Unit 5

Which of the following must be considered in evaluating the suitability of a DPP investment for a customer? 1. Risk tolerance 2. Other holdings 3. Financial situation 4. Age A) I, II, III, and IV B) I and II C) I and IV D) II and III

A) I, II, III, and IV The key here is to recognize that with DPPs, the customer's age is a relevant consideration in determining suitability. DPPs are long-term, illiquid, high-risk investments. It is unlikely that DPPs would be suitable for a customer near retirement age, regardless of the customer's financial situation.

In search of higher returns, many investors have turned to alternative investments, such as structured products. Non-exchange-traded structured securities products (SSPs) typically have A) some form of embedded derivatives. B) a place in the portfolio of conservative investors. C) FDIC insurance coverage. D) moderate liquidity.

A) some form of embedded derivatives. It is commonplace for SSPs to use derivatives, such as options. There is no insurance coverage and, unless listed for trading such as an ETN, low or no liquidity. These are highly complex products and would not be suitable for the average conservative investor.

One reason for including commodities in an investment portfolio is because they have a high correlation to A) the stock market. B) the inflation rate. C) the bond market. D) the U.S. dollar.

B) the inflation rate. Commodity prices tend to have a high correlation with the inflation rate. As inflation goes up, the value of the dollar generally falls. The relationship is inverse, a characteristic of negative correlation. As inflation increases, interest rates invariably do the same, leading to a decrease in bond prices. Stock prices have a random correlation to commodities—generally negative.

Being a limited partner in a direct participation program is analogous to being A) a member of the board of directors of a corporation. B) a holder of secured corporate debt. C) a holder of common stock in a corporation. D) an agent of a broker-dealer.

C) a holder of common stock in a corporation. Limited partners in DPPs are owners of the business in much the same way as common stockholders of a corporation. They assume no management responsibilities simply by virtue of their ownership interest. Similarly, limited partners share the same type of limited liability as corporate shareholders.

Your client who owns a DPP that generated a $10,000 passive loss for the year could A) deduct $10,000 against ordinary income. B) deduct $3,000 against ordinary income and carry over the rest. C) only deduct the passive loss against passive income. D) deduct $10,000 against capital gains.

C) only deduct the passive loss against passive income. Passive losses, such as those generated by limited partnership investments (DPPs), are only deductible against passive income.

If you overheard an analyst referring to an investment's indicative value, the discussion would most likely be about A) REITs. B) ETFs. C) TIPS. D) ETNs.

D) ETNs. The calculated value, called the indicative value or closing indicative value for ETNs, is calculated and published at the end of each day by the ETN issuer.

The term digital assets would include all of the following except A) stablecoins. B) electronic communications such as email. C) cryptocurrency. D) nonfungible tokens.

B) electronic communications such as email. Although email is a digital form of communication, there is nothing about it that makes it an asset. One cannot invest in someone's emails. The other three items are included in the definition of a digital asset.

Which of the following investments is not registered under the Investment Company Act of 1940? A) ETFs B) UITs C) ETNs D) FACCs

C) ETNs Exchange-traded notes, sometimes called equity-linked notes, are registered under the Securities Act of 1933 as debt instruments. All of the other choices are registered as investment companies under the Investment Company Act of 1940.

You have a client who wishes to allocate a portion of his funds to investment real estate in an attempt to generate additional income. That goal could be reached by investing in any of the following except A) real estate limited partnerships. B) REITs. C) rental real estate. D) raw land.

D) raw land. Raw land does not generate income; it is most often held for future capital appreciation.

An investor in a high tax bracket who invested in a DPP should have which of the following characteristics? 1. Need for tax benefits 2. Substantial liquid assets 3. Ability to identify both risks and merits of the program 4. Ability to commit money for a long time A) II and III B) II, III, and IV C) I and II D) I, II, III, and IV

D) I, II, III, and IV DPPs are appropriate for investors who can benefit from substantial tax deductions or credits, are not bothered by illiquidity, understand the business risks and benefits involved, and can stay in the program until completion.

One type of alternative investment considered to be a pooled investment vehicle is the exchange-traded note. Exchange-traded notes (ETNs) are which of these? 1. Unsecured debt securities 2. Unsecured equity securities 3. Issued by financial institutions, such as banks 4. Insured by the FDIC A) II and IV B) I and III C) II and III D) I and IV

B) I and III Exchange-traded notes are unsecured debt securities issued by financial institutions, such as banks. Their prices can be impacted by changes in the credit rating of the issuer, and they are not insured by the FDIC.

In order to achieve its goals, an inverse ETF uses A) preemptive rights. B) derivatives and debt. C) short selling. D) arbitrage.

B) derivatives and debt. An inverse ETF will almost always use derivatives, such as options, and—in the case of a leveraged ETF—will use debt, primarily in the form of margin. Inverse ETFs do not engage in short selling; they are an alternative to selling short a specific index without the unlimited risk potential of the short sale. Arbitrage is used, typically by institutional investors, to take advantage of temporary imbalances between the ETF's net asset value and market price.

Which of the following is a motivation for creating structured products? A) Structured products are less expensive for investors to buy and trade. B) Structured products reduce costs to issuers. C) Structured products improve profits for broker-dealers. D) Structured products improve market completeness.

D) Structured products improve market completeness. The primary motivation for financial structuring is to increase market completeness. What does that mean? As stated in the LEM, structured products are created to meet a specific need for which there is nothing available in the current market. Creating this structured product is said to be "completing the market." Creating structured products is a cost to issuers. Investors pay fees to access structured products in addition to transaction costs. They may, in fact, improve the structuring broker-dealer's profits, but that is not what NASAA will be looking for as an answer.

Which of the following statements regarding the general partner (GP) in a direct participation program (DPP) is not true? A) The GP is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations. B) A GP has a fiduciary relationship to the limited partners (LPs). C) The GP cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds. D) The GP, as the active manager of the partnership, does not maintain a financial interest in the partnership and only receives income distributions from profits on the business prior to the limited partners.

D) The GP, as the active manager of the partnership, does not maintain a financial interest in the partnership and only receives income distributions from profits on the business prior to the limited partners. General partners (GPs) must maintain a financial interest in the partnership and generally do not receive distributions from profits before those paid to the limited partners (LPs). The GP is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations and has a fiduciary relationship to the LPs. The GP, as a fiduciary, cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds.

Among the differences between an investment in a limited partnership offering and in a corporation is that A) limited partners take a more active role in the management of the enterprise than do stockholders of a corporation. B) limited partnership offerings do not pay dividends; corporations do. C) only corporations are organized to run a business. D) only corporations issue securities.

B) limited partnership offerings do not pay dividends; corporations do. One of the key features of a limited partnership investment is the concept of flow-through of operating results. If the business operates at a loss, the limited partner's share of that loss is treated as a passive loss on the investor's tax return. If the business is profitable, the limited partner's share of the profit is treated as passive income. Corporations issue securities, primarily stocks and bonds, while limited partnerships issue units representing the limited partner's interest in the venture. Those units are investment contracts and, as taught in Unit 4, LO4, securities. Limited partners who take an active role in the partnership lose their limited status.