Series 65 Practice Questions 9

When XYZ is selling at 38, an investor purchases an XYZ October 40 put for a total premium of $500. In dollars, what's the intrinsic value of the option?

1.) $0 2.) $200 3.) $300 4.) $500 Explanation: Puts are in-the-money if the market value of the underlying securities is down below the option's strike price. In this case, the 40 put is 2 points in-the-money, which also represents its intrinsic value. The 2 points x $100 per point equals $200. Ultimately, the premium of $500 consists of the $200 of intrinsic value and $300 (3 points) of time value.

A customer buys 100 shares of stock at $39 a share. She also sells a call option with a strike price of $40 and receives a premium of $2. What is the customer's breakeven point on this stock and why did she engage in this position?

1.) $38 sold to generate income 2.) $41 sold because she is bullish 3.) $37 sold to generate income 4.) This practice is prohibited under the Uniform Prudent Investor Act Explanation: A type of option position where an investor buys or holds stock and writes a call option is called a covered call. This strategy is typically used to generate income. The breakeven point is $37. It is determined by subtracting the premium from the cost basis of the stock ($39 - $2).

An investor pays $100 per share for 1,000 shares of a 6% cumulative preferred stock which has one year of dividends in arrears. One year after making the purchase, the issuer has paid its normal preferred dividend, plus the dividends in arrears. At that point, if the investor then sells the preferred stock at $104 per share, what is the total return on the preferred stock for the period?

1.) 16% 2.) 12% 3.) 10% 4.) 6% Explanation: A security's total return takes into account the cash flow from dividends or interest, plus appreciation or minus depreciation, and divides by the security's original value. In this question, at the end of the year, the stock paid the $6 of dividends in arrears, plus the $6 stated dividend, plus the stock appreciated by $4. Therefore, the total return is 16%($6 + $6 + $4 ÷ $100).

A brokerage client buys stock worth $40,000 and sells it three years later for $60,000. If his long-term capital gains rate is 10%, what is his after-tax total return?

1.) 30% 2.) 33% 3.) 40% 4.) 45% Explanation: Calculating after-tax total return starts with determining the capital gain, which is $20,000 ($60,000 - $40,000). If capital gains are taxed at a rate of 10%, then the tax is $2,000 ($20,000 x 10%). The after-tax gain is $18,000 ($20,000 - $2,000). Therefore, the after-tax total return is 45% ($18,000 after-tax gain / $40,000 original investment).

A young, married couple are ready to start investing and their main objective is long-term growth. Of the following choices, the most appropriate mutual fund for the couple is one with a portfolio that contains:

1.) 40% stocks and 60% bonds 2.) 50% domestic stocks and 50% foreign stocks 3.) 100% money-market investments 4.) 40% large-cap stocks, 20% mid-cap stocks, 20% small-cap stocks, and 20% bonds Explanation: The best choice for the young couple is a diversified portfolio that primarily consists of stocks along with a smaller percentage of bonds. When determining an appropriate asset allocation, a generally guideline is to start with the number 100 and subtract the investor's age to determine the percentage that may be devoted to equities. Although the question does not specify the ages of the couple, since they are young and want long-term growth, it should be assumed that a large percentage of equities is appropriate. Although Choice (b) is 100% equities, half of the portfolio is devoted to foreign stocks and is probably too risky.

During the first quarter, XYZ common stock paid a $1 dividend. The stock's price fell from $50 per share at the beginning of the quarter to $48 per share at the end of the period. Based on these results, what is the stock's annualized total return?

1.) 8% 2.) 2% 3.) -2% 4.) -8% Explanation: The total return from a security includes the cash flow from dividends or interest, plus appreciation or minus depreciation. In this case, the $1 dividend compared to the initial price of $50 per share is a 2% dividend return. The $2 loss in share price from a $50 initial value is a 4% loss. The total return for the quarter is 2% + (-4%) = (-2%). To annualize this quarterly result, multiply by four. 4 x (-2%) = (-8%).

Under SEC Release 1092, which of the following persons meets the definition of an investment adviser?

1.) A person that limits its advice to U.S. government securities 2.) Lawyers, accountants, teachers, and engineers 3.) Pension consultants, financial planners, and sports and entertainment representatives 4.) Broker-dealers, registered representatives, and investment adviser representatives Explanation: SEC Release 1092 provides clarity on the entities that meet the definition of an investment adviser. Prior to the release, it was unclear as to whether pension consultants, financial planners, and sports and entertainment representatives met the definition. However, after the release, the SEC definitively stated that those businesses/entities met the definition of an investment adviser and were subject to registration.

A front-end load is the fee that is payable on the purchase of:

1.) A private placement 2.) An IPO 3.) Mutual fund Class A shares 4.) Shares acquired through a rights exercise Explanation: When an investor buys Class A mutual fund shares, he is assessed a load (sales charge) at the time of purchase (i.e., at the front-end). The other choices are in no way associated with a load (sales charge).

A trader purchased orange juice futures at $1.70 per pound. Two months later, if orange juice has increased to $1.95, she has:

1.) A realized gain of $.25 per pound 2.) No realized gain or loss 3.) An option to buy at $1.70 4.) An obligation to deliver at $1.70 Explanation: This is a tricky question. Since the question doesn't indicate that the contract has been closed out, there's no realized gain or loss. However, if Hilary executes a sale transaction and closes out the position when orange juice is trading above $1.70, she would realize a profit.

Mary is setting up an investment advisory business in the town in which she was born and has known the town's mayor since childhood. Mary places an advertisement in the local newspaper that quotes the mayor as stating, "I have known Mary since we were kids and we're fortunate to have someone with her expertise and integrity setting up her investment advisory business in our community." This advertisement is:

1.) Acceptable only if the mayor received no compensation or benefit for the statement 2.) A violation of the Investment Advisers Act of 1940 and, therefore, prohibited 3.) Acceptable as long as the advertisement contained a footnote which describes the mayor's qualifications 4.) Prohibited because a mayor is not qualified to comment on the competence of an investment adviser Explanation: An investment adviser is permitted to use testimonials in its advertising. Additionally, individuals who provide testimonials may receive compensation for providing a testimonial. However, to ensure that clients are not being misled, both SEC and state rules require advisers to disclose the qualifications of the provider of the testimonial and whether compensation was paid.

Which of the following is a liability that's listed on a corporation's balance sheet?

1.) Accounts receivable 2.) Par value of preferred shares 3.) Retained earnings 4.) Taxes payable Explanation: Liabilities are items that a corporation needs to pay (i.e., owes) other persons or institutions. Receivables represents money that must be paid to a corporation by its customers (e.g., sales made using credit cards) and are considered assets of the corporation. Par value of preferred shares measures a part of the purchase price that investors paid the company to buy its preferred stock. The par value of preferred shares is a part of a corporation's shareholders' equity. Retained earnings is the historical net income of a firm and is also a part of shareholders' equity. Payables, including taxes payable, represent money that the company owes and are a liability on the balance sheet.

