Final Exam 10

Which of the following investment advisers would most likely NOT be required to register with the Administrator? A) A firm that provides advice on fixed annuities B) A firm that provides advice on listed securities C) A firm that provides investment advice to a tollway authority D) A firm that provides investment advice to an employer's pension plan

A) A firm that provides advice on fixed annuities **Investment advisers provide securities-related investment advice. A fixed annuity is not considered a security by state Administrators. Since the firm is not considered to be providing securities-related advice, it would be exempt from the definition of an investment adviser.**

After occurrence of the event for which a filing is required, when must a Form 8-K be filed? A) Four days B) Seven days C) 90 days D) As determined by the SEC

A) Four days **Unless otherwise specified, Form 8-K must be filed or furnished within four business days after the occurrence of the event for which the filing is made. Form 8-K is required by the SEC to announce certain significant changes in a public company, such as a merger or acquisition, a name or address change, bankruptcy, change of auditor or accountant, or any other information that may be reasonable for a potential investor to know.**

In order to better diversify a client's portfolio, an investment adviser recommends that its client invest in tangible assets, such as gold and silver. Which of the following risks is the adviser attempting to reduce? A) Business risk B) Inflation risk C) Any risks associated with the fact that the expected rate of return may be in error D) Any risks associated with the fact that the stock market may become illiquid and cause equity products to decrease in value

B) Inflation risk **When an adviser recommends that clients invest in tangible assets, such as precious metals (gold) and real estate, its general purpose is to help them hedge against inflation.**

A client wants to make a payment in perpetuity of $3,000 per year to a beneficiary. Assuming a 3% annual return, how much principal would your client need to deposit? A) $3,000 B) $30,000 C) $100,000 D) $250,000

C) $100,000 **The client would need to deposit $100,000. To calculate the required principal, take the annual payment in perpetuity of $3,000 and divide it by the annual rate of return of 3% ($3,000 / .03 = $100,000). The phrase in perpetuity may also be referred to as a perpetual payment, meaning that payments will continue to be made forever.**

A 70-year-old retiree is very risk-averse, but needs to generate investment income. She is not wealthy and is in a low tax bracket. Which of the following investments will BEST meet her needs? A) long-term municipal bond fund B) A growth mutual fund C) A certificate of deposit D) A diversified portfolio of stocks with covered calls written against them

C) A certificate of deposit **Since the client is risk-averse, needs income, and is concerned about her principal fluctuating, the best choice is a certificate of deposit. All of the other choices are unsuitable because they are either too speculative or they are tax-free, which provides her with little benefit since she is in a low tax bracket.**

A client of ABC Advisers has recently retired and is looking for an investment that will provide steady income and offer the ability to sell quickly if the need arises. Which of the following investments would be the BEST recommendation? A) Zero-coupon bonds B) Bank-issued CDs C) Treasury notes D) Preferred stock

C) Treasury notes **The best answer would be Treasury notes. Treasuries offer semiannual interest payments and the most liquid securities market. While some CDs and preferred stocks may be considered liquid, they are not as liquid as the Treasury market. Zero-coupon bonds do not provide semiannual interest payments.**

Z Best, a broker-dealer, has filed an application for registration with the Administrator of New York. Three years ago, the firm was suspended from trading on the London Stock Exchange, due to the activities of a rogue trader. The firm's clients were not affected in any way. Upon receipt of the application, the Administrator may: A) Grant registration since foreign governments have no jurisdiction in the U.S B) Deny registration, since any suspension is a securities-related misdemeanor C) Grant registration, because the evidence would be inadmissible in court D) Deny registration, as any action by a foreign securities regulator may result in a denial by the Administrator

D) Deny registration, as any action by a foreign securities regulator may result in a denial by the Administrator **Under Sec. 204(H.1) of the USA, the Administrator may, by order, deny, suspend, revoke, cancel, or withdraw the registration of any registrant (i.e., broker-dealer, agent, investment adviser, investment adviser representative) that has been the subject of a foreign securities regulator's disciplinary action, within the past five years. The fact that foreign governments have no jurisdiction or that evidence may be inadmissible is irrelevant.**

How is alimony treated for tax purposes? I) Alimony payments are deductible to the payer. II) Alimony payments are taxable to the payer. III) Alimony payments are taxable to the payee. IV) Alimony payments are not taxable to the payee. A) I and III B) I and IV C) II and III D) II and IV

D) II and IV **Alimony is taxable to the spouse who makes the payments (i.e., the payer), but is not taxable to the recipient (i.e., payee). Alimony is taxed at ordinary income rates.**

An IAR is calculating the internal rate of return (IRR) of a client's investment. While performing the calculation, the IAR assumes that the reinvestment rate of cash flows will equal: A) The nominal interest rate B) The fed funds rate C )The inflation rate D) The internal rate of return (IRR)

D) The internal rate of return (IRR) **The internal rate of return (IRR) assumes all cash flows are invested at the internal rate of return. The IRR is the rate that makes the discounted value of cash inflows and outflows equal to zero. If an investor is choosing between two investments, she should choose the one with the higher IRR.**

