3. Investment Recommendations (#3)
The best answer is C. Money market funds are an asset class that invests in short-term maturities of 1 year or less. Investments are typically Treasury Bills, Bank Certificates of Deposit, Commercial Paper and Repurchase Agreements. Treasury Bonds are a long-term investment with a 30 year life.
A money market fund would include which of the following in its portfolio? I. Treasury Bills II. CDs III. Guaranteed repurchase agreements IV. Treasury Bonds A) I and II only B) III and IV only C) I, II, III D) I, II, III, IV
The best answer is C. Distributions from an Individual Retirement Account must commence by April 1st of the year following that person reaching age 72.
A person must begin to make withdrawals from an IRA: A) the day after reaching age 59 ½ B) 2 months after reaching age 72 C) by April 1st of the year following the year the individual reaches age 72 D) 9 months following the date the individual reaches age 72
The best answer is B. The S&P 500 and NYSE Composite Index are generally composed of large capitalization mature companies. Mature companies are characterized by low growth rates and high dividend payout ratios. The NASDAQ Index is heavily weighted in younger high tech growth companies, with smaller market capitalizations (aside from some notable large cap issues like Microsoft, Intel and Apple). Growth companies are characterized by high growth rates and low dividend payout ratios. Finally, the Wilshire Index consists of all NYSE, AMEX (NYSE American) and NASDAQ issues, so it is a blend of small, mid and large cap issues.
A portfolio characterized by high growth and low dividend paying stocks would be invested in the stocks in the: A) S&P 500 Index B) NASDAQ Composite Index C) NYSE Composite Index D) Wilshire Index
The best answer is C. This customer needs income. If he margins the blue chip stock positions to "double up" on the amount of stock owned (since Regulation T margin is 50%), this does not come for free! He is borrowing the extra money to buy the new shareholding, using his existing stock as collateral, and he must pay interest on the loan. The interest charge will eat up any dividends that the stocks pay - so there goes his income!
A retired customer has an existing stock portfolio held in a cash account. He has heard that "leveraging" his portfolio can increase his return. The portfolio holds blue chip stocks that pay current dividends. He wants to transfer the positions to a margin account and use them as collateral to buy more stocks of the same blue chip companies. Which statement is TRUE? A) This is an appropriate strategy that will increase the customer's income B) This is not an appropriate strategy because the customer's tax liability will increase if the securities appreciate and are sold C) This is not an appropriate strategy because the customer's income will decline D) This is an appropriate strategy because the customer has the potential for larger capital gains
The best answer is B. A trust has a fixed life - either a fixed number of years specified in the trust document, or, often, the trust ends when the grantor dies and assets are distributed to the named beneficiaries. In contrast, a foundation has an indefinite life - it goes on until all of its assets are distributed - and this could be more than 100 years (think of the Ford Foundation, or think about how long the Bill and Melinda Gates Foundation might last with assets of over $40 billion). Unlike a trust, that can only accept a donation from the settlor or grantor, a foundation can accept donations from multiple sources, such as multiple family members. A board of trustees determines which charitable organizations receive contributions from the foundation - and family members can be on the board.
An extremely wealthy family that is seeking to establish a lasting charitable legacy would be best advised to set up a: A) testamentary trust B) foundation C) charitable lead trust D) charitable remainder trust
The best answer is A. This customer seeks liquidity and income. Liquidity means that the customer can easily cash-out the investment. A zero-coupon bond gives no income, so we can rule that one out. A bank CD gives income but is not liquid, in the sense that it cannot be sold in the market. Of course, it can be redeemed with the bank issuer, but there typically is an interest penalty to do so. A blue chip stock is liquid, but the dividend income is not as great as that provided by a fixed income security. A Treasury note gives a fixed rate of income and also is highly liquid. It is the best choice, (though a good argument could also be made for a bank CD!).