An IAR is experiencing financial difficulties and asks one of his clients for a loan. After the client tells the IAR that she does not have any funds available to loan, the IAR recommends that the client sell some of her securities holdings and then lend him the money. According to the Uniform Securities Act, the IAR has:

1.) Acted in an unethical manner and violated his fiduciary duty 2.) Churned the client's account 3.) Commingled the client's assets with his own 4.) Converted the client's cash for his own use Explanation: These actions are unethical and possibly illegal. However, since the IAR is not recommending that the client trade excessively in an effort to generate commissions, this is not a case of churning. Additionally, it is not commingling or conversion since the customer being asked to lend money to the IAR.

An IAR is comparing an S Corporation and a limited partnership for a client. What is an advantage of investing in an S Corporation that is not available with a limited partnership?

1.) An S Corporation offers unlimited personal liability. 2.) An S Corporation pays higher returns. 3.) An S Corporation allows for an unlimited number of shareholders. 4.) An S Corporation provides investors with more control over management decisions. Explanation: In an S Corporation, its shareholders have voting rights, which provides some control over management decisions. However, in a limited partnership, taking part in management decisions jeopardizes an investor's status as a limited partner and may result in creditors of the partnership considering the investor to be a general partner with unlimited personal liability for debts of the partnership. Both of these business entities provide investors with limited liability. As with a limited partnership, an S Corporation's gains and losses "flow through" to its investors, but there is no way to determine which will pay more since the flow-through is based on the performance of the specific vehicle's management. An S Corporation is limited to 100 shareholders.

Under the Uniform Securities Act, which of the following is an offer to sell securities?

1.) An investor receives more shares due to a stock split 2.) An investor receives a stock dividend 3.) An investor purchased bonds and receives a warrant as a bonus 4.) An existing shareholder receives a solicitation to purchase from a corporate entity Explanation: According to the Uniform Securities Act, the security that the investor received as a bonus would be considered an offer. The Act specifically states that a stock dividend or shares received due to a corporate action (e.g., stock split) are never considered an offer or offer to sell a security. If existing shareholders receive a solicitation to purchase from a corporate entity (e.g., through a tender offer), it's considered an offer to buy and NOT an offer to sell.

Under the USA, which of the following transactions would NOT be considered exempt?

1.) An offer to an investment company 2.) A transaction by an executor of an estate 3.) An unsolicited issuer transaction effected through a registered broker-dealer 4.) A transaction by a trustee that is involved in a bankruptcy proceeding Explanation: Under the Uniform Securities Act, any offer to an investment company or other institutional investor, a transaction by an executor of an estate, or a trustee involved in a bankruptcy, would be defined as an exempt transaction. An unsolicited nonissuer transaction may qualify as an exempted transaction.

Which of the following statements is TRUE about REITs?

1.) At least 75% of a REIT's income must be derived from investments in real property. 2.) A REIT must distribute 75% of its income to the shareholders. 3.) REITs can pass through both income and losses to their shareholders. 4.) At least 90% of a REIT's income must be derived from investments in real property. Explanation: At least 75% of a REIT's income must be derived from investments in real property. REITs are also required to distribute 90% of their investment income to shareholders each year. REITs can only pass through income, but cannot pass through losses to their shareholders.

When is a broker-dealer required to deliver a prospectus?

1.) At the time of sale 2.) No later than 24 hours after the sale 3.) By settlement date 4.) Prior to the sale Explanation: Broker-dealers are required to deliver prospectuses to purchasers of a new issue along with the confirmation, which is due by the settlement date.

The advantages of a living (inter vivos) trust include:

1.) Avoiding estate taxes 2.) Avoiding probate 3.) Receiving tax credits 4.) Avoiding gift taxes on all intrafamily asset transfers over $1,000,000 Explanation: A living (inter vivos) trust is a trust created while the grantor is still alive. One of the main advantages of a trust is that it allows the estate to avoid probate. Trusts do not allow people to avoid estate taxes, but they can be used to reduce them in certain circumstances. (Most living trusts are revocable which means the grantor may rescind them at any time. The assets of a revocable trust must be included in the estate when calculating the estate taxes due.)

Which of the following positions would expose the customer to the greatest possible loss?

1.) Buy 1,000 shares of Netflix at 200 and sell 10 Netflix July 210 calls 2.) Buy 10 Netflix June 200 calls and sell 10 Netflix June 220 calls 3.) Buy 1,000 shares of Netflix at 200 and buy 10 Netflix June 200 puts 4.) Short 1,000 shares of Netflix at 200 and buy 10 Netflix July 210 calls Explanation: In choice (a), the customer is writing covered calls by purchasing the stock and writing an equal number of call options. If the price of the stock falls to zero, the call options will expire worthless, but the customer would have a significant loss on the long stock position. The breakeven price is the cost of the stock minus the premium received from the call options. Choice (b) is a net debit spread in which the maximum loss is the net premiums paid. Choice (c) is a protective put in which the maximum loss is the cost of the premiums since the strike price is equal to the cost of the stock. Choice (d) is a hedged position since the customer could exercise the call options to close out the short stock position, incurring only a 10-point loss on each contract.

An investor has owned stock for several years and has an unrealized capital gain. If he is willing to sacrifice some yield in order to protect the unrealized gain, which option strategy is the BEST?

1.) Buying calls on the stock 2.) Writing calls against the stock 3.) Buying puts on the stock 4.) Writing puts against the stock Explanation: Using options, the best way to hedge or protect an unrealized gain is to buy puts. The downside to buying puts for protection is the fact that the premium must be paid. If the stock's price stays flat or rises, the option will expire worthless. This will ultimately result in a loss of the premium, which will negatively affect the performance of the portfolio.

An investment adviser is attempting to determine whether a fixed-income security is priced attractively relative to a client's desired annual interest rate. Which of the following methods would BEST determine a bond's fair value?

1.) Calculating the bond's duration 2.) Determining the future value of the bond 3.) Confirming the yield to maturity 4.) Discounted cash flows Explanation: Discounted cash flow evaluates each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for her client.

In which of the following types of accounts can an uncovered call writing strategy be executed?

1.) Cash 2.) IRA 3.) Custodial 4.) Margin Explanation: Uncovered calls can only be written in a margin account. Retirement accounts, custodial accounts, and cash accounts cannot utilize the uncovered call writing strategy.

Important considerations that an investor should take into account before investing in a limited partnership would include all the following matters, EXCEPT:

1.) Checking into the general partner's qualifications for running the entity as well as his financial position 2.) A complete assessment of the funding available to the partnership 3.) An analysis to determine whether the business will lose enough money to make the investment a viable tax shelter 4.) A determination as to whether the length of the investment program is compatible with the investor's financial position Explanation: The ideal situation for a limited partnership is for the business to generate a positive cash flow, but to report a loss due to the deductions that are applied to revenue. In the investment, there is an expectation of profit, which is made attractive to the investor by the timing of the profit and the way it is taxed. It is wrong to consider the merits of a limited partnership based on how poorly the business will perform.

A broker-dealer wants to include an offering of securities through a private placement on its platform. Before offering the securities to its customers, what would fulfill the broker-dealer's due diligence requirements?

