CSC 2: Practice Exam 1

41. Prices are falling in the equity market while trading volumes are increasing. What would a technical analyst predict might be occurring in the market?

Answer: Bear market In a bear market, volume should increase as prices decline while in a bull market, volume should increase when prices rise. This tells investors that the weight of money is on the buying side of the market. When prices rise and volume does not increase, the market may be in the beginning stages of a potential bearish reversal (possible market top). When prices fall and volume does not increase, the market may be in the beginning stages of a potential bullish reversal (possible market bottom)

9. Calculate the working capital of a company with $2,500,000 in current liabilities and $6,500,000 in current assets, with $10,000,000 in long-term bonds outstanding at 6%?

Answer: Working capital is calculated as the excess of current assets over current liabilities, and helps measure the amount of cash a company would have to continue operating the building after the satisfaction of all current liabilities by current assets. In this example, $6,500,000 - $2,500,000 = $4,000,000 in working capital. The bonds would be a long-term liability and not relevant to a consideration of working capital.

8. Identify disadvantages of investing in a structured product.

Answer: Although some structured products, like principal protected notes (PPNs), are publicly (but thinly) traded, most structured products either lack an active secondary market or have a very thin one. A structured product such as principal-protected notes can potentially offer equity-like returns while at the same time lowering or even eliminating long-term capital risk that is typically present when equities are held outright. However, this complexity can come at the expense of transparency. Even experienced, highly knowledgeable dealers, advisors and investors may not fully understand how these products work, where the source of return lies and how the principal is protected

10. During what calendar year must a Registered Retirement Savings Plan (RRSP) be de-registered?

Answer: An RRSP holder may make withdrawals or de-register the plan at any time but mandatory de-registration of an RRSP is required during the calendar year when an RRSP plan holder reaches age 71

57. A mutual fund organized as an open-end trust earns $850,000 in investment income, composed of $500,00 in capital gains, $250,000 in dividends and $100,000 in investment income. What portion of this investment income will be taxable to the trust?

Answer: $0 The open-end trust structure enables the fund itself to avoid taxation. Any interest, dividends or capital gains income, net of fees and expenses, is passed on directly to the unit holders. The fund itself does not incur any tax liability. Any income that has flowed through to the unit holder is taxed in the hands of the unit holder and the tax is based on the type of income that the fund generated.

79. What would the offering price be for a fund with a Net Asset Value of $12.50 and a front-end load of 2.5%?

Answer: $12.82 Most mutual funds report their Net Asset Value (NAV) in the financial press. However, this is not the "real price" you pay if the fund has a front-end load. Unlike equities, where you pay the price on the market plus a commission as determined by a broker, with mutual funds that have a front-end sales charge, you pay a price that includes the NAV plus the sales charge. Your purchase price will always be higher than the NAV. In this example, you would calculate the offering price by dividing the NAV of $12.50 by (100%-2.5%, the sales charge) for a result of $12.82

32. Mario opted to reset his $75,000 investment in a 100% guaranteed segregated fund after five years, when its market value was $84,000. Ten years after the reset date his segregated fund policy matured at a market value of $91,000 and Mario redeems the contract. Which of the following represents the capital gain Mario incurred?

Answer: $16,000 No capital gains liability is triggered at the time of reset. However, at the time of redemption (which is 15 years after the original deposit), the capital gain of $16,000 ($91,000 which was the proceeds at redemption less the original cost of $75,000) is taxable in the year in which the policy is paid out.

46. Calculate the NAVPS for a dividend mutual fund with $20,000,000 in assets, $2,000,000 in liabilities, 1,000,000 in units outstanding, and a historic dividend yield of 3%

Answer: $18.00 The NAVPS, or Net Asset Value Per Share of a mutual fund is calculated as: [Total assets- Total liabilitie]/Number of units outstanding. In this example, [20,000,000 - 2,000,000]/1,000,000= $18. The dividend yield is irrelevant to this calculation.

58. An investor purchased 200 shares of ABC Company at $25 a share and paid $35 in commissions. Two years later, the investor sold his holdings for $40 a share and paid $45 in commissions. Calculate the investor's capital gain, ignoring any other costs.

Answer: $2,920 Proceeds from the sale $8,000 Less commission on sale $45 Less adjusted cost base = 200 x $25 + $35 = $5,035 Capital Gain = $2920

14. Emma purchases $4,000 in LSVCC shares, receiving $600 in federal tax credits and $600 in provincial tax credits. She redeems the shares in Year 2. How much of the federal tax credits will she need to repay?

Answer: $600 The Income Tax Act requires that LSVCC shares be held for eight years to avoid the recapture of federal tax credits. If redeemed before this minimum holding time, the investor must repay the tax credits received on the LSVCC when the fund was originally purchased. In this example, $600 in federal tax credits would need to be repaid; Provincial requirements range from the right to redeem the shares immediately after purchase, to restrictions until a mandatory holding period has elapsed, to a ban on all redemptions

43. Andre sells 5,000 units of ABC No-Load Mutual fund on September 29 from his non-registered account. His adjusted cost base for the units is $85,000, and he receives $100,000. On October 2, the fund distributes $2 per unit. What is Andre's taxable capital gain for the year?

Answer: $7,500 When a fund holder redeems the shares or units of the fund itself, the transaction is considered a disposition for tax purposes, possibly giving rise to either a capital gain or a capital loss. Only 50% of net capital gains (total capital gains less total capital losses) is added to the investor's income and taxed at their marginal rate. In this example, Andre's gain of ($100,000 - $85,000) = $15,000 would result in a taxable capital gain of $15,000 x 50% = $7,500. As he did not hold the units at the time of distribution, he is not liable for the taxes on the distribution.

