Series 65 Incorrect Answer Questions 2

During prolonged periods of an economic recession: I interest rates can be expected to fall II interest rates can be expected to rise III the Federal Reserve will begin to loosen credit IV the Federal Reserve will begin to tighten credit A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. During prolonged periods of recession, interest rates drop. This occurs because the Federal Reserve loosens credit to get the economy moving again; and because demand for loans falls as business activity drops.

Which of the following stocks would be considered cyclical? A. automobile manufacturer B. pharmaceutical manufacturer C. gold mining company D. computer software developer

The best answer is A. The performance of cyclical stocks follows the business cycle. In times of GDP expansion, they do well; in times of recession, they do poorly. The classic cyclical stocks are home building, automobile manufacturers and durable goods producers. All of these purchases are deferrable in hard times. Pharmaceutical companies are defensive and are not affected by the business cycle; in good times or bad, people must take prescribed drugs. Gold mining stocks are counter-cyclical. In bad economic times, people "flee to safety" and buy gold stocks. Computer software companies are growth companies.

Which of the following technical indicators would be considered to be bearish? I Breakout through a support level II Head and shoulders top formation III Saucer formation IV Odd lot short sales A. I and II only B. III and IV only C. I, II, and IV only D. I, II, III, IV

The best answer is A. A breakout through a support level is bearish. This is a breakout on the downside, and it can be expected that the market will drop sharply once the support level is broken: A head and shoulders top formation is bearish. Such a formation shows that the market has topped and is heading downward: A saucer formation shows that the market has bottomed and is heading up. This is a bullish indicator: Finally, levels of odd lot purchases and sales are a technical indicator, with the theory being that small investors trade odd lots and that they are wrong. Thus, if there is a high level of odd lot purchases, then this is a bearish indicator. If there is a high level of odd lot sales, this is a bullish indicator.

Under the Investment Advisers Act of 1940, which of the following statements are TRUE about the acceptance of prepaid advisory fees by an investment adviser? I The fees must be detailed in writing in the advisory contract II The fees cannot amount to more than 6 months' payment in advance III Prepaid fees in excess of $1,200 require that the adviser's balance sheet be included in the "Brochure" IV Acceptance of a prepaid fee constitutes taking "custody" of customer funds A. I and III only B. II and IV only C. I, II, III D. I, II, III, IV

The best answer is A. Prepaid advisory fees are permitted, as long as they are detailed in the advisory contract; and there is a refund of such fees if the contract is canceled prematurely. There is no restriction on the amount of prepaid fees that can be accepted - but remember that under the Statement of Policy on unethical practices, adviser fees must be similar to those charged by other advisers for comparable services. If an adviser accepts $1,200 or more of prepaid fees, for 6 months or more of service in advance, then a balance sheet must be included in the "Brochure" given to customers (the "Brochure" is Part 2A of Form ADV). Acceptance of prepaid fees is not the same as taking custody of customer funds or securities.

Which of the following individuals is defined as an "agent" under the Uniform Securities Act? A. An individual who represents an issuer in sales of non-exempt securities B. A person who effects securities trades for his own account as a regular course of business C. A person who has no place of business in the State who offers a security to an existing customer who is not a resident of that State D. An individual who represents a broker-dealer in reporting completed trades to customers and answering customer account inquiries

The best answer is A. An agent is defined as an individual who represents either a broker-dealer or an issuer in effecting securities transactions with customers. An individual who represents an issuer effecting sales of exempt securities is excluded from the definition - this exclusion is not available to individuals who represent issuers in sales of non-exempt securities. For example, a salesperson hired by Ginnie Mae to market GNMA securities to institutional investors is excluded. A salesperson hired by an oil and gas limited partnership promoter to market the partnership units to broker-dealers is defined as an "agent" (of the issuer in this case). Choice B defines a broker-dealer - a person in the business of effecting securities trades for others or for its own account. Choice C is the definition of a person excluded from the definition of a broker-dealer. This exclusion is available to broker-dealers that are registered in their "home" State that are contacting existing customers who are vacationing in another State where the broker-dealer has no office and is not registered. Choice D is an individual that is only performing clerical duties and thus is not defined as an agent.

An investor's securities portfolio has depreciated by $5,000 this year. How much of the loss can the investor deduct on this year's tax return? A. 0 B. $2,000 C. $3,000 D. $5,000

The best answer is A. An investor cannot deduct depreciation of an asset that is currently held as a capital loss. To recognize the loss for tax purposes, he must first sell those securities. Investors can only deduct $3,000 of net realized capital losses per year.

When the market is reaching an "oversold" condition, which of the following statements are TRUE? I Market price averages are decreasing daily II Market price averages are increasing daily III The number of declining issues is decreasing relative to the number of advancing issues IV The number of declining issues is rising relative to the number of advancing issues A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. An oversold condition in the market occurs when the market price averages are decreasing daily, but the strength of the market decline (the number of issues declining versus the number of issues advancing) is weakening. The market is reaching an "oversold" condition, and is approaching a trough. Thus, the next market move is likely to be upwards.

EFFE stock has a beta of +1.5. The expected market rate of return is 10% and the risk-free rate of return is 2%. The standard deviation of returns is 1%. Using the Capital Asset Pricing Model (CAPM), what is the expected rate of return for EFFE stock? A. 14% B. 16% C. 18% D. 20%

The best answer is A. CAPM finds the "expected return of an investment" using the formula: Expected Return of An Investment = Risk-Free Rate of Return + Risk Premium* *Risk Premium is: Beta x (Expected Market Return- Risk-Free Rate of Return) Basically, the Risk Premium is the excess of the expected market rate of return over the risk-free rate of return multiplied by the risk level of the investment as measured by beta. Because the expected market rate of return is 10% and the risk-free rate of return is 2%, the risk premium is 8% x 1.5 beta = 12%. Thus, the Expected Return of The Investment is: 2% Risk-Free Rate of Return + 12% Risk Premium = 14%. Note that Standard Deviation has nothing to do with the formula and is a distractor in the question.

Under the Uniform Securities Act, all of the following are allowed forms of investment adviser compensation, provided it is disclosed to customers, EXCEPT: A. a flat fee assessed only if the portfolio increases in value B. an hourly rate which includes the time it takes to get to the client's office and back C. a varying fee based upon a fixed percentage of assets under management D. a flat fee per year regardless of the portfolio size

The best answer is A. Fees based upon a percentage of assets under management and flat fees (including hourly and annual fees) are permitted as long as the details are fully disclosed to customers. Performance fees are prohibited.

A customer buys 200 shares of GE at 72 and sells 2 GE 70 Calls @ $6. The maximum potential gain is: A. $800 B. $1,200 C. $7,000 D. unlimited

The best answer is A. If the market rises, the calls are exercised. The stock (which cost $72) must be delivered at $70 for a loss of $2 per share. Since $6 was collected in premiums for selling the call, the net gain, if exercised, is 4 points or $400 per contract x 2 contracts = $800.

If an investment yields 6% at the same time as inflation as measured by the CPI increases by 6%, the inflation-adjusted rate of return is: A. 0% B. 6% C. 12% D. 16%

The best answer is A. Inflation-Adjusted return deducts the rate of inflation from the investment return, to approximate the "real rate of return." If an investment yields 6% when the inflation rate of 6%, the inflation adjusted rate of return is 0%.

Which statement is TRUE regarding the State Administrator's authority to establish net capital standards for broker-dealers? A. The Administrator can only establish Net Capital standards that are the same as those set by the SEC B. The Administrator cannot establish Net Capital standards for broker-dealers C. The Administrator has the power to set Net Capital standards if it is in the public interest D. The Administrator can neither establish nor enforce Net Capital requirements for broker-dealers

The best answer is A. NSMIA made clear that Federal law has supremacy over State law regarding net capital rules, custody rules, margin rules, financial responsibility rules and recordkeeping rules. Since the SEC sets net capital requirement for broker-dealers, the State Administrator cannot set a minimum net capital amount that is higher than the SEC requirement.

Company A: Price Earnings Ratio 10 Price to Book Ratio 1 Company B: Price Earnings Ratio 20 Price to Book Ratio 2 Company C: Price Earnings Ratio 50 Price to Book Ratio 5 Company "C" is most likely a: A. mature company B. growth company C. cyclical company D. counter-cyclical company

The best answer is B. Growth companies usually have very high prices relative to their current earnings (people are paying a high price for expected future growth), so their Price-Earnings ratios tend to be high. Similarly, growth companies tend to have high Price to Book Value ratios as well. So, Company "C" can be characterized as a growth company. In contrast, mature companies tend to have low Price-Earnings ratios and low Price to Book Value ratios.

Which rule under the Securities Act of 1933 would be used to resell restricted stock of a publicly held company without having to file a registration with the SEC? A. Rule 144 B. Rule 145 C. Rule 146 D. Rule 147

The best answer is A. SEC Rule 144 permits the public resale of restricted, private placement stock without filing a registration statement with the SEC. To do so, the company must have gone public, the stock must have been held fully paid for 6 months, a Form 144 notice must be filed with the SEC, and only a limited amount can be sold every 3 months. Rule 145 requires that a registration statement be filed with the SEC for mergers and divestitures by publicly held companies; but that no registration statement filing is required for stock splits or stock dividends. Rule 146 is an old rescinded rule. Rule 147 is an exemption from registration for an intrastate offering of securities.

