s66 quizzes: investment vehicles

A customer buys 200 shares of Ford at 68 and sells 2 Ford 70 Calls@ $3. The maximum potential gain is: $500 $1,000 $6,800 unlimited

$1,000 If the market rises, the calls are exercised. The stock (which cost $68) must be delivered at $70 for a gain of $2 per share. Since $3 was collected in premiums for selling each call, the net gain, if exercised, is 5 points or $500 per contract x 2 contracts = $1,000.

A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate; a 15% cap and a 3% floor. Interest is credited to the contract under the annual reset method and is compounded annually. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+10% Year 2:-5% Year 3:-10% At the end of year 3, the customer will have a principal balance of approximately:

$116,000 The first year increase in the index of 10% with a 90% participation means that 9% would be credited to the account. The 15% cap is irrelevant. Thus, at the end of the first year, the $100,000 balance is worth $109,000. Because of the 3% floor, even though the index fell in each of the next 2 years, the account value increases to $109,000 x 1.03 = $112,270 at the end of year 2; and $112,270 x 1.03 = $115,638 at the end of year 3.

A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate and a 15% cap. Interest is credited to the contract under the annual reset method and is compounded annually. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+20% Year 2:-5% Year 3:+10% At the end of year 3, the customer will have a principal balance of:

$125,350 The first year increase in the index of 20% with a 90% participation means that 18% would be credited to the account - however, because of the 15% cap, this is the first year credit, so the $115,000 balance is worth $115,000 after the first year. Because this is an insurance product, the customer does not bear investment risk, and the "floor" rate is 0% (unless the product offers a higher floor rate). Because of the 0% floor, the balance stays at $115,000 as of the end of year 2. In year 3, the $115,000 balance will grow by 9% (90% of the 10% growth rate) for a balance of $125,350 at the end of year 3.

A customer buys 1 ABC Jul 45 Put at $4 when the market price of ABC is 46. The customer's maximum potential gain is: $400 $4,100 $4,900 unlimited

$4,100 The maximum gain for the holder of a put occurs if the market goes to "0". If it does, he can sell the stock at 45 and purchase it for nothing. Since he paid $400 in premiums for this right, the maximum potential gain is: $4,500 - $400 = $4,100.

A grandfather wishes to provide a perpetuity for his 2 grandchildren. He wants to give them the amount of $1,000 a month. How much principal is required assuming that it is invested at a 3% rate of return? $33,333 $40,000 $333,333 $400,000

$400,000 A perpetuity is a "perpetual payment" - so it is an annuity that goes on forever. If $400,000 is invested at 3%, it gives annual income of 3% of $400,000 = $12,000 without eating into the principal amount. $12,000 annual income / 12 months = $1,000 month income. The best way to deal with this type of question is to take 3% of the principal amount given in each choice to get the annual income and divide it by 12 months a year.

A customer, age 57, has made payments into a non-tax qualified variable annuity contract totaling $10,000. The investment in the separate account is now worth $16,000. The customer wishes to withdraw $5,000 from the account. The tax implications of the withdrawal are: $5,000 non-taxable return of capital and $0 penalty tax $5,000 taxable ordinary income and $0 penalty tax $5,000 taxable long-term capital gain and $0 penalty tax $5,000 taxable ordinary income and $500 penalty tax

$5,000 taxable ordinary income and $500 penalty tax Distributions from non-tax qualified retirement plans are accounted for on a LIFO - Last-In; First-Out basis. The first item that went into the plan was the original non-tax deductible contribution. The next item than went into the plan was the reinvestment of dividends, interest, and capital gains over time - all of which have been building tax deferred. When distributions commence, the first dollars out of the plan are accounted for as the return of the "build-up" - which was never taxed. The last dollars out of the plan are the original investment (cost basis) which was made with after-tax dollars and hence is not taxed. Thus, in this plan $10,000 was invested; and it built up to $16,000. Thus, the first $6,000 out of the plan is taxable ordinary income; the remaining $10,000 is a non-taxable return of capital. In addition, since this customer is under age 59½, a 10% penalty tax must be paid on any distribution, since this is a premature distribution. The customer withdrew $5,000, all of which is taxable as ordinary income, plus an additional 10% ($500) penalty tax is due on the distribution.

A customer sells 2 ABC Jan 65 Puts@ 3 when the market price of ABC is 66. The maximum potential gain is: $300 $600 $12,400 unlimited

$600 The maximum potential gain in any naked writing strategy is the premium received. If the put expires out the money, the writer keeps the premium. In this case, 2 contracts were sold @ $3, so the maximum gain is $600.

In December, a customer sells 1 ABC Jan 100 Call@ $9 when the market price of ABC is 102. The customer's maximum potential gain is: $100 $900 $1,020 unlimited

$900 The maximum potential gain for the writer of a naked call option is the premium received. This occurs if the market drops and the call expires "out the money".

Equity options are: American Style European Style Eastern Style Western Style

American Style Stock options are American style (exercisable any time). In contrast, index options (with only one exception) are only issued in European style (exercisable only at expiration).

