Series 66 Chapter 4
8. Sean would like to start saving for retirement. He is 25 years old, with a decent job and very few expenses. Which would be the least suitable investment? A. U.S. government Treasuries B. International stock fund C. Small-cap equity fund D. Corporate bonds
Answer: A. A 25-year-old person who is saving for retirement needs to beat inflation, and because they have a long time horizon they can tolerate ups and down in their portfolio. Equities are the most likely investment to beat inflation over the long run, so either an international stock fund or a small-cap equity fund would be suitable. Corporate bonds pay decent interest rates, so they also have a better chance of beating inflation. While an investment in U.S. Treasuries will keep his money safe, Treasuries are the least likely of these investments to beat inflation.
2. Which of the following would result in a joint owner automatically receiving all ownership of an account's assets in the event of another owner's death? A. Joint tenants with rights of survivorship B. Joint tenants in common C. General partnership D. LLC
Answer: A. A JTWROS account is automatically divided equally among the remaining joint account holders in the event of the death of one of the others. An individual's percentage ownership interest in a joint tenants in common account, a general partnership, or LLC is passed to their heirs according to their estate plan or state law
3. A client who wishes to retire in 40 years but does not have any desire to experience negative changes in his portfolio between now and then could best be described as having: A. A conservative risk tolerance B. A moderate risk tolerance C. Current income as their primary goal D. Very little investment experience
Answer: A. An inability to tolerate even temporary drops in a portfolio's value would best be described as a conservative risk tolerance. A moderate risk tolerance would be able to sustain temporary drops in value with the expectation of a rebound. Just because someone is conservative in their risk tolerance doesn't mean that they identify current income as their primary goal; even that may be too risky for some conservative clients.
11. Which of the following does not reduce the gross value of one's estate? A. Placing assets in a revocable trust B. Charitable gifts made after death C. The marital deduction D. Funeral and administrative expenses
Answer: A. Assets placed in irrevocable trusts leave the estate. Assets placed in revocable trusts bounce back into the estate at or before death.
30. If a security has a beta of 1.5, what does this mean? A. The security is subject to more systematic risk than a security with a beta of 1.0. B. The security is subject to less unsystematic risk than the security with a beta of 1.0. C. If the security had a market price of $10 at the beginning of the year, and the market returned 10% over the year, we can expect that the stock will now be priced at $15. D. It will outperform a security with a beta of 1.0
Answer: A. Beta is a measure of how the systematic (un-diversifiable) risk of the market affects an individual security. A security with a beta of 1.5 will be subject to more systematic risk than a security with a beta of 1.0. Beta is not a measure of unsystematic risk. If a security has a market price of $10, a beta of 1.5, and the market returned 10%, we can expect that the security will have a 15% return of $1.50, and therefore, be priced around $11.50. A security with a beta of 1.5 can only be expected to outperform a security with a beta of 1.0 when the market shows a positive return. The opposite can be expected when the market shows a negative return.
42. Danielle owns 100 shares of Company XYZ, which she bought for $80/share. Now that the market value of XYZ's stock has climbed to $89, she buys an out-of-the-money put on the stock. Which of the following is true? A. Danielle has bought protection for her recent gains against a decline of XYZ's prices. B. The put reverses her previous position, making the combined position bearish. C. Danielle has bought a married put. D. Danielle has put a ceiling on her winnings in buying downside protection.
Answer: A. By purchasing a put on XYZ's stock, Danielle has acquired protection should the stock fall below the strike price. If the value of the stock declines, she can exercise her put option, which will be in the money and negate the losses on her stock. The position will dampen her profits, but only by the amount of the premium paid for the option. Danielle's combined position is still bullish.
37. As part of a hedging strategy, Jon buys three ABC Apr 30 puts @ 2.50. The stock is currently selling at 31. Hedging in this way makes the most sense if he has which of the following positions? A. He is long 300 shares of ABC. B. He has shorted 300 shares of ABC. C. He is long 100 shares of ABC. D. He has shorted 100 shares of ABC
Answer: A. Investors typically hedge long positions with puts. If Jon is long 300 shares of ABC, three ABC puts will fully hedge his position.
40. Mary has shorted 1,000 shares of XYZ. XYZ is trading at $100. She has already made significant gains and would like to protect those gains. Of the choices listed, which of the following would be the best strategies to accomplish her goal? I. Buy calls on XYZ II. Buy puts on XYZ III. Close out her short position IV. Use leverage to buy more XYZ A. I and III B. I and IV C. II and III D. II and IV
Answer: A. Mary could protect her gains by closing out her short position and returning the borrowed shares. If she feels that XYZ's stock price may decline farther, she could buy calls on XYZ. If the price of XYZ's stock rises, she could exercise her calls and use the purchased shares to return the borrowed shares.
