SIE
study guide

Equity

• Represents ownership
• Examples of equity securities
  • Common stock
  • Preferred stock

Capital appreciation

• Also known as growth, realized as capital gains
• Occurs when stock prices rise
• Stock prices are driven by supply and demand

Retained earnings

• Profits retained by the company

Cyclical stock

• Perform well during periods of economic expansion
• Associated with industries that produce discretionary goods and services that consumers can delay purchasing in tough times
• Examples include automobiles, manufacturing, hotels, clothing, furniture, and restaurants

Defensive stock

• Provide essential goods and services that consumers continue to buy even during economic downturns
• Outperform during economic contractions or recessions
• Examples include healthcare, utilities, food and beverages, and tobacco

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

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

Concentration risk

• Lack of diversification
• Amplifies relevant non-systematic risks

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

Legislative risk

• New domestic law or regulation negatively affects a security

Political risk

• Foreign government instability negatively affects a security

Liquidity risk

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

Balance sheets

• Snapshot of company assets, liabilities, and net worth at a specific point in time
• Formula: Net worth (stockholder's equity) = Assets − Liabilities

Current assets and liabilities

• "Current" = short term (within one year)
• Current assets: cash, accounts receivable, inventory, prepaid expenses
• Current liabilities: accounts payable, wages/taxes/interest payable, near-term principal

Fixed and intangible assets

• Fixed assets: long-term physical assets (real estate, equipment, vehicles)
• Intangible assets: long-term non-physical intellectual property (trademarks, patents, copyrights)

Long-term liabilities

• Due in more than one year
• Includes bonds, mortgages, and pensions

Stockholder's equity

• Par value of stock + capital in excess of par + retained earnings
• Capital in excess of par: amount investors paid above par value
• Retained earnings: profits kept by the company rather than distributed as dividends

Income statements

• Summarizes revenues and expenses over a period of time (vs. balance sheet snapshot)
• Key line items: sales revenue → gross profit → EBIT → EBT → net income → retained earnings
• Footnotes explain significant changes in line items

Key income statement terms

• EBIT: earnings before interest and taxes (income from operations)
• EBT: earnings before taxes
• Net income: profit after all expenses and taxes
• Retained earnings: net income remaining after dividends are paid

Price-to-Earnings (PE) ratio

• Formula: PE ratio = Market price per share ÷ Earnings per share
• Higher PE = more expensive relative to current earnings; typical range is 15–25
• Growth companies: high PE (investors paying for expected future profits)
• Value companies: low PE; established firms with steady profits, often return value via dividends

Bond features

• Debt security
• Allows issuers to borrow from investors

Principal

• Original loan amount; the face value
• Also known as the par value

Interest

• Cost of borrowing money

Par value

• Known as a bond's "face value" or principal
• Typically $1,000 for bonds
• Typical sale price for new issue bonds
• Bond interest payments based on par
• Stays fixed for the life of the bond

Maturity date

• Date the issuer pays:
  • One final interest payment
  • Principal (par value)

Interest rate (coupon)

• Represents annual interest paid to bondholders
• Based on the bond's par value
• Largely dependent on market interest rates at the time of issuance

Interest payments

• Legal obligation of the issuer
• Typically made semi-annually

Bearer bonds

• Owned by whoever physically possesses them
• No longer issued in the US

Book-entry bonds

• Ownership tracked electronically by a transfer agent
• All modern securities issued in this format

Zero coupon bonds

• Do not make regular interest payments
• Issued at a discount and mature at par
• Longer maturities = deeper discounts

Short-term maturities

• Safer than long-term bonds
• Lower rates of return

Money markets

• Debt securities with one year or less to maturity

Long-term maturities

• Riskier than short-term bonds
• Higher rates of return :::: points

Term issuance

• All bonds issued and mature on the same day
• Typical issuers:
  • Corporations
  • US government
• Type of quote:
  • Price quotes
  • Dollar quotes
  • Percentage of par quotes
  • Term quotes

Serial issuance

• All bonds are issued on the same day, but mature on different days
• Typical issuers:
  • Municipalities
• Type of quote:
  • Yield quotes
  • Basis quotes
  • Serial quotes

