Series 7 Terms

Front 1

Arbitrage

(Term)

Back 1

Simultaneous buying and selling of a security to achieve a riskless profit.

Front 2

Bonds

(Term)

Back 2

Securities that convey an obligation to pay the debt of a company or governmental entity.

Front 3

Broker-dealer

(Term)

Back 3

A firm that buys and sells securities either for its customers (that is, as a broker) or on its own account (that is, as a dealer). In this guide the terms "broker-dealer" and "brokerage" are used interchangeably, if imprecisely.

Front 4

Customer

(Term)

Back 4

The person on whose behalf a registered rep trades. In this guide the terms "customer", "client" and "investor" are used interchangeably for style, but the Series 7 exam will use "customer" exclusively.

Front 5

Initial public offering (IPO)

(Term)

Back 5

The first sale of a security to investors at large; raises funds for the issuing company or agency.

Front 6

Margin

(Term)

Back 6

Money borrowed from a brokerage to purchase securities for a customer's account.

Front 7

Mutual fund

(Term)

Back 7

A company whose sole business is investing in securities.

Front 8

Options

(Term)

Back 8

Securities that convey a right to buy or sell an underlying asset.

Front 9

Registered representative

(Term)

Back 9

Someone who works for a federally regulated broker-dealer and handles customers' accounts. Registered reps traditionally carry the job title "account executive", but because other brokerage-related jobs - from sales assistants through middle managers - may from time to time touch clients' money, a broad range of financial industry workers are encouraged to become registered. Passing the Series 7 exam is the major hurdle to becoming a registered rep.

Front 10

Securities

(Term)

Back 10

Financial instruments that have value and can be traded.

Front 11

Securities and Exchange Commission (SEC)

(Term)

Back 11

The federal agency charged with regulating the financial markets.

Front 12

Stocks

(Term)

Back 12

Securities that convey partial ownership of a company.

Front 13

Inflationary Risk

(Investment Risk)

Back 13

This is the risk that investment returns fail to keep pace with inflation over long periods of time. Bond holders are most susceptible to this type of risk.

Front 14

Capital Risk

(Investment Risk)

Back 14

This is the risk that one may lose some or all of one's investment. The reasons could be numerous.

Front 15

Timing Risk

(Investment Risk)

Back 15

Applicable to most any investment, timing risk can occur upon purchase or sale. This type of risk speaks more broadly to valuation and risk management. At some point, some investors will be of the opinion that a certain price point would be the one at which to buy or sell a particular investment. Company-specific, as well as systemic risks, are both price determinants.

Front 16

Interest Rate Risk

(Investment Risk)

Back 16

Specific to bondholders and bond traders, interest rate risk impacts bond prices when rates fluctuate. Prices and rates have an inverse relationship. An increase in the latter causes a decrease in the former. The longer the bond's maturity and duration (the weighted average term to maturity of a bond's cash flows, a common risk metric of how quickly the creditor will be repaid), the more susceptible it is to interest rate risk. However, for investors who choose to hold the bond to maturity, such fluctuations are of no consequence, as they continue to receive the coupon and eventually will receive the principal in its entirety.

Front 17

Market/Systematic Risk

(Investment Risk)

Back 17

This is the risk embedded in financial markets that cannot be diversified away completely, only mitigated.

Front 18

Credit /Default Risk

(Investment Risk)

Back 18

This is the risk that a company's financial difficulties may impede its ability to satisfy its obligations, causing the yield on its fixed income obligations to rise.

Front 19

Liquidity Risk

(Investment Risk)

Back 19

Applicable to thinly traded domestic securities (e.g., pink sheet stocks with wide bid/ask spreads), private investments (all manner of private placements, debt and equity) that avoid public markets altogether, private equity, hedge funds, real estate (publicly traded REITs being an exception) and complex structured products that are hard to value, such as credit derivatives (various iterations of the Collateralized Debt Obligation). Liquidity risk is that which impedes the ability to dispose readily of an investment at the current market price (which may be difficult to determine) in an arm's length transaction.

