Practice Exam 3
A man is planning to start his own glass-sculpturing business. He wants to be able to deduct his anticipated losses for the first 2 years. He anticipates that the enterprise will borrow money from lenders and is willing to personally guarantee the debt. He also wants to attract other investors but does not want to give up control of the day-to-day business decisions. What business form do you recommend? A) Limited partnership B) S corporation C) C corporation D) General partnership
A) Limited partnership A limited partnership with him as general partner would allow for additional investment capital without giving up management control. C corporations do not allow deductibility of losses; S corporations do not allow guaranteed debt to be included in the taxpayer's basis. General partnerships could allow the other partners to more easily control the day-to-day operations than a limited partnership, in which the other investors (presumably limited partners) would not be permitted to take a role in the running of the business.
Which of the following characteristics best exemplifies a value stock? A) Low price-to-book, low price-to-earnings ratio B) Low price-to-book, high price-to-earnings ratio C) High earnings-per-share growth, high profitability D) Low earnings-per-share growth, high profitability
A) Low price-to-book, low price-to-earnings ratio A value investor focuses on share price in anticipation of a market correction and improving company fundamentals. Therefore, such an investor tends to select a stock featuring lower price-to-earnings and price-to-book value ratios. A growth investor focuses on high earnings-per-share, growth, and high profitability.
Which of the following best describes net present value? A) The difference between the sum of the discounted cash flows that are expected from an investment and its initial cost B) The amount of money that must be invested today at some specified rate of return to equal a targeted value in a specified number of years C) It is the true interest yield expected from an investment expressed as a percentage D) The discount rate that results in a return of zero for a series of future cash flows
A) The difference between the sum of the discounted cash flows that are expected from an investment and its initial cost Net present value is a computation taking into consideration future cash flows, discounted to the present, and comparing that to the capital investment necessary to obtain those flows. It is always expressed in monetary units and, if positive, indicates a potentially worthwhile investment.
Registration by qualification is effective A) when determined by the Administrator B) 20 days after the filing date C) when the federal registration becomes effective D) no earlier than 10 days after the filing date
A) when determined by the Administrator Registration by qualification is effective when determined by the Administrator. Qualification is the only form of registration where the timing of the effective date is determined by the Administrator.
Distributions from which of the following can be rolled over into an IRA? Another IRA Corporate pension plan Corporate profit-sharing plan Keogh plan A) II and III B) III and IV C) I, II, III, and IV D) I and IV
C) I, II, III, and IV Assets from any qualified corporate plan or from another IRA may be rolled over into an IRA.
A man divorces his spouse after 10 years of marriage and remarries. If the man is the sole provider, what part of the worker's Social Security benefits is the new spouse entitled to? A) The new spouse is entitled to splitting the benefits with the ex-spouse. B) The new spouse is entitled to more benefits than the ex-spouse. C) She is entitled to the same Social Security benefits as the ex-spouse. D) She will be entitled to the same Social Security benefits as the ex-spouse after 10 years of marriage.
C) She is entitled to the same Social Security benefits as the ex-spouse. When an individual remarries, the new spouse is entitled to full Social Security benefits. As long as the previous marriage lasted at least 10 years, that ex-spouse (if not remarried) is also entitled to full benefits. That means it is possible for 2 people to receive full benefits at the same time.
A technical analyst would be most interested in which of the following? A) Capitalization ratios B) Working capital C) Price-to-earnings ratios D) 200-day moving averages
D) 200-day moving averages Technical analysts try to predict the market by examining price and volume trends. They expect the market to act in the future as it has in the past. Technical analysts are not interested in the fundamental aspects of a company, such as its financial statement ratios.
An advisory client of yours dies in 2019, and you transfer the $1.4 million of securities in the individual's name to the estate account. You will A) notify the executor of the estate that he is able to do any trades to rebalance the account, and that taxes will be of no consideration B) tell the executor that he will be receiving a Form 1099 for tax purposes, representing the transfer of account over to the estate account C) inform the executor that you need to keep sufficient liquid funds in the account because estate taxes will be due in 6 months D) continue to manage the account unless the advisory contract called for termination upon death or informed otherwise by the executor
D) continue to manage the account unless the advisory contract called for termination upon death or informed otherwise by the executor Unless the advisory contract has a termination upon death provision or the executor wishes to assume management of the account, the investor adviser may continue to manage the account of the estate. Trades made in the account must take into consideration tax implications as with any other account. Estate taxes are due 9 months after death, and unless there are other assets not listed here, no tax is due because this estate is less than $11.4 million (the amount exempt from taxation for 2019).
