S65 - PROGRESS EXAM GREENLIGHT 1
When XYZ is selling at 38, an investor purchases an XYZ October 40 put for a total premium of $500. In dollars, what's the intrinsic value of the option?
$200 The put is 2 points in-the-money and this is its intrinsic value. Time value is 3 points. Since the contract size is 100 shares, the intrinsic value equals $200 and the time value equals $300.
If a bond with a 6% coupon is selling at a basis of 6.25%, and the bond's yield increases by 50 basis points, the yield to maturity is:
6.75% The term basis is synonymous with yield to maturity. Changes in yields are expressed in basis points, so if the bond's yield increased by 50 basis points, the yield to maturity would increase to 6.75 (50 basis points = .5% change in yield).
An investor's portfolio earned 2% in cash dividends and has appreciated by 8% over the last year. If the rate of inflation was 1.5% over the last year, what is the client's real rate of return?
8.5% The investor's real rate of return (inflation-adjusted rate of return) is the total return minus the rate of inflation. To find the real rate of return, simply determine the total return over the year (2% dividends + 8% appreciation) and subtract the corresponding rate of inflation over the same period (1.5%). Therefore, the real rate of return is 8.5% (10% - 1.5%).
Which of the following investment advisers would most likely NOT be required to register with the Administrator?
A firm that provides advice on fixed annuities Investment advisers provide securities-related investment advice. A fixed annuity is not considered a security by state Administrators. Since the firm is not considered to be providing securities-related advice, it would be exempt from the definition of an investment adviser.
Mary is setting up an investment advisory business in the town in which she was born and has known the town's mayor since childhood. Mary places an advertisement in the local newspaper that quotes the mayor as stating, "I have known Mary since we were kids and we're fortunate to have someone with her expertise and integrity setting up her investment advisory business in our community." This advertisement is:
Acceptable as long as the advertisement contained a footnote which describes the mayor's qualifications An investment adviser is permitted to use testimonials in its advertising. Additionally, individuals who provide testimonials may receive compensation for providing a testimonial. However, to ensure that clients are not being misled, both SEC and state rules require advisers to disclose the qualifications of the provider of the testimonial and whether compensation was paid.
Which of the following styles of options can be exercised sooner than the others?
American-Style Options America-style options may be exercised at any time before expiration. European-style options may only be exercised on a certain day. Capped style options are automatically exercised at the cap price. Uncovered options are a type of option, not a style, which may only be exercised by the holder.
An IAR is comparing an S Corporation and a limited partnership for a client. What is an advantage of investing in an S Corporation that is not available with a limited partnership?
An S Corporation provides investors with more control over management decisions. In an S Corporation, its shareholders have voting rights, which provides some control over management decisions. However, in a limited partnership, taking part in management decisions jeopardizes an investor's status as a limited partner and may result in creditors of the partnership considering the investor to be a general partner with unlimited personal liability for debts of the partnership. Both of these business entities provide investors with limited liability. As with a limited partnership, an S Corporation's gains and losses "flow through" to its investors, but there is no way to determine which will pay more since the flow-through is based on the performance of the specific vehicle's management. An S Corporation is limited to 100 shareholders.
Offering which of the following goods or services would be a violation of soft-dollar practices if the broker-dealer provides them to the adviser in exchange for executing transactions?
Assistance concerning its compliance responsibilities An adviser is permitted to use a broker-dealer to execute transactions in exchange for certain services. This practice is referred to as soft dollars and it is defined as a means of paying brokerage firms for their services through trade commissions. The key here is that the services that the adviser receives as part of a soft-dollar arrangement must benefit its clients. Some examples of allowable services would include traditional and third-party research reports and other related publications, discussions with research analysts concerning the securities they cover, portfolio analysis software, attendance at a conference or seminar where corporate executives discuss their company's performance, market and economic data services, and certain trading software. The permissible uses of soft dollars do not include compliance or administrative assistance, advertising and marketing, the adviser's travel expenses, meals or entertainment, overhead and administrative expenses, employee salaries, marketing, professional licensing fees, computer terminals, or the correction of trading errors.
Which of the following positions would expose the customer to the greatest possible loss?
Buy 1,000 shares of Netflix at 200 and sell 10 Netflix July 210 calls In choice (a), the customer is writing covered calls by purchasing the stock and writing an equal number of call options. If the price of the stock falls to zero, the call options will expire worthless, but the customer would have a significant loss on the long stock position. The breakeven price is the cost of the stock minus the premium received from the call options. Choice (b) is a net debit spread in which the maximum loss is the net premiums paid. Choice (c) is a protective put in which the maximum loss is the cost of the premiums since the strike price is equal to the cost of the stock. Choice (d) is a hedged position since the customer could exercise the call options to close out the short stock position, incurring only a 10-point loss on each contract.
An investor has owned stock for several years and has an unrealized capital gain. If he is willing to sacrifice some yield in order to protect the unrealized gain, which option strategy is the BEST?
