Study guide
Section II of the NASAA outline carries a 17 percent weight, about 17 scored questions, and surveys the full menu of investment products: cash equivalents, bonds, stocks, pooled vehicles, derivatives, alternatives, and insurance-based products. The exam rarely demands deep pricing math here; it tests whether you know each vehicle's defining features, risks, costs, and tax treatment well enough to tell similar products apart.
Cash Equivalents and Fixed-Income Valuation
Cash and cash equivalents are the safest, most liquid assets. Insured deposits include demand deposits (checking accounts) and certificates of deposit, both backed by FDIC insurance up to $250,000 per depositor, per bank, per ownership category. Money market instruments are high-quality short-term debt: commercial paper is unsecured corporate debt issued at a discount with maturities of 270 days or less, and Treasury bills are short-term U.S. government obligations sold at a discount, considered the risk-free benchmark. The tradeoff for safety is purchasing-power risk, since yields may not keep pace with inflation. For bonds, remember the seesaw: prices and interest rates move inversely. Duration measures how sensitive a bond's price is to rate changes; the longer the maturity and the lower the coupon, the higher the duration, so a 30-year zero-coupon bond is far more rate-sensitive than a 2-year high-coupon note. Yield to maturity is the total compound return if the bond is held to maturity, and yield to call recalculates the return assuming the issuer redeems early, which issuers do when rates fall. For a bond trading at a discount, yield to maturity exceeds current yield, which exceeds the coupon; a premium bond reverses that order. Credit quality is graded by rating agencies, with BBB/Baa and above deemed investment grade. The credit spread is the extra yield a corporate bond pays over a comparable Treasury; spreads widen when investors grow fearful. A convertible bond's conversion value equals the number of shares received upon conversion times the current stock price.
Equity Securities: Types, Rights, and Valuation
Common stockholders own a residual claim on a corporation: they vote for directors, may hold preemptive rights (antidilution rights letting them maintain their percentage ownership in new offerings), and stand last in line in liquidation, behind creditors and preferred holders. Foreign shares often trade in the U.S. as American depositary receipts (ADRs), receipts for foreign shares held by a bank; ADR investors face currency risk even though the ADR is dollar-denominated, and ADR holders generally do not vote the underlying shares. Preferred stock pays a fixed dividend and behaves like a bond, falling when interest rates rise; convertible preferred can be exchanged for common shares, and floating-rate preferred resets its dividend periodically, reducing rate sensitivity. Restricted stock is acquired in unregistered transactions and can be resold publicly only under conditions such as holding periods. Employee stock options come in two tax flavors: incentive stock options (ISOs) get favorable capital-gains treatment if holding rules are met but can trigger alternative minimum tax, while nonqualified options (NQSOs) produce ordinary income at exercise. Analysts value equities through fundamental analysis (studying financial statements, management, and the economy), technical analysis (studying price and volume charts to time trades), the dividend discount model (a stock is worth the present value of its expected future dividends), and discounted cash flow. New equity reaches the market through an initial public offering (IPO), a first-time sale to the public; a secondary offering of additional or insider shares; or a special purpose acquisition company (SPAC), a blank-check shell that raises cash first and finds a business to acquire later, carrying notable uncertainty for investors.
Pooled Investments: Funds, Trusts, and Their Costs
Open-end mutual funds continuously issue and redeem shares at net asset value (NAV), computed once daily under forward pricing, so orders execute at the next calculated NAV. Share classes differ by cost structure: Class A shares charge a front-end sales load (often with breakpoint discounts at larger purchase levels), Class B shares charge a contingent deferred sales charge that declines over time, and Class C shares charge a level annual fee. All funds bear ongoing expenses, including any 12b-1 distribution fees, expressed in the expense ratio. Closed-end funds sell a fixed number of shares in an IPO and then trade on exchanges at market prices that can sit at a premium or discount to NAV. Exchange-traded funds (ETFs) also trade intraday but typically track indexes cheaply and use an in-kind creation and redemption process that keeps prices near NAV and enhances tax efficiency. Unit investment trusts (UITs) hold a fixed, unmanaged portfolio that terminates on a set date, with no board or portfolio manager. Real estate investment trusts (REITs) invest in property or mortgages and must distribute at least 90 percent of taxable income to shareholders; exchange-listed REITs are liquid, while non-traded REITs are illiquid and carry high fees. Private funds, including hedge funds, private equity, and venture capital, are limited to wealthy or institutional investors, often charge a management fee plus a performance fee, and impose lockup periods restricting withdrawals. When comparing pooled vehicles, evaluate the right benchmark, manager tenure (has the manager who built the record stayed?), style consistency, and any change in investment policy.
