Series 66 Missed Questions 1A
Under the Investment Company Act of 1940, which of the following statements regarding the renewal provisions of an investment adviser's contract is not true? A) The renewal must be approved by either majority vote of the board or majority vote of the outstanding shares, as well as majority vote of the non-interested members of the board. B) The renewal may be executed orally, provided it is done within 2 years of the initial contract. C) The contract must be terminable upon no more than 60 days' notice. D) The renewal must state the adviser's compensation.
B) The renewal may be executed orally, provided it is done within 2 years of the initial contract. When an investment company employs an outside investment advisory firm to manage its portfolio, the act requires a written contract setting forth the adviser's compensation. The contract is for two years initially and must be renewed annually thereafter. The contract must be initially approved by a majority vote of the outstanding shares and the noninterested members of the board of directors and annually renewed by either a majority vote of the board of directors or of the outstanding shares, as well as a majority vote of the noninterested members of the board. The contract must be terminable at any time, with a maximum of 60 days' notice and with no penalty, upon a majority vote of the board of directors or of the outstanding shares, and it must terminate automatically if assigned. LO 3.a
DERP Corporation's 5% convertible debentures maturing in 2030 are currently selling for 120. The conversion price is $40. One would expect the DERP common stock to be selling A) somewhat below $30 per share. B) somewhat below $48 per share. C) somewhat above $30 per share. D) somewhat above $48 per share.
B) somewhat below $48 per share. The first step here is to compute the parity price. A conversion price of $40 means the debenture is convertible into 25 shares of the common stock (par of $1,000 divided by $40 = 25 shares). With a current market price of $1,200, the parity price of the stock would be $48. Because convertible securities generally sell at a slight premium over their parity price, the stock should have a current market value a bit less than $48 per share. LO 2.d
Buying a put option on a security one currently owns allows an investor to A) buy more stock if he exercises the put. B) receive the premium for the purchase of the put. C) increase his profit if the security declines in price. D) participate in additional gains if the security continues to increase in price.
D) participate in additional gains if the security continues to increase in price. This is an example of a protective put, that is, purchasing a put option on a stock the investor already owns. This allows the stockholder to lock in a sale price (the strike price of the put). If the market price of the stock continues to rise, the investor would not exercise the put. The put would expire, and the long stock remains in the account at the higher market price. The investor could hold the stock or sell it at the higher market price and in either case, the investor continues to participate in the additional gains. The protection (the hedge) occurs if the price of the stock falls. Then, the investor would be able to exercise the right to sell the stock at the strike price. That would offset the loss on the long position not generate additional profit. Remember that options buyers pay the premium; they do not receive it. And exercising a put gives the holder the right to sell the stock not buy it. Perhaps viewing an example will help. The investor owns 100 shares of ABC stock currently trading at $50 per share. Wanting to protect against a drop in price, the investor purchases an ABC put option with a strike price of 50 and pays a premium of 3. If the stock's price rises to $60 per share by the expiration date, the put option will expire worthless (who wants to put [sell] stock at $50 when it is selling for $60?). In this case, the investor has paid a premium of 3 points to ensure that the stock can always be sold (during the life of the option) for a price of $50 while still having the opportunity to participate in future price increases of the stock. In our example, the investor has gained $7 per share (the difference between the increase from $50 to $60 less the premium paid for the option). LO 4.b
The yield to maturity is: A) the annualized return of a bond if it is held to maturity. B) determined by dividing the coupon rate by the current market price of the bond. C) set at issuance and printed on the face of the bond. D) the annualized return of a bond if it is held to call date.
