Test 1 Part 3

One of the more popular money market instruments is the negotiable CD. These normally are found in minimum denominations of

$100,000 - Negotiable CDs, sometimes referred to as jumbo CDs, have a minimum denomination of $100,000. They are unsecured, interest-bearing obligations of banks.

When it comes to issuing a debt security, which of the following features will generally enable the issuing corporation to borrow at the lowest interest rate?

Convertible - Because the convertible feature offers potential growth through the exercise of the conversion option, the interest rate on these securities is generally lower than other debt issues of the same corporation.

A fixed-premium variable life insurance contract offers 1 a guaranteed maximum death benefit 2 a guaranteed minimum death benefit 3 a guaranteed cash value 4 a cash value that fluctuates according to the contract's performance

2 & 4 - A fixed-premium variable life contract offers a minimum death benefit and a variable death benefit over the minimum. Its cash value fluctuates with the performance of the separate account.

BFJ Corp's 5% convertible bond is trading at 120. The bond is convertible at $50. An investor buying the bond now and immediately converting into common stock, would receive

20 shares - The conversion ratio always uses the par value ($1,000), never the current market price. With a par value of $1,000 and a conversion price of $50 per share, this bond is convertible into 20 shares ($1,000 / $50). Remember, the number of shares in a conversion never changes. When the market price changes, the parity price changes, but that isn't relevant to this question.

A bond investor's portfolio consists of the following 3 bonds: ABC First Mortgage bond, current market value of $4 million with a duration of 5 years. DEF Debenture, current market value of $5 million with a duration of 8 years. U.S. Treasury bond, current market value of $1 million with a duration of 10 years. What is the average duration of the portfolio?

7 years - Weighted Average based on market value It is unlikely that you will have a question this complicated on the exam, but, just in case, we wanted to show you the way to do it. Computing average duration of a bond portfolio involves taking each bond and figuring the proportion of the portfolio its duration represents. In this question, ABC is 40% of the portfolio so we take 40% of its 5-year duration (2). Then, we do the same with the other two bonds. DEF is 50% of 8 (4) and the Treasury bond is 10% of 10 (1). When we add the 3 numbers together, it results in an average duration of 7 years.

A bond selling for $20 above par would be quoted

Bonds are quoted in percentages of $1,000 (par) (1% of $1,000 = $10). The proper quote would be 102; 102 is 102% of $1,000.

Which of the following statements is TRUE?

Dividends have a significant influence on the value of the corporation's stock. - Dividends play a large role in what someone is willing to pay for the stock. For example, the dividend discount model (DDM) values a stock as the discounted present value of future dividends. A company is not required to pay dividends. A growth company will tend to pay no cash dividends but rather use the money for expansion.

`Bail Bonds, Inc., might issue warrants in connection with a bond issue for which of the following reasons? - As an inducement to make the bonds more marketable - To lower their interest cost on the issue To increase the marketability of their common stock To increase the number of common shares outstanding

I and II Warrants permit the purchase of common stock of the issuer at a fixed price. A bond with warrants attached has more value than a straight bond and is more attractive (marketable) to investors. Attaching warrants to a bond issue usually permits the bonds to be issued with a lower interest rate.`

Which of the following is TRUE of a zero-coupon bond? 1. The rate of return is locked in. 2. There is no reinvestment risk. 3. The imputed interest is taxed as ordinary income on an annual basis. 4. A check for the interest is paid at maturity.

I, II, and III 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.

A money market mutual fund would be least likely to invest in which of the following assets?

Newly issued ​U.S. Treasury notes - A money market mutual fund typically invests in money market instruments, those with a maturity date not exceeding 397 days. Treasury notes are issued with maturity dates of 2-10 years.

A REIT is able to pass-through which of the following?

Taxable income from operations - REITs are required to distribute a minimum of 90% of their taxable income from operations. Unlike the traditional flow-through vehicle, they do not pass-through losses. When a gain is unrealized, there is nothing to distribute.

An individual seeking capital and possible guidance with a start-up would most likely seek funding from

VC - A venture capital fund, typically organized as a limited partnership, seeks out opportunities to get in on the ground floor. In additional to an ownership position, usually at least 10%, the venture capitalists provide managerial input. Because these start-ups are rarely publicly traded, they are of little interest to the other investment company choices.

Under the 1940 Investment Company Act, an investment company may take all of the following forms EXCEPT:

a limited partnership with partners as passive investors - An investment company is not a limited partnership. Investment companies are organized as open-end companies (mutual funds), closed-end companies, unit investment trusts, or face-amount certificate companies.

Ginnie Mae pass-throughs will pay back both principal and interest

monthly - 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 way in which universal life and variable life are similar is that both

permit loans against the cash value - As long as the policy has cash value, loans are permitted. Neither of these has a fixed minimum cash value, and only universal life has flexible premiums. Only variable life is considered a security.

A popular tool used by analysts is discounted cash flow (DCF). Most use this tool to evaluate

the present value of future cash flows to determine an appropriate current value. - The principle behind a DCF computation is that an investment made currently is worth an amount equal to the sum of all the future cash flows expected to be received. These future cash flows are discounted to arrive at a fair value.

A corporate bond that pays interest semiannually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 10%. What is the value of the bond today if the coupon rate is 8%?

$922.78, the only choice less than par value - How did we calculate that? We used tool that you won't have available at the test center (a financial calculator), but there is a great tool you will have - common sense. When a bond has a yield to maturity that is greater than its coupon rate, the bond must be selling at a discount and that only leaves one possible answer. The only way to get a 10% return on an 8% bond is to buy it at a price below par.

