Series 65 wk 3 Flashcards
(231 cards)
1
Q
What are the advantages and risks associated with ETFs that track alternatively weighted indices?
A
Equally weighted, alternatively weighted, fundamentally weighted and volatility weighted ETFs offer exposure to other investment styles and may provide enhanced performance.
These ETFs present additional risk factors such as being more complex, thinly traded and hard to understand for both advisers and retail investors.
Lack of liquidity can lead to wider spreads causing the product to be expensive to buy and sell for invsetors. The portfolio often have high turnover, which can lead to increased transaction costs for ETF.
2
Q
What is a front-end load? What are shares with front-end load called?
A
Sales charge that the investor pays when they purchase shares. The sales charge is added to the NAV of the fund and the investor purchases the shares at the POP. Shares that charge a front-end load are known as “A” shares
3
Q
What are back end loads? What is this also called? (2)
A
Back-end load is known as contingent differed sales charge (CDSC)
Investors that pay back-end loads will pay sales charge at the time of redemption of fund shares. (This sales charge declines as holding period increases). Mutual fund shares that charge a back-end load are known as “B” shares.
4
Q
What are the 2 other types of sales charge?
A
“C” shares - level load shares - based on NAV.
“D” shares - charge asset-based fee and back-end load.
5
Q
What does a 12B-1 fee (asset-based distribution fee) cover? How is this fee determined?
A
Covers expenses related to promotion and distribution of fund’s shares.
Fee is determined annually as a percentage of the NAV or as a flat fee
6
Q
How is 12B-1 fee charged to shares? What votes must be collected annually to approve of the 12B-1 fee?
A
12B-1 fee charged to shares quarterly. 3 votes required to approve and reapprove annually: 1. Majority of BOD 2. Majority vote of non-interested BOD 3. Majority vote of outstanding shares
7
Q
What votes are required to terminate a 12B-1 fee?
A
- Majority of noninterested BOD
2. Majority vote of outstanding shares
8
Q
What are the limits of a 12B-1 fee?
A
Mutual fund (no-load fund) may charge a 12B-1 fee no more than 0.25% Mutual funds that are not no-load funds are limited to 0.75% of assets - and must be reasonably related to anticipated level of expenses incurred for promotion and distribution.
9
Q
How often are 12B-1 fees reviewed?
A
Quarterly
10
Q
What must be done to evaluate and recommend mutual fund?
A
Mutual funds do not typically time the market, so it is important to:
1. Make sure investment objective of mutual fund matches investor’s objectives
2. Must compare costs, fees, and expenses among the funds
Priority should be to any fund company with whom the investor maintains an investment
11
Q
Why should priority be given for mutual fund company with existing investment? (Existing investment vs. new capital)
A
If client’s objective has changed, then fund most likely offers conversion privileges that will allow the investor to move into another portfolio without paying any sales charge.
If investor is committing new capital then fund company most likely offers combination privileges and rights of accumulation, which will help the investor reach a sale charge reduction
12
Q
What is a red flag for breakpoint sales violations and abusive sales practices? (3)
A
Switching fund companies and/or spreading out investment dollars among different fund companies. Making a large investment in class B shares as large dollar amount would have most likely resulted in a reduced sales charge for the investors
13
Q
When should investor invest in A shares vs. B or C shares?
A
A shares - Shorter time horizons
B shares - longer holding periods because expenses associated with B shares are higher, but sales charge upon redemption is better later
C shares - for investors who want to actively move money between funds to try to time the market (charge level load each year)
14
Q
Sales charge percentage calculation
A
SC% = (POP-NAV)/POP
15
Q
What is POP calculation?
A
POP = NAV/(100-SC%)
16
Q
If open-end mutual fund charges maximum 8.5% Sales charge, what 3 privileges must they also offer? If mutual fund does not offer all 3 of these benefits, what does sales charge drop to?
A
- Breakpoint sales charge reductions that reduce the amount of the sales charge based on dollar amount invested.
- Rights of accumulation that will reduce the sales charge on subsequent investments based on the value of the investor’s account
- Automatic reinvestment of dividends and capital gains at the NAV.
If fund does not offer these, sales charge drops to 6.25%
17
Q
What is incentive for investment of larger sums into mutual funds?
A
Breakpoint sale - Sale of a mutual fund at a set dollar amount that allows the fundholder to move into a lower sales charge bracket. As an incentive to invest larger sums of money, mutual fund will reduce sales charge based upon the dollar amount of the purchase.
18
Q
Who are breakpoint sales charge reductions available to? (4)
A
Corporations, trusts, couples, and accounts for minors
19
Q
What is a breakpoint schedule?
A
A sales charge amount related to dollar amount invested
Ex: $1-$24,999 (8.5% SC), $25K-$74,999 (7%), 75K-$149,999 (5%), $150K-$499,999 (3%), $500K or greater (1%)
20
Q
What is a letter of intent on breakpoint?
A
An investor unable to reach a breakpoint with a single purchase, can qualify for a breakpoint sales charge reduction by signing a letter of intent.
LOI will give investor up to 13 months to reach the dollar amount they subscribed.
LOI is binding only to fund company, not on investor.
Shares are held in escrow - if met - these are released; if not met - investor is charged adjustment to sales charge (investor can choose to send in a check or allow some of escrowed shares to be liquidated).
21
Q
What are the rules for backdating a letter of intent?
A
Investor can backdate LOI up to 90 days to include prior purchase and 13-month window starts from the back date.
22
Q
What is a breakpoint sale?
A
A breakpoint sale is a violation committed by a registered representative who is trying to earn larger commissions by recommending the purchase of mutual fund shares in a dollar amount that is just below the breakpoint that would allow investor to qualify for a reduced sales charge.
A breakpoint violation also may be considered to have been committed if a representative spreads out a large sum of money over different families of funds.
A registered representative must always notify an investor of the availability of a sales charge reduction, especially when investor is depositing a sum of money close to breakpoint.
23
Q
What are rights of accumulation?
A
Allow investor to qualify for reduced sales charges on subsequent investments by taking into consideration the value of the investor’s account, including the growth. This allows sales charge reduction for future payments made in new breakpoint schedule bracket, not retroactive reduction of sales charge on prior purchases
24
Q
What is automatic reinvestment of distributions?
A
Investors may elect to have their distributions automatically reinvested in fund and use the distributions to purchase more shares. Most mutual funds will allow investor to purchase the shares at NAV when they reinvest distributions.
This feature is required for mutual funds charging 8.5% sales charge
25
What are combination privileges?
A feature sometimes offered by mutual funds allowing investor to combine the simultaneous purchases of two different portfolios to reach a breakpoint sales charge reduction. (Different portfolios become known as a family of funds).
26
What are 3 other mutual fund features they can offer?
1. Combination privileges
2. Conversion or exchange privileges
3. 30-Day Emergency withdrawal
27
What is conversion or exchange privileges?
Mutual funds feature that allows investor to move money from one portfolio to another offered by the same fund company without paying another sales charge.
Fund company allows investor to redeem shares of one portfolio at NAV and use proceeds to purchase shares of another portfolio at the NAV.
28
How is conversion or exchange purchase taxed? What are the other 4 exchange conditions?
