Comprehensive practice exam

Plymouth Standard's common stock has an average return of 12%; its returns fall within a range of -2% to +26% approximately 68% of the time. Which one of the following numbers is closest to the standard deviation of returns of Plymouth Standard's stock? A) 14% B) 19% C) 28% D) 8%

A) 14% A standard deviation of 14% means an investor can expect a return on an investment to vary ±14% from the average return approximately 68% of the time. A return of +26% minus the 12% average return equals 14%. Likewise, the difference between the -2% return and the average of 12% is also 14%. LO 20.f

Which of the following forms of joint ownership is most associated with ownership of real estate? A) Tenancy by the entirety B) Tenants in common C) Joint tenants with right of survivorship D) Totten trust

A) Tenancy by the entirety

A balance sheet shows that a corporation builds its capital structure with all of the following except A) cash. B) long-term debt. C) retained earnings. D) capital stock.

A) cash. A corporation's capital structure consists of the capital raised through the issuance of long-term debt securities (bonds), equity securities (stocks), and money reinvested in the business (retained earnings). LO 7.a

A broker-dealer with no place of business in a state is not required to be registered in that state if the broker-dealer A) limits its clientele to employee benefit plans with assets of at least $1 million. B) is a member of the New York Stock Exchange. C) is a federal covered broker-dealer. D) is registered in the state where its principal office is locate

A) limits its clientele to employee benefit plans with assets of at least $1 million. A broker-dealer must be registered in every state in which it sells or offers to sell securities unless an exemption is available. If a broker-dealer has no office in a particular state and no business is done in that state other than with institutional clients, registration there is not required. There is no such term as federal covered broker-dealer. The term federal covered applies to certain investment advisers and securities. LO 11.b

LMN, Inc., is preparing to report its net income for the past year. An increase in which of the following would not cause a decrease in the reported net income? A) Year-end bonuses to employees B) Cash dividends C) Allowance for bad debts D) Corporate income tax rate increase

B) Cash dividends Cash dividends are paid out of the company's net income, so an increase or decrease will not impact that net income. Net income is a calculation determined by current operations, so an increase in the amount set aside as an allowance for bad debts will reduce operating income. Because net income is always after taxes, raising the company's income tax rate will obviously decrease the net income of the corporation. One of the major expenses for most corporations is labor, so any increase (whether in the form of raises or bonuses) will decrease the net income. LO 7.c

As defined in the Uniform Securities Act (USA), the term person would include which of the following? A limited partnership A political subdivision An unincorporated association The executor of an estate for a deceased individual A) I and IV B) I, II, III, and IV C) II and III D) I, II, and III

B) I, II, III, and IV All of these would be included in the USA's definition of person. Not included are a minor, a deceased person, or someone judged as mentally incompetent. LO 9.a

In order to come under the SEC's requirement to file a Form 13F, an institutional manager must have discretion over A) an equity portfolio of at least $50 million in 13(f) securities. B) an equity portfolio of at least $100 million in 13(f) securities. C) more than 10% of the outstanding voting securities of a reporting company. D) an equity portfolio of at least $100 million.

B) an equity portfolio of at least $100 million in 13(f) securities. Form 13F must be filed by institutional money managers with at least $100 million in 13(f) equity securities under discretionary management. LO 14.h

The discounted rate that equates a bond's cash flow to its current price is known as the bond's A) current yield. B) duration. C) yield to maturity. D) coupon rate.

C) yield to maturity. The yield to maturity of a bond considers the accretion of any discount or amortization of any premium as well as the annual coupon rate, taking into consideration the time value of money. LO 20.c

Which of the following is the primary advantage to the employer who offers a nonqualified plan when compared to one that offers a qualified plan? A) The qualified plan is permitted to discriminate in favor of key employees. B) The qualified plan costs less to administer than the nonqualified plan. C) The nonqualified plan allows for an immediate employer deduction for contributions. D) The nonqualified plan is permitted to discriminate in favor of highly compensated employees.

