Chapter 14: Investment Risks, Returns, and Disclosures

REQUIRED DISCLOSURES

What is Time of Trade Disclosures (MSRB G-47)?

When does this need to be done by?

• Requires a muni dealer to disclose all material info to their customer, even if unsolicited

• Prior or done at time of trade

What does it mean to act in an agency capacity?

How does the BD get paid?

What needs to be outlined on the trade confirm?

• To buy or sell on behalf of the client

• Commission

• Capacity and commission

What is a dual agency cross?

How does the BD get paid?

What needs to be outlined on the trade confirm?

• The BD matches one of its buying clients with one of its sellers

• Commissions from both sides

• Dual agent capacity and commission

What does it mean to act in an Principal capacity?

How does the BD get paid?

What needs to be outlined on the trade confirm?

• BD buys/sells out of its own inventory

• By charging mark ups on sales and taking mark downs on buys

• Capacity and mark up/mark down

What is a riskless principal trade?

What disclosures need to be made to the customer?

• When a BD buys shares into its inventory for a preexisting order so it can be flipped right away

• Just says Principal capacity and mark up/mark down

What is a net basis trade?

What needs to be done prior to trade?

What makes these trade confirms different?

• A trade where the dealer charges a different price rather than just a mark up, similar to principal

• Permission is need

• Will just say net basis trade and the price executed at

For a retail customer doing a net basis trade, how often do they need to get consent?

• Trade by trade basis

For an institutional customer doing a net basis trade, how often do they get consent?

• Oral or written permission before each transaction

• Blanket permission through a negative consent letter

What if a fiduciary is being used on an account?

• Same rules apply for either retail or institutional clients, the permission is just sent to the 3rd party

SOFT-DOLLAR ARRANGEMENTS

How does soft dollar commission work?

Do these need to be disclosed to customers?

• The IA can then receive research/resources from the BD and will pay for them through paying a higher commission on each trade

• Yes

What are soft dollar commissions used for?

• If the BD is providing APPLICABLE research, resources, or conventions

CLIENT NOTIFCATIONS

How often do account statements need to be provided?

• Quarterly

What does an account statement include? (3 of them)

• Description of all security positions

• All money balance

• All account activity since the last statement

  • If there is a movement in money, consider it activity

When would a firm need to hold a client’s mail?

How long can mail be held?

• If they are not at their normal address

• For 3 months then they need better reasoning to continue

How often do BDs need to provide financials?

• Annually

What is a confirmation statement?

When do they need to be provided?

What if an RR has discretion on an account?

• Confirms the details of a sale and purchase of securities

• Prior to settlement

• Still needs to be sent to customers

Can a confirm ever be sent to a 3rd party like an IA?

• Yes, if written consent from the customer is provided

How often does a BD need to update customer information?

If the account is updated by the customer, how long does the firm have to send confirm back to client?

• Every 36 months

• 30 days or with next statement

Why is address an important aspect that needs to be updated?

• If the client moves states, the firm and RRs may need to register with those blue state laws

BOOKS AND RECORDS

Records can be kept on other forms other than writing, as long as they are not…?

• Non-eraseable

If using micrographic media or electronic storage media, what does a member firm need?

• A place where SEC and SRO’s can review files

FINANCIAL EXPLOITATION OF SPECIFIED ADULTS – FINRA RULE 2165

What does this rule seek to do?

• Protect specified adults from financial exploitation

What is a specified adult?

• Age 65 or older

• Age 18 or older and impaired

What is a trusted contact?

What is the criteria?

Are they given POA?

• The contact a firm can each out to if they suspect financial exploitation

• Just needs to be over 18 and someone the contact trusts

• No this does not mean they can trade in the account

Does a member firm need to collect information on a trusted person?

• They should try, but it is not mandatory

What is financial exploitation?

• Essentially tricking a specified adult to wrongfully take their assets

What is a temporary hold?

What does it hold?

What does it not hold?

• A financial firm can put a temporary hold in place if they suspect exploitation is happening

• Stops disbursements from an account or transfers

• Does not stop trading or bill paying 

How long does a firm have to notify a customer after a hold has been put in place?

• 2 business days

When does the hold initially expire?

How long is the 1st extension?

How long is the 2nd extension?

• 15 business days

• 10 business days

• 30 business days

ACATS – TRASNFERRING ACCOUNTS

What needs to be submitted if accounts are being transferred from one firm to another?

• A Transfer initiation form

Once the receiving firm gets a TIF, how long do they have to notify the carrying firm?

