Final Exam 9

Which of the following securities would NOT be considered federal covered, but would still be considered exempt under the Securities Act of 1933? A) A municipal bond issued by a state and sold only in that state B) A variable annuity contract subject to the insurance commissioner's oversight C) A certificate issued by a court-approved trustee D) An exchange-traded futures contract

A) A municipal bond issued by a state and sold only in that state **While a municipal bond is considered an exempt security under the Securities Act of 1933, it is NOT a federal covered security. Federal covered securities include those listed on a national exchange (NYSE, AMEX, or Nasdaq) and those issued by a registered investment company. There is no federal exemption for either variable annuities or trust certificates.**

Under the Uniform Securities Act, all of the following persons are considered investment adviser representatives, EXCEPT: A) An employee of an advisory firm who provides administrative services that relates to portfolio selection B) A majority partner of an advisory firm established as a partnership C) A minority partner of an advisory firm established as a partnership D) An employee of an advisory firm who performs managerial functions that relates to portfolio

A) An employee of an advisory firm who provides administrative services that relates to portfolio selection **The Uniform Securities Act defines an investment adviser representative (IAR) as an employee, partner, officer, or director of the adviser, who performs research, makes recommendations, manages portfolios, or solicits advisory services. However, employees who perform administrative, clerical, and/or ministerial functions are excluded from the definition of an IAR.**

Bill Hendricks would like to open a Coverdell ESA for his three-year-old son. Which of the following statements is TRUE? A) Bill may contribute up to $2,000 per year B) At least 50% of the investments in the account must be conservative C) The account becomes the property of the child upon reaching the age of majority D) Only parents or grandparents may contribute for the benefit of the minor child up to age 18

A) Bill may contribute up to $2,000 per year **Any person (whose income does not exceed the threshold) can contribute to a Coverdell ESA for a child; however, the total contributions to the account are limited to $2,000 per year. An account becoming the property of the minor is true of an UGMA or UTMA account, not a Coverdell ESA. There is no percentage requirement for investments in the account.**

Which of the following entities pays federal income taxes? A) C Corporation B) S Corporation C) Sole proprietorship D) Trust

A) C Corporation **In the U.S., a C Corporation is taxed separately from the owners of the business. After the C Corporation has paid income taxes, it can pay their shareholders a dividend; however, this payment is then taxable to the shareholder (i.e., double taxation). Both S Corporations and sole proprietorships are not taxable entities. In other words, all of their income passes through and is taxed to the owners (i.e., single taxation). Taxation of trusts is more complicated, but in some instances, income from a trust is only taxable to the beneficiary. Since C Corporations are always taxed, it's the best answer to this question.**

In order for an individual to be eligible for a Health Savings Account (HSA) the individual must be: A) Covered under a high deductible health plan (HDHP) B) Covered under a qualified retirement plan C) A joint owner with their spouse D) Enrolled in Medicare

A) Covered under a high deductible health plan (HDHP) **To be eligible for a Health Savings Account (HSA), a person must be covered under a high deductible health plan (HDHP), not a qualified retirement account. Individuals cannot be enrolled in Medicare or be claimed on another individual's income taxes. Each eligible spouse must open a separate HSA. Joint HSAs are prohibited. Withdrawals from an HSA are tax free provided the funds are used to pay qualified medical expenses.**

The potential loss for a limited partner in a real estate limited partnership is limited to: A) Her initial investment plus any unpaid amounts to which she had committed to pay B) Her initial investment plus any real estate that is shared by the partners C) Only the amount of money that is borrowed by the partnership D) Only her initial investment

A) Her initial investment plus any unpaid amounts to which she had committed to pay **In a limited partnership, the liability for a limited partner may not exceed her initial investment amount plus any unpaid amounts to which she has agreed to pay. Generally, limited partners are not liable for the debts that are incurred by the partnership. However, when a limited partner cosigns a loan for the partnership and agrees to be responsible for a portion of the loan, the limited partner's liability is increased.**

A customer invested $1,000 per month, over six months, in the XYZ Growth Fund. Based upon the following table, which TWO of the following statements are TRUE? A customer invested $1,000 per month, over six months, in the XYZ Growth Fund. Based upon the following table, which TWO of the following statements are TRUE? Month 1 2 3 4 5 6 POP 15.00 14.00 12.00 10.00 8.00 11.00 I) The average price per share is $11.67. II) The average cost per share is $11.17. III) The average gain per share is $4.00. IV) The average loss per share is $1.60. A) I and II B) I and III CII and III DII and IV

A) I and II **This method of investing is referred to as dollar cost averaging. The objective, though not guaranteed, is for the average cost per share to be less than the average price per share. Month Investment POP # Shares Purchased 1 $1,000 $15 66.66 2 $1,000 $14 71.43 3 $1,000 $12 83.33 4 $1,000 $10 100.00 5 $1,000 $8 125.00 6 $1,000 $11 90.91 Total $70 537.33 Average price per share Average cost per share 70 / 6 = $11.67 $6,000 / 537.33 = $11.17

