SecuritiesPro: Part 3 (Investment Vehicle Characteristics)
An investor purchases a single premium deferred index annuity with a 6% bonus feature. The premium was $100,000. The annuity has an 80% participation rate with a 10% cap. If the underlying index increased by 15%, the account's value at the end of the year would be closest to A) $116,600. B) $118,720. C) $116,000. D) $110,000.
A) $116,600. The 6% bonus means that the client's initial payment is increased by 6%. That means the account shows a starting balance of $106,000. Although the index increased by 15% and the participation rate of 80% would be a 12% growth rate, the cap of 10% comes into play. That makes the calculation: $106,000 x 110% or $116,600.
Which of the following are features of Class C mutual fund shares? I. Typically charge no front-end load II. Typically charge a front-end load III. Typically impose lower CDSCs than Class B shares for a shorter period IV. Typically convert to Class A shares after they are held for a defined period A) I and III B) II and III C) II and IV D) I and IV
A) I and III Class C shares generally have the following features: no front-end sales charge, lower CDSCs than Class B shares for a shorter period, and no conversion to Class A shares regardless of how long they are held. Because of these features, Class C shares may be less expensive for investors with shorter investment horizons. They may be more expensive for investors who plan to hold their shares for a long time, because the level load never discontinues.
Specified in an exchange-traded futures contract would be I. the quantity of the underlying asset II. the quality of the underlying asset III. the time of delivery of the underlying asset IV. the location of delivery of the underlying asset A) I, II, III, and IV B) I, II, and III only C) II and IV only D) I and III only
A) I, II, III, and IV Typically, there are 5 standardized parts to an exchange-traded futures contract: - Quantity of the commodity (e.g., 5,000 bushels of corn or 100 oz. of gold) - Quality of the commodity (specific grade or range of grades may be acceptable for delivery, including price adjustments for different deliverable grades) - Delivery price (similar to exercise or strike price with options) - Time for delivery (e.g., December wheat to be delivered) - Location (approved for delivery)
If a customer's portfolio is heavily invested in common stock mutual funds, what is the customer's greatest risk? A) Loss of principal B) Loss of liquidity C) Loss of diversification D) Changes in interest rates
A) Loss of principal A mutual fund with a portfolio of common stock is subject to market risk. If the market falls, the value of the fund's shares also fall, subjecting the owner to loss of principal.
In a scheduled premium variable life insurance policy, the insured is guaranteed A) minimum guaranteed death benefit. B) nothing. C) cash value. D) positive return.
A) minimum guaranteed death benefit. The only real guarantee in a variable life policy is that the minimum death benefit will be the face amount of a scheduled (fixed) premium policy. Of course, any loans must be taken out first, but they are taken from that guaranteed amount. Cash value and a positive return depends on the performance of the separate account.
Which of the following is NOT a characteristic of a real estate investment trust (REIT)? A) Relatively low marketability B) Shares are traded on exchanges much like the stocks of other companies C) Potential dividends from investment income or capital gains distributions D) Pooling of capital to purchase properties or mortgage loans
A) Relatively low marketability A real estate investment trust (REIT) is a company that pools its capital to purchase properties and/or mortgage loans. Investors buy REIT shares and, in turn, receive dividends from investment income or capital gains distributions. REIT shares are traded on exchanges much like the stocks of other companies. This provides relatively high marketability, especially compared with most other types of real estate investments. Please note: We recognize that, over the past few years, there has been an enormous growth in non-traded REITs (exactly what that says—they don't trade; there is limited or no liquidity). However, we have received no feedback about that issue and, unless something in the question refers to a non-traded REIT, assume that all REITs are publicly traded either on the stock exchanges or OTC.
A manager of a venture capital fund would be most interested in investing in A) a young, promising company. B) a well-established company going through management changes. C) a company listed on a major stock exchange. D) a company interested in going private.
A) a young, promising company. Venture capitalists prefer to get involved in the earlier stages of a company's development. This would certainly not be a company listed nor would it be likely that the company is already publicly traded.
A sector fund is one where the assets are A) concentrated in a particular industry or geographical area B) invested in other mutual funds C) invested in special situations D) invested in emerging growth companies
A) concentrated in a particular industry or geographical area Sector funds (specialized funds) target at least 25% of their investments toward a specific industry or geographical location.
Compared to a publicly-traded fund, a private equity fund is most likely to A) disclose less information about its financial performance. B) provide more details regarding its financial performance. C) exhibit stronger corporate governance. D) be more concerned with short-term results.
