Checkpoint Exam U17
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 B) Bearish C) Neutral D) Bullish or bearish
A) Bullish Inverse (reverse) 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 (going up) 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. U17LO3
One of your clients approaches you 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) A limited partnership in rental real estate C) A money market mutual fund D) U.S. Treasury notes
B) A limited partnership in rental real estate The key is meeting both needs—marketability and income—and each of them supply both except the limited partnership. The client could expect income from a DPP investing in rental real estate, but the liquidity is missing. U17LO7
The price of which of the following commodities is most likely to be impacted by weather? A) Gold B) Livestock C) Lead D) Orange juice
D) 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 or cold, or rain and 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. U17LO7
Investing in commodities could involve investing in any of these EXCEPT A) industrial items B) agricultural items C) animals D) consumer durables
D) 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. U17LO6
Your client who owns a DPP that generated a $10,000 passive loss for the year could A) deduct $10,000 against capital gains B) deduct $10,000 against ordinary income C) deduct $3,000 against ordinary income and carry over the rest D) only deduct the passive loss against passive income
D) 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. U17LO1
One of the benefits of adding precious metals to an investor's portfolio is A) low transaction costs. B) a potential inflation hedge. C) a high correlation to the stock market. D) generous income.
B) a potential inflation hedge. Precious metals are traditionally viewed as a hedge against inflation. One of their benefits is that they have a low correlation with the stock market. Transaction costs for precious metals tend to be higher than securities—the dealer spreads can be relatively high. One significant negative is that these investments generate no income. U17LO6
A 3X leveraged fund priced at $42 tracks an index that is up 2% one day and then down 3% on the next day. What should this fund be approximately priced at following these 2 volatile days? A) $41.55 B) $45.86 C) $40.50 D) $43.18
Starting with the $42 purchase price, a 2% increase to the index on day 1 equals $0.84 up (0.02 × $42 = $0.84). Given the 3X leverage, this would equate to a $2.52 increase on day one (3 × $0.84 = $2.52). At the start of day 2, the fund would be priced at $44.52 ($42 + $2.52 = $44.52). On day 2, the index falls by 3%. A 3% decrease in the fund equals $1.34 [0.03 × $44.52 ($1.3356 rounds up to 1.34)]. Again due to the 3X leverage structure of the fund, the $1.34 decrease equates to a $4.02 drop in the fund price (3 × $1.34 = $4.02). Therefore, after the 2 volatile days, the fund should be priced at approximately $40.50. U17LO3
A REIT and a direct participation program are similar because they both A) are operated by a centralized management B) can be described as a limited partnership C) pass-through losses to investors D) are traded actively in the secondary market
A) 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. U17LO2
An investor owns a 2x leveraged reverse ETF. If the underlying index should increase in value, A) the fund shares will decrease in value B) the fund shares will also increase in value C) there is no correlation between the fund and the value of the index D) the fund shares will decrease in value by a factor of 2
D) the fund shares will decrease in value by a factor of 2 A reverse, or inverse, fund will move in the opposite direction of the underlying index. Because this is a 2x (2 times) leveraged fund, it will move at a rate that is twice that of the index. U17LO3
Lisa Brownard 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 Brownard can profit from the investment for many years. B) gold values are tied to cyclical industries. C) low correlation between traditional asset returns and gold. D) the investment horizon is longer than that of stocks and bonds, balancing the duration of the portfolio.
C) low correlation between traditional asset returns and gold. The returns on gold and other precious metals exhibit low correlation with stock and bond returns. This is generally cited as the key advantage to investing in hard assets. Cyclicality and a long investment horizon are disadvantages of gold investments. Gold is not a renewable resource. U17LO6
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 issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer. 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) ETNs are equity securities because they trade on exchanges. D) ETFs have a fixed coupon rate that I should expect to realize when they mature.
A) 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. While 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. U17LO3
A 75-year-old customer asks if it is possible to sell his $500,000 variable life insurance policy to a party other than the insurance company that issued the policy. If a sale occurs, known as a life settlement, which of the following would be a violation of industry rules? A) Not requiring the insured to pass a physical exam before the sale B) Requiring the customer to relinquish all ownership rights to the policy C) Disclosing that the buyer becomes responsible for all premiums while the insured is living D) Quoting the price using an exclusive buyer that handles all the firm's life settlements
D) Quoting the price using an exclusive buyer that handles all the firm's life settlements Because of the limited secondary market for life settlements, any firm that engages in these transactions should obtain several bids to ensure the customer receives a fair price for her policy. U17LO4
You have a 70-year-old client with a $500,000 whole life insurance policy purchased 25 years ago. The policy currently has a cash value of approximately $150,000. With all of the children on their own and successful, the client no longer feels the need for the insurance and asks you if there is any option that might result in netting more than surrendering the policy for its cash value. You might recommend A) keeping the policy because the cash value will continue to grow B) engaging in a life settlement C) using IRS Section 1035 to transfer the cash value into a deferred annuity D) canceling the policy, but leaving the cash value with the insurance company with interest
B) engaging in a life settlement A life settlement, involves selling an existing life insurance policy for an amount in excess of the cash value, but less than the death benefit. Exact numbers are hard to compute without knowing all the details of the type of policy and health of the insured, but it would certainly be well above the $150,000 cash value. If the question indicates a terminally ill individual, the answer would be a viatical. An IRS Section 1035 transfer to an annuity will not put any additional cash in the client's hands. U17LO4