21. All of the following are advantages of passive investing styles except: A. Outperforming the market B. Lower costs than active investing C. Simplified investing process D. No need to time the market
Answer: A. Passive investing allows for simplified investing, comes with lower costs, and does not require market timing when an investor makes investments
4. John is 25 years old and earns $45,000 as an Emergency Medical Technician. He has saved $15,000 to invest and would like to purchase a house in five to seven years. Which of the following would be the least suitable recommendation for him? A. Tax-free municipal bonds B. Large-cap equity fund C. Preferred stocks issued by an NYSE-listed company D. A balanced fund
Answer: A. Tax-free municipal bonds would be the least suitable for John because he is not in a high income tax bracket and therefore would not be able to take advantage of the tax benefits of municipal bonds. In addition, municipal bonds would not offer the liquidity necessary to buy his house
18. All of the following are components of the capital asset pricing model except: A. Alpha B. Beta C. Riskless rate of return D. Expected market return
Answer: A. The capital asset pricing model is comprised of the riskless rate of return, the expected return of the market, and a security's beta. Alpha measures the portion of a mutual fund's return that can be attributed to the active management efforts of the mutual fund manager. The CAPM is used to calculate the expected return of a security, using beta as part of its formula.
6. Sarah is a 34-year-old dental hygienist and makes $40,000 per year. She is a single mother and has a chronically sick child. She sometimes has trouble paying her son's medical bills. She has just inherited $400,000 and would like to invest it. She would like an investment that is relatively safe and liquid in case she needs to cash out of the investment. Of the following recommendations, which would be most suitable for Sarah? A. U.S. Treasuries B. Preferred stock C. Municipal bonds D. Blue chip stocks
Answer: A. U.S. Treasuries would be an appropriate investment for Sarah, because they are extremely safe and there is also a liquid market for them. They will also pay her a small amount of interest. While blue chip stocks are liquid, they are not safe, and she could lose part of her principal. Municipal securities and preferred stock are not liquid investments and not as safe as Treasuries.
35. Which of the following investment strategies involves rebalancing a portfolio on a regular basis? A. Strategic asset allocation B. Tactical asset allocation C. Dollar cost averaging D. Sector rotating
Answer: A. Under a strategic asset allocation model, a representative and client work together to design an optimal mix (on a percentage basis) of major asset classes and subclasses. They will rebalance the portfolio on a regular basis through a number of methods as the portfolio grows, recognizing that some portions will grow faster or slower than others. Unlike a strategic asset allocation model, which relies on keeping an optimum portfolio mix to maximize return, the tactical asset allocation model attempts to time the market, moving in and out of asset classes and sectors based on certain indicators of the direction of the market.
7. Rodney is an aggressive guy. He likes to talk loudly and brag about his successes. He has $200,000 in his bank account that he has told you he wants to invest aggressively. He has also said that he cannot stand to lose and will not accept any loss of his principal. He goes on to tell you that he expects a lot in life and he gets it! Which is the most suitable investment for Rodney? A. U.S. Treasuries B. Derivatives C. Small-cap fund D. High-yield bonds
Answer: A. While Rodney claims to have an aggressive investment strategy. In reality, his main goal is capital preservation, which means that appropriate investments include bank CDs, U.S. Treasuries, and maybe money market funds. He has a chance of losing his principal on the high-yield bonds if the issuer defaults. With derivatives he could lose it all and more, and with a small-cap fund he can definitely lose his principal
1. All of the following are pass-through tax entities except: A. S-corp B. C-corp C. LLC D. General partnership
Answer: B. A C-corp, or subchapter C-corp, does not pass through its earnings without taxation. A C-corp's net profits are actually subject to a corporate tax rate before they are distributed to its owners, who are then taxed again on that income.
25. An investor who uses a buy and hold strategy would most likely rebalance his portfolio by: A. Purchasing options B. Using available cash generated by investments C. Selling investments at the end of each month D. Sector rotation
Answer: B. A buy and hold investor would not want to sell positions or rotate sectors. They would try to rely on incoming cash to purchase additional investments that would round out their asset allocation
10. The individual put in charge of overseeing a trust's assets is known as the: A. Grantor B. Trustee C. Beneficiary D. Executor
Answer: B. A trustee is the person put in charge of overseeing a trust's assets. The trustee is named by the trustor, or grantor, of the trust. In many cases, the trustee and trustor are the same. The beneficiary is the person for whom the assets of the trust are ultimately destined. An executor is the person put in charge of overseeing a will, which is a different estate planning instrument than a trust.