1.) Conducting an independent review of the issuer and its management 2.) Reviewing the prospectus that's filed with the SEC 3.) Filing a due diligence document with the state Administrators so that they can approve the offering 4.) Reading the offering memorandum that's provided by the issuer Explanation: In order to offer and sell a private placement, broker-dealers need to review the issuer's business and its finances. This process is referred to as performing due diligence. Since private placement offerings are exempt transactions, this information is not required to be filed with the SEC or Administrator(s). The offering memorandum should be reviewed, but it alone is not sufficient to satisfy the broker-dealer's due diligence requirement.

An IAR has very little experience in the industry, but has a client enter his office with assets totaling $45 million. After completing a client profile, the IAR determines that the client has a high risk tolerance and her objective is capital appreciation. What should the IAR do in this situation?

1.) Consider consulting with a seasoned IAR or manager since he has little industry experience 2.) Build a portfolio that consists of stocks to meet the client's needs 3.) Research different stocks and then put together the portfolio 4.) Obtain permission from the State Administrator since the account exceeds $2.2 million Explanation: When an investment adviser representative opens an account with a significant amount of money, he should be familiar with his firm's policies and procedures. In a situation like this, the IAR may not have enough industry experience to recommend the appropriate investments. For this reason, it may be best if the inexperienced representative solicits the assistance of a seasoned IAR or manager.

An investor owns Treasury bonds that mature in 20 years. This investor is primarily exposed to:

1.) Credit risk 2.) Inflation risk 3.) Currency risk 4.) Capital risk Explanation: Credit risk is the risk that the investor will not receive interest and/or principal when it is due. Capital risk is the risk that the investor will lose all or part of the investment. Since Treasury bonds are direct obligations of the U.S. government, there is virtually no risk that the investor would not receive interest and/or principal when due. Therefore, they are free of credit risk. However, all fixed-income securities are exposed to inflationary risk (purchasing-power risk).

An individual is considering making some changes in her portfolio due to expectations that the economy may be moving into a recessionary period. In what type of stocks should she consider investing?

1.) Cyclical stock 2.) Defensive stock 3.) Growth stock 4.) Value stock Explanation: Defensive stocks tend to react less to negative changes in the economy than other stocks These are stocks of companies that produce items of necessity (e.g., utilities, pharmaceuticals, food, and alcohol).

With reference to the Uniform Securities Act, when does an agent's registration become effective?

1.) December 31 2.) 60 days after filing the application 3.) 30 days after filing the application 4.) As soon as the agent passes the exam Explanation: Under the Uniform Securities Act, registrations become effective at noon on the 30th day after filing the application.

An advisory client is discussing the purchase of AA-rated, 15-year municipal bonds with his adviser. The bonds offer a coupon rate of 3.2% and can be purchased at a small premium to par. The adviser is not certain if the bonds are trading at an advantageous price. Which calculation would provide the BEST method of determining whether the bonds should be purchased?

1.) Discounted cash flow 2.) Yield to maturity 3.) Real interest rate 4.) Weighted average cost of capital Explanation: Discounted cash flow evaluates each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for her client.

The beta of a stock would be useful when measuring:

1.) Diversifiable risk 2.) Non-systematic risk 3.) Market risk 4.) Risk-free return Explanation: Market risk (also referred to as systematic risk) refers to the risk that is inherent in all securities due to general market volatility and it cannot be eliminated by diversifying a portfolio. A stock's beta is a measure of its market risk (its volatility when compared to the volatility of the whole market). The market (the S&P 500 Index) has a beta of 1; therefore, stocks with a beta of more than one are more volatile than the market. Conversely, stock with a beta of less than one are less volatile than the market.

An advisory client is optimistic and believes that the economy is about to recover. He instructs his adviser to sell his holdings in consumer staples and utilities and purchase industrial and technology stocks. This strategy is known as:

1.) Diversification 2.) Sector rotation 3.) Tax selling 4.) Leveraging Explanation: Sector rotation is a strategy often used in anticipation of changes in the business cycle. If it is believed the economy is about to slow, profitable sectors to invest in would be consumer staples, or defensive stocks.

Which of the following factors is the BEST measure of a bond's volatility?

1.) Effective Yield 2.) Duration 3.) Alpha 4.) Standard deviation Explanation: Duration measures the price sensitivity of a particular bond based on changes in interest rates.

Which of the following investments are not standardized and do not trade on a listed exchange?

1.) Equity options 2.) Futures contracts 3.) Currency options 4.) Forward contracts Explanation: Forward contracts are negotiated between buyers and the sellers and trade OTC. Their features are not standardized. A clearing corporation standardizes the features of equity options, currency options, and futures contracts.

What type of broker-dealer sends orders to a market maker in order to execute orders for retail customers?

1.) FINRA member firm 2.) Custodian 3.) Introducing broker 4.) Clearing broker Explanation: Introducing brokers (IBs) don't have the ability to execute, clear, or settle trades for customers. Instead, IBs will send their customers' orders to a clearing broker (e.g., market maker) that will then execute customer trades on an exchange.

An adviser is concerned about the impact of stock option compensation paid to senior executives on the firm's future profitability. Which of the following documents would be the most useful to research?

1.) Form 8-K 2.) Form 10-K 3.) Form 4 4.) Form 13D Explanation: The annual 10-K filing includes information on executive compensation.

What form is required when registering as a broker-dealer?

1.) Form U4 2.) Form 3 3.) Form BD 4.) Form U5 Explanation: Form BD is the Uniform Application for Broker-Dealer Registration, which is filed with the SEC, SROs that have jurisdiction, and the appropriate states, through the Central Registration Depository (CRD) operated by FINRA.

In what type of investing would a passive asset manager engage?

1.) Fundamental or technical analysis 2.) Day trading or sector rotation 3.) Indexing or buy-and-hold 4.) Anchoring or herd trading Explanation: Passive asset managers believe that markets are efficient and don't believe in attempting to time the market. Indexing and buy-and-hold strategies are both types of passive approaches.

A mutual fund wants to report to its shareholders the fund's average return over a 10-year period. What's the best way to calculate the fund's annual return?

1.) Geometric mean 2.) Arithmetic mean 3.) Sharpe Ratio 4.) Standard deviation Explanation: The geometric mean, which is also referred to as the time-weighted return, is the best way to measure the performance of a mutual fund. This method eliminates the distortion from cash inflows and outflows (e.g., investors withdrawing their investments). On the other hand, the arithmetic mean can be misleading for reporting average returns over several continuous years since it's actually distorted by cash inflows and outflows.

A client contacts a firm and indicates his desire to buy a call option on a stock that he already owns. Why would the investor buy a call option on the stock?

1.) He wants to hedge his position 2.) He wants to generate income and increase his rate of return 3.) He wants the ability to buy more shares at a guaranteed price in case the stock goes up 4.) He wants to reduce his losses Explanation: When buying a call option on a stock, the client is able to buy the underlying security at a specific price. He would buy a call option if he believes the price of the security is going to increase. In this situation, buying a call does not generate income, hedge risk, or increase the rate of return.