Which of the following statements is TRUE regarding general partnerships? A) All the general partners have the authority to bind the partnership B) They may only be established by filing a written agreement with the appropriate state agency C) None of the partners is personally liable for the partnership's debts D) They are usually taxed like C Corporations

A) All the general partners have the authority to bind the partnership **Unless the partnership agreement specifies otherwise, all the partners in a general partnership have the authority to transact business on the partnership's behalf. A general partnership is formed by an agreement among the partners. No specific filing with the state is necessary. All the partners are personally responsible for the partnership's debts. Most partnerships qualify for flow-through taxation, which means that they are not taxed as individual entities unlike C Corporations, which are taxed as separate entities.**

If an investment increases in value, which of the following statements would be TRUE? A) If it was held for less than one year, the annualized rate of return would be greater than the holding period return B) If it was held for less than one year, the holding period rate of return would be greater than the annualized return C) Regardless of the actual holding period, the holding period and annualized return are always identical D) If held for more than one year, the holding period return would be less than the annualized return

A) If it was held for less than one year, the annualized rate of return would be greater than the holding period return **The holding period rate of return states how much an investor earns over the period an investment is held. The annualized rate of return states how much an investor makes over a one-year period. If an investor had a 5% rate of return over six months, her holding period rate of return would be 5%; however, her annualized rate of return would be 10% (the 5% return earned over the six-month period multiplied by two). If the holding period had been more than one year, the opposite would be true--the holding period return would be larger than the annualized rate of return.**

Which of the following return calculations removes the distortions caused by the deposit and withdrawal of capital from an investment account over time? A) Time-weighted return B) Dollar-weighted return C) Expected return D)( Current yield

A) Time-weighted return **Time-weighted returns eliminate biases caused by the inflow or outflow of investor money. It is often used to compare the performance of money managers. On the other hand, dollar-weighted returns provide a better idea of how an individual investor has done over time by eliminating the biases caused by superior performance in one year or inferior performance in another. **

When would a variable annuity be most suitable for a client? A) When the client wants capital appreciation or growth over a long period B) When the client wants a fixed rate of return C) When the client wants an inflation-adjusted rate of return D) When the client wants to receive a predictable amount of income at retirement

A) When the client wants capital appreciation or growth over a long period **Variable annuities are suitable for clients who are willing to invest for the long term and want to invest in the markets. The investment objective of variable annuities is capital appreciation (growth). Since a variable annuity's performance is tied to the market, its return is unpredictable and is not based on inflation.**

A father makes a gift of XYZ stock to his daughter. Two years ago, the father purchased the stock for $5,000 and, at the time of the gift, the stock was worth $10,000. If the daughter sells the stock 10 months later for $12,000, what is the tax implication? A) long-term capital gain of $7,000 B) A long-term capital gain of $2,000 C) A short-term capital gain of $2,000 D) Since the gifted amount is under the gift tax limit, it is a tax-free event.

A) long-term capital gain of $7,000 **When a person receives a gift of stock, the recipient's cost basis is the donor's cost basis or the stock's current market value, whichever is less. The stock was originally purchased by the father for $5,000, but was then given as a gift to the daughter when its current market value was $10,000. Since the original cost basis ($5,000) was less than the current market value ($10,000), the original cost basis is used to determine the gain or loss when the stock is sold. In this question, the daughter subsequently sells the stock for $12,000; therefore, she has a resulting capital gain. To determine the ultimate tax implication, the daughter's holding period is based on the donor's holding period. Since the donor had held the stock for two years prior to the gift, the daughter's holding period is considered long-term. By using the original cost basis of $5,000 and comparing it to the proceeds of $12,000, the result is a long-term capital gain of $7,000 ($12,000 - $5,000).**

Which of the following transactions meets the definition of an exempt transaction under the Uniform Securities Act? A) An issuer transaction of a security filed under the Securities Exchange Act B) A nonissuer transaction of a security filed under the Investment Company Act C) An isolated issuer transaction D) Any sale of a security for which a registration statement has been filed with both the Administrator and the Securities and Exchange Commission

B) A nonissuer transaction of a security filed under the Investment Company Act **Any nonissuer transaction of a security registered under the Securities Exchange Act, Investment Company Act, or an isolated nonissuer transaction would be considered exempt transactions. Any offer, but not sale, of a security filed with both the Administrator and SEC would be considered an exempt transaction.**

Under the Uniform Securities Act, which of the following statements is NOT TRUE concerning the state registration of an agent? A) An agent may only sell securities that have been properly registered in a state or qualify for an exemption from registration B) An agent's registration to sell securities in a given state expires at the end of the broker-dealer's fiscal year C) An agent may only solicit business in a state if both the agent and broker-dealer are registered in that state D) If an agent leaves a broker-dealer to go to another broker-dealer, the agent and both broker-dealers must notify the Administrator of the change