97. Ryan invests $6,500 in a 5-year PPN linked to the S&P/TSX 60 Index. The PPN has a participation rate of 60%. When Ryan invested in the PPN, the index was 695. At the end of 5 years, the index was 940. Calculate approximately how much Ryan receives from the issuer upon maturity.

Answer: $7,875 The index started at 695 and ended at 940 for a 35.25% gain (calculated as (940-695)/695). Since there is a 60% participation rate on the investment, Ryan would only be entitled to a gain of $1,375 (calculated as $6,500 x 35.25% x 60%). Upon maturity, Ryan would receive a total of $7,875 (calculated as $6,500 original investment + $1,375 gain).

52. A beneficiary receives a payment from a segregated fund on the death of the insured person. At the time of payment, the market value of the fund is $50,000, and the guarantee amount is $58,500 based on the most recent reset date. What is the death benefit amount owing?

Answer: $8,500 Death benefits are paid only when the market value of the fund is below the guaranteed amount. In this example, when the market value of the segregated fund at death is $50,000, the beneficiary will receive a death benefit payment of $8,500 above the market value. Therefore, in addition to the payment of the $50,000 market value of the fund, the total payment to the beneficiary is the guaranteed amount of $58,500. When the market value at death is above the guaranteed amount, there is no death benefit payable because the beneficiary receives the full market value of the investment which is higher than the guaranteed amount

15. What is the process known as when a market maker delivers a basket of stocks to the ETF issuer in exchange for a block of ETF shares?

Answer: 'In kind' creation When the market maker delivers a basket of stocks in exchange for a block of ETF shares, this is referred to as an 'in-kind' creation of ETF shares, because there is no exchange of cash between the market maker and the ETF issuer. Instead, the exchange is one set of goods (basket of stocks) for another set of goods (block of ETF shares).

99. What measure denotes a perfect positive correlation in a portfolio?

Answer: +1 If security price movements of two or more securities mirror each other exactly, or in other words they have a perfect positive correlation, the correlation is denoted as a correlation of +1

21. What services does an agency trader usually provide to institutional accounts? 1.Market intelligence. 2.Order execution. 3.Market making. 4.Security analysis.

Answer: 1 and 2 Agency traders do not merely take orders; they must manage institutional orders with minimal market impact and act as the client's eyes and ears for relevant market intelligence.

94. What type of risk is displayed when shares of ABC Co. fall by 5% while the market rises by 6%? 1. Business risk. 2. Non-systematic risk. 3. Market risk. 4. Specific risk.

Answer: 2 and 4. Non-systematic risk and specific risk (which are virtually the same thing) Non-systematic risk, or specific risk, is the risk that the price of a specific security or a specific group of securities will change in price to a different degree or in a different direction from the market as a whole.

93. Which statements explain why the market for managed and structured products has grown substantially over the past 25 years? 1.Changing investor preferences tied to the business cycle. 2.The difficulty beating the market index year after year. 3.Increased trading fees on common shares. 4.Increasing demand for passive indexing.

Answer: 2 and 4. The difficulty beating the market index year after year and the increasing demand for passive indexing. The growth in the market for managed and structured products is due in part to a number of key factor such as, The challenge faced by a majority of active investment managers to beat the market index year after year has driven many investors into index mutual funds and exchange-traded funds. Also, demand for passive investing products that provide important return and risk management characteristics has also fuelled growth in index-linked GICs and index-linked PPNs (principal protected notes).

25. What is the ideal minimum equity value per share (in each of the last five years) an investor should look for in a preferred share issue? a. 2 times the entitled dollar value of assets b. 1 times the entitled dollar value of assets c. 3 times the entitled dollar value of assets d. 4 times the entitled dollar value of assets

Answer: 2 times the entitled dollar value of assets Analysts like to see that the minimum equity value per preferred share in each of the last five fiscal quarters value of the assets that each preferred share would be entitled to receive in the event of liquidation.

1. Which statements best describe risk aversion as applied to investors? 1.In a choice between two assets, rational investors will select the investment with lower risk. 2.In a choice between two assets with equal returns, rational investors will select the investment with lower risk. 3.In a choice between two assets, rational investors will select the investment with the higher return. 4.In a choice between two assets with equal risk, rational investors will select the investment with higher return.

Answer: 2. and 4. Given a choice between two investments with the same amount of risk, a rational investor would always take the security with the higher return. Given two investments with the same expected return, the investor would always choose the security with the lower risk. Each investor has a different risk profile. This means that not all investors choose the same low risk security. Some investors are willing to take on more risk than others are, if they believe there is a higher potential for returns.

61. What is the approximate hedge fund's net market exposure if it is short 2,000 shares of ABC at $20 and long 3,000 share of DEF at $19?

Answer: 29.8% The two trades are worth $40,000 and $57,000 respectively. The "unhedged" component is $17,000 (57,000 - 40,000 = 17,000). The net market exposure is calculated as (57,000 - 40,000)/57,000 = 29.8%

81. XYZ has been moving in a sideways trend for several months. What is the most probable action an investor in XYZ will take when the oscillator value of the stock reaches the upper extreme of +1. 1. Sell put options on XYZ. 2. Purchase shares in XYZ. 3. Purchase put options on XYZ. 4. Sell existing holdings of XYZ.

