SIE Key Concepts

treasury stock

Authorized stock that was previously sold to the public but was repurchased by the issuer. Because it is no longer outstanding, the company's share count will fall, and the shares no longer receive dividends or have voting rights. They may be held by the company, reissued to the public, or cancelled.

company repurchases

A company that believes its stock is undervalued may repurchase shares in the open market (creating treasury stock).

voting rights

What holders of common stock have that allow them to exercise control by electing the board of directors and voting on corporate policy. This contrasts with holders of preferred stock, who typically do not have these rights.

statutory versus cumulative voting

Voting by common stockholders that can be carried out by one of two methods (statutory voting and cumulative voting).

statutory voting

Allows a shareholder to vote one time per share for each seat on the board of directors. For example, if an investor owns 100 shares of common stock and there are 3 board seats to be filled, they can cast up to 100 votes for each of the 3 seats.

cumulative voting

Allows a shareholder to pool their votes together and allocate them as desired. For example, if an investor owns 100 shares of common stock and there are 3 board seats to be filled, they can aggregate all their votes (300 total) and allocate them however they choose.

form 10-k

Annual financial reports (which includes financial statements) public companies must file with the SEC within 90 days of year-end.

pre-emptive rights (also called subscription rights)

Rights that allow a current shareholder to maintain their proportionate ownership interest and avoid dilution when a company issues additional shares.

warrants

Typically issued by a company in conjunction with another security to make that other security more attractive to investors. For example, a company might use it as a sweetener for investors as part of a debt deal. Unlike pre-emptive rights, they do not prevent dilution.

warrants as equity securities

Warrants are considered equity securities (not debt securities) because if the warrant is exercised, the investor will receive shares in the underlying company. Importantly, warrants do not make interest payments to investors.

value of warrants

A warrant provides an investor the ability to purchase a company's stock at a specified exercise price for a set time period. For example, the investor is given the right to purchase the stock at $100 per share. The investor would want to exercise this right if the price increases above the exercise price (e.g. an investor wants to pay $100 for stock worth $150 not for stock only worth $50) and therefore the market value of a warrant is tied to the value of the underlying stock.

issue price of warrants

Warrants are generally not issued with intrinsic value, meaning they are issued with an exercise price above the current market value of the stock. For example, if the current stock price is $50, the exercise price given to the warrants might be $80. For the warrants to be exercised by an investor, the price would have to increase above the exercise price.

penny stock

OTC equity securities (i.e. unlisted) worth less than $5.00 per share.

blue chip stock

Stock of well-established, stable companies with a long history of steady earnings and dividends. They are typically traded on the major exchanges such as the NYSE or Nasdaq.

blue chip stock versus penny stocks

Penny stocks are riskier, more volatile, and less liquid than blue chip stocks.

Wilshire 5000

An index which measures the value of US companies with actively traded stock

business risk

Non-systematic risk and the risk that a specific company may not be profitable.

risk of ADRs (American Depositary Receipts)

ADRs help facilitate the trading of a foreign corporation's stock in the US. Investors in ADRs face political risk, which is the risk that political instability and uncertainty in that foreign country might negatively impact their investment. Importantly, because ADRs are common stock and not debt securities, they do not have call risk or interest rate risk.

withholding taxes

When a foreign corporation pays a dividend, a bank will take the foreign dividend payment (e.g. Euro or Japanese Yen) and convert it into US dollars for the ADR holder. It is possible that the ADR holder might receive a lower dividend than was actually declared because the foreign government might withhold a percentage of the dividend for taxes.

cumulative preferred stock

Allows investors to receive dividends in arrears. This means that if a dividend is skipped for cumulative preferred shareholders, they must receive both current and skipped dividend payments before any dividend payment can be made to common shareholders. Opposite would be straight preferred.

transfer agent

Responsible for issuing and cancelling certificates and processing investor mailings (e.g. proxies).

custodian

Responsible for holding investor assets or securities for protections. They may also maintain certain investor records.

cash dividend taxation

Cash dividends on stock received by an investor are taxable as ordinary income and do not increase the investor's cost basis.

ex-dividend date

The first day purchasers of the stock will not receive a dividend. This is because the trade will not settle on or before the record date. For regular way trade, which settles T+2 (two business days after the trade date), this date is the business day before the record date.

order of dividend process

1. declaration date

2. ex-dividend date

3. record date

4. payment date

(DERP)

stock splits

An artificial adjustment in the issuer's outstanding share count and stock price. Importantly, because the number of shares and price change in proportion with one another, the overall value of the company as well as the investor's ownership position in the company remain unchanged. For example, if an investor owned $1,000 of stock before it, they will still own $1,000 of stock after.

