CSC 2: Practice Exam 2
42. How much earned income must you have in the current year to contribute to a Tax-Free Savings Account (TFSA)?
Answer: $0 You don't have to have earned any income in the preceding or current year to be able to contribute to a TFSA. The money you contribute can come from a tax refund, a bequest, savings, a gift, or earnings from employment or business.
78. An investor in a 40% tax bracket contributes 5,000 shares of ABC stock from his non-registered account to his RRSP. The adjusted cost base of the securities is $10,000, and the current market value is $15,000. Calculate the tax owing as a result of the transaction? Ignore the tax benefit of the RRSP contribution itself.
Answer: $1,000 A planholder may contribute securities already owned to an RRSP. According to the CRA, this contribution is considered to be a deemed disposition at the time the contribution is made. Consequently, to calculate the capital gain or loss, the planholder must use the fair market value of the securities at the time of contribution as the proceeds from disposition. Any resulting capital gain is included in income tax for the year of contribution. In this example, the taxable capital gain would be 50% x (15,000-10,000) = $2,500, with a tax owing of $2,500 x 40% tax rate = $1,000.
74. A mutual fund investor sold his holdings at a net asset value per share (NAVPS) of $11.00. Calculate the selling/redemption price per share if the investor is charged a redemption fee of 2% based on the NAVPS at the time of redemption.
Answer: $10.78 11 - ( 11 X 2%) = $ 10.78.
71. Matt purchases 300 shares of XYZ at $20 on September of Year 1; 200 more shares of XYZ at $22 in February of Year 2; and 400 more shares at $25 of XYZ in August of Year 2. He sells 300 shares in October of Year 2 at $30, and all of the remaining shares in January of Year 3 at $29. Calculate the approximate adjusted cost base of the shares sold in Year 3? Ignore all additional trading costs and commissions.
Answer: $13,600 The first group of shares have a cost base of (300 x 20=$6,000). The second group have a cost base of (200 x 22 = $4,400). The final group has a cost base of (400 x 25 = $10,000). The total cost base is $6,000+$4,400+$10,000=$20,400. The average cost per share is $20,400 / 900 = $22.67. Following the sale in October, 600 shares remain, with a cost base of (22.67 x 600) = $13,600.
96. What approximate amount of federal tax is payable on a $1,000 dividend received from a Canadian company if the investor is in a 26% federal tax bracket?
Answer: $152 Federal tax is calculated on the grossed-up amount of dividends received ($1,000 × 1.38). The tax payable is then reduced by the amount of the dividend tax credit or ($1,380 × 0.1502). In this example, the federal tax is 0.26 × ($1,000 × 1.38) = $358.80. The dividend tax credit is ($1,380 × 0.1502) = $207.28. The federal tax payable is ($358.80 - $207.28) = $151.52.
83. An investor sets up a mutual fund ratio withdrawal plan that will pay him 10% of the end-of-year value of his mutual funds. At the beginning of this year, his mutual fund portfolio is worth $150,000. At the end of this year, his portfolio increased by 15%. Calculate the amount the investor will receive from his ratio withdrawal plan at the end of this year (assume no deferred sales charges apply).
Answer: $17,250 Value of portfolio at the end-of-year= 150,000 X 115% = 172,500 Amount received at the end of this year= 172,500 X 10% = $ 17,250.
8. CCK stock closed at the following prices during the course of the last trading week: Monday - $15.50 Tuesday - $18.00 Wednesday - $18.25 Thursday - $17.50 Friday - $17.75 What is CCK's 5-day moving average as of the close of trading on Friday?
Answer: $17.40 A moving average is simply the sum of the closing prices divided by the number of closing prices. In this case, the closing prices for the five trading days sum to $87
94. An investor with a life expectancy-adjusted withdrawal fund has an actuarially determined life expectancy of 85 years. She begins the plan at age 70. Determine the amount she can withdraw in Year 3, assuming that all withdrawals are done at the beginning of the year and the fund had a value at the end of Year 2 of $560,000.
Answer: $43,076.92 The amount withdrawn on each occurrence is based on periods of time, which are continually readjusted to the changing life expectancy of the plan holder, taken from mortality tables. Thus, the amounts withdrawn vary in relation to the amount of capital remaining in the plan and the plan holder's revised life expectancy. In this example, the investor would receive a withdrawal of $560,000/[85 - (70 + (3 - 1))] = $43,076.92.
14. Based on the dividend discount model, what is the approximate intrinsic value of Glacier Energy if its expected dividend in one year is $1.20, the discount rate is 6.30%, and its long-term growth is expected to be continuous at 3.60%?
Answer: $44.44 The formula is Price = Div1 / (r-g). Div1 is the expected dividend paid out by the company in one year, r is the required rate of return on investments, and g is the assumed constant growth rate for dividends. Therefore, the price or intrinsic value of Glacier Energy = $1.20 / (.0630 - .0360) which equals $44.44
20. An investor purchased $50,000 of a segregated fund with a 100% guaranteed death benefit and a 75% maturity guarantee. Nine years later, the investor died when the market value of the fund was $45,000. Assuming that no deposits, withdrawals, or resets have been made, calculate the amount of death benefit the beneficiary will receive.
Answer: $5,000 The amount of the death benefit is equal to the difference, if any, between the guaranteed amount and the net asset value of the fund at death. $50,000 - $45,000 = $5,000.
1. Calculate what forecast might be made for the share price of BIB Inc. if projected earnings are $4 per share and the company has historically traded at a P/E of 20 during similar economic periods, which is similar to the P/E of BIB's industry.
Answer: $80 The P/E can be used to forecast a future price of a stock. In this example, if BIB has traded at a P/E ratio of about 20 during a similar economic period, further confirmed by the P/E of the industry, and the company should earn $4.00 per share over the next year, the stock should be priced at $80 ($4 × 20 = $80).
4. Your research department has provided you with a Return Expectation of the Major Asset Classes as follows: Cash and equivalents: in= 2.75% Max 4.25% Fixed-Income: Min= 2.2% Max 8.75% Equities: Min= -10% Max 4.25% Your client has a $200,000 portfolio, invested 10% in cash, 25% in fixed-income and 65% in equities. What is the minimum and maximum expected percentage return on his portfolio?
