Inv Veh Quiz #4

What is a Yankee Bond? A. A foreign bond traded in the U.S. market B. A foreign bond traded in a foreign market C. A U.S. bond traded in a foreign market D. A U.S. bond traded in the U.S. market

The best answer is A. The Yankee Bond market is where foreign issuers sell bonds in the U.S. market, typically because interest rates are lower and the market is very deep and safe. The biggest issuers of Yankee bonds are Canadian companies and the government of Canada, since the U.S. debt market is so much larger than the Canadian debt market. The bonds pay in U.S. dollars, semi-annually, like conventional domestic bond issues.

Negotiable Certificates of Deposit: I are issued at par II are issued at a discount to par III mature at par IV mature at par plus accrued interest A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Negotiable certificates of deposit (over $100,000 face amount) are issued at par and mature at par plus accrued interest. If they are traded prior to maturity, they trade with the amount of accrued interest due. All other money instruments are issued at a discount to par; and mature at par value. The difference is the interest earned.

An investor has a $1,000,000 portfolio that is split evenly between "blue chip" stocks and Treasury securities. The current economic environment is characterized by low interest rates and flat stock prices - and this is expected to remain unchanged for a number of years. However, the residential and commercial real estate market is expected to be strong. The investor would like to diversify the portfolio and enhance returns without adding much additional risk. Which of the following investment purchase recommendations would help achieve this objective? A. Mortgage REITs B. Mortgage Bonds C. Equity REITs D. Fannie Mae Pass-Through Certificates

The best answer is C. During periods when financial assets such as stocks and bonds are not doing well, "hard" assets such as real estate and artwork tend to do better (since investors reallocate their investments away from financial assets into housing, etc.) A way that investors can participate in this is by investing in equity REITs. Since equity REITs own real estate, the share price movement of the REIT parallels the value of the real estate owned. Mortgage REITs invest in mortgages (essentially the same as investing in a bond) and thus are not the best choice when interest rates are low, since the yield is meager. And, if market interest rates rise, the value of the mortgages held drops. The same would be true for investments in mortgage bonds and Fannie Mae Pass-Through certificates.

The price-earnings ratio is used to: A. calculate the future price of a security B. compare the price of a security in one industry to the price of a security in another industry C. compare the price of a security in one industry to other securities in the same industry D. determine if the current price of security is a fair value

The best answer is C. The Price/Earnings ratio is used to compare the price of security in a given industry to other securities in that industry. It is not valid to compare P/E ratios across industries. For example, IBM might have a P/E ratio of 20, while other companies in the computer hardware/software industry average a P/E ratio of 30. IBM's P/E ratio is lower because it is so large that it is hard to keep growing as rapidly as smaller competitors can. It would not be valid to compare IBM's P/E ratio of 20 to say, General Motors P/E ratio of 10, since they are 2 totally different industries; with different market prospects and growth characteristics.

Which annuity payout option usually results in the largest periodic payment? A. Unit Refund Annuity B. Joint and Last Survivor Annuity C. Life Annuity D. Life Annuity-Period Certain

The best answer is C. The shorter the expected annuity period, the larger the payment. A life annuity lasts only for that person's life - this is the shortest expected period of those given. A life annuity with period certain continues to pay for a fixed time period if the person dies early; a joint and last survivor annuity pays a spouse when one person dies; a unit refund annuity pays a lump sum if a person dies early.

Which statements are TRUE regarding taxation of distributions from municipal bond funds? I Dividend distributions representing interest are taxable II Dividend distributions representing interest are tax-free III Dividend distributions representing capital gains are taxable IV Dividend distributions representing capital gains are tax-free A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. While the interest income from a municipal bond (or municipal bond fund) is exempt from Federal Income Tax, any capital gains on the sale of the bonds (or redemption of the bond fund shares) are still taxable. Dividends distributed by municipal bond funds are broken out on the IRS Form 1099 into the portion that represents interest (tax free) and the portion that represents capital gains (taxable). It makes no difference if the dividends are reinvested or not.

Which of the following statements concerning a universal life insurance policy are TRUE? I The policy owner has a choice of investments for the cash value II The policy owner can change the amounts of premium payments III The policy owner can change the amount of the death benefit IV The policy owner receives a guaranteed, fixed rate of return on cash value A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. With a universal life policy, the policy owner can change the premium payments and the death benefit. The cash value is invested in the insurer's general account, so the policy owner does not have a choice of investments and the rate of return is not fixed - it will vary with the return of the general account.

Which statements are TRUE regarding Equity Indexed Annuities (EIAs)? I In a year of sharply rising stock prices, EIAs will match the positive return of the Standard & Poor's 500 Index II In a year of sharply rising stock prices, EIAs will not match the positive return of the Standard & Poor's 500 Index III In a year of sharply falling stock prices, EIAs will match the negative return of the Standard & Poor's 500 Index IV In a year of sharply falling stock prices, EIAs will not match the negative return of the Standard & Poor's 500 Index A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Equity Indexed annuities are an insurance product and are currently not defined as a "security." They give a return tied to the performance of the Standard and Poor's 500 Index, but this is subject to an annual cap of typically 7-9%. Thus, in a year of sharply rising stock prices, they will not give the return of the index. However, they are protected in a falling market and guarantee a yearly minimum return of 1-3%. Thus, they will give a better return than the Standard and Poor's 500 Index when the market is falling sharply.

A convertible debenture is convertible into common at $40 per share. If the market price of the bond rises to a 5 point premium over par, which statements are true? I The conversion ratio is 20:1 II The conversion ratio is 25:1 III The parity price of the stock is $40 IV The parity price of the stock is $42 A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. The conversion ratio is established when the bond is issued, and is par value divided by the conversion price. In this case, the conversion price is set at $40 per share, so the conversion ratio is $1,000 par / $40 conversion price = 25:1 (25 shares per bond). If the bond moves to a 5 point premium over par, its new price will be 105, or $1,050 per bond. For the common stock to be valued at parity to the bond, the price per share must be $1,050 / 25 shares per bond = $42 per share parity price.

Which of the following is MOST likely to fluctuate for an annuitant during the payout period of a fixed annuity? A. Death benefit B. Benefit payments C. Investment return D. Purchasing power

The best answer is D. With a fixed annuity, the investment return and benefit payments are guaranteed and fixed. During the payout period, there is no death benefit - the insurance company simply promises to make the fixed monthly payments until the annuitant dies. (Note that there can be a death benefit offered while the purchaser is making payments into the contract.) Because the benefit payments are fixed once the annuity payments start, the purchasing power of those fixed payments will fluctuate depending on the rate of inflation.