Progress Exam (chapter 11 and 12)
An investor writes an uncovered DPM Oct 55 call for a premium of 9. What is the maximum profit that the investor could realize?
$900.
Which TWO of the following statements are TRUE regarding the buyers of options? 1. Buyers of calls have the right to buy stock. 2. Buyers of calls have the right to sell stock. 3. Buyers of puts have the right to buy stock. 4. Buyers of puts have the right to sell stock.
Answer is 1 and 4. Once an investor pays the option's premium, the investor receives the right or the ability to control the option. Buyers of calls have the right to buy stock at the strike price, while buyers of puts have the right to sell stock at the strike price. Sellers of options assume obligations.
A customer enters a sell stop-limit order for 100 shares at 18.50. The last round-lot sale that took place before the order was entered was 18.88. Round-lot sales that took place after the order was entered occurred at 18.25, 18.38, 18.50, and 18.63. The trade was executed at: A) 18.25 B) 18.38 C) 18.5 D18.63
answer is C. After the order was activated by the round-lot sale of 18.25, the order became a limit order to sell 100 shares at 18.50 or better. 18.50 is the first price that meets this requirement and would be the execution price.
During the first quarter, TJG common stock paid a $.75 dividend. The stock's price fell from $75 per share at the beginning of the quarter to $67.50 per share at the end of the period. Based on these results, what is the stock's annualized total return? A) 2% B) -9% C) -10% D) -36%
Answer is D. The total return for a security is found by taking the ending value minus the beginning value plus any income. In this example, the ending value of the stock was $67.50 minus the beginning value of $75.00 plus $0.75 in dividends. Dividing this sum by the beginning value of $75.00 will equal a 9% loss for the quarter. Multiplying this by four quarters will equal an annualized loss of 36%.
A futures contract is different than a cash forward contract because the futures contract is: 1. A personal transaction between the buyer and the seller 2. For a standard amount of the commodity rather than for a specific amount and quality of the cash commodity 3. Not negotiated by open outcry in the trading pits and not subject to the rules of a futures exchange 4. Or may be offset on the exchange where the contract was established
2 and 4. A futures contract is a standardized contract whose terms are set by the exchange it trades on. Buyers and sellers of futures contracts are not required to take delivery of the underlying commodity. Instead, futures positions can be offset on the exchange where the contract is established.
Which of the following items are listed on a balance sheet? 1. Assets 2. Liabilities 3. Retained earnings 4. Operating expenses
Answer is 1, 2, and 3. Assets, liabilities, and retained earnings are balance sheet items and are not represented on the income statement. Retained earnings are the funds that a company earned that it did not pay out in the form of cash dividends.
An advisory client is pessimistic and believes that the economy is about to go into a recession. He instructs his adviser to sell his holdings in housing and technology stocks and purchase utilities and consumer staples. This strategy is known as: A) Diversification B) Sector rotation C) Tax selling D) Leveraging
Answer is B. Sector rotation is a strategy often used in anticipation of changes in the business cycle. If it is believed the economy is about to slow, profitable sectors to invest in would be consumer staples, or defensive stocks.
Which of the following would be used to determine the debt-to-equity ratio? A)The income statement B) The balance sheet C) The cash flow statement D) The statement of retained earnings
Answer is B. The debt-to-equity ratio is the amount of debt issued by a company in comparison to the amount of shareholders equity. The higher the ratio, the more leveraged a company is. The ratio is calculated by taking total debt capital and dividing by equity capital, which are both found on the balance sheet
On October 25, Thomas purchased 10 listed ABC Corporation Jan 40 puts and paid a $5 premium on each put. The current market price of XYZ Corporation is $48 per share. What would the breakeven point be for Thomas per option? A) $35 B) $40 C) $45 D) $53
Answer is A. The strike price minus the premium equals the breakeven point for the buyer of a put. The breakeven point is $35 ($40 strike price - $5 premium = $35).
Which TWO of the following statements are NOT TRUE regarding the investment risk of a life insurance policy? 1. Whole life policy writers bear the risk that the general account return will not meet the guaranteed rate. 2. Whole life policy owners bear the risk that the general account return will not meet the guaranteed rate. 3. Variable life policy writers bear the risk of poor separate account returns. 4. Variable life policy owners bear the risk of poor separate account returns.