A) disclose less information about its financial performance. Private equity funds are not held to the same financial reporting requirements as publicly-traded funds. Less public scrutiny and limited financial disclosure may lead to weaker corporate governance. Private equity funds generally need several years before the fruits of their labor are ready to be harvested.
Surrender charges may cause a reduction to all of the following EXCEPT A) the death benefit of a variable life insurance policy B) the liquidation value of a variable annuity C) the redemption value of Class B mutual fund shares D) the cash value of a variable life insurance policy
A) the death benefit of a variable life insurance policy Surrender charges never apply in the case of a death benefit. There may be a surrender charge in the case of early surrender of a variable annuity, taking out the cash value of a variable life policy, or redemption of Class B (back-end load) mutual fund shares.
You have a client who sold her $5 million whole life insurance policy through a life settlement broker. If she dies 2 years later, A) the new owner receives the $5 million death benefit. B) the insurance company is not obligated to pay the death benefit because she no longer owns the policy. C) the insurance broker must return all commissions to the insurance company. D) her estate can invoke the right of rescission and receive the policy proceeds minus the sale proceeds.
A) the new owner receives the $5 million death benefit. A life settlement contract involves the sale of a life insurance policy to a party other than the insured. In exchange for the payment, the new owner is entitled to the death benefit when the seller passes away. The right of rescission applies to illegal securities sales and this is not a security nor has any illegal activity been described.
An investor buys 5 put contracts with a strike price of $55 per share. The current price of the underlying stock is $60 and the option premium is $7. The commission schedule is shown as follows: Trade Amount Commission Rate ≤ $2,500 $35 + 0.9% of trade amount $2,501 to $11,999 $35 + 0.7% of trade amount ≥ $12,000 $35 + 0.5% of trade amount Using the information above, what is the total commission cost based for this trade? A) $39.90 B) $59.50 C) $297.50 D) $199.50
B) $59.50 The cost per contract is $7 x 100 shares, or $700. That makes the total trade amount $700 x 5 contracts, or $3,500, which qualifies for the commission rate of $35 + 0.7% of the trade amount. $35 + 0.7% of $3,500 = $35 + $24.50 = $59.50 total charge.
The Wall Street pundits are predicting a substantial increase in interest rates. If they are correct, which of the following bonds would be most sensitive to that increase? A) 5s of 2040 B) 5s of 2045 C) 5s of 2035 D) 4s of 2020
B) 5s of 2045 The bond with the longest duration will have the greatest sensitivity to change in interest rates. We examine two factors: the coupon rate and the length to maturity. When the coupon rates are the same, as they are for three of these bonds, the one with the maturity date farthest into the future will have the longest duration. Even though the 4% coupon is lower than the others, the maturity date is so much closer making it have the shortest duration (least sensitivity to change) of this group
An investor has been following the price movements of ABC common stock and believes that the stock is positioned for a significant upward move in the very near term. If the investor's goal is capital gains, which of the following would be the most appropriate position for this investor to take? A) Sell ABC call options B) Buy ABC call options C) Sell ABC put options D) Buy ABC put options
B) Buy ABC call options When an investor is expecting the price of a security to rise, we say that investor has a bullish outlook. Bulls buy call options, especially when the expected market move is anticipated shortly. Put options are purchased by investors who are of the belief that a stock's price will decline in the near term. Selling options is done for income (the premium), not for capital gains.
Which of the following is not a characteristic of American depositary receipts (ADRs)? A) Because ADRs are traded on the exchanges, they are relatively liquid and marketable investments. B) Dividends are declared in the foreign currency, so exchange rate, or currency, risk is completely eliminated. C) ADRs are denominated and pay dividends in U.S. dollars, not foreign currencies, thus saving the investor transaction costs with respect to converting currencies. D) ADR holders may surrender ADRs in exchange for receiving the shares of the non-U.S. company.
B) Dividends are declared in the foreign currency, so exchange rate, or currency, risk is completely eliminated. ADRs are receipts issued by a U.S. bank for shares of a foreign company purchased and held by a foreign branch of the bank. Dividends are declared in the local currency, so exchange rate, or currency, risk is not completely eliminated. They are generally traded on one of the major exchanges ensuring liquidity. They are an alternative to investing directly in foreign companies or foreign mutual funds. If the investor desires the foreign shares, the ADR may be surrendered and the exchange made.
