Series #66 Practice Exam #3 & #4

Which of the following situations would most likely cause an individual's application for a disability income insurance policy to be denied? A) Working in a hazardous occupation B) Being over 50 years of age C) Type 2 diabetes D) BMI over 26 Explanation In most cases, those who work in hazardous occupations will be denied disability income coverage. Premiums will be higher as one gets older and Type 2 diabetes or too high a BMI can lead to a premium surcharge (rated), but those are generally not causes for denial of coverage. U19LO5

A

An investor is of the opinion that the recent bull market has run its course, and she wants to protect her portfolio consisting largely of equities with a market cap of less than $1 billion. Her best choice would be to A) sell futures on the Russell 2000. B) buy puts on the Russell 2000. C) sell puts on the S&P 500. D) buy puts on the S&P 500. Explanation When a bull market runs out of steam, a decline usually follows. The best way to protect her positions is purchasing a put option on a benchmark that represents her holdings. Because this investor's portfolio is so heavily invested in small-cap stocks, the appropriate benchmark for hedging would be the Russell 2000. U23LO3

B

An investor purchases a Treasury note and the confirmation shows a price of $102.21. Rounded to the nearest cent, the investor's cost, excluding commissions, is A) $102.21. B) $1,022.10. C) $1,026.56. D) $1,022.21. Explanation Treasury notes are quoted in 32nds where each 32nd equals $.3125. The 102 in the quote equals $1,020 and the 21/32 is an additional $6.56 bringing the total to $1,026.56. U13LO2

C

RAP mutual fund had the following returns over the past 3 years: Year 1: 15%. Year 2: -5%. Year 3: 7%. What is the arithmetic mean of the returns for the RAP fund? A) 7.00% B) 20.00% C) 5.67% D) 9.00% Explanation The arithmetic mean (the average) is 5.67%, calculated as follows: (15% - 5% + 7%) ÷ 3 = 17 ÷ 3 = 5.67%. The median is 7% and the range is 20% (the difference between -5 and +15). If you didn't notice the year 2 return was negative, then your computation would be 9%. U10LO2

C

If a call option with an exercise price of $50 is purchased for $300, the maximum amount the investor can lose is A) $4,700 B) $5,000 C) unlimited D) $300 Explanation Think about it—you bought something for $300 (the premium on an option is per 100 shares). What is the most you can ever lose with anything of any type that you pay $300 for? Your purchase price! U16LO2

D

Which of the following would justify an investment adviser's use of a full-service broker? Obtaining special reports dealing with economic projections from the broker Expense-paid business trips paid for by the broker The use of the research analysis provided by the broker A) I and II B) I, II, and III C) II and III D) I and III Explanation Full-service brokerage firms often provide research reports, securities and portfolio analysis, and special reports without specific charges, but are usually compensated by their higher commissions. Nothing in industry rules prevents an adviser from using a full-service broker to effect customer transactions. However, it would be unethical if the adviser were to benefit personally from the direction of the client business. U7LO1

D

Which of the following types of businessowners has unlimited liability for the business's debts? A) Owner of a sole proprietorship B) Member of a limited liability company (LLC) C) Limited partner D) Shareholder of a corporation Explanation The owner of a sole proprietorship has unlimited personal liability for the debts of the business, and this is one of the main disadvantages of sole proprietorships. Limited partners, members of limited liability companies, and shareholders of corporations are not personally liable for the debts of the business. U18LO3

A

A bond analyst who determines the value of a debt security by adding the present value of the future coupons to the present value of the maturity value is using which of the following valuation methods? A) Discounted cash flow B) Future value C) Dividend discount D) Present value Explanation This type of question sometimes appears on the exam. There is a second answer that could be correct, but is not scored as such. In this example, a case could be made for present value, but the better choice is discounted cash flow; it is more correct. U13LO12

A

A client of yours owns some convertible preferred stock. She notices an article in the business section of her local newspaper that reports the company is going to pay a 20% stock dividend on their common stock. She wants to know how this will affect her? A) She will also receive 20% more shares because preferred stock has a priority claim ahead of common. B) There will be no effect. C) If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend. D) More than likely, the price of the preferred stock will rise. Explanation Most convertible securities are sold with antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends. U13LO9

C

Where would you be most likely to find an IPS? A) SPD B) IRA C) GRAT D) Defined benefit plan Explanation The investment policy statement (IPS), although not required under Department of Labor (DOL) rules, is generally found in corporate qualified plans, such as the defined benefit or defined contribution plan. Because the investor manages the IRA, there is no need to prepare an IPS for participants to review. U24LO5

D

A grandparent wishes to contribute funds to an account for the benefit of the college education of a grandchild. In which of the following does the donor have the greatest amount of control over the assets in the account? A) A Coverdell ESA B) An UGMA account C) An UTMA account D) A Section 529 plan Explanation It is the Section 529 plan that offers the greatest amount of control to the donor. In the case of the ESA, on the IRS form used to open the account, it states: "The 'responsible individual"' named by the depositor shall be a parent or guardian of the designated beneficiary." Unless we are told that the grandparent has been appointed as legal guardian, there is a lack of control. And, even then, one thing the "responsible individual" cannot do that the donor to a 529 plan can is take the money back. Although the grandparent could be named the custodian of the UGMA or UTMA account, the only authority there is to make the investment decisions and disbursements until the termination age of the account. U24LO6

A

A transactional exemption would be available under the Uniform Securities Act when an agent for a broker-dealer A) sells a large block of an unregistered nonexempt security to an insurance company that is not authorized to do business in this state B) sells a retail client $10,000 of U.S. Treasury bonds C) receives an unsolicited order from a client to purchase heating oil contracts D) sells a large block of an unregistered nonexempt security to an individual who meets the definition of an accredited investor Explanation The sale of a security to an institution, such as an insurance company, is considered an exempt transaction. The fact that the company is not authorized to do business in the state only means that its securities would not be exempt, but that does not change the fact that this is a sale to an institution and is, therefore, exempt. The term accredited investor is meaningless here, only institutions qualify for exempt treatment, not rich people. The T-bonds are an exempt security, but the sale to a retail client is not an exempt transaction. Heating oil contracts are a commodity, not a security. U4LO3

A

According to NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, under which of the following circumstances has the investment adviser acted properly? A) An adviser discloses confidential information about an advisory account to the spouse, who is a joint owner of the account. B) An adviser tells a client that, by keeping his entire portfolio invested in government securities, he will not experience a great deal of appreciation but is guaranteed not to lose money. C) An advisory firm states in the advisory contract that if the investor does not experience a minimum return of 6%, the firm will pay the client out of its own funds to make up any difference. D) An adviser promises a client that by following the firm's trademark investment program, the returns will exceed those of the previous 12 months or all fees paid will be returned. Explanation According to NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, it is unethical for an adviser to guarantee performance or rebate fees if performance is below a minimum standard. With respect to government securities, there is no, at least for exam purposes, default risk, but there is interest rate risk; all of the choices are improper. Disclosure of confidential account information may be made under a court or IRS order or when requested by a joint owner of the account. U7LO5

A

According to the Investment Advisers Act of 1940, which of the following is always a natural person? A) An investment adviser representative B) A broker-dealer C) The city of Chicago D) An investment adviser Explanation Natural persons are human beings. An adviser representative must be an individual. Although there are broker-dealers and investment advisers organized as a sole proprietorship, almost all are structured under some type of business form. A city is never an individual. U2LO1

A

All of the following statements regarding exchange-traded funds (ETFs) are correct except A) ETFs may not be sold short. B) ETFs trade based on supply and demand for the shares rather than their NAV. C) ETFs may be passively managed. D) ETFs can be bought on margin. Explanation Exchange-traded funds can be sold short and can be bought on margin just like other listed securities. Because most ETFs are based on an underlying index, they are passively managed and like other listed securities, their price is based on supply and demand rather than the NAV (although the price will generally be close). U14LO8

A

An individual owns assets worth $500,000 and has debts of $300,000. What is the individual's net worth? A) $200,000.00 B) $300,000.00 C) $800,000.00 D) $500,000.00 Explanation An individual's net worth equals the individual's assets minus his liabilities. Therefore, if someone has assets of $500,000 and debts of $300,000, the person's net worth is $200,000. U19LO2

A

An investment adviser representative has a 78-year-old prospect living on $26,400 per year from Social Security plus investment income. The individual's net worth is $141, 000 including the equity in her primary residence. Her net worth was higher until recently, but the aggressive fund she owns in the KAPCO family of funds is down over $20,000 in value. Which of the following would you recommend to her? A) Switch to a more conservative fund in the same family of funds B) Liquidate the fund shares and put the proceeds in a bank CD C) Sell her fund shares and reinvest in a vehicle offering her deferred accumulation D) Invest in a municipal bond fund Explanation Clearly the municipal bond fund is inappropriate because this client's income does not put her into one of the higher tax brackets where the tax exemption on the bond's interest is beneficial. Just as obvious is the poor choice of moving her assets to a deferred accumulation vehicle, such as an annuity, where there would probably be surrender charges and no income. That leaves using the exchange privilege where she can move her investment to a more conservative fund without paying a sales charge or buying a bank CD. Because this is an exam for representatives of an investment adviser and one of the requirements to be defined as an investment adviser is that advice be given on securities, the answer on the exam should be a security (bank CDs are not securities). U19LO6

A

Included in the Investment Advisers Act of 1940 are a number of different recordkeeping requirements. Wealth Preservation Specialists is a covered adviser that is organized as a partnership. If the firm were to dissolve, partnership agreements must be kept for A) 3 years after the dissolution B) 5 years from the date of organization C) the lifetime of the firm D) 5 years after the dissolution Explanation ​Both ​​the Investment Company Act of 1940 ​(applicable here because this is a covered adviser) and the NASAA Model Rule on Recordkeeping ​require that investment advisers maintain certain records, such as partnership agreements and corporate articles of incorporation, for a period of no less than 3 years after dissolution. U1LO5

A

One of your clients is 10 years away from retirement and is trying to decide what would be a suitable investment for this year's IRA contribution. You would probably NOT recommend A) leveraged ETFs B) conservative growth mutual funds C) broad market ETFs D) target date mutual funds Explanation Because most leveraged funds reset daily, they are best utilized by investors with a very short time horizon. U17LO3

A

One way in which universal life and variable life are similar is that both A) permit loans against the cash value B) have flexible premiums C) have a fixed minimum cash value D) are considered securities Explanation As long as the policy has cash value, loans are permitted. Neither of these has a fixed minimum cash value, and only universal life has flexible premiums. Only variable life is considered a security. U15LO6

A

Pontourny Advisory and Investment Services (PAIS) is a federal covered investment adviser. Its principal office is in State X. PAIS also maintains branch offices in States Y and Z. Brenda is the manager of the branch office in State Y. Some of the individuals being supervised by Brenda have clients in States X and Y, and others have clients in States Y and Z. Brenda must register as an IAR in A) State Y B) States X and Y C) States Y and Z D) States X, Y, and Z Explanation Those who supervise the activities of investment adviser representatives are themselves defined as IARs. An IAR representing a federal covered investment adviser need only register in the state or states in which she (the IAR) has a place of business. There is nothing in this question to suggest that Brenda has a place of business anywhere other than in State Y, where her branch office is located. Remember, when it comes to federal covered advisers, registration of their IARs is dependent on the IAR's place of business, not the location of their clients. U2LO3

A

Pricing of a closed-end fund is determined by A) supply and demand for the shares B) net asset value plus a sales charge C) net asset value plus a commission D) net asset value Explanation Shares of closed-end funds are traded in the secondary market where prices are determined by supply and demand. The NAV of a closed-end fund is computed and not determined by the market price or trading price. Closed-end funds do not have sales charges but do have commission charges added to the market price. U14LO3

A

There are several ways that a securities professional's registration can be terminated. Nonpunitive termination of a securities professional's registration could be done through cancellation suspension revocation withdrawal A) I and IV B) II and IV C) I and III D) II and III Explanation Cancellation and withdrawal are nonpunitive methods of termination of a person's registration. Suspension, revocation, and denial are considered forms of punishment. U5LO2

A

Under the Securities Exchange Act of 1934, the term associated person would include each of the following EXCEPT a person who is associated with a broker-dealer A) and whose functions are solely ministerial B) as a branch office manager C) as an agent D) in the capacity of a partner solely by virtue of a contribution of capital Explanation According to the act, the phrases "person associated with a broker or dealer" and "associated person of a broker or dealer" mean any partner, officer, director, or branch manager of such broker or dealer (or any person occupying a similar status or performing similar functions); any person directly or indirectly controlling, controlled by, or under common control with such broker or dealer; or any employee of such broker or dealer. However, a person who is associated with a broker or dealer but whose functions are solely clerical or ministerial shall not be included in the meaning of such term. U3LO3

A

Under the Uniform Securities Act, prepaid advisory fees must be detailed in the advisory contract may not exceed 2% of the customer's deposited assets in excess of $500 for 6 months or more of service require the adviser's balance sheet to be included in the brochure may never be accepted A) I and III B) I, II, III, and IV C) II and IV D) I, II, and III Explanation Under the Uniform Securities Act, prepaid fees are permitted if they are detailed in the advisory contract and there is a refund of the fees if the contract is canceled prematurely. If an adviser accepts more than $500 in prepaid fees, 6 months or more in advance of services, a balance sheet must be included in the brochure (Part 2 of Form ADV) given to customers. U6LO4

A

Which of the following are governed by the prudent investor rule? Trustee Executor Custodian Agent who has been granted discretionary authority A) I, II, III, and IV B) I and II C) III and IV D) I, II, and III Explanation The prudent investor rule applies to fiduciary accounts, or accounts in which someone is acting on someone else's behalf. In these accounts, the fiduciary must act prudently. An agent who has been granted discretionary authority is acting in a fiduciary capacity. U18LO4