IRS sees purchase and sale, so investor will have to pay taxes on any gain on the sale of portfolio shares.
Other exchange conditions:
1. Dollar value of purchase may not exceed sales proceeds
2. Purchase of new portfolio must occur within 30 days
3. Sale may not include a sales charge refund
4. No commission may be paid to a registered representative of broker dealer
29
How does date apply for back-end loads when there is a conversion of shares in mutual fund portfolio?
Original purchase date
30
What is a 30-day emergency withdrawal?
If investor needs to liquidate mutual fund shares for emergency purposes, the investor will be able to reinvest an equal sum of money at portfolio's NAV if they reinvest money within 30 days. (usually one-time privilege)
31
If client redeems shares within 7 business days of purchase, what happens to sales charge?
Sales charge earned by broker dealer and representative is returned to the fund company
32
What is dollar cost averaging?
Purchasing mutual fund shares through regularly scheduled investments of a fixed dollar amount (popular method).
33
How do you calculate average cost/share and average price per share for investor of mutual fund?
Average cost = total dollars invested/total # of shares invested ($400/27)
Average price = Total of purchase prices/number of purchases ($67.5/4)
Example: 4 $100 investments made at various share prices - $400 total investment; $67.5 (added share prices), 27 (number of shares purchased
34
How are mutual fund voting rights won?
By a simple majority, 51% of outstanding shares will win the vote. This is shares vote, not shareholders.
35
What are the major issues to be voted on for a mutual fund (11)?
1. Changing capitalization (going from open end to closed-end fund)
2. Changing sales load (going from a loaded fund to a no-load fund)
3. Changing or terminating business
4. Changing investment objectives
5. Lending money
6. Entering into real estate transactions
7. Issuing or underwriting other securities
8. Changing borrowing policies
9. Electing BOD
10. Electing investment adviser
11. 12B-1 fees
36
How are mutual fund yields calculated?
Annual income (dividends)/POP = current yield
37
What is portfolio turnover rate? What is disadvantage of high portfolio turnover rate?
Says how long the fund holds its securities, turnover rate of 100% means that the fund replaces its portfolio annually (the higher the rate, the shorter the fund's holding period).
Higher portfolio turnover cause fund to incur additional expenses in the form of execution charges.
38
The ex-dividend date on a closed-end mutual fund is set by who?
FINRA/NYSE
39
What is an annuity? What is an annuitant?
A contract between an individual and an insurance company. Once the contract is entered into, the individual becomes known as the annuitant.
40
What are the 3 types of annuities? What is generally similar and different?
1. Fixed annuity
2. Variable annuity
3. Combination annuity
All 3 types allow investor's money to grow tax deferred, but the type of investment made and how the money is invested varies according to the type of annuity.
41
What is a fixed annuity? What is risk?
Offers investors a guaranteed rate of return regardless of whether the investment portfolio can produce the guaranteed rate. If the performance of the portfolio falls below the rate that was guaranteed, the insurance company owes investors the difference.
Because purchaser of fixed annuity doesn't have investment risk, a fixed annuity is considered to be an insurance product, not a security.
Investments are typically in conservative investments like mortgages and real estate.
Because rate that insurance company guarantees is not very high, annuitant may suffer a loss of purchasing power due to inflation risk.
42
What is a variable annuity?
Seek to obtain a higher rate of return by investing in stocks, bonds, or mutual fund shares, these securities traditionally offer higher rates of return than more conservative investments.
These do not offer guaranteed rate of return and the investor may lose all or part of their principal. Because of this risk, contract is considered to be both a security and an insurance product (representatives who sell variable annuities must have both their securities and insurance license)
43
Where are the money and securities contained in a variable annuity contract held? What must the insurance company to begin operating?
Held in insurance company's separate account. (Must be kept separate from insurance company's general funds).
The insurance company must have a net worth of $1M or the separate account must have net work of $1M in order for separate account to begin operating
44
How can the separate account in a variable annuity invest? (2 ways)
Direct investment - If money in separate account is invested directly into individual stocks and bonds, the separate account must have an investment adviser to actively manage the portfolio. This is then considered to be an open-end investment company under Investment Company Act of 1940 and must register as such.
Indirect investment - If separate account uses money in the portfolio to purchase mutual fund shares, it is investing in the equity and debt markets indirectly and no investment and no investment adviser is required to actively mange the portfolio. This is considered to be a unit investment trust under the Investment Company Act of 1940 and must register as such.
45
What is a combination annuity?
Combination annuity offers the annuitant features of both a fixed and variable contract. Has a fixed portion that offers a guaranteed rate and a variable portion that tries to achieve a higher rate of return.
Most combination annuities will allow the investor to move money between the fixed and variable portions of the contract.
Representatives who sell combination annuities must have both their securities license and their insurance license.
46
What is a bonus annuity? In order to offer bonus annuity, what must it do?
An insurance company that issues annuity contracts may offer incentives to investors who purchase their variable annuities (these are referred to as bonuses).
1. Premium enhancement
2. Ability to withdraw account's earnings or up to 15% of total premiums paid without a penalty
Bonus annuities often have higher expense and longer surrender periods than other annuities.
In order to offer bonus annuities the bonus received must outweigh the increased costs and fees associated with the contract.
Fixed annuity contracts cannot offer bonuses to purchasers.
47
What is a premium enhancement?
A type of bonus annuity - under this option - the insurance company will make an additional contribution to the annuitant's account based on the premium paid by the annuitant.
48
What is an equity-indexed annuity? How do equity-indexed annuities credit interest to the investor's account? How are these rates shown (2)?
Offer investors a return that varies according to performance of a set index such as the S&P 500.
These annuities credit interest to investor's account based on contract's participation rate.
Participation rate of 70% and index return of 5% - investors return of 3.5% (70% of 5%) OR
Participation rate shown as spread rate. If contract has spread rate of 3% and index returned 10%, investor's return is credited 7% (10-3)
49
What is floor rate and cap rate?
Equity-indexed annuities may have floor rate (minimum interest rate that will be credited to investor's account - could be 0% or higher number)
Cap rate - maximum rate that will be credited to the contract; If index exceeds cap rate, investor's account will only be credited up to cap rate.
50
Who should you recommend variable annuities to?
More appropriate for investor who is looking to create an income stream, not trying to save for a large purchase or expense such as college tuition. Variable annuities are meant to be used as supplements to other retirement accounts such as IRAs and corporate retirement plans.
51
What are the 3 ways an investor may purchase an annuity contract?
1. Single payment deferred annuity
2. Single payment immediate annuity
3. Periodic payment deferred annuity
52
What is a single payment deferred annuity? What does money invested in this buy?
The investor funds the contract completely with one payment and defers receiving payments from the contract until some point in the future, usually after retirement.
Money being invested in a single payment deferred annuity is used to purchase accumulation units.
The number and value of the accumulation units varies as the distributions are reinvested and the value of the separate account's portfolio changes.
53
What is single payment immediate annuity? What does money invested in this buy?
With a single payment immediate annuity, investor funds contract completely with one payment and begins receiving payments from the contract immediately, normally within 60 days.
The money that is invested in a single payment immediate annuity is used to purchase annuity units.
The number of annuity units remains fixed and the value changes as the value of the securities in the separate accounts portfolio fluctuates.
