Series 66- Chapter 12
After occurrence of the event for which a filing is required, when must a Form 8-K be filed?
4 days. Unless otherwise specified, Form 8-K must be filed or furnished within four business days after the occurrence of the event for which the filing is made. Form 8-K is required by the SEC to announce certain significant changes in a public company, such as a merger or acquisition, a name or address change, bankruptcy, change of auditor or accountant, or any other information that may be reasonable for a potential investor to know.
Over the past 10 years, the annual percentage returns for a mutual fund have been 7%, 8%, -9%, 8%, -4%, 5%, 6%, 8%, 10%, and 12%. What is the arithmetic mean?
5.1% The arithmetic mean (or average) is found by calculating the sum of a given set of data and dividing by the size of the data set. In this example, the sum of the data is 51 and the size of the data set is 10. Therefore, 51 ÷ 10 = 5.1%.
A corporate bond is purchased at its par value of $1,000 and later sold at a discount. This would be indicative of which of the following risks? I. Opportunity risk II. Credit risk III. Currency risk IV. Interest-rate risk
Answer is 2 and 4. The most likely the reason for the bond's price decline is that interest rates have risen. The risk of interest rates moving against a bond investor is referred to as interest-rate risk. Another possible explanation for the bond losing value is that its credit rating fell (credit risk
A top-down approach to investing would generally include all the following, EXCEPT : A) An analysis of specific companies within an industry sector B) An analysis of economic trends C) An analysis of various industry sectors D) An analysis of a specific company's past stock price
Answer is D.Analyzing the past stock price of a specific company is typical with doing technical analysis. However, when doing a top-down analysis, the first step is to identify economic trends, then identify specific sectors or industries that may benefit from that trend. Lastly, identify specific companies within a sector that may be affected by a specific economic trend.
What is the benefit of discounting the cash flows of a fixed-income security? A) It compares the price of a bond against the sum of the present values of the bond's future payouts B) It provides the most accurate measurement of interest-rate fluctuations and volatility for bonds having maturities of 10 years or more C) It will measure the degree of price volatility that a bond will exhibit if interest rates increase D) An adviser can focus on a company's long-term growth potential and its ability to repay the bond's principal at maturity
Answer is A. A discounted cash flow evaluates each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determines the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client.
If a portfolio manager has a diversified portfolio of large-cap stocks, it would use index options to reduce which of the following risks? A) Systematic risk B) Timing risk C) Nonsystematic risk D) Interest-rate risk
Answer is A. If a portfolio manager wants to hedge a diversified stock portfolio from systematic (market) risk, it could buy puts or sell call options on the index. If the market declines as a whole, the puts would provide the best hedge by becoming more valuable and would offset the risk. In the event the overall market declines, the call options would provide only limited protection through the collection of the premium on the expiring call options.
All of the following risks are associated with bonds, EXCEPT: A) Put risk B) Interest-rate risk C) Inflation risk D) Market risk
Answer is A. Some bonds contain a put feature, which allows the holder to put the bond or redeem it with the issuer at a put price before maturity based on a specific event. Being able to redeem the bond before maturity is not a risk
An investor who believes in the inherent efficiency of the markets would be least likely to adopt which of the following strategies? A) Tactical asset allocation B) Indexing C) Fundamental analysis D) Strategic asset allocation
Answer is A. Tactical Asset Allocation Tactical asset allocation is a form of asset allocation that is based on the belief that markets are NOT efficient and that market timing can be beneficial (i.e., altering a portfolio to take advantage of changing economic conditions). For example, an investor who believes that interest rates are going to rise soon might reduce the number of fixed-income securities in his portfolio. (An increases in interest rates will cause existing bond prices to decrease.) A person who believes that the markets are inherently efficient (the efficient market hypothesis) is unlikely to engage in a market timing strategy. Instead, this type of investor is more likely to use a passive approach to investing, such as strategic asset allocation or indexing. Some proponents of the efficient market hypothesis do believe that fundamental analysis can be a useful tool in identifying investments that will outperform the market
Barry McKenna's equity portfolio was strongly correlated to the performance of the S&P 500 Index. Barry was concerned that the S&P was overdue for a correction, so he liquidated the portfolio and moved to short-term Treasury securities that were yielding 2%. After one year, the S&P 500 returned 8%. What is the BEST term to describe the difference in the Treasuries and the S&P 500 as it relates specifically to Barry's situation? A) Opportunity cost B) Systematic risk C) Interest-rate risk D) Reinvestment risk
Answer is A. The best choice here is opportunity cost. Opportunity cost is a term used in a variety of ways in economics. For purposes of the question, the focus here is on investment choices. Opportunity cost is the difference in return between an investment made and one that is not made. In this case, Barry invested in a Treasury and it returned 2% over the year. Barry gave up the opportunity of his old portfolio which returned 8%. In this situation, his opportunity costs are 6% (8% - 2%).
