SIE UNIT 5 Other Investment Vehicles

All of these are potential risks of private, nontraded, REITS except A) tax treatment. B) transparency. C) liquidity. D) reliability of valuations.

A) tax treatment. Nontraded REITs are taxed the same way as public (traded) REITs. There are concerns about the private REITs lack of liquidity, transparency in operations, and the difficulty of valuing the programs.

Which of the following is the best description of a limited partnership? A) An investment that permits both gains and losses to pass through to the investors B) An investment that exempts individual investors from reporting gains or losses C) An investment that allows for losses only to pass through as write-offs to the investors D) An investment that allows only for income to flow through to the investors

A) An investment that permits both gains and losses to pass through to the investors Limited partnerships (LPs) are investment opportunities that permit the economic consequences of a business to flow or pass through to investors (limited partners). These would include the consequences of both income received and losses incurred.

Which of the following securities would most likely have the lowest expense ratio? A) Exchange-traded fund (ETF) B) Qualified variable annuity C) Nonqualified variable annuity D) Mutual fund

A) Exchange-traded fund (ETF) Expenses tend to be lower than those of mutual funds, and the management fee is low as well. Remember that the portfolio is designed to track an index, and just as the securities contained in the index are change infrequently, so are the securities in the fund portfolio.

At the time of a limited partnership's dissolution, who is the last to be paid? A) General partners B) Secured lenders (creditors) C) Limited partners D) General lenders (creditors)

A) General partners When a limited partnership (LP) is dissolved, the general partners are paid last.

For ETFs, the phrase "tax efficiency" can best be described by which of the following concepts? A) Usually, for ETFs, there are no tax consequences for investors until the shares are sold. B) These exchange-traded products can be purchased on margin, allowing for a smaller initial investment. C) ETFs generally have reportable tax gains passed on annually. D) All transactions in ETFs are commissionable, and sales charges do not apply.

A) Usually, for ETFs, there are no tax consequences for investors until the shares are sold. The single greatest advantage associated with ETFs is the fact that while they can pass on capital gains from time to time, creating tax consequences in that year, they rarely do. Therefore, there would be no expected tax consequences until the shares are sold. This is the tax efficiency generally associated with ETFs.

Your customer, Amelia, is excited about an investment she recently purchased from another firm. At maturity, in five years, she will receive her principal back plus an interest payment based upon the returns of five well-known technology companies. It pays no interest during the five years. She has likely invested in A) an ETN. B) a VA. C) an ETF. D) a mutual fund.

A) an ETN. It appears Amelia has purchased an exchange-traded note (ETN). ETFs, VAs, and mutual funds do not have set maturity dates. ETFs and mutual funds may pay dividends, not interest.

A state sponsored investment pool designed for municipalities with short-term cash investment needs is called A) an LGIP. B) a city and county money plan. C) a tax-free money market. D) a 457 plan.

A) an LGIP. This is the basic definition of a Local Government Investment Pool (LGIP).

A REIT that owns and operates an office building in the Dallas Metroplex is an example of A) an equity REIT. B) a hybrid REIT. C) a mortgage REIT. D) a leasing REIT.

A) an equity REIT. A real estate investment trust that owns properties but does not hold mortgages is an equity REIT. One that holds mortgages but not the property is a mortgage REIT. One that does both is a hybrid REIT. There is no such thing as a leasing REIT.

A hedge fund having a lock-up provision means that A) investors are required to maintain the investment for a minimum length of time. B) the fund organizers are fully accountable and can be sued in the courts with full ramifications. C) provisions have been made to lock up new buyers so sales of shares can be made easily. D) a minimum return is guaranteed or investments are fully refundable—locked up.

A) investors are required to maintain the investment for a minimum length of time.

For real estate program partners, tax credits will A) reduce tax liability dollar for dollar. B) reduce taxable income from rents received dollar for dollar. C) add to the appreciation of the real estate properties. D) be applicable in all types of real estate programs.

A) reduce tax liability dollar for dollar. Offered by the federal government for only certain types of real estate programs (not all), tax credits reduce tax liability dollar for dollar. In this light, credits are considered far greater benefits than deductions, which only reduce taxable income.

All of the following are types of direct participation programs (DPPS) except A) retail distribution. B) real estate. C) leasing. D) oil and gas.

A) retail distribution.

An investor in a direct participation program wishes to divest of a partnership interest purchased some time ago. You would correctly advise that A) there is no secondary market making them highly illiquid. B) there is ample secondary market trading making them highly liquid. C) they trade in the secondary market and entering an order to sell should suffice. D) the interest in the business once purchased, can never be sold.

A) there is no secondary market making them highly illiquid. While one's interest in a DPP can be sold, there is virtually no secondary market. In this regard, they are considered highly illiquid.