The offering document for a fund states that the minimum initial investment is $500,000. This is most likely what type of fund? A) Small-cap growth B) Hedge C) Specialized D) Balanced
B) Hedge Hedge funds, due to their much higher risk, usually limit their investors to those who can afford to take that higher risk by having very high minimums. Do not be surprised if you see a test question referring to the hedge fund offering document as a prospectus. That is an acceptable term even though we tend to think of a prospectus referring to a registered issue (and hedge funds do not register with the SEC or the state).
Which of the following statements regarding REITs are NOT true? I. Investors receive flow-through benefits of income as well as loss. II. Hybrid REITs own properties, as well as make loans on others. III. Equity REITs are prohibited from using leverage to acquire properties. IV. REITs are easily traded in the secondary market. A) I and IV B) I and III C) II and IV D) II and III
B) I and III It is not true that REITs offer flow-through of losses; they are not DPPs. As with most real estate purchasers, leverage, usually in the form of a mortgage, is used to acquire property. A hybrid REIT contains the features of both an equity REIT and a mortgage (debt) REIT, and most REITs trade on the exchanges or Nasdaq. Note: Even though there has been an increase in the number of non-traded REITS, unless something in the question indicates that, the question will be dealing with publicly traded REITS.
Which of the following must be considered in evaluating the suitability of a DPP investment for a customer? I. Risk tolerance II. Other holdings III. Financial situation IV. Age A) I and II B) I, II, III, and IV C) I and IV D) II and III
B) I, II, III, and IV The key here is to recognize that with DPPs, the customer's age is a relevant consideration in determining suitability. DPPs are long-term, illiquid, and high-risk investments. It is unlikely that DPPs would be suitable for a customer near retirement age, regardless of the customer's financial situation.
Which of the following statements regarding a mutual fund that offers class A, B, and C shares are TRUE? I. Class A shares have a front-end sales charge and a low 12b-1 fee. II. Class B shares have a declining contingent-deferred sales charge and a high 12b-1 fee. III. Class C shares have a high 12b-1 fee and a level contingent-deferred sales charge. IV. Class B and C shares allow investors to put the shares back to the fund for their original purchase price for up to 1 year after purchase. A) I, II, III, and IV B) I, II, and III C) I only D) I and II
B) I, II, and III There is no put provision that guarantees the return of an investor's purchase price associated with mutual fund shares.
A money market mutual fund would be least likely to invest in which of the following assets? A) Newly issued U.S. Treasury bills B) Newly issued U.S. Treasury notes C) Repurchase agreements D) Jumbo CDs
B) Newly issued U.S. Treasury notes A money market mutual fund typically invests in money market instruments, those with a maturity date not exceeding 397 days. Treasury notes are issued with maturity dates of 2-10 years.
Which of the following statements is NOT true? A) The sale of open-end investment company shares is a continuous public offering and must be accompanied by a prospectus. B) Open-end investment companies must have a minimum of $1 million in assets to have a public offering. C) Mutual funds may be used as collateral in a margin account if they have been owned for more than 30 days. D) Mutual fund shares may not be purchased on margin because their shares are always public offerings of new shares.
B) Open-end investment companies must have a minimum of $1 million in assets to have a public offering. Minimum assets of $100,000 are required.
What happens to outstanding fixed-income securities when interest rates decline? A) No change B) Prices increase C) Coupon rates increase D) Yields increase
B) Prices increase When interest rates drop, prices will rise, decreasing effective yield. Thus, there is an inverse relationship between interest rates and bond prices.
A TIPS bond with a par value of $1,000 has a coupon rate of 4%. During years 1 and 2, the inflation rate has been 6%. What effect will this have on the TIPS 2½ years later? A) The next interest payment will be $20.00. B) The next interest payment will be $23.19. C) The next interest payment will be $46.37. D) The principal value will be $1,080.
B) The next interest payment will be $23.19. On a semiannual basis, the principal value of a TIPS is increased by that year's inflation rate. A TIPS bond adjusts principal every 6 months based on the inflation rate. With an annual inflation rate of 6%, each 6 months the principal will increase by 3% compounded. Because the question is asking about 2½ years later, there will be 5 periods (2 each year plus the first half of the 3rd year). Using the calculator at the testing center, you would enter the $1,000 initial par value and then multiply that times 103% five times to arrive at $1,159.27. Then, multiply that times the semiannual coupon rate (2%) and the result is $23.19. In almost every case, the "shortcut" will work. That is, if it was not a TIPS bond, then the interest would simply be 2% of $1,000, or $20. That will always be one of the choices—you look for the one that is a bit higher.
