Unit 5
Which of the following terms best describes ETNs and leveraged ETFs? A) Alternative investments B) Registered investment companies C) Speculative investments D) Forms of hedge funds
A) Alternative investments These are two popular alternative investments. Are they speculative? Yes, but there are many other speculative investments that are not considered alternative investments. The question asks for the best description and, although it might seem like a close call, these are "alts." The leveraged ETF is a registered investment company, but the ETN is not.
An agent must obtain written verification of an investor's net worth for which of the following investments? A) Direct participation programs B) Real estate investment trusts C) Variable contracts D) Unit investment trusts
A) Direct participation programs DPPs require complete financial disclosure because of minimum suitability standards set by the states in which they are sold. REITs, unit investment trusts, and variable contracts do not have specific net worth suitability requirements for investors.
A client wishing to invest in precious metals could consider each of the following except A) lead. B) silver. C) platinum. D) gold
A) lead. Although it has always been the alchemist's dream to convert lead into gold, until that becomes a reality, lead is not considered a precious metal.
The price of which of the following commodities is most likely to be impacted by weather? A) Lead B) Orange juice C) Livestock D) Gold
B) Orange juice If you ever saw the movie Trading Places with Eddie Murphy and Dan Aykroyd, you would certainly know that weather can have a major impact on the orange crop. Metals are not affected by heat, cold, rain, or snow. Years ago, before heated/air-conditioned barns and other protective devices, livestock would freeze in a bad winter, but that is no longer much of an issue.
Flow-through is one of the features of A) variable annuities. B) direct participation plans. C) open-end investment companies. D) REITs.
B) direct participation plans. Flow-through is the term commonly used to describe that any income or loss generated by a direct participation program flows through to the owner(s). In the case of a real estate investment trust (REIT), the only thing that passes through is income or gains, never losses.
Which of the following must be considered in evaluating the suitability of a DPP investment for a customer? I. Risk tolerance II. Other holdings III. Financial situation IV. Age A) I and IV B) I and II C) I, II, III, and IV D) II and III
C) 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.
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.
Which of the following would be considered a precious metal? A) Lead B) Copper C) Tin D) Platinum
D) Platinum The easiest way to answer this question is to add a word to each choice—copper wire, lead pipe, platinum ring, and tin can. Along with silver and gold, platinum is a commonly traded precious metal in the commodities markets.
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) target date mutual funds. B) conservative growth mutual funds. C) broad market ETFs. D) leveraged ETFs.
D) leveraged ETFs. Because most leveraged funds reset daily, they are best utilized by investors with a very short time horizon.
Inverse ETFs are suitable primarily for investors A) wishing to leverage their income. B) who follow a passive investment strategy. C) who are bullish on the market's future. D) with a very short time horizon.
D) with a very short time horizon. Inverse and leveraged ETFs are structured in such a manner that makes holding them for more than a few days or a week become unattractive. They are for bearish investors, which is why they are often referred to as short funds. They are purchased for short-term capital gains; there is no income. The passive strategy is for the long term, not the short term
Which of the following commodities is least likely to be affected by the weather? A) Wheat B) Pork bellies C) Silver D) Orange juice
C) Silver Silver is a precious metal and its price is not influenced by the weather. Crops, such as wheat and oranges, certainly are, and livestock is affected as well.
One reason for including commodities in an investment portfolio is because they have a high correlation to A) the stock market. B) the U.S. dollar. C) the inflation rate. D) the bond market.
C) 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.
All of the following are features of limited partnership direct participation programs except A) the limited partners have limited liability. 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 general partner controls the business activities of the partnership.
C) the limited partners may participate in the management of the partnership. Should a limited partner assume a management role, there is the danger that the limited liability protection will be lost and that partner will 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.
