Inv Veh; Other Investments

The difference between a cash forward contract and a commodity futures contract is that the forward contract: A. is traded over-the-counter B. has a standardized delivery date C. deals with a specific quantity of the commodity D. has an acceptable deliverable grade of range of grades of the commodity

The best answer is A. Futures contracts are standardized exchange traded contracts to deliver a commodity at a future date. The expiration/delivery date is standardized in the contract. The contract size is standardized, as is the minimum acceptable grade of the commodity to be delivered. The price of the contract is established by auction on the exchange, so it is not standardized. In contrast, a forward contract is NOT standardized. Rather, it is a custom-created contract between a buyer and seller for delivery of a specified commodity at a date in the future. All terms of a forward contract are negotiated, whereas the only thing negotiated in a futures contract is the price. Forward contracts are privately created and any trading (not likely) cannot occur on an exchange - rather, any trades would occur over-the-counter.

A client is short stock and wants to protect his position. The option strategy that should be used is: A. buy a call B. sell a call C. buy a put D. sell a put

The best answer is A. A customer loses on a short stock position if the market rises. If the customer buys a call, he or she buys the right to buy the underlying stock at a fixed price. Thus, in a rising market, the stock can be purchased at a fixed price by exercising the call and the purchased shares used to cover the short stock position.

A security where the contents of the investment portfolio do not change is a(n): A. unit investment trust B. mutual fund C. closed end fund D. direct participation program

The best answer is A. A fixed UIT (Unit Investment Trust) is an assembled portfolio of securities that is put into trust and then sold to investors in $1,000 minimum units. Once assembled, the trust contents to do not change - there is no management. In contrast, mutual funds, closed-end funds (traded on an exchange) and direct participation programs all have managers that can change investments at will.

When comparing options to futures contracts, which statements are TRUE? I Options are securities that are regulated and exchange traded II Options are not securities and are unregulated and trade OTC III Futures are contracts that are regulated and exchange traded IV Futures are not contracts and are unregulated and trade OTC A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Both options and futures are regulated, standardized, exchange-traded contracts. Only forward contracts are "custom" contracts that trade OTC.

What is the main objective of investing in Equity REITs? A. income and growth B. capital appreciation and stability C. tax deductions and tax credits D. speculation and aggressive gains

The best answer is A. Equity REIT investments typically generate good dividend income, because the REIT distributes most of the net rental income to shareholders. In addition, if real estate prices appreciate, there can be capital gains. Thus, Choice A is the best one offered.

A customer sells short 100 shares of DEF stock at $62 and sells 1 DEF Oct 60 Put @ $6. The maximum potential gain while both positions are in place is: A. $800 B. $4,400 C. $5,400 D. unlimited

The best answer is A. If the market drops, the short put is exercised and the customer must buy the stock at $60. Since he sold the stock at $62, he gains 2 points, in addition to collecting 6 points of premiums. Thus, the maximum gain is $800. Conversely, if the market rises, the short put expires, leaving a short stock position that has potentially unlimited loss.

A customer buys 200 shares of GE at 72 and sells 2 GE 70 Calls @ $6. The maximum potential gain is: A. $800 B. $1,200 C. $7,000 D. unlimited

The best answer is A. If the market rises, the calls are exercised. The stock (which cost $72) must be delivered at $70 for a loss of $2 per share. Since $6 was collected in premiums for selling the call, the net gain, if exercised, is 4 points or $400 per contract x 2 contracts = $800.

A customer buys 100 shares of ABC stock at 45 and sells 1 ABC Jan 45 Call @ 2 on the same day in a cash account. The customer's maximum potential loss is: A. $4,300 B. $4,500 C. $4,700 D. unlimited

The best answer is A. If the stock drops, the call expires "out the money". As the stock keeps dropping, the customer loses more and more on the stock position. Because he effectively paid $4,300 ($45 price - $2 premium collected) for the stock, this is his maximum potential loss.

