Series 66 Chapter 3

13. When recommending a large investment in mutual fund shares to a client with a long investment horizon, the most suitable investment would typically involve: A. A shares B. B shares C. C shares D. M shares

Answer: A. A shares are most appropriate for long-term investors with the ability to take advantage of breakpoints (reduced sales charges available to customers investing larger sums). The back-end charges on B shares will eventually go away over time, but B shares have higher 12b-1 fees than A shares, which will end up costing the investor more over time. For example, B shares may have a 12b-1 fee of 1%, versus 0.25% for A shares. C shares carry a relatively high 12b-1 fee that will be undesirable in the long run.

37. A particular equity-indexed annuity has a participation rate of 80% with a 10% cap. If the market index returns 24%, the annuitant's rate of return will be which of the following? A. 10% B. 19.2% C. 24% D. 8%

Answer: A. An equity-indexed annuity pays the participation rate times the return of the index. If this rate exceeds the annuity's cap, however, the annuity will only pay the cap. To find the return, first multiply the participation rate times the index rate (0.80 x 0.24 = 0.192, or 19.2%). This particular annuity is subject to a cap that is lower than 19.2%, so the annuity will only pay the cap. In this example, the cap is 10%, so the annuity will pay 10%. If the cap were higher, such as 20%, the annuity would pay 19.2%.

50. Which of the following is true of hedge funds? A. They are subject to registration with the SEC if they have over $150 million in assets under management. B. Shares can be redeemed at any time. C. Shares can be traded on the open market. D. They are required to register under the Investment Company Act of 1940.

Answer: A. Hedge funds are subject to registration with the SEC if they have over $150 million in assets under management. They are illiquid assets that cannot be redeemed at any time, and there is not an open market for them. They are not required to register under the Investment Company Act of 1940.

46. A farmer will have a corn crop ready for harvest in six months. To avoid taking the risk of selling at the prevailing market price in six months, the farmer enters into a futures contract. The farmer is: A. Hedging B. Speculating C. Forwarding D. All of the choices listed

Answer: A. Hedgers use futures markets to insulate themselves against price movements. In this case, the farmer has entered into the futures contract to avoid market price risk in six months; therefore, the farmer is hedging. A speculator, in contrast, has a view on whether future prices will rise or fall and invests in way to profit from that view. The farmer is not speculating in this case. Forwarding is not a typical term used to describe an investment strategy

29. How are taxes on a variable annuity determined once it enters the annuitization phase? A. The IRS splits the annuity into original investment and earnings and taxes the earnings only. B. The IRS assumes the LIFO method and taxes earnings first. C. The annuitant pays taxes on the entire amount once the original investment equals capital gains. D. Like Roth IRA withdrawals, variable annuities withdrawals are not taxed during the annuitization phase.

Answer: A. Once an annuity enters the annuitization phase, the IRS splits the annuity into original investment and earnings. The annuitant only pays taxes on the earnings portion. The earnings will be taxed at the annuitant's ordinary income rate.

10. When proposing mutual funds to a client, POP enters the conversation when discussing: A. A shares B. B shares C. C shares D. All of the choices listed

Answer: A. POP is a factor with only those shares sold with a front-end sales charge—A shares. B and C shares are sold at the fund's per-share NAV.

25. What is the purpose of an assumed interest rate (AIR)? A. It helps to determine the amount of the annuity payments to the investor. B. It helps to determine the rate of return on a fixed annuity. C. It helps to determine the interest rate of the surrender charge on a deferred annuity. D. It helps to determine the interest rate charges on loans taken against the account.

Answer: A. The assumed interest rate is an expected rate that the annuitant and insurance company agree that the annuity will grow at annually. This expected rate is not an actual rate; instead, it is simply an "assumed" rate. The insurance company uses the AIR as a benchmark to help determine the monthly annuity payments to investors.

35. Sally has an annuity contract with an AIR of 5%. She receives $1,000 for her first check. The account returns 5% the following month. Which of the following would be the most likely amount for Sally's monthly check? A. $1,000 B. $1,050 C. $950 D. $1,100

Answer: A. The assumed interest rate is an expected rate that the annuitant and insurance company agree that they expect the annuity to grow annually. This expected rate is not an actual rate, but simply an "assumed" rate. Each month the AIR is compared to the actual rate of the account. If the account returns are better than the assumed rate, the monthly check will be greater than the check for the previous month. If the account returns are the same as the AIR, the check will be the same as that of the previous month. If the actual performance is worse than the AIR, the check will be smaller than the previous month's check.