B) An agent's registration to sell securities in a given state expires at the end of the broker-dealer's fiscal year **The licenses of all agent, broker-dealer, investment adviser, and investment adviser representatives expire on December 31 each year and must be renewed in order to be effective. Renewal is accomplished by the payment of a filing fee.**

Which one of the following investments trade independently from its net asset value (NAV)? A) Open-end fund B) Closed-end fund C) Variable annuity D) Unit investment trust (UIT)

B) Closed-end fund **Mutual funds (open-end funds), unit investment trusts, and variable annuities are priced based on their net asset values. A closed-end investment company share may sell at, above, or below its net asset value since it trades on the stock exchange.**

In reference to storing customer books and records, an adviser is permitted to store records on: A) Microfilm or microfiche only B) Disks, provided the information cannot be altered C) The original format only D) Disks, provided they are password-protected

B) Disks, provided the information cannot be altered **Books and records must be maintained in an easily accessible place for five years. During the first two years, the records must be maintained in an appropriate office of the investment adviser. Records may be preserved on microfilm, microfiche, or any similar device. They may also be kept on various electronic storage media such as CD-ROMs, provided the disks are tamper-evident (write once read many). This means that any attempt to alter the records would become obvious and easily determined upon examination. These files do not need to be password-protected, but the adviser must be able to limit access to the records to authorized personnel and regulators.**

Who is eligible to enroll in a private 457 plan? A) All employees of a publicly traded company B) Employees who are members of a union C) New York City sanitation workers D) A librarian who works in the Philadelphia Public Library

B) Employees who are members of a union **Private 457 plans are retirement plans for non-governmental employers and there are restrictions regarding participant eligibility. Participants in a private 457 plan may include members of a union, hospital workers, and employees of charitable organizations.**

Sales of viatical investments can only be made to suitable investors. Which TWO of the following are considered suitable? I) An accredited investor under regulation D II) Anyone who has been specifically approved by the state Administrator III) Anyone who is in the highest marginal tax bracket and is in need of liquidity IV) Anyone with a minimum net worth of $150,000 and gross income last year of at least $100,000, or a minimum net worth of $250,000 A) I and III B) I and IV C) II and III D) II and IV

B) I and IV **A viatical investment involves the purchase of an interest in an insurance policy covering the life of an individual. The purchase may be for a whole or fractional interest in the policy at a price above the cash value. The investors pay the premiums on the policy until the death of the insured at which time the death benefit is paid to the investors. Since it is unknown when the insured will die and the funds are not readily assessable on demand, NASAA has specific suitability requirements as found in choices (I) and (IV).**

Bill is an investment adviser representative for an advisory firm that has satellite offices in Florida and California, but its principal office is in New York City. The adviser has assets under management of $63,000,000 and its largest client is the Aquarius SmallCap Growth Mutual Fund. Bill works in the New Jersey office and has clients that reside in Florida, New York, and New Jersey. In which of the following states must Bill register as an investment adviser representative? I) California II) New Jersey III) New York IV) Florida A) I, II, and III only B) II only C) II, III, and IV only D) I, II, III, and IV

B) II only **Although Bill's advisory firm has less than $100 million under management, it is an adviser to a registered investment company. For that reason, the firm is considered a federal covered investment adviser and is only required to register with the SEC (i.e., it is exempt from registration at the state level). The IARs of federal covered advisers are required to register with the Administrator in any state in which they maintain an office. In this question, since Bill only maintains a place of business in New Jersey, he is required to register as an IAR in New Jersey.**

A mutual fund is planning to issue 10 million Class B shares. Five hundred thousand shares will be offered in the state of Rhode Island. Under the Uniform Securities Act, the Administrator of Rhode Island will require the fund to: I) Register the shares in Rhode Island II) Include a prospectus with its registration III) Pay a filing fee IV) Sign a Consent to Service of Process A) I and II only B) III and IV only C) I, II, and III only D) I, II, III, and IV

B) III and IV only **Mutual funds are federal covered securities and, therefore, a state may not require registration or regulate any offering document. Except for securities that are listed on one of the exchanges (such as the NYSE or Nasdaq), the state may charge a filing fee. The state may also require issuers to submit a filing notice and sign a Consent to Service of Process.**

Which of the following choices is NOT a benefit of discounted cash flow, fixed-income analysis? A) It makes it possible to determine the present value of a series of future payments B) It permits an adviser to minimize cash flow reinvestment risk C) It allows for a direct comparison between the present value and the market value of a bond D) It provides a means to measure and compare the value of investments that have different rates of return

B) It permits an adviser to minimize cash flow reinvestment risk **Discounted cash flow (DCF) analysis does not offer relief from reinvestment risk when investing in fixed-income securities. A discounted cash flow evaluates the present value of each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against current rates of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determines a fair market value of a bond. By comparing the value calculated by the discounted cash flow formula to the current market price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client.**

Which of the following securities have no loan value? A) Preferred stocks that are listed on Nasdaq B) Options that have nine months or less until expiration C) Common stock that are listed on the NYSE D) Corporate bonds