Front 20

Political Risk

(Investment Risk)

Back 20

This is the risk that the political process through legislation, governmental fiat or gridlock, could impair returns on one's investments or obviate them altogether. Some examples are when a foreign government nationalizes an industry or promulgates a law that would adversely impact an industry, affecting its profitability. The summer 2011 debt ceiling fracas in the United States that caused a decline in the creditworthiness of its paper, is a more recent example. So, too, are the problems surrounding monetary union in the eurozone where the presence of monetary union, but lack of fiscal union and its attendant problems, have cause yields on sovereign debt of eurozone countries, such as Greece, Italy and Spain, to spike. ______ risk can affect equity and fixed income alike.

Front 21

Call Risk

(Investment Risk)

Back 21

This risk is specific to bondholders. When an issuer has a call provision written into the bond's indenture, it reserves the right to call the bond away when interest rates decline, so as to be able to refinance its debt as a lower interest cost. This benefit to the issuer is a risk to the creditor (lender), as it creates reinvestment risk.

Front 22

Currency Risk

(Investment Risk)

Back 22

A risk to individuals who invest in foreign equities and fixed income. The fluctuation of the foreign currency relative to the one in which the investor reports returns, could either benefit or detract from that investor's total return (currency returns and capital gains or losses). As an example, when the investor's currency purchases more units of a foreign currency, that investor is receiving more foreign units per domestic one, relative to a previous time period. As a rule, with reference to the currency in which the investor reports returns, the stronger it is relative to the foreign one, the lower the return; the converse is true when the reporting currency is weak. Currency strength or weakness is a function of fiscal and monetary policy and trade competitiveness.

Front 23

Reinvestment Risk

(Investment Risk)

Back 23

A corollary to call risk, reinvestment risk comes about when a bond is called away, leaving the investor with the task of finding a comparable yield at which to reinvest his or her cash.

Front 24

Business Risk

(Investment Risk)

Back 24

This is a risk of a downturn in a business due to factors unique to it; A manufacturer loses a major supplier, for example. The impairment could be temporary or permanent.

Front 25

Growth Stock Risk

(Stock Classification Risks)

Back 25

1. A _____ _____ generates a higher rate of return than others in the market; it can also be described as a stock that is expected consistently to provide returns in excess of the company's cost of capital.
2. _____ _____ are also sensitive to increases in interest rates and inflation because these drive up the cost of capital, and growth stocks, by definition, must exceed these hurdles.
3. _____ ____ are sensitive to capital, timing, market, political and currency risks.

Front 26

Speculative Stock Risk

(Stock Classification Risks)

Back 26

1. A ____ _____ is one that appears overpriced compared to how other stocks in the market are valued.
2. ____ ____ might be thinly traded and might not even be listed on an exchange, so liquidity risk is a consideration.
3. ____ ____ are sensitive to capital, timing, market, political and currency risks.
   
   

Front 27

Defensive Stock Risk

(Stock Classification Risks)

Back 27

1. A ____ ____ is not expected to lose its value as quickly as others during a bear market.
2. ____ ____ are safe havens during economic downturns since they hold their own during bear markets.
3. As more investment dollars search for fewer dependable securities, a ____ ____ might actually rise as other sectors fall.
4. ____ ____ also tend to have higher dividends to pay out - or miss - and are thus are sensitive to credit risk.
5. ____ ____ are sensitive to capital, timing, and currency risks.

Front 28

Earned income

(Income and Taxation)

Back 28

______ income is subject to income tax at a rate proportional to a person's income: salary, bonus, perquisites, fees for services and other remuneration for work you perform.

Front 29

Investment income

(Income and Taxation)

Back 29

____ income consists of interest, dividends, capital gains and gains (or losses) from selling securities or property.

Front 30

Capital Gain

(Income and Taxation)

Back 30

A ____ ____ is the difference between the price at which you bought a security and the price at which it is now. If you haven't sold that security yet, the capital gain is said to be unrealized. ____ ____ are not taxed until they are realized - that is to say, when you sell them. At that point, they become gains from selling securities and are generally taxed at a lower rate than other income.

Front 31

Cash Dividends

(Income and Taxation)

Back 31

_____ dividends are payable in the year paid and shareholders must pay tax on the full amount, even if they are reinvested.

• On the other hand, companies who own stock in other companies will typically qualify for a corporate dividend exclusion of 70% (if they own less than 20% stock in the other company), or 80% (if they own more than 20% of the other company).

Front 32

Stock Dividends

(Income and Taxation)

Back 32

______ Dividends are not taxable until a capital gain on those securities is realized by selling the securities. At this point, the investor must adjust the cost basis of his or her position to reflect the stock dividend. As a result, capital gains (and its respective tax) will be higher due to the lower cost basis.

