Part 2 Investing Concepts

A) the debt/equity ratio Explanation The debt/equity ratio is a measurement of the leverage employed in a corporation's capital structure. It compares the total long-term debt to the total capitalization (long-term debt plus equity capital). U10LO7

All of the following ratios are measures of the liquidity of a corporation except A) the debt/equity ratio. B) the current ratio. C) the quick ratio. D) the acid-test ratio.

C) REITs Explanation REITs are not derivatives, but options (both puts and calls), futures (and forwards), and warrants (and stock rights) are. U16LO4

An investment adviser representative attends a seminar discussing derivative investments. It would be unlikely that there would be any mention of A) warrants B) call options C) REITs D) futures

B) par value Explanation Bond prices are quoted as a percentage of par value. On the exam, the par value of bonds is always $1,000. U13LO2

Bond prices are quoted as a percentage of A) market value B) par value C) stated value D) conversion value

A) the internal rate of return Explanation Internal rate of return (IRR) is not a component of modern portfolio theory as are the other 3 terms. U20LO8

Each of the following terms is commonly found in modern portfolio theory EXCEPT A) the internal rate of return B) the efficient set C) the feasible set D) the capital asset pricing model

D) 12.5% Explanation The formula for this is: risk-free rate plus the (difference between the market return and the RF) times the beta. In this question, those numbers are: 5% + [(10% - 5%) × 1.5] = 5% + (5% x 1.5) = 5% + 7.5% = 12.5%. U20LO9

If the current risk-free rate is 5%, and the expected return on the market is 10%, what return can be expected from a security that has a beta of 1.5? A) 15% B) 15.5% C) 20% D) 12.5%

D) high frequency trading. Explanation This is the definition of high frequency trading (HFT). It is not considered market manipulation, although the regulators have uncovered cases where there were phony trades designed to manipulate market prices. Front running is when a securities professional enters an order for a personal account ahead of a large order just received. U22LO7

Investors using proprietary trading using high-speed systems to monitor and submit large number of orders to the markets are engaging in A) front running. B) market making. C) market manipulation. D) high frequency trading.

D) Inadequate life insurance coverage Explanation Because the client's only life insurance seems to be that with the company as beneficiary, it does not appear that he has adequately planned for his premature death and the potential estate taxes. U19LO5

One of your prospective clients is considered a key employee at his place of business. This individual has a net worth of almost $6 million, currently earns in excess of $500,000 per year, and is married with 2 teenage children. He currently has a little over $1 million in his 401(k), more than half of which is invested in his employer's common stock. The company is the beneficiary of a $1.5 million key person life insurance policy on his life. Given these facts, what is your greatest concern as his adviser? A) Too high a percentage of the retirement plan invested in the company's stock B) Inadequate funding for college savings C) Alternative minimum tax D) Inadequate life insurance coverage

C) lead Explanation Lead is not considered a precious metal. U17LO6

Someone who wishes to invest in precious metals would consider any of the following EXCEPT A) platinum B) gold C) lead D) silver

C) Efficient pricing Explanation Alternative assets are most often characterized by inefficient pricing, providing potential abnormal returns or alpha returns. U17LO3

The alternative asset investments class is least associated with which of the following characteristics? A) Diversification B) Illiquidity C) Efficient pricing D) Non-normal returns

D) It depends on the individual's life expectancy. Explanation The time horizon for an individual who has just retired is the balance of expected life. U19LO5

What would be the time horizon for a 65-year-old client who has just retired? A) None, because 65 is the age for retirement. B) It depends on the individual's available assets. C) It depends on the individual's insurance company's actuarial tables. D) It depends on the individual's life expectancy.

B) Straddle Explanation A straddle consists of a put and a call on the same stock with the same strike price and the same expiration date. Therefore, with two option positions, it is a multi-option strategy. U16LO2

Which of the following is a multi-option strategy? A) Long call B) Straddle C) Protective put D) Short call

D) the bond is selling at a discount. Explanation There is excess information in this question (a favorite trick of the test authors). We don't need to know the call price or the maturity date. Simple, we have a 6% bond when current market interest rates are 8%. The inverse relationship between interest rates and bond prices teaches us that this bond is going to be selling at a discount. Bonds are called when interest rates go down, not rise. The coupon on a bond is fixed. U13LO10

A corporation issued a bond with a coupon of 6%, callable at 103. The bond matures in 2059. Current interest rates are 8%. It is most likely that A) the coupon will be increased. B) the bond will be called. C) the bond will go into default. D) the bond is selling at a discount.

A) Almost no noticeable impact Explanation Adding additional securities to a portfolio usually increases the diversification, lowering the overall risk. However, that is more apparent when there is low or negative correlation. A +.95 correlation means that the "new" stock will perform close to exactly the same as the existing one so its addition should have little to no impact on performance. In a bearish market, values go down, not up or remain the same. If this additional stock had a negative correlation, that could have resulted in the portfolio going up or remaining the same, but not with a +.95 correlation. It is almost never that a question on the exam does not have enough information to arrive at the correct answer - steer away from that choice. U10LO6

An investor's portfolio consists of a single stock. If a stock with a correlation of +.95 was added to the portfolio and the stock market turned bearish, what would be the likely effect of having added this additional security? A) Almost no noticeable impact. B) Not enough information to tell. C) The portfolio's value would increase. D) The portfolio's value would remain the same

D) A balanced fund Explanation Balanced funds invest in a variety of investment vehicles; therefore, they have more diversification. Because of the diversification, they are better protected against downturns in the financial markets and are more conservative than the other choices listed. U14LO10

From the standpoint of diversification, which of the following would be considered the most conservative? A)An income fund B)A growth fund C)A sector fund D)A balanced fund

C) $12,500 Explanation Under the rule of 72, dividing 72 by the expected return shows the number of years it will take for a deposited sum to double. 72 divided by 8 equals 9 years. Over an 18-year period, there will be 2 doublings. So, dividing the future value ($50,000) by 4 solves for the present value required. U10LO1

If an investment can be expected to return 8%, using the rule of 72, what is the present value needed to have $50,000 for a child's education in 18 years? A) $25,000 B) $6,250 C) $12,500 D) $2,777

C) dividing the remainder of the risk-free rate subtracted from the security's actual return by its standard deviation Explanation The return from a security can be adjusted for the risk associated with it by subtracting the risk-free rate from the security's actual return and then dividing that by its standard deviation, the basic measure of unsystematic risk. This is commonly known as the Sharpe ratio. U23LO2

Risk-adjusted return is calculated by A) dividing the price of the stock by its standard deviation B) dividing the security's price by its beta C) dividing the remainder of the risk-free rate subtracted from the security's actual return by its standard deviation D) multiplying the return of an investment by its standard deviation

