CFP Investment Planning Securities Markets and Money Market Instruments

A client has $12,000 of capital gains and $15,000 of capital losses. How much unused loss is carried forward to the following tax year? A) $15,000 B) $0 C) $3,000 D) $12,000

The answer is $0. After netting capital gain and losses, the client has a net capital loss of $3,000. Because $3,000 of net losses can be deducted during any one tax year, there is no carryforward.

A strategy where investors with relatively large amounts of money to invest purchase multiple certificates with varying terms to maturity is A) swapping. B) laddering. C) staging. D) bulleting.

Laddering is the process of purchasing multiple CDs with staggered maturities, that are equally spaced, and with varying interest rates. As each CD matures, a CD is purchased with a maturity equal to the longest in the ladder. This strategy is used to manage interest rate risk. LO 1.1.1

Lloyd is a dealer in government securities. He has purchased government securities from another dealer, Fred, and has agreed to sell them back at a later date. From Lloyd's perspective, which transaction has been executed? A) Repurchase agreement B) Promissory note C) Reverse repurchase agreement D) Commercial paper investment

Lloyd, as the buyer, has entered into a reverse repurchase agreement, and Fred, as the seller, has entered into a repurchase agreement. 1.3.1

Mike places a market order to sell short 200 shares of ABC stock. The order is filled at $23.45 per share. Assuming he can cover the short by purchasing the shares at $20 per share, calculate his gain or loss. A) Loss of $345 B) Gain of $690 C) Gain of $850 D) Loss of $690

Mike will have a gain of $690 on the shares of XYZ stock. $23.45 proceeds - $20.00 cost $3.45 gain × 200 shares = $690 LO 1.2.1

What is the highest long-term capital gains rate on collectibles? A) 15% B) 20% C) 28% D) 25%

The answer is 28%. The long-term capital gains tax rate on collectibles (tangible assets other than real estate) is capped at 28%. LO 1.4.1

When investment bankers absorb the loss on an initial public offering, which one of the following terms represents this type of offering? A) Best efforts B) Firm commitment C) Green shoes D) Secondary offering

The answer is firm commitment. Firm commitment underwriting occurs when investment bankers purchase all shares from a company and resell them to the public at their own risk. LO 1.1.1

Identify which of the following statements regarding U.S. Treasury bills is CORRECT. They are purchased at 50% of face value. They are sold at auction in denominations ranging from $50 to $10,000. They are not subject to the original issue discount (OID) taxation rules. They are sold with maturities up to two years. A) III only B) I, II, and III C) I and II D) II and IV

A. U.S. Treasury bills are purchased at a discount to face value determined at auction. The lowest purchase amount is $100. They are not subject to the OID rules. T-bills have a maturity date of no more than one year. LO 1.3.1

All of the following statements correctly describe certificates of deposit (CDs) except A) CDs are commonly referred to as time deposits. B) CDs typically pay a variable interest rate. C) redemption prior to maturity typically results in an early withdrawal penalty. D) CDs are eligible for FDIC coverage.

Explanation B. The answer is CDs typically pay a variable interest rate based on the term of the certificate. CDs typically pay a fixed interest rate, with higher interest rates offered for longer-term certificates. LO 1.3.1

Which of the following statements best describes banker's acceptances? A) Negotiable, short-term, unsecured promissory notes issued by large corporations B) U.S. dollar-denominated deposits at banks outside the United States C) Promissory notes traded at a premium from their face value in the secondary market D) Short-term drafts drawn by a private company on a major bank used to finance imports and exports

Explanation Banker's acceptances are typically traded at a discount from their face value in the secondary market. Eurodollars are U.S. dollar-denominated deposits at banks outside the United States. LO 1.3.1

A money market mutual fund manager recently purchased negotiable, short-term, unsecured promissory notes issued by a number of large corporations for the portfolio. Select the type of investment the money manager purchased. A) Reverse repurchase agreements B) Repurchase agreements C) Banker's acceptances D) Commercial paper

Explanation Commercial paper is usually issued in denominations of $100,000 or more and is a substitute for short-term bank financing. Commercial paper is normally sold at a discount and is rated for quality by a rating service.

