Practice exam and subtopic quizzes missed q's

The form of technical analysis that utilizes Advances and Declines (also known as Breadth of the Market) as an indicator is known as: a. Price Indicator. b. Volume Indicator. c. Market Indicator. d. Charting Indicator.

A Advances and declines deal with price. Volume indicates the number of shares traded. Market indicators deal with directions of the market and related averages. Charts are used as indicators and in some instances, do not use price but rather movements.

n an after-dinner conversation, your neighbor states that Hot-Flow, Inc. must certainly be a good investment now that the stock has fallen from its recent high of $80 per share. The company currently trades for $65 per share. You ask your neighbor if she has any other information on which to base her buy recommendation. "Not really," she replies, "but if the stock was $80 per share last month, surely it will return to that level in the near future. After all," she continues, "how much can things change in just a few months of time?" Your neighbor's attitude is best described as: a. anchoring. b. hindsight bias. c. regret avoidance. d. representativeness.

A Anchoring results in buying securities that have fallen in value because it "must" get back up to that recent high B is incorrect. Hindsight bias is a form of overconfidence related to an investor's belief that they had predicted an event that, in fact, they did not predict. C is incorrect. Regret avoidance, also known as the disposition effect, causes investors to take action (or inaction) in hopes of minimizing any regret. D is incorrect. Representativeness is thinking that a good company is a good investment without regard to an analysis of the investment.

During the peak of the economic cycle, which of the following should one undertake? I. Sell debt instruments II. Begin allocations to cash positions III. Buy debt instruments IV. Sell gold and real assets a. I and II only. b. II and III only. c. III and IV only. d. I and IV only.

A At the peak of the market, there will be high demand for debt instruments, driving prices of bonds up. Bonds have an inverse relationship with interest rates, not the market. They tend to be a more stable (but still can have price movement) investment option when the market is making swings. It would be safer to move to cash when the market is expected to make a downturn. Interest rates will lag a bit after the peak of the cycle, and if you own bonds it would be a great time to sell for capital gains. The goal of investing is to buy low, sell high. Since inflation is still on (and rising after the peak), it often proves to be a good time to acquire metals rather than sell them.

Over the previous several months, Mathew Arkins, CFP®, has presented senior executives at West-Ark Financial Planning with numerous research reports indicating that several of the recommendations West-Ark has been making to their clients are no longer in favor with the analysts providing the research reports. Despite this apparent change in heart by the analysts, West-Ark has yet to adjust its advice to clients. Which behavioral bias is most evident for West-Ark? a. Belief perseverance. b. Herd mentality. c. Hindsight bias. d. Overconfidence.

A Belief perseverance is evident when people are unlikely to change their views given new information. B is incorrect. Herd mentality is the process of buying what and when others are buying and selling. C is incorrect. Hindsight bias is a form of overconfidence related to an investor's belief that they had predicted an event that, in fact, they did not predict. D is incorrect. Overconfidence suggests that investors overestimate their ability to successfully predict future market events.

Which of the following statements is correct with regard to the use of an arbitration clause in an investment advisory agreement? The SEC and FINRA require arbitration if voluntary negotiation fails. The SEC requires that such a clause be contained in any investment advisory agreement. The FINRA requires that such a clause stipulate that arbitration must be conducted by non-industry organizations. The clause must allow state regulations to take precedence over federal regulation.

A Both SEC and FINRA call for voluntary negotiations first. Barring success with this level of contact both SEC and FINRA require arbitration.

Which one of the following factors would be the strongest indication that interest rates might rise? a. Selling of dollar-denominated assets by foreign investors. b. Decreasing United States government deficits. c. Decreasing rates of inflation. d. Weak credit demand by the private sector of the United States economy.

A Foreigners selling dollar-denominated assets are preparing to take advantage of higher rates by increasing their liquidity. The rest signal a decrease in rates.

What is one reason a company may call bonds that were previously issued? a. The bonds are currently selling at a premium. b. The bonds are currently selling at a discount. c. The company expects interest rates to decrease. d. The bonds are selling at par.

A If the bonds are selling at a premium, then interest rates have decreased since the bonds were issued. The company would be motivated to retire the higher yield bonds and issue new bonds at lower market interest rates. A discount bond would indicate that interest rates have increased and the bond is paying a lower rate than current market interest rates. Companies do not make changes on expectations, but in actual rate changes.

Which one of the following is an advantage of equity REITs over mortgage REITs? a. Equity REITs can participate in the appreciation of the underlying properties. b. Equity REITs participate in the capital gains of the mortgages, whereas mortgage REITs receive only the coupon payments. c. Equity REITs retain the right to the potential appreciation of a property, but mortgage REITs retain the right to only the property's rental income. d. Equity REITs have the right to repossess the underlying property if the mortgage REIT fails to make its mortgage payments.

A Option "B" describes mortgage REITs, not equity REITs. Option "C" is incorrect as mortgage REITs have nothing to do with "rental income." Option "D" is an incorrect statement.

If one of your clients has a profitable long position in an oranges futures contract and does nothing as the contract expires, what should she expect to occur? a. The oranges will be delivered to her. b. She will receive a substantial check as soon as the account is settled. c. Her contract will expire worthless unless she takes some action. d. Her broker will arrange for sale of the oranges in an appropriate market.