21. Jane has a deferred annuity with a surrender period of seven years. After four years, she decides she wants to surrender the account. What is the result? A. Jane will pay a charge for surrendering the account. B. Jane will lose any additional earnings beyond the initial investment. C. Jane will not be penalized for surrendering the account. D. Jane must wait the full seven years to access her account.

Answer: A. When an annuitant decides to withdraw her money before the surrender period is over, she typically must pay a surrender charge.

3. When interest rates rise, which of the following are typically true about an open-ended bond fund? I. The NAV of the fund will go down. II. The NAV of the fund will remain unchanged. III. The fund's yield will increase in the longer term. IV. The fund's yield will decrease in the longer term. A. I and III B. II and III C. I and IV D. II and IV

Answer: A. When interest rates rise, bond prices fall, causing the NAV of a bond fund to decrease in the short-term and resulting in a short-term decrease in the bond fund's yield. The rising interest rates will also allow the bond fund manager to reinvest in bonds that pay higher rates as older bonds mature, however. This will result in the bond fund paying higher yields to its investors in the longer term.

48. Which of the following is not true of a RELP? A. Investors sometimes use losses from the RELP to offset their income. B. Each of its partners has limited liability. C. It may provide income to its investors right away. D. It comes with "flow-through" tax consequences for investors.

Answer: B. A RELP is a limited partnership that manages real estate. General partners in a RELP control its day-to-day operations and are subject to unlimited liability. As limited partnerships, RELPs come with flow-through tax consequences, meaning profits or losses associated with RELP investments appear on the income tax filings of individual investors and there are no corporate taxes associated with the partnership. Some RELP investors invest in a RELP with the expectation that their investment will lose money in its early stages. This is especially true for investors in high-risk RELPs. Any losses from a RELP can be used to offset an investor's income. Low-risk RELPs generally offer immediate income for investors and thus are the lowest-risk type of RELP. With that low risk comes low reward, however, and low-risk RELPS provide investors with the most limited potential returns.

12. According to the Investment Company Act of 1940, for 75% of its assets, a diversified mutual fund will have: A. No more than 5% of its assets in any one company and will own no more than 5% of any company's outstanding shares B. No more than 5% of its assets in any one company and will own no more than 10% of any company's outstanding shares C. No more than 10% of its assets in any one company and will own no more than 5% of any company's outstanding shares D. No more than 10% of its assets in any one company and will own no more than 10% of any company's outstanding shares

Answer: B. According to the Investment Company Act of 1940, for 75% of its assets, a diversified mutual fund will have no more than 5% of its assets in any one company and will own no more than 10% of any company's outstanding shares.

38. Which of the following is not an advantage of a variable life insurance policy? A. It gives the policyholder the ability to choose investments that better meet her goals. B. If the investments in the separate account grow, the guaranteed death benefit will also grow. C. The policyholder has a better chance of beating inflation for both the death benefit and the cash value. D. The policyholder has the ability to exchange the policy for a more traditional policy, such as a whole life policy, within the first two years of the contract.

Answer: B. As the investments in the separate account grow, the death benefit rises, but the guaranteed death benefit does not rise. On the other hand, if the investments start doing poorly, the death benefit will shrink; however, it cannot shrink below the guaranteed amount.

16. A mutual fund share that may charge an investor a contingent deferred sales charge if he doesn't own it long enough is known as a/an: A. A share B. B share C. Variable annuity D. Closed-end fund

Answer: B. B shares contain a contingent deferred sales charge. Instead of charging a front-end load as A shares do, B shares charge a back-end load upon selling, as well as a higher 12b-1 fee. After the investor participates in the fund for a designated amount of time, the back-end load goes away and the B shares essentially convert to A shares.