Select the arrangement that is commonly used by dealers in government securities to satisfy short-term liquidity needs. A) Commercial paper B) Repurchase agreement C) Negotiable CDs D) Banker's acceptance

Explanation Dealers in government securities use repurchase agreements, or repos, to satisfy short-term liquidity needs. LO 1.3.1

Identify which of the following statements pertaining to the various types of money market investments is CORRECT. Commercial paper offers higher yields than T-bills. Eurodollars are U.S. dollar-denominated deposits at banks outside of the United States. Banker's acceptances are short-term drafts drawn by a private company on a major bank to finance imports and exports. T-bills are subject to default risk and a lack of marketability. A) IV only B) II and IV C) I, II, and III D) II, III, and IV

Explanation Only statement IV is incorrect. T-bills are not subject to default risk and exhibit a high degree of marketability. As a result, the 90-day T-bill is often used as a proxy for the risk-free investment. LO 1.3.1

Galen has come to his financial planner with questions about dividends he received on some of his stock this year. He has received $1,000 in qualified dividends paid in cash. He also has received stock dividends of $4,000, but without a cash dividend option. How much will Galen have to report as dividend income for the current year? A) $5,000 B) $0 C) $4,000 D) $1,000

Explanation The answer is $1,000. Only the dividends paid in cash to Galen that are reported as income. The stock dividends did not have a cash-dividend option and are not taxable. LO 1.4.1

Choose the risk that is attributable to cash and cash equivalents. A) Marketability risk B) None of these because cash and cash equivalents are considered risk-free C) Liquidity risk D) Purchasing power risk

Explanation The answer is purchasing power risk. Cash and cash equivalents are subject to purchasing power (inflation) risk because they offer limited potential for growth. LO 1.3.1

Which of the following statements best describes banker's acceptances? A) Promissory notes traded at a premium from their face value in the secondary market B) Negotiable, short-term, unsecured promissory notes issued by large corporations C) Short-term drafts drawn by a private company on a major bank used to finance imports and exports D) U.S. dollar-denominated deposits at banks outside the United States

Explanation The answer is short-term drafts drawn by a private company on a major bank used to finance imports and exports. Banker's acceptances are typically traded at a discount from their face value in the secondary market. Eurodollars are U.S. dollar-denominated deposits at banks outside the United States. LO 1.3.1

Which of the following best describes the term marketability? A) The ability to sell an investment with a significant loss in principal. B) The ability to sell an investment quickly in a readily identifiable market. C) The ability to sell an investment quickly at a specific price. D) The ability to sell an investment quickly without transaction costs.

Explanation The answer is the ability to sell an investment quickly in a readily identifiable market. Liquidity is the ability to sell or redeem an investment quickly and at a known price, without a significant loss of principal. LO 1.3.1

Your client, Ralph, has $15,000 of capital gains and $20,000 of capital losses in the current tax year. How much unused loss may Ralph carry forward to the following tax year? A) $12,000 B) $2,000 C) $0 D) $3,000

The answer is $2,000. After netting capital gain and losses, the client has a net capital loss of $5,000. Because $3,000 of net losses can be deducted during any one tax year, the client will carry over the remaining $2,000 capital loss.

Nellie has accumulated $500,000 in a money market deposit account at ABC Bank and Trust. She is worried about the number of bank failures in the recent years and transfers $250,000 into a money market mutual fund paying a slightly higher return offered by her friend's investment firm. Determine the amount she has insured by the Federal Deposit Insurance Corporation (FDIC). A) $200,000 B) $0 C) $250,000 D) $500,000

The answer is $250,000. Nellie's FDIC insured funds remain at $250,000. The money market deposit account is insured up to $250,000, but the money market mutual fund is not FDIC insured.

