Series 65 part 3 continued study

A fundamental analyst would be most interested in which of the following? A) A 200-day moving average B) A P/E analysis of the stocks included in the Dow Jones Industrial Average C) Resistance and support levels D) The outstanding short interest in the market

B (Fundamentalists look at P/E ratios; the other tools mentioned are technical.)

The Investment Company Act of 1940 does which of the following? A) Regulates the secondary market B) Prescribes procedures for the establishment of investment companies C) Governs the issuance of new issues D) Sets rules for the registration of investment advisers

B (The Investment Company Act of 1940 requires all investment companies to register with the SEC as such and be regulated under the act. The companies are still subject to all the other applicable securities acts. However, the Investment Company Act of 1940 provides additional regulation to ensure that investors are fully informed and fairly treated by the management of investment companies.)

Ginnie Mae pass-throughs will pay back both principal and interest A) quarterly B) semiannually C) annually D) monthly

D (Ginnie Mae (GNMA) securities are called pass-through certificates because the monthly home mortgage payments, which consist of both principal and interest, pass through to the GNMA investor monthly.)

One of the likely consequences of a rating downgrade on a bond is A) an increase to the coupon by the issuer. B) the call feature will be employed. C) the current yield will be reduced. D) a reduction in the market price of the bond.

D (If the rating agencies downgrade the quality of a bond, potential investors will look to compensate for the increased risk by demanding a greater yield on the issuer's bonds. This will inevitably result in a lower bond price. A change in ratings is unlikely to lead to a call. In fact, with the reduction in the market price, the bond may be selling below par giving the issuer the opportunity to retire the debt at a discount. Bonds are fixed-income securities because the coupon rate is fixed when the bond is issued and does not change.)

One of the ways in which U.S. government agency issues differ from those offered directly by the U.S. Treasury is that A) agency issues are taxable on the federal level while Treasury issues are not B) agency issues typically carry higher returns than Treasury issues because of the lack of direct government backing C) agency issues frequently trade on the NYSE while Treasuries never do D) agency issues are more likely to be issued in larger amounts

b (Agencies, with only a very few exceptions, GNMA being one, do not carry the direct backing of the U.S. Treasury. While they are quite safe, that lack of direct backing causes their yields to be somewhat higher. Agencies are never traded on the stock exchanges and their float is almost always smaller than Treasuries. Both are taxable on the federal level.)

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

B (This option is out of the money and is therefore worthless. Remember, European-style options are exercisable only at expiration and a $35 put is worth zero unless the market price of the underlying asset is less than $35. As is the case with any long option position, the maximum loss is the premium paid.)

Which of the following securities is eligible for a Section 1031 exchange? A) Annuities B) Listed stocks C) Real estate limited partnership programs (RELPs) D) Direct participation programs

C (Section 1031 of the Internal Revenue code deals with like-kind exchanges of real property that is held for use in a trade or business or for investment. Real property, also called real estate, includes land and generally anything built on or attached to it. An RELP is a real estate-based security qualifying for the Section 1031 exchange. The benefit is that no taxes are paid on gains until the last sale of the property. In simple terms, it permits tax-deferral of gains when real estate is exchanged for other real estate.)

Which of the following investment companies registered under the Investment Company Act of 1940 can include senior securities in its capital structure? A) Face-amount certificate companies B) Unit investment trusts C) Open-end management investment companies D) Closed-end management investment companies

D (Only the closed-end company is legally permitted to issue senior securities (preferred stock and bonds).)

In order to perform a discounted cash flow estimation of the value of a bond, it would be necessary to know all of the following EXCEPT A) the parity price of the bond B) the future cash flow C) the discount rate D) the number of interest payments

a (In its simplest iteration, discounted cash flow is nothing more than taking all the money you are scheduled to receive over a given future period and adjusting that for the time value of money (the discount rate). Parity price is only relevant to convertible bonds.)

The term "derivative" would NOT apply to which of the following? A) Warrants B) REITs C) Futures D) Forwards

b (REITs are not based on the value of something other than their own assets. Warrants (and rights) derive their value from the underlying security. Futures and forwards are contracts whose value is based on some underlying asset.)

When a customer wants income from an annuity and chooses the option of life with 20-year period certain, how will distributions be taxed? A) As capital gains based on an exclusion ratio B) As capital gains based on LIFO accounting C) As ordinary income based on an exclusion ratio D) As ordinary income based on LIFO accounting

c (Life with 20-year period certain is an annuitization option. When an annuity is annuitized, ordinary income taxes are paid based on an exclusion ratio (cost basis divided by expected return = how much of the distribution is a return of cost basis (the original principal invested), and not subject to income taxes). Testing note: Unless the question specifically mentions that the annuity is qualified, or gives you a clue, such as it is in a 403(b) plan, the annuity is always nonqualified.)