According to NASAA's Statement of Policy on Unethical Business Practices, which TWO of the following statements are TRUE concerning information to be included in an investment advisory contract? I.) The fee for managing equity securities may not be higher than for fixed-income securities. II.) An assignment of the contract can be made only by the investment adviser with the consent of the client. III.) There is disclosure explaining that no prepaid fees will be returned if the contract is terminated. IV.) There is disclosure as to whether the contract grants discretionary power to the adviser.

1.) I and II 2.) I and III 3.) II and III 4.) II and IV Explanation: NASAA's Statement of Policy on Unethical Business Practices provides that the entering into, or renewal of, an investment advisory contract would need to include disclosure of: All fees and services provided The term of the contract A formula for computing the advisory fee The amount of prepaid fees to be returned in the event of an early termination of the contract The fact that no assignment of the contract will be made without the consent of the client Whether the contract grants discretionary power to the adviser The fee for managing equity securities may be higher than for fixed-income securities Choice (II) is true since the contract may be assigned with the consent of the client. Choice (III) is not true since some amount of prepaid fees should be returned if the contract is terminated.

Securities issued by which TWO of the following entities are NOT federal covered? I.) The U.S. Government II.) A NYSE-listed company III.) A registered investment company IV.) A municipality

1.) I and II 2.) II and III 3.) III and IV 4.) I and IV Explanation: Securities issued by the U.S. government and municipalities (the states and local government units) are exempt securities, not federal covered securities. Securities issued by companies listed on one of the national exchanges and securities issued by registered investment companies (mutual funds) are federal covered.

Under the Uniform Securities Act, all the following are considered to meet the definition of agent, EXCEPT: I.) A sales representative of a broker-dealer who sells only securities that are covered under a federal exemption II.) An assistant to a sales agent who accepts orders when the agent is unavailable III.) A subsidiary of a bank that is registered as a broker-dealer and sells non-exempt securities to the public IV.) A broker-dealer that sells only exempt securities within the state

1.) I and II only 2.) I and IV only 3.) II and IV only 4.) III and IV only Explanation: By definition, a sales representative of a broker-dealer is an agent. This is true regardless of whether the securities being sold are covered under a federal exemption. Also, a sales assistant is considered an agent if she is authorized to accept client orders. Choices (III) and (IV) describe activities involving the broker-dealer (firm) and not an agent (individual).

A portfolio manager heavily invested in bonds is concerned about an increase in interest rates. In order to make his portfolio less price sensitive to yield changes, the manager should make which two changes in the portfolio? I.) Buy bonds with low durations II.) Buy bonds with high durations III.) Buy bonds with small coupons IV.) Buy bonds with large coupons

1.) I and III 2.) I and IV 3.) II and III 4.) II and IV Explanation: Bonds with low durations and large coupons will be less price sensitive to changing interest rates. Bonds with high durations and small coupons will be more volatile in price as interest rates change.

An adviser is comparing two bonds of similar credit quality and duration for a client. The client is seeking a yield of 7.2%. After performing discounted cash flow analysis on each bond, the adviser has determined that Bond A is trading at a premium to its present value, while Bond B is trading at a discount to its present value. Which TWO of the following statements are TRUE? I.) Bond A is priced attractively and should be purchased. II.) Bond B is priced attractively and should be purchased. III.) The investor will earn an annual interest rate greater than 7.2% with Bond A. IV.) The investor will earn an annual interest rate greater than 7.2% with Bond B.

1.) I and III 2.) I and IV 3.) II and III 4.) II and IV Explanation: Discounted cash flow (DCF) analysis evaluates the present value of all coupon payments and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client. If a bond is trading at a discount to its present value, the investor will earn more than the interest rate that has been used to calculate the present value. Conversely, a bond that is trading at a premium to its total present value will be worth less than the price of the bond. (The investor would be overpaying for the bond.)

Which TWO of the following statements are TRUE regarding investment advisers with $135 million of assets under management? I.) They must register in any states in which they will conduct business. II.) They are exempt from state registration. III.) They must register with the SEC. IV.) They must register with the SEC only if their clients are all retail investors.

1.) I and III 2.) I and IV 3.) II and III 4.) II and IV Explanation: NSMIA, the National Securities Markets Improvement Act, was created to eliminate some of the dual requirements of federal and state securities law. The federal government and the states have a division of responsibility when regulating investment advisers. Unless exempt from registration, advisers are required to register with either the state Administrator or the SEC, but not both. According to Dodd-Frank, an adviser has a choice and may register with the state Administrator or the SEC once it has assets under management (AUM) of $100 million. Once the adviser's AUM reaches $110 million, it is categorized as a federal covered adviser and is required to register with the SEC. In addition, firms that provide advice to an investment company, or firms that provide advisory service in 15 or more states, are also categorized as federal covered. Once registered with the SEC, a mid-sized adviser may remain registered with the SEC provided it has AUM of at least $90 million. If an adviser's AUM falls below $90 million, it must instead register at the state level.

Your client would like to invest her traditional IRA contribution for long-term growth, but in such a way as to maximize diversification and minimize costs. Which of the following investments would be the best recommendation for her?

1.) Invest in a mutual fund that mirrors the S&P 500 Index 2.) Invest in a variable annuity that has a subaccount that mirrors the S&P 500 Index 3.) Buy a stock from each of 10 different sectors 4.) Invest in a variable life insurance policy that has a subaccount that mirrors the S&P 500 Index Explanation: A major advantage of investing in a variable annuity is the ability to participate in the earnings that the market offers while deferring tax on those earnings. Since an IRA is tax-deferred investment, the client could achieve this by investing the IRA contributions directly into a mutual fund. This would result in lower fees for the client, since variable annuities have a number of additional fees (e.g., mortality and expense risk fees) on top of the typical mutual fund expenses for each subaccount. Buying stock from 10 different sectors, the client would not have as much diversification as a portfolio that models the S&P 500 Index (a broad market index). The IRS does not permit IRA contributions to be used to purchase life insurance. Also, a life insurance policy should never be recommended to a person who does not need the insurance, since its cost will be subtracted from the cash value in addition to the usual mutual fund expenses for each subaccount.

Which of the following is not a sector rotation strategy?

1.) Investing in different industries that perform better based on the economic business cycle 2.) Investing in different countries' economies based on their ability to overperform 3.) Rotating assets between cyclical and counter-cyclical industries 4.) Rotating between long-term and short-term bonds Explanation: Sector rotation refers to a strategy that attempts to time the movement of assets into different market sectors based upon the superior performance in those segments. For example, an investor who anticipates that one emerging economy will outperform another, or one industry group that is correlated with the market (cyclical) will outperform the market as the economy recovers. Rotating between long-term and short-term bonds will help an investor reduce the volatility of the portfolio but is not a sector rotation strategy.

An investment advisory firm has done extensive research on the pharmaceutical industry and is in the process of buying shares of several companies. Many of the stocks are speculative issues but several of the firm's accounts are conservative. According to the Uniform Securities Act, the placement of shares in any of the clients' accounts:

1.) Is acceptable as long as the shares reduce the overall risk of the portfolio 2.) Is permitted as long as it is consistent with the clients' objectives 3.) Is permitted if it represents a small portion of the clients' portfolio 4.) Is acceptable because the investment adviser did extensive research Explanation: The adviser may only purchase securities that are consistent with client objectives. The fact that the firm has done extensive research does not alter this requirement. While it is important to manage the portfolio's risk, the investments must be consistent with the clients' objectives.