34. Which of the following risks would be least likely to apply to debt securities? A. Purchasing power risk B. Legislative risk C. Credit risk D. Interest rate risk
Answer: B. Debt securities are associated with purchasing power risk, credit risk, call risk interest rate risk, and often liquidity risk. Legislative risk is the risk that a piece of legislation will be introduced that will have an adverse effect on the company. For example, the healthcare industry is sensitive to changes in legislation relating to insurance coverage. This may affect debt securities, but it is more likely to affect equity securities
29. All of the following are true of diversification except: A. It involves investing in uncorrelated assets. B. It can lower systematic risk. C. It is a major tenet of modern portfolio theory. D. It supports the old adage, "Don't put all your eggs in one basket."
Answer: B. Diversification is grounded in the idea that it is unwise to put all your eggs in one basket. Specifically, diversification is the process of choosing a variety of assets to spread out the risk from any one asset. One strategy for achieving diversification is the buying of uncorrelated assets, or assets that do not have a history of moving the same direction at the same time. Diversification lowers unsystematic risk, but it does not lower systematic (market-wide) risk.
32. Which of the following would be most subject to purchasing power risk? A. Common blue chip stock B. Preferred stock C. ADRs D. REITs
Answer: B. Fixed-income securities are usually more subject to purchasing power than equity securities. Common blue chip stock, ADRs, and REITs are all equity securities whose returns are likely to beat inflation. While preferred stock usually pays higher dividends, its value hardly appreciates, resulting in typically lower overall returns than common stock. These lower returns make it more subject to purchasing power risk
39. Emma is long 1,000 shares of Apple, Inc. Apple is currently trading at $495. She doesn't expect the stock's market price to rise much in the near future and would like to earn some extra income. Which of the following strategies should she use in hopes of reaching her goal? A. Buy five AAPL 500 calls @ 7 B. Write five AAPL 500 calls @ 7 C. Buy five AAPL 500 puts @ 7 D. Write five AAPL 500 puts @ 7
Answer: B. If Emma writes five covered calls, she will be able to take in $3,500 of extra income. If the calls are exercised, she can use 500 of her shares to cover the calls.
15. Blythe dies, leaving an estate behind. Mark loaned Blythe some money a year ago and had not been fully paid back at the time of Blythe's death. How long does Mark have to file a claim against Blythe's estate? A. 30 days B. 6 months C. 1 year D. 5 years
Answer: B. In an estate, all creditors have six months to file a claim on the assets if they feel they are owed money. In this case, since Mark feels he is still owed money, he has six months to file the claim on Blythe's estate
13. A person who is appointed to have the legal right to make decisions on a person's estate, including an estate account, is considered: A. The probate court B. An executor C. The trustee D. A lawyer
Answer: B. Many people leave a will that defines who they wish to be the executor of their estate. However, if it was not stated in a will, a judge can decide to appoint an executor during probate. Due to the nature of an executor's duties, he is responsible for making decisions regarding estate accounts.
17. Modern portfolio theory attempts to: A. Avoid investing in fixed-income assets B. Maximize return by coordinating assets within the portfolio C. Outperform the market by focusing on each stock individually D. Reduce an investor's cost to the point where it does not affect returns
Answer: B. Modern portfolio theory attempts to maximize a portfolio's return by coordinating the assets in the portfolio with one another, instead of treating them as separate independent investments. Fixed-income assets are definitely an option under MPT.
5. Alex is a 55-year-old executive for a Fortune 500 company. His wife, who does not work, likes to live beyond their means. He has just inherited $500,000 and would like to invest it so that he can supplement his income when needed. What would be the most suitable investment for him? A. Blue chip stocks B. Tax-free municipal bonds C. REITs D. High-yield corporate bonds
Answer: B. Municipal bonds would be the most suitable investment for Alex, because as an executive for a Fortune 500 company, he would be earning a high income and, therefore, in a high tax-bracket. The interest on the municipal bonds would supplement his current income. While blue chip stocks pay dividends, the dividends would not be high enough to help him if he gets into a cash crunch. REITs pay high dividends, but they also are subject to taxation at Alex's ordinary income rate. Finally, while high-yield bonds offer higher coupon rates, their risk is probably too high for Alex to take a chance on.