Under the Investment Company Act of 1940, which of the following is not considered and investment company? A) Unit investment trust B) Hedge fund C) Management company D) Face-amount certificate company

B) Hedge fund Investment companies include face-amount certificates, unit investment trusts, and management companies (both open- and closed-end). Hedge funds are organized as private investment companies, which are excluded under the definition of investment company und the Act of 1940.

Which of following securities is least likely to have an active trading market? A) Preferred shares B) Limited partnership interests C) Municipal bonds D) Real estate investment trusts (REITs)

B) Limited partnership interests A disadvantage to limited partnership interests is the lack of liquidity. Of the choices above, direct participation programs such as limited partnership interests are generally deemed illiquid. Whereas municipal debt securities, preferred stock, and REITs are often freely traded in their respective marketplaces.

Which type of DPP would be most likely to enable the investor to claim a deduction for depletion? A) Equipment leasing B) Oil and gas income program C) Oil and gas exploratory program D) Real estate limited partnership

B) Oil and gas income program The depletion allowance is a tax benefit to compensate the program for the decreasing supply of oil or gas (or any other natural resource or mineral) after it is taken and sold. Exploratory programs have a low expectation of success—there may not be any oil or gas being taken out of the ground. With income programs, the wells have been drilled and are already producing, hence there is something being depleted.

Which of these statements regarding a general partnership is correct? A) Partners participate in the gains and losses of the business and are partially shielded from the businesses liabilities. B) Partners participate in the gains and losses of the business and are fully liable for the businesses actions. C) Partners participate in the gains and losses of the business and are fully shielded from the businesses liabilities. D) Partners participate in the gains but not the losses of the business and are fully shielded from the businesses liabilities.

B) Partners participate in the gains and losses of the business and are fully liable for the businesses actions. In a general partnership, the results of the business flow through to the partners and there is no liability protection in this type of organization.

Which of these is not considered an advantage of owning an exchange-traded fund? A) Intraday pricing B) Pass through of losses C) Tax efficiency D) Liquidity

B) Pass through of losses ETFs are taxed using pipeline theory and do not pass losses through to investors. The others all considered advantages of ETFs.

Which of the following securities are nonexempt from registration under the Securities Act of 1933? A) U.S. government Treasury issues and REITs B) Real estate investment trusts (REITs) and corporate equity issues C) Corporate debt issues and U.S. government agency issues D) Municipal securities and U.S. government agency issues

B) Real estate investment trusts (REITs) and corporate equity issues REITs are nonexempt securities subject to the registration and new issue disclosure provisions of the Securities Act of 1933. Agency issues, U.S. government issues, and municipal securities are exempt.

In a limited partnership, which of the following best describes who is responsible for tax consequences of the business? A) The business B) The investors C) The limited partners D) The general partners

B) The investors All tax consequences of the business flow through proportionality to the investors. All partners will have some tax impact, not just the general or just the limited partners.

Which of the following is not a characteristic associated with hedge funds? A) They can have highly leveraged portfolios. B) They are regulated under the Investment Company Act of 1940. C) They can invest in derivative products. D) They might speculate in commodities and currencies.

B) They are regulated under the Investment Company Act of 1940. Hedge funds are considered unregulated (not highly regulated). They employ strategies and invest in such a way that they are not considered suitable for anyone but accredited investors. These strategies might include utilizing derivative products, commodities and currencies, margin (borrowing) trading, and selling short.

Which of the following is true regarding general partners (GPs) in a limited partnership? A) They may compete with the partnership. B) They should participate in the day-to-day management of the partnership. C) They may borrow money from the partnership. D) Their management decisions are not legally binding on the partnership.

B) They should participate in the day-to-day management of the partnership. General partners have a fiduciary responsibility to manage the partnership in the best interest of the investors (partners). In doing so, they make decisions regarding all day-to-day management of the business. These decisions are, therefore, legally binding on the business. GPs may not, however, borrow money from or compete with the partnership.

Last year Brownstone Properties, LP distributed $200 per unit to investors and reported a $500 business loss per unit on the K-1. For tax purposes the investors received A) $200 per unit of passive income. B) a $500 per unit passive loss. C) a $500 reduction in ordinary income. D) a net $300 loss.

B) a $500 per unit passive loss. Income and losses in an LP are always treated as passive and are reported to the investor via the K-1. The tax results for the year are included in that document.

Limited partnership programs are categorized as direct participation programs. The term direct participation refers to the A) general partners directly participating in the day-to-day management of the partnership. B) flow through of profits and losses of the partnership to the individual limited partners. C) ability for each partner to have her vote flow through to the general partner. D) ability of any partner, limited or general, to participate in the running of the partnership.

B) flow through of profits and losses of the partnership to the individual limited partners.

