Practice Exam II Missed Questions

Feasible Set

-portfolios represents all portfolios that can be constructed from a given set of equities. (Page 444). -one selects a feasible set from the efficient set

Capital Needs Analysis

A capital needs analysis is used to determine how much life insurance is necessary to meet future needs. At a minimum, life insurance coverage should provide for: -payoff of the client's mortgage and other debts; -income for the survivor(s) for a reasonable time; -tuition for higher education; and -estate taxes if the taxable estate will exceed $11.4 million in 2019. (Page 419).

Class B Shares

A class of mutual fund share issued with a back-end load. A mutual fund offers different classes of shares to allow investors to choose the type of sales charge they will pay. (Page 577).

Class A Shares

A class of mutual fund share issued with a front-end sales load. A mutual fund offers different classes of shares to allow investors to choose the type of sales charge they will pay. (Page 577).

Which of the following employer-sponsored plans is NOT covered by ERISA? A) Defined benefit pension B) Deferred compensation C) 401(k) D) 403(b)

B. Deferred compensation plans are not ERISA-covered plans; that is what gives them greater flexibility than a covered plan.

Under NASAA's Model Rule dealing with Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, an investment adviser would have to disclose that the firm was acting in a principal capacity when A) the trade is being executed by an officer or partner of the firm B) purchasing shares from advisory clients that were originally acquired as a result of the adviser's previous buy recommendation C) directing securities transactions to an affiliated broker-dealer D) engaging in an agency cross transaction

B. There are 2 principals in every securities trade: the buyer and the seller. In this case, buying shares directly from clients who own those shares places the IA in the position of being one of the principals. This is an action that must be disclosed in writing to the client no later than completion of the transaction. In agency cross transaction, the firm is acting as an agent—that's the reason for the term.

One of your clients, a couple in their early 30s, asks you to recommend a plan to save for their newborn child's education. They are only able to contribute $1,800 per year. Which of the following would most likely be the best fit for their situation? A) Section 529 plan B) Coverdell ESA C) Equity index annuity D) UTMA

C. The key to this choice is the contribution level. The Coverdell ESA has a maximum annual limit of $2,000 and offers tax-free growth. Why not the Section 529 plan? Invariably, that will be the correct choice when the question involves higher contribution amounts or tax benefits on a state level. When the couple can only contribute $1,800 per year, it seems logical to assume that they are in a low tax bracket where those benefits would be of minimal value. UTMA offers less flexibility and the annuity would not be suitable for anyone wishing to use the funds prior to age 59½.

An agent registered in one state may solicit business in another state, provided A) the agent's firm is properly registered in the other state B) the agent was previously registered with a different firm in the other state C) both the agent and the employing broker-dealer are properly registered in the other state D) the agent applies for registration in the other state

C. An agent holding registration in one state may solicit and/or transact business in another state only if registered in that state and the employing broker-dealer is also registered in that state, unless an exemption is available.

Capital Asset Pricing Model (CAPM)

CAPM is a securities market investment theory allowing the investor to determine an asset's expected rate of return, a form of risk-adjusted return encapsulating how much risk the investor should assume to obtain a particular return from an investment. The CAPM does so solely on the basis of the asset's systematic (non-diversifiable) risk. William Sharpe first formulated the CAPM in the 1960s. The basic premise is that every investment carries two distinct risks; systematic, which cannot be diversified away, and unsystematic risk, which can be mitigated through appropriate diversification. As a result of this work, and its further refinements, Professor Sharpe was awarded the Nobel Prize in Economics in 1990 (that isn't tested). You will see several applications of the CAPM in upcoming paragraphs. (Page 442).

Investment Company Act of 1940

Congressional legislation regulating companies that invest and reinvest in securities. The act requires an investment company engaged in interstate commerce to register with the SEC. (Page 589).

CDSC

Contingent Deferred Sales Charge

Where would you be most likely to find an IPS? A) GRAT B) SPD C) IRA D) Defined benefit plan

D. he investment policy statement (IPS), although not required under Department of Labor (DOL) rules, is generally found in corporate qualified plans, such as the defined benefit or defined contribution plan. Because the investor manages the IRA, there is no need to prepare an IPS for participants to review.

Profit-Sharing Plans

Established by an employer allows employees to participate in the business's profits. The benefits may be paid directly to the employee or deferred into an account for future payment, such as retirement, or a combination of both. This discussion concerns profit-sharing plans that defer benefits toward retirement.

NSMIA 1996

Federal covered securities identified, don't have to register with the state. Only notice filling. -Any security on a well know stock exchange -Closed & open end mutual fund companies -Unit investment companies -investment companies registered under Investment Company Act 1940

Securities Exchange Act of 1934

Federal legislation that established the Securities and Exchange Commission. The act aims to protect investors by regulating the exchanges, the OTC market, the extension of credit by the Federal Reserve Board, broker-dealers, insider transactions, trading activities, client accounts, and net capital. Syn. Act of 1934; Exchange Act. (Page 601).

When discussing employment and production, which of the following industries are typically more affected by a recession? I. Capital goods II. Consumer durable goods III. Consumer nondurable goods IV. Services

I and II Durable goods and capital goods are more affected by a recession than are nondurable goods and services. This is primarily because they are larger items, last for a longer period, and are somewhat discretionary.

Which of these features are common to both variable annuities and scheduled premium variable life insurance? I. Income earned in the separate account is tax deferred. II. Separate account performance below the AIR causes a III. reduction in cash value. IV. Fixed contributions are required. Contract owners have voting rights.

I and IV All variable products offer tax deferral of earnings in the separate account. Unit holders of a variable annuity vote on the basis of the number of units they own; holders of variable life insurance receive 1 vote for each $100 of cash value. With variable life insurance, AIR applies only to the death benefit, not to cash value.

During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share have increased from $2.00 to $2.50 per share, and their dividend payout ratio has decreased from 50% to 40%. Based on this information, I. Kapco's P/E ratio has decreased II. Kapco's P/E ratio has increased III. an investor holding Kapco over this period would have noticed a decrease in income received IV. an investor holding Kapco over this period would have noticed no change in income received

I and IV At the beginning of the period, the P/E ratio was 23.5 to 1 ($47 divided by $2.). At the end of the period, the P/E ratio was 20 to 1 ($50 divided by $2.50). Initially, Kapco was paying out 50% of its $2.00 per share earnings, or $1.00 in dividends. At the end, Kapco was paying out 40% of its $2.50 per share earnings, also $1.00 in dividends.

