Series 7
study guide

Rights

• Right to purchase new shares at a fixed price
• Provided to current stockholders during additional offerings
• One right for every share owned
• Intrinsic value exists
• Little time value
• Short term (typically 90 days or less)
• Possible outcomes:
  • Exercise
  • Trade
  • Expire

Rights value (cum-rights) formula

• $\frac{\text{Market price - subscription price}}{\text{Rights needed per new share +1}}$
• Used prior to ex-date

Rights value (ex-rights) formula

• $\frac{\text{Market price - subscription price}}{\text{Rights needed per new share}}$
• Used on or after ex-date

Warrants

• Right to purchase new shares at a fixed price
• Issued as a sweetener with other securities
• No intrinsic value
• Time value exists
• Long term (typically 5 years or longer)
• Possible outcomes:
  • Exercise
  • Trade
  • Expire

Issuing warrants

• Dilutive action requiring stockholder approval

Forward stock splits result in:

• More shares outstanding
• Lower price per share
• Same overall value

Reverse stock splits result in:

• Fewer shares outstanding
• Higher price per share
• Same overall value

Stock dividend consequences

• More shares outstanding
• Lower price per share
• Same overall value

Stockholder approval (voting)

• Stock splits require approval
• Stock dividends do not require approval

American depositary receipts (ADRs)

• US-registered receipts for foreign investments
• Created by domestic financial firms with foreign branches
• Trade in US dollars in US markets
• Subject to currency exchange risk
• No voting or pre-emptive rights
• Foreign government tax withholding creates a US tax credit

Foreign investing

• Adds diversification to portfolios
• Subject to currency exchange risk

Currency (exchange rate) risk

• Currency conversion negatively affects investment

Weak domestic currency

• Unfavorable converting into foreign currency
• Favorable converting out of foreign currency

Strong domestic currency

• Favorable converting into foreign currency
• Unfavorable converting out of foreign currency

Emerging markets

• Traditionally smaller economies
• Increasing economic growth
• High risk & return potential

Subsidiaries

• Company owned by a larger company
• Also known as a "child company"

Spin-offs

• Larger company releases part of its business as its own company

Merger

• Two or more companies merge together
• Company 1 + company 2 = company 1

Consolidation

• Two or more companies merge together as a new company
• Company 1 + company 2 = company 3

Acquisition

• Large company buys out a smaller company

Tender offers

• Proposal to purchase security from current investors
• Offered at a premium to market price
• Participants must be long the security
• Must be available for at least 20 business days
• Must be available for an additional 10 business days if offer changes

Primary market

• Sale of securities where issuer keeps proceeds
• Where initial public offerings (IPOs) occur

Secondary market

• Sale of securities where a party other than the issuer keeps proceeds
• Where securities trade after their initial sale

Subdivisions of the secondary market

• First market
  • Listed stocks trading on exchanges
• Second market
  • Unlisted stocks trading OTC
• Third market
  • Listed stocks trading OTC
• Fourth market
  • Institutions trading through ECNs

Cash dividends

• Shared corporate earnings with investors
• Paid by larger well-established companies
• Smaller companies usually avoid paying

Cash dividend dates

• The BOD determines:

  • Declaration date
  • Record date
  • Payable date

• The NYSE determines:

  • Ex-dividend date for NYSE trades

• FINRA determines:

  • Ex-dividend date for OTC trades

Ex-dividend date (cash dividends)

• Same day as the record date
• Dividend not received if buying
• Dividend kept if selling

Ex-dividend date (stock splits)

• Day after the payable date

Order of dividend dates

• D - declaration date
• E - ex-dividend date
• R - record date
• P - payable date

Common stock suitability

• Comes with considerable market risk
• Generally suitable for younger investors
• Hedge against inflation

Benefits of common stock

• Capital appreciation
• Income from cash dividends

Capital appreciation

• Investment value rises above the cost
• Also known as:
  • Growth
  • Capital gains

Unrealized capital gain

• Current gain on an investment
• Investment has not been sold
• Gains at risk if the market declines

Realized capital gain

• Locked-in gain on an investment
• Investment has been sold
• Gains are not at risk

Growth stock

• Company with expanding business model
• Typical for smaller companies
• High capital appreciation potential
• Little or no dividend potential

Income

• Dividend payments from common stock
• Paid by larger, successful companies

Dividend payout ratio

• $\text{DPR} = \frac{\text{annual dividend per share}}{\text{annual earnings per share}}$

Value stock

• Company with a "bargain" stock price
• Usually well-established businesses
• Commonly pay cash dividends

Diversification

• Investing in multiple asset classes and investments
• Cannot diversify out of systematic risk