A customer sells short 100 shares of ABC stock at 38 and buys 1 ABC Mar 40 Call @ 5. The maximum potential gain is: A. $3,300 B. $3,500 C. $4,200 D. unlimited

The best answer is A. If the stock falls, the customer gains on the short stock position. He sold the stock for $38. If it falls to "0," he can buy the shares for "nothing" to replace the borrowed shares sold and make 38 points. He lets the call expire "out the money" losing 5 points, so the maximum potential gain is 33 points.

The primary reason for a customer to make a tax shelter investment is the: A. economic viability of the project B. immediate deductions generated by the project C. immediate tax credits generated by the project D. future capital gains generated by the project

The best answer is A. In considering a tax sheltered investment, economic viability comes first; tax benefits come second.

A customer buys 100 shares of XYZ at 49 and buys 1 XYZ Jan 50 Put @ $5. The maximum potential loss is: A. $400 B. $500 C. $4,400 D. unlimited

The best answer is A. The long put gives the stock owner the right to sell at $50. Since he bought the stock at 49, exercising results in a 1 point stock profit. However, the premiums paid of $5 are lost, for a net loss of 4 points or $400 maximum.

A portfolio manager that trades options would: A. buy a call option to lock in a stock's price prior to an anticipated price rise B. sell a call option to establish a short stock position prior to an anticipated price fall C. buy a put option to generate extra income against an existing long stock position D. sell a put option to protect an existing long stock position from a market decline

The best answer is A. The purchase of a call option gives the holder the right to buy stock at a fixed price. Choice B is incorrect because a short call will only result in a short stock position (sale of the shares) if the short call is exercised. A long put can be used to establish a short stock position prior to an anticipated market fall. A long put (right to sell at a fixed price) could be used to protect an existing stock position from a market decline. A short put (obligation to buy at a fixed price) will not protect an existing long stock position.

An options strategy where the maximum potential loss is equal to the difference between the value of the underlying long securities position and premiums received is a: A. naked call writer B. covered call writer C. naked put writer D. covered put writer

The best answer is B. A covered call writer sells a call contract against the underlying stock that is owned by that customer. If the market drops, the call expires unexercised and the customer keeps the premium. However, as the market drops, the customer loses on the long stock position. Thus, the maximum potential loss is the full value of the stock position, net of collected premiums.

The purchaser of a futures contract has the: A. right to buy a specific commodity at a certain price and grade at a specific date and location through an organized futures exchange B. obligation to buy a specific commodity at a certain price and grade at a specific date and location through an organized futures exchange C. right to sell a specific commodity at a certain price and grade at a specific date and location through an organized futures exchange D. obligation to sell a specific commodity at a certain price and grade at a specific date and location through an organized futures exchange

The best answer is B. A futures contract differs from an options contract because the buyer of an option has the right to exercise, but does not have to do so at expiration, while the holder of a futures contract has agreed to buy the underlying commodity at a fixed price at the expiration date, unless the contract is closed by trading. Similarly, the seller of a futures contract must deliver the underlying commodity at a fixed price at the expiration date, unless the contract is closed by trading.

A customer would sell call contracts because: A. the customer is bullish on the underlying security B. the customer is bearish on the underlying security C. the customer wishes to generate earned income D. the customer wishes to defer taxation of gains on the underlying stock

The best answer is B. Call contracts are sold when a customer is bearish on the market. If the market falls, the calls expire "out the money" and the writer retains the premiums earned. This is the maximum potential gain for the writer of a call. When the calls expire, the premium received is treated as a short term capital gain for income tax purposes. It is not earned income (which is income from one's occupation), making choice C incorrect.

Which statements are TRUE when comparing options contracts to futures contracts? I A futures contract requires future delivery of the underlying physical asset II A futures contract does not require future delivery of the underlying physical asset III An options contract requires future delivery of the underlying physical asset IV A options contract does not require future delivery of the underlying physical asset A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Futures contracts are standardized, exchange traded contracts that require future delivery of an asset at a fixed price and date in the future. In contrast, options contracts are standardized, exchange traded contracts that only require delivery if the option is exercised.

