Series-7-Handout Review PDF

Series 7 Classroom Four Day v16
About the Series 7

250 multiple-choice question exam
6 hours allowed
Two three-hour sessions
70% passing score
Securities Training Corporation
30, 30, 180 waiting period for failures
Series 7
General Securities
Registered Representative
Securities Training Corporation. All rights reserved.
Series 7 Exam Breakdown

Section
17
2) Brokerage Products
81
3) Derivatives
38
4) Handling Customer Accounts
27
5) Markets and Regulations
56
6) Order Entry, Confirmation, & Settlement
13
7) Factors Affecting Security Value
18
22-Chapter Study Manual

14 Final Examinations
125 question comprehensive exams
Written explanations provided
First attempt
Question / Answer method
Complete all final exams before progressing to Closed-Book
Second attempt
Closed-Book method
Scores of 80% + indicate adequate retention
Exam Preparation By Topic (on-line or CD)
Provides specific support by topic
Allows student to focus on areas of weakness
250
STC Study Materials
# of Questions
1) Customer and the Registered Rep.
Supplemental Study Aids
Progress Prep Exams -- CD-ROM or On-Line
CD Audio Learning Program
6 Additional Exams
First two exams represent halves of the book
Exam 1: Chapters 1 13
Exam 2: Chapters 14 22
Exams 3 and 4: Comprehensive Finals
Municipals and Options: Topical Exams
Covers heavily tested topic areas including: Bond

Basics, Investment Companies and Retirement Plans;
Margin; MSRB Rules; and, Options
STC Virtual Class Offerings

Internet-based Training with Audio and Visual Support
Audio available via telephone or VOIP
Regular Classroom Activities
Questions and Answers
In-session Quizzes
Homework Assignments
DVD Video Learning Program

Covers heavily tested topic areas: Markets and Regulations;
Bond Concepts; Municipal Bond Market; Fundamentals of
Options; Advanced Options Strategies and Margin Accounts;
and Investment Companies

Securities Training Corporation
Regional Sales Offices:
New York:
800-782-1223
Chicago:
800-782-8505
Boston:
800-782-2678
San Francisco:
800-642-4566
Session One
- Corporations and Equities
- Investment Banking
- Federal Securities Acts
Visit us on the web at www.STCUSA.com

Shareholders
Liquidation Hierarchy
Unpaid workers and Taxes
Rights of Shareholders
Limited Liability
Evidence of Ownership
Secured Creditors
Transferability
Inspection
Dividends
Determined by the board; not
guaranteed
All classes of Preferred must be
paid in full for common to receive
any dividend
Unsecured Creditors (debentures)
Preferred Stockholders
Common Stockholders
Common Stock Voting Rights
10
Preemptive Rights
Covers various issues affecting the corporation such as

directors, authorizing additional shares, and stock splits
(NOT for dividends -- cash or stock)
Available to Common Shareholders

Ability to maintain percentage of ownership
Accomplished through the distribution of rights
Current stockholders receive one right for every share
owned
If shareholders wish to have someone else vote their

shares they sign a Proxy
Voting power of attorney
Short-term right enabling holders to buy below the

market price before stock is offered publicly
Solicited by corporations
Required for NYSE and Nasdaq-listed issuers
Regulated by SEC under the Act of 34
11
12
Warrants
Stock Splits
A security that allows the holder to buy shares of common

stock at a pre-set price
Companys attempt to improve marketability of their stock

No economic gain or loss for holders
Attached to an offering of a bond or preferred stock of the

company
When issued, the pre-set price is set at a premium to the
current market price
Long-term expire in years; may be perpetual
Can be detached and traded separately
No change to issuers capitalization

No change to holders percentage of equity ownership
No immediate tax liability
Two Types:
Rights
Issued to
shareholders
Short-term
Discount
Warrants
Attached to
a new issue
Long-term
Premium
Forward more shares, lower price

Reverse fewer shares, higher price
Dividends per share also adjusted proportionately
13
Stock Split Example
14
Preferred Stock
Designed to provide returns comparable to bonds. Par value
is normally $100, with dividends stated as a percentage of par.
Example:
Investor owns 100 shares of XYZ at $180. XYZ
Company executes a 3:1 split.
Shares
Owned:
Value Per
Share:
Total
Value:
Before the Split:
100
$180
$18,000
After the Split:
300
$60
$18,000
Types:
Callable: Issuer has the ability to repurchase the stock,
typically at a premium
Participating: Investor may receive additional dividends
based upon profits of company
Convertible: Investor can convert into a predetermined
number of common shares
Example: An investor owns a 6% preferred stock which is
convertible at $20. What is their conversion ratio?
Par
Conversion Price
15
$100
$20
5:1
16
Types of Preferred Stock
American Depository Receipts (ADR)
Cumulative
A receipt for foreign securities held in a U.S. bank located in

the foreign country
ADRs facilitate the trading of foreign securities in the U.S.
Entitled to unpaid dividends (those in arrears) before

common is paid
ABC Co. intends to pay common stockholders a dividend in Year 3
Dividend paid to:
Year 1
Year 2
Year 3
8% noncumulative
$0
$2
$8
6% cumulative
$0
$2
$16
Common
$0
$0
Any amount

The receipts trade in U.S. markets like common shares

Priced in dollars
Dividends in dollars
Communication in English
Global Depository Receipts (GDR)

Receipts trade in more than one country
Denominated in investors home currency
17
18
The Primary Market

Issuer
Underwriting Manager
(Investment Banker)
Underwriting and
the Securities Act of 1933
Syndicate Members
Selling Group
-Needs capital
-Hires underwriter
-Facilitates distribution
-Assumes liability that varies with the type
of offering
-Signs U/W Agreement with issuer
-B/Ds assisting in selling and sharing liability
-Signs Syndicate Agreement with manager
-B/Ds accepting no liability, assist in sales only
-Signs Selling Agreement with manager
IPO versus Subsequent Offering

19
20
Types of Underwriting
Type of
Underwriting
Comments
The Underwriting Spread

Underwriter purchases from issuer at $19, and sells at the POP of $20
Who is
responsible for
unsold shares?
Firm
Commitment
Syndicate takes down the

entire offering
Syndicate
Best Efforts
Syndicate sells what it can
Issuer
Best Efforts
All-or-None
Offering is cancelled if all

shares are not sold
Issuer
Best Efforts
Mini-Maxi
Offering is cancelled if a set

minimum is not sold
Issuer
Stand-by
Syndicate agrees to buy any

shares not purchased by the
stockholders in a rights offering
Managers Fee Members/U/W Fee

$.20
$.30
Administration
Risk
21
If Member
Sells
If Selling
Group Sells
Customer pays:
$20,000
$20,000
$20,000
Issuer receives:
$19,000
$19,000
$19,000
Manager:
$1,000
$200
$200
Member:
$0
$800
$300
Selling group:
$0
$0
$500
22
1) Pre-registration Period
Regulates the primary market and requires to securities to be

registered unless they are:
Document preparation
No communication with the public
Exempt from registration or

Sold under an exemption
2) File Registration Statement; begin 20-day cooling-off period

No sales or money accepted
Issuer distributes preliminary prospectus (Red Herring)
All information except exact price and date
Non-binding indications of interest
"Blue Sky" the issue (register at the state level)
Registration of B/Ds, RRs and securities
Notification (Filing), Coordination, Qualification
Final due diligence meeting held prior to effective date
Scope of the law:

To provide for full and fair disclosure
Prevention of fraud in the sale of new issues
No ruling as to investment merit -- SEC no approval clause
on prospectus cover
Liability
Unconditional for issuers regarding information to investors
Conditional for underwriters who must perform:
reasonable investigation
due diligence
If Manager
Sells
Full Registration Timeline
Securities Act of 1933
$1.00
Spread
Example: 1,000 shares are sold to a customer at $20 per share
Syndicate
Concession
$.50
Selling
3) Post-registration Period
(Effective date)
Sales confirmed and final prospectus delivered

Publish Tombstone Ad
23
24
New Issue Regulations
New Issue Rule

Prohibits member firms from selling equity IPOs to accounts in which
a restricted person has a beneficial interest (more than 10%)
Shelf Registration (Rule 415)

Allows the flexibility of selling on delayed or continuous basis
for up to 3 years
Restricted persons include:

Member firms and any member firm employees
Immediate family members of member firm employees if:
There is material support or sharing a household or
Purchasing from family members firm
Other persons materially supported by the employee
Green Shoe Clause

Over-allotment provision
Allows for expansion of issue by a maximum of 15%
Stabilization
Exemption is provided for issuer-directed sales if:
Intervention in the secondary market in order to keep the

market price of a new issue from falling
Syndicate manager places one bid (unqualified) to buy the
securities at a price not higher than the POP
Only form of price manipulation allowed by SEC
Disclosed in prospectus
The associated person or a member of the associated persons

immediate family is an employee or director of the issuer
Firms must have written verification as to eligibility of purchasers

(updated annually)
25
Exempt Securities
26
Exempt Transactions
Rule 147: Intrastate Exemption
The following securities are exempt from registration:
A bulk of issuers activities must be confined to one state

80% of assets located
80% of revenues generated and
80% of proceeds used in the state
AND
100% of investors are state residents
No resale to non-residents for 9 months from last sale.
U.S. Government and Agency Securities

Municipal Securities
Securities issued by banks
Those issued by non-profit organizations
Short term corporate debt; not exceeding 270 days
Small Business Investment Company issue
Regulation A: Small Issue Exemption

All remain subject to antifraud provisions of the Act
Capital limitation of no more than $5,000,000 raised over

12-months
Offering Circular - disclosure document
27
28
Exempt Transactions
Regulation D (continued)
Regulation D Private Placement
No more than
35
Non-accredited Investors
Offering Memorandum
Purchasers Representative appointed by investor
- Evaluates risk and merits
- No blanket designation
A sale of securities directly to accredited investors

(and to a limited number of non-accredited investors)
No limit on number of accredited investors
Officer / Director of Issuer
Institutions
Individuals who have met a financial test
Net Worth of:
$1,000,000
or
Annual Income of: $200,000 in each of the
last 2 years ($300,000
for married couples)
Purchasers sign an Investment Letter

Indicates purchase is for investment purposes, not for
immediate resale
Restricted stock; stop transfer instructions
Can only be sold to the public if registered or sold in
accordance with Rule 144
29
Rule 144
30
Rule 144
To sell restricted or control stock:
Rule 144 - Permits the sale of restricted and control stock
SEC must be notified by filing Form 144 at the time the sell
order is placed
One then has 90 days to sell the specified securities
Restricted stock (unregistered)

- Six month holding period
Maximum amount that can be sold:
Control stock (Affiliated) registered stock owned by

officers, directors, or greater than 10% shareholders
Greater of 1% of outstanding shares or the average

weekly trading volume over the last four weeks
- No required minimum holding period
Exception to notifying the SEC:

If selling 5,000 or fewer shares and worth $50,000 or less
31
32
Rule 144: Maximum Sale
Rule 144A
ABC Inc. has 5,700,000 shares outstanding with recent

trading volume as indicated:
Week Ended:
Volume Traded:
2/28
62,000
2/21
60,000
2/14
56,000
2/7
58,000
1/31
58,000
Permits sales of certain unregistered securities to Qualified

Institutional Buyers (QIBs)
No limitations on amounts or frequency of transactions
5,700,000 x 1% = 57,000
1
2
Qualified Institutional Buyers

Only institutions
Minimum $100 million under management
3
4
4 week average is 59,000
Multiple Choices:
1. 57,000
2. 58,000
3. 58,800
4. 59,000
33
34
Securities Exchange Act of 1934

Secondary Market Regulation
Creation of SEC
Utilizes various Self Regulating Organizations (SROs)
Reporting requirement for publicly-traded companies
Empowered the Federal Reserve to regulate the extension
of credit where securities are the collateral (Regulation T)
The Securities
Exchange Act of 1934
Short Sales (defined)

Sale of securities that are borrowed from a B/D
Seller will return securities to the B/D at some future date
Sellers anticipate a price decline enabling them to cover their
position at a lower price
Regulation SHO (modernized short selling practices)
B/Ds must mark the ticket short and be able to locate
securities to be sold short
35
36
Securities Exchange Act of 1934
Insider Regulation
According to the Act of 34
Anti-Manipulation Rules
Front-running - trading ahead of client orders
Painting the Tape creating a misleading appearance of trading
Pegging manipulative activity used to keep a price from falling
Capping manipulative activity used to keep a price from rising
Tender Offers
Any officer or director of issuer or greater than 10% owner

Must register with SEC within 10 days
Report purchases and sales by the end of the 2nd
business day following the transaction
Cannot sell short
Cannot keep short swing profits; held less than 6 months
According to Insider Trading Act of 1988

Anyone who possesses material, non-public information cannot
use it to make a profit or to avoid a loss
Penalties for violations:
Criminal $5 million fine or 20 years imprisonment or both
Civil SEC can sue for three times the damage
(treble damages)
Offer to purchase a security at a stated price, usually at a

premium, by a corporate suitor, to gain control of a target
corporation
Can only tender shares when long the common stock or its
equivalent: convertibles, warrants and rights
37
38
Regulation FD
If inside information is disclosed to an individual who
does not have a fiduciary relationship with the company,
the information must be disseminated to the public
If the disclosure was accidental, the information must be
released within 24 hours
Session Two
If the disclosure will be intentional, e.g. a conference

call, the information must be released simultaneously
- Secondary Market
- Types of Orders
- Customers and Their Accounts
- Industry Rules
39
40
10
Settlement versus Regulation T
How Broker-Dealers Function

A BROKER: Firm that executes a customer order by locating another
party willing to take the other side of the transaction
Settlement date represents the date on which securities are to

be delivered and payment made (broker-to-broker); period
varies based upon securities involved
A gency
B roker
C ommission
Regulation T gives the customer five business days to meet

their margin requirement (pay for the trade)
Seller
Buyer
Applies to both cash and margin accounts

Failure to meet Reg. T
Sell out immediately
Freeze the account for 90 days
During freeze, all transactions in advance
Payment extensions may be granted by the firms SRO
A DEALER: Firm that executes a customer order by taking the other

side of the transaction itself
P rincipal
D ealer
M ark-up
Government and Municipal securities are exempt from

Reg. T; payment is generally due at settlement
Seller
or Buyer
41
Settlement versus Payment

Transaction
Settlement
Payment Date
Corporate Securities in a
cash or margin account
3 Business Days
(T + 3)
5 Business Days
(T + 5 or S + 2)
Municipal Securities
3 Business Days
(T + 3)
Exempt from Reg. T

(generally settlement)
U.S. Government
Securities
Next Business Day Exempt from Reg. T

(T + 1)
(generally settlement)
Option trades
Next Business Day

(T + 1)
Cash transactions for any security settle:
42
Settlement Dates - Examples

Security and Trade Date
Common Stock
Tuesday 6/7
5 Business Days
(T + 5)
Settlement Date:
Friday 6/10
U.S. T-Bills
Wednesday, June 15
Thursday 6/16
U.S. T-Bonds
Monday 7/3/XX
Wednesday 7/5
IBM Bonds for cash

