66 Incorrect Questions 8/26

A bond investor's portfolio consists of the following 3 bonds: ABC First Mortgage bond, current market value of $4 million with a duration of 5 years. DEF Debenture, current market value of $5 million with a duration of 8 years. U.S. Treasury bond, current market value of $1 million with a duration of 10 years. What is the average duration of the portfolio? A) 7 years B) 7.67 years C) 3.04 years D) 6.54 years

A) 7 years It is unlikely that you will have a question this complicated on the exam, but, just in case, we wanted to show you the way to do it. Computing average duration of a bond portfolio involves taking each bond and figuring the proportion of the portfolio its duration represents. In this question, ABC is 40% of the portfolio so we take 40% of its 5-year duration (2). Then, we do the same with the other two bonds. DEF is 50% of 8 (4) and the Treasury bond is 10% of 10 (1). When we add the 3 numbers together, it results in an average duration of 7 years.

Which of the following items would be included in a current ratio computation? A) Accounts payable, wages payable, and short-term debt B) Cash, dividends payable, and shareholders' equity C) Inventory, equipment, and cash D) Accounts receivable, inventory, and long-term debt

A) Accounts payable, wages payable, and short-term debt Current ratio is computed by dividing current assets by current liabilities. Current assets include cash, accounts receivable, and inventory. Current liabilities include accounts payable, wages payable, dividends payable, and short-term debt. Equipment is a fixed asset, and shareholders' equity is net worth.

Ways in which a Section 529 plan differs from a Coverdell ESA include tax-free distributions when the funds are used for qualifying educational expenses higher contribution limits no earnings limitations contributions that may be made by someone other than a parent or legal guardian A) II and III B) I and IV C) I and II D) II and IV

A) II and III Contributions to an ESA are limited to $2,000 per beneficiary per year, whereas the 529 limit is set by the plan sponsor, sometimes as high as $500,000. Unlike the ESA, where there is a ceiling on the earnings for a contributor, there is no limit for someone setting up a 529. Both Section 529 plans and Coverdell ESAs enjoy tax-free distributions, and plans may be established by almost anyone.

A person is excluded from the definition of investment adviser under the Investment Advisers Act of 1940 if the investment advice and reports are restricted to A) U.S. government securities. B) securities listed on a national stock exchange. C) bank and insurance company securities. D) foreign securities.

A) U.S. government securities. Among the exclusions found in the act is one for persons whose advice relates exclusively to securities issued or guaranteed by the U.S. government.

Included in the Uniform Securities Act's definition of broker-dealer would be A) a broker-dealer with a place of business in the state whose only clients are insurance companies. B) individuals who are registered as agents. C) issuers of securities. D) savings institutions.

A) a broker-dealer with a place of business in the state whose only clients are insurance companies. When the firm has a place of business in the state, regardless of its clientele, it is a broker-dealer. Exclusions from the definition include agents, issuers, and most financial institutions, such as banks and savings institutions. Also excluded are broker-dealers with no place of business in the state who only deal with institutional clients, such as banks and insurance companies.

The Uniform Securities Act's definition of investment adviser would include A) a person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities. B) an investment adviser representative of an advisory firm who makes securities recommendations on a regular basis for compensation. C) any person who is a federal covered investment adviser. D) a temporary employee hired to assist in administrative responsibilities of an advisory firm.

A) a person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities. A person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities meets the three-prong test as an investment adviser.

One of your clients purchases a European-style put option on a stock. The premium is $3 and the exercise price is $35. If the price of the underlying asset is $40 on the exercise date, the client has A) lost $300. B) made $200. C) lost $200. D) made $500.

A) lost $300. This option is out of the money and is therefore worthless. Remember, European-style options are exercisable only at expiration, and a $35 put is worth nothing unless the market price of the underlying asset is less than $35. As is the case with any long option position, the maximum loss is the premium paid.