Which statements are TRUE when comparing index options to index futures? I Index options are defined as security II Index options are not defined as a security III Index futures are defined as a security IV Index futures are not defined as a security A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Index options are regulated by the SEC and the States as a "security." In contrast, futures are not a security - they are regulated as "commodities futures" regulated by the CFTC.

The purchase of a put is a: A. bull strategy B. bear strategy C. neutral strategy D. bear/neutral strategy

The best answer is B. The buyer of a put has the right to sell stock at a fixed price in a falling market. The buyer has ever increasing gain potential as the market falls, so this is a bear market strategy.

A registered investment adviser pays $125,000 U.S. for a 250,000 CD (Canadian Dollar) bond that has a 6% coupon and a 15 year maturity. Which statement is TRUE? A. In 15 years, the adviser will receive $125,000 U.S. B. In 15 years, the adviser will receive $250,000 Canadian C. Every year, the adviser will receive $7,500 U.S. in interest D. The foreign exchange rate is locked in at the time of purchase of the bond

The best answer is B. This is a foreign bond (yes, Canada is a foreign country), that pays in the foreign currency. The amount of U.S. dollars that this equates to depends on the currency exchange rate at the time that the payment in Canadian Dollars is received.

The major risks of investing in a Real Estate Limited Partnership (RELP) are: I Interest rate risk II Liquidity risk III Regulatory risk IV Reinvestment risk A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Limited partnerships are illiquid - they do not trade and a limited partner can only sell his or her unit with general partner approval. So liquidity risk is a major issue. Because these are tax shelters that use provisions of the tax code to reduce tax liability, owners of limited partnerships face increased risk of tax audit; and also are subject to regulatory risk, which is the risk of tax law change. Interest rate risk is not so much of an issue; and there are no dividends or interest payments received that must be reinvested, so there is no reinvestment risk. However, business risk is another big issue here - because the business venture may fail.

A customer who is short stock will buy a call to: A. hedge the short stock position in a falling market B. protect the short stock position from a falling market C. protect the short stock position from a rising market D. generate additional income in a stable market

The best answer is C. A customer who has shorted stock is bearish on the market. However, the potential loss for a short seller of stock is unlimited if the market should rise, forcing the customer to replace the borrowed shares at a much higher price. To limit this risk, the purchase of a call allows the stock position to be bought at a fixed price (by exercising the call), if needed, in a rising market.

A vehicle that gives the right, but not the obligation, to buy a reference asset at a stated price for a stated period of time is a(n): A. forward contract B. futures contract C. options contract D. swap contract

The best answer is C. A key difference between an option contract and a futures or forward contract is that the holder of an option has the right to exercise, but is not required to do so. In contrast, a futures or forward contract obligates the buyer of the contract to buy the underlying reference asset at the delivery date, unless the contract is closed prior to this date. Swaps are custom OTC contracts that allow for a "swapping" of cash flows between 2 parties, with the most common being an interest rate swap, where a fixed interest rate is "swapped" for a floating rate. For example, Party A agrees that it will pay a fixed 4% interest rate for 5 years on a $100 million principal amount to Party B. Party B agrees that it will pay a floating rate of LIBOR (say it is currently at 3%) + 1% to Party A over this period. Party A "wins" if interest rates rise over this period; Party B "wins" if interest rates fall over this period.

An investment adviser manages the portfolio of a client on a discretionary basis. The customer's objective is conservation of principal and income. Under prudent investor standards, which statement is TRUE about the use of options in the portfolio? A. The use of options strategies is unsuitable for this client based on her investment objective B. The use of options strategies is only suitable if the customer has previous investment experience with options C. The use of options strategies is only suitable if the strategies are limited to the sale of covered options D. The use of options strategies is only suitable is the strategies are limited to the purchase of options

The best answer is C. Covered call writing is the most popular retail income strategy in a flat market, and is appropriate for conservative investors that are looking for extra income. The customer sells calls against stock that is already owned, getting premium income. If the stock stays flat, the calls expire and the customer keeps the premium. If the stock rises, the calls are exercised and the stock is called away at no loss to the customer. If the market falls, the calls expire and the customer loses on the stock (which he would have lost on anyway!).