Systematic risk

• Occurs when an event or circumstance negatively affects the entire market

Market risk

• An investment is negatively affected by a general downturn in the stock market

Inflation risk

• Also known as purchasing power risk
• General prices rise more than expected
• Common stock tends to outpace inflation over long-term periods

Non-systematic risk

• Affects specific investment or sector
• Can be reduced by diversification

Financial risk

• High debt levels negatively affect company performance

Business risk

• Products or services in low demand due to competition or mismanagement

Regulatory risk

• Potential or current government regulation negatively affects an investment

Liquidity risk

• Also known as marketability risk
• Inability to sell a security without dropping price dramatically

Concentration risk

• Lack of diversification
• Amplifies relevant non-systematic risks

Common stock typical investors

• Younger, risk-tolerant investors
• Long time horizons
• Seeking capital appreciation or income

Fundamental analysis

• Inspection of a company's finances

10-K annual report

• Audited financial report

10-Q quarterly report

• Unaudited financial report

Balance sheet

• Compares company assets and liabilities
• Indicates a company's net worth

Net worth

• Determines overall value of company or person
• $\text{NW} = \text{assets - liabilities}$

Income (cash flow) statement

• Displays company income and expenses

Footnotes

• Provides additional context for the information in financial statements

Current assets

• Assets able to be converted into cash within one year

Current liabilities

• Liabilities owed now or will be within one year

Current ratio

• $\text{CR} = \frac{\text{current assets }}{\text{current liabilities}}$

• Measures ability to pay short-term obligations

Net working capital

• $\text{NWC} = \text{current assets - current liabilities}$

• Determines liquid cash and marketable assets on hand

Quick assets

• $\text{QA} = \text{current assets - inventory}$

Quick ratio

• Also known as the acid test ratio

• $\text{QR} = \frac{\text{current assets - inventory}}{\text{current liabilities}}$

• Used to determine a company's liquidity

Debt service coverage ratio

• $\text{DSCR} = \frac{\text{net operating income}}{\text{debt service requirements}}$

• Measures ability to pay debts

Earnings per share (EPS)

• Reports an issuer's profitability on a per share basis
• Basic EPS only considers outstanding shares
• Fully diluted EPS considers:
  • Outstanding shares, plus
  • Shares to be received by option exercise or conversion

EPS formula

• $\text{EPS} = \frac{\text{Net income - pref divs}}{\text{Outstanding shares}}$

Price-to-earnings (PE) ratio

• Compares a security's market price to earnings

PE ratio formula

• $\text{PE} = \frac{\text{Market price}}{\text{EPS}}$

High PE ratios

• May indicate an overpriced investment
• Typical of growth companies

Low PE ratios

• May indicate an underpriced investment
• Typical of value companies

Technical analysis

• Identifying and predicting market trends
• Technical analysts are known as "chartists"

Fundamental vs technical analysis

• Technical analysis involves looking at trading data.
• Technical analysis is often used for short-term trading strategies
• Fundamental analysis focuses on financial statements, earnings, or company fundamentals
• Fundamental analysis is key for long-term investing.

Market trend

• Identifies general market movement
• Trend lines depict bullish or bearish directions

Advance/decline line

• Details the number of stocks up vs. down
• Helps determine overbought or oversold markets

Overbought market

• Rising market, but starting to trend downward
• Bearish indicator

Oversold market

• Falling market, but starting to trend upward
• Bullish indicator

Consolidation

• Market moves within narrow parameters
• Indicates uncertain or neutral market

Market volume

• Measures the number of securities traded

Saucer bottom formation

• Stock price falls, flattens, reverses upward
• A reverse downward trend
• Bullish indicator

Saucer top formation

• Stock price rises, flattens, reverses downward
• A reverse upward trend
• Bearish indicator

Head & shoulders top formation

• Outline of a person
• A reverse upward trend
• Bearish indicator

Head & shoulders bottom formation

• Outline of an upside-down person
• A reverse downward trend
• Bullish indicator

Resistance levels

• The market price where stock avoids going above
• Breakout above is a bullish indicator

Support levels

• The market price where stock avoids going below
• Breakout below is a bearish indicator

Round & odd lots

• A round lot is a standard trading denomination
• Typical round lot (stock) = 100 shares
• Odd lot denomination is less than a round lot

Odd lot theory

• Investors trading in odd lots are wrong
• Do the opposite of odd lot trends to profit

Short interest

• Percentage of shares sold short

Short interest theory

• High short interest = bullish indicator
• Low short interest = bearish indicator

Efficient markets theory

• Market prices instantly reflect new public info

Dow theory

• Three types of market trends:
  • Main trend
  • Medium trend
  • Short trend
• Trend changes confirmed with Dow averages:
  • DJ Industrial Average (30 stocks)
  • DJ Transportation Average (20 stocks)
  • DJ Utilities Average (15 stocks)
• If Dow averages move in:
  • Same direction: confirmation of new trend
  • Different directions: uncertainty

