Investment Vehicle Characteristics
Roughly 20% of the Series 66 tests the features and risks of the products you will recommend: equity, fixed income, pooled and packaged products, derivatives, and insurance-based vehicles. You do not need trading-desk depth, but you must know how each vehicle behaves, what risks it carries, and which client it fits. The recurring theme is matching a product's risk-and-return profile to the suitability picture built in the previous chapter: growth and voting from common stock, steady income from bonds and preferred, low-cost diversification from funds and ETFs, leverage and hedging from options, and tax-deferred insurance guarantees from annuities.
Equity Securities
Common stock represents an ownership (equity) interest in a corporation. Common shareholders get voting rights, letting them elect the board and approve major actions, and a residual claim on earnings and assets, meaning they are paid last, after creditors, bondholders, and preferred shareholders, in a liquidation. That last-in-line position makes common stock the riskiest layer of a company's capital structure, but it also captures the greatest upside: shareholders own the growth after everyone else is paid, so common stock is the primary vehicle for long-term capital appreciation. Dividends on common stock are discretionary and can be cut. Preferred stock is also equity but behaves partly like a bond. It typically pays a fixed dividend (stated as a percentage of par) and ranks ahead of common stock for both dividends and liquidation proceeds, though still behind all creditors. Because its income is fixed, a preferred share's price is sensitive to interest rates much like a bond, and it usually offers little capital-appreciation potential. Varieties matter: cumulative preferred accrues any skipped dividends that must be paid before common dividends resume; participating preferred can share in extra profits; and callable preferred can be redeemed by the issuer. Convertible securities blend debt or preferred income with equity upside. A convertible bond or convertible preferred can be exchanged, at the holder's option, for a set number of common shares. This gives the investor downside protection from the fixed income stream plus participation if the common stock rises, usually in exchange for accepting a lower coupon or dividend. Finally, every equity price reflects two forces: company-specific factors such as earnings and management (unsystematic risk, which diversification can reduce) and market-wide factors such as recessions and interest rates (systematic risk, which it cannot). Understanding that split ties equity analysis back to the portfolio theory of Chapter 2.
Debt Securities
A bond is a loan from the investor to the issuer, repaid with periodic interest and principal at maturity. The central relationship to memorize is inverse: bond prices and market interest rates move in opposite directions. When rates rise, existing bonds paying the old lower coupon become less attractive and their prices fall; when rates fall, existing bonds rise. The magnitude of that swing grows with maturity and duration, so a long bond is far more rate-sensitive than a short one, an idea you saw quantified by duration in Chapter 2. Issuer type drives the risk mix. U.S. Treasury securities carry virtually no default (credit) risk because they are backed by the full faith and credit of the federal government, but they are not risk-free: they still face interest-rate risk, reinvestment risk (having to reinvest coupons at lower rates), and inflation (purchasing-power) risk, which is especially damaging to long Treasuries. Treasury Inflation-Protected Securities (TIPS) adjust principal for inflation to address that last risk. Municipal bonds, issued by states and localities, usually pay lower nominal yields because their interest is generally exempt from federal income tax; to compare a muni fairly with a taxable bond, compute the taxable-equivalent yield = muni yield ÷ (1 − marginal tax rate). Munis therefore favor higher-bracket investors. Structure and credit quality round out the picture. Zero-coupon bonds pay no periodic interest; they are issued at a deep discount and mature at par, so the entire return comes from price appreciation, which makes them highly sensitive to rates and creates "phantom" taxable income each year on the accreted value. Investment-grade bonds (BBB−/Baa3 and above) carry lower default risk and lower yields, while high-yield or "junk" bonds (below investment grade) offer higher yields to compensate for materially higher default risk and behave more like equities in a downturn. Callable bonds add reinvestment risk because issuers redeem them when rates fall, exactly when the investor would least like to be repaid.
