Practice Test 2
Which of these are TRUE regarding a life settlement contract? I. Premiums will be paid by the contract owner. II. Premiums will be paid by the insured. III. Proceeds will be paid upon the death of the contract owner. IV. Proceeds will be paid upon the death of the insured. A) I and IV B) I and III C) II and IV D) II and III
A. A life settlement is the secondary sale of a life insurance policy. The buyer (the new owner) is responsible for paying the premiums and, upon the death of the insured, will receive the death benefit.
One of your clients has reached his company's mandatory retirement age of 67. He has been a participant in his employer's 401(k) plan and his account is valued at $400,000. The account is funded with mutual funds and company stock. The cost basis of the company stock is $25,000 and it is currently worth $125,000. If he were to rollover the entire account into an IRA, the tax treatment would be: A) no current tax, but any withdrawals would be taxed as ordinary income. B) current tax at ordinary income rates on the unrealized appreciation of the company stock, ordinary income rates on the balance when withdrawals are taken. C) no current tax, but any withdrawals representing the gain on the company stock would be taxed as long-term capital gains. D) no current tax on the portion applicable to the mutual funds; ordinary income on the cost basis of the company stock; and long-term capital gains on the unrealized appreciation of the company stock when it is sold.
A. As with any rollover from a qualified plan to an IRA, there is no current tax, but withdrawals are taxed at ordinary income tax rates. This client would have saved had he taken advantage of the NUA (Net Unrealized Appreciation) approach. In that case, taking the company stock and putting it into a taxable account would have resulted in ordinary income tax on the $25,000 cost basis, and long term capital gain rates on the appreciation whenever the stock was sold.
One of the respects in which the USA treats investment adviser representatives differently than investment advisers is that IARs: A) employed by federal covered advisers must register in each state in which they maintain a place of business whereas the IA registers only with the SEC. B) may be permitted to share in the profits and losses in a client's account whereas IAs never can. C) are always individuals whereas no individual can register as an IA. D) exercising discretion in client's account may be required to post a surety bond whereas IAs generally do not require bonding.
A. Investment adviser representatives employed by federal covered investment advisers must register as IARs in each state in which they have a place of business. Federal covered advisers register only with the SEC, not with any states. There are a number of individually registered IAs, and neither IAs nor IARs are permitted to share in profits and losses in customer accounts. Only IAs, but not IARs, may be required to post surety bonds if they exercise discretion in client accounts.
One of the respects in which the USA treats investment adviser representatives differently than investment advisers is that IARs: A) employed by federal covered advisers must register in each state in which they maintain a place of business whereas the IA registers only with the SEC. B) may be permitted to share in the profits and losses in a client's account whereas IAs never can. C) are always individuals whereas no individual can register as an IA. D) exercising discretion in client's account may be required to post a surety bond whereas IAs generally do not require bonding.
A. Investment adviser representatives employed by federal covered investment advisers must register as IARs in each state in which they have a place of business. Federal covered advisers register only with the SEC, not with any states. There are a number of individually registered IAs, and neither IAs nor IARs are permitted to share in profits and losses in customer accounts. Only IAs, but not IARs, may be required to post surety bonds if they exercise discretion in client accounts.
A life insurance policy where the premium increases each time the policy is renewed while the face amount remains level is A) renewable level term B) variable universal C) decreasing term D) increasing term
A. Level term insurance offers a fixed face amount over the life of the policy. If the policy is renewable, the owner has the ability to renew it for that same face amount and the new term, but at new, higher premiums as the insured's age increases.
A client of an investment adviser is thrilled with her portfolio's results and posts a note on her bridge club's cork board suggesting that some of the other members would probably benefit from the adviser's skills. Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, A) this would be permissible because it was done without the knowledge of the adviser B) cork boards are not considered social media and that is the only place where testimonials are prohibited C) if the investment adviser learns of the posting, it is not necessary to ask the client to remove it D) this would not be permissible because it is clearly a testimonial
A. There is a limit as to how far an investment adviser or IAR can go to prevent clients from giving testimonials. After all, as in so many businesses, referrals are a key to growth. As long as this note was posted without any knowledge of the IA (or IAR), there is no problem. However, once the IA (or IAR) finds out about it, a request must be made to remove it. The prohibition on testimonials is not limited to social media.