Bond transactions

• Initially sold in the primary market
• Trade in the secondary market

Bond market prices

• Influenced primarily by Interest rates
• Interest rates up, market prices down
• Interest rates down, market prices up
• Discount = market prices below par ($1,000)
• Premium = market prices above par ($1,000)

US Government bond trades

• Settle one business day after the trade (T+1)
• Settle through the Federal Funds system

Municipal and corporate bond trades

• Settle one business day after the trade (T+1)
• Settle through the Clearing House system

Accrued interest

• Paid by the buyer to the seller during a bond transaction
• Interest accrues up to, but not including the settlement date

30/360 method

• Assumes 30 days in each month "counted over"
• Utilized for corporate & municipal bonds

Actual/365 method

• Counts actual days in months
• Utilized for US Government bonds

Trading flat

• Bonds that trade without accrued interest
• Examples of flat bonds:
  • Zero coupon bonds
  • Bond trades settling on the payment date

Price volatility

• Measures how fast bond prices move when interest rates change
• Bonds with the most price volatility:
  • Long maturities
  • Low coupons
• Bonds with low price volatility:
  • Short maturities
  • High coupons

Duration

• Measures how fast bond prices move when interest rates change
• Measures the amount of time necessary to recoup the original cost
• Bonds with longer duration:
  • Long maturities
  • Low coupons
• Bonds with shorter duration:
  • Short maturities
  • High coupons

Bond benefits

• Primary benefit is interest income
• Interest payments are legal obligations of the issuer
• Capital appreciation may occur, especially if interest rates fall

Interest rate risk

• Interest rates rise, forcing bond market prices down
• Most susceptible bonds:
  • Long maturities
  • Low coupons
• Avoided by variable rate bonds

Purchasing power (inflation) risk

• Prices of goods and services rise, forcing bond prices down
• Typically results in higher interest rates due to Federal Reserve actions
• Avoided by short-term securities

Default (credit) risk

• Issuer unable to make required interest and/or principal payments

Bond ratings

• Only consider default risk
• Three bond rating organizations:
  • Standard & Poors (S&P)
  • Moody's
  • Fitch
• Investment grade bonds:
  • BBB or above
  • Low default risk
• Speculative (junk) grade bonds:
  • BB or below
  • High default risk

Liquidity (marketability) risk

• Security is difficult to sell or requires a large discount to sell

Legislative risk

• New domestic law or regulation negatively affects a security

Political risk

• Foreign government instability negatively affects a security

Reinvestment risk

• Market returns reinvested at lower rates
• Occurs when interest rates fall
• High coupon bonds are most susceptible
• Avoided by zero coupon bonds

Call risk

• Bond called when interest rates fall
• The worst form of reinvestment risk

Bond typical investors

• Seeking income
• Generally older, risk-averse (conservative)

Bond ladder strategy

• Investing in bonds with spread-out maturities
• Includes bonds of all maturities
• Provides most maturity diversification

Bond barbell strategy

• Investing in short and long-term bonds
• No intermediate-term bonds
• Provides benefits of short and long-term bonds

Bond bullet strategy

• Investing in bonds over time with a future target date
• All bonds mature at a target date

Non-self-supporting projects

• Do not make revenue

General obligation bonds

• Fund non-self-supporting projects
• Paid off with property (ad valorem) taxes

Used to analyze G.O. bonds

• Economic diversity
• Population trends
• Municipal obligations
• Tax collection figures

Municipal bond registration status

• Exempt from SEC registration

Municipal advisers

• Help structure bond issues
• Cannot act as an underwriter

Bond counsel

• Group of specialized lawyers
• Provides legal opinion on a bond's:
  • Validity
  • Legality
  • Tax-status
• Unqualified opinions are optimal
• Qualified opinions make bonds less marketable

Alternative minimum tax (AMT)

• Additional taxes paid on traditionally deductible income
• Private activity bonds are subject to AMT

Official statement

• Disclosure document for municipal securities
• Not required to be created
• Must be delivered to investors (if created)

Electronic Municipal Market Access (EMMA)

• MSRB-owned website
• Contains municipal market info, including:
  • Official statements
  • Trading activity
  • Market statistics
  • 529 and ABLE account information

Dated date

• Official starting date of a debt security
• The first day the security begins accruing interest

G.O. bond requirements

• Subject to voter approval
• Subject to debt limits
• Sold on a firm commitment basis

Official notice of sale

• Notifies underwriters of a municipal bond sale
• Found in the Bond Buyer

Competitive bids

• How G.O. bonds are sold
• Awards bond to cheapest underwriter

Revdex (25 bond index)