A Positions in futures contracts are closed by taking an equal and opposite position. One who is long on a contract at the expiration should expect delivery of the commodities at the stated contract price. It is the buyers responsibility, but in this case, we could say the broker was remiss in his or her duties!

Robin purchased a mutual fund at NAV of $20.00 and sold it 8 months later at $21.00. During the time he owned the fund, he received a LTCG of $1.00/share and a qualified dividend distribution of $.75/share from the mutual fund. He has a marginal tax rate of 32%. The tax on LTCG is 15%. What is his after-tax holding period return? a. 10.84% b. 11.5% c. 11.8% d. 12.3%

A Since this is a ST holding period, it is ordinary income at the marginal tax rate for the price increase. Since the dividend distribution is a qualified dividend, it receives capital gains tax treatment. HPR = (SP - PP +/- CF) × (1-TR) / PP [($21.00 - $20.00) × (1 - .32)] + [($1.00 + $.75) × (1 - .15)] / $20.00 Answer: 10.84%

A convertible bond has the following terms: Maturity value = $1,000 Time to maturity = 20 years Coupon rate = 8% Call penalty = One year's interest Exercise price = $10 per share. Given this information, you will inform your client as to how many shares of stock that the bond may be converted. a. 100 shares b. 80 shares c. 50 shares d. 20 shares

A The conversion ratio is used here (PAR/Conversion Price) to determine how many shares are available upon conversion. $1,000 / $10 = 100 shares.

Which of the following terms would be used to describe a municipal bond issued with a restricted revenue base? a. Limited general obligation bonds. b. Limited revenue bonds. c. Full faith and credit bonds. d. Revenue bonds.

A The limited general obligation bond is a bond issued by an entity that has some ability to levy taxes to support itself (for example, a school district). However, this ability is limited when compared to that of the general taxing power of the state.

David has $20,000 that is earmarked for a down payment on a house in two years. If David is in the 28% tax bracket, what should he invest the $20,000 in? a. A 4% tax free money market mutual fund. b. A 5.4% corporate bond. c. A well diversified growth mutual fund. d. An intermediate muni-bond fund paying 4.5%.

A The taxable equivalent yield for the tax free money market fund is 5.56%. TEY = .04 / (1 - .28) TEY = .0556 The taxable equivalent yield is greater than the taxable corporate bond paying 5.4%. The mutual fund and intermediate muni-bond fund are not appropriate given the investor's time horizon.

Which of the following elements of risk in mortgage-backed securities can be difficult to determine? I. Actual maturity is not known with certainty. II. Mortgage rates vary between the different investment pools. III. Actual cash flows are not known with certainty. IV. Government guarantees make the determination of an appropriate discount rate for calculating their present value difficult. a. I and III only. b. I and IV only. c. II and III only. d. II and IV only.

A lack of a definite maturity date (you won't know if mortgages are paid off early ahead of time) and uncertain cash flows (due to possible early payoffs) are the elements of risk in mortgage-backed securities.

You are faced with several fixed income investment options. Which of these bonds has the greatest reinvestment rate risk? a. A U.S. Treasury bond with an 11.625% coupon, due in five years with a price of $1,225.39 and a yield to maturity of 6.3%. b. A U. S. Treasury strip bond (zero-coupon) due in five years with a price of $735.12 and a yield to maturity of 6.25%. c. A corporate B-rated bond with a 9.75% coupon, due in five years with a price of $1,038.18 and a yield to maturity of 8.79%. d. A corporate zero coupon bond due in 5 years with a price of $750 and a yield to maturity of 5.9%

A since A is at a huge premium, it has a high reinvestment risk since yields in the market are lower (so its at risk of not being able to invest the coupons at a similar yield)

Robert has a margin account with a national brokerage firm. He has been researching the stock of a publicly-traded company, and is interested in the stock because he believes it will increase in value. Robert would like to employ a leveraged investing technique, but wants to limit his downside risk. Which would be the best strategy for Robert? a. Purchase the stock on margin then place a stop-loss order. b. Buy a put option and sell a call option on the stock. c. Short-sell the stock and purchase a call option. d. Sell a call option on the stock and purchase warrants.

A Purchasing the stock on margin would allow Robert to use leverage to purchase the stock. Placing a stop-loss order would minimize his downside risk.

You are faced with the following alternative fixed income investments: (its 1999) A- US treasury bond wiht 11.625% coupon, due in 2004 with a price of $142.5 and a YTM of 6.3% B- US treasury strip bond (zero coupon) due in 2004 with a price of $47 and YTM of 6% C- Corporate rated bond with a 9.75% coupon, due in 2004 with price of $104 and a YTM of 8.79% -Which has the greatest reinvestment rate risk? What bout greatest interest rate risk? What about longest duration?

A has greatest reinvestment rate risk since highest coupon, and B has both the greatest interest rate risk and duration since its a zero coupon bond (and all mature in 2004, so it must have longest duration and hence most interest rate risk)

In the mutual fund industry, 12b-1 fees are charged as part of: I. Fund management fees. II. Distribution fees. III. Commissions for sales. IV. Legal fees and expenses. a. I only. b. II only. c. I and III only. d. I, II and IV only.