Answer: -5.7% to 18.9% First, you must determine the amount attributable to each of the asset classes. 10% = 20,000; 25% = $50,000; 65% = $130,000. The minimum and maximum expected return for each class would be: Cash- $20,000 (Min=2.75%=$550) (Max=4.25%=$850) Fixed Income- $50,000 (Min:2.25%=$1,125) (Max:8.75%=$4,375) Equities- $130,000 (Min:-10%=$13,000) (Max: 25%=$32,500) Total Min= -$11,325 Total Max= $37,735 Percentage: Min=-5.7% Max= 18.9%
86. What portfolio beta would generally be considered most appropriate during a recession for Barry, age 75, widowed, retired on a fixed monthly income, and in a low tax bracket?
Answer: 0.9 The beta or beta coefficient relates the volatility of a single security to the volatility of the stock market as a whole. Defensive industries tend to have betas that are less than the market, that is, less than 1. This implies that when the market is falling in price, a defensive stock would normally fall relatively less and a cyclical stock relatively more. As Barry is considered an investor that should be reasonably risk-averse due to his financial circumstances, the lower-beta portfolio would be most appropriate, and the higher-beta portfolios would be inappropriate.
55. If you wanted in-depth and current information on your investment, which investment vehicles should you avoid? 1.Hedge funds. 2.Principal protected notes. 3.Open-end mutual funds. 4.Exchange-traded funds.
Answer: 1 and 2 As hedge funds are generally offered as private placements, they are not required by securities laws to provide the comprehensive initial and ongoing information associated with securities offered through a prospectus. This lack of transparency may create a situation in which hedge fund investors may not always know how their money is being invested. The complexity of PPNs comes at the expense of transparency. For example, the current fair value of a PPN is a "black box" - there is no formula or method for an advisor or investor to even determine what the fair value of PPN is at any given time
87. What would happen if a firm increased its current liabilities while keeping all other financial metrics constant? 1.Decrease the quick ratio. 2.Increase the debt/equity ratio. 3.Decrease the asset coverage ratio. 4.Increase the working capital ratio.
Answer: 1 and 3 In the formula for asset coverage, current liabilities is subtracted from the numerator. In the quick ratio, increasing current liabilities would decrease the ratio. Current liabilities do not factor in the other 2 ratios.
73. Select the correct statements about the management expense ratio (MER) of a mutual fund. 1.The MER represents the total of all management fees and other expenses charged to a fund. 2.The MER is expressed as a percentage of the fund's weekly average net asset value. 3.Trading or brokerage costs are excluded from the MER calculation. 4.Published rates of return are calculated before deducting the management expense ratio.
Answer: 1 and 3 The MER is the total annual cost of running a fund. The MER includes the management fees that are paid annually to the fund manager.
80. What are the best ways to evaluate the performance of a portfolio manager? 1.Compare the portfolio's total rate of return against a benchmark portfolio. 2.Compare the portfolio's performance against the economy's performance over the same period. 3.Compare the portfolio's total rate of return with the average total return of comparable portfolios. 4.Determine how much non-systematic risk was reduced in the portfolio.
Answer: 1 and 3 The success of a portfolio manager is determined by comparing the total rate of return of the portfolio being evaluated with the average total return of comparable portfolios. In this way, the portfolio manager and the client can compare their returns to industry norms and estimate their approximate ranking in relation to other portfolio managers. Another method is to measure portfolio performance against a predetermined benchmark that was specified in the investment policy statement. One common benchmark is the T-bill rate plus some sort of performance benchmark, perhaps the T-bill rate plus 4%.
69. A hedge fund has a hurdle rate of 4% and an annual return of 18%. Calculate the percentage of the annual return upon which the fund manager's incentive fee is based.
Answer: 14% A hurdle rate is the rate that a hedge fund must earn before its manager is paid an incentive fee. In this example, if a fund has a hurdle rate of 4%, and the fund earns 18% for the year, incentive fees will be based only on the 14% return above the hurdle rate, subject to any high-water mark.
62. The economy is moving into the late expansion phase of the equity cycle and the Bank of Canada is beginning to tighten monetary policy. What investment strategy would best take advantage of this phase of the equity cycle? 1.Buy long-term bonds. 2.Reduce exposure to common stocks. 3.Increase exposure to cyclical stocks. 4.Buy short-term interest-bearing paper.
Answer: 2 and 4 Recommendation for late expansion phase is to reduce common stocks exposure and invest in short-term interest-bearing paper. The equity cycle peak is generally followed by the contraction phase.
67. Which of the following statements are correct about investment risk? 1.Systematic risk is also known as specific risk. 2.Non-systematic risk can be eliminated through diversification. 3.Systematic risk is the risk that the price of a security will change in price in a different direction from the market. 4.The more a portfolio becomes diversified, the more it ends up mirroring that market.
Answer: 2 and 4 While non-systematic risk, also known as specific risk, can be eliminated by diversification, systematic risk is always present and cannot be eliminated. Systematic risk stems from such things as inflation and high interest rates
54. The most recent 1-week performance period of XYZ Money Market Fund appears in the following table: Fund: XYZ Money Market Current Yield - 2.06 Effective Yield - 2.10 Change from Previous Day - -.02 Change from Previous Week - -.03 Based on the information provided, what is XYZ's annualized rate of return?
Answer: 2.06% The performance of money market funds is presented somewhat differently. Because of the relatively fixed NAVPS that these funds maintain, business newspapers do not bother to report the NAVPS, but rather report each fund's current and effective yield. The current yield reports the rate of return on the fund over the most recent seven-day period expressed as an annualized percentage.
72. Generally speaking, which risk does an investor holding a well-diversified portfolio of Canadian equities still face? 1.Specific risk. 2.Business risk. 3.Systematic risk. 4.Market risk.
Answer: 3 and 4 Certain risks can be reduced by diversification. The risks known as systematic risks cannot be eliminated, as these risks affect all assets within certain classes. Systematic risk is always present and cannot be eliminated through diversification. This type of risk stems from such things as inflation, the business cycle and high interest rates. Systematic risk (also called market risk) is the risk associated with investing in each capital market: When stock market averages fall, most individual stocks in the market fall. When interest rates rise, nearly all individual bonds and preferred shares fall in value. Systematic risk cannot be diversified away; in fact, the more a portfolio becomes diversified within a certain asset class, the more it ends up mirroring that market.