Tuesday, December 24
Tuesday 12/24
On the same day
43
44
11
Dividend Dates
Dividend Dates
Declaration Date:
MAY
The date on which the stock begins to trade with the dividend
Payment Date:
The day the dividend, cash or stock, is distributed
Sun
Mon
Tues
Wed
Thurs
Fri
10
11
12
13
14
Ex-div
Record Date:
Owners of record receive dividend
For a buyer to receive the dividend, transaction must settle on, or
before, record date
Ex-Dividend Date:
2 business days before the record date
Stock begins to sell without dividend at reduced price
Regular way settlement is assumed
45
New York Stock Exchange
Settlement
Entitled to Dividend?
May 6
11th
Buyer
May 9
12th
Buyer
May 10
13th
Seller
May 12 (cash)
12th
Buyer
46
Create liquidity
Act in a principal capacity when necessary
Keep the Specialist Book

Accepts orders entered away from the market and will
act in an agency capacity
Stops and Limits
Can accept:
GTC (good til cancel) or Day
Cannot accept:
Not Held order (time/price discretion)
Floor Brokers (Commission House)

Two Dollar Brokers
Competitive Traders
Specialists
Trade Date
Maintain a fair and orderly market
Centralized, physical location

Auction market for Listed securities
One Specialist per security
Uses SuperDOT (Designated Order Turnaround)
An automated system for routing orders directly to the
specialist (bypasses floor brokers)
Members:

Record
Role of the Specialist
Details:

Sat
47
48
12
Reading the Tape
Over-the-Counter (OTC) Market

Details:
JMK 102.45
Non-physical, phone and computer network

Negotiated market
Unlimited number of market makers continuously willing to
buy or sell at their quoted price
ABC 5 s 40
100 JMK @ 102.45
500 ABC @ 40
MCD 99 s 32
ABC 10.400 s 39.87
9,900 MCD @ 32
10,400 ABC @ 39.87
JMK.SLD 8 s 102.50
Nasdaq Issues:
Global Market
Capital Market
STC 6 s 86.50 . 4 s .57
800 JMK @ 102.50
600 STC @ 86.50 and
Out of Sequence
400 @ 86.57
DEW 15 S 357.37
Nasdaq Market Center

Execution System
Others: pr, rt, wt
Non-Nasdaq Services:
Pink Sheets
Electronic (formerly printed)
Often low priced, thinly traded
No SEC reporting
OTCBB
Electronic, real-time
Requires SEC reporting
150 DEW @ 357.37

49
Nasdaq Levels
50
Other Secondary Market Terms
ABCO
Bid
Asked
Size
Inside:
22.75
23.00
10 x 30
MM1
22.50
23.12
50 x 50
MM2
22.75
23.25
10 x 40
MM3
22.50
23.00
20 x 30
Third Market
Listed securities traded OTC
Facilitated by Consolidated Quotation System (CQS)
Trades included in NYSE volume totals
Level 1:
Inside market only (Highest bid Lowest asked/ offer)
without identifying the market maker
Fourth Market
Transactions between institutions
Most true fourth market trades are internal crosses set
up by money managers
Level II:
Quotes of all market makers that deal in the security
Level III: (same information as Level II)
Allows market makers the ability to change their quote
51
52
13
Electronic Communication Network (ECN)

An electronic system, operated by a B/D or registered as an
exchange, that executes/displays orders from buyers and
sellers
When order is received, the system is instantaneously
scanned to determine if there is a matching order; if so, the
order is executed (if not, it will be displayed)
Types of Orders
May allow for trading outside of normal market hours

Risks include greater spreads, less liquidity, and increased
volatility
53
Types of Orders
Used to limit a loss or to protect a gain on a stock position
Customer wants to buy or sell

Order is immediately executed at the best price available
Customer specifies the security and size of the order only
Execution is certain
Investors would rather not have execution
Long Stock Position
Limit order :
Customer only wants to buy or sell at a set price or better
Order is only executed if the price can be met
Buy limits -- at set price or lower
Sell limits -- at set price or higher
Customer specifies the security, size, and price
Execution is uncertain
54
Stop Orders
Market order :

Hope:
Hope:
Fear:
Fear:
Need: Sell Stop below market
55
Short Stock Position
Need: Buy Stop above market
56
14
Stop Orders
Example: Sell Stop / Sell Stop Limit

An investor owns 1,000 shares of DEF bought at $82
Both stop and stop limit orders are triggered (activated)

by market trading at, or through, the stop price
Todays transactions:
82.....81.50.....81.12.....80.50
Sell Stop will activate at stop price or lower
Afraid of a large loss, she enters an order: Sell 1,000 DEF at 75 stop
Buy Stop will activate at stop price or higher
Later transactions: 76.12

Trigger Price? 75.00
Once activated:
Stop orders become:
market orders
(immediate execution)
Stop-limit orders become:
57
Example: Buy Stop / Buy Stop Limit
94.75
95.12
95.25
75.62
75.00
74.37
Execution Price?
58
95.50
Execution Price? 95.12
94.75
95.10
95.12
Buy Stop or
Buy Stop Limit
Sell Limit
95.25
75.00
75.00
Mkt.
If placed as a stop-limit: Buy 1,000 ABC at 95 stop-limit

74.87
Buy Limit
Sell Stop
Sell Stop Limit
Buy 1,000 ABC at 95 stop

95.10
Execution Price? 74.37
Specialist will reduce all orders that have been entered

below the market by enough to cover the full dividend
92.....92.12.....92.50.....92.87
74.37
Orders Reduced on Ex-Dividend
Three weeks ago, Homer sold short 1,000 shares of ABC at $105
In order to protect some profits,
he enters the following order:
75.00
If placed as a stop-limit: Sell 1,000 DEF at 75 stop-limit

limit orders
(uncertain execution)
Todays transactions:
75.62
95.50
Execution Price? No execution, Homer

has missed the
market

Mkt. On Ex
Buy Limit
59
Sell Stop or
Sell Stop Limit
60
15
FINRA Rules for Opening Cash Accounts

Know Your Customer
Each member shall maintain the following information
(required):
Customers Name and Residence
- Numbered accounts are acceptable
- Cannot open with P.O. Box only
Whether customer is of legal age
Customers and
Their Accounts
Signature of introducing registered representative (RR)

Signature of the principal who accepts the account (on the
day account is opened)
- Client signature not required
61
Opening Accounts
62
Customer Identification Program

The USA Patriot ACT requires each broker/dealer to establish a
written Customer Identification Program (CIP) to verify the
identity of each customer who opens an account within a
reasonable period of time after the account is opened
Each member shall also make a reasonable effort to

obtain the following customer information:
Tax I.D. / Social Security Number
Occupation and name / address of employer
Requirements of a broker/dealers CIP
Whether associated with another broker-dealer

Information to be used when making recommendations
Income
Net Worth
Risk Tolerance
Objectives
Verify the identity of any person seeking to open an account

Maintain records of the information used to verify the
customers identity
Check name against a list maintained by the Treasury
Department Office of Foreign Asset Control (OFAC list)
Suspected terrorists or criminals
If clients name appears on the list, all transactions must

be blocked and law enforcement notified
63
64
16
Customer Identification Program
USA PATRIOT Act

Designed to deter, detect, and punish terrorists in the U.S.
and abroad
What type of identifying information is required of customers?

Name
Date of birth
Legal address (residence or business) and an
Identification Number such as:
For a U.S. person:

Taxpayer ID or
Social Security
Number
Required Reports:
Filed for all currency transactions by single customer
Currency
during one business day exceeding $10,000
Transaction Report
- Filed also for structured transactions
For a non-U.S. person:

One or more of the following:
Taxpayer ID
Passport Number
Alien ID Card Number
Any other government-issued document
establishing residence and identity
Currency/Monetary Filed whenever anyone physically transports or

Instrument Report receives cash (or equivalents) exceeding $10,000
into, or out of, the U.S
(CMIR)
Filed whenever a transaction (or group of
Suspicious Activity
transactions) equals or exceeds $5,000 and the firm
Report (SAR)
is suspicious
65
SEC Regulation SP (Privacy Policy)
66
Types of Accounts
Requires all broker-dealers to adopt policies and procedures

designed to protect the privacy of the confidential information
they collect from their clients
Joint Account
New account information obtained for each owner
Any owner may initiate activity
Checks made payable to all parties
Clients provided a description of these policies (privacy notice)
Corporate
The privacy notice must include:

The type of personal information the firm collects
Categories of affiliated and non-affiliated third parties
to whom the information may be disclosed
The fact that clients may opt out and refuse to allow
disclosure
Always examine Corporate Resolution

If options or margin account, also Charter
Fiduciary
Person charged with responsibility of investing money
wisely or safeguarding securities for a beneficiary
Fiduciaries must provide documentation of their authority
e.g. Trustees, executors or administrators
67
68
17
Types of Accounts
Types of Accounts
Custodial
Discretionary
Opened under Uniform Gifts to Minors Act (UGMA) or a

newer version, Uniform Transfers to Minors Act (UTMA)
Requires written Power of Attorney from client and written

acceptance by a principal
May be full discretion, allowing removal of assets, or
Limited discretion
One minor
Legal owner
Responsible for taxes; minors Social Security Number
Role of the Principal

Approve all transactions promptly
Review the account frequently
One custodian
Has authority to initiate activity
Held to Prudent (Man) Investor Rule
Power of attorney is not required for Not Held Orders

Customer indicates a desire to buy or sell, a specific
security and a certain quantity
Time and price may be left to the RRs discretion
Gifts
Irrevocable
Cash or securities (fully paid, no margin)
No limit on number of donors nor value of gifts
Sell
Sell 20,000 shares of IBM whenever you think its best
69
Types of Accounts
70
Account Rules
Telephone Consumer Protection Act Cold Calling Rules govern
rights of those receiving phone solicitations
Acceptable call time frame: 8:00 am to 9:00 pm local
Do Not Call list maintained for 5 years
Excludes customers with existing business relationship:
One who has made any unsolicited inquiry or
Engaged in a transaction with the firm
Wrap Account
Advisory and custodial fees, along with commissions, are
wrapped into one comprehensive fee
Non-Managed Fee-Based Account

Firms DO NOT provide clients with advisory service
Penny Stock Regulations - apply to solicited sales of unlisted, non-Nasdaq
equities priced below $5 per share
Firms have special suitability, approval, and disclosure procedures
Established customers are exempt from these requirements:
With the firm for more than a year, or
Made three separate purchases of different penny stocks
Rather than pay transaction-based commissions, clients are

charged a fixed fee and/or a percentage of the account value
71
72
18
Account Rules
Death of an Account Holder
Firms may hold customer correspondence:
Individual Account:
Cancel all open orders
Mark the account deceased
Await documents from administrator or executor
For 3 months if traveling abroad

For 2 months if traveling within the U.S.
Transfer on Death (TOD)

Used to automatically transfer securities to a named
beneficiary without going through probate
Account Statements
Must be sent by broker-dealers at least quarterly
However, if an account is active, statements are sent
monthly
Joint Account:
Joint Tenants with Rights of Survivorship
Common for spouses
One dies, ownership passes to survivor without probate
Tenancy-in-Common (TEN-COM)
Common for business partners
One dies, decedents portion to their estate
73
74
Securities Investors Protection Corporation

SIPC
Protects Separate Customers (not accounts) against B/D
bankruptcy
Non-profit; not a government agency
Funded through assessments on broker-dealers
Covered:
Cash & street name securities: $500,000
Will only cover cash up to: $100,000
If limits are exceeded, customer becomes a: General Creditor
Industry Rules
Securities specifically identified as belonging to a customer are

distributed to customer without limit
Not Covered by SIPC
Fraud (fidelity bond), futures contracts, commodities
75
76
19
Registration of Individuals
Industry Regulation
Registration Requirements
Continuing Education
File Form U-4 with CRD (Central Registration

Depository)
Statutory disqualification
Conviction of a securities-related misdemeanor or any
felony within the last 10 years
After 2 years of inactivity, individual must re-qualify
Regulatory Element:
Required after RRs 2 year anniversary and every
three years thereafter
Must be completed within 120 days of notice
Firm Element:
On-going training directed by the firm
Based on needs assessment
Termination:
Outside Activities
Form U-5 is filed within 30 days of termination

Copy given to individual
Employer must be notified of all outside business

interests (not hobbies)
77
FINRA Rules
Uniform
Practice
Code
Deals with member-to-member rules

-Such as membership requirements, preference
among members, dues and assessments, good
delivery, settlement and clearing
Conduct
Rules
Deals with member to customer rules

-Such as suitability, recommendations, the gift limit,
and the 5% policy
Code of
Procedure
Sets out procedures by which members are disciplined

for violating industry rules
78
Accounts for B/D Employees

Industry rules for accounts of member firm employees, their
spouses, and dependent children
The carrying firm must:
Notify the employer in writing
Send duplicate confirmations and statements if requested
Rules do not require pre-approval of trades by clients

employer
Code of
Deals with the settlement of monetary disputes
Arbitration through binding arbitration
79
80
20
Conduct Rules
Conduct Rules
Communication with the Public
Customer protection rules
Advertisements
Material used in the public media
Newspapers/magazines, radio, TV, web pages
Client suitability is a focus

Know your customer prior to recommendations
Sales Literature
Material made available to the public
Notices, circulars, research reports, group e-mail, passwordprotected web pages
No unethical behavior, such as:

Churning, making untrue statements, trading without
permission
Sharing in Client Profits and Losses
Correspondence
A written letter or electronic mail message
Distributed to existing retail customers and/or fewer than 25

prospective retail customers within any 30 calendar day period
Prohibited unless joint account is created, both customer and

firm must approve, and sharing is proportionate
Gift Limit - $100

Entertainment and business expenses may be excluded
Note: Both advertising and sales literature must be pre-approved

by a principal; correspondence is only subject to review
81
Conduct Rules
Conduct Rules
Quotations
FINRA Filing Requirements: (filed with one SRO, good for all)
Quotations are firm unless qualified (informational)
Advertisements (not sales literature) of a general nature

First year of advertising, 10 business days prior to use
Thereafter, need not be filed, but be available for spot check
Firms may be sanctioned for not executing based upon

a firm quote
Referred to as Backing away
Option advertising:
10 calendar days prior to use
Interpositioning
The insertion of a third party between customer and
best market
CMO advertising:
10 business days prior to use
Specifically prohibited when it is to customers

detriment
Mutual fund advertising and sales literature:

Within 10 business days of initial use
82
Prohibition does not apply if the customer receives a

better price due to interpositioning
83
84
21
Conduct Rules
Code of Procedure
Process used to discipline members who violate industry rules
5% Policy for Commissions and Mark-ups

A guideline, not a rule
A determination is made by a Hearing Panel which could

result in a fine, censure, suspension / revocation of
registration, barring from association but NOT prison
Applies to transactions effected on an agency or principal basis

On principal trades, mark-up is based upon current market
not dealers cost
Decisions can be appealed first to the National Adjudicatory

