series 66 - chapter 11 questions
A front-end load is the fee that is payable on the purchase of: A) An IPO B) Mutual fund Class A shares C) Shares acquired through a rights exercise D) A private placement
answer is B. When an investor buys Class A mutual fund shares, he is assessed a load (sales charge) at the time of purchase (i.e., at the front-end). The other choices are in no way associated with a load (sales charge).
Which of the following statements is TRUE regarding futures and forward contracts? A) Forward contracts are standardized, and futures contracts are not standardized B) Both forward contracts and futures contracts are standardized C) Futures contracts are standardized, and forward contracts are not standardized D)Neither futures contracts nor forward contracts are standardized
answer is C. The terms of a futures contract are standardized and typically trade on an exchange. Forward contracts are privately negotiated between two counter parties and the terms are customized.
Which of the following products is NOT a derivative? A) CMOs B) LEAPS C) Swaps D) ETFs
answer is D. An Exchange-Traded Fund (ETF) is a type of investment company, where investors' money is pooled and invested in securities. Investors in ETFs can buy shares in the secondary market. The shares are priced according to the performance of the portfolio of securities purchased. An ETF is NOT a derivative, since its value is not based on a specific security, but on the entire portfolio. Long-Term Equity Anticipation Securities (LEAPS) are long-term call or put options and are derivatives. A swap and a collateralized mortgage obligation (CMO) are both derivatives
Which of the following securities is most susceptible to interest-rate risk? A) T-bills B) T-bonds C) Commercial paper D) Common stock
answer is b, t-bonds Long-term bond prices are more sensitive to interest-rate risk than short-term bonds. For example, if an investor owns a bond with a 5% coupon and interest rates rise to 7%, he would be earning less than new investors. If the investor only needs to wait two months for his bond to mature, he will be able to invest at the higher interest rate relatively quickly. If the investor's bond has a long maturity and he must wait 20 years for his bond to mature, his disadvantage will last longer. Conversely, if interest rates fall, the long-term bond will earn more than the market interest rate for a longer period. The short-term bond will not be as valuable since the maturity comes sooner and its advantage over the market rate will not last as long
Mark purchases an equity-indexed annuity contract that guarantees a 5% return with an 80% participation rate and a 12% interest-rate cap. The index to which the funds are tied rises in value by 10% this year. What return does Mark receive?
8% In an equity-indexed annuity, the owner receives a guaranteed minimum interest rate with potential upside based on the performance of the designated index. If the return on this index is less than the guaranteed rate, the owner receives the minimum. If the index return is greater than the guarantee, the owner receives the greater return up to the capped maximum. Many contracts only pay a portion of the index return. In this example, the client is entitled to 80% of the index return capped at a 12% maximum. The index increased by 10%, so the client's contract is credited with 80% of that amount, or 8%
Which of TWO of the following actions will increase an investor's basis in a limited partnership? I. The investor contributes additional capital to the partnership. II. The investor provides managerial services to the partnership. III. The investor contributes property to the partnership. IV. The partnership passes on investment losses to the partners.
Answer is 1 and 3. An investor's basis in a partnership is increased whenever she contributes additional cash or property to the partnership. The contribution of services will not increase the investor's basis. Cash distributions and losses that are passed through to the partners will actually decrease the investor's basis
When comparing variable annuities to fixed annuities, investment risk is assumed by the: I. Investor in a variable annuity 2. Annuity company in a variable annuity 3. Investor in a fixed annuity 4. Annuity company in a fixed annuity
Answer is 1 and 4 In a fixed annuity, the annuity company guarantees a fixed monthly payment. The company, therefore, must invest the monies and assume the investment risk. In a variable annuity, the annuity company makes no guarantee. The company will invest the investor's money and the investor's annuity benefits will depend on the value of the investments. The investor, therefore, assumes the investment risk.
When may an investment adviser representative project the future return of a variable annuity? A) Never B) If a state Commissioner approves of the projections C) If the projections are based on the previous quarter's results and explained in the prospectus D) If both FINRA and a state Administrator approve of the projections
Answer is A. It is prohibited to project the future earnings in a variable annuity separate account.
Which of the following is TRUE of the NAV for a closed-end fund? A) The NAV is calculated at the end of every business day. B) The NAV fluctuates independently throughout the trading day. C) The NAV is the price at which an investor can sell shares. D) The NAV is the price at which an investor can buy shares.
