Final Study Questions - Series 65

Which of the following is NOT a valuation method for a fixed-income security? A) Conversion parity B) Price-to-earnings ratio C) Dividend discount model D) Discounted cash flow

Ans. B. The P/E ratio is only used with common stock. The parity price is a way to value a convertible bond or convertible preferred stock. DCF is one of the most popular ways to value bonds. The DDM can be used with preferred stock, which, because of its fixed dividend, is considered in the general category of fixed-income security. Reference: 5.3 in the License Exam Manual

If a company with 10 million shares outstanding with total earnings of $50 million pays a $2 dividend, the dividend payout ratio is: A) 40%. B) 20%. C) 4%. D) 25%.

Ans. A 40% Dividend payout ratio is determined by dividends paid per share divided by earnings per share. In this case, earnings per share (EPS) is $50 million ÷ 10 million shares = $5 per share. The company paid out in dividends $2 for each $5 earned for a 40% payout ratio ($2 ÷ $5). Reference: 11.4.2.4 in the License Exam Manual

All of the following are general principles of the prudent investor standard EXCEPT A)liquidity of investment B)reasonable expected returns C)profit guarantees D)diversification

Ans. C Profit guarantees The prudent investor standard does not require a guarantee of profit, but it does include using skill and caution to achieve diversification, liquidity, and the goal of obtaining a reasonable return based on a reasonable amount of risk Reference: 20.4.1.1 in the License Exam Manual

Ebony sets up a revocable trust, naming her daughter, Sylvia, as the sole beneficiary. Ebony has appointed the Pacific Atlantic Trust Institution (PATI) as the trustee. Any distributed income will be taxable to A) the beneficiary B) the grantor C) the trust D) the trustee

Ans. A In most cases, the income distributed from any trust is taxed to the beneficiary (Sylvia). If the income is retained in a revocable grantor trust, then it will be taxed to the grantor. In most other trusts, if the income is retained, it is taxed to the trust. Reference: 17.4.1.1 in the License Exam Manual

Included in the definition of derivative would be all of the following EXCEPT A) options B) rights C) leveraged ETFs D) futures

Ans. C. ETFs, whether leveraged or not, are investment companies and are not included in the definition of derivative. Reference: 9.2.2 in the License Exam Manual

A new customer has a $35,000 CD maturing in 2 weeks. With the objective of maximizing his income on capital invested, he wishes to invest the proceeds in a mutual fund. Which of the following types of funds should be recommended? A) An income fund. B) A sector fund. C) A venture capital fund. D) A growth fund.

Ans. A An income fund is just what the name implies; it invests for income (regular payments of interest and/or dividends). Reference: 7.1.3 in the License Exam Manual

Which of the following vehicles make use of the unified estate tax credit? i. bypass trust. ii. generation skipping trust. iii. living trust. iv. simple trust. A)I and II. B)III and IV. C)II and III. D)I and IV.

Ans. A Both the bypass trust and the generation skipping trust are tools used by estate planners to reduce estate taxes. They do so by passing the amount in the unified credit (currently $5.34 million for 2014) to heirs other than the spouse, usually grandchildren in the case of the GST. Reference: 17.4.3 in the License Exam Manual

The present value of a dollar: A) cannot be calculated without knowing the level of inflation. B) indicates how much must be invested today at a given interest rate, to equal a specific cash value in the future. C) is equal to its future value if the level of interest rates stays the same. D) is the amount of goods and services it will buy in the future at today's rate price level.

Ans. B. The present value of a dollar will indicate how much must be invested today at a given interest rate, to equal a cash amount required in the future. Reference: 12.1.1.2 in the License Exam Manual

An investor who resides in New York reads a newspaper ad for advisory services in a newspaper published in New Jersey. More than 80% of the newspaper's circulation is in the state of New York. According to the Uniform Securities Act, an offer has been made in: A) New York. B) New Jersey and New York. C) neither New Jersey nor New York. D) New Jersey.