Council, then the SEC and finally Federal Court
Exemptions:
Municipals
New Issues and mutual fund shares
Securities sold under prospectus
If a fine exceeds $2,500, disciplinary action is

reported to CRD, which is available to the public
85
86
Code of Arbitration
System where monetary disputes are resolved by impartial panel
Decisions are in writing, are binding, and cannot be appealed
Not mandatory for harassment or discrimination claims
Six year statute of limitations
For disputes between members, Arbitration is mandatory

For disputes with public customers, Arbitration is voluntary
Pre-dispute arbitration agreements are allowed; do not limit awards
If accepted, a majority of arbitration panel will consist of those not
associated with securities industry
For disputes not exceeding $25,000, Simplified Arbitration is offered
No hearing held, document submission only
One single arbitrator
87
Session Three
Bonds
- Fundamentals
- Corporate Bonds
- U.S. Government Securities
88
22
Terminology
Bond Calculations
Bonds are a kind of fixed income investment
Interest payments and bond prices are stated as

percentages of par
Elements:
1% or 1 point for a bond =
Par Value
- Face Value or Principal
- $1,000
An
Maturity or Due Date

- Quoted by mm/dd/yy
- Date for return of principal and last interest payment
of a point for a bond =
When market interest rates change, the market price of a bond

changes in the opposite direction
Inverse relationship
Nominal Yield:
Example: At time of issue, ABC sets their coupon at the current

market rate and the bonds price is par
Current Yield:
Same as coupon; fixed
Annual Interest Current Market Price
Over time as interest rates change the bond will trade at a discount
or premium to par
At issuance:
7%
7%
$1,000 par
Later:
9%
7%
At a discount
Still later:
5%
7%
At a premium
Yield-to-Maturity or Basis:
Market price of
ABC bond
90
Bond Yields
Discounts and Premiums
Coupon on
ABCs bond
$1.25
Ms. Jones owns a 5% bond, which means she

receives $50.00 per year in interest. She paid a
price of 92 1/2 for the bond, or $925.00
89
Market
Rate
$10.00
For example:
Interest Rate
- Coupon rate, nominal yield
- Percentage of par
- Stated annually, paid semi-annually
1/
8
Investors total overall yield

Measured to bonds maturity
When quoting yield, 1% represents 100 basis points
91
92
23
Current Yield Calculation
Yield Relationships
Annual Interest Current Market Price

YTM
Premium
Nominal Yield
Bond Price
Calculation
Current Yield
8%
$1,000
$80
$1,000
8%
$1,125
$90
$1,125
8%
$65
$812.50
8%
CY
Par
NY
CY
YTM
CY
9%
6 %
$812.50
93
Price versus Yield Example

Example 1
Y.T.M.:
Price:
Coupon:
7.75%
102
?
YTM
Discount
94
Multiple choices
1.
8.00%
2.
7.65%
3.
7.75%
Example 2
Current Yield:
Y.T.M:
Price:
$1,020
8.45%
8.25%
?
Multiple choices
1.
100
2.
103 7/8
3.
98 1/2
$1,038.75
?
?
8.00%
8.45%
7.75%
8.25%
95
96
24

Example 3
Coupon:
Price:
Y.T.M:
6%
951/2
?
Largest Price Fluctuation

When interest rates change which bonds have the largest
price change?
Multiple choices
1.
5.85%
2.
6.00%
3.
6.47%
4.
6.25%
?
6.47%
Maturity?
Longest or Shortest
Coupon rate?
Highest or
Duration?
Longest or Shortest
Lowest
6.28%
6%
$60
$955
Duration: The measure, expressed in years, of a fixed-income

securitys price sensitivity to changes in interest rates. The
greater the duration, the greater percentage volatility.
= 6.28%
$955.00
97
Yield versus Maturity
98
Credit Ratings
Who pays for a bond to be rated?
Issuer
Whats the concern?
Risk of default
Inverted or Negative
Normal or Positive
Investment Grade
Yield
Speculative Grade
S & P / Fitch
Moodys
AAA
Aaa
AA
Aa
BBB
Baa
BB
Ba
+ or -
1, 2, 3
Maturity
Further differentiation:
99
100
25
Retirement of Debt
Call Feature
Put Features
Factors which make callable bonds marketable to investors:
Allows bondholder to redeem (put) bond back to issuer

on a date prior to stated maturity
Higher yield lower price

Call protection length of time during which a security
cannot be redeemed by issuer
Open Market Purchases
Call premium amount over par the issuer must pay an

investor for redeeming the security early
Bonds likely trading at a discount

Issuer has available funds with no better use
From where does the money come?
Call Features
Sinking fund
Refunding issue
Sale of a new bond to redeem an old bond
Done when interest rates have declined
Allows issuer to redeem bonds prior to maturity
101
Pre-refunding
Yield-to-Call
Hypothetical:
An issuer floated 20-year 10% bonds five years ago. The
bonds had seven years of call protection. Today, rates are
at 6%, but are expected to rise. What can the issuer do?
- Pre-refund the outstanding 10% bonds by selling 6% bonds
The investors yield if the bond is called at par

YTC
CY
Par
NY
CY
YTM
YTC
CY
YTM
Disc.
Advantages to issuer:
Captures lower interest rate
Pre-refunded bond no longer issuers liability
Defeasance eliminate restrictive covenants
YTC
For Callable Bonds always quote the lower of yield-to-call

or yield-to-maturity
Bonds selling at a discount use: Yield-to-maturity
Bonds selling at a premium use: Yield-to-call
Pre-refunded bonds always use Yield-to-call
Pre-refunded bonds continue to trade until the call date

Considered AAA rated
YTM
Prem.
Escrow account established for new bond proceeds

Managed by trustee
- Invested in U.S. Treasuries
Amount deposited is sufficient to pay debt service
102
103
104
26
Corporate Bond Overview

Securities Act of 1933
Trust Indenture Act of 1939 (applies to corp. debt only)
Trustee
Appointed by issuer to act in bondholders best
interest
Indenture- written contract which contains covenants
(promises)
Open-End - allows new bonds to be issued using
same collateral at same priority, or
Closed-End
Corporate Bonds
Interest received is fully taxable
105
Two Types of Corporate Bonds
106
Convertible Debentures
Allows investor to get stock growth with safety of principal
Secured
Conversion price a premium at issue

Lower coupon rate
Bond price is influenced by stock price
Backed by physical assets or collateral owned by issuer

Mortgage Bond
- Real property; land or buildings
Equipment Trust Bond
- Heavy machinery or rolling stock
Collateral Trust Bond
- Securities of other companies
Bond holders may convert the par value of the bond into
common shares at a given conversion price
What is the conversion ratio?
Unsecured (Debentures)
XYZ Corporation 6% Debenture

Market Price $1,100 - Convertible at $20
Backed by issuers full faith and credit
Par
$1,000
107
Conversion Price
$20
= 50 shares
108
27
Conversion Parity
Conversion Parity
Parity means equivalent market values
Price of
Convertible Bond
Aggregate Market
Value of Common Stock
Example 2)
Given: Bond convertible at $25 and the bond is priced
at 120
Find: Parity price of stock
First find conversion ratio:
$1,000 $25 = 40 shares
Knowing the value of all shares, now find the value of
each share:
Example 1)
Given: Bond is convertible at $50 and the market price of the
common stock is $60 per share
Find: Parity price of bond
First find conversion ratio:
$1,000 $50 = 20 shares
Then find the value of those shares:
20 shares x $60 = $1,200
Bond Value Total Shares

$1,200
40 shares
$30
An arbitrage opportunity exists if the stock

is selling at a premium to parity
An arbitrage opportunity exists if the bond

is available at a discount to parity
109
Anti-Dilutive Feature
110
Anti-Dilutive Feature - Example
If an issuer of convertible securities ever splits their stock or

issues a stock dividend, a covenant in the indenture would
require the issuer to adjust the terms of the convertibles.
Stock Dividend
A corporation has issued debentures convertible at $50. The
stock pays a 10% stock dividend. According to the non-dilutive
feature of the bond indenture, the new conversion price would be:
Adjustment of Conversion Prices and Ratios

Stock Split
Conv. Price
Conv. Ratio
Price x Ratio
Original:
$100
10:1
$1,000
After 2:1 Split:
$50
20:1
$1,000
1.
$19.23
2.
$20.83
3.
$45.00
4.
$45.45
Start:
End:
Price
Ratio
PxR
$50
20
$1,000
22
$1,000
?
$45.45
(20 x 10% = Extra 2)
111
112
28
Income (Adjustment) Bond
Euro, Eurodollar, and Yankee Bonds

Eurodollars:
U.S. dollar denominated deposits in foreign banks
Generally, issued by corporations after reorganization
Eurodollar Bond:
Issuer promises principal at maturity

No promise of interest payment unless income is sufficient

Generally sold at deep discount
Trade flat (without accrued interest)
Bond issued outside the United States

Pays interest and principal in U.S. dollars
Exempt from SEC registration
May trade in the U.S. in the secondary market after 40 days
Yankee Bond:

113
Zero Coupon Bond
Constant Yield Method

Zero - 10% Yield
Original Issue - $148.64
116
20
18
16
115
14
Attractive for those planning for a specific investment goal (e.g.

college funding or retirement), but not for those who desire
current cash flow
564.47
10.53
12
Has no reinvestment risk
10
Capital Gain
Investors carrying value (cost basis) must be accreted yearly
Basis
Accreted Basis
Taxes paid on earnings reported but not received (phantom

interest)
Proceeds $575.00
$1,000.00
$900.00
$800.00
$700.00
$600.00
$500.00
$400.00
$300.00
$200.00
$100.00
$0.00
Issued at deep discount, but matures at face value (par)
Pays no periodic interest
114
Investor sells after the

14th year for $575.
20 Year
What is the investors
capital gain or loss?
Foreign bonds issued in the the United States

Pays interest and principal in U.S. dollars
Must be SEC registered
May trade in the U.S. market immediately
29
Accrued Interest
Accrued Interest - Example
Interest that is due on a bond since the last interest payment was made
Given: An XYZ corporate bond, $1,000 par value, 8% coupon,

has a due date of 5/15/18 and is sold on Monday, September 10
for regular way settlement
The buyer pays the seller the market price of the bond plus the accrued
interest
The calculation begins with the number of days since the last coupon:
Settles 9/13
5/15
1/1
Start counting at: last coupon date
11/15
12/31
Count up to: but not including settlement date

Days:
16
May
June
30
June
30
July
30
July
31
# of accrued days
Aug.
30
Aug.
31
360 or 365
Sept.
12
Sept.
10
Corporates, Municipals and

Government Agencies
U.S. Government
T-Notes and T-Bonds
30 days in month and

360 days in year
Actual days in month and

365 days in year
Calculation:
Annual
Interest $
Mos:
May
Days of
Accrued
Interest:
If T-Note/T-Bond:
17
Amount of
Accrued Interest:
$85 x
118
360
= $27.86
$85 x
119
365
= $27.71
Total: 118 days Total: 119 days

117
118
Overview of U.S. Treasuries

Characteristics:
No credit risk
Highly liquid
Exempt from:
Both state (Blue Sky) and federal (33 Act) registration
Trust Indenture Act of 1939
Federal Reserves Reg. T
U.S. Government Securities
Interest received:
119
Exempt from both:
State and Local Taxes
But subject to:
Federal Taxes
120
30
Two Types of Government Securities
U.S. Treasuries
T-Bills
T-Notes
Non-Marketable (Non-negotiable)
T-Bonds
MATURITIES
Series EE Savings Bonds
2 to 10 years
Up to 1 year
Can only be bought from and sold back to the U.S.

Government
No secondary market
No price fluctuation
Greater than 10 years
DENOMINATIONS
All in $100 multiples

FORM OF ISSUANCE
Book Entry
INTEREST
Marketable (Negotiable)
-A discount security
-Stated annually, paid semi-annually
-Trades without accrued int. -Accrued Interest: Actual / 365
HOW THEYRE INITIALLY SOLD
Treasuries
Weekly Auction
121
Bidding at the Auction
$100 million U.S. Government Bond Auction

Due 06/01/XX
Coupon 7.5%
Competitive Bids (large financial institutions)

Indicate both quantity and price
Bidder
Non-competitive Bids (the public)

Indicate quantity only
Bidder agrees to pay:
the lowest price (highest yield) of
the accepted competitive bids
Bid
Fill
Jerry and Others
$20 million NC
$20 million at 98
Big Bank
$40 million at 99
$40 million at 98
Foreign Country
$40 million at 98
$40 million at 98
Government Dealer $40 million at 97
Filled first
122
Auction Example
Two Types of Bids:
At periodic auction
No fill
Known as single price or Dutch auction
123
124
31
Pricing of Government Securities
Other Government Securities
T-Notes, T-Bonds and Agency Securities
T-Strips and Receipts
A percentage of par and fraction 1/32

Quotation
Rewritten
Decimal
87.15
87 15/32
87.46875%
$874.69
106.25
106 25/32
106.78125%
$1,067.81
Coupon payments and principal sold separately as zero

coupon securities (each discounted)
Dollar Price
T-Notes and T-Bonds can be stripped (not T-Bills)

Wide range of maturities to choose from when shopping
for a zero coupon
T-Bills:
Quoted on a discount yield basis, not dollar
In a T-bill dealers quotation, the bids higher yield represents
a lower price and the askeds lower yield a higher price
Bid
Asked
2.94
2.90
125
Other Government Securities
Securities issued by U.S. Government Agencies and Government

Sponsored Enterprises (GSEs)
- Created to reduce borrowing costs for certain sectors of the economy
Stated coupon
Principal is adjusted for inflation, based on the CPI
Principal adjustments are taxed as ordinary income in
the year the adjustments are made
Adjusted principal paid at maturity
Coupon
Payment
$1,000
4%
$40.00
Mortgage
Government National Mortgage Assoc. (GNMA)
Federal National Mortgage Assoc. (FNMA)
Federal Home Loan Mortgage Corp. (FHLMC)
Education Student Loan Marketing Assoc. (SLMA)
Farming / Agriculture Federal Farm Credit Bank (FFCB)
Characteristics
CPI increases by 1%
$1,010
4%
$40.40
126
Government Agencies and Enterprises
TIPS (Treasury Inflation Protected Securities)
Principal
127
Registration:

Quote:
32nds
Accrued Interest: 30 days in month / 360 days in year
Exempt
128
32
Collateralized Mortgage Obligations
GNMA, FNMA, FHLMC Pass-Throughs

Represents an interest in a pool of mortgages
CMOs
A mortgage-backed bond created by dividing mortgage
pools (GNMA, FNMA, FHLMC, not SLMA) into various
bond classes (tranches).
Helps to manage pre-payment risk
Interest is generally paid monthly (fully taxable), with
principal paid sequentially
AAA rated and issued in $1,000 denominations
Monthly payments represent interest and principal

Interest portion is fully taxable
Subject to pre-payment risk
GNMA pass-throughs are U.S. Government

guaranteed, while FNMA and FHLMC are not
Advertising:
Offer educational material
No comparison to any other investment
Filed with FINRA 10 business days prior to use
129
CMOs Sequential Pay

P
PERIOD
ONE
130
Other CMO Tranches

I
Planned Amortization Class or PAC Tranche

Provides the most predictable cash flow and maturity
Tranche A
Tranche B
Tranche C
Support or Companion Tranche