A) the annualized return of a bond if it is held to maturity. The yield to maturity reflects the annualized return of a bond if it is held to its maturity. The computation reflects the internal rate of return and is frequently referred to as the market required rate of return for a debt security. The rate set at issuance and printed on the face of the bond is the nominal or coupon rate. Dividing the coupon rate by the current market price of the bond provides the current yield. The return of a bond if it is held to the call date is the yield to call. LO 2.e
Which of the following statements regarding the economics of fixed-income securities are true? Short-term interest rates are more volatile than long-term rates. Long-term interest rates are more volatile than short-term rates. Short-term bond prices react more than long-term bond prices given a change in interest rates. Long-term bond prices react more than short-term bond prices given a change in interest rates. A) I and III B) II and III C) I and IV D) II and IV
C) I and IV There are two separate issues in this question: the volatility of rates and the volatility of bond prices. Short-term rates are more volatile than long-term rates and move more quickly than long-term rates. Often the most volatile interest rate is the federal funds rate, which is an overnight rate of interest. Given a change in rates, long-term bond prices move more than short-term bond prices because of the compounding effect over a much longer period. LO 6.b
Although investing in managed investment companies can provide many benefits, investors should be aware that disadvantages could include all of these except A) high expenses. B) limited liquidity. C) unpredictability of tax consequences. D) poor management performance.
B) limited liquidity. Open-end and closed-end are the two categories of managed investment companies. Liquidity is never a problem with open-end companies with the federal law requiring redemption at NAV within seven days and, because almost all CEFs are traded on exchanges, they have a ready market as well. Management fees can be high and, because performance is due to the efforts of the portfolio managers, some just don't do very well. Finally, the investor has no say in when the fund elects to take gains or losses and that can have an impact on the investor's personal return. LO 3.i
Regarding open-end investment companies, which of the following sales charges is based on the NAV per share? A) Sales load B) Commission C) Redemption fee D) 12b-1 fee
C) Redemption fee If the fund has a redemption charge (CDSC), it is based on the NAV per share, not the public offering price (POP). That is, if the client liquidated shares when the NAV was $10 per share and the POP was $10.50, the CDSC would be charged based on the $10 rather than the $10.50. Commission is not a term used with mutual funds. The 12b-1 fee is a charge against overall assets of the fund; it is not considered to be a charge related to the buying or selling of fund shares. LO 3.c
Under the Investment Company Act of 1940, which of the following statements is true about an investment company that wishes to contract with an outside investment adviser to manage its portfolio? A) The investment adviser must be under common control with the investment company. B) The contract must provide for a minimum notice of at least two weeks if the contract is to be terminated. C) The contract between the investment company and the investment adviser must be in writing. D) The initial contract must be approved by either the board of directors or a majority vote of the outstanding shares.
C) The contract between the investment company and the investment adviser must be in writing. One of the requirements of the Investment Company Act of 1940 is that the contract between a management investment company (open- or closed-end) must be in writing. The initial contract must be approved by a majority vote of the outstanding shares and the noninterested members of the board of directors. It is renewed annually by either a majority vote of the outstanding shares or the board of directors, as well as a majority of the directors who are considered to be noninterested parties. If the adviser and investment company had to be under common control, then there would be no way to engage an outside adviser. The contract must call for a maximum 60-day termination clause; there is no minimum. LO 3.a
A client with limited assets seeking additional income in retirement would probably find which of the following investment choices to be the least suitable? A) ETNs B) Treasury bonds C) Insured bank CDs D) ETFs
A) ETNs The question describes an individual with a low risk tolerance, so the Treasury bonds and CDs would certainly be considered appropriate. Because ETNs are a debt security backed solely by a single issuer while an ETF based on a specific index of debt securities represents a large group of issuers, ETNs are only suitable for those who can understand and take the risks involved. LO 5.c
A client has 100 shares of GHI when the stock undergoes a split. After the split, the client has A) no effective change in the value of the position. B) a proportionately decreased interest in the company. C) greater exposure. D) a proportionately increased interest in the company.
A) no effective change in the value of the position. When a stock splits, the number of shares each stockholder has either increases or decreases (in the case of a reverse split). The customer experiences no effective change in position because the proportionate interest in the company remains the same. LO 1.b
In a portfolio containing common stock, straight preferred stock, convertible preferred stock, and adjustable-rate preferred stock, changes in interest rates would be most likely to affect the market price of the A) straight preferred stock. B) adjustable rate preferred stock. C) common stock. D) convertible preferred stock.