A portfolio manager generates a 10% rate of return on a "small cap" portfolio, compared to an 8% rate of return on the benchmark portfolio and a 6% rate of return on the Standard and Poor's 500 index over the same period. The active rate of return on the portfolio is: A. 2% B. 4% C. 6% D. 10%

The best answer is A. The "active rate of return" measures a manager's performance against the appropriate benchmark portfolio (typically an index of securities with similar characteristics to the portfolio being actively managed). The manager achieved a 10% rate of return; compared to the benchmark portfolio return of 8%. Thus, the active rate of return is 2%. The manager's abilities allowed him or her to do 2% better than a passive indexed portfolio of similar investments.

A customer has purchased shares of stock over an extended period of time at varying prices. The customer now sells some of the shares. Which statements are TRUE regarding the tax treatment of the sale? I The Tax Code allows specific identification of the shares being sold II The Tax Code prohibits the specific identification of shares being sold III FIFO accounting must be used to establish the cost basis of the shares sold, if no other tax election is available IV LIFO accounting must be used to establish the cost basis of the shares sold, if no other tax election is available A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. The IRS allows stockholders to select which shares they are selling when computing capital gains tax liability. Thus, the taxpayer can choose the higher cost shares to reduce any potential capital gain upon sale. If specific identification is not used, the shareholder must use FIFO - first in, first out - accounting.

The Second Market is the: A. trading of OTCBB stocks B. issuance of listed stocks C. trading of listed stocks on an exchange D. issuance of listed and unlisted stocks

The best answer is A. The Second Market is over-the-counter trading of securities that are not listed on a stock exchange. For equities, the Second Market is the OTCBB (Over The Counter Bulletin Board) and the Pink OTC Markets. The First Market is trading of listed stocks on an exchange. Choices B and D are definitions of the primary (new issue) market - not the secondary (trading) markets.

Which statements are TRUE regarding Treasury STRIPS? I Interest is accreted annually II Interest is not accreted annually III Interest is subject to Federal income tax annually IV Interest is not subject to Federal income tax annually A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. The accretion of the discount over the bond's life represents the interest earned. Even though no payments of interest are made annually, the discount must be accreted annually and is taxable as interest income earned.

An investor has $50,000 that she wishes to invest for her child's college expenses, which the child starts next year. The most suitable recommendation to the client is to invest the funds in: A. Treasury bills B. Intermediate-term bonds maturing in 5 years C. Long-term bonds of blue chip companies maturing in 10-30 years D. a mutual fund based on the S&P 500 Index

The best answer is A. The client will need access to the funds in 1 year to start paying for college. The client cannot afford an investment loss, so the safest most liquid security listed as a choice is Treasury bills - which have a maximum 1-year maturity limiting interest rate risk and are government guaranteed, limiting credit risk.

An issuer hires an agent and registers that individual to distribute an offering of its securities. Which statement is TRUE under NASAA rules? A. If the agent solicits transactions in a State where the agent is not registered, the issuer can be held liable B. If the agent finishes distributing this securities offering and there is time left until the agent's registration lapses at year end, he or she can work for another issuer distributing that issuer's securities C. The agent is only permitted to sell the issuer's securities to employees of that issuer D. The agent must also affiliate with a registered broker-dealer in order to distribute the offering of securities

The best answer is A. The definition of an "agent" under State law is an individual who represents a broker-dealer or issuer effecting, or attempting to effect, purchases or sales of securities. Thus, Choice D is incorrect. An example of an agent of an issuer would be a general partner of a limited partnership who hires a "wholesaler" to market partnership units to investors. This individual is an agent of the issuer, marketing securities to the public and the agent must be registered in the State where the agent resides to do so. The agent must also be registered in each State where he or she solicits individuals to buy partnership units. Choice B is false because if this person goes to work for another issuer, that issuer must register this person as an agent of that issuer. Choice C gets at an exclusion from the definition of an "agent" which is given to an employee of an issuer who only sells that issuer's securities to issuer employees without being compensated for those sales. This exclusion from registration is designed for issuer employees who place employee funds in stock purchases of that employer through stock option or retirement plans. It has no bearing on this question.

Which of the following statements is true for BOTH college savings plans and UTMA accounts? A. Contributions are made with after-tax dollars B. Earnings accumulate on a tax deferred basis C. State tax benefits are available on distributed earnings used to pay for qualified education expenses D. Earnings are tax-free at the Federal level when used to pay for qualified education expenses

The best answer is A. There is no tax deduction for contributions to UTMA (Uniform Transfers to Minors Act) accounts, nor for contributions to 529 accounts - all contributions are made with after-tax dollars. Earnings in 529 accounts build tax deferred; but in UTMA accounts, the earnings are taxed each year. If earnings in a UTMA account are used to pay for qualified education expenses, they are still taxed. Regarding State tax rules, 529 plan earnings are typically not taxed at the State level; UTMA account earnings, on the other hand, are taxable at the State level.

A customer that lives in State A is traveling by air to State C. While he is changing planes in State B, he receives a call on his cell phone from his broker, who solicits him to buy a security. He places the order with his broker and boards his connecting flight to State C. When he returns to his home in State A, he finds the trade confirmation in his mailbox. Which State Administrator(s) has (have) jurisdiction over the transaction? A. State A only B. State B only C. Both State A and B D. States A, B and C

The best answer is A. This is an existing customer that is temporarily in State B when he is changing planes to catch a connecting flight. In such a case, only the Administrator of the customer's home State (State A) has jurisdiction. If the customer were to spend a lot of time in State B (some States apply this if more than 2 weeks are spent in the State; others apply it after 30 days are spent in the State), then State B would also have jurisdiction. State C has nothing to do with this trade.

A 5% coupon bond is being offered on a 6% basis. If interest rates for similar bonds rise above 6%, the basis for this bond will: A. increase B. decrease C. be unaffected D. be volatile

The best answer is A. This is pretty simple. A basis quote is a yield to maturity quote. If market yields are rising, the basis quote will rise, forcing the bond's price down. If market yields are falling, the basis quote will fall, forcing the bond's price up.

The manager of a broker-dealer is discussing investment strategies with her in-house research assistant. The conversation leads to a discussion about a client for whom the broker-dealer is negotiating to underwrite a common stock offering. The research assistant tells the manager that she is preparing a report indicating that the company is having sales difficulties and is going to downgrade the stock from "Accumulate" to "Hold." What should the research analyst do? A. Wait until the status of the underwriting contract is resolved before taking any further action B. Issue the report as scheduled after changing the recommendation back to "Accumulate" C. Issue the report immediately D. Sell short the stock and then issue the report

The best answer is A. This one is a bit sticky. During the period when an underwriter is negotiating with an issuer to do an underwriting, the firm cannot issue research reports on that stock (except under very specific rules where the issuer has always previously been publishing reports about that company; and the new report is no more favorable than the old reports). The issue here is that a favorable report would tend to influence that issuer's price upward; and then if the underwriter gets the deal, the underwriter could then sell the issuer's shares at a higher price and earn a larger underwriting spread. This is a conflict of interest. In this case the research analyst is going to issue a report that would influence the price of the stock downward - and the underwriting firm probably would not go through with the underwriting deal if the downgrade made the public too negative on the stock. The best course of action is to wait until the status of the underwriting contract is resolved before issuing the report.

An investment adviser representative (IAR) has an oral agreement with a customer to provide advisory services and has given the new customer a glossy brochure describing the adviser's services, but has forgotten to give the customer Part 2 of Form ADV. Which statement is TRUE? A. The customer must receive the Form ADV Part 2 and then has 2 days to sign the agreement B. The customer must be given the Form ADV Part 2 at the time of signing the agreement C. The oral agreement is binding because the customer received the glossy brochure D. The customer must receive the Form ADV Part 2 and then has 5 days to sign the agreement

The best answer is A. Under NASAA rules, customers must receive Part 2 of Form ADV (the "Brochure" and "Brochure Supplement") at least 2 business days prior to the completion of an oral or written contract to provide advisory services. As an alternate to this "2 day free look," the customer can be given the brochure at the time the contract is signed; but must have the right to rescind the contract within the next 5 days after examining the brochure. Note that the wording of the brochure delivery rule states that it applies to "oral or written" contracts and we know that NASAA requires that advisory contracts be written, so this appears to be inconsistent. The use of the term "oral" covers the scenario where a customer does not sign an advisory contract, but writes a check to the adviser - which legally means that there is now a contract!

When it is expected that a recession will occur, which statement is TRUE? A. The yield spread between corporate and government bonds will widen B. The yield spread between corporate and government bonds will narrow C. The yield spread between corporate and government bonds will not be affected D. An arbitrage opportunity will exist between corporate and government bonds

The best answer is A. When a recession is expected, investors sell corporate bonds (increasing their yields) and buy government bonds (decreasing their yields). Thus, the spread between corporate and government bond yields will widen.

