Part 3 Investment Vehicle Characteristics

Which of the following investments would NOT be considered an exchange-traded derivative? A) Options B) Forwards C) Futures D) Warrants

B....Forwards are never traded on an exchange; the other 3 choices can be traded OTC or on an exchange.

Compared to a publicly-traded fund, a private equity fund is most likely to A) be more concerned with short-term results. B) exhibit stronger corporate governance. C) provide more details regarding its financial performance. D) disclose less information about its financial performance.

D...Private equity funds are not held to the same financial reporting requirements as publicly-traded funds. Less public scrutiny and limited financial disclosure may lead to weaker corporate governance. Private equity funds generally need several years before the fruits of their labor are ready to be harvested.

All of the following are characteristics of a rights offering EXCEPT A) it is issued to current stockholders B) the subscription price is below the current market value C) the rights are marketable D) the subscription period is up to 2 years

D...Rights offerings are usually very short-lived (30 to 45 days).

KapCo Balance Fund has a NAV of $9.50 and POP of $10. Over the past 12 months, it distributed dividends totaling $.75 and capital gains totaling $1.00. What is KapCo's current yield? A) 7.5% B) 10% C) 7.9% D) 17.5%

a....This question gives you excess information. The first point is that capital gains are not included in calculation of a mutual fund's current yield. You must also remember that the NAV is not involved. The calculation is: $0.75 (annual dividend) = 7.5%$10.00 (POP)

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

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

Surrender charges may cause a reduction to all of the following EXCEPT A) the death benefit of a variable life insurance policy B) the liquidation value of a variable annuity C) the cash value of a variable life insurance policy D) the redemption value of Class B mutual fund shares

A..Surrender charges never apply in the case of a death benefit. There may be a surrender charge in the case of early surrender of a variable annuity, taking out the cash value of a variable life policy, or redemption of Class B (back-end load) mutual fund shares.

What generally happens to outstanding fixed-income securities when the rate of inflation slows? A) Coupon rates go up. B) Prices go up. C) Short-term securities are affected the most. D) Yields go up.

B....When the rate of inflation slows and is expected to remain stable, coupons on new issue bonds will often decline to offer lower yields. The prices of outstanding bonds will go up to adjust to the lower yields on bonds of similar quality.

An investment adviser representative has a client who prefers the safety of securities guaranteed by the U.S. Government, yet is concerned about volatility due to uncertainties in the future direction of interest rates. Which of the following recommendations would best address these concerns? A) 5% Treasury bond, maturing in 2037 B) 8% Treasury bond maturing in 2036 C) 6% Treasury bond maturing in 2035 D) Treasury STRIPS, maturing in 2036

B...Generally speaking, those bonds with the highest coupons have the shortest duration, therefore, are the least subject to interest rate risk. STRIPS, which are zero-coupon bonds, are the most volatile because they have the longest duration. The actual calculation of the duration of each of the other bonds given is beyond the scope of this exam.

Which of the following statements concerning hedge funds are TRUE? 1Purchasers of hedge funds are generally required to be accredited investors. 2Short sales by the fund are not allowed. 3It is not uncommon for there to be a lock-up period that may last for as long one year or even longer. 4It would be unusual for the fund managers to have an ownership interest in the fund.

B...Purchasers of hedge funds are usually required to be accredited investors. Hedge funds often have high liquidity risk due to the lock-up provision, which can restrict an investor's ability to liquidate the position. An advantage of hedge funds is their ability to sell securities short during bear markets, adopt risky arbitrage strategies, and otherwise take direct steps to maximize returns in both up and down markets. In almost all cases, the fund managers have a significant ownership position in the fund, or as the phrase goes, they have "skin in the game."

A feature common to all passive real estate investing is A) high liquidity. B) someone other than the investor is doing the management. C) flow-through of operating losses. D) low initial investment requirements.

B...The concept of passive investing is that, in all cases, someone else is "running the show". Although some passive real estate investments, such as the exchange-traded REIT, are very liquid, others, such as DPPs, are generally not. In the same vein, while one can purchase a REIT for as little as the price of 1 share, a unit in a RELP (real estate limited partnership) can be $25,000 or more. Finally, although DPPs are flow-through vehicles, REITs and ownership of stock in real estate companies are not.

Which of the following factors has an inverse relationship to a bond's duration? A) Rating B) Time to maturity C) Yield to maturity D) Par value

C...Yield to maturity has an inverse relationship to duration. That is, the higher the YTM, the lower (shorter) the duration. The longer the time to maturity, the higher (longer) the duration; it is a direct relationship. The bond's rating and par value are irrelevant.

Starflier Mutual Fund, regulated under the Investment Company Act of 1940, wishes to change its investment policy. It may do so with approval of A) a majority of the board of directors B) a majority of the outstanding shares C) the fund's investment adviser D) no one because they do not need approva

b....Changes in investment policy require a vote of the majority of outstanding shares for approval.

Which of the following investment companies registered under the Investment Company Act of 1940 can include senior securities in its capital structure? A) Closed-end management investment companies B) Face-amount certificate companies C) Open-end management investment companies D) Unit investment trusts

A...Only the closed-end company is legally permitted to issue senior securities (preferred stock and bonds).

A mutual fund's computed NAV on April 24 is $100 per share. On April 25, the portfolio realized gains of $2 per share, and enjoyed $1 per share in unrealized appreciation. What would the NAV be on April 26 assuming an unchanged market? A) $101 per share B) $100 per share C) $102 per share D) $103 per share

A mutual fund's net asset value per share (NAV) is the fund's total assets minus total liabilities (net asset) divided by the number of shares outstanding. The major asset is the fund's portfolio. Portfolio securities are carried at their value as of the close of the markets (4PM ET). As a result, unrealized appreciation (and depreciation) are part of the NAV. Therefore, when that gain (or loss) is realized, paper profit (or loss) is now real and there is no change to total assets. In the subject question, the realization of the $2 per share gain has no effect, but, the new $1 in unrealized appreciation increases the NAV by that amount. A

Which of the following expressions describes the current yield of a bond? A) Annual interest payment divided by current market price B) Annual interest payment divided by par value C) Yield to maturity divided by par value D) Yield to maturity divided by current market price

A...The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond.

Market interest rates rise by 50 basis points. If each of these bonds has about the same maturity date, which of the following would decline the least? A) Treasury bond issued at par carrying a 7% coupon B) AAA corporate bond carrying a 6% coupon C) Treasury bond issued at par carrying a 6% coupon D) AA corporate bond carrying a 7% coupon

A.....All other factors being equal, bonds of higher quality experience less price volatility than do bonds of lower quality. Treasury securities have higher quality than other debt securities due to the elimination of default risk. When market interest rates rise, bonds having higher coupons will decline less than bonds having lower coupons.

A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of A) 5.56% B) 5.00% C) 7.80% D) 7.40%

A.....Current yield is determined by dividing the annual interest payment by the current market price of the bond ($50 ÷ $900 = 5.56%). Years to maturity is not a factor in calculating current yield.

A bond investor's portfolio consists of the following 3 bonds: ABC First Mortgage bond, current market value of $4 million with a duration of 5 years. DEF Debenture, current market value of $5 million with a duration of 8 years. U.S. Treasury bond, current market value of $1 million with a duration of 10 years. What is the average duration of the portfolio? A) 7 years B) 6.54 years C) 7.67 years D) 3.04 years

A.....It is unlikely that you will have a question this complicated on the exam, but, just in case, we wanted to show you the way to do it. Computing average duration of a bond portfolio involves taking each bond and figuring the proportion of the portfolio its duration represents. In this question, ABC is 40% of the portfolio so we take 40% of its 5-year duration (2). Then, we do the same with the other two bonds. DEF is 50% of 8 (4) and the Treasury bond is 10% of 10 (1). When we add the 3 numbers together, it results in an average duration of 7 years.

To be in compliance with the Investment Company Act of 1940, it is permissible for the portfolio manager of an open-end investment company to buy all of the following securities EXCEPT A) stock on margin B) call options C) high-yield bonds D) shares of other mutual funds

A.....The Investment Company Act of 1940 generally prohibits mutual funds from making purchases on margin. There are exceptions to this rule, such as in the case of hedge funds. A fund is not prohibited from buying options or low-quality bonds. A mutual fund may invest in other mutual funds so long as it does not acquire more than 3% of the outstanding shares of the other fund.

Section 15 of the Investment Company Act of 1940 spells out many of the specific requirements for the contract between a management investment company and its investment manager. Among those requirements is that A) no contract may be terminated with more than 60 days' written notice B) the contract should be in writing C) unless a specific exemption applies, the fund may not engage in margin trading D) the initial contract is for a maximum of one year and then may be renewed on either an annual or biannual basis

A....Contracts between funds and their advisers may not be terminated with more than 60 days' written notice, and these contracts must—not should—be in writing. The initial contract is for a two-year period and then renewed on an annual basis. Whether or not the fund can trade on margin is not a function of the management contract.

A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of A) 5.56% B) 7.40% C) 7.80% D) 5.00%

A....Current yield is determined by dividing the annual interest payment by the current market price of the bond ($50 ÷ $900 = 5.56%). Years to maturity is not a factor in calculating current yield.

Which of the following is likely to be characterized by no management fees and a portfolio consisting of municipal or corporate bonds? A) Unit investment trusts B) Closed-end investment companies C) Face-amount certificate companies D) Open-end investment companies

A....Only management companies, (open- and closed-end) have management fees.