Which of the following are defined as securities under the Uniform Securities Act? I. Real estate investment trust certificates II. Preorganization subscription agreements III. Shares of treasury stock IV. Voting-trust certificates issued by a corporation undergoing a reorganization

I, II, III, IV All the choices listed are defined as securities under state law. We believe the best thing for you to do is remember those few things that are not securities.

It is generally accepted that agents and IARs will give greater consideration to which of the following when making recommendations to their senior clients? I. Age II. Life stage III. Retirement savings IV. Tax status

II and III All of these are important suitability considerations for all customers. But when it comes to seniors, it is felt that life stage (including whether the customer is employed, retired, or nearing retirement) and current retirement savings relate particularly to seniors.

Under the Securities Act of 1933, the definition of prospectus includes I. an offer of a security made orally II. a tombstone advertisement for a new issue of common stock III. an offer of a security made in an email communication

III A prospectus is a communication made in writing or by radio or television that offers a security for sale. An oral offer would therefore not be a prospectus. Tombstone advertisements are specifically excluded from the definition of prospectus. An email meets the definition of a written communication.

Jake Aaron is registered as an agent with ABC Securities, a broker-dealer registered with the SEC doing business in 34 states. In addition, Aaron has his own investment advisory business, Jake's Money Advisers, and is registered with the SEC. To comply with all appropriate regulations, which of the following would have to be stated on the business card for Jake's Money Advisers? I. Jake Aaron, RIA II. Jake's Money Advisers, RIA III. Jake's Money Advisers, registered investment adviser IV. Securities offered through ABC Securities

III and IV It is not permissible to use the initials RIA, but one would properly describe the fact that the firm is a registered investment adviser. If one is registered as an agent with a broker-dealer, that fact always must be stated on that person's business card.

Investment Constraints

Limitations or restrictions that are specific to the adviser's client. Investment constraints include, among others, liquidity needs, time horizon, and personal ethical choices (no tobacco or alcohol stocks). (Page 589).

Sell Limit

Order to sell placed above the current market price that may be executed only if the bid price rises to the limit price or higher

Efficient Frontier or Efficient Set

Specifically, this curve represents that set of portfolios that has the maximum rate of return for every given level of risk. The objective is for the portfolio to lie on the curve. Then, by being on the efficient frontier, the optimal portfolio has been created. Any portfolio that is below the curve (not an efficient one) is said to be taking too much risk for too little return. A portfolio above the efficient frontier is impossible. (Page 444).

buy stop order

an order for a brokerage firm to buy a stock when the price rises to a specified level

CML

provides an expected return for a portfolio based on the expected return of the market, the risk-free rate of return, and the standard deviation of the portfolio in relation to the standard deviation of the market. The CML is generally used to evaluate diversified portfolios. (Page 445).

Present Value

the amount of money you would need to deposit now in order to have a desired amount in the future

buy limit order

the highest price at which an investor will purchase a specific stock

Class C Share

A class of mutual fund share issued with a level load. A mutual fund offers different classes of shares to allow investors to choose the type of sales charge they will pay. (Page 577).

A company that has issued noncumulative convertible preferred stock A) pays the current dividends on the preferred before paying a dividend on the common B) pays past and current preferred dividends before paying dividends on common C) pays the preferred dividend before paying the coupons due on its outstanding bonds D) can force conversion of the preferred trading at a discount to par to avoid paying dividends

A. A noncumulative preferred stock, while maintaining a preference to common stock in the payment of a dividend, is not subject to payment of dividends in arrears prior to payment of the common stock dividend. A preferred stock that is required to pay dividends in arrears prior to the common stock dividend would be a "cumulative" preferred stock. Debt obligations and interest must always be paid prior to a preferred stock dividend; debt is a legal obligation of the issuer and preferred stock is an equity position in the issuer. A conversion feature in a security is always subject to the security holder's decision and not the security issuer.

A registrant's registration may be canceled by the Administrator A) if the Administrator is unable to locate the registrant B) upon the order of a court of competent jurisdiction C) as long as there is opportunity for a hearing D) when the registrant has been found in violation of the Uniform Securities Act

A. Cancellation is nonpunitive—nothing wrong was done. But when the Administrator is unable to locate the registrant, or the registrant is declared mentally incompetent or is deceased, registration is canceled.

Investment Policy Statement (IPS)

Although it is not specifically mandated under ERISA, it is strongly suggested that each employee benefit plan have an investment policy statement (IPS), preferably in writing, which serves as a guideline for the plan's fiduciary regarding funding and investment management decisions. Investment policy statements address the specific needs of the plan. For employee benefit plans that use outside investment managers (such as mutual funds), the fiduciary must ensure that the investment alternatives available to plan members are consistent with the policy statement. A typical IPS will include: -investment objectives for the plan; -determination for meeting future cash flow needs; -investment philosophy including asset allocation style; -investment selection criteria (but not the specific securities themselves); and -methods for monitoring procedures and performance. The IPS will NOT include specific security selection and a copy of the Summary Plan Description (SPD) required by the Department of Labor (DOL)

An application has been filed with the Administrator of State A for registration as a broker-dealer by Assured Success Investments (ASI), a broker-dealer registered in States B, C, and D. While the application is pending, a lawsuit against ASI is filed in civil court in State B. The effect of this would be A) ASI's application in State A would be denied B) ASI's application in State A would proceed as normal C) ASI's registration in State B would be suspended D) ASI's application in State A would be put on hold Explanation

B. The filing of a lawsuit would have no immediate effect on a broker-dealer's application for registration. After all, one is innocent until proven guilty. Even a guilty verdict might not lead to any action, because we don't know whether the lawsuit is connected to the brokerage activities.