Answer is A. As with open-end (mutual) funds, closed-end funds must calculate the NAV of their shares on a daily basis. However, the NAV doesn't represent the price of fund's shares; instead, closed-end fund shares trade on the exchange at a price that's determined by the forces of supply and demand.
Regarding an equity-indexed annuity (EIA), which of the following statements is TRUE? A) If the index to which the EIA is linked increases in value, there may be a limit to the amount that is credited to the indexed annuity. B) The EIA's portfolio is linked to a bond index. C) The contract will always earn the same rate as the underlying index. D) The contract will always protect against inflation risk.
Answer is A. Equity-indexed contracts provide a guaranteed minimum rate of return, but also offer the potential for greater return based on the performance of a designated equity index, such as the S&P 500
A client who recently retired, received a $100,000 lump-sum payout from his company's pension plan. His objective is to receive fixed monthly payments starting immediately. As the IA, you may recommend a(n): A) Immediate, fixed annuity B) Deferred, fixed annuity C) Deferred, variable annuity D) Immediate, variable annuity
Answer is A. In an immediate annuity, payments begin after one payment period. For instance, if the client chose a monthly payout, the first payment will be made after one month. By choosing a fixed annuity, the insurance company guarantees the payouts, whereas with a variable annuity, payments are unpredictable.
A client contacts a firm and indicates his desire to buy a call option on a stock that he already owns. Why would the investor buy a call option on the stock? A) He wants the ability to buy more shares at a guaranteed price in case the stock goes up B) He wants to hedge his position C) He wants to generate income and increase his rate of return D)He wants to reduce his losses
Answer is A. When buying a call option on a stock, the client is able to buy the underlying security at a specific price. He would buy a call option if he believes the price of the security is going to increase. In this situation, buying a call does not generate income, hedge risk, or increase the rate of return.
A client has invested $20,000 in a variable annuity. After 10 years, the annuity is valued at $45,000. If the client withdrew $20,000 at age 59, he is subject to: A) Being taxed on the distribution as a capital gain B) Being taxed on the distribution as ordinary income, plus a 10% penalty on the amount withdrawn C) A 10% penalty on the amount withdrawn D) Being taxed on the distribution as ordinary income
Answer is B. If an individual purchases a variable annuity, it is not considered a tax-qualified plan. The contribution is not taxed upon withdrawal; however, any earnings withdrawn prior to age 59 1/2 are subject to a 10% penalty and ordinary income tax.
The most appropriate buyer(s) for a variable life insurance policy is/are: A) A person who requires the discipline of forced savings B) A person with an understanding of investments who can tolerate risk C) A person who wants the assurance of a guaranteed cash value D) Parents with a modest income who have young children
Answer is B. A person who is knowledgeable about investments is a candidate for variable life insurance because stocks and bonds are the foundation of the policy. As the market values of the securities fluctuate, cash value and death benefits change. Therefore, the insured must be able to tolerate risk.
Which of the following statements concerning duration is CORRECT? A) Duration is the measurement of the period in which a CDSC will be assessed on a Class B share B) Duration is a measurement of a given bond's sensitivity to interest-rate swings C) A well-diversified index stock fund will have duration of approximately 1.0 D) Due to their extended holding period, long-duration funds are right only for young investors with a suitable time horizon
Answer is B. Duration is a measurement of a given bond's sensitivity to interest-rate changes. Factors that affect a given bond's duration include its maturity and coupon. A long-duration bond portfolio is much more price sensitive to interest-rate swings than a short-duration bond portfolio.
One of the main differences between futures contracts and forward contracts is that: A) An investor may not be short a futures contract B) Forward contracts may not be offset without permission C) Futures contracts are always used to speculate D) Forward contracts do not involve commodities
Answer is B. One of the main differences between futures contracts and forward contracts is that future contracts may be offset (bought or sold). Indeed, most buyers and sellers of future contracts never actually take delivery of the underlying commodity or financial instrument. In a forward contract, however, both parties involved in the contract must agree before the contract may be bought or sold
Which of the following products is NOT a derivative? A) LEAPS B) UITs C) CMOs D) Index options
Answer is B. A unit investment trust (UIT) is a type of investment company where investors' money is pooled and invested in securities. Investors in UITs have shares of beneficial interest in the portfolio. The shares are priced according to the performance of the portfolio of securities purchased. A UIT is not a derivative, since its value is not based on a specific security, but on the entire portfolio. Long-Term Equity Anticipation Securities (LEAPS) are long-term call or put options and are derivatives. An index option and a collateralized mortgage obligation (CMO) are both derivatives.