John and Jane have a net worth of $20,000 and total assets of $150,000. If their revolving credit and unpaid bills totals $8,000, how much are their total liabilities? A) $138,000 B) $130,000 C) $122,000 D) $150,000

B) $130,000 The balance sheet formula is assets − liabilities = net worth. Therefore, $150,000 − liabilities = $20,000, where liabilities = $130,000. Did you answer $122,000? That is the amount of the liabilities other than the revolving credit, but that is not what the question is asking for.

All of the following situations are exempt transactions complying with the requirements of the Uniform Securities Act except A) the executor of an estate liquidates 1,000 shares of IBM held by the estate. B) Broker-Dealer B offers a private placement to 15 regular public customers and closes the offering at the end of 30 days. C) Mammoth Mutual Fund purchased 250,000 shares of common stock in a nonissuer transaction. D) Broker-Dealer A has put together a syndicate of 15 insurance companies and pension funds to purchase the entire issue of XYZ Corporation's preferred stock.

B) Broker-Dealer B offers a private placement to 15 regular public customers and closes the offering at the end of 30 days. Under the Uniform Securities Act, an unregistered private placement may be offered to no more than 10 prospective purchasers, with the exception of financial institutions and other broker-dealers. Transactions by executors, the sheriff, marshals, receivers, trustees in bankruptcy, guardians, or conservators are exempt. Sales to financial institutions, such as mutual funds and insurance companies, are also exempt.

Which of the following statements regarding unsystematic risk are true? It is the risk that an individual stock will not perform well. It is the same as market risk. Diversification reduces it. Diversification does not reduce it. A) I and IV B) I and III C) II and III D) II and IV

B) I and III Unsystematic risk is company risk, the risk that an individual investment will perform poorly. Diversification can reduce most unsystematic risks.

Common stock of KAPCO, Inc., trades on the NYSE. Which of the following securities would not be exempt from registration under the Uniform Securities Act? A) Stock rights to acquire KAPCO common stock B) Limited partnership interests in a shopping center with KAPCO, Inc., as the general partner C) KAPCO, Inc., subordinated debentures, traded on the OTC Pink Market D) KAPCO noncumulative preferred stock

B) Limited partnership interests in a shopping center with KAPCO, Inc., as the general partner When an issuer's stock is listed on the NYSE, any security it issues that is equal to or senior to that stock is a federal covered security and exempt from registration with any state. Remember that any debenture is senior to the issuer's stock. When that issuer acts as a general partner in a real estate offering, it is not its security that is being sold, so the exemption does not apply.

Which of the following statements regarding matched orders is true? A) Matched orders reflect the timing of capital gains to be offset by capital losses and are considered an effective and permissible tax minimization strategy. B) Matched orders violate trading rules because they create the illusion of trading volume where such volume would not otherwise occur. C) Advisers should pursue matched orders because they mirror an investor's trading objectives and time horizon. D) Matched orders are a prohibited practice because they entail allocation of IPO stock in proportion to the level of customer trading activity.

B) Matched orders violate trading rules because they create the illusion of trading volume where such volume would not otherwise occur. Matched orders violate trading rules because they create the illusion of trading volume where such volume would not otherwise occur.

A client has purchased a nonqualified variable annuity from a commercial insurance company. Before the contract is annuitized, your client, currently age 60, withdraws some funds for personal purposes. What is the taxable consequence of this withdrawal to your client? A) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn B) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis C) Capital gains taxation on the earnings withdrawn in excess of the owner's basis D) A 10% penalty plus the payment of ordinary income tax on funds withdrawn in excess of the owner's basis

B) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis Contributions to a nonqualified annuity are made with the owner's after-tax dollars. Distributions from such an annuity are computed on a LIFO basis with the income taxed first. Once the cost basis is reached, any further withdrawals are a nontaxable return of principal. Because the client is older than 59½ at the time of distribution, the additional 10% penalty tax is not incurred.

Which of the following illustrates an example of positive margin? A) The investment purchased on margin is sold for a price above its original purchase price. B) The rate of return on the investment exceeds the interest cost on the borrowed money. C) The stock purchase is being paid for in full rather than by using borrowed funds. D) The interest rate being charged on borrowings is less than the rate of inflation.