Based on the following information, which stock is most likely to appeal to a growth investor? A) P/E ratio of 8:1 B) Book value of $22 per share, current market value of $17 per share C) Dividend yield of 0.3% D) Dividend payout ratio of 65%

C. Growth investors usually seek stocks with high-growth expectations, reflected by a higher-than-normal P/E ratio, typically 20:1 or higher, and a low dividend yield, usually caused by a low dividend payout ratio. It would be unlikely to find a growth stock selling for close to its book value and certainly not below it.

If the dollar weakens, which of the following statements is TRUE? A) The dollar buys more foreign currency. B) A rise in U.S. interest rates might strengthen the dollar. C) U.S. exports will fall. D) Foreign securities denominated in their domestic currency decrease in value to the U.S. investor.

C. If U.S. interest rates rise, foreign investors would invest in U.S. dollar-denominated securities, thereby increasing the demand for dollars and causing the dollar to strengthen.

Centripetal Investment Advisers (CIA) has its principal office in State X and is also registered in States Y and Z. CIA would be considered to be maintaining custody of client assets in all of the following cases EXCEPT A) checks made out to CIA are deposited within 3 business days B) CIA's advisory contract calls for the automatic deduction of advisory fees C) checks made out to 3rd parties are forwarded within 3 business days D) CIA has a power of attorney granting authority to withdraw funds from the custodian

C. When a check made payable to a 3rd party is received by the investment adviser, it will not be deemed to be custody under the Uniform Securities Act if the check is forwarded within 3 business days. When a check is made payable to the investment adviser, it must be returned to the sender within 3 business days or it will be considered maintaining custody. Authority to withdraw funds or securities from the custodian or automatic deduction for fee payments are forms of custody

An agent receives a notice of execution for 500 shares on a customer's order for only 400 shares. Which of the following actions should he take? A) Break the trade within five minutes, enter a corrected order, and place the transaction on the error log B) Promptly sell the 100 share overage at the best available price C) Promptly report the execution of 500 shares to the customer and waive commissions on the overage D) Report the problem immediately to his supervisor Explanation

D. Agents are not empowered to fix errors. Agents should report errant trades to a supervisory individual immediately.

All of the following are true about education funding plans except A) proceeds in 529s may be withdrawn income-tax free only if used for qualified educational expenses. B) Section 529 plans allow a gift tax exclusion equal to five times the annual limit that may be repeated every 5 years C) proceeds in ESAs may be withdrawn income tax free for qualified education expenses even if the child is under age 18 D) a beneficiary of an ESA who withdraws the funds for nonqualified expenses will be taxed on the entire amount of the withdrawal plus a 10% penalty

D. The tax and 10% penalty is only levied against earnings since the contributions were made with after-tax dollars. ESAs may be used for any level of education, including elementary school where it is hoped that the student would be under age 18. In order to receive the favored tax treatment, the proceeds must be used to pay for qualified educational expenses. Section 529 plans have the unique 5-year front-loading feature.

Venture Capital Funds (VC)

Generally organized as limited partnerships where the investment decisions are made by the general partner with the capital coming from the limited partners (LPs). Those LPs can be wealthy individuals, pension and endowment funds, and even hedge funds. VC funds look for young, promising companies with an expectation of high returns in exchange for the high risk. Unlike private equity funds, it more typical that venture capital fund investments are made in businesses that are not yet fully operational. The funding (and sometimes management guidance) provided has the goal of developing an exit strategy in 10 years or less. One common characteristic of private equity and venture capital funds is the compensation to the fund manager. Typically, the annual management fee is 2% of committed capital plus 20% of the profits when the business is sold. This is usually referred to as the carried interest.

sell stop order

an order for a brokerage firm to sell a stock when the price falls to a specified level

SML (security market line)

determines the expected return for a security on the basis of its beta and the expectations about the market and the risk-free rate. Basically, we want to determine how much over the risk-free rate we should earn for taking the investment risk. You may be asked to compute the expected return using the SML. It is done like this. (Page 445). We start by comparing the market's return to the RF rate (expecting it will be higher because of the risk). Then we multiply that difference by the stock's beta and add that number to the RF rate. It is much easier to follow with the numbers. (Page 446).

What is needed to calculate Present Value?

1. Future Amount Needed 2. Expected Earnings Rate 3. Time the money will be invested

An investment adviser representative is evaluating ABC stock to see if it is a good fit for a client's portfolio. Using the security market line (SML), what is the expected return for ABC when the return on the market is 20%, the 91-day Treasury bill is yielding 4%, ABC's beta is 0.70, and the inflation rate, as measured by the CPI, is 3%? A) 15.2% B) 10.2% C) 14.0% D) 11.2%

A. The formula for this computation is as follows: 20% (the return on the market is a beta of 1.0) minus the risk-free rate of 4%, or 16%. Then, multiply that by the beta of this stock (0.7) to arrive at 11.2%. That is, the stock should return 11.2% over the risk-free rate of 4%, or 15.2%. Inflation rate is only important if we are looking for the real (inflation-adjusted) return, not the expected return.

A customer purchased new issue bonds at par 2 years ago. Since then, the CPI has declined by almost half and the current yield on his bonds has also declined. Which of the following best describes the value of the bonds he purchased? A) Their market price has declined. B) Their market price has increased. C) Their market price has remained unchanged. D) This cannot be determined from the information presented.

B. Because inflation is down and bond yields have declined, the bonds are selling for a premium due to an increase in value.

All of the following statements concerning capital market theory are correct EXCEPT A) the security market line (SML) is the graphical depiction of the capital asset pricing model (CAPM). B) beta is a measure of volatility, or relative unsystematic risk, for stock or portfolio returns. C) the market risk premium is the difference between the expected return for the equities market and the risk-free rate of return. D) the security market line (SML) depicts the tradeoff between risk and expected return for all assets, whether individual securities, inefficient portfolios, or efficient portfolios.

B. Beta is a measure of relative systematic risk for stock or portfolio returns. A stock or portfolio with a beta of 1.0 would have the same systematic risk as the overall market.

An analyst who wants to examine a firm's financing transactions during the most recent period is most likely to evaluate the firm's statement of A) comprehensive income. B) cash flows. C) changes in equity. D) financial position.