forward stock split

When this occurs, the number of outstanding shares increases, and the share price is reduced proportionally.

reverse stock split

When this occurs, the number of outstanding shares is reduced, and the share price is increased proportionally. It is generally used by a company to inflate their stock price and avoid falling below the minimum price required for exchange listing.

stock dividend taxation

Stock dividends are not taxed when received by a shareholder. However, the basis of the investor's position is adjusted downward to reflect the new number of shares.

short sale

When an investor, believing the price of the security will decline, sells borrowed shares in the market, hoping to repurchase and replace the shares at a lower price than what they were initially sold for. Theoretically, because the price of the shares can rise indefinitely (rather than fall as the investor wants), there is unlimited risk potential.

discount bond

A bond when the market value of the bond is below par value.

premium bond

A bond when the market value of a bond is greater than the par value.

nominal yield (also called coupon)

The annual interest rate paid to the investor. Unlike other bond yield,s this is fixed and does not change over the life of the bond.

current yield

Calculated as the annual interest divided by the market price. If the semiannual coupon is provided, make sure to multiply by two to annualize.

interest rate risk

The risk that if interest rates increase, the price of outstanding bonds will fall. Long-term, low-coupon bonds (including zero-coupon bonds) have the greatest risk, meaning they are most sensitive to changing rates. Although a treasury bond has no credit risk, as they are guaranteed by the full faith and credit of the US government, they still are very susceptible to interest rate risk given their long-term (e.g. 30 year) maturity.

reinvestment rate risk

The risk that as interest rates fall, that the semi-annual coupon payments that an investor receives will be reinvested back into the market at a lower rate of return. Note that zero coupon bonds do not have this risk as there are enough cash flows to reinvest.

duration

A measure of a bond's sensitivity to changing interest rates. Bonds with a longer of this are more sensitive to changing rates.

bond pricing

Affected most by interest rates. Factors like credit rating, market demand, and earnings potential of the company are not as impactful.

serial bonds

In a serial bond issue, the outstanding bonds mature at different intervals with a portion of the issue maturing each year.

call feature

Benefits the issuer, not the investor. If a bond is callable, the issuer has the right to buy it back from the investor prior to maturity. Typically, the issuer will redeem a bond if interest rates decline, allowing the company to issue new bonds at a lower interest rate.

call protection

Issuers can call callable bonds at any time unless they have this. If there is this, the issuer must wait until the period expires. This makes callable bonds safer for investors. (Example: A 20-yr bond with a 10-yr call protection period could be called any time after yr10 through maturity.)

call price

When an issuer calls bonds, it must pay the investor par value + any call premium (if applicable) + interest accrued to that date. Investors receive no interest after the bond is called.

default

What happens to the bond if an interest payment is missed on an outstanding debt obligation.

credit ratings

These are published to inform investors of a bond's credit quality. It may change periodically while it is outstanding. It is typically a big factor in the liquidity of bonds (even more so than the coupon or maturity).

amortization

Means that the cost basis will be adjusted downwards each year so that at maturity an investor's cost basis is $1,000 par. It effects a bond's cost basis (downwards) and should the investor sell the bond prior to maturity, the profit or loss on the transaction. It does not affect sale proceeds (what a purchaser is willing to pay).

adjusting premium bonds by amortization

Bonds purchased at a premium (>$1,000 par) must be amortized over the life of the bond. (Example: When an investor purchases a bond at a premium, the cost basis will be adjusted downward towards par on a straight-line basis--referred to as amortization).

accretion of discount bonds

Discount bonds will be accreted, which is similar to amortization, but the cost basis is adjusted upwards (towards par) each year.

accrued interest

The interest paid by the buyer of the bond to the seller of the bond when the bond is trading between coupon dates. A bond the trades with accrued interest is said to trade "and" or "with" interest. It is taxable for the recipient as ordinary income, through it does not impact the cost basis of the bond. A bond that trades without it (e.g. a bond in default or a zero coupon instrument) is said to trade flat.

dated date

The date when interest begins to accrue on fixed income securities. It is only relevant for new issuances and once regular semi-annual coupon payments begin, it is no longer relevant.

unsecured corporate debt (also referred to as a debenture bond)

Not backed by collateral or a specific asset of the corporation. Instead, it is backed by the good faith and credit quality of the company.

convertible bonds

A type of corporate bond where the investor has the right to convert the bond into the company's underlying common stock. Because of this conversion benefit for the investor, they pay a lower rate of interest compared to similar non-convertible bonds.

convertible bond pricing

The value of a convertible bond is based on the value of the underlying common stock, since the investor can exchange the bond for the shares. It is fixed at issuance of the convertible bond.

