Unit 7 and Unit 8

An investor wishes to invest $5,000 into the KAPCO Balanced Fund, an open-end investment company. How many shares will the investor receive if the next computed NAV per share after receipt of the order is $41.30 and the fund has a sales charge of 4%? A)116.225 B)43.021 C)121.065 D)116.414

A)116.225 The investor will pay the POP (public offering price) of $43.02 per share. That price is computed by dividing the NAV of $41.30 by (100% ‒ 4%). Remember, the 4% sales charge is a percentage of the offering price, not the NAV. Dividing the $5,000 investment by the POP of $43.02 results in a purchase of 116.225 shares.

An aggressive investor is willing to risk $25,000 to align with his bearish outlook on the overall market. He notes liquidity being important if he needs to divest quickly, and risk taken needs to be commensurate with the upside potential. Which of the following would align most suitably with these objectives? A)Broad-based market inverse index fund B)Shorting broad-based index calls C)Hedge fund D)Narrow-based index fund

A)Broad-based market inverse index fund Inverse, or reverse, funds attempt to deliver returns that are opposite of those returned by the index they are tracking. If the index fell, aligning with this investor's bearish market outlook, a broad-based inverse index fund should do well, generating positive returns as the index performs negatively. When shorting calls, gains are limited to the premiums collected, and losses are potentially unlimited, which embody too much risk with not enough gain. Hedge funds are not deemed to be liquid and can be eliminated based on the investor's desire to get out quickly. An index fund (not inverse or reverse) moves with the market, and losses would occur if the markets faltered as this investor expects.

Freddie Mac does which of the following? I. Issues pass-through securities II. Purchases student loans III. Purchases conventional residential mortgages from financial institutions IV. Issues securities backed directly by the full faith and credit of the U.S. government A)I and III B)I and IV C)II and III D)II and IV

A)I and III Freddie Mac is a publicly owned and traded U.S. government agency that issues pass-through securities based on a pool of conventional residential mortgages purchased from financial institutions. Ginnie Mae is the only U.S. agency that issues securities backed by the full faith and credit of the U.S. government.

Which of the following securities is sold at auction? A)T-bills B)Freddie Macs C)Ginnie Maes D)Corporate bonds

A)T-bills T-bills, T-notes, and T-bonds are sold through auction. These auctions award securities to the most competitive bids. Agency securities are sold through selling groups appointed by the agency.

A registered representative notices that a fund he has been recommending to a recalcitrant customer has just declared a $1 per share dividend. Recognizing this as a great opportunity, he calls the client and explains that if a purchase is made within the next week, at the end of the month, the investor will receive a cash dividend of $1 for each share purchased. With a current public offering price of approximately $20 per share, that is a return on investment of 5% in a matter of a couple of weeks. This registered representative is A)guilty of violating the practice of selling dividends. B)properly showing the return as a percentage of the offering price. C)guilty of guaranteeing a dividend. D)offering the client a wonderful opportunity.

A)guilty of violating the practice of selling dividends. What the registered representative has not explained is that, upon payment of the dividend, the net asset value of each share will drop by $1.00. That is why the practice of selling dividends is prohibited. There is no problem with stating the dividend of $1 will be paid; that is not guaranteeing anything because the dividend has already been declared. Rate of return on a mutual fund should always be shown as a percentage of the offering price, but that "good deed" does not count when performing a misleading activity.

Interest on direct debt issued by the U.S. government is taxable at A)the federal level and exempt at the state level. B)the state level only. C)different levels in different states. D)the federal and state level.

A)the federal level and exempt at the state level. Interest on direct debt (T-bills, T-notes, T-bonds, and STRIPS) is taxable by the federal government but not by state or local governments.

A customer purchases ten 8% Treasury notes at 101-16. What is the dollar amount of this purchase? A)$10,116 B)$10,150 C)$10,812 D)$10,015

B)$10,150 Though the denomination of the T-notes purchased is not given, always assume par ($1,000) unless told differently in the question. Remember that government notes and bonds are quoted in 32nds. Therefore, a quote of 101-16 means 101 plus 16/32. 101 plus 1/2 = $1,015; $1,015 × 10 bonds = $10,150.