B. The statement of cash flows describes a firm's inflows and outflows of cash during a reporting period from operating, investing, and financing activities. Financing transactions such as issuance of debt or stock are shown on the statement of cash flows. The statement of financial position (balance sheet) presents the firm's assets, liabilities, and equity at a point in time. The statement of comprehensive income (income statement) does not directly reflect a firm's financing transactions. Cash raised is not included in a firm's revenues and dividends paid and debt principal repaid are not included in its expenses.

Nonsecurities derivatives include futures and forwards. Among the differences between futures and forwards is that futures contracts A) are not regulated by the CFTC while forwards are. B) are preferred to forwards by producers. C) are rarely exercised while forwards generally are. D) are nonstandardized while forwards are.

C. In the vast majority of the cases, futures contracts are closed out prior to expiration. That is one reason they are more popular with speculators than forwards. Because forwards are generally delivered, they are the preferred tool by producers and it is futures which are standardized and CFTC regulates, not forwards

Washington, Adams, and Jefferson, Inc. (WAJI) is an investment adviser whose principal and only office is in Alexandria, VA. WAJI's sole business is advising institutional investors. Rutherford Buchanan is employed by the firm in the main office and has the responsibility of servicing the firm's bank and insurance company clients. Which of the following statements is correct regarding Rutherford's licensing requirements? A) Rutherford is exempt from registration because he has fewer than 6 retail clients. B) Rutherford cannot register as an IAR of WAJI because providing advice exclusively to institutions exempts the firm from registration. C) Rutherford must register as an IAR of WAJI with the state of Virginia. D) Rutherford is exempt from registration because his only clients are institutions.

C. Regardless of whom the clients are, Rutherford has a place of business in Virginia and that requires registration with the Administrator as an IAR. If WAJI does business in other states where it does not have a place of business, it is exempt from registration because the only clients are institutions. If WAJI is not registered in the state, Rutherford can't register as their IAR. The de minimis exemption for fewer than 6 retail clients only applies when there is no place of business in the state.

Life insurance companies offer many different products. Which of the following would NOT be considered a security? I. Index annuity II. Modified endowment III. Variable annuity IV. Variable life

I and II Any insurance product that includes the word variable is a security. Otherwise, it is not.

An exemption from state registration is granted under the specific authority of the Uniform Securities Act to securities issued by which of the following entities? I. State of Georgia II. City of London, Ontario III. City of London, England IV. Kapco Income Fund, an open-end investment company registered with the SEC

I and II Any state or Canadian province, or political subdivision thereof, is considered an issuer of exempt securities. The exemption also applies to securities issued by foreign governments with whom the United States has diplomatic relations, but not their political subdivisions such as the City of London, England. Although securities issued by investment companies registered with the SEC are exempt from state registration, the authority for that exemption is found in the NSMIA of 1996 (federal covered securities) rather than the Uniform Securities Act.

If a corporation has a dividend payout ratio of 70%, the undistributed earnings will A) increase retained earnings B) increase capital surplus C) decrease book value D) increase earnings per share

A. Retained earnings represent income that has not been paid out to shareholders.

A sale or offer to sell would NOT include A) a stock dividend that requires only a nominal payment by the shareholder B) any security given or delivered with, or as a bonus on account of, any purchase of securities C) a purported gift of nonassessable stock D) a sale or offer of a warrant or right to purchase or subscribe to another security of the same or another issuer

C. A gift of assessable stock would be an offer or a sale, but a gift of nonassessable stock is just a gift.

If a customer of your firm receives stock from the estate of her mother, the stock's cost basis in the hands of the customer is A) the original cost of the stock B) the original cost of the stock adjusted for any estate taxes paid C) the market value at date of distribution to the customer D) the market value at date of death

D. When securities are inherited, the heir receives a cost basis calculated as of the deceased party's date of death.

ERISA (Employee Retirement Income Security Act of 1974)

-The Employee Retirement Income Security Act is a federal law that implements standards for certain employer-sponsored retirement plans and regulations for plan fiduciaries. -The law has gone through a series of changes since it was first enacted in 1974. -ERISA prohibits fiduciaries from misusing funds and also sets minimum standards for participation, vesting, benefit accrual, and funding of retirement plans. -It also grants retirement plan participants the right to sue for benefits and breaches of fiduciary duty. -Regulations and standards established by ERISA also extend to employer-sponsored healthcare plans.

Form PF must be filed by A) SEC-registered advisers with at least $150 million in private fund assets under management B) SEC-exempt reporting advisers C) state-registered private fund managers, regardless of the amount of assets under management D) SEC-registered advisers with no more than $150 million in private fund assets under management

A. Form PF is the form used by those private fund managers who are registered with the SEC and whose private fund AUM reaches or exceeds the $150 million threshold. Exempt reporting advisers are, as the term implies, exempt from reporting. State-registered advisers don't report on the form because, among other things, if they reached the $150 million mark, they'd have to register with the SEC.

Which of the following statements regarding a zero-coupon corporate bond is TRUE? A) These bonds have higher reinvestment risk as to interest than bonds paying semiannual interest. B) The investor has phantom income, which must be reported on an annual basis. C) The investor reports the difference between the purchase price and maturity value as ordinary income at maturity. D) Bonds selling at a premium have a yield lower than the coupon rate.

B. On a taxable zero-coupon bond, the annual imputed interest is reported for tax purposes. Because this income is not actually received annually, it is referred to as phantom income. Zero coupon bonds always sell at a discount from their maturity value - never at a premium and one risk that zero coupon bonds avoid is reinvestment risk because there are no interest payments to reinvest.

An agent has recommended investments in the XYZ fund family to his customers for 10 years. He is referred by one of his customers to a prospect who has inherited $500,000 as beneficiary of a life insurance policy. The prospect tells the agent she has never invested in the market before, is risk averse, and wants safety of principal to be the first priority with liquidity second. The agent recommends the following investments: XYZ government bond fund, B shares $200,000 XYZ large-cap growth and Income B shares $150,000 liquid reserve money market $150,000 The recommendation is: A) suitable because it addresses the customer's liquidity objective B) unsuitable because it does not address the customer's two primary objectives C) suitable because he recommended conservative investments D) suitable because it addresses the customer's safety objective

B. The customer's objectives of safety and liquidity are not satisfied by these recommendations. The government bond fund and large-cap growth and income fund are both subject to market risk and, as Class B shares, are subject to a contingent-deferred sales charge in the event the customer wishes to access the funds before the back-end load expires. The back-end load is not consistent with the customer's liquidity objective.