Answer: 3 and 4 The oscillator is a measure used by technical analysts when a stock's chart is not showing a definite trend in either direction. The readings from an oscillator will fluctuate either from 0 to 100 or -1 to +1. The market is said to be overbought when prices are near the upper extreme and oversold when near the lower extreme. In this instance, it would indicate that XYZ is overbought and likely to decline, meaning that new purchases or selling put options would be inappropriate, whereas selling existing holdings might be wise. The oscillator is specific to the particular share, and does not indicate a broad trend for the market as a whole, making it irrelevant to a decision on an ETF purchase or sale.

38. At the beginning of last year, you invested $8,000 in 125 shares of LCC Corp. During the year, LCC paid dividends of $4 per share. At the end of the year, you sold the 125 shares for $82 per share. Assuming no transaction costs, calculate the approximate rate of return earned on the LCC shares.

Answer: 34.38% Beginning value = 8000/125 =$ 64 Ending value = $82 Cash flow =$ 4 Rate of return = $4 + ($82 - $64) / 64 X 100 = 34.38%

45. Calculate the Sharpe ratio for a portfolio with a return of 10% and a standard deviation of 1.2 during a period in which the risk free rate is 4%.

Answer: 5.0 The Sharpe ratio, which compares the return of the portfolio to the riskless rate of return, taking the portfolio's risk into account, is calculated as (Porfolio Return Rp - Riskless rate of return Rf)/standard deviation. In this example, (10% - 4%)/1.2 = 5.

27. The S&P 500 Index rises by 8%. ABC US Equity Fund has a beta of 0.9. Calculate the expected change in the value of ABC US Equity Fund.

Answer: 7.2 Any security, or portfolio of stocks, that moves up or down to the same degree as the stock market has a beta of 1.0. Any security or portfolio that moves up or down more than the market has a beta greater than 1.0 and a security that moves less than the market has a beta of less than 1.0. Rise of 8% x beta of 0.9= 7.2% change

37. Your client has both excellent investment knowledge, a high ability to tolerate risk, and seeks high investment returns. What managed product is the most appropriate for his particular investment philosophy?

Answer: A Hedge Fund While it is the intention of most managed products to control volatility through diversification, some managed products such as hedge funds specifically set out to achieve the highest returns possible and accept the resulting volatility. In this example, the hedge fund would most closely match the client's investment philosophy.

47. What type of investment fund issues a limited or fixed number of shares?

Answer: A closed-end fund Closed-end funds are pooled investment funds that initially raise capital by selling a limited or fixed number of shares to investors. The number of shares or units in closed-end funds remains fixed, except in rare cases of an additional share offering, share dividend or share buy-back.

22. Jeanne has decided to spend three weeks away from her residence in Calgary on a trip to South America. What type of account best suits her needs?

Answer: A discretionary account Discretionary accounts are usually opened for a short period of time. They serve as a matter of convenience for clients who are unwilling or unable to attend to their own accounts, for example, through illness or absence from the country.

85. What type of mutual fund withdrawal plan features a specified amount withdrawn over a pre-determined time frame with the intent that all capital will be exhausted when the plan ends?

Answer: A fixed-period withdrawal plan In a fixed-period withdrawal plan, a specified amount is withdrawn over a pre-determined period of time with the intent that all capital will be exhausted when the plan ends

84. Carol, a hedge fund manager, feels that with falling interest rates there is a huge opportunity for growth in Europe. Therefore, she has taken long positions in European assets. She also feels that with a runaway deficit, the United States is heading into a recession and has shorted the US dollar. Which hedge fund strategy is Carol following?

Answer: A global macro strategy Global macro investing makes bets on major events affecting entire economies. The goal is to attempt to profit from changes brought about by shifts in government policy that alter interest rates, thereby affecting currency, stock and bond markets. Global macro funds participate in all major markets including equities, bonds, currencies and commodities

82. Which company is most likely to have the highest degree of earnings stability? a) A forest products company. b) A retail merchandising company. c) A transportation company. d) A utility company.

Answer: A utility company In both the United States and Canada, some consumer stocks have generated such stable long term growth that they are considered defensive. The utility industry would be considered an example of a defensive blue-chip industry

63. Which of the following is most likely to result from an increase in the dividend tax credit? a) Increase in prices of Canadian dividend-paying shares. b)Decline in price of mutual funds with preferred share investment mandates. c)Decrease in disposable income of retired Canadians. d)Increase in proportion of Canadian taxes paid from investment income.

Answer: A. An increase in prices of Canadian dividend paying shares. The dividend tax credit is a fiscal policy initiative designed to increase the attractiveness of purchase of Canadian dividend paying shares. An increase in the credit would improve the after-tax yield of all dividend paying shares, which would tend to lead to an increase in the prices of such shares. It would also increase the disposable income of any individuals, including retirees, who receive dividend income, and decrease the amount of taxes the federal government would receive from dividend income.

39. Which of the following legal documents would an investor acquire to find out more about the risks and objectives of a hedge fund?

Answer: An offering memorandum Hedge funds usually issue an offering memorandum, a legal document stating the objectives, risks and terms of investment involved with a private placement.

4. What type of investment fund originates from public donations that puts the money to work in helping generate income for a charitable organization and their ongoing deliverables? a) Hedge fund. b) Endowment fund. c) Pension fund. d) Fund of funds.

Answer: B. An endowment is a pool of assets created from gifts and donations for the purpose of creating income to help an organization achieve its specific goals

28. Which of the following represents the total of all expenses charged to a mutual fund, excluding trading or brokerage costs? a. load b. management expense ratio c. management fee d. trailer fee

Answer: B. The management expense ratio (MER) represents the total of all management fees and other expenses charges to a fund, expressed as a percentage of the funds average net asset value for the year. Trading or brokerage fees are excluded from the MER calculation because they are included in the cost of purchasing or selling portfolio assets.