Ans. C An offer is not made when a newspaper is circulated but not published in the state, or if it is published in the state but has more than 2/3 of its circulation outside of the state. Reference: 2.13.1 in the License Exam Manual

It would be CORRECT to state that variable annuities A) rarely impose surrender charges B) generally have somewhat lower operating expenses than mutual funds with the same investment objective C) offer a way to accumulate funds on a tax-deferred basis D) offer a guaranteed rate of return with an opportunity to benefit from stock market performance

Ans. C One benefit of the variable annuity is the tax deferral of all earnings in the account. However, in almost all cases, the expense ratio of a VA is higher than that of a mutual fund pursuing a similar investment objective. There are no guaranteed returns with a VA, and most have a CDSC (surrender charge). Reference: 8.1.6 in the License Exam Manual

A broker-dealer registered with State A created a website 2 years ago to promote their services. Recently, they hired a new media person who totally redesigned the site. Under the recordkeeping requirements of the Uniform Securities Act, A) there are no requirements for storage of electronic data B) a copy of the new website page must be maintained for a period of three years from the first use of the original site C) copies of both the original and the new website page must be maintained for five years after original use D) a copy of the original website page must be maintained for three years from original use

Ans. D. Websites are treated as would be any other advertisement. So, the original site design is kept for three years and, whenever revised, the new copy is maintained and starts a new retention requirement for that copy. Therefore, you will likely have several different versions in your advertising file at the same time. Reference: 2.4.5.1.1 in the License Exam Manual

Which of the following statements is NOT true? i. A broker-dealer must be a firm or corporation (legal person) as opposed to a natural person (human being). ii. An investment adviser must be a firm or a corporation as opposed to a natural person. iii. An investment adviser representative (IAR) cannot, under any circumstances, be employed by a registered broker-dealer. A) I, II and III. B) I and III. C) I and II. D) II and III.

Ans. A. A broker-dealer or investment adviser can be either a natural person (i.e., organized as a sole proprietorship) or a legal person (i.e., a corporation or partnership). There is no prohibition against an investment adviser representative also being licensed as an agent with a broker-dealer. Reference: 2.3.3 in the License Exam Manual

All of the following investments are eligible for a traditional IRA EXCEPT: A)works of art. B)limited partnerships. C)growth-oriented securities. D)covered call writing.

Ans. A Gems, intangibles, and works of art are ineligible investments for an IRA. Covered call writing is allowed, but speculative options strategies are not. Limited partnerships are permissible investments for an IRA. Growth-oriented securities, and securities in general, are appropriate investment vehicles for IRAs. Reference: 20.1.5.4.1 in the License Exam Manual

All of the following are leading indicators for economic growth EXCEPT: A) stock prices as measured by the S&P 500 index. B) average weekly initial claims for state unemployment compensation. C) orders for durable goods. D) average prime rate.

Ans. D The average prime rate is a lagging indicator. The duration of unemployment is also a lagging indicator, but the number of initial unemployment claims is a leading indicator. The S&P 500 index and orders for durable goods are leading economic indicators. Reference: 11.3.6.1 in the License Exam Manual

An agent is using social media to try to build her business. If her Facebook page allows for followers to "like" her, that would be considered A) misleading content B) illegal content C) interactive content D) static content

Ans. C. One of the things that differentiate interactive content from static content is the ability for persons other than the originator of the content to have access. Posting a like to a Facebook page is an example of this.

Which of the following is guaranteed by a variable life policy? A) Cash value. B) Policy loans after the policy has been in effect for at least 24 months. C) Minimum separate account performance. D) Minimum death benefit.

