Unit 5 - Alternative Investments and Other Assets

Your client has turned bearish on the market, but does not have a margin account. Which of the following securities would probably best meet your client's needs? A) An inverse fund B) A long call option C) An interest rate swap D) A balanced mutual fund

A) An inverse fund Those who are bearish wish to profit in a market downturn. Inverse funds are sometimes called short funds because they deliver positive returns when the underlying benchmark declines in value. This client can't sell short because you need a margin account for that. LO 5.c

An alternative investment vehicle that is managed to perform contrary to a benchmark market index such as the S&P 500 is A) an inverse exchange-traded fund. B) a leveraged exchange-traded fund. C) a long put on the index. D) an equity-linked note.

A) an inverse exchange-traded fund. Inverse exchange-traded funds (ETFs), frequently referred to as bear or short funds, are designed to move in the opposite direction of the index they are tracking. They can be leveraged, but the term leveraged can also apply to an ETF that goes in the same direction as the index. A put option is not a managed alternative investment. LO 5.c

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

A) 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 forwards contracts result in the delivery of the actual commodity. Only about 1% of all futures contract positions involve the delivery of the underlying commodity. LO 5.g

One type of alternative investment considered to be a pooled investment vehicle is the inverse exchange-traded fund (ETF). Inverse ETFs, also known as bear or short funds, are managed to A) perform contrary to a benchmark market index such as the S&P 500. B) outperform a benchmark market index such as the S&P 500. C) be used only by professional traders and market makers. D) be profitable only when interest rates are rising.

A) perform contrary to a benchmark market index such as the S&P 500. Inverse funds, also known as short or bear funds, try to deliver returns that are the opposite of the benchmark index they are tracking. When they are exchange traded, they can be bought on margin and are priced throughout the trading day like other exchange-traded funds. LO 5.c

You have a client who wishes to allocate a portion of his funds to investment real estate in an attempt to generate additional income. That goal could be reached by investing in any of the following except A) raw land. B) rental real estate. C) real estate limited partnerships. D) REITs.

A) raw land. Raw land does not generate income; it is most often held for future capital appreciation. LO 5.b

Investing in commodities could involve investing in any of these except A) animals. B) consumer durables. C) agricultural items. D) industrial metals.

B) consumer durables. Commodity contracts are not available on consumer durables such as refrigerators and washing machines. They are available on agricultural items, such as corn, wheat, and soybeans. Likewise, investing in animal items such as cattle and pork bellies is possible. Finally, industrial items—primarily metals such as lead, zinc, and aluminum—are popular investments. LO 5.f

One of your clients is 10 years away from retirement and is trying to decide what would be a suitable investment for this year's IRA contribution. You would probably not recommend A) target date mutual funds. B) leveraged ETFs. C) conservative growth mutual funds. D) broad market ETFs.

B) leveraged ETFs. Because most leveraged funds reset daily, they are best utilized by investors with a very short time horizon. LO 5.c

In a DPP, a general partner is all of the following except A) one who buys and sells the program's property. B) one who has limited liability. C) a key executive who makes day-to-day business decisions. D) one who appoints the property manager.

B) one who has limited liability. A general partner of a limited partnership is a key executive of the program who purchases and sells the property and/or appoints someone to manage the property. The general partner does not have limited liability. By not allowing the general partner to have limited liability, the program is able to rule out limited liability as a corporate characteristic. LO 5.b

All of the following would flow through as a loss to limited partners except A) depletion. B) principal repayment on partnership debt. C) interest payments on partnership debt. D) accelerated depreciation.