Buying puts on the stock Using options, the best way to hedge or protect an unrealized gain is to buy puts. The downside to buying puts for protection is the fact that the premium must be paid. If the stock's price stays flat or rises, the option will expire worthless. This will ultimately result in a loss of the premium, which will negatively affect the performance of the portfolio.
When is a broker-dealer required to deliver a prospectus?
By settlement date Broker-dealers are required to deliver prospectuses to purchasers of a new issue along with the confirmation, which is due by the settlement date.
How is surrender value calculated?
Cash Value minus Surender Charges In an insurance policy or annuity, surrender value represents the amount that a policyholder will receive if she cancels it. Surrender value is calculated by taking the policy's cash value and deducting any surrender fees.
Which of the following investments is prohibited in an IRA?
Collectibles An investor is not permitted to put collectibles (e.g., art, antiques, etc.) in an IRA. Most types of securities are allowed in an IRA; however, the determination as to whether they are suitable is based on the owner's objectives and circumstances.
Which of the following investments is the MOST suitable for a person who is interested in aggressive growth?
Common Stock Of the choices listed, common stock has historically provided the greatest potential for growth. Bonds and preferred stock are typically suitable for investors who are seeking income.
An IAR has very little experience in the industry, but has a client enter his office with assets totaling $45 million. After completing a client profile, the IAR determines that the client has a high risk tolerance and her objective is capital appreciation. What should the IAR do in this situation?
Consider consulting with a seasoned IAR or manager since he has little industry experience When an investment adviser representative opens an account with a significant amount of money, he should be familiar with his firm's policies and procedures. In a situation like this, the IAR may not have enough industry experience to recommend the appropriate investments. For this reason, it may be best if the inexperienced representative solicits the assistance of a seasoned IAR or manager.
Who pays the income taxes in a revocable trust?
Grantor Any income generated by a revocable trust is taxable to the trust's creator (who is often also referred to as a settlor, trustor, or grantor) during the trust creator's lifetime. This is because the trust's creator retains full control over the terms of the trust and the assets contained within it.
When an investor buys a call option, she is considered:
I, II, III & IV When an investor buys a call option (derivative), she has a leveraged position since, for a relatively low cost, the contract allows her to buy 100 shares of stock at a specific price. This ability to buy stock at a preset price makes her bullish (i.e., she wants the stock to rise). If the investor has a short stock position, the purchase of a call option provides her with protection. The protection comes from the fact that she may exercise her call option and use the stock that she receives to cover the short stock position. Since buyers of options cannot lose more than the cost of the option, they have limited liability.
Under the Uniform Securities Act, all the following are considered to meet the definition of agent, EXCEPT:
III & IV ONLY By definition, a sales representative of a broker-dealer is an agent. This is true regardless of whether the securities being sold are covered under a federal exemption. Also, a sales assistant is considered an agent if she is authorized to accept client orders. Choices (III) and (IV) describe activities involving the broker-dealer (firm) and not an agent (individual).
In what type of investing would a passive asset manager engage?
Indexing or Buy & Hold Passive asset managers believe that markets are efficient and don't believe in attempting to time the market. Indexing and buy-and-hold strategies are both types of passive approaches.
When determining the risk tolerance of a client, which of the following choices will an investment adviser representative consider to be the LEAST important?
Information about the client's life insurance policies When determining a client's risk tolerance, the least important factor (of the choices given) for an IAR to consider is information regarding the client's life insurance policies. However, all of the other choices could potentially influence a client's risk tolerance, such as the person's financial status, goals/objectives, and investment experience. For example, experienced clients who have invested in different, unique types of securities are better able to understand how the various types of risk will affect a security's value.
According to the USA, if an investment adviser wants to charge a fee based on the average value of a client's portfolio, the fee:
Is permitted unless prohibited by the Administrator Asset-based fees are one of the most common methods that investment advisers use to charge their clients. Under the Uniform Securities Act, these types of fees are allowed provided they have stated time periods. Since Administrators may create rules prohibiting any type of fee, it would be incorrect to state that they are always permitted.
Which of the following types of stocks is the MOST suitable for a conservative investor who has a low-risk tolerance, but wants to invest in equity securities?
Large-caps Large-cap stocks are those that are generally issued by well-established companies that have a long history of profits and dividend payments. Of the choices given, the large-cap category is the most suitable for the investor with a low-risk tolerance and an interest in equities.
If an investor wishes to use leverage to increase potential gains in her account, she would most likely open a:
Margin account and meet the Regulation T requirement The percentage return available by trading on margin is greater than trading in a cash account, given the same transactions. The downside to using financial leverage is that future deposits may be required if the account value falls below the minimum set by the regulators.
Tax-adjusted returns are adjusted for:
Only taxes Tax-adjusted returns are impacted by taxes, but not by other factors.
Under SEC Release 1092, which of the following persons meets the definition of an investment adviser?
Pension consultants, financial planners, and sports and entertainment representatives SEC Release 1092 provides clarity on the entities that meet the definition of an investment adviser. Prior to the release, it was unclear as to whether pension consultants, financial planners, and sports and entertainment representatives met the definition. However, after the release, the SEC definitively stated that those businesses/entities met the definition of an investment adviser and were subject to registration.