Regarding the economic cycle, the period between a recession and a recovery is termed a(n): A. trough B. peak C. expansion D. depression

The best answer is A. The normal progression of the economic cycle is: Expansion: Economic growth accelerates until a peak is reached Peak: The period of maximum economic growth, after which growth ceases and a period of economic decline begins Recession: Economic decline accelerates until a bottom (trough) is reached Trough: Economic decline slows and slowly reverses itself to start a new period of economic growth Recovery: A new period of growth begins, slowly at first and then accelerates into an Expansion

Which order, if executed, guarantees a specific price or better? A. Market B. Limit C. Stop D. Not Held

The best answer is B. A "Limit" order specifies that the execution must comply with the limit price specified or better. Thus, limit orders are filled at that price or better. Buy limit orders must be filled at the limit price or lower. Sell limit orders must be filled at the limit price or higher. If a "Stop" order is elected, it becomes a market order to be filled at the first opportunity. Thus, the actual price at which the order is executed is not known. Market orders are filled immediately at the current market price, so the actual execution price is not known. A "not held" order is a market order that gives the trader price and time discretion during that trading day. The trader is supposed to use his or her judgment to get the best price, but there is no guarantee as to the fill price.

What options are available for a Coverdell Education Savings Account that is not used by the time the beneficiary is age 30? I The account balance is distributed tax-free to the educational institution selected by the beneficiary II The account balance is distributed to the beneficiary and distributions are taxed to the beneficiary III The account balance is rolled over to a family member who is under 30 years of age IV The account balance is rolled over to an IRA for the beneficiary A. I and II only B. II and III only C. II and IV only D. III and IV only

The best answer is B. A Coverdell Education Savings Account that is not used by the time the beneficiary is age 30 can be rolled over to a family member who is not yet 30 and remain tax-free, or the account balance must be distributed to the beneficiary and is subject to regular tax plus a 10% penalty tax. There is no such thing as a rollover from a Coverdell to an IRA; and the proceeds must be used to pay for qualified education expenses of the beneficiary to be tax-free. If the proceeds are donated to an educational institution, this is not a qualified distribution and the amount distributed is subject to regular income tax plus a 10% penalty tax.

A $1,000 par TIPS is issued with 3 years to maturity. The coupon rate on the bond is 2.50%. If the inflation rate for the next 3 years is 1.50%, the bond will be worth how much in 3 years? A. $1,000 B. $1,046 C. $1,077 D. $1,125

The best answer is B. A TIPS is a Treasury Inflation Protection Security. Aside from receiving the 2.50% coupon ($25 annual interest) paid to the bondholder, the principal is adjusted upwards by the inflation rate each year, and at maturity, the holder receives the inflated principal amount. $1,000 inflated by 1.50% annually equals: $1,000 x 1.015 x 1.015 x 1.015 = $1,046.

All of the following statements are true regarding a bond that is "registered to principal only" EXCEPT: A. the bond is negotiable B. interest coupons are detached from the corpus of the bond C. interest payments can be redeemed by anyone D. at maturity, the registered owner receives the face amount of the bond

The best answer is B. A registered to principal only bond has a physical certificate with the bond's face amount registered in the owner's name, but interest coupons are attached which are payable to the "bearer." Bearer coupons can be redeemed by anyone. The bonds are negotiable. No new issues have been sold in the U.S. since 1983 - after this point only fully registered or book entry bonds have been issued. However, these bonds still trade in the market (at least until 2023, if the bond had 40 years to maturity).

An advantage of convertible preferred stock is that it can be converted into: A. bonds of the same company at a specific price B. common stock of the same company at a specific price C. higher dividend paying preferred stock of the same company at a specific price D. any of the above, at the option of the holder

The best answer is B. Any convertible preferred security, whether convertible preferred stock or convertible bonds, can be converted into the common stock of the issuer. The conversion price at issuance is set at a premium to the market price of the common at that point in time. It only makes sense to convert if the market price of the stock rises above the conversion price.

Which business form has a limited life? A. S corporation B. General partnership C. Limited liability company D. C Corporation

The best answer is B. Any partnership has a limited life; if there is not a fixed life stated in the partnership agreement; then the life of the partnership ends when the partnership composition changes. If a partner leaves, or a new partner is added; the old partnership is dissolved and a new partnership is formed. All corporations have an unlimited life; a change in ownership does not dissolve the corporation. Also, limited liability companies have an unlimited life.

A 25-year old single customer earns $80,000 per year at a corporation. He contributes the maximum amount to his company's 401(k) plan and wants to put money aside on a tax-deferred basis for the 1st time purchase of a house in 6 years. The best recommendation is that this individual make contributions to a: A. Traditional IRA B. Roth IRA C. Coverdell ESA D. 529 Plan

The best answer is B. Coverdell ESAs and 529 plans are used to pay education expenses and offer no benefit when buying a home. The first $10,000 of 1st time home purchase expenses can be withdrawn from an IRA prior to age 59 1/2 without having to pay the 10% penalty tax. However, regular income tax is still due. The rules lay out as follows: The key to this question is that the individual wants to buy a house in 6 years. He is below the income phase-out range for a Roth, so he can contribute. As long as funds are held in a Roth for at least 5 years, and the withdrawal prior to age 59 1/2 is made for a "qualifying reason" (which is the case here), there is no tax due. If the contribution was made to a Traditional IRA, because this person earns $80,000 per year and is covered by another qualified plan, it would be a non-deductible contribution (it is above the $73,000 income limit for a deductible contribution in 2018). In that case, the $10,000 withdrawn would be subject to tax on any amount attributable to earnings in the account. This is a very picky question!

A valuation model used to predict portfolio performance is: A. net present value B. expected return C. internal rate of return D. inflation adjusted rate of return

The best answer is B. Expected return assigns a probability percentage to each possible rate of return for that asset class; multiplies the probability by the possible rate of return; and then "sums these up" to get the "expected" rate of return - which may vary higher or lower, depending on market conditions. Thus, it is a predictor of portfolio performance. Net present value is a means of determining the value of an investment's cash flows. Internal rate of return is the implicit yield of an investment's cash flows. Inflation-adjusted rate of return is the "real rate of return" - the actual rate of return minus the inflation rate.

Fundamental analysts would evaluate all of the following EXCEPT: A. Earnings trends B. Chart patterns C. Liquidity ratios D. Balance sheets

The best answer is B. Fundamental analysts select investments based on fundamentals such as earnings trends, balance sheet strength (liquidity ratios), management, etc. Technical analysts select investments based on chart movements, trading volumes, advance-decline ratios, etc.

Regarding Ginnie Mae Pass Through Certificates: I The certificates pay holders on a monthly basis II The certificates pay holders on a semi-annual basis III Each payment consists of interest only IV Each payment consists of a combination of interest and principal A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Ginnie Mae Pass Through Certificates "pass through" monthly mortgage payments to the certificate holders. Each payment is a combination of both interest and principal paid from the underlying mortgage pool.

A Registered Investment Adviser that is formed as a partnership has been in business for 15 years. They decide to merge with another investment adviser, in which they will have a 50% ownership interest. The RIA must: A. pay a new filing fee to the State B. have its existing clients sign an acknowledgment of the change of ownership C. liquidate its customer accounts and complete a new account application for each customer D. notify its customers of the change

The best answer is B. If the adviser is a partnership, any changes in the composition of the partnership must be told to customers; and if there is a change in the majority of the partners, the customer must sign a new advisory contract (since a majority change in a partnership is deemed to create a new business entity).

An investment portfolio indexed to the S&P 500 Index produced a return for the year of 12% with a beta of +1. Investment Manager "A" has an actively managed stock portfolio that produced at return for the year of 14.8% with a beta of 1.4. The "alpha" produced by Investment Manager "A" is: A. + 2% B. - 2% C. +2.80% D. -2.80%

The best answer is B. Investment Manager "A" produced a 14.8% return by assuming 40% more "risk" as measured by beta than if the portfolio was invested in a benchmark stock index with a beta of 1. To compare "apples with apples," a portfolio with a beta of 1.4 should return 1.4 times the benchmark index return of 12% = 1.4 x 12% = 16.80%. This manager produced a return of 14.8%, so the "alpha" (value of the active manager's expertise over investing in an index fund) is actually negative. This manager did worse, producing a negative alpha of -2%.

All of the following are examples of market manipulation EXCEPT: A. disseminating rumors B. churning C. painting the tape D. wash trades

The best answer is B. Market manipulation means that the price of a security is being manipulated in the market away from the true market value. Disseminating rumors to get people to buy or sell that stock, especially if it is thinly traded, will certainly get the price moving! "Painting the tape" is a term for doing rapid-fire buy/sell trades in that security to show action on the tape, without an actual ownership change. This activity will attract other market participants to trade, again moving the stock's price. Wash trading is another term for "painting the tape." Churning a customer's account is illegal, but it is not market manipulation. Churning is executing trades in a customer account that are excessive in frequency or size, just to generate commission income for that agent.

Constitutional debt limits are imposed on: A. self-supporting debt B. non-self supporting debt C. self-liquidating debt D. all of the above

The best answer is B. Municipalities impose debt ceilings on the dollar amount of bonds that can be issued backed by ad valorem taxing power (G.O. bonds). These are non-self supporting debts that are carried on the "backs" of taxpayers. To raise this limit requires a public referendum. Self supporting or self liquidating debts are financed by some enterprise activity. These are revenue bond issues. Since they pay their own way from the pledged revenue source only, they are not subject to constitutional debt limits.

Mutual funds must send their financial statements to shareholders: A. annually B. semi-annually C. quarterly D. monthly

The best answer is B. Mutual funds send their financial statements to shareholders semi-annually.