Which statement is FALSEabout the purchase of a non-qualified annuity? Amounts contributed are tax-deductible Earnings are tax-deferred until withdrawal Contributions may be invested entirely in mutual funds There is no limit on the amount contributed each year

Amounts contributed are tax-deductible Variable annuities are a non-qualified retirement plan. There is no deduction for amounts contributed, making Choice Afalse. Earnings build tax-deferred, making ChoiceBtrue. Contributions are invested in a separate account that buys shares of a designated mutual fund, making Choice Ctrue. There is no limit on contribution amounts, making Choice Dtrue.

What is a 10-year period certain annuity? An annuity that will pay for a stated period of time, regardless of when the purchaser dies An annuity that will pay for the lesser time period of life of the annuitant or a stated number of years An annuity that will pay for the greater time period of the life of the annuitant or a stated number of years An annuitant that will pay based on the estimated lifespan of a 10-year old individual

An annuity that will pay for a stated period of time, regardless of when the purchaser dies Be careful! There is no mention in the question that this is a "Life Annuity with a Period Certain" - in which case the answer would be Choice C. The question is simply asking about a 10-year period certain annuity. This would not be an annuity option in a variable annuity contract. It is an annuity option associated with the purchase of a fixed annuity. It is a type of annuity that can be purchased from an insurance company that only pays for a stated time period - in this case 10 years. These are used most often to bridge a gap between early retirement and when social security payments start. For example, if an individual retired at age 58 and full social security payments started at age 68, he or she could buy this contract to provide payments for that 10-year gap.

Which statements are TRUEregarding the annuitization of a variable annuity contract? I A Life Annuitypayout option may be elected by the policy holder II Life Annuity-Period Certainis the preferred payout option III The number of annuity units is fixed; the annuity payment may vary IV The annuity payment is fixed; the number of annuity units may vary

I A Life Annuitypayout option may be elected by the policy holder III The number of annuity units is fixed; the annuity payment may vary variable annuity contracts allow the holder to elect a payout option that meets that person's individual requirements. The statement that a life annuity-period certain is a preferred payout option is erroneous - the choice of payout method depends on the needs of the annuitant. Once the contract is annuitized, the number of annuity units is fixed. However, the value of each unit varies with the performance of the underlying securities, hence the monthly annuity payment may vary.

Which of the following statements are TRUEwhen comparing a corporation and a limited partnership? I A corporation is a taxable entity II A partnership is a taxable entity III A corporation allows for the flow through of gain and loss IV A partnership allows for the flow through of gain and loss

I A corporation is a taxable entity IV A partnership allows for the flow through of gain and loss Under IRS rules, a corporation is a taxable entity. If the corporation has net income, the corporation pays tax on that income. If the corporation wishes to distribute cash dividends to shareholders, the dividends received are paid out of after tax income and then the shareholders pay taxes on this, too. If a corporation has a net loss, no corporate tax is owed for that year and the corporation cannot distribute the losses to its shareholders. A partnership is not a taxable entity, rather, each partner is taxed on his or her pro-rata share of income or loss. The losses can be used to offset other "passive income."

An insurance company that sells an Equity Indexed Annuity(EIA) could use which of the following methods to credit the change in investment value? I Annual reset II Point-to-point III High-water mark IV Moving average

I Annual reset II Point-to-point III High-water mark EIAs base the annuity payments on the performance of a broad-based index, such as the S&P 500 Index. However, the return is capped and there is a minimum guaranteed return, regardless of the performance of the index. The most common methods of measuring index performance are the: Point-to-point method; Annual reset method; and High-water-mark method. Assume that a client buys an EIA that is based on a 7-year return. The "point-to-point" method compares the index value at purchase date to the value at the end date, 7 years later. Any value fluctuations that occur in-between the 2 measurement dates are irrelevant. Another common valuation method is the "annual reset" method, which would measure the return achieved each year over a 7-year life and add interest to the annuity based on the annual reset. The annual interest credit is based on the difference between the year-beginning index value and the year-ending index value. This risk here is that the market dumps at year end, so that the credit only equals the floor amount. The "high water mark" method avoids the "bad timing risk" that you can have with the "annual reset" method. Instead of basing the annual interest credit on year-beginning and year-ending index value, it bases the credit on year-beginning index value and the highest value that it had during that year.

Which actions taken regarding a universal variable life insurance policy could result in tax liability? I Cash surrender II Partial withdrawal III Loan of up to 95% IV Payout of death benefit

I Cash surrender II Partial withdrawal IV Payout of death benefit Proceeds distributed from a variable life insurance policy are taxable income if there is a distribution of benefits above the amount invested (tax basis) in the separate account. This would include a cash surrender (surrender of the entire policy for its current cash value, terminating the policy) or making a partial withdrawal from the policy. The payment of a death benefit from the policy, while not taxable income to the recipient, is included in the taxable estate of the deceased individual. If the aggregate value of the estate exceeds the estate tax exclusion, there will be estate tax liability. The only way to get cash out of a variable policy without a potential tax consequence is to borrow against the policy. In general, most "cash value" policies only permit a loan of up to 75% of cash value; but if the policy is fully paid, often the loan amount is raised to 95%.