Carly purchased $80,000 of JEM stock for $40 per share utilizing her margin account. She used $40,000 in her money market fund plus she borrowed $40,000 from her broker. She acquired a total of 2,000 shares of JEM stock. JEM stock is currently trading at $39.65 per share. Calculate the stock price that Carly would receive a margin call from her broker. Assume a maintenance margin requirement of 35% and an initial margin requirement of 50%. A) $30.77 B) $30.50 C) $29.68 D) $30.23

The answer is $30.77. Carly would receive a margin call when the stock fell to $30.77 per share. Margin call = [(1 − initial margin percentage) ÷ (1 − maintenance margin)] × purchase price of the stock = [(1 - 0.50) ÷ (1 - 0.35)] × 40 = 30.7692, or $30.77.

On December 27, 20X0, Jackie sells ABC stock for a loss at $12 a share that she originally purchased for $28 per share. On January 9, 20X1, she repurchases the shares for $15 per share. What is her cost basis on the repurchased shares? A) $40 B) $31 C) $27 D) $16

The answer is $31. This is a wash sale because the shares were repurchased within 30 days of their sale. The loss is then disallowed for tax purposes, and the disallowed loss is added to the repurchase price to determine the new cost basis. $28 - $12 = $16 disallowed loss, so $16 + $15 = $31 new basis.

Cosmo has a margin account with a balance of $50,000 with a national broker-dealer. The initial margin requirement on this account is 50%. Cosmo is interested in purchasing shares of Aardvark Inc., which is currently selling at $40 per share. Assuming the maintenance margin is 40%, what would the price of Aardvark be before Cosmo would receive a margin call? A) $37.50 B) $16.00 C) $33.33 D) $24.00

The answer is $33.33. Margin call = (50% × $40) ÷ (1 - 0.40) = $33.33.

Your client has just opened a margin account with your brokerage firm and purchased 500 shares of stock for $60 per share. The firm has a 55% initial margin and 35% maintenance margin policy. Calculate the stock price at which your client will receive a margin call. A) $41.54 B) $27.00 C) $50.76 D) $31.43

The answer is $41.54. The client will receive a margin call when the price of the stock drops below $41.54, calculated as follows: Margin call = ($60 × 0.45) ÷ (1 - 0.35) Margin call = $27.00 ÷ 0.65 = $41.5385, or $41.54

On December 18, 20X1, John sells some stock for a loss at $15 a share that he originally purchased for $40 per share. On January 9, 20X2, John repurchases the shares for $22 per share. What is his cost basis on the repurchased shares? A) $22 B) $15 C) $40 D) $47

The answer is $47. This is a wash sale because the shares were repurchased within 30 days of their sale. The loss is then disallowed for tax purposes, and the disallowed loss is added to the repurchase price to determine the new cost basis. $40 - $15 = $25 disallowed loss, so $25 + 22 = $47 new basis.

Amanda buys 75 shares of BR Enterprise stock for $67 per share on margin. The initial margin is 55%, and the maintenance margin is 40%. Calculate the market price at which Amanda will receive a margin call. A) $50.25 B) $56.95 C) $21.54 D) $33.00

The answer is $50.25. Margin call = ([1 - initial margin percentage] ÷ [1 - maintenance margin]) x purchase price of stock : $67 × ([1 − 0.55] ÷ [1 − 0.40]) = $67 x (0.75) = $50.25

An investor buys 100 shares of stock at $75 per share, with a 60% initial margin requirement and 40% maintenance margin requirement. Assuming the stock quickly falls to $40 per share, calculate the additional capital that the investor must provide to cover a margin call. A) $400 B) $800 C) $200 D) $600

The answer is $600. The current market value of the 100 shares is $4,000. The maintenance margin requires an equity of $4,000 × 0.40, or $1,600. The investor's equity in the account ($1,000) is the market value ($4,000) minus the loan amount ($3,000). A margin call for $600 ($1,600 - $1,000) will be ordered.