99. What type of hedge funds use an event-driven strategy? 1.An equity market-neutral fund. 2.A convertible arbitrage fund. 3.A merger or risk arbitrage fund. 4.A high-yield bond fund.
Answer: 3 and 4 Event-driven strategies (merger or risk arbitrage, distressed securities, high-yield bonds): profiting from unique events such as mergers, acquisitions, stock splits and buybacks
76. What is a potential disadvantage of fee-based accounts? 1.Dependence on index funds within the portfolio. 2.Inclusion of third party mutual funds. 3.Neglect by the investment advisor. 4.Trading and research time requirements.
Answer: 3 and 4 There is a chance that the advisor could become lazy due to the continuing stream of income regardless of time and effort put into the account and advisors are still required to spend significant amounts of time trading and researching securities.
44. What is the generally regarded minimum number of stock holdings in an equity portfolio at which point non-systematic risk is eliminated?
Answer: 32 It is estimated that virtually all non-systematic risk in an equity portfolio is eliminated by the time 32 securities are included in the portfolio
6. What correctly identifies the order of different mutual fund types from lowest to highest risk? 1. Equity funds. 2. Specialty funds. 3. Balanced funds. 4. Money market. 5. Fixed income funds.
Answer: 4, 5, 3, 1, 2 Risk and return can be seen as a scale with the lowest risk/lowest return funds category being money market funds and the highest risk/highest return funds category generally being specialty funds. Within that range there are (lower to higher risk) fixed-income funds, balanced funds, equity funds
75. How far back from the date of bankruptcy could a creditor challenge a segregated fund purchase if the investor was legally insolvent at the time of purchase?
Answer: 5 years Under the federal Bankruptcy and Insolvency Act, the proceeds of a segregated fund may be subject to seizure if it can be proven that the purchase was made within a certain period before the bankruptcy, normally within one year. But if the client was legally insolvent when the contract was purchased, the segregated fund purchases could be challenged as far as five years back.
30. Calculate the real rate of return of a portfolio with an annual rate of 10% during a period when the inflation rate is 3.5% and the risk-free rate is 4.5%.
Answer: 6.5% The real rate of return adjusts the nominal rate on a portfolio to reflect inflation. In this example, the real rate of return would be calculated as 10% - 3.5% = 6.5%.
59. What is the legislated segregated fund minimum principal guarantee and minimum holding period?
Answer: 75%, 10 year holdings period Provincial legislation requires that the maturity guarantee be at least 75% of the amount invested over a contract term of at least a ten-year holding period or upon the death of the annuitant.
17. Last year, an investor earned a 5% real rate of return on his portfolio. If inflation last year was 3%, what was the approximate nominal rate of return on his portfolio?
Answer: 8% The approximate real rate of return on a security or portfolio of securities is equal to the nominal rate of return minus the inflation rate. Thus, given the real rate of return and the inflation rate, the approximate nominal rate of return is equal to the real rate of return plus the inflation rate.
47. What are the withdrawal requirements of a fixed-period withdrawal plan for a mutual fund?
Answer: A specified amount must be withdrawn over pre-determined period of time In a fixed-period withdrawal plan, a specified amount is withdrawn over a pre-determined period of time with the intent that all capital be exhausted when the plan ends.
45. What type of fee does a mutual fund company charge an investor for exchanging units of one fund for another within the same fund family or company?
Answer: A switching fee Switching fees may apply when an investor exchanges units of one fund for another in the same family or fund company. Some mutual fund companies allow unlimited free switches between funds, while others permit a certain number of free switches in a calendar year before fees are applied. In many cases, the financial advisor may charge a negotiable fee to a maximum of 2% of the amount being transferred, but an advisor may choose to waive this fee altogether. A common requirement for switching is that the funds involved are purchased under the same sales fee options.
56. Which fee may a mutual fund manager pay to its distribution channels?
Answer: A trailer fee A trailer fee, sometimes called a service fee, is a fee that a mutual fund manager may pay to the distributor that sold the fund. This fee is paid to the mutual fund representative annually as long as the client holds the funds. Trailer fees are usually paid out of the fund manager's management fee.
66. Which statement correctly identifies what research shows about correlation and risk? a. Adding highly correlated securities to a portfolio increases risk, and each additional security added will reduce risk at a higher rate. b. Adding poorly correlated securities to a portfolio reduces risk, and each additional security added will reduce risk at a lower rate. c. Adding highly correlated securities to a portfolio reduces risk, and each additional security added will reduce risk at a higher rate. d. Adding poorly correlated securities to a portfolio increases risk, and each additional security added will reduce risk at a lower rate
Answer: Adding poorly correlated securities to a portfolio reduces risk, and each additional security added will reduce risk at a lower rate Adding highly correlated securities to a portfolio does little to reduce the risk of the portfolio, because highly correlated securities tend to move in the same direction at the same time. Adding poorly correlated securities to a portfolio reduces risk because the risks tend to offset each other. Research also shows that adding additional securities to a portfolio reduces risk, but at a lower rate the more securities you add to the portfolio.
63. On which of the following assumptions is technical analysis in the equity selection process based? a. All influences on market activity are automatically accounted for. b. Future prices cannot be predicted by analyzing past patterns. c. Investor behaviour rarely repeats itself. d. Prices move in trends, but trends rarely persist in the long term.
Answer: All influences on market activity are automatically accounted for. Technical analysis is the process of analyzing historical market action in an effort to estimate the probable future price trends of stocks, automatically accounting for all influences on market activity.
12. An investor believes that the securities markets are efficient, and at all times reflect all relevant information on expected return and risk. Based on this view, which fund best suits this investor?
Answer: An index fund Managers using a passive investment strategy tend to replicate the performance of a specific market index without trying to beat it. They believe that securities markets are efficient - that is, securities prices at all times reflect all relevant information on expected return and risk. The passive portfolio manager does not believe that it is possible to identify stocks as underpriced or overpriced, at least to an extent that would achieve enough extra return to cover the added transactions costs
41. What fund best suits an investor with a preference for market timing strategies and who does not believe in the Rational Expectations Theory?