Which statements are TRUE about Equity REITs? I Equity REIT share prices and overall stock prices are positively correlated II Equity REIT share prices and overall stock prices are negatively correlated III Equity REIT dividends paid to shareholders are taxed at regular income tax rates IV Equity REIT dividends paid to shareholders are taxed at a preferential 15% maximum rate A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Equity REIT share prices and overall stock market prices are negatively correlated. When stock prices are flat or falling, Equity REIT prices tend to rise (and vice-versa). REIT dividend distributions do not qualify for the lower 15% tax rate given to common stock cash dividends - a disadvantage when investing in REITs.

A 65-year old retired teacher living on a pension has $200,000 invested in 2 year certificates of deposit that are yielding 4%. $20,000 of the CDs are maturing and the customer wants to diversify into an investment that gives a higher return and a moderate level of risk. The BEST recommendation would be: A. High yield corporate bonds B. Treasury strips C. Equity REITs D. Income bonds

The best answer is C. Equity REITs tend to pay a high dividend yield, since they are structured to generate net rental income. Because the underlying real estate investments are diversified, the risk level is moderate. This is the best of the choices offered. High yield bonds (junk bonds) have a very high risk of default and thus are unsuitable. Treasury Strips are zero-coupon Treasuries that do not provide current income and thus are unsuitable. Finally, Income bonds only pay interest if the issuer has high enough net income, so there may not be any "income".

Which of the following terms apply to fixed unit investment trusts? I Managed II Unmanaged III Regulated IV Unregulated A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Fixed unit investment trusts are not managed; the portfolio is fixed and does not change. These are typically bond trusts, where a diversified portfolio of bonds is assembled and placed into trust; with units of the trust sold to investors. These are non-exempt securities that must be registered with the SEC and sold with a prospectus. They are regulated under the Investment Company Act of 1940 and are redeemable with the sponsor, who makes a market in trust units.

A customer buys 100 shares of ABC stock at $56 and buys 1 ABC Jul 55 Put @ 2.50 on the same day. The maximum potential loss is: A. 0 B. $250 C. $350 D. unlimited

The best answer is C. If the market should fall, the customer will exercise the put and sell the stock at the strike price, limiting potential loss. The put contract gives the customer the right to sell the stock at $55. Since the stock was purchased at $56, 1 point will be lost on the stock. In addition, 2.50 points were paid in premiums for a maximum potential loss of 3.50 points or $350.

A speculator that initiates a long futures position in Euros: I believes that the Euro will decline II believes that the Euro will increase III will need to sell Euro futures to close his position if he wants to avoid taking delivery in the future IV can only satisfy the terms of the contract by taking delivery of Euros on the delivery date A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. When one goes long a futures contact, this is a "bet" that the price of the reference asset will increase. Futures contracts can be offset at anytime by trading, so the contract can be closed with an offsetting sale. If the contract is not closed with an offsetting sale, then the seller is required to take delivery and pay for the Euros on the delivery date.

Which statements are TRUE when comparing cash forward contracts to futures contracts? I Forward contracts are non-standardized private contracts while futures contracts are subject to the rules and regulations of a futures exchange II Forward contracts are not subject to federal regulation while futures contracts are subject to federal regulation III Forward contracts are not priced in open competitive bidding while futures contracts are competitively priced in the market IV Forward contracts are traded OTC while futures contracts are exchange traded A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. Forward contracts are custom contracts that are negotiated between buyer and seller. They are issued OTC and there is very limited trading - thus it may not be possible to do an offsetting trade with a forward contract. Forward contracts are not subject to federal regulation. In contrast, futures contracts are standardized, exchange traded contracts. They are regulated by the CFTC - the Commodities Futures Trading Commission. Because they are actively traded, it is easy to do an offsetting trade before the delivery date.