The Canadian government is looking to create their own digital coin that will allow them to regulate digital assets safely and securely. What is the name of this developing stablecoin? A) Bitcoin B) Ethereum C) CanadaCoin D) Central Bank Digital Currency
D) Central Bank Digital Currency The key to the answer is that this is an official Canadian government action. A central bank digital currency (CBDC) is a digital currency that is issued and backed by a sovereign government's central bank. Unlike decentralized cryptocurrencies like bitcoin, CBDCs are centrally controlled and regulated by the central bank, such as the Federal Reserve in the United States, which has the authority to issue, distribute, and regulate the supply of the digital currency.
It would be correct to state that an inverse ETF A) is suitable for sophisticated investors with a long time horizon. B) is a form of private equity fund. C) moves in tandem with the index being tracked. D) utilizes derivatives to achieve its objectives
D) utilizes derivatives to achieve its objectives. Inverse, or short, ETFs move in the opposite direction of the index being tracked. To achieve their goals, various types of derivatives are used. This type of ETF is used only for short-term investments, rarely as long as a single month. These are registered investment companies, not private.
An investor in a high tax bracket who invested in a DPP should have which of the following characteristics? I. Need for tax benefits II. Substantial liquid assets III. Ability to identify both risks and merits of the program IV. Ability to commit money for a long time A) II, III, and IV B) I and II C) I, II, III, and IV D) II and III
C) 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.
An investment adviser who is discussing forward contracts with a client would most likely be referring to an investment in A) an equity index annuity. B) a diversified portfolio. C) puts and calls. D) an agricultural commodity.
D) an agricultural commodity. Forward contracts are available on commodities, such as agricultural products (e.g., corn, wheat, and soybeans). Puts and calls are options, not forward contracts; although this could be a way to diversify the portfolio, that does not directly answer the question.
Investing in commodities could involve investing in any of these except A) consumer durables. B) agricultural items. C) animals. D) industrial metals.
A) consumer durables. Commodity contracts are not available on consumer durables such as refrigerators and washing machines. They are available on agricultural items, such as corn, wheat, and soybeans. Likewise, investing in animal items such as cattle and pork bellies is possible. Finally, industrial items—primarily metals such as lead, zinc, and aluminum—are popular investments.
The term digital assets would include all of the following except A) electronic communications such as email. B) stablecoins. C) cryptocurrency. D) nonfungible tokens.
A) 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.
One reason for including commodities in an investment portfolio is because they have a high correlation to A) the bond market. B) the inflation rate. C) the U.S. dollar. D) the stock market.
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.
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? I. Unsecured debt securities II. Unsecured equity securities III. Issued by financial institutions, such as banks IV. Insured by the FDIC A) I and III B) I and IV C) II and IV D) II and III
A) 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.
All of the following would flow through as a loss to limited partners except A) depletion. B) principal repayment on partnership debt. C) interest payments on partnership debt. D) accelerated depreciation.
B) principal repayment on partnership debt. Principal repayments are not an expense for tax purposes. The interest on the debt is an expense and, along with depletion and depreciation expenses, does flow through to the limited partners as passive loss.
An investor owns a 2x leveraged inverse ETF. If the underlying index should decrease in value, A) the fund shares will increase in value. B) the ETF shares will increase in value by a factor of 2. C) there is no correlation between the fund and the value of the index. D) the fund shares will also decrease in value.
B) the ETF shares will increase in value by a factor of 2. An inverse, or short, ETF will move in the opposite direction of the underlying index. It is known as a short fund because as the underlying index goes down, the value of the shares increases. Because this is a 2x (2 times) leveraged fund, it will move at a rate that is twice that of the index. Although the choice, "the fund shares will increase in value" is a true statement, it is not the most accurate answer to the question because it ignores the 2x leverage.
Your customer is interested in a leveraged fund and makes the following statements about leveraged funds to you. All of the statements regarding leveraged funds are true except A) these funds sometimes use derivatives products to achieve their stated goals. B) there are no unusual risks associated with these funds other than those one would incur with any index tracking fund. C) the funds attempt to return a multiple of the return of a benchmark index they are tracking, perhaps two or three times. D) some leveraged funds are exchange-traded products.