6. Constant two-sided bid/ask prices on equities falls under whose responsibility at an investment dealer? a) Agency traders. b) Market makers. c) Liability traders. d) Coverage traders.

Answer: B. The primary role and responsibility of equity market makers is to provide a constant, two-sided (bid/ask) market for equities under their responsibility. They do so at an agreed-upon spread, and in compliance with all equity exchange rules and regulations.

86. What statistical measure is used to link the risk of individual equity securities to the market as a whole?

Answer: Beta Beta is a statistical measure that links the risk of individual equity securities to the market as a whole. Beta is important because it measures the degree to which individual stocks tend to move up and down with the market

3. Who is a front-end load on a mutual fund purchase payable to? a) Custodian. b) Representative. c) Distributor. d) Transfer and Registrar.

Answer: C. A front-end load is payable to the distributor at the time of purchase. The distributor will then receipt the funds to the Custodian, who is responsible for the safekeeping of all income and other monies received by the fund.

11. You have been Pierre's financial advisor for a few years. Today you receive an unexpected call from Pierre's cousin Benoit, whom you do not know. Benoit is worried that Pierre is heavily trading penny stocks. Pierre lost a lot of money day trading years ago and swore he would never day trade again. What should you say to Benoit? a) He may be day trading but I cannot discuss anything else with you. b) No, he is not day trading. c) I can't answer your question as Pierre's information is confidential. d) Yes, he may be day trading and I suggest you talk to him directly.

Answer: C. All information concerning the client's transactions and his or her accounts must be considered confidential and must not be disclosed except with the client's permission, for supervisory purposes or by order of the proper authority

2. How is a bond with a term to maturity of 16 years generally classified in terms of risk and volatility? a) High risk and low price volatility. b) Low risk and low price volatility. c) High risk and high price volatility. d) Low risk and high price volatility.

Answer: C. Long term bonds (over ten years) have high risk and high price volatility.

7. What represents the upfront legwork by investment dealers in raising investment capital by bringing new debt issues to the public? a) Prime brokerage. b) Soft dollar arrangement. c) Origination. d) Straight-through processing.

Answer: C. Origination (also referred to as Debt Capital Markets or underwriting) is the process of bringing new debt issues to market

29. Companies A,B,C and D are similar in size and other characteristics. Based on the following, what company is the most attractive to purchase for an aggressive investor, based on a subgroup P/E of 15.8? a. Company A: P/E 9.5, falling earnings b. Company B: P/E 11.9, rising earnings c. Company C: P/E 22.9, rising earnings d. Company D: P/E 16.8, constant earnings

Answer: Company B. Generally, if one is comparing similar companies with similar prospects in an industry subgroup, the company with the lower P/E is usually the best buy. In this example, Company C, with a lower than subgroup P/E and rising earnings would likely be the most interesting to further analyze in terms of being a potential purchase.

5. Based solely on the working capital ratio, interest coverage ratio and the cash flow/total debt ratios below, which company is the best credit risk? Company A Working Capital 1.10 Interest Coverage 7.83 Cash Flow / Total Debt 41.87 Company B Working Capital 1.85 Interest Coverage 2.25 Cash Flow / Total Debt 12.54 Company C Working Capital 4.16 Interest Coverage 12.25 Cash Flow / Total Debt 19.78 Company D Working Capital 3.50 Interest Coverage 9.12 Cash Flow / Total Debt 29.23

Answer: Company C. A working capital ratio below 2 is considered to be poor; a low cash flow/total debt is negative; and interest coverage is generally considered to be the most important quantitative test of risk when considering a debt security and a higher ratio is considered to be better than a lower ratio. Of Company A, B ,C and D, Company C has the highest working capital and interest coverage, with a cash flow/total debt at a reasonable level. Although, Company A had the highest cash flow/total debt ratio, the other two ratios were not strong.

98. Amanda is selling her technology stocks when the vast majority of investors expect their price to rise. What is Amanda's investment style?

Answer: Contrarian Sentiment indicators focus on investor expectations. Contrarian investors use these indicators to determine what the majority of investors expect prices to do in the future, because contrarians move in the opposite direction from the majority. For example, the contrarian believes that if the vast majority of investors expect prices to rise, then there probably is not enough buying power left to push prices much higher and the investor will decide to sell the stocks.

20. What ratio best determines the ability of a company to repay the funds it has borrowed? a)Debt/Equity Ratio. b)Interest Coverage Ratio. c)Working Capital Ratio. d)Cash Flow/Total Debt Outstanding.

Answer: D. The cash flow/total debt ratio gauges a company's ability to repay the funds it has borrowed.

87. What equity marketplace provides investors with anonymity as trades are concealed from the general public?

Answer: Dark pool A dark pool is a specific equity marketplace that does not offer pre-trade transparency on any trade orders. In Canada, dark pools are generally regulated as alternative trading systems (ATS), and are registered as investment dealers. For institutional investors, dark pools offer many of the same benefits and features as regular stock exchanges, except that they do not have to post their trade for the public to see.

83. What might be indicated by a firm's high dividend payout rate?

Answer: Declining earnings As earnings fall, the dividend number in the payout ratio is divided by an ever smaller earnings number and the overall ratio becomes larger.

12. What financial institution(s) can sell deferred annuities to the general public?

Answer: Deferred annuities are available only through life insurance companies

40. What stage in the portfolio management process must be completed before an investment advisor can determine an asset allocation strategy for a client?