A) the future value of the $25,000 Explanation To determine the money's worth at a future date (in this case, 5 years), the Smiths calculated the future value of the funds. Future value is a compounded rate of return, and in this case, the $25,000 was compounded at 5% per year for 5 years. The present value of an investment is the opposite of future value. U10LO1

The Smiths are saving money for a down payment on a house. The Smiths have $25,000 in cash, and they estimate that in 5 years they will have approximately $31,000 if they deposit their cash in a savings account that compounds interest yearly. To calculate the $31,000 amount, the Smiths determined A) the future value of the $25,000 B) the net present value of the $25,000 C) the internal rate of the return on the $25,000 D) the present value of $25,000

A) I and IV Explanation Income statements reflect the family's income and expenses, not assets and liabilities. Dividends represent money received, and mortgage interest is money paid out. Credit card debt is a liability and autos are assets. U19LO2

A client profile is not complete without a family income statement. A typical one would include dividends credit card debt autos mortgage interest A) I and IV B) I and II C) II and III D) III and IV

D) Strategic asset allocation Explanation At least annually, and sometimes more frequently, a portfolio manager who follows strategic asset allocation will examine the relative proportion of the selected asset classes and, based on market performance, rebalance the portfolio to bring it back to its ideal. Active (also called tactical) asset allocation attempts to time the market and doesn't pay the same amount of attention to proportionate holdings as does strategic asset allocation. By its very nature, buy and hold can go years without a portfolio change. U20LO3

A portfolio manager who is engaging in rebalancing on a semiannual basis is most likely using which portfolio management style? A) Tactical asset allocation B) Buy and hold C) Active asset allocation D) Strategic asset allocation

B) 11% Explanation Given the fact the client liquidated his shares at a price of $55, we can conclude that he attained a 10% ($5 profit ÷ $50 initial investment) return based on capital appreciation of the stock. He also received dividends of $2 per share giving him an additional return of 4% ($2 ÷ $50). By adding these 2 percentages together, we can conclude that his total return is 14%, less an inflation rate of 3%, which would give a real rate of return of 11%. U23LO2

An investor purchased stock for $50 per share at the beginning of the year. In December, the investor liquidated his stock for $55 per share, while also receiving dividends of $2 per share during the year. Assuming an inflation rate of 3%, what is the investor's real rate of return? A) 10% B) 11% C) 14% D) 4%

A) Interest rate risk Explanation The client is most exposed to interest rate risk because a rise in interest rates would cause a decline in the value of the long-term bonds. This client is also exposed to inflation, or purchasing power risk. There is very little marketability (liquidity) risk and no-default (credit) risk. U11LO1

An investor's portfolio that consists of all long-term Treasury bonds is most vulnerable to which of the following types of risk? A) Interest rate risk B) Business risk C) Marketability risk D) Default (credit) risk

B) It is canceled on the death of either principal. Explanation When the customer or her son dies, the power of attorney also expires. However, a durable power of attorney will survive a declaration of mental incompetence and is useful in those cases where a parent suffers from dementia. U18LO4

If a customer who has granted a durable power of attorney to her son dies, which of the following statements regarding the power of attorney is TRUE? A) It remains in effect only if the son is the sole heir to the estate. B) It is canceled on the death of either principal. C) It remains in effect until the son cancels it. D) It remains in effect until the executor of the estate cancels it.

B) purchasing a hedge fund Explanation Although the T-bills and the CDs will reduce the overall risk, they are not the best answer because the question is dealing with an aggressive investor. One of the reasons HNW clients buy these funds is for the diversification offered by adding an asset subclass to their portfolios. U14LO10

One way for an accredited investor with an aggressive stance to reduce the overall risk in his portfolio is by A) purchasing U.S. Treasury bills B) purchasing a hedge fund C) selling uncovered calls D) purchasing insured bank CDs

A)n 25% for a long account. Explanation The current minimum maintenance levels set by the SROs is 25% equity in a long margin account and 30% equity in a short margin account. The initial margin requirement under Reg. T is 50% for both long and short accounts. U22LO2

The SROs have instituted maintenance margin levels for those situations where the equity in a client's margin accounts is reduced to a dangerous level. Currently, those levels are A) 25% for a long account. B) 30% for a long account. C) 25% for a short account. D) 50% for a long accoun

B) A limit order Explanation The distinguishing feature of a limit order is that the investor sets a specific price limit. In the case of a buy limit, it is the maximum price he is willing to pay; in the case of a sell limit, it is the lowest price he is willing to accept. Although an all or none order does specify a price, it is categorized as a type of limit order so you must choose the most all-encompassing answer. U22LO6

What is the name given to an order to purchase or sell a stock where the investor has specified a price? A) An all or none order B) A limit order C) A market order D) A discretionary order

C) I and II Explanation Both the bypass trust and the generation-skipping trust are tools used by estate planners to reduce estate taxes. They do so by passing the amount in the unified credit (currently $5.34 million for 2014) to heirs other than the spouse, usually grandchildren in the case of the GST. U21LO5

Which of the following vehicles make use of the unified estate tax credit? Bypass trust Generation-skipping trust Living trust Simple trust A) I and IV B) III and IV C) I and II D) II and III

C) overconfident Explanation The behavioral finance bias of overconfidence refers to the observation that experienced (and even some "rookie") investors tend to overestimate their ability and the accuracy of the information available to them. U19LO3

A client of an investment adviser excitedly calls the adviser with the news that he is now going to handle his own investments. "I just read some great investment books, and now I know what to do." Based on the study of behavioral finance, it would appear that this individual is A) anchored. B) conservative. C) overconfident. D) following the herd.

C) expected return Explanation The CAPM suggests that we can determine the expected return of any security (or portfolio) by using the following mathematical formula: Er = Rf + Beta(expected return on the market − Rf). Er stands for expected return, Rf is the risk-free return. Remember, expected return is a form of risk-adjusted return and is the more specific answer to this question. U20LO9

The capital asset pricing model (CAPM) is most commonly used to determine an investor's A) holding period return B) time-weighted return C) expected return D) risk-adjusted return

A) inventory Explanation Current ratio = (current assets ÷ current liabilities) = [cash + marketable securities + receivables + inventory] ÷ current liabilities. Quick ratio = [cash + marketable securities + receivables] ÷ current liabilities. Thus, quick ratio excludes inventory, which current ratio does include. Both ignore goodwill and cost of goods sold. U10LO7

The main difference between the current ratio and the quick ratio is that the quick ratio excludes A) inventory. B) goodwill. C) assets. D) cost of goods sold.

