65 FINAL

Under the Investment Advisers Act of 1940, disclosure of which of the following is required to be made to customers? I Compensation paid to the adviser by the issuer for recommending that security II Compensation paid to the adviser by a broker-dealer for recommending the use of that firm to execute portfolio transactions III Compensation paid to the adviser by an insurance company for the recommendation of insurance products IV The ability of the customer to use any broker-dealer to execute recommended portfolio transactions

ALL. The best answer is D. If an investment adviser receives compensation from anyone other than the customer; related to the rendering of advisory services to that customer; this must be disclosed to the customer. Thus, Choices I, II and III are true. If the investment adviser recommends the use of a broker-dealer to effect recommended trades, (which it will do if the broker-dealer compensates the adviser for these trades); it must inform the customer that any broker-dealer can perform these transactions. The customer does not have to effect these trades through the broker-dealer favored by the investment adviser.

Which statements are TRUE about structured products? I The bond component pays interest based on an index rate such as the performance of the NASDAQ 100 Index II The interest rate paid is typically capped to an annual maximum rate III The derivative component establishes the payment at maturity and protects principal IV The security may be listed on a national securities exchange, but trading is typically very thin

ALL.The best answer is D. Structured products are securities based on, or derived from, a basket of securities, an index, or other securities, commodities or currencies. There are many types of structured products, but generally they consist of a "bond" portion, which pays interest based on the performance of a well known index such as the S&P 500 Index or NASDAQ 100 Index. However, there is most often a cap on the maximum annual return. For example, if there is a 15% cap, and the NASDAQ 100 Index goes up by 18% that year, the structured product will only yield 15%. In addition, structured products have a derivative component (an embedded option) that allows the holder to sell the security back to the issuer (at par) at maturity, protecting principal. These are often marketed as debt instruments, but that is not really the case. Structured products are created by many different brokerage firms and each firm's version is somewhat different. They can be exchange listed, though trading is typically pretty thin.

Which of the following are sources of income that can be used for debt service on municipal revenue bonds? I User Fees II Special Taxes III Lease Rentals IV Capitalized Interest

I,II,III. The best answer is C. A revenue bond is defined as a debt where payment of interest and principal is derived from a source other than ad valorem taxes. Thus, revenue bonds can be paid off by lease rental fees, user fees, and special taxes (such as excise taxes). Capitalized interest is not an income source; rather it is part of the cost of a construction project that is included in the total financing needs when building a facility.

A balance of payments deficit would be widened by which of the following? I Increased levels of U.S. imports II Decreased sales of U.S. securities to foreign holders III Decreased levels of foreign tourists visiting the United States IV Decreased dividends paid to foreign holders of U.S. securities

I,II,III.The best answer is C. As the deficit widens, more dollars are being spent abroad and fewer are being spent in the U.S. Increased levels of U.S. imports will cause more dollars to go outside the U.S., weakening the dollar and widening the deficit. Decreased sales of U.S. securities to foreign holders will decrease the value of the dollar (foreigners have to spend their currency to buy dollar-denominated securities and if demand is weakening, fewer dollars are being bought and fewer purchases in the United States are being made), widening the balance of payments deficit. Decreased levels of foreign tourists visiting the U.S. will widen the deficit, since fewer dollars are being spent in the U.S. by foreigners. Finally, decreased dividends paid to foreign holders of U.S. securities will cause more dollars to stay in the U.S., narrowing the deficit.

Under the Uniform Securities Act, which of the following persons are EXCLUDED from the definition of a "Broker-Dealer"? I An issuer of securities II An agent of an issuer of securities III An agent of a broker-dealer IV A person who has a place of business in the State that only effects securities transactions with institutions

I,II,IIIThe best answer is C. Under the Uniform Securities Act, a "broker-dealer" is defined as a person that engages in the business of effecting securities transactions for the account of others; or a person that engages in the trading of securities for its own account. An issuer is not considered to be a broker-dealer; rather it is an "issuer" and must meet relevant registration requirements for issuers. An agent of an issuer (an employee of that issuer), is also excluded from the definition of a broker-dealer. An agent of a broker-dealer is an employee of that firm that effects securities transactions. Again, this individual is not defined as a broker-dealer. Rather, this person is an agent of the broker-dealer. Finally, a person who has no place of business in that State, and who only deals with institutions, is EXCLUDED from the definition of a broker-dealer. However, this broker-dealer has an office in the State. Because it has a physical location in the State, even though it is dealing solely with professional investors - it still must register in that State! The exclusion is only permitted for broker-dealers with no office in the State that deal solely with professionals.

Under the Investment Advisers Act of 1940 which of the following is (are) disclosed in an investment adviser registration? I The approximate number of advisory clients II The approximate market value of the portfolios managed III The names and addresses of the adviser's clients IV The compensation basis to the adviser

I,II,IV. The best answer is C. The names and addresses of the adviser's clients are not in the Form ADV filed with the SEC. However, the approximate number of clients; approximate market value of portfolios managed; and the compensation basis to the adviser are all disclosed in the Form ADV.

Which of the following guarantees do insurance companies typically give with BOTH fixed and variable annuities? I Mortality guarantee II Expense guarantee III Investment return guarantee IV Benefit amount guarantee

I,II.The best answer is A. Insurers give mortality and expense guarantees for both fixed and variable annuities. Only issuers of a fixed annuity guarantee the investment return and the benefit payment amounts. The investment return and benefit payment amounts from a variable annuity contract are not guaranteed by the issuer - the actual amount to be paid depends on the performance of the underlying securities held in the separate account. Thus, the purchaser of a variable annuity contract assumes the investment risk.

When comparing the statutory voting method to the cumulative voting method, which of the following statements are true? I Cumulative voting gives the shareholder a disproportionate voting weight II Statutory voting gives the shareholder a disproportionate voting weight III Statutory voting allows the shareholder to apply as many votes per directorship as he has shares IV Cumulative voting allows the shareholder to apply as many votes per directorship as he has shares

I,III

Which of the following are attributes of a living trust? I Taxable build-up of earnings in the trust II Tax-deferred build-up of earnings in the trust III Upon death, the decedent's estate avoids probate IV Upon death, the decedent's estate is subject to probate

I,III. The best answer is A. Establishing a trust is primarily done to remove assets from the grantor's estate - that means these assets do not go through probate. Thus, the trustee is certain that the beneficiary will get those assets placed in the trust - there is no will that can be contested. Trusts are federally taxable entities, so there is no tax deferred build-up of earnings in the trust. Trusts do not eliminate estate taxes (otherwise everybody would use them!); and the trustee is subject to the prudent investor rule when selecting investments.

Under NASAA, investment advisers must update their ADV filing made with the State: I yearly, within 90 days of calendar year end II yearly, within 90 days of fiscal year end III within 30 days of any significant material change IV within 90 days of any significant material change

II, III. The best answer is C. Under NASAA rules, investment advisers must update their Form ADV (State registration form) annually, within 90 days of fiscal year end, to reflect current and accurate information and must send the updated Form ADV to its clients within 120 days of year end if there is a material change. In addition, if there is a significant material change in the ADV information that occurs during the year, the filing must be amended within 30 days. The Form ADV is stored in the IARD (Investment Adviser Registration Depository) system. It is used to register both State registered advisers and Federal covered advisers, and to send notice filings to States by Federal covered advisers. Also note that while the annual updating amendment required for both Federal covered and State registered advisers must be filed within 90 days of fiscal year end for either; the filing rule for an "other-then-year" end material change notification is "promptly" under SEC rules for Federal covered advisers; while NASAA requires that it be filed within 30 days for State registered advisers.

Buy and hold is an appropriate strategy when investing in: I stocks II stock mutual funds III stock exchange traded funds IV stock options

II, III.The best answer is C. Because funds are managed by an investment adviser, they are designed to be a "buy and hold" investment. The fund manager is constantly deciding which securities positions to add to, or subtract from, the portfolio to maximize returns. Therefore, the investment is continually rebalanced. Direct investments in specific assets, such as stocks or corporate bonds, require that the investor rebalance periodically to maximize returns.