A

Which of the following categories of assets is most likely classified as an alternative asset? A) Real assets B) Cash C) Preferred stocks D) Convertible bonds Explanation Traditional investments include cash, bonds, and stocks, regardless of the adjective used. Alternative investments include four major categories: real assets, hedge funds, private equity, and structured products. U17LO5

A

Which of the following indicates a bond selling at a discount? A) 7% coupon yielding 7.5% B) 5% coupon yielding 5% C) 10% coupon yielding 9% D) 7% coupon yielding 6.5% Explanation Whenever the yield is higher than the coupon, the bond is selling at a discount from the par value. U13LO10

A

Which of the following might be used by an analyst to approximate a reasonable price for a common stock? A) The dividend discount model B) Yield to maturity C) Book value per share D) Par value Explanation The simplest model for valuing equity is the dividend discount model—the value of a stock is the present value of expected divi¬dends on it. Yield to maturity only applies to debt securities with a fixed maturity date. The par value of a common stock has nothing to do with its market price. Although fundamental analysts will examine a company's book value per share, it generally has little or no bearing on the current market price of the stock. U12LO6

A

Which of the following statements regarding an S corporation owner and an owner of an LLC are TRUE? Creditors have very limited recourse rights to the owners. They may not be nonresident aliens. They both are considered stockholders. Both receive the tax benefit of owning flow-through entities. A) I and IV B) I and III C) II and IV D) II and III Explanation Creditors don't have recourse to the owners of either entity unless the owners have specifically allowed it. Both are flow-through or conduit entities. Owners of S corporations are stockholders, whereas those in an LLC are members. Nonresident aliens may not own an S corporation. U18LO3

A

Your client turns in a buy limit order for 100 shares of ABC at $58. Following the entry of the order, trades occur at 59, 59, 58.80, 58.20, 58.40, 57.95, 57.85. At what price was this limit order triggered? A) The order was not triggered. B) $57.85. C) $58.20. D) $57.95. Explanation Only stop orders have triggers. A buy limit order will be executed at the limit price or better (lower). In this case, $57.95. When you have a question like this on your exam, don't say to yourself, "But what if there is stock ahead?" We never want to overcomplicate a question by looking for something that isn't mentioned. U22LO6

A

An analyst estimates that a stock has a 40% chance of earning 10%, a 40% chance of earning 12.5%, and a 20% chance of earning 31%. What is the probable return of this stock? A) 13.00% B) 15.20% C) 7.58% D) 14.17% Explanation The probable return is computed by taking the probabilities and adding them together. It looks like this: 40% x 10% = 4% 40% x 12.5% = 5% 20% x 31% = 6.2% all of which total 15.2% probable return. U23LO2

B

Information required on an application for registration as an agent would include the form of business (corporation, partnership, LLC, etc.). felony convictions, whether securities related or not. a statement of financial condition. citizenship information. A) I and II B) II and IV C) I and III D) III and IV Explanation Applicants for registration as agents must include any felony conviction (misdemeanors are limited to those that are securities related) and a statement of citizenship. Agents can only be individuals, not business entities, and it is only broker-dealers and investment advisers that must submit financial information. U3LO5

B

Investment advisers who manage investment portfolios that total less than $100 million must register with A) both a state and the SEC B) a state only C) the SEC only D) neither the SEC nor a state Explanation Investment advisers who manage less than $100 million of investment assets are prohibited from registering with the SEC and are required to register with a state Administrator unless exempt under the laws of that state. Please do not confuse this with an SEC-registered IA whose AUM may drop to as low as $90 million with continued SEC registration allowed. Any question about that rule will state that AUM has "dropped." U1LO5

B

A financial ratio used by some analysts to help determine if a company's stock is over or undervalued is A) the dividend payout ratio B) the price-to-book-value ratio C) the current ratio D) the quick asset ratio Explanation The price-to-book-value ratio compares the company's market price with its book value per share. The higher the ratio, the greater premium the public is willing to pay over the intrinsic value of the enterprise. Usually, a ratio of less than 1 indicates an undervalued company. U10LO7

B

A form of business structure that exposes all personal assets of the owner to creditors is A) the C corporation B) the sole proprietorship C) the limited partnerships D) the LLC Explanation One of the reasons why few large businesses are organized as sole proprietorships is the fact that all personal assets, not just those of the business, are placed at risk if the business fails. In each of the other choices, the maximum potential loss is the amount of the investment. U18LO3

B

A number of different pooled investment vehicles are included in the term "alternative investment." One of them, a synthetic investment instrument that has been created to meet a specific need that cannot be met by a standardized financial instrument, is known as A) an arbitrage B) a structured product C) an inverse fund D) a z-tranche CMO Explanation Structured products are created as a tool to meet the issuer's debt financing needs when they will result in a lower cost than a standardized financial instrument available in the market place. U17LO3

B

An agent may open a joint account for which of the following? Lee and his 13-year-old son, Tom Mary and Kelley, 2 adult college roommates Jerry and Mark, friends and partners in business for more than 20 years Melinda and her minor nephew, John, for whom she is guardian A) I and III B) II and III C) I and IV D) II and IV Explanation Joint account owners share ownership of the account and must be adults. A minor may not legally exercise control over an account and may not be an owner of record of an account. Remember that a joint account is owned by 2 or more persons and, under both state and federal law, a minor is not a person. U18LO2

B

An individual has been employed by a broker-dealer to make cold calls to solicit prospects for the firm's new wrap fee program. Under the USA, it is true to state that this individual A) does not need supervision because he is only making cold calls B) would be defined as an investment adviser representative C) is not defined as an investment adviser representative because he is only making cold calls D) would be permitted to use the term investment counsel Explanation As we know, when a broker-dealer offers wrap fee programs, the exclusion from the definition of investment adviser is lost. Any individual soliciting for that program would be considered an investment adviser representative and would need adequate supervision. Cold calling is about as far as you can get from the role of an investment counsel. U2LO1

B

An individual works for an accounting firm that does not have a retirement fund. She is paid $18,000 per year. During her spare time, she is a commercial artist and earned $16,000 doing this work last year. What is the basis for her contribution under a Keogh plan (HR-10)? A) $18,000.00 B) $16,000.00 C) $0.00 D) $34,000.00 Explanation Contributions to a Keogh must be based on self-employment income. U24LO2

B

An investment adviser's model portfolio has returned 20% for 10 consecutive years. Which of the following statements regarding this adviser's advertisements is CORRECT? A) It may state that the portfolio will likely continue its past performance 20%. B) It may state the rate of return and that past performance does not guarantee future performance. C) No statement may be made about the performance. D) It may state that an investor will not lose money. Explanation Guarantees of performance are prohibited. Past performance may be shown, provided proper disclaimers regarding future performance are made. U6LO5

B

Bond prices are quoted as a percentage of A) conversion value B) par value C) stated value D) market value Explanation Bond prices are quoted as a percentage of par value. On the exam, the par value of bonds is always $1,000. U13LO2

B

It would not be considered a prohibited or unethical business practice for an investment adviser to A) use a testimonial from a bona fide client with the proper caveat that this individual's results may not be typical and it is possible they may not be reproduced in the future B) pay a nominal fixed fee to certain professionals as a form of thanking them for client referrals C) charge a performance-based fee to an individual who meets the SEC's accredited investor standard detailed in Rule 501 of Regulation D D) pay a nominal fee, based on account size, to certain professionals as a form of thanking them for client referrals Explanation Referral fees (not cash fees for full-time soliciting) may be paid to certain professionals (lawyers, accountants, insurance agents, and so forth) as long as the fee is both a nominal amount (up to several hundred dollars) and is the same amount for any referral. That is, it is not based on the size of the account. In order to charge a performance-based fee, investors must have a net worth in excess of $2.1 million while they can meet the accredited investor standard when their net worth exceeds only $1 million. Finally, under both state and federal law, investment advisers may never use testimonials from clients, even with disclaimers. U7LO1

B

Mary is a bowling buddy of Susan, a covered investment adviser. Mary refers Amanda, a wealthy widow, to Susan, and after a very pleasant meeting, Amanda places $15 million under management with Susan. If Susan were to give Mary a cash payment for the referral, A) she would have to obtain Mary's permission first B) she would be engaging in an prohibited practice C) both Susan and Mary would have to disclose the cash payment to Amanda D) only Susan would have to make disclosure to Amanda Explanation Although there are circumstances under which cash payments may be made to solicitors, none of the required conditions found in the Investment Advisers Act of 1940 appear to be met here. A formal written agreement must be in effect, not just a one-time reward. U7LO1

B

One way in which an investment adviser acting in the capacity of an agent in a transaction with a client differs from a broker-dealer performing the same task is that the investment adviser A) may not charge a commission on the transaction B) shall obtain client consent before completion of the transaction C) shall disclose the agency capacity before the transaction D) shall notify the Administrator of its capacity in the proposed transaction Explanation In order to act as an agent (or principal) in a trade with an advisory client, there are 2 requirements: The client receives full written disclosure as to the capacity in which the adviser proposes to act Consent of the client Both of these are required before the completion of the transaction. U6LO1

B

Probable return is A) the current worth of future income discounted to reflect what that income is worth today B) an estimate of all of the possible returns an investment is expected to yield C) the one discount rate that equates the future value of an investment with its net present value D) the difference between an investment's present value and its cost Explanation The probable return is computed by taking the various likely returns for an investment and adding them together. The difference between an investment's present value and its cost is the NPV. The current worth of future income discounted to today is used to determine present value. The one discount rate that equates the future value of an investment with its NPV is the internal rate of return (IRR). U20LO9

B

The management style that is most similar to buy and hold is A) active management B) strategic management C) contrarian D) tactical management Explanation A strategic management style, sometimes referred to as passive, is less apt to have a high degree of portfolio turnover than active or tactical management. Contrarian style generally involves taking positions that are currently out of favor in the market place, but would incur somewhat frequent activity. U20LO3

B

The statistical method used to determine the return profile of a security or portfolio that recreates potential outcomes by generating random values based on the risk and return characteristics of the securities themselves is known as A) the optimal portfolio B) the Monte Carlo simulation C) the capital asset pricing model (CAPM) D) the efficient market hypothesis Explanation This is the basic definition of the Monte Carlo simulation. U20LO8

B

To calculate the amount to be received on redemption of open-end investment company shares, which of the following would be used? A) The offering price, plus the redemption fee B) The NAV, minus the redemption fee C) The NAV, plus the redemption fee D) The offering price, minus the redemption fee Explanation The mutual fund will redeem shares at the NAV. Redemption fees or deferred sales loads, if any, are subtracted from the proceeds sent to the investor. U14LO3

B

Under the NSMIA, the term "federal covered adviser" includes a person registered with the SEC under the Investment Advisers Act of 1940 registered as an investment adviser in two or more states excluded from the definition of investment adviser under the Investment Advisers Act of 1940 required to register with the state Administrator A) I and IV B) I and III C) II and IV D) II and III Explanation The NSMIA defines "federal covered adviser" as a person who is either required to register with the SEC under the Investment Advisers Act of 1940 or who is specifically excluded from the definition of "investment adviser" under that act. Registration with the state Administrator is not required of a federal covered adviser. If an investment adviser who otherwise would not qualify for SEC registration would be required to register in 15 or more states, the Dodd-Frank Act makes that adviser eligible for federal registration. U1LO5

B

Under the Uniform Securities Act, which of the following statements relating to the registration requirements of investment advisers is TRUE? A) If an amendment to the registration is subsequently filed, the registration becomes effective 15 days after the amendment is filed. B) A registration becomes effective at noon, 30 days after the application has been filed, providing the registration is not in the process of denial. C) Registrations of securities professionals expire 1 year after their effective date, unless renewed. D) A registration is automatically effective at noon, 30 days after the application has been filed. Explanation A registration is effective at noon, 30 days after the application has been filed if there is no denial or stop order in process. Registrations of securities professionals expire on December 31, unless renewed. If an amendment to the registration is subsequently filed, the registration becomes effective 30 days, not 15 days, after the amendment is filed; filing the amendment starts the process anew. U1LO5

B

Which of the following are regulated under the Securities Exchange Act of 1934? New issues Broker-dealers Transfer agents A) I and III B) II and III C) I only D) I, II, and III Explanation The Securities Exchange Act of 1934 was designed to regulate securities transactions, securities markets, and the securities firms who do the trading. While the Securities Act of 1933 covers requirements relating to new issues, the Securities Exchange Act of 1934 covers almost everything else in the securities industry. Its greatest impact is on the securities firms and the people who sell securities (i.e., broker-dealers and their agents) in the secondary market. Of the choices listed, new issues would be regulated by the Securities Act of 1933. U12LO2

B

Which of the following statements concerning conflicts of interest under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers are TRUE? Where a conflict of interest exists, an adviser must decline taking on the client. A conflict of interest is defined as anything that may impair the impartiality of the advice being rendered. An investment adviser who receives a fee for investment advice, and whose investment adviser representatives are paid commissions from broker-dealers, presents a conflict of interest that must be disclosed. A) I, II, and III B) II and III C) I and II D) I and III Explanation Conflicts of interest could impair the rendering of unbiased and objective advice. This includes, but is not limited to, receiving compensation from sources other than clients' fees (such as a salary or commission from a broker-dealer) as a result of providing investment advice. Such conflicts of interest must be disclosed to a client in writing before the investment advisory contract is signed. U6LO1

