Unit 15 - Practice Exam (Ethics, Recommendations, and Taxation)

KLP Corporation has extensive investments in the stocks and bonds of other corporations. Its portfolio income this year amounts to $700,000 in interest income from bonds and $400,000 in dividend income from common and preferred stock. On how much of its portfolio income must it pay taxes this year? A) $300,000. B) $1.1 million. C) $120,000. D) $820,000.

Your answer, $1.1 million., was incorrect. The correct answer was: $820,000. The corporate exclusion is 70% of dividend income; therefore, KLP must pay taxes on all $700,000 of its interest income, but only 30% (or $120,000) of its dividend income, for a total of $820,000. Reference: 15.5.11.1 in the License Exam Manual.

A highly compensated customer owns 200 shares of Datawaq. He bought it 20 years ago, and it is now trading at 90. If he donates the stock to a not-for-profit corporation, how much can he claim as a tax deduction for this donation? A) $18,000. B) $0. C) $6,000. D) $12,000.

Your answer, $18,000., was correct!. Securities can be gifted to charity and deducted at their fair market value, as long as they have been held more than 1 year. The fair market value of the deduction allowed for 200 shares is 200 multiplied by the current market price of the stock, or $18,000. Reference: 15.5.9.1.1 in the License Exam Manual.

If a customer has $9,000 of capital losses and $2,000 of capital gains in a tax year, that year's consequences are a: A) $7,000 loss deduction with no carry forward. B) $9,000 loss deduction. C) $3,000 loss deduction with no carry forward. D) $3,000 loss deduction with $4,000 carry forward.

Your answer, $3,000 loss deduction with $4,000 carry forward., was correct!. For tax purposes, the customer can net gains with losses. In this case, the customer's net losses are $7,000. However, there is an annual capital loss deduction limit of $3,000. Therefore, the investor can deduct $3,000 this year and carry forward $4,000 to the following tax year. Reference: 15.5.6.1.3 in the License Exam Manual.

A customer purchases an XYZ municipal bond at 108. It is scheduled to mature in 16 years. After owning the bond for 10 years, he sells the bond at 102. What capital gain or loss must he report for tax purposes at the time of the sale? A) $60 loss. B) $10 loss. C) $10 gain. D) $20 gain.

Your answer, $60 loss., was incorrect. The correct answer was: $10 loss. If a municipal bond is purchased at a premium, the premium must be amortized over the time until maturity. An $80 premium on a 16-year municipal bond indicates that $5 will be amortized each year ($80 divided by 16 = $5). After 10 years, the tax basis would be 103 ($1,030). Since the sale was for 102 ($1,020), the customer has a $10 loss on one bond. Reference: 15.5.7.1 in the License Exam Manual.

*An investor purchases a corporate bond at 105 with a 10-year stated maturity and pays $30 of accrued interest. If he elects not to amortize the premium and holds the bond to maturity, what is his cost basis for tax purposes?* A) 1020. B) 1080. C) 1050. D) 1000.

Your answer, 1050., was correct!. While most taxpayers do elect to amortize the premium paid for a corporate bond, it is not mandatory. The investor chooses not to amortize, thus his cost basis at maturity is simply what he originally paid for the bond. *Accrued interest paid does not affect cost basis*. Reference: 15.5.7.1 in the License Exam Manual.

A single investor, age 26, wants to begin a long-term saving plan for retirement by opening an IRA with your broker/dealer. Comfortable with mutual funds, an appropriate asset allocation/mix would be A) 80% equity funds, 20% bond funds B) 10% equity funds, 90% bond funds C) 50% equity funds, 50% bond funds D) 40% equity funds, 60% bond funds

Your answer, 80% equity funds, 20% bond funds, was correct!. Long-term investors, such as those saving for retirement, would seek growth of capital as an objective over the safety associated with debt securities. An investor age 26 is far enough away from retirement to accommodate a growth objective and the greater risk associated with equities over debt. It would be suitable to initially allocate a high percentage of the portfolio to equities. Reference: 15.2.2.3 in the License Exam Manual.

Which of the following provides a measurement of the volatility of a particular stock or portfolio as compared to the volatility of the market as a whole? A) Gamma. B) Beta. C) Delta. D) Alpha.