Which of the following individuals are defined as an agent under the Uniform Securities Act? I An individual who represents an issuer in selling exempt securities II An individual who represents an issuer in selling non-exempt securities III An individual who represents a broker-dealer in selling exempt securities IV An individual who represents a broker-dealer in selling non-exempt securities

II,III,IV The best answer is C. An agent is an individual who represents a broker-dealer selling any type of security - whether it is exempt or non-exempt. Individuals who represent issuers in trading exempt securities or in exempt transactions are not defined as agents. However, an individual who represents an issuer selling non-exempt securities is an agent, and must be registered.

Premiums are invested in an insurance company separate account for which of the following policies? I Whole life II Variable life III Universal life IV Flexible-premium variable life

II,IV. The best answer is D. Variable contracts (either variable life or variable universal life) have the premiums deposited to a separate account. The performance of the separate account determines the ultimate death benefit, so the policyholder bears the investment risk. Flexible premium variable life is another name for variable universal life, which gives policyholders the right to skip a premium payment. Term life, whole life, and universal life premiums are deposited to the insurance company's general account. The death benefit is fixed based upon premium contribution and is not subject to investment risk. The insurance company invests the premiums collected through its general account and bears the investment risk.

The rate of inflation as measured by the Consumer Price Index has been rising rapidly over the last months. Ignoring other factors, the effect will be to: I raise stock market values II lower stock market values III raise bond market values IV lower bond market values

II,IV. The best answer is D. A rising inflation rate is a "lose-lose" situation for both the stock and long term bond markets. If the inflation rate rises, then interest rates are likely to rise, with short term rates rising more than long term rates (the yield curve "flattens" as the Fed tightens credit to tame inflation, with short term rates rising more than long term rates). If interest rates rise, then long term bond prices will fall fastest, and long bondholders will have large losses on their positions. Furthermore, during periods of inflation, corporate earnings tend to fall, because companies are not able to keep raising prices at the same pace as their costs rise. This lowered earnings outlook depresses stock prices. Thus, both stock and long bond prices tend to fall in inflationary periods. Instead, during these periods of high inflation, investors "flee to safety" - they abandon the stock and long term bond markets, and put money in short term money market instruments, which offer safety and relatively high interest rates during inflationary periods; and they also put money into real estate and other "hard" assets that tend to keep pace with inflation.

A sales representative who knowingly misappropriates customer securities for personal use: I has committed a fraudulent and misleading Act II has committed a felony III is subject to civil liability IV is subject to possible fines and/or imprisonment

II,IV.The best answer is D. This sales representative has stolen customer securities, which is considered to be a felony. In this case, the individual is subject to possible fines and/or imprisonment.

Which of the following actions are likely to cause the value of the U.S. Dollar to rise? I The Federal Reserve lowers the discount rate II The Federal Reserve raises the discount rate III United States investors purchase foreign securities IV Foreign investors purchase U.S. securities

II,IVThe best answer is D. If the Federal Reserve raises the discount rate, then interest rates would rise in the U.S. As interest rates rise, so does the U.S. Dollar's value, since dollar denominated investments are more attractive to foreign purchasers. If foreign investors make large purchases of U.S. securities, then they must sell their foreign currency to buy the U.S. dollars needed to pay for that security. As dollars are bought, the value will rise. Conversely, if U.S. investors make large purchases of foreign securities, then they must sell their dollars to buy the foreign currency needed to pay for that foreign security. As dollars are sold, the value will drop.

Under ERISA provisions, a pension fund manager who wishes to write naked index call options: A can only do so if explicitly allowed in the plan document B can do so if the plan document allows for options transactions C can do so without restriction D is prohibited under ERISA requirements

The best answer is A. ERISA does not specify securities strategies that are prohibited. It does state that all investments must meet both "fiduciary responsibility" tests and "prudent man" rule tests. As an example of the use of selling "naked" call options by the investment adviser, the adviser might sell index calls against the portfolio for additional income. Technically, the sale of these calls is "naked" because if the call is exercised, settlement is in cash - not in the delivery of the stocks in the index. However, any loss on the short index calls in a rising market would be offset by a gain on the underlying stocks in the portfolio. If the plan document specifically authorizes such a strategy, it would be permitted. However, the plan trustee bears unlimited liability, if this action is deemed to be imprudent.

Payments received by the owner of a tax qualified variable annuity are: A 100% taxable as investment income B only taxable to the extent of earnings above the holder's cost basis C only taxable to the extent of the holder's cost basis D non-taxable

The best answer is A. Funds paid into "tax qualified" retirement plans were never subject to tax, since the contribution amount was deductible from income at the time it was made. Earnings build up tax deferred in the plan. When distributions are taken, since all of the dollars in the plan were never taxed, all of the distribution is taxable. Funds paid into "non-tax qualified" retirement plans are not tax deductible. Any earnings build up tax deferred. When distributions are taken, the portion that represents the return of original after tax investment is not taxed, while the portion that represents the tax deferred earnings buildup is taxable.

A bond investment strategy that minimizes interest rate risk by adjusting the portfolio duration to match the client's investment time horizon is called: A portfolio immunization B portfolio diversification C portfolio rebalancing D portfolio hedging

The best answer is A. Portfolio immunization is the strategy of managing a portfolio to make it worth a specific amount at a stated date in the future. This strategy is typically used to fund a known future liability. Assume that a customer needs $50,000 in 10 years. If the customer buys a safe 10-year zero-coupon obligation with a $50,000 face amount such as Treasury STRIPS, then the customer will have the needed principal amount 10 years from now. (Note that the duration of the 10 year zero coupon bond is 10 (years) - exactly the same amount of time until the debt must be paid.) The intent of bond portfolio immunization is to eliminate interest rate risk. If the customer were to buy, say, a conventional 30-year Treasury bond to pay off this liability in 10 years, and interest rates rose substantially in the meantime, those bonds would drop in value, and the needed funds would not be there in 10 years. The bottom line is that to immunize a portfolio, the duration of the bonds used to fund the future liability must match the length of time until the liability must be paid.

State registration of a security registered by qualification becomes effective: A when the Administrator so determines B when the SEC registration becomes effective C 10 business days after filing D 20 calendar days after filing

The best answer is A. Registration by Qualification is the most difficult method of registering securities in a State. It is used when an issuer is not registering securities with the SEC and is doing its first time registration in the State. The State knows nothing about the issuer, so it must "qualify" to register securities in the State and the registration is effective only when the Administrator so determines. In contrast, Registration by Coordination "coordinates" an SEC registration with the State registration and the State registration is effective when the SEC registration is effective. Finally, the last registration method - Registration by Filing - can be used by issuers that are either doing SEC filings or by issuers that have previously registered issues in the State. Registration by filing generally becomes effective 5 business days after the filing is completed.

A customer, age 55, has a diversified portfolio of blue chip equity investments that pay a reliable cash dividend. The customer states that he is risk averse and would like to retire at age 65. The customer has an expensive lifestyle, and even though he makes a good income, he uses the dividend income from his investments to pay his large monthly bills. Your immediate concern should be that the: A portfolio needs to be rebalanced to include a percentage allocation to fixed income securities because of the customer's age B customer is unable to take advantage of the compounding effect of reinvesting dividends C customer increases his tax liability by spending the dividends rather than reinvesting them D customer needs to change his spending habits

The best answer is A. This guy is 55 and has his whole portfolio allocated to equities and nothing to bonds, and he says that he is risk averse. If there is a market dump, even though he is invested in quality stocks, they will be clobbered. If we were to use the simple "Take your age and subtract it from 100 rule" to get the equities allocation, we would get a proper allocation of 45% equities and 55% bonds. Since customers are living longer, this is now called the "120" rule. Using 120 minus the customer's age of 65, the customer's equity allocation would be 65%, with 35% in bonds. Regardless, this customer is risk averse and is too old to have 100% of his investments in stocks. The immediate concern is to rebalance the portfolio towards bonds for safety. This is the best answer. Choice B is good too, but it is not an immediate concern. By continually spending the dividends instead of reinvesting them, the customer gives up the compounding effect of adding to his investments each year. To grow the assets faster, the customer should probably cut back on the spending! But this is a longer-term issue. Choice C is clearly wrong - whether cash dividends are spent or reinvested, they are taxable. Choice D is basically the same issue as Choice B - the customer is spending too much and not saving enough. And, again, this is a longer term concern; it is not the immediate problem.

