Series 65 wk 6 Flashcards
(192 cards)
1
Q
What is an option?
A
A contract between two parties that determines the time and price at which a stock may be bought or sold. The two parties to the contract are the buyer and the seller.
2
Q
What is an option premium? What are the rights of the buyer and obligation of the seller?
A
The option premium is the money the buyer of the option pays to the seller. For this premium, the buyer obtains a right to buy or sell the stock depending on what type of option is involved in the transaction. The seller has obligation to perform under contract (depending on option involved, may have obligation to buy or sell the stock).
3
Q
How are options classified (3)?
A
- Type
- Class
- Series
4
Q
What are the two types of options?
A
- Calls
2. Puts
5
Q
What is a call option?
A
A call option gives the buyer the right to buy or to “call” the stock from the option seller at a specific price for a certain period of time. The sale of the call option obligates the seller to deliver or sell that stock to the buyer at that specific price for a certain period of time.
6
Q
What is a put option?
A
A put option gives the buyer the right to sell or to “put” the stock to the seller at a specific price for a certain period of time. The sale of a put option obligates the seller to buy the stock from the buyer at that specific price for a certain period of time.
7
Q
What does an option class consist of?
A
Consists of all options of the same type for the same underlying stock. For example: all XYZ calls would be one class of options and all XYZ puts would be another class of options
8
Q
What does an option series consist of?
A
Only options of the same class with the same exercise price and expiration month. For example, all XYZ June 50 would be one series of options and all XYZ June 55 calls would be another series of options.
9
Q
What are the two attitudes that option investors can be?
A
Bullish or bearish
10
Q
What does it mean if an investor is bullish? What are two actions that support being bullish?
A
Investors who believe a stock price will increase over time. Investors who buy calls are bullish on the underlying stock. They believe stock price will rise and have paid for the right to purchase the stock at a specific price known as the exercise price or strike price. An investor who has sold puts is also considered to be bullish on the stock. The seller of a put has an obligation to buy the stock and therefore believes stock price will rise.
11
Q
What does it mean if an investor is bearish? What are two actions that support being bearish?
A
Investors who believe that a stock price will decline are said to be bearish. The seller of a call has an obligation to sell the stock to the purchaser at a specified price and believes that the stock price will fall and is therefore bearish. The buyer of a put wants the price to drop so that they may sell the stock at a higher price to the seller of the put contract, and is also therefore bearish.
12
Q
What are the two terms that buyer and seller are known as (2 each)?
A
Buyer – Owner; Long
Seller – Writer; Short
13
Q
What does buyer and seller “have”? (1 each)
A
Buyer has rights; Seller has obligations
14
Q
What is the objective of the buyer vs. seller?
A
Buyer – Maximum speculative profit
Seller – Premium income
15
Q
When does the buyer vs. seller enter a contract?
A
Buyer – with an opening purchase
Seller – with an opening sale
16
Q
What type of option does a buyer vs. seller want?
A
Buyer wants the option to exercise while seller wants option to expire
17
Q
What are the possible outcomes for an option?
A
- Exercise
- Sold
- Expire
- Exercise price
18
Q
What does it mean if the option is exercised?
A
The buyer has elected to exercise their rights to buy or sell the stock depending on the type of option involved. Exercising an option obligates the seller to perform under the contract.
19
Q
What does it mean if option is sold?
A
Most individual investors will elect to sell their rights to another investor rather than exercise their rights. The investor who buys the option from them will acquire all the rights of the original purchaser.
20
Q
What does it mean if option expires?
A
If option expires, the buyer has elected not to exercise their right and the seller of the option is relieved of their obligation to perform.
21
Q
What is the exercise price? What is it also known as?
A
Exercise price is the price at which an option buyer may buy or sell the underlying stock depending on the type of option involved in the transaction.
Also known as strike price
22
Q
Where are all standardized option contracts issued and their performance guaranteed?
A
Options Clearing Corporation (OCC)
23
Q
Where do standardized options trade?
A
On exchanges such as the Chicago Board Options Exchange and the American Stock Exchange
24
Q
How many shares do all option contracts count for?
A
All option contracts are for one round lot of the underlying stock or 100 shares
25
How do you determine the amount that an investor either paid or received for the contract?
Take the premium and multiply it by 100
Ex: If an investor paid $4 for 1 KLM August 70 call, they paid $400 for the right to buy 100 shares of KLM at $70 per share until August
If another investor paid $2 for 1 JTJ May 50 put, they paid $200 for the right to sell 100 shares of JTJ at $50 until May
26
In an option trade, both the buyer and seller establish their position with what?
An opening transaction
27
During an opening transaction, what does buyer and seller have (1 each)?
Buyer has an opening purchase and seller has an opening sale
28
In order to exit option position, what must an investor do?
Close out the position
29
What are the 3 ways the buyer of the option may exit their position?
1. A closing sale
2. Exercising the option
3. Allowing the option to expire
30
What are the 3 ways the seller of an option may exit or close out their position?
1. A closing purchase
2. Having the option exercised or assigned to them
3. Allowing the option to expire
31
What do most investors do with options?
They don’t exercise their options and will simply buy and sell options in the same way they would buy or sell other securities.
32
When buying or selling calls OR buying or selling puts, what are the 3 things a buyer must look at when establishing their position?
