SIE Lecture Notes Review - Stocks, Bonds, Municipal Securities, Money Markets

Common Stock: Key Terms

  • Ownership in a company; used to raise money; shareholders are part-owners.

  • Market capitalization (market cap): extMarketcap=extoutstandingsharesimesextmarketpriceext{Market cap} = ext{outstanding shares} imes ext{market price}

  • Treasury stock: shares bought back by the company; no dividends or voting rights.

  • Authorized stock: total shares a company may issue per its charter.

  • Par value: a nominal accounting value (e.g., 11 per share) not equal to market price.

  • Issued stock: shares actually sold; may be less than authorized to reserve shares for later.

  • Outstanding shares: shares sold and held by investors; used to measure value.

  • Market cap example: 400,000extsharesimes400{,}000 ext{ shares} imes{10} = $4{,}000{,}000.</p></li><li><p>Equityfinancing:sellingownershipinexchangeforcapital.</p></li><li><p>Reuseoftreasurystock:canbereissued,usedinacquisitions,orgrantedtoemployees.</p></li></ul><h3collapsed="false"seolevelmigrated="true">RegularWaySettlement(Section2,Topic2)</h3><ul><li><p>EquitysecuritiestradeonexchangesorOTC.</p></li><li><p>Regularwaysettlement(T+1):tradesettlesonebusinessdayafterthetradedate.</p></li><li><p>Settlementconvertsownershiponthesettlementdate;buyerbecomestheownerofrecordthen.</p></li><li><p>ListedvsOTC:listedfollowstrictrules;OTCfromsmallerissuers.</p></li><li><p>Pricerisk:buyerbearsriskofpricechangeevenbeforesettlement.</p></li></ul><h3collapsed="false"seolevelmigrated="true">Dividends,StockSplits,andPreemptiveRights</h3><ul><li><p>Dividends:cashdividendspaidfromprofits;typicallyquarterly.</p></li><li><p>Stockdividends:extrasharesissued;totalvalueroughlyunchanged(moreshares,lowerper−sharevalue).</p></li><li><p>Stocksplits:increase(forward)ordecrease(reverse)thenumberofshareswithoutchangingtotalvalue;pricepershareadjustsaccordingly.</p></li><li><p>Parvalueadjustment:duringsplits,parvaluepershareisadjustedproportionately.</p></li><li><p>Tax:cashdividendsmaybetaxable;stockdividendsarenottaxeduntilsale;stocksplitshavenoimmediatetax.</p></li><li><p>Preemptiverights:short−term(usually30–60days)rightstobuynewsharesatdiscounttomaintainownershippercentage;ifnotexercised,ownershipcanbediluted.</p></li></ul><h3collapsed="false"seolevelmigrated="true">CommonStockValuationandFinancialStatements</h3><ul><li><p>BalanceSheet:assets=liabilities+stockholders’equity(networth).</p></li><li><p>IncomeStatement:revenues−expenses=netincome.</p></li><li><p>Earningspershare(EPS):.</p></li><li><p>Equity financing: selling ownership in exchange for capital.</p></li><li><p>Reuse of treasury stock: can be reissued, used in acquisitions, or granted to employees.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Regular Way Settlement (Section 2, Topic 2)</h3><ul><li><p>Equity securities trade on exchanges or OTC.</p></li><li><p>Regular way settlement (T+1): trade settles one business day after the trade date.</p></li><li><p>Settlement converts ownership on the settlement date; buyer becomes the owner of record then.</p></li><li><p>Listed vs OTC: listed follow strict rules; OTC from smaller issuers.</p></li><li><p>Price risk: buyer bears risk of price change even before settlement.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Dividends, Stock Splits, and Preemptive Rights</h3><ul><li><p>Dividends: cash dividends paid from profits; typically quarterly.</p></li><li><p>Stock dividends: extra shares issued; total value roughly unchanged (more shares, lower per-share value).</p></li><li><p>Stock splits: increase (forward) or decrease (reverse) the number of shares without changing total value; price per share adjusts accordingly.</p></li><li><p>Par value adjustment: during splits, par value per share is adjusted proportionately.</p></li><li><p>Tax: cash dividends may be taxable; stock dividends are not taxed until sale; stock splits have no immediate tax.</p></li><li><p>Preemptive rights: short-term (usually 30–60 days) rights to buy new shares at discount to maintain ownership percentage; if not exercised, ownership can be diluted.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Common Stock Valuation and Financial Statements</h3><ul><li><p>Balance Sheet: assets = liabilities + stockholders’ equity (net worth).</p></li><li><p>Income Statement: revenues - expenses = net income.</p></li><li><p>Earnings per share (EPS): ext{EPS} = rac{ ext{Net income after tax}}{ ext{Outstanding shares}}</p></li><li><p>Inventoryvaluationmethods:FIFO(older,cheaperitemsfirst)vsLIFO(newer,moreexpensiveitemsfirst);ininflation,FIFOshowshigherprofits.</p></li><li><p>Bookvalueandcapitalizationconcepts:long−termdebt+stockholders’equity=capitalization.</p></li><li><p>Inventorymanagementguidance:keepinventorylowrelativetosales.</p></li><li><p>P/Eratio(price−to−earnings):</p></li><li><p>Inventory valuation methods: FIFO (older, cheaper items first) vs LIFO (newer, more expensive items first); in inflation, FIFO shows higher profits.</p></li><li><p>Book value and capitalization concepts: long-term debt + stockholders’ equity = capitalization.</p></li><li><p>Inventory management guidance: keep inventory low relative to sales.</p></li><li><p>P/E ratio (price-to-earnings): ext{P/E} = rac{ ext{Price per share}}{ ext{EPS}}; higher for growth companies; lower for mature companies.