Answer: Design an investment policy statement. The portfolio management process is a continuous set of six basic steps, with the word process indicating that when the sixth step is completed, work begins anew on the first step. The six parts to the portfolio management process are: 1. Determine investment objectives and constraints; 2. Design an investment policy statement; 3. Formulate an asset allocation strategy and select investment styles; 4. Implement the Asset Allocation; 5. Monitor the economy, the markets, the portfolio and the client; 6. Evaluate portfolio performance.

73. What type of investment dealer focuses primarily on small- to mid-size clients who prefer to be in charge of managing and trading their own investment portfolios?

Answer: Discount dealers Discount dealers focus primarily on offering secondary equity trading services for small- to medium-size individual investors who prefer to manage and trade their own equity portfolio. Their service offering involves fast, user-friendly equity trading via both internet-based and telephone-based communication platforms

34. Susanna believes that extensive analysis of stocks does not provide superior returns, because a stock's price fully reflects all available information and represent the best estimate of the stock's true value. What market theory does Susanna support?

Answer: Efficient markets hypothesis. The Efficient Market Hypothesis assumes that stock prices fully reflect all available information and represent the best estimate of the stock's true value. The Random Walk Theory states that past price changes contain no useful information because any developments affecting the company have already been reflected in the current price of the stock. The Rational Expectations Hypothesis says that people are rational and have access to all necessary information. People will use information intelligently in their own self-interests and will make intelligent decisions after weighing all available information. Past mistakes can be avoided by using the information to anticipate change.

33. The benchmark index's performance last year was 8% with a volatility of 6%. What fund is most likely being managed by a closet indexer? a) Fund A return 12.8%, volatility 5%. b) Fund B return 8.1%, volatility 20%. c) Fund C return 7.8%, volatility 6.4%. d) Fund D return 10.3%, volatility 6%.

Answer: Fund C. A closet indexer does not replicate an index or benchmark exactly, but sticks fairly closely to the market weightings by industry sector, by country or region, or by average market capitalization. Some active managers are closet indexers. This can be determined by how closely their returns, their volatility and their average market capitalization correspond to the index as a whole. In this example, Fund C has the return and volatility closest to the benchmark index.

19. ABC Corp., DEF Inc., and GHI Ltd. are competitors in the same industry. The following table highlights some ratios derived from their most recent financial statements: ABC: Inventory turnover 6.5 times Working capital ratio 2:1 DEF: Inventory turnover 5.9 times Working capital ratio 1:1 GHI: Inventory turnover 6.9 times Working capital ratio 10:1 On average, select the company that operated most efficiently in terms of investment in inventory and explain why

Answer: GHI, because it had the highest inventory turnover ratio. The inventory turnover ratio measures the number of times a company's inventory is turned over in a year. It may also be expressed as a number of days required to achieve turnover, as shown in the example below. A high turnover ratio is considered good. A company with a high turnover requires a smaller investment in inventory than one producing the same revenue with a low turnover

24. What type of portfolio manager seeks companies that are considered to have higher earnings potential?

Answer: Growth managers Growth managers will focus on current and future earnings of individual companies, specifically earnings per share (EPS). Growth managers are looking for "earnings momentum" and they will pay more for companies if they feel the company's growth potential warrants the higher price.

55. What does a negative Sharpe ratio indicate about an investment manager's return?

Answer: His investments are less than the risk-free return A negative Sharpe ratio means the portfolio had a return less than the risk-free return. In other words, an investor could have placed all of their funds in a risk-free investment and still outperformed the return earned by the investment manager.

49. A hedge fund has a hurdle rate of 3% and no high water mark. Under which circumstance will the manager of the hedge fund receive an incentive fee? a) If the non-market related return on the fund is greater than 3%. b) If the return on the fund is greater than 3% over the risk-free rate. c) If the return on the fund is greater than its benchmark return plus 3%. d) If the return on the fund is greater than 3%.

Answer: If the return on the fund is greater than 3% A hurdle rate is the rate that a hedge fund must earn before its manager is paid an incentive fee. For example, if a fund has a hurdle rate of 5%, and the fund earns 20% for the year, incentive fees will be based only on the 15% return above the hurdle rate, subject to any high-water mark. Hurdle rates are usually based on short-term interest rates.

18. In what kind of withdrawal plan can an investor receive annual income from the fund by redeeming a specified percentage of fund holdings on each withdrawal date?

Answer: In a ratio withdrawal plan, the investor receives annual income from the fund by redeeming a specified percentage of fund holdings on each withdrawal date

77. The price-earnings ratio (P/E) is expected to have an inverse relationship with which of the following other factors?

Answer: Inflation Inflation creates widespread uncertainty and lack of confidence in the future. These factors tend to result in higher interest rates, lower corporate profits, and lower price-earnings multiples. There is an inverse relationship between the rate of inflation and price-earnings multiples.

65. Pension funds and life insurance companies would be examples of what type of market participant?

Answer: Institutional clients An institutional client is a legal entity that represents the collective financial interests of a large group. A mutual fund, insurance company, pension fund and corporate treasury are just a few examples.

48. What type of ETF would target to earn a positive return on a day the S&P/TSX Composite declines substantially?

Answer: Inverse ETF An inverse ETF increases in value when the reference index falls in value.

90. All else being equal, what effect does a Past Service Pension Adjustment (PSPA) have on an individual's Registered Retirement Savings Plan (RRSP) contribution room?

Answer: It decreases the RRSP contribution room The amount, calculated as the difference between the old plan PA and the new plan PA, is called the Past Service Pension Adjustment (PSPA). The PSPA also reduces the amount an employee can contribute to an RRSP.