31. Which of the following would you not expect from someone with an income strategy? A. Investment in a rental building B. Investment in growth stocks C. Investment in corporate bonds D. Investment in preferred stock
Answer: B. Someone who needs income might invest in a rental building so that they can collect the rental payments. They may also invest in corporate bonds to collect the interest payments. They may also invest in preferred stock to collect the dividends. They would not invest in growth stocks, because these stocks usually do not pay out dividends. An investor who invests in growth stock is an investor who seeks capital appreciation over income.
36. Within an investor's portfolio, which of the following types of risk will not be lessened through diversification? A. Credit risk B. Systematic risk C. Unsystematic risk D. Liquidity risk
Answer: B. Systematic risk is the risk that the whole system (i.e., the market) will drop, causing a drop in the performance of individual stocks or the entire portfolio. If a portfolio is sufficiently diversified, it is possible to reduce unsystematic risk to almost zero. Diversification does not reduce the systematic risk of a portfolio. Credit risk and liquidity risk are considered unsystematic risk and would be lessened by diversification.
19. The version of the efficient market hypothesis that states that all publicly available information regarding the prospects of an issuing company are already reflected in its stock's price is known as the: A. Weak form B. Semi-strong form C. Semi-weak form D. Strong form
Answer: B. The semi-strong form of the efficient market hypothesis (EMH) states that all publicly available information regarding the prospects of an issuing company must already be reflected in the company's stock price, including past market data and fundamental company data, such as balance sheet figures and earnings forecasts. The weak form of the EMH states a stock's price already reflects all information that can be derived by examining market trading data (but not company fundamental data). The strong form of the EMH states that a stock's price reflects all information relevant to the issuing company, both publicly available information and information known only to company insiders. Note that "semi-weak" is not a form of the EMH typically discussed
16. Federal estate taxes must be paid: A. Within 3 months of the date of death B. Within 6 months of the date of death C. Within 9 months of the date of death D. Within 12 months of the date of death
Answer: C. According to the IRS, estate taxes "are due within 9 months after the date of the decedent's death."
9. Which of the following is not contained on a client's personal balance sheet? A. Cash B. Car C. Wages D. Marketable securities
Answer: C. An individual's wages are included in their income statement. The balance sheet is for an individual's personal assets and liabilities.
28. Which of the following is not true of passive and active investment strategies? A. Passive investment strategies are usually lower cost than active investment strategies. B. Passive investment strategies are usually more tax-efficient than active investment strategies. C. Technical analysis would be considered passive investing strategy, while fundamental analysis would be considered an active investing strategy. D. Strategic asset allocation would be considered a passive investment strategy, while tactical asset analysis would be considered an active investment strategy.
Answer: C. Broad-based index funds and ETFs have low costs, because they employ a passive investing approach and, therefore, do not need to hire a traditional portfolio manager or a team of research analysts to select securities on a routine basis. Broad-based index funds and ETFs are also more tax-efficient, because fewer transactions take place in the fund, leading to lower capital gains taxes and lower transaction costs. Tactical asset allocation is considered an active strategy, because the investor is trying to time the market, while strategic asset allocation is considered a passive strategy, because the investor chooses an allocation and sticks to it, regardless of the performance of the market. Both technical analysis and fundamental analysis are considered active investing strategies.
38. Jane is long 1,000 shares of Apple, Inc. Apple is trading at $500. She is concerned that the market value of Apple's stock might fall, so she would like to hedge her position. Which of the following would offer the best protection? A. Buying 10 AAPL 500 calls @ 5 B. Shorting 10 AAPL 500 calls @ 5 C. Buying 10 AAPL 500 puts @ 5 D. Shorting 10 AAPL 500 puts @ 5
Answer: C. Buying a put offers the best protection for a long position. A put gives the holder the right to sell 100 shares of a given stock at a strike price. If Jane buys 10 AAPL puts @ 5, she will be able to sell all her shares at 500 if Apple declines. Thus, even if Apple declines to $2 per share, she can still sell her shares at 500 each. Her maximum gain is unlimited, because the price of Apple could go to the moon
33. Which of the following is true about call risk? A. Call risk is the risk that a bond will be called when interest rates are increasing. B. If the bond is not called, the bondholder will receive the call value of the bond at maturity. C. Non-callable bonds are typically offered with lower coupon rates than callable bonds. D. Call risk is a risk to the issuer rather than the investor.
Answer: C. Call risk is the risk that a bond will be called when interest rates are declining. If the bond is called, the bondholder will receive the call value of the bond at maturity. If the bond is not called, the bondholder will receive the par value of the bond at maturity. Non-callable bonds are typically offered at a lower rate than callable bonds. Call risk is a risk to the investor rather than the issuer.