All of the following are true about a dividend paid by a corporation to its shareholders, EXCEPT the dividend:

1.) Is determined by a corporation's board of directors 2.) Is voted upon by a corporation's shareholders 3.) May be in the form of the corporation's stock 4.) May be in the form of stock in another corporation Explanation: A corporation can pay a dividend to its stockholders in the form of its own stock, stock of another corporation, or in cash. The amount of dividend to be paid is determined by the board of directors. Shareholders do not vote for dividend payments.

A licensed insurance agent and an investment adviser have offices next door to each other. The insurance agent refers clients to the investment adviser, and the adviser pays the agent a referral fee plus a percentage of the management fee for each client who opens an account with the adviser. The insurance agent:

1.) Is exempt from registration 2.) May be required to register as an investment adviser representative 3.) Is considered a captive agent 4.) Must disclose the arrangement on Form ADV Explanation: Under the Uniform Securities Act, an investment adviser representative includes any person who "solicits, offers, or negotiates for the sale of or sells investment advisory services." Therefore, some states require solicitors to register as investment adviser representatives.

Which of the following statements about discounted cash flow (DCF) analysis is TRUE?

1.) It is based on the theory that markets are efficient and there is no way to predictably outperform the market as a whole. 2.) It uses cash flows that an investor has already received and reinvested. 3.) If the net present value of an investment is less than zero, it represents a good investment opportunity. 4.) If the net present value of an investment is greater than zero, it represents a good investment opportunity. Explanation: Discounted cash flow analysis uses an estimate of future cash flows (e.g., dividends and interest payments) to estimate the current value of an investment (i.e., the present value of the investment). If the present value of an investment is calculated and it is compared it to the investment's current market price, the net present value (NPV) is determined. A positive NPV means that the investment can be purchased for less than its present value. In other words, the DCF analysis indicates that with positive NPV the investment will pay out more in the future than what it costs to purchase. For that reason, positive NPV represents a good investment opportunity.

Which of the following choices is NOT a benefit of discounted cash flow, fixed-income analysis?

1.) It makes it possible to determine the present value of a series of future payments 2.) It permits an adviser to minimize cash flow reinvestment risk 3.) It allows for a direct comparison between the present value and the market value of a bond 4.) It provides a means to measure and compare the value of investments that have different rates of return Explanation: Discounted cash flow (DCF) analysis does not offer relief from reinvestment risk when investing in fixed-income securities. A discounted cash flow evaluates the present value of each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against current rates of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determines a fair market value of a bond. By comparing the value calculated by the discounted cash flow formula to the current market price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client.

Which of the following accounts do NOT ease probate?

1.) Joint tenants in common account 2.) Joint tenants with rights of survivorship account 3.) Account with a transfer on death designation 4.) Trust account Explanation: Joint tenants in common is a type of joint account that's split upon the death of one of the owners. At death, the decedent's portion of a joint tenants in common account will go into her estate. At that point, the probate process will determine the distribution of the assets. All of the other accounts/ designations in the question make the probate process quicker and easier.

The securities (interests) of which of the following types of business are often listed on an exchange?

1.) Master limited partnership 2.) S-Corporation 3.) Limited liability company 4.) Sole proprietorship Explanation: Master limited partnerships (MLPs) are publicly listed limited partnerships and they're securities (interests) are traded on a national securities exchange.

Which of the following types of stocks is the MOST suitable for a conservative investor who has a low-risk tolerance, but wants to invest in equity securities?

1.) Micro-caps 2.) Small-caps 3.) Mid-caps 4.) Large-caps Explanation: Large-cap stocks are those that are generally issued by well-established companies that have a long history of profits and dividend payments. Of the choices given, the large-cap category is the most suitable for the investor with a low-risk tolerance and an interest in equities.

Under Uniform Securities Act (USA), a person is defined as an investment adviser if it conducts a business of providing advice on all of the following securities, EXCEPT:

1.) Mutual funds 2.) Government securities 3.) Fixed annuities 4.) Federal covered securities Explanation: A firm is considered an investment adviser if it meets the three-prong A-B-C definition (A = advice, B = business, C = compensation). However, an IA's advice must pertain to securities. Of the answers provided, only fixed annuities are not defined as securities. A person that provides advice related fixed annuities doesn't meet the definition of an investment adviser.

Who must an adviser notify if they have custody of client assets?

1.) NASAA 2.) FDIC 3.) State Administrator 4.) FINRA Explanation: According to NASAA's Custody of Client Funds or Securities by Investment Advisers Model Rule, any investment advisers that maintain custody of client funds and/or securities must notify the state Administrator using Form ADV.

Are Section 457 plans required to follow ERISA guidelines?

1.) No, because they're non-qualified plans. 2.) Yes, despite the fact that they're a type of non-qualified plan. 3.) Yes, because they're qualified plans. 4.) No, despite the fact that they're a type of qualified plan. Explanation: Section 457 plans are retirement accounts for municipal government workers and certain non-profits. Unlike 401(k) plans, 457 plans are non-qualified and are not required to meet guidelines that were established by the Employee Retirement Income Security Act of 1974 (ERISA).

On Monday, a client e-mailed her agent asked him to buy 100 shares of ABC stock whenever he believes it's the right time. Is the client's request in violation of the Uniform Securities Act?

1.) No, provided a principal of the broker-dealer approves the transaction in advance. 2.) Yes, since the client did not specify a time to purchase. 3.) Yes, since the client did not specify a price for her order. 4.) No, but the order must be executed on the day it's entered or canceled at the end of the day. Explanation: Since the customer specified the action (i.e., buy), the amount (i.e., 100 shares), and the asset (i.e., ABC stock), the agent may determine the time and/or price of execution without obtaining a written power of attorney from the customer. These orders don't need to be pre-approved by a principal (i.e., supervisor) of the broker-dealer.

On Tuesday, June 3, an IA discovers its net worth has fallen below the minimum requirement. When must the IA file a report of its financial condition with the Administrator?

1.) On Tuesday, June 3 2.) On Wednesday, June 4 3.) On Thursday, June 5 4.) On Friday, June 6 Explanation: If an IA's net worth is less than the required minimum, it must notify the Administrator by the close of the next business day (in this question, Wednesday, June 4). After notification is made, the IA must file a report of its financial condition by the next business (in this question, Thursday, June 5). Thereafter, the Administrator may require the IA to post a bond for the deficiency.

How much will an investor receive from a deferred interest bond at maturity?

1.) Par Value - Accrued Interest 2.) Market Value + Accrued Interest 3.) Market Value - Accrued Interest 4.) Par Value + Accrued Interest Explanation: Deferred interest bonds—which are also referred to as deferred coupon bonds—don't pay semi-annual interest. Instead, these bonds pay interest in full at maturity. If an investor owns a 4%, $1,000 par value deferred interest bond that matures in one year, he will receive $1,040 ($1,000 par + $40 interest) at the end of the year.

Which of the following is NOT a precious metal?