• Tracks 25 revenue bonds rated A or better
• Published weekly

Bond Buyer index (40 bond index)

• Tracks 40 municipal (G.O. and revenue) bonds rated A or better
• Published daily

Bond Buyer 20 (20 bond index)

• Tracks 20 G.O. bonds rated A or better
• Published weekly

Bond Buyer 11 (11 bond index)

• Tracks 11 G.O. bonds rated AA or better
• Published weekly

SIFMA Index

• Tracks Variable Rate Demand Notes
• SIFMA = Securities Industry and Financial Markets Association
• Published weekly

Municipal Market Data (MMD) yield curve

• Yield curve of AAA-rated municipal bonds

Lead underwriter's role

• Establish the spread breakdown
• Define liability for syndicate
• Set sales priorities
• Lead the bidding effort
• Manage and settle the offering

Syndicate letter

• Agreement between syndicate members and lead underwriter
• Establishes dynamics and incentives of the syndicate

Syndicate members

• Financial firm participating in the syndicate
• Take liability for unsold shares
• Typically a broker-dealer

Selling group members

• Selling agent for the syndicate
• Do not take liability for unsold shares

Spread

• Difference between overall amount offered and capital given to the issuer
• Compensation for syndicate

Management fee

• Compensates lead underwriter for their services

Additional takedown

• Compensates syndicate members for liability

Selling concession

• Compensates firm for selling a new issue
• Could be paid to syndicate members or selling group members

Total takedown

• Earned by syndicate member if a sale is made
• Additional takedown and selling concession combined

Eastern syndicate

• Undivided syndicate
• All syndicate members share liability together

Western syndicate

• Divided syndicate
• Syndicate members are responsible for their sales only

Sales priority for municipal new issues

1. Pre-sale
2. Group net
3. Designated
4. Member

Reoffering yield

• Represents bid made by lead underwriter
• Determines the yields of new bonds being offered

Winning the bid

• Cheapest underwriter wins the bid as determined by net interest cost (NIC) or true interest cost (TIC)
• TIC factors in the time value of money

Settling the syndicate

• Lead underwriter must settle within 30 days

Advance refunding

• Refunding bonds refinance outstanding debt before it can be called
• Proceeds are placed in a Treasury-backed escrow account to pay refunded bonds
• Advance refunding = redemption after 90 days
• Current refunding = within 90 days
• Bonds become defeased, often receive higher ratings, and may be called pre-refunded or ETM bonds

Limited tax bonds

• Considered a type of G.O. bond
• Only have access to predetermined tax allotments
• Riskier than typical G.O. bonds

Used to analyze G.O. bonds

• Population demographics
• Economic diversity
• Municipal finances

Mill rate

• Used to assess property tax obligation
• 1 mill = 0.1% = 0.001 (decimal form)

Property tax liability calculation

• Assessed value x mill rate
• Does not utilize the market value

Debt statement

• Reports and categorizes various forms of municipal debt
• Direct debt
  • All debt directly issued by a municipality
• Net direct debt
  • Direct debt minus self-supporting debt (revenue bonds)
• Overlapping (coterminous) debt
  • Debt shared with other municipalities
• Net overall (total) debt
  • Net direct debt plus overlapping debt

Self-supporting ventures

• Make revenue to pay off borrowed funds

Revenue bonds

• Paid off with revenues from municipal ventures
• Finance self-supporting municipal ventures
• No voter approval is required
• Not subject to debt limits

Feasibility studies

• Forecast profitability of a municipal venture
• Created by independent consultants

Industrial revenue (development) bond

• Municipality builds corporate facility
• Corporate lease payments are used to pay off the bond
• Credit rating based on the corporation
• Potentially subject to AMT taxes

Lease-back bonds

• Municipality builds a municipal facility
• Department using facility leases facility, pays off the bond

Special tax bonds

• Paid off with "vice taxes"
• Proceeds do not have to benefit anything related to tax
• Non-self-supporting revenue bond

Special assessment bonds

• Fund improvements to specific parts of the municipality
• Local area taxes pay back borrowed funds
• Non-self-supporting revenue bond

New Housing Authority (NHA) bonds

• Also known as Public Housing Authority (PHA) bonds
• Municipality builds low-income living facility
• Tenants pay what they can (rent)
• Federal government pays the rest
• Highest rated municipal bond (AAA rated)

Moral obligation bonds

• Backed by moral obligation
• No legal obligation to pay off bonds
• State legislature may pay off bonds if revenues fall short

Double-barreled bonds

• Backed by revenue and property taxes
• If revenues fall short, property taxes kick in

Build America Bonds (BABs)