Answer: Asset Allocation Fund In this example, only the Asset Allocation funds would give an investor exposure to a manager with the ability to fully utilize market timing. The Index fund, as a passively managed fund, would have a fixed asset base regardless of market conditions; the Balanced Fund would have a set asset allocation with a specified minimum percentage of the fund in each relevant class of investment; and the Specialty Sector fund requires a manager to stay invested in the relevant sector. Asset allocation funds have objectives similar to balanced funds, but they differ from balanced funds in that they typically do not have to hold a specified minimum percentage of the fund in any class of investment. The portfolio manager has great freedom to shift the portfolio weighting among equity, money market and fixed-income securities as the economy moves through the different stages of the business cycle.
7. You overhear the following conversation between an Ontario licensed mutual fund salesperson and his Ontario resident client: "If you purchase XYZ mutual fund shares today you'll get the price at today's close. If you decide to sell them later, the mutual fund will definitely buy them back. If you're not ready to do the trade today, call me tomorrow and we'll give you today's closing price." What unacceptable sales practice has been exhibited within this conversation?
Answer: Backdating purchase orders The sole unacceptable sales practice here is found in the final statement, "If you're not ready to do the trade today..." It is unlawful for a salesperson to backdate an order in an attempt to buy shares or units at a previous day's price. Otherwise, all of the statements are accurate and acceptable. The salesperson states that the fund will buy back the securities, which is an explanation of the right of redemption that applies to all mutual funds. He correctly identifies what price the investor will receive if he purchases the shares today, but does not guarantee a specific price.
10. What industry would be most appropriate to include in the investment portfolio of a risk-averse investor during a recession? 1. Forest products industry. 2. Banking industry. 3. Utility industry. 4. Wireless technology industry.
Answer: Banking industry and Utility industry During a recession, industries that are considered to be defensive typically outperform cyclical or speculative industries. In this question, the banking and utility industries are considered to be defensive; forest products are considered to be cyclical, and the wireless technology industry an emerging or speculative industry.
82. What investment strategy stays clear of any potential interest rate risk on an early disposition by keeping each individual bond in the portfolio until its actual maturity date?
Answer: Buy and Hold A buy-and-hold strategy means purchasing bonds with available funds and holding each bond to its maturity, thereby avoiding the interest rate risk on an early sale.
26. Generally speaking, how are accounts divided among institutional sales people?
Answer: By geographical area and by relationships Accounts among salespeople are typically divided as follows: Geographically: Dealers segregate accounts by geographical area to make it logistically simpler for their salespeople to visit clients. By account type: Dealers categorize accounts into two types: fundamental and hedge/arbitrage. Fundamental accounts belong to long-only money managers. To get the managers business, the salesperson has to emphasize the dealer's intellectual resources and ability to generate money-making ideas that will help the manager s overall business. Hedge/arbitrage accounts are more like trading accounts and tend to be more interested in money-making ideas. By relationships: Some dealers allocate accounts to those salespersons with whom the client has the best relationship.
35. CBA Inc. and ZYX Inc. are in the same line of business. CBA Inc. has a debt/equity ratio of 0.94 and ZYX Inc. has a debt/equity ratio of 1.29. The average debt/equity ratio for the industry is 0.98. If the economy were to experience flat to slightly declining growth, which company would you recommend to your clients and why?
Answer: CBA Inc., since it has the lower debt/equity ratio All things being equal, a company with a lower debt/equity ratio is a safer investment. Thus CBA Inc. should be recommended
68. With which type of investment option would an ETF typically use a portfolio sampling construction approach?
Answer: Canadian bonds Sampling is typically used for fixed income ETFs.
39. You are evaluating a new client in order to determine an appropriate asset mix for her investments. Your client is 45, single, with no children and no expectation of ever having any. She has been investing extensively in a wide range of investment products, and is quite comfortable with risk. Her goal is to retire at 55, and then to travel extensively. She has no wish to leave an estate. What is the most appropriate asset mix for her?
Answer: Cash 5%/Fixed-Income 25%/Equities 70%. This individual has no significant personal obligations other than to herself, and with a goal of retiring early to a reasonably expensive lifestyle. Therefore, an aggressive, growth oriented asset mix would most likely be appropriate. Thus, a high weighting in equities, with some fixed-income for diversification and cash for liquidity, would be indicated.
13. What do you call the verification process of matching security buy and sell trade orders between two institutional firms?
Answer: Clearing Clearing is the process of confirming and matching security trade details.
81. Company A, Company B, and Company C all have the same amounts in current assets and current liabilities. Company A, however, has inventories 25% greater than Company B, and 50% greater than Company C. Ignoring any other considerations, how would the companies rank in liquidity from highest to lowest based on the most stringent test of corporate liquidity?
Answer: Company C/Company B/Company A The most stringent of the liquidity tests is the Quick Ratio, also known as the Acid Test. The Quick Ratio removes Inventories from the Current Assets figure, as these are typically the least liquid of all current assets. As Company A has a greater amount of its current assets in inventories, it would be the least liquid of the companies based on the Quick Ratio; as Company C has the least, it would be the most liquid.
100. Marcy, an IA, calls her clients regularly to update them on their portfolios. She knows that Mr. Collins worries if his investments drop in value, and she regularly reassures him that they haven't, even if there has been a decline in the portfolio. She reasons that her firm sends him investment statements on a monthly basis which he can read if he chooses to. Based on the Standards of Conduct, what obligation is Marcy violating, if any?
Answer: Complete and accurate information relayed to client Complete and Accurate Information Relayed to Client: Based on Standard B Trustworthiness, Honesty and Fairness, registrants must take reasonable steps to ensure that all information given to the client regarding his or her existing portfolio is complete and accurate. While the onus is on the investment firm to provide each client with written confirmations of all purchases and sales, as well as monthly account statements, the individual registrant must accurately represent the details of each client's investments to the client.
23. According to the financial planning pyramid, an investor who holds predominantly preferred shares and Government of Canada bonds in his portfolio, would be considered what type of investor?
