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68 Cards in this Set
- Front
- Back
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REIT's
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REIT's are: i) own commercial property (equity REITs); ii) own mortgages on commercial property (mortgage REITs); iii) or do both (hybrid REITs). Org as Trusts. REIT can avoid being taxed as a Corp by receiving >75% of its income from RE & distributing > 90% of its taxable income to its shareholders, who are then subject to tax @ ordinary income tax rates.
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What are the top upsides and downsides to investing in REIT's?
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Upsides - i) The opp to invest in RE without the degree of liquidity risk as in direct ownership; ii)
A negative correlation to the general stock market; iii) reasonable income &/or potential capital appreciation. Downsides; i) Quality of mgmt imperative; ii) Problem loans in the portfolio could cause income &/or capital to decrease; iii) Dividends aren't considered qualified (for 15% max tax) & are taxed at full ordinary income rates. |
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Definition of 'Funded Debt'
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Aka 'Long Term Debt.' Borrowed for a min of 5 yrs - typically 20 - 30 however.
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Upsides and Downsides of investing in Bonds?
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Upside: For highly rated bonds; i) Safety of principal, ii) Steady stream of income; iii) fixed maturity date; iv) for HY bonds - possibility of very high income
Downside: i) possibility of default; ii) inflation risk; iii) interest rate risk HY Bonds < BB, Ba ratings. |
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Liquidation Priority of a Corporation
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1) Secured creditors (e.g., mortgage bonds, equipment trust certificates, collateral trust bonds); 2) Unsecured creditors (e.g., general creditors incl debenture holders) 3) Subordinated debt holders 4) Preferred stockholders 5) Common stockholders
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Upsides and Downsides of Muni Bonds
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Upsides; Safety rating 2nd only to that of US Govt secs. Tax-free income (especially beneficial to those in higher tax brackets); Downsides; i) credit risk (some municipalities have defaulted in the past): ii) Inflation risk & iii) interest rate risk as with any other bond: iv) Possible AMT
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Key Points on T-Bills
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(1) T-bills are the only Treasury security issued at a discount; (2) T-bills are the only Treasury security issued without a stated interest rate; (3) T-bills are highly liquid; and (4) The 90-day T-bills are used in market analysis as the stereotypical “risk-free” investment.
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Description of TIPS
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Issued with a fixed interest rate, but the principal amount is adjusted semiannually by an amount equal to the change in the CPI. The interest payment the investor receives every six months is equal to the fixed interest amount times the newly adjusted principal. TIPS are exempt from state and local income tax. In any yr when the principal is adjusted for inflation, that increase is considered reportable income for that year even though the increase will not be received until the note matures.
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Upsides and Downsides of US Govt Securities
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Upsides: i) Highest safety of principal and interest payments, ii) Liquidity iii) T-bills are a great place to keep “cash”; iii) TIPS give inflation protection iv) 1 common benefit to all other bonds—fixed maturity date, regular income. Downsides; i) Inflation risk (except TIPS) ii) Interest rate risk iii) Lower rates of return in exchange for greater safety
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Federal National Mortgage Association (FNMA) Securities
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Fannie mae purchases & sells RE mortgages—primarily those insured by the Federal Housing Administration (FHA) or guaranteed by the Veterans Administration (VA). They are issued at par and pay semiannual interest. Like the other federal issues, they are only available in book entry form.
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Government National Mortgage Association (GNMA) Securities
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GNMAs are known as modified pass-through certificates. They represent an interest in pools of FHA-insured mortgages or VA or Farmers Home Administration-guaranteed mortgages. The term pass-through is used because, as the homeowners make their monthly mortgage payments, those payments are collected in the pool and the shares pass through to the investor. Received monthly and each payment consists partly of principal and interest. Min $25K denomination. Backed by US Govt. Interest taxable @ state & Fed.
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Other Govt Agency Securities & Upsides and Downsides of Agency Securities
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Non-mortgage-backed debt securities are the Federal Farm Credit banks and the Federal Home Loan bank (FHLB). Interest received by the investor on these secs is exempt from State and local income taxes but not Fed income tax. Upsides; i) Very high safety; ii) Higher income than Treasuries iii) Some agency securities are free from state income tax. Downsides: Interest rate, inflation, pre-payment on MBS's, some taxed at state and fed.