27. Leo and Katherine have been married for 25 years. Leo wants to set up an annuity so that his wife will receive payments beginning at his death and continue to receive them until her own death. Which of following payout options would be the best fit? A. Life with period certain B. Joint life with last survivor C. Life income D. Joint tenants in common

Answer: B. Because Leo wants payments to be distributed to his wife in the event of his death, joint life with last survivor would be his best option. With this type of payout option, payments continue until both parties have passed on. Under a life with period certain payout, payments continue for a designated period after the annuitant dies. This type of payment does not guarantee that Katherine will receive the payments until she dies. A life income payout ensures that only the annuitant will be paid during his lifetime. Finally, a joint tenants in common is a type of brokerage account and not an annuity payout option.

30. Sarah is a young, single mom who wants to make sure her two children are taken care of in the event of her death. She is in good health, but she wants to take precautions. She is on a limited income. Her financial adviser recommends that she take out a: A. Universal life insurance policy B. Term life insurance policy C. Variable life insurance policy D. Fixed annuity

Answer: B. Because Sarah is young and healthy, her risk of death is lower, and a term life insurance policy may be her best option. Sarah also doesn't have a lot of money to spend on life insurance. With term life insurance, premiums are low and the policyholder is insured for a fixed period of time.

42. Linda would like to borrow against her variable life insurance policy. She has a $100,000 cash value and a $250,000 death benefit. Which of the following is the maximum amount she can borrow by law? A. $0 B. $75,000 C. $100,000 D. $187,500

Answer: B. By law, an insurance company has to allow a policyholder to borrow up to 75% of the account's cash value. This would be $75,000.

4. David is considering an investment with the following characteristics: actively managed and invests exclusively in Asia, currently trades at a premium to the value of its underlying investments, can be bought and sold on the New York Stock Exchange, and is not redeemable. What type of security is David considering? A. Mutual fund B. Closed-end fund C. Unit investment trust D. ETF

Answer: B. David is considering a closed-end fund. Closed-end funds are one of the three main types of investment companies in the U.S. and must be registered with the SEC. Closed-end funds are typically actively managed and trade on an exchange. Additionally, unlike their investment trust and mutual fund cousins, they are not redeemable, which means investors in closed-end funds cannot sell their shares back to the investment company. ETFs do not generally trade at a premium or discount to the underlying net asset value, because unlike closed-end funds, ETF shares are redeemable to large investors who purchase big blocks of ETF shares in "creation units."

33. Which of the following is not a disadvantage of a variable annuity? A. The annuitant bears the investment risk. B. The annuitant is usually subject to purchasing power risk. C. It comes with high commissions and fees. D. There are surrender charges if the annuitant withdraws her money early.

Answer: B. Disadvantages of variable annuities include surrender charges if the annuitant pulls his money out early, high commissions and fees, the annuitant bears the investment risk, LIFO tax treatment for withdrawals, and mortality expense fees. Because variable annuities invest in the market, they usually have higher returns than inflation. For this reason, they are not subject to purchasing power risk.

49. Which of the following is not true of hedge funds? A. They tend to be illiquid investments. B. They are open to all investors. C. They often rely on a broader spectrum of investment strategies, including derivatives. D. They often share in investors' profits beyond a high-water mark.

Answer: B. Hedge funds tend to be illiquid investments because they are often subject to lock-up periods of up to two years, and investors can only redeem their shares at certain times. Hedge funds, unlike mutual funds, are not open to all investors. Instead, they often only allow up to 99 investors, and they are usually only open to accredited investors. Hedge funds rely on broader investment strategies, such as investing in derivatives to hedge risk and increase leverage. Hedge funds often share in investors' profits beyond a high-water mark, such as 5%.

9. Which of the following would be considered advantages of buying an open-end mutual fund? I. Diversification II. Liquidity III. Protection of principal IV. Tax-deferral A. I only B. I and II C. I and IV D. II and IV

Answer: B. Investors seeking ease of diversification and purchase/redemption process find it in mutual funds. Mutual funds, regardless of the investments within the fund, do not carry a guarantee of principal and are subject to taxes.

31. Mel wants to take out an annuity contract that offers him the maximum monthly payouts. He is unmarried and doesn't wish to include a beneficiary in his contract. Which would be most appropriate? A. Life with period certain B. Life income C. Joint life with last survivor D. Life with amount certain

Answer: B. Mel should select life income. With this option, he will receive the largest monthly check because this option provides him payments over the shortest amount of time and, therefore, is the least expensive payment type for the insurance company. It is also the only option that does not provide for a beneficiary to continue to receive payments. With the life with period certain option, Mel would receive a medium-sized monthly payment and could designate a beneficiary. Life with amount certain is not a payout option.