Answer: Conservative Within the financial planning pyramid, conservative investments include: fixed-income securities e.g., bonds, debentures, preferred shares, GICs and certain mutual funds
22. What organization is appointed by a mutual fund corporation to collect money received from the fund's buyers and from portfolio income and arranges for cash distributions through dividend payments, portfolio purchases and share redemptions?
Answer: Custodian The custodian is appointed to fulfill this role. In some instances, the custodian may also serve as a fund's transfer agent and registrar, however, this is a distinct function separate from the role of a custodian
60. The profit for SLE Inc. falls by a surprising 20%, far more than the 10% predicted by analysts. Indicate what a follower of the efficient market hypothesis would most likely expect to see happen for the shares of SLE.
Answer: Decrease in price The efficient market hypothesis assumes that profit-seeking investors in the marketplace react quickly to the release of new information. As new information about a stock appears, investors reassess the intrinsic value of the stock and adjust their estimation of its price accordingly
37. In technical analysis, what condition typically exists at a support level for a stock?
Answer: Demand exceeds supply A support level is the price at which the majority of investors start sensing value, and therefore are willing to buy (demand is strong), and the majority of existing holders (or potential short sellers) are not willing to sell (supply is low). As demand begins to exceed supply, prices tend to rise above support levels.
2. What is the underlying structure of an inverse leveraged ETF?
Answer: Derivatives An inverse leveraged ETF makes use of derivatives (typically swap contracts).
52. What theory concludes that there are repetitive, predictable sequences of numbers and cycles found in nature and similar predictable patterns in the movement of stock prices?
Answer: Elliot Wave Theory Many theories exist that attempt to relate movements in the stock markets to different inputs and factors. The Rational Expectations Hypothesis and the Random Walk Theory are Capital Market Theories that essentially relate to the effect, or lack of effect, of distribution of information on stock market prices. The Elliott Wave Theory states in essence that the stock market moves up in a series of five waves and down in a series of three waves.
21. If a portfolio manager anticipates a decrease in the general level of interest rates, which of the following strategies will she most likely pursue? 1. Extend the average term on bond investments held. 2. Shift long-term bonds to common equity. 3. Increase the duration of the portfolio. 4. Convert long-term bonds to short-term bonds.
Answer: Extend the average term on bond investments held and increase the duration of the portfolio In general, when investment managers anticipate that the general level of interest rates will decrease, they would extend the average term on their bond. Also, the higher the duration of the portfolio, the greater the gain from falling interest rates and the greater the potential for capital gains.
46. A large institutional asset manager recruited some high profile economists to help its portfolio managers operate a hedge fund. The objective is to analyze the government policies of various countries and their impact on equity markets. What hedge fund strategy is the asset management company preparing to implement?
Answer: Global macro The global macro strategy is one of the most highly publicized hedge fund strategies, although it constitutes only a small percentage of the strategies used by today's hedge funds. Rather than make investments on events that affect only specific companies, funds using a global macro strategy make bets on major events affecting entire economies, such as shifts in government policy that alter interest rates, thereby affecting currency, stock and bond markets.
65. The table below presents annual returns on the SLE Equity Mutual Fund and its comparable benchmark over a 3-year period. Year SLE Benchmark This year 15% 12% Last year -8% -5% Two years ago 4% 2% Over this 3-year period, determine SLE's beta relative to its benchmark.
Answer: Greater than 1 Any equity or equity portfolio that moves up or down to the same degree as the stock market has a beta of 1.0. Any security or portfolio that moves up or down more than the market has a beta greater than 1.0, and a security that moves less than the market has a beta of less than 1.0.
92. Over the last five years, the returns on ABC stock and the S&P/TSX Composite Index were as follows: Year Return on Return on the S&P/TSX ABC Stock Composite Index 1 12% 9% 2 6% 4% 3 -8% -5% 4 -6% -5% 5 10% 9% Given this data, what was the beta of ABC stock relative to the S&P/TSX Composite Index?
Answer: Greater than 1 Beta measures the volatility of a stock relative to the volatility of the stock market as a whole. A beta of 1 indicates that a stock has the same volatility as the market; a beta less than 1 indicates that a stock had less volatility than the market, while a beta greater than 1 indicates that a stock has more volatility than the market. In Years 1, 2, and 5, when the returns on ABC stock and the S&P/TSX Composite were positive, ABC out-performed the market. In Years 3 and 4, when the returns on ABC stock and the S&P/TSX Composite were negative, ABC under-performed the market. Thus, ABC's returns were more volatile than the market's, and its beta was greater than 1.
89. Which ratio is used to measure the comparative efficiency of a company in turning over its goods after deducting cost of sales?
Answer: Gross profit margin The gross profit margin ratio is useful both for calculating internal trend lines and for making comparisons with other companies, especially in industries such as food products and cosmetics, where turnover is high and competition is stiff. The gross margin is an indication of the efficiency of management in turning over the company's goods at a profit. It shows the company's rate of profit after allowing for the cost of sales.
64. What trading strategy uses sophisticated computer algorithms to move in and out of stocks in milliseconds to generate short-term profits?
Answer: High frequency trading High frequency trading is a sub-set of algorithmic trading, and is characterized by a very large number of orders for individual trades of very small size that are done at extremely high speed - generally measured in hundredths of seconds or even in thousandths of seconds. HFT attempts to profit from very small price imbalances but must accordingly execute a very large number of these types of trades at very high speeds in order to earn an acceptable rate of return on their invested capital.
11. Which fiscal policy action might a government take specifically to protect the domestic shoe manufacturing industry
Answer: Increased in import tariffs Fiscal policy can affect the economy broadly and also specific industries narrowly. In this example, the government wishes to protect a specific industry, which would indicate a targeted initiative. While increases in spending, reduction on sales tax, and reduction in personal income tax would tend to encourage purchases in the economy as a whole, the utilization of import tariffs would focus specifically on the goal of protecting the domestic shoe industry.
40. What type of closed-end fund has the right to periodically buy back their outstanding shares?
Answer: Interval funds Closed-end funds that have the flexibility to buy back their outstanding shares periodically are known as interval funds or closed-end discretionary funds.
70. Company Beta pays an annual dividend of $2.34 per common share. What impact will a rising share price have on its dividend yield ratio?