Ans. D. A variable life policy has a minimum guaranteed death benefit, but there is no minimum guaranteed cash value. There is no performance guarantee on separate accounts and policy loans are required after the policy has been in effect for at least 3 years (36 months). Reference: 8.2.4.5 in the License Exam Manual

If having discretion over $100 million or more in 13(f) securities, which of the following would be exempt from filing a Form 13F? A) A natural person who exercises investment discretion over the account of any other natural person or entity B) A trustee C) A natural person who exercises investment discretion over her own account D) An investment adviser that manages mutual fund assets

Ans. C An institutional investment manager is also a natural person or an entity that exercises investment discretion over the account of any other natural person or entity. For example, an investment adviser that manages private accounts, mutual fund assets, or pension plan assets is an institutional investment manager; so is the trust department of a bank. A trustee is an institutional investment manager, but a natural person who exercises investment discretion over her own account is not an institutional investment manager. Reference: 1.6.4.2 in the License Exam Manual

Under the Investment Company Act of 1940, an investment company may initially retain the services of an investment adviser only with approval of: A) the majority vote of the noninterested directors. B) the majority vote of the outstanding shares. C) the majority vote of the outstanding shares and a majority of that portion of the board of directors that are considered noninterested members. D) the majority vote of the board of directors.

Ans. C. The investment adviser's contract must be initially approved by a majority vote of the outstanding shares and a majority of the noninterested members of the board of directors. It is renewed annually by either a majority of the board or a majority of the outstanding shares. In addition, as with all contracts, initial and renewal, it requires a majority of the noninterested board members. Reference: 1.10.9 in the License Exam Manual

Jon, an agent with Johnson-Bayer Securities, was reacting to peer pressure to use email as a prospecting tool. He decided to highlight the exciting new process for drug delivery which was covered in the new offering prospectus when explaining why he felt the issuer found the next "aspirin." He summed up the email by stating potential investors needed to act quickly to get in on the ground floor. His decision to do so fell into the category of which of the following? A) Fraud B) Unethical business practice C) Advertising D) Phishing

Ans. B. NASAA considers it to be an unethical business practice to use any advertising or sales presentation in such a fashion as to be deceptive or misleading. Examples of such practices would be: i. a distribution of any nonfactual data; ii. any material or presentation based on conjecture; iii. unfounded or unrealistic claims in any brochure, flyer, or display by words, pictures, or graphs; or iv. anything otherwise designed to supplement, detract from, supersede, or defeat the purpose or effect of any prospectus or disclosure. Reference: 2.4.7 in the License Exam Manual

An investment adviser representative's client lost her father to lung cancer. Among the assets bequeathed to her were 2,000 shares of a tobacco stock. Which of the following is NOT a consideration when recommending to her what to do with the stock? A) Her financial goals. B) The cause of her father's death. C) Her father's years of investment experience. D) Her employment situation.

Ans. C An adviser's recommendations to a client are not impacted by the degree of someone else's investment experience or knowledge. In this case, one could expect some resentment towards holding shares of a tobacco company when the cause of a loved one's death is lung cancer. Reference: 15.2 in the License Exam Manual

One of your customers purchased a variable life insurance contract through your firm. After 14 years, he had deposited $15,000 in premiums, and his death benefit had grown to $80,000. Shortly after taking out a loan against cash value of $10,000, he was killed in an automobile accident. What will be the consequences of this situation to the death benefit? i. His beneficiary must agree in writing to pay off the loan before collecting the death benefit. ii. His beneficiary will receive the death benefit minus the value of the loan. iii. His beneficiary need not pay taxes on the death benefit. iv. His beneficiary must pay taxes on the amount of the death benefit that is over and above the cost base of $15,000. A) II and III. B) I and III. C) II and IV. D) I and IV.