A) I, II, III and IV Explanation Each of these persons is in a relationship of trust to the customer and is therefore a fiduciary. U18LO4

Which of the following are fiduciaries? Executor of an estate Administrator of a trust Custodian of an UGMA account Investment adviser representative granted with discretionary authority over the account A) I, II, III and IV B) I, II and III C) I and II D) II, III and IV

C) the need for liquidity is less important Explanation When the time horizon is long, there is little need for access to the funds now. Therefore, liquidity is a minor consideration. With a long time horizon, the investor can take greater risks (and should because it will be necessary to combat the higher inflation risk). U19LO5

It would be correct to state that when an investor has a longer time horizon, A) the risk level is lowered B) the exposure to inflation risk is lessened C) the need for liquidity is less important D) the greater the initial deposit to reach a projected future goal

C) Unit investment trust Explanation A unit investment trust (UIT) is a type of investment company whose units are sold in the secondary market and is generally unmanaged, or passively managed as the money manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the UIT terminates. U14LO7

Louis owns an investment that is an unmanaged portfolio in which the money manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the investment portfolio terminates. This statement best describes which type of investment? A) Open-end investment company B) Closed-end investment company C) Unit investment trust D) Hedge fund

B) the company's stock price trend Explanation The company's stock price trend is important to technical analysis. Remember that a technician "charts prices and volume over time". The others are factors to consider in fundamental analysis. U12LO6

All the following factors support fundamental analysis while assessing a wide range of qualitative factors except A) the company's competitive position. B) the company's stock price trend. C) the company's management team's quality and experience. D) the company's business model.

D) are paid ahead of holders of unsecured debt, as well as equity securities Explanation Secured bondholders are on the top of the list of creditors. The first priority for unsecured claims is that of employees and taxes.​ Even with a secured claim, there is no assurance that you will receive all your money back (think of the "short sales" on homes not long ago where the bank accepted less than the mortgage amount because the value of the home had fallen so far). U11LO4

Among the advantages of being the holder of secured bond is that if the issuer files for bankruptcy, you A) will receive your principal plus all unpaid interest B) are paid ahead of everyone, except past-due wages to employees C) are sure to recover 100% of your investment D) are paid ahead of holders of unsecured debt, as well as equity securities

B) increase Explanation Most mutual funds do not have 100% of their assets in securities, and they continually receive new money from investors. Any increase in the general interest rate would allow the fund to purchase new, higher-yielding instruments, which would increase the fund's income. U14LO3

If general interest rates increase, the interest income of an open-end bond fund whose sales exceed redemptions will likely A) remain unchanged B) increase C) It cannot be determined from the information given D) decrease

A) the efficient market hypothesis Explanation When all market participants have equal access, the theory is that stock prices will reflect that efficiently. U20LO10

That all market participants have equal access to information is a fundamental premise of A) the efficient market hypothesis B) Monte Carlo simulation C) portfolio correlation D) asset allocation

B) the fair market value of the asset on the day the decedent died Explanation Generally, a taxpayer's basis in an asset is the amount the taxpayer paid for the asset. When an asset is acquired by inheritance, however, the asset's basis is generally the fair market value of the asset on the date of the decedent's death (or 6 months after the date of death if the estate elects the alternate valuation date). Because this value is often higher than the price the decedent originally paid for the asset, this kind of basis is called a stepped-up basis. U21LO5

The basis of an asset received from a decedent's estate is referred to as a stepped-up basis. This means that the asset's basis is generally A) the fair market value of the asset on the day the decedent acquired it B) the fair market value of the asset on the day the decedent died C) the amount the decedent originally paid for the asset D) the amount the recipient ultimately sells the asset for

A) liquidity risk Explanation The market for U.S. Treasury bonds is highly liquid. As safe and as liquid as they are, they, like all fixed-income investments, are subject to purchasing power (also known as inflation) risk and reinvestment risk. U11LO2

U.S. Treasury bonds are generally subject to all of the following risks except A) liquidity risk. B) inflation risk. C) purchasing power risk. D) reinvestment risk.

D) Alternative investments Explanation These are two popular alternative investments. Are they speculative? Yes, but there are many other speculative investments that are not considered alternative investments. The question asks for the best description and, although it might seem like a "close call", these are "alts". The leveraged ETF is a registered investment company, but the ETN is not. U17LO3

Which of the following terms best describes ETNs and leveraged ETFs? A) Forms of hedge funds B) Registered investment companies C) Speculative investments D) Alternative investments

C) 9% Explanation If the NPV is a positive number, the investment's IRR must be greater than the investor's required rate of return. In this question, the required rate of return is 8% so the IRR (actual return) must be higher than that. There is only one choice higher than 8%. Remember, when the NPV is positive, it is a good investment. U10LO1

You have determined that the net present value (NPV) of your client's investment is positive. If your client's required rate of return is 8%, which of the following is most likely the investment's internal rate of return (IRR)? A) 4% B) 8% C) 9% D) 0%

A) the arithmetic mean Explanation When a true average return is shown, that is the arithmetic mean. The median return (the number in the middle of the group of 5) is 10%. U10LO2

An investor is looking at the past performance of a security over the past 5 years. The chart looks like this: 201310%201415%20153%201611%20176% The average return over this period is 9%. This would be properly referred to as A) the arithmetic mean B) the internal rate of return C) the median return D) the geometric mean

D) buy S&P 500 index puts Explanation A portfolio manager who expects a decline in the market as a result of a trade war (or any factor that might hurt stock prices) would buy puts on a broad market index such as the S&P 500 to protect his position. Selling calls limits upside potential and only protects the portfolio to the extent of the income received from the sale of the calls. U20LO12

Due to an escalating trade war, the portfolio manager of an equity mutual fund anticipates a negative impact on his fund's assets. To protect his investment portfolio, the fund manager would A) sell S&P 500 index calls B) sell S&P 500 index puts C) buy S&P 500 index calls D) buy S&P 500 index puts

A) a closed-end investment company Explanation It is only the closed-end investment company where shares trade at a premium or discount to the NAV per share. U14LO3

Early in the year, an investor purchased shares of the GEMCO Fund at $10.40 per share when the net asset value per share was $9.53. Just before the last trading day of the year, this investor liquidated the position at $10.60 per share when the net asset value per share was $10.77. From this, you can discern that GEMCO Fund is A) a closed-end investment company B) a face-amount certificate company C) a unit investment trust D) an open-end investment company

B) standardized terms Explanation Futures are contracts that trade on exchanges and have standardized terms, in contrast with forwards contracts, which are customized instruments. A futures clearinghouse reduces counterparty risk by guaranteeing the performance of buyers and sellers. Because futures contracts trade on organized exchanges and have standardized terms, they are more liquid than forwards contracts. U16LO4

In contrast with a typical forwards contract, futures contracts have: A) less liquidity. B) standardized terms. C) nonstandard terms. D) greater counterparty risk.

