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 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.