54
What is periodic payment deferred annuity? What does money invested in this buy?
Investor purchases the annuity by making regularly scheduled payments into the contract. (This is known as the accumulation stage). During this stage - terms are flexible and there is no penalty if investor misses a payment).
Money invested in periodic payment deferred annuity is used to purchase accumulation units.
The number and value of the accumulation units fluctuate with the securities in the separate account's portfolio.
55
What is an accumulation unit? How does the value of the accumulation unit change? When does an investor own accumulation units?
This represents the investor's proportionate ownership in the separate account's portfolio during the accumulation or differed stage of the contract.
Value of accumulation unit fluctuates as the value of the securities in the separate account's portfolio changes. (As investor makes contributions to the account or as distributions are reinvested, the number of accumulation units will vary)
An investor will only own accumulation units during hte accumulation stage where money is being paid into the contract or when receipt of payments is being deferred by the investor, such as with a single payment deferred annuity.
56
What is an annuity unit?
When an investor changes from the pay-in or deferred stage of the contract to the payout phase, the investor is said to have annuitized the contract.
At this point, the investor trades in their accumulation units for annuity units.
The number of annuity units is fixed and represents the investor's proportional ownership of the separate accounts portfolio during the payout phase.
57
What can affect the number of annuity units an investor receives?
1. Payout option selected
| 2. Annuitant's age, sex, value of the account, and the assumed interest rate
58
What are the annuity payout options?
Can take lump sum distribution or receive scheduled payments from the contract. If the investor to decides to annuitize the contract and receive scheduled payments, once the payout option is selected, it can't be changed.
The 3 options (from largest to smallest monthly payment):
1. Life only/straight life
2. Life with period certain
3. Joint with last survivor
59
What is "life only/straight life" annuity payout option?
This payout option gives annuitant the largest periodic payment from the contract and the investor will receive payments from the contract for their entire life.
However if investor dies, there are no additional benefits to their estate.
If an investor dies unexpectedly shortly after annuitizing the contract, the insurance company keeps the money in their account
60
What is "life with period certain" annuity payout option?
This will pay out from the contract to the investor or to their estate for the life of the annuitant or for the period certain, whichever is longer.
If investor selects 10-year period and lives 20 years, payments will cease upon the death of the annuitant, however if same investor dies only 2 years after annuitizing the contract, payments would go to their estate for another 8 years.
61
What is "joint with last survivor" annuity payment option? How are the monthly payments determined?
This annuity is jointly owned by more than one party and payments will continue until the last owner of the contract dies. If wife/husband have account and husband dies, wife continues to receive payments the rest of her life. These payments could be at the same rate or at a reduced rate, depending on the contract.
The monthly payments will initially be based on the life expectancy of the youngest annuitant.
62
What factors affect the size of the annuity payment? (5)
1. Account value
2. Payout option selected
3. Age
4. Sex
5. Account performance vs. the assumed interest rate (AIR)
63
What is the assumed interest rate (AIR)?
A benchmark "assumed interest rate" for the separate account's performance. When an investor annuitizes a contract, they trade their accumulation units in for annuity units.
AIR is not a guaranteed rate of return, it is only used to adjust the value of the annuity units up or down, based upon the actual performance of the separate account.
The annuity payments change with the value of the AIR. (if AIR increases, payment increases, and vice versa)
64
How is the investor's annuity payment using AIR calculated?
Number of annuity units owned by the investor multiplied by value of the annuity unit
65
When is the AIR relevant?
Only relevant during payout phase of the contract when the investor is receiving payments and owns annuity units. Not during the accumulation stage.
66
How are contributions made to an annuity (regarding taxes)?
Made with after-tax dollars; money deposited is allowed to grow tax deferred. When investor withdraws money, only growth is taxed (taxed as ordinary income).
67
What are 3 types of withdrawals from an annuity contract?
1. Lump sum
2. Random
3. Annuitizing
68
Which withdrawals are done last in, first out (LIFO)? What portion counts as the last money and how is this taxed?
Lump sum and random withdrawals. Growth portion of the contract is always considered to be last money that was deposited and is taxed at the ordinary income rate of the annuitant.
69
What happens if the annuitant is under age 59.5 and takes a lump sum or random withdrawal?
Withdrawal will be subject to a 10% tax penalty, as well as ordinary income taxes
(Variable annuity contacts sometimes allow borrowing from contract as long as interest is charged on loan and repaid by investor, not subjected to taxes)
70
What does an investor receive when they annuitize the contract? How is it determined what is taxable?
Monthly payments, part of which is investor's cost base and the other which is the distribution of the account's growth.
To determine how much of each payment is taxable and how much is the return of principal, the investor would look at the exclusion ratio.
71
What contracts are not subject to the 10% tax penalty?
Contracts that are annuitized prior to age 59.5 under a life-income option nor are withdrawals due to disability or death
72
What are sales charges of annuity contract?
No maximum sales charge.
Sales charge is assessed and must be reasonable in relation to total payments over life of the contract.
Most annuity contracts have back-end sales charge or surrender charges similar to a contingent deferred sales charge.
73
How are investment management fees determined in annuity contracts?
Individuals running separate account are compensates for their management of account through a fee-based agreement. Fee is deducted from separate account to cover management expense.
The more aggressive the portfolio, the larger the management fee will be.
74
What are the similarities (4) and differences (5) between variable annuities and mutual funds?
```
Variable annuity vs. mutual fund:
Similarities: All have investment advisers, custodian banks, transfer agent and voting rights
Differences:
Max sales charge: No max vs. 8.5%
Management: Board of managers vs. BOD
Tax of growth and reinvestments: Tax-deferred vs. currently taxed
Lifetime income: Yes vs No
Costs and fees: Higher vs. lower
```
75
What is difference between qualified vs. nonqualified? (5)
Qualified vs. Nonqualified:
Contributions: Pretax vs. After-tax
Growth: Tax-deferred vs. Tax-deferred
Participation must be allowed: For everyone vs. Corporation may choose who gets to participate
IRS approval: Required vs. Not required
Withdrawals: 100% taxed as ordinary income vs. Growth in excess of cost base is taxed as ordinary income
76
Are annuities qualified or nonqualified?
Money used to purchase an annuity has already been taxed, making an annuity a nonqualified product
77
What are the different types of individual retirement account (IRA)?
1. Traditional
2. Roth
3. SEP
4. Educational
78
Are contributions to traditional IRAs tax deductible?
They may or may not be tax deductible, depending on the individual's level of adjusted gross income and whether the individual is eligible to participate in an employer-sponsored plan.
Individuals who do not qualify to participate in an employer-sponsored plan may deduct their IRA contributions, regardless of income level.
79
What is a traditional IRA? How much can a person contribute?
Allows individual to contribute a maximum of 100% of earned income or $5500 per year or up to $11K per couple.
If only one spouse works, the working spouse may contribute $5500 to an IRA for themselves and $5500 to a separate IRA for their spouse, under the nonworking spousal option.
Investors over 50 may contribute up to $6500 of earned income to their IRA.
Regardless of whether the IRA contribution was made with pretax or after-tax dollars, the money is allowed to grow tax deferred.