51. PQR Ltd. reported the following earnings per share information over the past 4 quarters (quarter 4 was the most recent quarter). Quarter 1 EPS $2.00 Average Common Share Price $20 Quarter 2 EPS$1.75 Average Common Share Price$18 Quarter 3 EPS $1.65 Average Common Share Price $17 Quarter 4 EPS $1.45 Average Common Share Price$16 Over the last 4 quarters, determine the impact on PQR's price-earnings ratio.

Answer: It has increased Price-earnings ratio for the first quarter = 20/2 = 10.000 Price-earnings ratio for the second quarter = 18/1.75 = 10.2857 Price-earnings ratio for the third quarter = 17/1.65 = 10.3030 Price-earnings ratio for the fourth quarter = 16/1.45 = 11.0345 Over the last 4 quarters, the price-earnings ratio increased.

31. What tax treatment applies to the annual investment income earned on guaranteed investment certificates (GICs) in a non-registered account?

Answer: It must be reported on a tax return when the income is earned, regardless of whether a cash payment is received. For investments not held in registered plans taxpayers are required to report interest income (from such investments as CSBs, GICs and bonds) on an annual accrual basis, regardless of whether or not the cash is actually received

66. A stock is showing the final stages of a bottom head-and-shoulders formation. What does this signal to a technical analyst?

Answer: It signals an upside breakout is set to occur and the stock's price will rise Reversal patterns are formations on charts that usually precede a sizeable advance or decline in stock prices. Although there are many types of reversal patterns, probably the most frequently observed pattern is the head-and-shoulders formation. This formation can occur at either a market top, where it is referred to as a head-and-shoulders top formation, or at a market bottom, where it is called either an inverse head-and-shoulders or a head-and-shoulders bottom formation.

16. What terminology is used to refer to the investment strategy of purchasing fixed-income securities with consecutive terms to maturity?

Answer: Laddering When an investment manager constructs a portfolio using a variety of terms to maturity, or durations, it is called laddering, with the various consecutive maturities mimicking rungs on a ladder.

68. How would you classify the earnings of a company if the capital structure contains debt and/or preferred shares?

Answer: Leveraged The earnings of a company are said to be leveraged if the capital structure contains debt and/or preferred shares. The presence of senior securities accelerates any cyclical rise or fall in earnings. The earnings of leveraged companies increase faster during an upswing in the business cycle than the earnings of companies without leverage. Conversely, the earnings of a leveraged company fall more quickly in response to deteriorating economic conditions.

30. What risk is taken when an investor purchases a security with a limited secondary market?

Answer: Liquidity risk. A security that is difficult to sell suffers from liquidity risk (limited buying or selling opportunities)

69. Over the last 5 years, MHL has reported the following debt/equity ratio: Current Year 98% 2 Years Ago 125% 3 Years Ago 109% 4 Years Ago 160% 5 Years Ago 165% Based on the above table, determine what the trend in the debt/equity ratio indicates.

Answer: MHL has a declining reliance on debt Ratios calculated from a company's financial statements for only one year have limited value. They become meaningful, however, when compared with other ratios either internally, that is, with a series of similar ratios of the same company over a period of time.

64. Northern Cola has been in the soft drink business for 20 years. The company is in a very competitive marketplace but has maintained its market share, showing stable annual returns on equity. The introduction of 2 new soft drinks in the past year has resulted in a moderate increase in revenue. Identify the type of industry that Northern Cola operates.

Answer: Mature industry Industry maturity is characterized by a dramatic slowing of growth to a rate that more closely matches the overall rate of economic growth. Both earnings and cash flow tend to be positive, but within the same industry, it is more difficult to identify differences in products between companies. Therefore, price competition increases, profit margins usually fall, and companies may expand into new businesses with better prospects for growth. Where consumer goods are concerned, product brand names, patents and copyrights become more important in reducing price competition.

62. In what stage of an individual's life cycle are growth and tax minimization most likely the primary investment objectives?

Answer: Mid-earning years In mid-earning years, an individual's expenses usually decline and income and savings usually increase. As a result, savings continue to be a very important factor in the growth of a client's investment capital. Because such clients have more discretionary income, investment objectives tend to focus on growth and tax minimization.

72. An investor takes out a loan from his bank to contribute to his Registered Retirement Savings Plan (RRSP). Is the interest the investor pays on the loan tax-deductible? Why or why not?

Answer: No, because the loan is being used to earn tax-exempt investment income. Interest paid on funds borrowed to contribute to a registered retirement savings plan, a registered education savings plan, a registered disability savings plan, or a tax-free savings account (TFSA), is not tax-deductible because the borrowed funds are used to earn investment income that is tax-exempted.

53. Which category of ratio would you utilize if you wanted to determine how well management is making use of the company's resources?

Answer: Operating performance ratios Operating performance ratios illustrate how well management is making use of the company's resources. Value ratios show the investor what the company's shares are worth, or the return on owning them. Risk analysis ratios show how well the company can deal with its debt obligations. Liquidity ratios are used to judge the company's ability to meet its short-term commitments.

35. From a financial perspective, what are growth of capital, safety of principal, and income considered to be?

Answer: Primary investment objectives. In general, investors have three primary investment objectives: safety of principal, income, and growth of capital, and two secondary objectives: liquidity (or marketability) and tax minimization.

67. Generally, during what phase of Life Cycle Analysis would you expect to find clients with a high priority for capital preservation and income?

Answer: Retirement years During the Retirement Years, clients most frequently have fixed incomes and only limited opportunities for employment. Therefore the primary investment objectives of retired clients are preservation of capital and income, with the relative importance of each being determined by comparing the level of retirement income to budget requirements.

59. The share price of DMV Inc. breaks through the moving-average line from above on heavy volume. What type of trading signal does this represent?