A federal covered investment adviser would like to charge a client a performance fee based on a selected benchmark. The client has $400,000 invested with the adviser, but has a net worth of $2,150,000, of which $350,000 represents an investment account, 50% of which is shared with his cousin. A) Because we can allow none of the jointly-held property, this client does not have the necessary net worth to qualify for a performance-based compensation program. B) Because we can allow all of the jointly-held property, this client has the necessary net worth to qualify for a performance-based compensation program. C) Because the client's 50% share of the investment account is only $175,000, this client does not qualify for a performance-based compensation program. D) Because the total of the amount invested with the adviser ($400,000) plus the individual's personal net worth ($1,800,000 without counting the joint property) exceeds $2 million, this client has the necessary net worth to qualify for a performance-based compensation program.
A. Under federal (and state) law, in order to qualify for a performance-based compensation program, the client must have either $1 million in assets managed by the adviser or a net worth of $2.1 million. This requirement is described in Rule 205-3 of the Investment Advisers Act of 1940 and the NASAA Model Rule makes reference to the federal rule. If using joint assets, only those with a spouse are allowed. Please note: This differs from meeting the net worth standard as an accredited investor. Under Rule 501 of Regulation D of the Securities Act of 1933, one can use assets owned jointly with persons other than a spouse to qualify as an accredited investor, but only to the extent of his or her percentage ownership of the account or property.
A "margin account" is a type of brokerage account in which the broker-dealer lends the investor cash to purchase securities using marginable securities in the account as collateral. Which of the account documents authorizes the use of those securities as collateral for that loan? A) The secured agreement B) The credit agreement C) The loan consent agreement D) The hypothecation agreement It is the credit agreement, sometimes referred to as the margin agreement, which contains all of the terms of the loan. In addition to explaining how the interest is charged and the right of the firm to liquidate collateral if a call for additional funds is not made, the credit agreement contains the terminology which authorizes the broker-dealer to use the value of the account as collateral for the margin loan made by the BD to the client. The hypothecation agreement permits the broker-dealer to pledge the client's margin securities as collateral for a loan that the BD takes out. In simple terms, there are two loans taking place: The loan from the BD to the client with the client's securities used as collateral. That is covered in the credit agreement The loan from a bank to the BD with the client's securities used as collateral for the BD's loan. The authorization for the BD to use those securities is found in the hypothecation agreement.
B. It is the credit agreement, sometimes referred to as the margin agreement, which contains all of the terms of the loan. In addition to explaining how the interest is charged and the right of the firm to liquidate collateral if a call for additional funds is not made, the credit agreement contains the terminology which authorizes the broker-dealer to use the value of the account as collateral for the margin loan made by the BD to the client. The hypothecation agreement permits the broker-dealer to pledge the client's margin securities as collateral for a loan that the BD takes out. In simple terms, there are two loans taking place: The loan from the BD to the client with the client's securities used as collateral. That is covered in the credit agreement The loan from a bank to the BD with the client's securities used as collateral for the BD's loan. The authorization for the BD to use those securities is found in the hypothecation agreement.
Under the Uniform Securities Act, a person whose business model is selling reports on a subscription basis concerning specific securities to investors based on their individual objectives will be defined as A) an agent B) an investment adviser C) a broker-dealer D) a journalist
B. The definition of investment adviser includes any person who for compensation engages in the business of advising others as to the value of securities or the advisability of buying, selling, or investing in securities or who, as a part of a regular business, publishes securities analyses or securities reports for individual investors on a paid subscription basis.
According to the Uniform Securities Act, to determine whether an investment adviser is trading excessively in a customer's account, regulators primarily examine whether the: A) adviser received compensation for the trades. B) transactions matched the investor's objectives. C) adviser acted as a principal or an agent. D) customer approved the transactions in writing.
B. Trading in a customer's account must not be excessive in terms of size or frequency with respect to the customer's investment objectives and financial ability. For example, if the client's objective was speculative trading, a higher than normal volume would be expected. It could also be important to know whether the adviser was receiving trade-based compensation (which could be the reason for the possible churning), but that would be secondary to customer objectives.