B

Which of the following statements regarding an agent's registration is most accurate? A) If the broker-dealer with which that agent is registered should have its registration revoked, the agent may continue to do business only with existing clients and may not acquire any new ones until registered with an active broker-dealer. B) Revocation of the registration of that agent's broker-dealer will result in cancellation of that agent's effective registration. C) If the broker-dealer with which that agent is registered should have its registration revoked, the agent's license will be held by the Administrator and the agent will be required to register with an active broker-dealer within 30 days. D) Registration of a broker-dealer in a specific state automatically registers all the firm's agents in that state as well. Explanation The registration of an agent is not effective during any period when he is not associated with a particular broker-dealer registered under the Uniform Securities Act. Therefore, when the broker-dealer's registration is revoked, the agent's license is no longer in effect. The Administrator does not "hold" licenses. Agents must register in each state in which they wish to do business; there is no automatic registration other than for certain officers and partners when the firm first registers. U3LO5

B

Which of the following statements regarding risk diversification is least accurate? A) Unsystematic risk is company-specific risk that is particular to an individual company. B) Diversification can successfully remove all portfolio risk. C) There is a tradeoff between risk and return. D) Systematic risk or market risk results from unexpected changes in economic factors. Explanation Diversification cannot remove all the risk. There are certain things, such as economic news, that tend to impact the whole market. The risk that can be removed is known as the specific or unsystematic risk, and the risk that cannot be diversified away is market or systematic risk. U11LO2

B

Which of the following stocks would probably be most appealing to a value investor? A) A stock with a relatively low dividend yield B) A stock with a relatively low P/E ratio C) A stock with a relatively high price-to-book-value ratio D) A stock that has relatively high volatility Explanation Value investors look for stocks in companies that have been overlooked or undervalued by other investors. They often focus on stocks with relatively low P/E ratios or price-to-book-value ratios or stocks with relatively high dividend yields compared with other stocks in the same industry. U20LO5

B

Which of the following would be a violation of the NASAA Contents of Investment Advisory Contract Model Rule? A) Indicating a performance-based contract that the fee arrangement may create an incentive for the investment adviser to make investments that are riskier or more speculative than would be the case in the absence of a performance fee B) Without the consent of advisory contract holders, the owner of a majority of the stock of the advisory firm pledges that stock to a bank as collateral for a loan enabling the firm to acquire better cybersecurity technology. C) An investment adviser organized as a partnership has the practice of notifying clients of any change in the membership of the partnership within a reasonable time after the change. D) An investment adviser permits clients to renew their investment advisory contracts by email. Explanation The NASAA Contents of Investment Advisory Contract Model Rule states that no direct or indirect assignment or transfer of the contract may be made by the investment adviser without the consent of the client or other party to the contract. Pledging a majority interest in the company as collateral for a loan to the business is considered an indirect assignment; the reason for the loan is of no significance. All contract renewals for state-registered advisers must be in writing and email is considered written communication. Notification of changes to members of the partnership and warning of the incentive in a performance-based contract are requirements of the Model Rule. U6LO4

B

A customer with an aggressive growth investment objective and short-term (6- to 12-month) time horizon wants to invest $50,000 in a mutual fund. He has a substantial net worth, but none of it is invested in mutual funds. You inform him that mutual fund investments are intended to be long-term investments, but he expresses his intention to make the short-term investment anyway. If the XYZ fund family (one you have dealt with in the past) offers an aggressive growth fund that has a respectable track record, your recommendation should be to A) decline the transaction because short-term trading of funds is not allowed B) buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee C) buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee D) buy the XYZ Aggressive Growth Class B shares with a declining CDSC and 0.75% 12b-1 fee Explanation If the client insists on making this type of investment, then the Class C shares are most appropriate for this customer's objectives; the sales load would be lower than that of either Class A or Class B shares. But, you ask, we don't know what the CDSC is for the Class B shares—it isn't given. It doesn't have to be because the CDSC for redemptions in the first year would never be lower than the Class A front-end load (4% in this question and certainly higher than the 1% on the Class C shares). U14LO4

C

A management investment company owns portfolio securities with a current market value of $100 million. The company owes $10 million for securities purchased but not yet paid for and accrued management fees of $5 million. If there are 2,611,437 shares outstanding, the net asset value per share is closest to A) $34.46 B) $36.38 C) $32.55 D) $26.11 Explanation The net asset value per share of a management investment company (either open-end or closed-end) is computed by dividing the net assets (assets minus liabilities) by the number of outstanding shares. In this example, the net assets are the $100 million portfolio value minus the liabilities of $10 million for the unpaid securities plus the $5 million in accrued management fees. That leaves $85 million divided by the 2,611,437 shares outstanding which is approximately $32.55. U14LO3

C

A pension consultant who advises corporate retirement plans with assets of $135 million must register with which of the following? A) Both the state and the SEC B) Either the state or the SEC C) The state D) SEC Explanation Under the Dodd-Frank Bill, until a pension fund manager has at least $200 million in AUM, registration with the states is required. Once the $200 million level is reached, SEC registration becomes an option. U1LO5

C

A wealthy individual has set up a GRAT. Should she die during the time the trust is active, how are the remaining assets in the trust taxed? A) No tax is due if the grantor should die during the term of the trust. B) The original value plus any appreciation passes to the beneficiaries and is taxed as ordinary income. C) The original value plus any appreciation is taxed as part of the grantor's estate. D) The original value plus any appreciation passes to the beneficiaries but is subject to gift tax. Explanation One of the risks in setting up a GRAT is that if the grantor dies during the term of the trust (usually 3-10 years), the assets put in the GRAT, plus any appreciation, are included in her estate. U18LO5

C

According to NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, which of the following is unethical? A) Exercising discretion with regard to the time or price of an order without written authorization from the client B) Borrowing funds for personal use from a client that is a bank C) Recommending a certain limited partnership investment to all clients D) Omitting nonmaterial facts in a presentation to an advisory client about a recommended investment Explanation Recommending an investment without determining its suitability to each client is considered unethical. When the same investment is recommended to all clients, it is called a blanket recommendation and almost always raises the suitability question. Time and price are not considered to be discretion, so no written authority is needed. While borrowing from clients is usually prohibited, that rule is suspended when the lender is a person in the business of lending money, such as a bank or a broker-dealer. Omitting nonmaterial facts is permissible when recommending securities to a client; the material facts must be disclosed. U7LO4

C

Charles wishes to preserve his capital and generate income with moderate risk by investing in mutual funds. Which of the following mutual fund types would probably least meet these investment objectives? A) An income fund B) A bond fund C) Technology funds D) A balanced fund Explanation Technology mutual funds typically invest in high-risk, high-reward situations that are inappropriate for conservative investors. Balanced funds, income funds, and bond funds could be potential investments for conservative clients. U14LO10

C

According to NASAA's Statement of Policies Regarding Dishonest or Unethical Business Practices of Broker-Dealers and Agents, an agent may A) not exercise discretionary authority until 30 days after receipt of a written power of attorney from the client B) not recommend a specific professional money manager to those clients who want professional investment management services C) exercise discretionary investment authority over an account providing the client provides written discretionary authority D) borrow funds from a client only if the debt is formally documented and possesses a fixed maturity date, a stated rate of interest, and a schedule of repayment Explanation NASAA's Statement of Policy Regarding Dishonest or Unethical Business Practices of Broker-Dealers and Agents allows agents to exercise discretionary investment authority over an account, providing the client grants written discretionary authority. An agent may not borrow money from a client unless the client is a financial institution in the business of lending money. There is nothing in NASAA's policy that prohibits an agent from recommending money managers to clients who want their funds professionally managed. There is no requirement that discretionary authority cannot be exercised until a 30-day waiting period has transpired. U7LO2

C

Adell, a retiring social worker, has some money to invest. An agent suggests she look into investing in a private placement security that is raising money to build apartment buildings in Puerto Rico. According to the NASAA Statement of Policy on Unethical or Dishonest Business Practices of Broker-Dealers and Agents building projects are not appropriate for retirees who typically need immediate income private placements are not usually appropriate for retiring individuals because they are not liquid no rule has been violated because the customer has only been offered the product if the customer lives in Puerto Rico, the proposed investment may be suitable because there may be a ready market A) II and III B) I and III C) I and II D) II and IV Explanation This is not a suitable recommendation for a social worker about to retire. Based on the information given, one would expect that her objectives would be income with a high degree of safety, yet this building project will give her neither. Additionally, the private placement suffers from a lack of liquidity, something that could be an important factor in Adell's future. U7LO4

C

An Administrator may restrict the activities of a registered agent who is A) found to have inadequate experience B) found to have split commissions with another agent in his office C) determined to have become insolvent D) found to be a citizen of another country Explanation An Administrator may, by order, restrict the activities or revoke the registration of a registered agent who is determined to have become insolvent. Lack of experience by itself is not a sufficient reason to restrict an agent's activities. Citizenship is not a requirement for registration under the Uniform Securities Act. U5LO2

C

An agent receives an order from a client to purchase $20,000 worth of stock in whatever company looks good. In what type of account could the agent accept this type of order? A) Margin B) Custodial account managed by an administrator for the client's deceased cousin C) Discretionary D) Cash Explanation If the agent has the ability to make the decision with respect to the specific security, even though the client specified the action (buy) and the quantity ($20,000), discretionary authorization is required. U7LO2

C

Concerning index annuities and their method of crediting interest, which of the following is TRUE? A) Annual reset offers the best return regardless of market fluctuations. B) Point to point offers the best return when the market has had a single drastic decline during the period. C) High-water mark with look back offers the best return during periods of high volatility. D) On average, annual reset has a higher participation rate than point to point. Explanation Using the annual high-water mark with look back will generally result in the highest return during periods of high volatility. The reason is because under this method, the highest anniversary value is used to determine the gain. In a volatile market, there is likely to be a high spike sometime during the period and that is the value used. The problem with point to point when there is a single drastic decline during the period is that the decline might occur at or just prior to the annual crediting computation. Annual reset does ignore the daily market fluctuations, but if the index is lower at the end of the year, there is nothing credited. In reality, annual reset has a lower participation rate than point to point. U15LO3

C

Construction of an investment policy statement (IPS) requires identifying the client's objectives and constraints. Which of the following would not be in the list of constraints? A) Taxes B) Time horizon C) Risk tolerance D) Liquidity Explanation When constructing an investment policy statement (IPS) risk tolerance is an objective, not a constraint. Time horizon, taxes, and liquidity are all constraints. An easy way to remember the five constraints is TTLLU (time horizon, taxes, liquidity, laws, unique). U19LO5

C

In general, in a defined benefit plan, the pension to be received upon retirement is based on the number of years of service and the individual's A) life expectancy. B) agreed salary. C) final salary. D) current salary. Explanation The final salary at retirement and the length of service at the employer are most commonly used to calculate the total benefit to be paid to the employee in the defined benefit pension plan. U24LO2

C

Julian and Jane are discussing risk-return measures. Julian states that "beta is used when looking at the performance of a fund or portfolio and refers to the extent of any outperformance against its benchmark." Jane disagrees and says that "outperformance of a fund or portfolio is actually measured by standard deviation." Which of the following statement is correct? A) Only Jane is correct. B) Both Julian and Jane are correct. C) Both are incorrect. D) Only Julian is correct. Explanation Both Julian and Jane are incorrect. It is alpha, not beta, that is used when looking at the performance of a fund or portfolio. Alpha refers to the extent of any outperformance of a portfolio against its benchmark. Standard deviation is used for measuring volatility, not performance. U10LO5

C

Leslie is an IAR with Financial Visions (FV), a federal covered investment adviser. Leslie operates Innovative Financial Solutions (IFS), a separate financial planning company with its own office in State W. Should Leslie be found guilty of fraudulent business activities, FV would A) claim that IFS is a separate entity over which FV has no responsibility. B) be immune from State W's Administrator's jurisdiction because it is a federal covered adviser. C) be subject to possible disciplinary action brought by the State W Administrator if it could be shown that FV failed to supervise Leslie's activities. D) possibly have its State W registration suspended. Explanation Under the doctrine of respondeat superior, an investment adviser is responsible for the actions of any of its registered IARs, even those who operate an independent financial planning firm (independent contractors). Although, as a federal covered adviser, FV doesn't have a registration that can be suspended, state administrators do have jurisdiction over covered advisers when fraud is involved. U1LO6

C

Mark is a client of Gibraltar Investment Advisers. Gibraltar sells its investment advisory business to Alpha advisers. Which of the following best describes Mark's relationship to Alpha? A) The investment advisory contract Mark made with Gibraltar continues with Alpha. B) Mark may not become a client of Alpha. C) Mark may become a client of Alpha if he chooses to do so. D) Mark is automatically a client of Alpha. Explanation An investment advisory relationship may not be assigned without the consent of the client. The client may choose to enter into a contract with the new firm. The contract with the old firm becomes void when it sells its business. U6LO4

C

The Investment Advisers Act of 1940 contains the basic definition of persons who are investment advisers. Which of the following persons would be included in the listing of those who must register? A person who gives advice to investors on collectibles that are most likely to appreciate in value in the next 10 years A chemical engineer who gave advice on new product ideas that was solely incidental to the practice of the profession and for which no compensation was received A person, while receiving compensation, described the advantages of certain types of managed investments, such as mutual funds and REITs, but did not recommend a specific investment A fee-based financial planner who, on the basis of current economic forecasts, had many of his clients liquidate their investment-grade bonds and purchase gold coins with the proceeds A) III only B) I and II C) III and IV D) I, II, and IV Explanation It is not necessary to recommend specific stocks, bonds, or other investment products by name to be included in the definition of investment adviser. Although a person receiving a fee to suggest gold coins to clients would not be an IA, in this case the financial planner is giving securities advice (liquidate the bonds) to invest in a nonsecurities asset. U1LO3

C

The capital asset pricing model (CAPM) is an investment theory that serves as a model for A) measuring the correlation between a security and the overall market B) pricing securities based on their unsystematic risk C) pricing securities based on their systematic risk D) pricing securities based on their total risk Explanation Under the CAPM, securities are priced based on their systematic risk only, because this risk cannot be eliminated through diversification. The expected return of a security or portfolio is calculated by adding the rate on a risk-free security to a risk premium multiplied by the asset's systematic risk. U20LO8