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Zero Coupon Bonds
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Always issued at a discount; ■ Even though no periodic interest payments are received, the IRS requires issuer to send a form 1099-OID indicating the taxable interest to be reported each year. ■ More volatile than other bonds of similar quality - Additional credit risk, as entire payment is received at once. No reinvestment risk.
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Money Market Instruments
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Maturities of <= 1 yr. Most issued at a discount. Incl t-bills, Negotiable CD's ($100K min denom), CP, BA, Why invest in MM Secs? i) Safety ii) Liquidity iii) Virtually no interest rate or inflation risk iv) Best short term store of cash - however, low return, fluctuating income
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Investment Co. Securities >> Open End Investment Companies (Mutual Funds)
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Reduced sales charges by offering breakpoints, for instance, through a LoI or rights of accumulation. All MF's created after 4/1/00 offer auto reinvestment of capital gains and div's without a sales charge. Tax calc's are simplified as fund issues 1099 explaining everything. Inc Co. of 1940 req an OE fund to liquidate at NAV next biz day.
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Investment Co. Securities >> Closed End Investment Companies
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Trade on exchange or OTC > thus subject to force of supply & demand. May be diversified or non-diversified (75-5-10rule); may qualify as a regulated investment company by distributing at least 90% of net investment income (& avoiding tax on the portion distributed);
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Hedge Funds
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Why? absolute return (returns in rising and falling markets), many different choices (specific risks can be hedged), may reduce overall portfolio volatility. Downsides are expenses & possibility of strategy backfiring and huge losses.
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Limited Partnerships (Direct Participation Programs)
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Pay no dividends, rather, they pass income, gains, losses, deductions, and credits directly to investors. Ltd liability. Units of ownership in a partnership are called interests, rather than shares. Investors should choose a DPP because it's economically viable, investor can make use of the potential tax benefits; GP's have demonstrated mgmt ability, DPP's objectives match investors objectives, start-up costs & revenues are in line with benchmark.
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Limited Partnerships (Direct Participation Programs) >> Penalties for being judged an abusive tax shelter
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Disallows deductions; assesses back taxes, interest, and penalties; and, in some cases, charges the promoter with criminal intent to defraud.
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Disadvantages and Risks of Limited Partnerships
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1) Liquidity risk (ltd secondary market) 2) Inability to use passive losses (only deductible against passive income); 3) Legislative risk (tax laws may change and disallow deductions) 4) Risk of audit (Stat's from the IRS show that participation in a DPP results in a significantly higher % of returns selected for audit).
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Annuities
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3 types - fixed, variable and combination. A fixed annuity guarantees a fixed rate of return - need life licence to sell as not a security. VA is however a security & you need a securities license. FA's are guranteed fixed rate & interest rate, inv risk assumed by Ins Co., portfolio of FI secs, general account, vulnerable to inflation, insurance regulation
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Methods of Purchasing Annuities
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i) Deferred annuities ii) Periodic Payment Deferred Annuity iii) Immediate Annuity (payments begin within 60 days)
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Annuity Payout Stages
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An accumulation unit is an accounting measure that represents an investor’s share of ownership in the separate account. The payout period for an annuity is known as the annuity stage. when a contract is annuitized, accumulation units become annuity units. An Annuity Unit is a measure of value used only during an annuitized contract’s payout period.
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Factors that determine the value of an Annuity Payout
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Annuity Unit's determine the amount of each payment. The number of units credited to the annuitant’s account is based on the value of the contract when the payout period begins and on other variables (such as the payout option selected, accumulated value of the annuitant’s account, individual’s age and sex, and assumed interest rate).
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Annuity Payout Options
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Life Annuity/Straight Life/Pure Life: Single life-annuitant only. Life Annuity with Period Certain: annuitant receives payments for life, with a certain minimum period guaranteed. Joint Life with Last Survivor Annuity: Covers both lives.
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Variable Annuity Payments
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The value of the separate account upon annuitization is used to determine the number of annuity units in the account; future payouts are determined by the annuity unit’s fluctuating value.