• Fully-taxable municipal bonds issued with federal credit
• Federal government subsidizes 35% of the interest
• Used to improve infrastructure during the Great Recession of 2008

Certificates of Participation (COPs)

• Municipality gives up property to a third party and rents it back
• Investors purchase COPs to receive lease payments

Negotiated underwriting

• Issuer chooses their preferred underwriter
• Lowest cost underwriter is not required

Agreement among underwriters

• Syndicate agreement for negotiated underwritings

Revenue bonds overview

• Backed by project/facility income, not property taxes
• No voter approval or debt limit requirements
• Still face scrutiny via feasibility studies before issuance

Feasibility studies

• Conducted by independent third parties (consulting/marketing firms) for unbiased analysis
• Evaluates whether project will generate enough revenue to avoid default
• Key topics: cost of facility, demand, competition, economic impact, management structure

Debt service coverage ratio (DSCR)

• Formula: $\text{DSCR} = \frac{\text{net operating income}}{\text{debt service requirements}}$
• Higher ratio = more cushion to cover debt payments
• DSCR below 1:1 signals income doesn't cover debt obligations (default risk)

Trust indenture (bond resolution)

• Legal document listing issuer's covenants/promises to bondholders
• Virtually all revenue bonds issued with one, even though municipalities are exempt from Trust Indenture Act of 1939
• Investors typically demand one to protect their interests

Common bond covenants

• Insurance covenant: obtain insurance to reduce financial impact of accidents
• Catastrophe covenant: use insurance payout to call bonds if "act of God" destroys facility (catastrophe call)
• Books and records covenant: maintain accurate records, follow accounting standards, release periodic reports
• Rate covenant: set fees high enough to cover debt service and O&M, but not so high demand drops
• Maintenance covenant: keep facility properly maintained to protect revenue/customers

Additional bonds covenant

• Governs issuance of new bonds backed by same facility
• Open-end indenture: new senior bonds allowed if issuer passes earnings test; otherwise only junior bonds
• Closed-end indenture: only junior (subordinated) bonds allowed
• Affects existing bondholders' credit risk exposure

Flow of funds

• Revenue deposited into revenue fund, then applied per pledge order
• Gross revenue pledge order: debt service → O&M → reserve/renewal funds
• Net revenue pledge order: O&M → debt service → reserve/renewal funds
• Mnemonic: gross pledge prioritizes bondholders ("gross" to skip maintenance first)

DSCR under different pledges

• Gross revenue pledge: $\text{DSCR} = \frac{\text{gross revenue}}{\text{debt service requirements}}$
• Net revenue pledge: $\text{DSCR} = \frac{\text{gross revenue} - \text{O\&M}}{\text{debt service requirements}}$
• Net pledge produces lower DSCR since O&M subtracted first

Sinking fund covenant

• Mandatory redemption of portion of bonds (e.g., 5% annually), unlike optional call features
• Redeems randomly selected bonds at par, or buys back in market if price is lower
• Reduces risk of large lump-sum repayment at maturity; signals creditworthiness
• Still carries reinvestment risk if rates have declined

Trustee oversight

• Trustee (commercial bank/trust company) monitors issuer's compliance with covenants
• Sues issuer on behalf of bondholders if covenants are broken
• Indenture is technically an agreement between issuer and trustee, acting for bondholders

Trust Indenture Act of 1939

• Enforced by SEC; requires trust indentures for non-exempt debt issuers
• Applies to offerings of more than $50 million
• Municipalities are exempt by law, but market demand still drives them to include indentures

Anticipation notes

• Short-term municipal debt
• Paid off with future municipal cash flows

Tax anticipation notes (TANs)

• Paid off with future tax collections
• Typically property tax-related

Revenue anticipation notes (RANs)

• Paid off with future revenues from municipal ventures

Tax and revenue anticipation notes (TRANs)

• Combination of TANs and RANs

Bond anticipation notes (BANs)

• Paid off with money raised by a future bond issue

Grant anticipation notes (GANs)

• Paid off with future federal grants

Variable rate demand notes

• Municipal debt with short-term redemption (put) option
• Resetting interest rates on a periodic schedule
• Not significantly impacted by interest rate fluctuations

Municipal bond market

• Higher levels of liquidity risk
• No short sales

Yield (basis) quotes

• Typical for municipal bonds
• Provide yield, not price

Municipal debt benefits

• Tax-free income for residents
• Most securities are safe from default

Municipal bond risks

• Revenue bonds have a higher risk of default than G.O. bonds
• Liquidity risk
• Low yields (opportunity cost)

Typical municipal bond investor

• Investors seeking income
• Wealthy investors at high tax brackets

Tax-free equivalent yield

• TFEY = Corp. yield x (100% - tax bracket)