Series issuance

• Bonds are issued on different days, but all mature on the same day
• Typical issues:
  • Construction-related projects

Basis points

• Formal measurement of percent
• 1 basis point = 0.01%
• 100 basis points = 1%

Firm commitment underwritings

• Underwriter keeps unsold securities
• Riskier for underwriter
• Larger fees for underwriters

Best efforts commitment underwritings

• Issuer keeps unsold securities
• Riskier for the issuer
• Smaller fees for underwriter

Market prices

• Bonds trade freely in secondary market after issuance
• Bond prices move inversely to interest rates: rates up → price down, rates down → price up
• Discount = trades below par (buyer gains coupon + capital gain to par at maturity)
• Premium = trades above par (buyer gains coupon but loses value to par at maturity)

Price volatility

• Long maturity + low coupon = most price volatile bonds
• Long-term bonds swing more since rate changes lock in returns for longer
• Low-coupon bonds swing more since less cash flow available to reinvest at new rates
• Rate volatility (different concept) = short-term rates most volatile (% change basis)
  • Exam rule: Price volatility → long maturity & low coupon; Rate volatility → short-term rates

Settlement

• Trades require back-office processing before ownership updates
• Transfer agent tracks bondholders and distributes interest to owners as of payment date
• All bond types (Government, municipal, corporate) settle T+1 (one business day)
  • US Government settles via Federal Funds system
  • Municipal & corporate settle via Clearing House system
• T+1 counts business days (weekends and holidays skipped): a Friday trade settles Monday, or Tuesday if Monday is a holiday

Accrued interest

• Interest is earned daily but paid semiannually; accrued interest = interest earned but not yet paid
• Full payment goes to whoever owns bond on payment date (not prorated)
• Buyer pays seller market price + accrued interest to fairly compensate seller for holding period
• Buyer's interest earned = payment received from issuer - accrued interest paid to seller
• Accrual period: last interest payment date up to (not including) settlement date; weekends count
• J&J1 = pays interest January 1st and July 1st
• 30/360 method: corporate & municipal bonds; assumes 30 days/month, actual days counted in settlement month
• Actual/365 (actual/actual) method: US Government bonds; uses actual calendar days per month
• Bonds trade flat (no accrued interest) when: settlement falls exactly on payment date, or bond is a zero-coupon bond

Secured bonds

• Collateral backs the bond
• Safer investments vs. unsecured bonds

Unsecured bonds

• Also known as full faith and credit bonds
• No collateral backing
• Riskier investments vs. secured bonds

Call feature

• Allows issuers to end a bond before maturity
• Requires the payment of accrued interest, par, plus any call premium
• Typically utilized when interest rates fall

Call risk

• Occurs when a bond is called in an unfavorable environment
• Typically results in reinvestments at lower rates
• Type of reinvestment risk

Call premium

• Amount above par ($1,000) issuer must pay to call the bond

Call protection

• Number of years before a bond may be called

Tender offer

• Formal offer to buy a security from current investors

Put feature

• Allows bondholders to end a bond before maturity
• If exercised, the issuer must pay accrued interest plus par to the bondholder
• Generally utilized when interest rates rise

Bond yield basics

• Yield = overall return; influenced by coupon, purchase price, time to maturity
• Coupon and yield differ unless bond trades at par
• Bond point = 1% of par ($10 on $1,000 bond); different from basis point (0.01%, measures yield)

Reading bond prices

• Prices quoted as % of par, not dollars
• Premium/discount described in points (e.g., 7-point premium = 107% of par)
• Four yields covered: nominal, current, YTM, YTC

Nominal yield

• Same as stated coupon rate
• Also known as: coupon, interest rate, stated rate
• Formula: $\text{Nominal yield} = \frac{\text{Annual income}}{\text{Par}}$
• Fixed for life of bond; market price not a factor

Current yield

• Quick estimate of return; ignores time
• Formula: $\text{Current yield} = \frac{\text{Annual income}}{\text{Market price}}$
• Discount bonds: current yield > coupon
• Premium bonds: current yield < coupon

Yield to maturity (YTM)

• Also called bond's "basis"; assumes held to maturity; accounts for time
• Formula concept: annual income ± annualized discount/premium, divided by average of price and par
• Discount bonds: YTM > coupon
• Premium bonds: YTM < coupon
• Exact math rarely tested; focus on relationships