Which of the following would be included in the evaluation of the amount an investor would pay for a viatical or life settlement? I Life expectancy of the viator II Amount of discount from policy face amount III Availability of investors IV Tax consequence to the viator of selling the policy

I Life expectancy of the viator II Amount of discount from policy face amount III Availability of investors A "viatical settlement" is a contract between a life insurance policyholder (the "viator") and a viatical settlement provider, where, the policyholder gets an immediate cash payment in exchange for transferring ownership of the policy to the viatical settlement provider - the purchaser of the policy. These typically appeal to insured individuals who are terminally ill, who can get immediate cash to pay for medical and support needs by selling the policy. The policy is sold at a discount to face value, and the purchaser assumes the responsibility for making the premium payments until the insured individual/viator dies. When the insured person dies, the purchaser of the policy (the viatical settlement provider) who now owns the policy gets the policy face amount. The discount to policy face value is based on the estimate of the remaining life of the insured/viator. The shorter the expected life of the insured, the less the discount to face that will be paid for the policy. The viatical settlement provider can then sell interests in the policy to investors - and a readily available pool of investors will increase the amount that would be paid for the policy. The fact that the sale of the policy might result in taxable income to the viator/policyholder is a consideration for the insured person; not for the investor who is paying for the policy.

Which of the following statements are TRUEabout structured products? I Structured products offer an index-linked return and a fixed maturity II Structured products are principal protected III Structured products are highly liquid and actively traded IV Structured products have a credit rating based on that of the issuing bank

I Structured products offer an index-linked return and a fixed maturity II Structured products are principal protected IV Structured products have a credit rating based on that of the issuing bank Structured products are a derivative security created by different banks such as Barclays, J.P. Morgan Chase, Deutsche Bank, etc. They are "bond-like" but they are not bonds. Simple versions of structured products are offered with a notional value of $1,000 (just like a bond). They offer a rate of return linked to a well known index, such as the S&P 500 Index (but this rate can be capped to an annual maximum). At the maturity date, say is 3 - 7 years, they are "redeemed" at par, but the redemption is based on the fact that there is an embedded option in the product. As long as they are held to maturity - because of the embedded option, they are principal protected. There is little standardization to these products - each bank's version has different features. Thus, these are "buy and hold" securities - there is almost no trading market. The credit rating of each structured product is based on the credit rating of the issuing bank.

Which of the following statements comparing fixedand variable annuitiesis correct? I Fixed annuities pay for the annuitant's lifetime; variable annuities pay for varying lengths of time II Fixed annuities pay the same amount each period; variable annuities pay the same number of annuity units each period III The insurance company guarantees a rate of return for fixed annuities but not for variable annuities IV The insurance company guarantees an increasing payout for variable annuities but not for fixed annuities

II Fixed annuities pay the same amount each period; variable annuities pay the same number of annuity units each period III The insurance company guarantees a rate of return for fixed annuities but not for variable annuities Fixed annuities pay the same amount each period; variable annuities pay the same number of annuity units each period. The payout may increase or decrease with a variable annuity. The insurance company guarantees a rate of return for fixed annuities, but not for variable annuities. Both fixed and variable annuities make payments for the annuitant's lifetime.

Which statements are TRUEwhen comparing an index mutual fundto an index exchange traded fund? I Mutual funds can be purchased on margin; exchange traded funds cannot be purchased on margin II Mutual funds cannot be purchased on margin; exchange traded funds can be purchased on margin III Mutual funds can be sold short; exchange traded funds cannot be sold short IV Mutual funds cannot be sold short; exchange traded funds can be sold short

II Mutual funds cannot be purchased on margin; exchange traded funds can be purchased on margin IV Mutual funds cannot be sold short; exchange traded funds can be sold short Mutual funds cannot be purchased on margin because they are a new issue prospectus offering - and new issues are not marginable until they have "seasoned" for 30 days. Mutual funds cannot be sold short. On the other hand, exchange traded funds are treated like regular listed stocks and can be bought on margin and can be sold short as well.

When evaluating an investment in a direct participation program, which of the following are relevant considerations? I Experience of the limited partner(s) II Objectives of the program III Economic viability of the business venture IV Experience of the general partner(s)

II Objectives of the program III Economic viability of the business venture IV Experience of the general partner(s) Limited partners are passive investors who have no say in the management of the enterprise. Thus, experience of the limiteds has no relevance to the success of the program. General partners, however, manage the program for the limiteds. Their level of experience and "track record" is critical when evaluating the likely success of a program. Any evaluation should consider the objectives and economic prospects of the program.