C) by an auction process Explanation One of the chief characteristics of exchange markets is the auction process for determining the price of a security. In the OTC markets, prices are determined by negotiation. The stock exchanges do not set the price, and although FINRA's markup policy is used to determine the charges to customers, that is separate from determining the security's price. U22LO3

One of the primary differences between trading on listed exchanges and trading in the over-the-counter market is that only on the exchanges are prices determined A) by the FINRA 5% markup policy. B) by the exchange itself. C) by an auction process. D) through a negotiation process.

D) 8.19% Explanation No calculation is necessary here. Why not? Because anytime a bond is purchased at a premium over par (103½% is a premium), the YTM must be less than the nominal (coupon) rate. There is only one choice lower than 8.5%. It isn't about your computational skills; it is about your understanding the relationship between prices and yields. U13LO10

Richard purchased a 30-year bond for 103½ with a stated coupon rate of 8.5%. What is the approximate yield to maturity for this investment if Richard receives semiannual coupon payments and expects to hold the bond to maturity? A) 8.50% B) 8.68% C) 9.36% D) 8.19%

B) $100 per share Explanation Parity means equal. With a conversion ratio of 8 shares per bond, the investor can convert the bond into 8 shares. If the bond is currently selling for $800, then, to be of equal value (parity), the 8 shares must be selling at $100 each. U13LO9

The DERP Corporation has an outstanding convertible bond issue that is convertible into 8 shares of stock. If the current market price of the bond is 80, the parity price of the stock is A) $64 per share B) $100 per share C) $80 per share D) $125 per share

B) excess return earned compared to its total risk Explanation The Sharpe ratio is defined as a fund's excess return (fund's return exceeding the risk-free rate) divided by the total risk (standard deviation). U23LO2

The Sharpe ratio measures a stock's A) excess return earned compared to its unsystematic risk. B) excess return earned compared to its total risk. C) return earned compared to its total risk. D) excess return earned compared to its systematic risk.

C) The utilities industry Explanation Utilities are generally very heavily funded with debt. If interest rates go up, their new debt will be at higher interest rates, causing lower earnings available for common stocks. U11LO1

The common stock of companies within which industry sector would be most adversely affected by an increase in the general level of interest rates? A) The food industry B) The electronics industry C) The utilities industry D) The clothing industry

B) legislative risk Explanation The risk that an investment will decline in value as a result of a change in law is called legislative risk. Regulatory risk is when there is a change to the regulations under which a business must operate. U11LO2

The risk that the value of an investment in a limited partnership will decline because of a change in tax law that disallows favored tax treatment for oil exploration costs is called A) interest rate risk B) legislative risk C) market risk D) liquidity risk

A) Yield to maturity Explanation Yield to maturity has an inverse relationship to duration. That is, the higher the YTM, the lower (shorter) the duration. The longer the time to maturity, the higher (longer) the duration; it is a direct relationship. The bond's rating and par value are irrelevant. U13LO11

Which of the following factors has an inverse relationship to a bond's duration? A) Yield to maturity B) Time to maturity C) Par value D) Rating

B) market risk Explanation This short time horizon is a serious constraint and a portfolio that is largely equities, subjects the account to too much market risk. If the child had been 5 years of age, giving the client a 13-year time horizon, this would have made more sense. U19LO5

Years ago, following your advice, a client opened a 529 Plan to save for their son's college education. The child is now about 3 years from beginning his freshman year. The client, believing that the stock market is currently undervalued, wishes to reallocate the plan assets so that most of the funds are in a broad stock market index portfolio. At this time, your advice would probably be against this allocation because of A) interest rate risk B) market risk C) business risk D) liquidity risk

D) only deduct the passive loss against passive income Explanation Passive losses, such as those generated by limited partnership investments (DPPs), are only deductible against passive income. U17LO1

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 $3,000 against ordinary income and carry over the rest C) deduct $10,000 against ordinary income D) only deduct the passive loss against passive income

B) benefits are increased by 8% for each year from the full retirement age Explanation If an individual delays taking Social Security until age 70, the benefit is increased by 8% for each year from the full retirement age. If full retirement age is 66, four years at 8% means the payout is 132% of the base amount. Medicare (Part A) goes into effect at 65 and income tax rates do not change at 70. U19LO5

A benefit of waiting until the age of 70 to claim Social Security benefits is that A) a higher percentage of the monthly benefit is exempt from income taxes. B) benefits are increased by 8% for each year from the full retirement age. C) Medicare benefits are increased. D) the income tax rate is reduced once the claimant reaches 70.

C) zero Explanation A bond paying $100 in interest per year has a coupon rate of 10%. Whenever the coupon rate is equal to the discount rate, the NPV is zero. That is, the present value of a bond paying 10% interest when the current market rate is demanding a 10% interest rate is the bond's par value (as is the case with this bond). U10LO1

A bond is paying $100 per year in annual interest and is selling at par. If the discount rate is 10%, the net present value is A) negative B) the same as the coupon C) zero D) positive

A) he owns the stock and must submit payment Explanation The customer has entered into a contract to purchase a security as soon as the order is executed. The customer owns the stock and must submit payment. U22LO6

A customer's limit order to buy 500 shares of QRS at 60 is executed and the agent reports the trade execution to the customer. One hour later, the customer notices that QRS is down 2 points and informs the agent that he no longer wants the stock and is not planning to pay for it. The agent should tell the customer that A) he owns the stock and must submit payment B) he personally will repurchase the securities from the customer for the price paid C) the firm will repurchase the securities from the customer for the price paid D) he may sell the stock at the purchase price in the open market

D) a deceased individual. Explanation An account may only be opened in the name of a legal person. Deceased individuals are not considered legal persons - the account would have to be opened in the name of the estate. Governments meet that description as do charitable organizations. Although there are potential restrictions against convicted felons gaining employment in the securities industry, there are no specific prohibitions against opening an account for one. U18LO1

A registered broker-dealer would not be able to open an account for A) the American Cancer Society. B) a convicted felon. C) the sovereign government of Poland. D) a deceased individual

D) ETFs may not be sold short. Explanation Exchange-traded funds can be sold short and can be bought on margin just like other listed securities. Because most ETFs are based on an underlying index, they are passively managed and like other listed securities, their price is based on supply and demand rather than the NAV (although the price will generally be close). U14LO8

All of the following statements regarding exchange-traded funds (ETFs) are correct except A) ETFs can be bought on margin. B) ETFs may be passively managed. C) ETFs trade based on supply and demand for the shares rather than their NAV. D) ETFs may not be sold short.