Which of the following choices is another way of expressing the earnings multiple?
Price-Earnings Ratio The earnings multiple is also called the price-earnings ratio.
All of the following are characteristics of Certificates of Deposit, EXCEPT:
They have a maximum maturity of three years Certificates of Deposit (CDs) carry fixed rates of interest and mature after a specified period. There is no maximum maturity, though a minimum maturity of seven days exists. CDs are insured by the FDIC up to $250,000 and holders of CDs are assessed a penalty if redemption is made prior to maturity.
What is the motivation behind setting up an UTMA account?
To provide gifts to the child/owner Due to the popularity of 529 plans, the effectiveness of custodian accounts has diminished. Any of the earnings that are generated in an UTMA are subject to taxation. The primary purpose for establishing a UTMA is to provide gifts of cash and/or securities for a child's future benefit.
Which of the following statements is TRUE regarding an individual who takes benefits from a retirement account that's been awarded under a QDRO?
Withdrawals can be made without penalty, even if the individual is under the age of 59 1/2. A qualified domestic relations order (QDRO) is created to divide a person's retirement account during a divorce. The spouse who receives benefits awarded under a QDRO is exempt from the early withdrawal penalties, but the withdrawals are taxable. The beneficiary can also roll her portion of the account into an IRA, thereby delaying withdrawals and taxes. QDROs are used for any ERISA qualified retirement account, including pensions, 403(b) plans, and 401(k) plans.
Under NASAA's Statement of Policy on Unethical Business Practices, an adviser may share confidential client information with all of the following, EXCEPT:
an Affiliated Broker-Dealer An investment advisory firm must keep all information concerning its clients confidential. It may release the information only if required to do so by law or with the client's approval. The SEC, FINRA, and the IRS are regulatory agencies that could obtain the information without the client's approval.
A customer buys 100 shares of stock at $39 a share. She also sells a call option with a strike price of $40 and receives a premium of $2. What is the customer's breakeven point on this stock and why did she engage in this position?
$37 sold to generate income A type of option position where an investor buys or holds stock and writes a call option is called a covered call. This strategy is typically used to generate income. The breakeven point is $37. It is determined by subtracting the premium from the cost basis of the stock ($39 - $2)
An investor writes an uncovered DPM Oct 55 call for a premium of 9. What is the maximum profit that the investor could realize?
$900 The writer received the $900 premium. If the option expired, he would have no obligation, recognizing the entire premium as a profit. The premium represents the most that the writer could profit.
During the first quarter, XYZ common stock paid a $1 dividend. The stock's price fell from $50 per share at the beginning of the quarter to $48 per share at the end of the period. Based on these results, what is the stock's annualized total return?
-8% The total return from a security includes the cash flow from dividends or interest, plus appreciation or minus depreciation. In this case, the $1 dividend compared to the initial price of $50 per share is a 2% dividend return. The $2 loss in share price from a $50 initial value is a 4% loss. The total return for the quarter is 2% + (-4%) = (-2%). To annualize this quarterly result, multiply by four. 4 x (-2%) = (-8%)
An investor pays $100 per share for 1,000 shares of a 6% cumulative preferred stock which has one year of dividends in arrears. One year after making the purchase, the issuer has paid its normal preferred dividend, plus the dividends in arrears. At that point, if the investor then sells the preferred stock at $104 per share, what is the total return on the preferred stock for the period?
16% A security's total return takes into account the cash flow from dividends or interest, plus appreciation or minus depreciation, and divides by the security's original value. In this question, at the end of the year, the stock paid the $6 of dividends in arrears, plus the $6 stated dividend, plus the stock appreciated by $4. Therefore, the total return is 16%($6 + $6 + $4 ÷ $100).
A young, married couple are ready to start investing and their main objective is long-term growth. Of the following choices, the most appropriate mutual fund for the couple is one with a portfolio that contains:
40% large-cap stocks, 20% mid-cap stocks, 20% small-cap stocks, and 20% bonds The best choice for the young couple is a diversified portfolio that primarily consists of stocks along with a smaller percentage of bonds. When determining an appropriate asset allocation, a generally guideline is to start with the number 100 and subtract the investor's age to determine the percentage that may be devoted to equities. Although the question does not specify the ages of the couple, since they are young and want long-term growth, it should be assumed that a large percentage of equities is appropriate. Although Choice (b) is 100% equities, half of the portfolio is devoted to foreign stocks and is probably too risky.
Under the Uniform Securities Act, which of the following is exempt from registration as a broker-dealer in State B?
A broker-dealer whose only office is in State A, but deals only with institutional clients in State B A broker-dealer must generally register where it has an office or place of business. A broker-dealer is exempt from registration in any state in which it does not have an office AND its only clients in the state are institutional clients or existing clients who are in the state temporarily. A broker-dealer would have to register in any state it has a place of business (choice a). The broker-dealer subsidiary of a bank is subject to registration, not the bank (choice c). A broker-dealer is subject to registration in the state in which it has a place of business regardless of the types of clients (choice d).