B 12b1 fees are used for marketing and distribution costs. All other costs, such as legal, accounting and analysis are paid through management fees. Commissions are paid using either a front load or a back load.

Greg buys 100 shares of ABC Company stock at a cost of $48 per share. He later purchases a put option on ABC Company stock with a strike price of $42. He paid a premium of $100 for the option. On the date of the put option expiration, ABC stock is trading at $35, and Greg exercises the option. What is Greg's net gain or loss on this transaction? a. $400 gain. b. $700 loss. c. $800 loss. d. $1,300 loss.

B A put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. He paid $100 for the put option. His security basis is $48 per share, and the sale price is the strike price of the option, $42, resulting in a $6 per share loss x 100 shares = $600, plus the purchase price of the option leaves a $700 loss.

Developing cash flow projections and valuations for real estate can be difficult due to: a. A lack of comparable figures for other properties in the area. b. Changes in demographic and economic variables. c. Different financing methods amongst prospective purchasers. d. A lack of standardized methods for objectively evaluating an investment in a market that is considered inefficient.

B Cash flow projections and comparable equity capitalization rates are easily obtained for a valid comparison. The difficulty is one of the unpredictability of changes in economics and demographics which directly impact values. Real estate valuation models such as one using net operating income, adjust for variations in real estate financing.

James avidly follows several television shows that discuss securities, including, typically, making buy/sell recommendations of individual stocks. James almost always adjusts his portfolio as per these recommendations. James is best described as exhibiting which behavioral bias? a. Belief perseverance. b. Herd mentality. c. Hindsight bias. d. Overconfidence.

B Herd mentality is the process of buying and selling what and when others are buying and selling. A is incorrect. Belief perseverance is similar to anchoring in that people are unlikely to change their views given new information. C is incorrect. Hindsight bias is a form of overconfidence related to an investor's belief that they had predicted an event that, in fact, they did not predict. D is incorrect. Overconfidence suggests that investors overestimate their ability to successfully predict future market events.

An investor in the 30% marginal tax bracket purchased a bond for $980, received $75 in interest, and then sold the bond for $950 after holding it for seven months. The LTCG rate is 15%. What are the pre-tax and post-tax holding period returns? a. 4.6%, 4.6% b. 4.6%, 3.2% c. 11%, 4.6% d. 11%, 3.2%

B Pre-tax Holding Period Return = ($950 - $980 + $75) / $980 = 4.6% Since the holding period is ST, use the marginal tax rate: After-tax Holding Period Return = [($950 - $980 + $75) × (1 - .30)] / $980 = 3.2% Answer: 4.6%, 3.2%

A yield curve normally is upward sloping because: a. Long-term rates must be higher to compensate for higher expected future tax rates. b. Long-term bonds are, by their nature, more risky than short-term bonds. c. Higher long-term rates reflect inflationary expectations. d. Short-term bonds have a lower level of event risk.

B Short-term rates are lower because of the lower risk associated with them. The longer an investment ties up an investor's capital, the higher the rate must be to offset this risk. Inflation expectations may be lower in the future, resulting in a downward (inverted) sloping yield curve. Higher inflationary expectation is a driving force for an inverted yield curve as the Fed raised short term rates faster than the long term rates adjust to the higher risk. The "natural" position is an upward slope, which indicates a more "normal" environment.

Bristol-Buyers Company has a market price of $36.00 per share with earnings of $3.00 per share, a beta of 1.1 and a dividend of $1.20, which means a dividend payout ratio of 40%. Earnings for next year are projected to increase by 25%, and the retention ratio is projected to remain at 60%. Using the price/earnings multiplier, to what level might your client expect to see market prices move in a year? a. $39.60 b. $45.00 c. $50.40 d. $57.60

B The $36.00 per share price is divided by the $3.00 earnings per share resulting in a price/earnings multiplier of 12. The increase of earnings by 25% results in a projected earnings of $3.75 next year. This new earnings times the P/E multiplier of 12 (assuming the P/E ratio remains constant) results in a price of $45.00. The dividend information provided is unnecessary in answering the question.

Margin accounts involve security transactions performed using some amount of capital borrowed from the brokerage firm as well as some of the investor's own capital. The entity that establishes the initial margin requirement is the: a. Securities and Exchange Commission. b. Federal Reserve. c. National Association of Securities Dealers. d. Brokerage firm with which an investor is dealing.

B The Federal Reserve sets margin requirements for all security transactions.

A child is 8 years old and the parents want to invest today for the child's education. The parents have AGI of $210,000. Which investment vehicle would you recommend? a. Series EE savings bonds. b. S&P 500 index fund. c. Laddered CDs d. Money market mutual fund.

B The S&P 500 index fund is the best answer because the time horizon is long term (10 years). The parents are currently phased-out of the interest income tax exclusion benefit on the series EE savings bonds. The CDs and money market mutual fund are too conservative.

A stock that has produced superior earnings and rates of return but has gone mostly unnoticed by securities analysts and is often considered underpriced is said to benefit from the: a. P/E effect. b. Neglected firm effect. c. Small firm effect. d. Low price/sales effect.