Brett bought 500 shares of WCA stock at $27 per share on margin (50% initial margin percentage) with an annual margin interest rate of 5.25%. After one year, he sold the shares for $44 per share. The stock did not pay dividends during his holding period. Calculate Brett's holding period rate of return using margin. A) 125.93% B) 60.00% C) 120.68% D) 57.42%

The answer is 120.68%. Brett's holding period rate of return using margin is 120.68% [($22,000 - $13,500 - $354.38) ÷ $6,750]. With a margin account, Brett's initial investment will be 50% of the total purchase price of $13,500. Margin interest for the year is $354.38 ($6,750 × 0.0525).

All of the following statements correctly describe a type of money market instrument except A) Eurodollars are Eurodollar-denominated deposits maintained at banks within the United States. B) commercial paper is a short-term, unsecured promissory note issued by large firms and offers a nominally higher yield than T-bills. C) banker's acceptances are short-term drafts drawn on major banks to finance imports and exports. D) negotiable CDs are deposits of $100,000 or more and are traded in the open market.

The answer is Eurodollars are Eurodollar-denominated deposits marinated at banks within the United States. Eurodollars are U.S. dollar-denominated deposits in banks outside the United States. The average deposit is in the millions and has a maturity of less than six months.

Limited partnerships are distinguished by which of the following? The general partner controls the business activities of the partnership. The limited partners participate in the business venture with limited liability. The general partner determines when distributions are made to the limited partners. The limited partners may have difficulty selling their interests. A) I and III B) I, II, III, and IV C) I, II, and III D) II and IV

The answer is I, II, III, and IV. Limited partnerships are characterized by a partnership entity that consists of a general partner and limited partners.

Identify which of the following statements regarding money market deposit accounts (MMDAs) are NOT correct. They are FDIC insured. They offer unlimited check writing privileges. They are primarily offered by open-end investment companies. They require a minimum balance. A) I and IV B) III and IV C) I and II D) II and III

The answer is II and III. MMDAs provide limited check writing privileges and are offered by banks and savings and loans. MMDAs require a minimum balance. Unlike money market mutual funds, MMDAs are FDIC insured.

Which of the following types of federal income tax treatment generally apply to municipal bonds? Ordinary income Tax-free income Capital gains or losses Tax-deferred income A) II and IV B) II and III C) I and IV D) I and III

The answer is II and III. Municipal bond interest is received federal income tax free by the bondholder. In addition, when a municipal bond is sold by the investor, the net proceeds above/below basis may be subject to capital gain/loss.

All of the following statements concerning the types of orders used to buy and sell securities are correct except A) a stop order is an order specifying a certain price at which a market order takes effect. B) a good-til-canceled (GTC) order is an order to buy or sell a security at a specific or limit price that lasts until the order is completed or canceled. C) a market order has the lowest priority and is subject to the fluctuations and timeliness of the market. D) a limit order is an order to buy or sell at a specified (or better) price.

The answer is a market order has the lowest priority and is subject to the fluctuations and timelines of the market. The market order, which is the most popular and has the highest priority, is subject to the fluctuations and timeliness of the market.

Which of these is NOT correct when defining an accredited investor under Rule 501 of Regulation D? A) A director, executive officer, or general partner of the company selling the securities B) A natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase, including the equity in a primary residence. C) A charitable organization, corporation, or partnership with assets exceeding $5 million D) A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year

The answer is a natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase, including the equity in a primary residence. The $1 million net worth requirement excludes the equity in the investor's primary residence.

All of the following correctly describe disadvantages of cash and cash equivalents except A) an investor may quickly convert a money market deposit account to cash to meet short-term needs. B) investments in money market mutual funds are not insured or guaranteed by the U.S. government. C) investors choosing to redeem their certificates of deposit (CDs) prior to maturity may be subject to a substantial penalty. D) the rate of return on passbook savings accounts is relatively low when compared to higher risk alternatives such as government bonds.

The answer is an investor may quickly convert a money market deposit account to cash to meet short-term needs. One of the advantages of money market deposit accounts is their liquidity. They may be used by investors as a source of funds to meet emergencies and other short-term obligations.