Mutual funds

• Legally classified as open-end management companies
• Investors are known as shareholders
• Manage and invest shareholder assets according to fund's objective
• "Open-ended" (variable) amount of shares outstanding
• Purchases are considered primary market transactions
• Prospectus delivery required at sale
• $100k minimum capital to launch
• Provides diversification to investors

Fund sponsor (underwriter)

• Creates the fund's structure
• Registers the fund with the SEC
• Develops marketing strategy

Investment adviser

• Responsible for fund investments
• Employs and appoints fund manager

Fund manager

• Investment adviser employee(s)
• Implements investment strategy

Diversification

• Investing in many different securities
• Reduces non-systematic risks

Diversified funds

• 75%+ invested with no more than:
  • 10% of an issuer's voting power
  • 5% of its assets in one issuer

Expense ratio

• Represents total fund expenses
• Includes:
  • Management fees.
  • Custodian fees
  • Legal fees
  • Administrative fees
• Efficient funds have low expense ratios

Management fee

• Cost of investment adviser's services
• Typically the largest part of the expense ratio

Custodian fee

• Paid to financial firm holding fund assets

Mutual fund transaction limitations

• Cannot be purchased on margin
• Cannot be sold short

Shareholder rights

• Right to vote for Board of Directors
• Right to approve investment adviser contract
• Right to vote on fund-specific matters, including:
  • Fund's objective
  • Changes to fund structure
  • Changes to fee schedule
  • Changes to diversified status
• Right to receive pro-rata share of dividends
• Right to fund disclosures
  • Prospectus
  • Statement of additional information
  • Annual SEC filing
  • Semi-annual shareholder report

Board of Directors (mutual fund)

• Represents shareholder interests
• Oversees overall operation of the fund
• 40%+ must be independent (non-interested)
  • No more than 60% "interested"
• Approve dividend and capital gain distributions

Statutory prospectus

• Primary fund disclosure document
• Must be delivered when:
  • Financial professionals solicit investors
  • An investor purchases shares unsolicited
• Information disclosed includes:
  • The investment objective
  • Shareholder fees
  • Past performance (at least 1, 5, and 10-year returns)
  • Details on investment adviser and fund manager
  • Related risks
  • Fund policies
  • Financial highlights

Summary prospectus

• Condensed version of the prospectus
• May be delivered instead of statutory prospectus

Statement of additional information (SAI)

• Provides micro-details on fund operations

Annual SEC report

• Required disclosure report to regulators, which includes:
  • Market recaps over the previous year
  • Fund manager comments
  • Investment summary (details on fund portfolio)
  • Financial statements (balance sheet, income statement)
  • Financial highlights (income, expenses, returns)

Semi-annual shareholder report

• Required disclosure report to shareholders, which includes:
  • Investment summary (details on fund portfolio)
  • Financial statements (balance sheet, income statement)
  • Financial highlights (income, expenses, returns)

Mutual fund transactions

• Mutual funds are redeemable
• Transactions only occur with the issuer
• Completed through forward pricing

Net asset value (NAV)

• $\text{NAV} = \frac{\text{net assets}}{\text{shares outstanding}}$
• Fund value on a per share basis
• Calculated once per trading day
• Purchase price for no-load funds

Public offering price (POP)

• If sales charge given in percent (%)
  • $\text{POP} = \frac{\text{NAV}}{\text{100\% - SC\%}}$
• If the sales charge is given in dollars ($)
  • $\text{POP} = \text{NAV} + \text{SC}$

Loaded fund transactions

• Bought at POP, sell at NAV
• POP is also known as the "ask" price
• NAV is also known as the "bid" price
• Max load = 8.5% of POP
• $\text{SC\%} = \frac{\text{POP - NAV}}{\text{POP}}$

Mutual fund distributions

• Capital gains distributions may only occur once per year
• The BOD sets the ex-dividend date

Mutual fund redemptions

• Must be fulfilled within seven days

Mutual fund return potential

• Capital gains (growth)
• Dividend distributions
• Capital gains distributions

Class A shares

• Front-end loaded funds
• Sales charge assessed at purchase
• Subject to breakpoint schedules
• Low or no 12b-1 fees
• Suitable for:
  • Longer-term investors
  • Larger investments of money

Letter of intent (LOI)

• Pledge to deposit breakpoint shortfall
• Lower sales charge assessed
• Lasts 13 months
• Can be backdated up to 90 days
• Retroactive charge if not fulfilled

Breakpoint sales

• Failure to notify investors of breakpoint
• FINRA violation subject to penalties

Combination privilege

• Allows merger of multiple purchases for lower sales charge

Class B shares

• Back-end loaded funds (CDSCs)
• Sales charges assessed at redemption
• Moderate 12b-1 fees
• Suitable for:
  • Longer-term investors
  • Smaller investments of money

