Unit 17 - 4 questions

One of your clients approaches you looking for an investment that will provide ready marketability and income. Which of the following would be the least appropriate recommendation? A) A limited partnership in rental real estate B) A money market mutual fund C) U.S. Treasury notes D) NYSE-listed preferred stock

A) A limited partnership in rental real estate The key is meeting both needs—marketability and income—and each of them supply both except the limited partnership. The client could expect income from a DPP investing in rental real estate, but the liquidity is missing. U17LO7

A number of different pooled investment vehicles are included in the term "alternative investment." One of them, a synthetic investment instrument that has been created to meet a specific need that cannot be met by a standardized financial instrument, is known as A) a structured product B) an arbitrage C) a z-tranche CMO D) an inverse fund

A) a structured product Structured products are created as a tool to meet the issuer's debt financing needs when they will result in a lower cost than a standardized financial instrument available in the market place. U17LO3

In search of higher returns, many investors have turned to alternative investments, such as structured products. Non-exchange-traded structured securities products (SSPs) typically have A) some form of embedded derivatives B) FDIC insurance coverage C) moderate liquidity D) a place in the portfolio of conservative investors

A) some form of embedded derivatives It is commonplace for SSPs to use derivatives, such as options. There is no insurance coverage and, unless listed for trading such as an ETN, low or no liquidity. These are highly complex products and would not be suitable for the average conservative investor. U17LO3

Commodities

Agricultural Animal-based Natural resources Industrial metals Precious metals (gold, silver, platinum)

A REIT and a direct participation program are similar because they both A) pass through losses to investors B) are operated by a centralized management C) are traded actively in the secondary market D) can be described as a limited partnership

B) are operated by a centralized management Both a REIT and a DPP are run by centralized management. A REIT may not pass through losses to its investors, and it is not a limited partnership. A DPP cannot be easily traded in the secondary market. U17LO2

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 insurance broker must return all commissions to the insurance company. B) the new owner receives the $5 million death benefit. C) the insurance company is not obligated to pay the death benefit because she no longer owns the policy. D) her estate can invoke the right of rescission and receive the policy proceeds minus the sale proceeds.

B) 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. U17LO4

Being a limited partner in a direct participation program is analogous to being A) an agent of a broker-dealer. B) a holder of secured corporate debt. C) a holder of common stock in a corporation. D) a member of the board of directors of a corporation.

C) a holder of common stock in a corporation. Limited partners in DPPs are owners of the business in much the same way as common stockholders of a corporation. They assume no management responsibilities simply by virtue of their ownership interest. Similarly, limited partners share the same type of limited liability as corporate shareholders. U17LO2

In a life settlement, the seller receives more than the premiums paid into the policy but less than A) the accumulated dividends. B) the future premiums payable. C) the face amount. D) the cash value.

C) the face amount. The sale price of a life settlement is always more than the cash value and less than the face value. U17LO4

Risks of commodities

Loss of principle volatility foreign market risk high spreads lack of income

Section 1031 exchange

Section 1031 of the Internal Revenue code deals with like-kind exchanges of real property that is held for use in a trade or business or for investment. Real property, also called real estate, includes land and generally anything built on or attached to it. The benefit is that no taxes are paid on gains until the last sale of the property. In simple terms, it permits tax-deferral of gains when real estate is exchanged for other real estate. U17LO5

Benefits of commodities

hedge against inflation diversification (not correlated with stock market returns) profit potential

alternative asset investments

most often characterized by inefficient pricing, providing potential abnormal returns or alpha returns. That is the prime reason for their popularity, especially with institutional investors.