A 60-year old man seeks an investment that gives liquidity and income. The best recommendation would be: A) Short-term Treasury Note B) Blue Chip Stock C) Bank CD D) Zero-Coupon Bond
The best answer is B. If the yacht is purchased, then Cash and Cash Equivalents on the customer's balance sheet will decline by $200,000; and Fixed Assets will increase by $200,000. Total Assets remain the same, as does Total Liabilities and Net Worth. The transaction does not affect the client's personal income statement, though paying the operating expenses of running the yacht in the future certainly will!
A client wishes to buy a $200,000 yacht and wishes to know how this will affect his financial situation. You would illustrate the impact of buying the yacht by showing the changes that would occur on the client's: A) Personal income statement B) Personal balance sheet C) Personal net worth statement D) All of the above
The best answer is D. Passive losses (which are derived from direct investments in real estate and limited partnership investments) can only be offset against other passive income. Since there is $20,000 of passive income for this tax year, the $20,000 of passive losses can be deducted in full.
A customer has $20,000 in passive losses from a limited partnership investment. If the customer has $20,000 of passive income for that tax year, the customer may deduct: A) 0 B) $3,000 C) $10,000 D) $20,000
The best answer is D. The average price per share is: $25 + $16 + $27 = $68/3 = $22.67 The average purchase price per share is calculated as follow: February Purchase: $200 / $25 per share = 8 shares March Purchase: $200 / $16 per share = 12.5 shares April Purchase: $200 / $27 per share = 7.41 shares Total: 27.91 shares A total of $600 was spent to purchase 27.91 shares = $600 / 27.91 = $21.50 average purchase price per share.
A customer makes the following purchases of ABC stock: February $200 Purchase Stock Price: $25 March $200 Purchase Stock Price: $16 April $200 Purchase Stock Price: $27 The average price of the stock over this time period and the average purchase price per share for this customer are: A) Average Price: $16.00; Average Purchase Price Per Share: $16.00 B) Average Price: $22.67; Average Purchase Price Per Share: $16.00 C) Average Price: $16.00; Average Purchase Price Per Share: $22.67 D) Average Price: $22.67; Average Purchase Price Per Share: $21.50
The best answer is C. The account is set up as: Credits - Short Market Value = Equity % $60,000 - $35,000 = $25,000 71% The account has $25,000 of equity.
A customer short margin account shows: 200 shares of ABC @ $60 200 shares of DEF @ $75 200 shares of XYZ @ $40 Credit = $60,000 Reg. T = 50% What is the equity in the account? A) $11,500 B) $23,000 C) $25,000 D) $35,000
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.
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 A. Do not confuse bond portfolio immunization with "contingent" bond portfolio immunization. Portfolio immunization protects a bond portfolio against interest rate risk. It is the strategy of managing a portfolio to make it worth a specific amount at a stated date in the future. This strategy is typically used to fund a known future liability, and often uses a top-credit rated zero coupon bond that matures at the obligation due date as the funding vehicle. Contingent bond portfolio immunization is an "active management" strategy where the manager attempts to select bonds that will outperform a benchmark index; but if the portfolio drops below a predetermined value, the manager shifts to a defensive strategy, buying top-credit rated bonds with a lower rate of return, but this assures, at least, a minimum return rate.
Contingent bond portfolio immunization: A) is an investment approach where an active fund manager will switch to a defensive strategy if the portfolio falls below a predetermined point B) matches the maturity of each expected liability to an investment that will provide cash flows to match C) uses put options to hedge against potential market interest rate increases that will devalue the value of positions held in the portfolio D) periodically liquidates positions that have increased in value and uses to proceeds to invest in positions that have decreased in value
The best answer is C. Buy and hold is the oldest and simplest portfolio strategy. If interest rates are stable, then interest rate risk for a bond portfolio is minimized, and the risk of rising interest rates hurting stock valuations minimizes market risk for stock portfolios. Momentum investing is a technical strategy that says that stocks that have momentum behind them are likely to continue in that direction. Swaps and options are not strategies - they are derivatives.
One of the oldest portfolio strategies that is used in a stable interest rate environment is: A) swaps B) options C) buy and hold D) momentum
The best answer is B. Regulation T of the Federal Reserve Board controls the extension of credit on securities from broker to customer. Regulation U of the Federal Reserve Board controls the extension of credit on securities by banks.