An IAR is experiencing financial difficulties and asks one of his clients for a loan. After the client tells the IAR that she does not have any funds available to loan, the IAR recommends that the client sell some of her securities holdings and then lend him the money. According to the Uniform Securities Act, the IAR has:
Acted in an unethical manner and violated his fiduciary duty These actions are unethical and possibly illegal. However, since the IAR is not recommending that the client trade excessively in an effort to generate commissions, this is not a case of churning. Additionally, it is not commingling or conversion since the customer being asked to lend money to the IAR.
State Administrators have certain authority regarding the establishment of requirements related to net capital and registration of broker-dealers. Which of the following BEST describes this authority?
Administrators can act in the public's best interest and establish appropriate minimum net capital requirements for broker-dealers. The Administrator may set minimum net capital requirements which are deemed to be in the public's best interest and appropriate. Remember, as it relates to minimum net capital requirements, a state Administrator cannot impose a requirement that exceeds the SEC (federal) requirement.
According to the NASAA Model Rule on the Ethical Business Practices of Investment Advisers, which of the following statements is TRUE regarding investment advisory fees charged to customers?
Advisers may not charge fees that are unreasonably high in relation to fees charged by other advisers for similar services Although it is difficult to compare the advisory services provided to clients of different advisers, a general standard of reasonable fees is used to compare fees charged by various advisers. Fees that are obviously out of line with those charged for similar services are considered unethical.
Important considerations that an investor should take into account before investing in a limited partnership would include all the following matters, EXCEPT:
An analysis to determine whether the business will lose enough money to make the investment a viable tax shelter The ideal situation for a limited partnership is for the business to generate a positive cash flow, but to report a loss due to the deductions that are applied to revenue. In the investment, there is an expectation of profit, which is made attractive to the investor by the timing of the profit and the way it is taxed. It is wrong to consider the merits of a limited partnership based on how poorly the business will perform.
Which of the following statements is TRUE about REITs?
At least 75% of a REIT's income must be derived from investments in real property At least 75% of a REIT's income must be derived from investments in real property. REITs are also required to distribute 90% of their investment income to shareholders each year. REITs can only pass through income, but cannot pass through losses to their shareholders.
The advantages of a living (inter vivos) trust include:
Avoiding probate A living (inter vivos) trust is a trust created while the grantor is still alive. One of the main advantages of a trust is that it allows the estate to avoid probate. Trusts do not allow people to avoid estate taxes, but they can be used to reduce them in certain circumstances. (Most living trusts are revocable which means the grantor may rescind them at any time. The assets of a revocable trust must be included in the estate when calculating the estate taxes due.)
Which of the following measures the leverage of a company?
Debt-to-Equity Ratio The debt-to-equity ratio measures the leverage of a company (i.e., the amount that it has borrowed). Working capital and the quick asset ratio measure the short-term financial health (i.e., the liquidity) of a firm. The price-to-earnings (P/E) ratio measures the degree to which a company's share price has become over- or under-valued.
An individual is considering making some changes in her portfolio due to expectations that the economy may be moving into a recessionary period. In what type of stocks should she consider investing?
Defensive Stock Defensive stocks tend to react less to negative changes in the economy than other stocks These are stocks of companies that produce items of necessity (e.g., utilities, pharmaceuticals, food, and alcohol).
An advisory client is discussing the purchase of AA-rated, 15-year municipal bonds with his adviser. The bonds offer a coupon rate of 3.2% and can be purchased at a small premium to par. The adviser is not certain if the bonds are trading at an advantageous price. Which calculation would provide the BEST method of determining whether the bonds should be purchased?
Discounted Cash Flow Discounted cash flow evaluates each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for her client.
An investment adviser is attempting to determine whether a fixed-income security is priced attractively relative to a client's desired annual interest rate. Which of the following methods would BEST determine a bond's fair value?
Discounted cash flows Discounted cash flow evaluates each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for her client.
In reference to storing customer books and records, an adviser is permitted to store records on:
Disks, provided the information cannot be altered Books and records must be maintained in an easily accessible place for five years. During the first two years, the records must be maintained in an appropriate office of the investment adviser. Records may be preserved on microfilm, microfiche, or any similar device. They may also be kept on various electronic storage media such as CD-ROMs, provided the disks are tamper-evident (write once read many). This means that any attempt to alter the records would become obvious and easily determined upon examination. These files do not need to be password-protected, but the adviser must be able to limit access to the records to authorized personnel and regulators.
Which of the following factors is the BEST measure of a bond's volatility?
Duration Duration measures the price sensitivity of a particular bond based on changes in interest rates.
According to the NASAA Recordkeeping Requirements for Investment Advisers Model Rule, an investment adviser is required to maintain records for:
Five years, with the first two years in the principal office Investment advisors must keep books and records for five years total, but for the first two years they must be in their principal office. On the other hand, broker-dealers keep most books and records for only three years.
