Series 66 Kaplan Practice Exam #1

Which of these is not considered to be a systematic risk? A) Default risk B) Exchange rate risk C) Market risk D) Purchasing power risk

A) Default risk Recall the P.R.I.M.E. acronym for systematic (or nondiversifiable) risk: Purchasing power, Reinvestment, Interest rate, Market, and Exchange rate risks. Default or credit risk is a form of unsystematic (or diversifiable) risk.

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 A shares with a 5.5% front-end load and a 12b-1 fee of 0.25%. B) Class B shares with a 12b-1 fee of 0.75% and a six-year declining CDSC after which they convert to Class A shares. C) Class C shares with a 12b-1 fee of 0.75% and a CDSC of 1% during the first year. D) Class I shares with no load, no 12b-1 fee, and no CDSC.

B) Class B shares with a 12b-1 fee of 0.75% and a six-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 0.50% higher than with the Class A shares, but that only lasts for the six-year period until the B shares convert to A shares. That is a 3% difference over the six 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—over a 15-year or longer period, that can remove the advantage the lack of a front-end load has to offer.

A speculator, believing that a drought in the Midwest will lead to a weak corn crop, would probably A) take a short position in corn futures. B) take a long position in corn futures. C) take a long position in orange juice futures. D) take a long position in corn forwards.

B) take a long position in corn futures. A weak corn crop means a shortage in the supply. That will lead to an increase in prices. When one is speculating that prices will go up, the best position is a long one. So, why not the long forwards? Those who purchase forward contracts anticipate accepting delivery of the asset. This individual is merely speculating and has no interest in taking physical possession of the commodity and paying for transportation, silage, and insurance until the commodity is sold. If the person in the question had been a user of corn (a cereal maker, for example), then the forward contract would have been a better choice.

All of the following factors have an inverse relationship to a bond's duration except A) current yield. B) time to maturity. C) coupon rate. D) yield to maturity.

B) time to maturity. The relationship between the time to maturity (length) and duration is a linear one. That is, the longer the time until the bond matures, the higher (longer) the duration - it is a direct relationship. Yields, on the other hand, have an inverse relationship with duration. That is, the higher the yield, the lower (shorter) the duration. An example would be comparing a bond with an 8% coupon rate to one with a 6% coupon rate. All other things beging equal, the bond with the 8% coupon rate will have a shorter duration than the one with a 6% coupon; the relationship is inverse rather than linear.

Under Keogh plan provisions, a full-time employee is defined as one working at least how many hours per year? A) 500 B) 100 C) 1,000 D) 2,000

C) 1,000 Full-time employment is defined as 1,000 hours or more per year, regardless of the number of days, weeks, or months worked.

From the standpoint of diversification, which of the following would be considered the most conservative? A) A sector fund B) An income fund C) A balanced fund D) A growth fund

C) A balanced fund Balanced funds invest in a variety of investment vehicles; therefore, they have more diversification. Because of the diversification, they are better protected against downturns in the financial markets and are more conservative than the other choices listed.

Your client with $100,000 to invest is looking for maximum current income. Which of the following would offer the highest current return? A) $200,000 of utility common stock paying a current dividend of 3.5% B) $100,000 AA rated corporate bonds trading at par with a 6% coupon rate C) $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity D) $100,000 of zero-coupon bonds with a yield to maturity of 6%

C) $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity When you read the full question, including the answer choices, you can immediately disregard two of the four options. With $100,000 to invest, the answer cannot be to purchase $200,000 of anything. Maximizing current income excludes zero-coupon bonds because there is no current income. Now, to the correct choice. Why does a bond sell at a premium over par? Although there are exceptions, primarily it is because the coupon rate on that bond is higher than the current market interest rate. Therefore, with a higher coupon rate, the current income on the same amount of principal invested ($100,000 in our question) will always be higher for a bond selling at a premium. That is the KISS (Keep It Simple Student) answer. For those who want to delve further, here we go. For example, if current market interest rates are 6% (likely the case here because the AA rated bonds with a 6% coupon are trading at par), then a bond with a 7% coupon will be selling at a premium. The current yield on $100,000 of the 6% bonds would be $6,000 per year. If a bond's yield to maturity is 6% and it is selling at a premium, it must be that the coupon is higher than 6%. For example (and we're doing the math that you won't have to do), $93,000 par (93 times $1,000) value of bonds with a 7% coupon, selling at $100,000 (a premium over the $93,000), and maturing in 10 years has a YTM of 6%. Investing $100,000 into these bonds will result in current income of $6,510 per year ($93,000 par times the 7% coupon).