Moonglow Specialties, Inc., is currently trading at $20 per share. Recently, the company reported net income of $1 million. The company is capitalized with 200,000 common shares and $5 million of 20-year debentures with a coupon of 4%. Given the data, Moonglow's price-to-earnings (P/E) ratio is closest to A) 4 times. B) 2 times. C) 3 times. D) 5 times.

A....P/E ratio = market price per share ÷ earnings per share. Earnings per share = net income ÷ shares = $1 million ÷ 200,000 shares = $5. P/E = 20 ÷ 5 = 4. The net income is after all expenses including the interest on the debentures. As is frequently the case, the question includes information irrelevant to the answer.

A REIT is able to pass-through which of the following? A) Taxable income from operations B) Losses from passive activity C) Losses from active activity D) Unrealized capital gains

A....REITs are required to distribute a minimum of 90% of their taxable income from operations. Unlike the traditional flow-through vehicle, they do not pass-through losses. When a gain is unrealized, there is nothing to distribute.

Surrender charges may cause a reduction to all of the following EXCEPT A) the death benefit of a variable life insurance policy B) the liquidation value of a variable annuity C) the cash value of a variable life insurance policy D) the redemption value of Class B mutual fund shares

A....Surrender charges never apply in the case of a death benefit. There may be a surrender charge in the case of early surrender of a variable annuity, taking out the cash value of a variable life policy, or redemption of Class B (back-end load) mutual fund shares.

Which of the following individuals would be considered a noninterested person in a mutual fund? A) A member of the board of directors who does not hold another position within the investment company B) A person who holds a position with the fund's underwriter C) A shareholder who owns 10% of the fund's shares D) A member of the board of directors who is also employed as the investment adviser

A....The Investment Company Act of 1940 defines an interested person as someone employed by or who has a material business relationship with the fund, its adviser, or underwriter. Someone who owns 5% or more of the outstanding shares (an affiliated person) is also considered "interested." Merely sitting on the board does not make someone an interested person. Thus, a director with no other relationship with the fund qualifies as a noninterested person.

Bail Bonds, Inc., might issue warrants in connection with a bond issue for which of the following reasons? 1As an inducement to make the bonds more marketable 2To lower their interest cost on the issue 3To increase the marketability of their common stock 4To increase the number of common shares outstanding A) I and II B) I, II, III, and IV C) I only D) I and IV

A....Warrants permit the purchase of common stock of the issuer at a fixed price. A bond with warrants attached has more value than a straight bond and is more attractive (marketable) to investors. Attaching warrants to a bond issue usually permits the bonds to be issued with a lower interest rate.

One of your customers purchased a TIPS bond three years ago. The bond's nominal yield is 4% and inflation has averaged 6% over the holding period. The interest payment at the end of the three years would be closest to A) $23.88 B) $33.78 C) $21.60 D) $47.76

A....With a TIPS bond, the principal is adjusted every six months by the inflation rate. When that rate is 6%, there is a 3% semiannual adjustment. Multiplying the $1,000 par value times 103% six times (there are six semiannual adjustments in three years, results in a principal value just over $1,194. Because the 4% coupon rate is paid semiannually, the payment at the end of three years will be the adjusted principal of $1,194 times 2% and that equals $23.88. For testing purposes, you can always arrive at the correct answer by using simple instead of compounded interest. That is, with a 6% annual inflation rate, the bond's principal will increase by $60 per year for three years. That would make the adjusted principal $1,180. Take 2% of that and the result is $21.60. The correct answer will always be the next greater number.

A client owns an investment-grade bond that has a coupon of 7% and is priced to yield 5.4%. If similarly rated bonds are being issued today with coupons of 5%, it would be expected that the client's bond A) has a positive net present value B) has a negative net present value C) has a zero net present value D) will be selling at a discount from par

A....With a discount rate of 5% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 7% coupon rate will be selling at a premium (interest rates down, prices up). We are told that this bond is offering a yield of 5.4%, which is more than the current market rate. Because a present value computation using a 5.4% rate would reflect a lower value than a 5% rate (the higher the discount rate, the lower the value), the bond can be purchased at a price below its present value. Any time that occurs, the instrument has a positive net present value (the difference between the price and the present value).

Managers of bond portfolios who anticipate an increase in interest rates should A) decrease the portfolio duration B) increase the portfolio duration C) assume higher risk in the secondary market D) invest in high-yield or junk bonds

A...A bond portfolio manager who anticipates periods of rising interest rates should decrease the duration of a bond portfolio to minimize the price decline. Duration is inversely related to changes in market and coupon interest rates.

A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) Variable annuity B) Common stock C) REIT D) Fixed annuity

A...Longevity risk is the uncertainty that one will outlive his money. The only instrument that guarantees a payout for as long as one lives is an annuity. Because the question asks for a security, only the variable annuity is correct, otherwise the fixed annuity would also offer protection.

Which of the following statements regarding nonqualified annuities is CORRECT? A) It is possible to receive distributions from an annuity before age 59½ without incurring tax penalties. B) The exclusion ratio applies to accumulation units only. C) Because only insurance companies issue variable annuities, they are not considered securities. D) Because taxes on earnings are deferred, all money withdrawn will be subject to income tax when received.

A...Nonqualified annuities, fixed or variable, are those where contributions are made with after-tax dollars. Withdrawals due to death or disability or taking substantially equal annuity distributions over the life of the insured can begin before age 59½ without being subject to a tax penalty. The exclusion ratio only applies during the payout period. Even though taxes on earnings are deferred, that portion of the withdrawal that represents a return of principal on a nonqualified annuity, is not subject to tax or penalty.

Which of the following statements regarding convertible debentures is TRUE? A) When compared with similar nonconvertible debentures, convertible debentures are issued with a lower coupon rate. B) The issuer has the right to convert the debentures during the time period specified in the indenture. C) The debenture holders receive a variable rate of interest. D) The issuer pays a higher rate of interest, compared with a comparable nonconvertible debenture.Which of the following statements regarding convertible debentures is TRUE? A) When compared with similar nonconvertible debentures, convertible debentures are issued with a lower coupon rate. B) The issuer has the right to convert the debentures during the time period specified in the indenture. C) The debenture holders receive a variable rate of interest. D) The issuer pays a higher rate of interest, compared with a comparable nonconvertible debenture.

A...A conversion feature is a benefit to the debtholder. It allows the debtholder a choice to either continue holding the debt represented by the debenture or to convert it into shares of common stock of the underlying issuer. Everything that is done in the securities industry has to be a win/win situation. The win for the debtholder in this instance is the ability to take advantage of the capital appreciation potential the common stock may offer, and the win for the issuer is that by offering something extra to the debenture purchaser, that purchaser is willing to accept a lower interest rate on the debt (as compared to a nonconvertible debenture) and therefore giving the issuer a lower cost of capital. It is the debtholder, not the issuer who determines when and if to convert.

A mutual fund's expense ratio is found by dividing its expenses by its A) average annual net assets B) public offering price C) income D) dividends

A...A mutual fund's expense ratio is calculated by dividing its expenses by its average annual net assets. For example, if the fund had net assets of $100 million and its annual expenses are $1 million, the expense ratio is $1 million divided by $100 million = 1%.

All of the following positions expose a customer to unlimited risk EXCEPT A) Short 2 XYZ uncovered puts B) Short 200 shares of XYZ C) Short 2 XYZ uncovered calls D) Short 200 shares of XYZ and short 2 XYZ puts

A...A put writer will lose money if the stock goes down, but the furthest it can drop is to zero. Therefore, the potential loss is not unlimited. All of the other positions expose the client to unlimited risk because a loss will occur if the stock price rises.

Use the following chart to answer this question: STOCK50%30%10%0%BONDS50%70%90%100%High return39.4%37.2%34.3%32.7%Low return1.4%6.5%7.2%8.5%Ave. return15.8%16.2%15.5%15.2%Std. Dev.11.2510.7510.1510.34 Which portfolio mix would you recommend to a client who is most concerned about projected near-term volatility? A) 10%/90% B) 50%/50% C) 30%/70% D) 100%/0%

A...Although this might look complicated, this is very simple if you realize that standard deviation is the measure of volatility. So, just pick the allocation with the lowest standard deviation and that is the 10%/90% at 10.15.

XYZ Corporation common stock has a market price of $45 per share and earnings per share of $3 when XYZ announces a 3-for-1 split. After the split, the price-to-earnings ratio of XYZ stock will be A) 15 B) 3 C) 5 D) 45

A...Before the split, the stock had a P/E ratio of 15 ($45 per share ÷ $3). After the split, the price per share and the EPS drop in the same proportion, leaving the P/E ratio unchanged (new price = $15, new EPS = $1).

Which of the following statements regarding the properties of duration is NOT true? A) Duration measures the holding period return on a bond. B) Duration is a weighted-average term to maturity of a bond's cash flows. C) Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. D) Duration measures the effect of an interest rate change on the price of a bond or bond portfolio.

A...Duration does not measure the holding period return on a bond; it measures the effect of an interest rate change on the price of a bond or bond portfolio. Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. Duration is also a weighted-average term to maturity of a bond's cash flows.