C) Class A shares Explanation Class B shares are known for their back-end load. Class C shares usually only have one for 1 year; but, if the investor redeems within that period, there will be a CDSC. Class A shares do not carry a back-end load, except under conditions that are beyond the scope of this exam. U14LO4

An investor invests $25,000 into the KAPCO Balanced fund. It would be unlikely for this investor to be required to pay a CDSC when redeeming A) Class B shares B) any shares, regardless of Class C) Class A shares D) Class C shares

B) the person appointed as administrator of the estate Explanation Dying intestate means that there is no valid will. In that case, the state will appoint someone as administrator of the estate with the responsibility of handling all of the affairs of the deceased. Only when there is a will is there an executor, and a durable power of attorney is canceled upon the death of either party to the power. Only if the account were registered as JTWROS with the spouse (or if the spouse were named the executor) would the spouse have any authority. U18LO4

During a trip to visit grandchildren, one of your clients suffers a massive heart attack and dies, intestate. Directions for handling the account could only come from A) the person with a durable power of attorney B) the person appointed as administrator of the estate C) the person named as executor of the estate D) the spouse

D) Client's risk tolerance Explanation While forming a portfolio or investment policy statement (IPS), gauging a client's risk tolerance is the key task. U19LO4

Which of the following is a factor that must be considered when constructing a portfolio? A) Performance measurement B) Category of investment service required C) Verification of the client's identity D) Client's risk tolerance

D) AAA-rated zero-coupon bonds maturing in 16 years Explanation Because the assets are in a rollover IRA, the "phantom" tax on zero-coupon bonds is not an issue here. Being risk averse, the safety of AAA bonds with the guaranteed return of increased principal in 16 years makes this the most appropriate investment. The T-bills will probably not offer as much return and will be subject to continual reinvestment risk. Dividends on preferred stock are not guaranteed, even with a highly rated company, and the current tax advantage offered to dividends is wasted in an IRA. Most would agree that the worst option would be to keep the money in one single stock. U19LO6

A client is risk averse and is planning on retiring in 16 years. The client is rolling over $100,000 from his 401(k) plan, all of which is currently invested in his former employer's stock. As the client's investment adviser, which of the following would you recommend? A) Highly rated preferred stocks paying liberal dividends B) Keeping the money in the employer's stock C) Laddering U.S. Treasury bills D) AAA-rated zero-coupon bonds maturing in 16 years

C) Large-cap consumer goods company Explanation A large-cap consumer goods company is most appropriate for a risk-averse investor because of the relative stability of the stock price compared with the other choices, as well as the stability of its earnings. U19LO6

Of the following stocks, which would be the most suitable for a conservative, risk-averse investor? A) Mid-cap software company B) Large-cap cyclical company late in the economic cycle C) Large-cap consumer goods company D) Small-cap medical technology company

C) The contract may not be unilaterally assigned to another adviser. Explanation All contracts between an investment company and an outside adviser must be in writing and must contain certain provisions; these include that the contract may not be unilaterally assigned to another adviser. The initial contract may be for 2 years, but it is subject to annual reapproval by a majority vote of the outstanding shares or the board of directors, as well as a majority of the directors who are considered to be noninterested parties. U14LO1

Under the Investment Company Act of 1940, which of the following statements about advisory contracts between an investment company and an outside adviser is TRUE? A) The contract must be established for a 1-year period and renewed annually thereafter. B) The initial contract is effective once approved by the board of directors. C) The contract may not be unilaterally assigned to another adviser. D) The contract may be in writing, or it may be oral if there are at least 2 witnesses to the agreement.

C) IRR is most often used with growth stocks Explanation It is possible, although very difficult, to calculate IRR for investments with uneven cash flows such as growth stocks where dividends are generally not reliable. IRR is the rate of interest that equates the initial investment with the present value of future cash flows; it is the rate of return that results in an investment having a net present value of 0. U10LO1

All of the following statements regarding an investment's internal rate of return (IRR) are true EXCEPT A) IRR is the one rate of return that results in an investment having a net present value (NPV) of 0 B) IRR expresses the rate of interest that matches the initial investment with the present value of future cash flows C) IRR is most often used with growth stocks D) investments are acceptable when their internal rates of return exceed the investor's required rate of return

A) Strong form EMH Explanation This is the definition of the strong form EMH because it includes private information. Private sources include insider information, such as persons holding nonpublic access to information that may impact stock prices. There is no such term as passive form EMH. U20LO10

The statement, "Stock prices fully reflect all information from public and private sources," can be attributed to which form of the efficient market hypothesis (EMH)? A) Strong form EMH B) Weak form EMH C) Semi-strong form EMH D) Passive form EMH

B) The SEC Explanation The Securities Exchange Act of 1934 granted the SEC the power to close any registered stock exchange for up to 90 days. All that is required is notice to the president of the United States. U22LO3

Which of the following has the power to close a stock exchange for up to 90 days? A) The president of the United States B) The SEC C) The Administrator in the state where that stock exchange is located D) The president of that stock exchange

A) If NPV > 0, then IRR < required return Explanation If the NPV is a positive number, the investor's internal rate of return (IRR) is greater than the required rate of return (it is a good buy). When used with bonds, the required rate of return is the current market interest rate. Conversely, if the NPV is a negative number, the investor's IRR is less than the required rate of return (not a good buy). When the NPV is zero, the investor's IRR is equal to the required rate of return. U10LO1

Which of the following incorrectly states the relationship between NPV, IRR, and required return? A) If NPV > 0, then IRR < required return. B) If NPV = 0, then IRR = required return. C) If NPV > 0, then IRR > required return. D) If NPV < 0, then IRR < required return.

D) Face-to-face meeting at the client's home Explanation There are a number of ways to gather information about your client's financial resources, but it is highly unlikely that a social media page would be one of them. Privacy laws would make interviewing neighbors of a client unethical. U19LO1

Your firm onboards a new investment advisory client. Which of the following would be the most appropriate way to obtain information about the client's objectives and constraints? A) Client's LinkedIn page B) Interview with the client's neighbors C) Monitoring the client's Tweets D) Face-to-face meeting at the client's home

D) the maximum return for the least risk. Explanation The optimal portfolio is the one which provides the greatest return for the least risk. It will fall on the efficient frontier. It is important not to get hung up on terminology when common sense works. As an investor, wouldn't you always want the highest return you could get for the least risk? U20LO8

When attempting to construct the optimal portfolio, the investment adviser is looking to obtain A) returns that fall within the efficient frontier curve. B) the maximum return in the shortest time period. C) the maximum return with the greatest risk. D) the maximum return for the least risk.