1. Maximum gain
2. Maximum loss
3. Breakeven
33
In a long call position, maximum gain is what?
Always unlimited
34
Whenever an investor is long call or owns a stock, what is the risk to their maximum loss?
Maximum loss is always limited to the amount they invested. When an investor purchases a call option, the amount they pay for the option or their premium is always going to be their maximum loss.
35
How do you determine breakeven for long calls?
An investor who has purchased calls must determine where the stock price must be at expiration in order for the investor to break even on the transaction.
To determine break-even point on a long call: Breakeven = strike price + premium
36
What is maximum gain, maximum loss and breakeven for Long 1 XYZ May 30 call at 3?
Maximum gain: Unlimited
Maximum loss: $300 (amount of premium price)
Breakeven: $33 = $30 + $3 (strike price + premium)
If expiration XYZ is at exactly $33/share and the investor sells or exercises their option, they will break even excluding transactions costs.
37
How does an investor expect to make a profit by selling calls?
An investor who sells a call believes that the underlying stock price will fall and that they will be able to profit from a decline in the stock price by selling calls.
An investor who sells a call is obligated to deliver the underlying stock if the buyer decides to exercise the option.
38
When selling a call, what is upside for their maximum gain?
For an investor who has sold uncovered or naked calls, maximum gain is always limited to the amount of the premium they received when they sold the calls
39
What is maximum loss for short calls?
An investor who has sold uncovered or naked calls does not own the underlying stock and, as a result, has unlimited risk and the potential for an unlimited loss. The seller of the calls is subject to a loss if the stock price increases. Because there is no limit to how high a stock price may rise, there is no limt to the amount of their loss.
40
How do you determine the breakeven for short calls?
An investor who has sold calls must determine where the stock price must be at expiration in order for the investor to break even on the transaction. An investor who has sold calls has received the premium from the buyer in the hopes that the stock price will fall. If the stock appreciates, the investor may begin to lose money. The stock price may appreciate by the amount of the option premium received and the investor still will break even at expiration.
Formula to determine breakeven point on a short call: Breakeven = strike price + premium
41
What is investor’s maximum gain, maximum loss and breakeven for Short 1 XYZ May 30 call at 3?
Maximum gain: $300 (amount of the premium received)
Maximum loss: Unlimited
Breakeven: $33 = $30 = $3 (strike price + premium)
If at expiration XYZ is at exactly $33 per share and the investor closes out the transaction with a closing purchase or has the option exercised against them, they will break even excluding transactions costs.
42
How are buyer’s and seller’s maximum gain/loss connected?
Buyer’s maximum gain is the seller’s maximum loss and the buyer’s maximum loss is the seller’s maximum gain. Both buyer and seller will break even at same point.
43
How can an investor profit from purchasing a put?
An investor who purchases a put believes that the underlying stock price will fall and that they will be able to profit from a decline in the stock price by purchasing puts. An investor who purchases a put can control the underlying stock and profit from its price decline while limiting their loss to the amount of the premium paid for the puts.
44
What is the advantage for an investor for buying puts?
Buying puts allows the investor to maximize their leverage while limiting their losses and the investor may realize a more significant percentage return based on their investment.
45
What is maximum gain for a long put?
Limit to how far a stock price may decline, as a result, the investor who believes that the stock price will fall has a limited maximum gain.
Formula: Maximum gain = strike price – premium
46
What is the maximum loss for a long put?
Maximum loss is always limited to the amount they invested. When an investor purchases a put option, the amount they pay for the option or their premium is always going to be their maximum loss.
47
How do you determine breakeven for long puts?
Whenever an investor has purchased a put, they believe that the stock price will decline. In order for the investor to break even on the transaction, the stock price must fall by enough to offset the amount of the premium paid for the option. At expiration, formula for breakeven:
Breakeven = strike price – premium
48
What is investor’s maximum gain, maximum loss and breakeven for Long 1 XYZ May 30 put at 4?
Maximum gain: $26 or $2600 for the whole position (strike price – premium)
Maximum loss: $400 (amount of the premium paid)
Breakeven = $26 = 30-4 (strike price – premium)
49
Why would an investor sell a put?
An investor who sells a put believes that the underlying stock price will rise and that they will be able to profit from a rise in the stock price by selling puts. An investor who sells a put is obligated to purchase the underlying stock if the buyer decides to exercise the option.
50
What is maximum gain for short puts?
For an investor who has sold uncovered or naked puts, maximum gain is always limited to the amount of the premium they received when they sold the puts.
51
What is maximum loss for short puts?
An investor who believes that the stock price will rise has a limited maximum loss, because worst case scenario stock goes to zero and they are forced to purchase it at the strike price from the owner of the put.
Formula: Maximum loss = strike price – premium
52
How do you determine breakeven for short puts?
Investor who has sold a put, believes that the stock price will rise. If the stock price begins to fall, the investor becomes subject to loss. In order for investor to break even on the transaction, the stock price may fall the amount of the premium they received for the option. At expiration:
Breakeven = strike price – premium
53
What is the maximum gain, maximum loss, and breakeven for Short 1 XYZ May 30 put at 4?
Maximum gain: $400 (amount of the premium received)
Maximum loss: $26 or $2600 for the whole position (strike price -premium)
Breakeven = $26 = 30-4 (strike price – premium)
If XYZ is at exactly $26 per share at expiration and the investor closes out the position with a closing purchase or has the option exercised against them, they will break even, excluding transaction costs.