Front 33

Passive income

(Income and Taxation)

Back 33

_____ income is income generated from business activities in which you do not participate materially during the year, such as rental activities (as long as you are not a real estate professional), partnerships (if you are not one of the operating partners), and residuals.

Front 34

Dividends

(Taxation)

Back 34

_______ paid by a corporation, ______ are taxed as ordinary income. Some ______ qualify for the 0% or 15% tax rate, if they are paid by a U.S. or qualified foreign corporation and the investor meets holding period requirements.

Front 35

Interest Income

(Taxation)

Back 35

This type of income from treasury bills, notes and bonds is subject to federal income tax, but exempt from state income tax.

Front 36

Municipal Bond Interest

(Taxation)

Back 36

The interest income on state and local government obligations is tax-exempt.

Front 37

Capital Gains

(Taxation)

Back 37

______ ______ are taxable income and resulting from gain on the sale of a stock or bond, most are taxable at a lower rate, usually not exceeding 15%.

Front 38

Retirement Plan Distributions

(Taxation)

Back 38

______ ______ distributions from all manner of IRAs (SEP, SIMPLE) and ERISA qualified plans are taxed as ordinary income.

Front 39

Discount Bonds

(Taxation)

Back 39

_____ bonds issued and sold at a discount pay not semi-annual interest. The accretion or increase in value, however, is subject to ordinary income tax on an annual basis.

Front 40

Mutual Funds

(Taxation)

Back 40

______ _____ pass through interest, dividends and net realized capital gains each year to investors. This income is reported on Form 1099-DIV. Distributions retain their character from the fund to the individual investor (e.g., what the fund receives as dividends, it passes to the investor as dividends)

Front 41

Annuities

(Taxation)

Back 41

________ earnings on distributions from non-qualified annuities are taxable as ordinary income to the annuitant. Any after-tax contributions are a non-taxable return of capital to the investor on a pro-rata basis, as a general rule.

Front 42

Step-up In Basis

(Taxation)

Back 42

Securities inherited from the decedent acquire a step-up in basis. This means that the legatee's basis in the securities is their value, as of the decedent's date of death. For example, if the decedent had paid $17 a share for a stock which was worth $34 on the date of death, the recipient's basis would be $34, not $17.

Front 43

Taxation of securities received as a gift

(Taxation)

Back 43

The transfer will be tax-free up to $13,000. Amounts exceeding this threshold are subject to gift tax. The following gifts may be given without triggering the gift tax, to wit: gifts to a spouse, charity, political organization for its use, education expenses with payment made directly to the educational institution for tuition only (books, supplies and living expenses do not qualify) and medical expenses paid directly to the medical facility.

Front 44

The Unified Credit

(Taxation)

Back 44

Because federal gift and estate taxes are unified into one system, a donor who exceeds the annual gift tax exclusion in a given year may either pay tax on the excess or utilize the unified credit, to avoid paying the tax. The Unified Credit enables the donor to give away up to $5,000,000 during his or her lifetime, without having to pay any gift tax. Use of the unified credit during life reduces the amount available to offset estate tax upon death.

Front 45

Limited liability

(General Share Terms)

Back 45

Limited liability refers to the degree of personal financial risk an investor in securities generally takes. If you own a store and it is destroyed in a fire and you are uninsured, you could lose everything you invested in the store. If, heaven forbid, someone is in the store at the time and is disfigured or killed, you as the owner have unlimited liability. You could lose not only everything you invested, but also everything you own. However, if you buy shares of a corporation, you generally have limited liability as an individual and only risk losing the amount you invested.

Front 46

Stock Certificate

(General Share Terms)

Back 46

A stock certificate is a formal document stating you own a certain block of shares of stock of a company. It includes the name of the issuing corporation, the number of shares, the registered owner and the transfer agent.

Front 47

Transfer Agent

(General Share Terms)

Back 47

A transfer agent is a firm retained by a corporation or a mutual fund to maintain records that include each registered shareholder's name, address and number of shares owned. The transfer agent also ensures that stock certificates presented for transfer are properly cancelled and that new ones are issued in the name of the new owner.

Front 48

Registrar

(General Share Terms)

Back 48

A registrar is like a transfer agent, but its main purpose is to document the names of all stockholders and the number of shares each one owns.

