This Document Has a Complete Index at the End

Series 7 Study Notes

This document has a complete index at the end.

Table of Contents

Sec 1.1 Securites

Sec 1.2 Stocks

Sec 1.3 RIGHTS & Warrants

Sec 1.4 Types of Stocks Identified by Market Risk

Sec 1.5 Corporate Bonds

Sec 1.6 Interest, Yield, and Price Calculations

Sec 1.7 Convertible Securities (ConSec)

Sec 1.8 US Government Securities

Securites

Sec 1.1 Securites

I)Characteristics of Equity Securites

a)Two types of Securities

i)Equity

ii)Debt

b)Equity Securites

i)Authorized Shares

(1)corp first formed

ii)Issued Shares

(1)number of shares

iii)Outstanding shares

(1)held by shareholders

(2)doesn’t include repurchases by corp[1]

iv)Treasury stock

(1)repurchased shares by corp

(2)issue – outstanding = treasury stock

v)Par Value

(1)Arbitrary number

(a)Maybe $100

(b)Many corps use low par value now

(i)Benefits for taxes

(ii)Benefits for redemption

(iii)Issued between stated capital and capital surplus

vi)Limited liability

(1)protects individuals

vii)Persons rights as shareholder

(1)stock certificate

(2)selling when they want

(a)when selling, they have ‘stock power’

(i)stock power merely allows transfer of security from one person to another

(3)can hold in Street Name

(a)no rights lost

(b)usually named to broker/dealer

viii)Corp can issue Escrow Receipt

(1)provides evidence of ownership

(2)holder retains all rights

(3)non-transferable

(4)limits selling of shares

ix)ADR

(1)Issued from foreign bank

(2)deposited in American bank

(3)Some aren’t registered

(4)when selling ADR

(a)uses Transfer Agent who

(i)records

(ii)receives

(iii)ascertain propriety

(iv)cancels old shares

(v)issues new shares

(b)Share Agent

(i)Prevents over issue

(ii)Keeps current record of shares issued

Sec 1.2 Stocks

I)Rights of Common Stockholders

a)Common Stock

i)Equity Security

(1)Without definite dividend or other privileges

b)Rights of Common Stockholder

i)Pro Rata share of dividend

(1)Dividend = payment of earnings

ii)Inspect books

iii)Inspect shareholder list

(1)Though, limited to protect trade secrets

iv)Vote on

(1)board members

(2)charter changes

(3)issues presented by corp

v)residual assets

(1)after other creditors paid (bond holders etc.)

vi)Limited liability

(1)Can’t lose more than invested in stock

vii)Transfer of shares

(1)Selling a stock

viii)Voting rights

(1)Statutory

(2)Cumulative or Block

(3)Statutory

(a)Regular way. One share = one vote.

(i)If three offices available for vote and shareholder has 500 shares then shareholder can cast 500 votes PER OFFICE and must split votes equally among the three offices or 500 per office.

(4)Cumulative or Block

(a)Assists minority investors

(b)Shareholder owns 500 shares.

(i)Can cast 1,500 votes anyway shareholder chooses.

(ii)Can split votes anyway shareholder chooses, between number of offices being voted on, in this case, there are three offices. (Number of Shares*Offices = Number of votes cast).

(5)Proxy

(6)In Person

ix)Non Voting Shares

(1)Helps dilute equity to prevent takeover

x)Dividend (Div)

(1)No obligation by corp to issue

(2)Once declared all shareholders receive type declared

(a)Types

(i)Cash

(ii)Stock

(iii)Property

xi)Dilution of Common Stock and Pre-Emptive Rights

(1)Dilution is done by selling/issuing more shares

(2)Pre-Emptive Rights (PER)

(a)May be given to shareholders

(b)Offers shareholders First Right of Refusal

(c)Allows shareholders to hold equal percentage of company and not have shares diluted by issuance.

(d)Laws depend on State

(3)Mechanics of Rights Offering

(a)If corp declares PER

(i)Send ‘RIGHTS’ to shareholders

(ii)Short-term deal

30-90 days

(iii)Shareholder send check to corp (number of rights*subscription price)

(b)Corp may hire

(i)Rights Agent

Handles subscription

c)Stock Splits, Dividends, and Reverse Splits

i)Split

(1)Reduces price

(2)More affordable to public

ii)Dividend

(1)Same affect as a split

(a)Corp gets no funds

(b)Market value of outstanding shares DON’T change

iii)Reverse Split

(1)Opposite of split

(a)Increase price

(b)Reduces shares outstanding

II)Preferred Stock (PreStck)

a)Advantage

i)Dividend can be stated as a percentage

ii)More rights than Common shareholders

(1)Must be paid first incase of liquidation

(2)Must be paid dividend first also

iii)Issued at Par Value (usually)

iv)Doesn’t have

(1)Pre-emptive rights

(2)Right of first refusal on new issue

(a)There’s never a rights offering on Preferred Stock

(3)Voting rights (except in special circumstance that allows for voting of board members in case dividend hasn’t been paid.

