Series 66 Key Concepts 7-22

What is the purpose of the Pay-to-Play Rule?

The pay-to-play rule is designed to avoid conflicts of interest by preventing investment advisers from making political contributions to officials who influence investment decisions, promoting fairness, transparency, and protecting public interests.

What are the reporting requirements for Investment Adviser (IA) access persons regarding securities holdings?

IA access persons must annually report their securities holdings, excluding U.S. Treasuries, open-end mutual funds, and money market funds, to ensure transparency and manage potential conflicts of interest.

Describe the stages of money laundering.

1. Placement: Illicit funds are introduced into the financial system.
2. Layering: Illicit funds are separated from their source through complex transactions.
3. Integration: Funds are reintroduced into the economy, appearing legitimate.

What is the declaration date in relation to dividends?

The date on which the board of directors declares a dividend.

What is the record date for dividends, including T+1 settlement?

The date on which an investor must own the shares of a company to be eligible to receive a dividend. With T+1 settlement, the record date is the same day as the ex-dividend date.

Explain the tax implications of Non-qualified Stock Options (NSOs).

NSOs are not taxed when granted, but taxation occurs at the time of exercise. The difference between the fair market value (FMV) on the exercise date and the exercise price is considered ordinary income and subject to income and payroll taxes. Subsequent gains from selling shares are taxed as capital gains.

Under what conditions are Incentive Stock Options (ISOs) taxed as long-term capital gains?

If stock purchased through an ISO is held at least 2 years after grant and 1 year after exercise, profits are reported as long-term capital gains. Otherwise, the ISO is taxed like an NSO.

Differentiate between top-down and bottom-up investing.

• Top-down investing: Begins with broad macroeconomic analysis, then focuses on sectors and companies.
• Bottom-up investing: Starts with fundamental analysis of individual companies before considering the wider economy.

How did the Tax Cuts and Jobs Act (TCJA) of 2017 impact the Alternative Minimum Tax (AMT)?

The TCJA of 2017 reduced the number of taxpayers subject to the Alternative Minimum Tax (AMT).

Outline the bankruptcy priority in liquidation.

In bankruptcy liquidation, back taxes and unpaid wages are paid after secured debt holders but prior to unsecured debt holders and shareholders.

What is the term to maturity of a bond?

The amount of time remaining until a bond’s principal is repaid.

Example: A 5% corporate bond maturing in 2030, purchased in 2021, has a term to maturity of 9 years.

What are demand deposits?

Checking and savings accounts are demand deposits, meaning funds can be freely withdrawn without advance notice.

What is the conversion value of a convertible bond?

The value of a convertible bond if converted into shares of the underlying stock.

Formula: Conversion Value = Conversion Ratio \times Current Stock Price.

What does manager tenure indicate in relation to a mutual fund?

Manager tenure is the number of years the current portfolio manager has managed a fund. Positive returns over 5 – 10 years can indicate strong investing ability, and longer tenure is generally preferred.

What are 12b-1 fees?

Annual fees paid by mutual fund investors, based on a percentage of holdings, to cover marketing, distribution, and other expenses.

What are the characteristics of a Letter of Intent (LOI) for mutual funds?

A Letter of Intent (LOI) is valid for up to 13 months and can be backdated 90 days for mutual fund breakpoint discounts.

How are mutual fund capital gains taxed in terms of holding periods?

Mutual fund capital gain distributions are taxed according to the fund’s short-term/long-term holding period. Investor gains upon redemption are taxed according to the investor’s own ST/LT holding period.

How are mutual fund distributions generally taxed?

Mutual fund capital gain distributions are taxed in the year distributed, whether withdrawn in cash or reinvested.

Explain the taxation of REITs.

REIT dividends are usually taxed as ordinary income. Gains from REIT property sales are taxed as ST or LT capital gains depending on the holding period. Return of capital distributions reduce cost basis and are not taxed until shares are sold.

What are derivatives?

Options, rights, warrants, futures, and forwards are derivatives. REITs are not derivatives.

Describe options contracts.

Standardized, exchange-traded contracts with liquidity and minimal credit risk (exchange clearinghouse is counterparty). The buyer has the right, but not the obligation, to exercise or let expire.

What is a call option?

Grants the buyer the right to buy; obligates the seller/writer to sell.

What is a put option?

Grants the buyer the right to sell; obligates the seller/writer to buy.

How does an investor use options for hedging a stock position?

To hedge a stock position, an investor buys an option. To hedge a long stock position, buy a put; to hedge a short stock position, buy a call.

How can an investor generate income using options?

To generate income on a stock position, an investor sells an option and collects the premium.

Distinguish between American-style and European-style options.

American-style options can be exercised any time before expiration. European-style options can only be exercised at expiration.

Where do futures contracts trade?

Futures contracts trade on organized exchanges, the largest being the Chicago Mercantile Exchange (CME).

Describe futures contracts.

Standardized, exchange-traded contracts where both buyer and seller are obligated to fulfill the contract. They carry low credit risk.

Describe forward contracts.

Non-standardized, over-the-counter contracts where both buyer and seller are obligated to fulfill (OTC). They carry illiquidity and counterparty risk.

When does an investor profit from buying futures?

An investor profits if the underlying commodity or asset price rises.

When does an investor profit from selling futures?