Under the Uniform Securities Act, the definition of a broker-dealer includes A) an agent handling principal transactions with major institutional clients. B) an authorized representative of the issuer who receives a commission. C) a person in the business of making trades in his own account or for the accounts of others. D) a trust company when executing transactions in accounts in which it does not act in a fiduciary capacity.

C) a person in the business of making trades in his own account or for the accounts of others. A broker-dealer is defined as any person in the business of making trades in its own account or for the accounts of others.

In 1933, Congress passed the Securities Act, which required the registration of new issues before their offering to the public. However, the law contained a number of exemptions, including that for A) corporate common stock listed on the NYSE. B) stock issued by a regulated insurance company. C) equipment trust certificates issued by a regulated common carrier. D) obligations of the Canadian government.

C) equipment trust certificates issued by a regulated common carrier. Although each of these is considered an exempt security under the Uniform Securities Act (state laws), only the securities of a regulated common carrier carry an exemption from federal registration.

An investment adviser hires two individuals to solicit new customers for the firm's wealth management service. Under the Uniform Securities Act, A) soliciting is generally prohibited. B) they may begin soliciting as soon as they have passed their licensing examinations. C) registration as investment adviser representatives is required. D) each of them would have to register as an investment adviser.

C) registration as investment adviser representatives is required. The definition of investment adviser representative includes individuals who solicit for the firm's advisory business. Passing the exam is only one of several requirements before formally becoming registered as an IAR.

Which of the following activities would violate the Uniform Securities Act? I. An investment advisory partnership admits a renowned securities analyst to the partnership without informing its clients of this highly desirable addition. II. An investment adviser incorporated in California fails to inform its clients of the departure of the chief financial officer, who did not have an equity position in the firm. III. An investment advisory firm incorporated in Illinois charges clients a share of the capital gains on the basis of a guaranteed performance level above a designated benchmark. IV. An investment advisory firm assigns those accounts that fall to a low level to other firms willing to accept them with the consent of the account holder. A) I and II B) I, III, and IV C) II and III D) I and III

D) I and III Investment advisers who are partnerships must inform their clients of any change in the membership of the partnership within a reasonable period. Unless the question refers to a specific exemption, it is a violation of the USA for an advisory firm to charge on the basis of performance. An investment advisory firm may assign accounts to another firm with the consent of the client.

Which of the following statements regarding grantor trusts is not correct? A) The grantor may be taxed on trust income only if the grantor actually received the income. B) If the grantor can control the beneficial enjoyment of the trust, he is treated as the owner of the trust. C) If the grantor has the power to revoke the trust, he is treated as the owner of the trust. D) If the grantor can receive income from the trust, he is treated as the owner of the trust.

A) The grantor may be taxed on trust income only if the grantor actually received the income. The first step in answering this question is to recognize that it is looking for the incorrect statement (not correct). The key to the taxation on a grantor trust is the matter of control. As long as the grantor has the power to determine the beneficiary or to revoke the trust, the grantor is taxed on the trust's income. Obviously, if the income is paid to the grantor, there is tax liability. But, even when the grantor does not actually receive the income and controls who does, it is considered constructive receipt, and it is the grantor's tax liability.

Federal covered investment advisers must comply with the SEC's Model Marketing Rule for Investment Advisers. That rule includes A) a prohibition against showing the adviser's past performance. B) requiring a written agreement between an investment adviser and a promoter who receives more than $1,000 over a 12-month period for endorsing the services of the adviser. C) a prohibition against reduced-fee introductory offers. D) a requirement that a copy of all advertisements be sent to the SEC at the time they are disseminated to the public.

B) requiring a written agreement between an investment adviser and a promoter who receives more than $1,000 over a 12-month period for endorsing the services of the adviser. SEC-registered investment advisers must comply with the SEC Model Marketing Rule for investment advisers. This SEC rule incorporated significant amendments to the Investment Advisers Act of 1940. Among the requirements of the rule is that an adviser who compensates a nonaffiliated third-party promoter for endorsing the services of the IA must have a written agreement with that promoter if the compensation will exceed $1,000 over a 12-month period. Advertisements may not contain false statements, refer selectively to past recommendations, refer to a chart or device for evaluating securities without explaining its limitations and difficulties, or offer anything free of charge if, in fact, there will be some requirement (however minor) for obtaining the free item. There is no federal filing requirement for advertisements of covered IAs. As long as the past performance is displayed in a manner consistent with the rules, there is no problem.