Which of the following statements is (are) TRUE regarding the jurisdiction of the SEC under the Securities Exchange Act of 1934? The SEC has jurisdiction over exchanges and SROs. The SEC has jurisdiction over broker-dealers, investment advisers, and associated persons that are required to be registered under federal law. The SEC has jurisdiction over banks and savings and loans regarding their securities activities. A) II only B) I only C) I and II D) I, II, and III
C) I and II The SEC was created by the Securities Exchange Act of 1934 and has the responsibility of administering all federal securities laws. The SEC has jurisdiction over exchanges, SROs, and all persons required to be registered under federal law. The SEC does not enforce state securities statutes, nor does it have jurisdiction over banks or savings and loans regarding their securities activities. Banking authorities, such as the Federal Reserve Board, the Federal Deposit Insurance Corporation, and others, regulate banks and savings and loans.
According to the Investment Advisers Act of 1940, which of the following statements about agency cross transactions is NOT true? A) These transactions are allowed if the adviser is acting in the best interest of the client with respect to obtaining the best possible price. B) Advisers must provide a written disclosure of potential conflict of interest before obtaining the client's written consent to execute such a transaction. C) Investment advisers can recommend these transactions to both the buyer and the seller if both clients give written consent. D) Advisers must send statements to clients no less frequently than annually that identify the total number of these transactions during the period and the total amount of commissions received.
C) Investment advisers can recommend these transactions to both the buyer and the seller if both clients give written consent. An agency cross transaction occurs when an investment adviser acts as a broker for one or both sides of a transaction involving an advisory client. Investment advisers cannot recommend cross transactions to both buyer and seller, even if written consent is given. These transactions can be executed if the adviser is acting in the best interest of the client with respect to obtaining the best possible price. Disclosure is also required. The adviser must send a statement on at least an annual basis identifying the total number of these transactions during the period covered and the total amount of commission received. Advisers must provide a written disclosure of potential conflict of interest before obtaining the client's written consent to execute such a transaction.
Which of the following is least likely to be considered an investment constraint when preparing an investment policy statement? A) Liquidity needs B) Tax concerns C) Risk tolerance D) Legal and regulatory factors
C) Risk tolerance The commonly tested investment constraints are: liquidity needs, time horizon, taxes, legal and regulatory factors, and unique needs and preferences. Risk tolerance is used to help determine what investment objectives will best meet the investor's goals.
Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, which of the following must be included in an advisory contract? Whether the contract grants discretionary power to the adviser The term of the contract A clause preventing assignment without consent The formula used for computing the fee A) I and II B) II only C) I, II, and IV D) I, II, III, and IV
D) I, II, III, and IV Written advisory contracts must disclose services provided; the term of the contract; the amount of the fee or the formula used to compute it; the amount of fee to be refunded, if any, if the advisory fee is prepaid and the contract is terminated; provisions as to whether the adviser has discretionary authority and to what extent; and provisions requiring consent of the client to assign the contract.
One of the terms defined in the Uniform Securities Act is "broker-dealer." Which of the following is NOT included in that definition? An individual employed by a corporate entity to open new customer accounts for the purpose of trading securities A business entity seeking to raise additional capital using the regulated securities markets A person whose primary function is buying securities for his own account and for the accounts of others A person whose primary function is providing advice on what assets belong in clients' investment portfolios A) II and III B) III and IV C) I, II, and IV D) I, II, III, and IV
C) I, II, and IV A broker-dealer is defined as a person in the business of effectuating securities transactions for its own account or the account of others. Those employed to open new accounts are defined as agents. Those seeking to raise new capital are issuers, and a person who provides investment advice is an investment adviser.
Typical broker-dealer fees that must be disclosed as part of a fee disclosure document would include a charge when a client requests that a stock certificate be issued in his name a commission charge when a client buys a security on a listed exchange the interest charged by the firm on money owed by customers in their margin accounts fees for providing advisory services to high-net-worth individuals A) III and IV B) I and III C) II and III D) I and IV
B) I and III If we know what charges are not included in the fee disclosure, it is easy to recognize those that are. There are 3 primary expenses involved with brokerage accounts that are not included in the fee disclosure template. Those are: commissions; markups and markdowns; and advisory fees for those firms that are also registered as investment advisers.