B) principal repayment on partnership debt. Principal repayments are not an expense for tax purposes. The interest on the debt is an expense and, along with depletion and depreciation expenses, does flow through to the limited partners as passive loss. LO 5.a

What is the maximum amount of bitcoin that will ever be in circulation? A) 194,425 coins B) 21 billion coins C) 21 million coins D) Indefinite number of coins

C) 21 million coins The maximum amount of bitcoin that will ever be in circulation is 21 million coins. This is a feature of the bitcoin protocol, which is designed to create a finite supply of the cryptocurrency, which will prevent inflation on BTC. LO 5.h

Which of the following terms best describes ETNs and leveraged ETFs? A) Forms of hedge funds B) Speculative investments C) Alternative investments D) Registered investment companies

C) Alternative investments These are two popular alternative investments. Are they speculative? Yes, but there are many other speculative investments that are not considered alternative investments. The question asks for the best description and, although it might seem like a close call, these are "alts." The leveraged ETF is a registered investment company, but the ETN is not. LO 5.c

Which of the following would not be considered an agricultural commodity? A) Coffee B) Soybeans C) Aluminum D) Oats

C) Aluminum Aluminum is traded as an industrial commodity; all of the others are agricultural. LO 5.f

In search of higher returns, many investors have turned to structured products such as structured notes. Your clients need to be aware that these are complex instruments that have which of the following characteristics? I Credit or default risk because they are unsecured obligations of the issuing institution II High price transparency III Limited or no liquidity IV High initial returns that diminish over time A) I and IV B) II and III C) I and III D) II and IV

C) I and III As unsecured obligations, their safety of these notes is only as good as the financial strength of the issuer, and because these tend to be one-of-a-kind products, they do not have liquidity. A particular hazard of investing in structured notes is that there is a low level of pricing transparency; another concern is that the returns are generally not fully realized until the maturity date. LO 5.c

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) II, III, I C) III, I, II D) III, II, I

C) III, I, II The reason why the program's economic viability is the first priority in the assessment of DPPs is that the IRS considers programs designed solely to generate tax benefits to be abusive tax shelters. This can lead to tax penalties. During an audit, the first thing the IRS agent will examine is if the program has a reasonable expectation of generating a profit. As the IAR recommending the program to your client, you want to do your best due diligence to make sure to limit the potential audit exposure. Assuming this program passes that test, you want to examine the potential tax benefits. Finally, because there is a very limited secondary market for DPPs, liquidity and marketability should be a low priority. LO 5.g

All of the following are considered to be equity securities EXCEPT A) unit investment trusts B) exchange-traded funds C) equity-linked notes D) warrants

C) equity-linked notes Even though the term "equity" appears in the name, equity-linked notes (ELNs) or exchange-traded notes (ETNs) are technically debt securities. LO 5.c

An investment adviser representative (IAR) has several clients who are interested in adding precious metals to their portfolios. Which of the following is the IAR most likely to recommend? A) Nickel B) Copper C) Aluminum D) Platinum

D) Platinum The only one of these considered a precious metal is platinum. For the exam, there are likely only going to be three precious metals: gold, silver, and platinum. LO 5.f

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

D) 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. LO 5.b

Your client who owns a DPP that generated a $10,000 passive loss for the year could A) deduct $10,000 against capital gains. B) deduct $10,000 against ordinary income. C) deduct $3,000 against ordinary income and carry over the rest. D) only deduct the passive loss against passive income.

D) only deduct the passive loss against passive income. Passive losses, such as those generated by limited partnership investments (DPPs), are only deductible against passive income. LO 5.a

Someone who wishes to invest in precious metals would consider any of the following except A) lead. B) silver. C) gold. D) platinum.

A) lead. Lead is not considered a precious metal. LO 5.f

Which of the following is true regarding ETNs? A) They are suitable for conservative investors seeking income. B) Their value can be impacted by changes in the issuer's credit rating. C) As fixed-income investments, they do not have market risk. D) They are noncallable prior to maturity.

B) Their value can be impacted by changes in the issuer's credit rating. ETNs are unsecured debt obligations carrying credit risk based on the issuer's credit rating. Fixed-income investments have the market risk more commonly referred to as interest rate risk, and they are usually callable. These are sophisticated instruments that are not suitable for conservative investors. LO 5.c

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) an inverse fund. B) a structured product. C) a z-tranche CMO. D) an arbitrage.