B) The rate of return on the investment exceeds the interest cost on the borrowed money. Positive margin means that you were successful in your use of the leverage afforded by using margin (borrowed money). That means that the investor's total return exceeds the cost of the borrowed money. It is possible to actually sell the security for a price above its original purchase price, but not more than the total of the cost plus the interest. That would result in negative margin.

Under the Uniform Securities Act, an individual does not meet the definition of an agent if he is employed by a broker-dealer and only: A) represents the broker-dealer in effecting transactions between the issuer and underwriter. B) serves as a partner, officer, or director of the firm with full-time responsibilities in back office management. C) accepts unsolicited orders. D) trades for the firm's market-making account.

B) serves as a partner, officer, or director of the firm with full-time responsibilities in back office management. Broker-dealer employees who have only administrative or operational duties are not defined as agents under the USA. Any type of sales activity by an employee of a broker-dealer would require that individual to be registered as an agent.

A client approaches the investment adviser representative handling the advisory account with a request to find a preferred stock that will offer a 6% income return. The investment adviser representative suggests a stock paying a $0.28 quarterly dividend. That stock will exactly meet the income objective if it has a current market price of A) $6.72. B) $11.91. C) $18.67. D) $4.67.

C) $18.67. The first thing to do is annualize the dividend by multiplying the $0.28 by 4. Once we have the annual dividend of $1.12, divide by 6% and the result is $18.6666, or $18.67 properly rounded. If you left your math skills at home, all you have to do is multiply each of the choices by 6% to see which one is closest to $1.12.

A customer has invested a total of $10,000 in a nonqualified deferred annuity through a payroll deduction plan offered by the school system where he works. The annuity contract is currently valued at $16,000, and he plans to retire. On what amount will the customer be taxed if he chooses a lump-sum withdrawal? A) $16,000.00 B) $10,000.00 C) $6,000.00 D) He will not owe taxes because the annuity was nonqualified.

C) $6,000.00 Payments into a nonqualified deferred annuity are made with after-tax money; taxes must only be paid on the earnings of $6,000.

Which of the following is an allowable early withdrawal from a traditional IRA without a tax penalty? A) A person withdraws funds from his IRA to pay for elective cosmetic surgery. B) A single parent withdraws funds from her IRA to pay for the education of a nephew. C) A single person adopts a child and withdraws $5,000 from their IRA to pay the adoption expenses. D) A single parent supplements a home equity loan with funds from her IRA to pay for a second home.

C) A single person adopts a child and withdraws $5,000 from their IRA to pay the adoption expenses. An individual withdrawing up to $5,000 from their IRA to pay adoption expenses would have the 10% tax penalty waived. In the case of a married couple, each may withdraw up to $5,000 without penalty. Although there are certain circumstances in which funds may be withdrawn for medical expenses, elective cosmetic surgery does not qualify. Nephews are not included in immediate family for the purposes of avoiding the 10% penalty when paying for educational expenses. The waiver is effective for up to $10,000 to purchase a primary residence, not a second home.

Under the Uniform Securities Act, all of the following are required to be registered as investment adviser representatives except A) an individual who furnishes investment advice to clients of ABD Advisers, Inc. B) a vice president of ABD Advisers, Inc., who serves on the firm's advisory committee. C) ABD Advisers, Inc. D) an employee who solicits new customers for ABD Advisers, Inc.

C) ABD Advisers, Inc. The Uniform Securities Act defines an investment adviser representative as anyone who is a partner, officer, director, or other employee or person associated with an investment adviser other than clerical or ministerial personnel who (1) makes recommendations or provides advice regarding securities; (2) manages accounts or portfolios of clients; (3) determines which recommendations or advice should be given; (4) solicit, offers, or negotiates for the sale of, or sells, advisory services; or (5) supervises any such persons. An individual or a firm may be registered as an investment adviser, but only an individual can be an investment adviser representative.