Daniel has a number of investment company products within his retirement portfolio. One of these investments trades on an exchange, may trade at a premium or discount to its net asset value, and has a fixed capital structure. These features are most likely found in what type of investment?

Closed-end investment company - A closed-end investment company (closed-end fund) is a type of investment company whose shares trade in the secondary market.

A client of yours owns some convertible preferred stock. She notices an article in the business section of her local newspaper that reports the company is going to pay a 20% stock dividend on their common stock. She wants to know how this will affect her?

If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend. Most convertible securities are sold with antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends.

Passive real estate investment would include all of the following except

renting out single family homes.

A new convertible bond has a provision that it cannot be called for 5 years after the issue date. This call protection is most valuable to a recent purchaser of the bond if

the market price of the underlying common stock is increasing - Convertible bonds are more sensitive to the price of the underlying common stock than they are to interest rates. Call protection would enable this investor to hold on to the bond while the stock rises in value rather than having the bond called away.

In general, when describing the characteristics of equity index annuities and variable annuities, each of the following would be a true statement EXCEPT

both offer an opportunity for unlimited gain - EIAs almost always come with a cap rate, a ceiling beyond which earnings cannot be credited to the investor's account. There is, theoretically, no limit as to how much one could earn with a variable annuity. Both are issued by life insurance companies, and only the EIA offers a guaranteed floor (minimum return). Based on court rulings in effect at this time, the equity index annuity is not considered a security.

To a technical analyst, the resistance level signifies the price at which a stock's supply would be expected to

increase substantially - This is about comparing support and resistance levels. Most stock prices remain relatively stable and fluctuate up and down. The lower limit to these fluctuations is called a support level - the price range where a stock appears cheap and attracts buyers. The upper limit is called a resistance level - the price range where a stock appears expensive and initiates increased selling. This selling represents an oversupply of the stock which results in downward pressure on the stock.

A 47-year-old investor purchases a single premium deferred variable annuity from the ABC Insurance Company with an initial premium payment of $25,000. Six years later, a 1035 exchange is made to an annuity offered by the XYZ Insurance Company when the value of the account is $35,000. Seven years later, the account has a current value of $50,000 and the investor withdraws $20,000. The tax consequence of this withdrawal is

ordinary income tax on $20,000. - Withdrawals from nonqualified annuities (all annuities on the exam are nonqualified unless otherwise specified) are taxed on a LIFO basis. That is, the last money in (the earnings) is considered the first money withdrawn. The investor's cost is $25,000. The 1035 exchange doesn't affect the cost basis because it is nontaxable. Therefore, with the account currently valued at $50,000, the first $25,000 withdrawn is from the earnings. That makes all of the $20,000 in this question taxable as ordinary income. What about the 10% tax penalty for early withdrawal? If you add the years together (47 + 6 + 7), the investor is 60 and, once reaching 59½, there no longer is the tax penalty.

A terminally ill client wishing to access a portion of the cash value in his whole life insurance policy while still providing a death benefit for his beneficiaries could do so by

taking out a policy loan - One of the benefits of whole life insurance is the ability to borrow against the guaranteed cash value in the policy. At death, the amount of the loan is paid off from the death benefit, but the remainder is then paid to the beneficiaries of the policy. Surrendering the policy cancels the death benefit, and the purchaser of the viatical is now the one who determines the beneficiaries. You can't convert permanent insurance to term (and the exam will not consider the situation of leaving the cash value to purchase extended term insurance, which wouldn't work here anyway).

In search of higher returns, many investors have turned to alternative investments, such as structured products. Non-exchange-traded structured securities products (SSPs) typically have

some form of embedded derivatives - It is commonplace for SSPs to use derivatives, such as options. There is no insurance coverage and, unless listed for trading such as an ETN, low or no liquidity. These are highly complex products and would not be suitable for the average conservative investor.

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?

Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis - 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.

Which of the following may be done only with the approval of the shareholders of an investment company? - A change from diversified to nondiversified status The purchase of particular bonds on the open market Personnel changes in the transfer agent's organization - A change in the fund's objectives

1 & 4 - Any substantive change in an investment company's form, structure, investment objective, or business operation must be approved by a majority vote of the outstanding shares. Bond purchases are left to the fund's portfolio manager, and the transfer agent is trusted with its organization's personnel changes.

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? Participation rate Point to Point High-Water Mark Annual Reset

Participation rate - 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).

Which of the following investments is required by law to have at least 75% of its assets represented by real estate assets such as real property or loans secured by real property, cash, and U.S. government securities?

Real estate investment trust - REITs have a requirement that at least 75% of their assets include real property or loans secured by real property as well as cash and U.S. government securities. Specialized (or sector) funds are generally required to have at least 25% of their assets in the area of specialization. This should not be confused with the "names" rule (35d-1) of the Investment Company Act of 1940. The rule requires a registered investment company with a name suggesting that the company focuses on a particular type of investment (e.g., an investment company that calls itself the ABC Stock Fund, the XYZ Bond Fund, or the QRS U.S. Government Fund) to invest at least 80% of its assets in the type of investment suggested by its name. Please note: The names rule is not in your material - it is not tested on the exam. This question is an example of how the exam will sometimes include in the answer choices an incorrect reference to a topic you haven't seen. You need to focus on the correct information.