B The neglected firm effect is one of the market anomalies. This anomaly is said to exist because the security in question is allowed greater potential for movement as a result of the lack of scrutiny by analysts.

Which of the following can be eliminated using a "buy and hold" strategy with regard to fixed income securities? a. Future value risk. b. Interest rate risk. c. Stand alone risk. d. Reinvestment rate risk.

B The price changes when interest rates change but if you don't sell the bond (buy and hold) then the price change doesn't really matter. You still get the $1,000 par value at maturity. Option "A" - Future value risk does not exist as a term. Option "C" - Stand alone risk refers to single assets ownership. Option "D" will still require the investor to reinvest interest paid, thus not eliminating such risk.

Jennifer has asked you if you would advise her regarding several different types of investments. Her preference would be for an investment where she can simply put a fixed number of dollars into an investment and not worry about it. She wants the following: completely tax-advantaged investments, a moderately competitive interest rate, with relative safety, and very low fees. She would eventually like to be assured of getting her principal back, but does not require a great deal of liquidity. Which of the following would you recommend to her in order to best meet her goals? a. Municipal Bond Mutual Fund. b. Municipal Bond Unit Trust. c. High Yield Money Market Fund. d. Tax Free Money Market.

B UITs have no money manager, just a trustee, the fees will be lower. You can sell back to the fund or wait until maturity. Due the tendency of Muni-Bond Fund managers to attempt to maximize profits by buying and selling various bonds, there are generally taxable gains to be dealt with in most of these funds. High Yield and Government Bond funds offer no tax advantage. Tax Free Money fund is highly liquid and the client stated they did not require much liquidity, nor does it have a moderately competitive interest rate.

LeAnn Wallace, CFP®, is discussing with her colleague an article she recently read in a behavioral finance academic journal. She comments that while behavioral finance is quite interesting, it is also confusing. She finds it difficult to separate one behavioral trait from another, and difficult to separate the consequences of the various traits. She starts to diagram the traits and their consequences. Her first two entries read: Hindsight bias- Belief that one has predicted an event that, in fact, they did not predict -Cognitive dissonance Minimizing or forgetting past losses Which of the following behavioral biases is closest to the two identified in Ms. Wallace's diagram? a. Belief perseverance. b. Overconfidence. c. Regret avoidance. d. Representativeness.

B Hindsight bias and cognitive dissonance are each a type of overconfidence. A is incorrect. Belief perseverance is similar to anchoring in that people are unlikely to change their views given new information. C is incorrect. Regret avoidance, also known as the disposition effect, causes investors to take action (or inaction) in hopes of minimizing any regret. D is incorrect. Representativeness is thinking that a good company is a good investment without regard to an analysis of the investment.

Jasmine has a large paper profit in her Amalgamated Corporation shares, currently at $46 per share. She is happy with the stock, but realizes that a good thing CANNOT go on forever. She bought the stock so inexpensively that she is not worried about the downside. If she is willing to sell at $50, what strategy could you recommend to her? A) Buy $50 call options. B) Sell $50 call options. C) Buy $50 put options. D) Sell $50 put options.

B-> since she is happy with the stock, she may be willing to continue to hold the stock and by selling a call option, she can participate in additional appreciation of the stock before being called out of the stock.

Which of the following is an attribute of mortgage REITs? a. They receive income from the rental or lease of real estate properties. b. They provide more opportunity for capital gains than equity REITs. c. They receive monthly income from investing in real estate loans. d. They frequently invest in commercial properties.

C Options "A", "B", and "D" all describe equity REITs. Mortgage REITs are more volatile than equity REITs.

Herkimer Green has just inquired about purchasing callable bonds. You explain what this means, and you also explain the negative aspects for investors with regard to callable issues. These include: I. The uncertainty about the amount of payments to be made to the bondholders. II. The price risk for the investor. III. The inflation risk to the bondholder. IV. The reinvestment risk faced by the bond investor. The investor's liquidity risk. a. I only. b. II and III only. c. I and IV only. d. II, IV and V only.

C Price risk is not a callable bond concern; in fact, often when called a premium is paid. Inflation risk, where the purchasing power of the bond is affected might seem like a good choice, but because the bond is being held to call in this case, it is not a concern and liquidity risk is eliminated. When the bond is called, an investor does not need to worry about selling the bond

The bond investment strategy of "riding the yield curve" involves: a. Investing equal amounts in short-term and long-term bonds. b. Investing equal amounts in each of several maturity periods. c. Investing either short-term or long-term to take advantage of anticipated interest rate changes. d. Selling bonds with unrealized losses and replacing them with similar bonds.

C Riding the yield curve refers to the purchase of debt instruments in anticipation of fluctuations in the rates of return on both long and short-term instruments. Rising rates of interest require repositioning a portfolio in advance of the rise in order to avoid significant price drops. These moves are based on anticipated changes in the yield curve.