Yield to call (YTC)

• Applies only to callable bonds; assumes called at first call date
• Uses call price and years to call instead of par/maturity
• Discount bonds: YTC > YTM > current yield > coupon (gain realized sooner)
• Premium bonds: YTC < YTM < current yield < coupon (loss realized sooner)

Discount bond yield relationships

• Order (low to high): Coupon < Current yield < YTM < YTC
• Bond see-saw: price below par (discount) → yields rise

Premium bond yield relationships

• Order (high to low): Coupon > Current yield > YTM > YTC
• Bond see-saw: price above par (premium) → yields fall

Yield for par bonds

• Bond bought and matures at par → no gain/loss from price
• All yields equal the coupon: Coupon = Current yield = YTM = YTC
• See-saw is balanced/level at par

The bond see-saw

• Visual tool linking price and yield relationships across discount, premium, and par bonds
• Useful as a "dump sheet" item to memorize before exam
• Mnemonic: CYM Call = Current Yield, Maturity, Call (yield order)

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
• Type of systematic risk
• Most susceptible bonds:
  • Long maturities
  • Low coupons
• Avoided by variable rate bonds

Inflation (purchasing power) 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

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

Default risk

• Also known as credit or repayment 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

Bond typical investors

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

Municipality

• State, city, or local government

Corporate bond interest

• Subject to federal, state, and local taxes

Municipal bond interest

• Exempt from federal taxes
• Subject to state and local taxes

US territory bond interest

• Tax-free regardless of residence

US Government bond interest

• Subject to federal taxes
• Exempt from state and local taxes

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 the 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

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

Official statements

• Disclosure document for municipal securities
• Issuers are not required to create them
• Underwriters must deliver them by settlement (if created)
• Information disclosed includes:
  • The bond's interest rate
  • Timing of interest payments
  • Length of the bond (maturity)
  • Specific features of the bond (e.g., call features)
  • Source of repayment funds (e.g., property taxes)
  • The municipality's finances
  • Legal matters, including the legal opinion

Limited tax bonds

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

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

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

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

• Long-term municipal debt with short-term redemption options
• Resetting interest rates on a periodic schedule
• Contain a put option at par

Municipal bond market

• Higher levels of liquidity risk
• No short sales

Yield (basis) quotes

• Typical for municipal bonds
• Provide yield, not price

Municipal bond suitability

• Best for wealthy investors at high tax brackets
• Not suitable for retirement plans

Investment companies

• Financial institutions that invest their customers' money
• Regulated by the Investment Company Act of 1940

Investment company classifications

• Management companies
• Unit investment trusts (UITs)
• Face amount certificates

Types of management companies

• Open-end management companies (mutual funds)
• Closed-end management companies (closed-end funds)

Unit investment trusts (UITs)

• Fixed portfolios of securities
• At maturity, portfolio is liquidated and proceeds passed to investors

Face amount certificates (FACs)

• Periodic payment or lump sum contribution
• Redeemable securities
• Fixed payout at maturity

Investment Company Types Overview

• Most investment companies are funds: mutual (open-end), closed-end, ETFs
• Fund "type" based on investment objective and securities held
• Key types: growth, growth and income, balanced, income, specialized, sector, index, asset allocation, international/global

Growth Funds

• Objective: capital appreciation (buy low, sell high)
• Invests in growth-focused common stock, convertible preferred stock, and bonds
• Aggressive growth funds take on more risk (small/micro-cap, volatile/emerging industries)
• Market capitalization measures company size: shares outstanding × market price
  • Mega-cap: $200B+; Large-cap: $10B–$200B; Mid-cap: $2B–$10B; Small-cap: $250M–$2B; Micro-cap: under $250M
  • Smaller companies = higher risk/higher growth potential

Growth and Income Funds

• Seeks capital appreciation AND income
• Invests in income-producing common and preferred stocks only (no bonds)
• Generally more conservative than pure growth funds due to dividend-paying stocks

Balanced Funds

• Similar to growth and income, but includes debt securities (bonds) too
• Even split between growth-focused stock and income-producing securities
• Key distinction: balanced funds hold bonds + stock; growth and income funds hold only stock

