Tuesday, December 29, 2009

A sideways market

Joey Investor is long 1,000 shares of ORCL common stock. It is now June, and Joey feels that the market for ORCL is headed sideways over the next several weeks. Therefore, he should
A. sell 10 ORCL Jul calls
B. buy 10 ORCL Jul puts
C. sell 10 ORCL Jul puts
D. buy 10 ORCL Jul calls

EXPLANATION: Always sell options if the market is supposed to go "sideways" or "remain unchanged." That way, you get the premium now, and then the option expires. Don't sell puts if you own stock--if the stock goes to zero, you lose 100% on the stock, then you have the OBLIGATION TO BUY the stock for the strike price . . . even though it's worthless. Sell covered calls in this situation. Joey owns 1,000 shares, so he can cover 10 call options.


Friday, December 18, 2009

Bad Boys, Whatchu Gonna Do?

It's Friday morning, a balmy 30 degrees in Chicago, and, as usual, I am reading the disciplinary actions that FINRA has taken recently. Today I skipped over the firms that have been fined and sanctioned and jumped straight to the "Individuals Barred and Suspended." So far this month that category takes about 13 pages to cover . . . with almost two weeks more to go in December.

The first gentleman apparently decided to start entering trades using his discretion, the only problem being that the customer never gave him that discretion, and the firm never accepted the account as a discretionary account. Oopsie. The results? 60-day suspension from any FINRA firm in any capacity, $7,500 fine, and "disgorgement" of the $2,300 or so he made in commissions. The next guy up apparently thought FINRA and his compliance officers were kidding about the requirement to notify the firm of any outside business activities. I mean, I take my hat off to the guy for making $251,616.18, but I'm wondering if it was actually worth it, what with the whole four-month suspension and $10,000 fine that will now go into "broker check," the publicly available part of CRD, indefinitely. Then again, compared to the next guy on the list, that gentleman actually got off easy. The next individual only earned $13,950 through outside business activities, but through AWC (acceptance, waiver, and consent) was permanently barred from any association with any member firm.
Ever. Of course, he didn't help himself any by refusing to comply with FINRA's requests for information. Here's a tip--it's always better to cooperate with FINRA, no matter how much you have screwed up.

I guess the title of this post is a little off, with the "boys" reference, as Ms. Damon up there in Minnesota there showed by exercising discretion that she didn't actually have. She's also a walking test question, as she "only" used "time and price discretion," but, she used it the day after the order was entered. An order such as, "Buy me 1,000 shares of MSFT" is a "market not held order," but it's only good for that particular day. If not, some poor customer could have put in an order to buy 1,000 shares of Google when it was trading for $90 and then getting confirmation 10 months later that he just got filled at $555 a share. Of course, I think she'll remember that next time, after the 10-day suspension and $10,000 fine.

The next guy, in upstate New York, received a harsh $25,000 fine and one-year suspension for posting electronic communications on an Internet message board about a stock that his broker-dealer makes a market in. As the notice points out, "The findings stated that Dunne posted the advertisements without a registered principal’s prior approval and none of the advertisements named the firm or reflected Dunne’s relationship with the firm. The findings also stated that the advertisements constituted purchase recommendations for the company and failed to provide, or offer to furnish upon request, available investment information supporting each recommendation; failed to disclose that Dunne’s firm was a market maker in the company; that the firm and/or its officers or partners had a financial interest in the company, the nature of the
financial interest; and failed to provide a fair and balanced assessment, referring only to the company’s upside without any disclosure of the risks."
Oh well, it would take too much time to go through all these disciplinary actions in a blog post, but you are advised to go through them yourself at http://www.finra.org/web/groups/industry/@ip/@enf/@da/documents/disciplinaryactions/p120557.pdf
Have a nice weekend, and STAY OUT OF TROUBLE.

Friday, December 4, 2009

Municipal Bonds in the Lone Star State

Sometimes it's dangerous to read the Wall Street Journal, Forbes, etc. when studying for the Series 7 because the terminology used in the "real world" often doesn't jibe with what you're studying for the exam. However, more often than not, the "real world" will help you understand what the heck the Series 7 is talking about.

Take a look at the article from the Bond Buyer at the link posted below. You may struggle a bit with some jargon, but you will almost certainly come away with a better understanding of municipal bonds after reading this:


You will see why a credit analyst looks at competing facilities, such as a free highway, when analyzing the credit quality of a tollway bond. You will see that qualifying for tax-exempt status is something to be approached creatively. Since "PABs" would normally not be tax-exempt, the politicians figured out a way to create a separate entity to issue the bonds and thereby make the interest tax-exempt. And you'll see references to the three major credit ratings agencies.

I'll let you take it from here--feel free to post questions if you have them.

Wednesday, December 2, 2009

Securities Fraud Right Next Door

A few days ago while reading my morning Sun-Times, I found this headline: Investors bilked of millions: charges. Then the lead-in, which declared: A North Shore businessman was arrested this week after he allegedly swindled investors out of several million dollars.

According to the story, Jay C. Nolan was released on a $100,000 bond on allegations that he defrauded individuals who invested in a hedge fund that he managed. Hedge funds are not a big component of the Series 7, but they are testable. Remember that investors need to be accredited to buy into a hedge fund and that hedge funds employ higher risk trading strategies as well as being very difficult to liquidate. They are organized as limited partnerships (DPPs), as we notice by the name of Mr. Nolan's fund, "Lodge Diversified Fund LP," where the "LP" stands for limited partnership. Actually "LP" could also be said to stand for "losing plenty" or "lying phoney," but we'll stick to the traditional reading here.

What happened? Apparently, when the losses began to pile up, the hedge fund manager simply could not admit it to himself or to investors. Allegedly, he sent out account statements revealing that the fund was currently worth $6.3 million, but when an investor did some checking with other sources, he learned that the actual value was only $170,000.
Oopsie! That's more than a typo, isn't it? I'm not sure how large or scary the investor is, but according to the story, Mr. Nolan spilled his guts immediately and admitted he had been sending out bogus account statements.

So now what? First, there will be the massive legal bills paid to Mr. Nolan's attorneys, who will do their best to keep him out of jail or keep his sentence as short as possible. Maybe they'll take it to an embarrassing criminal trial in which angry investors take the witness stand one-by-one and call him every name in the book that the judge will allow. Or, maybe they'll accept a plea bargain in exchange for a shorter sentence. There will also be the civil cases in which investors try to sue to recover some of their money. And, the SEC and/or the State of Illinois will try to make sure he never works in the investment industry again.

Do a google search on "Lodge Diversified Fund LP" and see what you can find. And please remember that sending bogus account statements through the US Mail and by email equals criminal violations known as "mail and wire fraud." When you sit for your Series 63 or 66 you'll learn about "custody" issues in the sense that regulators don't like investment advisers to have control over client assets but prefer that the assets are held by a custodial broker-dealer, who sends account statements to investors with no motiviation to fudge the numbers. Letting your investment adviser tell you what your investment is currently worth is a recipe for fraud and disaster.

Sunday, November 22, 2009

Net Asset Value

All of the following would cause NAV for an open-end fund to increase except

A. stocks in the portfolio increase in value

B. stocks in the portfolio pay a dividend

C. investors buy new shares in unexpectedly large quantities

D. bonds in the portfolio make interest payments

EXPLANATION: if you owned stocks and bonds in a brokerage account, the account value would rise whenever the value of the stocks and bonds went up, or whenever they put money into your account via dividend and interest payments. If you multiplied the size of your portfolio by a bazillion and cut it up into shares, the same thing would happen to the mutual owners of your mutual fund. So "A", "B", and "D", all do make the NAV rise. Choice C has nothing to do with NAV--supply and demand does not apply here. At 4 PM or so each day the fund is revalued based on what we just mentioned--THEN, they let buyers in based on that NAV, and they pay sellers out the NAV. But it's all proportional and all done at the same price.


Wednesday, November 18, 2009

Broker Check

Up to now there has been a big difference in the way that state securities regulators and FINRA publish violations of agents, principals, and broker-dealers. While the state securities regulators tend to keep the notices of revocation up indefinitely, FINRA (formerly NASD) has allowed the violations to disappear after two years. That way if an agent were barred by NASD (now FINRA) for cutting bad checks and misappropriating client funds, the public would only know about it for 2 years after he got himself kicked out of the business. The state securities Administrator would usually issue an order of revocation, and that would stay up on the website indefinitely. Apparently, FINRA doesn't think that's good enough, and they're probably right in thinking that more investors will go to the "broker check" site at http://www.finra.org/ than their state regulators' site, especially with all the FINRA TV and radio commercials out there encouraging them to do exactly that.
In any case, starting in a few days, any agents or principals who get in trouble with FINRA will have the violation sitting in broker check indefinitely. That way, if they try to switch to, say, the insurance business, customers will be able to look them up at broker check and see that maybe they aren't the sort of people investors should trust with a $1.5 million annuity purchase.
Go ahead and check out the actual press release at the link below. And, more important, stay out of trouble once you get your securities license.


Monday, November 16, 2009

Get the Series 66 Done in 2009

Many people taking the Series 7 will also have to take the Series 66 exam. Usually, the tests are taken in that order, but you might want to consider getting the Series 66 exam done in 2009, even if you have to put the Series 7 on the back burner to make it happen.


