SIE Chapter 9

Which of the following is NOT a pass-through entity?

C Corporation A pass-through entity is a business that avoids double taxation. Instead, the income passes or flows through to the owners of the business. S Corporations, LLCs and REITs are considered pass-through entities. Income generated by C Corporations is taxed twice (once at the corporate level and again at the investor level); therefore, they are not pass through entities.

Which of the following is NOT a type of direct participation program (DPP)?

C Corporation Direct participation programs come in many different forms, including S Corporations, general partnerships, and limited partnerships. However, C Corporations do not offer flow through taxation. Instead, income is taxed first at the corporate level and taxed again if it's distributed to shareholders as a dividend.

When selling limited partnership interests, a registered representative is NOT required to:

Certify that the customer is an institution When selling limited partnership interests, a registered representative is required to ensure that she informed the customer of all relevant facts relating to the investment's lack of marketability and liquidity. In addition, after obtaining information about the customer's investment objectives, financial and tax status, other investments, and future financial needs, the RR must have reasonable grounds to believe the customer has sufficient net worth and income to lose his entire investment, or has other liquid assets. The RR must certify that the customer is suitable and is in a financial position to be investing in limited partnership interests. However, there is no requirement to certify that the customer is an institutional investor. Keep in mind, there is a difference between an accredited investor (e.g., a person who has net worth of at least $1,000,000 or annual income of at least $200,000), which is defined under Regulation D, and an institutional investor (a financial institution or an account with at least $50 million of invested assets), which is defined by FINRA.

A registered representative is NOT permitted to exercise discretion as it relates to which of the following investments?

DPPs Registered representatives are not permitted to exercise discretion over DPP investments for their clients.

Which of the following investments generally distributes dividends and capital gains, mirrors a securities index, and can be purchased on margin?

ETF ETFs have a portfolio that generally mirrors a securities index and will distribute the dividends and capital gains that are generated in the portfolio. In addition, since they are considered shares of stock and trade in the secondary market, most are marginable. Some mutual funds are structured to mirror an index; however, mutual fund shares are considered new issues and not initially marginable. ETNs are debt instruments that are structured to provide the return on a wide array of investments, but they don't purchase those securities for their portfolios. ADRs are depository receipts for foreign equities that are trading in U.S. markets.

Which of the following statements BEST describes exchange-traded notes (ETNs)?

ETNs are debt instruments linked to the performance of a commodity, currency, or index Exchange-traded notes (ETNs) are a type of unsecured debt security. This type of debt security differs from other types of fixed-income securities since ETN returns are linked to the performance of a commodity, currency, or index minus applicable fees. Similar to ETFs, ETNs are traded on an exchange, such as the NYSE, and may be purchased on margin or sold short. Investors may also choose to hold the debt security until maturity.

SPDR is considered a type of:

Exchange-traded fund Standard & Poor's Depositary Receipt (SPDR) is a type of exchange-traded fund (ETF). It can be used to refer to a specific exchange-traded fund that tracks the S&P 500 or a group of ETFs.

If the credit rating of an issuer is lowered, which investment will lose the most value?

Exchange-traded notes (ETNs) Although exchange-traded notes (ETNs) are a type of unsecured bond, their rate of return tracks an index. If the issuer of an ETN is unable to pay its investors, the investors don't have claim to any collateral and are general creditors. In other words, ETN investors are exposed to both credit risk and market risk. All of the other products represent ownership in a portfolio, rather than an unsecured bond, and don't have the same degree of credit risk as an ETN.

All of the following statements concerning hedge funds are TRUE, EXCEPT the funds:

Must register under the Investment Company Act of 1940 if offered to U.S. residents Hedge funds are investments that resemble mutual funds, but are typically only offered to wealthy investors. Hedge funds often employ aggressive financial strategies such as short selling, the use of leverage (borrowed funds), and placing large bets on individual companies or sectors of the market. These funds are not generally required to register with the SEC due to the accredited status of their investors.

A customer who has consistently invested in mutual funds is considering a first-time investment in a hedge fund. When comparing mutual funds to hedge funds, which of the following statements is NOT TRUE?