Answer is 2 and 3. Since the writer of a whole life policy guarantees the return, the insurer bears the risk that general account returns will not meet the guaranteed rate. In a variable account, the writer does not guarantee increases in death benefits and cash value. They are dependent on the returns in the separate account.
Which TWO of the following orders will be reduced when XYZ Corporation sells ex-dividend? 1. A GTC order to sell 100 XYZ at $50 2. A GTC to buy 100 XYZ at $50 stop 3. A GTC to buy 100 XYZ at $50 4. A GTC to sell 100 XYZ at $50 stop
Answer is 3 and 4. Open or good-until-cancelled (GTC) orders that are entered below the market are automatically reduced when a stock sells ex-dividend unless they are marked Do Not Reduce (DNR). Orders that are placed below the current market at the time of entry are buy limit orders, sell stop orders, and sell stop-limit orders. Open orders that are entered above the market are sell limit orders, buy stop, and buy stop-limit orders. The GTC buy limit and sell stop orders are entered below the market, and are reduced on the ex-dividend date.
When recommending a hedge fund as an investment vehicle, an adviser would disclose all of the following points to her client, EXCEPT: A) When the fund was registered with the SEC B) The name of the general partner C) The fact the fund may use leverage D) The performance fees
Answer is A. Hedge funds are exempt from registration with the SEC and there is a lack of regulatory oversight. In many cases, hedge funds can employ complex strategies like short selling, trading derivatives, and using leverage. Unlike mutual funds, the shares are not publicly traded and they often have relatively high performance fees.
As a group, limited partners may: A) Sue the general partner B) Sell assets to pay creditors C) Manage the day-to-day operations of the partnership D) Hire new employees
Answer is A. Limited partners are not permitted to be involved in management and could not sell assets to pay a creditor (a management decision). They do have the right to inspect the books, as well as sue and/or remove the general partner.
The top-down approach to investing generally includes the idea that: A) The price of a stock is based on external factors, such as the economy, not just facts about the company itself B) The management team of a company is usually a reliable gauge as to how the company will perform C) A company's position in its industry is an important predictor of future performance D) Investors should find companies with a history of profits and compare it to competitors
Answer is A. One of the factors involved in the evaluation of stocks in the top-down approach is the economic climate. All of the other choices are characteristics of a bottom-up approach.
A customer believes that a stock's price will increase in the near future. Which option position would be most appropriate? A) Buy a call B) Buy a put C) Sell a call D) Buy a put and a call
Answer is A. The customer would buy a call, which is a bullish position and would profit if the stock price rose. Buying a put and a call simultaneously is called a long straddle and it would not be appropriate for a bullish investor.
Mr. Brown is a client who must fulfill a $300,000 obligation in two years. He currently has the $300,000 and would like your advice as to how to invest these funds temporarily. Which of the following securities is most suitable? A) U.S. government securities maturing in two years B) High-grade, blue-chip equity securities C) AAA municipal bonds with a 15-year average maturity D) High-quality corporate debenture bonds maturing in two years
Answer is A. U.S. government securities are the safest investment. In two years when the securities mature, Mr. Brown is assured of having his $300,000 to fulfill his obligation. The other choices are incorrect even though they are high-quality securities. There is no guarantee that the price of these securities will be at the same level two years after they have been purchased. Since debentures are unsecured bonds, the government securities would be safer and, therefore, more appropriate.
A client is seeking a yield of 6.8%. An investment adviser has located two bonds with similar credit quality, duration, and the client s desired yield. After performing discounted cash flow analysis on each bond, the adviser has determined that Bond A is trading at a discount to its present value, while Bond B is trading at a premium to its present value. Which of the following statements is NOT TRUE? 1. Bond A is priced attractively and should be purchased. 2. Bond B is priced attractively and should be purchased. 3. The investor will earn an annual interest rate greater than 6.8% on Bond B. 4.The investor will earn an annual interest rate greater than 6.8% on Bond A. AI and III only B II and III only CII and IV only DII, lll, and IV only
Answer is B Discounted cash flow (DCF) analysis evaluates the present value of all coupon payments and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client. If a bond is trading at a discount to its present value, the investor will earn more than the interest rate that has been used to calculate the present value. Conversely, a bond that is trading at a premium to its total present value will be worth less than the price of the bond. (The investor would be overpaying for the bond.)