Answer: The dividend yield will fall The dividend yield ratio is calculated as the annual dividend per share divided by the current market price per share. As the share price changes so to does the dividend yield. If the share price rises, the dividend yield will fall; if the share price falls, the dividend yield will rise.
29. A client has $50,000 to invest. She is risk averse and does not want any erosion of her initial investment. She will use the investment proceeds to help finance the purchase of a cottage in 1 year. What investment strategy best suits her objectives?
Answer: Investing the full amount in a treasury bill One major objective is to have some assurance that the initial capital invested will largely remain intact. If this is the main concern among the three primary objectives, the client is effectively saying that, regardless of whether a small, large or nil return is generated on the capital, the advisor should try to avoid erosion of the amount initially invested. Government of Canada Treasury bills offer the highest degree of safety - they are virtually risk-free.
98. Who is the annuitant of a segregated fund contract that is purchased within Joe's RRSP?
Answer: Joe When a contract is held outside of a registered plan such as an RRSP, the contract holder does not need to be the annuitant. However, within a registered plan, the annuitant must be the contract holder. Why? Registered plans have specific Income Tax Act regulations regarding taxation, payments to individuals, etc. These rules prevent the payment of the proceeds from the contract to any individual other than the holder of the registered account. The insurance company is the organization issuing the contract.
77. Drew, a financial advisor with Elite Financial has been dealing with Victoria, a risk averse client, for several years. Of late however, Victoria has been getting some tips from her brother-in-law on tech stocks to buy and she decides to invest. Drew executes her trade requests even though she has not signed a disclosure document for non-recommended trades. Which of the following guidelines has Drew violated? a. Know your client rule. b. Bucketing. c. Front running. d. Portfolio pumping.
Answer: Know your client rule According to IIROC full-service brokers now have the opportunity to accept non-recommended trades without a suitability obligation. To meet regulatory requirements in this matter, clients are required to sign a disclosure agreement document that gives consent that non-recommended trades will not be subject to a suitability review. In Victoria's case, she didn't sign this disclosure document and as a result Drew should have refused to execute the trades as documented in the know your client regulations.
61. What is one benefit of investing directly in a hedge fund instead of purchasing it in a fund of hedge funds?
Answer: Lower management fees A fund of hedge funds can also have certain disadvantages such as, additional costs, no guarantees of positive returns, low or no strategy diversification, insufficient or excessive diversification, and increased risk because of additional layers of leverage
25. What is the single biggest ETF risk?
Answer: Market rsk Since most ETFs are designed to replicate the results of a market index, the biggest risk an ETF faces is systematic or market risk.
3. What makes a technical analyst's ability to predict market movements most challenging?
Answer: Mass investor psychology In times of uncertainty, factors that cannot be predicted by the use of technical analysis, such as mass investor psychology that may cause investors to act irrationally, can also affect market prices. This can make the technical analyst's job much more difficult.
91. What group of employees within an investment dealer commonly handles compliance and risk management matters?
Answer: Middle office The middle office of a dealer normally consists of the following functions: risk management; legal and compliance; corporate treasury
50. What type of fund aims to achieve moderate income and preserve capital and liquidity by investing primarily in instruments such as near-cash securities?
Answer: Money market fund Money market funds add liquidity to a portfolio and provide a moderate level of income and safety of principal. They are considered the least risky type of mutual fund.
33. Commonly, what is the minimum account size for clients to have access to a private family office account?
Answer: More than $50 million Generally, access to a family office is for clients with more than $50 million in an account
28. Which structured product is most suitable for a client with low risk tolerance requiring income?
Answer: NHA mortgage-backed security Investors buy an MBS because it effectively places their money in real estate (in the form of mortgages) without facing the risk of default (with the benefit of CMHC's guarantee), or the problems of collections and credit appraisal.
93. What organization is responsible for ensuring that federally regulated insurance companies are adequately capitalized?
Answer: OSFI The Office of the Superintendent of Financial Institutions (OSFI) is responsible for ensuring that federally regulated insurance companies are adequately capitalized under the requirements of the federal Insurance Companies Act.
97. How are capital gains distributions received by investors in closed-end mutual funds?
Answer: Paid directly to investors Because the number of units of a closed-end fund is generally fixed, capital gains, dividends and interest distributions are paid directly to investors rather than reinvested in additional units.
88. Your research department has provided you with a Return Expectation of the Major Asset Classes as follows: Min Max Cash & equivalents 2.75% 4.25% Fixed-Income 2.25% 8.75% Equities -10% 25% Portfolio Manager A, in reviewing the return expectation, chooses an asset mix of 5% cash, 40% fixed-income and 55% equities for his client's investment portfolio. Portfolio Manager B chooses an asset mix of 0% cash, 25% fixed-income, and 75% equities for his client's investment portfolio. The actual market returns turn out to match the maximum expectations shown above. By how much would one investment portfolio approximately outperform the other?
Answer: Portfolio Manager B outperforms by 3.5% Manager A performance = (0.05)*(0.0425)+(0.40)*(0.0875)+(0.55)*(0.25) = 0.1746, Manager B performance = (0.00)*(0.0425)+(0.25)*(0.0875)+(0.75)*(0.25) = 0.2094. 0.2094-0.1746 = 0.0347.
34. What type of purchase plan allows retail mutual fund investors to make pre-arranged regular purchases in small dollar amounts?
Answer: Pre-Authorized Contribution Plan There are many purchase plans for mutual funds, ranging from one-time, lump-sum purchases to regular purchases in small amounts under periodic accumulation plans called pre-authorized contribution plans or PACs.
85. For technical analysts, which of the following price patterns is considered a buy signal? a. Price breaks through the moving average from above on heavy volume. b. The advance/decline line flattens out after a long increase. c. Price breaks through the moving average from below on heavy volume. d. The formation of a top head and shoulders pattern.
Answer: Price breaks through the moving average line from below on heavy volume If price breaks through the moving average from below, it is considered a buy signal. Prices have been declining and pulling the moving average lower. The actual price line will be below the moving average line when prices are declining. If prices cross over the moving average from below, it is a signal that the price decline has stopped. This is a buy signal.
5. What is the name for a bundled package of equity trade-related services offered by investment dealers to special clients such as hedge fund managers?