B) Options that have nine months or less until expiration **Options that expire in nine months or less may not be bought on margin. These contracts have no loan value and, therefore, must be paid for in full. On the other hand, options that have maturities of greater than nine months have a margin requirement of 75% (i.e., customers must pay 75% of the cost and the firm may loan the remaining 25%).**

A client has terminated an investment advisory contract one week after signing the agreement. The adviser informs the client that a prorated portion of the advisory fee will be retained by the adviser, and the remainder will be sent to the client. Under the USA: A) This practice is considered unethical B) This practice is acceptable C) This practice is considered fraudulent D) The client may apply for a rescission

B) This practice is acceptable **Investment advisers are allowed to charge a prorated fee for the time that a contract is in force.**

When an accounting firm is auditing an issuer's balance sheet and income statement, which of the following auditor's opinions is the BEST? A) Qualified B) Unqualified C) Adverse D) Attestation

B) Unqualified **Unqualified opinions of auditors are typically considered the best, since they're issued without reservation. On the other hand, a qualified opinion is issued when an auditor questions at least one part of a company's finances (e.g., unusual expense). Adverse opinions are issued when an auditor doesn't believe that a company's finances represent the true results.**

Which of the following statements describes a semi-strong form efficient market? A) Past market prices and data are fully reflected in securities prices. B) All public information, including historical data, is reflected in securities prices. C) All public and private information is reflected in securities prices. D) Market prices are rational and based on an assumption that investors will attempt to maximize their potential returns for the risk being assumed.

C) All public and private information is reflected in securities prices. **The Efficient Market Hypothesis (EMH) explains three different forms -- strong, semi-strong, and weak form efficiency. In a weak form efficient market, all past prices and data are fully reflected in current prices. In a semi-strong form efficient market, all public data, including historical pricing, is reflected in current prices. In a strong form efficient market, both public and non-public (i.e., inside) information is reflected in current prices. The assumption that investors want to minimize risk and maximize returns is made in the Modern Portfolio Theory, not the Efficient Market Hypothesis.**

If an adviser has custody of customer funds and securities, the submission of Form ADV-E must be performed by: A) The adviser within 120 days after the completion of an audit B) The adviser within 90 days after the completion of an audit C) An independent accountant within 120 days after the completion of an audit D) An independent accountant within 90 days after the completion of an audit

C) An independent accountant within 120 days after the completion of an audit **Submission of Form ADV-E with the SEC is required if the adviser has custody of client funds and securities. The form must be filed by an independent accountant, not the adviser, within 120 days after the completion of the audit.**

According to the Uniform Securities Act, an Administrator is NOT allowed to demand that broker-dealers do which of the following? A) Approve their advertising prior to use B) Ensure that their advertising is maintained and available for inspection C) File their advertising related to federal covered securities with their state Administrator prior to use D) Review their advertising for accuracy prior to use

C) File their advertising related to federal covered securities with their state Administrator prior to use **According to the Uniform Securities Act, all advertising used by a broker-dealer must be supervised and checked for errors. They are also required to keep a file that is subject to audit by the Administrator. However, the Administrator does not regulate advertising that addresses only federal covered securities.**

When meeting with a potential customer for the very first time, which of the following would be a reasonable course of action?Prior to the meeting, informing the client to bring additional financial information.If necessary, an IAR may inform the client that he may not know the answer to one of her questions, but will find out and respond within a reasonable period.Inform the client that she needs to increase her risk tolerance to obtain her goals.Discuss the customer's current financial situation and her goals for retirement. A) I and II only B) I, II, and III only C) I, II, and IV only D) I, II, III, and IV

C) I, II, and IV only **When meeting with a potential customer, it would not be reasonable to tell her that she needs to change her risk tolerance. A client may increase the future value of a portfolio by saving more money or by allowing her money to compound over a longer period. It is often considered inappropriate to encourage a client to assume risk beyond her comfort level.**

Which TWO of the following clients may enter into an advisory contract that includes a performance-based fee? I) A joint account with a net worth of $1,000,000 II) A partner of the investment adviser with annual income of more than $200,000 III) An IRA account with $2,000,000 under management IV) An individual account with $750,000 net worth A) I and III B) I and IV C) II and III D) II and IV

C) II and III **Under the Investment Advisers Act of 1940, performance fees are generally prohibited. Exceptions include contracts for clients who have at least $1,000,000 under management with the adviser or who have a net worth in excess of $2,000,000. Performance-based fees may also be charged to a client who is an executive, a partner, or a knowledgeable employee of the adviser. The amount of funds under management is not a factor for these clients. The type of account (individual, joint, or IRA) is also not a factor.**

When opening a margin account, which TWO of the following MUST be signed? I) A loan consent form II) A hypothecation agreement III) A margin account form IV) Trading authorization A) I and III B) I and IV C) II and III D) II and IV

C) II and III **When opening a margin account, a customer must sign both a hypothecation agreement and a margin account form. The loan consent form is used when a customer authorizes the member to lend his securities, and is not required. Trading authorization is also not required.**