Regulation T controls credit on securities from: A) broker to broker B) broker to customer C) bank to broker D) bank to customer
The best answer is C. The Specialist is the Designated Market Maker on the NYSE trading floor. Though most trading is now done through automated matching, the Specialist has the "positive obligation" of standing ready to buy if there are no other buyers in the market; and standing ready to sell if there are no other sellers in the market - thus, buyers and sellers who place market orders are always assured of getting their orders filled. The Specialist also maintains the book of open orders and fills the orders as the market moves. Finally, the Specialist has the "negative obligation" of taking him- or herself out of trading and acting as an auctioneer, conducting an orderly auction between floor brokers who want to buy and those who want to sell, if the market becomes too "crazy."
The Specialist (Designated Market Maker) on the floor of a stock exchange does all of the following EXCEPT: A) act as an auctioneer in the designated security when necessary to maintain an orderly market B) act as the buyer of last resort when no one else wants to buy on the floor and as the seller of last resort when no one else wants to sell C) provide general market commentary during the trading day for the designated security D) match orders of buyers and sellers that are routed to the exchange floor
Qualified dividents
The best answer is D. Dividends paid by U.S. corporations generally qualify for the lower 15% tax rate. Dividends paid by foreign corporations to U.S. security holders only qualify for the lower rate if: The corporation is incorporated in a country that has a comprehensive tax treaty with the United States; The corporation is incorporated in a U.S. possession; or The corporation has its shares listed on an established trading market in the United States.
The best answer is B. Both 401(k) and 403(b) accounts are funded by voluntary employee contributions that are excluded from the employee's taxable income. These contributions grow tax deferred until distributions are taken. Thus, the employee is deferring taking the portion of his or her salary that is the contribution amount.
The defining characteristic of a 401(k) account is funding by: A) tax-deductible employer contribution B) employee salary deferral C) non-tax deductible employer contribution D) non-tax deductible employee contribution
The best answer is A. In a defined benefit (DB) plan, every employee that is full time, age 21 with at least 1 year of service, is included at the employer's expense. In a defined contribution (DC) plan, most of which are salary reduction plans, the employee contributes a portion of his or her salary and this amount is deductible to the employee (for example, a 401(k) plan is a salary reduction DC plan). In a DC plan, the employee can choose to participate, or may choose not to participate, each year. Thus, DB plans maximize employee participation, since all eligible employees are included in the plan, at the employer's expense. IRAs are set up by individuals - who may decide not to set up and fund an IRA and, instead, would rather spend that money! 401(k) plans are DC plans where the employee chooses to participate by a salary reduction contribution, and again, the employee might choose to not participate and instead, would rather spend that money!
The type of retirement plan that maximizes employee participation is a(n): A) defined benefit plan B) defined contribution plan C) individual retirement account D) 401(k) plan
The best answer is C. A DRIP is a Dividend Re-Investment Plan, where a corporate shareholder can elect to have dividend payments automatically reinvested by the company in additional common shares of that company. A shareholder should be earning a rate of return on these reinvestments that at least equals, or is better than, the return of other corporate investments. The best proxy for this is the S&P 500 Index. It consists of the 500 largest companies headquartered in the U.S., based on market capitalization. The S&P 500 Bond Index is a market cap weighted index of the bonds of the companies in the S&P 500 Index. This is not a relevant benchmark to stock investing.
When considering investing in a DRIP, the benchmark rate of return that should be used for comparison is the: A) 1 Year T-Bill rate B) Long-Term Treasury Bond Rate C) S&P 500 Index D) S&P 500 Bond Index
The best answer is C. The coupon rate has no bearing on diversification. In the trading market, the price of a bond is determined by the market yield for that type of security - not the coupon rate. To reduce non-systematic risk (meaning the risk that any one security may be a "bad" investment), diversification of a bond portfolio by choosing different issuers, different industries, different geographic issuer locations, and different maturities (since long term prices are more volatile than short-term debt prices) are all valid.