v)No Par Value

(1)Occasionally issued

b)Types of preferred stock

i)Cumulative (CUM v Non-Cumulative (NC)

(1)CUM

(a)Par preferred first if corp can’t meet div payment and corp decides to pay missed dividend at later date

(2)NC

(a)Corp doesn’t need to make-up missed dividend payment

ii)Convertible (CON) v Non-Convertible (NCON)

(1)CON

(a)Right to convert to Common Stock

(2)NCON

(a)No right to convert to Common Stock

iii)Participating (PART) v Non-Participating (NPART)

(1)PART

(a)If earnings are high, you can receive additional dividend after first dividend is paid to common and preferred holders

(2)NPART

(a)None of the above

iv)Prior (PRI)

(1)PRI

(a)Priority over preferred holders

(b)Existing preferred holders must vote on issuance of PR

(i)Corp may do this to get itself out of financial trouble.

(ii)Or, corp is in great shape and preferred holders really don’t care about prior.

v)Callable

(1)Most preferred is callable

(2)Forces preferred holders to sell the corp their shares, but usually at premium

(3)Corp must state price of call when stock is issued.

III)Fractional Shares

a)Usually happens due to splits, warrants, reverse splits, rights etc.

i)Holder may buy extra fraction to make whole share

ii)Corps usually like to call these shares in for redemption.

Sec 1.3 RIGHTS & Warrants

I)RIGHTS (RTS)

a)Usually 30-90 time frame

b)Subscription price is usually below current market price

c)Corp issues new shares

i)Send letter to SEC (or Files with SEC)

ii)Send letter to Common Shareholders (CS)

iii)Letter states

(1)Subscription Price (SP)

(2)Number of RTS issued (NORI)

(3)Time Period of Expiration (TPOE)

(4)Number of Shares in Issue (NOSINI)

d)Number of Rights Issued (NORI) = Number of Shares Outstanding (NOSO)

i)Or:

(1)NORI = NOSO

e)Calculate Number of Rights Per Share (NORPS)

i)NORI / NOSINI = NORPS

ii)Example

(1)GE has 100,000 Shares Outstanding

(2)Issues 50,000 more shares

(3)Calculate NORPS

(a)100,000 / 50,000 = 2 RIGHTS Per Share (RPS)

(b)So RPS = NORPS; NORPS = RPS

f)CUM-RIGHTS (CR)

i)From period of Filing with SEC to Effective Date (when issue begins trading) the shares trade CR.

(1)CR = Old shares trade with Cumulative Rights. Buyers can participate in new issuance buy purchasing old shares.

g)EX-RIGHTS (ER)

i)When issue begins trading on Effective Date, old shares are traded ER. There are no more CUM-RIGHTS. (Also, Effective date here can be called EX-DATE)

h)CR Formula

i)Market Price (MP) – Subscription Price (SP) / NORPS +1 = CR price

(1)Or:

(a)MP – SP / NORPS+1 = CR price

i)ER Formula

i)MP – SP / NORPS = ER price

II)Warrants

a)Subscription price is usually ABOVE current market price

b)Long term

c)Issued w/bonds

d)Perpetual Warrant = good for life

e)Has exercise price

i)Usually at a premium to current market price

f)Right to purchase Common Stock at exercise price (when stock hits said price)

g)Corps may issue to underwriters as incentive

h)Corps like warrants due to Low interest rate they can offer on the bond issuance

i)Warrants usually have Anti-Dilution agreements (ADA)

j)If there is ADA then warrant are adjusted for splits, dividends over time.