44. In March, Midwestern Agricultural shorts one September soybean futures contract at the current market price. One futures contract consists of 5,000 bushels of soybeans. At the time of the sale, the price of soybeans is 750¢ per bushel. Two months later the price of soybeans is 1,000¢ per bushel. Which of the following is true? A. If Midwestern Agricultural closes out its position, it will have gained $12,500. B. If Midwestern Agricultural closes out its position, it will have lost $12,500. C. If Midwestern Agricultural closes out its position, it will be obligated to receive 5,000 bushels of soybeans from the buyer of the contract. D. If Midwestern Agricultural closes out its position, it will have to deliver 5,000 bushels of soybeans to the buyer of the contract.

Answer: B. Midwestern Agricultural incurred a $12,500 loss on its investment. A seller of a futures contract makes money when the price declines. In this case, soybeans has risen by 250¢ per bushel. One futures contract is 5,000 bushels, so Midwestern Agricultural has incurred a $12,500 loss ($2.50 x 5,000).

18. A mutual fund breakpoint allows an investor to: A. Avoid a surrender charge by holding the investment past a certain date B. Lower her sales charge by investing more than a certain amount C. Lower her 12b-1 fees by investing more than a certain amount D. Exchange one fund for a different kind of fund within the same mutual fund family

Answer: B. Mutual fund breakpoints reward investors for investing larger sums in one mutual fund or a family of funds. Note that a representative who avoids helping clients take advantage of breakpoints in order to receive a higher commission is in violation of FINRA rules.

6. Which of the following two terms are associated with open-end mutual funds? I. Premium II. POP III. Accumulation units IV. NAV A. I and IV B. II and IV C. III and IV D. II and III

Answer: B. Open-end mutual funds are not sold at a premium (or discount) to their NAV. A sales charge may be added to arrive at a public offering price (POP), but a sales charge is not a premium. Accumulation units are what an investor buys when "accumulating" an annuity.

51. Karla has just started her career as a dental hygienist. She makes $40,000 per year. She rents an apartment and her only valuable asset is her Honda Civic. She is a risk-taker and is not too worried about the additional risk required to earn high returns. She has heard about a Regulation D private placement that was advertised in the newspaper, and is interested in investing in it. You have done due diligence on the issuing company and believe its stock can provide large financial gains down the road. What should you tell Karla about investing in this private placement? A. This seems like a suitable investment and you will arrange for her to purchase shares. B. She cannot invest, because she doesn't meet the requirements of the private placement. C. This is an unsuitable investment because even though she is a risk-taker, you have a fiduciary duty to make sure she invests prudently, and for someone with her income and investment experience, this investment would not be prudent. D. Even though you think it is not suitable for her, you buy it for her anyway, because as a securities professional, you need to listen to the customer.

Answer: B. Regulation D private placements that advertise publicly are only available to accredited investors. Karla is not an accredited investor, so she will not be able to make this investment.

2. What price will an investor pay when he purchases shares of a mutual fund? A. Market price B. Next calculated NAV C. Most recently calculated NAV D. Weighted average volume price

Answer: B. Shares of mutual funds are purchased through the issuer. When purchasing mutual funds, the shares will be priced at the NAV. The NAV is calculated once per day at the close of the market. When you place an order to purchase shares of a mutual fund, the price you will pay is the next calculated NAV. So if you place your order before the close of the market, you will pay the NAV that is calculated that day. If you place your order after the close of the market, you will get the next business day's NAV.

1. Which of the following is not a difference between open-end and closed-end funds? A. Shares of open-end funds can only be purchased through the issuer, while shares of closed-end funds can be purchased on the secondary market. B. Supply and demand dictates the price of open-end funds but not the price of closed-end funds. C. Shares of open-end funds are redeemable, while shares of closed-end funds are not. D. Shares of open-end funds are priced once a day, while closed-end funds are priced continually throughout the day.