80
How are withdrawals from a traditional IRA taxed? Penalty tax?
Taxed as ordinary income regardless of how the growth was generated in the account.
Withdrawals from an IRA prior to age 59.5 are subject to a 10% penalty tax as well as ordinary income taxes (this will be waived for first-time homebuyers or educational expenses for the taxpayer's child, grandchildren, or spouse. This will also be waived if payments are part of a series of substantially equal payments.
81
When must withdrawals from IRA begin? What will happen if they don't make withdrawals that are sufficient in size and frequency?
Withdrawals from an IRA must begin by April 1 of the year following the year in which the taxpayer eraches 70.5.
Individual will be subject to a 50% penalty on the insufficient amount
82
What happens if an individual makes a contribution to an IRA that exceeds 100% of earned income or $5500 (whichever is less)?
Subject to a penalty of 6% per year on the excess amount for as long as the excess contribution remains in the account.
83
What is a Roth IRA? What are contribution limits? Penalties?
A nonqualified account (made after-tax dollars). Same contribution limits apply for Roth IRAs. Roth IRA has same contribution limits as traditional ($5500), any contribution made to a Roth IRA reduces the amount that may be deposited in a traditional IRA and vice versa. All contributions deposited in a Roth IRA are allowed to grow tax deferred and all of the growth may be taken out of the account tax free provided individual has reached 59.5 and assets have been in account for at least 5 years. Same 10% penalty tax as traditional IRA.
84
What are rules for individuals taking distributions from Roth IRA by a certain age?
No requirements.
85
What is a simplified employee pension (SEP) IRA?
Used by small corporations and self-employed individuals to plan for retirement.
A SEP IRA is attractive to small employers because it allows them to set up a retirement plan for their employees rather quickly and inexpensively.
86
What are the contribution limits for SEP IRA?
Contribution limit for a SEP IRA far exceeds that of traditional IRAs.
Contribution limit is the lesser of 25% of the employee's compensation or $54K per year.
Employees can either make their annual IRA contribution to their SEP IRA or to traditional or Roth IRA.
87
What are the terms for participation in an SEP IRA? (3)
Employee must be at least 21 years old, have worked during 3 of the last 5 years for the employer, and have earned at least $550.
88
What are the rules for employer contributions?
Employer may contribute between 0-25% of the employee's total compensation to a maximum of $54K. Contributions to all SEP IRAs, including employer's SEP IRA must be made at the same rate.
All eligible employees are immediately vested in the employer's contributions to the plan.
89
What are the terms for SEP IRA taxation?
Employer's contributions to a SEP IRA are immediately tax deductible by the employer. Contributions are not taxed at the employee's rate until the employee withdraws the funds. Employees may begin to withdraw money from the plan at age 59.5. All withdrawals are taxed as ordinary income and withdrawals prior ot age 59.5 are subject to 10% penalty tax.
90
When must contributions to IRAs be made?
April 15th of the following calendar year, regardless of whether an extension has been filed by the taxpayer.
Contributions may be made between Jan 1 and April 15 for the previous year, the current year, or both.
91
What form must all IRA contributions must be made?
Cash
92
Where are all IRA accounts held?
In the name of the custodian for the benefit of the account holder. Traditional custodians include banks, broker dealers, and mutual fund companies
93
IRA investments (allowable vs. nonallowable) - 7 each
Allowable: Stocks, bonds, Mutual funds/ETFs/ETNs, annuities, UITs, Limited partnerships, US minted coins
Nonallowable: Margin accounts, short sales, tangibles/collectibles/art, speculative option trading, term life insurance, rare coins, real estate
94
Why shouldn't you put a municipal bond in an IRA?
Municipal bonds or municipal bond funds' interest income is free from federal taxes.
This means that interest rate that is offered will be less than the rates offered by other alternatives.
Since advantage of an IRA is that money is allowed to grow tax deferred, an individual would be better off with a higher yielding taxable bond of the same quality.
95
When an individual needs to move IRA from one custodian to another, what are the two ways to do this?
Rollover - With an IRA rollover, individual may take possession of the funds for a maximum of 60 calendar days prior to depositing the funds into another qualified account (can only rollover once every 12 months)
Needs to invest 100% of funds into another qualified account or they must pay ordinary income taxes on the distribution and a 10% penalty tax, if the investor is under 59.5
Transfer - Can transfer IRA directly from one custodian to another by simply signing an account transfer form. Investor never takes possession of the assets in the account and the investor may directly transfer their IRA as often as they like.
96
What happens if the IRA owner dies? Spouse vs. nonspouse beneficiary?
Should the owner of an IRA die, the account will become the property of the beneficiary named on the account by the owner. (If this is spouse, special rules apply)
Spouse - may elect to rollover the IRA to their own IRA or retirement plan such as a 401K. If this is elected, there will be no tax due on the money. However, if spouse is still subject to required minimum distribution rule at age 70.5, surviving spouse may also elect to cash in IRA. (These will be subject to 10% penalty tax).
If not spouse - cannot rollover into another IRA or retirement account; if account owner died prior to age 70.5, then money must all be distributed prior to end of fifth year or be distributed based upon beneficiary's life expectancy. If account owner has died after the start of required minimum distributions, the payment schedule of distributions will now be based on the life expectancy of the beneficiary
97
What is educational IRA/Coverdell IRA?
Educational IRA allows individuals to contribute up to $2K in after-tax dollars to an educational IRA for each student who is under the age of 18 years of age.
The money is allowed to grow tax deferred and the growth may be withdrawn tax free, as long as the money is used for educational purposes.
If all of the funds have not been used for educational purposes by the time student reaches 30, the account must be rolled over to another family member under 30 or distributed to the original student and is subject to 10% penalty tax as well as ordinary income taxes.
98
What is a 529 plan?
Also called a qualified tuition plan, can be set up either as a prepaid tuition plan or a college savings plan.
With pre-paid tuition plan - plan locks in a current tuition rate at a specific school (this can be set up as an installment plan or one where the contributor funds the plan with a lump sum deposit) - usually requires to be state resident.
College cost savings account - can be opened by any adult and donor does not need to be related to child.
99
What does a prepaid tuition plan cover? What about college cost savings account?
Prepaid tuition plan only covers tuition and mandatory fees, a room and board option is available for some plans
College cost savings account can be used to cover all costs of qualified higher education including tuition, room and board, books, computers and mandatory fees
100
How are contributions to a 529 plan made? How does this grow?
Made with after tax-dollars and allowed to grow tax deferred. Growth may be withdrawn federally tax-free. Most states also allow assets to be withdrawn tax free. Any funds used for nonqualified education expenses will be subject to income tax and a 10% tax penalty.
101
If funds are not used or remain in 529 plan, what happens?
Funds may be rolled over to another family member within 60 days without incurring taxes and penalties
102
What is a Keogh plan (HR-10)?
A Keogh is a qualified retirement set up by self-employed individuals, sole proprietors and unincorporated businesses. If the business is set up as a corporation, a Keogh may not be used.
103
What are the rules for Keogh contributions?
Can only be funded with earned income during a period when the business shows a gross profit. If the business realizes a loss, no Keogh contributions are allowed. A self-employed person may contribute the lesser of 25% of their post contribution income or $54K.