The risk adjusted rate of return of an investment is most closely correlated to the investment's: A alpha coefficient B beta coefficient C delta coefficient D gamma coefficient

The best answer is A. "Alpha" measures the portion of an investment's return arising from "stock specific" risk - that is, the portion of the return that is not variable with the market as a whole. It takes the risk level assumed by that investment for the return achieved and compares it to the benchmark index return, which is "beta-adjusted" to the same risk level. If the portfolio manager achieved an excess return, this is a "positive" alpha and the portfolio manager added value. If the portfolio achieved a lower return, this is a "negative alpha" and the portfolio manager produced an inferior return as compared to the beta-adjusted benchmark return.

All of the following are features of 401(k) plans EXCEPT: A 100% vesting in employer contributions B 100% vesting in employee contributions C Investment options D Matching contributions

The best answer is A. A 401(k) plan is a defined contribution plan established by the employer, but which is funded by employee contributions that are a reduction of that employee's taxable income. In addition, the employer can match a portion of the contribution made by the employee. Contributions made by the employee are immediately 100% vested, since this is the employee's money. In contrast, matching employer contributions are not required to vest 100% immediately - they can vest over the maximum ERISA time frame of 6 years. The employer typically gives the employee investment options in the 401(k) - for example, there might be an option of investing in that employer's stock; investing in a growth mutual fund; or investing in a bond mutual fund. The employee can choose the percentage allocation to each investment type.

Licensing of investment adviser representatives occurs at the: A State level only B Federal level only C Both the Federal and State level D Neither the Federal nor State level

The best answer is A. Advisers that manage $100,000,000 or more of assets; or that render advice to investment companies; or that are not regulated at the State level; must register with the SEC only. Note that the SEC registers the investment adviser only - it does not register investment adviser representatives. The smaller advisers are only required to be registered at the State level. However, the State can require registration of investment adviser representatives for any investment adviser firm.

Investment advisers that manage $100,000,000 or more of assets are subject to: A Federal registration only B State registration only C Both Federal and State registration D Neither Federal nor State registration

The best answer is A. Advisers that manage $100,000,000 or more of assets; or that render advice to investment companies; or that are not regulated at the State level; must register with the SEC only. The smaller advisers are only required to be registered at the State level.

What type of option can be exercised at any time? A American Style B European Style C Eastern Style D Western Style

The best answer is A. An American style option is one that can be exercised at any time. In contrast, a European style option can only be exercised at expiration - not before. Individual stock options are American style; most index options are European style.

Which statement made by a representative when selling an EIA is NOT misleading? A "EIAs are regulated by the State insurance commission" B "EIAs give a minimum guaranteed rate of return at no cost to the purchaser" C "EIAs outperform variable annuities in a bull market" D "EIAs are guaranteed by the PBGC"

The best answer is A. Equity Indexed Annuities are regulated as insurance, so Choice A is true. They do give a minimum guaranteed rate of return, but this adds to the expenses of the product. In a bull market, EIAs are capped to a maximum return of around 9%, so a variable annuity equity separate account will do better. Finally, the only guarantee backing an EIA is that of the issuing insurance company. They are not guaranteed by the Pension Benefit Guarantee Corporation.

An investment adviser that claims that it is a "fee only" adviser could be compensated based on: I a percentage of assets under management II a flat annual or hourly fee for all work performed III 12b-1 fees paid by mutual funds IV commissions paid by broker-dealers

The best answer is A. I, II Advisers that are "fee only" can charge hourly fees, fees based on a percentage of assets under management, and can charge performance fees - but only for wealthy investors (those with either at least $1,100,000 under management or a net worth of $2,200,000 as permitted under the Investment Advisers Act of 1940).) An adviser that advertises itself as a "fee only" adviser cannot be compensated from the sale of products that it sells. It cannot charge commissions on transactions, nor can it receive 12b-1 fees, which are basically annual commissions paid by a mutual fund to the broker-dealer or advisory firm that placed the customer into the fund. In both of these cases, the adviser has an incentive to either actively trade the customer's account in order to receive higher commissions or to place the customer only in those mutual funds that will pay 12b-1 fees to the adviser. A "fee only" adviser is supposed to be completely unbiased in its selection of securities for the customer and the frequency with which it trades the customer's account.

Open market operations of the Federal Reserve: I cause direct changes in M1 II do not cause direct changes in M1 III influence interest rate levels IV do not influence interest rate levels

The best answer is A. I,III Open market operations cause direct changes in money supply levels. (M1 is the money supply measure that includes all currency in circulation and demand deposits). As the money supply expands or contracts, this influences interest rate levels in the economy.

If an agent fails to renew his or her license at the end of the year, the registration: A expires with no action by the Administrator B is automatically renewed and the agent receives a bill for the fee C enters a 30 day grace period, during which it can be reinstated without a complete new filing D is revoked

The best answer is A. If an agent fails to renew his license after the 1 year registration period, the license expires with no action on the part of the Administrator. The renewal is handled by the registration department of the broker-dealer with whom the agent is affiliated.

Under the Investment Advisers Act of 1940, if a registered investment adviser, for the first time, decides to require prepayment of $1,200 or more of advisory fees, 6 months or more in advance of rendering services, the adviser must: A file an audited balance sheet promptly with the Securities and Exchange Commission B file a new brochure with the Securities and Exchange Commission promptly C file a new initial ADV application with the Securities and Exchange Commission D notify customers no later than with the next trade confirmation

The best answer is A. If an investment adviser, for the first time, will take custody of client funds or securities; or if the adviser takes $1,200 or more of prepaid advisory fees, 6 months or more in advance of rendering services; then the adviser must file a balance sheet with the Form ADV Part 2A filed with the SEC. This filing is required "promptly."

An investment adviser, age 33 and married, needs cash for the down payment to buy her first house. She asks her father if he can "help out" with the down payment. Her father is one of her advisory clients. Which statement is TRUE about this situation? A The investment adviser can accept the money from her father if he gives it as a gift B The investment adviser can accept the money from her father if he gives it as a loan C The investment adviser cannot accept the money from the father, whether given as a loan or a gift D The investment adviser can only accept the money from her father if there is a written agreement that details the terms and conditions

The best answer is A. Investment advisers cannot lend money to customers or borrow money from customers. The only exception is if the customer is a bank, broker-dealer, or affiliated company of the adviser. Note that an investment adviser can accept a gift!

Pension Benefit Guaranty Corporation covers: I defined benefit plans II defined contribution plans III corporate pension plans IV government pension plans

The best answer is A. Pension Benefit Guaranty Corporation provides insurance for defined benefit plans formed under ERISA that are terminated (typically due to the closing of a company) that have an unfunded pension liability. Note that PBGC only covers defined benefit plans; it does not cover defined contribution plans (where an annual contribution is made to a separate account for each employee and the employee decides on the investments to be made). Also note that PBGC only covers corporate plans; not government retirement plans.

An investment adviser has its principal office in State X. It also has offices in States Y and Z. The recordkeeping requirements of State Y are more stringent than those of State X and the recordkeeping rules of State Z are the most stringent of all. The investment adviser is required to maintain its records in accordance with the rules of: A State X B State Y C State Z D each State separately under that State's rules

The best answer is A. The Uniform Securities Act states that if an adviser complies with the provisions of the Act as adopted in the State where the adviser has its principal office, then other States cannot impose more stringent recordkeeping requirements or minimum net worth requirements on that investment adviser, even if the adviser has offices in those States.

An investment adviser representative recommends the purchase of DEFF stock to her client. DEFF is currently trading at $50 per share. The client is not terribly eager to make the investment, so the IAR tells the client that over the next 12 months, the adviser will repurchase the stock from the client at no less than $45 per share. This action is: A a prohibited performance guarantee B not a prohibited performance guarantee since the buyback price represents a loss to the client C a repurchase agreement, as defined under State law, since the buyback price is established D a round trip stock transaction

The best answer is A. The prohibition on guaranteeing a client against loss (a performance guarantee) applies not only to a promised buy back at the same price as the original purchase price, but to a promised buy back at ANY price.

The parents of a high school student are planning to send the child to college in one year. The investment adviser representative (IAR) should recommend a portfolio that: A tiers Treasury notes over a 5-year time frame B emphasizes municipal bonds of the state where the customer resides C emphasizes investment grade preferred stocks paying a high dividend rate D allocates funds among aggressive growth stocks and large capitalization stocks

The best answer is A. This child starts college in 1 year, and has another 4 years beyond that to finish school. Since college tuition, books, room and board, etc. must be paid yearly, the best choice is to construct a portfolio that tiers very safe securities such as Treasuries, with each tier maturing annually over the time frame that the student will attend school.