While reviewing nationwide industrial production figures, an analyst notices that inventories have been rising. From that information, one would gather that the economy is most likely in which phase of the business cycle? A) Peak B) Expansion C) Contraction D) Recovery

C) Contraction Downturns in the business cycle (a contraction) tend to be characterized by rising inventories due to a lack of consumer demand. During expansion or recovery, demand is high and goods are less likely to remain in inventory.

Howard is an investment adviser representative with Hughes & Company, a state-registered investment adviser having its principal office in State O and offices in States P and D. Howard works out of an office in State P and has 4 retail clients there. In addition, Howard has 25 retail clients in State D, 6 retail clients in State M, and 1 retail client in State O. Howard would be required to register as an investment adviser representative in A) State P. B) States D and M. C) States P, D, and M. D) States P, D, M, and O.

C) States P, D, and M. Individuals working as IARs for state-registered investment advisers must register in any state in which they (the IAR) maintain a place of business, as well as any other state in which they serve more than five retail clients (the de minimis exemption). With an office in State P, registration is required there, regardless of the number of clients. In both States D and M, the de minimis has been exceeded, so registration is required there. The fact that the IA's principal office is in State O has no bearing on Howard, and with only one retail client there, he qualifies for the de minimis exemption.

Charles wishes to preserve his capital and generate income with moderate risk by investing in mutual funds. Which of the following mutual fund types would probably least meet these investment objectives? A) A bond fund B) A balanced fund C) Technology funds D) An income fund

C) Technology funds Technology mutual funds typically invest in high-risk, high-reward situations that are inappropriate for conservative investors. Balanced funds, income funds, and bond funds could be potential investments for conservative clients.

Which of these is an advantage of using a Coverdell ESA rather than a 529 plan to fund a child's future education? A) Contributions to the Coverdell are eligible for the annual gift tax exclusion. B) The Coverdell allows for transfer of beneficiary. C) The Coverdell offers greater investment flexibility. D) The Coverdell has greater tax advantages.

C) The Coverdell offers greater investment flexibility. A Coverdell ESA works similar to a self-directed IRA where stocks, bond, mutual funds, ETFs, and other investment vehicles are options. With a 529 plan, the donor is limited to whatever is available in the state plan chosen. Tax advantages might be better for the 529 plan because many states allow a portion of the contribution to be taken as a deduction or credit against state income taxes. Both allow for transfer to a new beneficiary as long as that individual is a member of the original beneficiary's family. In both cases, whatever is contributed to the program is treated as a completed gift and is eligible for the annual gift tax exclusion.

Which of the following statements regarding the general partner (GP) in a direct participation program (DPP) is not true? A) The GP is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations. B) The GP cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds. C) The GP, as the active manager of the partnership, does not maintain a financial interest in the partnership and only receives income distributions from profits on the business prior to the limited partners. D) A GP has a fiduciary relationship to the limited partners (LPs).

C) The GP, as the active manager of the partnership, does not maintain a financial interest in the partnership and only receives income distributions from profits on the business prior to the limited partners. General partners (GPs) must maintain a financial interest in the partnership and generally do not receive distributions from profits before those paid to the limited partners (LPs). The GP is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations and has a fiduciary relationship to the LPs. The GP, as a fiduciary, cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds.

Under the Uniform Securities Act, the Administrator is empowered to do all of the following except A) publish information relating to violations committed in the state. B) issue a cease and desist order. C) file a civil suit against a broker-dealer who has sold an unregistered nonexempt security to a resident of this state. D) require an agent to submit a written statement relating to an investigation.

C) file a civil suit against a broker-dealer who has sold an unregistered nonexempt security to a resident of this state. A civil suit may only be filed by an aggrieved purchaser. The Administrator could take administrative action against the broker-dealer (issuing a cease and desist order, for example) but has no civil powers.

Regarding the treatment of estates by the IRS, it would not be correct to state any of the following except A) estates may be valued either at date of death or 9 months later using the alternative valuation option. B) income received by the estate is reported on Form 1040. C) the maximum tax rate on estates is the same as that on gifts. D) a deceased person may reduce the value of the estate by taking advantage of the annual gift tax exclusion.