The Series 66 exam is changing. The old 80/20 split between regulatory concerns and investing concerns is changing to 50/50. The test is adding questions on derivatives (options, futures, forwards), hedge funds, statistics (mean, median, mode), annuities, insurance, retirement plans, Efficient Market Theory, and a handful of other exciting topics.

Will the test be easier or harder starting in January?
Nobody knows, but nobody has ever seen these tests get any easier. The regulators feel that they protect investors by flunking a certain percentage of test takers, and we will never convince them otherwise.

To help you get the Series 66 off your plate before all the changes occur, I have created a 50% off coupon code to be used on any purchase at http://www.passthe66.com/. The coupon code is: 66now. Be sure to hit the APPLY button to get the discount.

Friday, November 13, 2009

Municipal Securities and the So-Called "Real World"

It always amazes me to hear Series 7 classroom instructors tell students that the Series 7 "has nothing to do with the real world."

Nothing could be further from the truth. As you'll see from the link below, the Series 7 material that you're studying about municipal securities is unfolding right across the street from my office. Across the street sits an old brick industrial building that was almost converted into lofts, condos, and townhomes except that the real estate market--as you may have heard--sort of went south before they could sell any of the units. I watched a few work crews install hundreds of windows and sandblast the original wooden beams, but this project never even got off the ground after that. The developers borrowed $15 million with nothing to show for it, and the lenders have sued to foreclose on the property.

A very familiar story playing out across America, isn't it?

What does this have to do with municipal securities? As you'll see from the article at the link below, the local park district now wants to purchase that huge former industrial campus with our tax dollars and use it for office space and recreational facilities. They'll have to borrow a ton of cash to buy the property now in foreclosure, and they'll do so only if we taxpayers vote "yes" in February to let them issue these municipal bonds backed by an increase in our property taxes. If the majority determines that tax payers should pay a few hundred bucks more a year in property taxes in order to expand the park system, the bonds will be issued. If the majority votes "no," the issue will die temporarily, until the politicians can think of another plan. It's kind of shocking to see how the village played their hand on this one. The village dragged out the development of the "Roos building" painfully by requiring all kinds of variances and rejecting round after round of architectural changes . . . by the time the developers got the village council to approve the project, the real estate market had completely turned south and--oopsie--no interested buyers at this time.
Now that the building is in foreclosure, that same local government steps in to buy it at a discount. Then again, this is basically Chicago here. I mean, you can see the Sears Tower by stepping outside and looking to your right. But it seems like some pretty strong-armed tactics for a village government to take just the same.
In any case, if you'd like to see how the same Series 7 material you're studying is unfolding right outside my office window, click on the link below:

Thursday, November 12, 2009

Public Offering Price (POP)

A customer buying a new municipal bond from a syndicate member pays the:
A. ask price, plus a commission
B. public offering price, plus a commission
C. public offering price, plus a reasonable markup
D. public offering price

What the above question is pointing out is that a primary offering of securities has one price called the "public offering price," or "POP." Built into that POP is the compensation to the underwriters and selling agents. This is true whether we're talking about municipal securities, corporate securities, mutual funds, or variable annuities. When securities are traded among investors in the secondary market, broker-dealers step in between and either make commissions or markups-markdowns. But when they act as underwriters on the primary market, their compensation is built into the POP.


Friday, November 6, 2009

Insider Trading

It's Friday morning and, as usual, I'm at the FINRA website looking up recent disciplinary actions. Today I find a well-known broker-dealer being fined for insufficient anti-money laundering policies. $600,000 is the fine, but I also know how much it costs to shoot advertisements involving helicopters, let alone running those ads in prime time, so I think their pocketbook will survive.
On the other hand, the individual referenced in the link I'll post below is done. Game over. Forced early retirement. As you'll see, when a broker-dealer is called in for investment banking work, they end up knowing information no one else has, information that can move the price of the company's stock up or down with near certainty. So, investment bankers are fiduciaries who have to keep the information confidential. Don't spread the news, and--for crying out loud--don't try to buy shares of the company's stock so you can dump it when the news becomes public. Tempting, sure. But it's a criminal violation. It leaves you open to all kinds of civil suits. And--as you'll see--it tends to end a registered representative's career permanently.

See what I'm talking about here:

Tuesday, November 3, 2009

Kicking the Series 7's Behind

I'm going to let one of our happy Series 7 customers write this blog post. In case you're thinking that passing the Series 7 is "impossible," see what my man Danny has to say below:

I just passed the Series 7 yesterday (Nov 2nd) and I wanted to thank you for your assistance. I've been sitting in on your free Friday webinars and they have been extremely helpful. Perhaps they were the key to me getting a 93% on the test!Your willingness to share your expertise and personal passion for this material is very uplifting, during a period of time when we (the test takers) are stressing out. You bring a level of reality to the material and your practical examples based on your real life experiences is very helpful. Keep it up, I'm off to the 66 now and will continue on the calls, I do enjoy them.

Danny Williams

The Series 7 Exam

Let's talk about the Series 7 exam itself. First, the basic facts:

  • 250 questions (plus 10 experimental)
  • 6 hours with a required "half-time" break
  • a calculator is provided--bring your photo ID only
  • you must be sponsored by a broker-dealer to take the test
  • to get a securities salesperson (agent) license from your state, you must also take the 63 or the 66 exam in virtually all states

Now let's dispel a few urban legends regarding the Series 7

  • there is no limit to the number of times you can take the test
  • however: you must wait 30 days to re-test after the first failed attempt, 30 days to re-test after the second failed attempt, then 6 months after every failed attempt going forward
  • the test does not adapt to anything you're doing on the computer
  • no one has the "actual Series 7 questions"

How do people perform on this exam?

  • on any given day, ~ 66% of those taking the test pass it
  • any company claiming to have a "90% pass rate or higher" is pulling a number out of thin air. how could anyone consistently beat the national average by 25+ points, especially when all other vendors have access to each others' materials? there are no secrets in the test prep industry
  • the average score is about 73% on the test
  • no one has results broken down by "first attempt," "second attempt," etc.

For more information on the Series 7 exam itself, go to YouTube and type in "Series 7 exam" or "What is a Series 7?" and click on our video clip.

Friday, October 30, 2009

Disciplinary Actions

It's Friday morning and, as usual, I'm at the FINRA website looking at recent disciplinary actions. For the month of October there are about 40 pages' worth of infractions, ranging from recordkeeping mishaps to outright bad behavior. I'll place the link below, or you can just go to http://www.finra.org/, then "industry professionals," and then look under "enforcement" for "disciplinary actions." This month you'll find several small fines resulting from sloppy reporting of trades. You'll notice that the same firm often has two or three violations in the same month. And you'll see that Regulation SHO, in which short sales have to be executed very carefully and properly, is a hot topic for the regulators. Reg SHO is all about making sure that when shares are sold short, there actually are shares available. Otherwise, the laws of supply and demand are being manipulated, and market manipulation is the number-one thing that the SEC and FINRA try to prevent. Before executing the short sale, the broker-dealer has to locate the securities and reasonably believe they can be delivered. Of course, the procedures involved to "locate" the securities are new, and it's tough to get the supervisory system in place. Luckily, FINRA is there to help motivate the firms to improve their systems by handing out fines and naming names .
I'll let you take it from here:

Tuesday, October 27, 2009

Taxation on OID municipal bonds

A Series 7 customer just emailed me to question the tax treatment for original issue discount (OID) municipal bonds. To be honest, I've never felt 100% comfortable teaching on this topic and should have done some research on it a long time ago. So, no matter how dry an email about the veracity of taxation on original issue discount municipal securities might seem, I was actually quite pumped to dive in. Luckily, I've been doing so much searching at http://www.irs.gov/ lately that I was able to find what I needed in less than one minute. And, luckily, all I needed was Publication 550. That, plus a handful of Excedrin, the reading skills of an attorney, and the patience of Job. But, in the end I was rewarded by knowing that the way I teach taxation on discounted municipal bonds is, apparently, exactly right. I also noticed that I do, apparently, provide a useful service for Series 7 candidates by taking nearly incomprehensible English and making sense of it. In my Pass the 7 book, I try to keep it simple. In the book, my job is to tell you that an original issue discount (OID) municipal bond is treated differently from a STRIP. Since the interest on a STRIP is taxable, you have to report some interest income you haven't actually received on 1099-OID each year and pay tax on it. But, a muni is tax-exempt; therefore, you don't have to pay tax on anything and don't have to file anything. If you sell the bond before maturity, you get to step up your cost-basis to help reduce or eliminate a capital gain on the bond. I also then point out that when you buy a tax-exempt (muni) bond at a discount from an investor, things are wholly different. Now, that discount is taxable . . . as ordinary income!
Turns out, that is exactly right, no matter how strange it seems. But what really struck me is how difficult it is to get that all from the orginal bureaucratic, legalistic version. This is how the IRS explains what I just wrote above (From Publication 550) :
Original issue discount. Original issue discount (OID) on tax-exempt state or local government bonds is treated as tax-exempt interest. If the bonds were issued after September 3, 1982, and acquired after March 1, 1984, increase the adjusted basis by your part of the OID to figure gain or loss.
Discounted tax-exempt obligations. OID on tax-exempt obligations is generally not taxable. However, when you dispose of a tax-exempt obligation you must accrue OID on the obligation to determine its adjusted basis. The accrued OID is added to the basis of the obligation to determine your gain or loss.
Market discount. Market discount on a tax-exempt bond is not tax-exempt. If you bought the bond after April 30, 1993, you can choose to accrue the market discount over the period you own the bond and include it in your income currently, as taxable interest. If you do not make that choice, or if you bought the bond before May 1, 1993, any gain from market discount is taxable.