An investor is considering the purchase of $100,000 maturity value of zero-coupon AAA-rated corporate bonds scheduled to mature in 20 years. Among the risks that this investor will be assuming are 1default risk 2interest rate risk 3prepayment risk 4reinvestment risk A) I and II B) II and III C) I and IV D) III and IV

A...Even though these bonds are rated AAA, 20 years is a long time and it is possible that this corporation may not even exist when the maturity date arrives. Adding to the risk is the fact that there are no interest payments in the interim. That is why the most commonly recommended zero-coupon bonds are those issued or guaranteed by the U.S. Treasury. Because zero-coupon bonds have the longest duration for their maturity of any bonds, they have the greatest exposure to interest rate changes. Prepayment risk is only found with mortgage-backed securities, and one of the benefits of zeroes is that there is no reinvestment risk.

In contrast with a typical forwards contract, futures contracts have: A) standardized terms. B) greater counterparty risk. C) less liquidity. D) nonstandard terms.

A...Futures are contracts that trade on exchanges and have standardized terms, in contrast with forwards contracts, which are customized instruments. A futures clearinghouse reduces counterparty risk by guaranteeing the performance of buyers and sellers. Because futures contracts trade on organized exchanges and have standardized terms, they are more liquid than forwards contracts.

A customer with no other mutual fund investments wishes to invest $47,000 in the XYZ Technology Fund. If the Class A shares are eligible for a breakpoint sales charge discount at the $50,000 investment level, the action LEAST appropriate for an agent is to A) place the order as instructed B) inform the customer that he can reduce his sales charge by combining purchases in other funds offered by XYZ group C) inform the customer that he can reduce his sales charge by investing an additional $3,000 D) inform the customer that he can reduce his sales charge through a letter of intent

A...If a customer intends to invest an amount just below a breakpoint threshold, he should be informed of the breakpoint discount, as well as the various methods by which he can receive it.

Which of the following bonds is most affected by interest rate risk? A) 7.6s of '41 yielding 7.2% B) 7.8s of '37 yielding 7.3% C) 7.5s of '34 yielding 7.2%. D) 7s of '32 yielding 7%

A...Interest rate risk is the decline in market price due to rising interest rates. Because there is little difference in coupon rates, the bond with the greatest time to maturity (longest duration) will experience the greatest fall in a rising interest rate market.

The market price of a convertible bond depends on all of the following EXCEPT A) the conversion prices of bonds from similar companies B) current interest rates C) the value of the underlying stock into which the bond can be converted D) the rating of the bond

A...There are two factors that impact the current market price of all bonds: current interest rates and the rating of the bond. A third factor is unique to convertible bonds and that is the conversion value. The conversion value is based on the price of the underlying stock into which the bond can be converted. Comparing the conversion price of one issuer's bond to another's tells us nothing about the value of a specific bond.

To a technical analyst, the resistance level signifies the price at which a stock's supply would be expected to A) increase substantially. B) decrease substantially. C) remain constant. D) cause the stock price to "break out".

A...This is about comparing support and resistance levels. Most stock prices remain relatively stable and fluctuate up and down. The lower limit to these fluctuations is called a support level - the price range where a stock appears cheap and attracts buyers. The upper limit is called a resistance level - the price range where a stock appears expensive and initiates increased selling. This selling represents an oversupply of the stock which results in downward pressure on the stock.

Which of these features are common to both variable annuities and scheduled premium variable life insurance? 1Income earned in the separate account is tax deferred. 2Separate account performance below the AIR causes a reduction in cash value. 3Fixed contributions are required. 4Contract owners have voting rights. A) I and IV B) I and II C) II and III D) III and IV

All variable products offer tax deferral of earnings in the separate account. Unit holders of a variable annuity vote on the basis of the number of units they own; holders of variable life insurance receive 1 vote for each $100 of cash value. With variable life insurance, AIR applies only to the death benefit, not to cash value A

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

B....Raw land does not generate income; it is most often held for future capital appreciation.

If the risk-free rate of return is 3.5%, the expected market return is 9.5%, and the beta of a stock is 1.3, what is the required return on the stock according to the capital asset pricing model? A) 8.85% B) 11.30% C) 7.80% D) 12.35%

B....The formula for the required return is: E(R) = Rf + (E (RM) - Rf) × Beta or 0.035 + (1.3 × [0.095 - 0.035]) = 0.035 + 0.078 = 0.113, or 11.3%.

All of the following are advantages of mutual fund investment EXCEPT A) exchange privileges within a family of funds managed by the same management company B) investors retain personal control over the investments in the fund's portfolio C) the ability to qualify for reduced sales loads based on accumulation of investment within the fund D) the ability to invest almost any amount whenever desired

B.......The control of the investment is given over to the investment manager. Exchange privileges, the ability to invest any amount at any time, and reduced sales loads are all considered advantages.

Among the reasons to consider investing in a variable annuity would be all of the following EXCEPT A) avoiding probate upon the death of the investor B) capital gains treatment on any realized gains upon withdrawal C) a guaranteed death benefit for death before annuitization D) basically, no limit on the amount that can be contributed

B......In return for granting tax deferral on all gains in the account, the IRS taxes everything over the investor's cost basis as ordinary income. There is never a capital gain with a variable annuity. Some insurance companies will place a limit on the amount that may be invested, especially for older clients, but unlike IRS rules on retirement plans, this is strictly a company-by-company decision, not a law. Variable annuities are generally sold with a death benefit provision guaranteeing that the beneficiary will receive the higher of the amount invested or the current value of the account. Because there is a specifically named beneficiary, annuities do not go through the probate process.

If XYZ Mutual Fund has an expense ratio of 1.85% that includes a 12b-1 fee of 0.30%, which of the following statements are TRUE? 1The fund may use the 12b-1 fee to pay for mailing sales literature. 2Advertising materials may state that the fund is no-load. 3Management fees may be paid from the 12b-1 fee. 4The fund's prospectus is required to disclose the fee. A) I and II B) I and IV C) II and III D) III and IV

B....12b-1 fees may only be used to cover promotional expenses, not fund management expenses. The amount of the fee must be disclosed in the prospectus. Funds that charge 12b-1 fees of more than 0.25% cannot call themselves no-load funds.

Under adverse market conditions, it is not unusual for mutual fund investors who had been investing on a regular basis to cease or reduce their level of financial commitment. This can have the effect of A) reducing the operating expense ratio of the fund B) net redemptions C) a reduction in the fund's net operating income due to a reduction in sales charges received D) reducing the NAV of the fund as the demand for new shares wanes

B....In adverse market conditions, not only do some investors stop putting money in, they liquidate their holdings. If new sales fall while liquidations rise, the effect could be net redemptions. The NAV is not affected by supply and demand, and if anything, the expense ratio would rise because some of the expenses would remain the same but would be shared by fewer assets. Mutual funds do not receive the sales charges—they go to the underwriter.

Investment companies must send financial reports to shareholders A) monthly B) semiannually C) quarterly D) annually

B....Investment company financial reports must be sent twice a year and must include a portfolio list, income statement, statement of compensation paid to the board of directors and the advisory board, and a statement of the total dollar amount of securities bought and sold during the period. One of these reports must be the audited annual report.

All of the following statements regarding universal life insurance are correct EXCEPT A) may include a minimum guaranteed interest rate B) premiums are fixed for the life of the policy C) there are two death benefit options D) offers the policyowner exceptional flexibility in adjusting the premiums, cash value, and death benefit

B....The single most distinguishing characteristic of universal life is the fact that premiums are flexible and not fixed.

A bond is paying $100 per year in annual interest and is selling at par. If the discount rate is 10%, the net present value is A) negative B) zero C) positive D) the same as the coupon

B...A bond paying $100 in interest per year has a coupon rate of 10%. Whenever the coupon rate is equal to the discount rate, the NPV is zero. That is, the present value of a bond paying 10% interest when the current market rate is demanding a 10% interest rate is the bond's par value (as is the case with this bond).

Many fixed-income investors are looking to avoid loss of principal. Which of the following would likely have the lowest degree of exposure to credit risk? A) A-rated general obligation municipal bond B) Aa-rated corporate debenture C) Ba-rated corporate mortgage bond D) Baa-rated municipal revenue bond

B...A bond's rating takes into consideration all factors, including collateral and tax base. The higher the rating, the lower the credit risk.

Under the Investment Company Act of 1940, which of the following qualify for a discount in a mutual fund's sales charge? 1Mr. and Mrs. Jones each purchase $5,000 worth of shares; the fund offers a volume discount for a single purchase of $10,000. 2Neighbors Jan, Mickey, and Lee form an investment club; Jan places an order for $10,000 worth of shares to be held in their 3 names. The fund offers a volume discount for a $10,000 purchase. 3Allen is the vice president of a firm under contract to provide investment advice to a mutual fund. He buys shares of that fund. A) II and III B) I and III C) I and II D) I, II, and III

B...A husband and wife and all children under 21 qualify as a single person for the purposes of obtaining a quantity discount, as do corporations formed for a purpose other than obtaining such a discount and employee benefit plans. But other associations acting collectively, such as the members of an investment club, do not qualify as a single person for such a purpose. Discounts may also be made to directors, officers, partners, employees, or sales representatives of the fund, its investment adviser, or its principal underwriter.

Which type of risk is a mortgage-backed security most likely to experience? A) Business B) Reinvestment risk C) Exchange rate risk D) Market risk

B...A mortgage-backed security, such as a Ginnie Mae, is most likely to experience reinvestment rate risk. As mortgages are paid off early and refinanced in the event of declining interest rates, the interim cash flows received from the obligation must be reinvested in lower-yielding securities. This is the practical effect of prepayment risk.

