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): ext{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., 1 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{,}000 ext{ shares} imes {10} = $4{,}000{,}000.

• Equity financing: selling ownership in exchange for capital.

• Reuse of treasury stock: can be reissued, used in acquisitions, or granted to employees.

Regular Way Settlement (Section 2, Topic 2)

• Equity securities trade on exchanges or OTC.

• Regular way settlement (T+1): trade settles one business day after the trade date.

• Settlement converts ownership on the settlement date; buyer becomes the owner of record then.

• Listed vs OTC: listed follow strict rules; OTC from smaller issuers.

• Price risk: buyer bears risk of price change even before settlement.

Dividends, Stock Splits, and Preemptive Rights

• Dividends: cash dividends paid from profits; typically quarterly.

• Stock dividends: extra shares issued; total value roughly unchanged (more shares, lower per-share value).

• Stock splits: increase (forward) or decrease (reverse) the number of shares without changing total value; price per share adjusts accordingly.

• Par value adjustment: during splits, par value per share is adjusted proportionately.

• Tax: cash dividends may be taxable; stock dividends are not taxed until sale; stock splits have no immediate tax.

• 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.

Common Stock Valuation and Financial Statements

• Balance Sheet: assets = liabilities + stockholders’ equity (net worth).

• Income Statement: revenues - expenses = net income.

• Earnings per share (EPS): ext{EPS} = rac{ ext{Net income after tax}}{ ext{Outstanding shares}}

• Inventory valuation methods: FIFO (older, cheaper items first) vs LIFO (newer, more expensive items first); in inflation, FIFO shows higher profits.

• Book value and capitalization concepts: long-term debt + stockholders’ equity = capitalization.

• Inventory management guidance: keep inventory low relative to sales.

• 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{,}000 per bond; coupon rate = annual interest as a percentage of par.

• Coupon payments: usually semiannual or annual.

• Bondholders are creditors, not owners.

Bond Types: Term, Zero-Coupon, Serial, Series; Pricing and Yields

• Term bonds: all bonds in issue share same coupon and maturity; common for corporates/government.

• Zero-coupon bonds: no interest payments; issued at a discount and mature at par; price appreciation is the return.

• Serial bonds: different portions mature at different times; common for municipal/corporate loans; balloon maturity if large one-year portion.

• Series bonds: all mature at same time but issued at different times.

• Bond pricing: quotes as % of par (par = 1000); e.g., 98 means $980; 1 point = 1% of par = $10 per $1,000 bond.

• Treasury vs corporate quotes: Treasuries quoted in 32nds; corporate bonds often in 1/8 of a point.

• Yield vs price: inverse relationship; as price rises, yield falls; as price falls, yield rises.

Bond Yields and Prices

• Yields types:

  • Nominal yield (coupon rate): fixed and based on par.

  • Current yield: ext{Current yield} = rac{ ext{Annual coupon}}{ ext{Current price}}

  • 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.

• Inverse price-yield relationship: if market rates rise, price falls; if rates fall, price rises.

• Price quotes vs yield quotes: some bonds quoted by price (as % of par), others by yield.

• Market scenarios (discount vs premium):

  • Discount bond: coupon < current yield < YTM.

  • Premium bond: coupon > current yield > YTM.

Bond Features: Call, Put, Convertible, and Priority of Payments

• Callable bonds: issuer can redeem early at a call price; compensated with higher coupon; often have call protection period.

• 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.

• Puttable bonds: investor-right to sell back to issuer at a set price; lower coupons as protection for investors.

• Convertible debentures: can be converted into a set number of shares; conversion price impacts value; usually lower coupons due to conversion feature.

• Priority of payments in liquidation: secured creditors → administrative claims → unsecured creditors → subordinated creditors → preferred stock → common stock.

• Bonds with credit risk: ratings by Moody’s and S&P; investment-grade (AAA–BBB) vs speculative/junk (BB–C).

Interest Rate Risk, Duration, and Price Volatility

• Interest rate risk: prices fall when rates rise; rise when rates fall.

• Duration: combination of maturity and coupon; longer duration means higher price sensitivity.

• Longer maturity + lower coupon → higher duration, more volatile.

• Short maturity + high coupon → lower duration, less volatility.

• Variable-rate bonds have lower interest-rate risk because coupons adjust with market rates.

• 3M Rule: longer maturity magnifies price move when rates change.

• Zero-coupon bonds are highly volatile because all value is realized at maturity.

Other Bond Risks

• Capital risk: loss of principal.