An adviser is concerned about the impact of stock option compensation paid to senior executives on the firm's future profitability. Which of the following documents would be the most useful to research?
Form 10-K The annual 10-K filing includes information on executive compensation.
What form is required when registering as a broker-dealer?
Form BD Form BD is the Uniform Application for Broker-Dealer Registration, which is filed with the SEC, SROs that have jurisdiction, and the appropriate states, through the Central Registration Depository (CRD) operated by FINRA.
Which of the following investments are not standardized and do not trade on a listed exchange?
Forward contracts Forward contracts are negotiated between buyers and the sellers and trade OTC. Their features are not standardized. A clearing corporation standardizes the features of equity options, currency options, and futures contracts.
Assuming an expected rate of return, a specific holding period, and a sum to be invested, an IAR is able to determine an investment's:
Future Value The future value of an investment is based on the present value of the amount invested, using a discount rate each year, and doing so over a given period of time. The assumption is that the annual return is reinvested at the same rate, or is compounded over the given time period, thereby resulting in a future value that exceeds the present value.
A mutual fund wants to report to its shareholders the fund's average return over a 10-year period. What's the best way to calculate the fund's annual return?
Geometric Mean The geometric mean, which is also referred to as the time-weighted return, is the best way to measure the performance of a mutual fund. This method eliminates the distortion from cash inflows and outflows (e.g., investors withdrawing their investments). On the other hand, the arithmetic mean can be misleading for reporting average returns over several continuous years since it's actually distorted by cash inflows and outflows.
A client contacts a firm and indicates his desire to buy a call option on a stock that he already owns. Why would the investor buy a call option on the stock?
He wants the ability to buy more shares at a guaranteed price in case the stock goes up When buying a call option on a stock, the client is able to buy the underlying security at a specific price. He would buy a call option if he believes the price of the security is going to increase. In this situation, buying a call does not generate income, hedge risk, or increase the rate of return.
Which TWO of the following statements are TRUE regarding portfolio management strategies?
I & IV Portfolio managers employing a value style are looking for companies carrying a market price that, when compared to its earnings, is inexpensive. In other words, stocks with low price/earnings ratios. Growth managers are looking for companies with extreme growth potential. These are companies that have not saturated the markets in which they reside and are planning to take earnings and pour them back into the organization to foster future growth. Companies like these usually pay little or no dividend.
A portfolio manager heavily invested in bonds is concerned about an increase in interest rates. In order to make his portfolio less price sensitive to yield changes, the manager should make which two changes in the portfolio?
I and IV Bonds with low durations and large coupons will be less price sensitive to changing interest rates. Bonds with high durations and small coupons will be more volatile in price as interest rates change.
Which TWO of the following statements are TRUE regarding investment advisers with $135 million of assets under management? They must register in any states in which they will conduct business. They are exempt from state registration. They must register with the SEC. They must register with the SEC only if their clients are all retail investors.
II & III ONLY NSMIA, the National Securities Markets Improvement Act, was created to eliminate some of the dual requirements of federal and state securities law. The federal government and the states have a division of responsibility when regulating investment advisers. Unless exempt from registration, advisers are required to register with either the state Administrator or the SEC, but not both. According to Dodd-Frank, an adviser has a choice and may register with the state Administrator or the SEC once it has assets under management (AUM) of $100 million. Once the adviser's AUM reaches $110 million, it is categorized as a federal covered adviser and is required to register with the SEC. In addition, firms that provide advice to an investment company, or firms that provide advisory service in 15 or more states, are also categorized as federal covered. Once registered with the SEC, a mid-sized adviser may remain registered with the SEC provided it has AUM of at least $90 million. If an adviser's AUM falls below $90 million, it must instead register at the state level.
An adviser is comparing two bonds of similar credit quality and duration for a client. The client is seeking a yield of 7.2%. After performing discounted cash flow analysis on each bond, the adviser has determined that Bond A is trading at a premium to its present value, while Bond B is trading at a discount to its present value. Which TWO of the following statements are TRUE? Bond A is priced attractively and should be purchased. Bond B is priced attractively and should be purchased. The investor will earn an annual interest rate greater than 7.2% with Bond A. The investor will earn an annual interest rate greater than 7.2% with Bond B.
II and IV Discounted cash flow (DCF) analysis evaluates the present value of all coupon payments and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client. If a bond is trading at a discount to its present value, the investor will earn more than the interest rate that has been used to calculate the present value. Conversely, a bond that is trading at a premium to its total present value will be worth less than the price of the bond. (The investor would be overpaying for the bond.)
When considering the suitability of investment advice, which of the following statements is NOT TRUE?
If a client refuses to supply complete information about her financial resources, the adviser may assume she has other assets that have not been disclosed Providing the same advice to all clients (even when recommending conservative investments) is rarely suitable. Investment advice should be suitable for each client's objectives and risk tolerance. For some clients, more aggressive investments that provide long-term growth may be more appropriate than more conservative strategies. If a client refuses to disclose fully her assets, an adviser must assume that the only assets the client has are those that have been disclosed.