Which of the following would NOT be of interest to a technical analyst? A) Moving averages B) Advance/decline line C) Volume D) P/E ratio

d (A technical analyst charts movement in market price and volume over a period of time. The price-to-earnings ratio is a tool used by fundamental analysts.)

On the initial public offering, an investor buys a $10,000 Aa-rated, 20-year corporate bond with a 4% coupon rate. One year later, the prevailing market rate is 5% and the bond has had its rating increased to Aa1. Which of the following statements is most likely TRUE with reference to the current market price of this bond? A) The bond would be selling at a premium. B) The bond would be selling at par value. C) The yield to maturity of this bond is above 4%. D) The bond would be selling at a discount.

d (When interest rates go up, bond prices go down. Had interest rates remained the same, the slight improvement in rating would have probably caused the bond to sell at a very slight premium, but that rating increase is not nearly strong enough to offset a 25% increase in market interest rates. Because this bond would be selling at a discount, its YTM would be above 4%, but the question is asking about the current market price, not the yield.)

Which of the following statements correctly describe similarities between exchange-traded funds and closed-end investment companies? I. There are a limited number of outstanding shares. II. They are traded on registered stock exchanges. III. They trade at prices that are not dependent upon but close to their net asset value. IV. Investors pay commissions to purchase and liquidate their positions. A) II and IV B) I and III C) II and III D) I and IV

A (Both exchange-traded funds and closed-end investment companies are traded on exchanges; therefore, investors pay a commission when purchasing and liquidating shares. Only closed-end investment companies have a limited number of shares. Closed-end funds may trade at significant premiums or discounts from their NAV, while ETFs rarely stray far from NAV.)

In the field of securities analysis, there are many tools available. Which of the following would most likely be used by an analyst to approximate a reasonable price for a common stock? A) The dividend discount model B) Yield to maturity C) Book value per share D) Par value

A (The simplest model for valuing equity is the dividend discount model—the value of a stock is the present value of expected dividends on it. Yield to maturity only applies to debt securities with a fixed maturity date. The par value of a common stock has nothing to do with its market price. Although fundamental analysts will examine a company's book value per share, it generally has little or no bearing on the current market price of the stock.)

According to the Investment Company Act of 1940, an open-end investment company must compute its NAV: A) annually B) no less frequently than once per day C) weekly D) monthly

b (Mutual funds must calculate the value of fund shares at least once per business day; funds may calculate the value more often and will disclose this fact in the prospectus.)

Which of the following insurance company products is likely to have the longest time for which a surrender charge will be levied? A) Class B shares B) Bonus annuity C) Variable annuity D) Whole life insurance

B (One of the characteristics of bonus annuities is that their surrender charges tend to be higher for a longer time than other insurance company products. When you see Class B shares on the exam, it will be referring to mutual funds, not insurance company products.)

Programs allowing for the direct pass-through of losses and income to investors include all of the following EXCEPT A) oil and gas drilling direct participation programs B) S corporations C) REITs D) new construction real estate direct participation programs

c (REITs allow for the direct pass-through of income but not losses. The other choices are forms of business which allow for pass-through of income and losses.)

A client in the 30% tax bracket owns a 5% XYZ, Inc., debenture due to mature shortly. What yield in a municipal will give him the same after-tax return that he now has with his debenture? A) 3.50% B) 1.50% C) 2% D) 5.30%

a (The client's tax rate is 30%; 70% of 5% is 3.5%. A nontaxable municipal bond with a 3.5% yield would give the client the same return.)

One of the likely consequences of a rating downgrade on a bond is A) the call feature will be employed. B) the current yield will be reduced. C) an increase to the coupon by the issuer. D) a reduction in the market price of the bond.

D (If the rating agencies downgrade the quality of a bond, potential investors will look to compensate for the increased risk by demanding a greater yield on the issuer's bonds. This will inevitably result in a lower bond price. A change in ratings is unlikely to lead to a call. In fact, with the reduction in the market price, the bond may be selling below par giving the issuer the opportunity to retire the debt at a discount. Bonds are fixed-income securities because the coupon rate is fixed when the bond is issued and does not change.)