A mutual fund's computed NAV on April 24 is $100 per share. On April 25, the portfolio realized gains of $2 per share, and enjoyed $1 per share in unrealized appreciation. What would the NAV be on April 26 assuming an unchanged market? A) $100 per share B) $101 per share C) $103 per share D) $102 per share

B...A mutual fund's net asset value per share (NAV) is the fund's total assets minus total liabilities (net asset) divided by the number of shares outstanding. The major asset is the fund's portfolio. Portfolio securities are carried at their value as of the close of the markets (4PM ET). As a result, unrealized appreciation (and depreciation) are part of the NAV. Therefore, when that gain (or loss) is realized, paper profit (or loss) is now real and there is no change to total assets. In the subject question, the realization of the $2 per share gain has no effect, but, the new $1 in unrealized appreciation increases the NAV by that amount.

Under industry rules, customers who wish to trade options must receive a copy of the options disclosure document (ODD) A) at or before the mailing of the confirmation representing the first options trade B) at or before account approval C) within 15 days of account approval D) at or before the mailing of the next monthly statement

B...All prospective options customers must receive a copy of the ODD at or before the time the account is approved to trade options. It is the options account agreement that must be signed and returned to the broker-dealer within 15 days of account approval.

Under industry rules, customers who wish to trade options must receive a copy of the options disclosure document (ODD) A) at or before the mailing of the next monthly statement B) at or before the mailing of the confirmation representing the first options trade C) at or before account approval D) within 15 days of account approval

B...All prospective options customers must receive a copy of the ODD at or before the time the account is approved to trade options. It is the options account agreement that must be signed and returned to the broker-dealer within 15 days of account approval.

Charlie Mindel is the portfolio manager for the Steady Yield Bond Fund. If Charlie was of the opinion that interest rates were going to fall, he would A) keep the average duration the same. B) increase the average duration of the portfolio C) decrease the average duration of the portfolio. D) move more of the portfolio into cash.

B...As interest rates go down, prices of bonds rise. Those with the longest duration will have the greatest price increase. To benefit from this move, managers of bond portfolios will lengthen the average duration of the portfolio. The reverse action would be taken if Charlie thought that interest rates were going to rise. Of course, if interest rates move in the opposite direction of that the manager expects, the fund might start looking for a new manager.

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

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

A hedge fund and a traditional mutual fund are similar in that A) both offer performance incentives to the fund manager B) their portfolio managers are required to adhere to the fund's stated objective C) both typically have low initial investment requirements D) both use long and short positions, swaps, and arbitrage

B...Both hedge funds and mutual funds have stated objectives. It is expected by owners that the management will follow those objectives. Only the hedge fund always has performance incentives, and only the mutual fund has a low initial investment requirement. Mutual funds are prohibited from selling short.

The XYZ Corporation's A-rated convertible debenture is currently selling for 90. If the bond's conversion price is $40, what is the parity price of the stock? A) $40 per share B) $36 per share C) $22.50 per share D) $44 per share

B...If the bond's conversion price is $40, it means the bond is convertible into 25 shares ($1,000 par value divided by the $40 conversion price). Parity means equal so, what does each share have to be worth so that 25 of them are equal to $900? Remember, bonds are quoted as a percentage of the $1,000 par value so a price of 90 means $900. Dividing $900 by 25 shares results in a parity price of $36. That does not mean the stock is selling for $36 per share (probably a bit less), but at $36, holding the bond, or converting into the stock, gives the investor equal value. Some students quickly see that the bond is 10% below its par value so the stock, to be equal, must be 10% below the conversion price. Take 10% off $40 and the result is $36. Either way works.

Under the Investment Company Act of 1940, purchases by which of the following are eligible for the reduced sales charges applicable at the fund's stated breakpoints? 1A qualified retirement plan 2The combined purchases of a man and a custodial account for his daughter where his wife, not he, is the custodian 3Two friends who have pooled their money to make a large purchase 4An investment club A) II and IV B) I and II C) I and III D) III and IV

B...Investment clubs and otherwise unaffiliated groups may not pool their money to receive a breakpoint. Incorporated or otherwise affiliated entities, such as spouses or a parent and minor child, may do so. The fact that the custodian of the daughter's account is the spouse does not change things.

Which of the following statements regarding REITs are NOT true? Investors receive flow-through benefits of income as well as loss. Hybrid REITs own properties, as well as make loans on others. Equity REITs are prohibited from using leverage to acquire properties. REITs are easily traded in the secondary market. A) II and III B) I and III C) I and IV D) II and IV

B...It is not true that REITs offer flow-through of losses; they are not DPPs. As with most real estate purchasers, leverage, usually in the form of a mortgage, is used to acquire property. A hybrid REIT contains the features of both an equity REIT and a mortgage (debt) REIT, and most REITs trade on the exchanges or Nasdaq. Note: Even though there has been an increase in the number of non-traded REITS, unless something in the question indicates that, the question will be dealing with publicly traded REITS.

Which of the following mutual fund share classes generally has a 1% CDSC that is eliminated once the shares have been held more than 1 year? A) Class 1% B) Class C C) Class A D) Class B

B...It is the Class C shares that have no front-end load, but they do have a 1% CDSC for a period of 1 year.

A policyowner could surrender a whole life insurance policy and choose from all the following EXCEPT A) purchasing a reduced coverage whole life policy B) transferring the policy to another person C) purchasing an extended term life policy D) taking the cash value

B...Life insurance policies are nontransferrable. Upon surrender, the cash value may be taken or used to purchase extended term insurance or a reduced value, paid-up, whole life policy.

Mark's company, which is located in Oregon, makes unfinished wood furniture. His company sells this furniture directly to the public from a large warehouse. Theresa's company, which is located in southern Georgia, grows cotton for t-shirts manufacturers. Which of the following statements correctly identifies hedging strategies for Mark and Theresa? 1Mark should buy lumber futures. 2Theresa should sell cotton futures. 3Mark should sell lumber futures. 4Theresa should buy cotton futures. A) III and IV B) I and II C) II and III D) I and IV

B...Mark is "short" lumber because he needs lumber to produce his products. A hedge position for Mark would be to go long lumber futures, that is, to purchase lumber futures. Theresa is "long" cotton because she owns cotton for manufacturing purposes. A hedge position for Theresa is to go short, that is, to sell cotton futures.

A client of yours owns some convertible preferred stock. She notices an article in the business section of her local newspaper that reports the company is going to pay a 20% stock dividend on their common stock. She wants to know how this will affect her? A) More than likely, the price of the preferred stock will rise. B) If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend. C) There will be no effect. D) She will also receive 20% more shares because preferred stock has a priority claim ahead of common.

B...Most convertible securities are sold with antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends.

A 45-year-old investor takes a lump-sum distribution from a nonqualified variable annuity. How is the distribution taxed? The entire amount is taxed as ordinary income. The growth portion is taxed as ordinary income. The growth portion is taxed as a capital gain. The growth portion is subject to a 10% penalty. A) III and IV B) II and IV C) II and III D) I and IV

B...On withdrawals from a nonqualified annuity, taxes are paid only on the amount that exceeds cost basis (the amount paid into the annuity). In this case, the investor is taking a lump-sum distribution before reaching age 59½ and must pay an additional 10% penalty on the taxable amount.

An investor has purchase a single payment, deferred non-qualified variable annuity. Each of the following statements is true EXCEPT A) money invested in this annuity represents the investor's cost basis B) taxes on earned dividends, interest, and capital gains are paid annually, until the owner withdraws money from the contract C) upon withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income D) random withdrawals are handled under LIFO tax rules

B...Taxes on earned dividends, interest, and capital gains are not paid annually. They are deferred and paid later, when the owner withdraws money from the contract. Money randomly withdrawn (not annuitized) is handled under LIFO tax rules; money invested in a non-qualified annuity represents the investor's cost basis; and on withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income.

Your customer, age 29, is seeking a long-term growth investment, is concerned about the loss of purchasing power as a result of inflation, and often complains about high commissions that reduce his investment returns. When he was in college, he took a few economics courses and firmly believes that securities analysts cannot consistently outperform the overall market. Which of the following mutual funds is the most suitable for the customer? A) ZB Asset Allocation Fund B) ARG Stock Index Fund C) NC Growth & Income Fund D) ATF Biotechnology Fund

B...The customer requires a mutual fund that offers potential for long-term capital growth. Because the client believes that money managers cannot outperform the market, an index fund, which simply mimics the market, is the appropriate investment. The client's complaint about high commission charges is a further argument for index funds, which have low expense ratios.

An investor purchased a Mosaks, Inc. put option with a strike price of $105. If Mosaks' stock price is $115 at expiration, the value of the put option is A) $105. B) $0. C) -$10. D) $10.

B...The put has a value of $0 because it will not be exercised. Why would you want to exercise (sell the stock) at $105 per share when the current market value is $115?

One of the rights of being a stockholder is the ability to vote on important corporate matters, such as the election of members to the board of directors. The date that determines which shareholders are eligible to votes is A) the ex-dividend date. B) the record date. C) the last day of the company's fiscal year. D) the election date.

B...The record date is a date announced by the company as the official date you must be an owner on the company's records in order to participate in the annual meeting and corporate election. A fact not tested is there is no standard regarding how far in advance of the voting date this should be other than it must be at least the normal settlement period, currently 2 business days.

An investor purchases a Treasury note and the confirmation shows a price of $102.21. Rounded to the nearest cent, the investor's cost, excluding commissions, is A) $1,022.21. B) $1,026.56. C) $102.21. D) $1,022.10.