Which of the following best describes the death benefit provision of a variable annuity? A) If death should occur before age 59½, the 10% early withdrawal penalty does not apply. B) The principal amount at death is the greater of the total of premium payments or the current market value. C) Upon death, the proceeds pass to the beneficiary free of federal income tax. D) Upon death, the beneficiary will receive the benefit as a lump sum.
B) The principal amount at death is the greater of the total of premium payments or the current market value. The death benefit insures that the investor will never receive back less than the original amount contributed to the account. Unlike life insurance proceeds, with annuities, anything above the cost basis is taxed as ordinary income. Receiving the benefit as a lump sum is only one of the options available to a beneficiary of a variable annuity death benefit. There are others, such as annuitizing the benefit.
An individual purchases a $10,000 CD with a 5-year maturity from her local bank branch. In doing so, she is eliminating A) opportunity cost. B) interest rate risk. C) inflation risk. D) purchasing power risk.
B) interest rate risk. Interest rate risk is the uncertainty that changes to market interest rates will cause the price of an investment to fluctuate in value. Because this type of bank CD is nonnegotiable (it doesn't trade), changes to interest rates do not impact the principal value of the investment - she can always redeem the CD for $10,000 (although there could be a penalty for early withdrawal). As a fixed-income investment, though, it does suffer from purchasing power risk, also known as inflation risk, and the investor has the opportunity cost of settling for a lower rate of return than could potentially be obtained with equities.
A life insurance policy where the premium increases each time the policy is renewed while the face amount remains level is A) decreasing term B) renewable level term C) increasing term D) variable universal
B) renewable level term Level term insurance offers a fixed face amount over the life of the policy. If the policy is renewable, the owner has the ability to renew it for that same face amount and the new term, but at new, higher premiums as the insured's age increases.
The portfolio manager of a bond fund believes that interest rates are going to increase in the near future. As such, it would be wise for that manager to A) shift into higher-rated bonds. B) shorten the average duration of the portfolio. C) lengthen the average duration of the portfolio. D) increase the equity portion of the portfolio.
B) shorten the average duration of the portfolio. Increasing interest rates lead to declining bond prices, regardless of the ratings. This is interest rate risk. Those bonds with the longest duration have the most sensitivity to that risk, while short-term maturities are only slightly affected. Reducing the average duration of the portfolio means that the average maturities will be shortened, thus reducing the effects of an increase to interest rates.
When referring to municipal bonds, the formula of (1 − tax bracket) is found in the computation of A) yield to maturity B) tax-equivalent yield C) return on investment D) current yield
B) tax-equivalent yield The computation for the tax-equivalent yield of a municipal bond is performed by dividing the bond's coupon rate by (1 − the investor's tax bracket). If the bond has a coupon of 4% and the investor is in the 20% bracket, the tax-equivalent yield is 4% divided by (1 − 0.20) or 4% divided by 0.80 = 5%
A corporation issued a bond with a coupon of 6%, callable at 103. The bond matures in 2059. Current interest rates are 8%. It is most likely that A) the bond will be called. B) the bond is selling at a discount. C) the coupon will be increased. D) the bond will go into default.
B) the bond is selling at a discount. There is excess information in this question (a favorite trick of the test authors). We don't need to know the call price or the maturity date. Simple, we have a 6% bond when current market interest rates are 8%. The inverse relationship between interest rates and bond prices teaches us that this bond is going to be selling at a discount. Bonds are called when interest rates go down, not rise. The coupon on a bond is fixed.
All of the following are features of limited partnership direct participation programs except A) the limited partners have limited liability. B) the limited partners may participate in the management of the partnership. C) the general partner determines when distributions are made to the limited partners. D) the general partner controls the business activities of the partnership.
B) the limited partners may participate in the management of the partnership. Should a limited partner assume a management role, there is the danger that the limited liability protection would be lost and that partner would now have the same unlimited liability of a general partner. It is the general partner who manages the program; the limited partner is a passive investor.
Disregarding any potential redemption or CDSC fees, an investor tendering shares of an open-end investment company for redemption will receive A) the next computed net asset value plus a portion of the sales load B) the next computed net asset value C) the last computed net asset value D) the next computed public offering price
B) the next computed net asset value When an investor redeems (or purchases) open-end investment company shares, the investor receives the next computed net asset value (NAV) of those shares. This is known as the forward pricing rule.
One of the rights of being a stockholder is the ability to vote on important corporate matters, such as the election of members to the board of directors. The date that determines which shareholders are eligible to votes is A) the last day of the company's fiscal year. B) the record date. C) the election date. D) the ex-dividend date.