A mutual fund would have net redemptions when A) the fund manager is selling more securities in the portfolio than are being purchased B) the fund is performing below the average of other funds with the same objectives C) the fund increases its sales charge D) the number of shares being liquidated by investors exceeds those being purchased

d (One of the characteristics of an open-end investment company (mutual fund) is the ease of redeeming holdings. When the dollar amount of shares being redeemed exceeds that of those being purchased, the result is net redemptions. Although poor performance could lead to net redemptions, that is not always the case, so it is not always a true statement.)

The Investment Company Act of 1940 requires certain types of investment companies to compute their net asset value on a regular basis. Excluded from that requirement are A) closed-end management investment companies. B) face-amount certificate companies. C) open-end management investment companies. D) unit investment trusts.

B (The two investment companies offering redeemable securities, open-end funds, and UITs, must compute their NAV on a daily basis. Closed-end funds can do it daily; many compute every Friday. The concept of NAV makes no sense with a FACC.)

Which of the following is TRUE of a zero-coupon bond? I. The rate of return is locked in. II. There is no reinvestment risk. III. The imputed interest is taxed as ordinary income on an annual basis. IV. A check for the interest is paid at maturity. A) I only B) I, III, and IV C) I, II, and III D) I and IV

C (Zero-coupon bonds pay no periodic interest and are always issued at a discount from par. The appreciation of the zero from its discounted purchase price to its face value is thought of as interest to the bondholder, but this annual "phantom income," so named because you don't receive it, is taxed as ordinary income on an annual basis. When the bond is purchased, the investor locks in that yield, and with nothing to reinvest, there is no reinvestment risk.)

Which of the following statements concerning equity securities is not correct? A) Equity securities provide a residual claim, after payment of all obligations to fixed-income claims, on the income and assets of a corporation. B) Common stock is an equity security representing an ownership interest in a corporation. C) Equity securities represent a lending interest in a corporation. D) Preferred stock is an equity security with an intermediate claim (between the bondholders and the common stockholders) on a firm's assets and earnings.

c (Equity securities represent an ownership interest in a corporation. Preferred stock, as a senior security, has a claim ahead of common, but behind debt securities.)

Which of the following is not a characteristic of hedge funds? Hedge funds A) offer managers high fixed fees. B) use leverage, short positions, and concentrated positions. C) are privately organized and generally unregistered. D) invest in private securities, real assets, derivatives, and structured products.

A (Hedge funds attempt to attract the top managers because they offer performance-based fees, which vary based on fund performance. The typical fee structure is 2% + 20% where 2% is the fixed fee and 20% of the profits is the performance portion.)

If a bond has a long duration, it will A) be relatively unaffected by small changes in interest rates B) be more sensitive to small changes in interest rates than a bond with a shorter duration C) be less sensitive to small changes in interest rates than a bond with a shorter duration D) continue paying interest into perpetuity

B (Duration measures how sensitive a bond will be to a small change in interest rates. The longer the duration of a bond, the more volatile (sensitive to interest rate changes) it will be.)

Current IRS regulations permit an unlimited contribution to which of the following tax-deferred plans? A) Annuity B) 401(k) C) SEP IRA D) Roth IRA

a (Nonqualified annuities offer tax deferral similar to that of qualified retirement plans. However, unlike qualified plans and IRAs, the IRS places no limitation on the amount that may be contributed.)

Assume that a corporation issues a 5% Aaa/AAA-rated debenture at par. Two years later, similarly rated debt issues are being offered in the primary market at 5.5%. Which of the following statements regarding the outstanding 5% debenture are TRUE? I. The current yield on the debenture will be higher than 5%. II. The current yield on the debenture will be lower than 5%. III. The dollar price per bond will be higher than par. IV. The dollar price per bond will be lower than par. A) I and IV B) II and III C) I and III D) II and IV

A (Because interest rates have risen after the issue of the 5% debenture, the bond's price will be discounted to result in a higher current yield (computed as annual income divided by current market price). Accordingly, the discounting of the issue will make the 5% debenture competitive with new issues offered with a 5.5% coupon.)

Which of the following statements regarding the properties of duration is NOT true? A) Duration measures the holding period return on a bond. B) Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. C) Duration measures the effect of an interest rate change on the price of a bond or bond portfolio. D) Duration is a weighted-average term to maturity of a bond's cash flows.

A (Duration does not measure the holding period return on a bond; it measures the effect of an interest rate change on the price of a bond or bond portfolio. Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. Duration is also a weighted-average term to maturity of a bond's cash flows.)

Your customer owns $100 par 5½% callable convertible preferred stock convertible into 4 shares of common stock at $25. What should she be advised to do if the board of directors were to call all the preferred at 106 when the common stock is trading at $25.50? A) Present the preferred stock for the call because the call price is $4 above the parity price. B) Place irrevocable instructions to convert the preferred stock into common stock and sell short the common stock immediately. C) Hold the preferred stock to continue the 5½% yield. D) Convert her preferred stock into common stock because it is selling above parity.