1.) Platinum 2.) Gold 3.) Silver 4.) Copper Explanation: Precious metals are metals that are relatively rare and more difficult to find than other types of metals. The rarity of precious metals is what allows them to command a higher price. Precious metals include gold, silver, platinum, and palladium.

Assuming an expected rate of return, a specific holding period, and a sum to be invested, an IAR is able to determine an investment's:

1.) Present value 2.) Discount rate 3.) Future value 4.) Internal rate of return Explanation: The future value of an investment is based on the present value of the amount invested, using a discount rate each year, and doing so over a given period of time. The assumption is that the annual return is reinvested at the same rate, or is compounded over the given time period, thereby resulting in a future value that exceeds the present value.

An S Corporation is similar to a partnership in that both:

1.) Provide limited personal liability 2.) Require full personal liability 3.) Do not provide flow-through of losses 4.) Provide flow-through of losses Explanation: Both S Corporations and partnerships are considered pass-through investments. In other words, any profits and losses that are generated by these entities are distributed (passed through) to the owners/partners and reported on their personal tax returns (i.e., profits are only taxed once). Since the question did not specify whether the partnership was a limited partnership, choice (a) is incorrect. In some partnerships (e.g., general partnerships), the partners assume unlimited personal liability.

An IA has chosen a new money manager to handle one of its client's assets. This manager was selected because of its expertise. Two years later, the money manager changes its approach and begins to make very speculative trades that are unsuitable for the client based on his risk profile. The client loses half of his investment and writes a complaint letter. In this situation, what should the adviser have done?

1.) Required the money manager to obtain the adviser's consent to change its management style 2.) Monitored the money manager's activities and detected that the trading was unsuitable 3.) Reminded the client that it is not managing his money and is not liable 4.) Informed the client that any complaints should be forwarded to the money manager Explanation: When an investment adviser directs its clients' assets to another adviser (sometimes referred to as a subadviser), it is the responsibility of the adviser to monitor these accounts to ensure that the subadviser is acting in the clients' best interests.

Which of the following represents the correct ranking of securities from longest to shortest life?

1.) Rights, options, warrants 2.) Options, warrants, rights 3.) Warrants, options, rights 4.) Warrants, rights, options Explanation: Rights usually last less than 60 days. Options usually last for nine months or less, although some can exist for three years. Warrants usually have a life span of several years and they can even be perpetual.

When a person acquires ownership of more than 5% of a voting class of a company's equity securities registered under the Securities Exchange Act of 1934, he is required to file a:

1.) Schedule 13D 2.) Schedule 13F 3.) Form 8-K 4.) Schedule H Explanation: When a person acquires ownership of more than 5% of a voting class of a company's equity securities registered under the Securities Exchange Act of 1934, he is required to file a Schedule 13D with the SEC. Schedule 13D is commonly referred to as a beneficial ownership report.

An adviser feels strongly that the economy is on the cusp of expanding. Therefore, the adviser recommends a shift from bonds to commodities to clients. This investment strategy is known as:

1.) Sector jumping 2.) Sector rotation 3.) Sector shifting 4.) Sector swapping Explanation: An investment strategy of making changes to an investment portfolio in anticipation of economic changes is known as sector rotation. Generally, in a slowing economy, interest rates decline, thereby increasing the price of fixed-income securities, such as bonds. As the economy begins to recover, prices of various products tend to rise, such as commodities, as their demand increases.

Which of the following actions will require an adviser to register under the USA?

1.) Selling fixed annuities 2.) Selling mutual funds 3.) Selling equity-indexed annuities 4.) Selling investment management services Explanation: Under the Uniform Securities Act (USA), firms that sell securities are typically required to register as broker-dealers, not investment advisers. On the other hand, firms that sell management services are required to register as investment advisers under the USA.

The prices of which of the following bonds would change the LEAST if interest rates rose?

1.) Short-term municipal notes 2.) Treasury securities 3.) AAA-rated corporate bonds 4.) Zero-coupon bonds Explanation: The prices of short-term bonds tend to decline less when interest rates rise than bonds with longer maturities. Zero-coupon bonds also tend to be particularly vulnerable to increases in interest rates.

Under NASAA's Statement of Policy on Unethical Business Practices, an adviser may share confidential client information with all of the following, EXCEPT:

1.) The SEC 2.) The IRS 3.) FINRA 4.) An affiliated broker-dealer Explanation: An investment advisory firm must keep all information concerning its clients confidential. It may release the information only if required to do so by law or with the client's approval. The SEC, FINRA, and the IRS are regulatory agencies that could obtain the information without the client's approval.

An employee of a federally chartered bank would like to sell mutual funds to the bank's current customers. Which of the following statements is TRUE?

1.) The bank employee is exempt from the definition of an agent in this situation 2.) The bank employee is exempt if the securities are sold only to current customers 3.) The bank employee needs to be registered as an agent 4.) The bank employee is exempt because of a safe harbor rule Explanation: Bank employees who solicit the sale of securities are considered agents of broker-dealers. The sale of mutual funds, which are considered securities, would cause the employee to meet the statutory definition of an agent.

Which of the following is NOT a characteristic of whole life insurance policies?

1.) The cash value is guaranteed 2.) The premiums are deposited into the general account of the insurance company 3.) The death benefit is guaranteed 4.) The death benefit fluctuates or adjusts to the market Explanation: In a whole life insurance policy, premium payments are invested in the general account of the insurance company. The insurance company guarantees the owner's cash value and provides a fixed, guaranteed death benefit.

When determining the risk tolerance of a client, which of the following choices will an investment adviser representative consider to be the LEAST important?

1.) The client's income and living expenses 2.) Information about the client's life insurance policies 3.) The client's long-term goals 4.) The client's history and experience with investments Explanation: When determining a client's risk tolerance, the least important factor (of the choices given) for an IAR to consider is information regarding the client's life insurance policies. However, all of the other choices could potentially influence a client's risk tolerance, such as the person's financial status, goals/objectives, and investment experience. For example, experienced clients who have invested in different, unique types of securities are better able to understand how the various types of risk will affect a security's value.

Which of the following is FALSE regarding a Health Savings Account (HSA)?

1.) The contributions are tax-deductible 2.) The earnings in the account are tax-free 3.) The distributions are tax-free if they are used to pay for qualified medical expenses 4.) The distributions that are used for non-qualified medical expenses are subject to a 50% penalty Explanation: The distributions that are used for non-qualified medical expenses are subject to a 20% tax, not a 50% penalty. All of the other statements are true.

A private equity fund manager has recently had poor performance and decides to change the fund's objectives. Which of the following statements is TRUE regarding changing the private equity fund's objectives?

1.) The fund manager may do this without notifying the fund's investors. 2.) Changing the fund's objectives requires approval from the owners of the fund. 3.) The fund manager must disclose the change in the fund's disclosure document. 4.) This practice is prohibited by the Investment Company Act of 1940. Explanation: Private equity funds are typically structured as limited partnerships and sold under an exemption provided by the Investment Company Act of 1940. The fund manager acts as the general partner and investors in the private equity fund are considered limited partners. As limited partners, investors are generally not permitted to vote on fund objectives. Mutual funds are regulated by the Investment Company Act of 1940 and shareholders of a mutual fund must approve changes in the fund's objectives. However, if a private equity fund manager changes the investment objectives, investors are only required to be informed of the change.