Income Funds

• Invest only in income-producing securities (bonds, preferred stock, dividend stocks)
• Generally conservative/lower risk than growth funds
• Subtypes: corporate bond, municipal bond, US Government bond funds
• High yield (junk) bond funds = higher risk/yield; conservative bond funds = investment-grade, lower risk
• International bond funds invest in foreign bonds
• Agency funds (Ginnie Mae, Fannie Mae, Freddie Mac) invest in mortgage-backed securities
  • Ginnie Mae guarantees MBS (doesn't purchase mortgages); Fannie/Freddie purchase mortgages
  • Subject to prepayment/extension risk but government-backed, suitable for risk-averse investors
• Money market funds:
  • Priced at constant $1.00/share
  • Highly liquid, short-term time horizon suitable
  • Rarely have sales charges/fees
  • Function similarly to savings accounts; default holding for uninvested cash

Specialized Funds

• Not defined by growth/income objective
• Invest in specific industry or region (also called sector funds)
• Risk/return varies widely based on focus area

Index Funds

• Aim to match performance of a specific index (e.g., S&P 500)
• Indexes track/average securities to gauge market trends
• Types: small/large-cap, bond, specialized indexes
• Passive management: tracks index closely, no security selection
• Active management: manager selects "best" investments
• Passive investing (index funds) growing in popularity

Asset Allocation Funds

• Invest across asset classes in set or shifting proportions
• Static allocation funds maintain constant mix (e.g., 70% stock/30% debt)
• Life cycle/target date funds: shift from aggressive to conservative over time
  • Start heavy in growth stocks, shift to fixed income as target date approaches

International/Global Funds

• International funds: invest only outside the US
• Global funds: invest worldwide, including US securities
• Provide diversification and potential hedge against domestic risk

Closed-end management companies

• During primary offering:
  • Sold in the primary market
  • Prospectus delivery required
• After primary offering:
  • Traded in the secondary market (negotiable)
  • No prospectus delivery is required

Closed-end fund transactions

• Purchased at market price
• Subject to commissions
• NAV represents the fund's book value
• Market price could be:
  • Higher than NAV
  • Same as NAV
  • Lower than NAV

Unit investment trusts (UITs)

• Fixed portfolios of securities
• No ongoing portfolio management
• No management fees
• Redeemable with the issuer
• Some UITs may trade in the secondary market

Alpha

• Measures over or underperformance of a portfolio or security
• Positive alpha = overperformance
• Zero alpha = meeting expectations
• Negative alpha = underperformance

Beta

• Volatility measure as compared to the market (benchmark index)

Investment taxes and dividends overview

• Tax treatment varies by security/transaction type
• Directly impacts investor's overall return
• Chapter focus: cash dividend taxation

Cash dividends

• Income from equity investments (common/preferred stock)
• Also passed through via mutual funds, closed-end funds, ETFs
• Generally taxed at lower rates than bond interest

Qualified vs. non-qualified classification

• Determines applicable tax rate
• Qualified dividends taxed lower than non-qualified
• Taxable income basis includes: salary, wages, commissions, bonuses, royalties
• Higher income generally = higher tax rate

Qualified dividend tax rates

• Three brackets: 0%, 15%, 20%
• Based on individual/joint filer income levels
• Don't memorize exact bracket dollar amounts (change over time)
• If exam question is vague on income/bracket, assume 15% rate

Requirements for qualified dividend status

• Must be distributed by a US corporation or qualified foreign corporation
  • Foreign corp qualifies if: incorporated in US possession, covered by US tax treaty, or stock trades on established US exchange (e.g., ADR on NYSE)
• Investor must meet an unhedged holding period requirement
  • Unhedged = no protective position (e.g., long put) preventing loss
  • Specific holding period details unlikely to be tested; just know requirement exists

Non-qualified (ordinary) dividends

• Taxed at investor's marginal federal income tax bracket
• Marginal bracket = rate applied to the last dollar earned
• Income taxed progressively across multiple brackets, but investor is classified by highest (marginal) rate reached

Qualified vs. non-qualified example

• $100 dividend, individual with $55,000 income
• Qualified: taxed at 15% → $15 tax
• Non-qualified: taxed at marginal rate 22% → $22 tax