104
How is money in Keogh plan taxed?
Allowed to grow tax deferred and is taxed as ordinary income when distributions are made to retiring employees and plan participants. Any excess contribution may be subject to a 10% penalty tax.
105
What is an eligible employee defined as for Keogh plan? (3)
1. Works full time (at least 1000 hours per year)
2. Is at least 21 years old
3. Has worked at least one year for the employer
Must be vested after 5 years
106
When can withdrawals begin for Keogh plan?
When participant reaches 59.5. Any premature withdrawals are subject to 10% penalty tax. Keoghs, like IRA may be rolled over every 12 months.
107
What are tax-sheltered annuities (TSAs) and tax-deferred accounts (TDAs)? What 4 organizations does this apply to?
These are established as retirement plans for employees of nonprofit and public organizations such as:
1. Public schools (403B)
2. Nonprofit organizations (IRC 501C3)
3. Religious organization
4. Nonprofit hospitals
108
How are TSAs and TDAs taxed and contributions made? What investment vehicles are available for participants of these?
Qualified plans and contributions are made pretax dollars. Money is allowed to grow tax deferred until it is withdrawn.
TSA and TDAs investment vehicles: stocks, bonds, mutual funds, CDs
109
In order for a public school to qualify to establish a TSA/TDA for their employees, what must be done?
School must be supported by the state, the local government or a state agency.
State supported schools:
1. Elementary schools
2. High schools
3. State colleges and universities
4. Medical schools
Any individual who works for a public school, regardless of their position may participate in the school's TSA or TDA.
110
What are the nonprofit organizations/tax-exempt organizations that qualify for TSA/TDA for their employees? What are examples of nonprofit organizations (8)?
```
Organizations that need to qualify under the internal revenue code 501C3.
Examples of nonprofit organizations:
1. Private hospitals
2. Charitable organizations
3. Trade schools
4. Private colleges
5. Parochial schools
6. Museums
7. Scientific foundations
8. Zoos
```
111
What do employees of organizations for non-profit TSA/TDAs need to do to qualify? (3)
1. Need to qualify under Internal Revenue Code 501C or 403B
2. At least 21 years old
3. Have worked full time for at least one year
112
What happens if distributions from TSA/TDA begins after age 70.5?
Subject to an excess accumulation tax.
113
Are corporate plans qualified or nonqualified?
Can be both.
114
How are payroll deductions made? To what investment vehicles? Pre-tax or after tax dollars?
Mutual funds, annuities, and savings bonds
| Contributions to a payroll deduction plan are made with after-tax dollars.
115
What is a deferred compensation plan?
Contract between an employee and employer where employee agrees to defer receipt of money owed to the employee until after the employee retires. After retirement, the employee will traditionally be in a lower tax bracket and will be able to keep a larger percentage of the money for themselves.
116
What are the rules of qualified plans set up by corporations?
Qualified corporate plans must be in writing and set up as a trust. A trustee or plan administrator will be appointed for the benefit of all plan holders.
117
What are the two types of qualified corporate plans?
1. Defined benefit plan
| 2. Defined contribution plan
118
What is a defined benefit plan? How are these normally set up? What do defined benefit plans require the services of?
A defined benefit plan is designed to offer the participant a retirement benefit that is known or defined (can be fixed percentage of salary - such as 74% of their average earnings during their first highest paid years; others are structured to pay a fixed sum of money for life.)
Require the services of an actuary to determine employer's contribution to the plan, based on life expectancy and benefits promised
119
What is a defined contribution plan?
Only the amount of money that is deposited into the account is known, such as 6% of the employee's salary.. Both employee and employer may contribute a percentage into plan and money is allowed to grow tax deferred
120
What is the employee's maximum contribution allowed to a defined contribution plan? How are these taxed?
18K/year
| All withdrawals from pension plans are taxed as ordinary income in the year in which the distribution is made.
121
What are the types of defined contribution plans (5)?
1. 401K
2. Money purchase plan
3. Profit sharing
4. Thrift plans
5. Stock bonus plans
122
What are profit-sharing plans?
Let employer reward the employees by letting them "share" in a percentage of the corporation's profits.
Profit-sharing plans are based on a preset formula and the money may be paid directly to the employee or placed in a retirement account.
123
What is needed for a profit-sharing plan to be qualified?
Corporation must have substantial and recurring profits.
124
What is maximum contribution of profit sharing plan?
Lesser of 15% of employee's compensation of $54K
125
What is a 401K and thrift plan?
401K and thrift plans allow the employee to contribute a fixed percentage of their salary to their retirement account and have the employee match some of all of their contributions.
126
What is a "self directed 401K plan"?
One where individual or plan participant selects the investments to be made in the account from a list of investment choices.
127
What are the 3 roles in creation and administration of a 401K plan?
1. The employer - the entity that creates the plan for the employees and known as the "creator or plan sponsor"
2. The investment adviser - company who determines the investment choices will be offered to the participants and who executes the orders entered by the participants
3. The plan administrator/trustee - also known as "third-party administrator" - the company that has physical custody of the plan's assets and provides communication to the participants regarding the plan.
128
What are the 2 ways an employee can move their pension plan to another company's plan or qualified account?
Rolling over the plan - employee takes physical possession of the assets. Plan administrator is required to withhold 20% of the total amount to be distributed and the employee has 60 days to deposit 100% of assets into another qualified plan. Employee must file with the federal government at tax time to receive a return of 20% of assets that were withheld by the plan administrator.
Direct transfer - assets in the plan go directly to another plan administrator and employee never has physical possession of the assets
129
What is an employee stock option?
Employers may establish stock option plans that allow employees to purchase shares of the employer's stock.
Employees who meet inclusion criteria in plan may be granted stock options to purchase the common stock of the employer at a stated exercise price
130
What are the two ways employee stock option plans can be established?
1. Nonqualified stock option plan - employee may exercise the options at the stated exercise price and sell the shares at the higher market price. (Difference between cost and sales proceeds for stock will be treated as compensation and taxed as earned income).
2. Incentive stock option plan - need to be approved by BOD and shareholders; if certain plan requirements are met under incentive stock option plan, any gain on the sale of the stock may be treated as capital gain.
131
What are the conditions for incentive stock option plan appreciation being treated as capital gain?
If employee has held stock purchased under an ISO for at least 2 years from grant date of the options and at least 1 year from the purchase/exercise date of the options, appreciation can be treated as capital gain.
132
What is ERISA?
The Employee Retirement Income Security Act of 1974 (ERISA) - federal law that establishes legal and operational guidelines for private pension and employee benefit plans. Also have "settlor" functions which are more business judgement type decisions.
133
What are 4 settlor functions of ERISA?
1. Choosing the type of plan, or options in the plan.
2. Amending a plan, including changing or eliminating plan options.
3. Requiring employee contributions or changing the level of employee contributions
4. Terminating a plan, or part of a plan, including terminating or amending as part of a bankruptcy process.
134
What 5 functions does ERISA also regulate?
1. Pension plan participation
2. Funding
3. Vesting
4. Communication
5. Beneficiaries
135
What are the two things that qualify employees to participate in pension plan?
1. They are at least 21 years old
| 2. They have worked at least one year full time (1000 hours)
136
How does ERISA regulate funding?