A (If the preferred stock is called, the client will receive $106. Tendering the preferred stock will provide the highest value. The value of converting the preferred stock into 4 shares of common is worth $102 (4 × $25.50 = $102), which is less than the call value of $106. The dividends will cease on the call date if the preferred stock is held beyond the call date.)

A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) Fixed annuity B) REIT C) Variable annuity D) Common stock

C (Longevity risk is the uncertainty that one will outlive his money. The only instrument that guarantees a payout for as long as one lives is an annuity. Because the question asks for a security, only the variable annuity is correct, otherwise the fixed annuity would also offer protection.)

If a group of money managers was having a discussion and the term SOFR was mentioned, the topic would most likely be A) long-term borrowing rates. B) contract negotiations with the employee's union. C) current economic conditions in Liberia. D) short-term borrowing rates.

D (For more than 40 years, the London Interbank Offered Rate—commonly known as LIBOR—was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages, and corporate debt. Over the last decade, LIBOR has been burdened by scandals and crises. Effective January 2022, LIBOR is no longer being used to issue new short-term loans in the U.S. It was replaced by the Secured Overnight Financing Rate (SOFR) which many experts consider a more accurate and more secure pricing benchmark. As is always the case with NASAA, we do not know when the exam questions will be updated. One thing we can promise you is that any question relating to this topic will not have both LIBOR and SOFR as choices, so you should choose whichever one appears.)

Which of the following statements regarding secondary trading in the private equity market is TRUE? A) Secondary trading generally causes investors to have to wait over a longer time period to generate returns from their private equity investment. B) Secondary markets are a form of distressed securities markets wherein limited partners sell securities with troubled performance histories. C) Secondary trading makes it more difficult for investors to make strategic shifts in the private equity allocations within their portfolios. D) A trade in a secondary market may be motivated by the desire for increased access to deals in the primary market.

D (One of the advantages to secondary trading is that making secondary purchases can give an investor exposure to a general partner, which can create opportunities to gain access to future opportunities from that partner. The other statements are all incorrect. Secondary trading may allow investors to get into a private equity deal at a later stage and, thus, realize positive returns more quickly. Secondary trading provides liquidity and makes it easier for investors to make strategic shifts in their portfolios. Secondary markets are often used by investors due to changing portfolio needs, rather than a change in the value of their private equity funds.)

One way in which incentive stock options (ISOs) differ from nonqualified stock options (NQSOs) is that A) the bargain element of the ISO is reported as wages on the tax returns of the employer and the employee. B) the bargain element of the ISO is an AMT preference item. C) gains on an ISO are always short-term while those on an NQSO are long-term. D) there is a maximum 5-year limit for exercise on the ISO while the time limit on the NQSO is 10 years.

b (The only true statement here is that the bargain element (the difference between the current market price at the time of exercise and the strike price) of the ISO (but not the NQSO) is one of the preference items for the alternative minimum tax. It is the bargain element of the NQSO which is reported as wages and it is possible, although difficult, to have long-term capital gains on both. Only the ISO has a maximum time limit and it is 10 years, not 5.)

An investor purchases a TIPS bond with a 4% coupon. If during the first year the inflation rate is 9%, the approximate principal value of the security at the end of that year will be A) $1,040. B) $1,092. C) $1,090. D) $1,045.

B (The principal value of a TIPS bond is adjusted semiannually by the inflation rate. The exact calculation would be $1,000 x 104.5% x 104.5% which equals $1,092.025. Each six months, the interest is paid on that adjusted principal and that is why the security keeps pace with inflation. Obviously, the answer must be something a bit higher than $1,090 because of the semiannual compounding.)

Which of the following statements is NOT true? A) Mutual fund shares may not be purchased on margin because their shares are always public offerings of new shares. B) Mutual funds may be used as collateral in a margin account if they have been owned for more than 30 days. C) Open-end investment companies must have a minimum of $1 million in assets to have a public offering. D) The sale of open-end investment company shares is a continuous public offering and must be accompanied by a prospectus.

C (Minimum assets of $100,000 are required.)

Which of the following statements regarding a unit investment trust is not true? A) It charges no management fee. B) Overall responsibility for the fund rests with the board of directors. C) It invests according to stated objectives. D) It is considered an investment company.

b (A unit investment trust has no board of directors; rather, it has a board of trustees. A UIT must follow a stated investment objective (as must any investment company) and does not charge a management fee because it is not a managed portfolio.)