C

The primary defining characteristic of an equity security is A) it pays dividends, usually quarterly. B) voting rights. C) it represents ownership in a corporation. D) the ability to keep pace with inflation. Explanation What does the term "equity" mean? It means ownership and that is the single most significant fact about an equity security, whether common or preferred stock. Many pay dividends, but that is not at the core of being an equity security. Equity securities include preferred stock, which, with its fixed dividend, does not offer inflation protection and does not have voting rights. U12LO1

C

To make a quantitative evaluation using the present value computation, which of the following is NOT needed? A) Anticipated rate of return of the portfolio B) Account value at the end of the period C) Account value at the beginning of the period D) Time period involved Explanation Present value is calculated to determine the amount required now to have a specified value at some time in the future. It is what we are looking for so we don't have it now. U10LO1

C

Which of the following are included in the definition of federal covered security? ABC common stock, domiciled in Delaware, listed on the NYSE, and sold to a resident of Delaware ABC common stock, domiciled in Delaware, listed on the NYSE, and sold to a resident of Maryland City of Portland, Maine, GO bond sold to a resident of Augusta, Maine City of Portland, Maine, GO bond sold to a resident of Augusta, Georgia A) I and II B) I, II, III, and IV C) I, II, and IV D) II, III, and IV Explanation Any security listed on the NYSE, regardless of the corporation's or the customer's state of domicile, is a federal covered security. Municipal bonds, exempt securities under the Securities Act of 1933, are also federal covered securities with one significant exception: if the issuer is a political entity in this state and it is sold to a resident of this state, it is not considered a federal covered security in this state. U4LO3

C

Which of the following statements regarding modern portfolio theory is NOT correct? A) The optimal portfolio for an investor depends upon the investor's ability to assume risk. B) The optimal portfolio offers the highest return for a given level of risk. C) The optimal portfolio will always lie above the efficient frontier. D) The optimal portfolio has the lowest risk for a given level of return. Explanation The optimal portfolio for an investor will always lie on the efficient frontier. That is where for any given level of risk, the return is the highest. Or, stated another way, for a given level of return, the risk is the lowest. U20LO8

C

Which of the following transactions on the NYSE in ABC common stock would meet the minimum size requirement to be considered a block trade? A) $100,000 total market value B) 100,000 shares C) 10,000 shares D) 200,000 shares Explanation A block trade is defined as at least 10,000 shares of stock or a trade with a total market value of at least $200,000. U22LO6

C

If a natural person files an initial application for state registration as an investment adviser representative on October 1, the registration will most likely expire A) the registration does not expire until the person resigns, retires, or is expelled by the Administrator B) on the anniversary date of the following year C) on a date set by the Administrator of that state D) December 31 of that year Explanation Although the Administrator may change the date, registrations typically expire on December 31 of each year. In this question, the registered person would have to renew his registration in 3 months. Thereafter, renewal would occur every 12 months on December 31. U2LO3

D

A married couple in their early 50s saving for retirement would most likely have which of the following objectives? A) Moderate risk, low safety, high liquidity B) High risk, moderate safety, low liquidity C) Low risk, high safety, high liquidity D) Moderate risk, moderate safety, low liquidity Explanation A middle-aged couple planning for their retirement is most likely interested in moderate risk, moderate safety, and low liquidity. A couple of their age should be planning for retirement and the demands for liquidity should be low; they need to take moderate risk to earn above-inflation returns. Moderate safety is appropriate for a middle-aged couple. Additionally, a middle-aged couple should not be invested in high-risk securities. U19LO5

D

A retired person seeking to maximize income with reasonable safety and liquidity should most likely consider investing in A) a large-cap growth fund B) a long-term government bond fund C) an intermediate-term government bond fund D) an intermediate-term, high-grade corporate bond fund Explanation In all of these cases, liquidity should not be a problem because mutual funds have a 7 day redemption requirement. However, interest rate risk increases as the maturities lengthen, so the intermediate-term portfolio offers that benefit, albeit at a slight reduction in income. The high-grade corporate bonds will offer a greater return with slightly more risk than the government bonds. If the question had said the investor wished to minimize risk, then the government bond fund would have been a better selection. U19LO6

D

A wealthy individual has set up a GRAT. Should she die during the time the trust is active, how are the remaining assets in the trust taxed? A) The original value plus any appreciation passes to the beneficiaries and is taxed as ordinary income. B) No tax is due if the grantor should die during the term of the trust. C) The original value plus any appreciation passes to the beneficiaries but is subject to gift tax. D) The original value plus any appreciation is taxed as part of the grantor's estate. Explanation One of the risks in setting up a GRAT is that if the grantor dies during the term of the trust (usually 3-10 years), the assets put in the GRAT, plus any appreciation, are included in her estate. U18LO5

D

All of the following are eligible to open an IRA EXCEPT A) a self-employed person covered by a Keogh plan B) a corporate officer not covered by his company's pension plan C) a corporate officer covered by his company's pension plan D) a divorced individual whose sole source of income is $10,000 per month in child support Explanation Anyone with earned income may open an IRA. However, child support is not considered earned income. If the corporate officer's (covered by the pension plan) earnings exceed a certain limit, the officer is subject to limitations on the amount of the deduction that may be taken for IRA contributions, but the contribution may still be made. U24LO1

D

All of the following statements regarding investment advisory contracts under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers are true EXCEPT A) the contract must not permit assignment without the client's consent B) the contract must be renewed in writing C) the contract must detail any prepaid fees to be refunded to the client upon termination D) the contract's term may not exceed 1 year Explanation The contract must set forth the term of the contract, which need not be for only 1 year. Any renewals or extensions of the contract at the end of the term must be in writing. The contract must describe any refunds upon termination and may not permit assignment without the client's consent. U6LO4

D

An agent follows the recommendations of another agent in the office with an impressive performance record, and based on the security the successful agent recommends, the representative recommends it to all his clients. According to NASAA's Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, this activity is prohibited A) as long as he discloses the source of the recommendation B) because it tends to induce excessive trading in the security C) because the other agent's recommendations are confidential D) because he failed to determine suitability for his clients and the reasonableness of the recommendations Explanation An agent should never recommend the purchase of a security without reasonable grounds, and the agent does not have enough information to justify these recommendations. The agent is also guilty of recommending security transactions without regard to each client's individual financial situation or investment objectives; the same security cannot be suitable for every client. This violation is known as blanket recommendation. U7LO4

D

An individual purchasing a flexible premium variable life contract should know which of the following? Timing and amount of premiums generally are discretionary. The death benefit will generally be higher than that of a comparable whole life policy. The face amount is fixed at the beginning of the contract. The performance of the separate account directly affects the policy's cash value. A) I and III B) II and III C) II and IV D) I and IV Explanation A flexible premium policy allows the insured to determine the amount and timing of premium payments, provided minimums are met. Depending on the policy, the face amount (death benefit) is recalculated each year. It is intended that the death benefit receive some inflation protection, but this cannot be guaranteed. If separate account performance causes the cash value to drop below an amount necessary to maintain the policy in force, the policy lapses unless the requisite amount is received within 31 days. U15LO7

D

An investment adviser (IA) has a number of clients who need high-quality estate planning. These clients are referred to the Rox Law Firm, and in exchange, Mr. Rox sends those of his clients needing investment advice to the IA. The IA pays a referral fee to Mr. Rox of $300 for each referral who becomes a client. Under the NASAA Model Rule on Unethical Business Practices Of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, A) this type of arrangement is never permitted B) this is permissible, but only if disclosed to the Administrator C) this is permissible, but does not need to be disclosed to clients because Mr. Rox is an attorney and this would be a violation of attorney/client privilege D) this is permissible, but only if disclosed to clients Explanation Actually, NASAA doesn't say anything at all about referral fees, but you have to pick an answer. It is the Investment Advisers Act of 1940 that deals with the topic and permits them as long as proper disclosures are made and the fee is not related to the size of the account. Because it is a flat $300, it would be the same for a $100,000 account as a $10 million account. U7LO1

D

An investment adviser is preparing an advertisement. Which of the following would be acceptable? An endorsement on radio or TV from a celebrity who is a client of the firm Identifying his best investment recommendations for the past 6 months Offering to provide his investment recommendations for the past 12 months Promoting his system of charts and formulas while mentioning their limitations and difficulties A) I and IV B) II and III C) I and II D) III and IV Explanation Any mention of investment recommendations in any adviser advertisement must always include all recommendations (not just good ones) made over the course of the last 12 months. If the adviser uses charts or formulas, any mention of them must always include a statement to the effect that they have limitations and may be difficult to use. No outside endorsements are ever allowable on the exam. U6LO5

D

An investment adviser representative is assuring clients of steady returns on an investment. Under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives and Federal Covered Advisers, this activity is A) acceptable if the security being recommended is an investment-grade bond B) prohibited because the customer may still experience loss C) acceptable if the client has been made aware of the risks D) prohibited because the IAR is guaranteeing a profit Explanation Assuring a steady rate of return is considered to be guaranteeing performance, a practice prohibited under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives and Federal Covered Advisers. Even in the case of investment-grade bonds, returns can never be "assured." U6LO3

D

If a broker-dealer offers or recommends products for which the firm receives greater fees or compensation than other products, it would be considered A) misrepresenting the registration status of a security B) arbitrage C) churning D) a potential conflict of interest Explanation There are certain products that carry higher compensation rewards to the broker-dealer than do others of a similar nature. This presents a potential conflict of interest, should the firm recommend these over others. There is nothing illegal about doing so, as long as disclosure of the conflict is made to the client. U6LO1

D

If an unaffiliated person acts on behalf of an investment adviser in an attempt to solicit or refer new investment advisory clients, which of the following conditions is NOT required by the Investment Advisers Act of 1940 for the adviser to pay the solicitor a fee for this service? A) The adviser must be registered as an investment adviser. B) There must be a written agreement between the solicitor and the investment adviser. C) There can be no outstanding SEC order barring the solicitor's activities. D) The solicitor must be registered as an investment adviser. Explanation An unaffiliated (nonemployee, or third party) solicitor is usually not required to register as an investment adviser or investment adviser representative under the Investment Advisers Act of 1940 as long as certain stipulations are met. The solicitor is not under the control of the SEC. There must be a written agreement between the solicitor and the investment adviser for whom he solicits clients. The solicitor cannot have a disciplinary item in his background that would prohibit that solicitor from registering as an adviser or adviser representative. U7LO1

D

In order to compute a client's realized holding period return, it is not necessary to know A) the original investment B) value at the end of the holding period C) income received during the holding period D) paper losses Explanation The question is asking for realized return. That means that we ignore paper losses, (just another term for unrealized loss). U23LO2

D

In response to high stock market volatility, if an investment adviser has all clients immediately sell their equity holdings and reallocate the proceeds to Treasury bills, under the Uniform Securities Act, this is A) unethical because the adviser may receive commissions when his customers sell their stock B) ethical because the adviser is responsive to current market conditions C) ethical because the adviser is recommending a lower-risk investment D) unethical because Treasury bills may not be appropriate for all the adviser's clients Explanation It is unlikely that Treasury bills, however conservative, are suitable for all clients. An adviser must always keep in mind each client's personal investment needs, risk tolerance, and investment objectives when trading the clients' securities. Blanket recommendations are not ethical. U7LO4

D

It is not uncommon to find financial planners who use their home as the base of their operations. When a financial planner who works from home is also registered as an agent of a broker-dealer, she must A) not remain open during hours when the broker-dealer is closed B) ensure that her office is separate from her living quarters C) not use personal computers to store client information D) have cybersecurity policies and procedures in place to protect customer data Explanation Cybersecurity policies and procedures are necessary for the broker-dealer to protect customer data in the firm's offices, and an agent's office at home is nothing more than an extension of the firm's office. As long as adequate cybersecurity measures are taken, a personal computer may be used. There are no restrictions on when the agent can use her home office to meet with clients, nor are there restrictions on where the office can be located within her home. U7LO7

D

Sally Sherman purchased 100 shares of Chocolate Manufacturers Corporation for $19 per share on February 12. She received a 10% stock dividend on May 18. She sold all of her CMC at $13 per share in June of the same year. What were her tax results? A) $575 long-term gain, $105 short-term loss B) $575 long-term loss C) $575 short-term loss; $105 long-term gain D) $470 short-term loss Explanation Sally paid $1,900 for 100 shares and sold 110 shares for $1,430 (13 at 110). Because the transactions all took place in less than a year, the transaction was a short-term loss. U21LO3

D

The term "federal covered investment adviser" would apply to a person who A) limits the advice offered strictly to securities listed on the New York Stock Exchange (NYSE) B) limits the advice offered strictly to securities issued or guaranteed by the U.S. government or 1 of its political subdivisions C) is registered as such under the Investment Company Act of 1940 D) is registered as such under the Investment Advisers Act of 1940 Explanation Only federal covered investment advisers register under the Investment Advisers Act of 1940. Even if the person only gives advice on exchange-listed securities (which are federal covered securities), that does not make the person federal covered. After all, if the AUM is under $100 million, registration is only possible with the state(s), unless meeting an exception. Although the term "federal covered adviser" does apply to those who limit their advice to securities issued or guaranteed by the U.S. government, it would not apply if advice is given on political subdivisions (states, cities, etc.). U1LO5

D

Two of the major factors involved in the capital asset pricing model (CAPM) are interest rates stock risk premium tax rates market risk premium A) II and III B) I and II C) I and III D) II and IV Explanation The model is made up of two separate components. One component is known as the stock risk premium and is the part of the model reflected by the following formula: (market return − the risk-free return) × beta of the stock. The other component is the market risk premium and is the part of the model reflected by the following formula: (market return − risk-free return). The stock risk premium is the inducement necessary to entice the individual to invest in a particular stock, whereas the market risk premium is the incentive required for the individual to invest in the securities market in general. U20LO8