B) there are no unusual risks associated with these funds other than those one would incur with any index tracking fund. Because the fund's objective is to achieve returns that are a multiple of the returns of the benchmark index, the result could be a multiple of any loss incurred by the benchmark index as well. In addition, because these funds utilize derivatives products to achieve their stated objectives, they may not be suitable for anyone who derivatives products are not suitable for, given the additional risks associated with those products.
An investment adviser who is discussing forward contracts with a client would most likely be referring to an investment in A) a diversified portfolio. B) an equity index annuity. C) an agricultural commodity. D) puts and calls.
C) an agricultural commodity. Forward contracts are available on commodities, such as agricultural products (e.g., corn, wheat, and soybeans). Puts and calls are options, not forward contracts; although this could be a way to diversify the portfolio, that does not directly answer the question.
A REIT and a direct participation program are similar because they both A) are traded actively in the secondary market. B) pass through losses to investors. C) are operated by a centralized management. D) can be described as a limited partnership.
C) are operated by a centralized management. Both a REIT and a DPP are run by centralized management. A REIT may not pass through losses to its investors, and it is not a limited partnership. A DPP cannot be easily traded in the secondary market.
In general, an investor wishing to gain economic exposure to commodities would find it easiest to do so by A) investing in forwards contracts. B) buying the commodity directly. C) growing the commodity. D) investing in futures contracts.
D) investing in futures contracts. It is generally agreed that using commodity futures is the easiest and most common way to gain economic exposure to commodities. Forwards are more commonly used by producers or users because, unlike futures, most forwards contracts result in the delivery of the actual commodity. Only about 1% of all futures contract positions involve the delivery of the underlying commodity.
A bullish client invests into a 3x leveraged fund based on the S&P 500 Index. If the index should rise by 10%, your client's investment would be expected to A) increase by 30% B) decrease by 30% C) increase by 20% D) increase by 50%
A) increase by 30% Although it doesn't always work out that way, a 3x leveraged fund should gain in value at a rate 3 times the reference index.
Which of the following is not a feature of owning a limited partnership? A) Flow-through of income and expenses of a business to the individual limited partner B) Tax-free income C) Legislative risk D) An investment managed by others
B) Tax-free income The income from limited partnerships is not tax exempt. An investor, however, may use a tax loss from a partnership to offset the income from another passive investment. In limited partnerships, the investor enjoys the advantages and disadvantages of owning a business without actually having actually manage one. Limited partnerships are vulnerable to legislative changes that adversely impact ownership of such investments.
Many sophisticated investors have added alternative investments to their portfolios. Benefits in doing so include A) greater regulation than traditional investments such as stocks and bonds. B) portfolio diversification. C) lower expenses than traditional stock and bond investments. D) returns that almost always exceed those of traditional stock and bond investments.
B) portfolio diversification. Alternative investments, such as limited partnership vehicles and hedge funds, have a tendency to add diversification to a traditional stock and bond portfolio. Many alternative investments have little or no regulation, and their expenses are typically high. Although many alts offer the opportunity for higher returns, that opportunity is not always realized. Therefore, we cannot make a statement that the returns almost always generate higher returns than traditional investments.
For a customer interested in buying an inverse exchange-traded fund (ETF) tracking the performance of the Standard & Poor's 500 Index, which of the following market views would make that purchase most inappropriate? A) Bullish or bearish B) Neutral C) Bearish D) Bullish
D) Bullish Inverse (short) ETFs are designed to deliver returns that are opposite of the benchmark index they are tracking. Therefore, buying an inverse ETF that tracks the S&P 500 Index at a time when the market outlook is bullish would be most inappropriate. If the index rises with the anticipated bullish market, the fund that delivers returns that are the opposite of the index would fall in value.
