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113 Cards in this Set

  • Front
  • Back

Future Value Formula

Pn = P0(1+r)n

Pn = P0(1+r)n
P0 is the Original amount invested
Pn is the future value of P0
n is the number of compounding periods (years, months, etc.)
r is the rate of interest

Present Value Formula

P0 = Pn / (1+ r) n

P0 is the Original amount invested
Pn is the future value of P0
n is the number of compounding periods (years, months, etc.)
r is the rate of interest

Internal rate of return = (Payoff / Investment) - 1

IRR = (1100 / 1000) - 1


IRR = 1.10 - 1


IRR = .10 or 10%




Payoff or return = 1100


Investment = 1000

Internal rate of return (IRR)

Internal rate of return (IRR) - This interest rate makes the net present value of a series of cash flows equal to zero.



TEST TIP: On the exam, "net present value equals zero" will be the correct answer.

Real return

Real return - This is also known as inflation-adjusted return. By adjusting the stated (nominal) return of an investment to consider inflation, the investor has a more realistic assessment of return.

Expected return

Expected return- This is the average of the probability distribution of possible returns, calculated by taking the probability of each possible return outcome and multiplying it by the return outcome, then adding each of these together to get the expected return.

Risk-adjusted return

Risk-adjusted return - This calculation allows an investor to determine if the amount of return received is commensurate with the risk taken. It incorporates both beta and the risk-free rate of return (typically the current rate of short-term Treasury bills).

Return on investment

(Measuring Portfolio Returns)

Return on investment - This is the classic measure of performance, taking into account all cash flows (including dividends, interest, return of principal, and capital gains). To calculate, simply divide the sum of all cash flows by the number of years the investment is held, and then divide that amount by the original amount invested.

Holding period return

(Measuring Portfolio Returns)

Holding period return - Refers to the return for the period of time the investment was actually held. This can be more meaningful than an annualized rate of return, particularly for investments held short term.

standard deviation of returns

The standard deviation of returns depends on the holding period, since stock returns are more volatile over shorter periods. As a result:


  • the shorter the holding period, the greater the variability of the return;
  • the longer the holding period, the smaller the variability of the return.

Annualized return

(Measuring Portfolio Returns)

Annualized return- Also referred to as average return, this expresses the geometric rate of return of a portfolio over any given period into an annual basis - in other words, it provides the average annual return per year over that period.

Risk-free rate of return

(Measuring Portfolio Returns)

Risk-free rate of return - The current rate for 90 day Treasury bills is typically used in calculations such as risk-adjusted return and the Sharpe ratio.

Total return

(Measuring Portfolio Returns)

Total return - This incorporates the rate of return from all sources, including appreciation (or depreciation), dividends and interest.

Risk premium

(Measuring Portfolio Return)

Risk premium- The risk premium is the higher return that is expected for taking on the greater risk associated with investing in a growth stock versus a stock from a more established company.

Expected return

(Measuring Portfolio Return)

Expected return - Since the expected return is the average of the probability of possible rates of return, it is by no means a guaranteed rate of return. However, it can be used to forecast the future value of a portfolio and provides a guide from which to measure actual returns. It is an integral component of the capital asset pricing model, which calculates the expected return based on the premium of the market rate over the risk-free return as well as the risk of the investment relative to the market as a whole (beta).

Benchmark portfolios

(Measuring Portfolio Return)

Benchmark portfolios - A common way to evaluate portfolio returns is to compare them to a benchmark such as an index. These are the most common benchmarks:


  • Standard & Poor's 500 - for large-cap stocks
  • Russell 2000 - for small-cap stocks
  • Europe, Australia and Far East Index (EAFE) - for international stocks

Yield to maturity

(Bond Yields)

Yield to maturity - This is the return based on the actual purchase price of the bond. It takes any premium or discount over par into account and uses the actual time to maturity for the number of compounding periods. If the bond was purchased at par, the yield to maturity will equal the stated coupon rate.

Yield to call

(Bond Yields)

Yield to call - This is a similar calculation, but it uses the call date for the number of compounding periods and incorporates any call premium into the future value.

