Series 66 Analysis
The Dividend Discount Model values common stock based on the: A. net present value of anticipated future dividend payments B. compound future value of anticipated future dividend payments C. expected growth of corporate earnings in future years D. portion of corporate earnings paid to shareholders as a dividend
The best answer is A. The Dividend Discount Model is a way of finding the theoretical price of common stock. It takes the anticipated future dividends to be paid by the company and discounts them to present value. Instead of having to discount each year's anticipated dividend payment, the formula can be reduced to one similar to that for a perpetuity. The reduced formula is: Expected Next Year Dividend Rate/ Required Rate of Return for Equity Investors - Dividend Growth Rate For example, assume a company is expected to pay a $1 dividend next year. If the required rate of return is 8% and the expected dividend growth rate is 3%, then the projected price of the common stock is $1 Dividend / 8% - 3% = $1/.05 = $20.
When comparing an ETN to a structured product, which statement is TRUE? A. ETNs can be traded at any time while structured products cannot B. ETNs offer current income while structured products do not C. ETN income is taxable at higher rates than income from structured products D. ETNs are equity securities that are exchange listed
The best answer is A. An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. They are not an equity security - they are a debt instrument. ETNs are listed on an exchange and trade, so they have minimal liquidity risk. In comparison, a regular structured product is non-negotiable and, if redeemed prior to maturity, imposes an early-redemption penalty. ETNs make no interest or dividend payments. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to other structured debt products.
A company has quarterly earnings of $3.00 per share. At the end of the year, it retained $9.00 per share. The company's dividend payout ratio is: A. 25% B. 33% C. 66% D. 75%
The best answer is A. If quarterly earnings were $3 per share, then annual earnings = $12. Since $9 per share was retained, then $3 was paid as dividends. The dividend payout ratio is $3 / $12 = 25%.
All of the following are permitted investments in a 403(b) plan EXCEPT: A. common stocks B. mutual funds C. fixed annuities D. variable annuities
The best answer is A. The "big kahuna" of 403(b) plans is "TIAA-CREF" - Teacher's Insurance Annuity Association - College Retirement Equity Fund. TIAA-CREF administers retirement plans for not-for-profits, including school systems, universities and hospitals. Its name gives you the clue as to which investments are permitted in 403(b) plans. The permitted investments are life insurance, fixed annuities, variable annuities and mutual funds. Direct investments in common stocks are not allowed; the investments must be managed by a professional manager.
Treasury investments yield 3.5%. Common stock investments yield 12.5%. Corporate bond investments yield 8%. The "risk free" rate of return is: A. 3.5% B. 8% C. 9% D. 12.5%
The best answer is A. The "risk free" rate of return is simply that return provided by a "riskless" investment. Treasuries are viewed as a "risk free" investment, since they are backed by the U.S. Government and have shown minimal variability of return over the last 50 years. Thus, the risk free rate of return is the rate given by the Treasuries - 3.5% in this example.
A $1,000 par bond is issued with 5 years to maturity. The coupon rate on the bond is 3.50%. If the inflation rate for the next 5 years is 2.50%, the bond will be worth how much in 5 years? A. $1,000 B. $1,131 C. $1,188 D. $1,338
The best answer is A. The bond matures in 5 years. At maturity, the bondholder receives par from the issuer. The 3.50% coupon ($35 in interest) is paid to the bondholder annually, divided into semi-annual payments. The inflation rate has nothing to do with this question.
Which asset allocation is BEST for a 35-year old single risk tolerant investor looking to achieve the highest returns? A. 25% Stocks / 25% Bonds / 25% REITs / 25% Money Markets B. 50% Stocks / 50% Bonds C. 60% Stocks / 40% Bonds D. 95% Stocks / 5% Money Markets
The best answer is D. The investor is 35 years old, single and risk tolerant. While an argument could be made for any one of the choices offered, the one choice that is clearly different from the others is Choice D - 95% equities and 5% money market instruments. This gives both the greatest growth potential for a relatively young investor along with the greatest risk - and this investor is risk tolerant. The other choices have a fairly large portion of the portfolio allocated to bonds, which do not have any growth potential over a long-term investment time horizon, but also have much lower risk.