Which of the following statements regarding certificates of deposit (CDs) is CORRECT? CDs are deposits made with a bank or savings and loan for a specified period, commonly one month to five years. Negotiable CDs are deposits of $100,000 or more placed with commercial banks at a specified interest rate for a term of up to one year. A) I only B) Both I and II C) Neither I nor II D) II only

The answer is both I and II. Both of these statements accurately describe CDs.

Which of the following statements regarding wash sales is CORRECT? A wash sale occurs if the taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities. The wash sale rules are easily avoided in the case of fixed-income securities by substituting a bond with the same or similar characteristics as long as it is issued by a different company. A) I only B) Both I and II C) Neither I nor II D) II only

The answer is both I and II. Both of these statements describe characteristics of wash sales.

When considering the purchase of a limited partnership interest, an investor should be most concerned with A) short-term trading opportunities. B) loss pass-through. C) economic viability. D) potential tax shelter.

The answer is economic viability. Economic viability is the number one reason for the purchase of an interest in a limited partnership. Tax sheltering and loss pass-through are also considerations but should not be the primary motive to invest. Short-term trading opportunities do not exist. The investor should expect to hold the interest until the partnership is dissolved or liquidated.

All of the following correctly identify advantages of U.S. Treasury bills except A) investors are provided a high degree of safety. B) interest income is not subject to federal income tax. C) they are not subject to default risk. D) investors can tailor purchases to meet short-term goals and obligations.

The answer is interest income is not subject to federal income tax. Interest income from U.S. Treasury bills is taxed at ordinary federal income tax rates but is not subject to state income tax. LO 1.3.1

Income or dividends produced by which of the following securities is exempt from federal income tax? A) Municipal bonds B) Common stock C) Corporate debt D) U.S. Treasuries

The answer is municipal bonds. Income produced by municipal bonds is exempt from federal income tax.

Which of the following accurately describes the certificate of deposit investment strategy known as laddering? A) Purchasing multiple certificates of deposit (CDs), rather than just one, with equally spaced terms of maturity B) Immediately purchasing another certificate as one certificate matures C) Redeeming a certificate of deposit and reinvesting in a new certificate when interest rates increase D) Purchasing certificates in progressively increasing deposit amounts

The answer is purchasing multiple certificates of deposit (CDs), rather than just one, with differing terms of maturity. Investors with relatively large amounts of money to invest should purchase multiple certificates with equally spaced terms to maturity, a strategy known as laddering.

A risk-averse client, living in Iowa, holds a high proportion of his investment portfolio in cash and cash equivalents in U.S. financial institutions in dollars. The advisor should point out to the client that the portfolio is most subject to which of the following risks? A) Reinvestment rate risk B) Exchange rate risk C) Market risk D) Purchasing power risk

The answer is purchasing power risk. Although these vehicles may assist in managing liquidity risk, they do have purchasing power risk because they have limited opportunity for capital appreciation. Exchange rate risk does not apply because this is a U.S. client with investments denominated in dollars.

Grant calls his broker and tells her to sell his XYZ stock if it falls to $20, but he does not want less than $19.75 for his shares. Select the type of order that his broker should place to sell the stock. A) Market order B) Limit order C) Stop limit order D) Good-til-canceled order

The answer is stop limit order. The stop limit order turns into a limit order when triggered (both the stop order price and the limit order price are specified). However, this type of order will not guarantee execution if the stock leapfrogs past the $19.75 mark.

All of the following correctly identify features of limited partnerships except A) the general partner determines when distributions are made to the limited partners. B) the limited partners have limited liability. C) the limited partners may participate in the management of the partnership. D) the general partner controls the business activities of the partnership.

The answer is the limited partners may participate in the management of the partnership. Disadvantages of limited partnerships include the following: (1) they are generally riskier than bonds or exchange-traded equities; (2) they are generally illiquid; (3) limited partners cannot participate in the management; and (4) the sale of partnership interest may be restricted. In addition, the general partner has unlimited liability. LO 1.1.1

All of the following are features of limited partnerships except A) the limited partners have limited liability. B) the limited partners may participate in the management of the partnership. C) the general partner controls the business activities of the partnership. D) the general partner determines when distributions are made to the limited partners.