An investor wishing to add some diversification to his portfolio wishes to purchase 200 shares of an ADR for a Japanese electronics manufacturer. The ADR is listed on the NYSE. Which of the following risks should be of most concern to this investor? I. Business II. Currency III. Inflation IV. Liquidity A) III and IV B) I and II C) II and III D) I and IV

B (Owning stock in any corporation always subjects the holder to business risk, the uncertainty that the entity might fail to meet its economic goals. Whenever one invests internationally, whether directly or through the vehicle of an ADR, one is subject to currency risk. Inflation risk is of concern to those who purchase fixed-income investments, and any security listed on the NYSE has little or no liquidity risk.)

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

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

Which of the following statements concerning international investing is correct? A) Information is not as readily available on foreign investments as on domestic ones. B) The addition of foreign securities to a portfolio may result in increased portfolio risk due to the different movements of foreign markets and U.S. markets. C) Foreign markets are usually mature and offer no growth advantages. D) The rates of return on foreign securities are generally less than those available from U.S. markets.

a (In general, foreign investments don't have the transparency of domestic ones. Investors may earn higher returns in foreign markets and including foreign securities in an investment portfolio may lower risk through greater diversification. This is because there may be a low correlation with U.S. markets. Although securities markets in most developed economies are mature, that doesn't mean they can't grow and the markets in emerging economies offer great potential growth commensurate with their greater risk.)

All of the following statements regarding futures contracts are correct EXCEPT A) completing a futures contract requires the delivery of the commodity. B) futures contracts can be written on financial assets or commodities. C) a short position will increase in value if the underlying commodity or asset declines in value. D) purchasing a contract for future delivery is considered taking a long position.

A (In almost all cases, the holder of the futures contract will purchase an offsetting contract canceling the original position or sell the contract prior to expiration. In isolated cases, delivery of the commodity may be made but is not required. Futures contracts can be written on financial assets such as currencies and stock indexes, as well as on commodities such as agricultural products or precious metals. As with anyone taking a short position, the value goes up when the price of the underlying asset declines. And, just as purchasing a stock or bond, a long position represents one of ownership.)

A bond with a par value of $1,000 and a nominal yield of 6% paid semiannually is currently selling for $1,300. The bond matures in 25 years and is callable in 15 years at $1,080. In the computation of the bond's yield to call, which of these would be a factor? A) Present value of $1,080 B) Interest payments of $30 C) 50 payment periods D) Future value of $1,300

B (The YTC computation involves knowing the amount of interest payments to be received, the length of time to the call, the current price, and the call price. With a 15-year call, there are only 30 semiannual interest payment periods, not 50. The present value is $1,300 and the future value is $1,080; the reverse of the numbers indicated in the answer choices.)

Among the differences between an investment in a limited partnership offering and in a corporation is that A) only corporations issue securities. B) limited partners take a more active role in the management of the enterprise than do stockholders of a corporation. C) only corporations are organized to run a business. D) limited partnership offerings do not pay dividends; corporations do.

d (One of the key features of a limited partnership investment is the concept of flow-through of operating results. If the business operates at a loss, the limited partner's share of that loss is treated as a passive loss on the investor's tax return. If the business is profitable, the limited partner's share of the profit is treated as passive income. Corporations issue securities, primarily stocks and bonds, while limited partnerships issue units representing the limited partner's interest in the venture. Those units are investment contracts and, as taught in Unit 4, LO4, securities. Limited partners who take an active role in the partnership lose their limited status.)

One way in which incentive stock options (ISOs) differ from nonqualified stock options (NQSOs) is that A) there is a maximum 5-year limit for exercise on the ISO while the time limit on the NQSO is 10 years. B) gains on an ISO are always short-term while those on an NQSO are long-term. C) the bargain element of the ISO is reported as wages on the tax returns of the employer and the employee. D) the bargain element of the ISO is an AMT preference item.

d (The only true statement here is that the bargain element (the difference between the current market price at the time of exercise and the strike price) of the ISO (but not the NQSO) is one of the preference items for the alternative minimum tax. It is the bargain element of the NQSO which is reported as wages and it is possible, although difficult, to have long-term capital gains on both. Only the ISO has a maximum time limit and it is 10 years, not 5.)

Securities issued by which of the following agencies offer direct government backing? A) Federal National Mortgage Association B) Federal Home Loan Mortgage Corporation (Freddie Mac) C) Federal Intermediate Credit Bank D) Government National Mortgage Association

D (FNMA, FHLMC, and FICB are considered GSEs (government-sponsored enterprises), and although their securities are quite safe, they do not have the direct backing of the Treasury. It is important to remember for the exam that the only security without the word Treasury in its name that is backed by the U.S. government is a GNMA.)