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Taxation of Annuities including Random Withdrawals
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Money invested in an annuity represents the investor’s cost basis. Tax on interest, divi- dends, & capital gains is deferred until the owner withdraws money from the contract. On withdrawal, the amount exceeding the investor’s cost basis is taxed as ordinary income. random withdrawals from annuity contracts are taxed under the last in, first out (LIFO) method - meaning you're taxed on early withdrawals because they're assumed not to be from your basis.
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Taxation of Annuities >> Lump Sum Withdrawals
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Lump-sum withdrawals are taken by using the LIfO accounting method. If an investor receives a lump-sum withdrawal < 59.5, the earnings portion withdrawn is taxed as ordinary income and is subject to an additional 10% penalty under most circumstances. The penalty does not apply if the funds are withdrawn > 591.5, are withdrawn because of death or disability, or are part of a life- income option plan with fixed payments.
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Annuitized Payments
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Annuitized payments are typically made monthly and are taxed according to an exclusion ratio. The exclusion ratio expresses the percentages of the annuity’s value upon annuitization of contribution basis to the total.
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Advantages to Investing in Variable Annuities
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Tax deferred growth, Guaranteed death benefit, Lifetime income (not guaranteed income), 1035 transfers (transfers from one annuity to another without tax consequences - possibly surrender charges however). No age 701⁄2 restrictions or RMD reqt's. Choice in investment options (sub-accoutns). Swapping sub-account funds from within an VA is not a taxable event. No probate at death seeing as they have a beneficiary designation.
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Disadvantages to Investing in Variable Annuities
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i) Earnings are taxed as ordinary income. ii) Fees much higher than MF's iii) pre-59.5 withdrawals incur 10% penalty tax + ordinary income. Most have a CDSC. Carry same investment risks as mutual funds
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Indexed Annuities >> Fixed and Index
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Indexed annuities (IAs) are currently popular among investors seeking market participation but with a guarantee against loss. Gains based on participation rate with max loss set at floor. Tend to have longer surrender periods.
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Whole Life Insurance
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Provided premiums are paid - coverage in force throughout lifespan. Premium and DB remains constant. Insurer invests cash value in conservative investments (in general account). Insured may surrender policy for cash value. May also borrow against in the form of a policy loan (paid back + interest). Doesn't provide as much protection per $ of premium as Term.
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Universal Life
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Provide greater flexibility in allowing policy owners to adjust the DB &/or premium. Instead of being fixed premiums & guaranteed DB's, the DB resembles 1-yr renewable term insurance & the CV grows according to current interest rates. Interest earned by the cash account will vary, subject to a guaranteed min.
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Universal Life >> Interest Rates, Death Benefit Options and Policy Loans
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Two different interest rates depending on prevailing market interest rates; current annual & contract (min rate) rates. Death benefits incl Option A & B. Option A provides a level DB. Option B is a rising DB. If a loan is taken, it is subject to interest and, if unpaid, both the interest and the loan amount will reduce the face amount of the policy. Cash withdrawal (aka 'partial surrender' ) also permitted (int free)
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Uses of Universal LIfe
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If the premium payments are reduced to the point where they can no longer support the policy, lapse could occur. Additionally, since this is a form of permanent insurance, poor investment results could cause premiums to increase (if the same face amount of coverage was desired).
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Variable LIfe Insurance
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VL provides policy holders a min guaranteed DB. DB may increase above min amount depending on investment results. Scheduled-premium (or fixed-premium) VLI contract min DB is determined at issue, & evidence of insurability is req'd. VUL has flexible premiums, no guaranteed DB.
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Insurance Related Expenses >> Deductions from the Premium
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i) Admin fee; ii) Sales load & iii) State premium taxes. (Use SAS to remember which charges are taken from gross premium)
Admin fee normally one time charge to cover cost of processing. Max allowable sales load is 9% of the premium calculated over a 20yr period. Can be front-loaded to a max of 50% of 1st yr premium but must avg out to 9% over 20yrs. Because of front-end loading - there are special refund rights spelt out in ICA of 40. |
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Insurance Related Expenses >> Deductions from the Separate Account
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Deductions from the separate account reduce investment performance. Charges incl; i) mortality risk fee ii) expense risk fee iii) investment mgmt fee. The mortality risk fee covers the risk that the insured may live for a period shorter than assumed. The expense risk fee covers the risk that the costs of administering and issuing the policy may be greater than assumed.