Answer: B. Shares of open-end funds (mutual funds) are purchased and redeemed through the issuer, while closed-end funds can be purchased from the issuer during their IPO and then on the secondary market. Shares of open-end funds are priced at the next calculated NAV, whereas the prices of shares of closed-end funds are influenced by supply and demand (supply and demand has no effect on the price of open-end funds). Shares of open-end funds are priced once a day, whereas closed-end funds are priced continually throughout the day.

47. What is true under partnership democracy? I. The limited partners and general partner have equal votes in day-to-day management decisions for the DPP. II. The limited partners may invest in businesses that compete with the DPP. III. The limited partners may sue to remove the general partner. IV. The limited partners may not vote to dissolve the DPP. A. I and II B. II and III C. III and IV D. I and IV

Answer: B. The general partner manages the DPP on a daily basis; the limited partners may invest in businesses that compete with the DPP, sue to remove the general partner, and vote to dissolve the DPP.

22. Which of the following is true of an equity-indexed annuity? I. The value of the account is influenced by the performance of the stock market. II. The investor will never lose more than the amount that she put into the annuity. III. The investor receives the full benefit of the market upswing in the value of the annuity. IV. The investor only receives the participation rate of increase on the annuity. A. II and III B. I and IV C. II and III D. I and II

Answer: B. The performance of an equity-indexed annuity tracks the performance of the stock market index, such as the S&P 500. There is a chance that the investor could lose money because the insurance company could go out of business, and often, the insurance company will only guarantee a certain percentage of contributions with guaranteed minimum amount of growth.

24. A variable annuity might be preferable to a fixed annuity for which of the following reasons? I. Lower investment risk II. Likelihood of higher returns on investment III. Lower purchasing power risk IV. LIFO tax treatment A. II and IV B. II and III C. I and III D. III and IV

Answer: B. The separate accounts associated with variable annuities carry higher risk and allow for more diversity. They also make it more likely that an investor will increase her earnings in a variable annuity than she would in a fixed annuity. Because variable annuities usually invest in the equity markets, the returns tend to be higher than those associated with fixed annuities and are therefore more likely to beat inflation. LIFO tax-treatment is actually worse for the investor, because withdrawals are assumed to be earnings first and therefore taxable.

36. Typically, how long is the "free-look" period for a variable annuity? A. 7 or more days B. 10 or more days C. 30 or more days D. 2 business days

Answer: B. Variable annuities typically come with a "free look" period for investors. The length of the free-look period varies depending on the state, but it is typically between 10 and 30 days.

41. John would like to vote on important issues relating to his variable life insurance policy. He has a cash value of $100,000 and a death benefit of $250,000. How many votes will he receive? A. None, variable life insurance policy owners do not get to vote B. 1,000 votes C. 2,500 votes D. Not enough information is provided to answer this question

Answer: B. Variable life policyholders get to vote on important issues in the same way as mutual fund and variable annuity shareholders. Variable life policyholders get one vote per $100 of cash value. This is different from variable annuity and mutual fund owners, who get one vote per share.

17. A mutual fund's sales charge can be calculated by: A. Adding the POP and the NAV B. Subtracting the POP from the NAV C. Subtracting the NAV from the POP D. Multiplying the NAV by the 12b-1 fees

Answer: C. A mutual fund's full sales charge can be calculated by subtracting its NAV from its public offering price.

28. Susan purchased an annuity in a lump sum. She has chosen to have the payment of her benefits delayed for five years. Which of the following purchasing methods did she use? A. Immediate annuity B. Periodic payment deferred annuity C. Single premium deferred annuity D. Periodic payment immediate annuity

Answer: C. A single premium deferred annuity is purchased with a lump sum. Payment of funds is delayed until a later date that is selected by the annuitant. Susan's annuity purchase and payouts fit this description.

39. Which of the following is true about a variable life insurance contract exchange? A. An investor must be allowed to use it at any time during the first 36 months of his policy. B. The insured will need a new medical exam before the exchange can occur. C. The new premiums will be calculated using the same beginning date as that of the original policy. D. The policy can be exchanged with only a term insurance policy.

Answer: C. A variable life insurance policy owner has the right to exchange her policy for a traditional policy (typically whole life) with comparable features. Federal law requires the insurance company to make the exchange option available for at least the first two years of the policy. The new policy must offer benefits that are comparable to those of the old policy, and the health of the insured does not need to be reevaluated before the exchange takes place. The length of time of the policy will be carried over when calculating the new premium values

34. Which of the following is not an advantage of fixed annuities? A. The insurance company guarantees a minimum return on the investment. B. Any investment risk associated with them is borne by the insurance company. C. Loans taken against the policy are not subject to tax penalties. D. They come without contribution limits.