Which of the following are associated with variable annuities? I Level benefit payments II Variable benefit payments III Benefit payments that will fluctuate based on stock market movements IV Benefit payments that are unaffected by stock market movements

II Variable benefit payments III Benefit payments that will fluctuate based on stock market movements the benefit payments from a variable annuity contract will fluctuate based on overall economic conditions. Variable annuity separate accounts are most often invested in equities. If economic growth increases, the performance of the equity securities held in the separate account will increase and so, the amount of the annuity payments will increase. In difficult economic times, the reverse is true.

Premiumsare invested in an insurance company separate accountfor which of the following policies? I Whole life II Variable life III Universal life IV Flexible-premium variable life

II Variable life IV Flexible-premium variable life Variable contracts (either variable life or variable universal life) have the premiums deposited to a separate account. The performance of the separate account determines the ultimate death benefit, so the policyholder bears the investment risk. Flexible premium variable life is another name for variable universal life, which gives policyholders the right to skip a premium payment.

Hedge funds are: I registered securities II unregistered securities III offered to the general public IV offered in private placements

II unregistered securities IV offered in private placements A hedge fund is a private investment fund that uses sophisticated investment strategies and leverage to enhance returns but also takes on higher levels of risk. Hedge funds are typically limited to 99 investors so they do not have to register as investment companies under the Investment Company Act of 1940 (which states that registered investment companies are those that have more than 100 investors). They are offered in private placements only to accredited (wealthy) investors.

Which of the following is NOT an advantage of owning a variable annuity? Separate account accumulation units allow for participation in the equity markets The costs and fees associated with owning the contract are lower than making direct investments in mutual funds The separate account growth is tax-deferred until distributions commence There are no limits on the amount that an individual can invest

The costs and fees associated with owning the contract are lower than making direct investments in mutual funds Variable annuity contracts have 2 layers of fees. One is the cost of running the mutual fund held in the separate account. The second is the insurance company's mortality and expense fees that are added to the contract. It is not uncommon for the total of these fees to exceed 2% per year. The high annual cost of the contract is the disadvantage of owning a variable annuity. The other 3 choices are advantages. Any individual can contribute to a variable annuity - there are no income limits. The separate account can be invested in an underlying equity mutual fund, allowing for participation in the equity markets. And reinvested dividends and capital gains grow tax deferred - tax is due only when distributions commence.

Which statement is TRUE about a hedge fund's investment allocation to a particular investment asset? No more than 10% of the fund's assets can be invested in a particular investment No more than 25% of the fund's assets can be invested in a particular investment No more than 75% of the fund's assets can be invested in a particular investment There is no limit on the percentage of a hedge fund's assets that can be allocated to a particular investment

There is no limit on the percentage of a hedge fund's assets that can be allocated to a particular investment Hedge funds are private placement limited partnerships that are not regulated under the Investment Company Act of 1940. They are not subject to any investment limits and can place 100% of assets in a single investment, if they so wish. In contrast, mutual funds that are "diversified" as defined by the Investment Company Act of 1940 must comply with the 75/5/10 rule, which states that 75% of mutual fund assets must be invested in securities, with no more than 5% of assets invested in a single issuer, and that any holding cannot represent more than 10% of the voting power in a single issuer. This question is trying to see if you might confuse the percentage allocation requirements for a diversified fund with the fact that there are no allocation requirements for a hedge fund.

All of the following statements are true for both limited partnerships and corporations EXCEPT both limited partnerships and corporations: limit liability for the business owners have centralized management allow for "flow-through" of gain and loss are formed with business intent

allow for "flow-through" of gain and loss The advantage of the partnership form of business is that the partnership itself is not a taxable entity; income and loss from the partnership "flows-through" onto the individual partners' tax returns. Thus, any net income is taxed once; and any net loss is included on the partner's tax return. In contrast, a corporation must compute net income or loss at the corporate level; and must pay tax on any income. The only way for the shareholder to receive a portion of the net income is for the corporation to pay a dividend, which must be included on the shareholder's tax return; and which is taxed again! Any net losses remain at the corporate level - they cannot be distributed to shareholders. Both limited partners and corporate shareholders have limited liability; both have centralized management; and both are formed to operate a business.

An investor writes 1 ABC Jan 45 Put@ $3. The contract subsequently is exercised. The writer is obligated to: buy stock at $42 per share buy stock at $45 per share sell stock at $42 per share sell stock at $45 per share

buy stock at $45 per share The writer of a put is obligated to buy stock at the strike price of $45 per share specified in the contract, if exercised. For selling the contract, the writer initially receives a premium of $3 per share.

All of the following statements are true about exchange traded index fundsEXCEPTexchange traded index funds: typically have the same or lower expense ratios than index mutual funds can be traded anytime during exchange trading hours at net asset value can be purchased on margin can be traded at no commission cost to the customer

can be traded at no commission cost to the customer . Exchange traded funds such as SPDRs (the "Spider" is the Standard and Poor's 500 Index ETF) can be traded anytime during normal trading hours; can be bought on margin and sold short; and typically have comparable or lower expense ratios than do similar index mutual funds. However, to buy or sell an ETF, a regular stock trade commission is charged.