Current yield

(Bond Yields)

Current yield - This is simply the annual income divided by the market value of the bond. If the bond is trading at a premium, the current yield will be less than the nominal yield. If the bond is trading at a discount, the current yield will be greater than the nominal yield.

Real interest rate

(Bond Yields)

Real interest rate - The investor receives this rate after inflation is taken into account. In essence, the nominal interest rate = the real interest rate plus an inflation premium. The inflation premium is typically higher for bonds with longer maturities.

Name the three types of client type Partnerships
  1. Business partnership
  2. Limited partnership
  3. Family limited partnership

Business partnership

(Client Types Partnership)

Business partnership- In this partnership, all partners are equally responsible for business debts and share equally in business profits (which pass through to be reported on each partner's personal income tax return).

Limited partnership

(Client Types Partnerships)

Limited partnership - Here the general partner is responsible for managing the business and has unlimited liability for its debts, while the limited partners are not responsible for any of the debts.

Family limited partnership

(Client Types Partnerships)

Family limited partnership - This arrangement is used primarily as a means of minimizing estate and gift taxes, but must have a legitimate business purpose (such as managing investment real estate, family business, etc.).

Name the three types of Client Type Corporations
  1. C Corporation
  2. S Corporation
  3. Limited Liability Corporation

C Corporation

(Client Type Corporations)

C Corporation - Thesecorporations must pay corporate income tax on their income, and the owners pay personal income taxes on profits received as dividends (known as double taxation).

S Corporation

(Client Type Corporations)

S Corporation - This arrangement is suitable for small companies (less than 75 shareholders) that want the legal protection of a corporation but the flow-through taxation of partnerships (corporate losses are applied to personal income tax return).

Limited Liability Corporation

(Client Type Corportation)

Limited Liability Corporation - This type of structure provides a company's owners with protection from debts, but is taxed as if it is a sole proprietorship.

Estates

(Other client type entities)

Estates - An estate account is typically open only a short time, until the estate assets are distributed to beneficiaries, so long-term or speculative investments are usually not appropriate.

Trusts

(Other client type entities)

Trusts - The IA must recommend investments that are suitable for the beneficiaries of the trust, not for the trustee.

What is the advantage of all types of corporations?

The main advantage of all types of corporations is that the owners are not personally liable for the corporation's debts.

Preservation of capital

(Financial Goals)

Preservation of capital - The investor is more concerned with safety than with return. Treasury bills and money market funds may be most appropriate.

Current income

(Financial Goals)

Current income - The investor needs a portfolio that produces steady income for current living expenses. Bonds, annuities, and stocks with high dividends (such as utility stocks) may be appropriate.

Growth and income

(Financial Goals)

Growth and income - The investor is looking for a portfolio that generates some income, but he/she is looking for capital appreciation as well (often for protection against inflation). Appropriate investments could include a mix of bonds and stocks.

Growth

(Financial Goals)

Growth - The investor's goal is likely retirement or another event in the future, where current income is not needed. A diversified stock or mutual fund portfolio is appropriate.

Speculation

(Financial Goals)

Speculation - The investor is looking for high-risk investments with a potential for very large returns. This is rarely the goal for an entire portfolio, but rather for a specific portion of assets. Aggressive growth funds and small-cap issues may be most appropriate.

Name the five financial goals that would describe a clients investment objectives

  1. Preservation of capital
  2. Current income
  3. Growth and income
  4. Growth
  5. Speculation

Capital and Other Needs to be examined:
  1. Emergency reserves
  2. Life insurance
  3. Other insurances

  • Disability
  • Medical Coverages

Emergency reserves

(Capital and other reserves)

Emergency reserves - While three to six months' living expenses are considered standard for emergency savings, other factors could dictate a larger or smaller need for liquid savings.

Life insurance

(Capital and other reserves)

Life insurance - If the client has a family whose income needs cannot be met through current assets, life insurance is needed. The total amount and type of insurance would depend on client circumstances.