A client's investment objective is safety of principal and income, and the client places an order with his agent to buy a speculative investment. The agent strongly encourages the customer to reconsider because he believes that the transaction would be unsuitable. If the customer insists that the trade proceed, the agent should: A) obtain a written statement of indemnification from the customer before effecting the unsuitable trade B) obtain prior approval from one of the firm's general securities sales principals before effecting the trade C) complete the trade D) refuse to make the unsuitable trade, notify the customer of this by telephone, then send written notification by first-class mail or other prompt means

C. If a client insists that a trade be done, then the agent should execute it. The firm may choose to protect itself by having the customer sign a nonsolicitation letter before effecting the trade.

An investment adviser representative meets with a couple who explains that they wish to be able to pay for their daughter's college education. The IAR is told that the child will be starting school in 5 years. This 5-year time period would be considered A) the present value needed B) a capital need C) an investment constraint D) an investment policy statement (IPS)

C. Investment constraints are limitations on the ability to make use of particular investments. They can be liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances (ethical objectives or social responsibility considerations). The easiest way to determine if it is a constraint or a capital need is if a dollar amount is stated. When a specific sum is mentioned, it is a capital need. The IAR might use a present value computation to determine the amount to be deposited,, and this may be part of the client's IPS, but neither of those answers the question posed.

Regarding open-end investment companies, which of the following sales charges is based on the NAV per share? A) Commission B) 12b-1 fee C) Sales load D) Redemption fee

D. If the fund has a redemption charge (CDSC), it is based on the NAV per share, not the public offering price (POP). That is, if the client liquidated shares when the NAV was $10 per share and the POP was $10.50, the CDSC would be charged based on the $10 rather than the $10.50. Commission is not a term used with mutual funds. The 12b-1 fee is a charge against overall assets of the fund; it is not considered to be a charge related to the buying or selling of fund shares.

One of your clients has told you that his employer has just instituted a Roth 401(k) plan. If the employer wishes to make matching contributions, A) current tax law does not permit matching contributions to be made on behalf of any employee participating in a Roth 401(k) plan B) the employee may choose whether he wants the matching contribution to be made to the Roth 401(k) or a regular 401(k) C) it may contribute a specified percentage of the employee's pay to the Roth 401(k) D) it may contribute a specified percentage of the employee's pay to a regular 401(k)

D. In order to have matching contributions, participants in a Roth 401(k) plan must actually have 2 accounts—the Roth and a regular 401(k). The employer contributions are made on a tax-deductible basis to the regular 401(k) and are fully taxable upon withdrawal.

Which of the following statements is TRUE regarding Section 529 plans? I. Funds withdrawn for qualified education expenses are always free of federal income tax. II. Funds withdrawn for qualified education expenses are always free of state income tax. III. The maximum contribution limits are determined on a federal level. IV. The maximum contribution limits are determined on a state level.

I and IV Section 529 plan withdrawals are exempt from federal income tax if used for the right expenses. In almost all cases, if the plan is one operated by your state of residence, it will be exempt from your state's income tax. But, if you elect to contribute to a plan operated by another state, more than likely, any withdrawals will be subject to your state's income tax. Because the plans are state operated, the maximum contribution limits are set by each state.

The Investment Advisers Act of 1940 requires delivery of a brochure containing information about the adviser's background and business practices in all of the following situations EXCEPT I. when the service provided is an individual supervisory service II. when the client is an investment company III. when the contract is for an impersonal advisory service IV. requiring payment of less than $500 when the client is an individual with a net worth of more than $1 million

II and III A disclosure brochure is not required to be delivered if the client is a registered investment company, or if the advisory service is of an impersonal nature and costs less than $500. A brochure is required when the service provided is an individual supervisory service and the client's net worth has no bearing on brochure delivery requirements.

Deferred Compensation Plans (NQDC)

-Nonqualified deferred compensation plan -contractual agreement between a firm and an employee in which the employee agrees to defer receipt of current compensation in favor of a payout at retirement. The agreement underlying a deferred compensation plan usually includes the following: 1. Conditions and circumstances under which some or all of the benefits may be forfeited, such as if the employee moves to a competing firm 2. A statement to the effect that the employee is not entitled to any claim against the employer's assets until retirement, death, or disability 3. A disclaimer that the agreement may be void if the firm suffers a business failure or bankruptcy

Securities Act of 1933

-Registration of Securities (Paper Act) -Nonexempt new issues can only be sold once the prospectus is effective. Indications of interest (but no orders or money) can be accepted during the time the issue is in "in registration" (before the effective date). -Federal legislation requiring the full and fair disclosure of all material information about the issuance of new securities. Syn. Act of 1933; Full Disclosure Act; New Issues Act; Prospectus Act; Trust in Securities Act; Truth in Securities Act. (Page 601).

Agency Cross Transactions

A similar case to the situation just described is the agency cross transaction where the investment adviser acts as an agent for both sides of the trade (hence the term, agency cross transaction). In an agency cross transaction, the adviser (or IAR acting on behalf of the firm) acts as agent for both its advisory client and the party on the other side of the trade. Both state and federal law will permit an adviser to engage in these transactions provided the advisory client executes a written consent prospectively (in advance) authorizing the investment adviser to effect agency cross transactions for such clients and the adviser discloses the following: 1. The adviser will be receiving commissions from both sides of the trade. 2. There is a potential conflict of interest because of the division of loyalties to both sides. 3. On at least an annual basis, the adviser will furnish a statement or summary of the account identifying the total number of such transactions and the total amount of all remuneration from these transactions. 4. In a conspicuous manner, indicates that this arrangement may be terminated at any time. 5. No transaction is effected in which the same investment adviser or an investment adviser and any person controlling, controlled by, or under common control with that investment adviser recommended the transaction to both any seller and any purchaser. (Page 111). In an agency cross transaction, the adviser may not recommend the transaction to both parties of the trade. (Page 112).