A customer buys stock and wants to buy call options on the stock. The customer would do this to: hedge the stock position from an adverse market move generate additional income against the stock position as a covered call writer enjoy the certainty of a fixed price for a future purchase speculate on the possibility of a price decline

enjoy the certainty of a fixed price for a future purchase The customer will profit on the long stock position if the market rises. The purchase of the call allows the customer to buy additional shares at a fixed price if the market rises. Only the purchase of a put against the stock position will protect it from an adverse market move. Only the sale of a call against the stock position will generate income. To speculate on a price decline, the customer would simply buy puts.

At the point where a variable annuity separate account interest is "annuitized," the holder of the contract receives a: fixed number of annuity units based on the number of accumulation units fixed number of annuity units based on the value of the accumulation units fixed value for the annuity units as set forth in the original contract lump sum payment equal to the value of the units

fixed number of annuity units based on the value of the accumulation units When a variable annuity separate account interest is "annuitized," the value of the separate account interest is divided by an "annuity unit factor" to arrive at the number of annuity units. The number of units is now fixed, but unit values fluctuate with the changes in value of the separate account securities funding the annuity units.

Variable Universal Life Insurance(VULI) policies provide policy owners with: guaranteed minimum cash values variable premiums and the guarantees of term insurance flexibility with respect to premiumpayments, investment options, and death benefits the guarantees of whole life insuranceplus the investment flexibility of variable life insurance

flexibility with respect to premiumpayments, investment options, and death benefits Variable Universal Life Insurance (VULI) is a combination of universal life insurance and variable life insurance. Thus, it provides flexibility in premium payments, investment-funding choices, and flexibility of death benefits based on investment results. VULI does not guarantee minimum cash value like whole life insurance, since investments are made in a separate account and the amount of cash value depends on separate account performance, making Choice (A) incorrect. VULI does not guarantee a fixed insurance amount, as is the case with term insurance. The amount of coverage will vary with the performance of the separate account, though there is a minimum guaranteed insurance amount, so Choice (B) is incorrect. VULI does not guarantee a fixed rate of return, as does a whole life policy, making Choice (D) incorrect.

A portfolio manager would sell calls against the securities in the managed portfolio in order to: protect the positions against a bear market increase income and cash flow increase the diversification of the portfolio speculate on the direction of the market

increase income and cash flow Covered call writing is one of the most conservative and popular strategies used by portfolio managers to increase income (and hence return) from the investments. In addition to the dividend income from the stocks, if the market stays flat, the calls will expire and the premium income will be earned. To protect the stock positions, puts would be purchased. Diversification would be increased by purchasing stocks or call options on other companies than those held in the portfolio. To speculate on the direction of the market, long calls (speculating on a bull market) or long puts (speculating on a bear market) would be used.

A 62-year old client makes her first withdrawal from a non-tax qualified annuity. This will result in: capital gains taxed at capital gains rates ordinary income taxed at ordinary income tax rates that is subject to a penalty ordinary income taxed at ordinary income tax rates that is not subject to a penalty capital gains taxed at ordinary income tax rates

ordinary income taxed at ordinary income tax rates that is not subject to a penalty Distributions from non-tax qualified retirement plans are accounted for on a LIFO - Last-In; First-Out basis. The first item that went into the plan was the original non-tax deductible contribution. The next item than went into the plan was the reinvestment of dividends, interest, and capital gains over time - all of which have been building tax deferred. When distributions commence, the first dollars out of the plan are accounted for as the return of the "build-up" - which was never taxed. Thus, the first distributions out of the plan are 100% taxable at ordinary income tax rates. There is no penalty tax (10%) due as long as the money is taken out after reaching age 59½, which is the case here.

A customer buys a variable annuity and elects a payout option of Life Income with a 20 year period certain. This means that: payments will continue for the annuitant's life, not to exceed 20 years payments will continue for the annuitant's life, but if he dies before 20 years elapse, payments continue to his heir(s) payments continue for the life of the annuitant and then cease payments continue for 20 years to the annuitant or beneficiary

payments will continue for the annuitant's life, but if he dies before 20 years elapse, payments continue to his heir(s) An annuity payout option of Life-with Period Certain means that the annuity continues for the customer's life, but if he dies before the "period certain" (20 years in this case) is completed, payments will continue to a beneficiary until the 20 year period is completed.

A 62-year old man owns a non-qualified variable annuity contract. He makes a withdrawal. The amount of the withdrawal is: not taxable potentially subject to taxation at capital gains rates potentially subject to taxation at ordinary income tax rates not taxable if used to pay for specified medical expenses

potentially subject to taxation at ordinary income tax rates Distributions from variable annuity contracts that take place after age 59½ are taxable at ordinary income tax rates. These distributions are 100% taxable and represent all of the tax-deferred earnings that have been reinvested and grown over the years. Once these are depleted, the original investment in the contract is returned with no tax due (since there was no deduction for the contribution amount, these are already "after-tax" dollars.)