Under SEC Release IA-1092, which TWO of the following statements are TRUE? I) An individual who provides tailored advice about securities but does not execute transactions is an investment adviser. II) An individual who writes an investment column for the Floor Street Journal is an investment adviser. III) An individual who provides advice about which fund manager a client should choose is an investment adviser. IV) An individual who provides advice about which fund manager a client should choose is an investment adviser only if he is compensated by the manager he is recommending. A) I and III B) I and IV C) II and III D) II and IV

A) I and III **According to SEC Release IA-1092, an individual that provides advice about a client's specific situation is still considered an investment adviser even if that individual does not implement the advice. Individuals selecting a particular investment manager would also be considered to be providing advice and fall under the definition of an investment adviser.**

A client purchases a TIPS with a 4% coupon at par. If the CPI indicates that the rate of inflation has increased by 5%, which TWO of the following statements are TRUE? I) The client will receive a 4% coupon rate II) The client will receive a 9% coupon rate III) The client will receive a 5% increase in his next payment IV) The client will receive a 1% increase in his next payment A) I and III B) I and IV C) II and III D) II and IV

A) I and III **Treasury Inflation-Protected Securities (TIPS) are U.S. government securities that have a principal amount that is adjusted for inflation (based on the Consumer Price Index or CPI). Choice (I) is correct since the coupon rate on a TIPS is fixed. The principal amount on which interest is based will change according to any increase in the rate of inflation, which has increased by 5% in this question; choice (III). The investor's coupon payment will represent 4% of the adjusted principal amount.**

According to the NASAA Custody Requirements for Investment Advisers Model Rule, an investment adviser that intends to send account statements directly to its clients: A) Is permitted to do so if the IA is audited by an independent CPA B) Is permitted to do so if the IA has been approved by the Administrator C) Is permitted to do so if the IA provides the statements on a monthly basis D) Will be committing a violation

A) Is permitted to do so if the IA is audited by an independent CPA **According to the NASAA Custody Requirements for Investment Advisers Model Rule, an investment adviser that intends to send account statements directly to its clients is permitted to do so if the IA is audited by an independent public accountant. Advisory clients must be provided with account statements on a quarterly (not monthly) basis.**

An firm has been hired to be the investment adviser of the Western Vistas family of funds. The fund family is the firm's only advisory client and it currently has $18 million under management. Which of the following statements concerning the adviser's registration is TRUE? A) Since it is a federal covered adviser, it must register with the SEC. B) It must register with both the SEC and each state in which it conducts business until its assets under management exceed $100 million. C) It is required to register only in the states in which the fund family has clients. D) Under the de minimis exemption, it is exempt from registration at both the federal and state levels since it only services one mutual fund complex.

A) Since it is a federal covered adviser, it must register with the SEC. **Investment advisers are ultimately required to be registered at either the federal level with the SEC or at the state level with the state Administrator; there is no requirement for them to register at both levels. Although there are exceptions, the typical basis for determining whether state or federal registration is required is the amount of assets under management (AUM) for the adviser. However, an important exception applies to firms that serve as advisers to registered investment companies. Regardless of the amount of assets under management for the adviser, any adviser of an investment company is considered a federal covered adviser and is only required to register with the SEC. In this question, the Western Vista family of funds is an investment company.**

An investor who resides in State Y is visiting State X. Before returning to his home, he meets with a friend who is an agent and is registered in State X. While at a restaurant in State X, the agent convinces the client to immediately buy a specific security, rather than waiting until the client gets home. The client pays for the purchase and is told that the confirmation will be sent to his home in State Y. If the agent sold this client an unregistered, non-exempt security, which of the following statements is TRUE? A) The Administrators of State X and State Y may take action against the agent. B) The Administrator of every state in which the agent is registered may take action against the agent. C) Only the Administrator of State Y may take action against the agent. D) Only the Administrator of State X may take action against the agent.

A) The Administrators of State X and State Y may take action against the agent. **An Administrator has jurisdiction over every offer or offer to sell that is made or accepted in a state. In this question, an offer was made and accepted in state X however, the client resides in state Y. Though the Administrator in state X has jurisdiction, action can be taken by the administrator of both states.**

Which of the following statements about testamentary trusts is NOT TRUE? A) The donor manages the assets in the trust. B) The trust goes into effect after the creator dies. C) The trustee manages the assets in the trust. D) The assets must go through probate before they're placed in the trust.