54
How are buyer’s and seller’s maximum gain/loss connected?
Buyer’s maximum gain is the seller’s maximum loss and the buyer’s maximum loss is the seller’s maximum gain. Both the buyer and seller will break even at the same point.
55
What is an option premium?
The price of an option
56
What are the factors that determine the value of an option and as a result, its premium (5)?
1. Relationship of the underlying stock price to the option’s strike price
2. Amount of time to expiration
3. Volatility of the underlying stock
4. Supply and demand
5. Interest rates
57
An option can be what (3)? (This describes the relationship of the underlying stock to the option’s strike price.)
1. In the money
2. At the money
3. Out of the money
58
What is an “in-the-money” option?
A call is in the money when the underlying stock price is greater than the call’s strike price Ex: An XYZ June 40 call is $2 in the money when XYZ is at $42 per share
A put is in the money when the underlying stock price is lower than the put’s strike price. Ex: An ABC October 70 put is $4 in the money when ABC is at $66 per share.
It only makes sense to exercise an option if it was in the money.
59
What is an “at-the-money” option?
Both puts and calls are at the money when the underlying stock price equals the options exercise price.
60
What is an “out-of-the-money” option?
A call is out of the money when the underlying stock price is lower than the option’s strike price. Ex: An ABC November 25 call is out of the money when ABC is trading at $22 per share.
A put option is out of the money when the underlying stock price is above the option’s strike price. Ex: A KDC December 50 put is out of the money when KDC is trading at $54 per share.
It would not make sense to exercise an out-of-the-money option
61
What is intrinsic value and time value of an option?
An option’s total premium is comprised of intrinsic value and time value.
Option’s intrinsic value is equal to the amount the option is in the money.
Time value is the amount by which an option’s premium exceeds its intrinsic value
62
How can an investor use options as a hedge?
Many investors will use options to hedge a position that they have established in the underlying stock. Options can be used to guard against a loss or to protect a profit the investor has in a position. Options in this case will operate like an insurance policy for the investor.
63
What is a strategy of protecting option position from downside risk?
Long stock long puts/Married puts: An investor who is long stock can purchase a protective put for protection against loss if the stock falls. By purchasing the put, the investor has locked in or set a minimum sale price that they will receive in the event of the stock’s decline for the life of the put. The minimum sale price in this case is equal to the strike price of the put. However, by purchasing the put, the investor has increased their break-even point by the amount of the premium they paid to purchase the put.
64
What is the maximum gain for a long stock long put?
Unlimited
65
What is breakeven for a long stock long puts? What is maximum loss?
Breakeven = stock price + premium
Example: Long 100 XYZ at 55; Long 1 XYZ June 55 put at 3; Breakeven stock price needs to be at $58
Maximum loss = breakeven – strike price
In example: 58-55 = 3; Maximum loss is $3 per share or $300 for the entire position
66
What is maximum loss for Long stock long puts?
In order to determine maximum loss, need to first determine the breakeven point, then use formula:
Maximum loss = breakeven – strike price
67
What is the maximum loss for Long 100 XYZ at 58; Long 1 XYZ June 55 put at 2?
Need to find breakeven first: stock price + premium investor paid for put = 58 + 2 = 60
Maximum loss = breakeven – strike price = 60 -55 = 5
Investor’s maximum loss is $5 per share or $500 for entire position
68
What are long stock short calls/Covered calls?
An investor who is long stock can receive some partial downside protection and generate some additional income by selling calls against the stock they own. The investor will receive downside protection or will hedge their position by the amount of the premium received from the sale of the call. Although the investor will receive partial downside protection, they will also give up any appreciation potential above the call’s strike price.
69
How does an investor determine breakeven for long stock short calls?
By selling the calls, the investor has lowered their breakeven on the stock by the amount of the premium received from the sale of the call. To determine investor’s breakeven (the price to which the stock can fall):
Breakeven = purchase price of the stock – premium received
70
What is breakeven for Long 100 ABC at 65 Short 1 ABC June 65 call at 4?
Breakeven = purchase price of stock – premium received “65-4 = 61” Stock price in this case can fall to $61 and investor will still break even
71
What is maximum gain for long stock short calls?
Because the investor has sold call options on the stock that they own, they have limited the amount of their gain; any appreciation of the stock beyond the call’s strike price belongs to the investor who purchased the call.
Maximum gain = strike price – breakeven
72
What is maximum gain for Long 100 ABC at 65 Short 1 ABC June 65 call at 4?
Maximum gain = strike price – breakeven; 65-61 = 4 (Maximum gain for investor is $4/share or $400 for entire position
73
For a long stock short call position, when the purchase price of stock and strike price of the call are the same, what is maximum gain equal to?
The amount of the premium received on the sale of the call
74
What is maximum gain for Long 100 ABC at 65 Short 1 ABC June 70 call at 2?
Breakeven = purchase price of stock – premium received “65-2 = 63”
Maximum gain = Strike price – breakeven – 70-63 = 7
Investor’s maximum gain is $7/share or $700 for the entire position
75
What is maximum loss for long stock short calls?