An IAR has been hired by an executor of an estate to manage the estate's financial assets until they are distributed to the heirs. The account holds the following assets: $2,000,000 ABC Common Stock with a Cost Basis of $600,000 $4,000,000 XYZ Common Stock with a Cost Basis of $4,000,000 The IAR believes that the ABC Common Stock position has peaked in value and is susceptible to a decline, while he also believes that the XYZ Common stock position has some near-term upside. The BEST action for the IAR to take is to: A. do nothing because the account assets must be distributed to the heirs within 9 months B. sell the ABC common stock position and retain the XYZ common stock position C. sell the XYZ common stock position and retain the ABC common stock position D. either hold or sell either of the stock positions using the prudent investor rule as a guideline

The best answer is B. One of the advantages built into estate taxes is that the assets are valued at market value as of date of death, and if there was any asset appreciation, this is not taxed as capital gains (this is called a "stepped up" basis). The goal of the IAR is to maximize investment returns using a time horizon of a maximum of 9 months (which is when estate tax is due). Because the IAR believes that ABC stock is peaking, he or she should sell the appreciated equity position (it has risen a lot!), locking in the gain without any capital gains tax due. The XYZ position should not be sold since it currently has no gains, but the IAR believes it has some near-term upside. If that occurs, then the estate can use the "alternate valuation date" 6 months after death to capture that gain without having capital gains tax liability. Choice D seems good and it also mentions "prudent man" - but the fact is that the greatly appreciated stock position should not be held if the IAR believes that the market is peaking. If the position were to be held untouched, it could lose a lot of its value in a falling market, and this is hardly the action that a "prudent man" would take.

All of the following statements are true about REITs EXCEPT: A. Gains may be passed to shareholders under conduit tax treatment B. Losses may be passed to shareholders under conduit tax treatment C. 75% of assets must be invested in real estate related activities to be regulated under Subchapter M D. 90% of Net Investment Income must be distributed to shareholders to qualify under Subchapter M

The best answer is B. REITs must distribute at least 90% of their Net Investment Income to be "regulated" under Subchapter M and thus qualify for conduit tax treatment. In addition, 75% of the REIT's assets must be invested in real estate related activities and 75% of its income must come from real estate related activities. Gains can be passed to shareholders under conduit tax treatment; however losses cannot be passed to shareholders. (Do not confuse REITs with Real Estate Limited Partnerships - abbreviated as RELPs - which are a tax sheltered investment that allow losses to flow through to investors).

When comparing Fannie Mae certificates to Ginnie Mae certificates, which of the following statements are true? I Ginnie Mae certificates are rated slightly higher than Fannie Mae certificates II Fannie Mae certificates are rated slightly higher than Ginnie Mae certificates III Ginnie Mae certificates will have a slightly higher yield than Fannie Mae certificates IV Fannie Mae certificates will have a slightly higher yield than Ginnie Mae certificates A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Since Ginnie Mae certificates are guaranteed by the U.S. Government, they are rated slightly higher than Fannie Mae certificates. In the same sense, though, since Fannie Mae certificates have a bit more risk (they are NOT guaranteed directly by the U.S. Government), they will have a slightly higher yield than Ginnie Mae certificates.

An investment adviser recommends that 10% of a customer's portfolio be allocated to small cap stocks. The customer disagrees with the adviser over this recommendation. The investment adviser should: A. explain to the customer that the benefit of asset allocation is to diversify the portfolio across all asset classes B. reduce the small cap allocation to 0% and further investigate the customer's financial situation and needs C. maintain the small cap allocation at 10% and explain to the customer why this is the most beneficial portfolio construction D. make an offer to reduce the small cap allocation to 5% and if the customer does not agree, terminate the advisory contract with the customer

The best answer is B. Since the customer is not comfortable with a portion of his portfolio being allocated to Small Cap stocks, which have a higher risk level, then follow the customer's wishes - after all, it is his account, not yours.

If an individual sells the shares of a stock included in the Standard and Poor's 500 Index and uses the proceeds to buy SPDRs, then the individual has: A. increased business risk B. decreased business risk C. increased regulatory risk D. decreased regulatory risk

The best answer is B. Since this customer is liquidating a single stock position, and investing the proceeds in an index ETF (which is diversified), the customer is reducing the unsystematic risk or business risk inherent in a single stock position.

A client purchases 1,000 shares of ACME Growth Fund in July of 20XX. In December of 20XX, the fund distributes a capital gain to its shareholders. This distribution is: A. taxable as a short-term capital gain based on the length of time that the client held the fund shares B. taxable as a long-term capital gain based on the length of time that the fund held underlying securities C. a tax-free return of invested capital D. exempt from taxation at the State level but not at the Federal level

The best answer is B. Taxation of mutual fund distributions is based on the length of time that the fund held the underlying securities. All fund distributions, whether they are dividends, short term capital gains or long term capital gains, are reported to shareholders and to the IRS on Form 1099-DIV. If a fund has held securities for more than 1 year and sells them at a profit, the resulting gain is reported on Form 1099-DIV in the box titled "Total Capital Gains Distribution." Long-term capital gains are taxed at a preferential maximum 15% rate (this increases to 20% for individuals in the highest tax bracket). If the fund distributes a dividend where the source of the distribution is dividends received from a portfolio of equity securities, these are reported on Form 1099-DIV in the box titled "Qualified Dividends" and are taxed at a preferential maximum 15% rate (this increases to 20% for individuals in the highest tax bracket). If the fund distributes a dividend where the source of the distribution is dividends received from a portfolio of debt instruments or short term capital gains from securities sold at a profit, these are reported on Form 1099-DIV as ordinary dividends ("non-qualified") and are taxed at ordinary income tax rates of up to 37%.

To evaluate investor sentiment, a technical analyst would examine all of the following EXCEPT (the): A. Put / Call ratio B. Revised corporate earning reports C. Short Interest figures D. Odd lot transactions

The best answer is B. Technical analysts do not look at the fundamentals of a company, such as earnings reports, in order to make investment decisions. Instead, they examine market movements and indicators such as the makeup of odd lot transactions, the put / call ratio, and short interest figures. The odd lot theory holds that small investors trade odd lots and they are always wrong. If odd lot purchases exceed odd lot sales, this is a sell indicator. If odd lot sales exceed odd lot purchases, this is a buy indicator. The put / call ratio measures the number of put contracts outstanding to the number of call contracts. If the ratio is very high, this is an indicator that the market is "oversold" and is ready for an upturn; if the ratio is very low, this is an indicator that the market is "overbought" and is ready for a down turn. The short interest figures are tallied on the15th and last day of each month and show the aggregate short positions for each listed security. A large short interest, while bearish in the short term, is bullish in the long term. This is true because if prices rise, the shorts will cover, adding to the buying in the stock.

Dealers are showing the following quotes for DEFF stock: DEFF Stock Bid Ask Size Dealer A 6.75 6.95 10 x 20 Dealer B 6.60 6.85 5 x 10 Dealer C 6.65 7.00 15 x 25 The "size" of the market is: A. 5 x 20 B. 10 x 10 C. 15 x 20 D. 30 x 55

The best answer is B. The "inside market" is the high bid and low ask. These are the best prices at which to trade. Stocks are purchased from a dealer at the dealer's ask price - and paying less to buy is better - so the low ask of $6.85 is the best price at which to buy. Stocks are sold to a dealer at the dealer's bid price - and receiving more to sell is better so the high bid of $6.75 is the best price at which to sell. Quotes are shown in Bid / Ask order, so the high bid is 6.75 and the low ask is 6.85. The size of this market is 10 x 10. Dealer A is posting the best bid of $6.75 and is willing to buy 1,000 shares (10 round lots) at that price. Dealer B is posting the best ask of $6.85 and is willing to sell 1,000 shares (10 round lots) at that price.

A corporation has issued $10,000,000 of 7 1/4%, 20 year, $1,000 par, convertible debentures, convertible at a ratio of 40:1. The bond is currently trading at 96, while the company's common stock is at 24. The parity price per share is: A. $20 B. $24 C. $25 D. $40

The best answer is B. The bond is currently priced at $960. For the common stock to be trading at "parity," 40 shares (the conversion amount per bond) must be worth the same $960. $960 divided by 40 shares per bond equals $24 per share parity price. Since the current market price is $24, this bond is trading at parity. The parity price formula is: $960 40

The dividend discount model can be used to determine: A. the yield of a common stock B. an approximate market price for a common stock C. the variability of a common stock's returns D. the variability of a common stock's price

The best answer is B. The dividend discount model takes the projected future dividend stream that a company will pay and "discounts" it back to its net present value, using a discount rate that is adjusted for the risk premium of investing in that company. This net present value gives an indication of what the current market price of the stock should be. It is not a yield measure, nor is a measure of variability (standard deviation of returns is a variability measure).

A customer's margin account statement shows the following: LONG Market Value: $200,000 Debit Balance: $124,000 SHORT Market Value: $6,000 Credit Balance: $10,000 SMA Available Balance: $12,000 The equity in the account is: A. $72,000 B. $80,000 C. $90,000 D. $134,000

The best answer is B. The equity in the long account is: $200,000 long market value - $124,000 debit = $76,000. The equity in the short account is: $10,000 credit - $6,000 short market value = $4,000. Total equity equals $76,000 + $4,000 = $80,000.