A) The donor manages the assets in the trust. **A testamentary trust goes into effect after the donor passes away. The assets are required to go through the probate process. Once the assets are put into the trust, the trustee (not the donor) manages the assets for the beneficiaries.**

What is the most suitable policy for an individual who wants to earn a higher return from an insurance policy, but does not want to assume market risk? A) Universal life insurance B) Whole life insurance C) Variable life insurance D) Non-qualified annuity

A) Universal life insurance **In some cases, universal life insurance will either pay a minimum rate of return or slightly higher. Depending on the contract specifics, the additional rate of return could be pegged to a stock index or interest rate. An individual who purchases a variable annuity assumes the investment (i.e., market) risk of the security. If the separate account performs well, the value of the investment will increase. However, if the securities in the separate account perform poorly, the value of the investment will decline.**

Which of the following must be included in a solicitor disclosure document? I) The manner in which the solicitor will be paid by the registered investment adviser II) The amount of the client's fee that is related to soliciting activities III) The details of the agreement between the solicitor and the registered investment adviser IV) The business history of the solicitor A) I and III only B) I, II, and III only C) I, III, and IV only D) I, II, III, and IV

B) I, II, and III only **In the solicitor disclosure document, investment advisers must disclose how they intend to pay the solicitor, how much of the client's fee will be paid to the solicitor, and a description of the relationship between the solicitor and the investment adviser. However, a full history of the solicitor is not required to be disclosed.**

If a corporation had annual earnings per share of $2.40, and $1.60 was retained by the corporation, the annual dividend payout ratio is what percentage of earnings? A) 80% B) 33% C) 6.6% D) 2.5%

B) 33% **To determine the annual dividend payout ratio, first determine the dividend, which is the earnings per share of $2.40, minus the retained earnings of $1.60 or $.80. Then divide the dividend of $.80 by the $2.40 of earnings per share to determine the percentage of earnings paid to the shareholders, 33%**

Mark purchases an equity-indexed annuity contract that guarantees a 5% return with an 80% participation rate and a 12% interest-rate cap. The index to which the funds are tied rises in value by 10% this year. What return does Mark receive? A) 5% B) 8% C) 10% D) 12%

B) 8% **In an equity-indexed annuity, the owner receives a guaranteed minimum interest rate with potential upside based on the performance of the designated index. If the return on this index is less than the guaranteed rate, the owner receives the minimum. If the index return is greater than the guarantee, the owner receives the greater return up to the capped maximum. Many contracts only pay a portion of the index return. In this example, the client is entitled to 80% of the index return capped at a 12% maximum. The index increased by 10%, so the client's contract is credited with 80% of that amount, or 8%.**

The portfolio manager of a growth fund is analyzing potential common stocks. Generally, the manager will give which of the following the MOST consideration? A) A company's low price-to-book value B) A company's year-to-year earnings momentum C) A company's short-interest D) A stock's current dividend yield

B) A company's year-to-year earnings momentum **For growth investors, a key consideration is a company's earnings momentum (growth). A growth company will typically have a significant year-over-year increase in its earnings. On the other hand, value investors will look for stocks that have a low price-to-book value and high current yield.**

All of the following are paid compensation for giving investment advice. Under the Investment Advisers Act, which one is not provided with a general exemption from the definition of an investment adviser? A) A trust company B) An agent for an athlete C) An accountant providing incidental investment advice D) A publisher

B) An agent for an athlete **Any person in a profession that does not have an exclusion from the definition of an investment adviser and who meets the three-prong test of SEC Release 1092 would be considered an investment adviser. When determining status, the regulators look at a person's activities, not her title.**

The advantages of a living (inter vivos) trust include: A) Avoiding estate taxes B) Avoiding probate C) Receiving tax credits D) Avoiding gift taxes on all intrafamily asset transfers over $1,000,000

B) Avoiding probate **A living (inter vivos) trust is a trust created while the grantor is still alive. One of the main advantages of a trust is that it allows the estate to avoid probate. Trusts do not allow people to avoid estate taxes, but they can be used to reduce them in certain circumstances. (Most living trusts are revocable which means the grantor may rescind them at any time. The assets of a revocable trust must be included in the estate when calculating the estate taxes due.)**

Which of the following advisory fees is prohibited? A) Charging a fee based on a percentage of an account's balance as the first of each month B) Charging a fee of 5% on the highest value of the account each month C) A $5,000 fee for creating a financial plan D) Charging a client an hourly rate for managing the account

B) Charging a fee of 5% on the highest value of the account each month **Advisory fees must be appropriate for the service being provided. Charging a flat fee, regardless of how much management has been provided by the adviser, is prohibited. Investment advisers are allowed to charge flat fees for creating financial plans, as well as hourly fees or fees that are based on assets under management, provided they're not excessive for the service being provided. Charging a 1% fee based on assets under management is roughly the industry average; however, charging 5% is most likely prohibited under both state and federal law.**

Which of the following statements is TRUE about ETNs? A) ETNs are unsecured bonds and investors are secured creditors if the issuer declares bankruptcy. B) ETNs may lose value even if the underlying index remains stable. C) ETNs are suitable for investors who want to capture long-term growth. D) Similar to ETFs, ETNs are suitable for passive investors.

