Series 7- Chapter 14 Types of Risk and Required Disclosures

A mutual fund invested in bonds with medium-length maturities. As the bonds matured, the fund reinvested the proceeds and purchased long-term bonds with maturities of up to 20 years. What might have happened to the fund if the reinvestment had occurred during a period when interest rates were rising? Decrease in yield Decrease in income Increase in yield Increase in income A) I and II B) II and III C) III and IV D) I and IV

C) III and IV The longer a bond's maturity, the greater the risk to the investor. As a result, long-term bonds generally pay higher interest rates than medium- or short-term bonds. If a fund replaces medium-term bonds with long-term bonds, the bonds would pay higher interest rates, and thus generate more income. Additionally, as interest rates increase, so do yields.

Which of the following best describes the investment characteristics of a high-quality long-term municipal bond? A) High inflation risk, high market risk B) Low inflation risk, high market risk C) Low inflation risk, low default risk D) High inflation risk, low default risk

D) High inflation risk, low default risk A longer term bond will be subject to more inflation risk. Because the quality of the bond is high, the level of default risk should be low.

Types of systematic risk

Market Risk Interest Rate Risk Reinvestment Risk Inflation Risk (Purchasing Power)

Designed to protect against inflation

TIPS

how is market risk measured?

beta

5 primary unsystematic risk:

business financial liquidity political regulatory

highest for investors whos portfolio contain stock in only one issuer or in lower rated bonds

business risk

operating risk, generally caused by poor management decisions

business risk

exists when a BD is owned by, is under common ownership with, or owns an entity that issues securities

control relationship

uncertainty that the value of either the foreign currency or the domestic currency will fluctuate

currency/exchange rate risk

there is no problem with a control relationship as long as it is

disclosed

Most susceptible to inflation risk

fixed income securities

when the market tanks, virtually all securities lose value

market risk

3 primary systematic risk

market risk interest rate risk inflation/purchasing power risk

political instability in the political underpinnings of the country

political risk

why would public utility stock be subject to interest rate risk?

price is largely determined by dividend yield. highly leveraged

a tender offer requires

shareholder approval

investment advisers must disclose ___ arrangements to their clients

soft dollars

good inflation hedges

tangible assets

one company to attempt to takeover another by acquiring a significant percentage of its voting shares. may also be made by an issuer of noncallable bonds when interest rates have fallen

tender offer

if the terms of the offer are changed, the revised offer must remain open for atleast 20 days from the commencement and ___ business days from the date the terms changed

10

tender offer under regulation 14E, must remain open for atleast __ business days from the date the offer is first announced

20

A client, who is a manager of a large pension plan, has recently changed the plan's portfolio weighting from 80% equities and 20% fixed income to 40% equities, 40% short-term Treasury debt, and 20% cash and cash equivalents. More than likely, this is an indication that the client's outlook concerning the market is A)unknown. B)bearish. C)bullish. D)neutral.

B

An investor has a portfolio containing 60% equities, 5% debt instruments, and 35% options and futures. Which of the following would best describe this investor's investment style? A)Moderate B)Aggressive C)Conservative D)Moderate/Aggressive

B

within how many days of the announcement must the target company provide shareholders with a statement: accepting or rejecting the offer expression no opinion on the offer unable to take a position on the offer

10 days

A customer is very concerned about investments that may not keep pace with inflation. He asks which securities would have the least exposure to inflation risk. Which of the following would be the best answer? A)Common stock B)Fixed annuity C)Cash D)Preferred stock

A

An investor who purchases 20-year Aaa rated corporate zero-coupon bonds would be least concerned with A)reinvestment risk. B)default risk. C)purchasing power risk. D)interest rate risk.

A

SEC Regulation FD is best described as a rule requiring disclosure by A)an issuer of securities. B)only those who provide "tips" of select information to securities market professionals. C)securities market professionals that trade on nonpublic information. D)only issuers of NMS securities.