Which of the following statements are TRUE regarding fixed unit investment trusts (UITs)? I Fixed UITs are managed II Fixed UITs are unmanaged III The composition of the portfolio can be changed IV The composition of the portfolio cannot be changed A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Fixed unit investment trusts are not managed; the portfolio is fixed and does not change. These are typically bond trusts, where a diversified portfolio of bonds is assembled and placed into trust; with units of the trust sold to investors. These are non-exempt securities that must be registered with the SEC and sold with a prospectus. They are regulated under the Investment Company Act of 1940 and are redeemable with the sponsor, who makes a market in trust units.

A customer buys 100 shares of ABC stock at 39 and sells 1 ABC Jan 45 Call @ 2 on the same day in a cash account. The customer's maximum potential gain until the option expires is: A. $200 B. $300 C. $700 D. $800

The best answer is D. If the market rises above 45 the short call will be exercised. The customer must deliver the stock that he bought at 39 for the $45 strike price, resulting in a $600 gain. Since $200 was collected in premiums as well, the total gain is $800. This is the maximum potential gain while both positions are in place.

What is the maximum potential loss for a customer who is short 100 shares of ABC stock at $33 and short 1 ABC Jan 35 Put at $6? A. $600 B. $900 C. $2,700 D. unlimited

The best answer is D. If the market rises, the put contract expires, but the customer is responsible for covering his short stock position. Thus, the potential loss on the remaining short stock position is unlimited, since the market can rise an unlimited amount.

If the writer of an equity call contract is exercised, the writer MUST: A. deliver cash in 1 business day B. deliver stock in 1 business day C. deliver cash in 3 business days D. deliver stock in 3 business days

The best answer is D. If the writer of an equity call contract is exercised, the writer must deliver the stock, receiving the strike price in payment from the holder. Settlement is 3 business days after exercise date - this is a regular way stock trade.

Which of the following are major tax benefits of real estate limited partnerships? I The real estate can be depreciated, even if its market value is increasing II Non-recourse financing is included in the basis III Interest on loans is fully deductible IV Long term capital gains may be achieved when the real estate is sold A. I and II only B. III and IV only C. I, III and IV D. I, II, III, IV

The best answer is D. The major tax benefits of real estate programs include all of the choices. Once property is ready for occupancy, it can be depreciated over a straight line basis over a 27½ year life (for residential property). Each year, a depreciation deduction is allowed, even if the market value of the property is rising. Non-recourse mortgage financing is included in the basis (real estate is exempt from the "at risk" rule) and increases overall deductions available to the partner. Interest on the mortgage is fully deductible. Finally, when the property is sold, there is the possibility of having a long term capital gain.

A customer that is long ABC stock in his portfolio buys call options on that stock. Why would the customer do this? A. To protect the ABC stock position from an adverse market move B. To derive additional income from the ABC stock position C. To speculate on the price of the stock going down D. To lock in a price at which shares can be added to the portfolio

The best answer is D. The purchase of a call gives the customer the right to buy shares at the strike price. The only reason why a person who is already long that stock would buy calls on the stock would be to give the customer the ability to buy more shares at the strike price if the market price of the stock should move up.

A customer that is short ABC stock in his portfolio buys put options on that stock. Why would the customer do this? A. To protect the ABC stock position from an adverse market move B. To derive additional income from the ABC stock position C. To speculate on the price of the stock going up D. To lock in a price at which the short position can be increased in the portfolio

The best answer is D. The purchase of a put gives the customer the right to sell shares at the strike price. The only reason why a person who is already short that stock would buy puts on the stock would be to give the customer the ability to sell more shares at the strike price if the market price of the stock should move down.

A customer sells 1 ABC Feb 50 Call @ $7 when the market price of ABC is 52. The customer's maximum potential loss is: A. $700 B. $4,300 C. $5,700 D. unlimited

The best answer is D. The writer of a naked call is obligated to deliver stock that he does not own. If exercised, the stock must be bought in the market for delivery. Since the market price can rise an unlimited amount, the maximum potential loss is unlimited as well.