Unit 17: Alternative Investments

What are the 4 types of alternative investments?

1. Real Assets 2. Hedge Funds 3. Private Equity 4. Structured Products

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

A- 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.

Which of the following most accurately identifies a private equity investment in income-producing real estate? A) Investment in a real estate investment trust (REIT) B) Direct ownership of real estate properties C) Investment in a real estate mutual fund D) Private market mortgage lending by an insurance company

B

Your client has heard about investment opportunities in life settlements. Among the risks involved with this investment is A) the insured may change the beneficiary without notifying the investor B) the insured may live well past the expected mortality date C) the insurance company may not have the funds to pay the death benefit D) the insured may cease paying premiums, leading to a policy lapse

B- Although it is always possible that the insurance company could default, that is so rare, it is not usually a consideration. Life settlements are priced based on providing a stated return assuming normal mortality. If the insured lives far past that, the rate of return to the investor goes way down. The insured does not pay the premiums (the investor does) and the insured no longer has the rights to change the beneficiary (the investor does).

A 75-year-old customer asks if it is possible to sell his $500,000 variable life insurance policy to a party other than the insurance company that issued the policy. If a sale occurs, known as a life settlement, which of the following would be a violation of industry rules? A) Not requiring the insured to pass a physical exam before the sale B) Requiring the customer to relinquish all ownership rights to the policy C) Quoting the price using an exclusive buyer that handles all the firm's life settlements D) Disclosing that the buyer becomes responsible for all premiums while the insured is living

C- Because of the limited secondary market for life settlements, any firm that engages in these transactions should obtain several bids to ensure the customer receives a fair price for her policy.

In general, an investor wishing to gain economic exposure to commodities would find it easiest to do so by A) growing the commodity B) buying the commodity directly C) investing in forwards contracts D) investing in futures contracts

D- It is generally agreed that using commodity futures is the easiest and most common way to gain economic exposure to commodities. Forwards are more commonly used by producers or users because, unlike futures, most forward contracts result in the delivery of the actual commodity. Only about 1% of all futures contract positions involve the delivery of the underlying commodity.

leveraged ETFs

Seek to deliver multiples of the performance of the index or benchmark they track.

what's the maximum loss in a limited partnership?

amount invested plus funds committed for

structured note with principal protection

any structured product that combines a bond with a derivative component and offers a full or partial return of principal at maturity

what's the main risk of ETN's?

credit risk because unsecured debt of issuer

what foreign market risk do commodities have?

currency and political

Private equity investment in real estate refers to what?

direct ownership of real estate properties

structured products improve what?

market completeness

In discussing a direct participation program with your customer, rank the following items in order of importance from most to least. 1. Tax write-offs 2. Liquidity and marketability 3. Potential for economic gain

3, 1, 2 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.

One way in which active and passive real estate investing differ is that A) only real estate professionals can deduct losses from active real estate investing. B) there are circumstances under which losses from active real estate investing can be deducted against ordinary income C) there are circumstances under which losses from passive real estate investing can be deducted against ordinary income D) losses from active real estate investing can only be deducted against income from other active investing projects

B!! There are certain conditions under which active real estate investors can deduct as much as $25,000 in losses from ordinary income. Those conditions are likely to be far more complex than the exam will delve, but it can be important to know that this is possible. Passive real estate losses can only be deducted against passive income.

private debt

Mortgage lending by banks or insurance companies

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

Note** limited assets means not a lot of money D- The question describes an individual with a low risk tolerance, so the Treasury bonds and CDs would certainly be considered appropriate. Because ETNs are a debt security backed solely by a single issuer while an ETF based on a specific index of debt securities represents a large group of issuers, they are only suitable for those who can understand and take the risks involved.

what are the returns of ETN's linked to?

market-index or benchmark

do limited partnerships pay dividends?

no, they flow through income, gains, losses, deductions, and creditors directly to the investor

what's the main benefit of investing in commodities?

potential hedge against inflation

what investment is the best for a hedge against inflation?

precious metals (gold)

Indirect ownership of real estate through equity securities such as REITs is an example of

publicly traded equity