2 years ago a woman leased a new car by putting $2,000 down and signing a 48 month lease at $500 per month. She has received a letter from the lease company saying that she can complete the lease right now by making a single $10,000 payment and keep the car for 2 more years; or she can finish the lease by making the remaining 24 monthly payments of $500. Assuming that this customer can earn 6% by investing in Treasury securities, and ignoring any tax consequences, to determine the best option, the method to be used is: A Net Present Value B Rule of 72 C Expected Return D Future Value

The best answer is A. This customer can get out of the lease by making a $10,000 payment now; or can continue to make $500 per month payments for the next 24 months, paying a total of $12,000 to complete the lease. One method to compute the best option (lowest cost) would be to use net present value. The customer can pay off the lease now by paying $10,000 now - this is the present value of this payment. Using NPV and a 6% risk-free rate of return, the present value of continuing the lease payments is: $6,000 paid in 1 year1.06= $5,660 NPV for year 1 payments$6,000 paid in 2 years1.06(2)= $5,340 NPV for year 2 paymentsTotal NPV = $5,660 + $5,340 = $11,000 Paying off the lease in one payment costs $10,000; while the net present cost of continuing the lease is $11,000. The up-front $10,000 payment is the best alternative (assuming that the customer has the $10,000 on hand!).

Under the Prudent Investor Rule, investment decisions must be made based primarily on: A an overall investment strategy that balances risk and return objectives B maximization of investment return to provide for the future needs of the beneficiary C avoidance of losses, even at the expense of a lowered investment return D those securities stipulated by the State's Legal List

The best answer is A. This one is common sense - the prudent investor rule states that investment decisions should be based on an overall investment strategy that seeks to balance risk and return.

A customer who is retired wants to select an investment that is liquid, marketable, and that provides regular income. The BEST choice would be to recommend: A Treasury Bills B Treasury Notes C Preferred Stock D Certificates of Deposit

The best answer is B. Certificates of Deposit are non-negotiable - they are non-marketable, so this does not meet the client's needs. Preferred stock is marketable, but not as marketable as Treasury securities, making Treasury securities the better choice. So we are left with either a T-Bill or a T-Note. Treasury notes pay interest semi-annually; while Treasury Bills do not provide a regular income stream, so a T-Note is the better choice. (One could argue that buying T-Bills at a discount and letting them mature at par and then rolling over the original investment amount into a new T-Bill purchase will also provide an income stream, but this requires continuous reinvestment on the part of the customer. Buying a T-Note is a completely passive investment in terms of the customer's needs.)

Which of the following are direct obligations of the U.S. Government? A Treasury Receipts B Ginnie Maes C Government Bond Mutual Funds D Fannie Maes

The best answer is B. Ginnie Maes (Government National Mortgage Association issues) are directly backed by the faith and credit of the U.S. Government, since Uncle Sam owns the agency. Fannie Maes (Federal National Mortgage Association issues) are implicitly backed by the Federal Government - Fannie Mae is a publicly held government sponsored corporation listed on the NYSE. Treasury receipts are issued by broker-dealers. The receipts are not backed by the U.S. Government - however the government securities in the underlying portfolio that back the receipt are government guaranteed. Government bond fund shares or units are also not backed by the U.S. Government. However, the securities in the underlying portfolio are government guaranteed.

The Dividend Discount model values common stock by discounting future dividends by the: A expected rate of return B required rate of return C discount rate D risk free rate of return

The best answer is B. The Dividend Discount Model is a way of finding the theoretical price of common stock. It takes the anticipated future dividends to be paid by the company and discounts them to present value. Instead of having to discount each year's anticipated dividend payment, the formula can be reduced to one similar to that for a perpetuity. The reduced formula is: Expected Next Year Dividend Rate Required Rate of Return for Equity Investors - Dividend Growth Rate For example, assume a company is expected to pay a $1 dividend next year. If the required rate of return is 8% and the expected dividend growth rate is 3%, then the projected price of the common stock is $1 Dividend / 8% - 3% = $1/.05 = $20.

An investor buys 1,000 shares of XYZ stock at $34. It goes to $43 in the next year and pays a $3 dividend. At the end of the year following, the stock is trading at $40 and the stock pays another $3 dividend. What is the total return? A 15.0% B 17.7% C 30.0% D 35.3%

The best answer is B. Total return must be presented on an annualized basis. This stock paid a $3 dividend during each of the last 2 years. Over these 2 years, the stock's price went from $34 original cost to $40 at the end of the second year, for a total capital gain of $6 over 2 years = $3 capital gain per year. $3 Dividend + $3 Capital Gain$34 per share = 17.7% Note that the relevant market price for the capital gain is the current market value of $40 per share - any interim price is irrelevant.

A corporation that has a market capitalization of $400,000,000 would be an appropriate investment for a: A Micro CapMutual Fund B Small CapMutual Fund C Mid CapMutual Fund D Large CapMutual Fund

The best answer is B. A "Micro Cap" stock is one with a market capitalization of up to $300 million. A "Small Cap" stock is one with a market capitalization between $300 million and $2 billion. A "Mid Cap" stock is one with a market capitalization between $2 billion and $10 billion. A "Large Cap" stock is one with a market capitalization over $10 billion.

Which of the following municipal securities would be considered a "double barreled" issue? A Revenue Bond backed by two sources of revenue B Hospital Revenue Bond backed by Ad Valorem taxing power C Moral Obligation Bond D Bond Anticipation Note

The best answer is B. A "double barreled" bond is a revenue issue that is also backed by a municipal issuer's taxing power. A revenue bond backed by two sources of revenue is known as a parity bond since the bondholders have equal claim to both sources of revenue backing the bond issue.

A client of an investment adviser, whose long-standing investment objective was "growth," is nearing retirement. With the aid of the investment adviser, the client changes her investment objective to preservation of capital and current income. The best asset allocation mix to recommend to this client is: A 100% common stocks B 50% common stocks; 50% bonds C 10% common stocks; 90% bonds D 100% bonds

The best answer is B. As a client's financial profile changes, so does his or her investment objective. Thus, the Investment Policy Statement must shift to reflect the client's current and expected needs. The client now has an objective of both income and capital preservation would invest in a balance of common stocks and fixed income securities. The fixed income securities provide income; while the common stocks provide little current income. The common stock values will tend to increase over time, as the economy grows, preserving the customer's capital. However, if interest rates rise, forcing the value of the fixed income securities down; the common stock portion of the portfolio would be minimally affected. If economic conditions deteriorate, forcing the value of the common stocks down; then interest rates would tend to fall. This would push up the prices of the fixed income securities in the portfolio, countering the loss in value of the common stocks. Thus, a relatively even mix of common stocks and fixed income securities best meets this customer's needs.

Contributions to a Coverdell Education Savings Account must cease when the beneficiary reaches the age of: A 16 B 18 C 21 D 30

The best answer is B. Contributions to a Coverdell Education Savings Account must stop once the beneficiary reaches age 18.

Which of the following persons is "in the business" of giving investment advice? A A full service broker-dealer who charges higher commissions than discount brokers because of the value of recommendations made B An insurance agent that advertises "no-fee" financial planning but who sells insurance for a commission to advisory clients C A real estate agent who receives a fee from customers to appraise the value of their real estate holdings D An accountant who charges a fee to customers where the services rendered include tax deferral strategies on securities positions

The best answer is B. If an insurance agent creates "no-fee" financial plans, and then takes commissions on insurance policies sold to these customers that are part of the plan, then this person is "in the business" of giving advice about "securities" (since the SEC views financial plans are giving advice about securities) and is "compensated," so this person must register. Broker-dealers who do not charge separately for advice are excluded and need not register; real estate agents appraising real estate holdings are not dealing in securities and are excluded; and accountants who do not charge separately are excluded.