A client purchases 1,000 shares of ACME Growth Fund in July of 20XX. In December of 20XX, the fund distributes a capital gain to its shareholders. This distribution is: A. taxable as a short-term capital gain based on the length of time that the client held the fund shares B. taxable as a long-term capital gain based on the length of time that the fund held underlying securities C. a tax-free return of invested capital D. exempt from taxation at the State level but not at the Federal level
The best answer is B. Taxation of mutual fund distributions is based on the length of time that the fund held the underlying securities. All fund distributions, whether they are dividends, short term capital gains or long term capital gains, are reported to shareholders and to the IRS on Form 1099-DIV. If a fund has held securities for more than 1 year and sells them at a profit, the resulting gain is reported on Form 1099-DIV in the box titled "Total Capital Gains Distribution." Long-term capital gains are taxed at a preferential maximum 15% rate (this increases to 20% for individuals in the highest tax bracket). If the fund distributes a dividend where the source of the distribution is dividends received from a portfolio of equity securities, these are reported on Form 1099-DIV in the box titled "Qualified Dividends" and are taxed at a preferential maximum 15% rate (this increases to 20% for individuals in the highest tax bracket). If the fund distributes a dividend where the source of the distribution is dividends received from a portfolio of debt instruments or short term capital gains from securities sold at a profit, these are reported on Form 1099-DIV as ordinary dividends ("non-qualified") and are taxed at ordinary income tax rates of up to 37%.
A father is writing his will (the testator) and is naming as beneficiaries his 2 adult sons - Son A and Son B. Each one will get an equal share of the father's estate "per capita" upon the father's death. Each of the sons has children (the grandchildren of the testator) who are not yet adults. Son A has 2 young children - Grandchild A1 and Grandchild A2 and Son B has 2 children, Grandchild B1 and Grandchild B2. If Son A predeceases the testator, then: A. Son A's 1/2 share goes into his estate B. Son A's share goes to Son B C. Grandchild A1 gets 25% and Grandchild A2 gets 25% of the estate's assets upon the death of the testator D. the deceased son's share reverts back to the father's estate
The best answer is B. When a will is created, the estate can be distributed either "per capita" or "per stirpes." These 2 ways deal with the issue of a named beneficiary dying before the testator. "Per capita" is Latin for "by the head." What this means is that each NAMED living family member gets an equal share of the estate. So if the father has 2 sons, Son A and Son B, each gets 1/2 of the father's estate upon the father's death. If Son A dies before the father, the 1/2 share now goes to living Son B - so Son B inherits 100% of the estate. The grandchildren are not named as beneficiaries, so they get nothing. If the testator had NAMED both the 2 adult sons and their 4 children "per capita," then there would have been 6 names, with each getting 1/6th of the estate. If 1 of them predeceased the testator, then the estate would be divided "per capita" 1/5th each among the remaining 5 living descendants.
What is the real rate of return? A. The rate of return adjusted by the beta coefficient of the security B. The rate of return adjusted by the inflation rate C. The rate of return adjusted by the internal rate of return D. The rate of return adjusted by the compounded dividend rate
The best answer is B. Any "real" rate of return factors out the effect of inflation. Thus, the real rate of return is the actual rate of return - the current inflation rate.
Which business form has a limited life? A. S corporation B. General partnership C. Limited liability company D. C Corporation
The best answer is B. Any partnership has a limited life; if there is not a fixed life stated in the partnership agreement; then the life of the partnership ends when the partnership composition changes. If a partner leaves, or a new partner is added; the old partnership is dissolved and a new partnership is formed. All corporations have an unlimited life; a change in ownership does not dissolve the corporation. Also, limited liability companies have an unlimited life.
A bank issuer's ETN has been downgraded by Moody's from Aaa to Aa. The price of the ETN rose 2% after the downgrade was announced. What should the registered representative tell the client? A. The bank downgrade does not matter because the price of the ETN rose by 2% B. The bank downgrade can affect the marketability of the ETN C. The bank downgrade is not meaningful because the ETN is still rated investment grade D. The bank downgrade does not matter because the ETN can be redeemed at par at maturity
The best answer is B. ETNs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated. What is not eliminated, however, is credit risk. These products are only as good as the guarantee of the issuing bank. These products typically have a 7 year maturity and a lot can go wrong in 7 years. If the issuing bank is downgraded, then it would be expected that investor interest in the ETN would fall. This should make the issue less marketable and also should cause the price to fall. In this question, the price rises, which can only be attributable to market interest rates falling. However, the ETN will still become less marketable after the downgrade.
