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: 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.

Wednesday, April 22, 2009

Economic Indicators

Bond yields would be expected to rise due to a drop in which of the following indicators?
A. prime rate
B. unemployment claims
D. building permits

EXPLANATION: remember that bond yields rise as economic activity increases. So, a drop in GDP is associated with falling yields, as is a drop in building permits. If the prime rate is dropping, we would assume other interest rates are dropping. But, when unemployment claims are dropping, that means people are going back to work, which is the only indicator that might point toward an increase in economic activity.


Thursday, April 16, 2009

Bond yields

Let's look at a possible exam question on everybody's favorite topic: bond yields.

S&P just downgraded a corporate bond, pushing the bond’s yield
A. down
B. sideways
C. up
D. in a bond-ladder direction

EXPLANATION: if the rating goes down, so does the “quality,” which means the price falls. And, when the price falls, the yield rises. Would you pay as much for a junk bond as you'd pay for a Treasury bond? Not a chance--the riskier bonds cost less and yield more.


Friday, April 10, 2009

MSRB Rules

It's Friday morning and, as usual, I am visiting the FINRA website to see which firms are being hassled currently for rule violations. I always enjoy seeing some of your testable points in action, and this morning I see that a firm is being fined for failing to deliver official statements with new issues of municipal securities. As always, this is not a dig on the particular firm--there are so many ways to violate MSRB and FINRA rules that it would only surprise me if a well known firm did not find itself in hot water every couple of months.

You can read the news release at:

Monday, April 6, 2009

Discretionary Authorization

Which of the following orders would require written discretionary authorization?
A. Buy 1,000 shares of XYZ today
B. Buy 1,000 shares of XYZ when the price is right
C. Buy as many shares of XYZ as you think I should buy when the price is right
D. All of the choices given

WHY: written discretionary authorization for the account is only required if the customer lets the rep choose the Action (buy/sell), the Asset (which stock?), or the Amount (# of shares). If the rep is merely choosing the time/price at which to enter an order where the customer has already named the 3 A's . . . that doesn't require written discretionary authorization. So any rep can choose time/price, but only those with discretionary authorization over the account can choose ANY of the three A's.

Saturday, April 4, 2009

The Dreaded Yield Spread

Let's enjoy a difficult practice question on a Saturday, shall we?

One of your customers, Joe Myers, calls to inquire about something he heard but did not quite understand on CNBC. "Why is the price differential between low-risk and high-risk debt securities smaller than usual?" he asks. You would respond
A. turn off the TV and get a life, Joe
B. it means investors are confident in the overall economy
C. it means investors are not insisting on safety to the same degree
D. both B and C

EXPLANATION: right now, investors will accept tiny yields on Tbills, Tnotes, and Tbonds and won't touch junk bonds (corporate and muni) unless the bonds offer ridiculously high rates. The "yield spread" has widened in other words because investors are freaking out. For a few days, investors dumped everything and ran to Treasuries, accepting NEGATIVE yields on Tbills. Seriously--people were giving Uncle Sam $1,005 in order to receive $1,000 in 3 months, essentially, which is known in financial textbooks as "really stupid." Now, if the difference in yields between ultrasafe Treasuries and junk bonds narrows, that expresses confidence. Investors aren't so worried about companies defaulting on them and will pay more for the bonds/accept lower yields.