Under SEC rules regarding taking custody of client funds: A custody can only be taken for clients who have at least $1,100,000 under management; or a net worth of at least $2,200,000 B customers must be notified of the location where the funds are being held C customers must receive semi-annual account statements D the advisory firm must be audited, on a surprise basis, at least semi-annually

The best answer is B. If an investment adviser takes custody of customer funds, the adviser must: segregate the customer funds and securities from those of the investment adviser. Note, however, that it is permitted for one customer's funds and securities to be "commingled" with those of other customers - this is the norm when an investment adviser opens an "omnibus" account at a broker-dealer. maintain any account holding customer funds or securities in the name of the investment adviser as trustee for the customer(s). notify the customer, in writing, of the place and manner in which funds and securities will be maintained. Any subsequent change in this requires written notice to the customer. send to each customer, at least quarterly, an itemized account statement. arrange for an independent public accountant to audit the firm annually; with the audit conducted on a "surprise" basis. The report of the independent accountant must be filed promptly with the SEC.

A registered investment adviser, while researching a company, decides that this investment is so compelling that he buys shares for his personal account; as well as recommends them to his customers. Which statement is TRUE? A This action is prohibited B The personal holding must be disclosed to customers who are recommended this security C The personal holding must only be disclosed to customers if it exceeds 5% of the issuer's stock D The investment adviser's personal holdings are proprietary information and are not disclosed to customers

The best answer is B. If an investment adviser will buy a recommended security for his own account; as well as for the account of customers; this is a conflict of interest that must be disclosed to the customers under IA-1092. The problem here is that the buy orders placed for customers may increase the market value of the position, increasing the wealth of the adviser who personally took that position at the same time.

Monetary aggregates have increased over the last month. Which statement is TRUE? A The Federal Funds rate is likely to increase B Loans made by banks are likely to increase C The prime rate is likely to increase D Reserve requirements are likely to increase

The best answer is B. If monetary aggregates increase (such as M 1), then deposits in banks have increased and the banks can loan out most of these funds (they only have to retain the reserve requirement). If there is more credit available, then interest rates are likely to fall.

An investor has a broadly diversified portfolio of blue chip stocks. The use of index options to hedge the portfolio: A reduces non-systematic risk B reduces systematic risk C reduces both systematic and non-systematic risk D cannot be used to reduce any risk since the portfolio is fully diversified

The best answer is B. Index options can be used to hedge a portfolio. If index puts are bought, then a drop in the market lowering the portfolio's value will be offset by a gain in the value of the index puts. This strategy hedges against market risk, also known as systematic risk. Non-systematic risk is the risk that any one security will perform poorly. The larger the portfolio, the lower the effect of non-systematic risk.

All of the following statements are true about registration of investment advisers EXCEPT: A an adviser with no office in the State that limits its clientele to insurance and investment companies is exempt from registration B an adviser that only renders advice on municipal securities is exempt C broker-dealers can act as investment advisers without registering as such if any advice given is solely incidental to the business of the broker-dealer D investment advisers must register with the State

The best answer is B. Investment advisers with no office in the State that limit their clientele to insurance companies and investment companies are exempt from registration because they are dealing with professionals - not the general public. Note that if an adviser is physically located in a State, then it still must register.There is no exemption from registration under state law for investment advisers that solely give advice on municipal securities - this adviser must register in the state. (Note, however, that if the firm only gives advice about U.S. Government securities, it is exempted from registration under both Federal and State law.) If a broker-dealer is registered as such with the state, then a second registration is not required for that firm to act in the capacity of an "investment adviser" - as long as such investment advice is solely incidental to the broker-dealer's business. This avoids the dual registration of these firms. Please note that if this firm were to actually sell investment advice, it would be required to register in the state as an investment adviser. Investment advisers must register in the state unless an exemption is available.

Under NASAA rules, if a customer wishes to trade a margin account prior to returning the signed margin agreement, such an action is: A prohibited B permitted only if the customer returns the signed margin agreement promptly C permitted only if the customer returns the signed margin agreement within 1 day of the first transaction in the account D permitted only if the customer returns the signed margin agreement within 3 days of the first transaction in the account

The best answer is B. NASAA wording states that the signed margin agreement must be obtained promptly after the first transaction in account. In contrast, FINRA requires that the margin agreement be signed and returned prior to settlement of the first transaction in the account. Since this is a NASAA question, the answer is their rule!

If a company in the 50% tax bracket has sales of $2,000 and a gross margin of $100, what is the pre-tax gross margin percentage? A 2 1/2% B 5% C 10% D 50%

The best answer is B. Since this question asks for pre-tax gross margin, the tax bracket is irrelevant. Gross margin is sales minus cost of goods sold. This question gives the gross margin as $100. Taking this as a percentage of sales, $2,000, gives the gross margin percentage. $100 / $2,000 = 5% gross margin percentage.

Tactical asset allocation is a method of: A stock selection B market timing C portfolio rebalancing D portfolio diversification

The best answer is B. Strategic asset allocation is the setting of "strategy" - which is deciding how much of the total investment to allocate to each asset class. Tactical asset allocation permits the manager to vary that allocation upwards by a maximum amount to take advantage of times when market prices for a given asset class are lower than expected; or to reduce exposure to an overvalued asset class. Thus, it permits the manager to "time" the market within the permitted variation.

An Investment Adviser falls below the minimum net capital required by the State on Monday. The IA must file a report with the Administrator no later than: A Tuesday of that week B Wednesday of that week C Thursday of that week D 10 business days after the event

The best answer is B. The NASAA model rule for investment adviser financial requirements (Rule 202(d)-1) states that "every adviser required to be registered in the State shall, by the close of business the next business day, notify the Administrator if such investment adviser's net worth is less than the minimum required." After transmitting such notice, each investment adviser shall file, by the close of business on the next business day, a report with the Administrator of its financial condition, including a: trial balance of all ledger accounts; statement of all client funds which are not segregated; compilation of the aggregate amount of client ledger debit balances; and statement as to the number of customer accounts. Since this IA's net capital fell below the minimum on Monday, notice to the Administrator must be given on Tuesday and the report filed on Wednesday.

Which item is NOT included in a client's income statement? A Salary B Insurance policy amount C Interest from municipal bond investments D Property taxes

The best answer is B. The cash value of whole or universal life insurance is included on the client's balance sheet as an asset. The income statement of the client reflects income (wages, commissions, bonuses, dividends, interest on investments) and expenses (living expenses, taxes, interest paid on loans on a mortgage, insurance expenses, etc.). Note that municipal bond interest received is income - it is just tax-free income.

The interest rate that is used as the "risk free" rate of return is the: A Discount rate B 90-day Treasury Bill rate C 90-day Eurodollar rate D Federal funds rate

The best answer is B. The interest rate used as the basis for the "risk free" rate of return is usually the 90-day Treasury Bill rate (since T-Bills are U.S. Government guaranteed and thus AAA rated; and 90-day T-Bills are a very short maturity, so there is almost no market risk). Note, however, that 1-year Treasuries can also be used as the basis for the "risk free" rate of return.

A registration application in a State filed by an Investment Adviser becomes effective: A on a date so determined by the Administrator B at noon, the 30th day after the application is filed C at noon, the 45th day after the application is filed D at noon, the 60th day after the application is filed

The best answer is B. The wording in the Uniform Securities Act is that: "If no denial order is in effect and no proceeding is pending, registration becomes effective at noon of the thirtieth day after an application is filed." It then goes on to say that: "The Administrator may by rule or order specify an earlier effective date and may by order defer the effective date until noon of the thirtieth day after the filing of any amendment."

A 100-year old company has a very large cash holding and pays a substantial quarterly dividend to shareholders. This would be called a: A growth company B value company C micro-cap company D socially responsible company

The best answer is B. There are not many companies which are 100 years old (GE and Ford are examples). These are usually blue chip companies with very stable earnings. They are value companies because their share prices are usually lower relative to their earnings, reflecting the fact that they do not have great growth prospects. These companies are still able to generate good earnings and make good dividend payouts to shareholders; therefore, they are a good "value."