D

Under the Investment Advisers Act of 1940, cash payment to a broker-dealer from an investment adviser in return for client referrals is A) permitted with no restrictions B) permitted if the investment adviser and broker-dealer are affiliated C) not permitted under any circumstances D) permitted if the investment adviser makes certain disclosures to the clients and meets other requirements Explanation Cash payments for referrals are permitted. All such compensation must be disclosed to affected clients. U7LO1

D

Under the USA, the term guaranteed refers to all of these EXCEPT A) principal B) interest C) dividends D) capital gains Explanation When a security is guaranteed, that means that someone other than the issuer has guaranteed timely payment of interest and principal on a debt security, or the payment of dividends on an equity security. No one ever guarantees that the investor will have a capital gain. U6LO3

D

Under the Uniform Securities Act, an agent may NOT make which of the following statements to a customer? A) This security is not registered with the Administrator. B) This security is registered with the state. C) This security is exempt from registration. D) This security is approved by the Administrator. Explanation The state Administrator does not approve any security. U6LO2

D

When an investment adviser representative terminates employment with a federal covered investment adviser and then registers with a different federal covered investment adviser in the state where the individual has an office, A) the investment adviser representative and the employing adviser must notify the Administrator promptly B) the investment adviser representative and the federal covered advisers must notify the Administrator promptly C) only the terminating investment adviser must notify the Administrator D) only the investment adviser representative must notify the Administrator promptly Explanation If you are working for a registered investment adviser within a specific state, that state securities Administrator wants to know who you are. The problem becomes a question of who is responsible for notifying the state securities Administrator of your employment. A federal registered investment adviser is exempt from registration at the state level and therefore has very little contact with the state. If you go to work for a federal registered investment adviser, it becomes your duty to notify the state securities Administrator that you are working there, as well as when you terminate. U2LO3

D

Which of the following business entities has an income tax filing due date (disregarding possible extensions) of March 15? Sole proprietorship Single-member LLC Multiple-member LLC electing to be treated as a corporation​ S corporation A) I and IV B) II, III, and IV C) I and II D) III and IV Explanation For partnership returns (including LLCs with more than 1 member) and S corporation returns, the due date is March 15. One effect of this is that LLCs, partnerships, and S corporations all have the same filing deadline. For C corporations, the due date is the 15th day of the 4th month following the close of the corporation's year; this date is April 15 for a calendar-year filer. U21LO6

D

Which of the following is NOT a standard used to determine whether a particular mutual fund is suitable for an individual investor? A) The investor's estimated tolerance for risk and volatility B) The amount of time elapsing between the deposit of the investment and the investor's anticipated use of the funds C) Components of an investor's current portfolio D) Whether the investment is made directly through the fund itself or through a broker-dealer Explanation Whether a mutual fund is offered through the issuer or through broker-dealer channels is not a suitability determinant. However, time horizon, risk tolerance, and existing portfolio components help determine investment suitability. U19LO6

D

Which of the following must register as an agent when representing a broker-dealer? A) The telephone switchboard operator who directs orders to the appropriate extension B) A partner of a broker-dealer who has no securities sales functions C) An individual who represents an underwriter only in transactions between an issuer and the underwriter D) An employee who accepts unsolicited orders from institutional clients Explanation An employee of a broker-dealer who accepts orders must register as an agent. The fact that it is unsolicited and/or from an institution (making them exempt transactions) has no bearing on the requirement for the individual to register as an agent. A partner of a broker-dealer with no securities sales functions and an individual who represents an underwriter only in transactions between an issuer and the underwriter need not register. Individuals whose function is strictly clerical do not register as agents. U3LO4

D

A client of an investment adviser representative of a state-registered investment wishes to place an encomium on the IAR's LinkedIn page. This action A) would be considered a testimonial and, therefore, be prohibited B) would need to be reviewed by the Administrator C) should be happily accepted by the IAR D) should be turned over to the IAR's supervisor, as should any complaint Explanation Testimonials for investment advisers and their representatives are a prohibited practice under both state and federal regulations. U6LO5

A

A letter of intent for a mutual fund purchase may be backdated to include previous investments in the same fund during the past A) 90 calendar days B) 5 business days C) 30 calendar days D) 10 business days Explanation Letters of intent may be backdated up to 90 calendar days, provided the total investment period used to qualify for the breakpoint does not exceed 13 months. U14LO4

A

A sector fund is one where the assets are A) concentrated in a particular industry or geographical area B) invested in emerging growth companies C) invested in other mutual funds D) invested in special situations Explanation Sector funds (specialized funds) target at least 25% of their investments toward a specific industry or geographical location. U14LO10

A

All of these are true about a traditional 401(k) plan EXCEPT A) the employer can contribute more than 25% of total payroll B) in service employees may be eligible for hardship withdrawals C) employees may have a portion of their contribution matched by the employer D) employees can choose from a variety of investment options Explanation There are exceptions to this, but, in general (and on the exam), you will have to know that the employer share of the contributions to a traditional 401(k) plan (or any other DC plan) may not exceed 25% of total payroll. Some students get this correct through process of elimination. The plan may have provisions for hardship withdrawals; there are a number of investment options available, and the employer may elect to match employee contributions. U24LO3

A

An increase in the earnings per share growth rate from one reporting period to the next is called A) earnings momentum. B) finding alpha. C) profitability. D) price-to-earnings ratio. Explanation When a company's rate of earnings per share growth is increasing, that is, not only is the company becoming more profitable, but it is doing so at an accelerating rate, analysts call that earnings momentum. The company may or may not be generating positive alpha. We would have to know its beta, the risk-free rate, the market return, and the stock's return to compute that. It is likely that earnings momentum would cause the P/E ratio to increase, but that doesn't answer the question. Earnings momentum is one of the goals of the growth style of investing. U20LO5

A

An owner of an annuity that has been annuitized, can do all of the following EXCEPT A) receive monthly payments for a defined period and then 2 years later change the contract to payment for life B) receive payments on a monthly basis until the time of death C) have a joint life with last survivor clause with payments paid until the death of the last survivor D) receive payments for life with a certain minimum period of time guaranteed Explanation The contract is annuitized when the investor converts from the accumulation (pay-in) stage to the distribution (payout) stage. Once a payout option is selected, it cannot be changed. An annuity owner can elect to receive the benefits on a monthly basis until the time of death. An annuity owner can elect to receive the benefits for life with a certain minimum period of time guaranteed. In addition, an annuity owner can have a joint life with last survivor clause with payouts made until the death of the last survivor. U15LO4

A

As a general matter, the regulators do not treat posts by customers or other third parties as the firm's communication with the public. Under certain circumstances, however, third-party posts may become attributable to the firm. Whether third-party content is attributable to a firm depends on whether the firm has (1) involved itself in the preparation of the content or (2) explicitly or implicitly endorsed or approved the content. Where the firm endorses or approves of the material, but has no part in its creation, it is known as A) adoption. B) usage. C) retail communication. D) entanglement. Explanation Adoption is the term used to describe material posted to a securities professional's social media site by a third party where the securities professional explicitly or implicitly endorses or approves of the content, but plays no role in its development. Where the firm is involved in the preparation of the content, it is known as entanglement. U6LO5

A

As a rule, loans from a 401(k) plan must be repaid within how many years? A) 5 B) 15 C) 20 D) 10 Explanation Most loans from a 401(k) plan are required to be repaid within 5 years. This rule does not apply to loans taken for a home purchase. U24LO4

A

Charlie Mindel is the portfolio manager for the Steady Yield Bond Fund. If Charlie was of the opinion that interest rates were going to fall, he would A) increase the average duration of the portfolio B) decrease the average duration of the portfolio. C) move more of the portfolio into cash. D) keep the average duration the same. Explanation As interest rates go down, prices of bonds rise. Those with the longest duration will have the greatest price increase. To benefit from this move, managers of bond portfolios will lengthen the average duration of the portfolio. The reverse action would be taken if Charlie thought that interest rates were going to rise. Of course, if interest rates move in the opposite direction of that the manager expects, the fund might start looking for a new manager. U13LO11

A

GEMCO Manufacturing Co. has appointed the company's CFO as the trustee for their employee retirement plan. You are an IAR and you advise a substantial portion of the plan's assets. You are contacted by the CFO requesting a short-term loan from the plan assets for which he will pay the plan prime + 2%. Your best course of action would be to A) refuse to allow this to happen because it would be a violation of your fiduciary responsibility B) permit the loan because the CFO is the plan trustee C) refuse to allow this to happen because the plan assets will suffer D) permit the loan once you have been satisfied that there is adequate collateralization in place Explanation ERISA never permits transactions of this type for a plan trustee. As an IAR handling some of the plan's investments, you would be placed in a fiduciary position and could not violate that trust. U24LO5

A

If John Good, a properly registered investment adviser, opens his own office and hires several representatives to work for him, his business card may NOT read A) Good Performance Advisers, Inc. B) Good's Investment Advisers, Inc. C) John Good Investment Advisers, Inc. D) Good and Associates Investment Advisers, Inc. Explanation John Good, a registered investment adviser, cannot put on his business card "Good Performance Advisers." In this instance, the word Good can be interpreted as an adjective modifying the word performance, as opposed to John's given name, Good. An adviser cannot present himself to the public in terms that can be misleading or interpreted as exaggerating performance. The other three choices are appropriate because they do not use the term Good as an adjective touting the results of the adviser, but as the name of the adviser. U6LO5

A

Leslie is an IAR with Financial Visions (FV), a federal covered investment adviser. Leslie operates Innovative Financial Solutions (IFS), a separate financial planning company with its own office in State W. Should Leslie be found guilty of fraudulent business activities, FV would A) be subject to possible disciplinary action brought by the State W Administrator if it could be shown that FV failed to supervise Leslie's activities. B) possibly have its State W registration suspended. C) claim that IFS is a separate entity over which FV has no responsibility. D) be immune from State W's Administrator's jurisdiction because it is a federal covered adviser. Explanation Under the doctrine of respondeat superior, an investment adviser is responsible for the actions of any of its registered IARs, even those who operate an independent financial planning firm (independent contractors). Although, as a federal covered adviser, FV doesn't have a registration that can be suspended, state administrators do have jurisdiction over covered advisers when fraud is involved. U1LO6

A

Nite Capital Group is a registered broker-dealer whose primary business model is providing quotations for OTC stocks in which they position trade. Nite would be known as A) a market maker B) a secondary market C) an investment company D) a specialist Explanation A market maker is a firm that stands ready to buy and sell a particular stock on a regular and continuous basis at a publicly quoted price. The term is most often used in the context of the over-the-counter (OTC) markets. Market makers trade for their own inventory (position trade). The term specialist historically referred to the person on the floor of a stock exchange who performed a similar function; the current term is designated market maker (DMM). U22LO4

A

Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, an investment adviser may NOT borrow money from which of the following clients? A) A federal covered investment adviser not affiliated with this adviser B) A finance company not affiliated with the adviser C) A bank not affiliated with the adviser D) A broker-dealer not affiliated with the adviser Explanation An investment adviser may only borrow from a client that is in the business of loaning money, such as a bank or a broker-dealer, or a client that is affiliated with the investment adviser. Investment advisers are not in the business of loaning money and the only way this could be done is if the 2 firms were affiliated. U7LO4

A

Under the Uniform Securities Act, if the Administrator does not deny an application for registration and no disciplinary proceeding is underway in regard to it, how many days after filing the application as an investment adviser representative does registration generally become effective? A) 30 B) 10 C) 5 D) 7 Explanation Registration becomes effective 30 days after the application is filed unless the Administrator begins a proceeding or issues a stop order before that time. The Administrator may specify an earlier date, or if an application must be amended, the Administrator may extend the date to 30 days after the amendment was filed. U2LO3

A

Under the Uniform Securities Act, it is NOT considered fraudulent if an agent A) actively solicited orders in unregistered exempt securities B) omitted a material fact because she knew she did not have time to cover everything in a short presentation C) deliberately failed to follow a customer's instructions D) made an untrue statement of a material fact Explanation Securities that do not require registration under the USA are exempt securities. Although the securities are exempt from registration, thereby making the solicitation permitted, the agent who makes the solicitation and the broker-dealer must be registered. An agent may not make an untrue statement of a material fact, omit a material fact, or deliberately fail to follow a customer's instructions. U7LO5

A

Under the Uniform Securities Act, the state Administrator may by order deny, suspend, or revoke an investment adviser's registration for A) violation of another state's securities laws within the last 10 years B) conviction for a securities-related misdemeanor more than 15 years ago C) lack of experience as an investment adviser D) conviction for a non-securities-related felony more than 15 years ago Explanation A violation of any state or federal securities or commodities law within the last 10 years is grounds for denial, suspension, or revocation of registration by order. This means that no hearing is required. Convictions are grounds for administrative action only if they occurred within the past 10 years. Lack of experience is not sufficient cause for revoking or denying registration. U5LO2

A

Under the Uniform Securities Act, which of the following is NOT an investment adviser representative? A) A clerk employed by a state-registered investment advisory firm B) A vice president of a state-registered investment advisory firm who supervises employees who solicit clients for the firm C) A director in a state-registered investment advisory firm who determines specific recommendations for clients D) A natural person representing an SEC-registered investment advisory firm who has a place of business in the state and manages the account of a single client Explanation Clerical and ministerial personnel are specifically excluded from the definition of investment adviser representative. Specifically included in the definition are directors, officers, partners, associates, and employees of state-registered advisers who carry out investment advisory or solicitation functions or who supervise those functions. Also included in the definition are persons who perform similar functions for SEC-registered advisers and who have a place of business in the state. U2LO2