Selling a put against a stock position sold shortis a suitable strategy when the market is expected to: remain stable rise sharply fall sharply fluctuate sharply

remain stable Selling stock short alone is a bearish position. Selling a put alone is neutral or bullish strategy. Selling a put against a short stock position is a neutral strategy (as is any income strategy). If the stock is sold short and a put is sold with the same strike price, then if the market stays the same, the put expires "at the money" and the premium collected is retained. If the stock falls, the short put is exercised, obligating the customer to buy the stock at the same price at which it was sold. In this case, only the premium is earned. If the put had not been sold, then the customer would have had an increasing gain on the short stock position as the market fell - so he does not make as much in a falling market. On the other hand, if the market rises, the short put expires "out the money" and the customer is exposed to unlimited upside risk on the short stock position that remains.

Which of the following strategies has unlimited loss potential? long stock/ short call long stock / long put short stock/ long call short stock / short put

short stock / short put With a long stock position, the maximum loss is the value of the stock. With a short stock position, the potential loss is unlimited. If a long call is purchased against a short stock position, the upside loss is limited. If a short put is sold against a short stock position the upside loss is still unlimited since in a rising market the short put will expire "out the money". The short stock position must be covered by purchasing the stock at the higher market price - and the price can rise an infinite amount.

If a customer purchases in a 300% leveraged ETF, the customer can lose: the investment amount more than the investment amount three times the investment amount an unlimited amount

the investment amount A leveraged ETF is designed to move at a faster rate than the overall market. A 300% leveraged ETF will move at three times the rate of the general market. If the market rises by 10%, the ETF will rise by 30%. If the market falls by 10%, the ETF would fall by 30%. However, the maximum potential loss is still that person's investment!

A customer has a young disabled child with multiple sclerosis and wishes to invest enough money to provide $5,000 a month in perpetuity to pay for ongoing medical expenses. Upon the death of the disabled individual, the principal amount will be left to a charity searching for a cure for the disease. Assuming that the principal can be invested at a 6% annual rate of return, the required principal amount is:

1,000,000 A perpetuity is a "perpetual payment" - so it is an annuity that goes on forever. If $1,000,000 is invested at 6%, it gives annual income of 6% of $1,000,000 = $60,000 without eating into the principal amount. $60,000 annual income / 12 months = $5,000 month income. The best way to deal with this type of question is to take 6% of the principal amount given in each choice to get the annual income and divide it by 12 months a year.

As the economy and the stock market fluctuate, which of the following can the holder of a fixed annuityexpect to occur during the payout years? Benefits will fluctuate according to the return the separate account earns Benefits may increase during periods of declining economic growth and a declining stock market Benefits will not fluctuate over time Benefits may decrease during periods of declining economic growth and a declining stock market

Benefits will not fluctuate over time The benefit payments for a fixed annuity are fixed (the name actually says what it is!), and they will not fluctuate during difficult economic conditions. Even if the insurer's general account performs poorly, the benefit payments remain the same because the return is guaranteed.

A married couple, ages 29 and 31, have approached an IAR about planning for their children's college education. They are interested in purchasing mutual funds and have heard about 529 plans, which they want to learn about. The IAR explains that 529 plans are not appropriate since the mutual fund investment options are limited and instead, recommends the purchase of a variable life policy, since the separate account invests in mutual funds. The IAR also discloses that he earns a higher commission when he sells a variable annuity than when he sells mutual funds. The couple already has life insurance policies that cover their needs. Which statement is TRUEabout this situation? A) The IAR has not breached his fiduciary responsibility because he has disclosed the fact that he earns a higher commission when selling variable life policies B) The IAR has not breached his fiduciary responsibility because he has recommended a product that offers tax benefits C) The IAR has breached his fiduciary responsibility because he has recommended an unsuitable investment D) The IAR has breached his fiduciary responsibility because he is prohibited from selling life insurance

C) The IAR has breached his fiduciary responsibility because he has recommended an unsuitable investment The best answer is C. This couple does not need additional insurance - plain and simple. Insurance is not an investment, though it may have some "investment features." The IAR has breached his fiduciary duty to the client.

What is the only type of investment company that can sell for less than NAV? Open-end management company Closed-end management company Unit investment trust Face amount certificate company

Closed-end management company Management companies are either "open-end" or "closed-end." An open-end management company is a mutual fund. Mutual fund shares are bought from the fund company and are redeemable at NAV with the fund company. In contrast, "closed-end" fund shares have a 1-time stock issuance like any other corporate stock offering. Then the books are "closed" to new investment and the shares are listed and trade like any other stock. Just like a company trading for less than its book value, closed-end funds can trade for less than NAV if investors are bearish on the fund. In contrast, mutual funds do not trade and can only be redeemed at NAV - they cannot go to a discount to NAV. Unit investment trusts are redeemable securities as well and do not trade. Face amount certificate companies are obsolete, but also were redeemable.