When is an IA or IAR permitted to publish a testimonial regarding the adviser? A) Never B) If the permission of the author of the testimonial is obtained C) If the testimonial appeared on an independent social media site over which the IA or IAR has no control D) If the testimonial is from a former client

C) If the testimonial appeared on an independent social media site over which the IA or IAR has no control **An IA or IAR is permitted to publish testimonials if (1) they are shown as they originally appeared on an independent third party social media site, (2) are unedited, and (3) the IA or IAR has no direct or indirect influence or control over the independent site.**

What's a basic assumption of Modern Portfolio Theory? A) The market will increase over the long-run B) The economy's growth rate will eventually decrease C) Investors will minimize risk when possible D) Investors should buy safer investments as they get older

C) Investors will minimize risk when possible **Modern Portfolio Theory (MPT) is based on the following two assumptions: 1) Investors will try to maximize their returns, and 2) Investors generally seek to assume as little risk as possible. Although many investors will take less risk as they age, MPT doesn't specifically mention an investor's age. Also, MPT doesn't make any assumptions about the market or the economy.**

Weldon Shalls, an investor, has a portfolio that provides him with a steady stream of income and some capital appreciation. Weldon believes he should diversify his portfolio by investing in an instrument that can provide additional income and the ability to absorb a portion of the investment's expenses. What type of investment vehicle will Weldon most likely choose? A) Real estate investment trust B) Mortgage bond C) Real estate limited partnership D) Listed call options

C) Real estate limited partnership **Investing in a limited partnership is considered a passive activity. Investors must understand the tax treatment for partnerships. Income and losses generated by the partnership is absorbed by the investor. All tax information is requireded to be reported on Form K-1 by the partnership.**

Under the Uniform Securities Act, all of the following statements are TRUE regarding the requirements for investment advisers that have a place of business in a state, EXCEPT: A) They may be required to file financial reports with the Administrator B) They must retain records as required by the Administrator C) The Administrator will inspect their books and records annually D) They are required to update their registration statement promptly if it becomes materially inaccurate

C) The Administrator will inspect their books and records annually **An Administrator will not inspect the books and records of an investment adviser on an annual basis. However, if an IA has custody of customer funds, an independent public accountant must perform an annual audit. All of the other choices are true.**

All of the following information would be permitted in an advertisement by an investment adviser, EXCEPT a list of: A) Public and private colleges that are asset management clients of the adviser B) Managing directors of the firm along with their professional designations C) The adviser's top-ten corporate pension fund clients along with the reasons they have accounts managed by the adviser D) Private foundations that allocate funds to the adviser's managed account program

C) The adviser's top-ten corporate pension fund clients along with the reasons they have accounts managed by the adviser **Regarding specific standards, investment adviser advertising may not refer, directly or indirectly, to any testimonials about the adviser or its services. A testimonial is an advertisement in which an individual recommends the investment adviser's services based on personal experiences with the adviser. Testimonials are prohibited whether or not the clients consented to allowing their names to be disclosed. There is no prohibition against listing the name(s) of clients or employees of the adviser along with their professional designations.**

According to the Uniform Prudent Investor Act, what would be of LEAST concern to an investment adviser? A) Tax implications of recommendations and strategies B) The possibility of a future increase in the rate of inflation C) The length of the adviser's contract and amount of fees collected D) Current market conditions

C) The length of the adviser's contract and amount of fees collected **The length of time remaining in the client's contract is the least of the adviser's concerns. Factors that are of greater concern include taxes, inflation, and the direction of the economy.**

According to the Investment Advisers Act of 1940, when is an investment adviser required to provide an audited balance sheet to its clients? A) When the adviser requires the prepayment of a fee that is greater than $500, six months or more in advance of providing service B) When the adviser requires the prepayment of a $500 initial advisory fee C) When the adviser requires the prepayment of a fee that is greater than $1,200, six months or more in advance of providing service D) When the adviser has limited discretion over the account

C) When the adviser requires the prepayment of a fee that is greater than $1,200, six months or more in advance of providing service **Since state and federal laws overlap regarding the concept of providing an audited balance sheet, it is important to identify which regulator is asking the question. According to the Investment Advisers Act of 1940 (federal law) an adviser is required to provide clients with an audited balance sheet if it collects prepaid fees of more than $1,200, six months or more in advance of providing advisory services. However, according to the Uniform Securities Act (state law), an adviser is required to provide clients with an audited balance sheet if 1) the firm collects/solicits prepaid fees of more than $500, six months or more in advance of the service, or 2) the firm maintains custody or discretionary control of clients' assets.**

The Smiths have little investment experience, but are interested in saving for retirement and their children's college education. They consult an investment adviser representative about purchasing mutual funds. The IAR recommends that they purchase variable life insurance instead, even though the Smiths already have large life insurance policies. The IAR discloses that he will earn a higher commission by selling a variable insurance policy instead of mutual funds. Given these circumstances, has the IAR violated his fiduciary responsibilities? A) No, the IAR fully disclosed his conflict of interest to the Smiths B) No, because variable life insurance has tax-deferred income benefits that mutual funds do not have and the IAR has disclosed that the higher commission applies C) Yes, a variable life insurance policy is not a suitable recommendation for the Smiths D) Yes, the IAR has violated his responsibility for best execution