A

Wealth Creation Advisers (WCA) is a federal covered investment adviser specializing in consulting to pension plans. WCA's principal office is located in State L. The governor of State L is running for re-election. If WCA were to make a $350 contribution to the campaign, under the SEC's pay-to-play rule, A) WCA would be prohibited from receiving compensation for advisory services rendered to any agency of State L for 2 years B) WCA would be prohibited from rendering any advisory services to any agency of State L for 2 years C) WCA's contribution is within the de minimis limitation because their principal office is located in State L D) WCA could be subject to disciplinary action Explanation The SEC's pay-to-play rule prohibits investment advisers from receiving compensation for advisory services to a government entity (any agency, authority, or instrumentality of a state or political subdivision), for 2 years after the advisory firm or any covered employee makes a political contribution to a public official or candidate who is or would be in a position to influence the award of investment advisory business by public retirement funds. Please note that the advisory relationship can continue, just without any compensation. The de minimis exemption of $350 applies to an individual, as long as that person is eligible to vote for the candidate ($150 if he is not), but it never applies to the firm. U7LO6

A

Which of the following activities of an investment advisory firm would NOT require notification to and consent of the clients of the advisory firm? A) A minority partner resigning from the firm to start his own advisory firm B) The chief operating officer of an investment advisory firm wishing to pledge her majority interest in the firm to a local bank for a loan to purchase an office building that will be leased to the advisory firm C) The retirement of a sole proprietor investment adviser who wishes to sell the practice to another investment adviser D) An investment adviser wishing to merge with a larger national advisory firm Explanation Any change in the controlling interest in an advisory firm, including pledging the controlling interest, is treated as an assignment of the contract and requires notification to and consent of the clients of the investment adviser. The change in a minority interest is not considered an assignment, so only notification, but not consent, is required. U6LO4

A

Which of the following would NOT be considered evidence of custody of a client's funds or securities? A) The investment adviser has discretionary authority over the client's account. B) The client makes a partial purchase, and the broker-dealer holds the securities until full payment is made. C) Client funds and securities are kept at a qualified custodian. D) The adviser writes checks on the client's account to pay for client's securities. Explanation "Custody" means possession (even temporary possession) of a client's funds or securities. It includes authority over a client's bank account for any type of disbursement, but does not include the acceptance by the adviser of prepaid advisory fees or discretionary authority. U7LO2

A

You are doing an investment plan for a new client, age 55, who plans to retire at age 70. The client is somewhat risk averse and wants to preserve capital while at the same time not falling prey to possible inflation. Which of the following portfolios would probably be most suitable? A) 60% high-quality bonds; 30% large-cap stocks; 10% cash equivalents B) 90% large-cap stocks; 10% high-quality bonds C) 40% high-yield bonds; 60% large-cap stocks D) 90% high-quality bonds; 10% large-cap stocks Explanation Although it is possible to debate this choice (but don't), NASAA would suggest that the bonds and cash offer sufficient capital preservation while this proportion of equities will combat the risk of inflation. High-yield (junk) bonds have no place in the portfolio of a risk-averse investor. U19LO6

A

A client is risk averse and is planning on retiring in 16 years. As the client's investment adviser, which of the following would you recommend? A) A government bond fund B) 50% in an S&P 500 index fund; 50% in a portfolio of high-quality bonds C) A diversified open-end investment company concentrating in small-cap stocks D) A high-yield bond fund Explanation Even though the government bond fund carries less market risk, with a 16-year retirement goal, some inflation protection is necessary. The index fund carries some market risk, but does offer purchasing power protection. The 50/50 mix would seem to be most appropriate. U19LO6

B

A common stockholder's rights include all of the following EXCEPT A) the receipt of dividends, if declared by the board of directors B) the right to determine the par value of the stock C) electing the board of directors D) preemptive rights Explanation Par value is an accounting decision made by the company when the stock is first issued and is not something voted on by shareholders. Common stockholders are the owners of a corporation. This basic form of ownership entitles them to all of the privileges discussed here. It also allows them to transfer their ownership, inspect company records, vote on corporate objectives, and lay claim to any residual assets in the event of a liquidation. U12LO2

B

A customer's portfolio has a beta coefficient of 1.1. If the overall market increases by 10%, the portfolio's value is likely to A) increase by 10% B) increase by 11% C) decrease by 10% D) decrease by 11% Explanation A beta of 1.1 means the portfolio is considered to be 1.1 times more volatile than the overall market. If the market is up 10%, the portfolio with a beta of 1.1 is likely to be up 11%. U10LO4

B

A mutual fund investor is using a dollar cost averaging strategy. For the average price per share to exceed the investor's average cost, which of the following conditions must be present? The market price per share fluctuates with each purchase. A fixed dollar amount is invested at regular intervals. A fixed number of shares is purchased monthly. A constant dollar value is maintained in the account. A) I and III B) I and II C) II and IV D) II and III Explanation Dollar cost averaging requires investing of a fixed amount of money at regular intervals. This procedure results in a lower average cost per share than average price paid if the mutual fund price fluctuates. The constant dollar plan involves buying and selling to maintain a constant dollar amount of either equity or debt securities in the account. U20LO11

B

All of the following would be reasons for an employer to choose a nonqualified plan over a qualified plan except A) the nonqualified plan provides greater flexibility. B) the nonqualified plan provides an immediate income tax deduction for the employer. C) the nonqualified plan can discriminate in favor of highly-compensated employees. D) the nonqualified plan is not subject to ERISA reporting and disclosure requirements. Explanation The answer is the nonqualified plan provides an immediate income tax deduction for the employer. Nonqualified plans do not provide a tax deduction to the employer until the employee receives the economic benefit as income at some point in the future. They are, however, more flexible because they do not have to comply with ERISA reporting and non-discrimination requirements. U24LO3

B

An agent in this state would be acting illegally if he sold A) federal covered securities not registered in the state B) revenue bonds of Illinois in Florida that were not registered in Florida C) nonexempt securities properly registered in a neighboring state but not registered in this state D) securities guaranteed by a federal credit union organized under the laws of the state Explanation An agent cannot sell securities in a state unless they are registered or exempt from state registration. Federal covered securities, tax-exempt municipal bonds, and securities guaranteed by a federal credit union organized in the state are all exempt from registration. U4LO3

B

An individual is deciding between a flexible premium variable life contract and a scheduled premium variable life contract. If she is concerned about maintaining a minimum death benefit for estate liquidity needs, she should choose A) the scheduled premium policy because earnings do not affect the contract's face amount B) the scheduled premium policy because the contract is issued with a minimum guaranteed face amount C) the flexible premium policy because the contract's face amount cannot be less than a predetermined percentage of cash value D) the flexible premium policy because earnings of the contract directly affect the face value of the policy and earnings can never be negative Explanation A scheduled premium variable life contract is issued with a guaranteed minimum death benefit. If the individual is concerned about having the minimum guarantee, you should recommend the scheduled contract. U15LO7

B

An investor wants to moderate overall portfolio risk and return profile with assets that have a low correlation to traditional asset classes. Which of the following is an appropriate asset class for the investor? A) Corporate bonds B) Private equity C) Small-cap shares D) Treasury bills Explanation Alternative asset classes like hedge funds, private equity, and commodities help moderate overall portfolio risk and different return profiles from traditional asset classes like stocks and bonds. U20LO1

B

As defined in the Uniform Securities Act, the term person would include a limited partnership a political subdivision an unincorporated association the executor of an estate for a deceased individual A) I, II, and III B) I, II, III, and IV C) I and IV D) II and III Explanation All of these would be included in the USA's definition of person. Not included are a minor, a deceased person, or someone judged mentally incompetent. U1LO1

B

As used in the regulations, the term impersonal investment advice means A) investment advisory services provided strictly by subscription B) investment advisory services provided by means of written material or oral statements that do not purport to meet the objectives or needs of specific individuals or accounts C) investment advisory services provided by a team of advisers D) investment advisory services provided where the client does not know the identity of the investment adviser representative Explanation This is the way the term is defined. U2LO2

B

If a stock has a beta of less than 1.0, the stock's price will A) increase more than the market when the market is up B) not increase as much as the market when the market is up C) decrease more than the market when the market is down D) decrease regardless of whether the market is up or down Explanation Beta compares a stock's price history to the movement of a total market index for the same period. A beta of less than 1 means that the stock's price does not swing as widely, up or down, as the average for the entire market. U10LO4

B

If an agent thought that a technology stock was undervalued and actively solicited purchase order from all of her customers, the agent A) did not violate the Uniform Securities Act if all material facts were disclosed B) committed an unethical business practice C) did not commit a violation if all clients were accurately informed of the price of the stock D) committed an unethical sales practice because the firm has not recommended this technology stock Explanation Agents must always determine suitability before soliciting purchases or sales. The key here is that the agent solicited buy orders for this stock from all of her clients. One investment cannot be suitable for all of your clients. U7LO4

B

In order to compute a client's realized holding period return, it is NOT necessary to know A) the ending value B) the paper profits and losses C) the income received D) the original investment Explanation An investor's realized holding period return is the total return received over the specified holding period. That return includes any income plus or minus any realized gain or loss. That is why paper gains or losses, which are not realized, are not part of the computation. U23LO2

B

It would be permissible for an investment adviser to make which of the following statements? A) The account is guaranteed to earn a rate of return equal to a Treasury bill. B) Past appreciation of all accounts over the past three years has exceeded 20%. C) According to past returns, the account is expected to earn at least 15%, with a minimum of 8% guaranteed. D) Because of the past performance of previous recommendations, this account is guaranteed to perform at least as well as the S&P 500. Explanation Stating past performance that is factual is not a violation of the act. However, this statement would probably also be accompanied by another saying that past performance is no assurance of future performance. Any type of guarantee, even related to government securities, is prohibited by the act. U6LO3

B

Olga holds XYZ stock. The stock recently increased in value by 50%. She would like to preserve as much of this gain as possible and retain the potential for additional price increases. Which strategy best meets Olga's goal? A) Write a call option B) Buy a put option C) Buy a call option D) Short the stock Explanation Buying a put option would allow Olga to hold the stock for additional gain but reserve the right to sell at or near the current value if the stock price plummets. Shorting the stock would lock in Olga's gain but not allow her to take advantage of additional price increases; additional price increases would be offset by the cost of replacing the shorted stock. Writing a call option would provide some offset to a drop in price but would not allow for potential gain in value. Buying a call option would not provide any downside protection. U20LO12

B

Peculator Advisory Services (PAS) is known for its outstanding research department. The head of research has notified the firm's IARs that she has uncovered a "sleeping giant" that is about to take off and strongly urges the retail staff to pass this information on to clients for whom this security is suitable. Bruce is an IAR with PAS with a clientele ranging from recent college graduates to retirees with everything in between. He sends a blast email to all of his clients informing them of this rare investment opportunity. More than likely, Bruce A) needs to validate the research himself before contacting his clients. B) is committing the violation of blanket recommendations. C) is properly following instructions. D) is churning his client's accounts. Explanation This may be a wonderful investment opportunity, but no stock can be suitable for all clients, especially with the range indicated here. When an investment adviser (or IAR) recommends the same security to all (on the exam, it might be a large majority) of clients, it is viewed as a blanket recommendation and that isn't following the suitability rules. Nothing here resembles churning, the excessive trading of client's accounts to generate commissions, and it is not expected that IARs should have to validate their firm's research reports (they're probably unqualified to do so). U7LO4

B

The NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives and Federal Covered Advisers generally prohibits an IA from disclosing any confidential account information without specific consent of the client. However, disclosure would be permitted to A) the client's accountant who is representing him before the IRS B) the client's spouse when this is a joint account C) the client's attorney representing him in a lawsuit D) the client's friends on his Facebook account Explanation In the case of a joint account, all owners are entitled to any information relating to the account. The trick here is that the IRS can compel disclosure in a tax case, but the client's CPA can't. U7LO5

B

The Uniform Securities Act's definition of investment adviser would include A) Any person who is a federal covered investment adviser B) A person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities C) A temporary employee hired to assist in administrative responsibilities of an advisory firm D) An investment adviser representative of an advisory firm who makes securities recommendations on a regular basis for compensation Explanation A person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities meets the 3-prong test as an investment adviser. U1LO3

B

The primary defining characteristic of an equity security is A) the ability to keep pace with inflation. B) it represents ownership in a corporation. C) voting rights. D) it pays dividends, usually quarterly. Explanation What does the term "equity" mean? It means ownership and that is the single most significant fact about an equity security, whether common or preferred stock. Many pay dividends, but that is not at the core of being an equity security. Equity securities include preferred stock, which, with its fixed dividend, does not offer inflation protection and does not have voting rights. U12LO1

B

Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, advertisements must comply with rules set out under the Investment Advisers Act of 1940. Those rules include A) a prohibition against reduced-fee introductory offers B) a prohibition against testimonials from clients C) a prohibition against showing the adviser's past performance D) a requirement that a copy of all advertisements be sent to the SEC at the time they are disseminated to the public Explanation Advertisements may not contain false statements, include testimonials from clients, refer selectively to past recommendations, refer to a chart or device for evaluating securities without explaining its limitations and difficulties, or offer anything free of charge if in fact there will be some requirement, however minor, for obtaining the free item. There is no federal filing requirement for advertisements of investment advisers (although filing may be required by the state Administrator). As long as the past performance is displayed in a manner consistent with the rules, there is no problem. U6LO5

B

Under the Uniform Securities Act, any partner, officer, or director of a registered investment adviser is an investment adviser representative if a function of the position involves offering advice concerning securities managing client accounts or portfolios determining securities recommendations for representatives to disseminate supervising personnel engaged in advisory activities but not directly dealing with the public A) I, II and III B) I, II, III and IV C) I only D) I and II Explanation The Uniform Securities Act defines persons associated with an investment adviser, who offers advice concerning securities, as an investment adviser representative. This includes any partner, officer, or director. The definition also includes persons who manage client accounts or portfolios, determine securities recommendations, or supervise personnel engaged in the above activities. U2LO1