• 1 business day

Can a carrying firm protest a transfer?

• Rarely, only really if the account info provided was wrong or if the account has no money

How many days does a carrying firm have to validate a transfer?

How many days do they have to transfer the assets?

• 1 day

• The 3 business days after validation

What is a non-transferable asset?

How long does a firm have to distribute funds, if the non-transferable assets are liquidated?

• Assets that are not eligible to be transferred from the carrying firm to the receiving firm

• 5 business days

What are residual credits?

How long can they be done for?

In what time period must the carrying firm transfer them?

• Cash/securities that were not received by the carrying firm at the time of transfer

• 6 months

• Within 10 business days of accruing

INVESTMENT RISKS

What is systematic risk?

• Risk events that effect the market, and can’t be mitigated by diversification

What is market risk?

• Risk of experiencing losses for total market fluctuations

What is interest rate risk?

What does duration measure?

• Prices of bonds can fluctuate based off the movement of rates

• Duration measures the sensitivity of a bond to changes in rates

  • A bond with a  duration of 10 years would decrease by 10% in value if the interest rate increased by 1%

What is the ladder strategy?

What is the barbell strategy?

• Investing in bonds with staggered maturities

• Investing into the short end and long end but not any mid

What is inflation risk?

What are the two ways it effects bonds?

• Risk that high inflation will hurt bond returns

• Eat away at fixed returns

• Higher inflation lowers bond prices through higher rates

What is the real interest rate?

• Real Interest Rate = Interest rate - inflation rate

What is event risk?

• Risk of a significant event effecting the market

What is unsystematic risk?

• Risk that is specific to a security

What is business risk?

What does beta measure?

What does alpha measure?

• Circumstances that have a negative effect on a company’s operations

• Measures how volatile an investment is relative to the whole market

• Measures how well a stock performed in comparison to its expected return

What is regulator risk?

• Risk that changes in regulations may affect the company

What is legislative risk?

• Risk that changes in law may affect the company

What is political risk?

• Risk of losing money due to changes in government

What is liquidity risk?

• Risk a security cannot be disposed of easily

What is opportunity risk?

• Risk that the return of one investment is lower than what you could have chosen

What is currency risk?

• Foreign investments may be worth less due to changes in the currency rates

What is capital risk?

• Risk that all or some of an investment can be lost

What is credit risk?

• Risk that a bond issuer may default on its payments

What is call risk?

• Risk that an issuer may payoff bonds early

What is prepayment risk?

• Tied to MBS where the borrower may pay off the mortgage early

INVESTMENT RETURNS

What is the formula for current yield of an equity?

• CY = annual dividend income / current market price of the stock

What is nominal yield of a bond?

• Same as the stated coupon rate

What is the current yield of a bond?

• CY = annual interest / current market price

What is the yield to maturity?

What is the yield to call?

• Takes into account everything an investor is earning till it matures

• Same as YTM but measures through a call date

What is yield to worst?

When is YTM the yield to worst?

When is YTC the yield to worst?

• It is the lower of YTM and YTC and is what needs to be quoted to the customer

• Discount

• Premium

What is the taxable equivalent yield?

What is the formula?

• Calculates how much an investor would need to earn on a taxable bond to match the yield they are getting on a tax-free bond

• Taxable Equivalent Yield = Muni Yield / (100%- tax bracket %)

COST BASIS, CAPITAL EVENTS, AND RETURN OF CAPITAL

What is the cost basis?

How do reinvested distributions effect the cost basis?

• The total amount an investor has paid to purchase a security including commission

• Raises it

What are capital gains?

What is considered short term?

What is considered long term?

• When a security is sold for higher value than its cost basis

• Held for a year or less

• Held for over a year

What are capital losses?

Are they short and long term?

• Security is sold for less than its cost basis

• Yes, same rules apply

What is a return of capital?

Is it taxable?

• Investor receives a portion of their original investment back

• Not taxable since it is not income or capital gain, just lowers their cost basis

How much can be left in an estate without incurring estate taxes?

What if spouses?

• $19K

• Unlimited amount

What is the cost basis for inherited securities?

What is this process called?

Is the holding period ever short term?

• When securities are inherited, the cost basis is equal to the market value of the securities at the time of deceased

• step up

• Regardless of how long the securities were held, deceased holding period is always long term

What is the cost basis for gifted securities?

• When securities are gifted, the recipient’s cost basis is the lesser of the market value or donors cost