C) the maximum tax rate on estates is the same as that on gifts. The maximum tax rate on estates and gifts is 40% (the number is not tested; only that the rates are the same). The alternative valuation date is 6 months after death; nine months after death is when the tax is due. Dead people can't make gifts and any income received by the estate before it is liquidated is reported on Form 1041.

One of the exemptions from registration under state and federal law applies to investment advisers to private funds. One characteristic of all private funds is that A) they have no more than 100 investors. B) their advisers are exempt from filing reports on Form ADV. C) they are not registered as investment companies. D) they have assets of less than $150 million.

C) they are not registered as investment companies. Private funds lose that distinction if they become registered as investment companies under the Investment Company Act of 1940. It is the adviser to a private fund who has a limitation on the amount of AUM, not the fund. In some cases, specifically when using the 3(c)(7) exemption, there is no limit to the number of investors. In many cases, the advisers to these funds, although exempt from registration, are considered exempt reporting advisers and must file Form ADV Part 1 answering most of the questions on the form.

An investor owns five DEF call options with a strike price of $40. The options are European style. If the holder exercises, the cost will be A) $0 because European options are exercisable only at expiration. B) $2,000. C) $4,000. D) $20,000.

D) $20,000. Each option contract represents 100 shares. Exercising five call options means buying 500 shares at a price of $40 each, which equals $20,000. Although it is true that European-style options are exercisable only at expiration, nothing in the question indicates the investor tried to exercise before then.

An investment adviser representative is evaluating DEF stock to see if it is a good fit for a client's portfolio. Using the security market line (SML), what is the expected return for DEF when the return on the market is 8%, the 91-day Treasury bill is yielding 6%, DEF's beta is 1.50, and the inflation rate, as measured by the CPI, is 4%? A) 8% B) 12% C) 5% D) 9%

D) 9% The formula for this computation is as follows: 8% (the return on the market is a beta of 1.0) minus the risk-free rate of 6%, or 2%. Then, multiply that by the beta of this stock (1.5) to arrive at 3%. That is, the stock should return 3% over the risk-free rate of 6%, or 9%. Inflation rate is only important if we are looking for the real (inflation-adjusted) return, not the expected return.

Which of the following is the act that extended the regulation of securities to the secondary market or exchanges? A) The Investment Company Act of 1940 B) The Securities Act of 1933 C) The Investment Advisers Act of 1940 D) The Securities Exchange Act of 1934

D) The Securities Exchange Act of 1934 The Securities Exchange Act of 1934 extended the regulation of securities to the secondary market. In addition, this act also established the SEC (Securities and Exchange Commission) as the primary regulatory body overseeing the sale and purchase of securities by a potential investor. The Exchange Act deals with the people involved in the subsequent sale and purchase of previously registered securities. The Securities Act of 1933 requires the registration of nonexempt securities before they may be offered to the public. The names of the two acts passed in 1940 describe the areas they regulate.

A client who is interested in investing in commodities might look at any of the following except A) heating oil. B) gold. C) corn. D) debentures.

D) debentures. Debentures are a security; each of the others is a commodity.

Registration with the state as an investment adviser would be required for a person with an office in this state who A) serves as a pension consultant to the XYZ Employees Retirement Plan, covering 1,200 employees with total assets of $278 million. B) only gives advice on securities issued by or guaranteed by the government of the United States. C) manages the portfolio of the KPF Balanced Fund, a registered open-end investment company with $22 million in net assets. D) manages $13 million in assets for four clients.

D) manages $13 million in assets for four clients. Under the Dodd-Frank bill, investment advisers with less than $100 million in assets under management must register with the states. If the adviser manages a registered investment company, the adviser must be federal covered. If the person serves as a pension consultant with $200 million or more in AUM, the person has the option of registering with the SEC. A person whose sole advice deals with U.S. government securities is excluded from the federal definition of investment adviser and, therefore, under the NSMIA, is considered a federal covered adviser.