Ans. A A death benefit payable on a life insurance policy or contract is not subject to taxation. The insurance company will deduct the balance of the $10,000 loan before it releases the death benefit to the beneficiary. Reference: 17.1.11 in the License Exam Manual

Creative Wealth Management (CWM), an investment adviser registered in five states, has a preferred brokerage arrangement with Bullish Bobbie Brown Securities (BBBS), a FINRA member broker-dealer. If one of CWM's clients chooses to use a broker-dealer other than BBBS, CWM must disclose that i. in a client-directed brokerage account, the client may pay higher brokerage commissions because the IA may not be able to aggregate orders to reduce transaction costs ii. the advisory contract is in danger of not being renewed if the client insists on using anyone other than BBBS for trade execution iii. the client may receive less favorable prices because the IA has arranged a preferred commission rate with a preferred broker-dealer iv. using BBBS assures the client of receiving research ahead of those clients who trade elsewhere A)I and III B)III and IV C)II and IV D)I and II

Ans. i and iii Because of preferred arrangements between the IA and the BD, it is likely that larger orders will be combined (with a concurrent cost saving) and there may be a better commission schedule available for the adviser's clients. This would not be a cause for the adviser to refuse to renew the contract and it would be an unfair business practice to make research available to certain clients ahead of others.

An agent taking which of the following actions would be committing a violation? A) Buying securities in a joint account at the request of one party only. B) Selling securities from a minor's custodial account without the custodian's consent but with the beneficial owner's consent. C) Buying securities in a cash account with the consent of the customer. D) Selling securities from a corporate account by using limited power of attorney trading authority for the account.

Ans. B The custodian, not the beneficial owner (minor), is the person who has the authority to make investment decisions for an account. Any tenant in a joint account may give instructions for the account. Reference: 20.8 in the License Exam Manual

One method used by some analysts to estimate the future value of a stock is the dividend growth model. This model would probably be most useful in the case of a: A) AAA corporate bond. B) small-cap stock. C) large-cap stock. D) cumulative preferred stock.

Ans. C The dividend growth model is a method to value the common stock of a company on the basis of assumed constant growth of dividends in the future. Therefore, it can only be applied to a corporation whose dividends might be expected to increase. It is far more likely that a large-cap stock will be paying dividends than a small-cap. Bonds don't pay any dividends and, in any event, their interest, just like the dividends on preferred stock, is fixed; there is no growth possible. Reference: 4.1.9 in the License Exam Manual

The separate account subaccounts chosen by the purchaser of a variable life insurance policy have had outstanding performance over the past 15 years. There would generally be no tax implications in which of the following situations? A) The policy is surrendered B) A loan is taken equal to 95% of the policy's cash value C) The death benefit is paid D) There is a cash withdrawal in excess of the cost basis

Ans. B Funds obtained from a policy loan are not considered taxable income (same as any loan - you owe the money). If the amount received at policy surrender is greater than the cost basis, the excess is taxed as ordinary income. The same is true with the withdrawal. Although the death benefit will always be free of income tax, it could be subject to estate tax. Reference: 17.1.11.4 in the License Exam Manual

An investment adviser wishes to engage the services of a third party to solicit new clients for the firm. To be in compliance with the Investment Advisers Act of 1940: i. the solicitor must be registered as an IAR. ii. compensation may not be sales related. iii. the solicitor must not be subject to statutory disqualification. iv. disclosure of the solicitation arrangement must be made to clients upon request. A) I and IV. B) II and III. C) II and IV. D) I and III.

Ans. B. II and III Third-party solicitors are not required to be registered as IARs and therefore may not receive sales-related compensation. However, they must not be subject to statutory disqualification that would prevent them from becoming registered. Disclosure is necessary whether or not it is requested. Reference: 3.16 in the License Exam Manual

All of the following statements regarding an investment's internal rate of return (IRR) are true EXCEPT: A)IRR can easily be calculated for investments with uneven cash flows. B)IRR expresses the rate of interest that matches the initial investment with the present value of future cash flows. C)IRR is the one rate of return that results in an investment having a net present value (NPV) of zero. D)investments are acceptable when their internal rates of return exceed the investor's required rate of return.

Ans. A IRR is the rate of interest that equates the initial investment with the present value of future cash flows; it is the rate of return that results in an investment having a net present value of zero. It is possible, although difficult, to calculate IRR for investments with uneven cash flows. That is why it is used primarily with debt securities and common stocks with stable dividends.