Answer: Prime brokerage Prime brokerage is a bundling of equity trading-related services used primarily by hedge funds.
79. What is a characteristic of an investment manager who follows a value manager style of investing?
Answer: Selects stocks that are currently out of favour with analysts For value investing managers, the focus is on specific stock selection. They are bottom-up stock pickers as well, with a research-intensive approach. Security turnover is typically low, as the manager will wait for a stock's intrinsic value to be realized. Since a stock is often cheap for a reason (it is out of favour), realizing its intrinsic value can take some time, if ever. Value managers seeks stocks that are often overlooked, disliked or out of favour with individual investors, institutional investors and equity analysts.
58. What type of fee-based account ranks highest in terms of its degree of customization?
Answer: Separately managed accounts In separately managed accounts, a client who has more than $150,000 to $500,000 in an account has the option of moving beyond pre-packaged and standardized mutual funds. The client can opt for a portfolio management service where the model of investments is held directly by the individual investor
38. Amy, married and age 45, owns 5,000 shares of ABC stock in her non-registered account which have declined to $2 per share since her initial purchase at $15 per share several years ago. Amy is uncertain about the future for ABC. Fortunately, she realized $65,000 in capital gains on a sale of shares in XYZ, although she is worried about the tax consequences as she is in the top tax bracket. What tax strategy would be best for Amy to consider?
Answer: She should consider a tax loss sale A tax loss sale would result in Amy reducing her taxes owing. Transferring the shares to her spouse would not generate a capital loss, nor would contributing them to her RRSP. If she were to sell the shares and immediately repurchase them she would likely be considered to have generated a superficial loss which is invalid for tax purposes.
53. What statement best describes an industry rotation strategy?
Answer: Shifting back and forth between cyclical and defensive industries The most basic industry rotation strategy involves shifting back and forth between cyclical and defensive industries. During periods in which stock prices are falling, cyclical stocks tend to fall relatively faster. Defensive stocks, such as banks or utilities, tend to preserve capital by falling relatively more slowly. However, during periods in which stock prices are rising, cyclical industries, such as paper and forestry or integrated mines, tend to rise relatively faster because their profit growth is more robust during an economic expansion.
32. Assume that in all other relevant financial indicators, SFO Inc. has approximately the same measurements as the industry averages. Considering the information provided below, which of the following statements is true? Debt / Equity Ratios Industry Average Year 1 - 1.45 Year 2 - 1.25 Year 3 - 1.50 Year 4 - 1.70 Year 5 - 1.85 5-Year Average - 1.49 SFO Inc. Year 1 - 1.39 Year 2 - 1.20 Year 3 - 1.10 Year 4 - 0.96 Year 5 - 0.64 5-Year Average - 1.80
Answer: Since SFO Inc. has exhibited a lower debt/equity ratio than the industry average, it can be concluded that SFO Inc. has consistently outperformed the industry. A lower debt/equity ratio, other factors being comparable, indicates a company with better performance. Since SFO Inc. has a consistently lower debt/equity ratio over the 5-year period, it can be concluded that SFO Inc. has outperformed the industry average.
19. What security trades as an exchange-traded structured product?
Answer: Split shares A split share is a security that has been created by a corporation (usually an investment trust) to divide (or split) the investment attributes of an underlying portfolio of common shares into separate components that satisfy different investment objectives. The shares created by the split share corporation are listed and trade on a stock exchange
90. What does beta measure?
Answer: Stock returns relative to the movements in the overall market Beta measures the degree to which equity securities or equity portfolios tend to move up and down with the market. The higher the beta, the greater the risk.
36. What savings vehicle is best suited to a 28 year old individual in a high income tax bracket who is setting aside money for a year-long vacation travelling through Europe?
Answer: TFSA A TFSA is a versatile and user-friendly type of account that makes it appealing to save, because the income earned in the account is never taxed, there is a lot of flexibility in making contributions and withdrawals and all residents over the age of 18 can set one up. Because the rules let you withdraw money and then replace it without being taxed, a TFSA is a good way to save for a variety of expenditures at different stages of a person's life.
48. What impact will an increase in intangible assets have on the asset coverage ratio, holding all other accounts that impact this ratio constant?
Answer: The asset coverage ratio will fall. The asset coverage ratio shows the net tangible asset position of a company and enables debt holders to measure the protection provided by the company's tangible assets after all liabilities have been met. An intangible asset is much different from a fixed asset like land or buildings, which is why it is subtracted from total assets in this ratio. Thus, an increase in intangible assets in the asset coverage formula, with all other items held constant, would reduce the physical assets available for coverage, and the asset coverage ratio would fall.
49. Which of the following statements is true about the link between the equity cycle and the economic cycle? a. The equity cycle is counter-cyclical to the economic cycle. b. The equity cycle occurs independently of the economic cycle. c. The equity cycle tends to lead the economic cycle. d. The equity cycle tends to follow the economic cycle with a lag.
Answer: The equity cycle tends to lead the economic cycle Evidence tells us the equity cycle follows the same pattern as the economic cycle, except that the equity cycle usually leads the economic cycle. This relationship explains why the equity market is often used as a leading indicator of economic activity.
95. An investor purchases a $1,000 5-year bond for $960. At the end of the calendar year, the investor notices that the bond is now trading at $980. Which of the following statements correctly describes the applicable taxation of this change in value for the investor? a. The investor must report a capital gain of $20 b. There is no amount taxable c. The investor must report interest earnings of $20 d. The investor must report interest earnings of $40
Answer: There is no amount taxable A capital gain or loss is calculated only at the time of disposition, and is based solely on the difference between the proceeds of the disposition and the adjusted cost base (book value) of the security. You are not required to declare capital gains or losses annually, unlike interest income from a bond.
31. Identify the characteristics of exchange-traded funds (ETFs) in Canada.
Answer: They are listed and traded on stock exchanges and they can be purchased on margin ETFs are structured as open-ended mutual fund trusts that trade on the stock exchange. ETFs typically have lower management fees than mutual funds.
18. Select the most accurate statements concerning the cash flow/total debt outstanding ratio. 1. This ratio gauges a company's ability to repay all the funds it has borrowed. 2. A relatively high ratio of cash flow to total debt outstanding is considered positive. 3. This ratio measures a company's ability to pay interest charges on its debt. 4. This ratio shows the net tangible assets of a company available to cover the total debt outstanding.