An investor who has sold covered calls has only received partial downside protection in the amount of the premium received. As a result, the investor is still subject to significant loss in the event of an extreme downside move in the stock price. Said another way, an investor is subject to a loss equal to their break-even price per share
Maximum loss = breakeven - 0
76
What is maximum loss for Long 100 ABC at 65 Short 1 ABC June 70 call at 2?
The investor will breakeven at $63 (purchase price of stock – premium received) so maximum loss is $63/share or $6300 for entire position. The investor will realize their maximum loss if the stock goes to zero.
77
When would an investor do a Short stock long call?
An investor who sells stock short believes that they can profit from a fall in the stock price by selling it high and repurchasing it cheaper. An investor who has sold stock short is subject to an unlimited loss if the stock price should begin to rise. An investor who has sold stock short would receive the most protection by purchasing a call. A long call could be used to guard against a loss or to protect a profit on a short stock position. By purchasing the call, the investor has set the maximum price that they will have to pay to repurchase the stock for the life of the option.
78
How does an investor determine breakeven for a short stock long call?
An investor who has sold stock short will profit from a fall in the stock price. When an investor has purchased a call to protect their position, the stock price must fall by enough to offset the premium the investor paid for the call.
Breakeven = stock price – premium
79
What is breakeven for Short 100 ABC at 60 Long 1 ABC October 60 call at 2?
Breakeven = stock price – premium (60-2 = 58) Stock would have to fall to $58 by expiration in order for the investor to break even
80
What is maximum gain for short stock long calls?
Maximum gain on the short sale of stock is always limited because a stock cannot fall below zero. When an investor has a short stock long call position, their maximum gain is found by using the following formula:
Maximum gain = breakeven - 0
81
What is maximum gain for Short 100 ABC at 60 Long 1 ABC October 60 call at 2?
Maximum gain = breakeven – 0 (58-0 = 58); If stock fell to $0 by expiration, the investor would realize their maximum gain of $58 per share or $5800 for the entire position
82
What is maximum loss for short stock long call?
An investor who has sold stock short and has purchased a call to protect their position is only subject to a loss up to the strike price of the call. In order to determine the investor’s maximum loss:
Maximum loss = strike price – breakeven
83
What is maximum loss for Short 100 ABC at 60 Long 1 ABC October 60 call at 2?
Maximum loss = strike price – breakeven; 60-58 = 2; Investor is subject to a loss of $2/share or $200 for the entire position
84
What is the investor’s maximum loss when the sale price and strike price are the same?
The amount of the premium that the investor paid for the call
85
What is maximum loss for Short 100 ABC at 56 Long 1 ABC October 60 call at 2?
This investor will break even at $54 per share (strike price – breakeven); Investor is subject to a loss of $6 per share or $600 for the entire position
Breakeven = stock price – premium; Maximum loss = strike price – breakeven;
86
Why would an investor have a short stock short put?
An investor who has sold stock short can receive some protection and generate premium income by selling puts against their short stock position. Selling puts against a short stock position will only partially hedge the unlimited upside risk associated with any short sale of stock. Additionally, the investor, in exchange for the premium received for the sale of the put, has further limited their maximum gain.
87
How does investor determine breakeven for short stock short puts?
An investor who has sold stock short and sold puts against their position is subject to a loss if the stock price begins to rise. To determine how high a stock price could rise after establishing a short stock short put position and still allow the investor to breakeven:
Breakeven = Stock price + premium
88
What is breakeven for Short 100 ABC at 55 Short 1 ABC November 55 put at 4What is maximum gain for short stock short puts??
Breakeven = Stock price + premium (55 + 4 = 59)
In this case, the stock could rise to $59 by expiration and still allow the investor to breakeven excluding transaction costs.
89
What is maximum gain for short stock short puts?
An investor who has established a short stock short put position has limited the amount of their gain even further by selling puts, because the investor will be required to purchase the shares at the put’s strike price if the stock declines.
Maximum gain = breakeven – strike price
90
What is maximum gain for Short 100 ABC at 55, Short 1 ABC November 55 put at 4?
Max gain = 59 – 55 = 4; $4/share or $400 for the entire position
Maximum gain = breakeven – strike price; Breakeven = stock price + premium
91
What is maximum gain for Short 100 XYZ at 60, Short 1 XYZ November 55 put at 4?
Max gain = 64 – 55 = 9; Investor’s maximum gain is $9/share or $900 for total position
Maximum gain = breakeven – strike price; Breakeven = stock price + premium
92
How much has investor who sold puts against their short stock position limited their loss?
Only limited their loss by the amount of the premium received from sale of the put, investor’s loss in a short stock put position is still unlimited
93
For a long stock, what provides the most protection, what about some protection and income?
Most protection – Long puts; Some protection and income – Short calls
94
For a short stock, what provides the most protection, what about some protection and income?
Most protection – Long calls; Some protection and income – Short puts
95
What is a long straddle?
A long straddle is the simultaneous purchase of a call and a put on the same stock with the same strike price and expiration month. An option investor would purchase a straddle when he or she expects the stock price to be extremely volatile and to make a significant move in either direction. An investor who owns astraddle is neither bullish nor bearish. Such investors are not concerned with whether the stock moves up or down in price, so long as it moves significantly.
96
What is a short straddle?
A short straddle is the simultaneous sale of a call and a put on the same stock with the same strike price and expiration month. Options investors would sell a straddle when they expect the stock price to trade within a narrow range or to become less volatile and not to make significant move in either director. An investor who is short a straddle is neither bullish nor bearish, just converned that the stock does not move significantly.
