Product Review Questions

A client interested in fixed income is viewing different bonds with the same rating and a coupon of 5%. Using the discounted cash flow method, which bond should have the highest market value?

12 year maturity when the discount rate is 3% Remember, the discount rate is just another way of stating the current interest rate in the marketplace. If the discount rate is higher than the coupon rate, the expected market price, (the present value), will be below par. Conversely, if the discount rate is lower than the coupon rate, the present value will be above the par value. As we've learned with duration, when interest rates change, the longer the time to maturity, the greater the effect on the market price of a bond.

A bond analyst who determines the value of a debt security by adding the present value of the future coupons to the present value of the maturity value is using which of the following valuation methods?

Discounted cash flow

Last year, an investor had a $5,000 loss after netting all realized capital gains and losses. This year the investor has a $1,000 capital gain. After netting his gains and losses, what will be his tax situation this year?

He will offset $1,000 ordinary income this year.

When reading the prospectus for a fund, you notice that it states that the fund may make portfolio purchases on margin, take short positions, and use arbitrage techniques. This is most likely what type of fund?

Hedge. Margin trading and selling short are techniques commonly found in hedge funds, rather than in open-end or closed-end management funds or ETFs.

Which of the following securities is the least suitable recommendation for a qualified money-purchase plan account?

Investment grade municipal bond. Investment-grade municipal bonds bear low yields that are tax exempt. Since money in a qualified retirement plan account grows tax deferred regardless of the investment instrument, tax-exempt securities are unsuitable. In addition, when the money is withdrawn it is taxable as ordinary income so, in effect, tax-free income has been converted into taxable income.

From the following four portfolios, choose the one that would generally be considered to be the most diversified. A) ABC common stock, beta 1.20, correlation to the S&P 500, +.82; DEF common stock, beta .90, correlation to the S&P 500, +.91; GHI common stock; beta +.65, correlation to the S&P 500, +.06. B) DCB common stock, beta 1.00, correlation to the S&P 500, +.75; HGF common stock, beta .10, correlation to the S&P 500, +.25; KJI common stock, beta -.50, correlation to the S&P 500 +.50. C) JKL common stock, beta 1.50, correlation to the S&P 500, +.77; MNO common stock, beta 1.00, correlation to the S&P 500, +.93, PQR common stock, beta .50, correlation to the S&P 500, +.34. D) STU common stock, beta .95, correlation to the S&P 500, +.84, VWX common stock, beta .90, correlation to the S&P 500, +.07; YZA common stock, beta .88, correlation to the S&P 500, -.45.

STU common stock, beta .95, correlation to the S&P 500, +.84, VWX common stock, beta .90, correlation to the S&P 500, +.07; YZA common stock, beta .88, correlation to the S&P 500, -.45. Most analysts would agree that the greatest portfolio diversification occurs when there are some holdings with a negative correlation. Beta measures volatility, so varying those positions will offer some protection against volatility. However, including securities that move in opposite directions will provide protection against general market declines.

One of the offshoots of the capital asset pricing model (CAPM) is the Capital Market Line (CML). The equation for the CML uses which one of the following?

Standard deviation

If a client wanted an investment that would eliminate interest risk as to principal, you would recommend

a bank insured certificate of deposit Because bank insured CDs are non-negotiable (we're not discussing the $100k minimum jumbos), there is no market fluctuation caused by changes in interest rates as with marketable securities. If you invest $10,000, you will always get back that $10,000 whenever you cash in the CD, regardless of current interest rates. This is true even when cashing in early. There may be a prepayment penalty, but that is considered separate from interest rate risk. TIPS offer inflation protection and preferred stock is interest rate sensitive in the same manner as a bond. The 90-day T-bill doesn't have much interest rate risk, but, if an investor was to attempt to liquidate the holding prior to maturity and interest rates increased, there could be a loss.

John Jones dies in June, 2014, leaving the proceeds of his $400,000 life insurance policy to his wife. When computing his gross estate

all $400,000 is included All of a deceased person's assets are included in the gross estate. Whether or not an asset is subject to estate tax is a different story and not part of this question. One way to have removed the policy from the gross estate would have been by using an ILIT.

A well-diversified investor following a rebalancing portfolio strategy in a rising market will most likely

sell part of the stock in the portfolio.

All of the following are advantages of a 401(k) plan EXCEPT:

the employer may make unlimited contributions, which generate unlimited tax deductions for the business.