An investor looking for income with the highest degree of safety would probably choose to purchase A)FNMAs. B)GNMAs. C)FHLMCs. D)SLMAs.

B)GNMAs. All of the choices are U.S. government agencies, but only those issued by the Government National Mortgage Association (GNMA) have the direct backing of the government.

Government agency bonds issued by which of the following carry a minimum denomination of $1,000 with $1 increments? A)Sallie Mae B)Ginnie Mae C)Federal Home Loan Bank D)Freddie Mac

B)Ginnie Mae GNMA securities are available with a minimum denomination of $1,000 and in increments of $1.00. That means, for example, that a client can purchase one for $1,003.00 or $1,337.00 if desired. The only other agency with that type of pricing is the FNMA.

Which of the following regarding T-bills are true? I. T-bills trade at a discount to par. II. T-bills have maturities of 1 to 10 years. III. Most T-bill issues are callable. IV. T-bills are a direct obligation of the U.S. government. A)II and III B)I and IV C)II and IV D)I and III

B)I and IV T-bills trade at a discount to par, are six months or less to maturity, and are a direct obligation of the U.S. government. T-bills are also noncallable.

Which of the following statements regarding Treasury receipts are true? I. Interest is paid annually. II. Interest is paid at maturity. III. Interest is taxed annually. IV. Interest is taxed at maturity. A)II and IV B)II and III C)I and III D)I and IV

B)II and III Treasury receipts are zero-coupon bonds issued by broker-dealers. Zero-coupon bonds pay all of their interest at maturity. They are issued at a discount and redeemed at par, and the difference represents the interest earned. For zeroes with a maturity of more than one year, the interest (or discount) must be accreted each year—and is taxable that year as income. This is called imputed interest.

If an investor watches the latest T-bill auction fall to 4.71% from 4.82%, the best interpretation is that A)the decline in yields indicates the Federal Reserve Board has raised the discount rate. B)investors who purchased bills at this auction paid more for them than purchasers last week. C)investors who purchased T-bills 12 weeks ago paid less than subsequent purchasers. D)the federal funds rate and other short-term interest rate indicators are probably rising.

B)investors who purchased bills at this auction paid more for them than purchasers last week. The rates on the T-bills fell, so prices rose, and the investor paid more for the bills this week than last week. The decline in yields indicates there was good demand for the securities because the price rose, driving the yields down. The question does not indicate the price of T-bills 12 weeks ago; it is unclear if the investor paid less for the T-bills then. The federal funds rate and other short-term interest rates would decline—not rise—in line with those of T-bills.

T-bills are quoted A)in 32nds. B)on an annualized discount yield basis. C)as a percentage of par. D)in 16ths.

B)on an annualized discount yield basis. T-bills do not bear interest. T-bills trade and are quoted on an annualized discount yield basis.

A dealer in U.S. government securities quotes a 5-year Treasury note at 89.12-89.16. In dollars, that represents a spread of A)$0.04. B)$0.125. C)$1.25. D)$4.00.

C)$1.25. Treasury notes and bonds are quoted in fractions of 32nds. The spread between the bid and the ask is 4/32nds. In simpler terms, that is 1/8th. Each point is $10.00, so this 1/8th of $10.00 is equal to $1.25.

An investor purchased a 2x leveraged inverse ETF for $10,000. The ETF was linked to the performance of the S&P 500. During the first period, the S&P 500 rose by 8%, while during the next period, the index fell by 7%. What is the investment's value at the end of the second period? A)$9,844 B)$10,044 C)$9,576 D)$9,976

C)$9,576 The investment's value at the end of the second period would be $9,576. In 2× leveraged inverse ETF, the value of the shares would move in an opposite direction to an index by twice the amount of movement of the index. When the S&P 500 rose by 8%, the leveraged inverse ETF would have fallen by 16%. The investment value would have declined to $8,400 ($10,000 × 16% = $1,600; $10,000 - $1,600 = $8,400). When the S&P 500 fell by 7%, the leveraged inverse ETF would have increased by 14% from $8,400 to $9,576 ($8,400 × 14% = $1,176). $8,400 + $1,176 = $9,576.