Your answer, Beta., was correct!. The beta value is an index that measures the volatility of a stock's or portfolio's movement as compared to the movement of the market as a whole. By definition, the beta of the market is equal to 1.0. Reference: 15.3.3.1 in the License Exam Manual.

Mr. and Mrs. Smith, both nearing retirement, want to reallocate $200,000 of their $500,000 portfolio of blue-chip stocks to an investment that would add to their monthly income after retirement. Of the possible investment choices below, which would be the most suitable recommendation given their investment objective? A) GNMA securities B) High-yield corporate bonds C) Exchange-traded notes D) Preferred shares of stock

Your answer, GNMA securities, was correct!. Of the answer choices given, only Ginnie Mae (GNMA) securities would offer monthly income. Additionally, GNMAs are backed by the US government, which adds to their suitability for this couple nearing retirement. None of the remaining answer choices offer monthly income, and 2 of them (high-yield corporate bonds and exchange-traded notes) have unique risk associated with them, making them unsuitable for those near or in retirement. Reference: 15.2.2 in the License Exam Manual.

A change in which of the following should be indicated in a customer's file? Name. Educational degrees held. Investment objectives. Professional society memberships. A) I and II. B) I and III. C) II and IV. D) III and IV.

Your answer, I and III., was correct!. *All primary information, such as name, address, and Social Security number, and all information that could affect recommendations or a customer's financial situation must be noted immediately in the file*. Educational degrees and society memberships do not affect investment recommendations. Reference: 15.2.1 in the License Exam Manual.

Regarding the taxation of dividends received from corporate securities, which of the following are TRUE? Nonqualified dividends are taxed at the rate the investor's ordinary income will be taxed. Nonqualified dividends are not taxed. Qualified dividends are taxed at a maximum rate specified by the IRS and will depend on the investor's income tax bracket. Qualified dividends are taxed at the rate the investor's ordinary income will be taxed. A) II and III B) I and III C) II and IV D) I and IV

Your answer, I and IV, was incorrect. The correct answer was: I and III Nonqualified (ordinary) dividends are taxed at the investor's ordinary income tax rate, while qualified dividends will be taxed at a maximum rate as specified by the IRS. Whether or not the qualified dividends are taxed at the maximum rate or a lower rate depends on the investor's income tax bracket. The higher the investor's income tax bracket the higher the tax on qualified dividends will be, up to the maximum. Reference: 15.5.4.2 in the License Exam Manual.

If a customer, while out of town, receives a margin call for securities purchased a day earlier, which of the following actions would be appropriate? The customer overnights a personal check to cover the call. The broker servicing the account writes a personal check to cover the call. The brokerage firm transfers the position to its trading account until the customer returns. The customer uses a wire transfer of funds to cover the call. A) II and IV. B) I and III. C) II and III. D) I and IV.

Your answer, I and IV., was correct!. Personal checks as well as wire transfers can be used to meet the call, but a broker may never loan money to a customer. Furthermore, the brokerage firm may never transfer a customer's position to its proprietary trading account pending the customer's return to satisfy a customer's margin call. Reference: 15.1.3.4 in the License Exam Manual.

A customer buys 100 XYZ at $30. Two years later, with the stock trading at $70, the customer makes a gift of the securities to his son. Which of the following statements are TRUE? For gift-tax purposes, the value of the gift is $3,000. For gift-tax purposes, the value of the gift is $7,000. The son's cost basis on the stock is $3,000. The son's cost basis on the stock is $7,000. A) II and IV. B) I and III. C) I and IV. D) II and III.

Your answer, II and III., was correct!. When making a gift of securities, the market value at date of gift is used to determine if any gift taxes are due. However, when making a noncharitable gift of securities, the donor's cost basis is passed to the recipient. Reference: 15.5.9.1.2 in the License Exam Manual.

Progressive taxes would include: personal income tax. gift taxes. estate taxes. excise taxes. A) I and III. B) I and II. C) I, II and III. D) II, III and IV.