97
What are futures?
Futures, like options, are a two party contract. Many future contracts are an agreement for the delivery of a specific amount of a commodity at a specific place and time. Futures begin to trade for commodities such as wheat and gold and over the years have expanded to include financial futures such as on Treasury securities and most recently, single stock futures.
98
How do most investors use futures?
As a hedge or to speculate on the value of the underlying commodity or instrument
99
What are forwards?
Forwards are privately negotiated contracts for the purchase and sale of a commodity or financial instrument. Forwards often are used in the currency markets by corporations and banks doing business internationally. If a corporation knows that it will need to make a payment for a purchase in foreign currency 3 months from now, the corporation can arrange to purchase the currency from a bank the day before the payment is due. There is no secondary market for forwards.
100
What does it mean for investments to be perfectly correlated?
If two investments move together at the same rate.
101
What does it mean for investments to be negatively correlated? What is an example?
If prices of two investments move in opposite directions. Example would be common stock and a put on the common stock (as price of stock increases, value of put decreases)
102
What does it mean to be uncorrelated?
Two investments move independently of one another.
103
What is a security?
Anything that can be exchanged for value that involves a risk to the holder. Also represents an investment in an entity managed by a third party.
104
What is the Howey test? What 4 characteristics?
A test used by the Supreme Court to determine a security. A security must meet the following 4 characteristics to be considered a security:
1. Be an investment of money
2. Involve a common enterprise
3. Give the investor an expectation of a profit
4. Entail the management of a third party
105
Name 8 examples of securities:
1. Stocks
2. Bonds
3. Notes
4. Debentures
5. Evidence of indebtedness
6. Transferrable shares
7. Warrants, rights, or options for securities
8. Mutual fund shares
9. Exchange traded funds and notes ETFs/ETNs
106
Most times when you see the term certificate, you have a security that is a (6):
1. Certificate of interest in profit sharing or a partnership agreement
2. Preorganization certificate
3. Collateral trust certificate
4. Voting trust certificate
5. Certificate of interest in oil or a gas mining title
6. Certificate of deposit for a security such as an American depositary receipt (ADR) or an American depositary share (ADS)
107
The term variable will also identify a security as in (3):
1. Variable annuity
2. Variable life insurance
3. Variable contract
108
The phrase “interest in” is another key identifying a security. What are 7 categories in “interest in”?
1. Farmland and animals
2. Whiskey warehouse receipts
3. Commodity options (not futures)
4. Insurance company separate accounts
5. Real estate condominiums or cooperatives
6. Merchandise marketing programs, franchises, or schemes
7. Multilevel distributorships such as Amway
109
The term option is also a good way to identify a security, include (4):
1. Stock option
2. Index option
3. Futures option
4. Commodity futures option
110
The following are not considered securities (11):
1. Real estate
2. Retirement plans such as IRAs and 401Ks
3. Bank accounts
4. Collectibles
5. Precious metals
6. Fixed annuities/fixed contracts
7. Whole and term life policies
8. Antiques
9. Futures contracts (commodities)
10. Trade confirmations
11. Prospectuses
111
What does the term person as it is used in the USA refer to? Who do these include (9)?
Any entity who may enter into a legally binding contract.
1. Natural person
2. Corporation
3. Trust
4. Government organization
5. Partnership
6. Joint stock company
7. Sole proprietor
8. Association
9. Unincorporated organization
112
What is a nonperson? What 3 are included in this definition?
A nonperson is an individual or entity who may not enter into a legally binding contract and therefore may not transact business in the securities market.
1. A minor
2. Someone deemed to be legally incompetent
3. A deceased individual
113
What is the definition of a broker dealer, what 5 things is it not?
A broker dealer is a person or a firm who maintains a place of business and affects transactions in the securities markets for its own account or for the account of others (must be registered in home state as well as state of individual clients). A broker dealer is not:
1. Agent
2. Bank
3. Saving and loan
4. Person with no place of business in the state, who deals exclusively with financial institutions or issues
5. Person with no place of business in the state who conducts business with existing clients who do not reside in the state and are in the state for less than 30 days
114
Who is an agent?
An agent or registered representative may only be an individual (natural person) who represents the issuer or a broker dealer in the purchase and sale or the attempted purchase and sale of securities with the public. Agents are required to register in their home state, their state of employment, and the state of residence of their customers.
115
When is an agent not required to register (2)?
1. When they represent the issuer or a broker dealer in an underwriting transaction
2. When they represent a bank or a savings and loan in the issuance of securities
116
What are examples of agents who are not required to register?
1. US government
2. State and municipal governments
3. Canadian federal and municipal governments
4. Commercial paper with maturities of less than 270 days, sold in denominations exceeding $50K
5. Investment contracts associated with employee pension plans, profit sharing, stock purchase, or savings plans
6. Foreign national governments recognized by the US
117
What is an issuer? Who do these include (3)
An issuer is any person who issues or simply proposes to issue a security.
1. Corporations
2. US government and agencies
3. State and local governments
118
What is a nonissuer?
Anyone who does not issue or propose to issue a security. All secondary market transactions that take place on exchange or OTC market are nonissuer transactions and selling security holder receives proceeds from the sale.