B) 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. LO 5.c

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

C) A limited partnership in rental real estate The key is meeting both needs—marketability and income; each of the choices supplies both except the limited partnership. The client could expect income from a direct participation program (DPP) investing in rental real estate, but the liquidity would be missing. LO 5.g

If an investor was of the opinion that the market was going to have a bad day, to maximize that investor's gains, you might recommend A) a leveraged ETF. B) selling a call option on the S&P 500 Index. C) an inverse ETF. D) an inverse leveraged ETF.

D) an inverse leveraged ETF. An inverse ETF should go up if the market goes down. Adding leverage to it means moving by a factor of 2x or 3x, so to maximize the potential gain, we combine leverage to the inverse and suggest the inverse leveraged ETF. LO 5.c

You have a client who wishes to allocate a portion of his funds to investment real estate in an attempt to generate additional income. That goal could be reached by investing in any of the following except A) real estate limited partnerships. B) REITs. C) rental real estate. D) raw land.

D) raw land. Raw land does not generate income; it is most often held for future capital appreciation. LO 5.b

A client wishing to invest in precious metals could consider each of the following except A) lead. B) silver. C) gold. D) platinum.

A) lead. Although it has always been the alchemist's dream to convert lead into gold, until that becomes a reality, lead is not considered a precious metal. LO 5.f

In order to achieve its goals, an inverse ETF uses A) arbitrage. B) derivatives and debt. C) short selling. D) preemptive rights.

B) derivatives and debt. An inverse ETF will almost always use derivatives, such as options, and—in the case of a leveraged ETF—will use debt, primarily in the form of margin. Inverse ETFs do not engage in short selling; they are an alternative to selling short a specific index without the unlimited risk potential of the short sale. Arbitrage is used, typically by institutional investors, to take advantage of temporary imbalances between the ETF's net asset value and market price. LO 5.c

Which of the following investments is least appropriate for a client primarily concerned with liquidity? A) Preferred stock B) Municipal bond mutual fund C) Bank savings account D) Direct participation program Explanation There is little secondary market liquidity for direct participation programs (DPPs). Compared to the other choices, they are the least appropriate for a client seeking liquidity. LO 5.g

D) Direct participation program There is little secondary market liquidity for direct participation programs (DPPs). Compared to the other choices, they are the least appropriate for a client seeking liquidity. LO 5.g

An investor looking for liquidity would be least likely to consider A) NFTs. B) REITs. C) CEFs. D) ETFs.

A) NFTs. NFTs are nonfungible tokens and, because they are nonfungible, their liquidity is limited. CEFs (closed-end funds) and ETFs (exchange-traded funds) are highly liquid. Although there are nontraded REITS, for exam purposes, all REITs are considered to be publicly traded unless something in the question indicates otherwise. LO 5.h

For a customer interested in buying an inverse exchange-traded fund (ETF) tracking the performance of the Standard & Poor's 500 Index, which of the following market views would make that purchase most inappropriate? A) Bearish B) Bullish C) Neutral D) Bullish or bearish

B) Bullish Inverse (short) ETFs are designed to deliver returns that are opposite of the benchmark index they are tracking. Therefore, buying an inverse ETF that tracks the S&P 500 Index at a time when the market outlook is bullish would be most inappropriate. If the index rises with the anticipated bullish market, the fund that delivers returns that are the opposite of the index would fall in value. LO 5.c

The term digital assets would include all of the following except A) cryptocurrency. B) electronic communications such as email. C) stablecoins. D) nonfungible tokens.

B) electronic communications such as email. Although email is a digital form of communication, there is nothing about it that makes it an asset. One cannot invest in someone's emails. The other three items are included in the definition of a digital asset. LO 5.h

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) moderate liquidity. B) a place in the portfolio of conservative investors. C) some form of embedded derivatives. D) FDIC insurance coverage.