Sec 1.4 Types of Stocks Identified by Market Risk

Blue Chip Stocks
Crop is strong, well established
Usually pays dividend in good and bad times
Appealing because it offers:
steady income
capital gains
Growth Stocks
Crop is growing steadily
Corp usually reinvests profits back into the corp
No significant div paid
Appealing because it offers:
Capital gains
Emerging Growth Stocks
Corp is in early stage of growth
Corp is young
Crop hasn’t reached profitability yet
No div
Appealing because it offers
Capital gains
Very risky
Income Stocks
Corps pay high div
Corp is mature in a stable industry
Utilities are common in this category
Appealing because it offers:
Income
Some potential for capital gains
Cyclical Stocks
Corp is dependent on business cycle
Manufacturers, retailers
Appealing because it offers:
Anticipation of economic recovery
Defensive issues Stocks
Corp is unaffected by business cycles
Food, utilities, tobacco
Appealing because it offers
Defense against recession or depression
Speculative Stocks
Corp has little or no earnings, maybe a start-up
Very risky
Penny stocks fall into this category (Stock trades below $5 a share)
Appealing because it offers
Large returns on capital
Special Situations Stocks
Special in a way that something is affecting the company that isn’t necessarily business related. Good news or bad news.
Pending tender offer where corp is seeking buyer
Corp ‘A’ is selling at $20 a share. Corp ‘B’ offers $30 a share. No one cares what Corp ‘A’ is earning at this moment in time, they are concerned with the offer of Corp B. If you own Corp ‘A’ at 20 and Corp ‘B’ offers 30, then you stand to make a lot of money if that offer goes through.
Or maybe the company is getting sued. If they win, their stock price goes up, if they lose, they will have to file for bankruptcy.

Sec 1.5 Corporate Bonds

Characteristics
Corp sells bonds to raise money. They are merely borrowing money.
Par value of a bond is assumed to be
$1,000 per bond
Interest payments are stated as a percentage of Par
Issuer redeems the bond at maturity for Par value
Interest payments are made semiannually
After August 1984, all corporate bonds are issued in ‘registered form’ or ‘book-entry’.
Registered Bonds
Physical certificates are registered with the issuing corp
Corp send interest payments to holder semi-annually
Book-Entry Bonds
No physical certificate issued.
Corp keeps record of persons and institution to whom it owes money,
Corp bonds used to be issued in bearer bond form
Actually sent out a certificate with coupons attached which the holder (buyer) redeems semi-annular for interest payments due to holder.
Indenture (or Trust Indenture)
Agreement the corp produces with all characteristics of the bond being sold included in this document.
Includes
Interest payment amounts and times paid
Call features
maintenance of certain financial ratio’s
appointment of a firm (maybe a bank) to act as trustee for the bondholders in case of default etc.
Terms
Callable:
Corp has right to call bond issue, however, this should be stated in the indenture. Sometimes it is in the best interest of the corp to call the bonds and pay a premium to the investor.
Convertible Bonds:
Bond holder has right to convert bond to common stock.
Put (tender) Option:
Gives bondholder right to sell the bond back at a specific time and specific price, normally Par.
Serial Bond
Many different maturity dates
Corp may issue $100mm in bonds but ladder (stagger) them from 5-10 years.
Intent is to NOT have the issue of 100mm come due all at once.
Series Bond
Bonds issues at different times
Example
Corp issues Series A in 1992. Then issues Series B in 1997.
Term Bond
Bonds mature at the same time
Issuers may establish a sinking fund with term bonds.
Sinking fund amounts to a savings account. In which the issuer lays money aside each year until the bond issuance matures so they have the money to repay the bondholders.
Redemption
Repayment of corp bond at or before maturity.
Same as calling the bond.
If redeemed at maturity, Par value is paid
If called early, the corp will usually pay premium. Corp will only do this if it is in its best interest to do this. Interest rates would have to be low enough that the corp can reissue and pay a premium on the old issue. Then, overall it would be saving money at the new interest rate.
Debt can be converted into stock also. More on this later.
Characteristics of Secondary Market
Highly liquid
Large market
Traded OTC
Dealers trade among themselves.
Traded in many different places including the NYSE but most are traded OTC
Yellow sheets
Prices are listed on them. These sheets are produced by a company called Pink Sheets LLC.
Available weekly in paper form. Daily by fax or email or through quote system.
2,500 corps listed and all are ‘Taxable’ debt, high yield, convertible and foreign.
Available on Internet based systems, organized as auction systems, single and multi dealer cross matching systems.
Participants include the small investor to large institutions.
Price considerations in the Secondary Markets (SM)
Bond owners use SM to sell bonds they own
price is determined by prevailing interest rate in SM
Determining price
Most bonds always yield a fixed interest rate
Interest rates mirror fixed-rate bond prices or said differently, interest rates and fixed-rate bond prices move in opposite directions.
bond price up / interest rate down
interest rate up / bond price down
Credit rating and reputation of the seller affects price
Standard and Poor’s Corporation (S&P) and Moody’s Investor Services rate corporations for credit rating.
Higher rating = better interest rate for issuer (corporation that sell the debt).
Higher rating = safer investment for buyer.
Moody’s rating system from best to worst: Aaa, Aa, A, Baa, C, D (D = in default)
S&P rating system from best to worst: AAA, AA, A, BBB, C, D (D = in default)
4th highest rating from either rating company are said to be ‘Investment Grade Bonds’.
Ratings affect the price of bonds. AAA will get a lower interest rate while B will get a higher interest rate.
Corporate bond prices are quoted as a percentage OF par
If bond is quoted at 95, then, it can be read as 95% of par which is
$950 ($1,000*95%).
if bond is quoted at 105, then, it can be read as 105% OF par which is
105 ($1,050*105%)
Types of Corporate Bonds
Types are classified according to
collateral pledged
purpose of the financing
Mortgage Bonds (MB)
collateralized by real property
corp is selling the bonds to by property (instead of taking a loan from a bank)
MB’s are issued as
Closed-ended or
If new bonds are issued on the same collateral the corp must pay the original issue off first (same as a 2nd mortgage on a house)
Also, in the new issue the new bonds are said to be ‘subordinated’ to the old issue.
Open-ended
There’s no subordination
New bonds have same right as old bonds concerning payments and rights of foreclosure
Equipment Trust Certificates
issued by transportation corps
collateralized by ‘rolling stock’
rolling stock is a long-term asset with wheels per say.
examples:
airplanes
trucks
railroad cars
corp is pledging the equipment as collateral
usually issued in Serial Form (staggered maturities)
3 types of equipment trust plans
equipment mortgage plan
borrower holds title
property is held in trust (same as a mortgage bond)
the New York plan
the trustee buys the equipment with funds from securities and the borrower pays cash payment and annual principal and interest payments until debt is paid off.
Title is then transferred to borrower
the Philadelphia plan
title remains with trustee until borrower finishes rental payments
Debentures
backed by the full faith and credit of issuer
usually issued under trust indenture
Income Bonds
interest is paid, ‘when, as, and if earned’.
also called ‘adjustment bonds’
issued by corps in bankruptcy
outstanding bonds in the corp are exchanged for Income bonds
extremely risky
usually trade at a substantial discount
Collateral Trust Bonds
secured by Securites of another corporation such as a subsidiary if the issuer
if issuer defaulted on interest payment, then collateral will be liquidated to pay bondholders
Eurodollar Bonds
in recent years corps have sold dollar denominated securities to tap the Eurodollar market
they are called Eurodollar bonds because they are issued outside the U.S.
don’t have to be registered with the SEC
often pay lower interest rates compared to other bonds due to issue costs, faster speed to the market, and they are attractive for private transactions.