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

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

A client of yours comes to the office and shows you some sales literature from a mutual fund that has him very excited. According to the material, the fund's average annual return over the past 10 years has been in excess of 15% and it has achieved the highest rating from the major fund rating services. Before recommending this fund to your clients, the first thing you would probably check for in the fund's prospectus is A) the fund's sales charge. B) the fund's objectives. C) the fund's expense ratio. D) the portfolio manager's tenure.

d (Because this client has been "sold" on past performance, you need to verify if the manager achieving those results is still on the job. That is the prime reason why the regulations require disclosure of the fund manager's tenure; it is important for investors to know if the current manager was the one who had the winning streak or if that manager just came on board. The other choices are something to look at, but in this instance, they take a back seat to checking on the manager's tenure. Sure, the expense ratio is important, but the past performance is after expenses so that has already been taken into consideration.)

Among the provisions of the Investment Company Act of 1940 designed to protect the interests of investors is the provision that A) communications with the public must be approved by FINRA before its use B) selection of company investments must be approved by SEC C) for diversification purposes, an investment company may own up to 10% of the shares of another investment company D) any change in fundamental investment policy must be approved by stockholders

d (One of the requirements of the Investment Company Act of 1940 is that an investment company cannot change its investment policy without approval of a majority vote of the shareholders. For example, the board of directors of a growth fund could not change the fund's investment objective to income without that approval. This has the effect of offering protection to the investors that they won't be "blindsided" by the board or the portfolio manager. On this exam, you shouldn't expect to see anything "approved" by the SEC as a correct answer. An investment company may own up to 3% of another investment company, not 10%. Even though FINRA rules do require approval of investment company communications with the public, such approval is not part of the Investment Company Act of 1940.)

An investor who chooses to use preferred stock as an income source instead of bonds would potentially incur which of the following risks? I. Loss of principal II. Price volatility of preferred stock is closely related to interest rates III. Preferred stock cannot be traded as readily as bonds IV. If the stock is callable, the client's income can be suddenly lowered A) III and IV B) I, II, and IV C) I and II D) I, II, III, and IV

B (Because bonds have seniority over any equity security, there is a greater risk of loss of principal with preferred stock than with bonds. The price volatility of preferred stocks, like bonds, is impacted by interest rate changes. Unlike bonds, however, preferred stock does not have a maturity date. This means that preferred shares may never return to their par value, as bonds do at maturity date. Because the preferred stock may have a callable feature, the company can redeem its shares anytime after the call protection period (if any) is over. This usually happens when interest rates have declined, so the client whose stock was called will not be able to reinvest the proceeds at the same rate and could, therefore, suffer an unexpected drop in income. Preferred shares, particularly those listed on the exchanges, are generally easier to trade than corporate bonds (and certainly no worse).)

Which of the following statements about preemptive rights are TRUE? I. Preemptive rights give shareholders the right to purchase shares in new stock issues in direct proportion to the number of shares they already own. II. Preemptive rights allow shareholders to buy as many new shares as they want at any time. III. Preemptive rights allow shareholders to maintain their proportionate share of ownership in the corporation. A) I and II B) I and III C) II and III D) I, II, and III

B (Preemptive rights give shareholders the right to purchase, in direct proportion to the number of shares they already own, shares in new issues of stock before they are offered to the general public. This allows current shareholders to maintain their proportionate share of ownership in the corporation.)

Which of the following statements regarding a mutual fund that offers class A, B, and C shares are TRUE? I. Class A shares have a front-end sales charge and a low 12b-1 fee. II. Class B shares have a declining contingent-deferred sales charge and a high 12b-1 fee. III. Class C shares have a high 12b-1 fee and a level contingent-deferred sales charge. IV. Class B and C shares allow investors to put the shares back to the fund for their original purchase price for up to 1 year after purchase. A) I and II B) I only C) I, II, III, and IV D) I, II, and III

D (There is no put provision that guarantees the return of an investor's purchase price associated with mutual fund shares.)

