SIE Chapter 9: Packaged Securities

Investment company

A company in the business of pooling investor money to invest in securities

• It must be registered with the SEC

• Has to disclose its investment approach, borrowing plans, and managements background

• Has to disclose whether its open-ended or close-ended

For an investment management company to be considered Diversified:

At least 75% of its assets are spread out in the following way:

• Management doesn’t own more than 10% of outstanding shares of a company

• No more than 5% of the management company’s money can be invested in one company’s securities (though through appreciation it may grow past 5% but the fund may not purchase any more past 5%)

NOTE: The other 25% of the management company’s assets can be invested in a any way

Net Asset Value (NAV)

(Fund assets - Liabilities)/Shares Outstanding

This is the open-end fund’s bid price

Open-end (mutual) fund

This type of fund continuously issues and redeems shares directly with investors (no secondary market trading)

• Must always have a prospectus available

• Never trades below NAV

• Can only issue common stock

Closed-end fund

This type of fund issue shares once (IPO) then trades investor-to-investor on the secondary market like a stock

• It can trade at a premium or discount to NAV

• Can be issue common stock, preferred stock, or bonds

Public offering price (POP)

For a mutual fund: NAV + sales charge

For closed-end fund: Current market price + commission

No-load fund

A Mutual fund with no sales charge

Money market fund

This type of fund Invests in short term debt

• There is no sales charge

• There is no early redemption penalty

  • Computes dividends daily and credits them monthly

Income fund

This type of fund aims for steady current income through interest and dividends rather than growth

• Good for retirees and conservative investors

Balanced fund

This type of fund mixes stocks and bonds to get a combination of both growth and income

• It cushions downturns but has not as strong performance in bull markets

Growth fund

This type of fund invests mainly in common stock for capital appreciation

• Has higher risk and also higher reward

• Best suited for younger investors

NOTE: Aggressive growth funds are the same thing except even riskier

Specialized (sector) fund:

This type of fund concentrates in one industry

• It is more volatile than a diversified fund

International fund (global fund)

This type of fund invests outside the investor’s home country

Global funds invest anywhere including the home country

• This funds carry currency risk and added political risk

Index fund

This type of fund passively tracks a benchmark index

• It has low or no management fees

Hedge fund

This type of fund is professionally managed pool only open to accredited investors and is exempt from SEC registration

• Has very broad flexibility in investment strategy (shorting, options, margin) and pursues typically aggressive strategies

Discount from Breakpoints

Breakpoint: A purchase-amount tier at which a mutual fund’s sales charge percentage drops; this must be disclosed in the prospectus

• This is available to individuals, family joint accounts, corporations, and UGMAs

NOTE: An agent must let investors know about the existence of breakpoints

Breakpoint sale:A violation where a agent sells an amount just under a breakpoint without telling the client about the breakpoint discount

Right of Accumulation (ROA)

Lets an investor count the current value of existing fund holdings toward reaching a breakpoint on a new purchase

• There is no time limit

Letter of Intent (LOI)

Lets an investor get a breakpoint discount immediately, in exchange for promise to invest enough to qualify within 13 months

• This LOI can be backdated up to 90 days, which also moves the 13 month clock back

  • Shares are held in escrow ( a 3rd party) to cover the sales charge difference if terms aren’t fuffilled

Sales charge (load)

The maximum sales charge is capped at 8.5% (this is built into the POP)

Sales Charge % = [(POP-NAV)/POP]

Share Classes and their charges

Class A Shares (front-end load): Sales charge is paid at purchase; they have lower expense ratios and are breakpoint eligible, good for long-term holders

Class B shares (back-end load): Sales charge is paid at redemption; they have higher expense ratios but can convert into Class A shares over time

Class C Shares (level load): These shares have an ongoing periodic (usually annual) fee plus a short-term exit fee (unless held for longer); their best for short term holders

Face amount certificate company

Similar to a zero-coupon bond

• Lump sum or periodic payments in exchange for a larger guaranteed payout

Unit Investment Trust (UIT)

Holds fixed unmanaged portfolio (usually bonds) and issues redeemable units

• Has a set termination date and Passes income to investors

Exchange traded product (ETP)

Umbrella term for ETFs and ETNS

• Both can be sold on margin or sold short and both usually charge trading commissions

ETFs

Exchange traded funds that passively track an index/benchmark or are actively managed

• They provide investors the ability to sell short and purchase shares on margins

Inverse ETFs: are like ETFs that use derivatives profit when the benchmark index falls

Leveraged ETFs: Aims for a multiple of an index’s daily return (they are rebalanced daily and not meant for long term holding)

ETNs (Exchange traded Note)

An unsecured bank debt security whose return tracks an index

• A lump sum is paid at maturity based on index performance

• Value suffers if bank’s credit rating drops

Fixed vs Variable Annuity

Fixed Annuity: Guarantees a set rate of return and payout; the insurer bears the investment risk

• Fixed annuities are exposed to inflation risk since the payout doesn’t grow

• No SEC registration

Variable annuity: Payout depends on the performance of an underlying securities portfolio

• Requires SEC registration, prospectus, and securities and insurance licenses

Separate account: Where variable annuity premiums are invested (they are kept apart from the insurer’s general business assets)

Assumed interest rate (AIR)

The projected growth rate built into a variable annuity contract; the actual performance (whether its above or below AIR) results in higher or lower payouts than expected

Buying In Payment Options for Annuities:

Single payment deferred annuity: One lump sum in; payouts start at a later predetermined date

Periodic payment deferred annuity: Ongoing (often times monthly) payments in; payouts start later (this is the most common structure)

Immediate annuity: A large lump sum in: payouts begin right away or within a few months

Accumulation phase (pay-in phase)

Period where premiums are paid with after tax dollars (meaning not deductible) but they grow tax deferred

• A variable annuity investor buys accumulation units (similar to mutual fund shares) during this phase

Annuity (payout) phase

Accumulation units convert into a fixed number of annuity units; only the value of units vary after that and it is based on the separate account’s performance

Payout Options:

Life (straight life) annuity: Pays for the annuitant’s life only and then stops; this is the riskiest for the investor as nothing passes on but it has the highest payout

Life annuity with period certain: Guarantees payments for a minimum number of years even if the annuitant dies early, an beneficary collects the remainder

Joint life with last survivor annuity: The payout continues over two lifetimes (usually spouses) and it has the lowest payout since it covers 2 people

Mortality guarantee: The insurer’s promise to keep paying out as long as the annuitant lives

Early withdrawal penalty: 10% penalty on withdrawals before age 59.5; this is usually only waived for death or disability

Variable life insurance (VLI)

Fixed premium; the death benefit has a guaranteed minimum and can rise with performance

• policy holders can borrow up to 75% of the cash value

Variable universal life (VUL)

Premiums are flexible and no minimum death benefit is guaranteed

Variable contracts

Umbrella term fro VLI and VUL