The rate of return implicit in the cash outflows and cash inflows from an investment is the: A. required rate of return B. internal rate of return C. holding period rate of return D. total rate of return
The best answer is B. The Internal Rate of Return finds the yield that discounts all cash flows (inflows and outflows) to a present value of "0." It is the same as the true Yield to Maturity of the investment.
What happens to the rate of return calculation on a non-callable bond if the rate of interest stays the same and the time intervals lengthen? A. The rate of return increases B. The rate of return declines C. The rate of return is unchanged D. The effect on the rate of return cannot be determined
The best answer is B. When the question is stating that the "time intervals lengthen," this means that the time period between each interest payment received lengthens. For example, assume that a 10% bond will pay interest annually, instead of semi-annually. At the end of each year, $100 of interest will be received, instead of receiving $50 every 6 months. Because the first $50 interest payment received can immediately be reinvested over the next 6 months until the second $50 payment is received, this will produce a higher rate of return than receiving the $100 payment at the end of the year. Thus, the actual rate of return will decline if time intervals lengthen, because the interest is actually being received more slowly, and thus cannot be reinvested as quickly to maintain the investment's rate of return.
Which statement is TRUE about the tax treatment of capital gains and capital losses? A. Capital gains are offset against capital losses and any net capital gains are taxed at earned income rates B. Capital gains are offset against capital losses and there is no limit to the amount of net capital gains that can be carried forward C. Capital gains are offset against capital losses and there is no limit to the amount of time that a net capital loss can be carried forward D. Capital gains are offset against capital losses and any net capital losses are deductible in full for that tax year
The best answer is C. The rules on capital gain taxation require that any capital gains be offset against capital losses. If there is a net capital gain, it is taxable that year at capital gains tax rates (37% maximum for a short term capital gains; 15% maximum for a long term capital gain for individuals who are not in the maximum tax bracket; for those in the maximum tax bracket, the rate increases to 20%). Capital gains tax rates are not necessarily the same as the tax rate on earned income. If there is a net capital loss, only $3,000 of the loss is deductible in that year, with the unused net capital loss carried forward to the next tax year. In that year, the net loss can be offset against any capital gains, with the same rules applying, etc.
A vehicle that gives the right, but not the obligation, to buy a reference asset at a stated price for a stated period of time is a(n): A. forward contract B. futures contract C. options contract D. swap contract
The best answer is C. A key difference between an option contract and a futures or forward contract is that the holder of an option has the right to exercise, but is not required to do so. In contrast, a futures or forward contract obligates the buyer of the contract to buy the underlying reference asset at the delivery date, unless the contract is closed prior to this date. Swaps are custom OTC contracts that allow for a "swapping" of cash flows between 2 parties, with the most common being an interest rate swap, where a fixed interest rate is "swapped" for a floating rate. For example, Party A agrees that it will pay a fixed 4% interest rate for 5 years on a $100 million principal amount to Party B. Party B agrees that it will pay a floating rate of LIBOR (say it is currently at 3%) + 1% to Party A over this period. Party A "wins" if interest rates rise over this period; Party B "wins" if interest rates fall over this period.
The yield to maturity on a bond is more than the yield to call. This bond is trading: A. at par B. at a discount C. at a premium D. in the money
The best answer is C. Aside from the coupon rate earned on a bond, yield to maturity and yield to call computations take into account whether the bond is purchased at a discount or at a premium. If a bond is purchased at a premium, the pro-rata annual loss of the premium as the bond approaches par value at maturity is deducted from the coupon rate, decreasing the yield. If such a bond is called prior to maturity (a likely event), then the premium is lost faster and the yield to the "call date" decreases below the yield to maturity. Thus, for a premium bond, the yield to maturity is higher than the yield to call.