• Inflation risk: purchasing power risk; TIPS protect against this.

• Marketability risk: liquidity concerns; government bonds are most liquid; municipals may be harder to sell.

• Reinvestment risk: risk of reinvesting coupons at lower rates.

• Currency risk: for foreign-denominated bonds or ADRs.

• Systematic vs nonsystematic risk: systematic cannot be diversified away; nonsystematic can.

U.S. Government Debt and Agency Obligations

• Debt types: T-bills (short-term), notes (2–10 years), bonds (10–30 years); STRIPS (zero-coupon) separated.

• TIPS: inflation-protected; principal adjusts with inflation; interest paid on adjusted principal.

• STRIPS: zero-coupon, severed interest from principal; ideal for long-horizon investors.

• Savings Bonds (Series EE): non-transferable; redeemable by government; not securities.

• Agency securities: back by government-related entities (GSEs like Fannie Mae, Freddie Mac; Ginnie Mae directly backed by the U.S. government).

• Mortgage-Backed Securities (MBS): pass-through certificates; monthly payments; prepayment risk; issued by agencies; pool of mortgages.

• Sallie Mae: student-loan-backed debentures.

• Tax treatment: U.S. government bonds typically taxed federally, exempt from state/local taxes; agencies vary; MBS (interest taxed at federal and state).

• Trading: government/agency debt trades OTC via primary/secondary dealers; Fed Open Market Operations influence rates.

• Fed operations: buying bonds to ease credit (dovish); selling bonds to tighten (hawkish).

• Auctions: Treasury securities sold via weekly auctions; agency securities sold by selling groups; yield spread vs Treasuries.

Municipal Debt: Key Concepts

• Municipal bonds: generally tax-exempt at federal level; in-state bonds often triple tax-exempt (federal, state, local).

• GO bonds: backed by full faith, credit, and taxing power; safer; unlimited tax GO bonds vs limited tax GO bonds with tax caps.

• Debt limits: many GO bonds are subject to statutory debt limits; voter approval may be required to raise limits.

• CABs (Capital Appreciation Bonds): zero-coupon bonds counting only discounted price toward debt limits.

• Revenue bonds: repaid from project revenues (not full taxing power); riskier, higher yields; often protected by a trust indenture.

• 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.

• 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.

• Short-term muni debt: BANs, CLNs, TANs, RANs, TRANs, GANs, tax-exempt commercial paper, VRDNs. These notes cover temporary financing and cash-flow needs.

Money Market Instruments (Section Two)

• Money market instruments: short-term debt maturing in 1 year or less; highly liquid; lower return but safety.

• Major instruments:

  • Treasury Bills (T-bills): short-term, government-backed; maturities 1–12 months; sold at discount; no interest payments.

  • Commercial paper: short-term corporate debt; max maturity 270 days; sold at a discount; large investors.

  • Banker’s Acceptances (BAs): bank-guaranteed international trade payments.

  • Negotiable Certificates of Deposit (CDs): large, tradable CDs (often $100k+); FDIC insured up to $250k per name; discount/premium marketable.

  • Repurchase Agreements (Repos): short-term loans backed by securities; collateralized; Fed actions influence liquidity (open market ops).

Long-Term Certificates of Deposit (CDs) and Brokered CDs

• Most CDs are short-term; brokered CDs are long-term (often >1 year) and split into smaller pieces for sale.

• Callable CDs: can be redeemed early by issuer; investor risks reinvestment at lower rates.

• Market risk: value fluctuates with rates; liquidity varies; early withdrawal penalties may apply (except some brokered CDs disclaimers).

• FDIC insurance protects deposits in the depositor’s name up to $250k.

Investment Companies (Chapter Six)

• What is an investment company? A business that pools investor funds to buy a diversified portfolio; examples include mutual funds.

• Registration: must register with the SEC under the Investment Company Act of 1940.

• Types (3):

  • Face-amount certificate company (rare today).

  • Management company (most common; includes mutual funds).

  • Unit Investment Trust (UIT): fixed set of investments with limited or no ongoing management.

• Management Companies:

  • Open-End (Mutual Funds): issue new shares on demand; shares redeemed by fund; no trading between investors.

  • 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.

• UITs: fixed securities portfolio; Fixed UITs have no trading after creation; Non-Fixed UITs invest in mutual fund shares.

• Variable Annuities: not investment companies themselves; use UITs or other funds; used in retirement planning.

Quick Takeaways for Exam Focus

• 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.