A portfolio manager's performance is often measured against a benchmark such as the S&P 500. A manager whose performance beats the benchmark by taking greater risk than the S&P 500 may not have had superior returns as measured on A) a total-return basis B) a risk-adjusted basis C) an expected-return basis D) an inflation-adjusted basis
B) a risk-adjusted basis Unless the portfolio's performance is better than the extra risk taken, the manager has not beaten the performance benchmark, the S&P 500, on a risk-adjusted basis. Risk-adjusted return is calculated by computing the Sharpe ratio. Total return comprises the yield plus the growth in value of an investment over time and is not related to risk. The expected return is an estimate of the probable return an investment may yield, whereas inflation-adjusted return is the nominal return reduced by the inflation rate. Neither of these returns is related to risk. Inflation-adjusted returns are often compared to a benchmark such as the Consumer Price Index (CPI). Unadjusted rates of return are called nominal rates of return.
A working group convened by NASAA has developed a model fee disclosure schedule to help investors better understand the costs involved in doing business with their broker-dealer. The template has broker-dealers disclose all of the following fees EXCEPT A) account inactivity fee B) advisory fees C) issuance of a stock certificate D) charges for late payments
B) advisory fees There are 3 primary expenses involved with brokerage accounts that are not included in the fee disclosure template. Those are: commissions; markups and markdowns; and advisory fees for those firms that are also registered as investment advisers.
Your client often makes irrational financial decisions because she bases her decisions on information that should have no influence on the decision at hand. The client's behavior is known as A) overconfidence. B) anchoring. C) herd mentality. D) confirmation bias.
B) anchoring. Making irrational decisions based on information that should have no influence on the decision at hand is known as anchoring. Herd mentality is the tendency to follow the actions of a larger group, whether rational or not. Confirmation bias is the tendency to pay attention to information that supports one's preconceived opinions while disregarding accurate, unsupportive information. Overconfidence occurs when an investor considers her abilities to be much better than they actually are.
Under ERISA, a pension portfolio manager may engage in writing covered options A) at no time; writing options is too high a risk B) only if it fits with the objectives of the plan C) under any circumstances D) only during declining markets
B) only if it fits with the objectives of the plan Writing covered options is appropriate as long as it matches investment objectives. While writing covered calls is sometimes done to generate income, writing uncovered, or naked, calls is not appropriate for a pension plan because of the unlimited risk potential.
Sharon Smith is an investment adviser representative with Highwater Advisers, a federal covered investment adviser with its principal office in State X. Sharon provides advisory services to a bank located in State X, a state in which she has no place of business. Under current regulations, A) because Sharon's client is a bank, she does not have to register as an IAR in State X. B) because Sharon has a client in State X, registration as an IAR would be required in State X. C) because Highwater's principal office is in State X, Sharon would be required to register as an IAR in State X. D) because Sharon has no place of business in State X, she does not have to register as an IAR in State X.
D) because Sharon has no place of business in State X, she does not have to register as an IAR in State X. The key is that Sharon is an IAR for a covered IA. When that is the case, the IAR is only required to register in states where she (the IAR) maintains a place of business. Sharon does not have a place of business in State X so no registration is required there. The fact that the client is a bank is of no relevance nor is the location of her employer's principal office.
The Uniform Securities Act requires client consent for assignment of the investment advisory contract. It would be considered that contracts were assigned in all of the following situations except A) the sole proprietor of an investment advisory firm sells the firm to another adviser B) 2 investment advisory firms intend to merge, causing a change in the majority interest of the partners C) the sole stockholder of the investment advisory firm pledges all of the stock in the firm as collateral for a bank loan D) the death of a partner holding a minority interest with the remaining partners acquiring that share equally
D) the death of a partner holding a minority interest with the remaining partners acquiring that share equally Whenever there is a change in a majority interest in an investment adviser structured as a partnership, it is considered an assignment of the advisory contracts. The assignment requires client consent. The death of a partner with a minority interest does not require consent because it is not considered an assignment. All that is necessary is notification of the change in the partnership within a reasonable period. The sole stockholder of the advisory firm can pledge the firm's stock as collateral but requires client consent to maintain the advisory contracts. The merger of partnerships or sale of a sole proprietorship involves a change in majority interest, which requires consent to maintain the advisory contracts.