B) ETNs Explanation The question describes an individual with a low risk tolerance, so the Treasury bonds and CDs would certainly be considered appropriate. Because ETNs are a debt security backed solely by a single issuer while an ETF based on a specific index of debt securities represents a large group of issuers, they are only suitable for those who can understand and take the risks involved. U17LO3

A client with limited assets seeking additional income in retirement would probably find which of the following investment choices to be the least suitable? A) Treasury bonds B) ETNs C) Insured bank CDs D) ETFs

C) Common stock listed on the New York Stock Exchange/unit in a direct participation program (DPP) Explanation Stock listed on the NYSE is considered highly liquid while ownership units in a DPP are generally illiquid. Once a variable annuity's accumulation units have been exchanged for annuity units (payout time), there is no liquidity. The corporate bonds and T-bills have the order reversed; it is the T-bills with high liquidity and corporate bonds have the lower liquidity. Variable annuity accumulation units are liquid and so are money market mutual fund shares. However, because the fund shares have check-writing privileges, they are the more liquid of the 2 choices and so the order is reversed from what the question seeks. U17LO7

If near-term liquidity is the only objective for a client, which of the following pairs of investments represents the most/least liquid? A) Variable annuity accumulation unit/money market mutual fund shares B) 10-year corporate bonds/U.S. T-bills C) Common stock listed on the New York Stock Exchange/unit in a direct participation program (DPP) D) Annuity units of a variable annuity/unit in a direct participation program (DPP)

A) I, II, III, and IV Explanation The computation of book value per share is basically net tangible worth per share of common stock. Included in the net worth are all assets and liabilities (such as long-term debt), as well as the stockholders equity (par value of the preferred stock and par + paid in surplus of the common stock and retained earnings). Subtracted from this to get tangible book value would be the par value of the preferred stock and the value of intangible assets such as goodwill. U10LO7

One measure of a corporation's liquidation value is its book value per share. When performing this computation, which of the following must be taken into consideration? Goodwill Long-term debt Retained earnings Par value of the preferred stock A) I, II, III, and IV B) II, III, and IV C) II and III D) I and II

D) ownership must be established by the record date Explanation Only stockholders who are on the company's books by the record date are eligible to vote. U12LO2

One of the rights of those owning common stock is the opportunity to vote on issues brought up at the corporation's annual meeting. To be eligible to cast a vote, A) the stock must be paid for in full before the annual meeting B) the company must be current on its dividends to preferred stockholders C) the stockholder must be a natural person D) ownership must be established by the record date

B) I and III Explanation Exchange-traded notes are unsecured debt securities issued by financial institutions, such as banks. Their prices can be impacted by changes in the credit rating of the issuer, and they are not insured by the FDIC. U17LO3

One type of alternative investment considered to be a pooled investment vehicle is the exchange-traded note. Exchange-traded notes (ETNs) are unsecured debt securities unsecured equity securities issued by financial institutions, such as banks insured by the FDIC A) II and IV B) I and III C) II and III D) I and IV

B) majority vote of the fund's board of directors or of the outstanding voting shares, as well as by majority vote of the noninterested members of the board Explanation When it comes to management investment companies (open-end or closed-end), renewal of the investment adviser's contract is approved annually by the fund's board of directors or a majority vote of the outstanding voting shares. The initial contract must be approved by both the board of directors and a majority vote of the outstanding shares. In both of these cases, initial and renewal, a majority vote of the noninterested (outside) members of the fund's board of directors is also required. U14LO1

In accordance with the stated provisions of the Investment Company Act of 1940, renewal of an open-end management investment company's investment adviser's contract must be approved by A) the principal underwriter of the fund B) majority vote of the fund's board of directors or of the outstanding voting shares, as well as by majority vote of the noninterested members of the board C) FINRA D) the SEC

C) The hypothecation agreement Explanation The hypothecation agreement gives permission to the broker-dealer to pledge a customer's margin securities as collateral. The firm hypothecates customer securities to the bank, and the bank loans money to the broker-dealer on the basis of the loan value of these securities. The credit agreement contains the terms of the loan, including the method of computing interest on the borrowed money. The loan consent agreement, granting permission to the broker-dealer to lend out the customer's securities, is optional. U22LO2

Margin is borrowing money from a broker-dealer to buy a stock using the investment as collateral. In many cases, the brokerage firm then uses that collateral for a loan from a bank. Which of the following account documents authorizes the firm to pledge the customer's stock? A) The credit agreement B) The securities pledge agreement C) The hypothecation agreement D) The loan consent agreement

B) the record date Explanation The record date is a date announced by the company as the official date you must be an owner on the company's records in order to participate in the annual meeting and corporate election. A fact not tested is there is no standard regarding how far in advance of the voting date this should be other than it must be at least the normal settlement period, currently 2 business days. U12LO2

One of the rights of being a stockholder is the ability to vote on important corporate matters, such as the election of members to the board of directors. The date that determines which shareholders are eligible to votes is A) the last day of the company's fiscal year. B) the record date. C) the ex-dividend date. D) the election date.

A) RJP, beta 1.2, return 17.5% Explanation We compare the expected return to the actual return to determine if the security outperformed (making it undervalued) or underperformed (making it overvalued). RJP's beta of 1.2 would have led to an expected return of 120% of that of the market. That would be 15% x 120% = 18%. With an actual return of 17.5%, the stock did not perform relative to the additional risk taken. The actual return for all of the others exceeded the expected return. LQR was 11% compared to 10.5%; BED was 23.5% compared to 22.5%; and ACR was 13.6% compared to 13.5%. U20LO9

Over the past year, the market, with a beta of 1.0, has returned 15%. Under CAPM, which of the following stocks would be considered overvalued? A) RJP, beta 1.2, return 17.5% B) ACR, beta 0.9, return 13.6% C) LQR, beta 0.7, return 11% D) BED, beta 1.5, return 23.5%

A) I, II, III, IV Explanation For a client seeking income, preferred stock, especially one that is cumulative, would likely be the most suitable of the choices given. Convertible preferred stock generally pays a lower dividend rate than other preferred stocks. This is because of the attractiveness of the convertibility. Although there are some categories of common stock (e.g., utility stocks that pay liberal dividends), unless specifically mentioned, you can assume that preferred stock dividends are higher than those for common stock of the same issuer. Warrants never provide any income. U12LO2

Rank the following securities from the same issuer from most suitable to least suitable for a client whose primary objective is income. Cumulative preferred stock Convertible preferred stock Common stock Warrant A) I, II, III, IV B) II, III, IV, I C) III, I, IV, II D) I, III, II, IV

C) At least 75% of the REIT's taxable income must be paid out as dividends to investors Explanation In order to qualify as a REIT, the REIT must distribute at least 90% of its taxable income, not 75%. At least 75% of the assets must be invested in real-estate related assets such as real property or mortgages. The same is true of the REIT's annual gross income. U14LO9

There are certain requirements for an investment to qualify as a REIT. Which of the following is not one of them? A) At least 75% of the REIT's annual gross income must be from real estate-related income such as rents from real property and interest on obligations secured by mortgages on real property. B) At least 75% of the assets must be invested in real-estate related assets, cash, and U.S. government securities. C) At least 75% of the REIT's taxable income must be paid out as dividends to investors. D) At least 90% of the REIT's taxable income must be paid out as dividends to investors.