After analyzing the financial sector, an analyst writes a report indicating that he expects a downturn in that sector. This could BEST be described as: A) Market risk B) Liquidity risk C) Business risk D) Interest-rate risk
Answer is A. market risk. A downturn in the prices for an entire sector of the economy is a form of market risk. Business risk is the risk that one company, not an entire sector, will perform poorly
A client has been watching a thinly traded stock and has noticed that it has not had any trading activity today. What type of risk is the MOST significant for this type of investment? A) Inflation risk B) Liquidity risk C) Business risk D) Market risk
Answer is B. If a security is thinly traded, it indicates that the market for that investment is illiquid. If an investment has a wide spread, it means the difference between the bid and ask prices is larger than normal. Market risk, or the risk that the market will affect a security's value, is a real risk, but not the most significant one for a thinly traded stock. Even if the stock market increases, the stock itself may still be illiquid.
Which types of investments have historically shown a great deal of exposure to regulatory risk? A) Common stocks B) Limited partnerships C) Corporate bonds D) Variable annuities
Answer is B. Regulatory risk is the possibility that changes in the law or regulations can have an adverse impact on the value of investments. Although all kinds of investments can be subject to regulatory risk, limited partnerships have historically been particularly vulnerable. For example, adverse changes in the tax laws in 1986 caused the value of many limited partnerships to drop
To measure the variability of returns on various investments, you would use which of the following metrics? A) Standard duration B)Standard deviation C) CAPM D) Correlation coefficient
Answer is B. Standard Deviation Standard deviation is used to measure the variation of returns from the weighted mean return of a security. The greater the standard deviation, the greater the risk.
What is an investor's internal rate of return if she invested $1,000 and it has grown to $4,000 in 10 years? A) 300% B)14.4% C) 30% D) 7.2%
Answer is b. This question can be solved using the Rule of 72. In order to determine the internal rate of return using the Rule of 72, first determine how long it took for the investment to double in value. In this question, $1,000 doubles twice in 10 years (i.e., $1,000 x 2 = $2,000, then $2,000 x 2 = $4,000); which means it took five years for the investment to double once. Then, take 72 and divided by 5 to find the internal rate of return of 14.4% (72/5).
Which of the following statements regarding the differences between an annual rebalancing strategy and a buy-and-hold strategy over a 30-year period is FALSE? A) The equity portion in a buy and hold portfolio could grow in relation to the fixed-income portion, whereas a rebalanced portfolio will remain balanced every year B) The risk in a buy and hold strategy portfolio will match the investor's risk tolerance C) The tax and transactions costs will be lower with a buy and hold strategy D) The buy and hold strategy is easier to manage than a rebalancing strategy
Answer is B. The risk levels in a buy and hold portfolio will rise and fall, while a rebalanced portfolio will be adjusted periodically to meet the investor's risk tolerance. Rebalanced portfolios will also attempt to maintain the percentage of equity and debt in the portfolio, while buy and hold portfolios will allow the percentages to drift. One of the advantages of a buy and hold strategy is that transaction and tax expenses are minimized since there is generally no continuous buying and selling.
Which of the following can time-weighted return be used to evaluate? A) The rate of return an investor will earn if he holds a bond until it matures B) Comparing the performance of portfolio managers C) The return on the market that exceeds the risk-free rate of return D) The discount rate that will make future cash flows equal to the present market value of an investment
Answer is B. Time-weighted return is used to evaluate the performance of money managers. Time weighted return minimizes the impact of investor deposits and withdrawals, which cannot be controlled by the manager.