The answer is the limited partners may participate in the management of the partnership. The disadvantages of limited partnerships include: (1) they are generally riskier than bonds or exchange-traded equities; (2) they are generally illiquid; (3) limited partners cannot participate in the management; and (4) the sale of partnership interest may be restricted. In addition, the general partner has unlimited liability.

To be eligible for preferential dividend tax rates A) the stock must be held for more than 60 days during the 121-day period beginning 60 days BEFORE the ex-dividend date. B) the stock must be held for more than 60 days during the 121-day period beginning 60 days AFTER the ex- dividend date. C) the stock must have paid dividends for four consecutive quarters. D) the taxpayer must make an election to waive tax deferral on the dividend.

The answer is the stock must be held for more than 60 days during the 121-day period beginning 60 days BEFORE the ex-dividend date. Investors should take special note of the holding period requirement for a stock in order for the dividend to qualify for the preferential rates. The stock must be held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date.

What is the holding period requirement for a stock investor for the dividend to qualify for the preferential tax rates? A) The stock must have paid dividends for two consecutive quarters. B) The stock must be held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. C) The stock must be held for more than 30 days during the 61-day period beginning 10 days before the ex-dividend date. D) The taxpayer must make an election to reinvest any cash dividends.

The answer is the stock must be held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date.

Which of the following statements regarding cash distributions of ordinary and capital gains dividend distributions to mutual fund investors is CORRECT? A) They are added to the tax basis of the shares once taxes on the distributions are paid B) They decrease the cost basis of the shares whether or not taxes are paid C) They are fully taxable to the investor D) They decrease the taxable gain or increase the loss on sale of the shares after taxes are paid

The answer is they are fully taxable to the investor. Ordinary and capital gain dividend distributions are taxable. If these distributions are reinvested, the individual receives an increased tax basis. If the distributions are made in cash, there is no increase in the tax basis of the underlying securities.

Identify the incorrect statement regarding savings accounts. A) They offer a relatively low interest rate B) They require a minimum balance of $500 C) Depositors are permitted to withdraw their savings at any time without penalty D) Accounts are established with a commercial bank or savings and loan

The answer is they require a minimum balance of $500. Money market deposit accounts (MMDAs) would require a minimum balance.

Equity investments made for the launch, early development, or expansion of a business are known as A) venture capital. B) mezzanine financing. C) leveraged buyouts. D) distressed debt investing.

The answer is venture capital. Equity financing associated with the early development of a business is called venture capital. Mezzanine financing is provided for expansion and new products. Leveraged buyout financing is provided to allow management to buy all or part of a business; often used when a public company divests a division that it feels is no longer part of its long-term plans. Distressed debt is distressed debt investing in the debt of companies that are in trouble or failing.

The market designed to facilitate the initial sale of securities to the public is referred to as the A) secondary market. B) primary market. C) third market. D) fourth market.

The purpose of the primary market is to facilitate the sale of initial public offerings (IPOs) of securities to the public.

Robert owns 400 shares of Intel stock that he purchased several years ago for $60 per share. Intel's current market price is $48 per share. On December 17, Robert decides to buy an additional 200 shares of Intel stock. On December 23, he decides to sell 200 shares that he purchased several years ago so that he can claim a loss on his current year's tax return. Which of the following statements is true? The loss will be disallowed, but Robert will have to reduce his tax basis in the shares he purchased on December 17 by the amount of the loss. The loss will be disallowed; the transactions are illegal and tax penalties will be imposed. The loss will be disallowed; the amount of the disallowed loss will be added to the cost basis of the shares purchased on December 17. The transaction is called a wash sale; wash sale rules apply when shares are sold for a loss and repurchased within 30 days before or after the sale date.

The transaction is a wash sale; losses are disallowed when substantially identical shares are repurchased within 30 days before or after a sale. The transaction is not illegal and no tax penalties are imposed on the transaction itself. The basis of the stock is adjusted for the disallowed loss. LO 1.4.1