A) III and IV Explanation For the fund to impose 12b-1 charges, the distribution plan must be in writing and approved by a majority of the outstanding shares, as well as a majority of the board of directors, including a majority of directors classified as outside directors. U14LO4

Under the Investment Company Act of 1940, SEC Rule 12b-1 allows a fund to charge distribution and sales expenses to net assets as a percentage of the total assets. Normally, the cost of distribution of the shares is paid by the underwriter out of the sales load paid by the individual purchaser. For a fund to impose 12b-1 charges, which of the following conditions apply (applies)? The board of directors has sole approval authority. The majority of the outstanding shares has sole approval authority. Both the board and the majority of outstanding shares must approve it. A distribution plan must be written. A) III and IV B) II and III C) I only D) I and III

D) the property is divided into as many equal shares as there are surviving children of the designated ancestor and deceased children who left surviving descendants Explanation When a will calls for a per stirpes distribution of assets, it provides that if any named beneficiary predeceases the testator (the maker of the will), surviving children of that individual share in the share that the individual would have received. For example, if the testator had 3 children and 1 of them died first, any children of the deceased would share in their parent's portion (they would split one-third of the estate between them). U18LO5

When a will calls for property to be distributed per stirpes, it means that A) the property is divided into as many equal shares as there are surviving children and grandchildren of the designated ancestor B) all living descendants of the ancestor receive equal shares in the property remaining after all estate expenses are paid C) the property is divided into as many equal shares as there are surviving children of the designated ancestor, with nothing going to surviving descendants of deceased children D) the property is divided into as many equal shares as there are surviving children of the designated ancestor and deceased children who left surviving descendants

A) the daily trading volume Explanation A technical analyst charts price and volume over time. The other choices are of interest to a fundamental analyst. U12LO6

When reviewing potential securities to select for an investor's portfolio, a technical analyst would be most likely to evaluate A) the daily trading volume B) the price-to-earnings ratio C) the management tenure D) the price-to-book ratio

D) Stock dividends Explanation Stock dividends, unlike cash dividends, are not taxable in the year of receipt. Instead, they reduce the owner's cost basis and, when sold at a price above that cost basis, are treated as capital gain rather than ordinary income. Deferred annuities never generate anything but ordinary income, and qualified withdrawals from Section 529 plans result in no taxation on the earnings. If they are not qualified, there is ordinary income tax plus a penalty. U21LO3

Which of the following offers the opportunity to realize a capital gain rather than ordinary income? A) Deferred annuities B) Section 529 plans C) Cash dividends D) Stock dividends

D) Purchasing power risk Explanation AAA-rated, long-term securities are the highest available quality as far as default or credit risk is concerned. It is highly unlikely that the company would be unable to pay their interest and principal payments on time. Because of their safety, the marketability of the bonds should be strong. However, like all fixed dollar investments, they are subject to purchasing power (inflation) risk. You may wish to note that these bonds would also be subject to interest rate risk. U11LO1

Which of the following risks would be associated with long-term, AAA-rated bonds? A) Marketability B) Unstable interest payments C) Ability of the issuing company to pay interest and principal D) Purchasing power risk

C) Total risk equals market risk plus company-specific risk Explanation Total risk equals systematic (market) risk plus unsystematic (company-specific) risk. Standard deviation is the tool that measures total risk. The unsystematic risk for a specific firm is not similar to the unsystematic risk for other firms in the same industry. Unsystematic risk is company-specific or unique risk, and when more stocks are added, the risk will change. The systematic risk of a portfolio can be changed up or down by adding high-beta or low-beta stocks. U10LO5

Which of the following statements about systematic and unsystematic risk is most accurate? A) As an investor increases the number of stocks in a portfolio, the systematic risk will go down. B) The unsystematic risk for a specific firm is similar to the unsystematic risk for other firms in the same industry. C) Total risk equals market risk plus company-specific risk. D) As an investor increases the number of stocks in a portfolio, the unsystematic risk will stay the same.

D) NPV assumes the cash flows can be reinvested at market interest rates. Explanation The first step in finding the NPV is to compute the present value (PV). The PV is computed by taking the future cash flows and discounting them by a "discount" rate. That rate is the current market interest rate. So, if NPV is based on PV and PV assumes reinvestment at the discount rate, that assumption must hold true for figuring NPV. In the case of the IRR, that is the yield to maturity of a bond and assumes that the cash flows are reinvested at that IRR. For example, a bond with a YTM of 7% assumes that all reinvestments will be made at that 7% rate. The periodic cash flow on a bond comes from the semiannual interest payments making reinvestments semiannually, not annually. U10LO1

Which of the following statements is most accurate regarding the net present value (NPV) and internal rate of return (IRR) on a bond? A) IRR assumes the cash flows are reinvested annually. B) NPV assumes that cash flows can be reinvested at the bond's IRR. C) IRR assumes the cash flows are reinvested at market interest rates. D) NPV assumes the cash flows can be reinvested at market interest rates.

C) Combining assets with less than perfect positive correlation will not reduce the total risk of the portfolio. Explanation Watch out for the double negatives here. Combining assets with less than perfect positive correlation can reduce the total risk of the portfolio. The further the correlation coefficient between the two assets is away from +1.0, the greater the diversification benefits that may be attained. U10LO6

Which of the following statements regarding the correlation coefficient is not correct? A) A correlation coefficient of 0.0 means there is no relationship between the returns of the assets. B) Perfectly positively correlated assets have a correlation coefficient of +1.0. C) Combining assets with less than perfect positive correlation will not reduce the total risk of the portfolio. D) Perfectly negatively correlated assets have a correlation coefficient of -1.0.