Answer: This ratio gauges a company's ability to repay all the funds it has borrowed and a relatively high ratio of cash flow to total debt outstanding is considered positive. The cash flow/total debt outstanding ratio gauges a company's ability to repay all the funds it has borrowed.
57. Normally, the dealer's commission in facilitating a stock trade is payable by the investor no later than what time line?
Answer: Three business days after the trade When the dealer acts in the capacity of an agent in a client's equity trade, the dealer's compensation for facilitating the trade is in the form of a commission. The commission amount is added to each transaction confirmation. It is paid to the dealer at the time that the equity trade is settled. By industry convention, equity trades normally settle at T+3. This means three business days after the date the trade occurs.
15. What is the difference between the return on the underlying reference asset and the return on the ETF?
Answer: Tracking error Tracking error measures the ETF's performance relative to its index.
84. Dwayne, an IA, is leaving the office on Monday for a doctor's appointment. He advises his assistant, an unlicensed individual, that if Nick Karan calls about an order he and Dwayne had discussed earlier that day, she is to take down the client order and input it into the firm's trading system. What Standard of Care is Dwayne violating?
Answer: Trades by registered and approved individuals Trades by registered and approved individuals means that all trades and all acts in furtherance of trades, whether with existing or potential clients, must be effected only by individuals who are registered and approved in accordance with applicable legislation and the rules of the SROs.
16. Identify the features of exchange-traded funds (ETFs) that make them attractive from the perspective of the retail investor. 1. Transparent. 2. Liquid. 3. Tax efficient. 4. Customizable.
Answer: Transparent, Liquid, and Tax efficient Exchange-traded funds are transparent and liquid investments that are considered to be tax efficient. ETF's are not customizable from the retail investor's perspective.
43. Adrian, an IA, receives a request from his client to purchase 100,000 shares of LFS Corp at $20. Adrian is unfamiliar with LFS. Adrian and his client have never discussed the possibility of placing orders for securities that Adrian himself has not recommended. If Adrian places the order without researching LFS, what duty of care would he be compromising?
Answer: Unsolicited orders Unsolicited Orders: Registrants who give advice to clients must provide appropriate cautionary advice with respect to unsolicited orders that appear unsuitable based on client information. The registrant must be aware of the objectives and strategies behind each order accepted on behalf of his or her clients, whether it is solicited or not. Registrants should take appropriate safeguarding measures when clients insist on proceeding with unsolicited, unsuitable orders. According to IIROC, full-service brokers now have the opportunity to accept non-recommended trades without a suitability obligation. To meet regulatory requirements in this matter, clients are required to sign a disclosure agreement document that gives their consent that non-recommended trades will not be subject to a suitability review. In this instance, Adrian and his client had not discussed the possibility of unsolicited orders, thus would not have such a disclosure agreement in place
51. Indicate the expected effect on the valuation of company ABC calculated with the dividend discount model if the expected constant growth rate for dividends is reduced.
Answer: Value will decrease The dividend discount model relates the value of a stock to dividends, market rates, and expectations for future company growth. Intuitively, even without calculating the actual figures of the model, if the expected growth for dividends is reduced, the value of the company is reduced as investors expect less in terms of future dividends.
9. An investor sells 300 shares of PQR Company, with an adjusted cost base (ACB) of $6,000, for net proceeds of $4,500. Two weeks later, the investor purchases 300 shares of PQR Company for $5,000. The investor continues to hold the shares 30 days later. In which of the following ways will the loss on the disposition of the shares be reported for income tax purposes? a) Canada Revenue Agency will not allow the investor to report a capital loss. b) The investor will report a capital loss of $1,000. c) The investor will report a capital loss of $1,500. d) The investor will report a capital loss of $500.
Answer: a) Canada Revenue Agency will not allow the investor to report a capital loss Taken together, these transactions are an example of a superficial loss. Superficial losses are not tax-deductible. They occur when securities sold at a loss are repurchased within 30 calendar days before or after the sale and are still held at the end of 30 days after the sale. The amount of the superficial loss - $1,500 in the example above - is added to the cost base (book value) of the repurchased shares.
24. Beth is 49, has no children, a secure job, and annual after-tax income of $55,000. While comfortable with investing, she is still slightly risk averse. Her total monthly expenses are manageable based on her and her husband's after tax income. Her husband's annual after-tax income is $35,000. Both have comprehensive employer paid health and dental plans. Each has a fully-paid employer workspace pension plan, sufficiently generous that each has the minimum possible RRSP contribution room accrual each year. Annually, they take vacations costing $3,500, and make charitable contributions of $3,600. Beth has inherited $250,000 in cash. Which asset mix would be most appropriate for her? a) Cash 5% / Fixed-Income 0% / Equities 95% b) Cash 5% / Fixed-Income 30% / Equities 65% c) Cash 10% / Fixed-Income 80% / Equities 10% d) Cash 15% / Fixed-Income 65% / Equities 20%
Answer: b) Cash 5% / Fixed-Income 30% / Equities 65% Beth has a secure job, no income or liquidity needs, is slightly risk-averse, and is in a high tax bracket. Therefore, an asset mix heavily weighted in fixed-income or cash would be inappropriate. The asset mix that is 95% invested in equities would be inappropriate, given Beth's preference to not assume excessive risk; also, it would not give her the benefits of diversification. Therefore, an asset mix of Cash 5%, Fixed-Income 30% and Equities 65% would be most appropriate, given its low weighting in cash and fixed-income.
27. Which of the following technical analysis signals indicates an increase in the breadth of the stocks in the S&P/TSX Composite Index? a) The index breaks through a significant resistance level. b) The index's cumulative advance-decline line increases from 25,200 to 25,700. c) The index breaks through its 200-day moving average from below. d) The index falls while its moving average convergence-divergence (MACD) increases.
Answer: b) The index's cumulative advance-decline line increases from 25,200 to 25,700. An increase in the cumulative advance-decline indicates an increase in the breadth of the stock in the S&P/TSX Composite Index. All the other signals are related to the trend of the overall market, which does not necessarily say anything about the breadth of the market