lower than duration to maturity.

Answer 46

Bond price change percentage = Duration x (change in yield in basis points/100) Bond portfolio with average duration of 7 years and interest rates rise 1% (or 100 basis points), portfolio manager can expect price of bonds to fall by 7%.

Answer 47

Measures bond's price volatility to large changes in interest rate. Bond prices tend to increase in price more and faster when interest rates fall than they would fall in price and slower if interest rates were to rise in a similar amount. Bonds that react in this way are thought to have positive convexity.

Answer 48

Mortgage backed and callable bonds (as interest rates increase both mortgage prepayments and likelihood the bonds will be called increase).

Answer 49

Convexity is better risk management tool than duration in volatile interest rate environment or when interest rates are low. Also convexity is only important when companies two investments with similar durations.

Answer 50

1. Coupon return - total of all interest payments received by portfolio plus accrued interest earned during a specific holding period (most important for 2-10 year term holding periods) 2. Reinvestment return - total interest earned from the reinvestment is in payments during a specific holding period (most important for long term and 2-10 year holding periods). 3. Price return - the total of the portfolio's appreciation or depreciation during a specific holding period (most important for short term holding periods).

Answer 51

Debt | Default risk

Answer 52

Risk that issuer will not be able to meet its obligations under the terms of the bond in a timely fashion. Also known as credit risk

Answer 53

1 month to 30 years

Answer 54

Treasury Department (These are legally binding obligation of the federal government)

Answer 55

Federal. | State and local governments do not tax the interest income.

Answer 56

Typically purchased directly from US government at discount from face value (typically 50%). Investor may elect to roll the matured Series EE bonds into Series HH bonds and continue to defer taxes. Interest: These pay no semiannual interest and may be redeemed at maturity for face value. Taxed: Interest earned through appreciation is taxable by the federal government and the investor may pay taxes on this money each year or may wait until the bond matures. Also called Savings bonds

Answer 57

Only can be purchased by trading in matured Series EE bonds. Interest: These pay semiannual interest Redeemed: Series HH bonds may be redeemed at their face value at any time. Denominations: $500-$10K and mature in 10 years.

Answer 58

Treasury bills, notes, and bonds

Answer 59

Issued: Issued at a discount from par, bill appreciates up to par at maturity and the appreciation represents the investors interest Maturity: Treasury bills range in maturity from 4-52 weeks Bought: They are auctioned off by the Treasury Department through a weekly competitive auction. (Large banks and broker deals, known as primary dealers, submit competitive bids or tenders for the bills being sold). Treasury awards to the highest bidders and works the way down to lower bidders until all of the bills are sold. Interest: Pay no semiannual interest Denominations: $100 to $1M

Answer 60

All noncompetitive tenders (agreeing to accept average of all yields accepted by the Treasury) area ccepted before competitive tenders (these are limited to a max amount of $500K)

Answer 61

Federal funds

Answer 62

A quote for Treasury bill appears higher than offer but bills are quoted on a discounted yield basis, therefore higher bid actually represents a lower dollar price than the offer.

Answer 63

US government's intermediate-term security and range in term from 1-10 years; These are auctioned off by the Treasury every 4 weeks Interest: These pay semi-annual interest Denominations: $100-$1M If Treasury note is refunded, the government will offer the investor a new Treasury note with a new interest rate and maturity. The investor may always elect to receive their principal payment instead of accepting a new note.

Answer 64

US government long term bonds Maturity: Range from 10-30 years Interest: Pay semi-annual interest and are issued in denominations form $100-$1M Some Treasury bonds may be called in at par by the treasury. If the Treasury Department calls in a bond issue, they must give holders 4 months notice before calling the bonds.