Exam assumptions and REIT exception

• Assume common stock, preferred stock, mutual funds pay qualified dividends unless stated otherwise
• REIT dividends are always non-qualified (taxed up to 37%)
• Higher REIT taxation means REITs often need higher returns to attract investors

Reporting: Form 1099-DIV

• Sent annually by brokerage firms to customers and IRS
• Shows dividend amounts and qualified/non-qualified status
• Dividend reported in the year it is paid, not declared

Stock dividends and splits

• Not taxable at time of distribution
• Share price adjusts proportionately; total position value unchanged
• New shares taxed only when sold

Interest overview

• Income earned from lending money via debt instruments (bonds)
• Generally not given favorable tax treatment (unlike qualified dividends)
• Only the interest portion is taxable; principal repayment is a non-taxed return of capital

US Government debt

• Taxed federally
• Exempt from state and local taxes

Mortgage-backed securities

• Taxed at federal, state, and local levels
• Pass-through payments = interest (taxable) + principal (non-taxable return of capital)
  • Principal includes both scheduled amortization and unscheduled prepayments
• Issuers/servicers (e.g., Fannie Mae, Freddie Mac, Ginnie Mae) report the interest/principal breakdown monthly

Municipal debt

• Exempt from federal taxes
• Subject to state and local taxes, unless:
  • Investor resides in issuing state
  • Bond issued by a US territory
• If exception applies, bond is 100% tax-free (triple tax-exempt)

Corporate debt

• Fully taxable: federal, state, and local levels

Tax rate & reporting

• Federal tax on interest = investor's marginal income tax bracket
• Taxed the same way as non-qualified dividends
• Marginal tax bracket: rate applied to the last dollar of income earned
  • Income taxed progressively across brackets, but marginal bracket reflects highest rate paid
• State tax treatment varies by state (specifics not required knowledge)
• Interest income reported annually via Form 1099-INT

Capital gain

• Securities sold for more than the basis
• Reported on tax form 1099-B

Long-term capital gain

• Gain on security held more than 1 year
• Tax rate: 0%, 15%, or 20%

Short-term capital gain

• Gain on security held for 1 year or less
• Tax rate: up to 37%

Inherited securities

• Cost basis is stepped up to the value on the date of death
• Holding period is always long term

Earned income

• Income from employment
• Includes wages, salaries, tips, bonuses, and commissions
• Taxable at the marginal income brackets

Investment income

• Income from securities
• Includes interest, dividends, and capital gains

Passive income

• Income from rental property and limited partnerships
• Passive losses only offset passive gains

Secondary market basics

• Trading occurs after initial issuance (primary market already raised capital)
• Investors trade with other investors at current market price
• Firms earn revenue by facilitating trades, either as agent or principal

Agency capacity

• Firm acts as broker/agent, matching customer orders with other market participants
• Doesn't trade from own inventory
• Earns a commission for the match

Principal capacity

• Firm acts as dealer, trading from its own inventory
• Often called a market maker:
  • Sells from inventory when customer buys
  • Buys into inventory when customer sells
• Earns mark-up (sell above market price) or mark-down (buy below market price)
• Carries risk: inventory value can decline, causing losses

Key distinction

• Agency = commission, no inventory risk
• Principal = mark-ups/mark-downs, inventory risk (buy low, sell high like a dealer)

Traders

• Buy and sell securities for clients
• Typically work on behalf of large portfolios (e.g. mutual funds, hedge funds)

Broker-dealers

• Buy and sell securities for clients
• May act in an agency or principal capacity

Market makers

• Buy and sell securities with the public
• Acts only in a principal capacity

Agency capacity

• Firms matching buyers & sellers
• Commission earned
• Associated terms
  • Brokers
  • Agents

Principal capacity

• Firms buying and selling with inventory
• Mark-ups and mark-downs earned
• Associated terms:
  • Dealer
  • Market maker

Bid/ask spreads

• Maintained by market makers
• Provide best buy & sell prices

Bid

• Market makers buy at the bid
• Customers sell at the bid

Ask

• Market makers sell at the ask
• Customers buy at the ask

Round lot

• 100 shares of stock

Efficient market

• A large number of market participants
• Small spreads and active trading

Securities Exchange Act of 1934

• Regulates the secondary market
• Applies to non-exempt securities
• Applies to market participants
• Required broker-dealers to provide:
  • Balance sheets
  • Net capital computations