B

Under the Uniform Securities Act, prepaid advisory fees must be detailed in the advisory contract may not exceed 2% of the customer's deposited assets in excess of $500 for 6 months or more of service require the adviser's balance sheet to be included in the brochure may never be accepted A) I, II, III, and IV B) I and III C) I, II, and III D) II and IV Explanation Under the Uniform Securities Act, prepaid fees are permitted if they are detailed in the advisory contract and there is a refund of the fees if the contract is canceled prematurely. If an adviser accepts more than $500 in prepaid fees, 6 months or more in advance of services, a balance sheet must be included in the brochure (Part 2 of Form ADV) given to customers. U6LO4

B

If GHI currently has earnings of $3 and pays an annual dividend of $1.75 and GHI's market price is $35, the current yield is A) 1.75% B) 8.6% C) 5% D) 3% Explanation The current yield is calculated by dividing the annual dividend by the current market value ($1.75 ÷ $35 = 5%). U23LO1

C

When doing cash flow analysis on a mortgage-backed pass-through security, you would want to know A) size of the tranche being analyzed B) the average maturities C) the quality of the mortgages D) whether there is a real estate "bubble" Explanation Mortgage-backed pass-through securities pass through interest and principal payments to their investors. The rate at which the cash flows are generated depends, among other things, on the rate at which the mortgages mature. U13LO12

B

Which of the following is specifically excluded from the definition of an investment adviser providing the investment advice is solely incidental to the business in which the person is engaged? A) Movie star's business manager who handles the star's investment portfolio B) Industrial engineer C) Sports representative who advises on securities for a fee D) Pension manager Explanation Lawyers, accountants, engineers, teachers, and broker-dealers whose advice is incidental to their profession and who do not charge a separate fee for investment-related advice are excluded from the definition under the Investment Advisers Act of 1940. U1LO3

B

A client of an investment adviser excitedly calls the adviser with the news that he is now going to handle his own investments. "I just read some great investment books, and now I know what to do." Based on the study of behavioral finance, it would appear that this individual is A) conservative. B) following the herd. C) overconfident. D) anchored. Explanation The behavioral finance bias of overconfidence refers to the observation that experienced (and even some "rookie") investors tend to overestimate their ability and the accuracy of the information available to them. U19LO3

C

Agent A with Firm Y and Agent B with Firm Z conduct a joint seminar. They agree to share the commissions on any resulting business. Under the Uniform Securities Act, which of the following statements regarding sharing commissions is CORRECT? A) Sharing commissions that are a result of a joint seminar is never permitted. B) In this instance, sharing of commissions could only be done with the approval of both firms. C) Sharing of commissions by agents of two unrelated firms is prohibited. D) Only an agent who makes a sale is eligible to earn a commission. Explanation Unless an exception is granted by the Administrator, it is prohibited for an agent to share commissions with any person not also registered as an agent for the same or affiliated broker-dealer. U7LO4

C

All of the following are features of limited partnership direct participation programs except A) the general partner controls the business activities of the partnership. B) the general partner determines when distributions are made to the limited partners. C) the limited partners may participate in the management of the partnership. D) the limited partners have limited liability. Explanation Should a limited partner assume a management role, there is the danger that the limited liability protection would be lost and that partner would now have the same unlimited liability of a general partner. It is the general partner who manages the program; the limited partner is a passive investor. U17LO2

C

Among investor objectives is preservation of capital. Which of the following would be most appropriate for inclusion in the portfolio of this kind of investor? A) U.S. Treasury bonds B) International funds C) A money market fund D) Blue-chip stocks Explanation Preservation of capital means no fluctuations. Money market funds are the only logical choice here. True, the Treasury bonds do not have default risk, but because they can have maturities as long as 30 years, they are subject to interest rate risk. U19LO5

C

An individual is employed by a federal covered investment adviser for the sole purpose of giving advice related to monitoring investment portfolios, but only to qualified employee benefit plans. Under the Uniform Securities Act, this individual is A) not defined as an IAR because the plan is considered an institutional client B) not defined as an IAR because the individual works for a federal covered investment adviser C) defined as an IAR because the individual is rendering investment advice D) defined as an IAR because the plan is qualified Explanation Regardless of whom the advice is given to, unless there is some kind of exemption involved, individuals working for IAs (state or federal) must register as IARs in at least one state. It makes no difference if the plan is qualified or not. U2LO1

C

An owner of an equity index annuity would be wise to use the high-water crediting method if the underlying index was expected to A) change its objective. B) decline. C) be volatile. D) remain steady. Explanation An advantage of the high-water crediting method is that the interest is calculated using the highest value of the index during the term. Therefore, in a volatile market, where prices are going up and down, it picks up the highest price. U15LO3

C

NASAA's Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents lists which of the following as an unethical business practice by a broker-dealer? A) Charging a higher than usual commission on a thinly traded stock B) Entering into a transaction with a customer at a price related to the current market price C) Engaging in a pattern of unreasonable and unjustifiable delays in the delivery of securities purchased by any of its customers D) Segregating customers' fully paid-for securities Explanation It is considered to be an unethical business practice for a broker-dealer to engage in a pattern of unreasonable and unjustifiable delays in the delivery of securities purchased by any of its customers and/or in the payment upon request of free credit balances reflecting completed transactions of any of its customers. Entering into a transaction with a customer at a price related to the current market price is a required action under NASAA's Statement of Policy. The nature of thinly traded stocks makes higher than usual commissions acceptable as long as disclosure is made. Broker-dealers must segregate customers' fully paid-for securities. U7LO4

C

Securities regulators have taken a strong position on the need for registered broker-dealers to disclose the fees they charge. Among the most common ways for making this disclosure are presenting a chart with all of the fees preparing a list of all of the fees displaying the fees in tabular form A) II and III B) I and II C) I, II, and III D) I and III Explanation Whether using a table, a chart, or a list, broker-dealers must make sure that it is easy for customers to determine what the fees and charges are and how they are computed. U6LO1

C

The Jones family has scheduled an initial visit with a financial planner. Mr. Jones has an annual salary of $70,000, and this is their first attempt at financial planning. Which of the following should be the first step taken by the financial planner? A) Pay off credit card debt B) Set goals and dates for reaching them C) Establish an emergency fund D) Determine a reasonable fee for designing the plan Explanation There are many questions on the exam where you will be forced to choose between two possible answers, only one of which is correct. In many cases, it is strictly a matter of opinion, but only NASAA's opinion counts. This is one of them. Goal setting is important, but the regulators feel that the first step in any plan is making sure that there is a "rainy day" fund. We can argue about that because some will say that a good plan can be used to establish that fund where none has existed before. But, please go with the right choice. U19LO2

C

The Securities Exchange Act of 1934 requires written authority for a discretionary account, unless the securities professional's discretionary authority is limited to determining the price of the stock the amount of the stock the time of the order A) I only B) II and III C) I and III D) I and II Explanation The securities professional's ability to determine the time or price at which a specific customer order will be executed does not constitute discretionary power and, therefore, does not require written authorization. U7LO2

C

The alternative asset investments class is least associated with which of the following characteristics? A) Diversification B) Illiquidity C) Efficient pricing D) Nonnormal returns Explanation Alternative assets are most often characterized by inefficient pricing, providing potential abnormal returns or alpha returns. That is the prime reason for their popularity, especially with institutional investors. U17LO3

C

The following table shows the individual weightings and expected returns for the 3 stocks in an investor's portfolio: StockWeightE(Rx)V0.4012%M0.358%S0.255% What is the probable return of this portfolio? A) 8.33% B) 9.55% C) 8.85% D) 9.05% Explanation Multiplying the weight of each asset by its expected return, then summing, produces the following: E(RP) = 0.40(12) + 0.35(8) + 0.25(5) = 8.85%. U23LO2

C

Under current federal tax law, which of the following would have an effect on the amount of taxes your client would pay? Age Citizenship Marital status as of the last day of the year Residency A) II and IV B) I and III C) I, II, III, and IV D) I, III, and IV Explanation Each of these can affect your tax rate. Taxpayers age 65 and older get an extra exemption, so that lowers their tax. If you are not a U.S. citizen, and are considered a nonresident alien, you are taxed somewhat differently than others. Only married persons can file a joint return, which usually, but not always, results in lower taxes. Residency determines if you will also have to pay a state income tax and receive deductions for that (or a state sales tax) on your federal income tax. U21LO1

C

Under the Securities Act of 1933, the term "person" would NOT refer to which of the following? A) A nonprofit, charitable corporation B) An unincorporated amateur athletic club C) A deceased individual D) A subdivision of a government Explanation There are 3 specific "nonpersons" on this exam. They are 1) deceased individuals, 2) an individual declared mentally incompetent, and 3) a minor. A person can be almost any entity, including a corporation, partnership, unincorporated association, subdivision of a government, trust that issues shares of ownership (such as a unit investment trust), or a natural person (an individual). U1LO1

C

Under the Securities Exchange Act of 1934, which of the following would NOT be considered associated with XYZ Corp., a broker-dealer? A) Brian, an XYZ vice president B) Paula, who is on XYZ's board of directors but who has no other connection with the firm C) Robert, a client who owns 1,000 shares of XYZ's voting stock D) Arvin, one of XYZ's agents Explanation An associated person of a broker-dealer includes any partner, branch manager, officer, or director of a broker-dealer, including outside directors. It also includes employees such as account executives or sales representatives who are not clerks or ministerial personnel, and anyone who controls, is controlled by, or is under common control with the broker-dealer. Being a client of a broker-dealer or owning shares of the firm's stock does not make one an associated person, unless something in the choice indicated that this ownership put Robert into a position of control. U3LO3

C

Under the USA, all the following statements regarding the registration of agents are true EXCEPT A) an agent can only sell securities that have been registered in a state or that are exempt from registration B) if an agent resigns and affiliates with another broker-dealer, both firms and the agent must notify the Administrator C) if a broker-dealer's registration is revoked by a state, it has no effect on the agent's registration D) a nonresident agent can solicit business in another state only if the agent and the broker-dealer are registered in that state Explanation If a broker-dealer's (or investment adviser's) registration is revoked by a state, the registrations of all its agents (or IARs) are suspended. That is, those individuals can no longer function in a registered capacity until they register with another active firm. U3LO5

C

Under the provisions of the Uniform Securities Act, which of the following transactions may be made legally with unregistered, nonexempt securities? A) A sale in a discretionary account B) A public offering C) A private placement D) A rights offering Explanation The USA states that unregistered, nonexempt securities may legally be sold in exempt transactions. Private placement transactions may legally include the sale of unregistered, nonexempt securities because they are defined as exempt transactions under the Uniform Securities Act. A transaction qualifies as private placement when the offer is directed to 10 or fewer noninstitutional persons during a 12-month period and no commission is paid on sales to noninstitutional buyers. U4LO3

C

Which of the following accounts could be opened with a TOD designation? Individual Joint tenants in common Joint tenants with rights of survivorship UTMA A) I and II B) I, III and IV C) I and III D) II and IV Explanation The only types of accounts that may have the Transfer on Death (TOD) designation are individual and JTWROS. Minors cannot designate a beneficiary. Upon the death of a minor, any assets belong in the deceased's estate. U18LO5

C

Which of the following bonds is most likely to exhibit the greatest volatility due to interest rate changes? A bond with A) a high coupon and a long maturity. B) a high coupon and a short maturity. C) a low coupon and a long maturity. D) a low coupon and a short maturity. Explanation Other things equal, a bond with a low coupon and long maturity will have the longest duration and therefore greatest price volatility. U13LO11

C

Which of the following is a multi-option strategy? A) Short call B) Long call C) Straddle D) Protective put Explanation A straddle consists of a put and a call on the same stock with the same strike price and the same expiration date. If the investor has purchased both options, it is known as a long straddle; if they've both been sold (written), it is known as a short straddle. Therefore, with two option positions, it is a multi-option strategy. U16LO2

C

Which of the following statements best describes cumulative preferred stock? A) Owners lose any claim to dividends that are not paid in any one year. B) Owners are allowed to vote for directors using the cumulative voting procedures. C) Owners have a continuing claim to their dividends, and all arrears must be paid before any dividends can be paid on common stock. D) Owners receive an extra dividend, along with common shareholders, in addition to the preferred dividend. Explanation Owners of cumulative preferred stock have a continuing claim to their dividends, even when the directors pass a dividend. Their claim accumulates, which means that all past dividends (arrears), as well as current dividends, must be paid before any dividend can be paid on common stock. By contrast, the owners of noncumulative preferred stock lose their claim to dividends that are not paid in any one year. U12LO2

C

Which of the following statements regarding broker-dealer registration under the Uniform Securities Act are TRUE? In the absence of any action by the Administrator, the effective date of a registration is noon of the 45th day. The Administrator may initiate a disciplinary action within 2 years of a broker-dealer's withdrawal of registration. The Administrator may request that the broker-dealer furnish a statement of assets and liabilities. If, before the effective date of the registration, the Administrator requires amendments to the application, the registration will be considered to have first been filed upon filing of those amendments. A) II and III B) I and II C) III and IV D) I and IV Explanation Normally, registration of persons becomes effective at noon of the 30th day following filing. If the Administrator requires the filing of amendments, the clock starts over again with the filing of those amendments. Broker-dealers have financial requirements, and the Administrator has a maximum of 1 year after termination to initiate any actions. U3LO5

C

Which of the following statements regarding grantor trusts is NOT correct? A) If the grantor can receive income from the trust, he is treated as the owner of the trust. B) If the grantor has the power to revoke the trust, he is treated as the owner of the trust. C) The grantor may be taxed on trust income only if the grantor actually received the income. D) If the grantor can control the beneficial enjoyment of the trust, he is treated as the owner of the trust. Explanation As long as the grantor has the power directly or indirectly to control the trust, he is treated as the owner. The grantor may be taxed on trust income if the grantor either actually or constructively receives the income. U21LO5

