Unit 17-Alternative Investments and Other Assets

Which of the following would NOT be considered an agricultural commodity? A)Soybeans B)Coffee C)Oats D)Aluminum

D)Aluminum Aluminum is traded as an industrial commodity; all of the others are agricultural.

The price of which of the following commodities is most likely to be impacted by weather? A)Orange juice B)Gold C)Livestock D)Lead

A)Orange juice If you ever saw the movie, Trading Places, with Eddie Murphy and Dan Aykroyd, you would certainly know that weather can have a major impact on the orange crop. Metals are not affected by heat or cold, or rain and snow. Years ago, before heated/air conditioned barns and other protective devices, livestock would freeze in a bad winter, but that is no longer much of an issue.

Investing in commodities could involve investing in any of these EXCEPT A)consumer durables B)industrial items C)agricultural items D)animals

A)consumer durables Commodity contracts are not available on consumer durables such as refrigerators and washing machines. They are available on agricultural items, such as corn, wheat, and soybeans. Likewise, investing in animal items such as cattle and pork bellies is possible. Finally, industrial items, primarily metals such as lead, zinc, and aluminum, are popular investments.

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)The general partners. C)Neither the general partners nor the limited partners. D)Both the general partners and the limited partners.

B)The general partners. 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.

A client wishing to invest in precious metals could consider each of the following EXCEPT A)silver B)platinum C)gold C)lead

C)lead Although it has always been the alchemist's dream to convert lead to gold, until that becomes a reality, lead is not considered a precious metal.

Real estate investing can be passive or active. An example of a passive real estate investment would be A)managing an apartment building B)renting out single family homes C)flipping homes D)a real estate limited partnership

D)a real estate limited partnership DPPs such as a real estate limited partnership offerings, are passive investments because the investor takes no part in the management or running of the enterprise. In each of the other choices, the investor must do some work.

One of your clients approaches you looking for an investment that will provide ready marketability and income. Which of the following would be the least appropriate recommendation? A)A money market mutual fund B)NYSE-listed preferred stock C)A limited partnership in rental real estate D)U.S. Treasury notes

C)A limited partnership in rental real estate The key is meeting both needs—marketability and income—and each of them supply both except the limited partnership. The client could expect income from a DPP investing in rental real estate, but the liquidity is missing.

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

B)direct participation plans 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.

For a customer interested in buying an inverse exchange-traded fund (ETF) tracking the performance of the Standard & Poor's 500 Index, which of the following market views would make that purchase most inappropriate? A)Bearish B)Bullish or bearish C)Bullish D)Neutral

C)Bullish Inverse (reverse) ETFs are designed to deliver returns that are opposite of the benchmark index they are tracking. Therefore, buying an inverse ETF that tracks the S&P 500 Index at a time when the market outlook is bullish would be most inappropriate. If the index rises with the anticipated bullish market, the fund that delivers returns that are the opposite of the index would fall in value.

A high net worth client of yours invested $250,000 into an oil and gas limited partnership drilling program for which she received a 10% interest in the project. Unfortunately, after 2 years of drilling without success, the project was foreclosed with outstanding debt of $4 million. Your client is liable to the partnership's creditors for A)$400,000 B)$250,000 C)$150,000 D)$0

D)$0 One of the benefits of being a limited partner is that the most you can lose is your investment. Just as it would for a stockholder in a corporation, the concept of limited liability applies. You can lose your entire investment, but you have no liability for debts of the business. This question describes a DPP that has gone bankrupt (liabilities exceed the assets) and wants to know the share of the $4 million in outstanding debt that is the responsibility of this investor. Even though she owns 10% of the partnership, as a limited partner, she has no liability for any of that debt.

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

A)there are circumstances under which losses from active real estate investing can be deducted against ordinary income 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.

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

B)investing in futures contracts 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.

Your client has heard about investment opportunities in life settlements. Among the risks involved with this investment is A)the insured may live well past the expected mortality date B)the insured may change the beneficiary without notifying the investor 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

A)the insured may live well past the expected mortality date 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).

Your customer is asking if either exchange-traded funds (ETFs) or exchange-traded notes (ETNs) might be suitable investments for his portfolio. The customer makes several statements regarding his understanding of the products, but only one of them is accurate. Which is it? A)ETFs have a fixed coupon rate that I should expect to realize when they mature. B)ETNs are equity securities because they trade on exchanges. C)ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer. D)If I want to sell my shares of an ETF, I have to wait until the next price is calculated to value the portfolio of securities.

C)ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer. The only accurate statement is the one expressing that ETNs are issued by financial institutions and, therefore, the credit worthiness of the issuer should be a concerning factor. ETNs are debt instruments, not equity instruments. ETNs have a final payment at maturity based on the return of a single stock, a basket of stocks, or an equity index. While ETF prices fluctuate based on the value of the securities within the fund portfolio throughout the trading day, they are priced by supply and demand, like all exchange-traded products. They are not forward priced like open-end mutual fund shares are.

A client was reading an offering document for an oil and gas drilling limited partnership program and noticed that one of the features was flow-through benefits. How would you explain this? A)Investors in the program are assured of a steady flow of income if the drilling is successful. B)Once the program has paid taxes on its income, the entire remaining balance passes through to the investors. C)Rather than being a separate taxable entity, the program's income or losses pass through directly to the investors. D)Losses generated by the program pass through to the investor and may be deducted in full against ordinary income.

C)Rather than being a separate taxable entity, the program's income or losses pass through directly to the investors. The philosophy behind flow-through is that any income or losses generated by a program of this type (DPP) flow directly to the investors—there is no tax at the entity level. If there are losses, they may only be deducted against passive income (e.g., income from other partnerships). No assurances can ever be given.

Although the terms are frequently used synonymously, historically, viatical settlements differed from life settlements in that A)the buyer of the viatical policy did not know the identity of the seller B)the buyer of the viatical policy was someone who was terminally ill C)the seller of the viatical policy was someone who was terminally ill D)the seller of the viatical policy was someone with a life expectancy of up to 15 years

C)the seller of the viatical policy was someone who was terminally ill Viatical settlements came of age during the AIDs crisis of the 1980s. They provide cash in exchange for the sale of a life insurance policy to those who were racking up substantial medical bills and had a short (generally less than 2 years) life expectancy. As medical advances changed the "death sentence" for an AIDS diagnosis (and many cancers as well), the life settlement became the more popular option when the policy owner was healthy but had reached an age (generally at least 70), and the need for life insurance was not as important as having the cash for personal use.

Your customer is interested in a leveraged fund and makes the following statements about leveraged funds to you. All of the statements regarding leveraged funds are true EXCEPT A)some leveraged funds are exchange-traded products B)the funds attempt to return a multiple of the return of a benchmark index they are tracking, perhaps 2 or 3 times C)there are no unusual risks associated with these funds other than those one would incur with any index tracking fund D)these funds sometimes use derivatives products to achieve their stated goals

C)there are no unusual risks associated with these funds other than those one would incur with any index tracking fund Because the fund objective is to achieve returns that are a multiple of the returns of the benchmark index, the result could be a multiple of any loss incurred by the benchmark index as well. In addition, because these funds utilize derivatives products to achieve their stated objectives, they may not be suitable for anyone that derivatives products are not suitable for, given the additional risks associated with those products.

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

D)Tax-free income 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.