I guess what also struck me was how much I enjoyed reading Publication 550 and how much I, apparently, need to find myself a hobby.

Friday, October 23, 2009

Why I Hate Covered Calls

During the Friday Free Broadcast this morning I showed the attendees one of my account statements. One of the gentlemen in attendance saw a couple of steep losses and suggested that I write some covered calls to "get my money back on those stocks." At first glance, maybe it seems that collecting premiums $2 or $3 per-share at a time might help me recoup some losses on the stock. But the closer you look at covered calls, the less you find to like. In one sense, it isn't even possible to do what he suggests. Why not? If you bought the stock for $50 a share, and it's now worth $20 a share, there will be no strike prices at 50 or above even offered by the options exchange . . . or, if they are available you would get so little premium income writing these frightfully deep-out-of-the-money calls that it wouldn't be worth doing. If the stock is at $20, nobody wants to bet you it's going above $50 any time soon. To collect any decent premium on a $20 stock, the strike price has to be near $20. So, let's see if we have this right--we pay $50 a share for the stock. Now in order to collect $2 or $3 per share in call premiums, we have to be willing to sell the stock for $20 or $25? This is how I get my money back?
Not a chance. The only way to make money on a covered call is to have the stock price remain near your purchase price--and, gee, isn't that sort of what all stock investors would like? If you buy the stock at $50 and sell a Nov 55 call @2, you're okay as long as the stock stays at $48 or higher, but never goes above $55. If the stock drops below $48, you lose just like any other owner of that stock. But--and here is why I absolutely hate covered calls--unlike any other owner of that stock, should the stock go way up, you make none of the upside above $55. None of it. So, you're still exposed to the downside by nearly as much as any other owner--it's just the premium that separates you--but you also sold away your upside for $2 a share, capping it at $7 per share, no matter how high the stock goes.
Of course, it's not likely that a stock will drop to zero that fast, but if the $50 stock drops $10, $20, maybe $30 per share, your days of writing covered calls on it are over. As I mentioned, the strike prices can't be $20 or $30 below your purchase price if you want to make a profit. Right? Could you place a sell-stop below the purchase price? Not really--if that stock is sold automatically, the call you wrote is suddenly naked.
Anyway, next time you hear somebody on the radio or the Internet trying to convince you that covered calls = investment nirvana, factor in some of what I just wrote. And, if you can follow what I just wrote, that's a good sign that you can understand even the toughest options questions.

Thursday, October 22, 2009

Municipal Securities Question

When studying for the Series 7, it would be nearly impossible to work "too many" municipal securities practice questions. Remember that you will see at least as many questions on municipal securities as you see on options. And, options are much easier to work with--once you understand how they work, it makes no difference how they ask the question. With municipal securities questions, you're often struggling to recall an arcane vocabulary word, or the question is extremely vague. How would you answer the following question on municipal securities?

Which of the following represent(s) an accurate statement?
A. Municipal bonds are traded on a highly liquid secondary market
B. Some municipal bonds pay interest that is non-tax-exempt at the federal level
C. Municipal bonds are exempt from registration requirements
D. All choices listed

First, municipal securities are not highly liquid; in fact, many are illiquid. The school district in which I live recently raised $2,000,000 by selling municipal securities. That means if the bonds were par value of $1,000, there were only 2,000 bonds issued. If the bonds were $5,000 par value, there are only 400 bonds in the entire issue. There is no way that thing could have a liquid secondary market. Secondly, most but not all municipal bonds pay tax-exempt interest. I have an official statement from the City of New York here on my desk. One issue is for $9.2 billion and is described as tax-exempt by the bond counsel. The other issue is for a mere $80 million and is not tax-exempt. Perhaps if I were more curious about the Internal Revenue Code I would track down why the second issue is not tax-exempt, but I'm not, so I won't. But I can now eliminate Choice A and Choice B and, therefore, Choice D has to go, as well.
Leaving me with my answer: C

Monday, October 12, 2009

What's the best way to prepare for the Series 7?

I hear the following question all the time: what's the best way to study for my test?

The answer?

Hard. Really hard.

Seriously. This exam is not just trying to flunk you--it's trying to harass and humiliate you. On any given day, 2/3 of all test-takers fail the Series 7 exam. Obviously, FINRA likes it that way. And, why wouldn't they? The more times people have to take and re-take the exam, the more testing fees they generate.

Okay, so it's a hard test. You already knew that--the question is, what's the best way to study for it?

I recommend that you study 5 days a week for a total of about 20 hours, and that you do this for about 8 weeks in a row. At a minimum.


So, after you buy the Pass the 7 full package plus DVD (http://www.passthe7.com/), I recommend that you watch the DVD lesson that corresponds to each Pass the 7 book chapter first. Then, I would read the book chapter. Then, I would watch the DVD lesson again. Then, I would do all the practice questions on that chapter. And, yes, that would take me a lot of time, but I would really know something about that chapter before I moved on to the next one. Also, it's very easy to pop in a DVD and hit the Play button--after a few minutes of that, you'll be awake enough to put in an hour or so of hard, concentrated reading. Watching the DVD lesson once again will be a nice cool-down after reading, and then applying what you've studied to the practice questions will kick it all up a notch and leave you with that satisfied post-study buzz that will allow you to get some sleep. Face it, you have to sleep the two or three months that you study for your Series 7. And eat. And live your life like a normal person. If you go into the testing center looking and feeling like a zombie, you have statistically no chance of passing.

Once you've gotten through the book and done all the questions by-topic, it's time to take some final exams, which you'll probably do for the last week or two before your exam. Make sure you aren't memorizing answers, because whatever you study will not look exactly like the exam, no matter how hard the company markets their "expertise," or "results." We have some "Go No Go" exams that we can send a link to, so send an email. We'll also talk more about studying for the exam, trying to keep it as concise as possible.

Sunday, October 11, 2009

Annuity Payout

I just uploaded seven Series 7 recorded classes that you can purchase "on demand" at www.passthe7.com/classes.htm. There are three lessons on options, two that break down 20 practice questions step by step, one on trading securities, and one on retirement and annuities. The following practice question is on variable annuities and is exactly the sort of thing that pops up on the Series 7 exam.

So, please enjoy:

An annuitant chooses life with a 10-year period certain. If the annuitant lives 12 years, what happens?
A. the beneficiary receives two years of payments
B. the annuity pays out for just 10 years
C. the annuity pays out for 12 years
D. annuity units are converted back to accumulation units

EXPLANTION: with a 10-year "period certain" the annuity company will pay for at least 10 years but will also pay as long as the annuitant lives. Whichever turns out to be longer--that's how long they end up paying, either to the annuitant or the beneficiary after the annuitant dies.


Wednesday, October 7, 2009

IRA Contributions

Let's look at a practice question on IRA contributions.

Which of the following could reduce the amount that an individual may contribute to a Traditional IRA?
A. Roth IRA contributions made for the year
B. High income level
C. Participation in an employer-sponsored plan
D. All of the choices listed

EXPLANATION: if you were going too fast, you might have been tricked by this one. The other choices only affect how much can be deducted from the contribution, but anyone with earned income can contribute to their Traditional IRA.


Tuesday, October 6, 2009

Margin Question on Combined Equity

Let's enjoy a fun question on margin accounts:

One of your investors has both long and short stock positions in her margin account. Today, if the value of the long positions increases by $4,000 and the value of her short positions increases by $2,000, the combined equity will
A. increase by $6,000
B. increase by $2,000
C. decrease by $2,000
D. decrease by $6,000

EXPLANATION: remember that you want the value of a short position to drop. It’s nice that the long position advanced $4,000, but that was reduced by the $2,000 advance in the short position’s value


Saturday, October 3, 2009

Covered Call question

A customer just emailed me with the following concern:

I saw a question like the one below on the software my firm gave me--I think it's an internal product somebody higher up put together. I don't think there's a right answer. Can you help?

Here is the qestion:

An investor purchases 300 shares ABC @50 and writes 3 ABC Aug 55 calls @1.50. His maximum loss is . . .

I chose "unlimited" because of the short call position--what am I missing?


If the investor only wrote the three ABC Aug 55 calls, his risk would be unlimited, but this investor already bought the 300 shares he is obligated to sell and deliver for $55 a share. Therefore, he no longer worries about the stock rising; in fact, that would be his maximum gain. If the stock rises, he can make $5 per share plus the premium . . . maximum. His maximum loss is now pointing downward--he owns the stock. If it drops from $50 to zero, all he got to offset that was $1.50 per share. His maximum loss, then, is still $48.50 per share, times 300 shares.
That's why they say that covered calls provide "partial protection." The premium income is a nice way to "increase yield" or "increase overall return" on the stock, but it does very little to protect against a big drop. The best way to protect a long stock position, remember, is to buy a put. Having the right to sell your stock at a set price in case it drops is much better than having to sell your stock at a set price only if it goes up. I'm going to leave you with that thought--enjoy.