Answer 65

Quoted as a percentage of par down to 32nds of 1% (Number after decimal points represent 32nds of a percent) Ex: Treasury bond quote of 92.02 translates into 92 2/32% x $1000 = $920.625

Answer 66

Stands for "Separate trading of registered interest and principal securities"; Separated into 2 parts: a principal payment and semiannual interest payment. A Treasury STRIP is a zero-coupon bond that is backed by US gvmt securities. An investor can purchase the principal payment component of $1000 due on a future date at a discount. An investor seeking some current income may wish to purchase the semi-annual coupon payments due over the term in the Treasury securities. A STRIP may be purchased by an investor who needs a certain amount available on a known date in the future. By purchasing the STRIP, the investor will be guaranteed to have $1000 on that date in the future for each STRIP purchased.

Answer 67

Similar to Treasury STRIPs, except that broker dealers and banks create them. Broker dealers and banks will purchase large amounts of Treasury securities, place them in a trust, and sell off the interest and principal payments to different investors.

Answer 68

``` Treasury Inflation Protected Securities - offer investor protection against inflation. Offered at fixed interest rate and principal amount is adjusted semiannually to reflect consumer price index. During times of inflation, principal amount of TIPS will be increased and investor's interest payments will rise, while during times of alling prices, the principal amount of bond will be adjusted down and investor will receive a lower interest payment. Adjusted principal = principal x 1/2 of inflation rate (because of semi-annual payment); then coupon rate is taken on this number Compounded interest (shortcut) = Take inflation rate over time and multiply it by principal, round up to answer (should be within $5) ```

Answer 69

Federal government has authorized certain agencies to issue debt securities Revenues generated through taxes, fees, and interest income back these agency securities. Interest: Usually offer interest rates between treasury securities and corporate securities Quoted: Quoted on a percentage of par just like corporate issue.

Answer 70

"Government National Mortgage Association" - often referred to as Ginnie Mae Wholly owned government corporation that is the only agency who securities are backed by full faith of US government Purpose is to provide liquidity to the mortgage market. Ginnie Mae buys up pools of morgages from Federal Housing Association (FHA) and VA (Veteran's Association) and sells off pools to private investors in form of pass-through certificates. Interest: Receive monthly interest and principal payments based on their investment. Risk: Only real risk is risk of early refinancing. Taxable: Interest is taxable at all levels. Denomination - minimum of $1000 Yield quotes: Based on 12-year prepayment assumption because most mortgages are repaid early as a result of refinancing, moving or a homeowner paying off mortgage.

Answer 71

Public For-profit corporation that stock trades publicly and is in business to realize a profit by providing mortgage capital. Also known as Fannie Mae. Fannie Mae purchases mortgages and in turn packages them to create mortgage backed securities Called an agency security because Fannie Mae has a credit facility with the government and receives certain favorable tax considerations Denominations: Issued from $5000 to $1M Interest: Pay interest semiannually Taxable at all levels Fannie Mae also issues debentures with a minimum denomination of $10K that mature in 3-25 years. Interest and tax is same.

Answer 72

Also known as Freddie Mac Publicly traded company in business to earn profit on its loans. Purchases residential mortgages from lenders and, in turn, package them into pool and sells off interest in those pools to investors. Interest earned from investors from FHLMC-issued securities is taxable at all levels: federal, state and local

Answer 73

Group of privately owned lenders that provide different types of financing for farmers. FFCS sells off far credit securities in order to obtain the funds to provide to the farmers. Securities are the obligations of all the lenders in the system and are not backed by the US govenment. Interest: Securities pay interest every 6 months and are only available in book-entry form. Several lenders: 1. Federal Land Bank provides mortgage money 2. Bank of the Cooperatives provides money for fees and grain 3. Federal Intermediate Credit Bank provides money for tractors and equipment

Answer 74

