Thursday, July 30, 2009
That's basically what you need to know about the Sharpe ratio. Now you can move on to the 9,873 other things that you need to know for your exam.
Thursday, July 23, 2009
See how the IL Administrator can protect IL investors from offers of unregistered securities, even if the issuer is in another state?
In the following order, you'll notice that even what seems like a private arrangement between two parties can meet the definition of a "security." Unfortunately, all that results is an "order of prohibition," which means as long as he doesn't do it again, he's okay. He doesn't have a license to take away, right? Unlike you and your co-workers, who had better be on your best behavior from Day 1.
Here's that order of prohibition:
See if you can make sense of the legalese. It's a good preparation for your exam, trust me.
Friday, July 17, 2009
A. straight preferred stock
B. convertible preferred stock
C. convertible debentures
D. common stock
EXPLANATION: bonds and preferred stock are subject to interest rate risk--rates up, market price down. They pay a fixed rate of return, so whenever interest rates on new fixed income securities go up, the market values of existing fixed income securities drop. Every single time. Common stock doesn't pay a fixed rate of return, so interest rates are not as relevant to its market price. The market price for common stock is based on expectation of future profits, with bits of news driving those expectations up and down every day.
All righty then. Using these fundamental concepts, we can eliminate common stock, and then, since common stock drives the value of convertible preferred and convertible bonds, we can eliminate those two choices, too. We're left with straight preferred stock, which pays a fixed rate of return, period.
Thursday, July 16, 2009
Which of the following represents a true statement concerning licensing and registration of registered representatives and investment adviser representatives?
A. passing a license exam constitutes the attainment of a license to sell securities or investment advice
B. upon passing a license exam a candidate is licensed subject to being granted a registration by the state
C. agents register with the SEC; investment adviser representatives register with FINRA
D. a conviction of misdemeanor theft does not need to be disclosed on Form ADV after 10 years
EXPLANATION: I wrote this question after receiving an email this morning from a customer studying the Series 65. He asked, "After getting a license do I need to register as an RIA?" In other words, he mistakenly thought that passing the exam = getting a license. And, he didn't realize that "license" and "registration" are two words for the same thing. Some states call it a "license," others call it a "registration." either way, passing an exam only allows you to APPLY for a license. Will you get one? Probably not if you have misdemeanor theft convictions in the previous 10 years. Believe it or not, Form ADV only goes back 10 years, while U-4 asks if you have EVER been convicted of securities-related misdemeanors or any felonies. Agents register with FINRA; IARs register with the state Administrator(s).
Tuesday, July 14, 2009
Like the following gem that you might actually see on your test:
If an investment adviser representative needs to calculate a portfolio's expected return, he will be working with which of the following?
A. geometric mean
B. arithmetic mean
C. mean reversion
D. harmonic mean
EXPLANATION: mean reversion can be eliminated. This is what the geniuses at Long Term Capital Management based their trading strategy on, allowing them to lose $500 billion dollars 15 years ago when something happened that their models didn't, like, factor in. I don't know what the "harmonic mean" is, and I'll probably indulge in a rare academic treat of not looking it up. If we calculated an "arithmetic mean," we would be figuring a simple average that would be misleading for investing. For example, if you put $10,000 into your brokerage account and had the following returns, what would your account be worth at the end of the third year?
Year 1: -10%
Year 2: -20%
Year 3: +30%
If we try to take a simple "arithmetic mean" or average of -10, -20, and +30%, it might seem that the account should be back at $10,000. But, in fact, the account would be worth only $9,360. When the value dropped 10%, the account went to $9,000. When it lost 20%, it dropped to $7,200. If that account rises 30%, we're only back to $9,360.
So, in order to avoid this mistake, we would need to find the so-called "geometric mean," rather than the "arithmetic mean." And, if you can choose the right term on this possible test question, you will be that much closer to passing. So, there you have it.
Let's look at something that is just weird and trivial enough to make it onto your exam:
An investment adviser purchased ABC 4.5% callable debentures for the omnibus trading account last May, allocating the bonds to various client accounts. Now in April the adviser receives warrants to purchase ABC common stock as a bonus for purchasing the debentures. If the adviser places the warrants in his own account
A. he has complied with prudent investor standards, as warrants are unsuitable for bond investors
B. he has breached his fiduciary duty to his clients
C. he has engaged in standard practice for omnibus trading accounts
D. the warrants are not subject to registration requirements
EXPLANATION: if the warrants were part of the offer of the bonds, I don't see why the adviser thinks he gets to keep them. And, if he does keep them, he's putting his interests ahead of his clients, which is a breach of fiduciary duty.