Common Stock: Rights, Voting, and Valuation Multiples

  • Basic rights: inspect records, transfer ownership, preemptive right, receive dividends, claim assets, vote.

  • Voting: statutory vs cumulative; proxy voting allowed for remote votes.

  • Voting rights: common stockholders have 1 vote per share; some items require shareholder approval (e.g., stock splits, issuing convertible bonds, preferred stock).

  • Proxy voting: proxies substitute for attendance; revocable before the meeting.

  • P/E ratio (multiple) insight: 15× (e.g., price $30, EPS $2 → P/E = 15).

  • Growth vs. maturity: growth firms have higher multiples; mature firms have lower multiples.

Common vs Preferred Stock; Warrants and ADRs

  • Common stock: voting rights; dividends variable; potential for capital appreciation.

  • Preferred stock: priority for dividends and liquidation proceeds; usually no voting rights; fixed dividend; behaves like a bond in some ways.

  • Warrant vs Rights: both give the right to buy stock in the future; warrants typically have longer duration and higher exercise price; rights are shorter and tied to existing shareholders.

  • ADRs (American Depositary Receipts): foreign stocks traded on U.S. exchanges; dividends in U.S. dollars; no voting or preemptive rights; bank votes and exchanges rights; currency risk affects ADR value.

Basics of Bonds (Chapter Two, Section 1)

  • Bond = a loan; issuer borrows money and promises to pay interest and repay principal at maturity.