Anti-fraud rule

• Part of the Securities Exchange Act of 1934
• Applies to all securities
• Applies to all market participants

Insider (affiliate) rules

• Cannot sell short company stock
• Must return short swing profits

Short swing profit

• Capital gain made within 6 months

Penny stock

• Non-listed stock trading for less than $5
• Investors must receive:
  • Risk disclosure document
  • Monthly statements

Penny stock suitability statement

• Required for solicitations
• Not required for established customers
• Established customer:
  • Account open for 1+ year
  • 3 unsolicited penny stock trades

Contributions

• Must be made in cash only (no securities/assets)
• Deductible contributions: reduce taxable income immediately (most qualified plans)
• Non-deductible contributions: after-tax funds, no immediate tax benefit
• Most plans are tax-deferred (exceptions: Roth IRA/401(k))

Eligible investments

• Prohibited: short sales, margin, uncovered/naked options, collectibles, art
• Municipal bonds generally not ideal (lose tax benefit advantage inside already tax-sheltered account)
• Allowed: stocks, bonds, mutual funds, UITs, US government-issued coins

Distributions

• Withdrawals can generally be taken anytime
• Penalties possible for early or missed required withdrawals
• Taxed as ordinary income at investor's marginal tax bracket

Penalties

• Excess contribution penalty: 6% annually on amount over contribution limit
  • 2026 IRA limit: $7,500 (under 50); $8,600 (50+, includes $1,100 catch-up)
• Early withdrawal penalty: 10% if taken before age 59½, plus ordinary income tax
  • Exceptions (no 10% penalty, but taxes still owed): disability, death (inherited accounts), first-time home purchase, education expenses, certain medical expenses, birth/adoption (QBAD up to $5,000)
• Required Minimum Distributions (RMDs):
  • Begin at age 73 (75 if born in 1960 or later)
  • Calculated using year-end balance ÷ life expectancy factor (uniform life expectancy table)
  • First RMD deadline can be delayed to April 1 of following year
  • Missed RMD penalty: 25% (reduced to 10% if corrected within two years)

Qualified vs. non-qualified plans

• Qualified plans meet legal requirements, governed by ERISA (private employers)
• Qualified plans offer substantial tax benefits to employer and employee
• Non-qualified plans lack these protections/benefits

Pre-tax contributions

• Reduce reported taxable income for the year
  • Example: $100,000 salary − $5,000 contribution = $95,000 taxed
• Payroll deductions often deposited without immediate taxation
• Distributions generally taxed later in retirement
• Exception: Roth 401(k)s don't use pre-tax contributions

Why employers offer qualified plans

• Tax advantages make them attractive for recruiting/retention
• Must comply with ERISA to qualify
• ERISA protects employee retirement assets from employer misconduct/mismanagement

ERISA standard: Minimum participation/non-discrimination

• Can't favor highly compensated employees/owners
• Can exclude certain employee groups if plan passes IRS minimum coverage tests
• Maximum eligibility limits: age 21+ and one year of employment (1,000+ hours)
  • These are ceilings, not floors — earlier eligibility allowed

ERISA standard: Reporting and disclosure

• Plan details must be provided in writing
• Employees receive annual updates

ERISA standard: Funding

• Defined benefit plans must be adequately funded

ERISA standard: Vesting

• Employer-provided benefits (e.g., matching contributions) must vest within a reasonable period
  • Typically 5 years or less
• Employee's own contributions are always 100% vested immediately

Plan document

• Required before plan offered to employees
• Defines contribution rules, employer benefits, vesting schedule, investment options, beneficiary rules, distribution guidelines

Fiduciary

• Administers plan per the plan document
• Owes duty of care/trust; must act primarily for participants' benefit
• Prioritizes plan participants' interests over the organization's
• Can be an internal employee (executive/board member) or third party

IRS approval process

• Plan document + fiduciary appointment submitted to IRS for approval
• Once approved, plan can be offered to employees