Under the Securities Exchange Act of 1934, credit extended to customers for the purchase of securities is controlled by the: A. Securities and Exchange Commission B. Board of Governors of the Federal Reserve C. Office of Comptroller of Currency D. Securities Investor Protection Corporation

The best answer is B. The extension of credit on securities is controlled by the Board of Governors of the Federal Reserve. Federal Reserve Regulation T controls credit on securities extended by brokers. Regulation U controls credit on securities extended by banks.

In 2018, a customer buys 1 GE 10%, $1,000 par debenture, M '33, at 115. The interest payment dates are Jan 1st and Jul 1st. The bond is first callable in 2028 at 102. The yield to call on the bond is: A. 6.96% B. 8.02% C. 8.37% D. 10.23%

The best answer is B. The formula for yield to call for a premium bond is: $100 - ($130 premium / 10 years to call) ($1,150 + $1,020) / 2 = $100 - $13 $1,085 = $87 $1,085 = 8.02% Note that because there is a 2 point ($20) call premium paid if the bond is called in 2028, $1,020 is the redemption price at that date. Also note that because of the 2 point call premium paid at early redemption, the full 15 point premium is not lost; rather, only 13 points ($130) is lost when the bond is called at 102.

The manager of a mutual fund is known as the: A. Sponsor B. Investment Adviser C. Custodian D. Underwriter

The best answer is B. The investment adviser manages the fund within its stated objective, deciding which securities to buy into the portfolio; and which securities to sell from the portfolio. The custodian bank always safekeeps the assets and usually acts as both paying agent and transfer agent. The sponsor of a mutual fund establishes the fund and registers the fund with the SEC before the security can be sold.

An investment adviser wants to charge a monthly fee to customers that engage in frequent options trading, equal to 6% of monthly options transaction volume. The adviser includes the options transaction fee in the brochure filed with the Administrator and discusses the fee with each customer that engages in options transactions. Which statement is TRUE? A. The monthly options transaction fee can be charged to customers because it has been disclosed to both the adviser's customers and to the State Administrator B. The monthly options transaction fee cannot be charged to customers because it is excessive C. The charging of a monthly options transaction fee is permitted without restriction D. The monthly options transaction fee is not permitted because such fees can only be charged quarterly or annually

The best answer is B. The overriding issue here is the fact that charging excessive fees is a prohibited practice - and a fee equal to 6% of options transactions is excessive. You could make an argument that because the fee was discussed with the customers and disclosed in the adviser's brochure, that makes it OK - but this is not the case.

A person who maintains an orderly market in a given security on a stock exchange floor is a(n): A. floor broker B. specialist/DMM C. insider D. floor governor

The best answer is B. The person who makes an orderly market in a given security on a stock exchange is the specialist (who specializes in making a market in that stock) - also known as a Designated Market Maker. Floor governors on the exchange are not market makers - they supervise trading in all stocks on the floor. Floor brokers manually handle the larger orders or special instruction orders on the exchange floor that cannot be routed through automated trading systems.

Which statement is TRUE? A. Market Maker = Agent B. Dealer = Market Maker C. Trader = Registered Representative D. Agent = Dealer

The best answer is B. The secondary market is the trading of issues outstanding in the market. The individuals making the secondary market are the market makers (also known as dealers). The firms "position trade" - meaning that they buy securities into their inventory and sell them out of their inventory. A trader acts as an agent, executing orders for retail customers with market makers or other traders. Traders do not maintain an inventory of securities. Both market makers (dealers) and traders deal with the public through registered representatives (retail brokers).

A customer makes the following investments in ABC stock: Date Amount Price Per Share 1/1 $6,000 $10 4/1 $6,000 $12 7/1 $6,000 $15 10/1 $6,000 $20 What is the customer's average cost per share? A. $13 B. $13.33 C. $14.25 D. $14.50

The best answer is B. This is a dollar cost averaging example. Date Amount Price Per Share # Shares Purchased 1/1 $6,000 $10 600 4/1 $6,000 $12 500 7/1 $6,000 $15 400 10/1 $6,000 $20 300 Total Investment = $24,000 Total Number of Shares Purchased = 1,800 Average Cost Per Share Purchased = $24,000 / 1,800 shares = $13.33 per share. Note that this is lower than the straight average price per share over this time period (which is $10 + $12 + $15 + $20 = $57 / 4 = $14.25).

Mutual fund performance charts show: I Time Weighted Average Return II Dollar Weighted Average Return III a return that is affected by investor cash inflows and outflows IV a return that is not affected by investor cash inflows and outflows A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Time Weighted Average Return is used by mutual funds on their performance charts to show average annual investment returns. It measures how well the fund manager performed in increasing the dollars that have been invested. Additional cash moving into the fund or out of the fund does not affect the computation. This is the average annual return that would be provided from a "buy and hold" strategy. Dollar Weighted Average Return is the same as the Internal Rate of Return. It is the discount rate that takes all of the cash flows from the investment. Dollar Weighted Return takes into account the impact of cash inflows and outflows from purchases and sales as well as growth in assets. The classic comparison of these 2 returns is where a fund receives a large cash inflow after a period of superior performance (which attracted the new investors to the fund) and then suffers a period of poor performance. Time Weighted Average Return shown over the following periods will be much higher than the Dollar Weighted Average Return experienced by the new investors. For example, $100 is invested in a fund at the beginning of the year with a $10 per share NAV = 10 shares purchased. After 6 months, the NAV per share increases to $20 per share and the happy customer invests another $100 (5 more shares). At the end of the year, the NAV falls back to $10 and the investor sells all 15 shares. In this example, the Time Weighted Average Return will be 0% (because the NAV per share was the same at year beginning and year end). However, this customer invested a total of $200 and sold the shares for $150 at year end, experiencing a $50 loss. This equals an annualized dollar weighted average return (IRR) of approximately -25%. If the investor did not make the additional cash deposit at mid year and did not sell the shares at year end, then the 2 measures would have been the same.

An investor buys 1,000 shares of XYZ stock at $34. It goes to $43 in the next year and pays a $3 dividend. At the end of the year following, the stock is trading at $40 and the stock pays another $3 dividend. What is the total return? A. 15.0% B. 17.7% C. 30.0% D. 35.3%

The best answer is B. Total return must be presented on an annualized basis. This stock paid a $3 dividend during each of the last 2 years. Over these 2 years, the stock's price went from $34 original cost to $40 at the end of the second year, for a total capital gain of $6 over 2 years = $3 capital gain per year. $3 Dividend + $3 Capital Gain $34 per share = 17.7% Note that the relevant market price for the capital gain is the current market value of $40 per share - any interim price is irrelevant.

All of the following statements are true regarding repurchase or reverse repurchase agreements EXCEPT: A. Under a reverse repurchase agreement, the dealer is buying securities from the Federal Reserve B. If a repurchase agreement extends for longer than overnight, the agreement is known as a "Due Bill" repurchase agreement C. Repurchase agreements are used by dealers to reduce the carrying cost of Government securities held in their inventory D. Repurchase agreements are initiated by the Federal Reserve to loosen the money supply

The best answer is B. Under a "repurchase agreement", a government securities dealer sells some of its inventory to another dealer or to the Federal Reserve, with an agreement to buy back the securities at a later date for a pre-established price. In this manner, the dealer gets a temporary inflow of cash. Since government dealers finance their inventory, by reducing the amount of inventory on hand, they are reducing inventory finance charges when such an agreement is employed. Under a "reverse repurchase agreement", the dealer is buying securities from the Federal Reserve, draining the dealer of cash. Choice B is false. Under any repurchase agreement, the underlying government securities are the collateral. The collateral that underlies the agreement must be transferred from seller to buyer to support the transaction. In previous years, dealers could do repurchase agreements that were backed by a promise to deliver the underlying securities (a "due bill" for the securities) instead of making physical delivery. Due bill repurchase agreements are no longer permitted.

A father is writing his will (the testator) and is naming as beneficiaries his 2 adult sons - Son A and Son B, and their children. Son A has 2 children - A1 and A2. Son B has 1 child - B1. Each one will get an equal share "per capita" of the father's estate upon the father's death. Son B predeceases the testator. This means that: A. Son A gets 100% of the assets of the estate upon the death of the testator B. The grandchild B1 gets 25% of the assets of the estate upon the death of the testator C. The grandchildren A1, A2, and B1, each get 33% of the assets of the estate upon the grandfather's death D. No assets will be distributed upon the death of the testator until the grandchildren become adults

The best answer is B. When a will is created, the estate can be distributed either "per capita" or "per stirpes." These 2 ways deal with the issue of a named beneficiary dying before the testator. "Per capita" is Latin for "by the head." What this means is that each NAMED living family member gets an equal share of the estate. In this case, the father has named the 2 sons and their 3 children as the beneficiaries "per capita" - so there are 5 names and each gets 1/5th of the estate. If 1 of them predeceased the testator (as is the case here with Son B dying first), then the estate would be divided "per capita" 1/4th each among the remaining 4 living named beneficiaries.

A customer that is long crude oil (a physical commodity): I can hedge by buying an oil futures contract II can hedge by selling an oil futures contract III typically plans on selling the crude oil at a future date in the cash market IV typically plans on selling the crude oil by making delivery on the contract delivery date A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A short futures contract establishes a pre-set sale price for the oil at the future date. If the price of oil declines, the customer will take a loss on the long crude oil position, but would have an equal gain on the short futures contract. Less than 3% of futures contracts are ever settled by physical delivery. To make a physical delivery, the crude oil would have to be delivered to a facility specified by the clearing house - which could be thousands of miles away. Rather, the customer is much more likely to sell the oil locally at the market price and not incur the transportation costs.