C) Yes, a variable life insurance policy is not a suitable recommendation for the Smiths **A variable life insurance policy is not a suitable recommendation for the Smiths, given their expressed interest in an investment other than insurance. The primary purpose of life insurance is protection against premature death, not investment. Furthermore, the fact pattern in this question indicates that the Smiths have already satisfied their life insurance needs. There is nothing to indicate that their coverage is inadequate. The IAR's disclosure of the conflict of interest does not make up for the fact that the investment recommendation is not suitable.**

An investment advisory client's holdings consists of: $ 6,000,000 -- Stock/bonds$ 1,000,000 -- Money-market funds$ 3,000,000 -- Real estate, commodities$10,000,000 -- Total assets Would these holdings be considered a securities portfolio? A) Yes, because it contains securities. B) No, because it also contains non-securities. C) Yes, because more than 50% of the assets are securities. D) No, because money-market funds are not securities.

C) Yes, because more than 50% of the assets are securities. **When securities represent a majority of an investor's total assets, the investor is considered to have a securities portfolio. In this question, it is important to recognize that money-market funds are also considered securities. For this client, 70% of her total assets represent securities. When determining the amount of assets under management for an IA, the securities portfolios of its clients are included. The amount of assets under management are disclosed by the IA in Form ADV Part 1.**

A client invested $100,000 in an Equity Indexed Annuity. The participation rate is 90% with a cap rate of 15%. In year one, the index increased by 20%. In year two, the index lost 5%. In year three, the index gained 10%. What is the value of the annuity after year three? A) $118,000 B) $115,000 C) $135,700 D) $125,350

D) $125,350 **An Equity Indexed Annuity is credited with the lesser of the participation rate or the cap rate, based on the performance of an index such as the S&P 500. In year one, the index increased by 20%. 90% of the gain is equal to 18%, but since the annuity can't be credited with more than the cap of 15%, the value of the annuity would be $115,000 (1.15 X $100,000). Many Equity Indexed Annuities have a floor of zero, thus a negative return in the index will not cause the value of the annuity to decline. Therefore, in year two, the value of the annuity would remain the same. In year three, the index increased by 10%. 90% of the gain is 9%, which is less than the cap rate, so the annuity would be credited with 9%, or $125,350 (1.09 X $115,000).**

What is a mid-cap stock called if it has a P/E ratio of 29, while stocks of other similar companies are selling with a P/E ratio of only 19? A) A blue-chip stock B) A consumer goods stock C) A value stock D) A growth stock

D) A growth stock **Growth stocks tend to have higher P/E ratios due to the premium investors are willing to pay for the potential future growth in earnings. On the other hand, value companies tend to have lower P/E ratios than other similar companies.**

Which of the following may be included in an advertisement created by an investment adviser (IA)? A) A testimonial from a satisfied customer B) A telephone number that individuals may call to obtain a list of the recommendations made by the IA in the last six months C) A chart that recommends specific stocks to buy or sell this year D) A no-strings-attached offer to furnish a list of all the recommendations made by the IA in the last two years

D) A no-strings-attached offer to furnish a list of all the recommendations made by the IA in the last two years **Investment adviser advertisements may not make reference to past recommendations unless they offer to furnish all of the recommendations made over at least the last year. Also, specific investment advice and the use of testimonials are generally not permitted in IA advertising.**

According to the Investment Advisers Act of 1940, when advertising the performance of its managed accounts, an investment adviser must deduct which of the following? A) The management fees, but not expenses B) The expenses, but not the management fee C) The management fees and a small percentage of the expenses D) All management fees and expenses

D) All management fees and expenses **It is a violation of the Investment Company Act of 1940 to advertise a fund's performance unless it deducts all of the associated fees and expenses. By not deducting the fees or expenses, returns would be exaggerated and the advertising would be considered misleading or unethical.**

All of the following statements about Benchmark Portfolio Management are TRUE, EXCEPT: A) Portfolio risk and return will be heavily influenced by the benchmark B) The manager determines what securities will and will not be included in the portfolio C) Certain benchmarks are better suited to specific investment goals than others D) Benchmarks should be reweighted at least quarterly to improve the relative performance of the portfolio

D) Benchmarks should be reweighted at least quarterly to improve the relative performance of the portfolio **When portfolio managers construct a portfolio, they usually start with the securities in the benchmark as a beginning point. Then the decision as to what additional positions to take is made in an effort to add value. The benchmark indicates not only the kinds of securities that should be included in the portfolio, but also the types that should not be. For example, choosing a government bond index as the benchmark makes it clear that the portfolio should not include a large percentage of securities with a high degree of risk. Reweighting a benchmark on a quarterly basis would not have any effect on the actual performance of the portfolio. If it were done to make the portfolio appear to perform better, that would be considered, at best, unethical and, more likely, fraudulent.**