After publishing a favorable report on a stock, an analyst was asked to appear on a television program to discuss the reasons for the bullish recommendation. Which of the following best describes how the analyst may communicate about the stock to others? A) The analyst may communicate about the stock and is not required to disclose any positions he or his firm holds in the stock. B) The analyst may not communicate about the stock to any other parties. C) The analyst may communicate about the stock to clients and prospective clients only if he has disclosed personal or firm holdings of that security. D) The analyst may not communicate about the stock to prospective clients but may discuss the stock with current clients.
C. Because the report has been published, the analyst's assessment of the stock is already public information. Thus, the analyst may recommend the stock to clients and prospects. However, the analyst must disclose whether he or his firm holds a position in the stock.
Which of the following vehicles make use of the unified estate tax credit? I. bypass trust. II. generation skipping trust. III. living trust. IV. simple trust. A) II and III. B) I and IV. C) I and II. D) III and IV.
C. Both the bypass trust and the generation skipping trust are tools used by estate planners to reduce estate taxes. They do so by passing the amount in the unified credit (currently $5.45 million for 2016) to heirs other than the spouse, usually grandchildren in the case of the GST.
If an elderly widow with no independent income other than Social Security payments wishes to invest the proceeds from her recently deceased husband's life insurance, which of the following would be the most suitable recommendation? A) Purchasing call options. B) Municipal bonds with short-term maturities. C) High quality dividend paying preferred stocks. D) Oil and gas exploration program that is going to strike.
C. High quality dividend paying preferred stocks will give her a reasonable income without great risk. Options are not income vehicles and are not income producing. Municipal bonds are not generally appropriate for low income clients because there would be little after-tax benefits. Oil and gas programs are speculative and not appropriate.
One of your clients dies. You could legally take instructions regarding the individual's estate from A) a CPA who prepared the deceased's tax return B) the spouse of the deceased C) the administrator in intestacy D) a person with durable power of attorney
C. If an individual dies without a will (intestate), the state will appoint an administrator in intestacy who, just as an executor for one who had a will, has control over the deceased's assets. A durable power of attorney, just like any other power, expires upon the death of either party to the power.
If a portfolio manager wished to reduce inflation risk, which of the following would be most appropriate to add to the portfolio? A) AAA bonds. B) Preferred stock. C) Tangible assets. D) Annuities.
C. Tangible assets, such as real estate, precious metals, and other commodities, tend to keep pace with inflation. Fixed dollar investments do not.
Kapco Advisers is registered with the SEC. They wish to employ the services of a third-party firm to solicit for their new asset management program. All of the following statements about this arrangement are true EXCEPT: A) scripts used to present the program must be under Kapco's supervision to ensure compliance with all appropriate regulations. B) if the use of these solicitors increases the cost to the client, the expense must be disclosed. C) employees of the solicitor firm must be registered as investment adviser representatives of Kapco Advisers. D) parties requesting further information must be furnished with Kapco's brochure as well as the solicitor's brochure.
C. The Investment Company Act of 1940 does not require registration of third-party solicitors. However, for those advisers who are not federal covered, under most conditions, the USA would require that solicitors be registered as IARs.
Which of the following statements best describes the effect of the NSMIA on securities regulation? A) Increased the power of state securities Administrators over registration of securities. B) Provided for the registration of intrastate securities. C) Preempts state registration of covered securities. D) Established the need for dual registration of securities.
C. The National Securities Markets Improvement Act preempts state registration of covered securities. State administrators may not impose registration requirements on securities that are subject to federal regulation.
If the expected return on the market is 20% and the risk-free rate is 4%, a stock with a beta coefficient of 0.8 would have an expected rate of return under CAPM of: A) 19.2%. B) 16.0%. C) 16.8%. D) 12.8%.
C. The formula is the risk-free rate (.04) plus the product of the stock's beta (.8) and the difference between the expected return on the market and the risk-free rate(.20 - .04). In this case, it would be .04 + .8(.16) or .04 + .128 = .168
The statistical method used to determine the return profile of a security or portfolio that recreates potential outcomes by generating random values based on the risk and return characteristics of the securities themselves is known as the A) efficient market hypothesis B) capital asset pricing model (CAPM) C) Monte Carlo simulation D) optimal portfolio
C. This is the basic definition of the Monte Carlo simulation.
Which of the following are prohibited practices? An investment adviser transferred a client's account to a brokerage house because the account went below the firm's minimum size and then informed the client. An investment adviser organized as a partnership did not inform its clients of the departure of a partner who had only a very small interest in the firm. An investment adviser subsidiary of a publicly traded bank holding company failed to inform its clients of the departure of the firm's chairman and major stockholder. An investment adviser firm organized as a general partnership sends prompt notification to all clients after the addition of a new partner. A) I and IV. B) III and IV. C) I and II. D) II and III.