B...Treasury notes are quoted in 32nds where each 32nd equals $.3125. The 102 in the quote equals $1,020 and the 21/32 is an additional $6.56 bringing the total to $1,026.56.

If an investment company invests in a fixed portfolio of municipal or corporate bonds, it is classified as A) a utilities fund B) a closed-end company C) a unit investment trust D) a growth fund

C,,,A unit investment trust issues shares that represent units of a particular portfolio; management has no authority, or only limited authority, to change the portfolio. The portfolio is fixed; it is not traded.

Listed options are also known as standardized options. Which of the following choices is not one of the standardized terms of a listed option? A) The underlying asset B) The expiration date C) The premium D) The exercise price

C...Supply and demand in the marketplace sets the premium of a listed option. All of the other choices are standardized.

Which of the following statements correctly describe similarities between exchange-traded funds and closed-end investment companies? 1There are a limited number of outstanding shares. 2They are traded on registered stock exchanges. 3They trade at prices that are not dependent upon but close to their net asset value. 4Investors pay commissions to purchase and liquidate their positions. A) II and III B) I and III C) II and IV D) I and IV

C.....Both exchange-traded funds and closed-end investment companies are traded on exchanges; therefore, investors pay a commission when purchasing and liquidating shares. Only closed-end investment companies have a limited number of shares. Closed-end funds may trade at significant premiums or discounts from their NAV, while ETFs rarely stray far from NAV.

Investors with a short time horizon most likely will invest in which class of mutual fund shares? A) Class A shares B) Class A shares, then convert to Class B shares C) Class C shares D) Class B shares

C.....Class C shares may be less expensive than Class A or B shares for investors with a short time horizon. The front-end load on Class A shares and the back-end load on Class B shares makes them unattractive for short-term investors. A shares do not convert to B shares; it goes the other way.

Market interest rates rise by 50 basis points. If each of these bonds has about the same maturity date, which of the following would decline the least? A) Treasury bond issued at par carrying a 6% coupon B) AAA corporate bond carrying a 6% coupon C) Treasury bond issued at par carrying a 7% coupon D) AA corporate bond carrying a 7% coupon

C....All other factors being equal, bonds of higher quality experience less price volatility than do bonds of lower quality. Treasury securities have higher quality than other debt securities due to the elimination of default risk. When market interest rates rise, bonds having higher coupons will decline less than bonds having lower coupons.

With regard to taxation of distributions from a REIT, in the majority of cases, dividends are taxed as ordinary income in the majority of cases, dividends are considered qualified for the lower tax rate capital gains distributions are treated as long-term capital gains capital gains distributions are taxed as ordinary income A) II and III B) II and IV C) I and III D) I and IV

C....Although there are some rare exceptions, you should consider any dividend paid to an investor in a REIT subject to taxation at ordinary income rates. Just as with mutual funds, capital gains distributions are treated as long-term capital gain.

A client is considering the purchase of American depositary receipts (ADRs). She is looking to further diversify her portfolio. Which of the following is not a feature of this type of investment vehicle? A) ADRs are denominated in and pay dividends in U.S. dollars. B) ADRs are traded on exchanges and the OTC markets. C) They are not subject to exchange rate, or currency, risk. D) Information regarding the foreign company is easily attainable.

C....Even though ADRs are denominated in U.S. dollars, they are subject to exchange rate, or currency, risk. In order to trade in the U.S. markets, information about the foreign company must be available to investors. ADRs representing the best known companies typically trade on the NYSE or the Nasdaq stock market while lesser companies trade OTC.

A customer buys a 5% bond at par. The bond is callable in 5 years at par and matures in 10 years. Which of the following statements is TRUE? A) YTC is higher than YTM. B) YTC is lower than YTM. C) YTC is the same as YTM. D) Nominal yield is higher than either YTM or YTC.

C....If a bond is trading at par, the nominal yield (coupon rate) = current yield = yield to maturity = yield to call (unless the call price is at a premium in which case the YTC would be higher). YTC is higher than YTM if the bond is trading at a discount to par. YTC is lower than YTM if the bond is trading at a premium over par. Nominal yield is higher than either YTM or YTC if the bond is trading at a premium over par.

A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) Fixed annuity B) Common stock C) Variable annuity D) REIT

C....Longevity risk is the uncertainty that one will outlive his money. The only instrument that guarantees a payout for as long as one lives is an annuity. Because the question asks for a security, only the variable annuity is correct, otherwise the fixed annuity would also offer protection.

Which of the following are true of Ginnie Maes but NOT of other agency mortgage-backed securities? A) Collateralized by mortgage. B) Are pass-through securities C) Backed by the full faith and credit of the U.S. government D) Yield more than T-bonds

C....Of the mortgage-backed government agency securities, only the Ginnie Maes are backed by the full faith and credit of the U.S. government. They are all collateralized by mortgages (the name, MBS gives that away) and, even the Ginnie Maes yield more than Treasury bonds. As an MBS, they all pass through the income and principal repayments to the investors.

Mr. Brown has received preemptive rights from one of the stocks held in his portfolio. Which of the following is NOT an alternative regarding these stock rights? A) Giving the rights to his son B) Exercising C) Redeeming them from the issuer for cash D) Selling at the market

C....Rights are not redeemable by the issuer. They may be sold in the secondary market or be given to someone else to exercise. If exercised, rights are exchanged for an appropriate number of shares of the underlying common stock.

A technical analyst (chartist) with a long position in a particular stock would most likely enter a sell stop order below that stock's A) 200-day moving average B) previous high C) support level D) resistance level

C....Sell stops are entered below the market. They are used to turn an order into a market order if the current market value falls below the stop level. In technical analysis, support levels are theoretical levels where the market supports the stock price (keeps it from falling below the stated level). A technical analyst who makes investment decisions by watching the technical graphs and numbers would enter a sell stop below a support level in order to sell out if the support level is breached. A breakthrough of a support level is believed to forecast a major market price decline.

The Sharpe ratio is the average annual return of a security A) divided by the risk-free rate B) divided by the expected return of the market C) minus the risk-free rate for the period divided by the security's standard deviation D) plus the risk-free rate divided by the security's beta

C....The Sharpe ratio is the average annual return of a security less the risk-free rate divided by the security's standard deviation. In other words, the Sharpe ratio is a risk-adjusted return because it measures the amount of return per unit of risk taken; the most common risk-free rate is that paid by 91-day U.S. Treasury bills.

A corporation with a 6%, $25 par cumulative preferred paid $.50 to preferred stockholders last year. This year, the company wants to pay common dividends. How much must it pay each preferred share? A) $11.50 B) $0.50 C) $2.50 D) $1.50

C...A 6% cumulative preferred stock with a $25 par value would pay an annual dividend of $1.50 ($25 × 6%). Cumulative preferred requires all dividends that have previously been skipped be paid before any dividends paid to common stock. The $.50 that was paid last year left $1 in dividends in arrears. Therefore, this year requires that a $2.50 dividend be paid to the preferred shareholders before any common dividend paid to common shareholders.

A mortgage-backed security (MBS), such as a Ginnie Mae, makes a combination principal and interest payment to an investor. This payment will be A) taxed as ordinary income B) taxed as a capital gain if underlying mortgage is prepaid C) partly taxed as ordinary income and partly a tax-free return of principal D) tax free

C...All interest payments made a MBS are taxed as ordinary income. Mortgage-backed securities may make principal and interest payments to investors, which would be partly taxed as ordinary income and partly a tax-free return of principal.

The most common collateral securing a Brady bond is A) the credit standing of the sovereign nation issuing the Brady bond B) the credit standing of the banking institution acquiring the Brady bond C) U.S. Treasury zero-coupon bonds with a maturity corresponding to the maturity of the individual Brady bond D) an asset, or group of assets, pledged by the borrowing entity

C...Although other securities may be pledged, the most common is zero-coupon U.S. Treasuries, selected to mature at roughly the same time as the specific Brady bond. An investor purchasing a Brady with collateralized principal knows that, at maturity, a third-party paying agent will receive a payment from the U.S. Treasury that will be used to repay the principal on the Brady issue. In the event of default, the bondholder will receive the principal collateral on the maturity date.

A client has invested $25,000 into a variable annuity which has grown to $150,000 over the accumulation period. At age 60, the account is liquidated. The tax treatment of the withdrawal would be A) partly ordinary income and partly capital gains depending on the length of time the variable annuity was in force. B) ordinary income tax on $125,000 with a 10% tax penalty. C) ordinary income tax on $125,000. D) capital gains tax on $125,000.

C...Any increase in the value of a variable annuity is taxed as ordinary income, never capital gain. In this case, there is no 10% penalty tax because the client is over 59½ years old. You can safely assume that any annuity is non-qualified unless something in the question says it is.

All of the following statements regarding convertible bonds are true EXCEPT A) holders may share in the growth of the common stock B) holders have a fixed interest rate C) holders receive a higher interest rate D) the issuer pays a lower interest rate

C...Because of the possibility of participating in the growth of the common stock through an increase in the market price of the common, the convertible can be issued with a lower interest rate.

When does a customer have to receive the OCC Options Disclosure Document? A) With the confirmation of his first options transaction B) Within 5 business days of the first options trade C) At or prior to the time the account is approved for options trading D) Within 15 days of account approval

C...Before opening an account to trade options, the owner must be told about the risks involved with trading options. By providing the owner with an options disclosure document titled Understanding the Risks and Uses of Options at or prior to the time of account approval, the broker-dealer satisfies the risk disclosure requirements.