One type of alternative investment considered to be a pooled investment vehicle is the inverse exchange-traded fund (ETF). Inverse ETFs, also known as bear or short funds, are managed to A) be used only by professional traders and market makers. B) perform contrary to a benchmark market index such as the S&P 500. C) outperform a benchmark market index such as the S&P 500. D) be profitable only when interest rates are rising.
B) perform contrary to a benchmark market index such as the S&P 500. Inverse funds, also known as short or bear funds, try to deliver returns that are the opposite of the benchmark index they are tracking. When they are exchange traded, they can be bought on margin and are priced throughout the trading day like other exchange-traded funds.
What is the maximum amount of bitcoin that will ever be in circulation? A) 21 billion coins B) Indefinite number of coins C) 21 million coins D) 194,425 coins
C) 21 million coins The maximum amount of bitcoin that will ever be in circulation is 21 million coins. This is a feature of the bitcoin protocol, which is designed to create a finite supply of the cryptocurrency, which will prevent inflation on BTC.
A high-net-worth client of yours invested $250,000 into an oil and gas limited partnership drilling program for which she received a 10% interest in the project. Unfortunately, after two years of drilling without success, the project was foreclosed with outstanding debt of $4 million. Your client is liable to the partnership's creditors for A) $400,000. B) $250,000. C) $0. D) $150,000.
C) $0. One of the benefits of being a limited partner is that the most you can lose is your investment. Just as it would for a stockholder in a corporation, the concept of limited liability applies. You can lose your entire investment, but you have no liability for debts of the business. This question describes a direct participation program (DPP) that has gone bankrupt (liabilities exceed the assets) and wants to know the share of the $4 million in outstanding debt that is the responsibility of this investor. Even though she owns 10% of the partnership, as a limited partner, she has no liability for any of that debt.
In discussing a direct participation program with your customer, rank the following items in order of importance from most to least. I. Tax write-offs II. Liquidity and marketability III. Potential for economic gain A) I, II, III B) III, I, II C) II, III, I D) III, II, I
B) III, I, II The reason why the program's economic viability is the first priority in the assessment of DPPs is that the IRS considers programs designed solely to generate tax benefits to be abusive tax shelters. This can lead to tax penalties. During an audit, the first thing the IRS agent will examine is if the program has a reasonable expectation of generating a profit. As the IAR recommending the program to your client, you want to do your best due diligence to make sure to limit the potential audit exposure. Assuming this program passes that test, you want to examine the potential tax benefits. Finally, because there is a very limited secondary market for DPPs, liquidity and marketability should be a low priority.
The alternative asset investments class is least associated with which of the following characteristics? A) Illiquidity B) Diversification C) Efficient pricing D) Nonnormal returns
C) Efficient pricing 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.
An exchange-traded fund whose strategy is to generate performance opposite that of the designated index is called A) an inverse fund. B) a leveraged fund. C) a hedge fund. D) a reverse fund.
A) an inverse fund. Inverse ETFs (also called short funds) seek to deliver the opposite of the performance of the index or benchmark they track. There are some who call these reverse funds, but the SEC, FINRA, and NASAA do not use that term. Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. There are leveraged inverse funds, but the term inverse would have to be in the description. Hedge funds are not exchange traded.
One of the benefits of being a limited partner in a direct participation program is that A) any losses generated by the partnership flow through to the limited partner and can be used against ordinary income in an amount up to $3,000 per year. B) any income generated by the partnership flows through to the limited partner and is treated as a long-term capital gain. C) the limited partner can make certain management decisions. D) the general partner is the only person liable for the debts of the business.
D) the general partner is the only person liable for the debts of the business In a DPP, it is only the general partners who have full liability; limited partners are liable only to the extent of their investment plus any future commitments. Limited partners lose their status if they undertake any management responsibility. Losses are passive losses and can be deducted only against passive income, not ordinary income. It is capital losses that are subject to the $3,000 limit. Any income is treated as passive income, and that is taxed at ordinary income tax rates, not the lower capital gains rate.