Answer: Sell If the price breaks through the moving average line from above on heavy volume and the moving average line itself starts to fall, the upward trend is reversed. This is a sell signal.

96. In a separately managed account arrangement, where are each client's securities held?

Answer: Separate dedicated account Each client has their own separate dedicated account for the selected investment to be directly held in. As the sub-advisor makes the investment decisions, the actual securities are debited and credited to the client's dedicated account within the firm.

13. Vicky tells her financial advisor Sheila that the pharmaceutical company where she works is about to be taken over by a U.S.-based drug firm. Sheila returns to the office and tells her manager and a few colleagues that this takeover is about to happen. Which primary ethical value did Sheila violate?

Answer: She did not keep material non-public information confidential. If a registrant acquires non-public, material information, the information must neither be communicated (outside of the relationship) nor acted upon. Employees of a firm's trading, corporate finance or research departments must be aware of the need to safeguard non-public, confidential, material information received in the normal course of business.

91. What type of ETF could replicate a reference index?

Answer: Standard ETF Standard ETFs are able to either replicate an index in full, or use sampling to construct an index. Rules-based ETFs do not follow an index. Active ETF investments vary according to the management style, trading when market conditions and opportunities permit, unlike a standard ETF that passively follows an index. Inverse ETFs rely on derivatives to achieve the inverse effects that they seek.

17. Christine actively adjusts the strategic mix of her portfolios when she believes short-term opportunities exist for a particular asset class. She then reverts back to the long-term mix. What type of asset allocation strategy is Christine using?

Answer: Tactical Tactical asset allocation involves short-term, tactical deviations from the strategic mix to capitalize on investment opportunities in one asset class before reverting back to the long-term strategic allocation.

95. Which type of asset allocation strategy allows for some short-term, tactical, deviations from the strategic mix to capitalize on investment opportunities?

Answer: Tactical asset allocation Tactical asset allocation allows a manager to temporarily diverge from the strategic asset mix if, in the opinion of the manager, there exists a period of time in which excess returns can be earned in a particular asset class. The manager will return the portfolio to the strategic asset mix once the opportunity is perceived as over.

100. Ian purchased a segregated fund contract and designated his common-law partner as annuitant and beneficiary. If Ian later dies before his partner, how will the contract be settled?

Answer: The contract becomes part of Ian's estate In cases where the contract holder and the person whose life is being insured are different people, it is possible that the contract holder will die before the annuitant. If that happens the contract may be transferred to a successor contract holder. If the original contract holder has designated no successor, the contract becomes part of the contract holder's estate. In this instance, it is stated that, other than the beneficiary and annuitant, Ian has made no other designations.

54. What does it mean if a firm has an inventory turnover above the average of its industry?

Answer: The firm wastes less material and product If a company has an inventory turnover rate that is above average for its industry, it generally indicates a better balance between inventory and sales volume. The company is unlikely to be caught with too much inventory if the price of raw materials drops or the market demand for its products falls. There should also be less wastage, because materials and products are not standing unused for long periods and deteriorating in quality and/or marketability.

56. Who directly pays the management fees of a mutual fund?

Answer: The fund All expenses are deducted directly from the fund, not charged to the investor

89. A technical analyst notices that the oscillator for the share price of DEF Inc. has reached an extreme value in the upper end of the band. What would the analyst likely conclude?The least risky and most liquid of mutual funds is the money market fund. In this example, the Canadian money-market fund would be more appropriate, as it avoids foreign-exchange risk.

Answer: The market for DEF shares is overbought When the oscillator reading reaches an extreme value in either the upper (for example, closer to 100 on a scale of 0 to 100) or lower end (for example, closer to -1 on a scale of -1 to +1) of the band, this suggests that the current price move has gone too far. The market is said to be overbought when prices are near the upper extreme and oversold when near the lower extreme. This warns that the price move is overextended and vulnerable.

71. What is one advantage of investing in a portfolio of securities?

Answer: The risk of the portfolio is almost always less than the average of the risks of the securities held, improving the risk/return trade-off While the return of the portfolio will be the weighted average of the returns of each security, the risk of a portfolio is almost always less than the risks of the individual securities that make up the portfolio. This results in an improved risk-reward trade-off from using the portfolio approach.

60. Why do defensive industry stocks tend to hold up relatively well in recessionary times?

Answer: They tend to have a stable return on equity (ROE) Defensive industries have relatively stable return on equity (ROE). Defensive industries tend to do relatively well during recessions. The term blue-chip denotes shares of top investment quality companies, which maintain earnings and dividends through good times and bad. This record usually reflects a dominant market position, strong internal financing and effective management.

44. What is used to weight the individual cash flows in the Modified Dietz Method?

Answer: Time held in the portfolio The Modified Dietz method weights each cash flow by the amount of time it is held in the portfolio. It assumes a constant rate of return through the period, eliminating the need to value the portfolio on the date of each cash flow.

26. Which phase of a typical equity cycle is most likely to include falling interest rates?

Answer: Trough Trough: The bottom of the business cycle has not been reached but has begun to advance because of expectations of an economic recovery

42. An equity manager who believes that stock markets are not always efficient is following which type of manager style?

Answer: Value A value manager's picks may not be immediately recognized as undervalued by the market. Value investing is more successful in inefficient markets, when stock prices may be out of line with corporate fundamentals, or in a stagnant or declining market, when there is greater emphasis on preserving capital or minimizing short-term losses

36. What type of manager would be most interested in a security with a low P/E ratio, low price/cash flow and a high dividend yield?

Answer: Value Managers Value managers are seeking companies that are out of favour with the general market and as a result are undervalued. This undervaluation would tend to result in a low P/E with a high dividend yield, and a low price/cash flow as well.