Tuesday, September 29, 2009

Regular Way Settlement

A customer just sent me an email that represents a concept many Series 7 students struggle with. She wrote:

Why is this answer 5 business days? I thought it was T+3 . . .?

An investor who buys 500 shares of common stock at $25 per share in a regular way transaction is required to deposit the money by
A. Trade Date
B. Settlement date
C. Trade Date plus 3 business days
D. Trade Date plus 5 business days

RESPONSE: broker-dealers must settle at T + 3. If they want to pay for their customer's trade and let the customer slide, they can only let him slide for 2 more business days; after that, they'd have to request an extension. So remember for a test question that firms settle at T + 3, but customers have 2 more business days to pay . . . if the firm wants to be that nice. We could say that customers must pay "5 business days after the trade," or "2 business days after regular-way settlement." It's imperative that we have at least two ways to say everything in this business in order to keep the customer totally confused.

Saturday, September 26, 2009

Ex-Dividend Date

A customer whom I am tutoring recently asked the following question:

Can you provide a timeline which explains why the record date is several weeks after the dividend is declared. I have been assuming the date the dividend was declared was when it was paid as well, therefore am confusing the ex dividend date.

The concept of the declaration, ex-, record, and payable date is almost certain to appear in one or two questions on your Series 7 exam. While options can be difficult, this topic is the equivalent of a two-inch putt in golf. Yes, you could miss it, but no you aren't going to let yourself. I don't care how tricky the question appears, understand that you will never miss an easy question involving the ex- or the record date.
First, the dividend has to be declared/announced by the Board of Directors. That's the declaration date. In the announcement, we discover the payable date, which is the date the dividend checks will be cut and delivered to shareholders. Only if you're a shareholder of record on the record date will you receive the dividend.
That's really the concept right there. If Abbott Labs declares a dividend of $1.00 per share, they announce when it's payable, and they announce the deadline for being an owner of the stock--if you want that dividend.
This is where T + 3 settlement enters in. You don't really own a stock until your purchase has settled/cleared between your broker-dealer and the broker-dealer whose customer sold you the stock. That takes three business days. Once the transaction clears/settles, you are recognized as the owner, but not until. So, if you bought the stock three business days before the record date, you would be recognized as the owner on that date and would, therefore, get the dividend when they pull up the big list of shareholders. However, if you bought the stock just two business days before the record date, you would not be the official owner of the stock in time. So, the seller gets the dividend, not you.
This day, two business days before the record date, is called the ex-dividend date because buyers won't get the dividend. Therefore, they won't pay for it either. If the dividend is $1, the share price drops by $1. Cash is an asset, remember, so if the company is paying out cash, the stock is worth that much less. And that's why it's a violation to hustle a customer into buying just to get this dividend--that's called "selling dividends." It's fraudulent in that it implies something false--the investor could just skip the dividend, buy the stock for that much less, and avoid the taxation on the dividend.

So, actually, these are simple concepts--it's just that they are woven together into a fabric of many, many concepts. You have to know what settlement means, and remember that it's T + 3 for "regular-way settlement." You have to remember that the board of directors declares a dividend, and how the dividend would affect an investor. The Series 7 is some pretty sophisticated stuff. But on any given day 2/3 of all test takers pass it.
Knowing the concepts for real--rather than pretending you've studied--is the only way to be in the happy 2/3 rather than the deflated 1/3 who have to come back in 30 days for another grueling day at the exam center.

If you can find an audience who'll listen, see if you can explain what I just told you about the ex-date, record date, etc. to a friend or loved one. If you can do that, then you know for sure you have a handle on it. On the other hand, if you just want to keep taking the same practice questions over and over again--the easy ones that give you that warm, happy glow inside--on the ex-date or record date, good luck with that. The questions on the Series 7 will look much different the ones you've taken 15 times now.

Thursday, September 24, 2009

Margin Update

Well, things on the margin front are looking very positive lately. My 90 shares of Hospira (HSP) are now worth about $4,000, with the debit balance at about $4,500. When I went into this, I was not planning on purchasing 100 shares FMBI on credit, but I did, and that added about $1,000 to the debit balance. Which is why HSP now has to pull more weight.

Luckily, it appears to be in a cooperative mood.

If it advances another $5-6 a share, I'll place a sell-stop slightly below the then-current market price. That means if the stock sits still or rises, I hold. But, if it drops, I fold.

Wish me luck. And, if I ever take another margin loan, somebody please shoot me.

Friday, September 11, 2009

Private Placement

It's early on a Friday morning, and--as usual--I'm looking through FINRA disciplinary actions and regulatory notices. I see that a firm in Okoboji, Iowa was fined $30,000 for doing "private placements" improperly. Remember that a firm can not, by definition, be doing a private placement if they're calling up a bunch of people they don't know. As FINRA indicates,
"The findings also stated that, in order to comply with Regulation D, the firm was required to have a substantive and preexisting relationship with each investor prior to the time that, acting through its representatives, it offered the company’s investment to prospective investors. The findings also included that the firm used the means of interstate commerce to offer and effect these transactions, engaging in a general solicitation with respect to the offering and, therefore, participated in the sale of unregistered securities."
Oops. Remember that to escape the registration requirement on the offering of securities, the SEC insists that the private placement is actually, you know, private. If you want to solicit a bunch of people, you're doing a public offering and must, therefore, register the stock, deal with the cooling off period, etc.

Tuesday, September 8, 2009

Inside market

The following practice question is likely to show up on everybody's version of the Series 7 in some form or another. I'm betting it will be on there almost verbatim. Not that you could, like, prove me wrong, but in any case, by the time you schedule your Series 7 exam, you should be pretty confident answering a question like this one:

The inside market is:
A. highest bid, lowest ask from the market maker quoting the largest position
B. highest bid, highest ask from all market makers
C. highest bid, lowest ask from all market makers
D. lowest bid, highest ask from all market makers

EXPLANATION: when a customer places a market order to buy or sell stock, he is willing to pay the best available price ASAP to get the stock or sell it. The best prices for the customer would be the highest bid--if he's selling and the lowest ask/offer price--if he's buying.


Monday, September 7, 2009

Balance Sheet

All of the following are affected when a company issues common stock except:
A. working capital
B. current liabilities
C. net worth
D. total assets

EXPLANATION: think through a tough question like this logically. Ask yourself what happens when a company sells stock in an IPO. They take in cash, right? Cash is a current asset, which is part of working capital and, by definition, part of total assets. Choices A and D are eliminated. Net worth is usually called "stockholders' equity," but you have to be flexible to pass the Series 7. Since the par value of the stock is listed under "net worth/stockholders' equity", as well as the "paid-in surplus," reflecting the price of the stock in the IPO, you have to eliminate choice C-net worth.
If that approach doesn't work for you, ask yourself where the "liability" comes into play--is the company borrowing money? No. Even if they issued a bond, that would be a long-term liability, so you can safely go with choice B.


Friday, September 4, 2009

FINRA Regulations

It's Friday morning and, as usual, I'm reading up on recent regulatory actions at the http://www.finra.org/ website. Reading the August recap, I see a pattern of firms being fined for failing to give customers a fair and reasonable price on transactions. But I also notice that often firms get fined by FINRA just for sloppiness. For example, NSM Securities in Palm Beach, Florida was just fined $50,000 for "failure to preserve all of its business-related electronic communications, including communications exchanged with its clearing firm for over a year." Institutional Capital Management of Houston, Texas was fined $10,000 for conducting business when their balance sheet (net capital) was insufficient. Prebon Financial Products, Inc. of Jersey City, New Jersey was fined $10,000 because it "failed to accurately report the execution time for corporate bond transactions to the Trade Reporting and Compliance Engine (TRACE); failed to accurately report the execution time for OTC equity transactions; and failed to accurately report the execution time or price for transactions in NASDAQ National Market securities. The findings also stated that the firm failed to include all of the terms and conditions of orders, the correct execution time on order tickets for equity securities transactions, and order tickets did not indicate whether transactions were long or short. The findings also stated that the firm prepared order tickets for transactions in TRACE-eligible securities that did not include the receipt time."
I am so glad I never did anything crazy like try and open my own broker-dealer. OMG, it would be a never-ending stream of fines and sanctions due to my decided lack of record-keeping skills. In any case, sanctions and fines often have little to do with malice or greed--it's just really hard to stay on top of all the details that need to be attended to in this industry.