B) ETNs may lose value even if the underlying index remains stable. **Unlike an ETF which is backed by an independent pool of securities, an ETN is an unsecured bond that's issued by a financial institution. That company promises to pay ETN holders the return on some index over a certain period and return the principal of the investment at maturity. However, if something happens to the issuing company (e.g., bankruptcy) and it's unable to make good on its promise to pay, ETN holders could be left with a worthless investment.**

Which TWO of the following statements are TRUE regarding the buyer and writer of a straddle? I) The buyer of a straddle expects the market to fluctuate. II) The writer of a straddle expects the market to fluctuate. III) The buyer of a straddle expects the market to remain stable. IV) The writer of a straddle expects the market to remain stable. A) I and II B) I and IV C) II and III D) DII and IV

B) I and IV **The writer (seller) of a straddle (call and put) believes the stock's price will remain stable. The buyer of a straddle expects that the market price of the underlying stock will be volatile.**

An IAR is analyzing various fixed-income securities for a client's portfolio. She notes that the yield curve is normal. This indicates that: I) Short-term bonds are yielding more than long-term bonds II) Short-term bonds are yielding less than long-term bonds III) The economy is expanding too rapidly IV) Long-term bonds are yielding more than short-term bonds V) Short-term bonds and long-term bonds are moving toward parity A) I and IV only B) II and IV only C) III and V only D) V only

B) II and IV only **A normal yield curve occurs when yields on long-term bonds are greater than yields on short-term bonds. Another way to understand normal yield curves is to remember that the longer the maturity of a bond, the more the yield investors demand for the additional time risk. Normal yield curves are generally understood to indicate a healthy economy. Alternate terms for a normal yield curve are positive, ascending, or upward sloping.**

An insurance agent works in an office building down the hall from a broker-dealer. They are not affiliated. What compensation may the agent receive from the broker-dealer in exchange for referrals? A) Discounted commissions B) Insurance referrals C) Commissions D) 12b-1 fees

B) Insurance referrals **Only individuals who are registered agents may receive monetary compensation from a broker-dealer based on the sale of a security. In this scenario, the insurance agent is not licensed and may not receive compensation in the form of commissions or fees, or soft-dollar compensation (no cash compensation) in the form of discounted commissions. If a broker-dealer wants to refer its clients to an insurance professional, this is permitted. Only licensed insurance professionals may be compensated for the sale of life insurance.**

A mathematical technique that uses randomly generated scenarios, known as simulations, to determine the probability of possible returns, is known as the: A) Capital Asset Pricing Model B) Monte Carlo Theory C) Sharpe Ratio D) Random Walk Theory

B) Monte Carlo Theory **Monte Carlo is a technique which uses randomly generated scenarios, called simulations, to attempt to determine the probability of possible returns. It is one of several computer programs that has been developed recently to give investors different tools to help them manage their portfolios.**

An investment adviser representative and a client have similar financial resources, investment goals, and risk tolerance. However, although the IAR recommends penny stocks as a small part of her client's portfolio, she would never consider investing in such securities herself. Which of the following statements is TRUE? A) As long as the recommendations to her clients are suitable for them, it does not matter what the IAR chooses to include in her portfolio B) The IAR should tell her client that the recommendation is inconsistent with her own investment policy C) An IAR is not allowed to reveal to a client what is in her personal portfolio D) Penny stocks are never suitable investments

B) The IAR should tell her client that the recommendation is inconsistent with her own investment policy **An investment adviser whose personal investing is inconsistent with recommendations made to clients generally has an obligation to disclose this to customers.**

Sharon Smith is a registered investment adviser who frequently recommends the purchase of limited partnership interests to her clients. Her personal financial condition and objectives are similar to her clients' but she does not purchase limited partnership interests for her own account. According to the Investment Advisers Act, which of the following statements is TRUE? A) An adviser should not purchase for her own account securities that are recommended to customers B) The adviser must disclose the fact that her personal securities transactions are inconsistent with the advice given to clients C) The adviser need not disclose information about her personal investment practices regardless of whether commissions are received for the products sold D) An adviser's personal investment practices are only required to be disclosed if the adviser receives performance-based fees

B) The adviser must disclose the fact that her personal securities transactions are inconsistent with the advice given to clients **An investment adviser generally must disclose that her personal securities transactions are inconsistent with the advice given to clients, regardless of whether the adviser receives performance-based fees.**

If an investment adviser recommends that its clients diversify their investments by purchasing gold coins, gold certificates, or gold futures, which of the following risks is the adviser trying to avoid? A) The risk associated with projecting returns over multiple asset classes B) The risk of some investments losing value or performing poorly due to inflation C) The risk of the stock market losing liquidity during a market downturn D) The risk that a single stock will perform poorly and cause the portfolio to lose value

B) The risk of some investments losing value or performing poorly due to inflation **Commodities investments, including futures, are a way to hedge against inflation risk. The risk that a single stock will perform poorly is referred to as business risk and may be diversified by purchasing stocks of multiple companies.**

In a retirement plan, if key employees own more than 60% of the plan's assets, it is considered a: A) Qualified plan B) Top-Heavy plan C) Non-qualified plan D) Special ERISA plan

B) Top-Heavy plan **A top-heavy plan is one in which key employees own more than 60 percent of the plan's assets. If a plan is determined to be top heavy, there are certain steps that an employer can take to maintain the tax-advantaged status of the plan.**

Which of the following insurance contracts have the elements of term insurance, a cash value that is not market-based, and a flexible death benefit? A) Whole life B) Universal life C) Modified endowment policy D) Variable life