An investor owns Treasury bonds that mature in 20 years. This investor is primarily exposed to:
Inflation risk Credit risk is the risk that the investor will not receive interest and/or principal when it is due. Capital risk is the risk that the investor will lose all or part of the investment. Since Treasury bonds are direct obligations of the U.S. government, there is virtually no risk that the investor would not receive interest and/or principal when due. Therefore, they are free of credit risk. However, all fixed-income securities are exposed to inflationary risk (purchasing-power risk).
Your client would like to invest her traditional IRA contribution for long-term growth, but in such a way as to maximize diversification and minimize costs. Which of the following investments would be the best recommendation for her?
Invest in a mutual fund that mirrors the S&P 500 Index A major advantage of investing in a variable annuity is the ability to participate in the earnings that the market offers while deferring tax on those earnings. Since an IRA is tax-deferred investment, the client could achieve this by investing the IRA contributions directly into a mutual fund. This would result in lower fees for the client, since variable annuities have a number of additional fees (e.g., mortality and expense risk fees) on top of the typical mutual fund expenses for each subaccount. Buying stock from 10 different sectors, the client would not have as much diversification as a portfolio that models the S&P 500 Index (a broad market index). The IRS does not permit IRA contributions to be used to purchase life insurance. Also, a life insurance policy should never be recommended to a person who does not need the insurance, since its cost will be subtracted from the cash value in addition to the usual mutual fund expenses for each subaccount.
All of the following are true about a dividend paid by a corporation to its shareholders, EXCEPT the dividend:
Is voted upon by a corporation's shareholders A corporation can pay a dividend to its stockholders in the form of its own stock, stock of another corporation, or in cash. The amount of dividend to be paid is determined by the board of directors. Shareholders do not vote for dividend payments.
Which of the following is TRUE of the investment policy statement of a qualified retirement plan?
It is a written document that describes the plan's investment objectives and guidelines The investment policy statement of a qualified retirement plan describes the plan's investment objectives and strategies. It may describe the types of assets to be purchased, the plan's risk tolerance, time horizons, and long-term goals. As for choice (d), a legal list is a type of state statute that limits fiduciaries to certain types of investments. In contrast, qualified retirement plans are subject to the prudent investor standard, which is outlined in ERISA.
Which of the following choices is NOT a benefit of discounted cash flow, fixed-income analysis?
It permits an adviser to minimize cash flow reinvestment risk Discounted cash flow (DCF) analysis does not offer relief from reinvestment risk when investing in fixed-income securities. A discounted cash flow evaluates the present value of each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against current rates of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determines a fair market value of a bond. By comparing the value calculated by the discounted cash flow formula to the current market price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client.
Two friends are starting their own business and are trying to decide whether to organize this new business as an S Corporation or a general partnership. What is a significant advantage of an S Corporation compared to a general partnership?
Limited Liability If they form a general partnership, both partners are fully liable for the partnership's debts. (Limited partners are not fully liable; however, the question gives no indication that one of the partners will be a limited partner.) In an S Corporation, the owners are not fully liable for the company's debts—they have only limited liability. As for choice (a), both entities receive favorable federal tax treatment. Since both business entities are pass-through vehicles for tax purposes, all losses and profits are passed through to the owners.
Value stocks are characterized by a:
Low price/earnings ratio Value stocks typically have low price-to-earnings (P/E) ratios and are companies that are trading in the market at a low stock price in relationship to their book value. These companies are perceived as being undervalued based on their sales. Value stocks tend to have positive earnings and high dividend yields. Value stocks are often compared to growth stocks, which typically have high P/E ratios. They tend to retain their earnings and have low dividend payout ratios.
In which of the following types of accounts can an uncovered call writing strategy be executed?
Margin Uncovered calls can only be written in a margin account. Retirement accounts, custodial accounts, and cash accounts cannot utilize the uncovered call writing strategy.
The securities (interests) of which of the following types of business are often listed on an exchange?
Master Limited Partnership Master limited partnerships (MLPs) are publicly listed limited partnerships and they're securities (interests) are traded on a national securities exchange.
A licensed insurance agent and an investment adviser have offices next door to each other. The insurance agent refers clients to the investment adviser, and the adviser pays the agent a referral fee plus a percentage of the management fee for each client who opens an account with the adviser. The insurance agent:
May be required to register as an investment adviser representative Under the Uniform Securities Act, an investment adviser representative includes any person who "solicits, offers, or negotiates for the sale of or sells investment advisory services." Therefore, some states require solicitors to register as investment adviser representatives.
A front-end load is the fee that is payable on the purchase of:
Mutual fund Class A shares When an investor buys Class A mutual fund shares, he is assessed a load (sales charge) at the time of purchase (i.e., at the front-end). The other choices are in no way associated with a load (sales charge).
Are Section 457 plans required to follow ERISA guidelines?