  • Par value: typically 1{,}000perbond;couponrate=annualinterestasapercentageofpar.</p></li><li><p>Couponpayments:usuallysemiannualorannual.</p></li><li><p>Bondholdersarecreditors,notowners.</p></li></ul><h3collapsed="false"seolevelmigrated="true">BondTypes:Term,Zero−Coupon,Serial,Series;PricingandYields</h3><ul><li><p>Termbonds:allbondsinissuesharesamecouponandmaturity;commonforcorporates/government.</p></li><li><p>Zero−couponbonds:nointerestpayments;issuedatadiscountandmatureatpar;priceappreciationisthereturn.</p></li><li><p>Serialbonds:differentportionsmatureatdifferenttimes;commonformunicipal/corporateloans;balloonmaturityiflargeone−yearportion.</p></li><li><p>Seriesbonds:allmatureatsametimebutissuedatdifferenttimes.</p></li><li><p>Bondpricing:quotesasper bond; coupon rate = annual interest as a percentage of par.</p></li><li><p>Coupon payments: usually semiannual or annual.</p></li><li><p>Bondholders are creditors, not owners.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Bond Types: Term, Zero-Coupon, Serial, Series; Pricing and Yields</h3><ul><li><p>Term bonds: all bonds in issue share same coupon and maturity; common for corporates/government.</p></li><li><p>Zero-coupon bonds: no interest payments; issued at a discount and mature at par; price appreciation is the return.</p></li><li><p>Serial bonds: different portions mature at different times; common for municipal/corporate loans; balloon maturity if large one-year portion.</p></li><li><p>Series bonds: all mature at same time but issued at different times.</p></li><li><p>Bond pricing: quotes as % of par (par = 1000); e.g., 98 means $980; 1 point = 1% of par = $10 per $1,000 bond.</p></li><li><p>Treasury vs corporate quotes: Treasuries quoted in 32nds; corporate bonds often in 1/8 of a point.</p></li><li><p>Yield vs price: inverse relationship; as price rises, yield falls; as price falls, yield rises.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Bond Yields and Prices</h3><ul><li><p>Yields types:</p><ul><li><p>Nominal yield (coupon rate): fixed and based on par.</p></li><li><p>Current yield: ext{Current yield} = rac{ ext{Annual coupon}}{ ext{Current price}}</p></li><li><p>YieldtoMaturity(YTM):totalreturnifheldtomaturity,includesinterestandanygain/lossfrompricerelativetopar,timevalueofmoney,andcompounding.</p></li></ul></li><li><p>Inverseprice−yieldrelationship:ifmarketratesrise,pricefalls;ifratesfall,pricerises.</p></li><li><p>Pricequotesvsyieldquotes:somebondsquotedbyprice(as</p></li><li><p>Yield to Maturity (YTM): total return if held to maturity, includes interest and any gain/loss from price relative to par, time value of money, and compounding.</p></li></ul></li><li><p>Inverse price-yield relationship: if market rates rise, price falls; if rates fall, price rises.</p></li><li><p>Price quotes vs yield quotes: some bonds quoted by price (as % of par), others by yield.</p></li><li><p>Market scenarios (discount vs premium):</p><ul><li><p>Discount bond: coupon &lt; current yield &lt; YTM.</p></li><li><p>Premium bond: coupon &gt; current yield &gt; YTM.</p></li></ul></li></ul><h3 collapsed="false" seolevelmigrated="true">Bond Features: Call, Put, Convertible, and Priority of Payments</h3><ul><li><p>Callable bonds: issuer can redeem early at a call price; compensated with higher coupon; often have call protection period.</p></li><li><p>Yield to Call (YTC): return if called before maturity; important for evaluating callable bonds; Worst-case yield (YTW) is the lower of YTM or YTC.</p></li><li><p>Puttable bonds: investor-right to sell back to issuer at a set price; lower coupons as protection for investors.</p></li><li><p>Convertible debentures: can be converted into a set number of shares; conversion price impacts value; usually lower coupons due to conversion feature.</p></li><li><p>Priority of payments in liquidation: secured creditors → administrative claims → unsecured creditors → subordinated creditors → preferred stock → common stock.</p></li><li><p>Bonds with credit risk: ratings by Moody’s and S&amp;P; investment-grade (AAA–BBB) vs speculative/junk (BB–C).