Plan funding requirements set forth guidelines on how the money is deposited into the plan and how employer and employee may contribute to the plan.
137
What are the restrictions for vesting schedules?
1. 3-6 year gradual vesting schedule
| 2. 3-year cliff; the employee is not vested at all until 3 years when they become 100% vested
138
What are rules for communication and beneficiaries by ERISA?
Communication - all corporate plans must be in writing at inception and the employee must be given annual updates
Beneficiaries - all plan participants must be allowed to select a beneficiary who may claim the assets in case of the plan participant's death
139
What is ERISA 404C Safe harbor? What 4 terms need to be met for this to be available?
ERISA Rule 404C provides an exemption from liability or a "safe harbor" for plan fiduciaries and protects them from liabilities that may arise from investment losses that result from the participant's own actions.
This safe harbor is available as long as:
1. The participant exercises control over the assets in their account
2. Participants have ample opportunity to enter orders for their account and to provide instructions regarding their account
3. A broad range of investment options is available for the participant to choose from and the options offer suitable investments for a variety of investment objectives and risk profiles.
4. Information regarding the risks and objective of the investment options is readily available to plan participants.
140
Who are considered to be fiduciaries of ERISA?
Investment advisers, trustees and all individuals who exercise discretion over the plan including those who select the administrative personnel and committee
141
What are the fiduciary standards for financial professionals who service retirement accounts for clients laid out by the Department of Labor?
Require financial professionals to place the interest of the client ahead of the interest of the broker dealer or investment advisory firm.
Professionals who service retirement accounts are still permitted to earn commissions, however rule requires that the client receive significant disclosures relating to fees and costs associated with servicing the account.
Broker dealers and advisory firms must establish written supervisory procedures and training programs to supervise and educate personnel on new requirements for retirement accounts.
Most representatives will not be required to obstain Series 65 or Series 66 to comply with new Department of Labor rules.
142
What is life insurance? What are the 4 types of life insurance policies?
```
A contract between an individual and an insurance company that is designed to provide financial compensation to the policyholder's beneficiaries in the event of the policyholder's death.
Types of life insurance policies:
1. Whole life
2. Variable life
3. Universal life
4. Variable universal life
```
143
What is whole life life insurance?
A whole life insurance policy provides the insured with a guaranteed death benefit that is equal to the face amount of the policy as well as a guaranteed cash value that the policyholder may borrow against. The cash value of the policy is held in the insurance company's general account and is invested in conservative investments such as mortgages and real estate.
144
How do whole life insurance policy's cash value increase?
Increase each year as the premiums are paid and invested. The death benefit and the premium payments are fixed by the insurance company at the time of the issuance and remain constant for the life of the policy.
145
How long is the policyholder of whole life insurance covered? Variable life insurance?
Whole and variable - From the date of issuance to the date of death, as long as premiums are paid.
146
What is Variable life insurance?
A variable life insurance contract is both an insurance policy and a security because of the way the insurance company invests the cash reserves. A variable life policy is a fixed-premium plan that offers the contract holder a minimum death benefit. The holder of the variable life insurance policy may choose how cash reserves are invested. Cash value of the policy is not guaranteed.
147
What type of investment vehicles are offered for variable life policies?
Stocks, bonds, mutual funds, and other portfolios as investment options.
148
Where are the cash and securities held by the insurance company for a variable life insurance policy?
In a separate account which is required to register as either an open-end investment or as a UIT under the Investment Company Act of 1940.
149
How long must owners of variable life insurance policies be allowed to exchange the policy for a whole life policy?
24 months
150
When must loans to policyholders of variable life insurance be made available? How much percent of cash value must be available in the form of a loan?
3 years - loans become available (based on cash value of the contract)
Insurance company must make 75% of cash value available in the form of a loan (not required to make 100% of cash value available.
151
What happens if the death benefit become payable during the time the loan is outstanding?
The death benefit will be reduced by the amount of the loan.
If the cash value of the contract falls into a negative balance while a loan is outstanding, the insurance company can require that enough of the loan be repaid to restore a positive cash balance.
152
What is a universal life insurance policy?
Unlike whole and life variable life policies, this has no scheduled premium payments and at face amount that can be adjusted according to the policyholder's needs.
A universal life policy allows policyholder to decide when premiums are paid and to determine how large those payments will be (the face amount of the policy is adjusted accordingly).
Policyholder has no scheduled premium payments, but the insured must make payments frequently enough to support the policy (enough cash to support payment of mortality and expense costs).
153
What are the two interest rates associated with universal life insurance policies?
A contract rate - sets minimum interest rate that will be paid to the holder
Annual rate - is set each year based on prevailing interest rates.
154
What is a variable universal life policy?
Allows the policyholder the ability to determine when premiums are paid and to decide how large those payments are.
Net premium is invested in the insurance company's separate account, and the policy's cash value and variable death benefit are determined by the investment experience of the separate account.
Policy will remain in effect as long as there is enough cash value in policy to support cost of insurance.
Can have a minimum guaranteed death benefit, but does not have to.
Representatives must have both insurance and securities licenses.
155
What are the tax implications of life insurance policies?
Generally, premiums paid to the insurance company for the life insurance policy are not tax deductible for federal income tax purposes. However, should the death benefit become payable the amount paid out to the beneficiary will be received tax free.
It is important to recognize who the "owner" of the policy is - if the insured person is deemed to be the owner, then the amount of the death benefit payable on the contract will be included in the value of the person's estate for estate tax purposes.
156
What are rights of "owner" of universal life insurance policy?
Person has right to name beneficiary, borrow from the policy, transfer ownership, and determine how dividends or cash value are invested.
157
What happens if ownership is established in an ILT (irrevocable life insurance trust)?
Death benefit will not impact the value of the insured's estate.
158
What is a tax advantaged health savings account good for?
To help offset potential impact of medical expenses incurred by individuals who maintain a high deductible health insurance plan.
Many individuals select a health insurance plan with a high deductible to lower the monthly premium expense.
159
Who can contribute to health savings account? What affects contribution limit? Pretax or after tax?
Individual, employer, or both can make contributions.
Contribution limit varies based on person's age and the type of health insurance coverage.
Pretax dollars, grow deferred and can be used tax free for qualified medical expenses (prescription drugs are considered to be qualified medical expense)
If money is used for non-qualified medical expenses, money will be subject to income taxes and could be subject to a 20% penalty tax.
160
How does money of health savings account work if owner dies?
Money is allowed to accumulate over time and any unused amounts may be carried over to future years.
If owner dies, the account will pass to the owner's spouse and will be treated as the spouse's HSA.
If beneficiary is not spouse, account will cease to be an HSA and the amount will be taxable to the beneficiary in the year in which the owner dies.
161
What are the two methods that an investor can use to analyze a potential equity investment?
1. Fundamental analysis - concerned with financial performance of the company
2. Technical analysis - uses past price performance of the stock to predict the stock's future price performance (not concerned with company's finances, only price patterns of stock)
162
What will a fundamental analyst examining the company's overall financial performance use to determine value for company's stock? (6)
1. Balance sheet
2. Income statement
3. Footnotes to financial statements
4. Financial ratios
5. Liquidity ratios
6. Valuation ratios
163
What will the balance sheet show?