Friday, August 21, 2009

More from the Margin Front

Well, things in the old margin account have certainly gotten interesting. Hospira, which I plan to sell in order to pay down the "debit balance," is doing okay--in fact, it's worth about $3,600, which is enough to pay down the initial loan. But, well, things got a little complicated. I had inherited 200 shares of FMBI, which is a bank holding company. Why did my 70-year-old mother hold shares of a bank holding company headquartered in Itasca, IL? Apparently, her father--my Grandpa Olson--was a founder of the Farmer's Bank of Wyanet, which was purchased by FMBI along with about a dozen other small Illinois banks. Why Mom had never mentioned any of this--who knows. In any case, the stock had been devastated, along with all other financial/bank stocks, and I was not willing to watch it drop to zero. So, I placed a sell-stop at $5.99. As you know, that meant that if the stock dropped to $5.99 or lower, it would be sold.
It did, and it was.
Well, I suffered the usual seller's remorse and started to worry that the stock would eventually rise without me. So, I placed a buy-stop on 100 FMBI at $10. As you know, that meant that if the stock rose to $10 or higher, it would be purchased.
It did, and it was.
This being a margin account, $1,000 of stock (plus a $9.99 commission) was purchased and placed on my tab, a tab which is now $4,557.78.
Hmm. I should probably place a sell-stop on HSP right now. That way if it plummets, I won't lose my best chance to pay off most of this silly margin loan.
I don't know. Every sell-stop I enter seems to be sold a few days later, at--by definition--a lower market price.
Oh well. Nobody forced me into this loan, and it isn't like I owe Tony Soprano. The interest rate is right around prime, and is tax deductible, unlike the juice I would have to pay to Mr. Soprano. I'll survive. I just want to win this one, even though I know how quickly I could end up losing.

Thursday, August 20, 2009

Economic Indicators

Today's headlines declare that US initial jobless claims rose unexpectedly. This, of course, is a negative sign. I'm just not sure why it's so "unexpectedly." There is a strange tendency of the media and investors to expect things to move in some smooth, linear path. If we're supposed to be in a recovery, surely all economic data will point to progressively more positive signs, right?
Not sure where that assumption comes from, but economic indicators never all point one way or the other. Maybe new claims for unemployment drop, while the number of people on unemployment rises a little bit--happens all the time. As I see in one of the news items today: The Labor Department said the number of people collecting long-term unemployment benefits edged up 2,000 to 6.24 million in the week ended August 8. However, the four-week moving average declined 2,500 to 6.27 million.
That's how tricky economic data can be--even though the number of people on unemployment ticked upward, the 4-week moving average declined. Moving averages, remember, help to show a trend as opposed to over-representing what happened just yesterday or just last week.
So, if you're wondering why it sometimes seems that nobody really knows where the economy is right now or where it's headed, there is a very good reason for that--nobody does.

Sunday, August 16, 2009

Active Military Duty

On the Series 7 exam you will see several questions about the registration of representatives and principals of a broker-dealer. One question might ask what happens when a registered representative volunteers or is called into active military duty. If he or she is away from the firm more than two years, does the license expire? Does he have to take continuing education courses in some cave in Afghanistan? Does she lose all the commissions she could have made on her "book of business"?

Not surprisingly, FINRA and the SEC are extremely accomodating when a registered rep or principal is called away from the firm to serve Uncle Sam. Here are the basic facts:

  • license is placed on "inactive status"
  • continuing education requirements waived
  • dues, assessments waived
  • two-year expiration period does not apply - exam might refer to this as "tolling"
  • can earn commissions, usually by splitting them with another rep who will service the book of business
  • the "inactive" rep can not perform any of the duties of a registered rep while on inactive status

You could see a question about a "sole proprietor" called into active military duty. If so, tell the test that the same bullet points above would apply.

Friday, August 14, 2009

Let's call it what it is--stealing

As usual, I'm up on a Friday morning reviewing the FINRA website to see if any new disciplinary actions or notices have been published. As usual, I'm not disappointed. As you can see by clicking the link below, it is a very bad idea to take money from clients and then try to cover it up with bogus account statements. Remember that you'll need to use the BACK arrow on your browser to return to the blog. See the full announcement at:

Also, I see a broker and her firm being sanctioned for talking people into taking out home equity loans in order to buy variable life insurance. This action is probably just the tip of the iceberg; I know of at least one firm who trains their new rep's to do exactly that--or did when the housing market made such loans readily available. See the full announcement at:

Today's Friday Free Broadcast covers industry rules and regulations. Sometimes I think every Friday should cover that topic.

Tuesday, August 11, 2009

Economic Indicators

If you're studying for the Series 7 exam right now, you picked a pretty good time. Every day the economy is in the news, it seems, and the news typically uses some of the same terminology you'll see on the test: new unemployment claims, unemployment rate, consumer confidence, corporate profits, GDP, recession, economic stimulus, etc. Try to relate what you're hearing, seeing, and reading in the news with what you're studying for your exam. When the media begins to chatter about new unemployment claims dropping, remember that this is a leading indicator, and it's good news. Recently, it was reported that while new claims for unemployment were dropping, the unemployment rate rose slightly. That's the difference between a leading indicator and a coincident indicator. The number of new unemployment claims was changing before it was being reflected in the number of people who remain on unemployment. GDP, a coincident indicator, has been shrinking, but since the rate of shrinkage has slowed lately, some economists point to this as "good news." The stock market, a leading indicator, has been rising since March, and many people pin their hopes of a recovery on that signal. If it seems that nobody really knows where the economy is headed over the next year or so, there is good reason for that--nobody does. But that doesn't stop anyone from reading the economic indicators and using the numbers to make predictions about the economy. Your job is to know which indicators are leading, coincident, and lagging, and to know their significance. Expect two or three questions on economic indicators on the Series 7 exam.

Friday, July 31, 2009

Closed-End Funds

As usual, I'm visiting the FINRA website on a Friday morning looking for recent regulatory actions. This morning I see an action against a couple of large firms concerning the fact that an IPO for a closed-end fund has a built-in sales charge (like any IPO) and, therefore, customers should not be advised to buy them during the offering and then dump them in the short-term. If you click on the link below you'll see how FINRA deals with such matters--they fine people, put them in the penalty box, and name names and reveal CRD numbers. In other words, it's a good idea to stay out of trouble. Check out the disciplinary action below. Once again you'll see how "real world" this Series 7 information actually is:


Friday, July 24, 2009

Order or Trade Tickets

The Series 7 is not all about crunching numbers; in fact, you might be surprised how little you use the calculator provided at the testing center. So, if options and certain bond questions intimidate you, please know that you can make up for that by knowing your vocabulary terms inside-out and knowing a lot of rules and procedures for the industry. One term you might encounter on your exam is "order ticket" or "trade ticket." Whenever a registered representative enters a buy or sell order for securities, the broker-dealer wants him to record certain information. The regulators also require that certain information be recorded at a minimum. Most of this is intuitive. If a customer tells you to buy 1,000 shares of ORCL for $21 or better, certain information is going to be required on the order ticket. How about if we identify the customer's account on this ticket? Sounds prudent. How about if we identify ourselves as the registered rep responsible either for getting the commission or screwing up the order, perhaps both? Then, we should probably indicate whether the customer placed the order himself--unsolicited--after we talked about it--solicited--or (much scarier) if we're using our discretion. This is a rather specific order, so we need to indicate "the terms and conditions of the order," which are that the customer will take 1,000 shares ORCL as long as the price is $21 or lower. Don't fill this order at $21.01, in other words.
As at most businesses, we should probably put down the time the order was received by the customer, and the department that places the trade can then record the time the trade was executed and the price.
The firm would probably require some more information on the trade ticket, but this is a regulatory exam, so know the minimum that is required on a trade ticket. Know that a principal must review each one by the end of the day and approve/reject each order. And, finanally, know that trade tickets are kept for three years, two years in a readily accessible location.


Wednesday, July 22, 2009

Options Question

We haven't done a practice question on options lately:

Your investor informs you that his market sentiment is currently "bullish-neutral." If the investor is not risk averse, you would most likely recommend that he
A. write call options
B. purchase call options
C. write put options
D. purchase put options

EXPLANATION: when you see "bullish" in the question, you can pretty well eliminate "A" and "D," which are bearish strategies. There is nothing "neutral" about purchasing a call option--you purchase a call only because you think the stock is going up in a hurry. If you write a put, you make money if the stock rises (bullish) or stays the same (neutral), which is why the answer is to write put options.

Saturday, July 18, 2009

Real-World Series 7

Ok, let's see if you can find the real-world significance of the following information. I just logged into my online brokerage account in order to write the previous blog post. When I reviewed the transactions over the past 14 days, I found something that illustrates an important testable point. See if you can explain the following:

07/09/2009 15:57:52 Sold 50 EQR @ 19.51 $965.48

07/10/2009 02:10:48 ORDINARY DIVIDEND (EQR) $36.19

If the stock was already sold on July 9th, why would I receive a dividend on July 10th? And, for extra credit, why is it an "ordinary" dividend?

On the Margin Trail

Hospira has advanced since I last reported, but is still down 11% from my purchase point. If the stock rises $3 a share, I'll be tempted to sell it, pay off the margin loan, and be done with it. But, if that happens, I would probably instead just place a sell-stop order slightly below the market price. In other words, if it rises to $40, I'll place a sell-stop at $38.50. That way if the stock stays above $38.50, I hold it; if it drops, it's liquidated. What I won't do is let the stock go up to $40 and then plummet with me still holding it like a total loser.
On the other hand, what if Hospira (HSP) drops from here? Then, I move on to Plan B, which is to take a loss, throw some cash money on the table and walk away from this crazy idea of borrowing money backed up with stock as "collateral."