Gabby, a CFP® professional, is working with Debby, a retiree. Debby has a concentrated position in a highly appreciated growth stock, which makes up the majority of her assets. Debby requires income from her portfolio but is hesitant to sell her stock position. Which of the following strategies should Gabby recommend that would provide the least amount of risk to the retiree? a. Purchase put options on the stock. b. Sell covered puts on the stock position. c. Sell covered calls on the stock position. d. Sell the stock position and purchase an immediate annuity

C Selling covered call options will generate income for Gabby's client. A "covered call" is an income-producing strategy where you sell, or "write", call options against shares of stock you already own. A is incorrect. Put options will not provide income. B is incorrect. Covered puts would create additional portfolio risk if the position decreased in value. D is incorrect. Purchasing an immediate annuity is inconsistent with the fact pattern presented.

Of the following indexes, which is the only one that uses the geometric average to compute its daily value? a. NASDAQ Index. b. Wilshire 5000 Index. c. Value Line Average. d. Dow Jones Industrial Average.

C The NASDAQ, the NYSE Composite, and the Wilshire all use value weighted average, while the Dow Jones Industrial is a simple price weighted average. Only Value Line uses the geometric average.

A convertible bond your client is interested in buying has a 8% coupon rate, a conversion ratio for 100 shares, while market rates on similar issues are currently 12%. It pays interest twice a year, has a par value of $1,000 with a maturity of 20 years. The current stock price is $8.50 per share. What price should your client expect to pay? a. $1,125 b. $1,000 c. $850 d. $699

C The calculated value as a debt instrument here is $699.07, but when the conversion value puts the rate at $850, you can be certain that the bond is selling in the market place at its convertible value of $850, not its debt value of $699. CV = (1,000 ÷ CP) × Ps $850 OR N = 20 × 2 = 40 i = 12 ÷ 2 = 6 PV = ? PMT = (.08 × 1,000) ÷ 2 = 40 FV = 1,000 PV = 699.07 The conversion price is not given; however, (1,000 ÷ CP) is the conversion ratio, which is given (100 shares). Therefore: CV = 100 shares × Ps CV = 100 × 8.50 CV = $850

Rank the following investments in order of expected volatility, from least volatile to most volatile: Bankers acceptances Treasury bills Commercial paper Treasury notes Agency issues a. Treasury bills, Treasury notes, Commercial paper, Bankers acceptances, Agency issues. b. Treasury notes, Treasury bills, Commercial Paper, Agency Issues, Bankers acceptances. c. Treasury bills, Commercial Paper, Bankers acceptances, Treasury notes, Agency issues. d. Agency issues, Treasury bills, Treasury notes, Bankers acceptances, Commercial paper.

C Treasury bills are short duration and backed by the full faith and credit of the United States government. Treasury bills have 4, 13 and 26-week durations. They are least volatile. Commercial Paper is a money market instrument with a 270-day maturity. Bankers Acceptances are money market instruments durations less than or equal to 12 months. Treasury notes have 1-10 year maturities and Treasury bonds have maturities greater than 10 years. Agency issues are not backed by the full faith of the federal government (though in practicality they may be) and are slightly more volatile and pay a higher yield.

A rise in the price of the Japanese Yen in relation to the U.S. Dollar results in: a. A devaluation of the Yen. b. Excess reserves in the U.S. current account. c. A revaluation of the Yen. d. A negative balance of payments.

C Were the Yen to fall in value against the dollar, this would constitute a devaluation, but when it costs more dollars to buy a Yen, this is considered an appreciation or revaluation of the Yen.

Which of the following best describes a long hedge position? a. The investor is short the underlying commodity and short the futures contract. b. The investor is long the underlying commodity and long the futures contract. c. The investor is short the underlying commodity and long the futures contract. d. The investor is long the underlying commodity and short the futures contract.

C -a long position in a futures contract is when they BUY the contract

My margin requirements are 50% initial margin and 25% maintenance margin. I purchase a total of 200 shares at $100 per share using full margin amount for the 200 share purchase. Shortly thereafter, share prices fall to $50 per share. What will my margin call be? a. $1,000 b. $1,500 c. $2,500 d. $5,000

C Required equity: $50 × .25 = 12.50 per share Actual equity: $50 - $50 = 0 (current price- loan amount) To meet required equity: $12.50 per share × 200 shares = $2,500

These bonds are considered to be owned by whoever possesses them: a. Serial bonds. b. Registered bonds. c. Bearer bonds. d. Reset bonds.

C Serial bonds are issued in series and mature in series. Registered bonds are paid interest based on to whom the bonds are registered. Bearer bonds pay interest to the holder of the bond. Interest rates can be reset on Reset bonds, and the U.S. government issues Treasury bonds; and both are registered.

If the market risk premium were to increase, the value of common stock (Everything else being equal) would: a. not change because this does not affect stock values b. increase in order to compensate the investor for increased risk c. increase due to higher risk free rates d. decrease in order to compensate the investor for increased risk e. decrease due to lower risk free rates

D

The SD of the returns of a portfolio of securities will be _______ the weighted average of the SD of returns of the individual component securities a. equal to b. less than c. greater than d. less than or equal to (depending on the correlation between securities) e. less than, equal to, or greater than (depending upon the correlation between securities)

D -if correlation is 1, then it will be equal to. If less than 1, then it will be less than

An investor in improved land (with an office building) is concerned most with which one of the following factors? a. Net income of investment. b. Reselling the property within three years. c. Real estate taxes. d. Cash flow expected to be generated by the property.