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Variable Life Insurance Death Benefit
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If actual Investment Returns > ssumed Investment Returns = DB increases. If actual IR = AIR, then no change in DB. If actual IR < AIR, then min DB is lowest DB can go to.
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Variable Life Insurance Cash Value
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The cash value cannot be negative, but the insurance company keeps track of negative performance. Therefore, like the death benefit, the cash value may not increase until prior negative performance has been offset.
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Frequency of Life Insurance Calculations
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- DB' are calculated annually;
- CV is calculated monthly; and - Separate account unit values are calculated daily (in the event there is a withdrawal of cash value). |
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Variable Life Policy Loans
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Restrictions exist - typically max loan is <= 75% of CV after policy has been in force for 3 yrs. Outstanding loans are deducted from DB if claim is made & interest rate charged is stated in the policy. Full CV is obtained by surrendering the policy to the insurer.
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Frequency of Life Insurance Calculations
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- DB' are calculated annually;
- CV is calculated monthly; and - Separate account unit values are calculated daily (in the event there is a withdrawal of cash value). |
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Variable Life Insurance Contract Exchange
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Policy holder may change their mind and convert to WL in early years of contract. Length of time this exchange privilege is in effect varies from Co to Co, but under no circumstances may the period be < 24 months (federal law). The exchange is allowed without evidence of insurability. New policy is issued as if everything were retroactive; original contract date (insurable age) & DB as the min guaranteed in the VLI contract.
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Variable Life Policy Loans
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Restrictions exist - typically max loan is <= 75% of CV after policy has been in force for 3 yrs. Outstanding loans are deducted from DB if claim is made & interest rate charged is stated in the policy. Full CV is obtained by surrendering the policy to the insurer.
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Variable LIfe CV Voting Rights
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Contract holders receive one vote per $100 of CV funded by the separate account. Changes in Inv objectives achieved by simple majority vote or by order of the state insurance commissioner. Do not confuse the voting rights of VA's with VL policies. VA's and MF's are the same: 1 vote per unit (share).
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Variable Life Insurance Contract Exchange
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Policy holder may change their mind and convert to WL in early years of contract. Length of time this exchange privilege is in effect varies from Co to Co, but under no circumstances may the period be < 24 months (federal law). The exchange is allowed without evidence of insurability. New policy is issued as if everything were retroactive; original contract date (insurable age) & DB as the min guaranteed in the VLI contract.
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Income Tax Implications of Life Insurance
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Premiums for individually purchased life insurance are generally nondeductible for income tax purposes. Generally, proceeds from life insurance policies made to a beneficiary are exempt from federal income tax.
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Variable LIfe CV Voting Rights
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Contract holders receive one vote per $100 of CV funded by the separate account. Changes in Inv objectives achieved by simple majority vote or by order of the state insurance commissioner. Do not confuse the voting rights of VA's with VL policies. VA's and MF's are the same: 1 vote per unit (share).
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Income Tax Implications of Life Insurance
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Premiums for individually purchased life insurance are generally nondeductible for income tax purposes. Generally, proceeds from life insurance policies made to a beneficiary are exempt from federal income tax.
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Estate Tax Implications to Owning Life Insurance
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If the insured person on a LI policy holds incidents of ownership in that policy (right to designate a beneficiary, transfer ownership of an insurance policy (assign), choose how dividends or policy proceeds will be paid out, borrow money from the accumulated CV of the policy), the entire DB payable under that policy is incl for fed Estate tax purposes.
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Irrevocable Life Insurance Trust
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If certain provisions, known as Crummey powers, are included in the ILIT document, premiums paid by the insured may qualify for the annual gift tax exclusion (currently $13,000 per year, per beneficiary).
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Forward Contracts
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A forward contract is a direct commitment between 1 buyer and 1 seller. If the position is held until the closing date, the forward seller is obligated to make delivery; the forward buyer is obligated to take delivery. A forward contract is nonstandardized. 5 components; qty of the commodity; quality of the commodity; time of delivery; place for delivery; & price to be paid at delivery.
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Estate Tax Implications to Owning Life Insurance
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If the insured person on a LI policy holds incidents of ownership in that policy (right to designate a beneficiary, transfer ownership of an insurance policy (assign), choose how dividends or policy proceeds will be paid out, borrow money from the accumulated CV of the policy), the entire DB payable under that policy is incl for fed Estate tax purposes.