A quote of 2.20 bid 2.18 offered would most likely be a quote on A)a general obligation bond. B)a T-bond. C)a T-bill. D)a Ginnie Mae bond.

C)a T-bill. Discounted instruments (such as T-bills) are quoted on a discount yield basis. Even though the number representing the bid is higher than the ask, it would be lower when converted into dollars. The greater the yield, the lower the price.

All of the following events will affect the net asset value (NAV) per share of a mutual fund except A)changes in the market value of the fund's portfolio of securities. B)wholesale redemption of fund shares. C)the fund receives cash dividends on the securities in its portfolio. D)the fund pays dividends to its shareholders.

C)the fund receives cash dividends on the securities in its portfolio. Dividends paid and received by the fund directly affect NAV. Changes in the portfolio value affect NAV because the securities are marked to market daily. While share redemption will reduce total NAV, the number of shares outstanding decreases in proportion, so the NAV per share stays the same.

Interest income from all of the following are exempt from state and local taxation except A)Series EE savings bonds. B)Treasury bills. C)Treasury bonds. D)FNMA mortgage-backed issues.

D)FNMA mortgage-backed issues. As a general rule, the interest income from U.S. government and agency securities is subject to federal taxation only; it is generally exempt from state and local taxation. However, the interest income from mortgage-backed securities is fully taxable.

Which of the following agency securities has the strongest backing of timely payment of principal and interest? A)Treasury notes B)FNMA C)FHLMCs D)GNMAs

D)GNMAs Of the agency securities listed here, the only one that is a direct obligation of the U.S. government is the GNMA. The others are quite safe but are only a moral obligation. Please do not be fooled by the Treasury note - that is not an agency security. This is a perfect example of why it is so important to carefully read the question. This is a perfect example of why it is so important to carefully read the question.

A customer, currently finding the income offered from a money market fund quite low, asks if there might be any debt instruments providing income that one could expect to at least keep pace with inflation as well as offer some tax relief. What suitable recommendation could be made that meets the investor's investment objectives? A)GNMAs B)U.S. T-bills C)Participating preferred D)TIPS

D)TIPS The investor has requested a debt security that can meet three criteria: provide income, keep pace with inflation, and offer tax relief. Treasury Inflation Protection Securities (TIPS) are specifically designed to provide income that keeps pace with inflation. In addition, the interest is tax exempt at the state and local level, providing some tax relief. GMNAs will provide income, but they are fully taxable on a state and federal level and offer no inflation protection. T-bills provide income that is probably lower than the money market fund the investor was unhappy with, and participating preferred stock is not a debt security.

An investor studying the annual report of a registered investment company reads that the net asset value per share has increased from $16.10 to $17.45. He notes that the market price has declined over the period. The investment company must be A)an open-end company. B)a real estate investment trust. C)a unit investment trust. D)a closed-end company.

D)a closed-end company. It is the closed-end investment company (CEF) where the market price is determined by supply and demand rather than the NAV. As a result, the trading price can be the same, above, or below the NAV. Although REITs do have a net asset value per share and their prices are also set by supply and demand, they are not registered investment companies.

Capital gains distributed by a mutual fund to shareholders are reported and taxable for the year A)the shareholder chooses but not later than two years after all shares are redeemed. B)the shares are redeemed by the fund. C)paid by the fund. D)earned (accrued).

D)earned (accrued). Capital gains can be distributed to shareholders by a mutual fund no more than once per year and are reported and taxable for the year earned (accrued).

One respect in which TIPS bonds differ from all other U.S. Treasury securities issued at par value is that they A)pay interest annually. B)have a variable coupon rate. C)are quoted in 1/8 increments. D)subject the investor to phantom income.

D)subject the investor to phantom income. The inflation protection of a TIPS bond comes from the semiannual adjustment to the principal value. Those increases are reported to the IRS as ordinary income to the investor. It is called phantom income because the investor does not "see" that money currently, but still must pay taxes on it. Like other Treasuries issued at par (T-notes and T-bonds), interest is paid semiannually at the fixed coupon rate. The actual interest will vary based on the principal adjustment, but the coupon is fixed. As with the other two mentioned, quotes are in 32nds.