General partners (GPs)

must maintain a financial interest in the partnership and generally do not receive distributions from profits before those paid to the limited partners. The GP is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations and has a fiduciary relationship to the LPs. The GP, as a fiduciary, cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds. U17LO2

The sale of a life insurance policy in the secondary market by a terminally ill individual is known as A) a trade in the OTC market B) a viatical settlement C) an unethical trade practice D) a vertical settlement

B) a viatical settlement A viatical settlement is the sale of a life insurance policy to a third party (the investor). The owner (viator) of the life insurance policy sells the policy for an immediate cash benefit. The buyer becomes the new owner of the life insurance policy, pays future premiums, and collects the death benefit when the insured dies. At one time, most viatical settlements were from people with a life-threatening illness. Now, individuals who are not facing a health crisis may sell their life insurance policies to get cash.

If near-term liquidity is the only objective for a client, which of the following pairs of investments represents the most/least liquid? A) 10-year corporate bonds/U.S. T-bills B) Common stock listed on the New York Stock Exchange/unit in a direct participation program (DPP) C) Variable annuity accumulation unit/money market mutual fund shares D) Annuity units of a variable annuity/unit in a direct participation program (DPP)

B) Common stock listed on the New York Stock Exchange/unit in a direct participation program (DPP) Stock listed on the NYSE is considered highly liquid while ownership units in a DPP are generally illiquid. Once a variable annuity's accumulation units have been exchanged for annuity units (payout time), there is no liquidity. The corporate bonds and T-bills have the order reversed; it is the T-bills with high liquidity and corporate bonds have the lower liquidity. Variable annuity accumulation units are liquid and so are money market mutual fund shares. However, because the fund shares have check-writing privileges, they are the more liquid of the 2 choices and so the order is reversed from what the question seeks. U17LO7

One way in which active and passive real estate investing differ is that A) there are circumstances under which losses from passive real estate investing can be deducted against ordinary income B) only real estate professionals can deduct losses from active real estate investing. C) there are circumstances under which losses from active real estate investing can be deducted against ordinary income D) losses from active real estate investing can only be deducted against income from other active investing projects

C) there are circumstances under which losses from active real estate investing can be deducted against ordinary income There are certain conditions under which active real estate investors can deduct as much as $25,000 in losses from ordinary income. Those conditions are likely to be far more complex than the exam will delve, but it can be important to know that this is possible. Passive real estate losses can only be deducted against passive income. U17LO5

limited partner

passive investors in a partnership whose liability is limited to the amount of funds they have invested and committed to, but have not yet contributed. They do not manage the funds in the partnership; the general partner has that responsibility. U17LO2

In general, an investor wishing to gain economic exposure to commodities would find it easiest to do so by A) buying the commodity directly B) growing the commodity C) investing in forwards contracts D) investing in futures contracts

D) investing in futures contracts It is generally agreed that using commodity futures is the easiest and most common way to gain economic exposure to commodities. Forwards are more commonly used by producers or users because, unlike futures, most forward contracts result in the delivery of the actual commodity. Only about 1% of all futures contract positions involve the delivery of the underlying commodity. U17LO7

One type of alternative investment considered to be a pooled investment vehicle is the exchange-traded note. Exchange-traded notes (ETNs) are I. unsecured debt securities II. unsecured equity securities III. issued by financial institutions, such as banks IV. insured by the FDIC

I and III Exchange-traded notes are unsecured debt securities issued by financial institutions, such as banks. Their prices can be impacted by changes in the credit rating of the issuer, and they are not insured by the FDIC. U17LO3

Which of the following is a motivation for creating structured products? Structured products A) reduce costs to issuers. B) improve profits for broker-dealers. C) are less expensive for investors to buy and trade. D) improve market completeness.

D) improve market completeness. Primary motivation for financial structuring is to increase market completeness. What does that mean? As stated in the LEM, structured products are created to meet a specific need for which there is nothing available in the current market. Creating this structured product is said to be "completing the market." Creating structured products is a cost to issuers. Investors pay fees to access structured products in addition to transaction costs. They may, in fact, improve the structuring broker-dealer's profits, but that is not what NASAA will be looking for as an answer. U17LO3