An 85-year old risk averse investor is not happy about the minimal return she is earning on her current investments. She is stressed about having enough income because her cost of living has been increasing by more than 10% annually. Her current portfolio composition consists of: 40% Money Market Fund 50% Bonds 10% Equities What changes should you suggest to her portfolio? A Reduce the Money Market Fund allocation by 10% (to 30%) and put the released funds in commodities such as gold B Reduce the Money Market Fund allocation by 30% (to 10%) and put the released funds in AAA-rated corporate bonds C Liquidate the entire Money Market Fund allocation and put the released funds in Equities, bringing that allocation up to 50% D Liquidate the entire Money Market Fund allocation and put the released funds in U.S. Treasury securities

The best answer is B. This woman is looking for income. Commodities do not generate income, and equities do not generate as much income as bonds. So we are left with either increasing the allocation given to corporate bonds or to U.S. Government bonds. AAA-rated corporate bonds will yield more than Treasury bonds, and are safe (they are AAA), so this recommendation better meets the customer's needs.

A stock trader believes that the economy is slowing down and that the price of a stock that is his major holding will trend sideways. As a way to enhance income during this time period, the trader should: A buy calls on that stock B sell calls on that stock C buy puts on that stock D sell puts on that stock

The best answer is B. To earn income against an existing stock position, options must be sold to collect the premium. If calls are sold against the long stock position, the customer is a "covered call writer" (if the calls are exercised, the customer delivers the stock that is owned to satisfy the exercise, and hence is "covered" against the risk of having to go to the market and buy the stock at a much higher market price to deliver on an exercise). If the market stays flat as expected, then the calls written against the long stock position will expire and the customer will earn the premium income. If the market falls, the customer loses on the long stock position, partially offset by the premium income received from selling the calls (which will expire). If the market rises, the customer will deliver the stock at the strike price since the calls will be exercised. If the strike price of the calls is about the same as the market value of the stock at the time the calls are written, then if the calls are exercised, there is no gain or loss on the stock - the customer will just earn the collected premium.

Which characteristic is NOT common to both Treasury STRIPS and Treasury Bills? A Minimum $100 denominations B Quoted as a percent of par in 32nds C Pay interest at maturity D Guaranteed by the U.S. Government

The best answer is B. Treasury Bills and STRIPS have a minimum $100 par value; are zero coupon original issue discount obligations that do not have a stated interest rate, paying interest at maturity; and are directly backed by the U.S. Government. T-STRIPS are quoted in 32nds, as are all other long term Treasuries and Agency securities. T-Bills are quoted on a discount yield basis since they are a short term money market instrument.

Which item is used when computing a corporation's Current Ratio? A Net Working Capital B Net Worth C Accounts Receivable D Long-Term Debt

The best answer is C. The Current Ratio is: Current Assets / Current Liabilities. It is a measure of liquidity, because it looks at whether the company can pay its current bills as they come due. Cash, Accounts Receivable and Inventory are the primary "Current Assets." Net Working Capital is Current Assets - Liabilities. Net Worth is All Assets - All Liabilities. Long-Term Debt is not a current liability and is not included.

An offering of fractional interests in oil and gas programs would be registered in a state by: A Filing B Coordination C Qualification D Any of the above

The best answer is C. The Uniform Securities Act specifically says under the definition of an "issuer" that fractional interests in oil and gas programs have "no issuer." This was done to ensure that these must go through Registration by Qualification before being offered in a State, since it is available to anyone, while the other 2 registration methods are only available to securities that have "issuers." What happened here is that there were many frauds selling these securities to investors, so State law is written to make sure that these offerings get the most stringent review before they can be sold in a State.

An agent of a broker-dealer is solicited by the general partner of an oil and gas income program being offered as a private placement only to accredited investors. The general partner explains that for each customer that the agent brings to the general partner, he will pay a finder's fee of 10% of the amount invested. The agent gets 20 copies of a full-color brochure from the general partner and distributes them to his largest customers for their consideration. Based on this information, you should be LEAST concerned about: A a potential violation of Regulation D B whether the investment is defined as a security C the track record of the general partner D the information disclosed in the brochure

The best answer is C. Well, the immediate violation that is present here and NOT addressed in the choices is that the agent is "selling away from his firm." There is no mention that the firm knows what the agent is doing. The agent's customers think they are buying the partnership unit from the broker-dealer, when, in fact, they are not. Rather, the agent has made himself a "statutory broker-dealer" by doing this and is in violation of State law by not being registered as such in the State. However, based on the choices offered, this question really is about private placements under Regulation D of the Securities Act of 1933. First - Is the partnership a "security?" - which it sounds like it is, since the general partner is the manager and the limited partners are passive investors. Second, this is an offering only to accredited (wealthy investors), but there is no mention that the agent checked to see if the customers to whom he sent the brochures were accredited. Third, does the brochure give the disclosures required under Regulation D? These are all legal issues that must be looked at first (remember, this is a test largely written by securities attorneys). The track record of the general partner is a business issue, and while important, will never take precedence over legal issues in a test written by lawyers!

A private fund adviser: A must file Form PF with the SEC B must file Form ADV with the SEC C must file both Form PF and Form ADV with the SEC D is neither required to file Form PF nor Form ADV with the SEC

The best answer is C. A private fund adviser (such as a hedge fund adviser) with at least $150 million of AUM (assets under management) is required to register with the SEC. This is accomplished by filing Form PF - as in Private Fund adviser. In addition, private fund advisers must file Form ADV Parts 1 and 2 with the SEC and update these annually. These are all public documents.

A public company has high cash reserves that are set aside in a "rainy day" fund. The company has a price-earnings ratio of 6:1 while its industry group has a price-earnings ratio of 12:1. The common stock of this company would be classified as: A blue chip B growth C value D bellwether

The best answer is C. A value stock is one that offers good "value." These are companies that are "undervalued" as measured by low price-earnings ratios and low price to book value ratios (a company with a lot of cash and a lower-than-industry-average stock price will have a low price to book value ratio.) The "idea" is that the market will realize that these companies are "undervalued" and their prices will rise accordingly. Blue chip stocks are established industry leader stocks with large market capitalizations; strong management; and strong profitability in good times or bad. A bellwether stock is one that leads its industry segment. A growth stock is one that has higher-than-average growth and a high price-earnings ratio to go along with that.

Which of the following would be defined as a broker-dealer in State A? A The municipal bond department of a bank located in State A B A person who gives advice about investing in securities in State A C A broker-dealer located in State B who has an existing active customer who moves to State A D An agent of a broker-dealer who effects trades in securities in State A

The best answer is C. Banks are excluded from the definition of a broker-dealer, making Choice A incorrect. Choice B defines an investment adviser; not a broker-dealer. Choice D defines an agent of a broker-dealer; not the broker-dealer itself. Choice C gets at an interesting point. Because the customer has moved and is now located in another State (State A), and the customer is "active" -meaning the customer is trading securities, then the firm must be registered as a broker-dealer in State A (and the agent servicing the customer account must be registered in State A as well).

DEFF stock has a beta of +1.5. The expected market rate of return is 8% and the risk-free rate of return is 2%. The standard deviation of returns is 3%. Using the Capital Asset Pricing Model (CAPM), what is the expected rate of return for DEFF stock? A 6% B 8% C 11% D 12%

The best answer is C. CAPM finds the "expected return of an investment" using the formula: Expected Return of An Investment =Risk-Free Rate of Return + Risk Premium* *Risk Premium is: Beta x (Expected Market Return- Risk-Free Rate of Return) Basically, the Risk Premium is the excess of the expected market rate of return over the risk-free rate of return multiplied by the risk level of the investment as measured by beta. Because the expected market rate of return is 8% and the risk-free rate of return is 2%, the risk premium is 6% x 1.5 beta = 9%. Thus, the Expected Return of The Investment is: 2% Risk-Free Rate of Return + 9% Risk Premium = 11%. Note that Standard Deviation has nothing to do with the formula and is a distractor in the question.

All of the following can initiate repurchase agreements with government and agency securities as collateral EXCEPT: A Government securities dealers B Federal Reserve Banks C Federal Home Loan Banks D Commercial banks

The best answer is C. Government securities dealers, Commercial banks, and the Federal Reserve through its open market trading desk, all initiate repurchase agreements. Federal Home Loan Banks sell bonds to obtain funding. With the funds, it buys mortgages from Savings and Loans, making a secondary mortgage market and injecting fresh funds into the S&L's.

Income received from partnership investments is characterized under the tax code as: A earned income B active income C passive income D portfolio income

The best answer is C. Income received from partnership investments is characterized under the tax code as passive income. Passive losses can only be offset against other passive income - they cannot be offset against earned income or portfolio income.