One of the features of an index annuity is the ability for the principal value to increase based on the performance of the specified index. Which of the following is NOT used as a method to compute the amount of interest to be credited to the account? A) High-water mark B) Annual reset C) Participation rate D) Point to point

c (Although the participation rate is a component of the computation, it is not a method of computing the interest credit. In the annual reset index method, interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the contract year. Interest is added to the annuity each year during the term. Using the high-water mark, the index-linked interest, if any, is decided by looking at the index value at various points during the term, usually the annual anniversaries of the date the annuity was purchased. The interest is based on the difference between the highest index value and the index value at the start of the term. Interest is added to the annuity at the end of the term. And finally, with the point-to-point method, the index-linked interest, if any, is based on the difference between the index value at the end of the term and the index value at the start of the term. Interest is added to the annuity at the end of the term. In each of these, the insurance company will specify the participation rate (what percentage of the increase will be credited) and a cap rate (the maximum amount to be credited).)

The term derivative would apply to which of the following? A) DPPs B) Warrants C) REITs D) UITs

B (A derivative has its value based upon some underlying asset. The value of a warrant is based on the value of the security into which it is exchangeable.)

When investing in mutual funds, each of the following is a sales charge EXCEPT A) 12b-1 fees B) a front-end load C) a CDSC D) a back-end load

A (12b-1 fees are not defined as sales charges because they are not a function of buying or selling your shares. These fees are asset-based, generally charged quarterly, and come out of the NAV. Front-end loads and back-end loads (CDSCs) are charged either when you buy the fund (front end) or sell your shares (back-end).)

Which of the following is true regarding ETNs? A) Their value can be impacted by changes in the issuer's credit rating. B) They are non-callable prior to maturity. C) They are suitable for conservative investors seeking income. D) As fixed-income investments, they do not have market risk.

A (ETNs are unsecured debt obligations carrying credit risk based on the issuer's credit rating. Fixed-income investments have the market risk more commonly referred to as interest rate risk, and they are usually callable. These are sophisticated instruments that are not suitable for conservative investors.)

Bright-Lite Incandescent Bulb, Inc., has recently suffered significant operating losses and is planning a bankruptcy filing. Which of the following debt issues have the most junior claim? A) Common stock B) Mortgage bonds C) Debentures D) Senior notes

C (Although the most junior claim of all is that of the common stockholder (equity), this question is about the priority of debt issues. In that case, the most junior (last in line) of the creditors are the holders of the company's debentures.)

Early in the year, an investor purchased shares of the GEMCO Fund at $10.40 per share when the net asset value per share was $9.53. Just before the last trading day of the year, this investor liquidated the position at $10.60 per share when the net asset value per share was $10.77. From this, you can discern that GEMCO Fund is A) an open-end investment company B) a unit investment trust C) a closed-end investment company D) a face-amount certificate company

C (It is only the closed-end investment company where shares trade at a premium or discount to the NAV per share.)

Which of the following is used in technical analysis in an attempt to modify fluctuations of stock prices over the long term into a smoothed trend? A) Trend lines B) Support and resistance C) Moving averages D) Consolidation

C (To avoid the volatility frequently present in stock price trends, analysts will frequently use moving averages. These averages reduce short-term distortions to a minimum.)

Which of the following U.S. government securities do NOT bear a stated interest rate but are sold at a discount through weekly auctions? A) Treasury notes B) TIPS C) Treasury bills D) Treasury bonds

C (Treasury bills bear no stated interest rate. They are sold at a discount through weekly auctions and are actively traded in the money market. Treasury notes and Treasury bonds both carry stated interest rates.)

Which of the following statements correctly describe similarities between exchange-traded funds and closed-end investment companies? I. There are a limited number of outstanding shares. II. They are traded on registered stock exchanges. III. They trade at prices that are not dependent upon but close to their net asset value. IV. Investors pay commissions to purchase and liquidate their positions. A) I and IV B) I and III C) II and III D) II and IV

D

If a client prefers mutual fund investments in companies that primarily generate capital appreciation to companies that pay a steady dividend, what type of mutual fund and associated investment objective would you recommend? A) A growth and income fund B) An income fund C) An index fund D) A growth fund

D (A growth mutual fund invests in stocks that are growing rapidly and stresses capital appreciation rather than income. The key is that the growth and appreciation are synonymous.)

The Investment Company Act of 1940 allows a majority vote of outstanding shares of a registered investment company to authorize the fund to do all of the following EXCEPT A) change the objectives of the fund B) change the nature of its business and cease to be an investment company C) change from an open-end to a closed-end investment company D) invest in securities consistent with the fund's objectives

D (Shareholder approval is not necessary to authorize the fund to invest consistent with the fund's objectives; it is required as part of the contract with the fund's investment adviser. Under the Investment Company Act of 1940, a vote of the majority of outstanding shares may approve changing from an open-end to a closed-end company, changing the investment objectives of the fund, and deciding to cease to be an investment company.)