Which of the following are permitted investments in an IRA? I U.S. minted gold coins and gold bullion II Partnership units III Art IV REITs A. I and II only B. III and IV only C. I, II and IV D. I, II, III, IV

The best answer is C. A strange but true fact - IRAs can invest in U.S. minted gold coins and gold and silver bullion. They cannot invest in collectibles, artwork or life insurance. They can invest in REITs. There is no prohibition on investing in partnerships, but the only thing that makes sense are MLPs. MLPs are Master Limited Partnerships that trade like stock. These are liquid investments

A public company has high cash reserves that are set aside in a "rainy day" fund. The company has a price-earnings ratio of 6:1 while its industry group has a price-earnings ratio of 12:1. The common stock of this company would be classified as: A. blue chip B. growth C. value D. bellwether

The best answer is C. A value stock is one that offers good "value." These are companies that are "undervalued" as measured by low price-earnings ratios and low price to book value ratios (a company with a lot of cash and a lower-than-industry-average stock price will have a low price to book value ratio.) The "idea" is that the market will realize that these companies are "undervalued" and their prices will rise accordingly. Blue chip stocks are established industry leader stocks with large market capitalizations; strong management; and strong profitability in good times or bad. A bellwether stock is one that leads its industry segment. A growth stock is one that has higher-than-average growth and a high price-earnings ratio to go along with that.

During a period of stable interest rates, which type of preferred stock would show the greatest price volatility? A. Cumulative B. Convertible C. Participating D. Callable

The best answer is C. Preferred stock is interest rate sensitive, since it is a fixed income security. As market interest rates rise, preferred stock prices fall. As market interest rates fall, preferred stock prices rise. If market interest rates are stable, preferred stock prices should be stable as well. However, participating preferred stock gives the preferred participation in any "extra" dividends declared by the company to its common shareholders. Thus, the declaration of such an extra dividend would make the preferred stock more valuable and its price would go up in the market - and this did not happen because market interest rates fell.

An investment adviser has a fee structure that states: Assets Under Management Annual Fee 0 - $1,000,000 2.00% >$1,000,000 - $5,000,000 1.50% >$5,000,000 - $10,000,000 1.00% >$10,000,000 Negotiable With Client Which statement is TRUE about such an arrangement? A. This is prohibited under NASAA rules because it favors customers with more assets under management B. This is prohibited because advisers cannot have negotiable fees C. This is permitted as long as the negotiated fee is less than 1% D. This is permitted without restriction

The best answer is C. An adviser cannot charge "unreasonable" fees. A fee structure that reduces the fee percentage for more assets under management is permitted and is reasonable. The adviser is also permitted to have negotiable fees, as long as they are reasonable and are consistently applied. Thus, the adviser could negotiate a fee lower than 1% for a customer that has $15,000,000 of assets to invest (it could not be more than 1%, since that would be charging the customer more than other customers that have a lower investment amount with the adviser.)

An investment adviser providing advice solely about municipal securities is subject to: I state registration II federal registration III state advertising filing requirements A. I only B. II only C. I or II D. I, II, III

The best answer is C. An investment adviser who provides advice solely about municipal securities is subject to either Federal or State registration, depending on the amount of assets the adviser has under management (note that this is not the case for an adviser that gives advice only about U.S. Government securities, where there is an exemption from Federal registration but not from State registration). There are no advertising filing requirements in a State for securities or transactions that are exempt; or for federal covered securities. Since municipals are exempt securities, the Administrator cannot impose an advertising filing requirement on offerings of these securities.

In March, an investment adviser wishes to increase its annual management fee from 1% of assets annually to 1.25% of assets annually, starting the following July 1st. In order to do this: I the investment adviser must amend the Form ADV filed with the State immediately II the investment adviser must amend the Form ADV filed with the State within 30 days III the adviser's customers must approve of the change by July 1st IV the adviser's customers are not required to approve the change A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Any changes to an advisory contract are a material change that must be filed as a Form ADV update with the State within 30 days. In addition, since this is a contract between the customer and the investment adviser, both parties must agree to any changes.

A client, age 40, covered by a high-deductible health insurance plan, opens a Health Savings Account and contributes the maximum permitted. She is currently healthy, but intends to use the money to pay for medical expenses that are expected after age 65. The best investment option in the HSA for this individual is a: A. bank account B. money market fund C. target date fund D. growth fund

The best answer is C. Health Savings Accounts (HSAs) are only available to individuals who are covered by high-deductible health insurance plans. A deductible contribution is made to the HSA (in 2018, it is a maximum of $3,450 for an individual and $6,850 for a couple). Earnings build tax-deferred and distributions used to pay for qualified medical expenses are not taxable - so there are 3 tax benefits. Since this person wants to use the HSA to pay for medical expenses expected in 25 years (at age 65 and later), a target date fund with an end-date 25 years in the future is the best investment option.

If the Federal Reserve Open Market Committee authorizes its trading desk to enter into system wide repurchase agreements, the effect will be to: I increase yields II decrease yields III raise debt prices IV lower debt prices A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. If the Federal Reserve trading desk enters into repurchase agreements with bank dealers, it is temporarily buying government securities from the dealers, giving them cash. This increases free reserves which can be loaned out by the banks. The net effect is to lower market interest rates since funds are readily available. If interest rates drop, debt prices will rise.

Which statements are TRUE about an issue that is registered in a State by Coordination? I The statutory cooling off period under the Securities Act of 1933 is 10 days II The statutory cooling off period under the Securities Act of 1933 is 20 days III The statutory cooling off period under the Uniform Securities Act is 10 days IV The statutory cooling off period under the Uniform Securities Act is 20 days A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. In order for Registration by Coordination to be effective in a State, the registration statement used for the SEC filing must have been filed with the State 10 business days prior to the proposed sale date. In contrast, the Securities Act of 1933 requires that the registration statement be filed with the SEC at least 20 days prior to the proposed sale date.

All of the following risks are essentially equivalent for long term corporate bonds EXCEPT: A. Interest rate risk B. Market risk C. Default risk D. Inflation risk

The best answer is C. Interest rate risk is the risk that market interest rates rise, forcing bond prices down. This is the same as market risk for bonds. In an inflationary environment, market interest rates rise, so bond prices are forced down. Thus, these 3 risks are very similar for bonds. Default risk is specific to each corporate bond issuer, so it is the exception in this question.

Offers of pre-organization certificates are exempt under the Uniform Securities Act if which of the following are TRUE? I Commissions or other compensation may be received in connection with the offering II Commissions or other compensation may not be received in connection with the offering III Advertisements are permitted IV Advertisements are not permitted A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Offers of pre-organization certificates are exempt under the Uniform Securities Act if no commissions are paid for soliciting potential subscribers; the number of subscribers is limited to 10 persons; and no payment is made by any subscriber. (This generally parallels the private placement exemption under State law, except that advertising is allowed for pre-organization certificates -but not for private placements.) Note that advertisements for such offerings are permitted because the intent of this law is to enable a new enterprise to obtain the minimum number of subscribers required to form the business under corporate law.

Which of the following statements are true regarding repurchase agreements? I Repurchase agreements typically mature in 1 to 90 days II Repurchase agreements are used by the Federal Reserve to influence money supply levels III Investors in repurchase agreements have no price risk IV Investors in repurchase agreements have no interest rate risk A. I and II only B. III and IV only C. I, II, and III only D. I, II, III, IV

The best answer is C. Repurchase agreements are used by the Federal Reserve to inject funds into the money supply. The agreement stipulates that the Fed buy government securities from the dealer's inventory, with an agreement to sell back those securities at a pre-agreed price (hence there is no price risk) at a pre-set future date. The dealer gets a temporary infusion of cash, which the dealer can use to buy other securities or (if the dealer is a bank) which may be loaned to someone else. Most repos are "overnight," though durations can extend for longer periods. Repos expose the dealer to interest rate risk because, even though the agreement stipulates that the securities will be repurchased at a pre-agreed price; if interest rates rise substantially, the actual value of those repurchased securities can fall dramatically. When the dealer attempts to resell the securities, it can incur a substantial loss.

The Board of Directors of a company will set which of the following? I Declaration date II Record date III Ex date IV Payable date A. I and II B. III and IV C. I, II, IV D. I, II, III, IV

The best answer is C. The Board of Directors will set the declaration date (the day the dividend was declared), record date (the date on which customer's name must be on the record books to receive the dividend), and the payable date (the day on which the checks are mailed). The ex date is set by the exchange on which the stock trades, based upon the report of the record date.

A customer places an order to "Buy 100 ABC @ $90 Stop". The customer wishes to buy the stock at: A. 90 per share B. the market price, if the market falls to $90 per share or lower C. the market price, if the market rises to $90 per share or higher D. a price that is no higher than $90 per share

The best answer is C. This order is a Buy Stop order, which is placed above the current market value. If the market price rises to $90, the order is elected and becomes a market order to buy. Once elected, the order is executed at the next available price as a market order. The order is executed, but the specific execution price is unknown.