B) the record date. The record date is a date announced by the company as the official date you must be an owner on the company's records in order to participate in the annual meeting and corporate election. A fact not tested is there is no standard regarding how far in advance of the voting date this should be other than it must be at least the normal settlement period, currently 2 business days.
Shareholders of mutual funds have all of the following rights EXCEPT: A) voting proxies B) the right to vote on the selection of specific securities for the portfolio C) voting rights D) receiving semiannual reports
B) the right to vote on the selection of specific securities for the portfolio Shareholders of mutual funds have all of the rights mentioned except the right to vote on the selection of specific securities for the portfolio. Those decisions are made by the fund's investment adviser.
BFJ Corp's 5% convertible bond is trading at 120. The bond is convertible at $50. An investor buying the bond now and immediately converting into common stock, would receive A) 24 shares B) 2.4 shares C) 20 shares D) 20 shares plus cash for fractional shares
C) 20 shares The conversion ratio always uses the par value ($1,000), never the current market price. With a par value of $1,000 and a conversion price of $50 per share, this bond is convertible into 20 shares ($1,000 / $50). Remember, the number of shares in a conversion never changes. When the market price changes, the parity price changes, but that isn't relevant to this question.
If interest rates were to decline sharply, which of the following securities is likely to appreciate the most? A) 20-year mortgage-backed security currently trading at a small discount B) 20-year municipal bond currently trading at par C) 20-year zero-coupon Treasury bond currently trading at a deep discount D) 20-year corporate bond currently trading at a small premium
C) 20-year zero-coupon Treasury bond currently trading at a deep discount As a rule, the longer the duration, the greater the price appreciation. In this case, all the fixed-income securities have 20-year maturities. Another general rule is that the lower the coupon on the bond, the longer the duration. The zero-coupon bond has the lowest coupon and would likely appreciate the most.
A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of A) 7.80% B) 5.00% C) 5.56% D) 7.40%
C) 5.56% Current yield is determined by dividing the annual interest payment by the current market price of the bond ($50 ÷ $900 = 5.56%). Years to maturity is not a factor in calculating current yield.
An investor invests $25,000 into the KAPCO Balanced fund. It would be unlikely for this investor to be required to pay a CDSC when redeeming A) any shares, regardless of Class B) Class B shares C) Class A shares D) Class C shares
C) Class A shares Class B shares are known for their back-end load. Class C shares usually only have one for 1 year; but, if the investor redeems within that period, there will be a CDSC. Class A shares do not carry a back-end load, except under conditions that are beyond the scope of this exam.
Why would you suggest a client invest in international mutual funds or ETFs? I. Diversification II. Tax benefits III. Avoids having to pick individual stocks IV. Greater regulatory controls A) I, II, III, and IV B) II and III C) I and III D) I and IV
C) I and III An international mutual fund (or ETF) invests in the securities of companies that are not domiciled in the United States. Therefore, we have the benefit of added diversification. These pooled investment vehicles offer investors the specific benefit (whether foreign or domestic) of not having to worry about individual stock selection—the professional managers do that. There are no specific tax benefits to investing through the fund rather than directly and, in most cases, the regulatory controls in other countries do not offer the same degree of investor protection as those of the United States.
Which of the following is TRUE of GNMA securities? I. Interest is subject to federal income tax. II. Interest is exempt from federal income tax. III. They are backed by farm mortgages. IV. They are backed by residential mortgages. A) I and III B) II and IV C) I and IV D) II and III
C) I and IV Income received by investors in Government National Mortgage Association (GNMA) securities is subject to both state and federal income tax, and the asset backing them is residential mortgages.
Which of the following activities would have an effect on the NAV of a mutual fund? I. The sale of securities from the portfolio II. Automatic reinvestment of dividends by the shareholders III. Market appreciation of portfolio securities IV. Market decline in the value of portfolio securities A) I and II B) I, III, and IV C) III and IV D) I, II, III, and IV
C) III and IV The formula to determine NAV is: assets minus liabilities divided by shares outstanding. The sale of securities from the portfolio will replace the asset (securities) with an equal value of the asset (cash) and will have no effect on the NAV. The reinvestment of dividends will also not affect the NAV, because the shares going out are offset equally by the cash coming in. Market appreciation or decline will, however, affect the NAV because asset value will either increase or decrease, but liabilities and shares outstanding will remain unchanged.