A) straight preferred stock. Fixed income securities, such as straight preferred stock, are the most sensitive to interest rates among the alternatives listed. Convertible preferred stock is influenced more by the common stock because it is convertible into the underlying security. Because the dividend rate on adjustable rate preferred stock is usually tied to changes in interest rates, the price of this stock remains stable in the face of rising or falling rates. LO 1.c
Net asset value per share for a mutual fund can be expected to decrease if A) the issuers of securities in the portfolio have made dividend distributions. B) the fund has made dividend distributions to shareholders. C) the securities in the portfolio have appreciated in value. D) the fund has experienced net redemptions of shares.
B) the fund has made dividend distributions to shareholders. If dividends are distributed to shareholders, the fund's assets will decrease and value per share will fall accordingly. Appreciation of the portfolio and dividends paid to the portfolio will increase the value. If issuers have made distributions to the portfolio, the net asset value will increase. Net redemptions have no effect on the net asset value, because the money paid out is offset by a reduced number of shares outstanding. LO 3.b
A frequently used metric by analysts is the yield, or credit, spread. Common methods of computing this would be comparing which of these? Bonds of similar quality and similar maturities Bonds of similar quality and different maturities Bonds of different quality and different maturities Bonds of different quality and similar maturities A) II and III B) II and IV C) I and IV D) I and III
B) II and IV The term spread always signifies a difference. Therefore, the correct choices have to reflect some kind of difference. One way is when the quality (rating) of the bonds is the same but the length to maturity is different. A very common example of this is the U.S. 2-year Treasury note plotted against the 10-year Treasury note. The other method is to take bonds of different quality (ratings) having the same maturities. An example might be comparing two bonds with a 20-year maturity: one has a AAA rating and the other a BBB rating. LO 6.b
Market conditions are deteriorating and your client, who owns a plumbing business, is looking for a safe haven that will also provide some income. Which of the following would most likely be your recommendation? A) Precious metals B) High-yield bonds C) Commodity futures D) Rental real estate
D) Rental real estate In general, rental real estate will provide returns, even in a down market. Of note, the client is in the plumbing business which means that maintaining the property will be easier than someone in a white collar profession. Precious metals and commodity futures will generate zero income and high yield (junk) bond are definitely not the place to be in a sour market. LO 5.e
An investor purchasing 10 corporate bonds at a price of 102¼ each will pay A) $1,020.25. B) $10,202.50. C) $10,225.00. D) $1,022.50.
C) $10,225.00. At 102¼, each bond cost $1,022.50 (102 = 1,020 and ¼ of $10 = $2.50). There are 10 bonds so the total is $1,022.50 × 10 = $10,225. LO 2.c
Looking at the balance sheet, a corporation builds its capital structure with all of the following except A) cash. B) retained earnings. C) long-term debt. D) capital stock.
A) cash. A corporation's capital structure consists of its long-term debt plus shareholders' equity. Included in shareholders' equity are the equity capital (stock) and the retained earnings. LO 7.a
One of your advisory clients indicates that he would like to sell forward contracts in soybeans. It would be wise to warn the client that he will be facing which of these risks? Liquidity Creditworthiness of the buyer Lack of assurance that the delivery price will remain stable Location for the delivery may change A) II and III B) I and IV C) I and II D) III and IV
C) I and II Because there is no standardization for forward contracts, they are considered to be illiquid. Because there is no entity backing up the contract (as the OCC does with listed options), a seller must always be concerned about the ability of the buyer to pay. Although the market price probably will change, the delivery price is always agreed upon at the time of the contract, as is the method, location, and time of delivery. LO 4.e
An investor using yield curve analysis would expect to view bonds of A) a single issuer over varying maturities B) varying quality over a number of maturities C) similar quality over varying maturities D) varying quality of similar maturities
A) a single issuer over varying maturities The most common yield curves are drawn using U.S. Treasury securities. The curve is plotted using maturities ranging from the short-term T-bills to the long bonds. There are other curves drawn with bonds from other sectors, such as corporate bonds, to show the yield spread, but that is going beyond the scope of this question. LO 6.b
The Investment Company Act of 1940 requires certain types of investment companies to compute their net asset value on a regular basis. Excluded from this requirement are A) face-amount certificate companies. B) unit investment trusts. C) open-end management investment companies. D) closed-end management investment companies.