A client is considering the purchase of American depositary receipts (ADRs). She is looking to further diversify her portfolio. Which of the following is not a feature of this type of investment vehicle? A) ADRs are denominated in and pay dividends in U.S. dollars. B) Information regarding the foreign company is easily attainable. C) They are not subject to exchange rate, or currency, risk. D) ADRs are traded on exchanges and the OTC markets.

C...Even though ADRs are denominated in U.S. dollars, they are subject to exchange rate, or currency, risk. In order to trade in the U.S. markets, information about the foreign company must be available to investors. ADRs representing the best known companies typically trade on the NYSE or the Nasdaq stock market while lesser companies trade OTC.

Suzie McQueen has a very successful interior design shop she has run as a sole proprietorship. She has just celebrated her 60th birthday and has been giving thought to an eventual sale of the business. She wants your opinion on whether she should incorporate or change to a partnership. You might respond that A) the partnership form of business structure would be the easiest for ultimate transfer of ownership B) the corporate form of business structure would be the least expensive to form C) the corporate form of business structure would be the easiest for ultimate transfer of ownership D) the partnership form of business structure would enable Suzie to maximize her sale price

C...In general, the corporate form of business leads to the easiest transfer of ownership. Because Suzie would probably own 100% of the stock, all she would have to do is sell that stock to a new purchaser and the corporation could continue just as before. If Suzie wanted to reorganize as a partnership, she would have to bring in at least one additional individual, ending her total ownership of the business. Even then, a partnership interest is not as easy to sell as stock.

One of the purposes of filing the annual updating amendment to the Form ADV Part 1A is to A) provide updated information on those associated persons who are in charge of giving investment advice B) ensure that full disclosure has been made in the adviser's brochure C) verify that the investment adviser still qualifies for SEC registration D) disclose the amount and location of securities or funds of clients that are being held by the adviser or a qualified custodian

C...In order to maintain SEC registration, an investment adviser must maintain assets under management of no less than $90 million. The annual updating amendment is used to disclose this information.

Which of the following would make a corporate bond more subject to liquidity risk? Short-term maturity Long-term maturity High credit rating Low credit rating A) I and III B) II and III C) II and IV D) I and IV

C...Liquidity risk is the risk that when an investor wishes to dispose of an investment, no one will be willing to buy it, or that a very large purchase or sale would not be possible at the current price. The available pool of purchasers for bonds with a low credit rating is much smaller than for those with investment-grade ratings (many institutions are only able to purchase bonds with higher credit ratings). As a result, the lower the credit rating, the greater chance of the bond having liquidity issues. Similarly, bonds with short-term maturities attract many more investors than those with long-term maturities, causing the long-term bonds to be less liquid.

A mutual fund would have net redemptions when A) the fund manager is selling more securities in the portfolio than are being purchased B) the fund increases its sales charge C) the number of shares being liquidated by investors exceeds those being purchased D) the fund is performing below the average of other funds with the same objectives

C...One of the characteristics of an open-end investment company (mutual fund) is the ease of redeeming holdings. When the dollar amount of shares being redeemed exceeds that of those being purchased, the result is net redemptions. Although poor performance could lead to net redemptions, that is not always the case, so it is not always a true statement.

Which of the following most accurately identifies a private equity investment in income-producing real estate? A) Private market mortgage lending by an insurance company B) Investment in a real estate investment trust (REIT) C) Direct ownership of real estate properties D) Investment in a real estate mutual fund

C...Real estate investments take four major forms: private equity, publicly-traded equity, private debt, and publicly-traded debt. Private equity investment in real estate refers to direct ownership of real estate properties. Mortgage lending by banks or insurance companies is best described as private debt. Indirect ownership of real estate through equity securities such as REITs is an example of publicly-traded equity.

Which of the following is most commonly used when the author wants to express end-of-life wishes? A) A living trust B) A testamentary trust C) A living will D) A revocable trust

C...Sometimes referred to as a medical directive or advanced care directive, a living will is used to express the author's end-of-life wishes, such as organ donation plans, desired medical treatment, and so forth.

The Investment Company Act of 1940 requires that a mutual fund do which of the following? 1Provide a monthly balance sheet to investors 2Have $100,000 minimum capitalization prior to making a public offering 3Provide semiannual reports to shareholders 4Not acquire more than 5% of the outstanding shares of another registered investment company A) II and IV B) I and III C) II and III D) I and IV

C...The Investment Company Act of 1940 requires that an open-end investment company have a minimum of $100,000 in net assets prior to commencing a public offering. Reports must be sent to shareholders on a semiannual basis. No fund is permitted to own more than 3% of the outstanding shares of another registered investment company.

Which of the following best describes the death benefit provision of a variable annuity? A) If death should occur before age 59½, the 10% early withdrawal penalty does not apply. B) Upon death, the proceeds pass to the beneficiary free of federal income tax. C) The principal amount at death is the greater of the total of premium payments or the current market value. D) Upon death, the beneficiary will receive the benefit as a lump sum.

C...The death benefit insures that the investor will never receive back less than the original amount contributed to the account. Unlike life insurance proceeds, with annuities, anything above the cost basis is taxed as ordinary income. Receiving the benefit as a lump sum is only one of the options available to a beneficiary of a variable annuity death benefit. There are others, such as annuitizing the benefit.

One way in which incentive stock options (ISOs) differ from nonqualified stock options (NQSOs) is that A) gains on an ISO are always short-term while those on an NQSO are long-term. B) there is a maximum 5-year limit for exercise on the ISO while the time limit on the NQSO is 10 years. C) the bargain element of the ISO is an AMT preference item. D) the bargain element of the ISO is reported as wages on the tax returns of the employer and the employee.

C...The only true statement here is that the bargain element (the difference between the current market price at the time of exercise and the strike price) of the ISO (but not the NQSO) is one of the preference items for the alternative minimum tax. It is the bargain element of the NQSO which is reported as wages and it is possible, although difficult, to have long-term capital gains on both. Only the ISO has a maximum time limit and it is 10 years, not 5.

All of the following statements regarding universal life insurance are correct EXCEPT A) there are two death benefit options B) offers the policyowner exceptional flexibility in adjusting the premiums, cash value, and death benefit C) premiums are fixed for the life of the policy D) may include a minimum guaranteed interest rate

C...The single most distinguishing characteristic of universal life is the fact that premiums are flexible and not fixed.

Concerning index annuities and their method of crediting interest, which of the following is TRUE? A) Annual reset offers the best return regardless of market fluctuations. B) Point to point offers the best return when the market has had a single drastic decline during the period. C) High-water mark with look back offers the best return during periods of high volatility. D) On average, annual reset has a higher participation rate than point to point.

C...Using the annual high-water mark with look back will generally result in the highest return during periods of high volatility. The reason is because under this method, the highest anniversary value is used to determine the gain. In a volatile market, there is likely to be a high spike sometime during the period and that is the value used. The problem with point to point when there is a single drastic decline during the period is that the decline might occur at or just prior to the annual crediting computation. Annual reset does ignore the daily market fluctuations, but if the index is lower at the end of the year, there is nothing credited. In reality, annual reset has a lower participation rate than point to point.

A money market mutual fund would be least likely to invest in which of the following assets? A) Jumbo CDs B) Newly issued ​U.S. Treasury bills C) Repurchase agreements D) Newly issued ​U.S. Treasury notes

D....A money market mutual fund typically invests in money market instruments, those with a maturity date not exceeding 397 days. Treasury notes are issued with maturity dates of 2-10 years.

If your 60-year-old customer purchases a nonqualified variable annuity and withdraws some of her funds before the contract is annuitized, what are the consequences of this action? A) Capital gains tax on earnings exceeding basis B) 10% penalty plus payment of ordinary income tax on all funds withdrawn exceeding basis C) 10% penalty plus payment of ordinary income tax on all funds withdrawn D) Ordinary income tax on earnings exceeding basis

D....Distributions from a nonqualified plan represent both a return of the original investment made in the plan with after-tax dollars (a nontaxable return of capital) and the income from that investment. The income was deferred from tax over the plan's life, so it is taxable as ordinary income once distributed. A 10% penalty applies only if distributions begin before age 59½.

One would look at the average maturities when doing a cash flow analysis for A) Brady bonds B) subordinated debentures C) revenue bonds D) mortgage-backed pass-through securities

D...Mortgage-backed pass-through securities pass through interest and principal payments to their investors. The rate at which the cash flows are generated depends, among other things, on the rate at which the mortgages mature.

A TIPS bond with a par value of $1,000 has a coupon rate of 4%. During years 1 and 2, the inflation rate has been 6%. What effect will this have on the TIPS 2½ years later? A) The principal value will be $1,080. B) The next interest payment will be $20.00. C) The next interest payment will be $46.37. D) The next interest payment will be $23.19

D....On a semiannual basis, the principal value of a TIPS is increased by that year's inflation rate. A TIPS bond adjusts principal every 6 months based on the inflation rate. With an annual inflation rate of 6%, each 6 months the principal will increase by 3% compounded. Because the question is asking about 2½ years later, there will be 5 periods (2 each year plus the first half of the 3rd year). Using the calculator at the testing center, you would enter the $1,000 initial par value and then multiply that times 103% five times to arrive at $1,159.27. Then, multiply that times the semiannual coupon rate (2%) and the result is $23.19. In almost every case, the "shortcut" will work. That is, if it was not a TIPS bond, then the interest would simply be 2% of $1,000, or $20. That will always be one of the choices—you look for the one that is a bit higher.

