SIE Exam Section 2: Understanding Products and Their Risks

Common Stock - ANSWER-Is a security that represents ownership in a corporation. Exercise control by electing a board of directors and voting on corporate policy. Are on the bottom of the priority ladder for ownership structure Have rights to a company's assets only after bondholders, preferred shareholders and other debt holders are paid in full. Preferred Stock - ANSWER-Is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights. Preferred stock combines features of debt, in that it pays fixed dividends, and equity, in that it has the potential to appreciate in price. The details of each preferred stock depend on the issue Rights - ANSWER-_________ offering is a group of rights offered to existing shareholders to purchase additional stock shares, known as subscription warrants, in proportion to their existing holdings. In a rights offering, the subscription price at which each share may be purchased is generally discounted relative to the current market price. Rights are often transferable, allowing the holder to sell them in the open market. Warrants - ANSWER-are a derivative that give the right, but not the obligation, to buy or sell a security—most commonly an equity—at a certain price before expiration. An American depositary receipt (ADR) - ANSWER-is a negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in a foreign stock traded on a U.S. exchange. Control & Restrictions SEC Rule 144 - ANSWER-When you acquire restricted securities or hold control securities, you must find an exemption from the SEC's registration requirements to sell them in a public marketplace. Rule 144 allows public resale of restricted and control securities if a number of conditions are met. A Treasury Bill (T-Bill) - ANSWER-is a short-term debt obligation backed by the Treasury Department of the U.S. government with a maturity of less than one year, sold in denominations of $1,000 up to a maximum purchase of $5 million on noncompetitive bids. ________ have various maturities and are issued at a discount from par. A Treasury Note - ANSWER-is a marketable U.S. government debt security with a fixed interest rate and a maturity between one and 10 years. Treasury Receipts - ANSWER-is a zero-coupon bond that does not pay interest at regular intervals between the date of issue and maturity, but instead accrues the interest and pays it with the principal at maturity. A Treasury bond (T-bond) - ANSWER-is a marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest payments semiannually, and the income received is only taxed at the federal level. Treasury bonds are known in the market as primarily risk-free; they are issued by the U.S. government with very little risk of default. An asset-backed security (ABS) - ANSWER-is a financial security collateralized by a pool of assets such as loans, leases, credit card debt, royalties or receivables. A mortgage-backed security (MBS) - ANSWER-is a type of asset-backed security that is secured by a mortgage or collection of mortgages. Corporate Bonds - ANSWER-is a debt security issued by a corporation and sold to investors. The backing for the bond is usually the payment ability of the company, which is typically money to be earned from future operations. In some cases, the company's physical assets may be used as collateral for bonds. Municipal Securities - ANSWER-A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures, including the construction of highways, bridges or schools. Municipal bonds are exempt from federal taxes and most state and local taxes, making them especially attractive to people in high income tax brackets. General obligation (GO) bonds - ANSWER-A general obligation bond (GO) is a municipal bond backed by the credit and taxing power of the issuing jurisdiction rather than the revenue from a given project. General obligation bonds are issued with the belief that a municipality will be able to repay its debt obligation through taxation or revenue from projects. No assets are used as collateral. Revenue Bonds - ANSWER-is a municipal bond supported by the revenue from a specific project, such as a toll bridge, highway or local stadium. Revenue bonds are municipal bonds that finance income-producing projects and are secured by a specified revenue source. taxable municipal securities - ANSWER-is a fixed-income security issued by a local government such as a city or county or related agencies which has its income not exempt from tax. short-term obligations - ANSWER-is an account shown in the current liabilities portion of a company's balance sheet. This account is made up of any debt incurred by a company that is due within one year. The debt in this liabilities account is usually made up of short-term bank loans taken out by a company, or of commercial paper, among other types. Money Market Instruments - ANSWER-Give businesses, financial institutions and governments a means to finance their short-term cash requirements. Three important characteristics are: Liquidity - Since they are fixed-income securities with short-term maturities of a year or less, money market instruments are extremely liquid. Safety - They also provide a relatively high degree of safety because their issuers have the highest credit ratings. Discount Pricing- A third characteristic they have in common is that they are issued at adiscount to their face value. Certificate of Deposit (CD) - ANSWER-is a savings certificate with a fixed maturity date, specified fixed interest rate and can be issued in any denomination aside from minimum investment requirements. A CD restricts access to the funds until the maturity date of the investment. CDs are generally issued by commercial banks and are insured by the FDIC up to $250,000 per individual. bankers' acceptance - ANSWER-is a short-term debt instrument issued by a company that is guaranteed by a commercial bank. commercial paper - ANSWER-is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts payable and inventories, and meeting short-term liabilities. par value - ANSWER-is the face value of a bond. is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. Par value for a bond is typically $1,000 or $100. The market price of a bond may be above or below par, depending on factors such as the level of interest rates and the bond's credit status. Yield - ANSWER-refers to the earnings generated and realized on an investment over a particular period of time, and is expressed in terms of percentage based on the invested amount or on the current market value or on the face value of the security. It includes the interest earned or dividends received from holding a particular security. Depending on the nature and valuation (fixed/fluctuating) of the security, yields may be classified as known or anticipated. Ratings and rating agencies - ANSWER-Bond rating agencies are companies that assess the creditworthiness of both debt securities and their issuers. The ratings are published by credit rating agencies and used by investment professionals to assess the likelihood that the debt will be repaid. Coupon Value/Rate - ANSWER-is