Derivatives and Alternative Investments
The Series 66 requires only definitional command of derivatives. An option is a contract giving the buyer the right, but not the obligation, to buy (a call) or sell (a put) an asset at a set strike price before expiration; the buyer pays a premium, which is the most the buyer can lose, while the seller (writer) collects the premium and takes on the obligation to perform if the option is exercised. Investors buy calls when bullish and puts when bearish, and a put can hedge a long stock position like an insurance policy. A futures contract, by contrast, obligates both parties: the buyer must take delivery and the seller must deliver the underlying commodity or financial asset at a set price and date. Futures are standardized, exchange-traded, and marked to market daily, and most positions are closed out before delivery. Among alternatives, leveraged funds use derivatives to deliver a multiple (say two times) of an index's daily return, and inverse funds deliver the opposite of the daily return. The trap is the word daily: because the multiple resets each day, compounding causes long-term results to drift far from the stated multiple in volatile markets, making these products unsuitable as long-term holdings for typical investors. Structured products are bank-manufactured notes combining a bond with derivatives to offer customized payoffs, often illiquid and complex. Exchange-traded notes (ETNs) are unsecured debt obligations of the issuing bank that track an index; unlike an ETF, an ETN holds no underlying assets, so the investor bears the issuer's credit risk on top of market risk.
Insurance-Based Products, Commodities, and Digital Assets
An annuity is an insurance contract designed to provide income, often for life. A fixed annuity pays a guaranteed rate backed by the insurer's general account; the insurer bears the investment risk, so a fixed annuity is not a security, though the owner bears purchasing-power risk. A variable annuity invests in subaccounts held in a separate account; the owner bears the investment risk, so it is a security requiring a prospectus and both securities and insurance credentials to sell. An indexed annuity credits interest tied to an index's performance, limited by a participation rate (the share of the index gain credited) and a cap, with a floor typically protecting against loss. Life insurance parallels this structure. Term insurance is pure death protection for a set period with no cash value, offering the largest death benefit per premium dollar. Whole life has fixed premiums and a guaranteed cash value. Universal life allows flexible premiums and adjustable death benefits, with cash value growth tied to current interest rates. Variable life invests cash value in separate-account subaccounts, making it a security. Commodities and precious metals such as gold are real assets often used as inflation hedges, but they generate no income and can be volatile. Digital assets, such as cryptocurrencies and tokens, are recorded on distributed ledgers; the exam expects you to know they may be regulated as securities when sold as investment contracts under the Howey analysis, and that they carry distinctive risks including extreme volatility, custody and cybersecurity exposure, and evolving regulation.
Key terms
- Duration
- — A measure of a bond's price sensitivity to interest-rate changes; higher for longer maturities and lower coupons.
- Yield to maturity
- — The compound annual return earned if a bond is held to maturity, with all payments made as scheduled.
- Credit spread
- — The extra yield a corporate bond pays over a comparable Treasury, which widens as perceived credit risk rises.
- American depositary receipt (ADR)
- — A U.S.-traded receipt for foreign shares that carries currency risk despite being priced in dollars.
- Preferred stock
- — An equity security paying a fixed dividend, with priority over common stock and bond-like interest-rate sensitivity.
- Net asset value (NAV)
- — A fund's assets minus liabilities divided by shares outstanding, the per-share price for open-end fund transactions.
- Closed-end fund
- — A fund with a fixed share count that trades on an exchange at a premium or discount to NAV.
- Unit investment trust (UIT)
- — An unmanaged pooled vehicle holding a fixed portfolio that terminates on a set date.
- REIT
- — A pooled real estate vehicle that must distribute at least 90 percent of its taxable income to shareholders.
- Exchange-traded note (ETN)
- — An unsecured bank debt obligation tracking an index, exposing holders to the issuer's credit risk.
- Variable annuity
- — An insurance contract funded through separate-account subaccounts in which the owner bears investment risk, making it a security.
- Call option
- — A contract giving the buyer the right, not the obligation, to buy an asset at a set price before expiration.
Exam tips
- Sort products by who bears investment risk: fixed annuities and whole life shift risk to the insurer (not securities), while variable annuities and variable life shift risk to the owner (securities requiring a prospectus).
- Leveraged and inverse funds track a multiple of the DAILY return; any answer choice recommending them as a long-term buy-and-hold is almost certainly wrong.
- ETF versus ETN is a credit-risk question: an ETN is unsecured debt of the issuer, so if the issuing bank fails, ETN holders can lose money even if the tracked index rose.
- For discount bonds, rank the yields: nominal (coupon) is lowest, then current yield, then YTM, then yield to call is highest. Premium bonds reverse the order exactly.
- Closed-end funds and non-traded REITs are classic pairing traps: closed-end funds are liquid but can trade below NAV, while non-traded REITs avoid market-price swings but sacrifice liquidity.