Who is responsible for filing estate income tax returns and making sure that the payments are made on the estate's behalf?

1.) The heirs 2.) The administrator or executor 3.) The probate court 4.) The decedent or testator Explanation: An executor or administrator is responsible for managing the estate's assets and distributing the property to the heirs. These responsibilities include paying any estate taxes that are due as well as income taxes that might be due on income earned by the estate before the assets are distributed to the heirs.

A sell limit order can be executed at:

1.) The limit price or higher 2.) The limit price or lower 3.) Only at the limit price 4.) The most immediately available price in the market Explanation: Limit orders can be executed at the limit price or better. For sell limit orders, a better price is one that's higher. Ultimately, investors are certainly willing to sell a security at a higher price.

In an effort to generate new business, an investment adviser wants to publish a list of its past recommendations. According to the USA, which of the following best describes the adviser's obligations?

1.) The list must include all recommendations that it made within the past three months 2.) The list must include all recommendations that it made to retail accounts during the prior six months 3.) The list must include all recommendations that it made over a minimum one-year time frame 4.) The adviser may publish a list of its most favorable recommendations if it is based on an investment period of at least one year and the list is maintained for a minimum of three years Explanation: An investment adviser may include a list of its previous investment recommendations in advertising and sales materials as long as the list includes all of the adviser's recommendations during the relevant period (which must be at least one year).

What's a basic assumption of Modern Portfolio Theory?

1.) The market will increase over the long-run 2.) The economy's growth rate will eventually decrease 3.) Investors will minimize risk when possible 4.) Investors should buy safer investments as they get older Explanation: Modern Portfolio Theory (MPT) is based on the following two assumptions: 1) Investors will try to maximize their returns, and 2) Investors generally seek to assume as little risk as possible. Although many investors will take less risk as they age, MPT doesn't specifically mention an investor's age. Also, MPT doesn't make any assumptions about the market or the economy.

An individual has recently inherited a life insurance policy. What's the individual's tax liability on the insurance policy's death benefit?

1.) The proceeds exceeding the cost basis are taxable at the long-term capital gains rate. 2.) The proceeds exceeding the cost basis are taxable at the individual's ordinary income rate. 3.) Zero, since the death benefit from an insurance policy is only taxable to the deceased's estate. 4.) 100% of the death benefit is taxable at the individual's ordinary income rate. Explanation: Beneficiaries are NOT required to pay taxes on death benefits from life insurance policies. The death benefit is included in the assets of an estate and could be subject to the estate tax. The death benefit from a non-qualified annuity could be taxable as ordinary income, but only on the amount that exceeds the contributions (i.e., basis).

Under what circumstances will the payout from a variable annuity increase?

1.) The rate of inflation exceeds the AIR 2.) The performance of the separate account exceeds the rate of inflation 3.) The performance of the separate account exceeds the AIR 4.) The performance of the separate account for the current period exceeds the performance of the separate account for the previous period Explanation: Whether the payment from a variable annuity changes depends on the relationship between the performance of the separate account and the assumed interest rate (AIR) in the contract. If the account performance exceeds the AIR, the payment will be greater than the last payment. If the account performance equals the AIR, the payment will be unchanged from the last payment. If the account performance is less than the AIR, the payment will decline from the last payment.

Which of the following is NOT TRUE regarding a viatical settlement contract?

1.) The rate of return cannot be determined before the insured dies 2.) The inability to accurately calculate the actual life expectancy of the insured 3.) An investment in a viatical settlement contract is considered to be liquid 4.) If the insured lives longer than expected, the investor is required to pay the premiums to keep the policy in force Explanation: With a viatical settlement contract, if the insured lives beyond life expectancy, the investor is required to continue to pay the insurance premiums. Since the death of the insured is ultimately unpredictable, the future financial commitment is unknown. A viatical settlement contract is not a liquid investment as there is not a secondary market for such investments.

Which of the following can time-weighted return be used to evaluate?

1.) The return on the market that exceeds the risk-free rate of return 2.) The rate of return an investor will earn if he holds a bond until it matures 3.) Comparing the performance of portfolio managers 4.) The discount rate that will make future cash flows equal to the present market value of an investment Explanation: Time-weighted return is used to evaluate the performance of money managers. Time weighted return minimizes the impact of investor deposits and withdrawals, which cannot be controlled by the manager.

When considering the suitability of investment advice, which of the following statements is NOT TRUE?

1.) The suitability of investment advice is determined by the appropriateness of the advice for that particular client, not the profitability of the client's account 2.) If a client refuses to supply complete information about her financial resources, the adviser may assume she has other assets that have not been disclosed 3.) IARs should document their inquiry into the client's financial background and investment objectives by completing a data-gathering form 4.) Counseling a client to choose very conservative investments is not always a defensible approach to providing investment advice Explanation: Providing the same advice to all clients (even when recommending conservative investments) is rarely suitable. Investment advice should be suitable for each client's objectives and risk tolerance. For some clients, more aggressive investments that provide long-term growth may be more appropriate than more conservative strategies. If a client refuses to disclose fully her assets, an adviser must assume that the only assets the client has are those that have been disclosed.

Which of the following statements regarding the differences between an annual rebalancing strategy and a buy-and-hold strategy over a 30-year period is FALSE?

1.) The tax and transactions costs will be lower with a buy and hold strategy 2.) The buy and hold strategy is easier to manage than a rebalancing strategy 3.) The risk in a buy and hold strategy portfolio will match the investor's risk tolerance 4.) The equity portion in a buy and hold portfolio could grow in relation to the fixed-income portion, whereas a rebalanced portfolio will remain balanced every year Explanation: The risk levels in a buy and hold portfolio will rise and fall, while a rebalanced portfolio will be adjusted periodically to meet the investor's risk tolerance. Rebalanced portfolios will also attempt to maintain the percentage of equity and debt in the portfolio, while buy and hold portfolios will allow the percentages to drift. One of the advantages of a buy and hold strategy is that transaction and tax expenses are minimized since there is generally no continuous buying and selling.

Tax-adjusted returns are adjusted for:

1.) The volatility inherent in all securities 2.) Both taxes and inflation 3.) Only taxes 4.) The risk taken by an investor over the investor's holding period Explanation: Tax-adjusted returns are impacted by taxes, but not by other factors.

According to the NASAA Model Rule on the Ethical Business Practices of Investment Advisers, which of the following statements is TRUE regarding investment advisory fees charged to customers?

1.) There is no limit on the size of the fee that may be charged as long as the customer understands and agrees to the method of computation and the method is disclosed in writing to the client 2.) Investment advisory fees may not exceed an annual rate equivalent to 5% of the total assets under management at the end of the computation period 3.) Advisers may not charge fees that are unreasonably high in relation to fees charged by other advisers for similar services 4.) Fees charged by an investment adviser on an annual basis may not exceed the gains in the portfolio during the same period Explanation: Although it is difficult to compare the advisory services provided to clients of different advisers, a general standard of reasonable fees is used to compare fees charged by various advisers. Fees that are obviously out of line with those charged for similar services are considered unethical.