All of the following factors are disadvantages for a limited partner, EXCEPT: A) Lack of liquidity B) The conduit (flow-through) treatment for income and loss C)Lack of voting power D) Possible adverse changes in the Internal Revenue Code
Answer is B. Limited partnerships are not a liquid investment. Investors should have staying power if they are considering a purchase of a limited partnership interest. Another risk would be changes in the Internal Revenue Code, which could cause the tax benefits from the program to be invalid. Also, a limited partner has no voice (vote) in the operation of the program. A major advantage is that the partnership is not a taxable entity. All income and losses flow through to the partner for treatment on the partner's own tax return.
Which of the following is NOT a precious metal? A) Gold B) Copper C) Platinum D) Silver
Answer is B. Precious metals are metals that are relatively rare and more difficult to find than other types of metals. The rarity of precious metals is what allows them to command a higher price. Precious metals include gold, silver, platinum, and palladium.
When would a variable annuity be most suitable for a client? A) When the client wants a fixed rate of return B) When the client wants capital appreciation or growth over a long period C) When the client wants to receive a predictable amount of income at retirement D) When the client wants an inflation-adjusted rate of return
Answer is B. Variable annuities are suitable for clients who are willing to invest for the long term and want to invest in the markets. The investment objective of variable annuities is capital appreciation (growth). Since a variable annuity's performance is tied to the market, its return is unpredictable and is not based on inflation
Which of the following is NOT TRUE regarding a viatical settlement contract? A) The inability to accurately calculate the actual life expectancy of the insured B) An investment in a viatical settlement contract is considered to be liquid C) The rate of return cannot be determined before the insured dies D) If the insured lives longer than expected, the investor is required to pay the premiums to keep the policy in force
Answer is B. With a viatical settlement contract, if the insured lives beyond life expectancy, the investor is required to continue to pay the insurance premiums. Since the death of the insured is ultimately unpredictable, the future financial commitment is unknown. A viatical settlement contract is not a liquid investment as there is not a secondary market for such investments.
When recommending a leveraged ETF to a client, an agent should disclose that: A) Since leveraged ETFs may only be purchased on margin, the leveraging factor is reduced B) Since leveraged ETFs are considered long-term investments, short-term strategies are unsuitable C) Due to the daily resetting of the portfolio, a leveraged ETF's performance does not provide true tracking of the underlying index over long periods D) A leveraged ETF's performance will improve as the underlying index increases in value over time
Answer is C. Since an ETF's underlying portfolio is reset daily, price changes are based on a percentage value for one day only. Therefore, a leveraged ETF's performance does not provide true tracking of the underlying index over longer periods. Keep in mind, purchasing a leveraged ETF on margin increases leveraging; it does not decrease it. Due to the daily resetting feature, leveraged ETFs are not considered to be suitable long-term investments.
Four municipal bonds each have a 3% coupon, the same face value, but different maturities. One bond matures in one year, another in five years, another in 10 years, and the last in 20 years. Duration is: A) The longest for the one-year bond and shortest for the 20-year bond B) The same for all four bonds C) Longer than the maturity for each bond D) The longest for the 20-year bond and shortest for the one-year bond
Answer is D. Duration is a measure of a bond's interest-rate risk. Long-term bonds will have a larger duration and more interest-rate risk. However, for a bond that pays interest, the duration will be less than its maturity.