D) The nonqualified plan is permitted to discriminate in favor of highly compensated employees. Unlike a qualified plan, a nonqualified plan is permitted to discriminate in favor of highly compensated employees. Because so few regulations are involved, the administrative costs of a nonqualified plan are much lower than those for a qualified plan. The nonqualified plan, typically deferred compensation, allows for a tax deduction when the money is ultimately paid out to the employee or beneficiary. LO 18.e

Under the provisions of Regulation SP, a person who has an investment advisory contract with a registered investment adviser is known as A) a consumer. B) a client. C) a cohort. D) a customer.

D) a customer. Regulation SP uses two terms: customer and consumer. The customer is one with an ongoing relationship, such as would be the case with an advisory contract. A consumer is basically a one-shot deal. LO 14.l

Section 15 - Among those requirements is that A) the initial contract is for a maximum of one year and then may be renewed on either an annual or a biannual basis. B) the fund may not engage in margin trading unless a specific exemption applies. C) the contract should be in writing. D) no contract may be terminated with more than 60 days' written notice.

D) no contract may be terminated with more than 60 days' written notice. Contracts between funds and their advisers may not be terminated with more than 60 days' written notice, and these contracts must—not should—be in writing. The initial contract is for a two-year period after which the contract is renewed on an annual basis. Whether or not the fund can trade on margin is not a function of the management contract. LO 3.a

What is the definition of small cap, mid cap, and large cap?

Small cap - $300M - $2B Mid cap - $2B - $10B Large cap - $10B +

Current market interest rates are 6%. Using the discounted cash flow method of valuation, you would expect to arrive at the highest valuation for which of the following? A) 10% coupon maturing in 10 years B) 5% coupon maturing in 20 years C) Zero-coupon bond maturing in 11 years D) 7% coupon maturing in 9 years

A) 10% coupon maturing in 10 years The discounted cash flow method considers the future expected free cash flow (the interest payments plus the eventual return of the principal) and discounts it to arrive at a present value. In its simplest iteration, this is nothing more than taking all the money you are scheduled to receive over a given future period and adjusting that for the time value of money. In general, bonds with higher coupons will have the greatest value because they will clearly produce the most cash flow, and zero-coupon bonds will produce the lowest because they have no cash flow other than the return of the face value at maturity. LO 20.c

Which of the following bonds would most likely be exposed to the greatest amount of interest rate risk? A) ABC 5s of 2050 B) DEF 6s of 2051 C) GHI 7s of 2052 D) JKL 4s of 2022

A) ABC 5s of 2050 The bond with the longest duration is generally going to have the greatest exposure to interest rate risk. Because there is very little difference between maturity dates of 2050 through 2052, the bond with the lowest coupon will have the longest duration. The 4s of 2022 have a relatively short duration, even though their coupon is low. LO 20.b

Which of the following clients of a federal covered investment adviser are not exempt from the delivery requirements of the brochure rule? A) An individual investor purchasing the investment adviser's newsletter with an annual subscription price of $410 B) An employee benefit plan with assets of at least $5 million C) A closed-end investment company traded on the New York Stock Exchange D) An open-end investment company with less than $25 million in assets

A) An individual investor purchasing the investment adviser's newsletter with an annual subscription price of $410 The only exemptions from the investment adviser brochure rule are registered investment companies (both open- and closed-end) and impersonal advice costing less than $500 per year. LO 13.g

It would be reasonable to expect an increase in exports from the U.S. if which of the following happen? The dollar strengthened against the euro. The yen strengthened against the dollar. The Swiss franc weakened against the dollar. The dollar weakened against the British pound. A) I and III B) I and II C) II and IV D) III and IV

A) I and III U.S. exports should increase when foreigners have greater purchasing power. That occurs when their currency is stronger than the dollar. LO 6.c

Initial and renewal contracts between investment advisers and their clients must be in writing when the contract is under the jurisdiction of which of the following? The Securities Exchange Act of 1934 The Investment Company Act of 1940 The Investment Advisers Act of 1940 The Uniform Securities Act A) II and IV B) II, III, and IV C) I and III D) I, II, and III

A) II and IV The requirement for written advisory contracts is found in both the Investment Company Act of 1940 for those advising registered investment companies and the Uniform Securities Act for state-registered advisers. Oddly, there is no mention made of this requirement in the Investment Advisers Act of 1940. Sure, it makes good sense, but it is not required. Nothing in the Securities Exchange Act of 1934 relates to investment advisers, much less their contracts with clients.