Which of the following bonds has the shortest duration? A bond with A) a 10-year maturity, 6% coupon rate. B) a 20-year maturity, 6% coupon rate. C) a 10-year maturity, 10% coupon rate. D) a 20-year maturity, 10% coupon rate.
C) a 10-year maturity, 10% coupon rate. Two factors go into the computation of a bond's duration - the length to maturity and the coupon rate. When the maturities are the same, the bond with the highest coupon has the shortest duration. When the coupons are the same, the bond with the nearest maturity has the shortest duration. The 10% bond maturing in 10 years "wins" on both counts. It has the nearest maturity with the highest coupon. All else being equal, a bond with a longer duration will be more sensitive to changes in interest rates.
An individual seeking capital and possible guidance with a start-up would most likely seek funding from A) a hedge fund. B) a unit investment trust. C) a venture capital fund. D) an open-end investment company.
C) a venture capital fund. A venture capital fund, typically organized as a limited partnership, seeks out opportunities to get in on the ground floor. In additional to an ownership position, usually at least 10%, the venture capitalists provide managerial input. Because these start-ups are rarely publicly traded, they are of little interest to the other investment company choices.
Among the reasons to consider investing in a variable annuity would be all of the following EXCEPT A) a guaranteed death benefit for death before annuitization B) avoiding probate upon the death of the investor C) capital gains treatment on any realized gains upon withdrawal D) basically, no limit on the amount that can be contributed
C) capital gains treatment on any realized gains upon withdrawal In return for granting tax deferral on all gains in the account, the IRS taxes everything over the investor's cost basis as ordinary income. There is never a capital gain with a variable annuity. Some insurance companies will place a limit on the amount that may be invested, especially for older clients, but unlike IRS rules on retirement plans, this is strictly a company-by-company decision, not a law. Variable annuities are generally sold with a death benefit provision guaranteeing that the beneficiary will receive the higher of the amount invested or the current value of the account. Because there is a specifically named beneficiary, annuities do not go through the probate process.
When discussing the differences between purchasing a mutual fund and a hedge fund, the investor should be aware that A) hedge funds only offer Class A shares, while mutual funds offer many different classes. B) managers of hedge funds are generally registered with the SEC while mutual fund managers are registered with the state(s). C) hedge funds do not offer the transparency of mutual funds. D) hedge fund shares are generally listed on an exchange while mutual fund shares are not.
C) hedge funds do not offer the transparency of mutual funds. Because hedge funds are not registered with the SEC (or the states), there are limited disclosures—the transparency is not nearly what investors have with mutual funds. Mutual fund investment managers always register with the SEC, and the same is true of must hedge fund managers, typically those with AUM of at least $150 million. Neither hedge funds nor mutual funds trade on listed exchanges and hedge funds do not have traditional share classes; they may offer a choice of different currencies, but that is totally different from the share classes of mutual funds.
A 68-year-old individual, who purchased a single premium immediate fixed annuity, elected monthly payments for life with a 10-year certain settlement option. If the individual lives to the age of 80, A) monthly payments will cease at age 78. B) monthly payments will remain fixed until age 78 and then reduce until death. C) monthly payments will continue until death. D) monthly payments will continue to the beneficiary(s) for 10 years after the annuitant's death.
C) monthly payments will continue until death. When choosing the settlement option, life with 10 years certain, the annuitant will receive payments until the later of death or 10 years.
An investor purchases a 30-year zero-coupon corporate bond. The bond was issued by a Fortune 500 company. Her investment is subject to all of the following risks except A) default risk. B) purchasing power risk. C) reinvestment risk. D) interest rate risk.
C) reinvestment risk. Zero-coupon bonds are not subject to reinvestment risk because there is nothing to reinvest. However, they are subject to purchasing power, interest rate, and default risk.
Money market instruments are: A) long-term debt B) intermediate debt C) short-term debt D) long-term equity
C) short-term debt Money market instruments are high-quality debt securities with maturities that do not exceed 1 year.
The dollar amount of purchase at which sales charges are reduced in the purchase of open-end investment company shares is known as A) the load point B) the leverage point C) the breakpoint D) the basis point
C) the breakpoint Large purchases of investment company shares receive reduced sales charges at given minimums of investment. These are known as breakpoints.
Net asset value per share for a mutual fund can be expected to decrease if A) the fund has experienced net redemptions of shares B) the securities in the portfolio have appreciated in value C) the fund has made dividend distributions to shareholders D) the issuers of securities in the portfolio have made dividend distributions
C) the fund has made dividend distributions to shareholders If dividends are distributed to shareholders, the fund's assets will decrease and value per share will fall accordingly. Appreciation of the portfolio and dividends paid to the portfolio will increase the value. If issuers have made distributions to the portfolio, the net asset value will increase. Net redemptions have no effect on the net asset value, because the money paid out is offset by a reduced number of shares outstanding.