B) Universal life **Universal life is an insurance contract that allows the customer to select the amount of coverage and the size of the premium. Additionally, it has a cash value that grows at a minimum guaranteed rate. However, the performance of the cash value is not market-based.**

When is an investment adviser NOT required to provide a balance sheet to its clients? A) When the adviser has discretionary control over a client's funds or securities B) When the adviser requires the prepayment of a $150 initial advisory fee C) When the adviser requires the prepayment of a fee that is greater than $500, six months or more in advance of providing service D) When the adviser has taken custody of the client's funds or securities

B) When the adviser requires the prepayment of a $150 initial advisory fee **NASAA's model rules require an adviser to file a balance sheet whenever the adviser requires the prepayment of fees in excess of $500, six or more months in advance of providing any services. The filing would also be required if an investment adviser maintains custody of customer funds and securities. Remember, an IA that has full discretion (i.e., the ability to withdraw funds or check-writing privileges) is considered to have custody.**

A portfolio has a beta of 1.0 and an expected return of 12%. What would the alpha of the portfolio be if the beta was 1.4 and the actual return was 18.8%? A) 6.80% B) -6.80% C) 2.00% D) -2.00%

C) 2.00% **Alpha is the difference between the portfolio's actual return (which is given) and expected return. The expected return can be determined by using the Capital Asset Pricing Model (CAPM). Since this question doesn't provide a risk-free rate, the calculation of expected return is simply beta multiplied by the market return (Expected Return = Beta x Market Return). As this question begins, a portfolio with a beta of 1.0 will have the same expected return as the market return. In other words, both the expected and market returns are 12% (Beta of 1.0 x Market Return of 12% = 12%). However, if the beta changes to 1.4, the expected return will rise to 16.8% (Beta of 1.4 x Market Return of 12%). The question specifically states that the actual return of the portfolio was 18.8%. Therefore, the alpha can then by calculated by taking the actual return on the portfolio minus the expected return (actual return of 18.8% - expected return of 16.8% = +2.00% alpha).**

An agent solicits the purchase of MPH, Inc, a nonexempt, unregistered security. The agent requests the client sign a document, acknowledging the security's status. The document also includes an exculpatory provision absolving the agent and the broker-dealer from any liability or wrongdoing. The waiver the client signed is: A) Acceptable B) Acceptable with the Administrator's approval C) Null and void D) Subject to civil liability and criminal penalty

C) Null and void **Agents must not solicit nonexempt, unregistered securities nor should they request a client sign documents absolving the agent or broker-dealer from wrongdoing. Such statements are sometimes called exculpatory clauses and are prohibited. These documents would be null and void under the Uniform Securities Act.**

The Uniform Securities Act considers which of the following to be an investment adviser representative (IAR)? A) A CPA who gives occasional advice in connection with his tax service, but charges no additional fees B) A clerical employee of an advisory firm that has a place of business in the state C) A CPA with an office in a state who charges a fee for advice that is more than just incidental to his profession D) An officer or director of a federal covered adviser who has clients in a state, but has no office in that state

C) A CPA with an office in a state who charges a fee for advice that is more than just incidental to his profession **According to the Uniform Securities Act, an individual who solicits, sells, or negotiates investment advisory services is defined as an investment adviser representative (IAR). The rule excludes any person serving in a clerical or administrative position or any employee of a federal covered adviser who does not have an office in the state. Professionals (lawyers, accountants, teachers, and engineers) qualify for the exemption if their advice is incidental to their profession and no additional fee or charge is assessed for the advice.**

Under the Investment Advisers Act, which of the following statements is TRUE? A) If an IA is given brokerage discretion by a client, the IA may not choose a full-service broker-dealer due to the higher fee schedule B) Since an IA is prohibited from exercising brokerage discretion, the client must choose a broker-dealer through whom the trades will be executed C) An adviser who has investment discretion may not always have brokerage discretion D) Commissions may not be levied on transactions if the client is paying an advisory fee

C) An adviser who has investment discretion may not always have brokerage discretion **The client can decide which firm will execute the trades, or the client can give the investment adviser brokerage discretion. If given the authority to select a broker, the investment adviser has the flexibility to select either a full-service broker or a discount broker. Information regarding these arrangements is found in Form ADV Part 2.**

A new investment advisory firm registers with the Administrator on June 1. Just before its one- year anniversary on June 1 of the following year, the firm renews its registration and the registrations of each of its investment adviser representatives. Which of the following statements is TRUE? A) The firm has complied with the Uniform Securities Act since registrations are valid for one year from the initial registration (June 1) B) The firm effectively renewed prior to the deadline, but the representatives did not C) Both the firm's and its IARs' registrations lapsed on December 31 of the prior year D) The representatives are properly registered, but the firm's registration has lapsed

C) Both the firm's and its IARs' registrations lapsed on December 31 of the prior year **Under the Uniform Securities Act, all registrations expire on December 31 and then must be renewed. In this situation, both the firm and the investment adviser representatives have allowed their registrations to lapse.**