Yeah, so when you get yourself licensed as an IAR or RIA, please remember not to keep all them-there warrants that issuers send your way. And, for now, be ready for a test question like this one, or even goofier.
Monday, July 13, 2009
So there's that. But, what if you saw a question like this one?
Several of your advisory clients are retired investors in need of estate planning services. Your firm does not specialize in these services and, therefore, you have an arrangement with a local tax attorney by which you receive a flat $275 referral fee for every advisory client who becomes an estate planning client of the attorney's pursuant to your referral. Therefore
A. you must disclose the referral arrangement to all clients who use the attorney's services
B. you must disclose the referral arrangement to all clients referred to the attorney
C. you need not disclose the referral arrangement
D. you have violated the Uniform Securities Act's prohibition against advisory referrals
EXPLANATION: everything the adviser does must be totally objective and, when that's not possible, disclosure of the conflict is required. If the adviser refers clients to the attorney, clients might assume he's just looking out for their interests. But, by definition, he's looking out for his own financial interests, too--so he's no longer being objective. And, maybe there are better attorneys out there at better rates. So, disclosure is definitely required.
Friday, July 3, 2009
"What's that?" my buddy asked.
My buddy, in a somewhat condescending tone, explained to his uncle that "these days, earnings don't matter, Uncle Jim."
A few months later the tech bubble burst, NASDAQ crashed, and is still below 2,000, when it was at about 5,000 at that time!
Earnings don't matter?
Good thing Uncle Jim knew better. Five years later he passed away and, having no children of his own, left a stock portfolio worth just shy of $1 million to his three nieces and two nephews, even the one who tried to tell him that earnings don't matter. Since that time I have never bought a stock in a company that is not showing a profit/earnings. And, by golly, not one of my companies has ever gone bankrupt or had their stock de-listed--having, like, a profit can really keep a company out of trouble as it turns out. I don't buy sexy, exciting companies--I buy companies with strong brand names quietly churning out millions of dollars a year in profits. Companies like the JM Smucker Company. Most people would think--you want me to buy stock in a jelly and jam company? No. Dig a little deeper and you see that they own all of the following brands: Crisco, Jif, Hungry Jack, PET, and Pillsbury. Look at their income statement and you'll see that their sales jumped from about $2.5 billion in 2008 to $3.7 billion in 2009, after climbing steadily the previous three years. Their net profit margin is fairly high for their industry space --7.08%. We all probably use some of their products, or know people who do. Therefore, I'll become rich off the 100 shares I purchased this morning, right?
Unfortunately, no one can tell you that. I don't care if they use modern portfolio theory, technical analysis, or the kind of fundamental analysis I'm referring to in this post--nobody knows the future. Not even Warren Buffett. The name of Buffett's company, Berkshire Hathaway, by the way, comes from the first acquisition Buffett ever made, which, ironically, turned out to be one of his all-time worst investments . . . a textile manufacturer.
In any case, your assignment today is to take some big, boring company like Microsoft, IBM, J M Smucker, or Procter & Gamble, and look at a profile. What are their sales/revenue? What are their profits? Do they pay a dividend? How much, and what is the dividend yield? Smucker's (SJM) is trading for about 15 times earnings (P/E ratio), pays a dividend of $1.40, for a dividend yield of 2.9%. What about the companies that you're interested in?
Thursday, July 2, 2009
Here is Question 8 and the answer from the Colorado Division of Securities website:
Q: Are there any exemptions from licensing for an IA located in another state, that are not FCAs?
A: The law contains a diminimus exemption from licensing for an IA that has no place of business in Colorado and has five or less clients in Colorado.
By "FCA" can you guess what they mean? Federal Covered Adviser. So, if I'm not a federal covered adviser, I have no place of business in Colorado, can I have 5 clients there without registering there? Yes. This saves you some time and money. Of course, if you defraud these Colorado residents, Colorado can come after you, and so can your state securities Administrator. But, you don't plan to do anything like that, of course.
And, of course, things change when the adviser employs an IAR with a place of business in Colorado, as # 9 on the website explains:
Q: What is required of an IA located in another state that is not a FCA, has five or less clients in Colorado and employs one or more IARs with a place of business in Colorado?
A: The difference between this question and the one immediately above is the IA employs IARs with a place of business in Colorado. It does not matter how many clients are located in Colorado. An IA should file a current Form ADV and pay the appropriate fee. For each IAR with a place of business in Colorado the IA shall file a Form U-4 for each individual and pay the IAR fee.
As you can see--and as I've written before--much of the information that you study for your exam is connected to the real world. It's just buried under a bunch of tricky exam questions filled with mumbo-jumbo. But the de minimis exemption is 5 on the test and 5 in the real world. Just thought you'd like to know that.