Front 49

Transfer Procedures

(General Share Terms)

Back 49

Transfer procedures are the means by which ownership of a security is passed from one party to another, whether it involves physically moving paper or doing an electronic data transfer (which is more often the case in the 21st century). The legal change of ownership can come by way of a gift, sale or resale of a security. The task of transferring may involve the physical delivery of a stock certificate or the change of ownership on the books of the corporation by the transfer agent.

Front 50

Endorsement

(General Share Terms)

Back 50

An endorsement is the signature used to legally transfer a security, whether it is an interest-rate option or a personal check.

Front 51

Escrow Receipt

(General Share Terms)

Back 51

An escrow receipt is a bank guarantee that an options writer has the option's underlying securities on deposit and that they are ready for delivery if the option is exercised.

Front 52

No-par value

(Share Value Terms)

Back 52

No-par value is what you will encounter most often. For legal reasons, most companies defer to the market and make no claims as to the intrinsic value of their stock.

Front 53

Stated value

(Share Value Terms)

Back 53

Stated value is the worth of the no-par value stock as assigned by the issuing company's directors. This is strictly for accounting purposes and is not reflected in the share's market price.

Front 54

Par, or face, value

(Share Value Terms)

Back 54

Par, or face, value is a nominal price assigned by the issuing company. Few common stock issues have a par value, and those tend to be very low. It is a term more likely to apply to bonds or to preferred stock, which is similar in many ways to bonds. In those cases, par value is used in computing interest or dividend rates.

Front 55

Authorized Shares

(Descriptive Share Terms)

Back 55

Authorized refers to the maximum number of shares an enterprise may issue according to its own articles of incorporation. It is not obligated to issue all those shares.

Front 56

Issued or Outstanding Shares

(Descriptive Share Terms)

Back 56

Issued or outstanding refers to the number of shares actually sold.

Front 57

Treasury Shares

(Descriptive Share Terms)

Back 57

Treasury refers to the number of shares that were once outstanding, have been repurchased by the company. Treasury stock can be either reissued or retired by the company; these shares typically have neither voting rights nor claims to dividends.

Front 58

Common stock

Back 58

Common stock is a simple ownership interest in a publicly traded corporation.

Front 59

Blue chip

(Types of Stocks)

Back 59

Blue chip: strong, stable and mature, with a long history of consecutive quarterly dividends; may also be income.

Front 60

Growth

(Types of Stocks)

Back 60

Growth: strong potential for improving profits faster than it has to pay back its debts, and thus a strong potential for outperforming the market.

Front 61

Emerging growth industry

(Types of Stocks)

Back 61

Emerging growth industry: young firm in new industry with good growth prospects, but also high-risk.

Front 62

Income

(Types of Stocks)

Back 62

Income: mature company with high dividend yield and few prospects for growth or diversification. These are typically utility companies; however, they may also be blue chip companies.

Front 63

Cyclical stocks

(Types of Stocks)

Back 63

Cyclical stocks move with the broader market - and often with greater volatility - so they outpace the market during an expansion but whipsaw back during a contraction. Automotive stocks are one example.

Front 64

Counter-cyclical / defensive stocks

(Types of Stocks)

Back 64

Counter-cyclical or defensive stocks do better in bear markets, when investors are looking for safe places - that are not affected greatly by economic currents - to park their money. Companies in the food, health care and defense industries are all examples.

Front 65

Speculative

(Types of Stocks)

Back 65

Speculative or special situation stocks are those that, for whatever reason, an investor believes will rise quickly in market price. There can be an element of guesswork here, but other factors may be at play too. Often, these are companies emerging from reorganization or bankruptcy. Sometimes investors will be drawn by the fact that a company's incompetent or corrupt management is being replaced by turnaround specialists. Alternatively, it might be that a company is either fundamentally undervalued or selling at the low end of its historic trading range and is thus ripe for a sharp upward movement in stock price.

Front 66

Cumulative preferred stock

(Types of Preferred Stock)

Back 66

Cumulative preferred stock has a provision that ensures it pays a steady dividend at regular intervals. If a company cannot pay a dividend, it keeps a record of all the dividends that should have been paid on the cumulative preferred stock. These accumulated dividends must be paid before any payment is made to the common shareholders. Preferred stock is designated as either cumulative or non-cumulative, meaning that the articles of incorporation do not formally stipulate this arrangement.