D An office building is purchased to rent space; therefore, cash flow is of paramount importance. Net income without the information that leads up to this final figure is not as valuable as cash flow information. Resale, commissions and taxes are secondary concerns if the property is purchased (with an office building) for cash flow.

Whenever there is a cash dividend issued on an underlying stock, the price (or premium) for a call option available on that stock tend to be: a. Unaffected b. Higher. c. Volatile. d. Lower.

D Cash dividends will generally tend to drive the price of the underlying security lower and along with it, the call option prices.

Company A has 60% debt and 40% equity; Company B has 20% debt and 80% equity. Assume both companies have the same dollar amount of assets and net income before interest and taxes. Which one of the following statements is true? a. The unsystematic risk for the two companies is about equal. b. Company A's tax obligation will exceed Company B's. c. The company with the higher return on equity should be purchased by a risk-averse investor. d. The return on equity for Company A can be expected to exceed the return on equity for Company B.

D Company A has a smaller amount of its assets financed by equity, therefore, with the same earnings in net income as Company B, the level of return on the equity of Company A would be greater. Sample information (net income is provided, not calculated in this sample information): A: Assets $10M; Liabilities $6M; Equity $4M; EBIDTA = $1M; I/Y = 5% Net Income = $700K; ROE = $700,000 ÷ $4M = 17.5% B: Assets $10M; Liabilities $2M; Equity $8M; EBIDTA = $1M; I/Y = 5% Net Income = $900K; ROE = $900,000 ÷ $8M = 11.25% EBIDTA = Earnings before interest, taxes, depreciation, and amortization

The Chesapeake Bay apartment complex contains 60 one-bedroom apartments renting for $650 per month. In addition, the complex generates $625 per month from laundry, parking, and vending machines. Vacancy and collection losses have averaged 8% of Potential Gross Income (PGI) and are expected to continue at about the same rate in the future. Annual expenses totaling $117,000 include: Property taxes = $2,000 Property management = $7,000 Interest expense = $72,000 Swimming pool = $5,000 Professional fees = $8,000 Other expenses = $23,000 There is a monthly mortgage payment of $10,000 per month. Out of the $10,000 mortgage, $6,000 is interest expense and $4,000 is repayment of principal. Assuming a capitalization rate of 9%, what is the market value of the Chesapeake Bay complex? a. $1,941,422 b. $2,884,140 c. $3,560,667 d. $4,360,667

D Gross rental receipts ($650 × 60 × 12) = $468,000 plus non-rental income ($625 × 12) = $7,500 equals potential gross income (PGI) ($468,000 + $7,500) = $475,500. PGI minus vacancy and collection losses [$475,500 - (.08 × $475,500)] = $437,460 equals Effective Gross Income (EGI). EGI minus expenses equals net income $437,460 - $117,000 = $320,460. Next, determine net operating income by adding interest and depreciation expense back to net income. NOI = $320,460 + $72,000 interest + $0 depreciation = $392,460. Market value = $392,460 ÷ .09 = $4,360,667

Bob and Betty have approached you looking for the right hedge against possible, expected future inflation. You suggest to them that they: a. Invest in technology stocks. b. Invest in commodity futures. c. Invest in long-term U.S. Treasury issues. d. Invest in precious metals.

D None of the choices are necessarily stellar, but in contrast to the other choices, Option "D" makes far more sense, as metals have generally performed well as inflation hedges over time.

Bottom-up equity managers include: I. Group rotation managers. II. Value managers. III. Market timers. IV. Technicians. a. I only. b. II only. c. I and III only. d. II and IV only.

D Options "I" and "III" are both "top down" style managers.

Mark is the 100% owner of Widget Manufacturing, Inc. (WMI). The WMI 401(k) plan covers 35 employees with 70% of the employees under age 40. Employee turnover is high. Mark wants to retire in 20 years at age 65. Mark has a medium tolerance for volatility within his investments. The market value of the 401(k) is $4,000,000 and Mark is the trustee and manages the investments. The portfolio consists of the following assets: - 10% short-term CDs with staggered maturity date. - 20% limited partnership interest in a private commercial real estate project which generates a high income yield. - 40% in a brokerage account invested in four stocks. - 30% in long-term government bonds with staggered maturity dates. You have been retained to evaluate the appropriateness of the portfolio. Which of the following statements best describes the portfolio? I. Short-term certificates of deposit have a fixed maturity date and therefore are not appropriate for liquidity purposes. II. The brokerage account investments are not adequately diversified. III. The investment in the limited partnership may be subject to unrelated business taxable income and therefore is inappropriate. IV. Overall, the asset classes selected by the plan are sufficiently diversified and therefore minimize overall portfolio volatility. a. I and II only. b. II and III only. c. I, II and III only. d. II, III and IV only.

D Statement "I" - Short-term CDs are an appropriate choice for liquidity needs due to fixed value of the vehicle and short maturity periods. Statement "IV" - Even though the current investments within the asset classes are not properly positioned, the asset class allocation would, under Modern Portfolio Theory, reduce overall volatility to the plan.