If a client's objective is long-term capital appreciation, all of the following insurance policies may be recommended by an adviser, EXCEPT: A) Whole life B) Variable life C) Universal life D) Term life
Answer is D. A term life policy would not provide future capital as it does not accumulate cash value. A whole life policy would accumulate cash value, though generally at a low rate. Universal life would also accumulate cash value that can be used to pay the premium, which reduces the cash value. With a variable life policy, a portion of the premium is invested in the separate account, which historically would provide a higher market based return
The disadvantages of limited partnerships include: A) Inflation risk B) Double taxation of distributions C) Limited liability D) Potential assessments
Answer is D. An investor in a limited partnership may receive an assessment (i.e., a demand that he contribute additional capital to the partnership). Many partnerships invest in assets, such as real estate, that may actually be a hedge against inflation, which addresses inflation risk. One of the advantages of limited partnerships compared to C Corporations is that they are not subject to double taxation, which eliminates that choice. For tax purposes, limited partnerships are pass-through entities. This means that all income, losses, and gains are passed through to the partners, who must declare the income on their own tax returns. When investing in LPs, limited liability is considered an advantage, not a disadvantage
What is the most suitable policy for an individual who wants to earn a higher return from an insurance policy, but does not want to assume market risk? A) Whole life insurance B) Variable life insurance C) Non-qualified annuity D) Universal life insurance
Answer is D. In some cases, universal life insurance will either pay a minimum rate of return or slightly higher. Depending on the contract specifics, the additional rate of return could be pegged to a stock index or interest rate. An individual who purchases a variable annuity assumes the investment (i.e., market) risk of the security. If the separate account performs well, the value of the investment will increase. However, if the securities in the separate account perform poorly, the value of the investment will decline
Which TWO of the following statements are TRUE regarding non-qualified annuities? I. There is a 10% penalty on any taxable withdrawals that are taken before age 59 1/2 II. There is no 10% penalty on any taxable withdrawals that are taken before age 59 1/2 III. Distributions must begin by age 70 1/2 IV. There is no required minimum distribution at age 70 1/2
Answer is I and 4. Non-qualified annuities are funded with after-tax (non-deductible) contributions. If funds are withdrawn before age 59 1/2, the earnings portion will be subject to taxation and a 10% penalty. However, since non-qualified annuities are funded after-tax, the IRS does not require distributions to begin at age 70 1/2.
A group of investors is starting a business to explore and drill for oil. All want to be actively involved in the business, but none wants to be personally liable for the venture's debts. Which of the following business structures would meet their objectives? I. A limited partnership II. A general partnership III. A limited liability company IV. An S Corporation
Answer is III and IV. Since none of the group is willing to be liable personally for the business's obligations, they cannot form a general partnership or a limited partnership. All general partners have unlimited liability for any obligations that the business incurs. A limited partnership requires at least one general partner. Also, they all want to be involved in management and a limited partner who becomes actively involved in management loses the shield of limited liability. A partnership is not an option for them. Either a limited liability company (LLC) or an S Corporation would allow all of them to take an active role in running the venture without incurring personal liability
If an investor owns a portfolio of fixed-income securities, to which of the following risks would an investor be subject? I. Interest-rate risk II. Inflation risk III. Credit risk IV. Opportunity risk
Answer is all four. All of the risks listed apply to fixed-income securities. Interest-rate risk is the risk that a security's value will change due to a change in interest rates. Inflation risk is the chance that the cash flows from an investment will not be worth as much in the future because of changes in purchasing power due to inflation. Credit risk represents the risk that an investor will experience a loss of principal due to a borrower's failure to repay a loan or otherwise meet a contractual obligation. Opportunity risk is the risk that a better opportunity may present itself after an irreversible decision has been made
A client is interested in trading actively, purchasing on margin, and having broad exposure to the U.S. equity market. Which of the following investments is the LEAST suitable? A) An S&P 500 Index ETF B) An S&P 500 Index mutual fund C) A DJIA Index ETF D) A closed-end fund
Answer is b. Open-end investment company (mutual fund) shares are not appropriate for short-term trading, do not trade on an exchange, and cannot be purchased on margin. On the other hand, most ETFs and closed-end fund shares trade on an exchange and allow the use of margin and short selling.
An investor is evaluating two different bonds-one that matures in three years and another that matures in 25 years. Both bonds have a high credit rating. The 3-year bond has a 4% coupon and the 25-year bond has a 7% coupon. If interest rates are expected to decrease, how will the bonds' prices be affected?
Both bonds will gain value. The movement of existing bond prices is inversely related to the changes in market interest rates. Since interest rates are expected to fall, prices will then rise. In this case, both bonds will gain value. However, long-term bonds are more volatile and will fluctuate more than short-term bonds.