Which of the following are reasons an investor might purchase an ETF tracking a broad market index instead of selecting individual securities? A) It is the best way to be fully diversified against unsystematic risk. B) Historically, a broad-based index offers greater potential for abnormal gains than that offered by the purchasing of individual securities. C) It is a simple way to hedge the investor's existing stock portfolio against a market decline. D) It reduces the level of systematic risk

A) It is the best way to be fully diversified against unsystematic risk. Buying an exchange-traded fund (ETF) that tracks a broad-based index avoids the risk associated with any one company (business risk). A disadvantage of investing in a broad-based index is that it virtually eliminates the opportunity for outsized gains. The performance of one or two highfliers is subsumed by the large portfolio. If one wants to hedge, you take the opposite position. Buying an index ETF or fund is essentially doubling down on the bullish bet the investor has already made. Diversification reduces unsystematic risk, not systematic risk. LO 19.b

One of the purposes of filing the annual updating amendment to the Form ADV Part 1A is to A) verify that the investment adviser still qualifies for SEC registration. B) provide updated information on those associated persons who are in charge of giving investment advice. C) disclose the amount and location of securities or funds of clients that are being held by the adviser or a qualified custodian. D) ensure that full disclosure has been made in the adviser's brochure.

A) verify that the investment adviser still qualifies for SEC registration. In order to maintain SEC registration, an investment adviser must maintain assets under management of no less than $90 million. The annual updating amendment is used to disclose this information. LO 9.e

A technical analyst who has been charting the common stock of Kloud Information Storage Systems (KISS) would most likely sell KISS stock short when the market price of the stock is A) just above the support level. B) below the support level. C) above the resistance level. D) just below the resistance level.

B) below the support level. The support level of a stock is the historic repeating bottom. That is, whenever the stock gets that low, it brings out the buyers and pushes the price up. However, when a stock breaks through the support level, it is usually an indication that the support has dried up and there is going to be further decline. That is good for the short seller. LO 21.d

One respect in which advertising by investment advisers differs from that of broker-dealers is that A) investment advisers are not permitted to use the internet while broker-dealers can. B) investment adviser advertising is regulated by federal law while advertising by broker-dealers is regulated by FINRA. C) investment advisers are permitted to conduct seminars while broker-dealers cannot. D) investment advisers are permitted to refer to charting systems in their advertisements while broker-dea

B) investment adviser advertising is regulated by federal law while advertising by broker-dealers is regulated by FINRA. When it comes to investment advisers, state registered or federal covered, any advertisement that does not comply with the SEC's Investment Adviser Marketing Rule as found in the Investment Advisers Act of 1940 (federal law) would be prohibited. On the other hand, broker-dealers must comply with FINRA's rule on communication with the public as well as the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents. LO 13.i

Which of the following statements regarding REITs are true? Equity REITs offer possible income and capital appreciation. Investors receive interest and principal payments periodically. In order to receive favorable tax benefits, the REIT must pay out at least 90% of its taxable income in the form of dividends. Interests in REITs offer the benefit of flow-through of income or loss. A) II and III B) I and IV C) I and III D) II and IV

C) I and III REITs are pooled tangible real estate assets. Owning an equity REIT gives the investor beneficial ownership of tangible real estate with the possibility of both income and capital appreciation. Most REITs trade in the open market, and their price is determined by supply and demand; there is no redemption by the issuer. REITs pay distributions in the form of dividends and not a pass-through of principal and interest, as is the case with a mortgage-backed security, such as those issued by GNMA. Although REITs pass-through at least 90% of their taxable income, there is no flow-through of losses as is the case with direct participation programs (DPPs). LO 3.g

The issuance of new common stock will affect which of the following balance sheet items? Total assets Current liabilities Retained earnings Net worth A) I and III B) II and III C) I and IV D) II and IV

C) I and IV Issuing stock brings in new capital in the form of cash. This raises the assets and, since stock is equity, raises the net worth by the same amount. LO 7.b