If an analyst wants to measure the degree to which a company or partnership is leveraged, he would calculate the: A) Return on equity, which is net income / average stockholders' equity B) Current ratio, which is current assets / current liabilities C) Debt-to-total capital ratio, which is debt / total capital D) Quick asset test, which is (current assets - inventories) / current liabilities

C) Debt-to-total capital ratio, which is debt / total capital **The debt-to-capital and debt-to-equity ratios both measure the amount of a company's capital that is financed with debt (i.e., its degree of leverage). The quick asset test and current ratio both measure a company's liquidity or short-term financial health.**

In order to form a limited partnership, two or more people must: A) Agree to operate a business together B) Elect to be taxed under Subchapter S C) File a certificate with the appropriate state or local official D) File a registration statement with the SEC under Regulation A

C) File a certificate with the appropriate state or local official **The only way to create a limited partnership is by filing a certificate (or other document) with a state or local agency. A general partnership, in contrast, is created whenever two or more people agree to form a partnership. The agreement does not even need to be in writing.**

If an individual forms a broker-dealer as a sole proprietorship, what information needs to be provided to the Administrator? A) Tax returns for the past three years B) Net income figures C) Financial statements D) Annual tax returns

C) Financial statements **The USA requires a broker-dealer to file its financial statements with the Administrator annually and, in some cases, quarterly.**

Which of the following statements is/are TRUE of an investment adviser who takes custody of cash and securities belonging to its customers? I) The funds must be deposited into one or more separate accounts that only contain customer funds. II) The adviser may combine customer cash with its own if proper disclosure is made. III) The adviser must also be registered as a broker-dealer with the Administrator. IV) The adviser must disclose to its clients both the location and manner in which the securities are held. A) II only B) I and III only C) I and IV only D) II, III, and IV only

C) I and IV only ** Firms that maintain custody of customer assets must satisfy these guidelines: (1) Customer funds must be segregated, (2) The location of assets must be disclosed in writing and, (3) The records must be audited annually. When a firm has custody of customer cash and securities, it is required to be a qualified custodian. Broker-dealers, banks, and trust companies may be recognized as qualified custodians and may, therefore, hold cash and securities belonging to customers. Since these different entities may serve as qualified custodians, it is incorrect to state, as in choice (III) that the adviser may only maintain custody if it is also registered as a broker-dealer.**

A portfolio manager is interested in purchasing bonds, but is concerned about an increase in interest rates. In order to make the portfolio less price sensitive to yield changes, the manager does which TWO of the following? I) Buy bonds with a long duration II) Buy bonds with a short duration III) Buy bonds with a high coupon IV) Buy bonds with a low coupon A) I and III B) I and IV C) II and III D) II and IV

C) II and III **Bonds with short durations and high coupons are less price sensitive to changing interest rates. On the other hand, bonds with long durations and low coupons have more price volatility as interest rates fluctuate.**

An investment adviser is registered and located State A. One of the IAR's has three non-institutional clients and one institutional client in State B. A different IAR has four non-institutional clients in State B. If the investment adviser does NOT have an office in State B, who must register in that state? A) Only the IARs B) The IARs and the investment adviser C) Only the investment adviser D) Neither the IARs nor the investment adviser

C) Only the investment adviser **An advisory firm that has more than five non-institutional clients residing in a state is required to register in that state. Since one IAR has three clients and the other has four clients, the investment adviser has seven clients total and must register. However, since neither IAR has more than five non-institutional clients, neither one needs to register in State B. Notice that all persons (the IA and IARs) need to be registered in State A.**

Which of the following statements is TRUE regarding SEC Release IA-1092? A) Investment advisers are considered to be rendering advice only in cases where they recommend a specific individual security or mutual fund B) It effectively overrode the definition of adviser found under the now antiquated ABC test C) The Release noted that an individual who provides advice about securities in general may meet the definition of investment adviser D) IA-1092 has deemed the Investment Advisers Act of 1940 definitions to be moot, null, and void

C) The Release noted that an individual who provides advice about securities in general may meet the definition of investment adviser **SEC Release IA-1092 was created to provide guidance to the industry on how existing statutes (the Investment Advisers Act of 1940 and the Uniform Securities Act) applied to some of the newer types of advisory services being offered (e.g., wrap accounts, etc.). The Release was not intended to replace either the Investment Advisers Act or the USA. One of the issues that IA-1092 examines is how the ABC test is met by someone who provides general advice about securities investing but does not recommend specific investments. Under the Release, persons who give generalized advice about investing in securities, as a business, and for compensation, are deemed to be investment advisers.**

Which of the following statements about variable annuities is FALSE? A) The assets in a separate account are managed with a specific investment objective B) The portfolio may be invested in shares of other mutual fund companies C) The annuity feature protects investors from capital losses D) A change in investment objectives requires voter approval

C) The annuity feature protects investors from capital losses **Variable annuity assets are directed into a separate account and invested in a portfolio that fluctuates with the market. Therefore, an investor's principal will fluctuate over time as it remains invested in a variable annuity. Mutual funds are often an investment choice within an annuity. If an investor is interested in principal protection and a guaranteed rate of return, he should consider a fixed annuity.**