Collateralized Mortgage Obligation - mortgage backed security issued by private finance companies, as well as FHLMC and FNMA. The securities are structured much like a pass-through certificate and their term is set into different maturity schedules known as tranches. Pools of mortgages on one family to four-family homes collateralize CMOs. Risk: Because CMOs are backed by mortgages on real estate, they are considered relatively safe investments and are given an AAA rating. Only real risk is risk of early refinance. Payments: CMOs pay interest and principal monthly. However they pay the principal to only one tranche at a time in $1000 payments. The CMO pays off each tranche until final tranche known as a "Z tranche" is paid off - this is most volatile CMO tranche.

Answer 75

1. If interest rates fall, homeowners will refinance more quickly and the holder of the CMO will be paid off more quickly than they had hoped 2. If the rate of principal payments may vary 3. If interest rates rise, refinancing may slow down and investors will be paid off more slowly

Answer 76

Yes, but some more complex CMOs may not.

Answer 77

At all levels: federal, state and local.

Answer 78

1. Principal only (PO) - receives only principal payments made on underlying mortgage (receive both scheduled principal payments as well as any prepayments made by home owners in the pool). Sold at a discount to its face value and appreciation of CMO represents investor's return. Price of principal only CMO will be sensitive to changes in interest rate. As interest rates fall, value of CMO will rise as prepayments accelerate. 2. Interest only (IO) - receive interest payments made by homeowners in pool of underlying mortgages. These also sell at a discount to their face value due to the amortization of the underlying mortgages. Interest only CMOs will increase in value as interest rates rise and decrease as interest rates fall (as a result of changes in prepayments on the underlying pool of mortgages). 3. Planned amortization class (PAC) - These are paid off first and offer the investor th emost protection against prepayment and extension risk. If prepayments come in too quickly, principal payments will be deferred to another CMO known as a support class to protect the owner of the PAC from prepayment risk. If principal payments are made more slowly, principal payments will be taken from a support class to protect the investor against extension risk. 4. Targeted amortization class (TAC) - these only offer investor protection from prepayment risk. If principal payments are made more quickly, they will be transferred to support class. However, if come in more slowly, payments will not be taken from a a support class and will be subject to extension risk.

Answer 79

Issued by investment banks and payment of interest and principal payments are responsibility of the issuing investment bank. Payments due to a holder of private-label CMOs are not guaranteed by government agency, credit rating of these CMOs is based on collateral that backed the CMO and the credit rating of the issuer. If the private label CMO uses agency issues as collateral, these agency issues still carry the guarantee of the issuing government agency.

Answer 80

1. Type of investment companies 2. Investment company structure 3. Investment company registration 4. Investment company taxation 5. Investment strategies and recommendations 6. Investor benefits

Answer 81

As either a corporation or a trust Individual investor's money is poole together in a single account and used to purchase securities that will have the greatest chance of helping the investment company reach its objectives. All investors jointly own the portfolio that is created through these pooled funds and each investor has an undivided interest in the securities. No single shareholder has any right or claim that exceeds the rights or claims of any other shareholder regardless of the size of the investment.

Answer 82

1. Securities Act of 1933 - requires the investment company to register with the SEC and to give all purchasers a prospectus 2. Investment Company Act of 1940 - sets forth guidelines on how investment companies operate.

Answer 83

1. Face-amount company (FAC) - investor may enter into contract with FAC to receive a stated or fixed amount of money at a stated date in the future. In exchange for this future sum, the investor must deposit an agreed lump sum or make scheduled installment payments. These are rarely offered today as most of the tax advantages have been lost through changes in the tax law. 2. Unit investment trust - either invest in a fixed portfolio of securities or in a nonfixed portfolio of securities Fixed UIT traditionally invests in a large block of government or municipal debt. Bonds will be held until maturity and the proceeds will be distributed to investors in the UIT. Once proceeds are distributed, UIT will ahve achieved objective and cease to exist. Nonfixed UIT (contractual plan) will purchase mutual fund shares in order to reach a stated objective. 3. Management investment company (mutual funds) - a management investment company employs an investment advisor to manage a diversified portfolio of securities designed to obtain its stated objective. Can be organized as open-end or closed-end company. Main difference is how shares are purchased and sold.