A customer buys a TIPS at par with a 3½% coupon. Inflation stays at 4% over the life of the security. What is the total return on the investment? A. 3½% B. 4% C. 7½% D. This cannot be determined from the information presented

The best answer is C. Treasury Inflation Protection Securities (TIPS) give a fixed coupon rate (3½% in this example), but they also adjust the principal value of the bond up each year for inflation (4% per year in this example). At maturity, the investor gets the inflated principal amount. The Total Return on this TIPS would be 3½% annual income + 4% annual gain = 7½%.

A registered representative receives a telephone call from a customer who tells the representative to: "Sell my 500 shares of ABC stock at the market." The representative has the record of the customer purchasing the shares 2 years ago, but the shares were transferred into the customer's name and shipped to the customer at his home address. The representative asks the customer where the shares are and the customer responds as follows: "The shares are in a fireproof safe in my bedroom." The representative should: A. not accept the sell order because the stock is not in custody of the broker-dealer B. accept the sell order, but mark the order ticket short because the shares are not in custody of the broker-dealer C. accept the sell order, but mark the order ticket long because it can be reasonably expected that the customer will deliver the shares by settlement D. not accept the sell order because the stock is not in good deliverable form

The best answer is C. Under SEC rules, a sell order can be marked "long" if the representative determines the location of the shares and it can reasonably be expected that the shares will be delivered on settlement. The representative has determined that the customer has the shares at home, and since this is a long-time customer (the shares were purchased through that firm 2 years ago), it can be assumed that the customer will deliver them on settlement.

Which of the following securities issues MUST be registered in a State? I Common shares of a public utility II Subordinated debentures of a bank holding company listed in the Pink Sheets III Common shares of an industrial company listed in the OTCBB IV Investment company securities A. I and II only B. III and IV only C. II and III only D. I, II, III, IV

The best answer is C. Under Uniform State Law, securities issued by public utilities regulated under the Public Utility Holding Act of 1935 are exempt securities. While bank, and savings and loan issues, are exempt, securities issued by bank holding companies are not. So if a bank offers its own common stock, it must be registered in the state unless the security is "federal covered" - meaning that it is listed on a major exchange (NYSE, AMEX (NYSE American) or NASDAQ). The Pink OTC Market has no listing standards and is not an exchange. Common shares of industrial companies are non-exempt unless they are listed on a major stock exchange (blue chip exemption). The OTCBB (Over-The-Counter-Bulletin-Board) has no listing standards and is not an exchange. Investment company securities are federal covered securities, and cannot be required to be registered in the State - only registration with the SEC is required.

Under the Uniform Securities Act, it is unlawful for any person to offer or sell any security in a State unless the: I security is registered in the State II security is exempt from registration in the State III transaction is exempt in the State IV transaction is non-exempt in the State A. I only B. II and III only C. I, II, III D. I, II, III, IV

The best answer is C. Uniform State law requires that for a security to be sold or offered in a State, it must be registered in that State; or it must be a federal covered security; or it must be exempt from registration; or it must be sold in an exempt transaction. If a security is sold in a non-exempt transaction, then that security must be registered in the State. Also, please note that if an agent of a broker-dealer offers a security in a transaction that is either exempt or non-exempt - that agent must still be registered in the State!

An individual that has made a passive investment has bought into a: A. sole proprietorship B. general partnership C. LLC D. DPP

The best answer is D. A "DPP" is a Direct Participation Program - another name for a limited partnership tax shelter investment. In such an investment, the customer is a "passive investor" and has no management role. Management is performed by the general partner (each limited partnership must have at least 1 general partner and can have multiple limited partners). In a sole proprietorship, general partnership or limited liability company, each "owner" is an "active" participant in the business, making day-to-day business decisions.

The Specialist (Designated Market Maker) can handle all of the following orders on the NYSE floor EXCEPT a: A. market order B. limit order C. marketable order D. not held order

The best answer is D. A Specialist (Designated Market Maker) cannot exercise discretion over price or time of execution, and therefore cannot accept a not held order. Specialists accept market, marketable limit and limit orders for execution.

All of the following are considered when creating the financial profile for a customer EXCEPT: A. investment experience B. financial knowledge C. financial goals D. investment timing

The best answer is D. A customer's previous investment experience is relevant in determining the types of investments that this customer is comfortable with. Financial knowledge is relevant in determining how sophisticated the type of investment that can be recommended to the customer. Financial goals are a primary consideration in creating the customer's financial profile. Investment timing is not relevant to creating the financial profile; it is relevant once the investment vehicles have been selected. One wishes to time the investments so that they are made at the best possible prices.

All of the following terms are synonymous EXCEPT: A. principal B. market maker C. dealer D. agent

The best answer is D. A dealer is a market maker, who is a principal in a transaction, earning a mark-up or mark-down. An agent is a broker who is middleman in a transaction, earning a commission.

A defensive stock is characterized by: I earnings variability due to changes in economic growth II no earnings variability due to changes in economic growth III a stock price that tends to move in the same direction of the market as a whole IV a stock price that tends to move independently of the market as a whole A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. A defensive stock is one that is unaffected by the economic cycle. The classic defensive stocks are food, pharmaceuticals, tobacco, and beer.

The executor of an estate has which of the following fiduciary obligations? I Maintenance of records of transactions involving estate assets II Filing of the will in probate court and filing of tax returns for the estate III Payment of taxes due to State and Federal Governments IV Distribution of assets to beneficiaries of the estate A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. A person that assumes responsibility for managing the assets of another (an estate in this case) is required to carry out his duties with utmost care. The executor must act in the best interests of the estate and must oversee all legal, accounting, investment, and other professionals that render services to the estate. The executor must keep accurate records and must make all appropriate tax filings and payments. Finally, the executor must distribute the remaining assets of the estate to the beneficiaries.

The rate of inflation as measured by the Consumer Price Index has been rising rapidly over the last months. Ignoring other factors, the effect will be to: I raise stock market values II lower stock market values III raise bond market values IV lower bond market values A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. A rising inflation rate is a "lose-lose" situation for both the stock and long term bond markets. If the inflation rate rises, then interest rates are likely to rise, with short term rates rising more than long term rates (the yield curve "flattens" as the Fed tightens credit to tame inflation, with short term rates rising more than long term rates). If interest rates rise, then long term bond prices will fall fastest, and long bondholders will have large losses on their positions. Furthermore, during periods of inflation, corporate earnings tend to fall, because companies are not able to keep raising prices at the same pace as their costs rise. This lowered earnings outlook depresses stock prices. Thus, both stock and long bond prices tend to fall in inflationary periods. Instead, during these periods of high inflation, investors "flee to safety" - they abandon the stock and long term bond markets, and put money in short term money market instruments, which offer safety and relatively high interest rates during inflationary periods; and they also put money into real estate and other "hard" assets that tend to keep pace with inflation.

An adviser with $106,000,000 of assets under management has its main offices in Illinois and branch offices in Wisconsin, Indiana, and Missouri. Which statement is TRUE regarding registration of the adviser? A. The adviser must register only in Illinois B. The adviser must register in Illinois, Wisconsin, Indiana, and Missouri C. The adviser must register with the SEC D. The adviser must register with the SEC or the States of Illinois, Wisconsin, Indiana, and Missouri

The best answer is D. Any adviser with $100,000,000 or more of assets under management is a "federal covered adviser" that is only required to register with the SEC. The State cannot require registration of a federal covered adviser; but it can require a "notice" filing in the State along with payment of a fee. However, the SEC has issued an interpretation that advisers with $100-$110 million of assets have the option of registering with the SEC or with the states. Since this adviser falls into the $100-$110 million range, it has the choice of either becoming a Federal Covered Adviser or of registering in each State where it does business.

An investment adviser includes a list of its "Top Ten" recommendations made over the last year in its advertising. Under the Investment Advisers Act of 1940, which statement is TRUE? A. This is permitted if the adviser gets the permission of the issuers to use their names B. This is permitted if the adviser files the advertisement in advance with the SEC C. This is permitted without restriction D. This is a violation of the Act and is fraudulent

The best answer is D. Prior recommendations cannot be shown in investment adviser advertising - doing so is a violation of the Investment Advisers Act of 1940 (but the advertisement can offer to provide a list of prior recommendations upon request, as long as such list shows ALL recommendations made over the last 12 months; the date of the recommendation; the price at that time; the current market price; accompanied by a statement to the effect that "the performance of prior recommendations is not a predictor of future performance").

All of the following are defined as "giving advice about securities" under IA-1092 EXCEPT a person who: A. advises on the selection of an investment adviser B. prepares a list of securities that may be purchased without making specific recommendations C. prepares an asset allocation plan that specifies percentage investments in stocks, bonds, real estate and insurance D. charts the price movements of stocks and distributes them to subscribers

The best answer is D. Charting of the price movements of stock is not "investment advice." An investment adviser, under the Investment Advisers Act of 1940, is "a person who receives compensation for advising others about securities, or about the advisability of investing in securities." Under the SEC's interpretations, a person who prepares a "list" of securities is making an implicit recommendation of these securities and is giving advice; a person who prepares asset allocation plans is also giving advice (if one of the assets included is securities). Furthermore, a person who recommends investment advisers is also one who gives advice! A person who prepares and distributes charts of stock price movements is not giving advice. Note, however, that if this information is used by the preparer to determine which securities to buy or sell, it would be considered to be "investment advice."