Which of the following is a characteristic of a Money Purchase Plan? A) Employees must make mandatory contributions B) Employer contributions are discretionary C) Employees and the employer must make mandatory contributions D) Employers must make mandatory contributions

D) Employers must make mandatory contributions **A Money Purchase Plan is a type of defined contribution plan to which an employer makes mandatory contributions, regardless of the company's profitability. For tax purposes, the employer is able to deduct the contributions.**

Gary and Mary were recently divorced. Mary has been ordered to pay child support to Gary, who has custody of their two children. Which of the following statements is TRUE regarding child support payments? I) Child support is not tax-deductible for the payer. II) Child support is tax-deductible for the payer. III) Child support is taxable for the receiver. IV) Child support is not taxable to the receiver. A) I and II only B) II and III only C) II and IV only D) I and IV only

D) I and IV only **Child support payments are not tax-deductible for the payer and not taxable for the recipient.**

A broker-dealer would be required to register in Pennsylvania if the broker-dealer: I) Has an office in Pennsylvania and executes nonissuer transactions of securities listed on a national securities exchange II) Has no office in Pennsylvania and executes nonissuer transactions of securities listed on a national securities exchange with clients that are residents of Pennsylvania III) Has an office in Pennsylvania and executes transactions of municipal securities with clients that are not residents of Pennsylvania IV) Has no office in Pennsylvania and executes transactions of municipal securities with clients that are residents of Pennsylvania A) I and II only B) I and III only C) III and IV only D) I, II, III, and IV

D) I, II, III, and IV **In all four choices, the broker-dealer would be required to register in Pennsylvania. A nonissuer transaction of a security listed on a national securities exchange is an exempt transaction and a municipal security is an exempt security. A broker-dealer executing a transaction in an exempt security or exempt transaction is required to register, unless it is exempt from the definition of a broker-dealer in that state. Since the broker-dealer either has an office in Pennsylvania or is transacting business with residents of that state, it would be required to register.**

Limited partnerships are offered to the public or are sold through private placement. To avoid registration with the SEC, partnership interests can only be sold to which of the following persons? I) Any number of accredited investors II) No more than 35 nonaccredited investors III) No more than 35 accredited investors IV) Both accredited and nonaccredited investors A) I only B) I and II only C) I, II, and III only D) I, II, and IV only

D) I, II, and IV only **In a private placement under Regulation D, the securities are exempt from registration with the SEC, provided all investors are accredited investors and/or, no more than 35 nonaccredited investors. To be accredited, the investor must be a financial institution, or an individual with a net worth of at least $1 million, or at least $200,000 of annual income ($300,000 if married).**

According to NASAA Model Rule 502(c), regarding contents of investment advisory contracts, an advisory contract would include which of the following choices? I) The term of the contract II) An exculpatory clause waving compliance with the Investment Advisers Act of 1940 III) A nonassignment clause IV) A clause requiring the adviser to notify clients of any change in membership if the firm is a partnership A) I only B) I and III only C) I, II, and III only D) I, III, and IV only

D) I, III, and IV only **It is unlawful for an investment adviser, investment adviser representative, or federal covered investment adviser to enter into, extend, or renew any investment advisory contract unless it provides, in writing, the term of the contract, how the fees will be calculated, the fact that the adviser may not be compensated on gains only, and a nonassignment clause. It is unlawful to include any condition, stipulation, or provision binding any person to waive compliance with any provision of this Rule or of the Investment Advisers Act of 1940. This prohibited practice is known as an exculpatory clause.**

Mark is a registered representative and also an investment adviser representative for his firm. One of Mark's clients requests that he create a comprehensive financial plan for her. To implement the plan, Mark must: A) Abstain from implementing the financial plan since a conflict of interest exists B) Notify his supervisor before implementing the plan to avoid any conflicts of interest C) Obtain a signed dual capacity waiver of compliance from his client D) Inform his client that he will be acting as a registered representative when implementing the plan and will be receiving compensation

D) Inform his client that he will be acting as a registered representative when implementing the plan and will be receiving compensation **Investment advisers and investment adviser representatives must disclose all relevant facts so their clients can make informed decisions regarding potential conflicts of interest. If an adviser acts in more than one capacity when dealing with a client, this may present a conflict of interest. In this case, Mark should inform his client that he will be acting in more than one capacity (IAR when creating the plan and RR/agent when implementing the plan) and will be receiving additional compensation.**

A pension fund manager wants to protect the fund's diversified stock portfolio against a market downturn. To best meet this objective, she should purchase: A) Call Options on the stocks in the portfolio B) Covered puts on the stocks in the portfolio C) Calls on a comparable index D) Puts on a comparable index

D) Puts on a comparable index **Index options would move in the same direction as the market as a whole and, therefore, provide a better hedge for a diversified portfolio than individual stock options.**