An investor owns a TIPS worth $1,000 that has a coupon of 3.5%. Over a three-year period, the annual inflation rate is 4%. What is the total return after three years? A) 3.50% B) 4.00% C) 11.36% D) 23.85%

D) 23.85% **The formula for calculating total return is an investment's ending value minus its beginning value plus any income received (interest and/or dividends) divided by the beginning value. Since this question involves TIPS, part of the challenge is calculating the ending value. To calculate the ending value, the principal amount is upwardly adjusted each year based on the rate of inflation and this amount is then multiplied by the fixed coupon rate to determine the annual interest. To solve this problem, the following method may be used: Beginning value of the TIPS: $1,000 Coupon Rate: 3.5% Annual Inflation Rate: 4% After Year Principal Coupon Interest Paid 1 $1,040.00 3.5% $36.40 2 $1,081.60 3.5% $37.86 3 $1,124.86 3.5% $39.37 Total Interest Received = $113.63 Ending Value:$1,124.86 Beginning Value:- $1,000.00 Total Appreciation:$124.86 Interest Income:+ $113.63 Sum of Appreciation & Income:$238.49 Total Return = $238.49 / $1,000 = 23.85%

Mirage Adviser, a registered investment adviser, receives referrals from Ted, a retired businessman. Mirage gives Ted $500 for every client he refers who opens an account with Mirage. Which of the following documents must Mirage's personnel collect from any client Ted refers who opens an account with them? A) Mirage's Form ADV Part 2 B) A copy of the contract that the client signed with Ted C) A copy of Ted's driver's license or other identification D) A signed and dated acknowledgment that the client received Mirage's Brochure and a separate solicitor's disclosure document from Ted

D) A signed and dated acknowledgment that the client received Mirage's Brochure and a separate solicitor's disclosure document from Ted **An unaffiliated solicitor who receives cash compensation for referring clients to an investment adviser must furnish these clients with both the investment adviser's Brochure and a separate written disclosure document. The separate disclosure document describes the terms of the solicitor's arrangement with the investment adviser including the compensation that the solicitor receives for referrals. The adviser must receive a signed and dated acknowledgment from the client confirming receipt of the adviser's Brochure and the solicitor's disclosure document. The acknowledgment must be collected before the client enters into a contract to retain the adviser's services or at the time this agreement is entered into.**

Under the Uniform Securities Act, which of the following is exempt from the definition of an investment adviser? A) An insurance company that provides investment advice to clients for a fee B) A company that provides investment advice to non-profit organizations and municipalities for a fee C) A firm that solely provides advice on municipal bonds for a fee D) A trust company that provides investment advice to trust clients for a fee

D) A trust company that provides investment advice to trust clients for a fee **Under the Uniform Securities Act, a trust company is exempt from the definition of an investment adviser. The other persons that are exempt from the definition include: Banks and/or savings institutions Lawyers, accountants, teachers, and engineers (remember L,A,T,E) whose advice is incidental to their profession Broker-dealers whose advisory services are incidental to their business Bona fide publishers Federal covered advisers Any other person that is designated by the Administrator A firm that provides advice about securities (even if they are municipal bonds) for a fee is considered an investment adviser.**

According to NASAA provisions, an investment adviser that maintains custody of a client's funds must: A) Notify the client of the location of the funds within 90 days of taking custody B) Provide prior verbal notification to the Administrator of its intention to take custody of the client's funds C) Notify the client of the location of the funds within 30 days of taking custody D) Be subject to a surprise audit by an independent accountant

D) Be subject to a surprise audit by an independent accountant **If an investment adviser maintains custody of its clients' funds, it must provide prompt written notification as to the location of where the funds are being held as well as whether the location is changed. The notification of taking custody of client funds must be provided in written form, not verbal. Any audit of the records must be performed by an independent accountant, not by the Administrator.**

An IAR who is registered in State A decides to conduct a series of investment seminars in State B. One of the clients who attends the seminar in State B invests with the IAR, and loses a significant part of his investment. If the client wanted to alert the regulators, which Administrator would have the ability to initiate an investigation and take action? A) The Administrator in State A would be able to, since that is where the IAR is registered B) The Administrator in State B would be able to, since that is where the client resides C) Neither Administrator will investigate since it is only a customer complaint D) Both Administrators may investigate the IAR

D) Both Administrators may investigate the IAR **The Uniform Securities Act provides the Administrator with the ability to investigate investor complaints within the state or from outside the state if the investor has done business with an individual or business within the state. Since the customer resides within State B, the Administrator in that state has jurisdiction. The Administrator in State A also has jurisdiction since the IAR is located within his state. The Administrator's role is to protect potential investors within its state and to prevent professionals within its state from acting in a way that could harm other potential investors.**

Frank is in a high tax bracket. He is presently setting up an investment program to provide for his retirement in approximately 30 years. Frank has informed his investment adviser that his major concern is inflation and that, over this 30-year period, inflation will depress the purchasing power of his assets, preventing Frank from continuing the lifestyle he hopes to enjoy. The most appropriate investment recommendation would be: A) Fixed annuities B) Municipal bonds C) High-yield preferred stock D) Common stock