Provides the least predictable cash flow and maturity
PERIOD
TWO
Z-Tranche
Last tranche to receive payments
Tranche B
Tranche C
P
PERIOD
THREE
Tranche C
131
132
33
Money Market Instruments
Long-Term CDs
Characteristics:
Short-term debt instruments (one year or less to maturity)
Safety of principal and liquidity
Provide investors with a stable alternative pending an
investment decision
Long-Term CDs or Brokered CDs are not money market instruments

Maturities range from 2 to 20 years
May be callable
Principal Types:
FDIC insurance may not apply
T-Bills
Bankers Acceptances Facilitate foreign trade (import / export)
Commercial Paper Unsecured corporate debt
Negotiable Certificates of Deposit (CDs) Unsecured bank debt
($100,000 minimum)
Repurchase Agreements (Repos) A dealer selling securities to
another dealer with the agreement to repurchase
133
Investors may experience a loss of principal if sold prior to

maturity
May have limited liquidity
134
Municipal - Overview
Issuers:
States and their political subdivisions
Cities
Counties
School districts
Session Four
Public agencies and authorities

Territories and possessions
Puerto Rico, U.S.V.I, Guam, American Samoa
- Municipal Bonds
- Municipal Securities Rulemaking Board (MSRB)
135
136
34
Municipal Exemptions
Yield Calculations
Ms. Jones is earning 4.55% on a tax-free municipal and is in
the 35% tax bracket. What must a taxable bond yield to be
equivalent?
Tax-Free Yield
Taxable Equivalent
Yield Formula:
(100% - Tax Bracket %)
Exempt from:
Both state (Blue Sky) and federal (33 Act) registration
Trust Indenture Act of 1939
Federal Reserves Reg. T
4.55
Interest Exemption:
4.55
Interest received is exempt from Federal tax

But may be subject to State and Local tax
(100% - 35%)
Note: Capital gains are taxable
Net Yield Formula:
Taxable Yield x (100% - Tax Bracket %)
7.5 x (100% - 35%)

137
REVENUE
and
Issuers full
faith and credit
(user fees)
of a specific project
State: - Sales
- Income
Local: - Ad valorem
(property)
4.88%
138
Two Types of Municipals
Revenue
TAXES
= 7.5 x 65%
Two Types of Municipals

General Obligation
7.0%
65%
Ann Investor purchased a 7.5% corporate bond and is in the

35% tax bracket. What amount will Ann be able to keep after
taxes have been paid?
Territories and Possessions

Interest is triple tax exempt
Source for
Payment of
Debt Service:
- Toll roads
- Bridges
- Stadiums
- Airports
General Obligation
Revenue
Risk?
Less
More
Yield?
Lower
Higher
Voter approval?
Yes
No, feasibility study
Subject to debt
limitations?
Yes
No
Self-supporting debt
139
140
35
Analyzing Municipal Bonds
Types of Revenue Bonds
G.O. Bond analysis is based upon the municipalitys tax

revenues and liabilities outstanding
Factors analyzed:
Property values
Current debt, including overlapping* (coterminous) debt
Tax delinquencies
Unfunded pension liabilities
Per capita income
Population growth
* Overlapping debt: situation where multiple authorities in a given
geographic area have the ability to tax the same residents
Revenue Bond analysis will examine revenue, operating

costs and competition from similar projects
141
Types of Revenue Bonds

Type:
Source of Debt Service:
Moral Obligation
If project revenue is insufficient, state

legislature is morally, but not, legally
obligated for shortfall
Industrial
Development
Revenue (IDR)
Rent
Transportation
Tolls, user fees
Special Tax
Excise taxes on purchases such as

gasoline, tobacco, and liquor
Special
Assessment
Assessments on the benefited properties;

used for sidewalks, sewers, etc.
142
Maintenance Pledge to maintain project in good

and Operation: working order and to contribute to a fund
for that purpose
Insurance: Pledge to carry insurance on the property
Lease agreements (payments) with a

corporate user of the facility
The credit rating is only as good as
Catastrophe Call: Allows issuer the ability to call a bond due

to the destruction of the revenue source
backing the bond
the corporation
May be subject to the AMT
Housing
Rate: Pledge to maintain user fees at a level

sufficient to meet debt service and other
obligations
Project Revenue
Tax Dollars (G.O.)
Source of Debt Service:
Covenants from Issuer (Revenue)
Two sources:
Double Barreled
Type:
143
144
36
Covenants from Issuer (Revenue)
Net versus Gross Revenue

Net Revenue Pledge Bond
From: Gross Revenue
First comes: Maintenance and Operating
Leaving: Net Revenue
From which we pay: Debt Service
Additional Issue: Open versus closed-end indenture
Non- Pledge not to grant special rates to any one

Discrimination: person or group
Gross Revenue Pledge Bond

From: Gross Revenue
Flow (Allocation) Establishes the priority for payment of debt

of Funds: service
Will debt service be paid by:
Net Revenue (always assumed), or
Gross Revenue
First comes: Debt Service

From whats left we pay: Maintenance and Operating
Debt Service Coverage Ratio is calculated by taking the amount available
for debt service and dividing by the amount needed for debt service
145
Municipal Notes
146
Ratings for Municipal Notes
Tax-Free Anticipation Notes
S&P
Moodys
Short-term, interim financing
SP-1
MIG 1
Get a project started
SP-2
MIG 2
Help in managing cash flows
SP-3
MIG 3
Tax Anticipation Notes (TAN)
MIG 4
Revenue Anticipation Notes (RAN)
MIG = Moodys
Investment
Grade
Bond Anticipation Notes (BAN)

Grant Anticipation Notes (GAN)
147
148
37
Other Types of Securities
Municipal Documents
Official Statement
Variable Rate Demand Obligation (VRDO):

Debt security offering a variable rate of interest that is adjusted
at specified intervals (such as daily, weekly, or monthly)
Holders can redeem for par plus accrued interest at any time
that rates are reset
Auction Rate Securities:
Legal Opinion
Long-term bonds (municipal or corporate) with a variable

interest rate that is periodically set through a Dutch Auction
The auction sets the lowest interest rate at which all the
securities being offered for sale will clear the market
(net clearing rate)
Interest rate reset periods range from 7, 28, or 35 days
Contains most detailed disclosures regarding:

Issuer
Purpose
Preparation is NOT required, since the MSRB has no
control over issuers
If prepared, MSRB requires B/Ds to distribute it
Written by the Bond Counsel prior to sale

The counsel renders opinions as to:
Issuers legal, valid and enforceable obligation
Tax exempt status of the issue
Unqualified opinion is better than a qualified opinion
149
Municipal Documents
150
Selecting an Underwriter
Indenture (a.k.a. Bond Resolution)
With a Negotiated Sale

Issuer appoints their underwriter
A contract which addresses the legal protections

afforded the bondholders and terms of the issue, such
as:
Both issuer and underwriter negotiate terms of the deal

Usually used for Revenue Bonds
Coupons
Maturity
With a Competitive Sale
Call provisions
Issuer advertises bonds by publishing a Notice of Sale

in the Bond Buyer
Issuer is inviting underwriters to submit sealed bids
Usually used for General Obligation Bonds
Covenants
151
152
38
Notice of Sale Contents
Notice of Sale Contents

Call Provisions
(if any)
Bidding
Date, time and place to return bids
Procedures:
Dated Date:
Company guarantees payment of principal and

Bond Insurance interest if issuer defaults
(if any): FGIC, MBIA, or AMBAC
Improves credit rating of the issue
For a new issue, date on which interest begins

to accrue
Maturity Structure: Term:

Entire issue matures on one date
Mandatory sinking funds are common
Quoted on a dollar basis (% of par)
Serial:
Issue has series of maturity dates
Provides issuer with level debt service
Quoted on a yield basis
Legal Opinion: Identifies the Bond Counsel providing the

opinion
Good Faith Deposit: Must accompany bid
Right of Rejection: Issuers ability to reject any or all bids
153
Syndicate Practice
Preparing the Official Bid Form
Manager invites other B/Ds to participate and share

liability
Sends prospective firms a Syndicate Letter to provide
information about the issue (also referred to as
Agreement Among Underwriters):
Figure re-offering scale

Determine the price to be paid to issuer
The bid is summarized with a single number based
upon interest cost
Net Interest Cost (NIC)
or
True Interest Cost (TIC) -Canadian method
- Takes into account time value of money
- Size and type of offering

- Percentage required to participate
- Priority of orders
Winning syndicate bid (lowest overall cost to issuer)

takes bonds as a firm commitment
- Type of syndicate
154
Syndicate Practice
Formation of Syndicate
155
156
39
Priority of Orders
Priority of Orders
Contingent order, taken before the bonds

have been priced
Example: $62 million offering with the following orders on the

managers desk
Group Net
Benefits the entire syndicate by

percentage of liability
Pre-Sale:
$32 million
Member:
$20 million
3)
Designated
Profit designated to two or more

members, but not all
Group Net:
$20 million
Second filled, all $20 million
4)
Member
Profit to only one member
Designated:
$30 million
Third filled, only $10 million
1)
Pre-Sale
2)
First filled, all $32 million
How many of the designated orders will be filled? $10 million

With justification, manager may change priority
157
Syndicate Liability for Unsold Bonds
158
Syndicate Liability for Unsold Bonds
Eastern Account
Undivided Syndicate
A three-member
syndicate
Each member takes some of the unsold bonds (same

percentage as original allocation)
C
25%
Reallocation of: $
Divided Syndicate
Members only responsible for their individual allocation
B
25%
$100,000,000 Issue
Western Account
A
50%
159
$20 million
If Western Style If Eastern Style
Member
Sales
$50 million
$0
$10 million
$ 5 million
$20 million
$5 million
$25 million
$80 million
$0
$5 million
160
40
Components of the Spread
Components of the Spread

Total Takedown 3/4
The manager of an underwriting syndicate receives 1/4 point per

bond. The syndicate members compensation is 3/4 point for each
bond they sell, and a selling groups concession is 1/2 point for each
bond they sell.
(Hint: the total spread for the example is 1%)
Mgr. Fee
1/ or
4
Additional Takedown
$2.50
Example:
Additional
Takedown
1/
4
1/ or
4
or $2.50
Administration
$2.50
1/
2
Member sells
Selling Group
sells
Manager
$100.00
$25.00
$25.00
Member
$75.00
$25.00
Sell. Group
$50.00
or $5.00
Selling
161
Municipal Information
Statistics
Visible Supply
Total par value of both negotiated and competitive
issues expected to reach the market within next 30 days
Compiled daily
Bond Buyer
- 20 G.O.s with
20 year maturities
Placement Ratio
Par value sold (placed) versus total par value that was
available for sale
Compiled weekly
- Average rating AA or Aa2

11 Bond:
- 11 of the above 20
- Average rating AA+ or Aa1
25 Revenue: - 25 Revenues with 30 year maturities
No. New
Accounts
Total Amt. New

Accts. ($000s)
Sales from New

Accts. ($000s)
Placement
Ratio (%)
6/15
20
1,729,781
1,588,601
91.8
6/8
17
476,595
432,585
90.8
6/1
23
952,278
843,508
88.6
2005
- Average rating A+ or A1
162
Bond Buyer Information
Indexes:
20 Bond:
$5.00
Manager sells
Concession
Risk
For the Primary Market:
Concession
1/ or
2
or $2.50
A customer buys $10,000 worth of bonds, how is

the spread distributed?
Total Takedown 3/4 or $7.50

Managers
Fee
1/
4
163
164
41
MSRB Overview
Municipal Securities Rulemaking Board

(MSRB)
The MSRB formulates and interprets rules

MSRB rules regulate:
Broker-dealers and salespersons engaged in
municipal business, and
Municipal advertising
MSRB rules do not apply to municipal issuers
Since the MSRB has no enforcement power, rules are
enforced by a separate regulatory agency
For broker-dealers:
and Municipal Taxation

- FINRA or
- SEC
165
Municipal Securities Representative
166
Role of the Principal

Must promptly review and approve in writing:
All new accounts
All municipal transactions
All municipal correspondence
Summaries / abstracts of an Official Statement
All complaints
Conduct day-to-day firm business

Must pass the Series 7 or 52 during the first 180
calendar days after joining the firm
Minimum 90-day apprenticeship period
As an apprentice, individuals may not deal with
customers (only other municipal professionals) or be
compensated by commission (only salary)
- Comptroller of the Currency

- FRB or
- FDIC
Municipal Securities Principal
Requirements:
For bank dealers:
Regarding complaints:
Must be in writing and signed by the customer
Investor Brochure delivered to customer
Resolution and complaints maintained for six years
167
168
42
Financial Advisory Relationship
Control Relationship
Agreement between a broker-dealer and an issuer to provide

financial advice for a fee. Requirements are in place if the
financial advisor now wishes to underwrite a bond issue for
that issuer.
For a Competitive Sale:
Obtain issuers written permission
A broker-dealer employs (controls) a person who has

influence as to an issuers debt service
If the broker-dealer wishes to trade that issuers bonds for or
with a customer the broker-dealer must:
Disclose relationship, at least orally, before the trade
For a Negotiated Sale:

Terminate the relationship
Obtain issuers written permission
Disclose to issuer all anticipated compensation
Disclose previous relationship to customers
Disclose relationship in writing at or prior to settlement

And if for a discretionary account, obtain the customers
specific, written permission
169
Political Contributions
170
Municipal Discounts and Premiums
Contributions made by municipal finance professionals

(MFP) to candidates or a PAC could potentially aid in
attaining business, therefore a conflict exists
Original Issue Discount (O.I.D.)