An Equity Indexed Annuity tied to the Standard and Poor's 500 Index is sold with a participation rate of 70%, a 10% cap and a 3% floor. In a year when the S&P 500 Index increases by 2%, the principal will be credited with a: A. 1.40% increase B. 2.00% increase C. 3.00% increase D. 10.00% increase
The best answer is C. Features of EIAs are a "participation rate" along with a cap (maximum) interest rate and a floor (minimum) interest rate. While some contracts have a participation rate of 100%, most have a participation rate of somewhere between 70%-90%. In this example, the S&P 500 index increased by 2% this year, and with a 70% participation, 1.40% would be credited to the account. However, because of the 3% floor, this amount will be credited. The 10% cap is irrelevant here.
The Vice-President of a publicly traded company has been granted stock options as part of her compensation package. What is the tax treatment of the options? A. The value of the options is taxable ordinary income as of the date of the grant B. The options are taxed only if exercised, based on the difference between the exercise price and the current market price of the stock, with the difference taxed at ordinary income tax rates C. The options are not taxed unless they are exercised and subsequently sold, with any capital gain based on the difference between the exercise price and the sale price D. The value of the options is not taxable because this is non-cash compensation
The best answer is C. Stock options granted to an employee are not taxable unless the options are exercised and the stock purchased via the exercise is subsequently sold. The difference between the exercise price and the sale price is a capital gain, and the tax rate applied depends on the holding period of the stock. The holding period starts counting as of exercise date. If the stock is held for 1 year or less as of the date of sale, any gain is taxed at short-term rates. If the stock is held for more than 1 year as of the date of sale, any gain is taxed at long-term rates.
Limited partnership "democracy" provisions allow for all of the following EXCEPT: A. the limited partners' claim to assets upon dissolution B. a majority vote of the limited partners before investments are sold or refinanced C. the limited partners' right to manage the partnership D. the right to inspect partnership records and receive reports about partnership operations
The best answer is C. The limited partnership "democracy" provisions attempt to protect the limited partner's investment since the limited partner does not have a management role. Such provisions include requiring of a majority vote (in most instances) by the limited partners before investments are sold or refinanced; giving the limited partners the right to inspect the books of the partnership; and giving the limited partner a claim to assets in a dissolution. Limited partners are not permitted to assume a management role in the partnership - this function is performed by the general partner.
Which of the following statements concerning 403(b) plans are TRUE? I Investments are limited to annuities II An employee who elects salary deferral to a 403(b) plan cannot elect salary deferral to another retirement plan III A 403(b) plan can provide only for employee contributions without employer contributions IV Deferrals to a 401(k) plan reduce the amount that an employee can defer to a 403(b) plan A. I and II only B. I and III only C. II and III only D. III and IV only
The best answer is D. A 403(b) plan is typically invested in annuities or mutual funds but can also be invested in life insurance. The "big kahuna" of 403(b) plans is "TIAA-CREF" - Teacher's Insurance Annuity Association - College Retirement Equity Fund. TIAA-CREF administers retirement plans for not-for-profits, including school systems, universities and hospitals. Its name gives you the clue as to which investments are permitted in 403(b) plans. The permitted investments are life insurance, fixed annuities, variable annuities and mutual funds. Direct investments in common stocks are not allowed; the investments must be managed by a professional manager. If an employee is eligible to participate in both a 401(k) plan and a 403(b) plan, the $18,500 contribution limit in 2018 is applied to both of these combined. Thus, if $9,250 is contributed to a 401(k) plan, that person could only contribute $9,250 to a 403(b). Both 401(k) and 403(b) plans can provide for employee contributions without employer contributions or can provide for employee contributions and matching employer contributions. (Also note that TIAA-CREF shortened its name in 2016 to simply TIAA, but knowing the original name helps with test questions!)