An IAR with a state covered adviser would like to employ the services of an individual as a solicitor to help bring in more business. The solicitor will be compensated by receiving a percentage on all assets placed under management. In order to do this, all of the following must be complied with EXCEPT A) the IA and the solicitor brochure must be delivered at least 48 hours prior to entering into the contract B) the terms of the compensation must be spelled out C) the solicitor must be registered as an IAR in order to receive compensation based upon advice D) disclosure of the arrangement must be made to the client

Ans. A In this example, the IA brochure and solicitor brochure are required to be delivered with the sales presentation. The contract is not signed until the client agrees to engage the services of the IA If these are not delivered at least 48 hours prior to signing, the client has a 5-day penalty-free withdrawal option. Reference: 3.16 in the License Exam Manual

An IAR with a state-registered adviser would like to employ the services of an individual as a solicitor to help bring in more business. The solicitor will be compensated by receiving a percentage on all assets placed under management. In order to do this, all of the following must be complied with EXCEPT: A)the client must sign the contract at the same time as he receives the IA brochure and the solicitor disclosure document. B)disclosure of the arrangement must be made to the client. C)the solicitor must be registered as an IAR in order to receive compensation based upon advice. D)the terms of the compensation must be spelled out.

Ans. A These brochures must be delivered at the time of the sales presentation. As a practical matter, the signing of the contract won't take place until the prospective client decides to engage the services of the IA.

One of your clients has reached his company's mandatory retirement age of 67. He has been a participant in his employer's 401(k) plan and his account is valued at $400,000. The account is funded with mutual funds and company stock. The cost basis of the company stock is $25,000 and it is currently worth $125,000. If he were to use the net unrealized appreciation (NUA) approach when taking the distribution of the company stock, the tax treatment would be: A) ordinary income on the $25,000 cost basis, long-term capital gain on the appreciation when sold. B) ordinary income on the entire $125,000. C) long-term capital gain on the entire $125,000. D) ordinary income on the $25,000 cost basis, short-term capital gain on the appreciation when sold.

Ans. A Under IRS rules, if part of your retirement plan assets includes company stock, taking that as a distribution (not rolling it over into an IRA) subjects the cost basis to ordinary income tax and any unrealized appreciation is taxed as long-term capital gain when sold. Reference: 20.4.5.7 in the License Exam Manual

Under which of the following circumstances would it most likely be presumed that an adviser holds custody of client property? A) Harold, a client, makes a check intended for his investment account payable to Gibraltar Advisers, which is dually registered as investment adviser and broker-dealer. Harold's fee is automatically withdrawn from his account on a semiannual basis. B) Paul is a client of Gibraltar Advisers. Although he makes deposits to his investment accounts by checks payable to Delta Securities, checks for his semiannual financial planning fees are made payable to Gibraltar Advisers. C) Carol gives her investment adviser associate a check made payable to the custodian of Carol's IRA. D) Ellen engages Sam, a representative of a registered investment adviser, to prepare a financial plan. In conjunction with the plan preparation, Ellen provides Sam with access to all her brokerage account statements and tax returns.

Ans. A When fees are automatically withdrawn from the client's account, custody of client funds can be presumed. Merely handing an adviser a check payable to a third party, such as a retirement account custodian, does not represent custody, nor are direct payments of advisory fees to the adviser considered custody. In the context of this question, account statements are considered to be information rather than property. Stock and bond certificates, as well as cash, are examples of client property. Reference: 3.11 in the License Exam Manual

Which of the following are considered to be exempt issuers under the Uniform Securities Act? i. State of Georgia. ii. City of London, Ontario. iii. City of London, England. iv. Kapco Income Fund, an open-end investment company registered with the SEC. A) I and II. B) I, II, III and IV. C) I, II and IV. D) I, II and III.