A) face-amount certificate companies. The two investment companies offering redeemable securities, open-end funds and UITs, must compute their NAV on a daily basis. Closed-end funds can do it daily; many compute every Friday. The concept of NAV makes no sense with a FACC. LO 3.a
One reason that a private equity fund may operate under the Section 3(c)(7) exemption of the Investment Company Act of 1940 is that A) it would be able to have more than 100 investors. B) greater liquidity would be assured. C) the compensation grid to the manager of a 3(c)(7) fund is higher than to a 3(c)(1) fund. D) investors would only need to be accredited rather than qualified.
A) it would be able to have more than 100 investors. Private equity funds operate under two exemptions found in the Investment Company Act of 1940. The 3(c)(1) exemption limits the number of investors to 100 while no such limit applies to the 3(c)(7) exemption. Under the 3(c)(7) exemption, all investors must be qualified, a significantly higher standard than accredited. Investment advisers to private funds generally have to register and the selection of which exemption to use doesn't impact that. As private investments, liquidity is very limited. The compensation to the manager of a private equity fund is not based on the exemption used. LO 3.d
One reason for including commodities in an investment portfolio is because they have a high correlation to A) the inflation rate. B) the stock market. C) the bond market. D) the U.S. dollar.
A) the inflation rate. Commodity prices tend to have a high correlation with the inflation rate. As inflation goes up, the value of the dollar generally falls. The relationship is inverse, a characteristic of negative correlation. As inflation increases, interest rates invariably do the same, leading to a decrease in bond prices. Stock prices have a random correlation to commodities—generally negative. LO 5.g
For a customer interested in buying an inverse exchange-traded fund (ETF) tracking the performance of the Standard & Poor's 500 Index, which of the following market views would make that purchase most inappropriate? A) Bullish or bearish B) Bullish C) Bearish D) Neutral
B) Bullish Inverse (short) ETFs are designed to deliver returns that are opposite of the benchmark index they are tracking. Therefore, buying an inverse ETF that tracks the S&P 500 Index at a time when the market outlook is bullish would be most inappropriate. If the index rises with the anticipated bullish market, the fund that delivers returns that are the opposite of the index would fall in value. LO 5.c
A 75-year-old customer asks if it is possible to sell his $500,000 variable life insurance policy to a party other than the insurance company that issued the policy. If a sale occurs, known as a life settlement, which of the following would be a violation of industry rules? A) Not requiring the insured to pass a physical exam before the sale B) Quoting the price using an exclusive buyer that handles all the firm's life settlements C) Requiring the customer to relinquish all ownership rights to the policy D) Disclosing that the buyer becomes responsible for all premiums while the insured is living
B) Quoting the price using an exclusive buyer that handles all the firm's life settlements Because of the limited secondary market for life settlements, any firm that engages in these transactions should obtain several bids to ensure the customer receives a fair price for the policy. LO 5.d
Some prominent stock market pundits are predicting that the economy will slide into a recession in the near future. Furthermore, they are expecting moderate deflation during the same period. If this were to happen, your clients would probably enjoy the greatest overall return from investing in A) real estate B) U.S. Treasury bonds C) common stock D) commodities
B) U.S. Treasury bonds The combination of recession and deflation leads us to a security with the highest safety. The other 3 choices tend to rise with inflation and, therefore, are often thought of as inflation hedges. But, deflation is the opposite and you'd want to be in fixed investments because their purchasing power will increase. LO 6.a
A benefit of active investment in real estate that is not available to purchasers of REITs is A) the Section 1035 exchange privilege. B) the Section 1031 exchange privilege. C) greater liquidity. D) dividends from active investments are generally qualified.