Haley Mills has been a client of yours for quite some time. She recently unearthed some share certificates that her grandmother had left to her a few years ago. These shares that Grandma Mills bought were from an Internet start up. The timing was perfect, because the firm was about to undertake another stock offering and Haley had preemptive rights. Of the firm's initial 1,700,000 share offering, Grandma Mills had invested enough to buy 10,000 shares at $11 per share. The new offering was an 850,000 share offering at $87 per share. If Haley fully exercised her preemptive rights, how much total cash would she pay for the shares in this new offering? a. $55,000 b. $217,500 c. $385,750 d. $435,000

D The 10,000 share purchase of the 1,700,000 share initial offering was .59% (10,000 ÷ 1,700,000). That amount relative to this new offering of 850,000 shares was equivalent to 5,000 (850,0000 × .59%) shares if all preemptive rights were exercised. This 5,000 shares times the $87 offering price means that to fully exercise this right, Haley would require $435,000. INSTRUCTOR NOTE: Use all decimal places.The exam will use all decimals place beyond what is shown on your screen. After dividing 10,000 into 1,700,000 do not clear your calculator before multiplying by 850,000. Preemptive rights allow the shareholder to purchase additional shares to retain the same percent ownership they had prior the secondary offering. For example. 100 shares outstanding, and you own 10 shares, or 10% of the company. The company does a secondary offering which brings their outstanding shares to 200 shares. Your 10% ownership is now, 5% (10 shares / 200 shares). If you purchase and additional 10 shares, for a total of 20 shares, you retain your 10% ownership (20 shares / 200 shares).

You are about to choose a new mutual fund to add to client portfolios. As you review the Morningstar reports for the funds you are considering, you have focused on each fund's alpha as reported by Morningstar. Alpha tells you: a. Each fund's performance relative to a benchmark, such as the S&P 500. b. A fund's percentage return above the risk-free rate of return. c. By what percentage a fund's capital appreciation exceeded the capital appreciation of the average fund in its asset class. d. The difference between a fund's realized return and its risk-adjusted expected return.

D The alpha of a security may be calculated using the Jensen Model. The Jensen formula is on the formula sheet included with the CFP® exam materials. Alpha is the fund's actual return minus the risk adjusted expected return, as measured by CAPM.

Holly bought a stock at the minimum margin, when the stock was trading at $10. The stock paid quarterly dividends of $.25. Holly held the stock for one year and sold the stock when it was trading at $11. What was Holly's holding period return? a. 10%. b. 20%. c. 30% d. 40%.

D The first key to this question is knowing that the "minimum margin" is 50%, which is established by the Federal Reserve. So, Holly is required to pay $10 × .50 = $5 in cash and borrow the other $5 per share to make the investment. The question does not reference any margin interest, so it's excluded from the calculation. The second key to this problem is that the Purchase Price in the numerator reflects both the equity contribution of $5 per share and the $5 per share that must be repaid to the broker. The Purchase Price in the denominator only needs to reflect the $5 in equity paid. HPR = (SP - PP +/- CF) ÷ PP HPR = ($11 - $10 + ($.25 × 4) ÷ ($10 × .5) HPR = 40%

Several individual investments each have high standard deviations. Which of the following are true about the standard deviation for a portfolio of these same investments? I. Has to be high since the standard deviations are high. II. Has to be low since the standard deviations are high. III. Can be low if there is a low correlation of returns between the investments. IV. Can be high if there is a high correlation of returns between the investments. a. I and III only. b. I and IV only. c. II and III only. d. III and IV only.

D The relationship between correlations and standard deviation are direct in nature. A high correlation means securities will move in the same direction. High standard deviation with high correlation means high risk. Low correlation means that even the impact of high deviation securities can be reduced.

Which of the following have been repurchased by the corporation? a. Unissued shares. b. Repurchased shares. c. Authorized shares. d. Treasury shares.

D Unissued shares have never been held by investors to be repurchased. There is no such thing as "repurchased" shares. Authorized shares may be unissued or outstanding shares, but not necessarily Treasury shares (which are those the company has repurchased).

Using the constant growth dividend valuation model, calculate the intrinsic value of a stock that pays a dividend this year of $2.00 and is expected to grow at 6%. The beta for this stock is 1.5, the risk free rate of return is 3% and the market return is 12%. a. $48.27 b. $35.33 c. $28.75 d. $20.19

D Use the constant growth dividend model to solve for intrinsic value. The question does not provide the required rate of return, however the capital asset pricing model can be used solve for required rate of return. V = D1/(r - g) V = 2 (1.06) / (.165 - .06) V = 2.12 / .105 V = $20.19 R = Rf + b(Rm - Rf) R = .03 + 1.5(.12 - .03) R = .03 + 1.5(.09) R = .03 + .1350 R = .1650 (used above for required rate of return)

Jim and Anne Taylor are baby boomers who would like to add an equity investment to their portfolio. They require a 12% rate of return and are considering the purchase of one of the following two common stocks: Stock 1: Dividends currently are $1.50 annually and are expected to increase 8% annually; market price = $35Stock 2: Dividends currently are $2.25 annually and are expected to increase 7% annually; market price = $50 Using the dividend growth model, determine which stock would be more appropriate for the Taylors' to purchase at this time: a. Stock 2, because the stock is undervalued. b. Stock 2, because the return on investment is greater than the Taylor required rate of return. c. Stock 1, because its dividend growth rate is greater than Stock 2's growth rate. d. Stock 1, because the expected return on investment is greater than the Taylor required rate of return.