Other Insurances:


  1. Disability
  2. Health Insurance

Other insurance - The IA should review the client's disability and health insurance coverage, since any investment or estate plans could be disrupted if this coverage is inadequate.

Name the 4 types of Income Tax
  1. Ordinary income
  2. Capital gains
  3. Dividends
  4. Passive income

Ordinary income

(Income Tax)

Ordinary income- This includes all income earned from salary, commission and business income. Some investment gains, such as bond interest and withdrawals from Traditional IRAs and company retirement plans, are taxed at "ordinary income" rates.

Capital gains

(Income Tax)

Capital gains - This refers to income resulting from the appreciation of a capital asset (e.g. stocks, real estate, coins). Capital gains are not realized until the asset is sold. Capital gains are classified as short term or long term:


  • Short term - Assets held for 12 months or less are considered short-term capital gains and are taxed at ordinary income rates.
  • Long term - Assets held for longer than 12 months benefit from reduced tax rates (based on your marginal tax bracket). Those in the lowest tax brackets (10% or 15%) pay only 5% capital gains tax rate, while those in the higher brackets (25% and above) pay only 15%.

Dividends

(Income Tax)

Dividends - Prior to 2003, dividends were taxed at ordinary income rates, along with bond interest. Due to a change in tax law, "qualified" stock dividends (common and preferred) are now taxed like capital gains, with a maximum income tax rate of 15%. REIT dividends do not qualify for this special treatment.

Passive income

(Income Tax)

Passive income - Income from sources such as real estate limited partnerships or directly owned (but professionally managed) real estate is taxable at ordinary income rates and can only be reduced by passive losses, not by capital gain losses.

Holding Period

(Income Tax)
  1. The holding period begins the day after the security is purchased (not the settlement date).
  2. The holding period ends the day of the sale.
  3. It is important to keep detailed records of these dates, to ensure that a security is not sold too soon and thus qualifies for preferential tax treatment.

Cost basis = Original Price + transaction costs + dividends

The amount of capital gains to be taxed is calculated by subtracting the investor's cost from the sales proceeds.


To determine the cost basis of an investment, start with the original price (plus any transaction costs). Next, add the dollar value of dividends that were reinvested. This would apply to both stocks in a dividend-reinvestment program and mutual funds where dividends are automatically reinvested. Reinvested capital gains are also added to the cost basis for mutual funds.

stepped-up cost basis

If you inherit an investment, your cost basis is the value of the asset as of the decedent's date of death. This is known as a stepped-up cost basis. Also, the holding period is always considered long-term, even if the deceased hadn't owned the investment for 12 months before death.

Cost basis when investments are received as a gift

If you receive an investment as a gift, there are actually two different cost bases that apply:


  1. The actual cost basis of the giver
  2. The market value on the date of the gift.

Rules for Netting Capital Gains and Losses
  1. Net short-term gains against short-term losses.
  2. Net long-term gains against long-term losses.
  3. If both holding periods result in gains (or both in losses), they are reported separately on Schedule D
  4. If one holding period results in a gain and the other in a loss, they are then netted against each other
  5. If capital losses exceed capital gains, up to $3,000 can be deducted against ordinary income in any one year.
  6. Unused capital losses can be carried forward indefinitely to future years - each year, unused capital losses will first be netted against the current year's capital gains, followed by the $3,000 deduction against ordinary income.

What is the Wash Sale Rule?

The wash rule applies to transactions before and after the sell date. For example, you cannot buy additional shares of the security on October 1, sell the original shares on October 20 and then buy more shares of the same security on November 10. In essence, the wash sale rule covers a period of 61 days: the sell date plus 30 days before and 30 days after that date.

Corporate Income Taxes

Corporate Income Taxes
Corporations get a tax break for investing in common and preferred stocks (of companies other than their own).


  1. There is a dividend exclusion of 70% that applies to corporations that own less than 20% of the other company.
  2. If the company owns more than 20%, the dividend exclusion is 80%.
  3. Since there is no corporate tax break on bond interest (for corporate or government bonds), there is no incentive for corporations to purchase these.
  4. Of course, municipal bond interest is not taxable to the corporation (unless it is a private-purpose bond, which would be taxable to an individual as well).