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Futures Contracts
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Standardized and exchange traded. Gains & losses computed daily. To offset, close, or liquidate a futures position before delivery, an investor must complete a trans opp to the trade that initiated (opened) the position. The offsetting transaction must occur in the same commodity, for the same delivery month, and on the same exchange. 4 standardized parts; Qty, quality, time for delivery and location.
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Exchange Markets
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Securities traded on exchanges. Exchanges require certain criteria to be met to list. Location, Pricing System (Listed markets operate as double-auction markets. Floor brokers compete to execute trades at favorable prices), Price Dynamics (Price up-ticks (plus-tick) and down-ticks (minus-tick)), Specialists.
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Irrevocable Life Insurance Trust
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If certain provisions, known as Crummey powers, are included in the ILIT document, premiums paid by the insured may qualify for the annual gift tax exclusion (currently $13,000 per year, per beneficiary).
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Forward Contracts
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A forward contract is a direct commitment between 1 buyer and 1 seller. If the position is held until the closing date, the forward seller is obligated to make delivery; the forward buyer is obligated to take delivery. A forward contract is nonstandardized. 5 components; qty of the commodity; quality of the commodity; time of delivery; place for delivery; & price to be paid at delivery.
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Futures Contracts
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Standardized and exchange traded. Gains & losses computed daily. To offset, close, or liquidate a futures position before delivery, an investor must complete a trans opp to the trade that initiated (opened) the position. The offsetting transaction must occur in the same commodity, for the same delivery month, and on the same exchange. 4 standardized parts; Qty, quality, time for delivery and location.
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Exchange Markets
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Securities traded on exchanges. Exchanges require certain criteria to be met to list. Location, Pricing System (Listed markets operate as double-auction markets. Floor brokers compete to execute trades at favorable prices), Price Dynamics (Price up-ticks (plus-tick) and down-ticks (minus-tick)), Specialists. Regulated by the NYSE.
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Over-the-Counter (OTC) Market
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Interdealer market in which unlisted securities. Location - no physical loc. Pricing System - registered market makers compete to post the best bid and ask prices. The OTC market is a negotiated market. Market Makers - BD listing a Sec - req'd to buy/sell. Regulated by FINRA.
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The function of Dealer's
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Dealers, or principals, buy/sell Secs for their own accounts. AKA 'position trading'. When selling from their inventories, dealers charge the buying customers a markup rather than a commission. Markup is the difference btwn the current interdealer offering price and the actual price charged the client. When a price to a client incl a dealer’s markup, it is called the 'net' price.
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Limitations on BD's in arranging transactions
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A BD cannot be both B & D in single transaction. A firm can't make a market in a stock , mark up that stock, & then add an agency commission. If the firm acts as a broker, it may charge a commission. If it acts as a dealer, it may charge a markup or markdown. Violation of this practice is called 'making a hidden profit'.
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Types of Orders
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Market, Limit (limits the amount paid or received), Stop (becomes a market order if the price reaches the stop loss), Stop Limit - entered as a stop order and changed to a limit order if the stock hits or goes through the trigger price) Time of Orders - Day, GTC, Fill or Kill (Filled immediately in full or cancelled), Immediate or Cancel (Filled immediately in full or in part, any part unfilled is cancelled), All or None (executed in full but not necessarily immediately)
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Block Trade
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Most common definition of a block trade is one of 10,000 or more shares of a stock.
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Dividend Disbursement Policy
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4 dates involved; 3 of which determined by issuer, other by FINRA. 1) Declaration date - declared by Co's BoD
2) Record Date - Date at which shareholders of record are set for pmt of div. Generally several weeks after the decl date (no standard time) & a week or so before the payable date. 3) Payment Date 4) Ex-Div Date - |
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Definition of a Diversified Investment Company under the 1940 Investment Company Act?
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75-5-10 test. This test requires that 75% of the assets be invested in securities issued by companies other than the investment company (regardless of the type of Co.) so that no more than 5% of total assets can be invested in any one company and no more than 10% of an outside corporation’s voting securities are owned by the investment company. There are no restrictions on the other 25%,
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