No, because they're non-qualified plans. Section 457 plans are retirement accounts for municipal government workers and certain non-profits. Unlike 401(k) plans, 457 plans are non-qualified and are not required to meet guidelines that were established by the Employee Retirement Income Security Act of 1974 (ERISA).
How much will an investor receive from a deferred interest bond at maturity?
Par Value + Accrued Interest Deferred interest bonds—which are also referred to as deferred coupon bonds—don't pay semi-annual interest. Instead, these bonds pay interest in full at maturity. If an investor owns a 4%, $1,000 par value deferred interest bond that matures in one year, he will receive $1,040 ($1,000 par + $40 interest) at the end of the year.
Which of the following is not a sector rotation strategy?
Rotating between long-term and short-term bonds Sector rotation refers to a strategy that attempts to time the movement of assets into different market sectors based upon the superior performance in those segments. For example, an investor who anticipates that one emerging economy will outperform another, or one industry group that is correlated with the market (cyclical) will outperform the market as the economy recovers. Rotating between long-term and short-term bonds will help an investor reduce the volatility of the portfolio but is not a sector rotation strategy.
When a person acquires ownership of more than 5% of a voting class of a company's equity securities registered under the Securities Exchange Act of 1934, he is required to file a:
Schedule 13D When a person acquires ownership of more than 5% of a voting class of a company's equity securities registered under the Securities Exchange Act of 1934, he is required to file a Schedule 13D with the SEC. Schedule 13D is commonly referred to as a beneficial ownership report.
An adviser feels strongly that the economy is on the cusp of expanding. Therefore, the adviser recommends a shift from bonds to commodities to clients. This investment strategy is known as:
Sector Rotation An investment strategy of making changes to an investment portfolio in anticipation of economic changes is known as sector rotation. Generally, in a slowing economy, interest rates decline, thereby increasing the price of fixed-income securities, such as bonds. As the economy begins to recover, prices of various products tend to rise, such as commodities, as their demand increases.
An advisory client is optimistic and believes that the economy is about to recover. He instructs his adviser to sell his holdings in consumer staples and utilities and purchase industrial and technology stocks. This strategy is known as:
Sector rotation Sector rotation is a strategy often used in anticipation of changes in the business cycle. If it is believed the economy is about to slow, profitable sectors to invest in would be consumer staples, or defensive stocks.
Which of the following actions will require an adviser to register under the USA?
Selling investment management services Under the Uniform Securities Act (USA), firms that sell securities are typically required to register as broker-dealers, not investment advisers. On the other hand, firms that sell management services are required to register as investment advisers under the USA.
Which of the following activities require a CPA to register as an investment adviser representative under the Uniform Securities Act?
Soliciting advisory services on behalf of an investment adviser for a fee Under the USA, third-party solicitors for an investment adviser may be required to register as an IAR. The Investment Adviser's Act of 1940 does not require registration of IARs. Recommending that the client buy municipal securities in general is incidental to giving tax advice. The other activities are not securities-related.
Who must an adviser notify if they have custody of client assets?
State Administrator According to NASAA's Custody of Client Funds or Securities by Investment Advisers Model Rule, any investment advisers that maintain custody of client funds and/or securities must notify the state Administrator using Form ADV.
An issuer's capitalization refers to the amount of:
Stocks and bonds it has sold Capitalization refers to how a given company has raised money to start or expand its business. This is generally accomplished through the sale of stocks and/or bonds. Capitalization has nothing to do with stocks or bonds the company owns. These holdings are referred to as the company's portfolio holdings.
Dividends are:
Taxed as ordinary income Dividends are taxed as ordinary income at the investor's tax rate (even if reinvested to acquire more shares), usually at no more than a tax rate of 20%.
Under the Uniform Securities Act, all of the following are exempt from registration as an investment adviser EXCEPT an IA:
That has five or fewer clients in the state, but is actively soliciting for more clients If an investment adviser actively solicits more than five individual customers in a state, registration is required there. There are a number of situations in which a person may provide advice and yet not be required to register as an investment adviser. Some examples include professionals (e.g., the CPA in this question) whose advice is incidental, advisers whose only clients are insurance companies or other institutions, and firms that do not receive compensation (i.e., nonprofits).
Who is responsible for filing estate income tax returns and making sure that the payments are made on the estate's behalf?
The Administrator or Executor An executor or administrator is responsible for managing the estate's assets and distributing the property to the heirs. These responsibilities include paying any estate taxes that are due as well as income taxes that might be due on income earned by the estate before the assets are distributed to the heirs.
A sell limit order can be executed at:
The Limit price or higher Limit orders can be executed at the limit price or better. For sell limit orders, a better price is one that's higher. Ultimately, investors are certainly willing to sell a security at a higher price.
An employee of a federally chartered bank would like to sell mutual funds to the bank's current customers. Which of the following statements is TRUE?
The bank employee needs to be registered as an agent Bank employees who solicit the sale of securities are considered agents of broker-dealers. The sale of mutual funds, which are considered securities, would cause the employee to meet the statutory definition of an agent.
Which of the following is NOT a characteristic of whole life insurance policies?