B) the Section 1031 exchange privilege. Under Internal Revenue Code Section 1031, no gain or loss is recognized on the exchange of real estate held for investment if such property is exchanged solely for real estate of like-kind, which is to be held for investment. This does not apply to REITs, where an exchange is considered a sale with a realized gain or loss for tax purposes. Section 1035 is similar in concept but deals with insurance products, usually annuities. Dividends are paid by corporations, not those who flip houses, and because most REITs are publicly traded, they are the ones with greater liquidity. LO 5.e
Which of the following is not included in the calculation of a mutual fund's NAV per share? A) Accrued management fees B) Accrued custodian bank fees C) Accrued sales charges D) Closing values of portfolio assets
C) Accrued sales charges Sales charges have nothing to do with a mutual fund's net asset value (NAV). The NAV is computed by subtracting all liabilities (it is the investor who pays the sales charge, not the fund) from the fund's assets. The principal asset is the portfolio, and that is valued as of the close of the markets, generally 4:00 pm ET. LO 3.b
KPT, Inc., is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? Tax rate Cash dividend Interest charged on bank loans A) II only B) I and II C) I and III D) I only
C) I and III Higher taxes mean less net income. Interest charged on loans is an expense item; increasing it lowers operating income. Dividends are paid out of retained earnings and have no effect on the net income the company reports. LO 7.c
The fee charged by some mutual fund companies if shares are redeemed within a specified time after being purchased is known as A) a breakpoint fee. B) a 12b-1 fee. C) a contingent-deferred sales charge. D) a forward pricing fee.
C) a contingent-deferred sales charge. Some mutual funds impose contingent-deferred sales charges (CDSC) on investors who redeem their shares within a specified period after purchasing them. These fees are designed to encourage investors to leave their money in the fund for longer periods. Typically, the amount of the contingent-deferred sales charge decreases the longer the investor owns the shares. LO 3.c
A manufacturer of soybean oil is concerned that the price of soybeans will increase over the next six months. The best strategy to employ would probably be A) a neutral hedge. B) a short hedge. C) a long hedge. D) a trimmed hedge.
C) a long hedge. The concern is that the price will go up. Just as with options, when we are concerned that the price of something will go up, we go long that item. With options, it would be a long call; with futures, it is simply hedging by going long (buying) the soybean futures. The soybean farmer who would be concerned about a decline in the price would go short soybean futures. LO 4.d
When investors tend to increase their investments in debt securities on the short end of the spectrum, it generally leads to A) short-term yields that exceed long-term yields B) an inverted yield curve C) a positive yield curve D) a flat yield curve
C) a positive yield curve Investors buying short-term debt rather than long-term debt will have the effect of driving the prices of short-term instruments up and, as a result, their yields down. This will produce a normal, or positive, yield. It is when the demand for bonds on the long end of the spectrum exceed demand for those in the near term that short-term yields exceed those of long-term yields. This creates an inverted or negative yield curve. LO 6.b
Investing in commodities could involve investing in any of these except A) industrial metals B) agricultural items C) consumer durables D) animals
C) consumer durables Commodity contracts are not available on consumer durables such as refrigerators and washing machines. They are available on agricultural items, such as corn, wheat, and soybeans. Likewise, investing in animal items such as cattle and pork bellies is possible. Finally, industrial items, primarily metals such as lead, zinc, and aluminum, are popular investments. LO 5.f
As defined in the Investment Company Act, investment companies include A) open-end companies, closed-end companies, and unit investment trusts. B) mutual funds, closed-end companies, and unit investment trusts. C) face-amount certificate companies, management companies, and unit investment trusts. D) diversified companies, nondiversified companies, and face-amount certificate companies.
C) face-amount certificate companies, management companies, and unit investment trusts. The act defines investment companies as being management companies, face-amount certificate companies, or unit investment trusts. Management companies are further categorized as being open-end or closed-end, diversified or nondiversified. LO 3.a