Basis must be accreted * at a rate which will bring basis
to par at maturity
Held to maturity produces: No gain or loss
Sale prior to maturity could produce: Capital gain or loss
using adjusted basis
A violation would occur if:

A municipal securities professional makes a political
contribution in excess of $250 (per election) to a
candidate for whom they may vote, or
Makes any contribution to a candidate for whom they
may not vote
Secondary Market Discount

When the bond is sold or redeemed, the accreted
market discount is taxed as: Ordinary income
If a violation occurs, there is a two year ban on business

with the issuer (no negotiated deals, however this does
not include competitive)
171
172
43
Municipal Discounts and Premiums
Example 1 of 3
An investor purchased a municipal bond at a discount. If the
investor holds the bond to maturity, any gain will be
considered:
Premiums
Basis must be amortized * at a rate which will bring
basis to par at maturity
Held to maturity produces: No gain or loss
Sale prior to maturity could produce: Capital gain or loss
using adjusted basis
I.
II.
III.
IV.
1)
2)
3)
4)
* IRS requires the constant yield method for accretion and/or

amortization. However, not calculated for test. Test will only ask for
straight-line.
Tax-free interest if the bond is an OID

A capital gain if the bond is an OID
Ordinary income if the bond is not an OID
Tax-free income if the bond is not an OID
173
I and III only

I and IV only
II and III only
II and IV only
Example 2 of 3
Example 3 of 3
A municipal bond that was issued at par is purchased in

the secondary market at a price of 90. What would be
the tax consequence if the bond was held to maturity?
An investor purchases a $100m face value municipal

bond with a 5-year maturity at 105. After two years, the
bond is sold at 95. For tax purposes, the investor has a:
1)
2)
3)
4)
1)
2)
3)
4)
$100 capital gain

$100 capital loss
$100 tax-free interest
$100 ordinary income
174
175
$ 2,000 loss
$ 4,000 loss
$ 8,000 loss
$10,000 loss
176
44
Options - Overview
A contract between two parties
The Owner
Buyer, Holder, Long
Session Five
Options
Pays the Premium

(creates debit)
- Fundamentals of Options
- Basic Options
- Straddles and Spreads
The Writer
Seller, Short
Receives the Premium
(creates credit)
Acquires a right / control
177
Assumes an obligation
Two Types of Contracts
178
Standardized Elements
IBM Feb 90 Call at 3
The Buyers
Right
CALL
To Buy Stock
The Sellers
Obligation
To Sell Stock
An option to?
Buy
What stock?
IBM
How many shares?
100 shares
At what price?
$90 per share
Aggregate contract price? $9,000
PUT
To Sell Stock
To Buy Stock
179
Good til when?
Saturday following third Friday in

February
Premium?
$3.00 per share
Aggregate premium?
$300
180
45
In-the-Money
In, At, or Out-of-the-Money
The relationship between the market price of the

underlying security and the option strike price
Option and Premium
Market Price
In, At, or
Out-of-the-Money
Calls are in-the-money when the market is

UP above the strike price
STC Jun 35 Call at 3
36
IN
Puts are in-the-money when the market is

DOWN below the strike price
ELG Apr 60 Put at 7
54
IN
CJM Jul 35 Put at 1.50
35
AT
XYZ Aug 110 Call at 2
109
OUT
Call UP
and
Put DOWN
181
In-the-Money versus Out-of-the-Money
182
The Options Premium
Buyers want options to be: In-the-Money

Sellers want options to be: Out-of-the-Money or At-the-Money
Premium
Intrinsic Value
Time Value
Case 1:
Susan owns 1 XYZ Jun 90 Call for which she paid a premium of 3
and XYZ is trading at $112 a share
A contract has intrinsic value if it is in-the-money

Its intrinsic value equals its in-the-money amount
It has zero intrinsic value if it is out-of-the-money or atthe-money
- Consider the option: In-the-Money

- Consider Susan:
Time Value is based upon:
Case 2:
Time left until expiration

More time = more time value
Market volatility
Increased market volatility causes premiums to rise
Jerry wrote the XYZ Jun 90 Call for which he received a premium
of 3 and XYZ is still trading at $112 a share
- Consider the option:
- Consider Jerry:
Still In-the-Money
183
184
46
The Options Premium

Option and Premium
Market In, At, or Out- Intrinsic

Price of-the-Money
Value
The Life of an Option

Time
Value
STC Jun 35 Call at 3
36
IN
ELG Apr 60 Put at 7
54
IN
CJM Jul 35 Put at 1.50
35
AT
1.50
XYZ Aug 110 Call at 2
109
OUT
1) Expire worthless
- Standard option life is 9 months
- LEAPS (Long-term equity options) have lives up to 39 months
2) Exercised at owners discretion:
- American Style:
Can be exercised at any time up until expiration
- European Style:
Can only be exercised during a specific period
3) Close-out, Trade, Liquidate, or Offset

- Investor executes an opposite transaction on the same series
of option
185
Closing a Position
Exercise versus Close-out
Marking the option order ticket for a close-out:

Opening Transaction:
Closing Transaction?
Opening Purchase
Closing Sale
Opening Sale
An investor is long 1 ABC Dec 65 Call at 3. Later ABC

increases to 72, with the Dec 65 Calls trading at 8. What
could the investor do?
If exercised and stock sold:
Debit
Cash Out
Closing Purchase
Credit
Cash In
300
Profit or loss is determined by the difference between price
paid for option and price received from sale
187
If closed-out at its then premium:

Debit
Cash Out
Credit
Cash In
300
6,500
7,200
6,800
7,200
+ 400
186
800
300
800
+ 500
188
47
Basic Options: Long & Short Calls
Basic Options Long Call
CALLS
Buyer, Owner, Long
Seller, Writer, Short
Rights
Right to buy stock at

the strike price
None
Obligations
None
Obligation to sell stock

at the strike price
Strategy
Bullish
Bearish
Breakeven
Strike Price
+ Premium
Strike Price
+ Premium
Maximum Gain
Unlimited
Premium
Maximum Loss
Premium
Unlimited
An investor buys 1 XYZ Feb 45 Call at 3
189
Rights or
Obligations:
Right to Buy at 45
Strategy:
Bullish
Breakeven:
45 + 3 = 48
Max. Gain:
Unlimited
Max. Loss:
$300 premium
$
48 B/E
45
190
Basic Options Short Call
An investor buys 1 XYZ Feb 45 Call at 3
Debit
Cash Out
52
+4
Long Call with T Account
Later when XYZ is at $52 the

investor exercises and immediately
disposes of the stock position.
Result?
Later when XYZ is at $52 the

investor exercises and immediately
disposes of the stock position.
Result?
An investor sells 1 XYZ Feb 45 Call at 2.50

Rights or
Obligation to sell at 45
Obligations:
Credit
Cash In
Strategy:
300
Later when XYZ is at $49, the

option is exercised. Result?
Bearish
Breakeven: 45 + 2.50 = 47.50
4,500
5,200
4,800
5,200
Max. Gain:
$250 premium
- 1.50
49
$
Max. Loss:
Unlimited
47.50 B/E
45
+400
191
192
48
Short Call with T Account
Basic Options: Long & Short Puts

PUTS
Buyer, Owner, Long
An investor sells 1 XYZ Feb 45 Call at 2.50
Debit
Cash Out
Later when XYZ is at $49, the

option is exercised. Result?
Credit
Cash In
250
4,900
4,500
4,900
4,750
-150
Rights
None
Obligations
None
Obligation to buy stock

at the strike price
Strategy
Bearish
Bullish
Breakeven
Strike Price
Premium
Strike Price
Premium
Maximum Gain
(Strike Price
Premium
Premium) x 100 sh
Maximum Loss
Premium
(Strike Price
Premium) x 100 sh
194
Basic Options Long Put
Long Put with T Account
Dan is the holder of one ABC Apr 95 put

and he paid a premium of 3.50
Dan is the holder of one ABC Apr 95 put

and he paid a premium of 3.50
Rights or
Right to Sell at 95
Obligations:
Strategy:
193
Seller, Writer, Short
Right to sell stock at

the strike price
Bearish
Later when ABC is at $80 the

investor exercises the put option.
Result?
95
Breakeven: 95 3.50 = 91.50

Max. Gain:
($95 3.50) x 100 sh. = $9,150
Max. Loss:
$350 premium
Later when ABC is at $80 the

investor exercises the put option.
Result?
91.50 B/E
+ 11.50 $
80
Debit
Cash Out
Credit
Cash In
350
8,000
9,500
8,350
9,500
+1,150
195
196
49
Basic Options Short Put
Short Put with T Account
Lori wrote one DELL Nov 35 put for

which she received a premium of 4
Rights or
Obligation to Buy at 35
Obligations:
Strategy:
Bullish
Later when DELL falls to 25, the

put is exercised and Lori disposes
of the stock that was put to her.
Result?
Breakeven: 35 4 = 31
Max. Gain:
Max. Loss:
Lori wrote one DELL Nov 35 put for

which she received a premium of 4
$400 premium
($35 4) x 100 sh. = $3,100
35
Later when DELL falls to 25, the put

is exercised and Lori disposes of the
stock that was put to her. Result?
31 B/E
-6
25
197
3,500
2,500
3,500
2,900
Buy 1 XRX Jun 40 Call at 3

Buy 1 XRX Jun 40 Put at 4
Both options have the same underlying interest
Long Straddle or Combination:
Buy both; seeking Volatility
Short Straddle or Combination:
Sell both; expecting Stability
Same expiration months

and
Same strike prices
400
198
Long Straddle
Buying both a call and a put or

Selling both a call and a put
Straddle
Credit
Cash In
-600
Straddles and Combinations

Created by either:
Debit
Cash Out
Breakeven:
Combination
Different expiration months
and / or
Different strike prices
Combined premium of 7
47 and 33
Maximum Gain:
Unlimited
Maximum Loss:
$700 premium
Strategy:
Volatility
47
L
O
S
S
40
33
$
0
199
200
50
Short Straddle
Long Combination
Buy 1 DEF Aug 60 Put at 1
Buy 1 DEF Aug 65 Call at 2
Lynn sells 1 ABC Oct 45 Straddle at 3.50
Combined premium of 3
(Combined premium is $350)
Breakeven:
48.50 and 41.50
Maximum Gain:
$350 premium
Maximum Loss:
Unlimited
Strategy:
Stability
L
O
S
S
48.50
$
45
$
L
O
S
S
Breakeven:
68 and 57
Maximum Gain:
Unlimited
Maximum Loss:
$300, the premium
Strategy:
Volatility
$
68
65
L
O
S
S
60
57
$
41.50
0
0
201
Spreads
202
Types of Spreads
Positions which allow an investor to limit losses in

exchange for limiting the gains
Buy 1 ABC Jun 40 Call and

Sell 1 ABC Jun 50 Call
Price, Dollar, or Vertical Spread
Spreads are created with the purchase and sale of two

options of the same class and different series
Buy 1 STC Dec 40 Call and

Sell 1 STC Sep 40 Call
Class consists of the same underlying stock with the

same type of option
Time, Calendar, or Horizontal Spread
Series consists of options of the same class with same

expirations and strike prices
Buy 1 STC Sep 40 Put

Sell 1 STC Mar 30 Put and
Spreads may be bullish or bearish
Diagonal Spread
203
204
51
Vertical Spread
Vertical Spread
Buy 1 XYZ Feb 80 Call at 3

Sell 1 XYZ Feb 90 Call at 1
2
Sell 1 XYZ Feb 40 Put at 1

Buy 1 XYZ Feb 50 Put at 4
3
90
Net Premium: $200

Buyer or Seller: Buyer
Debit or Credit: Debit
Widen or Narrow: Widen
+ 8 $ GAIN
82
Breakeven: 80 + 2 = 82
Bull or Bear: Bull
Maximum Gain: $800
- 2 LOSS
80
Maximum Loss: $200 net premium

205
Vertical Spread
47
+ 7 $ GAIN
Breakeven: 50 - 3 = 47
Bull or Bear: Bear
Maximum Gain: $700
40
206
Working with Vertical Spreads

Identify the dominant leg the option with the larger premium
Sell 1 IBM Nov 95 Put at 8

Buy 1 IBM Nov 80 Put at 1
7
For Calls this will be the lower strike price

For Puts this will be the higher strike price
The dominant leg determines whether one is a buyer or seller
and therefore ones strategy
95
Net Premium: $700
Breakeven: 95 - 7 = 88
Bull or Bear: Bull
Maximum Gain: $700 net premium
- 3 LOSS
Maximum Loss: $300 net premium
Buyer or Seller: Seller

Debit or Credit: Credit
Widen or Narrow: Narrow
50
Net Premium: $300

Buyer or Seller: Buyer
Debit or Credit: Debit
Widen or Narrow: Widen
+7
$ GAIN
For a buyer, this is the investors maximum loss

For a seller, this is the investors maximum gain
88
-8
Calculate the net premium the larger less the smaller
LOSS
Determine the breakeven point

80
Maximum Loss: $800

207
From the dominant legs strike price move an amount equal to

the net premium
Call-Up or Put-Down
208
52
Is it a Debit/Credit, Bull/Bear Spread?

Buy an XYZ Nov 90 Call
and Sell an XYZ Nov 80 Call Credit and Bearish
Session Six
Write an ABC Mar 35 Put

and Buy an ABC Mar 40 Put Debit and Bearish
Short a JMK Oct 75 Call

and Long JMK Dec 75 Call Debit
Generally not referred to as bull/bear

due to different expiration months
- Stock and Option Positions

- Non-Equity Options
- Option Account Rules and Taxation
- Taxation
More time value

209
Stock and Option Positions
210
Stock and Option Positions
Recognized when investor simultaneously has a stock

position (long or short) and a related option position
The option must be on the opposite side of the market from

the stock
If long the stock, the investor is: Bullish; option must be Bearish
Do not use Call-Up and Put-Down
If short the stock, the investor is: Bearish; option must be Bullish
For gains and losses follow the stock
If long stock and desiring:
To protect stock in a volatile market: Buy an option

To add income in a stable market:
Sell a covered option

If short stock and desiring:
211
Protection
Income
Buy Put
Sell Covered Call
Protection
Income
Buy Call
Sell Covered Put
212
53
Long Hedge or Protective Put
Short Hedge or Protective Call
-Investor is Bullish
-Downside risk hedge
Buy 100 shares IBM at 96 and

Buy 1 IBM Jun 90 Put for 3
-Investor is Bearish
-Upside risk hedge
Sell short 100 shares DEF at 92 and

Buy 1 DEF Dec 95 Call for 2
In order to breakeven, IBM

must be trading at:
Later, IBM falls to 71, the put is exercised

and the stock is sold. Result?
In order to breakeven, DEF

must be trading at:
Later, DEF rises to 102, the call is exercised

and the short is covered. Result?
1) 87
1) $2,800 loss 2) $900 loss 3) $2,800 gain
1) 87
1) $1,200 loss 2) $500 loss 3) $500 gain
2) 93
Debit
Cash Out
3) 99
Credit
Cash In
Debit
Cash Out
9,600
Credit
Cash In
9,600
?
9,900
300
300
9,000
9,900
9,000
2) 93
3) 90
Debit
Cash Out
Credit
Cash In
200
9,200
213
214
Provide the opportunity to speculate on, or hedge against, the

movement of the market rather than movement of a specific stock
In order to breakeven, XYZ

must be trading at:
Later, XYZ rises to 67, the call writer is

exercised against. Result?
1) 40
1) $2,700 gain 2) $500 loss 3) $500 gain
Debit
Cash Out
Credit
Cash In
Debit
Cash Out
Credit
Cash In
4,200
200
4,200
200
4,200
9,200
Index Options
-Conservative strategy
-Seeks income
4,000
?
9,200
9,700
Covered Call Writing
3) 44
200
500 loss
2) 47
Credit
Cash In
9,500
?
9,000
900 loss
Buy 100 shares XYZ at 42 and

Sell 1 XYZ Jun 45 Call for 2
Debit
Cash Out
Comparison
Equity
Index
Underlying
Interest
Stock
Value or average of an index
Multiplier
100 shares
$100
Exercise
Receive or deliver stock
Receive or deliver cash
3 Business Days
Next Business Day
Settlement
4,500
Broad-based Index: reflects performance of the entire market

E.g. S&P 100 (OEX) or S&P 500 (SPX)
4,700
Narrow-based Index: reflects performance of a particular sector
500 gain
E.g. Pharmaceuticals or Computer-Technology

215
216
54
World Currency Options
Provides the opportunity to speculate on, or hedge against,

the movement of exchange rates on foreign currencies
compared to the U.S. dollar
Currencies are selected by the PHLX
Interbank Market:
Market in which currency spot prices are established

Unlimited trading hours
Unregulated
Decentralized
Hours of Trading:
9:30 a.m. to 4:00 p.m.
Exercise Deadline:
5:30 p.m. ET on last trading day prior to

expiration
Expiration:
Saturday following the third Friday of the

expiration month
Exercise:
U.S. dollar-settled, European style exercise
Contract Size:
10,000 units, except Yen which is 1 million
Point Value:
1 point = $100 (e.g. 2.25 = $225)
Currency options trade on the Philadelphia Stock Exchange

When assessing foreign currency movement compared to the
U.S. dollar, it is an inverse relationship
There are no options on the U.S. dollar issued on U.S.
exchanges
217
218
World Currency Option Strategies
Contract specifications:
If a trader believes the Canadian dollar will decline in value

in the coming months, which position would not be
beneficial?
Option strikes and premiums are generally quoted in cents per

unit ($0.01)
Except Japanese yen which are in 100ths of cents ($0.0001)
For example: A speculator believes the euro will rally and

therefore buys 1 Euro June 160 call at 3.35 (10,000 unit
contract size)
The cost is $335, as each point equals $100
(3.35 equals $.0335 x 10,000 = $335)
a.
Debit put spread
b.
Uncovered call
c.
Uncovered put
d.
Credit call spread
If the euro is 166 cents ($1.66) at expiration, the call is worth $600
(A 160 call with the euro at 166 is 6 points in-the-money x $100)
219
220
55
World Currency Option Strategies
Interest Rate Options
Van de Lay Industries, a U.S. corporation, is importing

latex from Europe. It has agreed to a pay 2.5 million
euros on delivery in November.
Price-based
Remember, there is an inverse relationship between interest
rates and the price of debt securities
Which two of the following would increase the importers cost?