Which of the following statements regarding preemptive rights is TRUE? A) Neither common nor preferred stockholders have the right to subscribe to a rights offering. B) Common stockholders do not have the right to subscribe to a rights offering. C) Both common and preferred stockholders have the right to subscribe to a rights offering. D) Preferred stockholders do not have the right to subscribe to a rights offering.

D....Preferred stockholders have a preference as to liquidation and distribution of dividends, but the right to maintain a proportionate interest in the company only applies to common stock.

An investor owns a TIPS bond with an initial par value of $1,000. The coupon rate is 6%, and during the first year, the inflation rate is 9%. How much interest would be paid for the year? A) $65.40 B) $90.00 C) $60.00 D) $64.11

D....TIPS bonds have a fixed coupon rate with a principal that varies each 6 months based on the inflation rate. With an annual inflation rate of 9%, each 6 months, the principal increases by 4.5% (half of the annual rate). Each semiannual coupon is half of the 6% rate times the new principal. The arithmetic is: $1,000 × 104.5% = $1,045 × 3% = $31.35 plus, $1,045 × 104.5% = $1,092 × 3% = $32.76. Adding the 2 interest payments together results in a total of $64.11 for the year.

One of your clients purchases a European-style put option on a stock. The premium is $3 and the exercise price is $35. If the price of the underlying asset is $40 on the exercise date, the client has A) made $200. B) lost $200. C) made $500. D) lost $300.

D....This option is out of the money and is therefore worthless. Remember, European-style options are exercisable only at expiration and a $35 put is worth zero unless the market price of the underlying asset is less than $35. As is the case with any long option position, the maximum loss is the premium paid.

For a bond selling at a discount, the yield to maturity will be A) equal to the nominal yield B) lower than the nominal yield C) higher than the yield to call D) higher than the nominal yield

D....Yield to maturity is a measure of the total return on a long-term bond, including capital appreciation and interest, while nominal yield measures the interest rate stated on the face of the bond. An investor who buys a $1,000 bond at a discount (for less than $1,000) will receive the interest payments on the bond at the nominal rate and will still receive $1,000 for the bond when it matures. As a result, the total return will be higher than the nominal yield. When a bond is selling at a discount the YTC will always be higher than the YTM.

If a customer buys a 6% bond maturing in 8 years on a 7.33 basis, the price of the bond is A) at par B) inverted C) above par D) below par

D...A bond with a basis, or yield to maturity, greater than its coupon is trading at a discount, or below par.

News reports indicate that the wheat crop scheduled to be harvested in 3 months will be much larger than normal. To hedge, a wheat farmer would most likely A) sell wheat stocks short. B) take a long position in wheat futures. C) grow corn instead. D) take a short position in wheat futures.

D...A bumper crop means lower prices for the producers (farmers). The appropriate protection is a short hedge - selling wheat futures. Think of it this way - if you thought a stock's price was going to decline, you would sell that stock short. Here, believing that wheat prices will decline, you take a short position in that commodity futures contract. There is no such thing as wheat stock and the wheat has already been planted; it is too late to switch crops.

Which of the following would be a difference between a universal life insurance policy and a scheduled premium variable life insurance policy? A) There is a minimum guaranteed return on the variable life, while there is no guaranteed return on the universal. B) The universal life policy will generally outperform the variable life policy during a period of falling interest rates and rising stock prices. C) There is a greater choice of separate account subaccounts in the universal life policy. D) Premiums on a scheduled premium variable life policy are fixed, while those on a universal life policy are flexible.

D...A major difference between these two insurance programs is the payment of premiums. Scheduled premium is just another way of saying fixed premium. In a universal life policy, including universal variable life, the premiums are flexible. There is no choice of separate account subaccounts for universal life. Universal life is designed to benefit from periods of high interest rates, not falling ones. Finally, universal life policies have a minimum guaranteed interest rate; no such guarantee applies to variable life.

What can you tell about these investment companies from the information below? NAVASKCompany A12.3412.85Company B15.4514.90 A) Company A must be open-end; Company B must be closed-end. B) Company A is closed-end and Company B is open-end. C) Company A and Company B can be either open-end or closed-end. D) Company A can be either open-end or closed-end; Company B must be closed-end.

D...All open-end investment companies sell at NAV plus sales charge (if any). Therefore, the asking price can never be less than the NAV. Closed-end company asking prices are determined by supply and demand, so their prices are independent of the fund's NAV.

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? A) High-water mark B) Point to point C) Annual reset D) Participation rate

D...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).

An investor goes short 5 soybean futures contracts on the Chicago Mercantile Exchange (CME). When the contract expires, A) only the buyer is obligated to perform B) only the exchange is obligated to perform C) only the seller is obligated to perform D) both the buyer and the seller are obligated to perform

D...Among the ways in which futures differ from options is that both parties, long and short, are obligated to execute the contract. At expiration date, if not exercised before, the buyer must purchase at the contract price and the seller must deliver at the contract price. In the case of options, the buyer (long position) is the one who chooses to exercise or not, and it is the seller (short position) who becomes obligated to perform.

An Administrator may take disciplinary action against a broker-dealer or its agents when the Administrator 1determines that the action is in the public interest 2auspects that the registrant's action violated a rule, order, or the USA 3issues an injunction that carries the force of law 4provides for a public hearing, which must precede issuing a cease and desist order A) III and IV B) II and III C) I and III D) I and II

D...An Administrator may take disciplinary action against a broker-dealer or its agents when the Administrator determines that the action is in the public interest and suspects that the action violated a rule, order, or the Uniform Securities Act. An Administrator may act upon suspicion that a violation of a rule, order, or provision of the Uniform Securities Act is about to occur. Administrators cannot issue injunctions; they must seek injunctions from a court of competent jurisdiction. Administrators need not conduct public hearings before issuing a cease and desist order.

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

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

A bond is selling at a premium over par value. Therefore, its A) yield to maturity is greater than its current yield B) none of the above C) nominal yield is less than its current yield D) current yield is less than its nominal yield

D...Any bond selling at a premium will yield less than the coupon rate (nominal yield). Conversely, of course, a bond trading at a discount will certainly yield more. Remember, there is an inverse relationship between bond prices and bond yields.

When an open-end management investment company computes its net asset value per share, each of the following occurrences would have an impact EXCEPT A) interest payments made on debt securities held in the fund's portfolio B) a drop in the value of equity securities held in the fund's portfolio C) a capital gains distribution D) a greater value of shares being redeemed than purchased

D...Because shares are purchased and redeemed at NAV, net redemptions (this case) or net purchases have no effect on the net asset value of the fund's shares. However, receipt of cash in the form of interest payments causes assets to increase, while falling equity prices leads to a decrease. Distributions of capital gains (or dividends) represents a payment of cash, thus decreasing the amount of assets on hand.

Which of the following classes of mutual fund shares would be appropriate for an investor who doesn't mind paying some sales charges on a purchase, but wants to minimize operating expenses over a long-term holding period? A) No-load shares B) Class B shares C) Class C shares D) Class A shares

D...Class A shares have a front-end load, but their operating expense ratio is usually lower than that of any other class. Because the question states that the investor is willing to pay a sales charge, no-load shares is an inappropriate choice.

Net asset value per share for a mutual fund can be expected to decrease if A) the issuers of securities in the portfolio have made dividend distributions B) the securities in the portfolio have appreciated in value C) the fund has experienced net redemptions of shares D) the fund has made dividend distributions to shareholders

D...If dividends are distributed to shareholders, the fund's assets will decrease and value per share will fall accordingly. Appreciation of the portfolio and dividends paid to the portfolio will increase the value. If issuers have made distributions to the portfolio, the net asset value will increase. Net redemptions have no effect on the net asset value, because the money paid out is offset by a reduced number of shares outstanding.

With an annuity, 1taxes on earned dividends, interest, and capital gains are paid annually until the owner withdraws money from the contract. 2random withdrawals are taxed on a LIFO basis. 3money invested in a nonqualified annuity represents the investor's cost basis. 4upon withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income. A) I, II and IV B) IV only C) I only D) II, III, and IV

D...Money randomly withdrawn (not annuitized) is handled under LIFO tax rules. Money invested in an annuity represents the investor's cost basis and on withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income. Taxes on earned dividends, interest, and capital gains are not paid annually. They are deferred and paid later, when the owner withdraws money from the contract.

Which of the following best describes net present value? A) The discount rate that results in a return of zero for a series of future cash flows B) It is the true interest yield expected from an investment expressed as a percentage C) The amount of money that must be invested today at some specified rate of return to equal a targeted value in a specified number of years D) The difference between the sum of the discounted cash flows that are expected from an investment and its initial cost

D...Net present value is a computation taking into consideration future cash flows, discounted to the present, and comparing that to the capital investment necessary to obtain those flows. It is always expressed in monetary units and, if positive, indicates a potentially worthwhile investment.

A new client is looking for a recommendation. The client is 72 years old, has sufficient income from Social Security and a pension plan to cover all of her living expenses. She has just inherited $100,000. She wants to invest this money to have a bit more income so she can spoil her grandchildren. Which of the following would be antipodal to her wishes? A) Public utility stock B) Jumbo CDs C) Treasury bonds D) Treasury strips

D...The answer is Treasury strips. If she wants additional income, she cannot get that from Treasury strips. They are zero-coupon bonds and pay nothing until maturity.