C) 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. LO 5.c

One of the benefits of being a limited partner in a direct participation program is that A) any income generated by the partnership flows through to the limited partner and is treated as a long-term capital gain. B) any losses generated by the partnership flow through to the limited partner and can be used against ordinary income in an amount up to $3,000 per year. C) the limited partner can make certain management decisions. D) the general partner is the only person liable for the debts of the business.

D) the general partner is the only person liable for the debts of the business. In a DPP, it is only the general partners who have full liability; limited partners are liable only to the extent of their investment plus any future commitments. Limited partners lose their status if they undertake any management responsibility. Losses are passive losses and can be deducted only against passive income, not ordinary income. It is capital losses that are subject to the $3,000 limit. Any income is treated as passive income, and that is taxed at ordinary income tax rates, not the lower capital gains rate. LO 5.b

One reason for including commodities in an investment portfolio is because they have a high correlation to A) the bond market. B) the U.S. dollar. C) the stock market. D) the inflation rate.

D) the inflation rate. Commodity prices tend to have a high correlation with the inflation rate. As inflation goes up, the value of the dollar generally falls. The relationship is inverse, a characteristic of negative correlation. As inflation increases, interest rates invariably do the same, leading to a decrease in bond prices. Stock prices have a random correlation to commodities—generally negative. LO 5.g

A bullish client invests into a 3x leveraged fund based on the S&P 500 Index. If the index should rise by 10%, your client's investment would be expected to A) increase by 30% B) increase by 50% C) decrease by 30% D) increase by 20%

A) increase by 30% Although it doesn't always work out that way, a 3x leveraged fund should gain in value at a rate 3 times the reference index. LO 5.c

One type of alternative investment considered to be a pooled investment vehicle is the exchange-traded note. Exchange-traded notes (ETNs) are which of these? I Unsecured debt securities II Unsecured equity securities III Issued by financial institutions, such as banks IV Insured by the FDIC A) I and III B) I and IV C) II and III D) II and IV

A) 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. LO 5.c

Flow-through is one of the features of A) open-end investment companies. B) direct participation plans. C) variable annuities. D) REITs.

B) direct participation plans. Flow-through is the term commonly used to describe that any income or loss generated by a direct participation program flows through to the owner(s). In the case of a real estate investment trust (REIT), the only thing that passes through is income or gains, never losses. LO 5.a

An alternative investment vehicle that is managed to perform contrary to a benchmark market index such as the S&P 500 is A) a leveraged exchange-traded fund. B) an equity-linked note. C) an inverse exchange-traded fund. D) a long put on the index.

C) an inverse exchange-traded fund. Inverse exchange-traded funds (ETFs), frequently referred to as bear or short funds, are designed to move in the opposite direction of the index they are tracking. They can be leveraged, but the term leveraged can also apply to an ETF that goes in the same direction as the index. A put option is not a managed alternative investment. LO 5.c

In a limited partnership program, which partners manage the partnership's day-to-day operations and incur unlimited personal liability for the partnership's debts? A) The limited partners B) The general partners C) Both the general partners and the limited partners D) Neither the general partners nor the limited partners

B) The general partners In a limited partnership, the general partners manage the day-to-day operations and incur unlimited personal liability. Limited partners invest money in the partnership and have no liability beyond the amount invested, including commitments made but as of yet unpaid. They are denied a voice in the management of the partnership because having a voice in management could cause them to lose their limited liability status. LO 5.b

In order to achieve its goals, an inverse ETF uses A) preemptive rights. B) short selling. C) derivatives and debt. D) arbitrage.

C) derivatives and debt. An inverse ETF will almost always use derivatives, such as options, and—in the case of a leveraged ETF—will use debt, primarily in the form of margin. Inverse ETFs do not engage in short selling; they are an alternative to selling short a specific index without the unlimited risk potential of the short sale. Arbitrage is used, typically by institutional investors, to take advantage of temporary imbalances between the ETF's net asset value and market price. LO 5.c

Among the characteristics of leveraged exchange-traded funds is that A) they are generally suitable for investors with a long time horizon. B) leveraged ETFs generally obtain the leverage through bank borrowing. C) leveraged ETFs may be purchased on margin. D) they can only be sold to accredited investors.