Class C shares

• No sales charge or a 1-year CDSC
• High 12b-1 fees
• Suitable for:
  • Short-term investors

12b-1 fees

• Marketing and promotion fees used to reduce expense ratio
• Maximum fee of 1%
  • Distribution fee max = 0.75%
  • Service fee max = 0.25%
• Loads capped at 7.25% for funds charging any 12b-1 fee (not just the 1% maximum)
  • 6.25% if charging both a distribution fee and a service fee (as every fund at the 1% maximum does)
• Cannot market fund as "no load" if charging higher than 0.25%

Subchapter M

• Tax regulation for certain securities
• Taxable income passed to investors
• Also known as the "conduit" rule
• Must pass 90% of net investment income to qualify

Exchange-traded funds (ETFs)

• Usually structured as open-end management companies (a few are unit investment trusts)
• Negotiable securities

Passive management

• Track the performance of indexes
• Pursues the return of the overall market

Passive ETFs

• Aim to match the returns of a benchmark index
• Low expense ratios

Active management

• Picking the best individual securities in the market
• Attempts to outperform indexes

Specific ETFs

• "Spyders" = S&P 500 ETF
• "DIAmonds" = Dow Jones Industrial Average ETF
• "Qubes"** = Nasdaq 100 ETF

ETFs vs. mutual funds

• Trade status:
  • ETFs are negotiable
  • Mutual funds are redeemable
• ETFs have lower expense ratios
• ETFs are more tax efficient

Active management

• Picking the best individual securities in the market
• Attempts to outperform indexes

Active ETFs

• Aim to outperform the returns of a benchmark index
• Higher expense ratios than passive ETFs

Inverse ETFs

• Provide an opposite return of the index
• Only suitable for sophisticated investors

Leveraged ETFs

• Provide amplified gains and losses
• Amplify at 200% and 300% rates
• Only suitable for sophisticated investors

Leveraged inverse ETFs

• Provide an opposite return of index with amplified gains and losses
• Amplify at 200% and 300% rates
• Only suitable for sophisticated investors

Exchange traded notes (ETNs)

• Debt instruments
• Promise to pay the return of an index
• Subject to default risk
• Negotiable securities
• Can be bought on margin
• Can be sold short

New York Stock Exchange

• Auction market
• DMM acts as the NYSE auctioneer
• All trades occur in the first market

Designated market maker (DMM)

• Facilitates trading in NYSE stocks
• Acts only in a principal capacity (trades for its own account)
• The specialist it replaced in 2008 could also act as an agent

Super Display Book

• Order routing system of the NYSE
• Universal Trading Platform is the modern system

DMM's book

• Holds limit orders currently away from the market
• Market orders from other investors matched against the book

Floor brokers

• Employees of financial firms operating on the exchange floor
• Obtain the best execution for the firm's large customer orders

Stopping stock

• DMM freezes a stock price for a short amount of time
• Must be for a public customer

Circuit breakers

• Shuts market down in event of quick and large market decline
• Thresholds:
  • 7% decline - 15-minute halt
  • 13% decline - 15-minute halt
  • 20% decline - rest of day halt

Price discovery

• DMMs analyze market data to determine a stock's opening price

Dual-listed stock

• Listed on a national and regional exchange

Consolidated Quotation System

• Provides the consolidated tape
• Displays quotes on securities across multiple markets
• Combines first and third market quotes

NASDAQ

• Negotiated market
• Made up of numerous market makers
• Considered an OTC market
• Normal operating hours from 9:30am - 4:00pm ET

Level 1 quote

• Shows the inside market
• Displays the highest bid and lowest ask

Level 2 quote

• Shows all market maker quotes

Level 3 quote

• Like level 2, but interactive
• Only market makers have access

NASDAQ Market Center Execution System

• Trade routing system used by NASDAQ
• Accepts quotes for up to 999,999 shares

Self-regulatory organizations (SROs)

• Granted the power to regulate markets

FINRA

• A self-regulatory organization (SRO)
• Regulates financial professionals

OTC Markets Overview

• OTC markets serve stocks not meeting NYSE/NASDAQ listing standards
• Operated mainly under the OTC Markets Group (descended from historical "Pink Sheets")
• Eligibility often based on financial requirements (market cap, share price, shareholder equity) — know existence, not specifics

Four Principal OTC Tiers (July 2025 restructuring)

• Ranked highest to lowest listing requirements:
  • OTCQX
  • OTCQB
  • OTCID Basic Market
  • Pink Limited Market

OTCQX

• Most prestigious OTC tier
• Companies cannot be bankrupt or penny stocks
• Requires audited financial disclosures