Mutual funds pool investors' money and manage the portfolio, whereas hedge funds manage each investor's assets separately. Both mutual funds and hedge funds pool investors' money to manage the assets. Unlike mutual funds, hedge funds are often exempt from regulatory oversight, use leverage, and employ aggressive financial strategies such as short selling and placing large bets on individual companies or sectors of the market. Hedge funds typically have high minimum investment requirements that make them suitable only for professional and wealthy investors.

Which of the following is NOT a benefit of investing in a real estate investment trust (REIT)?

Passive losses Unlike DPPs, real estate investment trusts (REITs) do not generate passive losses. REITs offer investors stable dividends based on the income being produced by owning a diversified portfolio of properties and/or mortgages. Most REITs trade on an exchange and offer investors liquidity. Since investors typically purchase REITs for their high dividend yield, if interest rates increase, the value of their shares will usually decrease as other newly issued income-earning securities become more attractive.

An equity inverse exchange-traded fund (ETF) is most similar to:

Selling stock short An equity inverse ETF is designed to deliver the opposite of the performance of an index or other benchmark. Similarly, a customer who sells stock short is anticipating a decline in the price of the equity securities. For example, an inverse ETF that's based on the DJIA seeks to deliver the opposite performance of that index. Therefore, if the DJIA rises by 1%, an inverse ETF's value should decrease by 1%. Conversely, if the DJIA falls by 1%, the inverse ETF's value should increase by 1%.

The person who distributes interest in a DPP is referred to as the:

Syndicator A syndicator (underwriter) is the person that distributes interests in a direct participation program (DPP).

Which of the following statements is TRUE concerning exchange-traded funds (ETFs)?

The securities may be used by individuals to pursue a market timing strategy Exchange-traded funds (ETFs) represent a basket of securities. ETFs are structured to track an index of securities such as the Nasdaq 100, Standard and Poor's 500, or the Dow Jones Industrial Average. Shares are issued and then trade in the secondary market, much like closed-end investment company shares. Shares are purchased and sold on an exchange and may be purchased on margin and sold short. The price of an ETF is based on market sentiment (supply and demand) are changes throughout the trading session. An index fund (a type of mutual fund that also mirrors an index of securities) is priced only once a day, typically at 4:00 p.m. Individuals that pursue a market timing strategy are frequent users of ETFs. Market timers are active investors who trade frequently based up economic trends, technical factors, and corporate information.

If a REIT generates at least 75% of its income from rents or mortgage interest, and pays out at least 90% of its income to the shareholders, for tax purposes the income distributed by the REIT will be taxable to:

The shareholders and not the REIT To qualify as a REIT, it must receive no more than 25% of its revenue from subsidiary (non-real estate) activities and must be structured and established as a trust. Also, the REIT must distribute a minimum of 90% of its income. Shareholders are responsible for paying taxes on the income distributed by the REIT. This income is treated as a nonqualifying dividend for tax purposes.

Which of the following statements concerning ETFs is TRUE?

These funds' values may fluctuate throughout the trading day. Exchange-traded funds (ETFs) are investments that resemble unit investment trusts (UITs). A fixed portfolio is constructed either to track a specific index (such as the S&P 500) or a given market segment (such as gold or semiconductors). An ETF's portfolio typically remains constant unless there is a change to the underlying index or one of the individual investments within the fund is affected by a corporate action such as a sale or spin-off. ETFs are normally listed on NASDAQ or a traditional exchange and may fluctuate in price throughout the day as a regular stock would. They have a bid and ask as opposed to the NAV and POP found in mutual funds investments. Commissions are paid when trading ETFs as opposed to sales charges when purchasing mutual funds.

Which of the following statements concerning hedge funds is TRUE?

These investments are typically sold to accredited investors. Hedge funds are typically sold to accredited investors. As a product, hedge funds can be extremely risky and illiquid.

Which of the following descriptions characterizes leveraged exchange-traded funds (ETFs)?

They are designed to deliver a multiple of the performance of an index or other benchmark A leveraged ETF is designed to deliver a multiple of the performance of an index or other benchmark. For example, a 3X leveraged ETF based on the DJIA seeks to deliver three times the performance of that index. So, if the DJIA rises or falls by 1%, a leveraged ETF would increase or decrease by 3% before fees and expenses. The other choices include a regular ETF which equals the performance, an inverse ETF which seeks to deliver the opposite of what it is tracking, and a leveraged inverse ETF designed to deliver a multiple of the opposite direction.