D) Common stock **Fixed annuities primarily invest in U.S. government-issued debt and investment-grade corporate bonds. These are debt instruments, which have historically performed poorly in an inflationary environment. An investment in municipal bonds would give the investor tax-free interest, but not the inflation protection that the client is seeking. Although preferred stock is an equity instrument, it will perform similarly to debt instruments, due to the payment of a fixed dividend. Investments in common stock have, over long periods, historically outperformed the inflation rate and have provided investors with a better inflation-adjusted rate of return than interest-rate-sensitive instruments.**

Which of the following statements is FALSE regarding discounted cash flow methods used to evaluate an investment? A) Net present value is a discounted cash flow method B) Internal rate of return is a discounted cash flow method C) Holding period return is a discounted cash flow method D) Discounted cash flow calculations consider cash inflows, outflows, and the time value of money

D) Discounted cash flow calculations consider cash inflows, outflows, and the time value of money **Holding period return does not discount or compound cash flows. Holding period return is calculated by adding any income, plus capital gains, minus capital losses, and dividing by the value of the initial investment.**

One of your clients, John Smith, would like to buy one share of ToyKids Inc. for each of his 12 grandchildren. The average transaction cost on these trades would be 16% based on your firm's minimum commission schedule. What action should you take? A) Advise Mr. Smith to do the trades elsewhere, as your compensation would violate the USA 10% threshold B) Advise Mr. Smith to open a wrap account for each child to avoid commissions C) Do the trades D) Do the trades, provided you have already informed the client of the higher-than-normal commissions

D) Do the trades, provided you have already informed the client of the higher-than-normal commissions **Anytime a client will be subject to higher-than-normal charges, he should be informed of this fact prior to execution. Opening a wrap account for each child is not practical since these accounts typically have minimum asset requirements.**

Which of the following statements is NOT TRUE regarding a SEP-IRA? A) An employer makes contributions to an employee's SEP-IRA. B) An employer is not required to make annual contributions. C) Employees are immediately vested for any contributions that are made to the account. D) Employees are permitted to make contributions to the account.

D) Employees are permitted to make contributions to the account. **A simplified employee pension plan (SEP-IRA) does not allow employees to make contributions. Instead, SEPs are funded by employer contributions only and these contributions are elective (discretionary).**

The portfolio manager of an open-end investment company has investment discretion for amounts of more than $125 million in equity securities. What form must the manager file with the SEC? A) Form 13D B) Form 144A C) Form 144 D) Form 13F

D) Form 13F **If a portfolio manager has investment discretion for more than $100 million of equity securities, the manager must file Form 13F with the SEC within 45 days of the end of quarter.**

According to Reg. T, if a client fails to pay for securities by the fifth business day following the trade date, the client's account will be: A) Closed B) Restricted for 90 days C) Suspended for 90 days D) Frozen for 90 days

D) Frozen for 90 days **According to Reg. T, if a client fails to make payment for securities being purchased by the fifth business day following the trade date, and an extension has not been granted by FINRA, the client's account will be frozen for 90 days. During the 90-day frozen period, trading may occur in the client's account; however, any purchases that are made during the frozen period must be fully paid for in advance. In other words, no credit (margin) may be extended to the customer for 90 days.**

A corporate bond is purchased at its par value of $1,000 and later sold at a discount. This would be indicative of which of the following risks? I) Opportunity risk II) Credit risk III) Currency risk IV) Interest-rate risk A) I only B) III only C) I and III only D) II and IV only

D) II and IV only **The most likely the reason for the bond's price decline is that interest rates have risen. The risk of interest rates moving against a bond investor is referred to as interest-rate risk. Another possible explanation for the bond losing value is that its credit rating fell (credit risk).**

A complex trust: A) Must have multiple beneficiaries B) Uses derivatives as part of its assets C) Uses an outside portfolio manager D) Is permitted to retain some of its annual investment income

D) Is permitted to retain some of its annual investment income **A complex trust is permitted to retain some of its investment income. (In a simple trust, this income must be distributed to the beneficiaries in the year received.) Trustees of a complex trust are also empowered to distribute principal. The term complex has nothing to do with the number of beneficiaries of the trust, the use of derivatives within the trust, or the employment of an outside portfolio manager by the trustee.**

Which of the following is FALSE regarding a Health Savings Account (HSA)? A) The contributions are tax-deductible B) The earnings in the account are tax-free C) The distributions are tax-free if they are used to pay for qualified medical expenses D) The distributions that are used for non-qualified medical expenses are subject to a 50% penalty

D) The distributions that are used for non-qualified medical expenses are subject to a 50% penalty **The distributions that are used for non-qualified medical expenses are subject to a 20% tax, not a 50% penalty. All of the other statements are true**

Which of the following is a valuation model used to calculate the anticipated return for a portfolio of securities? A) The internal rate of return B) The holding period return C) The real rate of return D) The expected rate of return

D) The expected rate of return **The expected rate of return is used to estimate or anticipate the performance of a portfolio by averaging all of the possible returns and the probability that they will occur.