119
What is an investment adviser? (6)
Any person who is actively involved in and receives a fee for any of the following:
1. Issuing research reports or analysis
2. Publishing a market letter based on market events
3. Advising clients as to the advisability of the purchase or sale of a security
4. Providing investment advisory services as a complement ot their services and claiming to provide such services for a fee
5. Presenting themselves as investment advisers, also known as the Shingle Rule
Act as a pension consultant
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What is an investment adviser not (6)?
1. A bank or savings and loan
2. A broker dealer
3. An agent
4. A lawyer, accountant, teacher, engineer (LATE) whose services are incidental to their business and who do not receive a specific fee for such services
5. Any person exempted by the administrator
6. Publishers of newspapers and magazines
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What is a pension consultant?
Anyone who advises employees on how to fund their employee benefit plan. Would also be considered to be a pension consultant if they advise the employees on the selection of asset managers or investment advisers for the plan.
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Who can be considered investment counsel?
An investment counsel must be principally in the business of giving continuous investment advice and must supervise or manage the accounts. The Act does not define how much of the professional’s time musts be dedicated to providing advice, just that the professional’s principal business is giving advice.
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What are the key words that are key to meeting the definition of an investment counsel?
“Continuous and regular supervisory or management services”
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What is Form ADV?
An investment adviser begins formal registration process by filling out Form ADV. The ADV form will provide detailed information regarding the investment adviser and it is comprised of 4 parts.
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What are the 4 parts of the Form ADV? Which are given to clients?
1. Part 1A
2. Part 1B
3. Part 2A
4. Part 2B
Form ADV Parts 2A and 2B are provided to clients
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What does ADV Part 1A include (10)?
General information about the investment adviser including:
1. Principal office address
2. Information regarding direct owners
3. Type of organization such as corporation or partnership
4. How the adviser will conduct business
5. If the firm engages in other activities such as that of a broker dealer
6. Biographical data on the officers, directors, or partners
7. Disciplinary history of the officers, directors, partners, and the firm
8. Location of books and records if other than principal office
9. If the adviser has custody of customer assets
10. If the adviser has discretionary authority over customer assets
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What does ADV Part 1B provide details about?
Provides details on the indirect owners of the firm and is filed with the state securities administrator for advisers registered at the state level. Advisers who are federally registered do not file ADV Part 1B.
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What is Form ADV Part 2A? What does it include (5)?
ADV Part 2A is the adviser’s narrative brochure and will disclose information relating to clients. It will state:
1. How and when fees are charged
2. Types of securities the adviser does business in
3. How recommendations are made
4. Type of clients the adviser has
5. Qualifications of officers and directors
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What is Form ADV Part 2B? What does it include (2)?
ADV Part 2B provides information relating to individuals who:
1. Provide investment advice and who have direct contact with advisory clients
2. Have discretion over client assets regardless of whether the individual has contact with clients
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What do new rules about the form ADV require investment advisers to disclose on the form ADV (6)?
1. Total number of offices and detailed info relating to adviser’s 25 largest offices
2. Detailed info regarding adviser’s separately managed account including type of assets held, use of derivatives, leverage and ownership or operation of private funds
3. Detailed info regarding number of clients serviced by adviser and amount of assets managed for each category of client, such as individual, institutional and the like
4. Advisers with over $1B in assets under management must report the value of their AUM within one of three ranges: $1-10B, $10-50B, and greater than $50B
5. Advisers who utilize social media must disclose all social media accounts
6. If chief compliance officer of the firm is employed at any other adviser the fact must be disclosed to, but not approved by regulators
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What is the Investment Adviser Registration Database (IARD)?
Where investment advisers will file Form ADV and all of the required parts based on their business profile and place of registration. IARD is a centralized clearing-house for all investment adviser registrations. Advisers electronically file all required registration documents, disclosures and any required updates or amendments through the IARD.
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When must investment advisers file on IARD?
Must file annual updates to their Form ADV within 90 days of the end of the adviser’s fiscal year.
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What changes are advisers responsible for promptly filing to Form ADV through the IARD (8)?
1. Change in business location
2. Name changes
3. Changes in custody policy or location of assets
4. Material changes to the adviser’s brochure
5. Change of contact information or personnel
6. Change in legal structure (how the firm is organized, ie corporation, partnership, etc)
7. Changes to disciplinary history
8. Change in location of books and records
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Who is an investment adviser representative? Who does it include (4)?
A natural person who is under the control of the investment adviser and includes:
1. Officers and directors
2. Partners
3. Solicitors
4. Supervisors
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What is a solicitor?
A solicitor is any person who, for compensation, actively seeks new business for an investment advisor. Can also include professionals who refer clients to the investment adviser for a fee.
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What do all solicitors need to be registered as?
Investment adviser representatives
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What is a solicitor brochure? What does it include (2)?
Solicitors need to provide investors with this if they are introduced to an adviser through the use of a solicitor. Solicitor’s brochure will include details of solicitor’s relationship with the adviser and the compensation arrangement including the amount of the management fee paid to the solicitor.
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What is an access person?
Anyone employed by the investment adviser who has access to nonpublic information relating to activity and holdings in client accounts or in the investment adviser’s portfolio account. A person will also be deemed to be an access person if that individual makes recommendations to clients or has access to recommendations prior to the release of such recommendations
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Who are deemed to be access persons at advisory firms?