If the dollar is increasing against foreign currencies, which TWO of the following results would most likely occur? A) An improvement in the U.S. balance of trade B) A worsening of the U.S. balance of trade C) An increase in imports into the U.S. D) Increased exports by the U.S.
Answer is B and C. If the U.S. dollar is rising against foreign currencies, U.S. goods will be more expensive to foreigners. This should lead to decreased U.S. exports and increased imports into the U.S. These events would worsen the U.S. balance of trade.
Patrick invests in a diversified portfolio of income-producing equity investments. Patrick is investing to achieve the goal of early retirement. He takes all of his dividend income and uses it to pay bills. What is the main problem with this type of strategy? A) By spending the dividends, Patrick incurs a current tax liability each year. B) Patrick does not take advantage of compounding (reinvestment of dividends) to increase earnings. C) Bills should always be paid from earnings, not investment income. D) Patrick should definitely balance his portfolio with some mutual fund investments.
Answer is B. By choosing to use his dividend income to pay bills, Patrick loses the opportunity to earn interest on his interest (compounding) and, therefore, loses a powerful tool in achieving his long-term goal of early retirement. Patrick's dividends are currently taxable as ordinary income, regardless of whether he reinvests or not.
Which of the following option strategies is the BEST hedging strategy if a client is short 1,000 shares of common stock? A) Sell puts short B) Buy calls C) Sell calls D) Buy puts
Answer is B. If the investor wants to hedge against upside moves in a stock, he should buy call options. Purchasing call options is an efficient hedging strategy because the investor is limiting his potential losses. Buying puts is considered a bearish strategy and would be ineffective as a hedge. Selling or shorting options is an income strategy and only provides limited protection to the extent of the premium received.
Which of the following statements is TRUE of variable annuities? A) The investment risk is borne by the insurance company. B) The product must be sold with a prospectus. C) Withdrawals are first treated as tax-free return of principal. D) If the contract owner dies, the beneficiary receives any proceeds tax-free.
Answer is B. Variable annuities must be sold with a prospectus because they are securities. Although partial surrenders of variable life insurance policies are first treated as a return of principal up to the amount of basis, variable annuities are subject to interest-first taxation. Only life insurance proceeds pass to beneficiaries tax-free. Beneficiaries of variable annuity contracts are taxed on the proceeds in the same manner as the annuitant.
Which of the following choices is NOT a characteristic of equity-indexed annuities? A) guaranteed minimum rate of return B) A rate of return that varies along with the underlying index C) A rate of return that is determined by the subaccounts that the contract owner selects D) A return that is less than that of the underlying index
Answer is C. In an equity-indexed annuity, the insurance company guarantees the contract owner a minimum rate of return. The insurance company usually guarantees that the investor will receive most of her premium payments back plus a fixed return based on current interest rates. The investor's ultimate returns may be higher than the minimum guaranteed rate depending on the performance of the index to which the contract is linked; however, it will always be lower than the return on the index.
Investors often use financial futures to hedge portfolios against which of the following types of risk? A) Business risk B) Political risk C) Event risk D) Market risk
Answer is D. Buyers and sellers of financial futures are often trying to hedge portfolios against interest-rate risk, exchange-rate risk (also called currency risk), and market risk. Business risk is the possibility that certain circumstances will affect the profitability of a company. Political risk is usually high in emerging markets and is the risk of losing money due to changes is a foreign country's government or regulatory environment. Financial futures cannot protect against these types of risks.
An investment adviser representative manages a portfolio for a client on a discretionary basis. The client's objective is conservative growth. According to prudent investor standards, which of the following statements is TRUE regarding the inclusion of options in his portfolio? A) Options, although generally not appropriate in a conservative portfolio, would be permitted with the prior written consent of the client. B) Options would be appropriate only if the investor has had previous experience investing in options. C) Options strategies may be appropriate as part of a conservative portfolio. D) Options strategies may be appropriate for conservative portfolios, provided the strategy does not include the purchase of uncovered options.
Answer is c. Prudent investor standards are applied to the client's total portfolio, not on an investment-by-investment basis. Rather than restricting individual investments, anything might be appropriate as part of a portfolio if the investment helps the portfolio achieve specific objectives. For example, writing covered calls or buying protective puts could be part of a conservative growth portfolio. There are no purchases of uncovered options. An uncovered position is the sale of an option without an underlying position in a stock.