All of the following are characteristics of Certificates of Deposit, EXCEPT:

1.) They have a minimum maturity of seven days 2.) They have a maximum maturity of three years 3.) They are insured by the FDIC to a maximum of $250,000 4.) A penalty is assessed if redemption is made prior to maturity Explanation: Certificates of Deposit (CDs) carry fixed rates of interest and mature after a specified period. There is no maximum maturity, though a minimum maturity of seven days exists. CDs are insured by the FDIC up to $250,000 and holders of CDs are assessed a penalty if redemption is made prior to maturity.

Offering which of the following goods or services would be a violation of soft-dollar practices if the broker-dealer provides them to the adviser in exchange for executing transactions?

1.) Third-party research 2.) Market data services 3.) Trading software used to route orders to a market center 4.) Assistance concerning its compliance responsibilities Explanation: An adviser is permitted to use a broker-dealer to execute transactions in exchange for certain services. This practice is referred to as soft dollars and it is defined as a means of paying brokerage firms for their services through trade commissions. The key here is that the services that the adviser receives as part of a soft-dollar arrangement must benefit its clients. Some examples of allowable services would include traditional and third-party research reports and other related publications, discussions with research analysts concerning the securities they cover, portfolio analysis software, attendance at a conference or seminar where corporate executives discuss their company's performance, market and economic data services, and certain trading software. The permissible uses of soft dollars do not include compliance or administrative assistance, advertising and marketing, the adviser's travel expenses, meals or entertainment, overhead and administrative expenses, employee salaries, marketing, professional licensing fees, computer terminals, or the correction of trading errors.

An agent recommends that her client exchange her shares in XYZ's Income Fund for shares in XYZ's Growth Fund. Which of the following is TRUE of this recommendation?

1.) This is considered switching and may only be done if a supervisor's permission is obtained 2.) Since the exchange is done within the same fund family, there are additional sales charges 3.) Since the exchange is done within the same fund family, there are no additional sales charges; however, it may be a taxable event 4.) Agents may recommend that clients switch from one fund to another to achieve higher commissions Explanation: Many fund families allow shareholders to exchange shares in one fund for shares of a different fund without incurring additional sales charges. However, if an exchange results in a capital gain, the gain is taxable.

What is the motivation behind setting up an UTMA account?

1.) To fund higher education 2.) To provide gifts to the child/owner 3.) For tax savings 4.) To reduce the estate of the donor Explanation: Due to the popularity of 529 plans, the effectiveness of custodian accounts has diminished. Any of the earnings that are generated in an UTMA are subject to taxation. The primary purpose for establishing a UTMA is to provide gifts of cash and/or securities for a child's future benefit.

According to the Uniform Securities Act, why must investment advisers record and file the holdings and transactions of their access persons?

1.) To properly maintain control over assets that are controlled by the investment adviser on behalf of its clients 2.) To ensure that investor returns are maximized 3.) To avoid conflicts of interest 4.) Prevent material, non-public information from being publicized Explanation: Access persons include officers, directors, and employees of an investment adviser who have access to and can exploit non-public information (e.g., client stock positions). In order to ensure access persons don't use information to exploit clients for their own benefits, both state and federal regulations require access persons to file transaction and holding reports. In these reports, access persons are required to disclose their personal investments and trades in order to avoid conflicts of interest.

An approach to investing that selects stocks based on a company's financial health, management team, product offerings, and then compares the market price of the stock to similar companies to determine if the company is undervalued is generally referred to as:

1.) Top-down investing 2.) Linear sequencing 3.) Bottom-up investing 4.) Horizontal modeling Explanation: The bottom-up analysis method examines stocks based on a variety of factors, including fiscal health, management team, competitive market position, and current and prospective future product offerings. The market price of the stock is then compared to similar companies to ascertain if the company is undervalued in the investor's mind.

What's the formula for calculating working capital?

1.) Total Debt/Total Equity 2.) Assets - Liabilities 3.) Current Assets - Current Liabilities 4.) Current Assets/Current Liabilities Explanation: A company calculates its working capital by taking Current Assets and subtracting Current Liabilities. Working capital measures liquidity, which is the short-term financial health of a company.

Regarding a company's financial statements, total assets are equal to:

1.) Total Liabilities + Stockholders' Equity 2.) Total Liabilities - Stockholders' Equity 3.) Total Liabilities + Stockholders' Equity - Depreciation 4.) Stockholders' Equity + Goodwill Explanation: The balance sheet formula is Total Assets = Total Liabilities + Stockholders' Equity. Total Assets is, therefore, equal to Total Liabilities + Stockholders' Equity.

Who pays the income taxes in a revocable trust?

1.) Trust 2.) Trustee 3.) Grantor 4.) Beneficiary Explanation: Revocable trusts can be amended or revoked by the creator (i.e., grantor) at any time. Since the grantor has control over the assets in the trust, any income generated by the trust during the grantor's life is taxable to the grantor.

Which of the following statements is TRUE regarding an individual who takes benefits from a retirement account that's been awarded under a QDRO?

1.) Withdrawals can be made without penalty, even if the individual is under the age of 59 1/2. 2.) Withdrawals can be made with a 10% penalty if the individual is under the age of 59 1/2. 3.) Withdrawals cannot be made until the individual is over the age of 59 1/2. 4.) Withdrawals can only be made five years after the QDRO was issued. Explanation: A qualified domestic relations order (QDRO) is created to divide a person's retirement account during a divorce. The spouse who receives benefits awarded under a QDRO is exempt from the early withdrawal penalties, but the withdrawals are taxable. The beneficiary can also roll her portion of the account into an IRA, thereby delaying withdrawals and taxes. QDROs are used for any ERISA qualified retirement account, including pensions, 403(b) plans, and 401(k) plans.

According to the Uniform Securities Act, if the Administrator revokes, denies, or suspends a registration, it would NOT be required to provide which of the following?

1.) Written findings of facts or conclusions 2.) Written prior notice 3.) All documents created by the Administrator's office regarding the action 4.) An opportunity for a hearing Explanation: Prior to revoking a registration, an Administrator is required to provide a registrant with a written notice, written findings of fact, and an opportunity for a hearing. However, the Administrator is not required to release every document created in the course of the investigation.

Janet has been married twice and earned more than each husband. Both marriages ended in divorce. Her first marriage lasted for 10 years, while her second marriage lasted for 12 years. Janet is now collecting Social Security. Are either of her ex-spouses eligible to collect Social Security based on Janet's work history?

1.) Yes, but only the first spouse. 2.) Yes, but only if each ex-spouse does not remarry. 3.) No, since neither spouse was married to Janet for longer than 15 years. 4.) Yes, but only if Janet does not remarry. Explanation: If a person is divorced, but his marriage lasted 10 years or longer, he is entitled to receive benefits on his ex-spouse's work history (even if she has remarried) provided: He is unmarried; He is age 62 or older; His ex-spouse is entitled to Social Security or disability benefits; and The benefit he is entitled to receive based on his own work history is less than the benefit he would receive based on his ex-spouse's work history