A

Which of the following may not be a reason to reach out to the trusted contact person of an elderly client? A) A request by email regarding a joint account with instructions to sell all securities and forward a check made payable to the named parties to the account B) An emailed request to liquidate certain account holdings and transfer the sales proceeds to a third party C) An urgent request that funds be sent to an overseas bank account not previously known to be associated with the client D) An email received that cannot be verified by the registered representative as having come from the customer

A) A request by email regarding a joint account with instructions to sell all securities and forward a check made payable to the named parties to the account Scenarios that should raise a red flag are those where unusual instructions are received. For accounts with owners age 65 or older, firms must try to obtain the name of a trusted contact person in the event of a red flag. All firms must have in place written supervisory policies and procedures for reviewing and monitoring the transmittal of funds and a method of verifying that instructions received by email came from the customer and not an unknown third party. Urgency that might be intended to circumvent or deter broker-dealer verification procedures should always be viewed with extreme caution. An email regarding a joint account to liquidate and forward a check to the parties named to the account would not generally be viewed as a red flag. However, if it gave instructions to forward a check to only one party named to the account, it would be deemed unusual and not in keeping with how distributions are made from joint accounts.

Under SEC rules, soft dollars may be used to pay for all of the following except A) seminar registration fees. B) research reports. C) computer hardware. D) computer software.

A) seminar registration fees. Soft dollars is a term used to describe payments made by broker-dealers to investment advisers in return for research and other eligible services. The difference between soft dollars and hard dollars (cash) is that instead of paying a broker-dealer with cash, the fund will pay with brokerage business. Soft dollars may be used to pay for research, software, services for the benefit of clients, and seminar registration fees. Not permitted by the SEC are computer hardware, office equipment, and reimbursement of travel expenses to attend seminars.

A customer, age 62, wants to retire at age 64 and has accumulated investments in an IRA currently valued at $500,000. The IRA portfolio consisting of all mutual funds is allocated as follows: 70% growth funds, 10% corporate bond funds, and 20% sector funds. Still wanting to use mutual funds, which might be the most suitable reallocation of the portfolio as this customer nears retirement? A)30% municipal bond funds, 30% corporate bond funds, 40% growth funds B)70% municipal bond funds, 30% broad market index funds, 10% sector funds C)60% U.S. government bond funds, 30% broad market index funds, 10% growth funds D)80% broad market index funds, 10% corporate bond funds, 10% U.S. government bond funds

C

Which of the following statements regarding a bond ladder strategy is correct? A)A bond ladder strategy works best when interest rates are stable. B)A bond ladder strategy involves the purchase of very long-term and very short-term bonds. C)A bond ladder strategy is a relatively easy way to immunize a portfolio against interest rate risk. D)A laddered portfolio of bonds will provide lower yields than a portfolio consisting entirely of short-term bonds.

C

Which of the following statements regarding a bond ladder strategy is correct? A) A laddered portfolio of bonds will provide lower yields than a portfolio consisting entirely of short-term bonds. B) A bond ladder strategy works best when interest rates are stable. C) A bond ladder strategy is a relatively easy way to immunize a portfolio against interest rate risk. D) A bond ladder strategy involves the purchase of very long-term and very short-term bonds.

C) A bond ladder strategy is a relatively easy way to immunize a portfolio against interest rate risk. A bond ladder strategy is a relatively easy way to immunize (protect) a portfolio against interest rate risk. By holding many positions across the yield curve, the individual is diversified in the event that yields behave differently in one part of the curve than in another. The laddered portfolio will generally provide higher, not lower yields than a portfolio consisting entirely of short-term bonds. Buying bonds with very short maturities and bonds with long maturities is the concept behind the barbell strategy.

An investor who is 50 years old would like to save for a child's college education, which begins in 10 years. The investor is willing to take a moderate amount of risk. Which of the following would be the least appropriate recommendation? A) Open a Coverdell Education Savings Account B) Fund a variable annuity and use equity-based subaccounts C) Fund an existing IRA with a municipal bond fund D) Buy an BBB zero-coupon bond that matures in 10 years

C) Fund an existing IRA with a municipal bond fund Although investing within an IRA in anticipation of needing the money after age 59½ is a pretty good idea, municipal bonds, which provide federally tax-free income, are not appropriate for retirement accounts. The federally tax-free interest income will be fully taxable upon withdrawal. In addition, municipal bonds are low risk, not moderate risk, as indicated in the question.