parity price

The value at which the investor is mathematically indifferent between owning the convertible bond or converting into the underlying shares.

conversion ratio

The number of shares received upon conversion of a convertible bond. An investor can calculate it by taking par value and dividing it by the conversion price. It is fixed at the issuance of the convertible bond.

non-marketable US government securities

Issued by the US government and cannot be resold by investors. They have no secondary market. An example is US savings bonds.

marketable US government securities

Issued by the US government and can be freely traded by investors. They include US Treasury securities, such as Treasury bills, Treasury notes, and Treasury bonds.

series I bond

A non-marketable US Treasury savings bond. It pays a combination of fixed and variable interest (linked to the rate of inflation).

risk of treasury securities

Treasury securities do not have credit risk but are subject to interest rate risk, purchasing power risk, and political risk. An investor purchasing treasury securities would be more concerned with interest rate risk than political or credit risk.

taxation of treasury securities

The interest income from Treasury bonds is taxed at the federal level, but not at the state or local levels.

treasury receipts

Are zero-coupon bonds that are structured by broker-dealers but backed by cash flows from Treasury securities.

STRIPS (Separate Trading of Registered Interest and Principal Securities)

Are zero-coupon bonds that are issued and backed by the US government. They are issued at a discount and mature to face value.

GO Bonds (General Obligation Bonds)

Are municipal securities used to finance non-revenue facilities, such as public parks, public schools, and public libraries. The interest and principal is backed by the full taxing power of the issuing municipality.

industrial development revenue bonds

Are a type of taxable municipal security that is issued by a municipality on behalf of a corporation. Specifically, the municipality will issue to debt to build a facility on behalf of a corporation and then lease that facility to the corporation. Because the bonds are backed by lease payments made by the corporation, the debt is the responsibility and credit quality of the corporation.

official statement

The primary disclosure document used in a municipal security offering. It includes all relevant information for investors, such as the risks of the bonds.

Ginnie Mae

An issuer of mortgage-backed securities (MBC) along with Fannie Mae and Freddie Mac. However, it is the only one of the three that is backed by the full faith and credit of the US government. Because Fannie andFreddie are government sponsored enterprises, they only have an implied, but not an explicit backing of the US government.

agency securities

Securities issued by Ginnie Mae, Fannie Mae, and Freddie Mac - sometimes collectively referred to as :Agency Securities" - are taxable at the federal, state, and local levels

risks of mortgage-backed securities

MBS issued by Ginnie, Fannie, and Freddie face prepayment risk and extension risk.

money market instruments

Are short-term debt instruments with maturities of one year or less. Because of their short-term nature, they tend to be relatively liquid and low risk compared to the longer-term bonds. Examples include Treasury bills, commercial paper, negotiable CDs, and banker's acceptances. Also once a Treasury bond only has one year or less remaining until maturity, it can trade in the money market.

commercial paper

An unsecured promissory note, issued by corporations at a discount. It typically has a maximum maturity of 270 days.

banker's acceptances

A short-term, negotiable money market instrument that is used to finance and facilitate international trade. It has a maturity of 180 days or less and is issued by a borrower and guaranteed by a commercial bank.

eurodollar deposit

Eurodollars are US dollars held in a depository (bank) abroad. E.g. A swiss bank account denominated in US dollars would hold Eurodollar deposits. These are used by foreign corporations (or individuals) who have US currency abroad.

eurodollar bonds

Are bonds issued outside the US but denominated in US dollars. Par is $1,000 USD; coupon payments are made in USD. These are issued and trade outside the US and are not registered with the SEC. Issuers use them to make their securities more marketable (e.g. the issuer's home currency is unstable).

tax-equivalent yield

To determine the interest an investor must earn on a taxable corporate bond to equal the tax-free yield of a municipal bond, an investor can calculate this. It is the tax-free yield of the municipal bond divided by (100% - Tax Rate).

summary prospectus

A compilation of highlights from the longer prospectus that the SEC allows a mutual fund to deliver to shareholders. It includes the fund's investment objectives, fee structure, and other pertinent information. It must be provided to investors prior to or at the time of sale.

mutual fund shareholder reports

Mutual funds are required to send financial reports to shareholders which include financial statements (e.g. a balance sheet and income statement) and detail the holdings of the fund's portfolio. These reports must be sent semiannually.

mutual fund custodian

A bank or trust company acts as custodian for mutual funds and is responsible for the holding and safekeeping of the fund's securities and cash.

net investment income

Is the total profits that an individual earns from their investments. For mutual investments, this would include any dividends plus interest income plus net capital gains.

forward pricing

When an investor purchases shares of a mutual fund, the price they pay is based on the next NAV (net asset value) calculation after the order is received. The NAV is calculated daily based on the closing price of the market.

expense ratio

Is the percentage of the fund's total assets that will be used to cover the expense of the fund. It is calculated as (management fees plus operating expenses) divided by the average annual net assets of the fund. Every mutual fund has one, and it would increase if the operating expenses of the fund were rising faster than the value of the fund's investments.