Your answer, II, III and IV., was incorrect. The correct answer was: I, II and III. Progressive taxes are those taxes where the rate of taxation increases as the dollars being taxed increase. Personal income tax, while not as progressive as it was prior to the 1986 reform, is still considered a progressive tax since the highest tax rate is levied against the highest earnings. Gift taxes and estate taxes are highly progressive, but excise taxes, such as fuel tax and transportation tax, are a fixed rate and therefore would not be considered progressive. Reference: 15.5.2 in the License Exam Manual.

Your customer's portfolio consists of 40% long-term government bonds, 20% preferred stock, and 40% common shares of utility companies. Which of the following may have the single largest impact on the entire portfolio? A) Corporate earnings B) Foreign currency fluctuations C) Oil and gas price movements D) Interest rate movements

Your answer, Interest rate movements, was correct!. Of the four answer choices, interest rate movement is the most likely to impact each of the portfolio components. Interest rates and bond prices have an inverse relationship, and their movement often determines whether investors might seek out investment alternatives with higher returns, such as dividend paying utilities and fixed dividend preferred shares. Reference: 15.3.2.4 in the License Exam Manual.

A convertible corporate bond with an 8% coupon yielding 7.1% is available, but may be called some time this year. Which feature of this bond would probably be least attractive to your client? A) Coupon yield. B) Current yield. C) Convertibility. D) Near-term call.

Your answer, Near-term call., was correct!. The near-term call would mean that no matter how attractive the bond's other features, the client may not have very long to enjoy them. Reference: 15.3.2.6 in the License Exam Manual.

What is a basic assumption in an active management investment style? A) Some securities are mispriced and value can be captured through security selection. B) The market is efficiently priced and that will make an active management style effective. C) There is no opportunity cost to investing. D) Asset allocation makes no difference.

Your answer, Some securities are mispriced and value can be captured through security selection., was correct!. An investment manager using an active management investment style believes that by using investment expertise he can select securities that are undervalued to achieve superior returns over time. Reference: 15.4.3 in the License Exam Manual.

If a customer is concerned about interest rate risk, which of the following securities is least appropriate? A) 10-year corporate bonds. B) 5-year corporate bonds. C) Treasury bills. D) 25-year municipal bonds.

Your answer, Treasury bills., was incorrect. The correct answer was: 25-year municipal bonds. Interest rate risk is the danger that interest rates will rise and adversely affect a bond's price. This risk is greatest for long-term bonds; short-term debt securities are affected the least if interest rates change. Reference: 15.3.2.4 in the License Exam Manual.

The ABCD Corporation has a beta coefficient of 1.25. Your client's portfolio contains $20,000 of ABCD. After a rise in the overall market of 10%, we would expect the value of this client's ABCD to: A) decrease by 25%. B) increase by $5,000. C) increase by $2,000. D) increase by $2,500.

Your answer, increase by $5,000., was incorrect. The correct answer was: increase by $2,500. A stock with a beta coefficient of 1.25 could be expected to rise in value at a rate 25% greater than the overall market. Since the market has increased by 10%, this stock should increase by 12.5% or $2,500 (10% × 1.25 × $20,000 = $2,500). Reference: 15.3.3.1 in the License Exam Manual.

The term for the annual reduction of a municipal bond's cost basis purchased at a premium is: A) straight line amortization. B) compound amortization. C) straight line accretion. D) compound accretion.

Your answer, straight line accretion., was incorrect. The correct answer was: straight line amortization. Amortization is the process by which the cost basis of a bond bought at a premium is decreased during the holding period. Because the cost basis is reduced by equal amounts every year, amortization is done on a straight line basis. At maturity, the cost basis has been reduced to par. Reference: 15.5.7.1 in the License Exam Manual.

A U.S. citizen owns stock in a Canadian company and receives dividends. The Canadian government withholds 15% of the dividends as a tax. As a result, the investor reports a: A) reduction in the investor's ordinary income. B) tax credit on the investor's Canadian tax return. C) non-recoverable loss on the investor's U.S. tax return. D) tax credit on the investor's U.S. tax return.

Your answer, tax credit on the investor's U.S. tax return., was correct!. An investor receives a credit for taxes withheld on investments by countries with which the United States has diplomatic relations; the tax credit directly decreases the investor's American tax liability. Reference: 15.5.4.3 in the License Exam Manual.