On another note, the 200 shares of FMBI that I inherited a few years ago were triggered and sold at $5.99 when my sell-stop was activated. But, now that the big banks are reporting positive earnings, little bank holding companies like this one are starting to rise again. Unwilling to jump in just now, I placed a buy-stop-limit order for 100 shares FMBI, with an activation price of $10 and a limit price of $10.50. What if the stock drops from here? I'll be glad I never bought it. But if it rises to $10 or more, I'll end up with 100 shares.

Again, the idea that "this Series 7 stuff has nothing to do with the real world" is crazy. I'm using sell-stops, buy-stop-limits, and margin loans in my daily life. And pretty soon so will many of you.

Careful out there.

Friday, July 17, 2009

Even the little things

I know I often preach how "real world" the Series 7 information is, but this morning I have to point it out again. I'm doing the usual early Friday morning routine of visiting the FINRA website to see what sorts of disciplinary actions or hot topics are being discussed, and suddenly I'm clicking on a link to SIPC. You've probably seen a few questions about SIPC, but I doubt you've really considered the signficance of this industry-funded organization. Without the protection SIPC provides, I can't imagine how the brokerage industry would function. Take a look at www.sipc.org this morning, and you'll see three headlines dealing with SIPC's protection of missing assets at the now-famous Bernard L. Madoff Investment Securities, LLP (BLMIS). We're talking about hundreds of millions of dollars that investors would otherwise have to eat . . . all protected by this "SIPC" thing that is often just a tricky test question that no one thinks twice about.
Enjoy the real-world view and remember the most testable points about SIPC, including--but not limited to:
  • Protects customer assets at failed broker-dealers
  • Covers $500,000 per "customer" of which no more than $100,000 "cash" is covered
  • An industry-funded, non-profit insurance provider
  • Does not cover commodities, only securities

Monday, July 13, 2009

Interest Rates

A practice question on interest rates:

If explaining the concept of interest rates to an investing client, you would likely describe the concept in which of the following ways?
A. the real interest rate is the rate earned after taxes
B. the real interest rate is the rate earned adjusted for risk (i.e. beta, standard deviation)
C. the real interest rate is established by the Federal Reserve Board at regular policy meetings
D. the real interest rate is the rate earned above CPI

EXPLANATION: keep it real--if you earn 5% on your preferred stock when prices are rising 6%, you are losing ground; your real interest rate is negative. Inflation is measured by CPI; the real interest rate is only the amount you earn above inflation.

Saturday, July 4, 2009

Unit Investment Trusts

Under the Investment Company Act of 1940, there are three types of investment companies: face-amount certificate companies, unit investment trusts, and management companies. The two management companies are generally managed actively by a portfolio manager. The difference is just that you redeem the open-end shares for the NAV while you have to sell your closed-end shares for whatever the market will give you, often a discount to the NAV. The UIT (unit investment trust), unlike the open-/closed-end funds, is just a fixed trust of income-producing securities. It holds bonds or preferred stock usually, and the investors holding units earn a fixed stream of income until the trust is terminated, the unit values paid out to the unit holders. If interest rates rise, unit values will drop in value, but the income that the trust earns will stay the same. In a management company (open- or closed-end fund), the portfolio manager could take advantage of a rise in interest rates by buying new bonds paying higher yields. A UIT, however, is not managed. The investments are selected. Often the bond portfolio would terminate when all the bonds mature. Preferred stock, which is generally perpetual, would only be turned into cash if it were called by the issuer.

I'm not sure that UITs will make much of an appearance on the Series 7, but they're on the outline, and, therefore, you could easily see one or two questions. As always, you have to know just enough information about a vast array of topics to pass the Series 7 exam.

Wednesday, July 1, 2009

Margin Update

Just logged into my margin account and saw some interesting developments. I had inherited 200 shares FMBI when my mother passed away 5 years ago. They were worth $33.50 (fair market value), and after watching them fall farther and farther along with the financial sector, I decided to pick a pain threshold of $5.99. So, I placed a sell-stop order on 200 FMBI with a trigger price of $5.99. As fate would have it, the stock dropped and was sold automatically at $5.99 which, after the $9.99 commission, turned the stock into $1,198 cash money.

Except, since I owe the broker-dealer for the money I borrowed, guess how that "cash" was applied? Yep--they used it to pay down my debit balance, which is now $3,528.76.

My 90 shares of Hospira (HSP) are worth $3,425.40, so maybe it's time to think about selling them and paying off the margin balance?

Should I place a sell-limit a few dollars above the current price? Or, should I try to set a floor below the current price with a sell-stop order, selling only if the stock drops from here?
Or, should I just watch the market every day and place a market order if I have to? Who knows? The Series 7 doesn't tackle important questions like that--they just expect you to know the basic terminology and be able to follow a blog post like this one.

Saturday, June 27, 2009

One More on Margin

A good way to dig into the concepts behind "margin accounts" is to download the margin handbook at an online broker-dealer. After reading TD Ameritrade's Margin Handbook, I felt as if I could go on and on for hours about the topic . . . if I could get anyone to, you know, listen.

Or, you might just want to slog through annoying practice questions, like this:

If your investor sells 1,000 ABC short @37, makes the required Reg T deposit, and then sees that ABC is trading for $18, what is true of the equity in the account?
A. the equity is unchanged
B. the equity is below the minimum maintenance requirement
C. the equity has decreased by $19,000
D. the equity in the account is $37,500

EXPLANATION: whenever someone sells stock short, he wants the stock price to drop. Since ABC does drop, you know that A and B can't be right. The equity has certainly changed even if you aren't sure how. And, since the stock went the correct direction, the equity is improved not "below the minimum maintenance requirement." Do this type of work before you start calculating--knock things off your plate as soon as possible. Now, really, you could eliminate "C," since the equity has increased, and then to check your work do this . . . add the $37,000 the investor receives on the sale plus 1/2 that amount ($18,500), which is the cash he puts down. His Credit - $55,500. Just subtract the current market value of $18,000 from that, and you get the correct answer of $37,500. The opening credit on a short sale is "half again as much" as the short sale. Subtract the market value of the stock from that, and you've figured the "investor's" equity.

Thursday, June 25, 2009

Margin Update

Logged into my TD Ameritrade account this morning and found that Hospira (HSP) is still trading in the same range. My "SMA" is still about $2,000 and I'm still not going to tap that line of credit, let alone use my buying power to purchase up to $5,700 worth of stock. Good thing I took the $5,000 loan against SMA for educational purposes only, because this is a losing proposition as a so-called "investment." See, Hospira isn't paying any dividends, and even if they were, it's pretty unlikely that any stock's dividend yield is going to outweigh the margin interest that the "investor" is paying, even after-tax. As at the casino, the margin investor needs really fast movement on the stock, preferably in the correct direction. I'm lucky I have the $5,000 in checking because if HSP announces bankruptcy or that one of their I.V. systems accidentally killed 27 patients nationwide, the stock could drop to $2, or zero even. Probably not going to happen, but it's always a possibility when you're dealing with a stock. Investing in the stock market always involves market risk in general and non-systematic risk specific to the particular company. To then buy that stock on credit is to take an already dangerous animal and pump it up with steroids, which probably explains why I'm having so darned much fun with this. I'm a guy. I take stupid risks. What can I tell you?

Wednesday, June 17, 2009

Margin Question

Let's enjoy a challenging practice question on margin accounts:

A customer in a new margin account purchases 100 XYZ @38 and makes the required Reg T deposit. If XYZ rises to $52 a share, the equity in this long margin account will be
A. $3,300
B. $3,400
C. $3,200
D. $1,400

EXPLANATION: this is a very tough question. First, if you simply take 1/2 of $3,800, you will get the question wrong. But, if you're lucky enough to remember that the minimum maintenance is $2,000, you could easily mess up by writing $2,000 as the Debit Balance. Remember that if the customer deposits $2,000 on a $3,800 position, the Debit Balance is only $1,800. So, when the stock rises to $5,200, the equity is the difference of $3,400.

Margin Question

Not much to report on my adventures with margin loans. Hospira (HSP) is still about where it was, and unless it rises sharply, I'm going to have to dip into savings to pay back the loan I took from "SMA." Oh well. I'll keep you posted on that.

For now, let's do a question on margin accounts:

An investor purchased 1,000 shares of XYZ @50 in a new margin account, making the required Reg T deposit. If XYZ rises to $75 per share, the investor's buying power will be equal to:
A. $12,500
B. $25,000
C. $50,000
D. $75,000

EXPLANATION: the investor has a Debit Balance of $25,000 after putting down $25,000 cash money. When the stock value rises to $75,000, the equity rises to $50,000. Now--carefully--what is the Reg T requirement on $75,000? Only $37,500. So, there is $12,500 of excess equity or SMA. The customer can borrow $12,500; his buying power is twice that amount, or $25,000.