</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Interest Rate Risk, Duration, and Price Volatility</h3><ul><li><p>Interest rate risk: prices fall when rates rise; rise when rates fall.</p></li><li><p>Duration: combination of maturity and coupon; longer duration means higher price sensitivity.</p></li><li><p>Longer maturity + lower coupon → higher duration, more volatile.</p></li><li><p>Short maturity + high coupon → lower duration, less volatility.</p></li><li><p>Variable-rate bonds have lower interest-rate risk because coupons adjust with market rates.</p></li><li><p>3M Rule: longer maturity magnifies price move when rates change.</p></li><li><p>Zero-coupon bonds are highly volatile because all value is realized at maturity.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Other Bond Risks</h3><ul><li><p>Capital risk: loss of principal.</p></li><li><p>Inflation risk: purchasing power risk; TIPS protect against this.</p></li><li><p>Marketability risk: liquidity concerns; government bonds are most liquid; municipals may be harder to sell.</p></li><li><p>Reinvestment risk: risk of reinvesting coupons at lower rates.</p></li><li><p>Currency risk: for foreign-denominated bonds or ADRs.</p></li><li><p>Systematic vs nonsystematic risk: systematic cannot be diversified away; nonsystematic can.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">U.S. Government Debt and Agency Obligations</h3><ul><li><p>Debt types: T-bills (short-term), notes (2–10 years), bonds (10–30 years); STRIPS (zero-coupon) separated.</p></li><li><p>TIPS: inflation-protected; principal adjusts with inflation; interest paid on adjusted principal.</p></li><li><p>STRIPS: zero-coupon, severed interest from principal; ideal for long-horizon investors.</p></li><li><p>Savings Bonds (Series EE): non-transferable; redeemable by government; not securities.</p></li><li><p>Agency securities: back by government-related entities (GSEs like Fannie Mae, Freddie Mac; Ginnie Mae directly backed by the U.S. government).</p></li><li><p>Mortgage-Backed Securities (MBS): pass-through certificates; monthly payments; prepayment risk; issued by agencies; pool of mortgages.</p></li><li><p>Sallie Mae: student-loan-backed debentures.</p></li><li><p>Tax treatment: U.S. government bonds typically taxed federally, exempt from state/local taxes; agencies vary; MBS (interest taxed at federal and state).</p></li><li><p>Trading: government/agency debt trades OTC via primary/secondary dealers; Fed Open Market Operations influence rates.</p></li><li><p>Fed operations: buying bonds to ease credit (dovish); selling bonds to tighten (hawkish).</p></li><li><p>Auctions: Treasury securities sold via weekly auctions; agency securities sold by selling groups; yield spread vs Treasuries.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Municipal Debt: Key Concepts</h3><ul><li><p>Municipal bonds: generally tax-exempt at federal level; in-state bonds often triple tax-exempt (federal, state, local).</p></li><li><p>GO bonds: backed by full faith, credit, and taxing power; safer; unlimited tax GO bonds vs limited tax GO bonds with tax caps.</p></li><li><p>Debt limits: many GO bonds are subject to statutory debt limits; voter approval may be required to raise limits.</p></li><li><p>CABs (Capital Appreciation Bonds): zero-coupon bonds counting only discounted price toward debt limits.</p></li><li><p>Revenue bonds: repaid from project revenues (not full taxing power); riskier, higher yields; often protected by a trust indenture.</p></li><li><p>Special types: special tax bonds, special assessment bonds, moral obligation bonds, double-barreled bonds, parity bonds, subordinated bonds, COPs, lease rental bonds, IDBs, BABs, PABs.</p></li><li><p>Tax status: municipal interest typically exempt from federal tax; triple tax exemption possible when in-state; PABs may be federally taxable but tax-advantaged locally.</p></li><li><p>Short-term muni debt: BANs, CLNs, TANs, RANs, TRANs, GANs, tax-exempt commercial paper, VRDNs. These notes cover temporary financing and cash-flow needs.