the yield paid by a fixed-income security; a fixed-income security's coupon rate is simply just the annual coupon payments paid by the issuer relative to the bond's face or par value. The coupon rate is the yield the bond paid on its issue date. This yield changes as the value of the bond changes, thus giving the bond's yield to maturity. callable bonds - ANSWER-A callable bond is a bond that can be redeemed by the issuer prior to its maturity. If interest rates have declined since the company first issued the bond, the company is likely to want to refinance this debt at the lower rate of interest. In this case, the company "calls" its current bonds and reissues them at a lower interest rate. convertible bonds - ANSWER-Bonds that can be converted into common stock at the bondholder's option Call Options - ANSWER-provide the holder the right (but not the obligation) to purchase an underlying asset at a specified price (the strike price), for a certain period of time. If the stock fails to meet the strike price before the expiration date, the option expires and becomes worthless. Investors buy calls when they think the share price of the underlying security will rise or sell a call if they think it will fall. Selling an option is also referred to as ''writing'' an option. Put options - ANSWER-give the holder the right to sell an underlying asset at a specified price (the strike price). The seller (or writer) of the put option is obligated to buy the stock at the strike price. Put options can be exercised at any time before the option expires. Investors buy puts if they think the share price of the underlying stock will fall, or sell one if they think it will rise. Equity vs. index - ANSWER-Equity is a stock index is a bunch of stocks Hedging or speculation - ANSWER-A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract strike price - ANSWER-is the price at which a derivative contract can be exercised. The term is mostly used to describe stock and index options. For call options, the strike price is where the security can be bought by the option buyer up till the expiration date. For put options, the strike price is the price at which shares can be sold by the option buyer. Premium - ANSWER-An option premium is the income received by an investor who sells or "writes" an option contract to another party. An option premium may also refer to the current price of any specific option contract that has yet to expire. For stock options, the premium is quoted as a dollar amount per share, and most contracts represent the commitment of 100 shares. Expiration date - ANSWER-An expiration date in derivatives is the last day that a derivative, such as options or futures, is valid. On or before this day investors will have already had to decide what to do which their expiring position. Underlying or cash settlement - ANSWER-A cash settlement is a settlement method used in certain futures and options contracts where, upon expiration or exercise, the seller of the financial instrument does not deliver the actual (physical) underlying asset but instead transfers the associated cash position. In-the-money, out-of-the money - ANSWER-In the money (ITM) means that a call option's strike price is below the market price of the underlying asset, or that the strike price of a put option is above the market price of the underlying asset. An option that is in the money has intrinsic value, where as an option that is out of the money (OTM) does not. Out of the money (OTM) is term used to describe a call option with a strike price that is higher than the market price of the underlying asset, or a put option with a strike price that is lower than the market price of the underlying asset. An out of the money option has no intrinsic value, but only possesses extrinsic or time value. An uncovered option - ANSWER-is an options strategy where the investor writes, or sells, options contracts without holding an offsetting position in the underlying asset. The investor writes an uncovered call when they do not own a long position in the underlying asset. When the investor writes an uncovered put, they do not hold a short position in the underlying asset. This strategy is also called a naked option. Covered Call - ANSWER-Covered calls are an options strategy where an investor holds a long position in an asset and writes (sells) call options on that same asset to generate an income stream. This is often employed when an investor has a short-term neutral view on the asset and for this reason holds the asset long and simultaneously has a short position via the option to generate income from the option premium. A covered call is also known as a "buy-write". American vs. European - ANSWER-The key difference between American and European options relates to when the options can be exercised: A European option may be exercised only at the expiration date of the option, i.e. at a single pre-defined point in time. An American option on the other hand may be exercised at any time before the expiration date Exercise - ANSWER-the process to buy or sell a position assignment - ANSWER-is the designation by a clearinghouse of an option writer who will be required to buy (in the case of a put) or sell (in the case of a call) the underlying futures contract or security when an option has been exercised, especially if it has been exercised early Long - ANSWER-Bullish - Thinking a stock is going up Short - ANSWER-Bearish - Thinking a stock is going down An Options Disclosure Document (ODD) - ANSWER-mandated by the Securities Exchange Act of 1934, is filed with the SEC by an options exchange. The document describes the characteristics and risks of standardized options to be traded in its market. An ODD includes the following information: Options Clearing Corporation (OCC) for listed options - ANSWER-is an organization that acts as both the issuer and guarantor for option and futures contracts. The OCC operates under the jurisdiction of the U.S. Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) Under its SEC jurisdiction, the OCC clears transactions for put and call options, stock indexes, foreign currencies, interest rate composites and single-stock futures. Closed-end funds - ANSWER-A closed-end fund is organized as a publicly traded investment company by the Securities and Exchange Commission (SEC). Like a mutual fund, a closed-end fund is a pooled investment fund with a manager overseeing the portfolio; it raises a fixed amount of capital through an initial public offering (IPO). The fund is then structured, listed and traded like a stock on a stock exchange. Open-end funds - ANSWER-An open-end fund is a type of mutual fund that does not have restrictions on the amount of shares the fund can issue. The majority of mutual funds are open-end, providing investors with a useful and convenient investing vehicle. When a fund's investment manager(s) determine that a fund's total assets have become too large to effectively execute its stated objective, the fund will be closed to new investors, and in extreme cases, will be closed to new investment by existing fund investors.