A customer, age 55, is in the 30% tax bracket. The customer has a non-tax qualified variable annuity separate account to which he contributed $12,000 that has a current market value of $30,000. The customer takes a distribution of $10,000 from the account. The tax that will be due on this distribution is: A. 0 B. $1,000 C. $3,000 D. $4,000

The best answer is D. Distributions from non-tax qualified variable annuity separate accounts are taxed on a LIFO (Last In First Out) basis. The original non-tax deductible contribution of $12,000 was the first in. The tax-deferred build up of $18,000 occurred second. When distributions are taken, the "build-up" portion comes out of the account first and is taxed at regular tax rates. After the build-up is depleted, the original investment of $12,000 comes out of the account and is not subject to tax. The customer is withdrawing $10,000 - which is all counted as "build-up" for tax purposes (last in - first out). This is taxable at 30%, plus the customer must pay a 10% penalty tax on a premature distribution (prior to age 59½). The total tax due is 40% of $10,000 = $4,000.

An investment in common stock provides dividends equal to 4% per year and expected long term capital gains equal to 8% per year. For a lower-earning investor in the 30% tax bracket, the after-tax rate of return is: A. 8.40% B. 9.00% C. 9.60% D. 10.20%

The best answer is D. Dividends and long-term capital gains are taxed at a maximum rate of 15% for lower earners and 20% for the highest earners. Thus, the after-tax rate of return on the dividends is 4% (100% - 15% Tax Bracket) = 3.4%; and capital gains is 8% (100% - 15% Tax Bracket) = 6.8%. Thus, the after-tax rate of return is 3.4% + 6.8% = 10.2%.

A municipality has issued a general obligation bond. Which of the following are sources of income available for debt service? I Collected current ad valorem taxes II Collected back due ad valorem taxes III Fines IV Assessments A. I and IV B. II and III C. I, III, IV D. I, II, III, IV

The best answer is D. General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Ad valorem taxes, fines collected for paying taxes late, assessments of additional taxes, as well as fees collected that are not a specified income source for revenue bonds, are all sources of income backing G.O. issues.

A joint account is held as tenants in common. Which statement is TRUE upon death of one of the owners? A. The deceased owner's share bypasses the estate and bypasses probate B. The deceased owner's share does not bypass the estate but bypasses probate C. The deceased owner's share bypasses the estate but does not bypass probate D. The deceased owner's share does not bypass the estate and does not bypass probate

The best answer is D. If a joint account is owned as "tenants in common," there is a specified percentage ownership for each person in the account. If a single tenant dies, that person's share goes to the estate and is passed by will. The will is subject to probate before any distributions can be made from the estate.

A middle-aged couple that is renting an apartment wants to determine the amount of money needed today to buy a retirement home in 10 years. To calculate the amount of money that would be required to be invested today, all of the following are needed EXCEPT: A. expected rate of inflation B. assumed rate of return on investment C. current cost of the home D. risk free rate of return on investment

The best answer is D. In this example, we need to determine the capital needed 10 years from now to buy the house. To do so, we would take the current cost of the house and inflate it over the next 10 years by the expected rate of inflation. Then we need to take this future dollar amount and discount it back by our assumed investment return, to get the dollar amount that must to be invested today to fund this capital need The risk free rate of return is not part of the formula (unless the couple wanted to make their required investment in ultra-safe short term Treasury securities, which will give an extremely low rate of return - not the best idea).

All of the following business forms give a "flow-through" tax benefit and limited liability to owners EXCEPT: A. Limited Partnership B. S Corporation C. Limited Liability Companies D. General Partnership

The best answer is D. Limited liability is only provided by limited partnerships; corporations (whether S or C); and limited liability companies. Sole proprietorships and general partnerships have unlimited liability. Flow-through taxation is provided by S corporations, partnerships, sole proprietorships, and limited liability companies. The only business entities that provide both unlimited liability and flow-through taxation are general partnerships and sole proprietorships.

All of the following are advantages of owning preferred stock EXCEPT: A. it trades on exchanges like common stock B. it gives a higher return than long-term corporate bonds C. dividends received are taxed at long-term capital gains rates D. it is not subject to interest rate risk

The best answer is D. Preferred stock is a fixed income security, just like a bond, so it is subject to interest rate risk. This is the risk that as market interest rates go up, the prices of bonds and preferred stock go down. Preferred trades on exchanges like other stocks, so there is little marketability risk. In contrast, corporate bonds only trade OTC, so the market is less liquid. Preferred pays a higher dividend rate than the interest rate paid on bonds, because the dividend payment decision is discretionary on the part of the company's Board of Directors, whereas interest payments must be made, or a default will be declared by the bond trustee. An advantage of receiving dividends is that they are taxed at a preferential rate (15%) as opposed to bond interest that is taxed at ordinary income tax rates (up to 37%).

All of the following are objectives that a capital needs analysis would attempt to address EXCEPT: A. paying for a child's college 15 years from now B. the maturing of a medical resident's balloon loan 10 years from now C. having funds 20 years from now to enjoy a comfortable retirement D. borrowing 5 years from now using a home equity line to make a major home improvement

The best answer is D. Put simply, a "capital need" means that a specific sum of money is needed at a future date to meet an upcoming need or obligation. Thus, a capital need might be the need to pay for a kid's college; the need to accumulate enough money to make a down payment on a home purchase; the need to have the funds to pay off a maturing loan; the need to have enough funds for retirement, etc. Borrowing money is not a capital need, but it can be a way of meeting a capital need.

All of the following terms are synonymous EXCEPT: A. capital in excess of par B. capital surplus C. additional paid in capital D. retained earnings

The best answer is D. Retained earnings represents accumulated earnings of a corporation that have not been paid out as dividends. Capital in Excess of Par, Capital Surplus, and Additional Paid In Capital all refer the same account. Any monies that are paid by shareholders that are in excess of the stated par value are credited to this account.

A disadvantage of an S Corporation as compared to a Partnership is: A. longevity of the enterprise B. federal and state tax status C. ability to transfer ownership D. ease of formation

The best answer is D. S corporations must be formed by filing formation papers in the State and getting a certificate of incorporation. This requires legal fees and State filing fees. In contrast, sole proprietorships and partnerships (we are assuming they mean general partnerships) require no such paperwork. So S corporations are not as easy to form - this is a disadvantage. S corporations have an unlimited life, while partnerships have a fixed life, so this is an advantage of S corporations. Both S corporations and partnerships allow for flow-through of income and loss, so they are equal on this. S corporation shares can be transferred freely, while partnership interests cannot be transferred unless the other partner(s) approve, so this is an advantage for S corporations.

An offer of a tax-qualified variable annuity would be an unethical practice, if made to which of the following individuals? A. A school teacher B. A hospital technician C. A church administrator D. A telephone operator

The best answer is D. Tax-qualified annuities are offered via 403(b) plans and are available only to employees of not-for-profit entities such as hospitals; universities and school systems. Contributions are made by the employee and are deductible to the employee. Such a plan must be established by the not-for-profit employer. Telephone companies are "for profit" entities and cannot establish 403(b) plans. The "big kahuna" of 403(b) plans is "TIAA-CREF" - as in Teachers Insurance Annuity Association - College Retirement Equity Fund. TIAA-CREF administers most 403(b) plans of colleges, universities, school systems and hospitals across the United States.

An investment policy statement would NOT include: A. recommended allocations among differing asset classes B. expected returns of the recommended strategy and the expected range of these returns C. strategies used for selecting specific stocks in the equity portion of the portfolio D. disclosure of the fees that the adviser will earn for implementing the recommended strategy

The best answer is D. The investment policy statement prepared for a client for whom a portfolio is to be constructed details the allocation percentages for each chosen asset class; and the expected returns from each class along with the possible variance of these returns. In addition, it can detail any strategies used for "tactically" timing the market when choosing specific investments within each class. Thus, the customer has a written statement detailing the major aspects of how the portfolio will be constructed and managed. The statement does not include the fees that the adviser will earn. These would be disclosed separately to the customer.

ADAP Advisors is a State-registered adviser with 7 IARs. One of the IARs, Mark, leaves the employ of ADAP to join another advisory firm. His accounts are assigned by ADAP to the remaining 6 IARs at ADAP. By taking this action, ADAP: A. is required to notify each of Mark's customers of the change of IAR and get the customer's approval B. is required to send a negative consent letter to each of Mark's clients and if no response is received, the assignment is permitted C. has violated the Investment Advisers Act of 1940 because advisory contracts cannot be assigned D. is not required to take any further action

The best answer is D. The transfer of an investment adviser account to another investment adviser must be approved by the customer. However, this situation is different. The advisory client's account is being transferred to another IAR at the same firm. This is not an assignment of the account to another adviser. The customer's contract is with the advisory firm; not the IAR. The firm can reassign customer accounts to any IAR at the same firm without notifying the customer.

All of the following sources of REIT income are counted towards the 75% test required by Subchapter M EXCEPT: A. Net rental income B. Interest income from mortgages C. Real estate tax refunds D. Dividend income from investments

The best answer is D. To qualify as a regulated investment company, 75% of REIT income must be real estate related. This income includes rents, mortgage interest earned, and real estate tax refunds received (as a source of income, an REIT can buy a property and attempt to get its tax assessment lowered - any resulting tax refund is income to the REIT).