I.
Rising value for euro
II. Rising value for U.S. dollar
III. Falling value for euro
IV. Falling value for U.S. dollar
Exercise would cause the delivery of the underlying Treasury

(T-Bills, T-Notes or T-Bonds)
If the investor believes:
How may Van de Lay hedge their exchange rate risk?

Buy Euro Call options
221
Yield-Based Options
Yields will increase
- Buy yield calls or

- Sell yield puts
- Buy interest rate puts or

- Sell interest rate calls
I.
II.
III.
IV.
They should:
Yields will decline
Interest rates will increase
222
Someone who wishes to hedge a portfolio of

preferred stocks would buy:
Exercise would cause delivery of cash (like index options)
- Buy yield puts or

- Sell yield calls
Interest rates will decline
Interest Rate / Yield-Based Example
Based on the yield of a Treasury security, not its price
If the investor believes:
They should:
- Buy interest rate calls or
- Sell interest rate puts
223
Yield-based option calls

Yield-based option puts
Interest-rate option calls
Interest-rate option puts
224
56
Option Account Rules

1)
Option Account Rules
Gather customer information through Option

Account Agreement
- Financial status, objectives, experience
- Data need not be verified, but copy sent for customer
signature
- Send OCC Risk Disclosure Document
2)
Registered Options Principal (ROP) Approval
Allow Opening Transaction (only after approval)
4)
Within 15 days after the ROPs approval, client must

sign and return Options Account Agreement
- If not, only closing transactions would be permitted
-ROP must determine that account is suitable

- Does client understand strategies, profit / loss potential,
ability to assume risk
-ROP approves the account to a certain level of trading
based upon the customers profile
3)
225
Adjustment of Terms
Start: 1 ABC Feb 60 Call
Adjust for:
Number of
Contracts
Shares per
contract
Adjustment of Terms
Aggregate Strike Price:

$6,000
Strike Price
226
Start: 1 ABC Feb 60 Call
Aggregate
Strike
Adjust for:
Aggregate strike price remains constant

Even Splits
Increase
Unchanged
Decrease
Aggregate
2 for 1
100
$30
$6,000
Odd Splits/
Stock
Unchanged
Dividends
3 for 2
Even split is any split to 1

Only time number of contracts changes
Number of
Contracts

$6,000
Shares per
Contract
Strike Price
Aggregate
Strike
Increase
Decrease
Aggregate
Strike
150
$40
$6,000
Cash Dividends: strike price is not adjusted on ex-dividend date
227
228
57
Adjustment of Terms
$500
Start: 1 BBA Mar 5.00 Call

Number of
Contracts
Adjust for:
Deadlines for Equity Options
Shares per
Contract
Strike
Price
Expiration:
: 11:59 PM ET (Eastern Time) on the

Saturday following the third Friday of
the expiration month
Trading:
: 4:00 PM ET on the business day before

expiration
Submission of
exercise notice
to broker:
: 5:30 PM ET on the business day before

expiration
Aggregate
Price
Reverse Splits
Unchanged
Decrease
Increase
Aggregate
1:10
10
$50
$500
Note: All options in-the-money at least $.01

will be automatically exercised at expiration
229
Exercise of Equity Option

Options Clearing
Corporation (OCC)
Customers
Broker/Dealer
Long ABC Feb 60 Call
Option Taxation
Expire Worthless
Broker/Dealer
A
Issues the notice

to a broker by using
Random Selection
Short-term capital gain or loss for listed equity options,

recognized in the year the contract expires
(may be long-term for purchasers of LEAPS)
Broker/Dealer
B
Settles in 3 bus. days
Broker/Dealer
C
Is Closed-out
Assigns the notice

to a customer by using:
1) Random
2) FIFO
3) Any other fair/equitable
Short ABC
Feb 60 Call
230
231
Short-term capital gain or loss for listed equity options

(may be long-term for purchasers of LEAPS)
Is Exercised
The option premium itself will not generate a gain or loss
The premium will be added to the strike price for calls, or
subtracted from the strike price for puts, to establish the
cost basis or sale proceeds for tax purposes
Calculated in the same manner as breakeven
232
58
Taxation of Exercised Option
Taxation of Exercised Option

Paige Turner owns 100 shares of XYZ at $42 a share. She
sells 1 XYZ Dec 40 Call for a premium of $300. Later the
option is exercised. What are Paiges sales proceeds for
tax purposes on exercise of the call?
An investor is long one ABC Jun 90 Call at 4. If the

option is later exercised, the investor will have:
1)
A basis of $9,200
2)
A basis of $8,800
3)
A basis of $8,600
4)
A basis of $9,400
90 + 4 = 94
233
1)
$3,700
2)
$3,900
3)
$4,300
4)
$4,500
Stock Holding Periods and Puts

If a stocks long-term holding period is not yet established:
The purchase of a put terminates the holding period for the stock
The holding period begins anew when put is lifted
If a stocks long-term holding period is already established, a put
purchase would not change it (it remains long-term)
Married Put:
A put purchased on the same day that stock is purchased
The holding period for the stock starts
The premium paid becomes part of the stocks basis, even after
expiration
234
Option Strategy Review
Holding Periods:
40 + 3 = 43
235
If an investor is:
They should:
Bullish
Buy Calls (limited risk)

Sell Puts (large risk)
Bearish
Buy Puts (limited risk)

Sell Calls (unlimited risk)
Long stock
and wants protection
Buy Puts
Long stock
and wants income
Sell Covered Calls
Short stock
Buy Calls
236
59
Option Strategy Review

If an investor is:
They should:
Long portfolio of stock

Buy broad/narrow-based index puts
Long portfolio of stock

and wants income
Sell broad/narrow-based index calls
Expecting volatility
Buy straddles or combinations
Expecting stability
Sell straddles or combinations
Mildly bullish, wants limited risk,

& willing to accept limited gain
Establish Call Debit Spread

or Put Credit Spread
Taxation
Mildly bearish, wants limited risk, Establish Call Credit Spread

& willing to accept limited gain
or Put Debit Spread
237
Types of Taxes
Earned Income
Wages, Salary
Self-Employment
Federal income taxes

Estate taxes
Gift taxes
Investment Income
Interest
Dividends
Qualifying cash dividends are taxed at 15%
Taxes paid on foreign dividends can be used as a tax
credit or as a deduction
Regressive (flat): System that results in taxes, as a

percentage of income, being a larger percentage for low
income taxpayers than for higher income earners
Stock dividends received are generally not taxed as income

This treatment is similar to stock splits
The investors total basis is not changed; but the basis
per share would be reduced
Sales taxes
Gasoline tax
238
Ordinary Income
Progressive (graduated): The larger the amount subject

to tax, the higher the rate at which it will be taxed
239
240
60
Taxation of Interest
Capital Gains and Losses

Capital Gains
Subject to Tax By:

Federal?
State?
Sale or redemption of an asset with proceeds that

exceed basis
Corporate Bonds
Yes
Yes
Short-term: Assets held for one year or less
Municipal Bonds
No
Maybe
U.S. Treasury Debt
Yes
No
Debt of Territories
and Possessions
No
No
Source
Taxed at:
Long-term:
Ordinary rates
Assets held for greater than one year

Taxed at:
Maximum of 15%
Capital Losses (netted against gains without limit)

If losses exceed gains, $3,000 may be deducted from
ordinary income that year
Un-deducted losses are carried forward
241
Capital Losses Situation
242
Basis Special Cases

Securities converted to stock
Capital Losses
$40,000
Capital Gains
$25,000
(25,000)
$15,000 Net Losses
Stock takes the basis of the converted security

A tax-free exchange
Ordinary Income
$110,000
Inherited Securities (currently under Congressional review)
(3,000)
Beneficiarys basis is the market value at the time of death

Estate taxes are paid based on that market value
Holding period is always long-term
$107,000
$12,000 Carried
Forward
Gifted Securities
Recipients basis is the donors cost or market value,
whichever is less
The value, in excess of $13,000, of any gift to a single
recipient is subject to the gift tax (taxable to the donor)
How much could the investor realize in gains next

year without tax? $12,000
243
244
61
Tax Swaps and Wash Sales
Sale and Repurchase of Stock
Tax Swap
Lois Lane owns 1,000 shares of DEW with a basis of $43 per
share. The current market value is $22, but Ms. Lane expects it
to rise again.
A sale of bonds to realize a capital loss followed (sometimes

preceded) by a purchase of similar bonds
The investors portfolio remains basically unchanged
The loss is used to offset capital gains otherwise taxable
Wishing to offset significant capital gains she sells the stock on

December 3 at $22, recording a $21,000 loss. Fearing an
imminent rise in the stocks value, on December 20 she
repurchases 1,000 shares of DEW at $24.
Consequences?
Loss is disallowed and added to the basis of the new purchase.
Wash Sale
The loss will be disallowed by the IRS if within 30 days of the
sale the investor purchases substantially the same security
Certain factors should be varied:
Issuer
Coupon
Maturity
New basis $45 ($24 + 21)

What if she bought DEW Jan 25 Calls? DEW convertible bonds?
Both would trigger the wash sale
245
Identifying Securities Sold

FIFO; creates a
Shares
1,000
2,000
2,000
1,000
Price
$5
$10
$8
$18
246
Comparing After-tax Returns
A taxpayer made the following XYZ stock purchases:

Year
2001
2002
2003
2004
Which is the best investment for a corporation in the

34% tax bracket?
$15,000 cap. gain
Corporate bond with a 6.5% coupon

Specific ID; creates a
$2,000 cap. gain
City of Chicago G.O. with a 4.9% coupon

Preferred stock paying 5.5%
In the current year, the taxpayer sells 1,000 shares of XYZ at

$20 a share.
The solution follows. We will compare after-tax income

assuming a $1,000 investment made at par in each
case.
Taxpayer may use specific identification

Must be identified at time of transaction
If not identified, IRS assumes FIFO (first in-first out)
247
248
62
First and Second Choice
Third Choice
Preferred Stock with a 5.5% dividend
Gross income
Corporate bond with a 6.5% coupon

Gross income
$65.00
Taxes
Taxes
(22.10)
Net, after tax
34% of $65.00
Net, after tax
$42.90
Taxes
Dividend Exclusion Rule: for a corporation receiving dividends from

another corporations common or preferred stock:
$49.00
34% of $0.00
(0.00)
Net, after tax
If ownership is:
$49.00
(5.61)
$49.39
70%, at least, is excluded - 30% of $55.00 is $16.50
City of Chicago G.O. with a 4.9% coupon

Gross income
$55.00
34% of $16.50
249
Percentage excluded:
- Less than 20%
70%
- 20% or greater
80%
250
Investment Companies - Overview

A corporation (sometimes a trust) that invests the pooled funds
of investors; typically into a diversified portfolio of securities
Allows investors to own an interest in a greater number of
securities which are professionally selected and managed
Main advantages:
Session Seven
Diversification
Professional Management
- Investment Companies
- Annuities
- Retirement and Educational Plans
$
$
$
251
Investment
Company
Portfolio
252
63
Types of Investment Companies
Open versus Closed-End

Open-End (Mutual Fund)
Face Amount Certificate Company

Issues debt certificates
Issuer promises face value at maturity or surrender value if
presented prior to maturity
Unit Investment Trust Company

Supervised, not managed (no management fee)
Portfolio generally remains fixed for life of the trust
Management Company
Managed by investment advisor who receives a fee
Open-End or Closed-end
253
Sold at NAV + sales charge (if any)
Shares may trade at discount or

premium to NAV with commission or
mark-up added (supply and demand)
Sponsor stands ready to redeem

shares at the next calculated NAV
(forward priced)
Sponsor does not stand ready to

redeem shares
Shares stay in the primary market
Shares trade in secondary market
Cannot be sold short
May be sold short
Mutual Fund Features
Fund Company
Liquidity - Redemption at Net Asset Value (NAV) within 7 calendar days

Transfer Agent
XYZ
Fund
-Majority of board
must be independent
vis
Ad
en
t
Usually a one-time issuance of

common shares
-Could issue preferred or bonds
Mutual Fund Structure
Board
Underwriter /
Distributor /
Sponsor
or
Inv
es
tm
Closed-End
Continuously issue new shares

-Common shares only
-Sold by prospectus
-Manages portfolio
Dealer
254
Convenience
Daily determination of NAV
-Issues, redeems and

cancels fund shares;
distributes dividends
Custodian Bank
-Holds funds cash
and securities
255
Reinvestment of earnings at NAV (taxable event)

Switching / Exchange
Permitted within family without sales charge
IRS will tax any resulting gains
RR may be required to justify such recommendation
Dollar cost averaging
Same dollar amount invested regardless of share price
Usually results in average cost being less than the
average price
256
64
Types of Funds
Index Funds versus ETFs

Index Funds
Exchange Traded Funds

(ETF)
Primarily invest in bonds (possibly some

dividend paying stocks) for investors who
desire current income
Portfolio consists of a basket of

securities which mirror an index
(Low expenses)
Portfolio consists of a basket of

securities which mirror an index
(Low expenses)
Invest in one industry or geographic area for

investors willing to assume more risk for a
higher potential return
Shares are redeemed back to

fund; cannot be sold short
Shares trade in the secondary

market; may be sold short
Usually have no sales load
Commission is paid on trade
Forward priced, once daily
Intra-day pricing
Growth
Invest in common stocks for long-term

investors seeking capital appreciation
Income
Specialized
(Sector)
Invest in cash equivalents (money market