With a variable annuity, the insurer takes the risk that expenses for administration will not be more than it expected. What is the charge the insurer makes for taking this risk? Investment management fee Administrative expense fee Expense risk charge Mortality risk charge

Expense risk charge The expense risk charge compensates the insurer for the expenses that it incurs for administering the contract, and these are capped to a maximum percentage. If the expenses exceed this percentage, then the insurance company is responsible for the excess charges; not the purchaser of the annuity.

A customer has heard from a relative that he should invest money in a "hedge" fund. The customer asks you to tell him about this type of investment. Which statement about hedge funds is FALSE? Hedge funds are only suitable for wealthy investors that meet the "accredited investor" definition Hedge funds are regulated as "mutual funds" under the Investment Company Act of 1940 Hedge funds typically allow withdrawal of funds once per year Hedge funds use aggressive investment strategies that entail a high level of risk

Hedge funds are regulated as "mutual funds" under the Investment Company Act of 1940 Hedge funds are set up as private placements, open only to accredited investors. They are illiquid, since money can only be withdrawn once per year (and usually only with general partner approval). They use sophisticated aggressive investment strategies that are high-risk (but these can also be high-reward). Most hedge funds are now registered with the SEC (as investment advisers), but they are not "regulated" and are not subject to the 1940 Act rules.

Which statements are TRUEregarding hedge funds? I Hedge funds are subject to little regulatory oversight II Hedge funds must register as management companies under the Investment Company Act of 1940 III Hedge fund managers are compensated based on a percentage of capital appreciation in the fund IV Hedge fund managers can only be compensated based on a percentage of assets under management

I Hedge funds are subject to little regulatory oversight III Hedge fund managers are compensated based on a percentage of capital appreciation in the fund Hedge funds are set up as private placements, open only to accredited investors. They are not regulated as investment companies and are subject to minimal regulatory oversight. Unlike regulated mutual funds, which can only compensate the adviser based on a percentage of assets under management, hedge fund managers typically take both a percentage of assets under management (say 2%) plus a percentage of capital gains in the fund (say 20%). Needless to say, this can result in very rich compensation for successful hedge fund managers.

Which of the following guarantees do insurance companies typically give with BOTH fixedand variable annuities? I Mortality guarantee II Expense guarantee III Investment return guarantee IV Benefit amount guarantee

I Mortality guarantee II Expense guarantee Insurers give mortality and expense guarantees for both fixed and variable annuities. Only issuers of a fixed annuity guarantee the investment return and the benefit payment amounts. The investment return and benefit payment amounts from a variable annuity contract are not guaranteed by the issuer - the actual amount to be paid depends on the performance of the underlying securities held in the separate account. Thus, the purchaser of a variable annuity contract assumes the investment risk.

The holder of a put on a listed stock exercises. The holder MUST: I deliver stock II deliver cash III take delivery of stock IV take delivery of cash

I deliver stock IV take delivery of cash If the holder of a put option on a listed stock exercises, he must deliver 100 shares of stock, for which the holder will receive the strike price in cash.

Index ETFs are: I passively managed II actively managed III negotiable IV redeemable

I passively managed III negotiable Almost all ETFs are based on a benchmark index. They mirror the composition of the index, so they are "passively" managed and have low management fees. An actively managed fund is one where the investment adviser chooses which securities to buy and sell. Active management comes with higher management fees. There are only a very few actively managed ETFs - almost all are passively managed. They trade like any other stock and are not redeemable.

Which statements are TRUE? I A call option is in the money when the current market value of the stock is less than the option contract strike price II A call option is in the money when the strike price of the option contract is below the current market value of the stock III A put option is in the money when the current market value of the stock is less than the option contract strike price IV A put option is in the money when the strike price of the option contract is below the current market value of the stock

II A call option is in the money when the strike price of the option contract is below the current market value of the stock III A put option is in the money when the current market value of the stock is less than the option contract strike price Call options go "in the money" when the market price exceeds the contract strike price - which is the same as the contract strike price being below the current market value of the stock. Put options go "in the money" when the market price is below the contract price. The "in the money" amount will set the minimum premium for the contract. On top of this, the premium will increase based on the length of time remaining to the contract, the volatility of the underlying stock and market interest rate levels.

When comparing an ETNto an ETF, which statements are TRUE? I ETNs are a type of investment company offering II ETFs are a type of investment company offering III ETNs are a debt instrument IV ETFs are a debt instrument

II ETFs are a type of investment company offering III ETNs are a debt instrument An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. An ETF is an Exchange Traded Fund. It is an investment company that owns an underlying portfolio of securities. The shares of the ETF are listed and trade like any other stock.

Which statements are TRUEregarding structured products? I Structured products are standardized II Structured products are not standardized III Structured products have a fixed maturity date (similar to a debt security) IV Structured products do not have a maturity date (similar to an equity security)

II Structured products are not standardized III Structured products have a fixed maturity date (similar to a debt security)

Which of the following statements concerning a universal life insurancepolicy are TRUE? I The policy owner has a choice of investments for the cash value II The policy owner can change the amounts of premium payments III The policy owner can change the amount of the death benefit IV The policy owner receives a guaranteed, fixed rate of return on cash value

II The policy owner can change the amounts of premium payments III The policy owner can change the amount of the death benefit With a universal life policy, the policy owner can change the premium payments and the death benefit. The cash value is invested in the insurer's general account, so the policy owner does not have a choice of investments and the rate of return is not fixed - it will vary with the return of the general account.