D Use the intrinsic value formula to determine whether the stock is over valued or under valued. Then use the expected rate of return formula to determine whether the stock meets the investor's required rate of return. r = D0(1 + g) + g (P) Stock 1 = $1.50 (1.08) + .08 =12.63% $35 Stock 2 = $2.25 (1.07) + .07 =11.82% $50

Jack Rich has an investment portfolio equally divided among the following funds: Energy sector fund, Bond Unit Investment Trust (25-year average maturity), and a Money Market fund. He is a buy-and-hold investor. Which of the following risks is his portfolio exposed? I. Business risk. II. Interest rate risk. III. Political risk IV. Purchasing power risk. a. I and III only. b. II and IV only. c. I, II and III only. d. III and IV only.

D Interest rate risk does not affect a bond investor if he or she holds the securities to maturity. This is how unit investment trusts are structured. The energy sector will be directly impacted by regulatory influences of a political nature.

The market where exchange and broker dealer services are eliminated entirely is: a. The primary market. b. The secondary market. c. The third market. d. The fourth market.

D The fourth market is the market where corporation and institutional investors deal directly with one another. Primary market is where investment bankers and corporations meet to arrange offerings to the public. Secondary markets are where previously issued securities are sold (exchanges, etc.).

if the client needs to accumulate wealth but is risk averse, which of the following is the most crucial action the planner needs to take to help the client achieve the goal of wealth accumulation? Advise investing the client's current assets: a. in the products which will bring the highest return to the client regardless of risk b. in products which produce high income for the client because fixed income products are generally safe c. in diversified mutual funds because of the protection which diversity provides d. after determining the client's risk tolerance e. in 100% cash dividends because most software programs recommend this safe approach

D- time horizon and risk tolerance must be determined before allocation occurs

Your client's federal marginal tax rate is 37% and the state marginal rate is 7%. THe client does not itemize deductions on his federal return and is considering investing in a muni issued in his state of residence which yields 5%. What is the taxable equivalent yield? a. 3.2% b. 5.38% c. 7.94% d. 8.93% e. 9.48%

E TEY=.05/(1-(.037-.07-.038)) -don't have to worry about multiplying state rate by fed tax yield since did not itemize deductions. but the client is over the income threshold for the additional medicare tax of 3.8% on investment income

An investor may use options on debt instruments to protect against: a. Interest rate risk. b. Reinvestment rate risk. c. Default risk. d. Call risk.

Solution: The correct answer is A. Put options that lock in the price at which the security may be sold may be used to protect an investor from a drop in bond prices caused by rising interest rates. Options are derivatives. They derive their value from an underlying investment. Reinvestment risk, default risk, and call risk have no associated value. Interest rates do have an associated value.

Milton has researched four capital investment projects. The following are the internal rate of return (IRR) and net present value (NPV) of each project: Project IRR NPV Project 1 12.0% $9,861 Project 2 13.7% $9,690 Project 3 11.6% $7,500 Project 4 12.9% $8,379 Assuming he only has the capital to choose one of the projects, which project should Milton select? a. Project 1. b. Project 2. c. Project 3. d. Project 4.

Solution: The correct answer is A. = NPV is a better method for evaluating projects than the IRR method. The NPV method: Employs more realistic reinvestment rate assumptions. Is a better indicator of profitability and shareholder wealth. Mathematically will return the correct accept-or-reject decision regardless of whether the project experiences non-normal cash flows or if differences in project size or timing of cash flows exist.

Which of the following is not an appropriate match? a. Classification by time: Spot markets. b. Classification by type of claim: Equity markets. c. Classification by participants: Mortgage markets. d. Classification by products: Money markets.

Solution: The correct answer is D. Money market securities are short-term instruments categorized by time considerations, not product. Look at this from the product to determine the classification. For example, money markets and spot markets are classified as according timing because they are either short term maturities or current price. The common component when classifying these type of securities is timing. Equity and debt markets can be classified as to the order of claims in the event of liquidation. "Type of claims" simply refers to debt vs. equity and which is more senior. Bond markets, which include mortgage bonds, are divided into short, intermediate and long term markets. Each market has participants that prefer different segments of the yield curve. A participant in this case is an insurance company, bank, manufacturing company, etc. Different participants will prefer mortgage bonds over shorter term maturities.

In May, 1993, Joe bought a tax exempt original issue discount (OID) bond. Which of the following statements apply? 1. the bond basis increases at a set rate each year 2. the difference between the maturity value and the original issue discount price is known as the OID 3. the bond's earnings are treated as exempt interest income 4. the bond was issued at a discount to its par value a. 2 and 3 b. 1 and 4 c. 1, 2, and 4 d. 3 only e. 1, 2, 3, and 4

e OID is sold at a discount to par, and as it matures the price of the bond increases until it reaches par value. -the OID is the diff between its maturity value and the OID price, and since its tax exempt, the earnings are treated as tax exempt interest income