Series 65 Unit 2 Direct Participation Programs (DPPs)

Which of the following investments is least appropriate for a client primarily concerned with liquidity? A) Bank savings account. B) Direct participation program. C) Preferred stock. D) Municipal bond mutual fund.

Answer: B There is little secondary market liquidity for direct participation programs (DPPs); of those securities listed, they are the least appropriate for a client seeking liquidity.

All of the following are common to both DPPs and REITs EXCEPT: A) pass-through of losses. B) pass-through of income. C) centralized management. D) capital gains distributions.

Answer: A Both DPPs and REITS are professionally managed pools that pass through income and capital gains distributions to participants. REITS, unlike DPPs, do not pass through losses.

Investing in undeveloped land satisfies which of the following primary objectives? A) Tax-deferred income. B) Appreciation. C) Investment tax credits. D) Deductible interest expense.

Answer: B The primary reason to invest in raw land is the appreciation in value.

Flow-through is one of the features of A) REITs B) open-end investment companies C) direct participation plans D) variable annuities

Answer: C Flow-through is the term commonly used to describe that any income or loss generated by a direct participation program "flows through" to the owner(s). In the case of a REIT, the only thing that passes through is income or gains, never losses.

Which of the following must be considered in evaluating the suitability of a DPP investment for a customer? I. Risk tolerance. II. Other holdings. III. Financial situation. IV. Age. A) I and IV. B) II and III. C) I, II, III and IV. D) I and II.

Answer: C The key here is to recognize that with DPPs, the customer's age is a relevant consideration in determining suitability. DPPs are long-term, illiquid, and high-risk investments. It is unlikely that DPPs would be suitable for a customer near retirement age, regardless of the customer's financial situation.

An agent must obtain written verification of an investor's net worth for which of the following investments? A) Direct participation programs. B) Real estate investment trusts. C) Unit investment trusts. D) Variable contracts.

Answer: A DPPs require complete financial disclosure because of minimum suitability standards set by the states in which they are sold. REITs, unit investment trusts, and variable contracts do not have specific net worth suitability requirements for investors.

A client has told you that she has been reading in the financial press about something known as an "alternative investment". Which of the following would fit that description? I. Direct participation programs. II. ETFs. III. Hedge funds. IV. Preferred stock. A) III and IV. B) I and III. C) I and II. D) I, II and III.

Answer: B Although the term alternative investment may mean different things to different people, on your exam it will refer to DPPs and Hedge funds.

A REIT and a direct participation program are similar because they both: A) can be described as a limited partnership. B) are traded actively in the secondary market. C) are operated by a centralized management. D) pass through losses to investors.

Answer: C Both a REIT and a DPP are run by centralized management. A REIT may not pass through losses to its investors, and it is not a limited partnership. A DPP cannot be easily traded in the secondary market.

In discussing a direct participation program with your customer, rank the following items in order of importance from most to least. I. Tax write-offs. II. Liquidity and marketability. III. Potential for economic gain. A) III, II, I. B) III, I, II. C) I, II, III. D) II, III, I.

Answer: B A program's economic viability is the first priority in the assessment of DPPs. The IRS considers programs designed solely to generate tax benefits abusive. Because there is a very limited secondary market for DPPs, liquidity and marketability should be a low priority.

Which of the following statements is NOT true? A) An S corporation is a form of incorporation that is taxed as a partnership but in all other respects operates like a regular corporation. B) Limited partners actively manage the investments in the partnership but are not liable for funds in excess of the amounts they have invested. C) Members of a limited liability company (LLC) are not personally liable for debts that arise under the LLC. D) A sole proprietorship account is for tax and legal purposes indistinguishable from the business owner.

Answer: B Limited partners are passive investors in a partnership whose liability is limited to the amount of funds they have invested. They do not manage the funds in the partnership; the general partner has that responsibility. Owners, called members, are not personally liable for the debts that arise under an LLC. The LLC is a separate legal entity from its owners. A sole proprietorship account is the business account of an individual business owner and is handled in much the same way as an individual account. An S corporation is taxed as a partnership, although it operates like a regular corporation.

An investor in a high tax bracket who invested in a DPP should have which of the following characteristics? I. Need for tax benefits. II. Substantial liquid assets. III. Ability to identify both risks and merits of the program. IV. Ability to commit money for a long time. A) II and III. B) II, III and IV. C) I, II, III and IV. D) I and II.

Answer: C DPPs are appropriate for investors who can benefit from substantial tax deductions or credits, are not bothered by illiquidity, understand the business risks and benefits involved, and can stay in the program until completion.

In a limited partnership program, which partners manage the partnership's day-to-day operations and incur unlimited personal liability for the partnership's debts? A) The limited partners. B) Both the general partners and the limited partners. C) Neither the general partners nor the limited partners. D) The general partners.

Answer: D In a limited partnership, the general partners manage the day-to-day operations and incur unlimited personal liability. Limited partners invest money in the partnership and are liable for the partnership's debts only up to the amount invested. They are denied a voice in the management of the partnership.

Which of the following is NOT a feature in owning a limited partnership? A) An investment managed by others. B) Flow-through of income and expenses of a business to the individual limited partner. C) Legislative risk. D) Tax-free income.

Answer: D The income from limited partnerships is not tax exempt. An investor, however, may use a tax loss from a partnership to offset the income from another passive investment. In limited partnerships the investor enjoys the advantages and disadvantages of owning a business without having to actually manage one. Limited partnerships are vulnerable to legislative changes that adversely impact ownership of such investments.