Answer 84

1. Are organized as a trust and operate as a holding company for the portfolio 2. Are not actively managed and do not have BOD or investment advisors 3. Issue units or shares of beneficial interest to investors which represent as undivided interest in the underlying portfolio of shares 4. Must maintain a secondary market to offer some liquidity to investors.

Answer 85

Main difference is how shares are purchased and sold. Open end company - offers new shares to any investor who wants to invest (known as continuous primary offering). Capitalization is unlimited because offering is continuous. Open-end must repurchase its own shares from investors who want to redeem them. There is no secondary market. Shares must be purchased from the fund company and redeemed from the fund company. Closed end fund - offers common shares to investors through an IPO just like a stock. Its capitalization is limited to a number of authorized shares that have been approved for sale. Shares will trade in secondary market in over the counter market just like common shares.

Answer 86

Open vs. Closed Full and fractional shares vs. full shares only Common shares only vs. Common and preferred shares and debt securities Shares priced by formula NAV + SC = POP vs. Shares priced by supply and demand Dividends and voting vs. Dividends, voting and preemptive

Answer 87

Investment Act of 1940 laid out an asset allocation model that must be followed in order for the fund to call itself diversified mutual fund. 75-5-10 Test 75% of fund's assets must be invested in securities of other issuers. Cash and cash equivalents (can be a T-bill or a money market instrument) are counted as part of the 75% 5% - investment company may not invest more than 5% of its assets in any one company 10% - The investment company many not own more than 10% of any company's outstanding voting stock

Answer 88

Must register if the company operates to own, invest, reinvest, or trade in securities. A company must also register as an investment company if the company has 40% or more of its assets invested in securities other than those issued by the US government or one of the company's subsidiaries.

Answer 89

1) Minimum net worth of $100K 2) At least 100 shareholders 3) Clearly defines investment objectives (Can register if they will meet these requirements within 90 days)

Answer 90

The date the SEC receives its notice of registration

Answer 91

1) Type of investment company (open-end, closed-end, etc) 2) Biographical information on the officers and directors of the company 3) Name and address of each affiliated person 4) Plans to concentrate investments in any one area (sector fund) 5) Plans to invest in real estate or commodities 6) Borrowing plans 7) Conditions under which investment objective may be changed through a vote of shareholders

Answer 92

1) raise money though sale of shares 2) Lend money to earn interest 3) Borrow money on a limited basis

Answer 93

Once company is operating, it may lend money to earn interest such as by purchasing bonds or notes. An investment company may borrow money for such business purposes as to redeem shares. If the investment company borrows money, it must have $3 in equity for every dollar it want to borrow (must have asset-to-debt ratio of at least 3-to-1 or at least 300%)

Answer 94

1) Taking over or controlling other companies 2) Acting as a bank of a savings loan 3) Receiving commission for executing orders or for acting as a broker? 4) Continuing to operate with less than 100 shareholders or less than $100K net worth

Answer 95

1) Selling securities short 2) Buying securities on margin 3) Maintaining joint accounts 4) Distributing its own shares

Answer 96

1) Broker dealers 2) Underwriters 3) Banks and savings and loans 4) Mortgage companies 5) Real estate investment trusts (REITs) 6) Security holder protection committees

Answer 97

1. Board of Directors 2. Investment adviser 3. Custodian bank 4. Transfer agent

Answer 98

1) Defines investment objectives 2) Hires the investment adviser, custodian bank and transfer agent 3) Determines what type of funds to offer (i.e. growth income, etc) BOD is elected by a vote of the shareholders

Answer 99

Makeup of board is determined by Investment Company Act of 1940 which states that majority or at least 51% of board must be noninterested persons (person whose only affiliation with the fund is as a member of the board). Therefore 49% of board may hold another position within the fund company or may otherwise be interested in the fund.

Answer 100