23. Generally speaking, what risk profile is most appropriate for an investment advisor (IA) recommendation of purchasing an initial public offering (IPO)?

Answer: Very aggressive Looking at the financial planning pyramid, an IA would note that IPOs are classed with investments such as precious metals, real estate and OTC securities as being most typical for very aggressive investors due to the inherent risks in these particular securities.

88. What fund best suits a Canadian risk-averse investor with a time horizon of six months?

Answer: a Canadian money-market fund The least risky and most liquid of mutual funds is the money market fund. In this example, the Canadian money-market fund would be more appropriate, as it avoids foreign-exchange risk.

70. A $2,000,000 portfolio with a strategic asset mix of 10% cash/30% fixed-income/60% equity has changed composition to 10% cash/20% fixed-income/70% equity due to strong equity performance. What action would occur under a dynamic asset allocation strategy? a)No action. b)Sell $200,000 equities, buy $200,000 fixed-income. c)Sell $200,000 equities, buy $100,000 fixed-income, increase cash by $100,000. d)Sell $200,000 equities, increase cash position by $200,000.

Answer: b) Sell $200,000 equities, buy $200,000 fixed-income. A dynamic asset allocation strategy will rebalance a portfolio back to its strategic asset mix if it diverges due to market or other influences. In this instance, the manager would need to sell $200,000 in equities and use the resultant funds to purchase $200,000 in fixed-income. This would result in a portfolio with allocations of $200,000 in cash, $600,000 in fixed-income, and $1,200,000 in equities.

78. What is a non-price measure that could be used to indicate the beginning of a bull market? a) A stock's Moving Average Convergence-Divergence (MACD) breaks through the signal line from below. b) The number of advancing issues begins exceeding the number of declining issues. c) A stock's price breaks through the moving average line from below on increased volume. d) The stock's price breaks above the head and shoulders bottom formation neckline on heavy volume.

Answer: b) The number of advancing issues begins exceeding the number of declining issues. The cumulative advance-decline line is the most popular way of measuring breadth. It is a non price measure of the trend of the market. Declining issues are stocks that have fallen in price in comparison to their closing price on the previous trading day. Alternatively, Advancing issues are stocks that have increased in price in comparison to their closing price on the previous trading day. In a rising market, you will generally see more advancing issues, whereas in a falling market, you will usually find more declining issues

74. What provides the best understanding of the liquidity of an exchange-traded fund (ETF)? a) Total volume traded of the ETF's units. b) Total volume traded of the ETF's underlying securities. c) Number of the ETF's units outstanding. d) Total market capitalization of the ETF.

Answer: b) Total volume traded of the ETF's underlying securities. The liquidity of an ETF does not rest on the liquidity of the ETF units themselves but rather on the liquidity of the underlying securities that make up the ETF. The volume of the underlying securities is the true indication of the ETF's liquidity

75. Rebecca works for NTD Financial as a portfolio manager. She is in charge of a Canadian bond fund and her primary objective is to actively manage the average term of the holdings. Which option best describes her fixed-income management style? a) Credit quality. b) Momentum. c) Spread trading. d) Interest rate anticipation.

Answer: d) Interest rate anticipation. Managing through interest rate anticipation means lengthening the average term of a portfolio when interest rates are expected to fall, and shortening the term or taking refuge in cash when interest rates are expected to rise.

50. Under what circumstances is a stock's price said to have reached a "support level"? a) Investors sense that value and supply is high. b) Prices fall below resistance levels. c) Supply exceeds demand and prices reverse. d) Investors sense value and are willing to buy.

Answer: d) Investors sense value and are willing to buy. A support level is the price at which the majority of investors start sensing value, and therefore are willing to buy (demand is strong), and the majority of existing holders (or potential short sellers) are not willing to sell (supply is low).

92. Based solely on age, what client is best suited to purchase a GWMB (Guaranteed Minimum Withdrawal Benefit) plan? a) Melanie, age 28. b) Pamela, age 68. c) Richard, age 79. d) Marg, age 55.

Answer: d) Marg, age 55 GWMBs are especially suitable for clients with 5 to 10 years to retirement, who cannot afford significant losses in their portfolio during that time. These clients also want to be able to share in the growth of selected financial markets. In this example, only Marg is within 5 to 10 years of normal retirement age; Melanie at 28 is far from retirement, and both Pamela and Richard are well beyond retirement age.

76. Which statement about the role played by the portfolio manager in a single-manager account is correct? a) The portfolio is designed by the lead portfolio manager and two co-lead portfolio managers. b) The portfolio manager focuses exclusively on tax minimization. c) The portfolio manager uses a separate firm to handle the bond and equity trades. d) The portfolio manager executes bulk purchases and sales based on the investment decisions of the model portfolio.

Answer: d) The portfolio manager executes bulk purchases and sales based on the investment decisions of the model portfolio. Single-manager accounts are directed by a single portfolio manager who focuses considerable time and attention on the selection of securities, the sectors to invest in and the optimal asset allocation. The portfolio manager often maintains a model portfolio and then executes bulk purchases and sales based on their investment decisions. The manager then allocates the sales and purchases to their respective clients' accounts

80. Which statement about defined contribution plans is correct? a) The retirement benefits depend on how the contributions were invested. b) Only the employee contributions are tax deductible. c) Contributions are based on the employee's previous year's earned income. d) The retirement benefits are known in advance and based on years of service.

Answer:a) The retirement benefits depend on how the contributions were invested. In a defined contribution plan, the contributions to the plan are predetermined and the benefits, at retirement, will depend on how the contributions were invested