Money Market instruments) for short-term investors seeking
liquidity and safety
Balanced
Cannot be purchased on margin May be purchased on margin
Invests in both stocks and debt instruments
257
Hedge Funds versus Fund of Funds
Amount deducted from the investors purchase

Benefits the selling brokers
Used to cover the costs of promotion and sales literature
Investment fund generally for wealthy investors

Not considered a registered investment company
Uses exotic strategies involving derivatives, leverage, and
selling short
May place restrictions on investors withdrawing money
(lack of liquidity)
Not required to publish NAV daily
Industry rules prohibit assessing charges in excess

of 8.5 % of the Public Offering Price (POP)
Distributors use three methods to collect sales charge:

Front-end Load:
Total investment, less the sales charge, goes into the portfolio
Deferred Sales Charge (Back-end Load)
Assessed at time the investor redeems
12b-1 Fee
Annual fee levied against the funds assets
Fund of Funds:
Fund which allocates money to hedge fund managers
Generally suitable for wealthy investors
May also have some restrictions on withdrawing money
258
Sales Charges
Hedge Funds:
259
260
65
Other Fees
Mutual Fund Expense Ratio
Redemption Fee (not a sales charge)
Defined as the percentage of a funds assets paid for

operating expenses and management fees, including
12b-1 and administrative fees, and all other asset-based
costs incurred by the fund
Does not go to underwriter or dealer

Remains behind, in the fund, benefiting other owners
No load funds
Shows the actual amount a fund takes out of its assets

each year to cover its expenses
NAV = POP
A fund can be described as a no load only if it has:
No front-end sales charge
No deferred sales charge, and
No 12b-1 charges exceeding .25% per year
May have a redemption fee
Management fee (largest fund expense)

Usually a percentage of assets under management
Does not include sales charges
261
Sales Charge Calculation
Calculating Public Offering Price
Remember, sales charge is expressed as a percentage of the POP

(POP NAV)
Sales Charge % =
POP
Fund
NAV
POP
Sales
Charge %
Vanity 500
15.20
16.00
5%
Equity Tech
51.24
56.00
8.5%
Alger Capital
23.17
23.17
Far East
18.71
15.12
Blue Rock
20.25
32.25
When given the NAV and sales charge percentage, use the following
procedure to calculate the offering price:
No Load
Sales
Charge
NAV
NAV
(100 Sales Charge %)
5.00%
$69.80
69.80
(100 5%)
69.80
95%
$73.47
8 %
$45.95
45.95
(100 8.5%)
45.95
91.5%
$50.22
Closed-End
at Discount
Closed-End
at Premium
262
263
Simplify
=Resulting
POP
264
66
Methods to Decrease Sales Charge
Breakpoints - Example
A customer invests $35,000 and the next calculated NAV is
$19.61 and the maximum offering price is $21.32. The fund
charges a 1% redemption fee. Using the previous breakpoint
schedule, how many shares is the investor able to purchase?
Breakpoints
Dollar levels at which sales charge is reduced
Example:
Invested Amount
Sales Charge
$0
$10,000
8%
$10,001
$25,000
7%
$25,001
$50,000
6%
$50,001
$100,000
5%
$100,001
Over
4%
265
6.00%
$19.61
NAV
(100% Sales Charge %)
19.61
(100% 6%)
Simplify
=Resulting
POP
19.61
94%
$20.86
266

Rights of Accumulation
Letter of Intent (LOI)

Optional provision allowing investor to qualify for a
breakpoint without initially depositing the entire amount
required
Right to add up all purchases made from same family of

funds
When a breakpoint is crossed, current and future
purchases will have a lower sales charge
13 month time period
Can be back dated
NAV
$35,000 $20.86 = 1,677.852 shares
Sales
Charge
90 days
If an Investment Company does not offer breakpoints and
rights of accumulation, the maximum sales charge it can
assess is lowered using a set schedule
If backdated, the fund will recompute sales charges on

previous purchases
Non-binding on customer; a portion of shares held in
escrow in case of non-performance
LOI is not required
267
268
67
Distribution and Taxation
Investors Cost Basis
To qualify as a Regulated Investment Company, the fund must

distribute at least 90 % of net investment income to investors
(net investment income = dividends + interest expenses)
Represents the invested amounts and reinvested earnings

Example:

If qualified, fund is only taxed on undistributed portion

Burden for paying taxes ultimately falls on shareholders
The fund may also distribute realized capital gains annually
Jun. 2005:
Dec. 2005:
Dec. 2006:
Feb. 2008:
Invest $10,000 into HighRise Growth

1099 Reports $600 of income
1099 Reports $700 of income
Redeem shares for $14,500
Taxable gain?
Income and gains are taxable to investors and reported on Form
1099-DIV
Proceeds:
$14,500
Taxed in the year distributed whether received or reinvested
Basis:
$11,300
Taxable Amount:
$ 3,200
Both able to be reinvested at NAV without sales charges

269
Conduct Rules
270
Real Estate Investment Trust (REIT)

A company that manages a portfolio of real estate investments to earn
profits for shareholders, but is not an investment company
Prohibited Actions:
Tax Benefit: No taxation on income if 90 % is distributed

Note: Unlike Limited Partnerships (DPPs), no flow-through of losses
Breakpoint sales
Solicited sales at amounts just below a breakpoint
Characteristics:
Selling dividends
Inducing a client to purchase shares because of an
impending dividend
Since prices will be adjusted downward on the exdividend date there is no monetary benefit
Subject to registration requirements of the Act of 1933

Trade in the secondary market, similar to stock
Can be purchased on margin and can be sold short
Dividends not eligible for 15% tax treatment and do not
qualify for the corporate dividend exclusion rule
Note: Ex-dividend date is determined by mutual

funds sponsor
Offer limited liability to shareholders

Attractive to investors seeking current income
271
272
68
Non-Qualified Annuities
A tax-deferred investment sponsored by an insurance
company
Contributions are not deductible, but investment income
grows tax-deferred
No limit on amount that can be invested
Variable Annuities and

Tax-Deferred Annuities
No withdrawal requirement
Funding (Pay-In)
- Lump-Sum
- Periodic
versus
Benefit (Pay-Out)
- Immediate
- Deferred
May be fixed or variable
273
Fixed versus Variable Annuities

Fixed
Variable
Investment risk:
Insurance Company
Annuitant
Is it a security?
No
Yes
Account:
General
Separate
Portfolio:
Safe, secure,
predictable
Hedge against
inflation:
Poor
274
Receiving Benefits - Withdrawals

During the Pay-In or Accumulation Phase:
Account is valued in terms of accumulation units
Units are purchased after-tax, no deduction
Investment income is tax-deferred until withdrawn
While still in the accumulation phase, annuitants may

choose to take withdrawals from their annuity
Annuitants control the timing and amount of their
withdrawals
Only the earnings portion is taxable
Sub-accounts; to meet
investor objectives
Superior
275
276
69
Receiving Benefits - Withdrawals
Receiving Benefits - Annuitization

Annuitization of a Variable Annuity
Premature Withdrawals:
Accumulation units are exchanged for a fixed number of

annuity units
Payout established by multiplying fixed number of
annuity units by the unit value
Unit value will fluctuate based upon separate account
performance
Can be scheduled to pay for life
If withdrawn before age 59

A penalty is assessed: 10 % of investment income
Upon death of annuitant:

The death benefit is the greater of cost basis or
accumulated value
Proceeds above basis are taxable to beneficiary as
ordinary income
During the Annuity Phase payments are broken down

proportionately:
Percentage being a return of contributions (tax-free)
Percentage being receipt of investment income (taxable)
277
Payout Options
Straight Life
Annuity
Tax-Sheltered or Tax-Deferred Annuities (TSA/TDA)
Annuitant receives payments for life

- Highest possible payout - highest risk
403(b) Plans
For public school employees
and non-profit organizations
Joint and Last

Payments are made for life so long as one
Survivor Annuity annuitant is living
457 Plans
For employees of state and
local governments
Contributions excluded from current income

All income and gains are tax-deferred
Payouts entirely taxed as ordinary income
Annuitant receives an amount at least equal to

their original investment
- At death, any remaining amount is paid to a
beneficiary
278
Qualified Annuities
Payments are made to annuitant for life or to

Life Annuity with
beneficiary (in the case of annuitants death) for
Period Certain
specified minimum number of years
Unit Refund Life

Annuity
279
280
70
Qualified versus Non-Qualified

A 62-year old retired individual had contributed $10,000 into an
annuity. This year, she received a lump-sum payment from the
annuity of $16,000. How is the distribution taxed?
Contributions:
Earnings:
Basis:
Taxable:
If Qualified
If Non-Qualified
$10,000
$10,000
6,000
6,000
10,000
$16,000
$6,000
Tax Advantaged Retirement and

Educational Plans
281
ERISA
282
Keogh (HR-10) and Simplified Employee Pension (SEPs)

- for the self-employed
Similarities:
Based on self-employment income
Employer must contribute an equal percentage for
employees
For the self-employed, the maximum contribution is
20% of net income, not to exceed $49,000 (2010)
Determines qualified status

Both employer and employee contributions are tax
deductible
No discrimination
Open to all
21 or older
With one year of full-time service (1,000 hours)
Vesting provisions
Specify the amount of money to which an employee is
entitled when withdrawing from the plan
Applies to contributions made by employer
Keogh and SEP Plans
Created standards for private sector employee pension

plans
Differences:
Keogh plans allow employees to make non-deductible
contributions; SEPs do not
Keogh plans may follow a vesting schedule, while SEPs
require immediate vesting
283
284
71
Employer Retirement Plans
Traditional and Roth IRAs

Traditional
Similarities
401(k) for any type of company (public or private)
Tax Year
Contribution Limit
2010
$16,500
Differences
Maximum employee contributions:
Employers may, but need not, match

If employer matches, must follow a vesting schedule
285
100% of earned income up to

maximum of $5,000
Spousal option: extra $5,000
Spousal option: extra $5,000
Age 50 or older: extra $1,000
Age 50 or older: extra $1,000
May be a deductible contribution
Contribution is NEVER deductible
Contribution always allowed
Higher income individuals may not

contribute
Required Minimum Distribution

(RMD) by Apr. 1 following year the
owner reaches 70 (50% penalty
for failure to take distribution)
No withdrawal requirement
Withdrawals subject to tax
Withdrawals are tax-free
Traditional and Roth IRAs
State-sponsored, college savings plan
Early withdrawal penalty:
One child per account; but the child is not the owner
Investment cannot be self-directed, but owners may
change portfolio annually
Before age 59 and 10% of taxable amount

Except in case of death, disability, qualified higher
education expenses, or qualified first-time homebuyer
distributions ($10,000 lifetime)
Gift and Estate Taxes

Can contribute up to $13,000 per year without gift tax
Contributions are excluded from the estate of the donor
Individuals may contribute up to $65,000 at once and
apply the amount to the next 5 years
Amounts double for married couples
Rollovers and Transfers (no penalty no withholding)

Rollover:
Owner receives proceeds
Once per year (rolling 12 months)
Must be completed within 60 days
Trustee-to-Trustee Transfer:
Owner does not have access to the funds
May be more than one per year
286
529 Plans
For both Traditional and Roth:
Roth
100% of earned income up to

maximum of $5,000
287
288
72
529 Plans
Coverdell Education Savings Account
Distributions
Education IRA
Withdrawals used for qualified higher education

expenses will be tax-free on the federal level
Maximum contribution: $2,000 annually per child up to

age 18
If withdrawal not used for qualified education expenses,

earnings are subject to ordinary income taxes plus a
10% penalty
Contribution is non-deductible, but earnings are tax-free

if used for qualified education expenses
If not used for one childs education, funds can be

transferred to a relative without tax penalty
Funds must be used by the childs 30th birthday or

transferred to another relatives Education IRA
289
290
Marginable Securities
Only specific securities are deemed marginable according to
the Federal Reserve Board
Listed securities: NYSE or Nasdaq securities
Regulation T sets the margin requirement on these securities

at 50 % of the transaction amount
Session Eight
Deposit Cash (equal to the Reg. T Call)

Deposit Stock (equal to 2 times the Reg. T Call)
Not marginable:
- Margin Accounts
- Direct Participation Programs (DPPs)
- Fundamental and Technical Analysis
- Economics
Options
Unlisted non-Nasdaq securities
New issues: IPOs and mutual fund shares
These shares do have loan value after 30 days
The loan value is 50% of the current market value
291
292
73
Margin Account Documents
Hypothecation
Call rate
Margin rate
Broker/Dealer
New Account Form

Credit Agreement
hypothecate
Bank
re-hypothecate
Terms of the loan

Disclose interest amount, how computed, when charged
Loan Consent (not mandatory)
Customer buys $100,000 of stock on margin
B/D can lend the customers securities to others
Hypothecation (Pledge) Agreement
Cash B/D will

borrow from bank
$50,000
DEBIT
$50,000
Customer hypothecates securities to B/D as collateral

B/D borrows money from a bank to replace loan to customer
Stock pledged
by B/D to bank
$70,000
100% of
debit
293
Long Margin Account
Investor purchases $100,000 of XYZ

Activity
The broker-dealer monitors the account using three balances:
Debit Balance = Equity
Long Market
Current market value of securities held in account
Value (LMV):
Debit
Balance:
Equity:
294
Long Margin Account
An investor borrows the portion of the purchase price of

securities not made up of the Reg. T Margin Call from the B/D
Long Market Value
140% of
debit
LMV
Debit
Equity
New purchase
$100,000
$50,000
$50,000
Market value
increases by
$10,000
$110,000
$50,000
$60,000
Excess Equity
Equity greater than 50% of the current LMV
Creates a line of credit for the customer; recorded in the
Special Memorandum Account (SMA)
Loan amount by B/D to customer, secured by LMV
Customers ownership interest in the account
295
296
74
Using SMA
Using SMA
Special Memorandum Account (SMA) can also be used for:
Special Memorandum Account (SMA) can be used for:
Meeting margin call on new purchase

The buying power is two times its value
Again note: Using SMA increases the debit balance
Loan advances (a.k.a Withdrawing SMA)

Note: Using SMA increases the debit balance
LMV
Debit
Equity
SMA
Initial:
100,000
50,000
50,000
LMV by 10%
110,000
50,000
60,000
5,000
How much cash can the investor withdraw?

