Investment Vehicle Characteristics
Which of the following is NOT a valuation method for a fixed-income security?
Price-to-earnings ratio The P/E ratio is only used with common stock. The parity price is a way to value a convertible bond or convertible preferred stock. DCF is one of the most popular ways to value bonds. The DDM can be used with preferred stock, which, because of its fixed dividend, is considered in the general category of fixed-income security. Reference: 5.3 in the License Exam Manual
For a given amount of principal, which annuity option would produce the largest monthly income stream?
Straight life. This is just an example of the risk/reward philosophy. Taking payments for life only (which can end rather suddenly) exposes the annuitant to greater risk than period certain and joint payout so the rewards are higher. Reference: 8.1.4.1.1 in the License Exam Manual
An investment adviser representative has a client who needs a safe, secure investment that generates regular income. Which of the following choices would be appropriate? I. U.S. Treasury bill. II. U.S. Treasury bond. III. U.S. Treasury note. IV. U.S. Treasury STRIP.
II and III. Treasury Bills and STRIPS are purchased at a discount and pay no interest so neither of them would be appropriate investments based upon the client's need for regular income. Reference: 5.2.1 in the License Exam Manual
A bond's duration is:
longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon. Duration measures a bond's price volatility by weighting the length of time it takes for a bond's cash flow to pay for itself. If two bonds with differing coupon rates have identical maturities, the one with the lower coupon has the longer duration. The cash flow from an interest-bearing bond makes its duration shorter than its maturity. Bonds with longer duration carry greater price volatility. Duration is expressed in years (time) rather than in percentage. Reference: 5.3.3 in the License Exam Manual
One way in which universal life and variable life are similar is that both
permit loans against the cash value As long as the policy has cash value, loans are permitted. Neither of these has a fixed minimum cash value, and only universal life has flexible premiums. Only variable life is considered a security. Reference: 8.2.4.7 in the License Exam Manual
A life insurance policy where the premium increases each time the policy is renewed while the face amount remains level is
renewable level term Level term insurance offers a fixed face amount over the life of the policy. If the policy is renewable, the owner has the ability to renew it for that same face amount and the new term, but at new, higher premiums as the insured's age increases. Reference: 8.2.1 in the License Exam Manual
A terminally ill client wishing to access a portion of the cash value in his whole life insurance policy while still providing a death benefit for his beneficiaries could do so by
taking out a policy loan One of the benefits of whole life insurance is the ability to borrow against the guaranteed cash value in the policy. At death, the amount of the loan is paid off from the death benefit, but the remainder is then paid to the beneficiaries of the policy. Surrendering the policy cancels the death benefit, and the purchaser of the viatical is now the one who determines the beneficiaries. You can't convert permanent insurance to term (and the exam will not consider the situation of leaving the cash value to purchase extended term insurance, which wouldn't work here anyway). Reference: 8.2.5 in the License Exam Manual
If interest rates fall, which of the following bonds would be most affected?
Long-term maturities with low coupons. As a general statement, the longer it has to maturity, the more a bond will react to changes in interest rates. In addition, discount bonds (lower than market coupons) will react more than premium bonds (higher than market coupons) because they have a longer duration. Thus, long-term bonds with low coupons will react more to rate changes than other bonds. Conversely, short-term bonds with high coupons will react the least to changes in interest rates. Reference: 5.3.3 in the License Exam Manual
One of the features of an index annuity is the ability for the principal value to increase based on the performance of the specified index. Which of the following is not used as a method to compute the amount of interest to be credited to the account?
Although the participation rate is a component of the computation, it is not a method of computing the interest credit. In the annual reset index method, interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the contract year. Interest is added to the annuity each year during the term. Using the high-water mark the index-linked interest, if any, is decided by looking at the index value at various points during the term, usually the annual anniversaries of the date the annuity was purchased. The interest is based on the difference between the highest index value and the index value at the start of the term. Interest is added to the annuity at the end of the term. And finally, with the point-to-point method, the index-linked interest, if any, is based on the difference between the index value at the end of the term and the index value at the start of the term. Interest is added to the annuity at the end of the term. In each of these, the insurance company will specify the participation rate (what percentage of the increase will be credited) and a cap rate (the maximum amount to be credited). Reference: 8.1.2.3 in the License Exam Manual
A 64 year-old woman wishes to withdraw funds from her non-qualified single premium deferred variable annuity purchased a number of years ago. The withdrawal would be:
taxed as ordinary income. Yes, I know that only the portion of the withdrawal that exceeds the cost basis is subject to tax, but what else are you going to pick here? Sometimes you have to go with the best choice, even if it isn't the most accurate. Reference: 8.1.5.2 in the License Exam Manual
All of the following are advantages of universal life insurance EXCEPT:
the policy is guaranteed never to lapse. A universal life policy may lapse if the accumulation fund drops below a specified level and an additional premium is not paid. Reference: 8.2.3.5 in the License Exam Manual
The main benefit that variable life insurance has over whole life insurance is:
the potential for a higher cash value and death benefit. Premiums of variable life insurance policyholders are invested in the insurer's separate account. This allows the policyholder the opportunity (though there are no guarantees) to enjoy significant returns and substantially higher cash values than are obtainable through a whole life policy. Reference: 8.2.4 in the License Exam Manual