The Value Line Index fund consists of: A all issues traded on the New York Stock Exchange B only issues rated in the top 2 ratings by the Value Line Investment Survey C all companies included in the Value Line Investment Survey D small capitalization issues not listed on the New York Stock Exchange

The best answer is C. Index funds attempt to "shadow" the performance of a designated index, such as the Standard and Poor's 500 index; or the Value Line Index. Such funds match their composition and weighting every day to match the designated index - thus, the Value Line Index Fund would include all stocks included in the Value Line Investment Survey, which is the basis of the index.

An investment adviser personally has a short position of 10,000 shares of ABC stock. The investment adviser believes that the short ABC Corp. position would be a good investment for one of his customers who is bearish on the stock and transfers his short ABC Corp. stock position to that customer at the current market price. This action is: A prohibited because short sales can only be effected on an up-tick B permitted since the adviser believes that it is in the best interests of the client C an unethical business practice unless the conflict of interest was disclosed in advance to the client and the client gave written consent D an unethical business practice because all securities transactions for customers must be effected in the public market

The best answer is C. It is an unethical business practice for an investment adviser to take an opposite position to that being recommended to the customer. To close out the short position, the investment adviser is "buying" this stock that is being "sold short" by his customer. To do so, the conflict of interest must be disclosed in advance to the customer. In addition, when an adviser takes the opposite side of a recommended transaction to a client, the client must give written consent to that trade.

Passive portfolio management is: A buying and holding the investments chosen by the Registered Investment Adviser B determining the securities to be bought or sold based on investment research performed by the Registered Investment Adviser C managing a portfolio to meet the performance of a benchmark portfolio D managing a portfolio to exceed the performance of a benchmark portfolio

The best answer is C. Passive portfolio management is the management of a portfolio to meet the performance of a benchmark, such as a designated index. Active portfolio management attempts to beat the performance of the benchmark portfolio through better security section and better investment timing.

The Prudent Investor Act requires that fiduciaries manage the assets of their beneficiaries based upon: A legal list requirements B efficient market theory C modern portfolio theory D value investing theory

The best answer is C. The Prudent Investor Act, adopted in most States, is a modernization of the "prudent investor rule" restricting the investment authority of fiduciaries. Instead of setting forth a list of "approved" securities (a "legal list") for investment, the Prudent Investor Act allows fiduciaries to use modern portfolio theory for investment decision making. Thus, instead of just investing in securities that have minimal risk, the fiduciary can apply risk-return analysis to choose the "best" investments for the level of risk assumed. Investment performance is not measured on each individual investment, but rather by looking at the overall portfolio return.

During the past year, an agent of a registered broker-dealer has offered partnership units to wealthy investors in a private placement. The agent finds that he has been named in a civil lawsuit filed by one of the buyers of the private placement units, claiming that untrue statements were made by the agent in connection with the sale of the issue. Which of the following is a defense against the buyer's claim that is most likely to be upheld by a court of law? A The agent can claim that the buyer was informed of all material facts and is filing a frivolous lawsuit to extract a large settlement from the agent B The agent can claim that because the investor was wealthy, he or she is "sophisticated" and understood the merits of the transaction prior to entering into a contract to buy the partnership unit C The agent can claim that he took reasonable care to ensure that no untrue statements were made at, or before, the sale of the securities and that the agent did not, and could not, know of the untrue statement D The agent does not have to make a showing in a court of law because the burden of proof rests on the claimant and not on the defendant in civil suits

The best answer is C. The agent is being accused of making untrue statements when selling a security to a customer. Making untrue statements of material fact or omitting statements of material fact when selling securities is fraudulent. However, if the agent can show that he took reasonable care to ensure that no untrue statements were made in connection with the sale of the security and that the agent did not, and could not, know of the untrue statement, then the court will reject the claim of the customer. This is the only defense of the 4 choices offered that addresses the customer's claim. The other defenses offered do not address the customer's claim (e.g., the suit is frivolous; the customer is wealthy and knew what he was doing, etc.)

If stockholders' equity is subtracted from total assets, you are left with: A current liabilities B long term debt C current liabilities and long term debt D retained earnings

The best answer is C. The balance sheet formula is: Total Assets = Total Liabilities + Stockholders' Equity If Stockholders' Equity is subtracted from Total Assets, you are left with Total Liabilities - which consists of both Current Liabilities and Long-Term Liabilities.

With a variable annuity, the insurer takes the risk that expenses for administration will not be more than it expected. What is the charge the insurer makes for taking this risk? A Investment management fee B Administrative expense fee C Expense risk charge D Mortality risk charge

The best answer is C. The expense risk charge compensates the insurer for the expenses that it incurs for administering the contract, and these are capped to a maximum percentage. If the expenses exceed this percentage, then the insurance company is responsible for the excess charges; not the purchaser of the annuity.

Under the Investment Company Act of 1940, an investment adviser's contract is initially set for: A 1 year; and is subject to renewal every year thereafter B 1 year; and is subject to renewal every 2 years thereafter C 2 years; and is subject to renewal every year thereafter D 2 years; and is subject to renewal every 2 years thereafter

The best answer is C. The investment adviser's contract is initially set for 2 years and is then renewed annually. The contract renewal is approved either by the Board of Directors of the Fund; or a majority vote of the outstanding shares.

During the normal sequence of the economic cycle, after a period of recovery, the economy will move to a period of: A depression B recovery C expansion D prosperity

The best answer is C. The normal sequence of the economic cycle is a period of expansion, followed by an economic peak (prosperity), followed by a decline in economic activity (recession), followed by an economic recovery leading to further expansion etc.

The person that administers a trust is the: A grantor B beneficiary C trustee D conservator

The best answer is C. This one is pretty simple. The trustee administers a trust for the benefit of a beneficiary. The person who donates the assets into the trust is the grantor.

A stock with a P/E Ratio of 10 has just closed at $50 per share. This means that the approximate EPS for this company is: A $.20 B $2.00 C $5.00 D $10.00

The best answer is C. To find the EPS, divide the Price ($50) by the "multiple" of 10 = $5 per share EPS. This is correct because the stock is currently trading at 10 times earnings. 10 x $5 = $50 price.

The client of a Registered Investment adviser is dependent upon the income from his portfolio. The client notices that a stock that is owned in the portfolio has declared a dividend and wants to know when he is entitled to that dividend. The RIA should respond that the client is entitled to the dividend as of the: A Declaration Date B Ex-Date C Record Date D Payable Date

The best answer is C. To receive the dividend, the customer must be on the shareholder list, which is taken on the Record Date. The actual checks are sent out on the Payable Date, which is typically 2 weeks after Record Date.

Which of the following persons can use the term "investment counsel"? A Investment advisers who are also attorneys admitted to the Bar in that State B Investment advisers who are also broker-dealers registered in that State C Investment advisers whose primary business is the rendering of investment advice D Any investment adviser registered with the SEC under the Investment Advisers Act of 1940

The best answer is C. Under the Investment Advisers Act of 1940, the term "investment counsel" may only be used by an investment adviser if the giving of advice is the primary business of the firm.

If an issuer files a registration statement with the SEC under the Securities Act of 1933, registration is effective: A immediately B no earlier than 10 days from the filing date C no earlier than 20 days from the filing date D no earlier than 30 days from the filing date

The best answer is C. When a registration statement is filed with the SEC for a new issue under the Securities Act of 1933, the issue enters the "20 day cooling off period," during which time the SEC reviews the filing for full disclosure. Thus, registration cannot be effective until this period elapses.

A 20-year, 6% bond is quoted by a dealer on a 5% basis. The bond is callable in 10 years at par. To calculate the dollar price for the bond, the dealer would use the: A redemption date to find the number of years over which the discount would be earned B call date to find the number of years over which the discount would be earned C redemption date to find the number of years over which the premium would be lost D call date to find the number of years over which the premium would be lost

The best answer is D. This is a premium bond. To approximate the price for a long-term bond, divide the coupon by the basis = 6/5 x $1,000 par = $1,200. The issue is that a premium bond is one that the issuer is likely to call - because the issuer can refund at lower current market rates. To bring a 6% coupon down to a 5% yield implies that 1% will be lost each year = 1% of $1,000 = $10 annual loss of premium. If the bond is called in 10 years at par, the dealer cannot charge a $200 premium because then $20 would be lost each year to the call date. The dealer could only price the bond at $1,100 (so that $100 would be lost over 10 years at the rate of $10 per year). The bottom line is that premium bonds quoted on a yield basis are priced to the near-term call date. This is where the premium is lost the fastest, since the bond will, in all likelihood, be called. In contrast, discount bonds are priced to maturity. These are bonds the issuer will not call, since market interest rates are higher than the coupon rate being paid by the issuer.