Which of the following descriptions characterizes inverse exchange-traded funds (ETFs)?

They are designed to deliver the opposite of the performance of an index or other benchmark An inverse ETF is designed to deliver the opposite of the performance of an index or other benchmark. For example, an inverse ETF based on the DJIA seeks to deliver opposite performance of that index. So, if the DJIA rises by 1%, an inverse ETF would decrease by 1%, and if the DJIA falls by 1%, the inverse ETF would increase by 1% before fees and expenses. A regular ETF is designed to deliver the same performance as an index or other benchmark. A leveraged ETF is designed to deliver a multiple of the performance of an index or other benchmark. A leveraged inverse ETF is designed to deliver a multiple of the opposite performance of an index or other benchmark.

Which of the following statements is TRUE concerning registered nontraded real estate investment trusts (REITs)?

They are required to distribute the same percentage of taxable income as exchange-traded REITs Most REITs are traded on an exchange, such as the NYSE, and offer investors a high degree of liquidity. Nontraded REITs do not have their shares listed on an exchange and offer very limited liquidity, similar to limited partnerships. They would not be suitable for investors seeking liquidity. Both invest in various types of real estate and are subject to the same tax consequences (90% distribution on taxable income). Since they are both registered, they are required to make the same disclosures to investors.

Regarding ETFs, which of the following statements is TRUE?

Typically, ETFs may be sold short. Exchange-traded funds (ETFs) are investments that resemble UITs. These products may be sold short, may be purchased on margin, and may invest in either equity or debt instruments. A fixed portfolio is typically constructed to either track a specific index (e.g., the Wilshire 5000) or a given market segment (e.g., airlines or medical companies). An ETF's portfolio typically remains constant unless there is a change to the underlying index or in one of the individual investments within the fund. Since ETFs are not hedge funds, there is no requirement for the investors to be accredited.

Which of the following limited partnerships is the least likely to generate income?

A raw land limited partnership A limited partnership that invests in raw land is not designed to generate income. Instead, raw land investments are suitable for investors who are seeking appreciation in the value of the property. Partnerships that invest in existing properties and government-assisted housing properties are types of real estate programs that are more likely to generate income.

Which of the following may be subject to a capital call?

DPPs In some cases, DPP investors may be required to contribute additional capital (i.e., they may be subject to a capital call). Failure to meet the call could result in the investors forfeiting their initial interest.

An investor is interested in selling 500 shares of her listed REIT. The sale will be handled in a manner that's similar to the:

Liquidation of a stock on the NYSE A secondary market exists for real estate investment trusts (REITs). The vast majority of REITs trade on the NYSE with prices that are determined by the forces of supply and demand.

Which of the following often provides capital to start-up businesses?

Private equity funds Private equity funds often provide capital to start-up businesses.

What is the typical maturity for an ETN?

10 to 30 years Exchange-traded notes (ETNs) are long-term securities which typically have maturities between 10 and 30 years.

A REIT will receive preferential tax treatment if it distributes at least what percentage of its income to shareholders?

90% If an REIT distributes at least 90% of its ordinary income to shareholders, the income will only be taxed once (at the investors' level).

Which of the following requires a limited partner to deposit additional funds?

An assessment If a limited partner is subject to an assessment, it is a request by the partnership for additional funds. Failure to provide the funds may result in the limited partner's losing her investment interest in the program.

An investor with an investment objective of speculation wants to purchase a security that will increase by the same percentage as a decline in the S&P 500 Index. Which of the following securities should be recommended?

An inverse exchange-traded fund (ETF) An inverse ETF is designed to deliver the opposite of the performance of an index or other benchmark. An inverse ETF based on the S&P 500 Index seeks to deliver the opposite performance of that index. For example, if the S&P 500 rises by 1%, an inverse ETF would decrease by 1%, and if the S&P 500 falls by 1%, the inverse ETF would increase by 1% before fees and expenses are deducted. A leveraged exchange-traded fund (ETF) is suitable if the customer anticipates an increase in the S&P 500 and wants a multiple of that increase. A leveraged inverse exchange-traded fund (ETF) is suitable if the customer wants a return that is a multiple or higher return and anticipates a decrease in the S&P 500. An exchanged-traded fund (ETF) is suitable if the customer only wants to track the return of the S&P 500.