For a family limited partnership account, who gets the termination benefits? A. Grantor B. Trustee C. Income beneficiary D. Remainder beneficiary
The best answer is D. Family limited partnerships are set up primarily to protect family assets (e.g., a family business or family farm) from creditors and to protect the assets from being sold to someone outside the family. There is a general partner (typically a parent) and limited partners (typically children). The main benefit is that these family assets can be transferred over time to the children at a lower tax basis, since, in theory, they have "lost" value (because they are no longer marketable). This structure can allow parents to gift assets to children yearly with minimal or no gift tax. The beneficiary of such a family limited partnership will be each limited partner (meaning each child). Beneficiaries can be designated to get only income from the partnership; or can be designated to get remaining assets when the partnership is terminated; or can be designated to receive both. The "termination benefit" refers to the distribution of remaining partnership assets when the partnership is dissolved. This can be set up as the date of death of the parent(s); a specified future date; or by majority vote of the partners.
Which item is used when computing a corporation's Current Ratio? A. Net Working Capital B. Net Worth C. Sales D. Cash
The best answer is D. The Current Ratio is: Current Assets / Current Liabilities. It is a measure of liquidity, because it looks at whether the company can pay its current bills as they come due. Cash, Accounts Receivable and Inventory are the primary "Current Assets." Net Working Capital is Current Assets - Current Liabilities. Net Worth is All Assets - All Liabilities. Sales are found on an income statement, not on a balance sheet.
A husband and wife with 2 adult children have established a revocable trust to remove assets from their taxable estate. After doing so, they find that they are $100,000 over the estate tax exclusion that qualifies for the maximum unified tax credit of $4,371,600 in 2018. In order to reduce the size of their taxable estate by $100,000, they can donate: A. $50,000 to each of their children B. $50,000 to each other C. $50,000 to a charity and $50,000 to a child D. $50,000 to a charity and $50,000 to another charity
The best answer is D. The first $11,200,000 (in 2018) is excluded from tax. This is dealt with by giving a "unified tax credit" to the estate against tax due. This tax credit amount in 2018 is $4,371,600, which is roughly 40% of the estate value and matches the maximum estate tax rate of 40%. If the estate exceeds $11,200,000, the unified credit does not cover the tax bill and estate tax will be due. Any charitable contributions reduce the size of the taxable estate. In this case, if the estate were valued at $11,300,000 and $100,000 of charitable contributions were made, the taxable estate becomes $11,200,000 and the unified credit covers the entire estate tax liability.
A corporation is similar to a partnership in that: A. neither entity can be taxed directly B. both entities flow through gain and loss to owners C. both entities provide limited liability to owners D. both entities have no limit to the number of owners
The best answer is D. There is no limit to the number of shareholders in a corporation (other than an S Corporation which is limited to 100 shareholders) and there is no limit to the number of partners in a partnership. Corporations are taxable entities; partnerships are not. Partnerships allow for flow-through of gain and loss to owners, with income only taxed at the partner level. In contrast, a corporation must compute net income and pay tax on it before it distributes income to shareholders as a dividend. The shareholders must, in turn, include distributed dividends on their tax returns and pay tax on it again! Corporate shareholders have limited liability, general partners have unlimited liability. (Note that this question does not specifically mention general partnership or C Corporation, but from the choices, these must be assumed. If the question used S Corporation or Limited Partnership, then everything would change!)
A customer, age 50, is in the 35% tax bracket. The customer has a non-tax qualified variable annuity separate account to which he contributed $15,000 that has a current market value of $35,000. The customer takes a distribution of $10,000 from the account. The tax that will be due on this distribution is: A. 0 B. $1,000 C. $3,500 D. $4,500
The best answer is D. Distributions from non-tax qualified variable annuity separate accounts are taxed on a LIFO (Last In First Out) basis. The original non-tax deductible contribution of $15,000 was the first in. The tax-deferred build up of $20,000 occurred second. When distributions are taken, the "build-up" portion comes out of the account first and is taxed at regular tax rates. After the build-up is depleted, the original investment of $15,000 comes out of the account and is not subject to tax. The customer is withdrawing $10,000 - which is all counted as "build-up" for tax purposes (last in - first out). This is taxable at 35%, plus the customer must pay a 10% penalty tax on a premature distribution (prior to age 59½). The total tax due is 45% of $10,000 = $4,500.
The closest approximation of the internal rate of return on a bond is the bond's: A. coupon rate B. current yield C. duration D. yield to maturity
The best answer is D. The internal rate of return on a bond is the interest rate that will discount the bond's cash flows to the purchase price of the bond. It is the same as the bond's yield to maturity.
