Analysis practice (finals)
A 60-year old man, whose investment objectives are income and capital gains, wishes to buy securities that allow for liquidity during the trading day. The BEST recommendation would be: A. ETFs B. ETNs C. UITs D. Mutual Funds
The best answer is A. Both ETFs (Exchange Traded Funds) and ETNs (Exchange Traded Notes) trade, so they allow for liquidity during the trading day. There is no trading of mutual funds and UITs - these are redeemable securities. Mutual funds can be redeemed at NAV based that the close of the trading day; UITs are redeemable with the marketing agent, who will buy them at current NAV and remarket them to another investor for their remaining value. Therefore, we are down to the choice of an ETN or an ETF. This customer is looking for capital gains. This is possible with an ETF, because it holds a portfolio of equity securities that can grow in value over time. An ETN is a fixed income structured product that trades - fixed income securities are not designed to provide capital gains.
A head and shoulders "bottom" formation is: I bullish II bearish III a reverse upward trend IV a reverse downward trend A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. A head and shoulders bottom formation is bullish since the market has bottomed out and is now moving back upwards. It is a downtrend that has reversed itself.
A corporation issues $100,000,000 of 10% convertible debentures, convertible at $50. If all bondholders convert, which of the following choices are affected? I Total Assets II Total Liabilities III Net Working Capital IV Stockholders' Equity A. I and II B. II and IV C. II, III, IV D. I, II, III, IV
The best answer is B. If all bondholders convert, long term liabilities fall (because the bonds are eliminated) and stockholders' equity increases (because new common shares are issued). There is no effect on Total Assets or Net Working Capital.
If the Federal Reserve Open Market Committee authorizes its trading desk to enter into system wide reverse repurchase agreements, the effect will be to: I increase yields II decrease yields III raise debt prices IV lower debt prices A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. If the Federal Reserve trading desk enters into reverse repurchase agreements with bank dealers, it is temporarily selling government securities to the dealers, draining them of cash. This decreases free reserves which can be loaned out by the banks. The net effect is to raise market interest rates since funds are not readily available. If interest rates rise, debt prices will fall. The Fed will take such action if it believes the economy is growing too rapidly.
The dollar has depreciated against foreign currencies. The likely result is a(n): I increasing trade surplus II decreasing trade surplus III increasing trade deficit IV decreasing trade deficit A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. If the dollar depreciates, U.S. goods become cheaper to foreigners and foreign goods become more expensive in the U.S. Thus, we are likely to export more, increasing any trade surpluses or decreasing any trade deficits.
An elderly female client has income from her pension plan and social security that meets her needs. She has extra money available that she would like to use to help fund her favorite 8-year old grandson's college education. Which investment would be the best recommendation? A. 10 year Treasury notes B. Growth stocks C. S&P 500 Index fund D. Income bonds
The best answer is B. Since the child will be starting college in 10 years, growth stocks would be the best recommendation. These will grow the greatest amount over 10 years and this is sufficient time for the portfolio to absorb market volatility and recover. The second best choice would be the S&P 500 Index fund, but this would provide a lower return (and lower risk). Treasury notes and bonds give a much lower yield in return for absolute safety. Income bonds are corporate bonds that only pay interest if the corporation has enough "income." These are risky investments. Don't confuse the female client's needs with the child's needs in this question. The female client's needs are covered. This question asks what is appropriate for the child.
In a deflationary period, which security would be most negatively affected? A. Long-term bond B. Intermediate-term bond C. Common stock D. Preferred stock
The best answer is C. In a deflationary period, interest rates will fall, raising the prices of fixed income securities. Thus, fixed income securities are defensive securities in times of deflation. Remember that preferred stock, which pays a fixed dividend rate, is a fixed income security. In contrast, common stock price movements will depend on the state of the economy at the time deflation occurs, and thus would not be defensive during deflationary periods.
The highest interest rate listed below is the: A. discount rate B. federal funds rate C. prime rate D. broker loan rate
The best answer is C. The highest major interest rate in the economy is the Prime Rate. Ranking the major interest rate measures from lowest to highest: Fed Funds Rate, Discount Rate, Broker Loan Rate, Prime Rate
A 25-year old client with a low risk tolerance wishes to invest in bonds. The client has invested in equities before, but has no experience investing in bonds. The BEST recommendation would be: A. BB-rated short-term bonds B. BB-rated intermediate-term bonds C. AA-rated short-term bonds D. AA-rated long-term bonds
The best answer is C. This client has a low risk tolerance. Therefore, to minimize credit risk, investment grade bonds are appropriate (BBB or higher). To minimize interest rate risk, short-term maturities are better than long-term maturities. Both of these factors will result in a safer bond investment. However, the customer will get a lower yield, but that is not addressed in the question.
A young couple wishes to save $50,000 as the down payment on a new house that they plan to purchase in the next 6 months. Which of the following are suitable investment vehicles to recommend to the couple? I Money market funds II Bank certificates of deposit III Blue chip stocks IV Commercial paper A. I only B. II and III C. I, II and IV D. I, II, III, IV
The best answer is C. This couple needs $50,000 cash in 6 months. Clearly, money market funds and bank certificates of deposit are suitable. Blue chip stocks are not suitable, since they are subject to market risk. Commercial paper is usually not marketed to individuals; it is mainly an institutional market. However, some corporations sell commercial paper directly to customers in minimum $10,000 units via their websites. This is another very safe short term investment, and is suitable.
A Registered Investment Adviser has a retired client who wishes to put aside funds for the purchase of a car 5 years from now. Preservation of capital is important to this client. The RIA should recommend investments in: I Money market funds II Bank certificates of deposit III 5 Year Treasury Bonds IV 30 Year Treasury STRIPS A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV
The best answer is C. This customer needs funds in 5 years and preservation of capital is important to the client. Money market funds and bank certificates of deposit are clearly suitable. The 5 year Treasury Bond works as well, since the funds are needed in 5 years and this bond will mature at that time. The 30 year Treasury STRIPS is clearly unsuitable, since in 5 years, its value may have dropped sharply if interest rates rise (bonds with low coupons and long maturities are most affected by interest rate risk).
Which of the following securities are directly interest rate sensitive? I Utility Stocks II Growth Stocks III Preferred Stocks IV Common Stocks A. I and II B. III and IV C. I and III D. II and IV
The best answer is C. Utility stocks are directly interest rate sensitive since utilities have an extremely large portion of their capitalization as debt. If interest rates rise, as the utilities refund maturing debt, their interest costs increase, depressing earnings and therefore the stock price. Preferred stocks are directly interest rate sensitive because they pay a fixed dividend rate. If interest rates rise, their prices must fall to provide comparable market yields; and vice-versa. Common stocks and growth stocks are priced primarily on future expectations of earnings for these companies. Their prices are not directly interest rate sensitive.
All of the following are functions of the Federal Reserve Board EXCEPT: A. acting as fiscal agent for the U.S. Treasury B. auditing commercial banks for compliance with banking and MSRB regulations C. lending funds to member banks through the discount window D. setting margins on municipal securities
The best answer is D. The Federal Reserve has the power to set margins for non-exempt securities only. It cannot set margins for exempt securities such as governments and municipals. The Fed acts as fiscal agent for the Treasury, conducting the weekly Treasury auctions. It audits commercial banks for compliance with banking and MSRB rules. It lends funds to member banks at the discount rate.