C) leveraged ETFs may be purchased on margin. Because an exchange-traded fund is purchased and sold on an exchange, the rules generally applying to all exchange products, such as purchasing them on margin, would apply. Leveraged funds use derivative products to generate the leverage, not bank borrowing. When it comes to suitability, they are for aggressive investors, but there is no requirement that they meet the accredited investor standard. However, the very nature of the product is that it is designed for short-term trading, not long-term trading. LO 5.c

Your customer is asking if either exchange-traded funds (ETFs) or exchange-traded notes (ETNs) might be suitable investments for his portfolio. The customer makes several statements regarding his understanding of the products, but only one of them is accurate. Which is it? A) ETNs are equity securities because they trade on exchanges. B) ETFs have a fixed coupon rate that I should expect to realize when they mature. C) If I want to sell my shares of an ETF, I have to wait until the next price is calculated to value the portfolio of securities. D) ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer.

D) ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer. The only accurate statement is the one expressing that ETNs are issued by financial institutions and, therefore, the credit worthiness of the issuer should be a concerning factor. ETNs are debt instruments, not equity instruments. ETNs have a final payment at maturity based on the return of a single stock, a basket of stocks, or an equity index. Although ETF prices fluctuate based on the value of the securities within the fund portfolio throughout the trading day, they are priced by supply and demand, like all exchange-traded products. They are not forward priced like open-end mutual fund shares are. LO 5.c

An investor in a high tax bracket who invested in a DPP should have which of the following characteristics? I Need for tax benefits II Substantial liquid assets III Ability to identify both risks and merits of the program IV Ability to commit money for a long time A) I, II, III, and IV B) II, III, and IV C) II and III D) I and II

A) I, II, III, and IV DPPs are appropriate for investors who can benefit from substantial tax deductions or credits, are not bothered by illiquidity, understand the business risks and benefits involved, and can stay in the program until completion. LO 5.a

Which of the following is not a feature of owning a limited partnership? A) Tax-free income B) Flow-through of income and expenses of a business to the individual limited partner C) An investment managed by others D) Legislative risk

A) Tax-free income The income from limited partnerships is not tax exempt. An investor, however, may use a tax loss from a partnership to offset the income from another passive investment. In limited partnerships, the investor enjoys the advantages and disadvantages of owning a business without actually having actually manage one. Limited partnerships are vulnerable to legislative changes that adversely impact ownership of such investments. LO 5.a

When a client is interested in investing in commodities, you would expect to discuss A) oil-drilling programs. B) soybeans, wheat, and corn. C) museum-quality art. D) investment-grade coins.

B) soybeans, wheat, and corn. Agricultural products, including soybeans and other grains, are popular commodities. LO 5.f

The price of which of the following commodities is most likely to be impacted by weather? A) Livestock B) Lead C) Orange juice D) Gold

C) Orange juice If you ever saw the movie Trading Places with Eddie Murphy and Dan Aykroyd, you would certainly know that weather can have a major impact on the orange crop. Metals are not affected by heat, cold, rain, or snow. Years ago, before heated/air-conditioned barns and other protective devices, livestock would freeze in a bad winter, but that is no longer much of an issue. LO 5.g

Which of the following would be considered a precious metal? A) Tin B) Copper C) Platinum D) Lead

C) Platinum The easiest way to answer this question is to add a word to each choice—copper wire, lead pipe, platinum ring, and tin can. Along with silver and gold, platinum is a commonly traded precious metal in the commodities markets. LO 5.f

A high-net-worth client of yours invested $250,000 into an oil and gas limited partnership drilling program for which she received a 10% interest in the project. Unfortunately, after two years of drilling without success, the project was foreclosed with outstanding debt of $4 million. Your client is liable to the partnership's creditors for A) $0. B) $400,000. C) $250,000. D) $150,000.