Revocable trusts

(Trust Income Taxes)

Revocable trusts- these trusts manage assets that the owner ("grantor") has placed in the trust during his or her own lifetime.


  • The grantor has the right to change or terminate the trust at any time and can serve as the trustee of the trust.
  • The trust becomes irrevocable upon the grantor's death.
  • Revocable trusts are taxed at the grantor's personal income tax rate - currently a maximum of 39.6%.

Irrevocable trusts

(Trust Income Taxes)

Irrevocable trusts- these trusts may be created during the grantor's lifetime or may be contained within a will and become active only upon their death.


  • Irrevocable trusts are taxed at special trust income tax rates.

Tombstone

a

Red Herring

A Red Herring is used to acquaint investors with essential facts with the new issue and to solicit indications of buyers interest.

Cooling off period
  • Can be as short as 20 days but is not the norm, can be as long as several months. It depends on how long it takes the SEC to review and correct the docs
  • No one is permitted to solicit sales during this time but indications of interst can be solicited with a red herring.

Securtiy

(Definition)

a

Howey Case defining an investment contract as:
  1. the investment of money
  2. in a common enterprise (pooling)
  3. with an expectation of profits; and
  4. that results solely from the efforts of others.

On the basis of the Howey case, a security are the following:
  1. stock
  2. bond
  3. debenture
  4. right or warrant
  5. note
  6. put, call or other option
  7. limited partnership interests
  8. cerfiticate of interest in a profit sharing arrangement

Uniform Securities Act


(Definition)

a

Securities Act of 1933

(Definition)

a

Issuer

a

Underwriter

a

Person

a

Prospectus

The prospectus summarizes the information in the Registration Statement (which is very long and complex). It should never be altered in any way.

Sale

a

A sale does not include:
  1. Prelimary negotiations or agreements between the issuer and underwriter
  2. a gift of securities

Exempted Securities under the Securities Act of 1933:

These securities are exempt from registration requirements and the Uniform Securities Act:


  1. Securities issued or guaranteed by the United States, any state or political subdivision of the state (all federal government issues and municipal securities are exempted securities)
  2. Commercial paper with a maturity date of no more than 9 months (270 days); must be used soley for working capital and no other means. No denomination or rating restrictions
  3. Any security issed by a religous, educational, charitable or non profit organization
  4. Any railroad or common carrier
  5. Any security issued by a federal or state bank, savings and loans, or building and loan associations (it does NOT apply to bank holding companies)

Rule 147

a

Name the three securities that are exempt from the Uniform Security Act but NOT the Securities Act of 1933
  1. Foreign government securities
  2. Securities listed on the NASDAQ or a National Exchange (often referred to as a blue-chip stock)
  3. Securities issued by insurance companies

Exempt transactions under the Securities Act of 1933
  1. Transactions by any other person other than an issuer, underwriter or dealer
  2. Transactions by an issuer that do not involve a public offering (aka private placement under Regulation D)

The Securities Act of 1933 protects investors who buy new issues by:


(Registration of Securities)
  1. requiring reg of new issues that are to be distributed interstate
  2. Requiring an issuer to provide full and fair disclosure about itself and the offering
  3. Requiring an issuer to make avail necessary for an investor to judge the issuer's merit
  4. Regulating the UW & distribution of primary and secondary issues

Registration Statement

Information in the Registration Statement is summarized as:


  1. Purpose of issue
  2. Public Offering price (anticipated range)
  3. Underwriters commissions or discounts
  4. Promotional expenses
  5. Expected use of the net proceeds of the issue to the company
  6. Balance sheet
  7. Earnings sheet for the last three years
  8. Names, addresses, and bios of officers, directors, underwriters and stockholders owning more than 10% of outstanding stock
  9. Copy of uw agreements
  10. Copies of aritcle of incorporations

The 3 phases of Underwriting
  1. Issuer files registration statement with the SEC (Prior to the filing of the Reg Statement, no sales can be soliticed and no prospectus can circulate)
  2. Cooling Off period (No one can solicit sales during hte cooling off period, but indications of interest can be solicited with a red herring.)
  3. Effective datte - offering period may begin (Sales can now be solicited, but the firm must use a final prospectus.