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Money Market Instruments (Section Two)</h3><ul><li><p>Money market instruments: short-term debt maturing in 1 year or less; highly liquid; lower return but safety.</p></li><li><p>Major instruments:</p><ul><li><p>Treasury Bills (T-bills): short-term, government-backed; maturities 1–12 months; sold at discount; no interest payments.</p></li><li><p>Commercial paper: short-term corporate debt; max maturity 270 days; sold at a discount; large investors.</p></li><li><p>Banker’s Acceptances (BAs): bank-guaranteed international trade payments.</p></li><li><p>Negotiable Certificates of Deposit (CDs): large, tradable CDs (often $100k+); FDIC insured up to $250k per name; discount/premium marketable.</p></li><li><p>Repurchase Agreements (Repos): short-term loans backed by securities; collateralized; Fed actions influence liquidity (open market ops).</p></li></ul></li></ul><h3 collapsed="false" seolevelmigrated="true">Long-Term Certificates of Deposit (CDs) and Brokered CDs</h3><ul><li><p>Most CDs are short-term; brokered CDs are long-term (often &gt;1 year) and split into smaller pieces for sale.</p></li><li><p>Callable CDs: can be redeemed early by issuer; investor risks reinvestment at lower rates.</p></li><li><p>Market risk: value fluctuates with rates; liquidity varies; early withdrawal penalties may apply (except some brokered CDs disclaimers).</p></li><li><p>FDIC insurance protects deposits in the depositor’s name up to $250k.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Investment Companies (Chapter Six)</h3><ul><li><p>What is an investment company? A business that pools investor funds to buy a diversified portfolio; examples include mutual funds.</p></li><li><p>Registration: must register with the SEC under the Investment Company Act of 1940.</p></li><li><p>Types (3):</p><ul><li><p>Face-amount certificate company (rare today).</p></li><li><p>Management company (most common; includes mutual funds).</p></li><li><p>Unit Investment Trust (UIT): fixed set of investments with limited or no ongoing management.</p></li></ul></li><li><p>Management Companies:</p><ul><li><p>Open-End (Mutual Funds): issue new shares on demand; shares redeemed by fund; no trading between investors.</p></li><li><p>Closed-End: fixed number of shares; traded on an exchange like stocks; can be bought/sold between investors; can raise money using common stock, preferred stock, or debt.</p></li></ul></li><li><p>UITs: fixed securities portfolio; Fixed UITs have no trading after creation; Non-Fixed UITs invest in mutual fund shares.</p></li><li><p>Variable Annuities: not investment companies themselves; use UITs or other funds; used in retirement planning.</p></li></ul><h3 collapsed="false" seolevelmigrated="true">Quick Takeaways for Exam Focus</h3><ul><li><p>Know the key formulas: ext{Market cap} = ext{outstanding shares} imes ext{price};; ext{EPS} = rac{ ext{Net income}}{ ext{Outstanding shares}};; ext{P/E}= rac{P}{ ext{EPS}}$$; price per bond point = 1% of par (for par $1{,}000$, each point = $10$).

  • Understand the main debt and equity instruments: common stock, preferred stock, warrants/ADR basics; bonds (par, coupon, maturity, types), money market instruments, municipal debt, government debt.

  • Grasp the risk/return landscape: yield types (nominal, current, YTM, YTC, YTW); duration and price volatility; credit risk ratings; tax considerations for different debt types.

  • Be able to distinguish GO vs Revenue bonds, and the special muni debt types; and the general tax treatment for government vs corporate vs municipal debt.

  • Recognize the flow of bond prices and yields: when rates rise, prices fall; when rates fall, prices rise; longer duration means greater price movement (the 3M rule).

  • Know settlement conventions (T+1) and basic trading mechanics (OTC, primary vs secondary dealers) for government, agency, and municipal debt.

  • Basic concepts for investment companies: differences between open-end, closed-end, and UIT structures; where fees and management decisions come from.