D) Growth mutual funds Explanation IRA accounts are designed to provide for future retirement needs. An IRA is a personal pension plan for anyone who receives earned income. While the rules are fairly liberal regarding suitable investments for IRAs, penny stocks, options, or oil and gas programs would not likely be suitable because of the high risks inherent in these securities. However, growth mutual funds are suitable. U19LO6

Which of the following would be most suitable for a young couple investing the assets of their IRAs? A) Penny stocks B) Call options on large-cap stocks C) Oil and gas exploration programs D) Growth mutual funds

A) I and III Explanation ETFs can be traded throughout the trading day. Changing price quotes are available in real time as investors buy and sell. Although ETFs have an NAV that is calculated on the basis of the portfolio holdings, the trading price is determined by supply and demand in the open market, with customers paying commissions. U14LO8

A customer is interested in an exchange-traded fund (ETF). With regard to the trading of ETFs, the customer should be aware that ETFs can be purchased throughout the trading day ETFs use forward pricing, as all mutual funds do real-time quotes are available for ETFs the NAV calculated at the end of the day, plus a sales charge, will equal the trading price A) I and III B) II and III C) I and IV D) II and IV

B) the new owner receives the $5 million death benefit Explanation A life settlement contract involves the sale of a life insurance policy to a party other than the insured. In exchange for the payment, the new owner is entitled to the death benefit when the seller passes away. The right of rescission applies to illegal securities sales and this is not a security nor has any illegal activity been described. U17LO4

You have a client who sold her $5 million whole life insurance policy through a life settlement broker. If she dies 2 years later, A) the insurance company is not obligated to pay the death benefit because she no longer owns the policy. B) the new owner receives the $5 million death benefit. C) her estate can invoke the right of rescission and receive the policy proceeds minus the sale proceeds. D) the insurance broker must return all commissions to the insurance company.

D) LMN Investment-Grade Bond Fund Explanation These clients cannot afford a downturn in the stock market between now and the time they want to send their children to college. An investment-grade bond fund will provide the income and safety required for accumulating additional funds for college expenses. U19LO6

Your married customers are both 42 years old, have 2 children ages 14 and 12, and have spent the past 10 years accumulating money to provide for their children's education. Their oldest child will enter college in 4 years, and the customers are very cautious investors. If they need a safe investment that provides regular income to help them meet tuition payments, which of the following mutual funds is the most suitable for these customers? A) RST Balanced Fund B) ABC Stock Index Fund C) ATF Overseas Opportunities Fund D) LMN Investment-Grade Bond Fund

B) If the confirmation states that the broker-dealer acted in a principal capacity, we charged you a markup instead of a commission Explanation Broker-dealers can act in the capacity of a broker (charging commissions) or a dealer (charging a markup or markdown). That capacity is always indicated on the confirmation, so the first thing to do is have the client look for the indication (firms use different methods to make the disclosure) of capacity. It will most likely show "principal" and that is why there is no commission; there is a markup on the purchase. U22LO5

A client calls her agent and very excitedly says, "I just received a confirmation for my recent purchase and notice that you didn't charge me any commission; thank you so much". What would be the appropriate response? A) You probably misread the confirmation and didn't notice the commission. B) If the confirmation states that the broker-dealer acted in a principal capacity, we charged you a markup instead of a commission. C) There must be an error and I'll make sure you receive a new confirmation with the proper commission charge. D) We like to do little favors periodically for our clients to keep them happy.

A) A mix of investment-grade bonds and cash/cash equivalents Explanation An individual with an investment objective of capital preservation should be investing in a mix of investment-grade bonds and cash/cash equivalents. Lower-risk capital appreciation vehicles, such as large-cap common stock, should also be considered. The other choices noted are too risky for a risk-averse investor. U19LO6

A client has a more-than-average aversion to risk with a primary investment objective of capital preservation. Given the following choices of portfolio allocations, which would probably be the most suitable for this investor? A) A mix of investment-grade bonds and cash/cash equivalents B) A mix of high-yield bonds and cash/cash equivalents C) A preponderance of growth stocks and limited partnership vehicles D) A preponderance of speculative stocks and high-yield bonds

D) If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend. Explanation Most convertible securities are sold with antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends. U13LO9

A client of yours owns some convertible preferred stock. She notices an article in the business section of her local newspaper that reports the company is going to pay a 20% stock dividend on their common stock. She wants to know how this will affect her? A) More than likely, the price of the preferred stock will rise. B) She will also receive 20% more shares because preferred stock has a priority claim ahead of common. C) There will be no effect. D) If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend.

B) has a positive net present value Explanation With a discount rate of 5% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 7% coupon rate will be selling at a premium (interest rates down, prices up). We are told that this bond is offering a yield of 5.4%, which is more than the current market rate. Because a present value computation using a 5.4% rate would reflect a lower value than a 5% rate (the higher the discount rate, the lower the value), the bond can be purchased at a price below its present value. Any time that occurs, the instrument has a positive net present value (the difference between the price and the present value). U10LO1

A client owns an investment-grade bond that has a coupon of 7% and is priced to yield 5.4%. If similarly rated bonds are being issued today with coupons of 5%, it would be expected that the client's bond A) will be selling at a discount from par B) has a positive net present value C) has a negative net present value D) has a zero net present value

C) Credit or default risk Explanation A company using borrowed capital to expand is increasing its financial leverage. As such, the possibility of default increases. Investors can reduce their risk either by diversifying into companies using minimal leverage or selecting those issuers with higher credit ratings. The other risks noted are systematic or nondiversifiable risk. U11LO2

A company using debt obligations to finance business expansion is indicative of what type of investment risk? A) Purchasing power risk B) Market risk C) Credit or default risk D) Reinvestment rate risk

C) The agent convinced the client to invest in a Treasury bill on the basis of its safety. Explanation Investment in a Treasury bill is the only suitable investment among the choices listed. Purchase of annuities and a real estate partnership are long-term investments not suitable to an individual who wants to invest funds on a short-term basis. Although an IPO may be liquid, it is not suitable for short-term funds earmarked for the purchase of a house because there is too much risk to the principal. U19LO6

An individual with $100,000 to invest will require these funds in 6 months for the purchase of a house. In which of the following circumstances did the agent act CORRECTLY? A) The agent convinced the client to purchase a $100,000 lump sum annuity on the basis of its security and backing by an insurance company. B) The agent convinced the client to invest in a real estate partnership as a hedge against the rise of real estate values until the client purchases the house. C) The agent convinced the client to invest in a Treasury bill on the basis of its safety. D) The agent convinced the client to invest in an IPO on the basis of its high-growth prospects.

D) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client. Explanation Even when the IAR is convinced that the optimal recommendations have been made, the final decision is always that of the client. However, there is nothing in the laws or policies dealing with ethical conduct that prohibit the IAR from attempting to "sell" the client, especially through an educational approach. U19LO6

An investment adviser representative prepares a detailed portfolio restructuring for a new client. The client is not impressed with the recommendation, and at least to the IAR, it appears that the rejection is more due to a lack of understanding than a valid dislike. What should be the first step taken by the IAR? A) Go ahead with the recommendation anyway because the client's lack of understanding should not stand in the way of potentially superior results. B) Suggest that if the client will not follow the IAR's recommendations, it would be best to engage the services of another firm. C) Prepare a new set of recommendations that will hopefully be received more favorably by the client. D) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client.