What should a Red Herring NOT be used for?
  • A confirmation of sale
  • In place of a registration statement; or,
  • Declaration of the final public offering price (an estimated range is okay)


Under no circumstances can you accept money or orders prior to the Effective date (last stage)!

What are the two items that are missing from the prelimary prospectus (red herring)?
  1. Public Offering Price
  2. The Effective Date

During the cooling off period, underwriters may not:
  • make offers to sell the securities
  • take orders; or
  • distribute sales literature or advertising material

During the cooling off period, underwriters may:
  • take indications of interest
  • distribute prelimary prospectuses (a red herring); or
  • publish tombstone advertisements to provide information about hte potentional availability of the securities

When does the prospectus need to be delivered by?

The prospectus must be given to every person who purchases no later than with the confirmation of the sale.



When additonal sales literature is distributed, a prospectus must also accompany it.

Rule 482 (Omitting Prospectus)

Describes the mutual fund advertisements.

Statue of Liabilities for omitting or providing false information contianed in the registration statement under the Securities Act of 1933 are:

The statue of limitations for bringing action is the earlier of one year after discovery of the violation or three years after the date of action.

Powers of the SEC include the ability to:
  1. Make, amend and recind rules
  2. Administer oaths
  3. Subpoena witnesses and other records for evidence
  4. Seek injunctions or restraining orders in teh appropriate court; and
  5. Turn over evidence to the attorney general of the United States for possible criminal prosecution.

If false or misleading statements are made in the registration statement or prospectus intentionally, the individuals are subject to:

Criminal Prosecution

Under Civil Liability Laws, a purchaser of a security under a registration statement containing false statement of a material fact to sue:

(Basically anyone who was involved in putting it together!)


  • Every person who signed the registration form
  • All directors of the issuer
  • Attorneys & Accountants
  • Appraisers and other experts;
  • Underwriters; and
  • Parent Companies

Under the Securities Act of 1933, the liability of being found guilty in court the civil penatlies are:
  • Substatantial fines and
  • Being barred from serving as an officer or director of a public corporation for a number of years.

Under the Securities Act of 1933, if found guilty in court involving criminal prosectution, the penalties include:
  • A fine
  • Prison
  • or both!

What is Form D?

Form D requires basic info about the issuer and the offering such as, total size of offering, amount sold to date, use of proceeds, names of people paid commissions.

When does Form D need to be filed?

Under Rule 503 of Regulation D, an issuer must file Form D with the SEC no later than 15 days after the first sale of securities in the offering.

Under the Securities Act of 1933, securities issued under the Regulation D rules are federally covered, this means ....

A state may not impose registration or qualification requirements on any security. However, the states may impose notice filing requirements.

Three other names describing Private Placements.
  1. Restricted Securities
  2. Letter Securities
  3. Legend Securities

Control Person

(Defined)

Any corporate director, officer, greater than 10% voting shareholder, or the spouse of any of the proceding. They are loosely referred to as insiders or affiliates because of their unique status with the issuers.

Securities Exchange Act of 1934

(Defined)

Federal legislation that established the Securities and Exchange Commission (SEC). The act protects investors by regulating the exchanges, the OTC market, the extension of credit by the Federal Reserve Board, B/D's, insider transactions, trading activities, client accounts and net capital.

Securities and Exchange Commission (SEC)

The SEC is composed of 5 commissioners appointed for 5 year terms by the US President and the approval of the Senate. Terms are staggard so no more than 3 of 5 commissionars are part of the same political party. This is the only job they are permitted to have and any personal securities must be placed into a blind trust so not to have an affect on personal gains.