All of firms’ officers and directors at advisory firms where primary business is providing investment advice.
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What must all access persons report and to who?
Their personal transactions must be reported to the firm’s chief compliance officer or duly designated compliance officer.
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Who do institutional investors include (9)?
1. Broker dealers
2. Investment advisers
3. Investment companies
4. Insurance companies
5. Banks
6. Trusts
7. Savings and loans
8. Government agencies
9. Employment benefit plans with more than $1M in assets
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What is an accredited investor?
An individual who meets one or more of the following criteria:
1. Has a net worth of $1M excluding primary residence OR
2. Earns $200K per year or more for the last two years and has expectation of earning the same in the current year OR
3. Is part of a couple earning $300K per year or more
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What is a qualified purchaser? (3)
A qualified purchaser must meet strict minimum financial requirements. Securities sold to qualified purchasers are not required to register in the state where the qualified purchaser resides. A qualified purchaser is a:
1. Individual with at least $5M in investments
2. Family-owned business with at least $5M in investments
3. Trust sponsored by qualified purchasers
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What is a private investment company?
An unregistered investment company or hedge fund that raises funds through the sale of securities to qualified purchasers for any business purposes.
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What is a private investment company?
An unregistered investment company or hedge fund that raises funds through the sale of securities to qualified purchasers for any business purposes.
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What is an offer?
Any attempt to solicit the purchase or sale of a security for value. An offer is not considered to be made if it was received through a TV, radio broadcast, OR a newspaper, or magazine published out of state or a magazine published in state that has 2/3 of its paid circulation outside of the state.
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Where is an offer considered to have been made?
In the state where the offer originated as well as in the state where it is received or directed.
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Who does not have jurisdiction over offers?
State securities administrator does not have jurisdiction over offers that are deemed to be made exclusively outside of the administrator’s state.
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What does it mean to sell a security?
To sell a security, its ownership must be conveyed for value.
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When is a sale considered to have been made?
At the time of the contract (trade).
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What are all considered to be sales of securities (3)? What does it not include?
1. A sale of a security that has warrants or a right attached is also considered a sale of the attached security
2. A sale of a security that is convertible or exercisable into another security is considered to include a sale of the security for which the security is convertible or exercisable
3. A gift of assessable stock is also considered a sale.
A sale does not include a dividend or the pledge of a security for a collateral loan.
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What does the term guarantee mean?
Means that another party other than the issuer of the security has guaranteed the payment of principal, interest or dividends.
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Who are the 3 parties that may guarantee something?
1. US government
2. Insurance company
3. Parent company – they may guarantee obligations of a subsidiary.
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What is contumacy?
The willful display of contempt for the administrator’s order.
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What can contumacy result in?
The agent’s or firm’s registration being revoked or other disciplinary action. Administration may petition the court to have a person who has displayed contumacy for their order to be found in contempt of court. A finding of contempt of court may result in the court ordering a jail term.
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What is a federally covered exemption?
Provides for a full exemption from state registration for federally covered investment advisers and federally covered securities.
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What is a federally covered investment adviser?
One that meets the requirements for assets under management and is registered with the Securities Exchange Commission (SEC).
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What is included as a federally covered security (3)?
1. A security listed on a centralized US stock exchange or on the Nasdaq
2. An investment company security issued under the Investment Company Act of 1940
3. Securities sold to qualified purchasers
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What does a power of attorney allow?
A power of attorney once given to an individual allows that person to make decisions on behalf of the grantor with the same force and effect as if the grantor had entered into the agreement themselves.
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What is a limited power of attorney?
Most powers of attorney in the investment world are limited powers of attorney that allow an investment professional to purchase and sell securities without speaking to a client first.
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What is a full power of attorney?
Will allow the individual to withdraw cash and securities from an account.
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What is a standard power of attorney terminated?
Will terminate upon death or incapacitation of the grantor
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What is durable power of attorney?
Will remain in full force during the incapacitation of the grantor and will only terminate upon grantor’s death.
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What is escheatment?
In the event an account owner cannot be located after a significant effort by the broker dealer or investment adviser, the account will be considered to be abandoned and the state will claim the account through the escheatment process. The state will hold account on its records as a bookkeeping entry. The former account owner or their estate may make a claim for the assets if they become aware of the existence of the account.
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What is a negotiable certificate of deposit (CD)?
A negotiable CD is one that may be sold by the holder prior to the maturity date of the certificate. With a standard CD issued by a bank, if a holder needed to access funds prior ot maturity date, owner would pay a penalty for early termination. A negotiable or jumbo CD is issued by a bank for a time deposit in excess of $100K with many jumbo CDs being in excess of $1M. The CDs pay periodic interest and will trade in the money market with accrued interest. FDIC insurance only covers the first $250K of the principal amount should the bank fail.
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Prior to conducting business is any state, what does a broker dealer need to do?
Must be properly registered or exempt from registration in that state.
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When must a broker dealer register in the state?
If the firm has an office in the state. An agent must register in their state of residence even if their firm is located in another state.
Ex. An agent who lives in NJ and who commutes to their office in NY must register in both NJ and NY
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Where must agents also register?
In states where they sell securities or offer to sell securities as well as where they advertise. If the firm does not have an office in the state, they may or may not be required to register depending on with whom they do business. If a broker dealer does not have an office in the state and engages in securities transactions with the general public, then they must register.