An investor is looking to add some bonds to her portfolio. One of the bonds she is analyzing has a 3% coupon and the other a 6% coupon. Assuming both bonds have the same maturity date, a change in interest rates will have a more profound effect upon the market price of which bond? A) The 6% coupon B) Changes in interest rates affect both bonds equally C) The bond with the lower rating D) The 3% coupon

D (The longer a bond's duration, the more its price is affected by changes to interest rate. When bonds have the same maturity, the one with the lowest coupon has the longest duration. Ratings have little or nothing to do with price changes caused by interest rate changes.)

A company's dividend on its common stock is A) determined by its board of directors B) mandatory if the company is profitable C) specified in the company charter D) voted on by shareholders

a (A common stock's dividend payment and amount are determined by the company's board of directors.)

Which of the following are characteristics of newly issued warrants? A) Intrinsic value, but no time value B) Time value, but no intrinsic value C) Time value and intrinsic value D) No intrinsic value and no time value

b (Warrants could be thought of as call options with a long expiration period. They are always issued with a strike price in excess of the current market value, so there is no intrinsic value. One could say that on issuance, they are always out-of-the-money. The only value is in the time to expiration, usually several years or longer.)

If yields should change by 75 basis points, which of the following bonds would have the greatest price change? A) JKL 4s 2020 B) ABC 4s 2040 C) DEF 4s 2035 D) GHI 4s 2030

b (When all coupons are the same, the bond with the longest maturity will have the longest duration and, therefore, will be subject to the greatest price fluctuations.)

One of the rights of those owning common stock is the opportunity to vote on issues brought up at the corporation's annual meeting. To be eligible to cast a vote, A) the company must be current on its dividends to preferred stockholders B) the stockholder must be a natural person C) the stock must be paid for in full before the annual meeting D) ownership must be established by the record date

d (Only stockholders who are on the company's books by the record date are eligible to vote.)

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

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

An investor sells ten 5% bonds at a profit and buys another 10 bonds with a 5¼% coupon rate. The investor's yearly return will increase by A) $2.50 per bond B) $1.50 per bond C) $2.00 per bond D) $1.00 per bond

A (The first bonds are 5% and pay $50 per year per bond. The new bonds are 5¼% and pay $52.50 per year per bond. 5% coupon rate × $1,000 face value = $50 per year per bond; 5¼% coupon rate × $1,000 face value = $52.50 per year per bond.)

An investor reading the open-end investment company section of today's The Wall Street Journal sees that Bull in the Teashop Fund has a NAV of $10.65 and an offering price of $11.15. He knows that he would have received which of the following if his redemption order had been received by the fund prior to yesterday's market close? A) $11.15, less redemption fee, if any B) $10.65, less redemption fee, if any C) $10.65, less commission D) $10.65

B (An investor redeeming his shares will receive the NAV less any redemption fee that may be described in the prospectus. Investors redeeming through the fund are not charged a commission.)

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

B (ETFs, whether leveraged or not, are investment companies and are not included in the definition of derivative.)

John owns a nonqualified, tax-deferred annuity. When he retires, what will be the tax consequences of his annuity payments? A) His annuity payments are partly taxable as capital gain and partly taxable as ordinary income. B) His annuity payments are all taxable as ordinary income. C) His annuity payments are partly taxable and partly tax-free return of capital. D) His annuity payments are tax free.

C (The key word here is nonqualified! The investment John made was with after-tax dollars, the money grows tax-deferred, and only the earnings are taxed at distribution. A computation will be made at John's retirement called the exclusion ratio to determine how much of each retirement payment will be treated as a return of cost basis and how much as taxable ordinary income. No annuity payment is ever treated as a distribution of capital gains.)

A 35-year-old client purchases a variable life insurance policy. Under current regulations, the maximum sales charge permitted over the life of the policy is A) 9% per premium payment B) 8.5% per premium payment C) 8.5% of total premiums over the life of the plan D) 9%

D (A variable life insurance plan may charge a maximum sales charge of 9% over a period not to exceed 20 years.)

A bond is selling at a premium over par value. Therefore, its A) none of the above B) nominal yield is less than its current yield C) yield to maturity is greater than its current yield D) current yield is less than its nominal yield

D (Any bond selling at a premium will yield less than the coupon rate (nominal yield). Conversely, of course, a bond trading at a discount will certainly yield more. Remember, there is an inverse relationship between bond prices and bond yields.)

As defined in the Investment Company Act of 1940, the term "investment company" would NOT include A) a holding company B) a unit investment trust C) a management company D) a face-amount certificate company

a (Holding companies are not included in the definition of "investment company.")