Everything the corporation owns (assets) and owes (liabilities) at the time the balance sheet was prepared
164
What is "Assets - liabilities" equal to?
Net worth of corporation (The net worth is the shareholders' equity)
165
What is balance sheet equation?
Assets = liabilities + shareholder's equity
166
What are the 3 asset entries on balance sheet?
Current assets, Fixed assets, and other assets
167
What are the 8 liabilities and shareholder's equity terms on the balance sheet?
Current liabilities, long-term liabilities, equity/net worth, preferred stock par value, common stock par value, additional paid in surplus, treasury stock, retained earnings.
168
What are current assets? What do current assets include? (5)
Cash and assets that can be converted into cash within 12 months.
Current assets include:
1. Money market instruments
2. Marketable securities
3. Accounts receivable net of any delinquent accounts
4. Inventory including work in progress
5. Prepaid expenses
169
What are fixed assets? What do fixed assets include (2)?
Fixed assets are assets that have a long useful life and are used by the company in the operation of its business.
Fixed assets include:
1. Plant and equipment
2. Property and real estate
170
What are other assets? What do these include (4)?
```
Intangible/non-physical assets that belong to the company.
Other assets include:
1. Goodwill
2. Trademarks
3. Patents
4. Contract rights
```
171
What are current liabilities? What do they include (5)?
Current liabilities are obligations that must be paid within 12 months.
Current liabilities include: (listed in order of when they are due)
1. Wages payable, including salaries and commissions owed to employees
2. Accounts payable to vendors and suppliers
3. Current portion of long-term debt; that is, any portion of the company's long-term debt due within 12 months
4. Taxes due within 12 months
5. Short term notes due within 12 months
172
What are long term liabilities? What do these include (3)?
```
Debts that will become due after 12 months
Long-term liabilities include:
1. Bonds
2. Mortgages
3. Notes
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173
What is "funded debt"?
The corporation's debt which becomes due in five years or more.
174
What 3 categories is stockholders' equity (net worth) broken up into?
1. Capital stock at par: the aggregate par for both common and preferred stock
2. Additional paid in surplus: sometimes known as capital in excess of par is any sum paid by investors when the shares were issued by the company
3. Retained earnings: profits that have been kept by the corporation, sometimes known as earned surplus
175
What does the term capitalization refer to? What are used to determine company's capitalization (2)?
Refers to the sources and makeup of the company's financial picture
Used to determine cap:
1. Long term debt
2. Equity accounts, including par value of common and preferred and paid in and earned surplus
176
What does it mean when a company is said to be highly leveraged? What is considered to be more conservative method for corporation to raise money?
Company that borrows a large portion of its capital through the issuance of bonds
More conservative method is sale of common stock since the corporation doesn't need to pay money back
177
What are the 7 transactions that affect the balance sheet? How do each affect balance sheet?
1. Purchasing equipment for cash - long term asset will increase and cash and current assets will be decreased
2. Depreciation - impacts both income statement and balance sheet of a corporation; Accumulated depreciation reduces value of the asset on company's balance sheet
3. Issuing securities - If the company were to issue additional shares of $1 par common stock, the net worth of the company would increase by the amount of the par value sold, plus any paid in surplus. Company's cash position would also be increased by the net proceeds of the offering.
4. Declaring a dividend - Corporation's retained earnings are reduced by the amount of the dividend and the company's current liabilities are increased by the amount of the dividend payable. (Once dividend is paid, company's cash and current assets are reduced by amount dividend paid -payment also eliminates current liability)
5. Conversion of convertible securities - if holder of convertible bond converts the bond into common stock, the par value of the bonds will be eliminated as a long-term liability and the par value will be credited to the equity account on balance sheet
6. Bond redemption - If corporation uses cash to pay off principal amount of bonds (at maturity), then long term liabilities and cash and current assets will be reduced by equal amount
7. Stock splits - Shareholders' equity is not affected as a result of a stock split
178
How does depreciation affect taxable income?
Company's taxable income is reduced by the amount of depreciation taken in the current period
179
What are the two types of depreciation?
Straight line depreciation - Taken in equal amounts over the estimated useful life of the asset
Accelerated depreciation - Depreciates most of the value of the asset in the first few years of useful life and by lesser amounts during the remaining years.
180
What happens to number of shares outstanding in forward and reverse stock split?
Forward stock split will increase the number of shares outstanding and reduce par value of the shares.
Reverse stock split will reduce number of outstanding shares and increase the par value.
181
What financial information (10) might a fundamental analyst be looking for on a balance sheet?
1. Net worth
2. Working capital
3. Current ratio
4. Quick assets
5. Acid test ratio/quick ratio
6. Cash assets ratio
7. Debt-to-equity ratio
8. Common stock ratio
9. Preferred stock ratio
10. Bond ratio
182
What is "book value per share" formula and purpose?
```
Formula is (Assets - liabilities - intangibles - par value of preferred)/No. of outstanding common shares
Purpose: To determine the value of the company's common stock
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183
What is "working capital" formula and purpose?
Formula: Current assets - current liabilities
Purpose: To determine the company's liquidity
184
What is "current ratio" formula and purpose?
Current ratio = Current assets/Current liabilities
| Purpose: A relationship between current assets and liabilities
185
What is "quick assets" formula and purpose?
Quick assets = current assets - inventory
| Purpose: To determine highly liquid assets
186
What is "acid test/quick ratio" formula and purpose?
Acid test = Quick assets/Current liabilities
| Purpose: To determine the company's liquidity
187
What is "cash assets ratio" formula and purpose?
Cash assets ratio = Cash & Equivalents/Current liabilities
Purpose: The most stringent liquidity measure
188
What is "debt-to-equity ratio" formula and purpose?
Debt-to-equity ratio = Total long term debt/Total shareholders' equity
Purpose: To examine the company's capital structure
189
What is "common stock ratio" formula and purpose?
Common stock ratio = Common shareholders' equity/Total capitalization
Purpose: To examine the company's capital structure
190
What is "preferred stock ratio" formula and purpose?
Preferred stock ratio = Preferred stock/Total capitalization
| Purpose: To examine company's capital structure
191
What is "bond ratio" formula and purpose?
Bond ratio = Total long term debt/total capitalization
| Purpose: To examine the company's capital structure
192
What does a company's income statement detail?
A corporation's revenue and expenses for the period for which it was produced.
193
How often are income statements usually prepared?
Quarterly and annual basis
194
What are the 3 levels of earnings listed on the income statement?
1. Operating income
2. Net income after taxes
3. Earnings available to common
195
What is operating income? What is it also known as?
Business profit or loss from operations and is known as earnings before interest and taxes (EBIT)
196
What is net income after taxes?
Corporation's earnings after all federal and state taxes have been paid. Dividends to shareholders will be paid from net income after taxes.
197
What is earnings available to common?
What is left from the corporation's net income after taxes, after the corporation has paid preferred dividends (if a corporation wants to pay a dividend to common shareholders, then the preferred dividends must have already been paid).
198
What information can the analyst determine from what is contained in the balance sheet and the income statement? (5)
1. Earnings per share primary
2. Earnings per share fully diluted
3. Price earnings ratio
4. Dividend payout ratio
5. Debt service ratio
199
What is earnings per share primary?