Defined benefit plans

• Varying contributions made over time
• Defined retirement benefit
• Most beneficial for employees:
  • With higher salaries
  • Closest to retirement age

Pensions

• Common form of defined benefit plan
• Pay retirement income until death

Unfunded pension liabilities

• Payouts exceed assets (forecasted)

Defined contribution plans

• Defined contributions
• Unknown benefit at retirement

401(k) plan

• Qualified retirement plan
• For private (non-government) companies

Solo 401(k) plan

• Qualified retirement plan
• For private (non-government) self-employed businesses with no employees
  • Working spouses do not count

403(b) plan

• Qualified retirement plan
• For non-profit organizations
• Also known as tax-sheltered annuities

Keogh (HR-10) plans

• Qualified retirement plan
• For self-employed businesses
• 2026 contribution limit is lesser of:
  • $72,000
  • 25% of income

Profit-sharing plans

• Qualified retirement plan
• Employer shares a portion of profits
• Employer under no obligation to contribute

Money purchase plans

• Qualified retirement plan
• Employer must contribute a fixed percentage of salary annually

SEP and SIMPLE IRAs

• Qualified retirement plans
• For small businesses
• Higher contribution limits than traditional or Roth IRAs

Deferred compensation plan

• Non-qualified retirement plan
• Allows senior employees to defer compensation, invest it, and receive it in retirement

457 plan

• Government & certain non-profit retirement plan
• Allows pre-tax contributions and tax-deferred growth
• No early withdrawal penalty

Individual Retirement Accounts (IRAs)

• Personal retirement savings vehicles outside employer plans
• Two main types: Traditional IRAs and Roth IRAs

Traditional IRAs

• Non-qualified but function like qualified plans
• Contributions may be tax-deductible; distributions taxed as ordinary income
• Non-deductible contributions: only growth taxed on withdrawal (basis returned tax-free)

Traditional IRA Contribution Limits

• 2026 limit: lesser of $7,500 or earned income
• Must have earned income (wages, salaries, tips, bonuses, commissions, self-employment, royalties) to contribute
• Contributions for a tax year allowed until following year's tax-filing deadline (~April 15)

Spousal IRAs

• Working spouse can contribute to non-working spouse's IRA
• Allows non-working spouse to have IRA contributions despite no earned income

Catch-Up Provision

• Age 50+ can contribute additional $1,100/year
• 2026 total limit for 50+: $8,600 ($7,500 + $1,100)

Deductibility of Traditional IRA Contributions

• Not covered by workplace plan: always fully deductible
• Covered by workplace plan + low income: fully deductible
• Covered by workplace plan + high income: partially or not deductible
  • Phaseout ranges exist (not required to memorize exact numbers for exam)

Roth IRAs

• Contributions made after-tax (non-deductible)
• Growth is tax-sheltered; qualified withdrawals are tax-free
• Same $7,500 contribution limit (combined with traditional IRA contributions)
• Catch-up: additional $1,100 for age 50+
• High-income earners may be phased out or ineligible to contribute (exact numbers not required for exam)

Roth IRA Distributions

• Tax-free withdrawal requires: age 59 ½+ AND account open 5+ years (five-year aging period)
• Five-year period starts Jan 1 of year of first contribution
• Age 59½+ but before 5-year mark: pay ordinary tax on gains, no 10% penalty
• Ordering rule: withdrawals treated as contributions (basis) first, then earnings
  • Contributions can be withdrawn anytime, tax- and penalty-free
• No Required Minimum Distributions (RMDs) for Roth IRAs

Roth 401(k)s

• Same tax treatment as Roth IRA: after-tax contributions, tax-free qualified withdrawals, no RMDs
• Same age 59½ and five-year rules apply
• Unlike Roth IRA, considered a qualified workplace plan and governed by ERISA

Inherited IRAs

• IRS requires eventual distribution of inherited IRA assets (cannot stay tax-sheltered indefinitely)
• Two beneficiary categories: spousal and non-spouse

Spousal Beneficiary Options

• Claim IRA as own: roll into own IRA, no RMDs required if under 73, but 10% penalty possible if withdrawn before 59½
• Claim as inherited IRA: required distributions (annual RMDs or full distribution within 10 years), no early withdrawal penalty