The expected return for a portfolio is 12%. The portfolio has a beta of 1.4 and the actual return is 18.8. What is the alpha? A) -2.00 B) -6.80 C) +6.80 D) +2.00
Answer is C. A portfolio's alpha is calculated by taking the actual return and subtracting the expected return. A portfolio's beta is used to determine the expected rate of return according to the capital asset pricing model (18.8 - 12 = +6.80). In this question, the portfolio has beta of 1.4, which is included in the 12% expected return. Conversely, if the actual return was 12% and the expected return was 18.8%, the alpha would be -6.80
Modern Portfolio Theory (MPT) defines risk as the: A) Possibility of loss of principal B) Possibility that returns will be less than the rate of inflation C) Variability of expected returns about the mean D) Slope of the regression line of portfolio returns versus the market
Answer is C. In MPT, risk is defined as the degree to which investment returns deviate from what was expected or predicted. It is usually measured by the standard deviation of expected returns about the mean (δ), although its square, variance (δ2), is sometimes used
An investor buys a two-year U.S. Treasury note that has a 6% coupon. If the note is purchased at par and held to maturity, what is the real rate of return over the holding period, assuming the CPI is 3%? A) 6% B) 3.3% C) 3% D) 6.3%
Answer is C. The method used to calculate the note's real rate of return (or inflation adjusted return), is to subtract the rate of inflation as measured by the CPI, from the note's coupon. Therefore, the real rate of return is 3% (6% coupon less the CPI of 3%).
A client of an IA has over 20% of his assets invested in a coal mining company's stock. The IA recommends greater diversification and indicates that stocks in this sector have been continually declining in value over the last 10 years. The client believes that the stock will eventually recover and refuses to sell it. The client's behavior may be described as: A) Overconfidence B) Regret aversion C) Conservationism D) Anchoring
Answer is D. Anchoring This is an example of anchoring. Anchoring involves a client being attached to the belief in an investment's potential upside despite indications to the contrary.
Which of the following choices is NOT a benefit of discounted cash flow, fixed-income analysis? A) It provides a means to measure and compare the value of investments that have different rates of return B)It allows for a direct comparison between the present value and the market value of a bond C)It makes it possible to determine the present value of a series of future payments D) It permits an adviser to minimize cash flow reinvestment risk
Answer is D. Discounted cash flow (DCF) analysis does not offer relief from reinvestment risk when investing in fixed-income securities. A discounted cash flow evaluates the present value of each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against current rates of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determines a fair market value of a bond. By comparing the value calculated by the discounted cash flow formula to the current market price of the bond, the adviser will be able to determine if the bond is an attractive investment for a client.
The prices of which of the following bonds would change the LEAST if interest rates rose? A) AAA-rated corporate bonds B) Zero-coupon bonds C) Treasury securities D) Short-term municipal notes
Answer is D. Short-term municipal notes the prices of short-term bonds tend to decline less when interest rates rise than bonds with longer maturities. Zero-coupon bonds also tend to be particularly vulnerable to increases in interest rates
A client wants to make a payment in perpetuity of $3,000 per year to a beneficiary. Assuming a 3% annual return, how much principal would your client need to deposit? A) $3,000 B)$30,000 C) $250,000 D) $100,000
Answer is D. The client would need to deposit $100,000. To calculate the required principal, take the annual payment in perpetuity of $3,000 and divide it by the annual rate of return of 3% ($3,000 / .03 = $100,000). The phrase in perpetuity may also be referred to as a perpetual payment, meaning that payments will continue to be made forever.
What's the formula for calculating total return? A) (Return on Investments - Risk Free Rate)/Standard Deviation B) Coupon Rate - Inflation Rate C) Risk Free Rate + Beta(Return on Market - Risk Free Rate) D) (Ending Value - Starting Value + Investment Income)/Starting Value
Answer is D. Total return measures an investor's return over his entire holding period. Total return incorporates capital gains or losses, adds investment income (e.g., dividends or interest) and then divides by the original investment.
Which of the following is a measure of risk according to the Modern Portfolio Theory? A) Correlation coefficient B) Beta C) Alpha D) Standard deviation
Answer is D. Under the Modern Portfolio Theory, an investment's risk can be measured by calculating its standard deviation from its expected return. Alpha is a measure of diversifiable risk, while beta is a measure of non-diversifiable risk in the Capital Asset Pricing Model.
Which of the following terms BEST describes the process for calculating future value?
Compounding. To calculate future value, cash flows are compounded to determine the expected value at a future date. The process of compounding involves periodically reinvesting earnings on the principal. Amortization is an accounting term that's used to describe how a company recognizes certain costs/expenses over multiple years. Annualizing is a situation in which a return for a certain period is projected out over the year. Since interest is not always compounded on an annual basis, compounding is the best answer
Those investors, who believe markets are not perfectly efficient, may use an active strategy in which the asset mix of a portfolio is altered in anticipation of economic events. This market timing approach is known as:
Tactical Asset Allocation Tactical Asset Allocation is used to identify and buy into sectors that are anticipated to outperform the market. Strategic asset allocation is used to assemble an investment portfolio based on the client's risk tolerance and objectives. As the assets change in value, the portfolio may then be rebalanced frequently. Indexing is a passive investment approach.