Searching Out New Growth (SONG) is a venture capital fund. As such, all of the following statements are true EXCEPT A) SONG must have less than $150 million in assets in the fund B) SONG's investment adviser is exempt from registration C) SONG is not registered under the Investment Company Act of 1940 D) SONG only issues securities which are, except in extraordinary circumstances, non-redeemable

A. Although venture capital funds are included in the general definition of private funds, unlike the private equity fund, there is no ceiling on the size of the fund before the adviser loses the exemption. Advisers to VC funds are exempt from registration. The funds themselves do not register with the SEC under the Investment Company Act of 1940 (and don't register with the states as well). These investments do not offer ready liquidity.

A customer with an aggressive growth investment objective and short-term (6- to 12-month) time horizon wants to invest $50,000 in a mutual fund. He has a substantial net worth, but none of it is invested in mutual funds. You inform him that mutual fund investments are intended to be long-term investments, but he expresses his intention to make the short-term investment anyway. If the XYZ fund family (one you have dealt with in the past) offers an aggressive growth fund that has a respectable track record, your recommendation should be to A) buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee B) buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee C) decline the transaction because short-term trading of funds is not allowed D) buy the XYZ Aggressive Growth Class B shares with a declining CDSC and 0.75% 12b-1 fee

A. If the client insists on making this type of investment, then the Class C shares are most appropriate for this customer's objectives; the sales load would be lower than that of either Class A or Class B shares. But, you ask, we don't know what the CDSC is for the Class B shares—it isn't given. It doesn't have to be because the CDSC for redemptions in the first year would never be lower than the Class A front-end load (4% in this question and certainly higher than the 1% on the Class C shares).

Under the Uniform Securities Act, the Administrator has the power to do all of the following EXCEPT A) cite a witness in contempt for refusing to appear at a hearing B) issue a cease and desist order without a prior hearing C) investigate a complaint against a broker-dealer with no office in his state D) issue a subpoena for the production of documents

A. Only a court can cite an individual to be in contempt of court. As long as the broker-dealer is doing business in the state, the Administrator can investigate complaints against the firm. A cease and desist order may be issued with or without a prior hearing.

The Uniform Securities Act gives the Administrator the authority to do all of the following EXCEPT A) issue injunctions B) issue cease and desist orders C) conduct hearings D) examine the records of a broker-dealer, regardless of the state where those records are located

A. Only a court of competent jurisdiction has the power to issue an injunction. The Administrator may go to the court to request the injunction but cannot issue it himself. The Administrator may issue a cease and desist order with or without a prior hearing. Records, no matter where they are located, may be subpoenaed by the Administrator.

One respect in which an LLC differs from an S corporation is that A) there is no statutory limit on the number of investors in an LLC B) not only income, but losses, if generated, pass through to investors in an LLC C) there is more favorable tax treatment afforded to members of an LLC D) an LLC can be formed with as little as a single investor

A. There is no limit to the number of investors (members) in an LLC, while current regulations limit the number of investors (shareholders) in an S corporation to 100. The tax treatment is the same, and both can be formed with a single owner.

When an agent transfers employment from a broker-dealer registered with the SEC to a broker-dealer registered solely in this state A) the agent, the former broker-dealer, and the current broker-dealer must all notify the Administrator B) only the agent and the state-registered broker-dealer must notify the Administrator C) only the agent must notify the Administrator promptly D) only the agent and the SEC-registered broker-dealer must notify the Administrator promptly

A. When an agent transfers employment from any broker-dealer to any other broker-dealer, both the agent and the broker-dealers must notify the state securities Administrator.

When does a customer have to receive the OCC Options Disclosure Document? A) Before accepting the customer's first order to trade options covered by the ODD B) Within 5 business days of the first options trade C) Within 15 days of account approval by the firm's designated options supervisor D) With the confirmation of the first options transaction

A. When opening an account to trade options, the owner must be told about the risks involved with trading options. By providing the owner with an options disclosure document titled Understanding the Risks and Uses of Options, the broker-dealer satisfies the risk disclosure requirements. There are 2 alternatives for meeting the delivery requirement. It may be done before or at the time the broker-dealer approves that customer's options account or accepts the customer's first order to trade the listed options covered by the ODD.

Under modern portfolio theory (MPT), all portfolios that can be constructed from a given set of stocks is referred to as A) the feasible set B) the correlation coefficient C) the efficient set D) the capital market line

A. A feasible portfolio is defined as a portfolio that an investor can construct given the assets available. The feasible set is the collection of all feasible portfolios. Once we have the feasible set, we can select the efficient set (the most return for a given amount of risk, or the least risk for a given amount of return).

A customer who follows a strict dollar cost averaging program to acquire shares in a diversified common stock mutual fund should achieve A) lower average cost to acquire fund shares relative to the fund's average price over the buying period B) reasonable assurance against loss of principal, presuming the customer dollar cost averages over an extended period C) significant reduction of market risk due to enhanced diversification D) allocation among various funds within a single investment company's family of funds

A. By investing a constant amount of dollars at regular intervals, the investor buys fewer shares when the fund's price rises and more shares when the share price drops, thereby lowering the average cost.

As the use of social media has mushroomed, most firms in the securities business have created and maintain websites. In addition to password-protected areas for existing clients, these websites generally have pages accessible to anyone. Which of the following statements could be on an investment adviser's website that would not be on that of a broker-dealer? A) A statement that the firm is registered with the SEC under the Investment Advisers Act of 1940 B) The firm is a member of FINRA C) The content found on this website has been approved by the SEC D) A statement that the firm is registered with the SEC under the Securities Exchange Act of 1934

A. Investment advisers register with either the SEC or the state(s). Those who are registered with the SEC do so in compliance with the Investment Advisers Act of 1940. Broker-dealers cannot make that statement because they are registered with the SEC as required by the Securities Exchange Act of 1934. Neither can state that the website has been approved and FINRA membership is for broker-dealers only. Here is where a problem arises. Many of our students will be representing firms that are registered as broker-dealers and investment advisers. That is why it is so important to read the question carefully. It specifically refers to an investment adviser and makes no implication that the firm is also a broker-dealer.