The death benefit fluctuates or adjusts to the market In a whole life insurance policy, premium payments are invested in the general account of the insurance company. The insurance company guarantees the owner's cash value and provides a fixed, guaranteed death benefit.
Which of the following is FALSE regarding a Health Savings Account (HSA)?
The distributions that are used for non-qualified medical expenses are subject to a 50% penalty 20% penalty to non qualified medical expenses
In an effort to generate new business, an investment adviser wants to publish a list of its past recommendations. According to the USA, which of the following best describes the adviser's obligations?
The list must include all recommendations that it made over a minimum one-year time frame An investment adviser may include a list of its previous investment recommendations in advertising and sales materials as long as the list includes all of the adviser's recommendations during the relevant period (which must be at least one year).
A company's market capitalization (size) can be measured by using which of the following calculations?
The number of common shares outstanding multiplied by the market value of the stock To calculate the market capital (market cap) of a company simply multiply the number of common shares outstanding by the current market price of the stock. Companies are referred to as either being small-cap, mid-cap, or large-cap.
Which of the following features would NOT affect the annual return of an equity-indexed annuity contract?
The payout option The performance of an equity-indexed annuity is based on the participation rate (the percentage of the index's performance credited to the account), the cap rate (the greatest rate of return that will be credited), and the margin fee (the spread or asset-based fee deducted from the performance of the index). The payout option will only affect the investor if she annuitizes.
Under what circumstances will the payout from a variable annuity increase?
The performance of the separate account exceeds the AIR Whether the payment from a variable annuity changes depends on the relationship between the performance of the separate account and the assumed interest rate (AIR) in the contract. If the account performance exceeds the AIR, the payment will be greater than the last payment. If the account performance equals the AIR, the payment will be unchanged from the last payment. If the account performance is less than the AIR, the payment will decline from the last payment.
When making recommendations to senior investors, which of the following features is the LEAST important consideration?
The state in which the client has her primary residence FINRA published a notice discussing the suitability issues of senior investors. Some of the important questions advisers should ask prior to recommending a securities product are: What is the client's current employment status and what are her primary expenses? Does the client still make mortgage payments? How much income does she need and what are her sources of income? How important is liquidity, health care, and insurance? What are the client's investment goals? While the state in which the client has her primary residence may be important for tax and estate considerations, it should not be a primary concern of the adviser.
According to the Uniform Securities Act, why must investment advisers record and file the holdings and transactions of their access persons?
To avoid conflicts of interest Access persons include officers, directors, and employees of an investment adviser who have access to and can exploit non-public information (e.g., client stock positions). In order to ensure access persons don't use information to exploit clients for their own benefits, both state and federal regulations require access persons to file transaction and holding reports. In these reports, access persons are required to disclose their personal investments and trades in order to avoid conflicts of interest.
Regarding a company's financial statements, total assets are equal to:
Total Liabilities + Stockholders' Equity The balance sheet formula is Total Assets = Total Liabilities + Stockholders' Equity. Total Assets is, therefore, equal to Total Liabilities + Stockholders' Equity.
An investor's goal is to buy a security that establishes a fixed return, for a long period of time, with no reinvestment risk. Which of the following BEST suits the investor's needs?
Treasury STRIPS The typical yield to maturity calculation assumes that each interest payment is reinvested at the same yield. There would be no guarantee that the investor could reinvest at the same yield (reinvestment risk). Treasury STRIPS are zero-coupon bonds (long-term). Interest is automatically reinvested and compounded at the same yield and reinvestment risk is avoided.
The security with the longest expiration date would normally be a:
Warrant A warrant generally has an expiration date longer than a put, call, or right. There are some warrants which never expire.
Which of the following represents the correct ranking of securities from longest to shortest life?
Warrants, options, rights Rights usually last less than 60 days. Options usually last for nine months or less, although some can exist for three years. Warrants usually have a life span of several years and they can even be perpetual.
Janet has been married twice and earned more than each husband. Both marriages ended in divorce. Her first marriage lasted for 10 years, while her second marriage lasted for 12 years. Janet is now collecting Social Security. Are either of her ex-spouses eligible to collect Social Security based on Janet's work history?
Yes, but only if each ex-spouse does not remarry. If a person is divorced, but his marriage lasted 10 years or longer, he is entitled to receive benefits on his ex-spouse's work history (even if she has remarried) provided: He is unmarried; He is age 62 or older; His ex-spouse is entitled to Social Security or disability benefits; and The benefit he is entitled to receive based on his own work history is less than the benefit he would receive based on his ex-spouse's work history
An individual has recently inherited a life insurance policy. What's the individual's tax liability on the insurance policy's death benefit?
Zero, since the death benefit from an insurance policy is only taxable to the deceased's estate. Beneficiaries are NOT required to pay taxes on death benefits from life insurance policies. The death benefit is included in the assets of an estate and could be subject to the estate tax. The death benefit from a non-qualified annuity could be taxable as ordinary income, but only on the amount that exceeds the contributions (i.e., basis).