An option that may be exercised before its expiration date is said to be A) Premature style B) Flexible style C) European style D) American style
D) American style There are two forms of option exercise—American and European. American style can be operationally exercised any day that the market is open before the expiration date. With European style, the only time you can operationally exercise your contract is the last trading day before expiration. Remember, even though there is only one day in which you can exercise your contract, you can always close out your option position in the secondary market any day prior to expiration.
The Straitened Corporation has filed for bankruptcy. One of your clients held a mortgage secured by the corporation's building. When the building was sold, the proceeds were less than the mortgage balance creating a deficiency balance. Where does this investor's claim stand? A) There is no further claim once the building has been sold B) After the unsecured creditors C) After the secured creditors D) As a general creditor on a pro rata basis
D) As a general creditor on a pro rata basis Secured creditors, such as those holding mortgage bonds, always have priority in a liquidation. If it happens, as in this question, that the asset(s) securing the debt are insufficient to satisfy the claim, the balance is considered to be an unsecured debt. In that case, those bondholders are considered general creditors and share in any remaining assets proportionate to the amount of the deficiency. The Latin legal term for this is pari passu, but we don't expect you'd see that on the exam.
An individual wishing to invest $15,000 into a mutual fund with the intent of having it remain invested for at least 15 years should probably purchase A) Class C shares with a 12b-1 fee of .75% and a CDSC of 1% during the first year. B) Class I shares with no load, no 12b-1 fee, and no CDSC. C) Class A shares with a 5.5% front-end load and a 12b-1 fee of .25%. D) Class B shares with a 12b-1 fee of .75% and a 6-year declining CDSC after which they convert to Class A shares.
D) Class B shares with a 12b-1 fee of .75% and a 6-year declining CDSC after which they convert to Class A shares. There are several keys to answering this question. First is recognizing this is an individual investor. Although Class I shares generally offer the best deal, that share class is sold only to institutional investors. Next, we see that the size of the investment is $15,000. That is too small to reach any significant breakpoint. Finally, the client intends to hold the investment for at least 15 years so the CDSC attached to the Class B shares becomes irrelevant. Because the Class B shares are sold without a front-end load, all of the investor's money goes to work. True, the 12b-1 charge is .50% higher than with the Class A shares, but that only lasts for the 6-year period until the B shares convert to A shares. That is a 3% difference over the 6 years, barely over half as much as the 5.5% front-end load. The Class C shares have no front-end load and the CDSC is unimportant here because it disappears after 1 year, but the 12b-1 fee never ends and, over a 15-year or longer period, that can remove the advantage the lack of a front-end load has to offer.
Which of the following types of mutual funds would be most likely to have capital appreciation as its stated objective? A) Income B) Balanced C) Municipal bond D) Growth
D) Growth As the name implies, a growth fund looks for growth of capital (capital appreciation). Income funds are looking for income, municipal bond funds for tax-free income, and balanced funds for both income and growth with minimal risk to capital.
Which of the following statements about the redemption of mutual fund shares are TRUE? I. A mutual fund may, but is not required to, redeem its shares if requested by a shareholder. II. A mutual fund will redeem fractional shares as well as full shares. III. Redemptions of mutual fund shares are handled under forward pricing. A) I and II B) I and III C) I, II, and III D) II and III
D) II and III A mutual fund is required by law to redeem (buy back) its shares on the request of a shareholder, and a mutual fund will redeem fractional shares, as well as full shares. Redemptions are handled under what is known as forward pricing, which means that the redemption price will be the next net asset value per share calculated after the mutual fund receives the request for redemption.
In discussing a direct participation program with your customer, rank the following items in order of importance from most to least. I. Tax write-offs II. Liquidity and marketability III. Potential for economic gain A) I, II, III B) III, II, I C) II, III, I D) III, I, II
D) III, I, II A program's economic viability is the first priority in the assessment of DPPs. The IRS considers programs designed solely to generate tax benefits abusive. Because there is a very limited secondary market for DPPs, liquidity and marketability should be a low priority.