What is the tax equivalent yield of a 7% municipal bond to an investor in the 35% federal income tax bracket? A) 20% B) 9.45% C) 4.55% D) 10.77%

D...The computation for tax equivalent yield is found by dividing the municipal bond's coupon rate (7%) by (100% - tax bracket) or (100% - 35%). When dividing 7% by.65, the result is closest to 10.77%. In other words, an investor would have to receive a taxable return in excess of 10.77% to put more money in the pocket than owning this 7% municipal bond.

Juliette, a math teacher in the local high school, owns a qualified, tax-deferred annuity. When she retires, what will be the tax consequences of her annuity payments? A) Her annuity payments are partly taxable as capital gain and partly taxable as ordinary income. B) Her annuity payments are partly taxable and partly tax-free return of capital. C) Her annuity payments are tax free. D) Her annuity payments are all taxable as ordinary income

D...The key word here is qualified! The investment Juliette made was with pre-tax dollars, the money grows tax-deferred, and everything is taxed at distribution at ordinary income rates. No annuity payment is ever treated as a distribution of capital gains. Note: On the exam, all contributions to retirement plans are fully -deductible unless something in the question specifies otherwise.

If a customer owns 7% of a publicly-traded company's stock and his spouse owns 6% and wants to sell her shares, which of the following statements is true? A) The spouse is an affiliate and Rule 144 does not apply. B) The spouse is not an affiliate and Rule 144 applies. C) The spouse is not an affiliate and Rule 144 does not apply. D) The spouse is an affiliate and Rule 144 applies.

D...Together, the client and wife own 13% of the company's stock, so the spouse is considered an affiliate and is bound by Rule 144. If there is a 10% or more ownership interest among members of an immediate family living at the same residence, then all members are considered control persons (affiliates) subject to Rule 144. For exam purposes, assume that spouses share the same residence.

An investment adviser representative has a client who prefers the safety of securities guaranteed by the U.S. Government, yet is concerned about volatility due to uncertainties in the future direction of interest rates. Which of the following recommendations would best address these concerns? A) Treasury STRIPS, maturing in 2036 B) 8% Treasury bond maturing in 2036 C) 5% Treasury bond, maturing in 2037 D) 6% Treasury bond maturing in 2035

Generally speaking, those bonds with the highest coupons have the shortest duration, therefore, are the least subject to interest rate risk. STRIPS, which are zero-coupon bonds, are the most volatile because they have the longest duration. The actual calculation of the duration of each of the other bonds given is beyond the scope of this exam. B

Which of the following hedge funds characteristics is least accurate? A) They are heavily regulated by capital market authorities. B) Most can borrow funds and use derivatives. C) Their investment style is generally aimed at producing "absolute" returns. D) They require large entry-level investment amounts.

Hedge funds are unregulated collective investment vehicles. This means they cannot be generally marketed to private individuals because they are considered too risky for the less financially-sophisticated investor. The initial outlay is usually quite high. Financial leverage and derivatives are a common practice with hedge funds. By hedging, the portfolio manager attempts to produce returns in both up and down markets. U14LO6 A

Your customer owns $100 par 5½% callable convertible preferred stock convertible into 4 shares of common stock at $25. What should she be advised to do if the board of directors were to call all the preferred at 106 when the common stock is trading at $25.50? A) Place irrevocable instructions to convert the preferred stock into common stock and sell short the common stock immediately. B) Convert her preferred stock into common stock because it is selling above parity. C) Present the preferred stock for the call because the call price is $4 above the parity price. D) Hold the preferred stock to continue the 5½% yield.

If the preferred stock is called, the client will receive $106. Tendering the preferred stock will provide the highest value. The value of converting the preferred stock into 4 shares of common is worth $102 (4 × $25.50 = $102), which is less than the call value of $106. The dividends will cease on the call date if the preferred stock is held beyond the call date. C

Which of the following bonds would be the least price sensitive to changes in market interest rates? A) Zero due in one year with a YTM of 6% B) 10% BB bond due in 21 years with a YTM of 8.7% C) 4.5% Treasury bond due in 20 years with a YTM of 4.1% D) 6% AA bond due in 18 years with a YTM of 6.8%

In almost every question like this, the zero will have the longest duration and the greatest price sensitivity to interest rate changes. This is the odd case where the zero is due so soon that its duration is by far the shortest of any of the choices. Shorter duration means less price sensitivity A

A European corporation seeking a short-term loan would probably be most concerned about an increase to: A) the U.S. Treasury bill rate B) the Fed funds rate C) the Eurobond rate D) the LIBOR

LIBOR stands for London Interbank Offered Rate and, for the rest of the world outside of the U.S., is the standard upon which short-term rates are based. D

Discounted cash flow is commonly thought of as applying solely to fixed-income securities. However, forms of DCF used for the valuation of common stock also include 1the price-to-earnings ratio 2the dividend discount model 3the discounted book value model 4the dividend growth model A) I and II B) II and III C) II and IV D) I and IV

The 2 most common forms of DCF used in the valuation of common stock are the dividend discount and dividend growth models. C

A client is interested in purchasing a REIT and asks you what the differences are between a listed REIT and an unlisted REIT. You could respond that all of the following are differences EXCEPT A) suitability requirements B) fees and expenses C) regulatory oversight D) liquidity

The internal operating costs of a REIT, such as management fees and administrative expenses, have nothing to do with where units of the REIT are traded. One of the major risks inherent in an unlisted REIT is lack of liquidity. As a result, there is a greater stringency when it comes to suitability, and this leads to stronger oversight by the regulators. B

One way in which incentive stock options (ISOs) differ from nonqualified stock options (NQSOs) is that A) the bargain element of the ISO is reported as wages on the tax returns of the employer and the employee. B) the bargain element of the ISO is an AMT preference item. C) there is a maximum 5-year limit for exercise on the ISO while the time limit on the NQSO is 10 years. D) gains on an ISO are always short-term while those on an NQSO are long-term.

The only true statement here is that the bargain element (the difference between the current market price at the time of exercise and the strike price) of the ISO (but not the NQSO) is one of the preference items for the alternative minimum tax. It is the bargain element of the NQSO which is reported as wages and it is possible, although difficult, to have long-term capital gains on both. Only the ISO has a maximum time limit and it is 10 years, not 5. B

Jasper Whitlock is considered an affiliated person of the Tahor Clean Energy Mutual Fund. Under the Investment Company Act of 1940, Mr. Whitlock is prohibited from all of the following except A) borrowing from the fund (money or property) B) being elected to the fund's board of directors C) buying securities from the fund's portfolio D) selling stock to the fund for its portfolio

There is no problem with an affiliated person being elected to the fund's board of directors. Under the act, as many as 60% of the board members may be affiliated persons. Affiliated persons may not have any dealings with the investment company (outside of contractual obligations and the purchase or redemption of shares of the investment company), such as buying securities, furniture, real estate, or other property from the company or selling such property to the company. B

One of your customers owns an index annuity. The percentage of the index's return the insurance company credits to the annuity is determined by A) the annuity reset rate B) the participation rate C) the CDSC D) the cap rate

Virtually all index annuities have a specified participation rate, the percentage of the index's earnings that will be credited to the account. For example, if the index returned 8% and the participation rate is 80%, the customer's account will be credited with 6.4%. Not all index annuities have a cap rate, but even then, the cap rate only takes effect when the credited earnings exceed the cap. For example, if the cap in our example was 5%, that is what the customer would receive. It is important to read the questions carefully. The cap rate puts an upper limit on the amount credited, but it is the participation rate that specifies the percentage of the return that will be credited. B

Corporations have found that one way to increase employee motivation is to grant options to purchase stock in the company. Incentive (qualified) options differ from nonqualified options in all of the following respects except A) there is a maximum 10-year limit for exercising an ISO; no such time limit exists for an NSO. B) the holder of an ISO can recognize capital gain (loss) as a result of exercise, whereas ordinary income (loss) is the result with an NSO. C) ISOs may only be granted to employees while NSOs may be given to virtually anyone. D) the recipient of the grant of the ISO has no income tax consequences at the time of the grant.

Whether the grant is of an ISO (qualified) or an NSO (nonqualified), there are no tax consequences to the recipient at the time of the grant. It is only after exercise (NSO) and sale after exercise (ISO) that the recipient of the grant has tax consequences. Each of the other choices represents a difference. ISOs can only be granted to employees while the NSO can also be granted to members of the board of directors and even to vendors. With an ISO, capital gain (loss) treatment is available upon the sale of the stock if the recipient holds the stock purchased through exercise at least 1 year from the date of exercise and at least 2 years from the date of the grant. With an NSO, the recipient can only have ordinary income (loss) based on the difference between the exercise price and the market value when the option is exercised. Finally, if the recipient of an ISO does not exercise the option within 10 years of the grant, it is treated as an NSO for tax purposes. D

When an open-end management investment company computes its net asset value per share, each of the following occurrences would have an impact EXCEPT A) interest payments made on debt securities held in the fund's portfolio B) a capital gains distribution C) a greater value of shares being redeemed than purchased D) a drop in the value of equity securities held in the fund's portfolio

c....Because shares are purchased and redeemed at NAV, net redemptions (this case) or net purchases have no effect on the net asset value of the fund's shares. However, receipt of cash in the form of interest payments causes assets to increase, while falling equity prices leads to a decrease. Distributions of capital gains (or dividends) represents a payment of cash, thus decreasing the amount of assets on hand.