An investment advisory client's holdings consists of: $ 6,000,000 -- Stock/bonds $ 1,000,000 -- Money-market funds $ 3,000,000 -- Real estate, commodities $10,000,000 -- Total assets Would these holdings be considered a securities portfolio?
Yes, because more than 50% of the assets are in securities. When securities represent a majority of an investor's total assets, the investor is considered to have a securities portfolio. In this question, it is important to recognize that money-market funds are also considered securities. For this client, 70% of her total assets represent securities. When determining the amount of assets under management for an IA, the securities portfolios of its clients are included. The amount of assets under management are disclosed by the IA in Form ADV Part 1.
Why would an investor use a dollar cost averaging strategy to purchase bonds? I. To ensure that the average cost per bond is less than the average of the prices at which the bonds were purchased II. To ensure a profit on the bonds when they are sold III. To reduce timing risk in volatile markets IV. To reduce systematic risk in markets that lack volatility
answer is 1 and 3. Dollar cost averaging produces a cost per bond that is less than the average of the prices at which the bonds were purchased, assuming there was some price fluctuation. This helps reduce timing risk in volatile markets. However, it does NOT guarantee a profit, since the eventual sale price of the bonds could be less than the investor's average cost
As the result of a legislative change, municipal bonds have increased in value. Which of the following BEST describes the reason for this occurrence? A) S&P has slightly downgraded the rating of all municipalities B) There is a general increase in interest rates C) Income tax rates have increased D)The number of corporate IPOs has increased
answer is C. Legislative risk is the risk that changes in legislation will materially impact investment returns. When income tax rates increase, investors are required to pay taxes at a higher rate. If this happens, investors will seek investments that provide tax-free returns (e.g., municipal bonds). Therefore, as the demand for municipal bonds increases, so too will the value of these investments.
The Dividend Discount Model is BEST described as: A) A model that determines a stock's price based on past dividends. B) A relative valuation model that compares companies in the same sector. C) A model that determines a stock's price based on future dividends. D) A model that determines whether a growth stock is overvalued.
answer is C. The Dividend Discount Model indicates that the current value of a stock should be based on its future dividends which are discounted to present value. If the current market value of a stock is less than the discounted value of future dividends, it is considered a bargain. From a practical standpoint, the model has value for utility stocks, REITs, and companies that pay steady dividends.
A project manager is evaluating a project and determines that she needs an internal rate of return of 10%. Currently, the project has a positive net present value (NPV). Based on this information, the project's estimated internal rate of return (IRR) must be:
greater than 10%. When using the net present value calculation to determine if a project is a viable investment, a required minimum rate of return is established. In order for it to be viable, the cash contributed to the project plus the required rate of return need to be paid out of the project. If the NPV is positive, then the rate of return earned on the project is greater than required. However, if the NPV is negative, then the rate of return earned on the project is less than required
An individual who primarily invests in securities that have a low dividend payout ratio, a high level of retained earnings, and a high price-to-earnings ratio would be described as a:
growth investor. Stocks with high retained earnings and low dividend payout ratios are considered growth- oriented investments. A value-oriented investor would seek investment in stocks that have low price-to-earnings ratios, or below what is perceived to be the stocks' intrinsic value. A conservative investor invests in low-risk investments that have stable cash flows. This would be consistent with stocks that have a high dividend payout ratio. A contrarian invests in stocks that are currently out of favor with investors.
A dollar-weighted return is also referred to as:
internal rate of return A dollar-weighted returns is the same as the internal rate of return (IRR). It represents the discount rate that will make the present value of future cash flows (i.e., interest payments and principal) equal to the current market price (i.e., current value).
A client is in the 35% tax bracket. She has three children, ages 8, 12, and 16 and would like to invest in a 529 plan for the two oldest children. The client has $20,000 that she can invest in each account. If she anticipates her children will enter college at age 19, and will need $75,000 each for their college expenses over four years, an adviser would determine the future value of each account by inputting all of the following factors, EXCEPT the:
rate of inflation. The inflation rate is not a factor in the calculation of the future value of an investment. Future value calculation: Pn = P0(1 + r)n Pn = Future Value n = Number of compounding periods r = Rate of Interest P0 = Original Principal