Anyone who could exercise control over the company, can be 1) accountant 2) broker dealer 3) attorney 4) immediate family of an affiliated person 5) anyone else the SEC designates

Answer 101

Selling securities or property to the investment company or any of its subsidiaries.

Answer 102

Anyone who has been convicted of any felony or securities-related misdemeanor or who has been barred from the securities business

Answer 103

Investment company is required to obtain a bond to cover itself and each officer, director and employee with access to the investment company's assets. Blanket bond covers all employees that are required to be bonded (names of employees must be listed). Bond only covers the employees for negligence, not criminal acts or acts of bad faith.

Answer 104

The BOD hires the investment adviser to manage the fund's portfolio. Investment adviser is a company, not a person, which must also determine the tax consequences of distributions to shareholders and ensure that the investment strategies are in line with the fund's stated investment objectives.

Answer 105

Percentage of net assets of the fund, not a percentage of the profits, although performance bonuses are allowed. Investment adviser's fee is typically the largest expense of the fund and the more aggressive the objective, the higher the fee. Investment adviser may not borrow from the fund or have any security-related convictions.

Answer 106

Holds all of the fund's assets (cash and securities) for safekeeping and provides other bookkeeping and clerical functions for the investment company, such as maintaining books and records for accumulation plans for investors. Must be done in line with SEC guidelines and ensure that only approved persons have access to account. Another name is "exchange member broker dealer" Hired by investment company

Answer 107

1) Handles issuance, cancellation and redemption of fund shares 2) Handles name changes Transfer agent may be part of the fund's custodian or a separate company.

Answer 108

The underwriter. The underwriter for a mutual fund is also known as the sponsor or distributor. Underwriter selected by BOD

Answer 109

Receives a fee in the form of a sales charge for the shares it distributes.

Answer 110

As underwriter receives orders for the mutual fund shares, it purchases the shares directly from the fund at the net asset value (NAV). The sales charge then is added to the NAV as the underwriter's compensation. (This process of adding sales charge to the NAV is responsible for the mutual fund pricing formula, which is NAV + SC = POP (public offering price)

Answer 111

The underwriter may purchase shares from the mutual fund only to fill customer orders, may not hold mutual fund shares in inventory in anticipation of receiving future customer orders

Answer 112

These can purchase mutual fund shares at a discount from public offering price (POP) and then sell the mutual fund shares to investors at the POP and earn part of the sales charge. Must be member of FINRA, otherwise treated as members of the general public and pay POP.

Answer 113

No-load mutual funds do not charge a sales charge to investors who invest in mutual fund; therefore mutual fund may sell shares directly to investors at the NAV.

Answer 114

1. Mutual fund company -> (NAV) Sponsor underwriter distributor -> (Discount from POP) Selling group member -> (POP) Investor 2. Mutual fund company -> (NAV) Sponsor underwriter distributor -> (POP) Investor 3. Mutual fund company -> (NAV No-load fund) Investor

Answer 115

The prospectus is the official offering document for open-end mutual fund shares. The prospectus must be presented to all purchasers of the fund either before or during the sales presentation.

Answer 116

1) Fund's investment objectives 2) Sales charges 3) Management expense 4) fund services 5) Performance data for the past 1, 5, and 10 years or for life of the fund

Answer 117

1) Fund's securities holdings 2) Balance sheet 3) Income statement 4) Portfolio turnover data 5) Compensation paid to the board of directors and investment advisory board

Answer 118

Summary prospectus that contains past performance data

Answer 119

Mutual fund prospectus: 1. Should be updated by the fund every 12 months 2. Must be updated by the fund every 13 months 3. May be used by a representative for up to 16 months 4. Should be discarded after 16 months from publication

Answer 120

1. Performance graph showing performance of fund 2. Names of officers and directors who are responsible for the portfolio's day-to-day management 3. Disclosure of any factors that materially affected performance over the latest fiscal year. 4. Summary information at front of prospectus which includes fund's investment objectives, past performance, costs, and biographical info for management of fund. Also includes investment strategies, compensation, purchase and redemptions and tax implications

Answer 121