Answer: C. Advantages of fixed annuities include returns that are guaranteed by an insurance agency, investment risk that is born by the insurance agency, tax-deferred earnings,no contribution limits, and a death benefit. Early withdrawals, including loans, are subject to a 10% tax penalty and often surrender charges. Withdrawals taken before the contract has been annuitized are subject to LIFO tax treatment. This is a disadvantage because earnings are assumed to be taken out first and are taxed at the annuitant's ordinary tax rate.

7. All of the following help an investor partially lower his sales load on mutual fund purchases except: A. Breakpoints B. Letter of intent C. Conversion privileges D. Rights of accumulation

Answer: C. Conversion privileges do not help an investor lower his sales charge. Rather, they allow an investor to convert shares between different mutual funds in the same family without incurring a new sales charge.

43. For a variable life insurance policy, death benefits are calculated _____, cash values are calculated _____, and the NAV, which is used to calculate the separate unit values, is calculated _____. A. Monthly, daily, yearly B. Daily, monthly, daily C. Yearly, monthly, daily D. Yearly, daily, monthly

Answer: C. For a variable life insurance policy, death benefits are calculated annually; cash values are calculated monthly; and the NAV, which is used to calculate the separate unit values, is calculated daily.

8. Right of accumulation refers to an investor's right to: A. Reinvest her capital gains and dividends without paying a new sales charge B. Accumulate new shares of a mutual fund before other investors who did not previously own the fund C. Receive a lower sales charge if her existing investment appreciates past the next breakpoint D. Combine different mutual funds from the same family when she has accumulated a minimum amount

Answer: C. Rights of accumulation allow an investor to combine purchases and NAV growth over an extended period of time for the sake of calculating breakpoints.

19. A closed-end fund sold yesterday for 38.00. Today the same fund sold for 33.50 when it had an actual value of 33.10. Which of the following is true of the fund? A. It sold at a discount of .4. B. It sold at a discount of .1. C. It sold at a premium of .4. D. It sold at a premium of .1.

Answer: C. The fund's actual value was 33.10, and it sold for 33.50. This means the fund sold at a premium of 0.4. Yesterday's price is irrelevant. Closed-end funds can be sold at their NAV, a premium to the NAV, or a discount to their NAV.

14. Issuing new shares, canceling shares that sellers redeem, and distributing dividend and interest income to investors are all responsibilities of the investment company's: A. Underwriting company B. Custodian C. Transfer agent D. None of the choices listed

Answer: C. Underwriters sponsor and bear the costs of distributing funds. The custodian holds the assets, receives interest and dividend payments, and forwards them to the transfer agent for distribution to clients.

23. Mary contributed $50,000 to her nonqualified variable annuity. Eight years later, at the age of 60, she makes a random withdrawal of $75,000 from the annuity. How is the withdrawal taxed? A. $25,000 at the capital gains rate B. $75,000 at the capital gains rate C. $25,000 at her ordinary income rate D. $75,000 at her ordinary income rate

Answer: C. When a random withdrawal is made from an annuity, it is taxed using the LIFO (last in, first out) method. This means that the IRS would tax the deferred tax dollars as early as possible. The first $25,000 of earnings would be taxed at her ordinary income rate. The remaining dollars have already been taxed.

40. Which of the following is a feature of both whole and variable life insurance policies? A. Both are not securities. B. Both have a fixed death benefit. C. Both have fixed premiums. D. Both have guaranteed minimum returns on the cash value of the policy.

Answer: C. Whole life insurance is not a security, while variable life insurance is considered a security. Whole life insurance has a death benefit that is written in the prospectus; however, the death benefit may be higher if the insurance company gives out dividends. For variable life, there is a minimum death benefit, but beyond this, the death benefit will depend on the performance of the separate accounts. Both whole life and variable life have fixed premiums. Whole life offers guaranteed minimum returns on the cash value of the policy, while variable life does not. Instead, the returns on the cash value in a variable life policy are based on the performance of the separate account.