Ans. A. Any state or Canadian province, or political subdivision thereof, is considered an exempt issuer. Foreign governments with whom the United States has diplomatic relations, but not their political subdivisions, are considered exempt issuers. SEC-registered investment companies are non-exempt issuers under the USA. That is, the act does not include them in the list of exempt issuers. However, under the NSMIA, they are federal covered securities and, as such, do not register with the states other than filing a notice. All the more so, hedge funds that are NOT registered with the SEC would not be exempt issuers. Reference: 2.8.1 in the License Exam Manual

An individual has borrowed $500,000 for a business loan. The loan agreement requires payment in one lump sum at the end of 7 years and stipulates that protection be provided in the form of a life insurance policy on the individual. Which type of insurance would probably be most appropriate in this situation? A) Variable universal life B) Level term C) Decreasing term D) Whole life

Ans. B Term insurance is frequently referred to as temporary insurance, because it is often used to cover a specific need. In this case, because the payback is in a lump sum, level term is most appropriate. If it were being amortized over the seven years (similar to a mortgage), then perhaps the decreasing term would be the best choice. Reference: 8.2.1 in the License Exam Manual

Judy is in the business of giving general investment advice, suggesting appropriate asset allocation percentages, but not recommending specific securities. George's business model is giving investment advice and recommending specific securities. Assuming that both receive compensation, who must register as an investment adviser under the Uniform Securities Act? A) Neither must register. B) Both must register. C) Only George. D) Only Judy.

Ans. B Two of the three critical elements in the definition of investment adviser are whether the person provides advice regarding securities and receives compensation for doing so. (The third element is "being in the business" and the question states that both are). Even without recommending specific securities, the fact that Judy suggests asset allocation percentages constitutes investment advice. Both Judy and George provide advice regarding securities for compensation and must register, unless specific exemptions apply. Reference: 3.7 in the License Exam Manua

An investment adviser is doing some research on a company and notices that the current market price is $21 per share. The most recently reported EPS is $3 and the company is paying a 19 cent quarterly dividend. On the balance sheet, the company is carrying a significant amount of cash. This company would probably be attractive to this adviser if his investment style was: A) contrarian. B) value. C) micro-cap. D) growth.

Ans. B. This is an example of the kind of company appealing to those who follow a value style of portfolio management. The company is selling at a low P/E ratio of 7 to 1 ($21/3) with a liberal dividend yield of 3.62% (.76/$21). The high cash balance only adds to the value. Reference: 16.3.2 in the License Exam Manual

With regard to the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, proscribed actions would include: i. accepting an order from a third party after written trading authorization has been received ii. forwarding a written complaint from a customer to the appropriate supervisory person iii. offering to repurchase a security at its original cost if it does not increase in value iv. borrowing money from a client who was the agent's college roommate A) II and IV B) I and II C) III and IV D) I, II, and IV

Ans. C. Prohibited actions under the policy would be guaranteeing a client against loss by agreeing to repurchase a security at its cost and borrowing money from a client who is not in the money-lending business. Reference: 2.11.25 in the License Exam Manual

A "margin account" is a type of brokerage account in which the broker-dealer lends the investor cash to purchase securities using marginable securities in the account as collateral. Which of the account documents authorizes the use of those securities as collateral for that loan? A) The loan consent agreement B) The hypothecation agreement C) The secured agreement D) The credit agreement

Ans. D. It is the credit agreement, sometimes referred to as the margin agreement, which contains all of the terms of the loan. In addition to explaining how the interest is charged and the right of the firm to liquidate collateral if a call for additional funds is not made, the credit agreement contains the terminology which authorizes the broker-dealer to use the value of the account as collateral for the margin loan made by the BD to the client. The hypothecation agreement permits the broker-dealer to pledge the client's margin securities as collateral for a loan that the BD takes out. In simple terms, there are two loans taking place: The loan from the BD to the client with the client's securities used as collateral. That is covered in the credit agreement The loan from a bank to the BD with the client's securities used as collateral for the BD's loan. The authorization for the BD to use those securities is found in the hypothecation agreement. Reference: 18.1.2.1 in the License Exam Manual