Withdraw
$5,000
110,000
55,000
Initial:
LMV by 10%
Buy stock, no
cash deposit
297
Equity
50,000
50,000
60,000
5,000
120,000
60,000
SMA
$10,000
60,000
Restricted Accounts
Activity
Debit
50,000
How much buying power does the investor have?
$5,000
55,000
LMV
100,000
110,000
298
Increasing SMA
LMV
Debit
Equity
SMA
Existing Account:
110,000
50,000
60,000
5,000
MV falls to $90,000
90,000
50,000
40,000
5,000
Appreciation, excess equity

Voluntary cash and dividend deposits
100 % reduces debit, and 100% recorded in SMA
Sales of stock from the account

100% reduces debit, and 50% recorded in SMA
Activity
Subsequent market declines DO NOT reduce SMA
Existing account:
The only way to LOSE SMA is to USE SMA
Account is called restricted, but does not have to be remedied

Reg. T is a transaction requirement; NOT a maintenance
requirement
Debit
Equity
SMA
90,000
50,000
40,000
5,000
$10,000 of stock is sold from the restricted account
Equity is below initial Reg. T of 50% of LMV
LMV
Sell $10,000
299
80,000
40,000
40,000
10,000
300
75
Minimum Maintenance Requirement

Activity
LMV
Debit
Equity
SMA
Continued from
previous slide:
90,000
50,000
40,000
5,000
MV falls to $60,000
60,000
50,000
10,000
5,000
Short Margin Account

Investor borrows securities from B/D in anticipation of decline,
with the B/D holding customer cash as collateral for the
borrowed stock
Credit Balance
Minimum Maintenance Equity Requirement is 25% of Current LMV

If below, prompt maintenance is required!
Short Market
Value (SMV):
A Maintenance Call of $5,000 is received which can be met by:

Depositing Cash
Depositing fully paid marginable securities
Selling all or part of the position
Credit
Balance:
Equity:
301
Sell short 1,000 shares

DEF at $40 and make Reg.
T deposit
DEF falls to $32 per share
SMV
Equity
40,000
+20,000
60,000
40,000
20,000
60,000
48,000
Customers ownership interest in the account

302
Short Position
$2,000
Purchase:
Short Sale:
Between $2,000
and $4,000
28,000
Above $4,000
DEF rises to $48 per share
Current market value of the securities sold short
Long Position
The lesser of $2,000 or
100% of the market value
Below $2,000
32,000
Customers cash that is held by B/D as collateral

Total short sale proceeds plus Reg. T on sale
Customer must deposit an amount equal
to 50% of short sale proceeds
Minimum Initial Equity
Credit
60,000
= Equity
Short Margin Account

Activity
Short Market Value
12,000
$48,000 x 30% = $14,400

A maintenance call of $2,400 would be received ($14,400 - $12,000)
$2,000
303
Deposit:
Below $4,000
$2,000
Above $4,000
50% (Reg. T)
50% (Reg. T)
Buy $1,500 of ABC

Deposit $1,500
Buy $3,000 of ABC
Deposit $2,000
Buy $5,000 of ABC
Deposit $2,500
Minimum Maintenance Equity Requirement is 30% of SMV
Deposit:
100% of purchase
Short $1,500 of XYZ

Deposit $2,000
Short $3,000 of XYZ
Deposit $2,000
Short $5,000 of XYZ
Deposit $2,500
304
76
Margin Requirements on Options

Buy an Option:
Deposit 100% of the premium
Sell a Covered Option:
No required deposit on the option
Sell an Uncovered Option: Margin required (not calculated)

On margin, buy 100 shares RFQ at $90
and buy 1 RFQ Dec 85 Put at 2.
What is the margin requirement?
1) $4,600
2) $4,700
3) $9,200
On margin, buy 100 shares DEF at $80

and sell 1 DEF Dec 85 Call at 2.
What is the margin requirement?
1) $3,800
2) $4,000
3) $4,200
How much cash must the customer deposit?
Direct Participation Programs (DPPs)
$3,800
305
DPPs - Introduction
306
Formed by filing a Certificate of Limited Partnership

with the state and are owned by partners
General Partner
A business venture designed to pass through both

income and losses to investors
Examples: Limited Partnerships, General Partnerships,
Subchapter S Corporations, and Joint Ventures
Those considering DPPs as a potential investment should:
Passive investor with limited

liability
Must have at least a 1%

interest
Contributors of capital
Last at liquidation:
Secured Lender
General Creditor
Limited
General
Have a need for both present and future tax benefits

Be aware of the risks involved
Be able to tie up funds for a long period of time
307
Limited Partner
Day-to-day manager with

unlimited personal liability
Fiduciary toward limited

partner
Have liquidity in other investments
Limited Partnerships
Definition:
General
Creditor
Have certain rights:
Lend to the partnership,
inspect books, and compete
Ways to endanger limited
status:
Negotiating contracts, hiring /
firing employees, or
lending their name
308
77
Offering Practices
Subscription Agreement
If a sponsor (GP) conducts a public offering of securities:
Suitability determination is accomplished via this

document and will state the following:
Registration is required under the Securities Act of 1933

Note: the maximum underwriting compensation is 10% of
the gross dollar amount of securities sold
Purchaser has read the prospectus (or offering

memorandum) and understands the risks
Purchaser has met the net worth, income and suitability
requirements
If a sponsor (GP) conducts a private placement:
To whom the check is made payable
Securities then qualify for an exemption from registration
Limited Partners are not accepted until the General

Partner signs
Reg. D offering to an unlimited number of accredited, but

not more than 35 non-accredited
309
Advantages
Disadvantages

Flow-through of income and expenses

Limited liability
Various Tax Benefits:
Tax Credits dollar-for-dollar reduction of tax due
Construction of low income housing
Rehabilitation of certified historic sites
Tax Deductions reduces gross income to arrive at
taxable income (tax savings is based upon tax rate)
Depreciation -not raw land
Depletion -for oil and gas programs
Intangible drilling costs; such as site prep, labor, and
testing -not machinery
310
311
Lack of liquidity
General partners approval may be required to sell
Limited voting power
Effects of tax law changes
Increased tax complexity
Multi-state filings
Subject to audits
Subject to Alternative Minimum Tax (AMT)
Certain tax preference items are added back, such as:
Excess intangible drilling costs
Accelerated depreciation (higher deductions
taken in early years)
312
78
Oil and Gas Programs

Category
Exploratory
Wildcatting
Developmental
Step-Out
Balanced
Income
Details
Real Estate Programs
High risk with high potential

reward
Drilling near an existing field
Combination of exploratory and

developmental
Purchase of existing wells;

creates immediate cash flow
Category
Risk
313
Details
Raw Land
Speculation on land appreciation; no

positive cash flow or depreciation
New Construction
Risks of overbuilding, cost overruns,

long duration, etc
Existing
Creates cash flow; but potential

problematic tenant issues
(e.g. long-term leases)
Low Income
(Government Assisted)
Beneficial potential tax credits; little

chance of appreciation and high
maintenance costs
314
Adjustments to Limited Partners Basis

The LPs basis is their amount at risk
Basis will increase for the following reasons:
Contributions
Income reported
Recourse loan -- Loan to the partnership for which the limited
partner is responsible
Fundamental Analysis
Basis will decrease for the following reasons:
Balance Sheet/Income Statement,

Market Share, Executive Biographies
Cash (or property) distributed

Not taxable; a return of investment
Losses reported -- passive losses
Aggregate losses cannot exceed, but could equal, the basis
Passive losses can only offset other passive income
Unused losses are carried forward
Technical Analysis
Charts, Trends, Patterns, Theories
315
316
79
Balance Sheet
Key Formulas
Current Liabilities
Current Assets
- Cash
- Marketable Securities
- Accounts Receivable
- Inventory
Working Capital:
- Accounts Payable
- Dividends Payable
- Interest Payable
Fixed Assets
Current Ratio:
Quick Asset / Acid Test
Long-Term Liabilities
- Land
- Buildings
- Equipment
- Notes
- Bonds
Intangibles
Current Yield:
Earnings Per
Share (EPS):
Shareholders Equity
- Goodwill
- Preferred / Common
- Retained Earnings
- Paid-In Capital
Total Assets
Price / Earnings
Ratio:
Total Liabilities
+ Shareholders Equity
317
Changes to Balance Sheet

Transaction
Effect on
Working Capital
1)
Issue Stock
Increase
2)
Issue Bonds
Increase
3)
Buy Equipment for Cash
Decrease
4)
Declare Cash Dividend
Decrease
5)
Pay Cash Dividend
Current Liabilities
Current Assets
Inventory
Current Liabilities
Annual Dividend
Current Market Price
Net Income Preferred Dividend
Common Shares Outstanding
Market Price
Earnings Per Share
318
Finding Earnings Per Share (EPS)
C.A.
1) +
3) -
C.L.
4) +
2) +
5) -
5) -
F.A.
3) +
Current Assets
ABC Corporation has $15,000,000 in capitalization

which is composed as follows:
$5,000,000 of 10% bonds due June 1, 2025
$2,000,000 of 5% preferred stock ($100 par)
$8,000,000 of common stock, $10 par value
(800,000 shares outstanding)
L.T.L.
2) +
The corporation has earnings before interest and taxes

of $5,000,000 and is in the 34% tax bracket.
No Change
INTANG.
SH. EQ.
1) +
With the above numbers, calculate the EPS.
4) Securities Training Corporation. All rights reserved.
319
320
80
EPS Calculation
Earnings Before Interest
and Taxes (EBIT):
Technical Analysis
Uses various theories and pattern analysis to predict the
direction of the overall market or specific stocks
$5,000,000
Less Bond Interest:
(500,000)
Earnings Before Taxes:
4,500,000
Less Taxes:
(1,530,000)
Net Income:
2,970,000
Less Preferred Dividend:
(100,000)
Available to Shareholders:
$2,870,000
$2,870,000
800,000 shares
= $3.59
321
Short Interest
and Theory:
Amount of a companys common stock sold

short, but not yet covered
Large short interest is a
Bullish
Indicator
Odd Lot Theory:
Small public investors are always wrong
Advance /
Decline Figures:
Measure of the number of stocks that have

increased versus number of issues that have
decreased (breadth of the market)
Technical Analysis
322
Technical Analysis
Dow Jones Composite Average
Support
Comprises 65 stocks:
Price level at which stock tends to stop falling
- 30 Industrials, 20 Transportation and 15 Utilities
Resistance
Price level at which stock tends to stop rising
NYSE places restrictions on trading if DJIA declines by

significant amounts from previous days close:
-DJIA declines by 10%:
One-hour trading halt
Two-hour trading halt
Trading halts for the day
Breakout
When a stock breaks through an area of support or
resistance
Breakout of an level of support is a bearish indicator
Breakout of an level of resistance is a bullish indicator
323
324
81
Technical Analysis
Head and Shoulders Patterns
Breakout
Head and Shoulders (Top)
In order to profit on a breakout one could:

enter sell stop orders below a support level
(or buy puts), or
enter buy stop orders above a resistance level
(or buy calls)

81.50
Reversal of an upward trend

Bearish indicator
Head and Shoulders (Bottom)

Reversal of a downward trend
Bullish indicator
Head
(Top)
Buy 81.53 stop GTC

Resistance
79.70
Left
Shoulder
Support

Neckline
Sell 79.66 stop GTC
Right
Shoulder
325
326
Types of Risk
Beta
Measures an assets volatility relative to the entire market
Market risk also called systematic or non-diversifiable risk
Stocks beta is often compared to the beta of the S&P 500,
which is always 1.00
When assets beta is more than 1:
Economics
Asset outperforms when market is up, but underperforms when market is down (growth stock)
When assets beta is less than 1:
Asset under-performs when market is up, but
outperforms when market is down (defensive stock)
327
328
82
Key Economic Terms
The Business Cycle
Measurement of the output of goods and

Gross Domestic
services produced within the U.S. without
Product (GDP)
regard to origin of producer
Consumer Price Measures the prices of a fixed basket of
goods bought by typical consumers
Index (CPI)
Peak

(Recovery)
Inflation
(C
Recession

Rise in the level of prices

Expansion
Disinflation
)
ion
act
r
t
on
Reduction in the rate of inflation

Trough
Deflation
Decline in the level of prices
329
Keynesian versus Monetary Theory
Utilizes what to
accomplish goals
Type of Policy
Responsible for
Implementation
Keynesian
Monetary
Taxes
and
Expenditures
Money Supply
Fiscal
Monetary
Congress
Federal
Reserve
Board
330
Tools of the Fed

The following tools are listed from least to most used
331
Regulation T:
Extension of credit by broker-dealers
Discount Rate:
The only rate directly controlled by Fed

Provides a back-up source of liquidity to
depository institutions on a short-term basis
Reserve
Requirement:
Amount of money a bank must maintain

based upon a percentage of deposits
332
83
Tools of the Fed
Suitability Issues
Federal Open
Trades U.S. Treasuries through primary
Market Committee
government dealers
(FOMC):
Customer Situations:
Tax Bracket:
If high, then municipal debt is appropriate
If low, then corporate debt is appropriate
Action of the FOMC:
1)
To increase money supply

and ease credit:
Time Horizon:
If long, then more equity is appropriate
If short, then less equity is appropriate
(100 age = percent in equities, while age = percent in debt)
BUY SECURITIES
Deposits and reserves: increase
2)
To decrease money supply

and tighten credit:
Inflation:
If fearing high inflation, appropriate actions would be
increasing equity ownership, reducing debt, and investing in
variable (not fixed) annuities and TIPS
SELL SECURITIES
Deposits and reserves: decrease
333
334
Final Preparations
Complete Final Exams, reading explanations
Review your notes
Call 800-782-3926 if you have questions or need assistance
Thank you for your kind attention
Make sure you have all of your proper identification to

enter the exam (Be sure your drivers license or passport
has not expired !!)
Best Wishes & Good Luck

- from all of us at STC
Check www.stcusa.com for possible course updates
335
336
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Series 7 Classroom Four Day v16

About the Series 7

70% passing score

Securities Training Corporation

30, 30, 180 waiting period for failures

Series 7 Classroom Four Day v16

Series 7 Exam Breakdown

4) Handling Customer Accounts

5) Markets and Regulations

6) Order Entry, Confirmation, & Settlement

7) Factors Affecting Security Value

22-Chapter Study Manual

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STC Study Materials

1) Customer and the Registered Rep.

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Series 7 Classroom Four Day v16

Supplemental Study Aids

Supplemental Study Aids

Progress Prep Exams -- CD-ROM or On-Line

CD Audio Learning Program

Covers heavily tested topic areas including: Bond

STC Virtual Class Offerings

DVD Video Learning Program

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Supplemental Study Aids

Visit us on the web at www.STCUSA.com

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Securities Training Corporation. All rights reserved.

Series 7 Classroom Four Day v16

Series 7 Classroom Four Day v16

Unsecured Creditors (debentures)

Securities Training Corporation. All rights reserved.

Common Stock Voting Rights

Securities Training Corporation. All rights reserved.

Covers various issues affecting the corporation such as

Available to Common Shareholders

If shareholders wish to have someone else vote their

Short-term right enabling holders to buy below the

Securities Training Corporation. All rights reserved.

Securities Training Corporation. All rights reserved.

Securities Training Corporation. All rights reserved.

Series 7 Classroom Four Day v16

A security that allows the holder to buy shares of common

Companys attempt to improve marketability of their stock

Attached to an offering of a bond or preferred stock of the

No change to issuers capitalization

Securities Training Corporation. All rights reserved.

Forward more shares, lower price

Stock Split Example

Securities Training Corporation. All rights reserved.

Before the Split:

After the Split:

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Securities Training Corporation. All rights reserved.

Series 7 Classroom Four Day v16

Types of Preferred Stock

American Depository Receipts (ADR)

A receipt for foreign securities held in a U.S. bank located in