If you’ve studied for a securities exam other than the Series 66, you’ve probably noticed how sensitive the term guarantee is. In most situations, using it suggests an unethical and/or illegal practice. The same idea applies here, but there’s one specific context where the word can be used legally.
A security is considered guaranteed when a third party (usually an insurance company) promises to cover any unpaid interest, dividends, and/or principal.
It’s important to separate payment protection from market value. A guaranteed security can still lose value in the market, and that loss isn’t covered by the third party.
For example, suppose an investor buys a bond with a $1,000 principal (par) value* for $1,200. If the bond defaults (meaning the issuer can’t repay the borrowed funds), the insurance would cover only:
The extra $200 the investor paid above par would not be covered.
*The specifics related to bonds and other securities are generally not tested on the Series 66. You should know what the term ‘guaranteed security’ refers to and what’s covered by the third party. The exam typically doesn’t go much further than that.
Outside of guaranteed securities, the term guaranteed is usually tied to unethical activity. In particular, financial professionals must never guarantee that a security will perform in a certain way. This includes:
One defining characteristic of a security is the possibility of loss. That’s why performance guarantees and securities don’t mix.
Even if a guarantee against loss sounds appealing, it isn’t feasible for broker-dealers, agents, investment advisers, or investment adviser representatives (IARs) to offer. If a registered person guarantees more than they can actually cover, the promise can become a serious financial risk - especially during a major bear market (for example, the Great Recession). For that reason, financial professionals should avoid performance guarantees entirely.
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