A) $0. One of the benefits of being a limited partner is that the most you can lose is your investment. Just as it would for a stockholder in a corporation, the concept of limited liability applies. You can lose your entire investment, but you have no liability for debts of the business. This question describes a direct participation program (DPP) that has gone bankrupt (liabilities exceed the assets) and wants to know the share of the $4 million in outstanding debt that is the responsibility of this investor. Even though she owns 10% of the partnership, as a limited partner, she has no liability for any of that debt. LO 5.b

Your customer is interested in a leveraged fund and makes the following statements about leveraged funds to you. All of the statements regarding leveraged funds are true except A) the funds attempt to return a multiple of the return of a benchmark index they are tracking, perhaps two or three times. B) there are no unusual risks associated with these funds other than those one would incur with any index tracking fund. C) some leveraged funds are exchange-traded products. D) these funds sometimes use derivatives products to achieve their stated goals

B) there are no unusual risks associated with these funds other than those one would incur with any index tracking fund. Because the fund's objective is to achieve returns that are a multiple of the returns of the benchmark index, the result could be a multiple of any loss incurred by the benchmark index as well. In addition, because these funds utilize derivatives products to achieve their stated objectives, they may not be suitable for anyone who derivatives products are not suitable for, given the additional risks associated with those products. LO 5.c

A client invests $100,000 in a commercial real estate venture taking a 10% interest as a limited partner. Unfortunately, the demand for new office space deteriorates and the partnership is unable to meet the mortgage payments. The end result is foreclosure with a net loss of $2 million. This would have the effect of: A) giving the client a passive loss of $200,000. B) requiring the client to pay his share of the loss to the creditors. C) a potential claim against the agent who sold the client this program. D) giving the client a passive loss of $100,000.

D) giving the client a passive loss of $100,000. The most the client can lose is the amount of the investment, in this example, $100,000. Because DPPs are considered passive investments, the loss may only be deducted against passive income. As a limited partner, the loss is "limited" to the original investment. Sure, the client could always make a claim against the agent, but nothing in this question indicates that the agent did anything wrong so that would not be the "best" answer. LO 5.a

One of your clients expresses interest in purchasing a unique piece of art in digital form. More than likely, the client is referring to A) a way to add liquidity to the portfolio. B) a nonfungible token. C) cryptocurrency. D) a new way to decorate the home.

B) a nonfungible token. Nonfungible tokens (NFTs) are digital assets that reside as code on a blockchain. The owner of an NFT buys ownership of that particular bit of alphanumeric code associated with whatever has been tokenized. NFTs can be digital representations of artwork, a video, music, or even a tweet. They are not cryptocurrency but are usually paid for with that currency. Each NFT is unique, a one of a kind, making the tokens nonfungible. That means investors can't exchange one NFT for another just like it as they can with dollars or publicly traded securities. Artwork is a good example of something produced as an NFT; the digital copy owned by the investor is the only copy. LO 5.h

Among the differences between an investment in a limited partnership offering and in a corporation is that A) limited partnership offerings do not pay dividends; corporations do. B) limited partners take a more active role in the management of the enterprise than do stockholders of a corporation. C) only corporations issue securities. D) only corporations are organized to run a business.

A) limited partnership offerings do not pay dividends; corporations do. One of the key features of a limited partnership investment is the concept of flow-through of operating results. If the business operates at a loss, the limited partner's share of that loss is treated as a passive loss on the investor's tax return. If the business is profitable, the limited partner's share of the profit is treated as passive income. Corporations issue securities, primarily stocks and bonds, while limited partnerships issue units representing the limited partner's interest in the venture. Those units are investment contracts and, as taught in Unit 4, LO4, securities. Limited partners who take an active role in the partnership lose their limited status. LO 5.a

Among the differences between an investment in a limited partnership offering and in a corporation is that A) limited partnership offerings do not pay dividends; corporations do. B) only corporations issue securities. C) only corporations are organized to run a business. D) limited partners take a more active role in the management of the enterprise than do stockholders of a corporation.