Regulation FD covers A) customer notification requirements regarding a firm's privacy policies. B) standardization of financial reporting to the SEC. C) the selective disclosure of material nonpublic information by issuers. D) certifications required of research analysts who make public appearances.

C) the selective disclosure of material nonpublic information by issuers. Regulation FD was enacted to curb the selective disclosure of material nonpublic information by issuers to financial analysts and institutional investors. The rule helps ensure that all investors receive equal access to a company's material disclosures at the same time.

Which of the following types of risk cannot be eliminated through diversification under the modern portfolio theory? A) Liquidity risk B) Business risk C) Interest rate risk D) Systematic risk

C) Interest Rate Risk Market risk, sometimes referred to as systematic risk, cannot be diversified away. The risk of investing in a single industry or sector can be diversified away by investing in several industries with returns not correlated to each other. A general downturn in the market, however, cannot be eliminated through diversification.

At 3:55 pm ET, a registered representative receives a market order from an officer of XYZ to buy 75,000 shares of XYZ for the company's account. The registered representative must A)advise the officer that a safe harbor under SEC Rule 10b-18 no longer exists before refusing the order. B)place the order without taking any further action. C)refuse the order. D)advise the officer that a safe harbor under SEC Rule 10b-18 no longer exists before placing the order.

D

Institutional managers are moving to increase their cash position. This action would be viewed as A)bullish. B)neutral. C)neutral bull. D)bearish.

D

Which of the following carries the least amount of market risk? A)Treasury bills B)Treasury bonds C)Common stock D)Savings accounts

D

deals with disclosures for unintentional leaks that could effect the price of the stock. immediate public disclosure of the info must be made.

Regulation Full Disclosure (FD)

Deals w issuer buying back his own stock in the open market Transactions cannot affect the opening or closing of the security (first trade at opening or last 30 minutes of trading day) Transactions can be executed at prices no higher then the highest independent bid or the last reported sale price, whichever is higher

SEC Rule 10b-18

compensation to an investment adviser from a BD that will generally not be considered unethical

Safe harbor/ Section 28E

relates primarily to the companies that use debt financing (leverage). Inability to meet those debt obligations could lead to bankruptcy and, once again, total loss for the stockholders

financial risk/credit risk/default risk

popular way of reducing interest rate risk

laddering a bond or CD portfolio (ladder rungs, all purchased at same time but mature at different times (like steps on a ladder). once they mature they are reinvested and become longer ones)

change in the law ex: changes to tax code

legislative risk

speed or ease of converting an investment into cash without causing a price disruption

liquidity risk/marketability rsk

have virtually no liquidity risk

listed stocks mutual funds

if a tender offer is for less than 100% of the outstanding shares or is contingent on a minimum number of shares being tendered, holders of convertible securities can tender without first converting. They will only be required to convert if their tender is accepted

partial tender

common stock investments that have interest rate risk

public utility companies

sudden change in regulatory climate

regulatory risk

variation of interest rate risk

reinvestment risk

zero coupon bonds avoid

reinvestment risk (there is nothing to invest)

uncertainty that an investment will earn its expected return

risk

when an investment adviser receives research, products, or other services as a result of using the commissions generated by client trades

soft dollars

capture the risk of a country defaulting on its commercial debt

sovereign risk

risk in the return of an investment that is associated with the macroeconomic factors that affect all risky assets changes in the overall economy will have an adverse effect on individual securities regarldless of the companies circumstance ex: market risk, interest rate risk, purchasing power risk,

systematic risk

adviser accepting soft dollars must explain that:

the adviser benefits bc it does not have to produce or pay for research the adviser has an incentive to select or recommend brokers based on advisers interest in receiving these benefits, rather than on the clients interest in getting the most favorable execution