OTCQB ("venture market")

• Designed for smaller, developing companies
• Requirements: not bankrupt, min. 50 shareholders, audited financials
• Earlier-stage issuers than OTCQX

OTCID Basic Market

• Baseline disclosure tier (replaced "Pink Current Information")
• Requires timely quarterly/annual financials, management certification, verified company profile
• Ranks below OTCQB but above Pink Limited Market

Pink Limited Market

• No financial standards; only the minimum disclosure SEC rules require for broker-dealer quotes
• May include bankrupt/distressed companies or those with limited financial reporting
• High risk due to limited transparency

Other Notes

• OTCBB (Over-the-Counter Bulletin Board) shut down by FINRA in November 2021; not part of OTC Markets Group
• Trades of non-listed stocks in OTC markets = second market trades

Chicago Board Options Exchange (CBOE)

• Primary options trading exchange
• SRO with regulatory abilities in the options markets

Designated Primary Market Maker (DPM)

• Facilitates options trading on CBOE
• Helps create a fair and orderly market
• Similar to DMM on NYSE

Order Types Overview

• Four main types: market, limit, stop, stop limit
• Investor must specify execution method when placing a trade

Market Orders

• No price specified; executes at next available market price
• Typically fills within seconds of placement
• Execution guaranteed, price NOT guaranteed
  • Main risk: price uncertainty, especially overnight

Market Order Price Risk

• Overnight news can cause big price swings before market opens
• Buy example: stock at $50 after close, news causes open at $200 — order fills near $200
• Sell example: overnight drop causes execution at much lower price than expected
• Investors generally avoid placing market orders when market is closed

Order Duration: Day vs. GTC

• Day orders: cancel automatically at end of trading day if unfilled
• Good-til-canceled (GTC) orders: stay active until customer cancels (days/weeks/months)
• Applies to all order types (market, limit, stop, stop limit)
• Broker-dealers default market orders to day orders unless customer requests GTC

Limit orders

• Seek better prices for investors
• Guarantee price, but not execution
• Day or GTC orders

Buy limit orders

• Execute when the price falls to or below the limit price

Sell limit orders

• Execute when the price rises to or above the limit price

Stop orders

• Typically utilized to "stop losses" on stock
• Do not guarantee price or execution
• Trigger (elect) first, then execute
• Become market orders after trigger
• Day or GTC orders

Sell stop orders

• Trigger when the price falls to or below the stop price

Buy stop orders

• Trigger when the price rises to or above the stop price

Stop limit orders

• Normal stop orders up until the trigger
• After the trigger, becomes a limit order
• Day or GTC orders

Orders placed above current market

• Sell limits
• Buy stops
• Not adjusted for cash dividends

Orders placed below current market

• Buy limits
• Sell stops
• Adjusted for cash dividends

Cash dividend adjustments

• Orders below the market adjusted downward by the amount of the dividend

DNR (do not reduce) orders

• Never adjusted for cash dividends

All or none (AON)

• Fill all shares or none at all
• Multiple attempts allowed

Immediate or cancel (IOC)

• Fill as many shares as possible
• One attempt allowed

Fill or kill (FOK)

• Fill all shares immediately
• One attempt allowed

Market on open (MOO) orders

• Market order that fills at market open

Market on close (MOC) orders

• Market order that fills at market close

Not held (NH) orders

• Trade request without a price and/or time specifications
• Floor brokers determine the best price or time
• Must be day orders or require a POA

Proceeds transactions

• Sell a security and use proceeds to buy another security

Order tickets

• Must be prepared before order entry
• Promptly reviewed by principals
• Changes subject to principal approval

Order ticket components

• Customer identifier
• Cash or margin account
• Registered representative identifier
• Long or short sale
• Security identifier (symbol or CUSIP)
• Number of shares or units
• Order type
• Date and time
• Solicited or unsolicited order
• If order is discretionary

Unsuitable customer orders

• Must be placed if the customer insists
• Marked unsolicited
• Should note interaction in the customer file

Name changes

• Any name changes made to account must be approved by principal
• Approval must be made before any trade execution

Trade error

• A misplaced trade that is the fault of the firm or its representative(s)
• Firm must make the customer whole
• Mistakenly purchased securities placed in firm's error account

Regulation SHO

• Short sale regulation
• Enforces the locate requirement
• Firms may use easy to borrow list to streamline short sales

The 5% rule

• Firms generally cannot charge more than 5% for transaction fees
• Does not apply to exempt securities or new issues

Proceeds transaction

• Sell a security and uses the proceeds to buy a new one

Riskless transaction

• Type of principal transaction
• Request to purchase a security the firm does not hold in inventory
• Security bought into inventory from the market, then sold to customer