SIE Exam: Understanding Products & Their Risks

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Are warrants typically issued in connection with another security in order to make that security more attractive?YesWhat are characteristics of penny stocks?Unlisted Low-priced Risky Volatile Less liquid than blue chip stocksWhat happens when a dividend is issued to an ADR holder?The ADR holder can receive a lower dividend than was actually declared by the foreign company. The foreign government might have withheld a % of the dividend for tax purposes.Do ADRs have call risk?No, because they are common stock.What types of risk do ADRs have?Currency risk and political riskDo holders of preferred stock have voting rights?No, only common stock holders.What is a preferred stock dividend quoted as a percentage of?As a % of par NOT as a % of the price at which the stock is currently tradingWhat is cumulative preferred stock?Entitles investors to receive dividends in arrears (i.e. entitles them to receive missed dividend payments).What types of preferred shares provide an advantage to the investor?Cumulative Convertible Participating preferredWhat types of preferred shares provide an advantage to the issuer?Callable preferredDo preferred shares that benefit the investor or issuer pay higher dividends?Preferred shares that benefit the issuerDo preferred or common stock have a higher potential for appreciation/capital gains?Common stockWhat does a transfer agent do?Responsible for ensuring that investors receive the appropriate shares in a corporate event (i.e. stock split or stock dividend).What is regular way trade?Settles T+2 daysWhat is the ex-date for regular way trade?The business day before the record date.What is the order of 4 dates that occur in the payment of a cash dividend?DERP: 1. Declaration date 2. Ex-dividend date 3. Record date 4. Payable dateIn a stock split, how does the overall value of the investors' position change?It does not changeHow do you calculate the new number of shares after a split?Shares * first number / second numberHow do you calculate the new price after a split?Price / first number * second numberWhat risk do short-sellers have?UnlimitedWhat is the par value of a bond?$1,000What is a bond quoted at 97 worth?$970When a bond matures, what do investors receive?Principal ($1000) + Semiannual Coupon PaymentIs interest calculated based on bond's par value or market price?Bond's par valueWhat is the relationship between interest rates and bond prices?As interest rates increase, bond prices decreaseWhen is a bond trading at a premium?Market value > par valueWhen is a bond trading at a discount?Market value < par valueAs a bond reaches maturity, what does the price move towards?Towards the par valueWhen will an issuer call a bond?When interest rates are decliningWhat happens if an issuer calls a bond?The bondholder receives final semiannual coupon payment + call premiumDoes a call feature benefit the issuer or investor?IssuerWhen would investors exercise a put feature?When interest rates increaseWhen is a bond's yield to call calculated?Using the first date on which the issuer could call the bondIn terms of yields, what happens when a bond is trading at a premium?YTC < YTM < CY < NYIn terms of yields, what happens when a bond is training at a discount?YTC > YTM > CY > NYIf an investor buys a bond with a YTM > coupon, was the bond purchased at a discount or premium?DiscountAre long-term bonds more or less volatile than short-term bonds?More volatileAre low-coupon bonds more or less volatile than high-coupon bonds?More volatileDo zero-coupon bonds have reinvestment rate risk?No because they don't pay a coupon, so there is no interest to reinvestWhat risks are US government securities susceptible to?Interest rate and inflationary risk NOT default riskWhat does trading flat mean?A bond is not trading with accrued interest.What are examples of when a bond would trade flat?1. Settlement date = interest payment date 2. Settlement date = dated date 3. Bond was in default 4. Zero-coupon bondWhat is the term debenture bond synonymous with?Unsecured corporate debtDo convertible bonds or nonconvertible bonds pay a higher coupon rate?Nonconvertible bondsWhat are convertible bonds?Bonds that can be exchanged for a fixed number of shares of the issuer's common stock.Do convertible bonds trade more like equities or bonds?More like equitiesWhen is the price of a convertible bond most volatile?During STABLE interest ratesWhat are non-marketable debt securities?US Savings Bonds Cannot be resold by investors (i.e. no secondary market)Which are more affected by interest rates: treasury bonds, T-notes, or T-bills?Treasury bonds because of their longer maturityDo STRIPS have reinvestment rate risk?No, because they do not pay a couponDo any of the following pay coupons: T-notes, T-bonds, T-bills, T-receipts?Notes & Bonds: Pay coupons Bills & Receipts: No couponsHow are T-bills quoted?On a discount yield basisWhat are agency securities, also known as mortgage-backed securities (MBS)?Ginnie Mae, Fannie Mae, Freddie MacHow do MBS pay interest?Monthly -- this differs from other US securities which pay semiannuallyWhich type of MBS is backed by the full faith and credit of the US government?Ginnie Mae (GNMA)What do collateralized mortgage obligations (CMOs) consist of?TranchesWhat are asset-backed securities?Permit securitization of financial assets (i.e. student loans, auto loans, equipment leases), not hard assets (i.e. equipment)What are general obligation bonds (GO bonds) backed by?The full taxing power of the issuing municipalityAre revenue bonds municipal bonds or corporate debt?Municipal bondsWould a revenue bond be issued to build a public high school?No, only private-sector projectsDo municipal bonds pay tax-exempt interest?YesWhat is the taxation of municipal bonds?Interest paid is exempt from taxes, but capital gains isn'tWho are tax-free municipal bonds most suitable for?Higher tax bracket individuals (since interest is tax-free) Not beneficial for retirement accounts or pension funds, that have income-tax shelteringWhat are industrial development revenue bonds backed by?Lease payments made by the corporation to the municipalityDoes the debt generated by the industrial development revenue bonds affect the credit quality of a corporation?YesWhat should investors subject to the alternative minimum tax (AMT) avoid?Private activity bondsWhat types of US securities can trade in money market?Treasury bills T-notes and T-bonds with 1 year or less to maturityWhat is a money market instrument that is used to finance and facilitate international trade?Banker's acceptanceHow often must financial reports be sent to mutual fund holders?SemiannuallyWhat is the greatest expense of any mutual fund management company?Management feeIn a mutual fund, what do investors pay tax on?Net investment income (dividends + interest income + net capital gains)What NAV do money markets aim to maintain?A stable NAV of $1.00 per shareWhat is the taxation for municipal bond funds?Dividend distributions = tax-free Capital gains distributions = taxableWho are index funds most appropriate for?Investors seeking to invest in mutual funds that charge lower feesWhen a mutual fund pays a distribution, what happens?The NAV decreases by the amount of the distributionWhat is forward pricing in relation to mutual funds?The price investors pay for mutual funds is based on the next day's closing price NAVAre mutual fund shares redeemable?Yes, they are sold back to the fund. There is no secondary market for them.How is a mutual fund sales load expressed?% of Public Offering Price NOT a % of NAVWhat do 12b-1 fees cover?Marketing and administrative expenses of the fund, NOT management fees or trading expensesWhen would a mutual fund's expense ratio increase?If its operating expenses are rising faster than the value of investmentsWhat is a no-load mutual fund?When NAV = purchase priceHow long is a letter of intent good for?Up to 13 months and backdated 90 daysDoes automatically reinvesting dividends at the NAV avoid tax?NoDo closed-end funds have a NAV?Yes, but can trade above or below based on the supply and demand of shares.Are commissions paid for both closed-end funds and mutual funds?Only for closed-end funds, NOT mutual fundsWho is a closed-end fund appropriate for?An investor who values intraday tradingAre unit investment trusts (UITs) actively traded?No, they are supervised.Are unit investment trusts (UITs) traded in the secondary market?No, shares must be redeemed by the trust.What is reconstitution?The process of adding or removing securities from an ETF portfolio to ensure it mirrors the underlying index.What types of investors should consider ETFs?Those who: - want exposure to indices - want tax efficiency - don't want management fees - don't want high trading costsDo investors pay commission when purchasing ETF shares?Yes, because they are exchange-tradedHow do the following funds trade on the secondary market: closed-end funds, ETFs, mutual funds, UITs?Closed-end & ETFs: trade intraday Mutual funds & UITs: no tradingAre investments with secondary market training considered more or less liquid?More liquidWhich of the following funds are actively managed: closed-end funds, ETFs, mutual funds, UITs?Closed-end & mutual funds: actively managed ETFs and UITs: supervisedWhat is the criteria for a REIT to pass through gains to shareholders?1. 75%+ of total assets must be in real estate 2. 75%+ of income must be from rent or mortgage interest 3. 90%+ of income must be distributed to shareholders as a dividendAre REITs able to pass through losses and gains to shareholders?No, only gains can be passed through to shareholdersWho are REITs most appropriate for?Retail investors since they are exchange-traded and offer the most liquidity Investors seeking incomeWhat are equity REITs?Professionally managed to generate income from rent and sales connected to the properties they holdDo direct participation programs (DPPs) pass through both losses and gains to shareholders?Yes, both losses and gains are passedWho are DPPs most appropriate for?Institutional and sophisticated investors because they are high risk and lack liquidityWhat is the order of liquidation for a LP?1. Secured lenders 2. General creditors 3. Limited partners 4. General partnersWhat is depletion?A tax deduction that compensates a LP that uses up a natural resource.Can real estate be depleted?No, only depreciatedWhy are MLPs more liquid and less risky than DPP investments?Because they are exchange-tradedWho are MLPs most appropriate for?A wide range of investors, including retail investorsAre hedge funds appropriate for investors who need short-term liquidity?No, because of lock-up periodsWho are hedge funds most appropriate for?Sophisticated investors with high net worths Hedge funds lack liquidity, are high-risk, and aggressively managedWhat is the credit quality of an exchange-traded note (ETN) based on?The creditworthiness of the issuer (i.e. investment bank), not the underlying asset that its performance is tied to (i.e. common stock)Are ETFs or ETNs more liquid?ETFs are more liquidDo ETFs and ETNs own the securities in their portfolios?No, only ETFs own the securitiesAre ETFs or ETNs more suitable for the average investor?ETFsDoes the premium influence whether the option holder exercises an option or not?No, it does not influence it. The execution decision is based on the market value of the underlying stockWhen can American-style options be exercised?At any time the buyer chooses prior to the expiration dateWhen can European-style options be exercised?Only on the expiration dateWhen an option is in-the-money, who does it benefit?It always benefits the owner/buyer of the option and hurts the writer/seller of the optionWhat does the writer of a call have the obligation to do?To sell the stock at the strike price and, in turn, to receive a premiumWhat is the risk of uncovered calls?Unlimited (therefore, it's inappropriate for retail investors)How do you calculate the breakeven of a covered call?Strike Price - PremiumWhat is the max gain, loss, and breakeven of a long call (i.e. call buyer)?Max gain: unlimited Max loss: premium paid Breakeven: strike + premiumWhat is the max gain, loss, and breakeven of a short call (i.e. call writer/seller)?Max gain: premium earned Max loss: unlimited Breakeven: strike + premiumWhen is a call contract in the money?When market value > strike priceWhat is the max gain, loss, and breakeven of a long put (i.e. put buyer)?Max gain: Strike - Premium Max loss: Premium Paid Breakeven: Strike - PremiumWhat is the max gain, loss, and breakeven of a short put (i.e. put seller)?Max gain: Premium Earned Max loss: Strike - Premium Breakeven: Strike - PremiumWhen is a put contract in the money?When market value < strike priceIs buying or selling options a better hedge?Buying optionsIf an investor wants to generate income, is buying or selling a call/put better?Selling an option because they will receive the premiumWhat is the Volatility Market Index (VIX)?Measures the volatility of S&P 500 Index optionsWhat type of transaction results from equity options and index options?Equity options: stock transaction Index options: cash transactionHow can an investor use options to protect her portfolio and protect against market risk?Purchase a put option on that indexWhat is the formula for an option premium?Option Premium = Intrinsic Value + Time ValueAt expiration, what is the time value of an option?Zero, because time value decays as expiration approachesWill an option with earlier or later expiration have more time value?An option with later expirationDo out-of-money contracts have intrinsic value?No, only in-the-money options have intrinsic valueDo listed options impact the capital structure of a corporation?No, because the options are issued by the OCC not the underlying corporationIf an investor wants to exercise an options position, what happens?Her broker-dealer would notify the OCC, which would then assign her contract to a counterpartyWhat is the settlement time for options?T+1 T+2 is for equities, corporate bonds, and municipal bondsWhen must an investor who owns a call option exercise to receive the dividend?Prior to the ex-dateIs a client's educational background important when determining the suitability of an investment?No, it is not importantWhich investments have the most call risk?Callable bonds and callable preferred stockWhich investments have the most reinvestment rate risk?Callable bonds and callable preferred stockWhich investments have the most capital risk?Speculative investments (i.e. options, penny stocks, DPPs)Which investments have the most credit risk?High-yield bondsWhich investments have the most inflationary risk?Fixed-income securities (i.e. bonds, preferred stock)Which investments have the most interest rate risk?Fixed-income securities (especially bonds with lower coupon and longer maturity)Which investments have the most prepayment risk?Mortgage-backed securitiesWhich investments have the most liquidity risk?DPPs, hedge funds, penny stocks, municipal bondsWhich investments have the most political risk?ADRs and other foreign securitiesWhich investments have the most currency risk?ADRs and other foreign securitiesWhich investments have the most systematic risk?Common stock and ETFs Can mitigate by purchasing put optionsWhich investments have the most non-systematic risk?Common and preferred stock Can mitigate through diversificationWhat are suitable investments for safety and preservation of capital?Treasury securities, money market securities, bank CDs, government bond mutual funds, money market mutual fundsWhat are suitable investments for current income?Utility stocks, REITs, preferred stock, fixed-income securities, income-orientated mutual fundsWhat are suitable investments for tax-free income?Municipal bonds and municipal bond fundsWhat are suitable investments for growth?Common stock, ETFs, common stock mutual fundsWhat are suitable investments for liquidity?Money market securities, money market fundsWhat are suitable investments for speculation?High-yield bonds, options, DPPs, penny stocksHow do you calculate the total return on equity?Total Return on Equity = (Dividends + Capital Gains) / Initial Purchase PriceHow do you calculate the total return on bonds?Total Return on Bonds = (Interest Income + Capital Gains) / Initial Purchase Price