DEF Investment Advisers, organized as a partnership, is currently registered with State Y. Marjorie is one of the partners and is registered as an IAR. If DEF were to register with State Z, A) Marjorie would automatically be registered as an IAR in State Z. B) Because DEF is a state-registered investment adviser, Marjorie could only register in State Z if she was a resident of the state. C) Marjorie would be required to complete an application for IAR registration with State Z. D) Marjorie's registration as an IAR in State Z would become effective after passing the Series 65 or Series 66 exam.

A. When DEF's registration becomes effective in State Z, those individuals included in the filing are granted automatic registration - they don't have to file an individual Form U4. That filing includes the names and other pertinent information about all of the partners, officers, or directors who are already acting as IARs. Please note, it is not any IAR, it is only those listed or, as the rule states, those occupying a similar status, etc., who receive this treatment.

A retired person seeking to maximize income with reasonable safety and liquidity should most likely consider investing in A) a large-cap growth fund B) an intermediate-term, high-grade corporate bond fund C) an intermediate-term government bond fund D) a long-term government bond fund

B. In all of these cases, liquidity should not be a problem because mutual funds have a 7 day redemption requirement. However, interest rate risk increases as the maturities lengthen, so the intermediate-term portfolio offers that benefit, albeit at a slight reduction in income. The high-grade corporate bonds will offer a greater return with slightly more risk than the government bonds. If the question had said the investor wished to minimize risk, then the government bond fund would have been a better selection

One of your clients just inherited some money and wishes to invest $250,000 into the GEMCO International Equity Fund. The client is attracted to the Class B shares because there is no up-front sales charge on them while the Class A shares have a 3% front-end load. The appropriate response would be that A) because of the higher 12b-1 charges levied against the Class B shares as well as the CDSC, Class A shares are recommended for a purchase of this size B) as long as the client will hold the Class B shares no longer than 4 years, the higher 12b-1 fees will be much less than the load paid on the Class A shares C) the client is doing the smart thing by avoiding the sales charge, even though you will be losing out on the opportunity to earn a nice commission D) you feel so strongly that the Class A shares represent a more attractive solution for the client that you will rebate your share of the commissions

B. In the real world, there is probably no fund group that would accept a $250,000 order for Class B shares; more than likely, no fund group would even accept one above $100,000. That is because at that level, the reduced front-end load available on the Class A shares due to reaching a breakpoint, combined with the lower (or lack of) 12b-1 charge and no redemption charge (CDSC), makes them a better deal than the Class B shares. Rebating of commissions is not permitted, and even at the 4-year holding period, there still is a CDSC.

All of the following statements are consistent with the Uniform Securities Act EXCEPT A) state Administrators may require federal covered investment companies to file documents with the Administrator using a procedure known as notice filing B) state Administrators do not require consent to service of process to be submitted with notice filings for covered securities C) any security may be registered with the state by the procedure known as registration by qualification D) a security for which a registration statement is filed under the Securities Act of 1933 may simultaneously register with the state by the procedure known as registration by coordination

B. The Administrator will require the filing of a consent to service of process with any securities registration. If required by the Administrator, notice filing is the procedure followed by federal covered securities. Any security may be registered by qualification, and coordination is the simultaneous registration with the SEC and the states.

Who safeguards the securities held in a mutual fund's portfolio? A) The manager B) The custodian C) The trustee D) The corporation

B. The Investment Company Act of 1940 requires that investment companies employ the services of a commercial bank as custodian to hold and safeguard the physical assets (cash and investment portfolio) of the fund.

Wade Kimmons purchased 200 shares of ABC common stock on March 9, 2009, paying $32 per share. Since the date of the purchase, Mr. Kimmons has received $518 in dividends. With the stock selling for $89 per share on July 27, 2016, Wade gives all 200 shares to his niece, Kendra. One week later, Kendra sells all of the ABC stock for $85 per share. The tax consequences of this are A) long-term capital gain of $11,118 B) long-term capital gain of $10,600 C) long-term capital loss of $800 D) short-term capital loss of $800

B. When securities are the subject of a gift, the donee (recipient) acquires the donor's cost basis and holding period. That means that Kendra's cost was $32 per share and the holding period was over 7 years. That is a gain of $53 per share or a total of $10,600, and it is long term. The dividends have nothing to do with the question.

Ms. Abbot has a joint account with her sister. She enters a sell order in the account and instructs that the proceeds check be made out to her only. If your firm sends the check but makes it payable to both Ms. Abbot and her sister, this is an example of A) an unfortunate error that can be reconciled with the broker-dealer through a process called reclamation B) the proper joint account procedure C) not following instructions, a prohibited practice under the Uniform Securities Act D) an unlawful practice because the transaction was unauthorized

B. In joint accounts, either party may act. However, by law, all checks must be made payable to all owners, so the firm is following required procedure.

One of your clients will be separating from his current employer and asks you for your suggestion as to what should be done with the assets in his contributory 401(k) plan. The plan documents indicate that plan assets must be distributed upon termination. Given the following choices, your recommendation would be to A) take the cash and put it into a managed account B) reconsider the decision to separate C) use a direct rollover to have the assets placed into a rollover IRA D) take the distribution in cash and rollover the assets into an IRA within 60 days

C. Most would agree that the best plan is to preserve the tax deferral as long as possible. A direct rollover into a rollover IRA is preferable to taking the cash first because there is no 20% withholding, so all the money goes to work immediately.

Who of the following is not exempt from registration as an investment adviser under the Investment Advisers Act of 1940? A) An adviser to seven private funds with total assets under management in the U.S. of $125 million B) An adviser whose only office is in State G who deals only with State G residents, none of whom is a private fund, and does not deal in securities listed on any national securities exchange C) An adviser, specializing in stocks listed on the New York Stock Exchange, whose only place of business is in State F and whose only clients are 110 State F resident individuals D) An adviser whose clientele consists solely of insurance companies

C. The intrastate exemption has no numerical limitation, only that all of the clients be residents of the state and none of the clients can be private funds. However, no advice may be given on securities traded on a national stock exchange which causes this State F adviser to lose the exemption. Under the federal law, an exemption from registration applies if the adviser's only clients are insurance companies. And, if an adviser's only clients are private funds (regardless of how many) and AUM in the United States is less than $150 million, that adviser is exempt as well.