Will tell analyst how much of the company's earnings are credited to each common share
Earnings available to common/# of common shares
200
What is earnings per share fully diluted? Formula?
Will tell how much of company's earnings are credited to each common share after all convertible securities and all rights and warrants have been exchanged for common stock.
Earnings available to common/# of common share
201
What is price earnings ratio?
Relationship between earnings per share and the common stock price
Stock price/Earnings per share
202
What is dividend payout ratio? Formula?
How much of earnings per share were paid out to shareholders as dividends
Annual dividends per common share/EPS
203
What is debt service ratio? Formula?
Tells the ability of the company to meet their debt service obligations.
EBIT/annual interest and principal payments.
204
What are the 3 industry categories that show how susceptible the company's earnings are to a change in the economy?
1. Growth industries
2. Cyclical industries
3. Defensive industries
205
What are growth industries?
Earnings of companies in these will grow faster than overall growth of economy as a whole (computers and technology).
206
What are cyclical industries?
The earnings of a company are highly susceptible to the condition of the overall economy (include manufacturing, raw materials, automobiles)
207
What are defensive industries?
The earnings of a company will be the least susceptible to the changes in the overall economy (food and pharmaceuticals) - these things people will buy no matter how the economy is performing
208
Why may a dividend valuation model be used?
To determine a fair valuation for an equity security and to determine if an investment is warranted.
209
What are the 2 dividend valuation models?
Dividend discount model - Takes the sum of all future dividends to be received and discounts them into a net present value. Model states that the market price of the stock should be equal to the net present value of all future cash flows.
Annual dividend/Rate paid by other similar investment (estimate of value)
Ex: If utility stock is paying a $2 annual dividend and other similar utilities are yielding 5%, the market price can be estimated to be $40 ($2/.05 = $40)
Dividend Growth Model - values the stock based on the net present value of the cash flow to be generated by a dividend that is expected to grow over time. (net present value is significantly higher for an equity with a dividend that is predicted to grow)
210
What does technical analyst use to determine future stock price?
Uses patterns created by the past price performance of the stock to predict the direction of the stock price in the future.
211
What are some of the chart patterns that a technical analyst will look to identify? (5)
```
1. Support
2 Resistance
3. Trend lines
4. Reversals
5. Consolidations
```
212
What is a support chart pattern? What is resistance?
Support is created at the point to which the stock falls and attracts buyers. The new buyers that are brought into the market, because of the lower price, create demand for the stock and prevent it from falling any further.
Resistance is created at the point to which the stock appreciates and attracts sellers, new sellers that are brought into the market because of the higher price, create supply for the stock and prevent it from rising any further.
213
What is upward trend line? Downward trend?
Characterized by a series of higher highs and a series of higher lows. The chartist would draw a line connecting the series of higher lows to confirm the trend and the trend line should provide some support to the stock price.
Downward trend - Series of lower highs and series of lower lows. Chartist would draw a line connecting the series of lower highs.
214
What are reversals?
Indicates a significant change in the price action of the stock. A bullish reversal indicates the end of a downward trend and the beginning of a new upward trend.
A bearish reversal indicates the end of an upward trend and the beginning of a new downward trend.
One of th emost significant reversal patterns is the head-and-shoulders formation -"top" -a bearish reversal of an uptrend, while a head-and-shoulders "bottom" is a bullish reversal of a downtrend.
215
What is consolidation?
A consolidation pattern is characterized by a horizontal movement in the stock price. Buyers and sellers are attracted to the market and are willing to trade the stock at almost the same prices.
216
What 3 indicators will a technical analyst look at to interpret the overall market's direction?
1. Short interest
2. Odd lot trading
3. Advance decline line
217
What is short interest?
Investors who have sold stock short are betting that the stock price falls. In order to close out their position, they must repurchase the stock. All investors who have sold stock short must eventually repurchase the stock. Because all of the short sellers are potential buyers for the stock, a high short interest is considered a bullish indicator.
218
What is odd lot trading?
Odd lot trading theory believes that smaller investors, who cannot afford to buy or sell one round lot of stock, will invariably buy and sell at the wrong time.
A high level of odd lot purchases is indicative of a market top, high level of odd lot sales is indicative of a market bottom
219
What is advance decline line?
Indicates the breadth of the market. The market's breadth is a good indicator of the overall health of the market and can be used to confirm or reject a trend.
Advance decline line will tell an investor how many stocks are trading higher in price and how many are trading lower in price.
220
What is efficient market theory? What are the 3 types?
Believes all of the available information is priced into the market at any given time and it is impossible to beat the market by taking advantage of price of time inefficiencies.
1. Weak form efficiency
2. Semi-strong form efficiency
3. Strong-form efficiency
221
What is weak-form efficiency?
States that the future price of a security cannot be predicted by studying the past price performance of the security. This form of theory believes that technical analysis cannot produce excess returns as all of the past prices and volume information related to a security are widely known.
222
What is semi-strong form efficiency?
States that the market price of a security adjusts too rapidly to newly available information to achieve an excess return by trading on that information.
223
What is strong-form efficiency?
States that the current price of a security reflects all information known and unknown to the public and there is no opportunity to earn excess returns. Investors who subscribe to strong form believe that even someone in possession of non-public material info will not be able to earn excess returns by trading on that information.
224
What is the random walk theory?
States that prices of securities adjust too rapidly to all info and that throwing a dart at a listing of stocks would produce the same returns as detailed analysis.
225
What are the 3 statistical measures to determine the midpoint of the range of distributions under the curve of a security's trading price?
1. Arithmetic mean - found by adding all of the price observations together and dividing the total by the number of price observations (average price security traded over observation period)
2. Median - Exact middle of all price observations
3. Mode - Price observations that appears more frequently on price distribution curve.
226
What does the company's market capitalization refer to?
Total value of all outstanding common shares
227
Market cap is divided into the following 3 categories?
1. Large cap - companies with a market value of greater than $5B
2. Middle cap - companies with a market value between $1-5B
3. Small cap - companies with a market value less than $1B
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What do investors use market indexes for? What two main types are they characterized as?
As a way to measure the performance of the overall market and to measure the performance of a portfolio against a benchmark index.
Capitalization-Weighted and Price-Weighted Index
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What is Capitalization-Weighted Index? What are examples of cap-weighted indexes?
Market benchmark whose value is derived from the price action of the companies whose shares are included in the index. More weight is given to the price performance of the shares of the companies with the greatest market capitalization. (NASDAQ composite, NASDAQ 100, NYSE Composite, Russell 2000, S&P500, S&P100, Wilshire 5000 are all cap-weighted indexes.)
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What is price-weighted index? What are examples?
Market benchmark whose value is derived from the price action of the companies whose shares are included in the index. More weight is given to the price performance of the shares of the companies with higher stock prices. (a change in the price of a $100 stock would have a greater impact on the value of the index than a change in the share price of a $10 stock). The Down Jones Industrial, Transportation, and Utility averages are all price weighted indexes
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What is international index? Examples?
Foreign markets also have created indexes to track performance of markets (Nikkei in Japan, FTSE in England, DAX in Germany)