Front 67

Participating preferred stock

(Types of Preferred Stock)

Back 67

Participating preferred stock allows the holder to receive additional dividend distributions under specified conditions. The condition is, typically, if the dividend on the common stock rises above a defined threshold. Thus, participating preferred stock provides all the upside potential of common stock with all the steadiness of preferred. Companies that urgently need an infusion of money - early-stage start-ups looking for venture capital - might float participating preferred issues. Most preferred stock, however, is non-participating.

Front 68

Convertible preferred stock

(Types of Preferred Stock)

Back 68

Convertible preferred stock gives the holder the option to exchange it for shares of the issuer's common stock according to a defined ratio. Like participating preferred stock, it tries to give select investors the benefits of both stock and bond holding. These securities offer an answer for investors who want the profit potential of stocks but not the risk.

Front 69

Callable preferred stock

(Types of Preferred Stock)

Back 69

Callable preferred stock can, at the issuing company's choosing, be repurchased and added to the treasury stock. The investor would have no choice or recourse but to return it for the agreed-upon call price. Then again, it is usually no secret when a company wants to do this, as callable preferred shares are always covered by a sinking fund provision. A sinking fund is money that is taken from a corporation's earnings and used to redeem preferred shares or corporate bonds periodically. If a preferred stock issue has a sinking-fund provision, it means a portion of the issue must be retired each year.

Front 70

Adjustable-rate preferred stock

(Types of Preferred Stock)

Back 70

Adjustable-rate preferred stock dividends vary with some benchmark, typically the T-bill rate. Because adjustable-rate preferred stock always provides returns consistent with prevailing interest rates, its share price does not tend to move much.

Front 71

Rights offerings

(Equity Instruments )

Back 71

Rights offerings present common stock to current shareholders at a discount. Rights can be exercised, sold to another party or given as gifts. They cannot be sold back to the company for cash. If rights are not exercised during a brief window of opportunity, they simply expire.

Front 72

Warrants

(Equity Instruments )

Back 72

Warrants are certificates entitling a bondholder to buy other securities, at some point in the future, at a specific price above the current market price. If the price of the security exceeds the warrant's exercise price, then the investor can buy the security at that price and resell it immediately at a profit.

Warrants generally have longer expiration periods than rights do, and they may have no expiration date at all. They can be detached from, and traded separately from, the bonds with which they were issued.

Front 73

American Depository Receipts (ADRs)

(Equity Instruments )

Back 73

American Depository Receipts (ADRs) are issued by U.S. banks and represent shares of a foreign stock traded on a U.S. exchange. For American investors, ADRs help to simplify the process of investing in foreign companies by denominating the investment in dollars, providing a more convenient local market and lowering transaction costs.

Front 74

Direct participation programs (DPPs)

Back 74

Direct participation programs (DPPs) enable investors to have an immediate claim on an enterprise's cash flow and tax benefits, typically as a passive investment.

DPPs do not involve exchange-traded stock at all. This is the form of ownership known as partnership.

Front 75

Warrants

Back 75

Warrants: similar to an option, but issued by the company the stock of which gives the holder the right, but not obligation to purchase, warrants may be attached to a company's debt as a sweetener or trade separately. Options, by contrast, are created by the exchange. There are call warrants enabling the holder to purchase a certain number of shares of the security by a certain date, and put warrants enabling the holder to sell a certain number of shares back to the company issuing the warrant by a certain date. This exercise may be American style (on any date) or European (only at expiry). Below are warrants based upon markets and currencies that may subject the investor to market and foreign currency risk.

1. Index Warrants – Based on the performance of an underlying stock index; settlement is in U.S. dollars.
2. Currency Index Warrants – Based upon the performance of an underlying currency index, these settle in U.S. dollars.
3. Currency Warrants – Based upon the performance of an underlying currency. Settlement is in cash, to the extent that the warrant is in the money (the strike price is below the currency price for a call and above the price for a put).

Front 76

Options

Back 76

Options: derivatives and/or contracts the value of which are based upon, or derived from, the value of the security upon which they are based. The options tested on the Series 7 exam include stock, stock index and foreign currency options. Know how to calculate payoffs using a T chart, maximum gains and losses. Options may be used to protect an existing stock position, generate income or simply gain exposure to actual securities without owning them, a lower cost alternative.