Broker

(Defined)

A broker is any person engaged in the business of effecting transactions in securities for the account of others. Banks are NOT included in this definition.

Dealer

(Defined)

A dealer is any person regularly engaged in the business of buying and selling securities for his own account. Banks, insurance companies, investment companies, and any persons engaged in investing, reinvesting or trading for securities for their own account, either individually or in some fiduciary capicity, but not as part of a regular business, are not included in this definition.

Associated Person

(Defined)

A person associated with a broker/dealer is any partner, officer, or director of the B/D, or any person directly/indirectly controlling or controlled by the B/D (including employees).



A person whose functions are solely clerical or ministerial is NOT considered to be an Associated Person.

Market Maker


(Defined)

A dealer willing to accept the risk of holding securities to facilitate trading in particular securities.

Securities Information Processor (SIP), name the 4 most obvious ones:
  1. The Consolidated Ticker Tape
  2. Bloomberg and Reuters
  3. NASDAQ
  4. The Pink Sheets

The term securities information processor does not include:
  1. A bona fide newspaper, news magazine, or business/financial publication of general or reg circulation i.e. The Wall Street Journel
  2. Any SRO other than Nasdaq
  3. Any bank or B/D supplying quotation and transactional information as part of its customary banking or brokerage businesss
  4. Any common carrier subject to the jurisdiction of the FCC or state commission (radio / tv stations).

A transfer agent is any person who engages on behalf of an issuer of securities in:
  1. countersigning the certificates
  2. registering the transfer of the isssuers securities
  3. exchanging or converting the issuers securities and
  4. transferring record ownership of securities by bookkeeping entry w/o

A person exercises Investment Discretion in an account if, directly or indirectly, that person is authorized, in writing to determine:
  1. which securities will be purchased or sold by or for the account
  2. the amount of the securities to be bought or sold for the account
  3. whether the transaction will be a purchase or sale.


It does not include the decision as to the time or price of a particular transaction.

Time and / or Price Exception

An oral grant of time and price discretion is limited to the end of the business day on which the client grants it.If a client says, "Buy 100 shares of ABCD, get the best price you can" it is acceptable orally and not needed in writing. Anything beyond the same day that instruction was given, needs to be in writing. Time/Price discretion needs to be written on the order ticket

The Securities Exchange Act of 1934 requires brokers and dealers operating in interstate commerce (including those operating on the exchanges and OTC) to file an application for membership (in order to operate). 1) What is the name of that form? 2) How long does the SEC have to either accept or deny the registration?
  1. Form BD
  2. 45 days for the SEC to accept or deny the application

The Securities Exchange Act of 1934 requires exchanges to file an application, how long does the SEC have before accepting or denying the application?

90 days

The Securities Exchange Act of 1934 requires registration for national securities associations as well. Name two national securities associations.
  1. FINRA
  2. MSRB (The Maloney Act of 1938)

The Securities Exchange Act of 1934 requires corporations with listed securities to register which must include:

page 19

Regulation T

Prevents the excessive use of credit.


Rules for use: p. 22

Insider transactions under the exchange act of 1934

The act regulates securities transactions for individuals who own more than 10% of a company and officers or directors of the issuers of the securities. The act requires notification of any changes in ownership of securities. Its to prevent a short sale / gains within a short period of time by the insiders. Exercise of stock options are not prohibited.

What needs to be filed under the rules of Insider transactions under the exchange act of 1934?
  • Schedule 13 (D)


  • Schedule 13(F)


  • Schedule 13 (G)

Schedule 13G

An SEC form similar to the Schedule 13D used to report a party's ownership of stock that is over 5% of the company. Schedule 13G is shorter and requires less information from the filing party.



1) ownership must be between 5- 20%


2) must be a passive investor (not seeking control)

Schedule 13D

(aka Regulation 13D, Section 13D)

A form filed with the SEC under Rule 13D. The form is required when a person or group acquires more than 5% of any class of a company's shares. This information must be disclosed within 10 days of the transaction. Rule 13D requires the owner to also disclose any other person who has voting power or the power to sell the security.