C

A feature of which of the following business entities is limited liability but no flow-through of earnings or losses? A) Sole proprietorship B) LLC C) Limited partnership D) Corporation Explanation The corporation (always assume C corporation unless it says different on the test) offers limited liability to its shareholders, but there is no flow-through of income or loss. LLCs and limited partnerships offer both and the sole proprietorship has unlimited liability. U18LO3

D

Which of the following statements regarding the properties of duration is NOT true? A) Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. B) Duration is a weighted-average term to maturity of a bond's cash flows. C) Duration measures the holding period return on a bond. D) Duration measures the effect of an interest rate change on the price of a bond or bond portfolio. Explanation Duration does not measure the holding period return on a bond; it measures the effect of an interest rate change on the price of a bond or bond portfolio. Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. Duration is also a weighted-average term to maturity of a bond's cash flows. U13LO11

C

Which of the following would NOT be considered an unethical practice for a registered investment adviser? A) Failing to notify the Administrator that the adviser is maintaining custody of client funds and securities B) Acting as a principal in a recommended transaction without consent of the client prior to completion of the trade C) Acting as a trustee for a client's trust D) Unfairly criticizing an estate plan prepared by the client's attorney Explanation Please notice the word not in the question. Although acting as a trustee for the client's trust is probably not a good business practice, it is not included in the list of unethical activities for an adviser. U7LO3

C

A market maker is quoting ABC common stock at $76.10 - $76.31. That means A) the market maker is willing to pay $76.31 for the stock. B) the market maker's commission is $.21 per share. C) the spread is probably excessive. D) the market maker is willing to pay $76.10 for the stock. Explanation Marker makers provide a two-sided quote. Because market makers stand ready to buy and sell the specific security, they provide a bid price, the price the firm is willing to pay for the stock, and the offer price, the price they are asking to receive when selling the stock. Market makers do not earn a commission; they charge a markup or markdown. A $.21 spread on a stock at this price is certainly not excessive. U22LO5

D

An analyst is viewing a subject company's financial statements. She notices that the company has current assets of $20 million, fixed assets of $50 million, and total liabilities of $45 million (of which $10 million is considered long-term). This company's debt-to-equity ratio is A) 64.3% B) 40% C) 22.2% D) 28.6% Explanation The debt-to-equity ratio is computed by dividing the issuer's long-term debt by their total capitalization. Total capitalization is the company's net worth (assets minus liabilities) plus the long-term debt. In this example, the net worth is $70 million minus $45 million, or $25 million. Adding the long-term debt of $10 million results in total capital of $35 million. Divide the $10 million by that $35 million to arrive at 28.57%. As we point out in the LEM, this is really a misnomer—it should be called the debt-to-total-capital ratio, but probably will not be shown that way on the exam. U10LO7

D

An investor purchases a Treasury note and the confirmation shows a price of $102.21. Rounded to the nearest cent, the investor's cost, excluding commissions, is A) $1,022.10. B) $1,022.21. C) $102.21. D) $1,026.56. Explanation Treasury notes are quoted in 32nds where each 32nd equals $.3125. The 102 in the quote equals $1,020 and the 21/32 is an additional $6.56 bringing the total to $1,026.56. U13LO2

D

An investor signed a letter of intent to purchase $50,000 worth of Sky-High Mutual Fund. At the end of 13 months, he had only invested $48,000 in the fund. Which of the following is TRUE? A) He must sign a new letter for the $2,000 to receive the breakpoint. B) There are no additional requirements; he will receive the breakpoint. C) He has 90 days to invest the additional $2,000 for the breakpoint. D) The fund will liquidate shares to meet the additional sales charge. Explanation An investor has only 13 months to meet a letter of intent commitment. Once that period of time has elapsed, the investment company is entitled to a refund of the discount it had originally given the investor. This is accomplished by liquidating a sufficient number of shares to cover the additional sales charge to be imposed. U14LO4

D

If the current risk-free rate is 4%, and the expected return from the market is 10%, what return should we expect from a security that has a beta of .9? A) 13% B) 9% C) 6.4% D) 9.4% Explanation Required return = 4% + ([10% - 4%] × .9) = 4% + (6% x .9) = 4% + 5.4% = 9.4%. U20LO9

D

In which of the following cases is the exemption from registration with the SEC not based on the value of assets under management? A) An investment adviser that acts as an adviser solely to one or more national banks B) An investment adviser with assets under management of less than $25 million C) An investment adviser that acts as an adviser solely to private funds and has assets under management in the United States of less than $150 million D) An investment adviser that acts as an adviser solely to one or more venture capital funds Explanation It is only in the case of the adviser to venture capital funds where there is no dollar limitation on AUM. Private fund advisers with AUM of $150 million or more must register, and "small" investment advisers, those with less than $25 million in AUM, are generally prohibited from SEC registration. If the investment adviser's only clients are insurance companies, the adviser is exempt from SEC registration even if the firm has billions in AUM, but that exemption does not apply when the only clients are banks. U1LO4

D

Mark is a client of Gibraltar Investment Advisers. Gibraltar sells its investment advisory business to Alpha advisers. Which of the following best describes Mark's relationship to Alpha? A) Mark is automatically a client of Alpha. B) The investment advisory contract Mark made with Gibraltar continues with Alpha. C) Mark may not become a client of Alpha. D) Mark may become a client of Alpha if he chooses to do so. Explanation An investment advisory relationship may not be assigned without the consent of the client. The client may choose to enter into a contract with the new firm. The contract with the old firm becomes void when it sells its business. U6LO4

D

Seven years ago, Ivan was found guilty of embezzling securities from clients. He now wishes to join another brokerage firm. Which of the following statements is TRUE regarding this situation? A) He may be employed by a brokerage firm, provided he is not involved directly in any dealings with clients. B) He may be employed in a sales position, provided the firm agrees to be liable for any losses due to his misconduct. C) There are no provisions restricting his employment because the restriction time period has elapsed. D) He cannot be employed because he is still subject to statutory disqualification provisions. Explanation Under the Securities Exchange Act of 1934, there are a number of items that disqualify a person from becoming a member of, or from associating with, a member of a self-regulatory organization (SRO). The items include being currently under suspension, revocation, or injunction by any court, regulatory authority, or SRO (foreign or domestic); currently employing a person statutorily disqualified; having been convicted in the past 10 years of a felony or a securities- or financially related crime; or falsifying an application for registration. Ivan cannot be employed by a brokerage firm, because he was convicted 7 years ago. Because the Securities Exchange Act of 1934 requires a broker-dealer to join one or more SROs, being statutorily disqualified eliminates the possibility of employment. U3LO1

D

There are certain requirements for an investment to qualify as a REIT. Which of the following is not one of them? A) At least 75% of the REIT's annual gross income must be from real estate-related income such as rents from real property and interest on obligations secured by mortgages on real property. B) At least 90% of the REIT's taxable income must be paid out as dividends to investors. C) At least 75% of the assets must be invested in real-estate related assets, cash, and U.S. government securities. D) At least 75% of the REIT's taxable income must be paid out as dividends to investors. Explanation In order to qualify as a REIT, the REIT must distribute at least 90% of its taxable income, not 75%. At least 75% of the assets must be invested in real-estate related assets such as real property or mortgages. The same is true of the REIT's annual gross income. U14LO9

D

Under industry rules, customers who wish to trade options must receive a copy of the options disclosure document (ODD) A) at or before the mailing of the next monthly statement B) within 15 days of account approval C) at or before the mailing of the confirmation representing the first options trade D) at or before account approval Explanation All prospective options customers must receive a copy of the ODD at or before the time the account is approved to trade options. It is the options account agreement that must be signed and returned to the broker-dealer within 15 days of account approval. U18LO2

D

Under the NASAA Statement of Policy of Dishonest or Unethical Business Practices of Broker-Dealers and Agents, the Administrator may bring an action against an agent's registration if the agent borrows money from his wealthy clients' accounts solicits orders for nonexempt unregistered securities buys and sells securities in accounts to generate a high level of commissions alters market quotations to induce a client to invest in an attractive growth stock A) I, II, and III B) I and III C) I and IV D) I, II, III, and IV Explanation An Administrator may commence an action against an agent's registration if the agent engages in prohibited practices such as those described in each of the choices in the question. U7LO4

D

Under the Uniform Securities Act, each of the following statements regarding a sale, an offer, or an offer and sale is true EXCEPT A) every sale or offer of a warrant or stock right to purchase or subscribe to another security is considered to include an offer of the other security B) any security given or delivered, with or as a bonus for any purchase of securities, is considered to have been offered and sold for value C) a purported gift of assessable stock is considered to involve an offer and sale D) a bona fide pledge is considered an offer and sale Explanation The term "sale" does not include a bona fide pledge. It does, however, include securities given as a bonus with a purchase and gifts of assessable stock because the owner of the stock may be called on to produce additional money. Sales of rights or warrants are considered sales of the underlying security. U5LO1

D

When an agent recommends a proprietary mutual fund to a client, it is considered A) an obvious attempt to maximize personal compensation B) a violation of the agent's fiduciary responsibility C) an unethical business practice D) a potential conflict of interest Explanation There is nothing improper about recommending a proprietary mutual fund, as long as the potential conflict of interest is disclosed. It is investment advisers and their representatives who have a fiduciary responsibility to their clients; agents operate under a best interest standard, which is not quite the same. U6LO1

D

Which 2 are most associated with a U. S. Treasury bond? Credit risk Liquidity risk Reinvestment risk Interest rate risk A) I and II B) II and III C) I and IV D) III and IV Explanation We negate credit risk when it comes to U.S. Treasury securities. Liquidity is also not an issue. However, any interest-bearing bond carries interest rate risk, as well as reinvestment risk. U11LO1

D

Which of the following activities would NOT be considered a prohibited practice under the NASAA Statement of Policy on Unethical or Dishonest Business Practices of Broker-Dealers and Agents? A) In order to meet production quotas, an agent opens several accounts under fictitious names B) An agent purchases a suitable stock for a client's account prior to receiving written discretionary authorization C) An agent opens a brokerage account at his employing broker-dealer in his wife's maiden name in order to purchase an IPO being underwritten by the firm D) An agent shares in the profits and losses in a customer's account without making a financial contribution to the account Explanation As long as the agent has the consent of the customer and the employing broker-dealer, profits and losses may be shared and no financial contribution is required of the agent. No purchases can be made by an agent in a discretionary account prior to receipt of the written trading authorization. Opening accounts in fictitious names or a spouses name in order to hide improper purchases are prohibited practices. Please note: The correct choice does not include the consent requirements so the statement is only partially correct. But, the other answers are definitely prohibited actions so you pick the best answer when you get something like this on the exam. U7LO4

D

Which of the following is a stock valuation ratio? A) Dividend payout ratio B) Revenues to assets C) Operating profits to net sales D) Price-earnings Explanation The price-earnings (PE) ratio is a valuation ratio used to calculate the value of a stock. For example, if a stock has a PE of 20, it means that the security is priced at 20 times earnings. U10LO7

D

Which of the following statements is an accurate description of dollar cost averaging? A) An investor averages the costs of his shares purchased and then enters limit orders to purchase additional shares at the average price. B) An investor buys the same number of shares each interval, averaging out his purchase prices over time. C) An investor sells shares when the market rises and buys shares when the market declines in order to average his costs. D) An investor invests a set amount of money each interval to buy more shares when the prices are low and fewer shares when prices are high. Explanation Dollar cost averaging involves investing a set amount of money each interval. If the market fluctuates, this will cause the client to buy more shares when the prices are low and fewer shares when prices are high. The result of this is a lower average cost per share than average price paid. An investor who sells shares when the market rises and buys shares when the market declines is not dollar cost averaging, but is attempting to time the market. An investor who averages the cost of the shares purchased and then enters limit orders to purchase additional shares at the average price is not engaged in a dollar cost averaging program. In dollar cost averaging, the same dollar amount is invested each interval. U20LO11

D

Which of the following statements regarding both traditional and Roth IRAs is true? A) Distributions must begin in the year after the owner reaches age 72. B) Withdrawals at retirement are tax free. C) Contributions are tax deductible. D) Contribution limits are the same. Explanation The common factor for both traditional and Roth IRAs is that contribution limits are identical. Roth contributions are made with after-tax dollars rather than pre-tax dollars (the usual case with a traditional IRA). On the other hand, it is only the Roth where, assuming the conditions are met, the withdrawals are tax-free. There are no RMDs for Roth IRAs. U24LO1

D

While reading the prospectus of a mutual fund, you notice that the management describes their style as contrarian. They further explain that they A) have higher-than-average income as their goal. B) tend to invest in stocks with a high correlation coefficient. C) believe that indexing provides the most attractive returns. D) generally buy when the majority of other investors are selling and sell when the majority of other investors are buying. Explanation As the term implies, a contrarian takes positions that are opposite to the prevailing opinions. U20LO5

D

Your client has given you discretionary authority to trade her account with a beginning balance of $100,000. Market conditions have been volatile for the past 6 months, and her primary objective is long-term growth with low to moderate risk. A review of the account at the end of that period shows that while the Dow Jones Industrial Average has dropped by 2.2%, the client's account value is $105,300. During the period, if commissions from trading totaled a bit over $6,000, it is likely that your principal will A) suggest that you contact the client about investing more money with the firm B) inquire as to why a $100,000 account only generated $6,000 in commissions in a 6-month period C) congratulate you on helping your client beat the averages D) discuss the possibility that you may have been churning the account Explanation Churning can occur even when an account makes money. If the amount of commissions generated is out of line with the account's objectives and resources (and 12% annual charges, in this case), churning will probably be suspected. U7LO4

D