C. Transfer or assignment of an advisory account without prior client consent is always prohibited. An investment adviser need not inform clients of departures of employees, senior or otherwise, from investment advisory firms that are incorporated. Clients must, however, be informed of the departure or addition of any partner if the firm is organized as a partnership. The legal requirement for this notification is "within a reasonable period of time", but there is nothing prohibited about doing it promptly.
A client needs funds for an unexpected medical emergency. If the client takes out a loan against the cash value of his life insurance policy and does not pay it back, the insurance company can do which of the following? A) Cancel the policy B) Increase the premium amortized over the life of the policy C) Reduce the death benefit when the client dies D) Reduce the cash value at the next anniversary
C. Unpaid cash value loans reduce the death benefit.
If the Administrator has summarily suspended an investment adviser representative's registration, the registrant may request a hearing by written request and the hearing will be granted within: A) 60 days. B) 30 days. C) 15 days. D) 45 days.
C. When an Administrator summarily suspends a registration, the registrant has a right to a hearing if the request is made in writing. The hearing must be granted within 15 days of receipt of the request. Registration of professionals takes place at noon of the 30th day and an appeal for review of an Administrator's order must be filed within 60 days.
Tamika is an investment adviser representative with Financial Engineers, LLC, a covered investment adviser. The firm uses an investment policy statement to help design financial plans for their clients. One of Tamika's current clients plans to purchase a new boat 7 months from now. When using the IPS, this would be considered A) a capital need B) an investment goal C) a financial objective D) an investment constraint
D. Investment constraints are obstacles or restrictions that must be met in order to meet objectives. In this case, we are dealing with a liquidity constraint—in 7 months, cash will be necessary to make the purchase.
As defined in SEC Release IA-1092, which of the following is a pension consultant? A) A person who provides securities-related advice for compensation. B) A person who prepares a plan for a client's future based on analyzing needs, objectives, tax situations, and resources. C) A person who charges a fee for advising retirees on how to maximize their pension payouts. D) Persons suggesting portfolio managers to administrators of employee benefit plans.
D. Pension consultants provide various forms of investment advice to administrators of employee benefit plans. They might manage the assets or, as in this case, provide suggestions of portfolio managers.
Your customer is asking if either exchange-traded funds (ETFs) or exchange-traded notes (ETNs) might be suitable investments for his portfolio. The customer makes several statements regarding his understanding of the products, but only 1 of them is accurate. Which is it? A) ETNs are equity securities because they trade on exchanges. B) If I want to sell my shares of an ETF, I have to wait until the next price is calculated to value the portfolio of securities. C) ETFs have a fixed coupon rate that I should expect to realize when they mature. D) ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer.
D. The only accurate statement is the one expressing that ETNs are issued by financial institutions and, therefore, the credit worthiness of the issuer should be a concerning factor. ETNs are debt instruments, not equity instruments. ETNs have a final payment at maturity based on the return of a single stock, a basket of stocks, or an equity index. While ETF prices fluctuate based on the value of the securities within the fund portfolio throughout the trading day, they are priced by supply and demand, like all exchange-traded products. They are not forward priced like open-end mutual fund shares are.
A broker-dealer receives a written complaint from one of its customers. The most appropriate action to take is to: A) immediately notify the Administrator. B) immediately freeze the client's account. C) immediately notify NASAA. D) immediately reply to the client in writing.
D. When a broker-dealer receives a written complaint from a customer, it must document that complaint and begin an investigation as to the complaint's merits. Part of that procedure would be sending a written acknowledgment to the client that the complaint has been received.
The purpose of SEC Release IA-1092 is to: unify the requirements of the Uniform Securities Act and the Investment Advisers Act of 1940. I. clarify the Securities Exchange Act of 1934. II. clarify the activities that would subject a person to regulation under the Investment Advisers Act of 1940. A) I and II. B) I only. C) II only. D) III only.
The purpose of SEC Release IA-1092 is to clarify the definition of investment adviser in the Investment Advisers Act of 1940 and to clarify the types of activities that are subject to regulation.