Which of the following activities might result in a positive yield curve in the bond market? A) A parallel downward shift in interest rates B) A parallel upward shift in interest rates C) Investors buying short-term bonds and selling long-term bonds D) Investors buying long-term bonds and selling short-term bonds

C) Investors buying short-term bonds and selling long-term bonds A positive yield curve is the normal condition and occurs when long-term rates are higher than short-term rates. Buying short-term bonds tends to drive their prices up and their yields down, while selling long-term bonds has the opposite effect. LO 6.b

If a portfolio manager wished to reduce inflation risk, which of the following would be most appropriate to add to the portfolio? A) Fixed annuities B) Preferred stock C) Tangible assets D) AAA bonds

C) Tangible assets Tangible assets—such as real estate, precious metals, and other commodities—tend to keep pace with inflation. Fixed-dollar investments do not. LO 21.a

All of the following would decrease the U.S. balance of payments deficit except A) a decrease in imports of foreign goods into the U.S. B) a decrease in dividend payments by U.S. companies to foreign investors. C) a decrease in purchases of U.S. securities by foreign investors. D) an increase in exports of domestic goods from the U.S.

C) a decrease in purchases of U.S. securities by foreign investors. Anything that brings foreign money to the U.S. will decrease the balance of payments. Foreign investors pulling their money out of the U.S. or investing less in the U.S. will increase the deficit. LO 6.c

One of the major goals of most hedge funds is to A) generate higher fees for their advisers. B) generate liberal tax write-offs for their investors. C) use long and short strategies to provide a stable return in both up and down markets. D) appeal to the sophisticated investor.

C) use long and short strategies to provide a stable return in both up and down markets. Hedge funds are known for using speculative strategies such as selling short and margin trading. The reasoning behind such strategies is to enable the fund to perform well in both bull and bear markets. Although they do appeal to the sophisticated investor, that is a by-product, not a goal. Yes, the management fees are higher than with other investments, but that is the goal of the adviser, not the fund. LO 3.e

One of your customers purchased a TIPS bond three years ago. The bond's nominal yield is 4%, and inflation has averaged 6% over the holding period. The interest payment at the end of the three years would be closest to A) $47.76. B) $21.60. C) $33.78. D) $23.88.

D) $23.88. With a TIPS bond, the principal is adjusted every six months by the inflation rate. When that rate is 6%, there is a 3% semiannual adjustment. Multiplying the $1,000 par value times 103% six times (there are six semiannual adjustments in three years) results in a principal value just over $1,194. Because the 4% coupon rate is paid semiannually, the payment at the end of three years will be the adjusted principal of $1,194 times 2%, and that equals $23.88. For testing purposes, you can always arrive at the correct answer by using simple interest instead of compounded interest. That is, with a 6% annual inflation rate, the bond's principal will increase by $60 per year for three years. That would make the adjusted principal $1,180. Take 2% of that, and the result is $23.60. The correct answer will always be the next greater number.

An investor has many tax preference items. Computing the investor's income tax using the regular method results in a tax burden of $29,200 while computing the alternative minimum tax (AMT) results in a tax liability of $27,500. Based on this information, the investor's income tax liability for the year is A) $30,900. B) $56,700. C) $27,500. D) $29,200.

D) $29,200. To determine if you owe AMT, you compute both your regular tax and your AMT and pay whichever is the higher amount. The IRS has an unusual way of stating this. It says that the AMT is the regular tax plus the amount by which the AMT exceeds the regular tax. So if the AMT computation shows a lower amount than the regular tax, the regular tax is the liability. LO 15.d

A company with no operations that is formed to raise capital through an initial public offering for the purpose of acquiring a private company or business to be identified after the IPO is A) a direct participation program. B) a sponsored investment company. C) an open-end investment company. D) a special purpose acquisition company.

D) a special purpose acquisition company. Special purpose acquisition companies (SPACs) are usually shell companies. Rule 405 of the Securities Act of 1933 (not tested) defines a shell company as a registrant that has no or nominal operations and assets. The SPAC has an initial public offering and, under the direction of the SPAC's sponsor, determines the private company or companies to be acquired. If the acquisition is successful, the formerly private company is now publicly owned and investors can buy and sell interest in the company through shares of the SPAC. LO 8.a