Thursday, June 11, 2009

Why I Do This

People often ask me why I choose to spend most of my waking hours thinking, speaking, and writing about exam material that most sane people wouldn't touch with a 10-foot pole. The answer is simple--the money. Seriously. Who'd a thunk that a guy could be a teacher and a writer and also be able to make a decent living. Not me, that's for sure. A few years ago, I was this close to resigning myself to the fate of a daily, per-diem Series 7 instructor for a big test prep company. Now here I am running a viable test prep business myself, having a ball thinking, speaking, and writing about exam material that most sane people wouldn't touch with a 10-foot pole. Or, if they did, they would probably focus on just one or two exams--covering the Series 6, 7, 63, 65, and 66 does seem overwhelming at times. But then I open up my inbox some days and get thank-you emails from glowing, proud, successful customers. Check out the two that I received this afternoon and you'll see that the reason I do this is about more than just the money:

Hey bob,

I'm delighted to inform you that I pass the 63. You material were key to my success. Let me know if you can use my referral. Now, I can keep my job with this difficult economy. Thank you for everything. Now, I want you to get me through the series 7 and 66 within the next 8 months if possible.


I just want to drop you a note and thank you for all that you have done for me. I sat for the Series 7 last Thursday and passed!I took the exam 3 years ago and really didn't know how to take the test.Everything in your book, cds, and quiz set make this very easy. I felt very comfortable, in fact I felt that you had me so prepared that when I finished I hit the button to see if I passed or failed and I did not even look up at the screen. I walked out and asked the proctor what my score was!!!!!!!!!!!!I have told numerous people around the country to look up your website.P.S. I will miss your Friday broadcasts!

Tuesday, June 2, 2009

What's a Hospira?

I've mentioned that the exit strategy for my little foray into margin loans is the inevitable rise of Hospira common stock. If Hospira rises to $55, I can sell my 90 shares, pay back the margin loan and continue to hold the other shares I currently hold in an IRA. But, what is this "Hospira" I keep referring to? It's a former unit of Abbott Labs, which is another stock I own (and love). Hospira was spun off from the parent comany, which is where I got my initial dose of the stock. Later, when I became the executor of my mother's estate, I purchased 270 shares, or 90 for me and each of my two sisters. Hospira is a very simple, straightforward company--basically, they make injectables and I.V. systems for use in hospitals, clinics, and in-home care. In the past five fiscal years, their sales/revenue came in at about $2.64 billion, $2.62 billion, $2.68 billion, $3.43 billion, and $3.63 billion. Their net income (profit) has been anywhere from $107 million to $321 million most recently. The stock is not trading expensively--like most stocks these days--at only 13 times earnings. It earns $2.61 per share but--like many companies--pays no dividends. How do you make money on a stock that pays no dividends? You wait for it to rise in value, at which point you can sell for a capital gain or, perhaps, the company eventually does start paying dividends, making it both a growth and an income investment. From a technical standpoint, the short interest is very low in the stock; only about 2.5% of the shares have been sold short. The 52-week high is about $42; the 52-week low is about $21. Lately, it's on an uptrend: +7% last 5 days, +8% last 30 days, +15% last 60 days. What does this all mean for my chances of Hospira rising to $55 or higher, allowing me to sell and pay back the $5,000 I borrowed from my margin account?
No idea. Luckily, the exam doesn't expect you to know something like that. The exam just wants you to have an idea what earnings and P/E ratios might be, which stocks are generally more volatile and which are generally more stable, that sort of thing. Being able to relate some of this exam material to the real world will give you a big edge when studying, so I encourage you to look up some of your favorite companies and look for testable points. Glance at the income statement, click on the "overview," and have yourself as much fun as I'm currently having at 4:55 AM on a cold, dreary morning in early June.

Tuesday, May 26, 2009

Fun with Margin

For those of you following my adventures with margin loans let me provide an update. I received a check for $5,000--no questions asked--from TD Ameritrade last Thursday and deposited it on Friday. Was this a withdrawal? Well, the test would probably call it that, but it's actually a loan backed up by the ever-volatile market values of the stocks inside the account. It's a loan against "SMA," and now I have to repay the $5,000 plus interest.

Interestingly, after I requested the check, I got good news from my publisher, First Books, who was kindly sending me a royalty check larger than I anticipated. I also sold 80 shares of NTRS and that check for $4,000 is now on its way, so I'm only partying at this point in the name of helping my customers and blog readers--I no longer even need the five grand. Either way, remember that the $4,000 was a withdrawal of funds after a sale of stock--I made sure they waited until the T + 3 settlement date so they wouldn't think I was taking another hit off that metaphorical crack pipe known as SMA. It's just my cash--please send it to me. And, they did, with no fees, no postage charges, and no questions asked. Remember that cash in a customer's account does earn the broker-dealer interest, but that cash amount is owed to the customer upon request and must be paid out promptly. Of course, with a margin loan against SMA, nobody has to cajole the broker-dealer--they can't wait to start charging me interest on that loan with the same enthusiasm that VISA apparently has for those little pretend "checks" they keep sending me, three to a page.

Remember, I "plan" to sell 90 shares of HSP after they rise at least $10 a share. If so, I'll pay back the $5,000 loan and likely never hit that pipe again. But, how often do a gambler's "plans" pan out? Not very often, so, as they say on the Mythbusters--please do not try this at home.

UGMA accounts

Let's look at a practice question that will look similar to something you'll probably see on your Series 7 exam:

To establish an account under the Uniform Gifts to Minors Act, the custodian must be a:
A. trustee
B. a registered investment adviser
C. an immediate family member of the beneficiary
D. a person who has reached the state's age of majority

EXPLANATION: the custodian simply needs to be an adult (not a minor). He/she does not need to be related to the beneficiary and does not need to be a professional investor. If you open an UGMA account for your niece, you can manage the investments yourself for the benefit of the minor child. And, the beneficiary does not need to be a relative; perhaps the neighbor boy you hire to cut your grass would enjoy a surprise upon his 18th or, perhaps, 21st birthday . . .?

Wednesday, May 20, 2009

Margin and the Real World

A "margin account" is simply an investment account that has been approved for the use of borrowed money. Most people would prefer not to put borrowed money into the stock market, but a margin account allows us to do just that. Of course, nobody's forcing us to use the line of credit that a margin account offers, any more than VISA is forcing us to spend money we don't actually have. As I've written elsewhere, a margin account is no more inherently dangerous than a bottle of Jack Daniels sitting on the shelf. It just depends on who opens it and how they manage things once the cap is off.
When we borrow against "SMA" we pay in the neighborhood of the prime rate, and, believe it or not, margin interest is tax deductible, meaning you can use it to offset/reduce any dividends or bond interest you receive in that account. So, it's a pretty decent line of credit to tap in an emergency. At least that's what I'm telling myself now that I just tapped it for $5,000. Long story short, I split up with a woman a few months ago and badly underestimated all the costs associated with the unwinding of that particular merger. I now sit here with $500 in checking, $251.11 in savings, and no car after buying a house in Texas that she will rent and eventually buy from me. In other words, I have two mortgages starting in July and almost no cash. You're derned tootin' I hit that line of credit called "SMA" yesterday. Took about 30 seconds to send TD Ameritrade an electronic request for $5,000. And, if the stock market cooperates, I should be able to borrow another $5,000 or more in a few months. Like every other gambling junkie who puts it all on number 21, I'm telling myself that Hospira is going to rise $10 a share, and I'll be able to sell 1/2 my shares to pay back the $5,000. Of course, you know how these "plans" tend to pan out, but for right now, I am really looking forward to receiving the $5,000. It might be intersting to track the progress of this potentially bone-headed decision; in fact, let's plan on it.

Tuesday, May 19, 2009

Stop, Limit, and Market Orders

Let's look at a question on stop, limit, and market orders. Try to use process of elimination until you find a strategy that works for the following pretend customer:

Your customer purchased shares of XYZ for $40 last year. Currently, with the stock trading for $65, your customer is concerned that the stock could drop sharply from its current price, although long-term, she wants to hold this investment if possible. You would recommend that she place
A. a market order to sell
B. a buy-stop order @66
C. a sell-stop order @67
D. a sell-stop order @64

EXPLANATION: the customer does not need to buy any more stock, so you can eliminate choice B. You can eliminate choice A since the customer thinks the stock may be worth holding long-term. A sell-stop order at $67 would be executed as soon as the stock traded at $67 or lower--since the stock is already there, the order would effectively be a market order to sell that might even cost the customer more $ to place than a market order to sell. Choice C, then, can be eliminated, leaving you with the right answer, D.


Wednesday, May 13, 2009

UGMA Accounts and Gift Taxes

For Tax Year 2009 the maximum gift that a donor can make to a non-related minor child in an UGMA account is
A. $11,000
B. $12,000
C. $13,000
D. None of these choices

EXPLANATION: don't jump to conclusions! Sometimes test questions try to mislead you. You're supposed to start thinking about the annual gift tax exclusion amount, which was $12,000 for 2008 and is $13,000 for 2009. That only has to do with gift taxes. If you give someone more than $13,000 this year, you pay gift taxes on the excess above $13,000, which has absolutely nothing to do with this question. There is no such thing as a "maximum gift" for an UGMA account.


Saturday, May 9, 2009

Practice Question, Bonds

Which of the following corporate debt instruments issued by the same corporation would tend to offer the highest yield?
A. 10-year convertible bond
B. 10-year non-convertible bond
C. 15-year subordinated debenture
D. 15-year collateral trust certificate

EXPLANATION: bonds with longer terms pay higher interest rates to investors, just as you would expect to pay a higher rate on a 30-year vs. a 15-year mortgage. So, you can eliminate choice A and B. Now that you're left with two 15-year bonds, ask yourself which one is more secure? Choice D has collateral behind it (a portfolio of securities). So, eliminate D, and you're left with C. Subordinated debenture holders are the lowest creditors in the pecking order.