Sec 1.6 Interest, Yield, and Price Calculations

Computation of Accrued Interest for Bonds
This calc is necessary when someone purchases a bond after the original issue date
Buyer pays seller accrued interest from date of last payment, not including the settlement date
Settlement date is when brokerage firms swap the bond and the cash
Settlement normally takes place 3 business days after the trade.
Accrued interest is calculated using
30 day months
360 day years
formula
Principal (P)* Rate (R) * # Days (ND) / 360
Or
P*R*ND / 360
Mid-month payments
in interest payments fall in the middle of the month, special consideration is taken
Example: Bond issued by corp states that the interest payments will be Feb 15th and Aug 15th as opposed to Feb 1st and Aug 1st.
formula
remember, interest is paid UP TO but not including the payment date itself
therefore if the payment falls on the Feb 15th then interest is paid through the Feb 14th. Since we assume a 30 day month and 14 days have already been paid, then there would be 16 days left in Feb.
We’d use the formula above (1.f.)
P*R*16 / 360
Or
Principal * Rate * 16 (days left in Feb) / 360
Government Bonds
Settle the next business day after the trade (instead of 3-days mentioned above (1.d.)
Use actual calendar year of 365 days (instead of 360 days mentioned above (1.e.ii.)
Bonds that don’t trade w/ Accrued Interest (there are 3 types)
Bonds in default
don’t pay any interest at all (issuer has missed interest, or principal payment)
Income bonds
pays ‘when, as, if earned’
Both of the above are said to be ‘trading flat’
Zero-coupon
When an individual buys a bond and has to pay accrued interest that accrued interest is subtracted from the gross interest to arrive at the net taxable interest.
formula
interest for the first year = interest payments (IP) – accrued interest paid (AcIntP).
or
IP – AcIntP = Interest for first year
Yield Calculations
5 important calcs
nominal yield (NY) or coupon rate (CR)
current yield (CY)
yield to maturity (YtM)
yield to call (YtC)
dividend yield (DY)
nominal yield (NY) or coupon rate (CR)
interest rate stated on bond
based on % of par value
NM doesn’t change, regardless of any change in the market price (after security is issued)
current yield (CY)
Annual Interest Payment (AnIntP) / Current Market Price(CMP), or
AnIntP / CMP
AnIntP is also known as Coupon Rate (CR)
Example
10% bond is trading 90
10% can be expressed as NY = 10% or
Nominal Yield is 10% or
Coupon rate (CR) is 10%.