Which of the diversification factors below will NOT reduce the non-systematic risk of a portfolio? A) maturity B) industry in which issuer operates C) coupon rate D) geographic location of issuer
The best answer is A. Defined contribution plans specify a "defined contribution" that the employer must make to the plan each year - typically a percentage of salary. There is no mandatory employee contribution. A variant of a defined contribution plan is a 401(k), which is a salary reduction plan. In such a plan, the employee makes voluntary contributions which reduce that employee's taxable income. The employer may also make a matching contribution, but is not required to do so.
Which of the following is NOT permitted in a defined contribution plan? A) Mandatory employee contributions B) Mandatory employer contributions C) Voluntary employee contributions D) Voluntary employer contributions
The best answer is B. A "Limit" order specifies that the execution must comply with the limit price specified or better. Thus, limit orders are filled at that price or better. Buy limit orders must be filled at the limit price or lower. Sell limit orders must be filled at the limit price or higher. If a "Stop" order is elected, it becomes a market order to be filled at the first opportunity. Thus, the actual price at which the order is executed is not known. Market orders are filled immediately at the current market price, so the actual execution price is not known. A "not held" order is a market order that gives the trader price and time discretion during that trading day. The trader is supposed to use his or her judgment to get the best price, but there is no guarantee as to the fill price.
Which order, if executed, guarantees a specific price or better? A) Market B) Limit C) Stop D) Not Held
The best answer is C. Contributions to a 401(k) are made by the employee and reduce the employee's taxable income. Earnings build tax-deferred until distribution. Thus, all dollars in the plan have never been taxed. When distributions commence, 100% of the distribution is now taxable.Employee contributions immediately 100% vest, since this is the employees' money. On the other hand, employer matching contributions may vest over the typical 5-6 year vesting schedule.
Which statement is FALSE regarding employee contributions to a 401(k) plan? A) Employee contributions reduce the employee's taxable income B) Employee contributions are immediately vested C) Earnings on employee contributions are taxed at capital gains rates D) Taxes on employee contributions are deferred until distribution
The best answer is A. In a Joint Tenants account, each person owns 100% of the assets. This is typical for a husband and wife. If one dies, the other automatically 100% owns the assets in the account. The asset transfer does not go through the deceased individual's estate and bypasses probate. Thus, the assets of the deceased person do not go to a beneficiary - they go the other account owner. There is no requirement that the assets be sold upon the death of one of the tenants - the other tenant simply owns the entire account. Because these accounts are used by married couples and each of the 2 tenants is an equal owner, it could be stated that a contribution by one of the tenants of more than 50% of the assets is essentially a gift to the other tenant (Choice A).
Which statement is TRUE about property held in a Joint Tenancy account? A) A contribution of more than 50% by one of the parties is essentially a gift to the other B) Each tenant has a specified ownership interest in the property in the account C) If an owner in a joint tenancy account dies, his or her ownership percentage will be transferred to his or her beneficiary D) Upon death of one of the tenants, the assets in account must be sold and the proceeds distributed to the survivor(s)
The best answer is C. To form a trust, a tax identification number for the trust must be obtained and an annual tax filing on Form 1041 is required. (Remember that the 1040 is the personal income tax return; and the 1065 is a partnership tax return.)
Which statement is TRUE about trust taxation? A) The trust is a non-taxable entity B) A Form 1040 must be filed reporting income, gain and loss C) A Form 1041 must be filed reporting income, gain and loss D) A Form 1065 must be filed reporting income, gain and loss
The best answer is B. (I & IV) Stop orders are placed "away" from the current market - sell stop orders are placed below the current market price (and elected at or below the stop price) while buy stop orders are placed above the current market price. (and elected at or above the stop price). Once the "stop" price is reached, the order is elected and becomes a market order to be filled at the next price - which could be higher, lower, or the same as the stop price.
Which statements are true regarding sell stop orders? I. Sell stop orders will be elected at the stop price or lower II. Sell stop orders will be elected at the stop price or higher III. Once elected, sell stop orders will be executed at the stop price specified only IV. Once elected, sell stop orders may be executed at, above, or below the stop price specified