12b-1 fee

Are annual fees paid by mutual funds shareholders to cover the marketing and administrative expenses of the fund. They do not cover management expenses or trading fees.

fund share classes

Mutual funds can have different share classes. Class A shares have an upfront sales charge. Class B shares have a back-end load (aka contingent deferred sales charges or CDSCs), which investors pay when they redeem their shares. Class C shares have level loads. All share classes have 12b-1 fees, but Class B and C 12b-1 fees are usually higher than Class A shares. Class A shares are the only share class that can benefit from breakpoints.

sales charge (also called sales load)

Generally applies when an investor buys mutual fund shares. It can be expressed as a percentage of the POP, never the NAV.

no-load fund

Are mutual funds that do not charge a sales charge. They are purchased by investors at the NAV.

mutual fund sustainability

When deciding on a mutual fund investment, the investor's investment objectives are the primary considerations. Fees are of secondary importance, and the size of the fund is typically the least important factor.

letter of intent (LOI)

Allows a mutual fund shareholder to invest in installments and receive breakpoints, where are discounts off of the sales charge. It can be used for up to 13 months and can be backdated 90 days.

breakpoint sale

A violation where a registered rep suggests that an investor purchases a mutual fund just below the point at which they would receive a discounted sales charge.

municipal bond funds (also called tax-exempt bond funds)

A mutual fund consisting of tax-free municipal bonds. These funds are most appropriate for high-net-worth investors in high tax brackets who will most benefit from the tax-free nature of the interest income. When the fund pays out its net investment income to investors, the dividends are tax-free because they represent the tax-free interest income, though any capital gains distributions are taxable.

money market fund

A mutual fund consisting of money market securities, which are debt securities with matures of one year or less. Because of the nature of the securities they invest in, they are extremely safe and highly liquid. These funds generally attempt to maintain at stable NAV of $1 per share, thought the price can fluctuate above or below that amount. Investments in this fund are least exposed to currency risk as the investments are held in US dollars but they would be subject to inflationary risk.

mutual fund investment strategies

Mutual funds can invest in equities, corporate bonds, and other registered securities. An investor who is seeking a combination of interest income and growth potential can invest in a diversified mutual fund that offers exposure to both debt and equity.

prohibited mutual fund strategies

Mutual funds cannot sell stock short or borrow money.

cost basis

Is the original value of an asset for tax purposes. If the asset is later sold for a profit, the difference between the cost basis and sales proceeds reflects the investor's taxable capital gain. Importantly, any dividends reinvested by an investor would increase their cost basis as the investor will have already paid tax on that income.

mutual fund dividends

Are taxable for investors regardless of whether they are taken in cash or reinvested back into the fund.

impact of dividends on NAV

The NAV of a mutual fund share will decrease by the amount of the dividend on the ex-date. This is because the fund is paying out cash so the fund's assets will fall.

index fund

Is a mutual fund that seeks to track the performance of a specific index such as the S&P500. Because they simply track an index and are not actively managed they have lower fees and expenses than other types of mutual funds.

index fund reconstitution

The process of updating the portfolio to continue to mirror the underlying index. Generally, the only time the portfolio changes is when a company is added or subtracted from the benchmark index.

closed-end fund pricing

They have a NAV, which is the total assets of the fund minus the total liabilities. Because they are exchange-traded, they can trade at a price either above or below their NAV based on the supply and demand of the shares .

unit investment trust (UIT)

An investment company security that combines redeemable shares with a fixed portfolio. Specifically, the portfolio is assembled by a sponsor, who does not actively trade the portfolio.

exchange-traded funds (ETFs)

Investment company securities that are designed to track a specific index or benchmark. Like closed-end funds, they are exchange-traded and thus investors pay commissions when purchasing the shares.

ETFs vs. Mutual Funds

Mutual fund shares are redeemable, which means they can only be bought from and sold back to the mutual fund. There is no secondary market for mutual funds. In contrast, ETFs are exchange-traded and can be bought and sold between investors throughout the day. Because ETFs have a secondary market, they are considered more liquid than mutual funds.

ETFs vs. Mutual Fund Expenses

Because mutual funds are actively managed, they typically have higher fees for investors than ETFs.