Which of the following would be common features of mutual funds and hedge funds? A) Registration with the SEC B) Redemption of ownership interests within 7 days C) Portfolio transparency D) Investors have pooled their money together
D) Investors have pooled their money together Both of these are in the category of pooled investment vehicles. Only the mutual fund is registered with the SEC and that means full disclosure, including portfolio holdings. No such disclosure is required of hedge funds. The mutual fund offers the 7-day redemption - no such policy exists with hedge funds. In fact, most have a lock-up period where redemption cannot take place.
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 remained unchanged. C) This cannot be determined from the information presented. D) Their market price has increased.
D) Their market price has increased. Because inflation is down and bond yields have declined, the bonds are selling for a premium due to an increase in value.
Which of the following statements regarding warrants is TRUE? A) Warrants' terms are generally shorter than rights' terms. B) Warrants are safer than corporate bonds. C) Warrants give the holder a perpetual interest in the issuer's stock. D) Warrants are often issued with other securities to make the offering more attractive.
D) Warrants are often issued with other securities to make the offering more attractive. Warrants are generally issued with bond offerings to make the bonds more attractive. Warrants are long-term options to buy stock, and because they are equity securities, warrants, as investments, are considered less safe than bonds.
As defined in the Securities Exchange Act of 1934, the term municipal security would include all of the following EXCEPT A) a New Jersey Turnpike revenue bond B) a city of Atlanta, GA public library bond C) a State of Texas general obligation bond D) an Illinois Tool Company debt issue backed by its full faith and credit
D) an Illinois Tool Company debt issue backed by its full faith and credit The Illinois Tool Company is a corporation, even though it has a state in its name. Under federal law, municipal bonds are those issued by any domestic political body or subdivision from the state level on down.
An investor will likely exercise a put option when the price of the stock is A) above the strike price. B) at the strike price. C) above the strike price plus the premium. D) below the strike price.
D) below the strike price. First of all, we know this investor is long the put. How? Because only those who own options (are long) can decide to exercise. The owner of a put (long put) profits when the stock falls. The put would be exercised when the price of the stock is below the strike price. For example, if this is a 50 put, the investor has the right to exercise and sell the stock at $50 per share. That is a benefit when the market price of the stock is below 50 and the lower the better. Remember the phrase "put down" because a put option becomes valuable to the holder when the market price goes below the exercise (strike) price.
When an agent is discussing possible discounts related to the purchase of mutual funds shares, she would be referring to A) reinvesting distributions B) the CDSC C) 12b-1 fees D) breakpoints
D) breakpoints Mutual funds that carry a load will have a schedule of reduced sales charges when reaching specified quantity levels known as breakpoints.
If general interest rates increase, the interest income of an open-end bond fund whose sales exceed redemptions will likely A) decrease B) It cannot be determined from the information given C) remain unchanged D) increase
D) increase Most mutual funds do not have 100% of their assets in securities, and they continually receive new money from investors. Any increase in the general interest rate would allow the fund to purchase new, higher-yielding instruments, which would increase the fund's income.
With respect to liquidity and potential for diversification, in comparing alternative investments to exchange-traded stocks, the markets for alternative investments are generally: A) more liquid and provide less opportunity for diversification. B) less liquid and provide less opportunity for diversification. C) more liquid and provide more opportunity for diversification. D) less liquid and provide more opportunity for diversification.
D) less liquid and provide more opportunity for diversification. Alternative investments can provide exposure to unique risks and trading strategies and thus provide good diversification to a stock and bond portfolio. The markets for alternative investments are generally less liquid than most listed stocks.
Five years ago, an investor purchased an ABC Corporation BBB-rated debenture with a coupon of 6% maturing in 2037. Currently, new BBB-rated debentures maturing in 2037 are being issued with coupons of 7%. Based on the discounted cash flow method, one could say that the present value of the investor's security is A) more than the par value B) negative C) equal to the par value D) less than the par value
D) less than the par value The discounted cash flow method is just a technical way of computing the value of a security that demonstrates the inverse relationship between interest rates and bond prices. The discount rate here is the current market rate of 7%. Because this investor's debenture is paying at a rate of 6%, its cash flow is less valuable than a 7% bond; therefore, it will sell at a discount (below par).
The Alpha-Gamma Mutual Fund reports a large number of their investors liquidating shares of the fund, so much so that the dollar amount of liquidations exceeds the incoming cash for new purchases. This would lead to a condition known as A) improved performance B) reduced leverage C) cash outflow D) net redemptions
D) net redemptions One of the main features of open-end investment management companies (mutual funds) is that there is a continuous offer of new shares and ready redemption of old ones. When redemptions exceed new purchases, the fund suffers from net redemptions.