A) limited partnership offerings do not pay dividends; corporations do. One of the key features of a limited partnership investment is the concept of flow-through of operating results. If the business operates at a loss, the limited partner's share of that loss is treated as a passive loss on the investor's tax return. If the business is profitable, the limited partner's share of the profit is treated as passive income. Corporations issue securities, primarily stocks and bonds, while limited partnerships issue units representing the limited partner's interest in the venture. Those units are investment contracts and, as taught in Unit 4, LO4, securities. Limited partners who take an active role in the partnership lose their limited status. LO 5.a

A client was reading an offering document for an oil and gas drilling limited partnership program and noticed that one of the features was flow-through benefits. How would you explain this? A) Investors in the program are assured of a steady flow of income if the drilling is successful. B) Once the program has paid taxes on its income, the entire remaining balance passes-through to the investors. C) Rather than being a separate taxable entity, the program's income or losses pass-through directly to the investors. D) Losses generated by the program pass-through to the investor and may be deducted in full against ordinary income.

C) Rather than being a separate taxable entity, the program's income or losses pass-through directly to the investors. The philosophy behind flow-through is that any income or losses generated by a program of this type (a direct participation program or DPP) flow directly to the investors; there is no tax at the entity level. If there are losses, they may be deducted only against passive income (e.g., income from other partnerships). No assurances can ever be given. LO 5.a

Lisa is considering investing in gold. She owns a portfolio of stocks, bonds, and money market securities. Relative to her existing portfolio, the primary benefit of the gold investment is most likely A) gold is a renewable resource, so Lisa can profit from the investment for many years. B) the investment horizon is longer than that of stocks and bonds, balancing the duration of the portfolio. C) low correlation between traditional asset returns and gold. D) gold values are tied to cyclical industries.

C) low correlation between traditional asset returns and gold. The returns on gold and other precious metals exhibit low correlation with stock and bond returns. Investment experts generally cite this as the key advantage to investing in hard assets. Precious metals do not generally follow cyclical industries. Indeed, most look at them as countercyclical investments. The investment time horizon is whatever the investor makes it. Investors can hold stock indefinitely and buy bonds with short or long maturities, depending on portfolio objectives. Gold is not a renewable resource. LO 5.f

One of your clients is considering allocating about 10% of her portfolio to commodities. Her current portfolio is a mix of stocks, bonds, and broad market index ETFs. Relative to her existing portfolio, you would explain to her that the primary benefit of the commodity investment is most likely A) lower trading costs. B) an increase in the reliability of income generated in the portfolio. C) increased short-term performance. D) commodity returns have a low or negative correlation to the other assets in her portfolio. Explanation

D) commodity returns have a low or negative correlation to the other assets in her portfolio. The returns on commodities exhibit low or even negative correlation with stock and bond returns. This is generally cited as a major advantage to investing in commodities. Commodities do not generate income; there are no dividends or interest paid on them—the investor recognizes a gain or a loss, but no income. In general, allocating a small percentage of the portfolio to commodities should be viewed as a long-term, not short-term, strategy. There is no evidence that trading costs on commodities are lower than on traditional investments. In fact, it seems likely the opposite is true. LO 5.g

One of the benefits of being a limited partner in a direct participation program is that A) any losses generated by the partnership flow through to the limited partner and can be used against ordinary income in an amount up to $3,000 per year. B) the limited partner can make certain management decisions. C) any income generated by the partnership flows through to the limited partner and is treated as a long-term capital gain. D) the general partner is the only person liable for the debts of the business.

D) the general partner is the only person liable for the debts of the business. In a DPP, it is only the general partners who have full liability; limited partners are liable only to the extent of their investment plus any future commitments. Limited partners lose their status if they undertake any management responsibility. Losses are passive losses and can be deducted only against passive income, not ordinary income. It is capital losses that are subject to the $3,000 limit. Any income is treated as passive income, and that is taxed at ordinary income tax rates, not the lower capital gains rate. LO 5.b