Non-Spouse Beneficiary Options

• Two types: eligible designated beneficiary (minor child, disabled, chronically ill, or ≤10 years younger than decedent) vs. designated beneficiary (all others)
• Must claim as inherited IRA; no 10% penalty but distributions required
• Eligible designated beneficiaries: may take RMDs over lifetime
• All others: must distribute all assets within 10 years

Variable life insurance

• Coverage for the entire life of the policyholder
• Fixed premiums
• Guaranteed death benefit
• Cash value invested in the separate account
• Cash value grows based on investment performance
• Policyholder subject to investment risk
• Cash value may be
  • Withdrawn or borrowed
  • Returned to the insurance company upon death
  • Kept upon surrender of the policy
  • Retained and potentially paid with a death benefit
• Considered a security

Variable annuities

• Unlimited non-deductible contributions
• Contribution options:
  • Lump sum
  • Periodic contributions
• Offers tax-deferred growth
• Distributions taxable above basis

Immediate annuity

• Investor contributes a large lump sum
• Immediately annuitizes and receives payments

Deferred annuity

• Investor contributes over time
• Takes withdrawals or annuitizes later in retirement

Accumulation phase

• When contributions are made
• Death benefit applies

Death benefit

• Beneficiary keeps GREATER of:
  • Amount invested
  • Account value
• Applies if the account owner dies during the accumulation phase

Variable annuity insurance company risks

• Mortality risk
  • Investor dies earlier than expected, triggering the death benefit
• Expense risk
  • Business expenses rise
• Longevity risk
  • Investor lives longer than expected, forcing annuity payments to be paid longer

Separate account

• Where assets are held
• Customer in control of investing
• Investment choices:
  • Equity-based portfolios
    • Hedge against inflation
  • Debt-based portfolios
    • Subject to inflation risk

Distribution phase

• Investor receives income in retirement
• Non-annuitization options
  • Lump sum
  • Periodic payments
• Annuitization options:
  • Straight life annuity
  • Life with period certain
  • Joint and last survivor
  • Unit refund

Non-qualified annuity taxation

• Growth is taxable as ordinary income
• Withdrawals (non-annuitization)
  • Growth is distributed first (LIFO)
• Annuitization
  • Basis and growth distributed simultaneously
  • Taxed on a "pro-rata" basis (a.k.a. exclusion ratio)
• Not subject to RMDs

Qualified annuity taxation

• All distributions taxed (growth and basis) as ordinary income
• Subject to RMDs starting at age 73

Fixed annuities

• Like a variable annuity, but:
  • Not a security
  • General account instead of a separate account
  • More exposed to inflation risk

Coverdell ESAs

• Savings accounts for child's educational expenses
• Cover virtually all types of education
• Assets grow tax-deferred

Coverdell ESA contributions

• $2,000 per person per year limit
• Non-deductible
• Can no longer be made at age 18

Coverdell ESA distributions

• Not taxable if used for education
• Full distribution or rollover by age 30
• Rollovers only to family members
• Penalties if not used for education:
  • Ordinary income taxes on gains
  • Additional 10% penalty

529 plans

• Also known as qualified tuition programs (QTPs)
• State-sponsored education savings plans
• Assets grow tax-deferred
• Assets invested in state-approved funds
  • Plan participant may make two changes annually
• Cover college expenses
• Cover up to $20,000 of qualified K-12 education expenses annually
• May move to another state plan once per calendar year

529 plan parties

• Plan participant
  • Controls and manages plan for a beneficiary
• Beneficiary
  • Person receiving plan assets to pay for education

Prepaid tuition plans

• Pays for future tuition costs at today's rates

College savings plans

• Assets grow tax-deferred in funds

529 plan contributions

• Subject to gift taxes
  • $19,000 annual gift tax exemption
• Generally non-deductible
• Some states allow for state tax deduction

529 plan distributions

• Tax-free if used for education expenses
• Penalties if not used for education:
  • Ordinary income taxes on gains
  • Additional 10% penalty on gains

ABLE accounts

• Savings plans for people with disabilities
• Must be disabled by age 46 to qualify (as of 2026)
• After-tax contributions
• Tax-sheltered growth
• Qualified distributions are tax-free