Wednesday, May 6, 2009

Berkshire Hathaway annual meeting

I enjoyed listening to Warren Buffett and Charlie Munger mention many concepts and terms used on your Series 7 exam this past Saturday. The very first slide that Mr. Buffett displayed showed a trade ticket, which, right there, is a Series 7 concept. A trade ticket is just a record of a trade--what was bought or sold, how much was bought or sold, at what price the securities were bought or sold, etc. This trade ticket illustrated how panicky the markets became starting last September, and how hard traders had to scramble to post collateral. How? The ticket showed that Berkshire Hathaway was able to sell $5 million par value of T-bills for more than $5 million--$90 more to be exact. It wasn't that Warren was excited about making a risk-free $90; he was showing us that for a while, people were accepting negative yields on Treasuries. In a flight from stocks to Treauries, investors kept pushing up the price of T-bills, pushing their yields so low that the yields went negative for a while. Yes, that means people were willingly losing money on T-bills for a few days, and, yes, the money would have been much better off under their mattresses. Crowds do crazy things when spooked. If the Qwest center had been hosting a heavy metal band as opposed to 35,000 laid-back shareholders, I might have been concerned about a stampede or a melee erupting at any point. Same thing happens in the markets. People freak out on stocks and send a great company like Wells-Fargo below $10 a share while simultaneously snatching up T-bills that give them back less money than they started with.
Wild stuff.
Moody's was brought up in one of the harder-hitting questions posed by shareholders. Somebody wanted to know why Berkshire didn't use its influence over Moody's after purchasing the company. Not sure if the Series 7 cares, but the fact is that Moody's and S & P are paid by the issuers of the bonds to assign credit ratings. Talk about a conflict of interest, right? If you're being paid by GE to assign a credit score that determines GE's cost of borrowing, might you not be just a little bit kind in your ratings? But Buffett said that conflicts didn't cause the housing bubble, and that he and Charlie don't micromanage their investee companies like that. Then Charlie pointed out that Moody's had just downgraded Berkshire Hathaway's Aaa credit rating, so "maybe that shows a little bit of independence" he said, with a shrug of cool sarcasm that got a big laugh from the massive crowd.
When asked about the derivatives markets that seized up, Warren pointed out that unregulated trading markets involving vast sums are dangerous--there is a reason that the Fed mandates 3-day settlements and 50% collateral in margin accounts. See, those funky mortgage-based derivatives that nearly wiped out Wall Street completely were trading in unregulated markets where settlement dates were vague, and the "contra parties" to the contracts could just hem and haw until finally it became apparent that the contracts were no good.
I certainly did not expect to hear about Reg T and 3-day settlements at this meeting, but there were many cool surprises like that. Not to mention, the $15 box of See's candies turned out to be frighteningly good. Warning: don't open a box of See's candy if you're on a strict diet. Good thing I run so many miles a week.

Thursday, April 30, 2009

Insider Trading, OMG

So that stuff you're learning about insider trading is, like, important. Luckily for us, the recent SEC insider trading enforcement action provides the perfect example of how insider trading works and why you've seen questions about "firewalls" or "Chinese Walls" that are supposed to separate a broker-dealer's investment banking division from the trading division. Notice how the individual at the link below knew about upcoming deals and then both passed out and traded upon this knowledge.
Can't do that--it's like shooting fish in a barrel, and the SEC wants to maintain a fair and orderly market for securities so that people don't just walk away and refuse to provide capital to companies and governments issuing securities on the primary market. I have nothing to add here--just read the news story at the link below, or click the title, which is always a URL, as well.


Omaha, Somewhere in Middle America

Sitting in a hotel room in Lincoln, Nebraska getting ready to speak at an Omaha Public Library at noon about how securities regulations affect both industry professionals and investors. Hoping for a good turnout, but one never knows. On Saturday, the turnout at the Berkshire-Hathaway annual shareholder meeting is expected to be about 35,000, or about 5,000 more than the White Sox usually draw even when still in playoff contention. If you want to learn about investing and perhaps pick up some good information related to the exam, check out Buffett's shareholder letters, starting with 2008. You'll find them at: http://www.berkshirehathaway.com/letters/letters.html If you open the 2008 letter, you'll see an amazing track record stretching back to 1965 (the year after I was born) and showing a percentage gain of 362,319% for Berkshire-Hathaway vs. the S & P 500's 4,276% gain. In other words, although few people can beat the S & P 500, the few who do can trounce the thing. And, those who invest simply in the S & P 500 index funds can also expect to do pretty well. I'll let you read the 22-page masterpiece that discusses Berkshire's business model, its recent forays into municipal bond insurance, and how it expects to do in 2009 after having its worst year ever in 2008.

Monday, April 27, 2009

On the road to Omaha

This week I'm off to Omaha for the Berkshire-Hathaway annual shareholder meeting. I'm actually speaking Thursday at the W. Dale Clark Library, 215 S. 15th St., in Omaha from noon - 1:30 PM. I'm going to talk about how regulations and registration requirements affect both financial services professionals and investors. Should be a rip-roarin' good time.

Friday, I'll be doing the Friday Free Broadcast (on Taxation) from my luxury hotel room then trying to figure out what the heck to do in the Lincoln-Omaha area for the rest of a Friday. Knowing me, I'll be blogging, writing practice questions, or otherwise engaging in geeky pursuits.
Saturday is the shareholder meeting, and my two B shares (BRK.B) get me into the event. Luckily, this year a panel of journalists will ask a question after each shareholder question is posed. In previous years, the shareholder questions have gotten so far off track, it reminds me of a Series 7 class being run by a lazy instructor who sneaked a few cold ones at lunch on a Friday. With any luck, this year we'll get to talk about the holding company known as Berkshire-Hathaway and any investment wisdom that Warren and Charlie care to impart.

So, yes, I'm excited about the week ahead, which, by definition, makes me a nerd. That's okay. It's spring in the Midwest, I own two whole shares of Berkshire-Hathaway, and I get to write about my little roadtrip to an appreciative audience. Things could be worse.

I promise I'll only write about topics related to the exam, but that should not be hard. From the cumulative or statutory voting used at the meeting, to the income statement and balance sheet, to the EPS and P/E ratio, there will be plenty of test-related informaton to impart from the road. If you really want to dig in, read the annual shareholder report at:

Be well and study hard. See you in Omaha, if you happen to, like, live there.

Sunday, April 26, 2009

The Bond See-Saw

Many test questions based on math concepts are presented without numbers, which actually makes things harder to deal with. Let's take a look at an example early on a Sunday morning:

If your customer purchases a corporate bond whose face amount exceeds the market price, which of the following statements is inaccurate?
A. the bond's yield to maturity will exceed its current yield
B. the bond's curent yield will exceed its nominal yield
C. the bond's nominal yield will exceed its yield to maturity
D. all choices listed

EXPLANATION: first, the way this question is worded is intentionally deceptive. You see the word "exceeds," and you automatically read it as if the market price exceeds the par value. No--just the opposite. The phrase describes a discount bond. I bet 40% of all test-takers would miss that right off the bat and, therefore, continue down a path of doom. Second, the question exploits the inherently intimidating relationship between bond prices and bond yields. Third, by asking which statement is in-accurate, the test question takes it all up to an even higher, nastier level. What should you do? I recommend smiling and taking a deep breath, realizing that anyone who chooses to write tricky Series 7 questions as a career path can't be all that damned smart--this question can be figured out with patience and confidence. As always, attack a problem step-by-step. Step one--what the heck are you being asked? The question is saying, in its deceptive way, that a bond was purchased at a discount. Step two, what does that mean? It means that all yields will rise above the yield printed on the bond (nominal yield), and they go up in this order: current yield, yield to maturity, yield to call. Once you have that visual, you just start eliminating wrong answers. Unfortunately, if the statement is true, you have to eliminate it. Oy! Okay, the first statement is true--YTM will be higher than current yield, so A is eliminated. The next statement is true--current yield will be higher than nominal yield--so B is eliminated. Now, many test-takers get a false sense of rhythm and confidence. They feel a "flow" building and get too lazy to really read Answer Choice C, assuming that all three statements are probably false because, well because they're done thinking about this damned question.
No way. I learned from my years of throwing elbows on the basketball court that you have to hustle right through the final buzzer. You snooze for one second, and your man can get by you and win the game. When my opponent is some weasle like the Series 7, I am just not willing to let him shuck-and-jive his way past me for a cheap point. So, is Choice C true or false? Is the YTM lower than the nominal yield? No, so we eliminate it, right? Only if we want to lose--remember, we're still looking for the in-accurate statement. C is in-accurate and, therefore, it is the correct answer.


Don't get discouraged--not all Series 7 questions are this hard. In fact, if they were, few would pass it. Approximately 67% of all test-takers pass the Series 7 on any given day, so there is no way that all the questions could hit this hard. However, a certain percentage do hit this hard. Therefore, if you can get in shape to handle even the hard-hitting questions like the one we just looked at, you will pass with flying colors. Remember that the bond see-saw is fundamental on the Series 7, providing some of the trickiest questions of all. If you need extra help send me an email.