Unit 11b

Your client, Allyson, has consulted you regarding increasing the overall yield on her portfolio. It is currently invested almost entirely in domestic and foreign equity. She would like to reduce her risk exposure to equity securities. You have suggested real estate investment trusts (REITs) and explained that there are several different kinds of REITs. Which of the following accurately describes the characteristics of equity REITs? A. They earn rental income from leasing properties they own. B. They are designed to be liquidated in a specific future year. C. They are most similar to open-end mutual funds. D. They earn interest income from mortgages on real estate properties.

A. They earn rental income from leasing properties they own. Equity REITs own properties. Whether residential or commercial (think apartments, office buildings, or shopping centers), the tenants pay rent. After paying the expenses associated with operating their properties, equity REITs pay out annually the bulk (at least 90%) of the net income to their shareholders as dividends. Equity REITs can also generate capital gains from the sale of properties. Mortgage REITs receive interest income from mortgages they own. It is unusual for an equity REIT to pre-determine an ending date. REITs are more like closed-end funds than open-end ones because they trade in the secondary markets based on supply and demand. Allyson's risk reduction comes from the fact that there is a negative correlation to the general stock market. That means real estate prices and the stock market frequently move in opposite directions.

Intangible drilling costs would include all of the following except A. casing. B. wages. C. fuel. D. land surveys.

A. casing. Intangible drilling costs are those associated with drilling a well, but do not include the cost of capital equipment (e.g., pumps, casing). They include wages, fuel, repairs, hauling, supplies, surveys, tests, and drilling mud, and they are incidental to and necessary for the drilling activity.

A direct participation program shows the following operating results for the year: Revenues: $3 million Operating expense: $1 million Interest expense: $200,000 Management fees: $200,000 Depreciation: $3 million The cash flow from program operations is A. $1.4 million. B. $1.6 million. C. $3 million. D. a loss of $1.4 million.

B. $1.6 million. The cash flow for a direct participation program is the net income (or loss) plus the depreciation. In this question, there is a loss of $1.4 million. When the depreciation of $3 million is added to the negative $1.4 million, the cash flow is a positive $1.6 million. How did we get the loss of $1.4 million? The money that came in was the revenue of $3 million. From that, we subtract all of the expenses. Total operating expense of $1.2 million ($1 million plus $200,000 management fees) Interest expense of $200,000 Depreciation of $3 million Total expenses: $4.4 million Net loss of $1.4 million

A married couple both hoping to retire within the next five to seven years have expressed having a low-risk tolerance regarding the stock market. They have a combined income of $350,000. Given this information, which of the following portfolio mixes would be most suitable? A. Treasury bills, common stock, options B. Treasury notes, municipal bonds, GNMAs C. Treasury bills, corporate bonds, preferred stock D. Direct participation programs, real estate investment trusts, preferred stock

B. Treasury notes, municipal bonds, GNMAs In light of their low risk tolerance, U.S. government securities would certainly be suitable, and the time frame noted for retirement allows for middle term T-notes to be useful. Given their higher income level, tax-free municipal bonds could also have a place in the portfolio. Longer term GNMAs would accommodate monthly income, should that be desirable upon retirement. The remaining product suggestions are either illiquid (DPPs) or do not align with their risk aversion (common, preferred, options, and REITs).

Among the differences between a real estate investment trust (REIT) and a real estate limited partnership investment (a DPP) is that A. REITs generally trade on the listed exchanges, while DPPs actively trade OTC. B. only the DPP is a flow-through vehicle. C. the DPP generally has more investors than the REIT. D. the DPP takes an ownership interest in the property, while the REIT only makes mortgage loans.

B. only the DPP is a flow-through vehicle. DPPs are the investment vehicle providing flow-through of income and loss. REITs are required to return at least 90% of their net investment income to investors, but losses do not pass through. Both investments can take equity or debt positions. They can also be hybrid and take both. Because DPPs are almost always private placements, the number of investors is usually small. On the other hand, because most REITs are publicly traded, they can have a large number of investors. As private placements, there is no active secondary market for DPPs.

There are four corporate characteristics, more than two of which must not be in evidence for a direct participation program to avoid corporate taxation. Which of the four is virtually impossible to avoid? A. Free transferability of interest B. Continuity of life C. Centralized management D. Limited liability

C. Centralized management Centralization of management is almost impossible to avoid because the general partner(s) provide the management of the program. Continuity of life is the easiest to avoid because DPPs specify the event or time at which the program will terminate. Free transferability is avoided because most DPPs required the approval of the other limited partners or general partner for an investor's interest to be transferred to a new owner. Although the limited partners have limited liability, the general partner(s) have full personal liability.

A general partner may do all of the following except A. act as an agent for the partnership in managing partnership assets. B. sell property to the limited partnership. C. borrow money from the partnership. D. make general management decisions regarding the partnership.

C. borrow money from the partnership. All these situations offer the potential for conflicts of interest. However, the general partner is not forbidden by law to engage in any of these acts, except for borrowing money; the general partner may never borrow money from the partnership.

There are various direct participation program offerings giving investors a range of choices of different types of oil and gas drilling opportunities. All of the following are types of oil and gas direct participation programs except A. income B. developmental. C. exploratory D. functional allocation

D. functional allocation Functional allocation is the most common form of revenue sharing. It is not a type of program. There are three basic types of programs. The exploratory, sometime called wildcat, which is drilling in an unproven area. The next is development where an existing field is continued to be developed by additional drilling. Finally, there is the income, sometimes called production, programs. This is a program that purchases producing wells. There are some program sponsors who split the proceeds from the offering into two or three of these types making it a combination program.

All of the following would flow through as a loss to limited partners except A. interest payments on recourse debt. B. depletion. C. accelerated depreciation. D. principal repayment on recourse debt.

D. principal repayment on recourse debt. Principal repayments are not deductible for tax purposes. The interest is deductible.