20. Which of the following are true of fixed annuities? I. Investments are deposited into the insurance company's general account. II. Investments are deposited into separate subaccounts that take on more risk. III. A fixed annuity is a security. IV. An equity-indexed annuity is an example of a fixed annuity. A. I and III B. II and IV C. I and IV D. II and III

Answer: C. With fixed annuities, contributions are deposited into the insurance company's general account and managed by the insurance company. The insurance company guarantees the payments and, therefore, is responsible for the risk. In contrast, variable annuities utilize separate accounts. The annuitant chooses from several subaccounts that operate like mutual funds. The amount in the account will vary based on the performance of the subaccount. Fixed annuities are not considered securities because insurance companies offer a guaranteed rate of return on them. An equity-indexed annuity is an example of a fixed annuity because it usually comes with a minimum guaranteed rate of return.

45. All of the following are true of futures contracts except: A. A futures contract is an agreement to buy or sell an asset at a future date. B. Futures contracts are traded on exchanges. C. Futures contracts trade in standard units. D. Purchasing a futures contract represents a right to do something rather than an obligation to do something.

Answer: D. A futures contract is an agreement to buy or sell an asset at a future date. Futures contracts trade on exchanges in standard amounts. For example, 5,000 bushels of soybeans is one futures contract. Futures contracts are different from options contracts, because they always involve an obligation on both sides of the contract. For example, purchasing a futures contract represents an obligation to deliver or receive an asset on a future date. If the buyer does not want to receive the asset on this date, he can trade the position before the exercise date.

11. Rank the following categories of mutual funds in order of volatility, from highest to lowest. I. Growth and income II. Balanced III. Growth IV. Equity income A. I, III, II, IV B. III, II, I, IV C. III, I, II, IV D. III, I, IV, II

Answer: D. A straight growth fund is the most volatile of these choices. A growth and income fund blends growth companies and dividend-producing companies. Equity income funds generally focus more closely on dividend-paying companies, and balanced funds will often own bonds, which are more stable than stocks.

32. Which of the following is not a benefit of a variable annuity? A. Earnings grow tax deferred B. No contribution limits C. Death benefit D. LIFO tax treatment for withdrawals

Answer: D. Advantages of variable annuities include the fact that they provide higher returns that can usually beat inflation, their earnings grow tax deferred, they come without contribution limits, and they provide a death benefit. Withdrawals taken before the contract has been annuitized are subject to LIFO tax treatment. This is a disadvantage because earnings are assumed to be taken out first and are taxed at the annuitant's ordinary tax rate.

15. From an investor's perspective, which of the following are advantages of having capital gains and dividends automatically reinvested in her mutual fund account? I. Avoiding taxation on the gains II. Avoiding market timing considerations by dollar cost averaging III. Purchasing new shares at POP IV. Purchasing new shares at NAV A. I and II B. II and III C. I and IV D. II and IV

Answer: D. Automatic reinvestment does not allow the investor to avoid or defer paying taxes on the gains but does permit the investor to purchase additional shares at NAV without sales charges. Another advantage of automatic reinvestment is that it allows the investor to avoid market timing considerations by dollar cost averaging.

26. Marco is receiving monthly payments for his variable annuity. If his last payout was $500 and this month the return on his account drops below the AIR, his next payment will be: A. $400 B. $500 C. More than $500 D. Less than $500

Answer: D. If the separate account's rate of return is less than the AIR, the next payment will decrease. Since this month Marco's actual return on his account dropped below the AIR, he will receive less than $500 for his next payment.

5. ETFs and equity index mutual funds both offer all the following except: A. Diversification B. Low expense ratios C. Tax efficiency D. Flexible trading

Answer: D. Like indexed equity mutual funds, ETFs (exchange-traded funds), typically track an equity index and, thus, offer the diversification and low expense ratios of indexed mutual funds. By tracking an index, ETFs and indexed mutual funds also have lower turnover (buying and selling of stocks in the ETF or mutual fund), which means that they generally report lower capital gains taxes than actively managed funds or investments. Hence, both are considered tax efficient. ETFs, however, because they represent a share of a fixed basket of stocks that is being traded on an exchange, can be traded in ways that an indexed mutual fund cannot. For instance, ETFs can be purchased on margin and sold short, while shares of an indexed mutual fund cannot.