27. All of the following would be an example of a passive investment strategy except: A. Investing in a broad-based ETF B. Dollar cost averaging C. A risk arbitrage activity D. Laddering
Answer: C. Investment strategies can be broadly categorized into two types: active strategies and passive strategies. Investors who use active strategies play an active role in choosing the specific securities in their portfolios. In contrast, passive investors do not play an active role in managing their portfolios. Instead, they often rely on investment vehicles that are managed by others, such as mutual funds. They also invest in vehicles that mimic the performance of a market index. Index funds, exchange-traded funds (ETFs), and unit investment trusts are passively managed investment vehicles. Other passive strategies include dollar cost averaging, bond laddering, and hedging. If investing in individual securities, passive investors often employ a buy and hold strategy.
14. Jenny wants to avoid having certain assets taxed as part of her estate when she dies. To do this, she could place assets in a(n): A. Revocable Trust B. Fixed rate annuity C. Irrevocable trust D. IRA
Answer: C. Only assets placed in an irrevocable trust are not included in the value of the estate when calculating estate taxes. Note that certain property that is transferred within three years of death is subject to estate taxes, even if it is placed in an irrevocable trust
24. Which of the following are true regarding the use of options to limit risk? I. Selling an uncovered call to another investor lowers a client's risk profile. II. Purchasing a call in a down market can allow a client to participate in a turnaround without putting herself at greater risk. III. An investor can create leverage by buying options that cover more securities than she actually owns. IV. Writing covered calls is an appropriate strategy for a flat market. A. I only B. I and II C. II, III, and IV D. III and IV
Answer: C. Purchasing calls in a down market offers investors a way to participate in a market turnaround without having to commit all their funds. Writing covered calls is a good way to generate income on a portfolio in a flat market, since it's likely that the calls will go unexercised, allowing the investor to keep the premium they received, as well as the underlying stocks they sold the calls against. Options can also create leverage, since a standard option contract covers 100 shares of stock but can be purchased for a fraction of the price of those shares
20. Strategic asset allocation is primarily distinguished by the fact that an investor who uses the strategy: A. Moves in and out of sectors to profit from trends B. Only utilizes a buy and hold strategy C. Rebalances to target amounts of each asset class D. Cannot be used in a weak form of the efficient market hypothesis
Answer: C. Strategic asset allocation assigns target percentages to asset classes and then attempts to maintain those percentages through rebalancing. Tactical allocation attempts to move in and out of the market. Strategic asset allocation can be used under a weak form efficient market view
26. Given the following assumptions for Stock ABC, what is its expected return using the capital asset pricing model? Riskless rate of return: 3%; return of broader stock market: 11%; beta: 1.2, standard deviation: 2. A. 6.3% B. 8.1% C. 12.6% D. 9.6%
Answer: C. The formula for the capital asset pricing model is given by the following: return on stock = riskless rate of return + beta of stock x (market return - riskless rate of return). Plugging in for Stock ABC gives: return on Stock ABC = 3% + 1.2 x (11% - 3%) = 12.6%. Note: The standard deviation is not used in the CAPM formula.
22. A client just sold all her positions in the well-performing healthcare industry and wants to invest in the poorly performing tech industry. This is a likely example of: A. Rebalancing B. Diversification C. Sector rotation D. Leverage
Answer: C. This client is likely moving out of the healthcare industry, which she believes has hit its peak, and is moving into technology stocks before they start climbing. Thus she is changing or rotating the sectors in which she has placed her investments
23. Dividend-paying income stocks may help to accomplish all of the following except: A. Lower a portfolio's overall volatility B. Increase a portfolio's total return C. Provide cash for rebalancing the portfolio D. Guarantee capital preservation
Answer: D. Dividend-paying stocks may offer lower volatility than other stocks. This is because, since they can increase a portfolio's total return and provide cash for rebalancing, investors often sell them after selling other securities. However, they do not guarantee capital preservation in any way. Keep in mind, dividends can be eliminated by a company at any point.
41. Your client is short 100 ABC @ 55 and wants to hedge his position by putting a floor on his possible losses. To protect him from the risk that ABC's stock price may rise, you recommend that he: A. Buy a put B. Sell a put C. Sell a call D. Buy a call
Answer: D. To protect short sale gains, an investor can buy a call to hedge against a rise in the price of the shorted security.
12. Which of the following investments would typically be the most appropriate to hold in an estate account? A. Corporate bond with a 10-year maturity B. Aggressive growth fund C. International mutual fund D. Money market funds
Answer: D. Typically, estate accounts are temporary and exist only until all beneficiaries have been paid out. Because of the general short-term nature of the account, it would be appropriate to have short-term and low-risk securities such as money market funds.