Prohibited business practices under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents would not include A) making specific investment recommendations to the group attending a free lunch seminar. B) sharing commissions with an agent of a nonaffiliated broker-dealer. C) sharing in the profits and losses in a client's account without making a financial contribution to the account. D) borrowing money for graduate school tuition from a client who happens to be the agent's father.

C) sharing in the profits and losses in a client's account without making a financial contribution to the account. Unlike the FINRA rule, agents may share in the profits and losses in a client's account without making a financial contribution; all that is required is consent of the client and the employing broker-dealer. The so-called free lunch seminars are typically promoted as educational, and in any case, how can the agent make specific recommendations to a group without having suitable information on each attendee? Borrowing money from a client, regardless of the purpose, is not permitted unless the lender is in the business of lending money. Sharing commissions with an agent licensed with the same or affiliated broker-dealer is permitted, but one with which there is no affiliation is not permitted.

There are several ways that a securities professional's registration can be terminated. Nonpunitive termination of a securities professional's registration could be done through which of these? I. Cancellation II. Suspension III. Revocation IV. Withdrawal A) I and III B) II and IV C) II and III D) I and IV

D) I and IV Cancellation and withdrawal are nonpunitive methods of termination of a person's registration. Suspension, revocation, and denial are considered forms of punishment.

The Investment Advisers Act of 1940 excludes from the definition of "investment adviser" persons whose advice: I. relates solely to municipal issues. II. relates solely to issues issued by or guaranteed by the U.S. Treasury. III. is solely incidental to their professional practice as an aeronautical engineer. IV. is limited to insurance companies only. A) I, II, III, and IV. B) III and IV. C) I, II, and IV. D) II and III.

D) II and III. Among the exclusions from the definition of" investment adviser "under both state and federal regulations is the case where certain professionals, including engineers, render the advice in a manner solely incidental to the practice of their professions. Unique to the federal law is the exclusion granted to those persons whose advice deals exclusively with federal government issued or guaranteed issues. Advice to solely insurance companies qualifies one for an exemption from registration, but does not exclude the person from the definition of IA.

Without prior authorization from the client, an investment adviser could release information relating to the client's account I. in order to comply with the brochure delivery requirements of the USA II. when requested by the IRS as part of litigation against the client III. for the purpose of furnishing information for a statistical survey being compiled by the Administrator IV. upon the receipt of a subpoena from a court of competent jurisdiction A) I, II, III, and IV B) II and III C) I, III, and IV D) II and IV

D) II and IV Without the prior consent of the client, an IA may disclose information relating to specific accounts only when requested by the IRS or by court order.

An individual purchased a variable life insurance policy 10 years ago with a guaranteed death benefit of $100,000. The annual premium for this policy was $2,000 per year. The individual dies and, due to outstanding performance of the separate account, leaves a death benefit to the beneficiary of $121,000. What are the income tax consequences to that beneficiary? A) Ordinary income tax is due on $21,000. B) There is a long-term capital gain of $1,000. C) Ordinary income tax is due on the $1,000 that exceeds the original cost. D) No tax is due.

D) No tax is due. One of the nice things about life insurance proceeds is that even when the death benefit is increased due to separate account performance, it is still free of income tax.

A living will is used to A) eliminate, or at least reduce, estate taxes. B) avoid the cost and time of probate. C) ensure that the author's assets are properly distributed after death. D) express the author's end-of-life wishes.

D) express the author's end-of-life wishes. Sometimes referred to as a medical directive or advanced care directive, a living will is used to express the author's end-of-life wishes, such as organ donation, when to end life-prolonging efforts, and so forth. It has nothing to do with a last will and testament describing the distribution of assets after death.

An intrastate offering is exempt from A) all registrations. B) blue-sky registration. C) state registration. D) federal registration.

D) federal registration. An intrastate offering (Rule 147 exemption) is limited to companies that do business in one state and limit stock or bond sales to that state's residents. Even though this offering may be exempt from SEC registration, it is not exempt from registering with that one state. Blue-sky registration (Uniform Securities Act registration) means the same thing as state registration.