Public offering price and net asset value

Answer 122

Seven calendar days. Suspension of seven day rule may be allowed only if: 1. NYSE is closed for an extraordinary reason 2. NYSE trading is restricted or limtied 3. Liquidation of the securities would not be practical 4. An SEC order has been issued

Answer 123

1. Diversification 2. Professional management 3. Low minimum investment 4. Easy tax reporting, Form 1099 5. Reduction of sales charges through breakpoint schedule, letter of intent and rights accumulation 6. Automatic reinvestment of dividends and capital gains distributions 7. Structured withdrawal plans

Answer 124

1. Equity funds - growth funds seeking capital appreciation, do not produce significant dividend income 2. Equity Income Fund - Purchase both common and preferred shares that have long record of paying dividends 3. Sector fund -higher risk/reward since these concentrate 25% or more of their assets in one business area or region 4. Index funds -generally passively managed (comprised of stocks that are included in the index that fund is designed to track) 5. Growth and income (combination fund) - Invests to achieve both capital appreciation and current income (common and preferred shares that pay high dividends) 6. Balanced funds - invests in both stocks and bonds, according to a predetermined formula 7. Asset allocation funds - invest in stocks, bonds, and money market instruments, according to expected performance for each market

Answer 125

1. Foreign stock funds - invest outside US 2. Special situation funds - invest in takeover candidates and restructuring companies 3. Option income fund - purchases common shares and sells call options against the portfolio in order to generate premium income for investors

Answer 126

Investors who purchase equity security that represents their undivided interest in a portfolio of debt. Bond funds invest mainly to generate current income for investors through interest payments generated by the bonds in the portfolio.

Answer 127

1. Corporate bond funds - invest in debt securities issued by corporations. Subject to all taxes. 2. Government bond funds - invest in debt securities issued by the US government such as Treasury bills, notes, and bonds. Many also invest in government agencies such as Ginnie Mae. Dividends only subject to federal taxation 3. Municipal bond funds - portfolios of municipal debt. Investors receive dividend income, free from federal taxes. Investors are still subject to taxes for any capital gains distributions or for any capital gains realized through sale of mutual fund shares 4. Money market funds - invest in short-term money market instruments such as banker's acceptances, commercial paper, and other debt securities with less than one year remaining to maturity. These are no-load funds, NAV is always equal to $1, however this is not guaranteed. Interest is earned by investors daily and is credited to their accounts monthly.

Answer 128

1. Prospectus must clearly state that fund is not insured or guaranteed by US government and fund's NAV may fall below $1 2. Securities in the portfolio may have a maximum maturity of 13 months 3. The average maturity for securities in the portfolio may not exceed 90 days. 4. No more than 5% of fund's assets may be invested in any one issuer's debt securities. 5. Investments are limited to the top two ratings awarded by nationally recognized ratings agency (S&P, and Moody's) 6. 95% of portfolio must be in the top ratings category with no more than 5% being invested in second tier

Answer 129

(also known as alt funds or liquid alts) invest in nontraditional assets or illiquid assets and may employ alternative investment strategies

Answer 130

1x/day; Most price at close of business of NYSE (4pm EST), this is listed in mutual fund prospectus when fund calculates price. Calculation is required to determine both redemption price and purchase price of fund's shares

Answer 131

Assets - liabilities = net asset value | NAV per share = Total NAV/Total # of outstanding shares

Answer 132

Causes increase in NAV: 1. Value of securities in the portfolio increase 2. Portfolio receives investment income, such as interest payments from bonds Causes decrease in NAV: 1. Value of securities in portfolio fall 2. Fund distributes dividends or capital gains No effect on NAV: 1. Investor purchases and redemptions 2. Portfolio purchases and sales of securities 3. Sales charges

Answer 133

1. Underwriters commission 2. Commission to brokerage firms and registered representatives * It is important to note that the sales charge is not an expense of the fund; it is a cost of distribution, which is borne by the investor

Answer 134

No sales charge. | Investor will pay current market price + the commission their brokerage firm charges them to execute the order

Series 65 w2 Flashcards

(159 cards)