All investing carries risk of loss. Some positions have much higher risk than others. Among the riskiest is selling stock short. Which of the following types of orders would you recommend to a short seller as a potential hedge against loss? A) Sell limit B) Buy limit C) Sell stop D) Buy stop

C. The risk to a short seller is to the upside (there is, at least theoretically, no limit as to how high the stock's price can go). Remember, a short seller is obligated to buy back the shorted stock. Therefore, we want to place an order that will enable the customer to purchase the stock before the price rises too high. That reduces the choices to the two that include the word, buy (we've already sold the stock, selling it again doesn't help). To protect against an increase to the stock's price beyond the point the investor is willing to lose, it is wise to enter a buy stop order at that price. If the stock should reach that price, the order is triggered, a market order is entered, and the short position is closed out. This is why stop orders are usually referred to as stop loss orders; they keep you from losing any more money. A buy limit order is always placed below the current market. That won't help the short seller when the price of the stock rises.

Which of the following persons is defined as an agent by the Uniform Securities Act? A) Silent partner of a broker-dealer B) Secretary of a branch office sales manager C) President of the state university who sits on the broker-dealer's board of directors D) Clerk at a broker-dealer who is authorized to take orders

D. Anyone who solicits or receives an order while representing a broker-dealer is an agent. Silent partners, administrative personnel, and certain executives of broker-dealers, such as outside directors, who have nothing to do with the sales end of the business are not agents under the terms of the USA because they do not solicit or receive orders or supervise those who do. Remember, broker-dealers are not agents; agents represent broker-dealers. If, however, any of these individuals were authorized to accept orders, or supervise those that do, registration as an agent would be required.

A federal covered investment adviser has decided that it is necessary to increase its fee schedule and charge commissions on securities trades. However, they are going to leave the fee structure in place for existing customers. This information must be A) disclosed promptly to the Administrator of the state where the IA maintains its principal office B) disclosed in the summary of material changes in the annual updating amendment to the SEC C) disclosed promptly to all customers by amending the brochure D) disclosed promptly only to those customers who will be affected by the change through an amended brochure

D. Explanation Because this will only affect new clients, the brochure (or Part 2A of the ADV) must be amended to reflect this new method of operation and made available promptly to these clients and to the SEC; it cannot be part of the end-of-year amendments. The state has no cause to receive a copy of a federal covered adviser's brochure.

While listening to a commentator on cable TV, you hear the statement "the flight to quality has ended." What would you expect the effect of this to be? A) Airline stocks are in for a beating. B) Pessimism is spreading. C) Yield spreads are widening. D) Yield spreads are narrowing.

D. The term yield spread refers to the difference in yield between very-high-quality debt instruments, such as U.S. government bonds, and those with lower ratings. The spread compensates for the additional risk. When investors perceive that the risk has lessened, they won't demand as much in return from the lower-rated instruments.

There are many different legal ways to structure a new business entity. One of these is the general partnership. Among the benefits of using this structure would be A) the 50% dividends received exclusion B) limited liability C) substantial capital can be raised with little effort and low cost D) ease of formation

D. Compared with a corporation, it is generally easier to form (and dissolve) a partnership. General partners have full liability and there is no 50% dividends received exclusion for partnerships; that only applies to corporations. C corporations are the entity for raising a lot of capital.

Among the reasons why a corporation might choose to utilize a deferred compensation plan for retirement planning would be A) compliance with ERISA B) current tax savings on money contributed to fund the plan C) the plans are nondiscriminatory D) employees who leave the company prior to retirement would not receive benefits

D. Deferred compensation plans are usually structured so that if the employee leaves prior to retirement or is terminated with cause, benefits are forfeited. These plans are discriminatory and there is no current tax saving, hence the term "deferred." As nonqualified plans, they do not have to comply with ERISA.

Defined Benefit Plan (qualified)

Defined benefit plans are designed to provide specific retirement benefits for participants, such as fixed monthly income or a specified sum at retirement (cash balance plan). Regardless of investment performance, the promised benefit is paid under the contract terms. A defined benefit plan sponsor assumes the investment risk. The benefit is usually determined by a formula that takes into account years of service and average salary for the last five years before retirement. Older, highly compensated employees are likely to have the largest annual contributions on their behalf. Because of the expenses and complexities involved (the Plan's annual return must be signed by an actuary), 3% of workers had defined benefit plans in 2011, whereas in 1979, that number was 28%. (Page 527).

Defined Contribution Plan (qualified)

Defined contribution plans include money-purchase pension plans as well as profit-sharing plans and 401(k) plans. As with other business plans (as compared to an IRA), the maximum employer contribution is currently $56,000. Defined contribution plan participants' funds accumulate until a future event, generally retirement, when the funds may be withdrawn. The ultimate account value depends on the total amount contributed, along with interest and capital gains from the plan investments. In this type of plan, the plan participant assumes the investment risk. The deduction for contributions to a defined contribution plan, such as a profit-sharing plan, (including 401(k)), or money-purchase pension plan, cannot be more than 25% of the total payroll for the year to the eligible employees participating in the plan. (Page 527).

When an Administrator issues a final order, an agent subject to the order may I. obtain a review of the order in an appropriate court of law II. request that additional evidence be presented to the court III. request a hearing 90 days after the final order IV. not appeal a court's decision

I and II An agent subject to a final order of an Administrator has the right to have the order reviewed by an appropriate court in the state. If the court finds that the circumstances warrant such action, additional evidence may be submitted by any party to the case. An agent subject to an order must file for a judicial review of the Administrator's final order within 60 days.

Which of the following statements is (are) TRUE regarding the jurisdiction of the SEC under the Securities Exchange Act of 1934? I. The SEC has jurisdiction over exchanges and SROs. II. The SEC has jurisdiction over broker-dealers, investment advisers, and associated persons that are required to be registered under federal law. III. The SEC has jurisdiction over banks and savings and loans regarding their securities activities.

I and II The SEC was created by the Securities Exchange Act of 1934 and has the responsibility of administering all federal securities laws. The SEC has jurisdiction over exchanges, SROs, and all persons required to be registered under federal law. The SEC does not enforce state securities statutes, nor does it have jurisdiction over banks or savings and loans regarding their securities activities. Banking authorities, such as the Federal Reserve Board, the Federal Deposit Insurance Corporation, and others, regulate banks and savings and loans.