Under the Uniform Securities Act, the registration of a broker-dealer may be revoked for all of the following reasons EXCEPT the firm does not: A maintain required records B file financial reports with the Administrator C file advertising with the Administrator D file customer complaints with the Administrator

The best answer is D. A broker-dealer's registration may be revoked if the firm fails to maintain required records, fails to file financial reports with the Administrator or fails to file advertising with the Administrator, if required to do so. There is no requirement under the Uniform Securities Act for customer complaints to be filed with the Administrator.

Under the Uniform Securities Act, a person could give advice about all of the following securities without having to register in the State as an investment adviser EXCEPT: A Treasury Bonds B Ginnie Mae Pass-Through Certificates C Fannie Mae Debentures D State General Obligation Bonds

The best answer is D. A person who gives investment advice relating solely to U.S. Government securities (including Agency securities), is excluded from Federal registration under the Investment Advisers Act of 1940. Any person excluded from registration with the SEC under the Investment Advisers Act of 1940 is a "federal covered adviser" and cannot be required to register in the State. Note that if the person gives advice about municipal bonds (Choice D), that person is not excluded and must register

At the beginning of the year, an investor buys 1,000 shares of XYZ stock, purchased at $33 per share. Subsequently, the stock rises to $40 by the end of the year and the stock pays a $4 dividend during the year. By the end of the following year, the stock has fallen to $25 and pays the same $4 dividend. What is the stock's dividend yield? A 4% B 10% C 12% D 16%

The best answer is D. Dividend yield is based on the current market share price, not on cost of the stock. The annual dividend amount paid is $4 per year. Since the stock is currently trading at $25 per share, the dividend yield is $4 / $25 = 16%.

Which of the following is NOT an ECN? A INSTINET B ISLAND C ARCHIPELAGO D PENINSULA

The best answer is D. ECNs - Electronic Communications Networks - only accept orders for actively traded securities - that is, NYSE listed and NASDAQ stocks. Essentially they are electronic matching services, matching customer buy and sell orders for a very low fee (often as low as $1 per trade). ECNs do not act as dealers - only as agents, earning a fee on each successful transaction. ECN volumes have been growing, as institutions use them to reduce trading costs. The major ECNs are Island, Instinet and Archipelago. (Also note that in 2006, the NYSE purchased Archipelago, and NASDAQ purchased Instinet and Island (which had merged into INET), and are running them as separate trading systems.)

Private equity firms: I make short term investments II make long term investments III in the debt of companies IV in the common stock of companies

The best answer is D. II,IV Private equity investors seek to buy businesses that can be "improved" and then re-sold to other investors at a profit. They are most often structured as privately-held limited partnership entities, whose limited partner investors are often insurance companies, pension funds, very wealthy individuals, etc. Two of the larger private equity firms are Blackstone and The Carlyle Group. When they buy companies, they seek to grow them, aggregate smaller companies into larger firms, improve operations and improve management. They are long term investors, often holding the assets for 5 to 10 years, at which point they cash out by either selling the assets to other investors or taking the company public.

If a broker-dealer with no office in a State with a de minimis exemption is not registered in a State, then it may effect: A trades municipal bonds in that State with customers in that State B trades in corporate bonds in that State with customers in that State C a trade in a municipal bond in that State with a customer that has recently moved to that State D an isolated trade in a corporate bond in that State with a customer in that State

The best answer is D. If a broker-dealer with no office in a State is not registered in a State, then it cannot effect securities transactions in that State - it makes no difference if the securities involved are exempt (such as municipal bonds) or non-exempt (such as common stock). Thus, Choices A and B are incorrect.If the broker-dealer is contacting a customer who is temporarily vacationing in a State in which the broker-dealer is not registered, this is OK. The exclusion does not apply when an existing customer has moved to another State, only if they are vacationing there. Thus Choice C is incorrect. Choice D is only correct if that State has adopted a "de minimis" exemption for broker-dealers (some States have done this, others have not). Most States that have "de minimis" exemptions typically allow up to 3 clients in the State for a non-resident broker-dealer and that broker-dealer is not required to be registered in the State. Thus, Choice D is a true statement, since this State has a "de minimis" exemption. Finally, if the broker-dealer with no office in the State only effects transactions with institutional investors in the State, then the general public is not being solicited and the firm is excluded from the definition of a broker-dealer.

What is a benefit of investing in precious metals? A Exchange trading B Aesthetic value C Price stability D Inflation protection

The best answer is D. Investing in precious metals, such as gold, silver, platinum and palladium, is most often done as either an inflation hedge or as a protective investment in a bear market. When there is high inflation, precious metals' values tend to increase with inflation, whereas stock and bond prices fall. Part of the reason for this is that high inflation leads to falling stock and bond prices, so investors "flee to safety" and buy gold (and other precious metals), pushing their prices up. Precious metals are not exchange traded - they are sold through dealers. While coins made from precious metals might have aesthetic value, the precious metals themselves do not (other than it is shiny!). Finally, precious metals' price movements can be quite volatile, and this is a risk of the investment.

Which of the following risks is the primary concern when investing in a municipal bond? A purchasing power risk B market risk C credit risk D legislative risk

The best answer is D. Legislative (regulatory) risk is the risk of law changes; primarily the risk of tax law changes. Since the interest income from municipal bonds is exempt from Federal income tax, the main risk associated with these securities is that the Federal government may attempt to tax their interest income (this has already happened with certain types of municipal bonds). Also note that these securities are subject to purchasing power risk, market risk, and credit risk; but this is not the "primary" concern with these investments.

All of the following statements concerning mutual funds are correct EXCEPT fund shares: A must be offered for sale continuously B must be redeemed upon request C do not trade on stock exchanges D fluctuate in price due to supply and demand

The best answer is D. Mutual funds offer their shares for sale continuously and must redeem shares upon request. A mutual fund can issue only one class of voting common stock. Mutual funds cannot issue preferred stock or bonds.Mutual fund shares do not trade on stock exchanges. Their shares are purchased from the fund and are redeemable with the fund. The purchase price or redemption price is based on the next computed NAV per share. Thus, supply and demand does not determine the share price.

Registration of securities in a State by Coordination becomes effective: A when the filing with the State is completed B 2 business days after the filing with the State is completed C 5 business days after the filing with the State is completed D when the Federal registration becomes effective

The best answer is D. Registration of securities in a State by coordination becomes effective at the same time that the Federal registration becomes effective. However, the Administrator requires that the registration information be on file with the State for at least 10 business days prior to the State registration becoming effective.

12b-1 fees are assessed by investment companies: A when shares are purchased B when shares are redeemed C when shares are exchanged D as shares are held

The best answer is D. SEC Rule 12b-1 allows management companies to charge against total net assets, an annual fee for the cost of soliciting new investors to the fund. In reality, though the fee is expressed as an annual percentage of total net assets, it is imposed pro-rata for every day that the investor holds the shares.

A trader liquidates a single stock position and invests the proceeds in a stock index fund. The trader has reduced: A Market risk B Inflation risk C Liquidity risk D Business Risk

The best answer is D. The best of the choices is that this trader is reducing business risk. Since this trader is liquidating a single stock position, and investing the proceeds in an index fund (which is diversified), the trader is reducing the unsystematic risk or business risk inherent in a single stock position. Market risk is the risk that the market will drop and takes all stocks with it. This is a risk that cannot be diversified away.

The quantitative method of evaluating investments that finds the interest rate that discounts periodic cash inflows and outflows to a present value of "0" is: A inflation-adjusted return B net present value C total return D internal rate of return

The best answer is D. The internal rate of return of an investment is the implicit interest rate that discounts the cash flows generated by the investment to a value of "0." This is the true "yield" of the investment, considering the time value of money. Net present value takes the expected annual cash flows from an investment over the years and discounts them, using the market rate of interest compounded over time, to today's "present value." This is basically the opposite of future value.