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Broker dealers not required to register in that state if a broker dealer with no office in the state conducts business exclusively with what 11 parties?
1. Other broker dealers
2. Issuers of securities
3. Investment companies
4. Insurance companies
5. Banks
6. Savings and loans
7. Trust companies
8. Pension plans with more than 100 participants
9. Other financial institutions
10. Institutional buyers
11. Existing customers with less than 30 days’ temporary residency in the state (on vacation or business trips)
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A broker dealer will not be deemed to have a place of business in a state where it does not maintain an office simply by fact that firm’s website is accessible from that state as long as what 3 criteria are met?
1. The firm’s website clearly states that the firm may only conduct business in states where it is properly registered to do so
2. The firm’s website only provides general info about the firm and not give specific investment advice.
3. The firm may not respond to internet inquiries with the intent to solicit business without first meeting the registration requirements in the state of the prospective customer
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Who must register as an agent?
If agent works for a broker dealer, agent must register. Only exception is for officers and directors of a broker dealer who have no involvement with customers, securities transactions or supervision. If the agent works for an exempt issuer, the agent is exempt from registration no matter what security is involved.
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Who are considered exempt issuers (4)?
1. US and municipal governments
2. Canadian federal and municipal governments
3. Foreign federal governments recognized by the US
4. Banks, savings and loans, and trust companies
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When is an agent also exempt from registering (2)?
If they represent an issuer in the sale of an exempt security such as:
1. Bankers’ acceptances or time drafts with less than 270 days to maturity sold in denominations of $50K or more
2. Investment contracts relating to employee savings, stock purchase, pension plans, or other benefit plans as long as no commission is received for such sales.
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What must a broker dealer wishing to become registered in a state do?
Must first file an application with the state securities administrator. Must also pay all filing fees and sign the consent to service of process – this causes broker dealer to appoint administrator as their attorney and allows the administrator to receive legal papers for the applicant (All legal papers received by administrator will have same force and effect as if they were served on the broker dealer).
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What must all applications of registering broker dealers include (6)?
1. Types of organization (corporation, partnership)
2. Address of business
3. Description of business to be conducted
4. Backgrounds and qualifications of officers and directors
5. Disclosure of any legal actions
6. Financial condition
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When does the firm’s registration become effective?
At noon 30 days after the initial application has been received or at noon 30 days after the administrator has received the last piece of required information.
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What does registering a broker dealer in a state automatically require officers and directors to do?
Officers and directors who act in a sales capacity must now register as agents in that state.
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TAKE NOTE: Where must broker dealers register?
With the SEC and with states where they conduct business
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What are the financial requirements of the broker dealer?
Must meet SEC minimum net capital requirements.
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If broker dealer does not meet SEC’s net capital requirements, what are the required to do?
Must post a surety bond to ensure their solvency – the amount of the bond required by the administrator for broker dealers who have custody or discretion over client accounts is limited to the amount of capital required by the Securities Exchange Act of 1934.
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Broker dealers who offer investment services at bank branches must follow what guidelines?
1. Setting where broker dealer conducts its business should be separate from where the retail banking business is being conducted
2. Broker dealers must disclose to the customer at or before the time the customer opens the account that their deposits are not guaranteed by the FDIC or financial institution and are subject to loss of principal. (These same disclosures must also appear in all advertising and asles literature issued by broker dealer operating on the location of other financial institutions.
3. Host financial institution must sign an agreement stating that FINRA and SEC are allowed to have access to any location where member conducts its business
4. Member is required to promptly notify the financial institution if it terminates an associated person for cause.
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In addition to successfully passing the Series 65 exam, an agent must (3)?
1. Abide by and understand state securities laws and regulations
2. Recognize that the state may require additional certification regarding the state’s securities laws
3. Understand that they may not conduct business until they are properly registered.
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What does an agent need to do in order to be registered in any state?
Needs to be employed by a broker dealer or issuer.
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When an agent changes firms, who must notify the state securities administrator (3)?
The agent, the former employer and the new employer
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How is the state securities administrator notified when an agent changes employment?
The central registration depository (CRD) system
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When does an agent’s termination become effective after notifying the state of change in employment?
30 days unless administrator is in the process of suspending or revoking the agent’s registration. (The administrator may still revoke an agent’s registration for up to one year after their registration has been terminated.
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Who is notified if an agent is denied a registration as a result of information received on the agent’s form U5 termination notice filed by the previous employer?
Only new employer and agent are notified of the denial
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What must a broker dealer do when acquiring another broker dealer?
The successor firm must file an application for registration within the state which will become effective upon completion of the transaction
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When do all state registrations expire for all broker dealers, investment advisers, and agents?
December 31st
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What are broker dealers, investment advisers and agents required to do when registration expires?
File a renewal application and pay a renewal fee. The consent to service of process does not get refiled with the renewal application.
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When is a Canadian firm or agent not required to register under USA?
As long as they do not maintain an office within the state.
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State registration exemptions are made for investment advisers who (5):
1. Are federally registered
2. Manage portfolios for investment companies
3. Manage portfolios in excess of $110M
4. Have no office in the state and conduct business exclusively with financial institutions
5. Have no office in the state and offer advice to five clients or less in any 12-month period. This is known as the de minimis exemption