When comparing an optionscontract to a futurescontract, which statement is FALSE? Both are exchange traded Both are standardized If not closed by trading, both require delivery of the underlying asset Both are regulated

If not closed by trading, both require delivery of the underlying asset Both options and futures contracts are regulated, standardized, exchange-traded contracts. Both can be closed by making an offsetting trade. However, if a listed option is not closed by an offsetting trade and it is "out-the-money," it will expire worthless. There will be no "delivery." In contrast, if a futures contract is not closed by trading before the delivery date, then there must be a delivery of the reference asset at the contract price (this happens less than 3% of the time for futures contracts).

Which statement concerning the AIR of a variable annuitycontract is TRUE? It is the insurer's best estimate of the future performance for accumulated income retained in the separate account It applies during the accumulation period It must be adjusted annually for inflation It applies only during the annuity period

It applies only during the annuity period AIR refers to the assumed interest rate used to determine the initial monthly payment to the annuitant - it is set when the contract is annuitized and only applies during the annuity period. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases. The AIR has no meaning during the accumulation period. Also note that the prospectus has an "AIR Illustration" that is an estimate of the annuity to be paid based on a conservative growth estimate, but the actual AIR is not set until the contract is annuitized.

If it is expected that the price of an asset will fall in the future, which strategy is profitable? Buy a call Sell a put Buy a future Sell a future

Sell a future If a call is purchased and the market falls below the strike price, the call will expire worthless "out the money" and the premium will be lost. If a put is sold and the market falls below the strike price, the put will be exercised, obligating the put writer to buy the stock at the strike price in a falling market, so the customer will lose on the purchased stock position as the market falls. If a futures contract is purchased, the customer has a contract to buy the commodity or financial asset at a fixed price at a fixed future date. If the asset price goes down, the client will lose. If a futures contract is sold, the customer has a contract to sell the commodity or financial asset at a fixed price at a fixed future date. If the asset price does down, the client will win (because the asset can be purchased at the current cheaper price and delivered at the higher contract price).

The purchaser of an immediate 15-year period certain annuity will receive payments for: a 15-year time frame following annuitization, even if the purchaser dies before the end of the 15-year term a minimum 15-year time frame, or the life of the annuitant, if this is shorter the life of the annuitant, but will pay for a minimum of 15 years if the annuitant dies before this period elapses any selected 15-year time frame, even if the purchaser dies before the end of the 15-year term

a 15-year time frame following annuitization, even if the purchaser dies before the end of the 15-year term The question is simply asking about an immediate 15-year period certain annuity. This would not be an annuity option in a variable annuity contract. It is only available as a fixed annuity. The purchaser makes a lump sum payment, which is immediately annuitized and which will then pay for 15 years. There is no life annuity feature associated with this. It is a type of annuity that can be purchased from an insurance company that only pays for a stated time period - in this case 15 years. These are used most often to bridge a gap between early retirement and when social security payments start. For example, if an individual retired at age 55 and full social security payments started at age 70, he or she could buy this contract to provide payments for that 15-year gap.

Which of the following are tax preference items included in the Alternative Minimum Tax? I Excess depreciation II Excess depletion III Excess intangible drilling costs IV Private purpose municipal interest income

all All of the items listed are "tax preference" items for the Alternative Minimum Tax (AMT) calculation - excess depreciation deductions above straight line; excess intangible drilling cost deductions (IDCs); excess depletion deductions; and non-essential use private purpose municipal interest income.

the purchase of a put is a: bull strategy bear strategy neutral strategy bear/neutral strategy

bear strategy The buyer of a put has the right to sell stock at a fixed price in a falling market. The buyer has ever increasing gain potential as the market falls, so this is a bear market strategy.

If the writer of an equity callcontract is exercised, the writer MUST: deliver cash in 1 business day deliver stock in 1 business day deliver cash in 2 business days deliver stock in 2 business days

deliver stock in 2 business days If the writer of an equity call contract is exercised, the writer must deliver the stock, receiving the strike price in payment from the holder. Settlement is 2 business days after exercise date - this is a regular way stock trade.

A 60 year old man wishes to receive an annuity payment for himself and his beneficiary for at least 15 years. The recommended payout option is: life annuity life annuity - period certain life annuity - unit refund installments for a designated amount

life annuity - period certain A life annuity-period certain will pay for one's life, however if that person dies early, the annuity will still pay for a designated period. In this case, the period certain would be 15 years. A life annuity simply pays for one's life. Once that person dies, payments cease. A unit refund annuity pays the remaining balance as a lump sum if the annuitant dies "early." The annuity option that chooses installments for a designated amount allows the annuitant to choose the monthly amount to be received. Payments continue for that amount until the account is exhausted.