An Administrator has determined that a broker-dealer is selling unregistered securities in the Administrator's state. Which of the following statements is TRUE if the broker-dealer does not comply with the cease-and-desist order issued by the Administrator? A) The Administrator may bring action in federal court to request an injunction B) The Administrator will refer this case to the SEC as the governing authority regarding the sale of securities C) Failure to follow an Administrator's order is grounds for the automatic suspension of a broker-dealer's registration D) The Administrator may bring action in a court of competent jurisdiction to request an injunction

D) The Administrator may bring action in a court of competent jurisdiction to request an injunction **The Administrator may take more severe action if a broker-dealer does not comply with a cease-and-desist order to stop selling unregistered securities in the Administrator's state. This would entail the Administrator going to state court to ask for an injunction.**

In what way does variable life insurance provide for a death benefit that can keep up with inflation? A) The death benefit will increase by the same percentage as the CPI B) The death benefit will increase by a certain percentage of the increase in a specified index C) The minimum guaranteed death benefit goes up by a fixed percentage every year D) The earnings in the subaccounts are added to the guaranteed minimum death benefit every year

D) The earnings in the subaccounts are added to the guaranteed minimum death benefit every year **The death benefit will be increased each year by any increase in the value of the subaccounts. If the value of the subaccounts declines, the death benefit will decline but never below the minimum guaranteed amount. A variable life policy would be chosen because the owner feels that the growth in the subaccounts will provide a death benefit that is likely to keep up with inflation over the long run.**

An investment adviser is registered in 10 states. The firm wants to transact business with three clients in a state in which it is not registered. According to the Uniform Securities Act, which of the following statements is TRUE? A) The firm would be required to register in the new state if the clients were not accredited investors B) The firm would be required to register in the new state if the clients were employee benefit plans with assets greater than $1,000,000 C) The firm would be required to register as an investment adviser with the SEC since it is now doing business in more than 10 states and is defined as a federal covered adviser D) The firm would not be required to register as an investment adviser if it did not lease an office in the state in which it is not registered

D) The firm would not be required to register as an investment adviser if it did not lease an office in the state in which it is not registered **According to the Uniform Securities Act, if a firm has five or fewer clients in a state (during a 12-month period) in which it has no office, it is exempt from registration in that state. Also, if all the clients, regardless of their number, are banks, trust companies, insurance companies, or employee benefit plans, the firm is exempt from state registration.**

ABC Inc., a financial services company, is registered as both a broker-dealer and an investment adviser. On a regular basis, ABC is required to provide its clients with disclosures and obtain written agreements from them regarding acting in both a broker-dealer and investment adviser capacity. In which of the following situations is ABC not required to obtain a written agreement from the client prior to effecting the transaction? A) The client sells a security, and ABC (acting in a principal capacity) buys the security for its own account B) The client buys a security, and ABC (acting in a principal capacity for its own account) sells the security to the client C) At the time of initiating her contract, the client signed a document waiving her right to receive any and all disclosure documents D) The investment adviser side of ABC makes no recommendation to the client, but the client decides to effect a securities transaction through the broker-dealer

D) The investment adviser side of ABC makes no recommendation to the client, but the client decides to effect a securities transaction through the broker-dealer **If the investment adviser side of ABC makes no recommendation and the client decides to effect a securities trade through the broker-dealer, the investment adviser disclosure rules don't apply since the client has not used the adviser's services. However, broker-dealers are required to disclose on trade confirmations whether they have acted in a principal or agency capacity.**

Advisers whose advice is limited to U.S. government securities are defined as investment advisers and required to register with: A) The SEC only B) The SEC and state Administrator C) The appropriate SRO D) The state Administrator only

D) The state Administrator only **According to the Investment Advisers Act of 1940, any adviser that limits its advice to U.S. government securities is excluded from the investment adviser definition. However, the Uniform Securities Act does not offer the same exclusion. For that reason, an adviser that provides advice only about U.S. government securities is defined as an investment adviser at the state level and is required to register with the appropriate state Administrator.**

Howie is both a registered investment adviser and a licensed real estate agent. He recently prepared a financial plan for Bob. In this plan, Howie recommended that Bob increase his life insurance coverage and also consider putting a portion of his portfolio in hard assets, such as real estate. Howie knew of a property called Blackacre that was currently for sale and told Bob about it. Bob eventually purchased Blackacre using Howie as his real estate agent and Howie received a commission for the purchase. Would Howie's commission for selling Blackacre be considered compensation under the Investment Advisers Act? A) Yes, but only if Howie did not fully disclose that he was receiving a commission from the sale of Blackacre B) No, since the commission was not connected with the purchase or sale of a security C) No, real estate transactions are governed by state regulation D) Yes, Howie's commission for Blackacre would be considered part of his compensation as an investment adviser

D) Yes, Howie's commission for Blackacre would be considered part of his compensation as an investment adviser **SEC Release 1092 states that investment adviser compensation includes "any economic benefit." It can include commissions generated by the sale of nonsecurities products such as insurance or real estate. Thus, Howie's commission for Blackacre would be considered investment adviser compensation within the meaning of the Investment Advisers Act.**