An investor profits if the underlying index or commodity declines.

Provide an example of a profit/loss calculation for futures.

Investor long 1,000 contracts at $0.60 , closes at $0.55 \rightarrow $0.05 loss per contract \times 1,000 = $50 total loss.

What are considered precious metals?

Precious metals include gold, silver, platinum, and palladium.

What are 'sweeteners' in the context of securities, and who do they appeal to?

Warrants are 'sweeteners' that may lead investors to accept a lower yield if attached to a security. Warrants appeal to long-term bullish investors.

What is the most common type of life insurance offered as a fringe benefit in retirement plans?

Group term life insurance is the most common type of life insurance offered in retirement plans as a fringe benefit.

Describe whole life insurance.

Whole life insurance is permanent, cash-value life insurance with fixed premiums and a guaranteed death benefit.

Describe universal life insurance.

Universal life insurance is a flexible policy with two components: 1) death benefit (face amount or face + cash value), and 2) cash value that grows with interest rates or market performance.

What does a customer receive if a life insurance policy is surrendered?

If a life insurance policy is surrendered, the customer receives the cash value minus any surrender charge.

What is the primary risk associated with a fixed annuity?

A fixed annuity carries inflation (purchasing power) risk because payments are fixed and lose value over time.

What are the characteristics of an Equity-Indexed Annuity (EIA)?

An Equity-Indexed Annuity (EIA) offers market-linked returns with downside protection. Growth is capped by a participation rate (e.g., 80% ) and a cap rate (e.g., 12% ).

What are bonus annuities, and are they sufficient to determine suitability?

Bonus annuities offer a bonus credit (e.g., 3% ) as an incentive for deposits. This bonus alone is not sufficient to determine suitability for an investor.

What are private funds, and are they registered under the 1940 Act?

Private funds are large investment pools of sophisticated/high-net-worth investors (e.g., hedge funds, private equity). They are exempt from 1940 Act registration.

Is there a regulatory limit on the maximum percentage a hedge fund can invest in a single investment?

There is no regulatory limit, but hedge funds use internal diversification rules to manage risk.

Can a hedge fund invest in mutual funds, and is frequent trading appropriate?

A hedge fund can invest in mutual funds, but frequent trading in/out is not appropriate due to suitability concerns for mutual funds.

What is the strategy of market-neutral hedge funds?

Market-neutral hedge funds seek to profit in rising and falling markets using long/short positions and derivatives.

What are structured products, and are they suitable for retail investors?

Structured products are complex investments with high risks and fees. They are often unsuitable for retail investors.

What is the basis of Exchange Traded Note (ETN) returns?

ETNs track an index or strategy, with returns tied to its performance.

What is the key difference between ETNs and ETFs?

ETNs are unsecured debt instruments, not investment companies, unlike ETFs.

List the risks associated with ETNs.

ETNs face call, early redemption, liquidity, issuer credit, and conflict-of-interest risks.

For whom are Leveraged & Inverse ETFs suitable, and why?

Leveraged & inverse ETFs reset daily, so their returns can diverge from the index. They are suitable only for very short-term ( 1 – 2 days) investors.

Are Real-Estate Limited Partnerships (RELPs) considered securities?

Yes, Real-Estate Limited Partnerships (RELPs) are securities.

Differentiate between GDP and GNP.

• GDP (Gross Domestic Product): Goods/services produced within a nation’s borders.
• GNP (Gross National Product): Goods/services produced by a nation’s residents, regardless of location.

Who are considered institutional accredited investors under Regulation D?

Institutional accredited investors under Reg D include banks, insurance companies, and investment companies. Investment advisers are not automatically included unless they meet net worth thresholds.

Provide an example of an accredited investor based on the income test.

An individual meeting the income test must have $200,000 annually for the past 2 years with an expectation this year. Retired individuals without current income typically do not qualify.

Differentiate between a sell limit order and a sell stop order.

• Sell limit order: Placed above the current price (e.g., sell ABC at $75 if trading at $50 ).
• Sell stop order: Placed below the current price (e.g., sell ABC at $40 if trading at $50 ).

What are Special Purpose Acquisition Companies (SPACs)?

SPACs (blank-check companies) raise IPO funds to acquire/merge with a private firm, typically within 2 years.

What is the impact of repurchased (treasury) stock on shareholder equity?

Repurchased stock reduces shareholder equity/net worth.

How does a dividend declaration impact working capital?

Working capital decreases when a dividend is declared (current liabilities rise, assets unchanged).

How does dividend payment impact working capital?

Working capital is unchanged when a dividend is paid (assets decrease, liabilities decrease equally).

What is the current ratio, and what does it measure?

Current Assets \div Current Liabilities. It measures short-term liquidity.

What is the quick ratio (acid-test ratio), and what does it measure?

(Current Assets - Inventory) \div Current Liabilities. It measures liquidity with the most liquid assets.

What is the Debt-to-Equity (D/E) ratio, and what does it measure?

Total Debt \div Shareholders’ Equity. It measures leverage.

What is the Price-to-Earnings (P/E) ratio?

Stock Price \div Earnings per Share (EPS).

Example: $30 \div $1.25 per share = 24\times .

How do P/E ratios typically differ between growth and value companies?

Growth companies usually have higher P/E ratios; value companies tend to have lower P/Es.