Lisa is considering investing in gold. She owns a portfolio of stocks, bonds, and money market securities. Relative to her existing portfolio, the primary benefit of the gold investment is most likely A) gold is a renewable resource, so Lisa can profit from the investment for many years. B) low correlation between traditional asset returns and gold. C) gold values are tied to cyclical industries. D) the investment horizon is longer than that of stocks and bonds, balancing the duration of the portfolio.
B) low correlation between traditional asset returns and gold. The returns on gold and other precious metals exhibit low correlation with stock and bond returns. Investment experts generally cite this as the key advantage to investing in hard assets. Precious metals do not generally follow cyclical industries. Indeed, most look at them as countercyclical investments. The investment time horizon is whatever the investor makes it. Investors can hold stock indefinitely and buy bonds with short or long maturities, depending on portfolio objectives. Gold is not a renewable resource.
One of your clients approaches you and is looking for an investment that will provide ready marketability and income. Which of the following would be the least appropriate recommendation? A) NYSE-listed preferred stock B) U.S. Treasury notes C) A limited partnership in rental real estate D) A money market mutual fund
C) A limited partnership in rental real estate The key is meeting both needs—marketability and income; each of the choices supplies both except the limited partnership. The client could expect income from a direct participation program (DPP) investing in rental real estate, but the liquidity would be missing.
Which of the following statements regarding the general partner (GP) in a direct participation program (DPP) is not true? A) 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. B) The GP is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations. C) A GP has a fiduciary relationship to the limited partners (LPs). D) The GP cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds.
A) 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.
A client was reading an offering document for an oil and gas drilling limited partnership program and noticed that one of the features was flow-through benefits. How would you explain this? A) Investors in the program are assured of a steady flow of income if the drilling is successful. B) Rather than being a separate taxable entity, the program's income or losses pass-through directly to the investors. C) Once the program has paid taxes on its income, the entire remaining balance passes-through to the investors. D) Losses generated by the program pass-through to the investor and may be deducted in full against ordinary income.
B) Rather than being a separate taxable entity, the program's income or losses pass-through directly to the investors. The philosophy behind flow-through is that any income or losses generated by a program of this type (a direct participation program or DPP) flow directly to the investors; there is no tax at the entity level. If there are losses, they may be deducted only against passive income (e.g., income from other partnerships). No assurances can ever be given.
Which of the following is true regarding ETNs? A) They are suitable for conservative investors seeking income. B) Their value can be impacted by changes in the issuer's credit rating. C) They are noncallable prior to maturity. D) As fixed-income investments, they do not have market risk.
B) Their value can be impacted by changes in the issuer's credit rating. ETNs are unsecured debt obligations carrying credit risk based on the issuer's credit rating. Fixed-income investments have the market risk more commonly referred to as interest rate risk, and they are usually callable. These are sophisticated instruments that are not suitable for conservative investors.
Your customer is asking if either exchange-traded funds (ETFs) or exchange-traded notes (ETNs) might be suitable investments for his portfolio. The customer makes several statements regarding his understanding of the products, but only one of them is accurate. Which is it? A) ETNs are equity securities because they trade on exchanges. B) If I want to sell my shares of an ETF, I have to wait until the next price is calculated to value the portfolio of securities. C) ETFs have a fixed coupon rate that I should expect to realize when they mature. D) ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer.
D) ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer. The only accurate statement is the one expressing that ETNs are issued by financial institutions and, therefore, the credit worthiness of the issuer should be a concerning factor. ETNs are debt instruments, not equity instruments. ETNs have a final payment at maturity based on the return of a single stock, a basket of stocks, or an equity index. Although ETF prices fluctuate based on the value of the securities within the fund portfolio throughout the trading day, they are priced by supply and demand, like all exchange-traded products. They are not forward priced like open-end mutual fund shares are.