Pooled Investment Vehicles
Pooled or packaged products let many investors share a professionally managed portfolio, and the exam wants you to distinguish their structures and share classes. An open-end fund (the traditional mutual fund) continuously issues new shares and redeems existing ones directly with the fund at net asset value (NAV), which is calculated once per day after the market close using forward pricing. Because shares are bought and sold at NAV (plus any sales charge), open-end funds do not trade on an exchange and cannot be sold short. Share classes change how you pay: Class A charges a front-end sales load but lower ongoing 12b-1 fees, favoring large or long-term investments; Class B historically used a back-end contingent deferred sales charge that declines over time and then converts to A; Class C charges a level load (higher annual 12b-1 fees, little or no front load), which suits shorter holding periods but is costly if held for many years. Closed-end funds differ sharply. They issue a fixed number of shares in an IPO, after which the shares trade on an exchange between investors at a market price set by supply and demand, which can be at a premium or a discount to NAV. Their fixed capitalization lets managers hold less liquid assets. Exchange-traded funds (ETFs) combine features of both: like closed-end funds they trade intraday on an exchange, but a creation/redemption mechanism keeps their price close to NAV. ETFs are prized for low expense ratios, transparency, intraday liquidity, and tax efficiency (their in-kind redemptions generate few capital-gains distributions). Unit investment trusts (UITs) hold a fixed, unmanaged portfolio and have a set termination date, offering low cost but no ongoing management. Real estate investment trusts (REITs) give investors real-estate exposure and income in a liquid, exchange-traded form. To keep their special pass-through tax status, a REIT must distribute at least 90% of its taxable income to shareholders, so REITs are income vehicles, but those distributions are generally taxed as ordinary income rather than as qualified dividends. Equity REITs own property and earn rents; mortgage REITs lend and are highly rate-sensitive. Note that REITs are not the same as limited-partnership real estate DPPs, which are illiquid and pass through both income and losses.
Derivatives
An option is a contract whose value derives from an underlying security, and the Series 66 tests only the basics of the four positions and their uses. A call option gives its holder (buyer) the right, but not the obligation, to buy 100 shares of the underlying at a fixed strike (exercise) price on or before expiration. A put option gives its holder the right to sell 100 shares at the strike price. The buyer pays a premium for these rights; the writer (seller) receives the premium and takes on the obligation to perform if assigned. Buyers of calls are bullish (they profit if the stock rises above the strike plus premium); buyers of puts are bearish or hedging (they profit or are protected if the stock falls below the strike minus premium). The two everyday uses are speculation and hedging. A speculator buys a call to gain leveraged upside with limited downside (the most a buyer can lose is the premium), or buys a put to bet on a decline without shorting stock. A hedger uses options as insurance: an investor who owns a stock can buy a protective put to lock in a floor selling price, paying the premium as the cost of that protection, much like paying for insurance on a house. Writing options generates income but reshapes the risk. A covered call, writing a call against shares you already own, collects premium income and modestly cushions a decline, but it caps your upside because your shares can be called away if the stock rises above the strike. It is a suitable income strategy for a neutral-to-slightly-bullish investor willing to give up big gains. Writers must respect the asymmetry: an uncovered (naked) call writer faces theoretically unlimited loss. Because options embed leverage and lose value through time decay as expiration approaches (all else equal), they demand careful suitability review and, at most firms, an approved options account and signed options agreement before trading.
Insurance-Based Products
Insurance companies package investment and insurance features together, and the exam's central question is who bears the investment risk, because that determines whether the product is a security and who is qualified to sell it. A variable annuity invests the owner's premiums in separate-account subaccounts (essentially mutual funds), so the account value rises and falls with market performance. Because the contract owner bears the investment risk, a variable annuity is a security, and selling it requires both a securities registration (a Series 6 or 7 plus 63/66) and an insurance license. Variable annuities offer tax-deferred growth, a death benefit, and optional living-benefit riders, but they carry high fees, surrender charges, and ordinary-income taxation on gains at withdrawal, so they demand a strong suitability case, especially for older clients or inside an already tax-deferred IRA. A fixed annuity, by contrast, guarantees a minimum interest rate and a fixed payout; the insurer, not the client, bears the investment risk by investing in its general account. Because the client is not exposed to market performance, a fixed annuity is an insurance product, not a security, and can be sold with an insurance license alone. Its trade-off is inflation risk: a fixed payout loses purchasing power over a long retirement. Between the two sits the fixed-indexed annuity (equity-indexed annuity). It credits interest linked to an index such as the S&P 500 but limits both upside and downside through a cap (a maximum credited rate), a participation rate (the fraction of index gain credited), and a floor (usually 0%, so principal is protected in down years). These moving parts make the real return hard to predict and the products easy to misrepresent, so suitability review is essential; whether a given fixed-indexed annuity is treated as a security depends on its design and regulatory guidance. A crucial disclosure across all of these: insurance-company guarantees are only as strong as the insurer's claims-paying ability, and unlike a bank deposit, annuities and cash-value life insurance are not FDIC insured.
Last updated: September 2026
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