All of the following would be associated with hedge funds except A) commodity speculation. B) investing in government debt securities. C) the use of short positions (selling securities the portfolio does not own). D) highly leveraged portfolios (borrowing to purchase securities).

B) investing in government debt securities. Hedge fund managers often employ highly speculative strategies and products associated with substantial risk. These might include using leverage (borrowing to purchase securities), selling securities short, (selling securities the portfolio does not own), investing in commodities or currencies, and utilizing derivative products such as options or futures. Investing in federal government debt securities, considered among the safest and risk-free investments would be uncharacteristic of hedge funds.

The primary risk associated with ETNs is A) reinvestment risk. B) risk of default. C) business risk. D) call risk.

B) risk of default. Exchange-traded notes (ETN) are debt instruments (that is what note means) and subject to default. Business risk is not a significant concern as these notes are not normally based on the cash flow of a business. They are not callable nor do they pay an ongoing interest payment, so no significant call or reinvestment risk exists.

Yusef would like to save money for his 10-year-old daughter's college tuition costs. She has her heart set on a small liberal arts school with a growing reputation in the arts. His biggest concern is the potential increase in cost over the next several years. The program best suited to hedge against the increasing cost of college tuition at the school is a A) Coverdell ESA account. B) custodial account in the child's name. C) 529 prepaid tuition program. D) 529 college savings program.

C) 529 prepaid tuition program. The 529 prepaid tuition plan is designed to pay tuition costs, at today's rate, to be used later. It is the best-suited option to cover tuition inflation. Both the college savings and ESA accounts allow for investing that has good growth potential, but not specifically locking down costs in today's dollars. A custodial account has similar issues, and the account is in the child's name, potentially harming scholarship and grant eligibility.

All of the following would be considered advantages of exchange-traded funds (ETFs) as opposed to mutual funds except A) ETFs trade on exchanges. B) ETFs are marginable. C) ETFs are commissionable. D) ETFs are priced continuously throughout the trading day.

C) ETFs are commissionable. Trading on exchanges, ETFs are priced throughout the trading day making them easy to trade and liquid. They can also be bought or sold on margin. The purchase or sale of ETF shares is a commissionable transaction. However, the commissions paid can erode the low expense advantage of ETFs and this would have the greatest impact when trading in and out of ETF shares frequently, or when investing smaller sums of money.

An investor considering the differences between purchasing open-end investment company shares or ETFs with a similar objective should understand which of these? I. Each time an investor purchases and sells ETFs there is a commission. II. The operating expense ratio for an ETF is generally very high because they usually track indexes such as the S&P 500. III. It is possible that an investor liquidating ETF holdings will receive less than the NAV per share. IV. The margin requirements to purchase an ETF are higher than that for an open-end investment company. A) II and IV B) I and IV C) I and III D) II and III

C) I and III Because ETFs usually track an index, the operating expense ratios are generally lower than that of open-end companies. That advantage can be canceled out by the commission charges when purchasing and selling an ETF. An open-end investment company must redeem shares at the NAV per share; ETFs pricing is based upon supply and demand making it possible to receive less than NAV. One cannot purchase open-end shares on margin.

At the time of dissolution, which of the following regarding a limited partnership is true? A) Limited and general partners are paid after the IRS. B) Limited and general partners are paid concurrently. C) Limited partners are paid before general partners. D) Limited partners are paid after general partners.

C) Limited partners are paid before general partners. When a limited partnership (LP) is dissolved, limited partners are paid before general partners. Remember that with an LP, all tax consequences are passed on to the partners. Therefore, it is the individual partners who may incur a tax liability to be paid to the IRS, not the partnership entity.

Each of the following is defined as an investment company except A) Fixed and nonfixed unit investment trusts (UITs). B) A closed-end management company. C) An open-end management company. D) Real estate investment trusts (REITs).

D) Real estate investment trusts (REITs). Real estate investment trusts (REITs) are not investment companies such as UITs and management companies (both open and closed-end).

Partners in direct participation leasing programs can receive write-offs for all the following except A) operating expenses. B) interest expenses. C) depletion. D) depreciation.

C) depletion. Write-offs (deductions) associated with leasing programs are those taken for operating expenses, depreciation of the equipment owned and leased, and interest costs on the loans to purchase the equipment. Depletion, however, is a deduction associated with natural resources programs, such as oil and gas.

A limited partnership (LP) A) is limited and can have only investors and no partners. B) has one type of partner. C) has two types of partners. D) is run by investors who are the limited partners.

C) has two types of partners. LPs have two types of partners: general and limited. There must be at least one of each. It is the general partner who is responsible for running the partnership entity.

All of the following would be advantages of a limited partner in a DPP except A) cash distributions of capital gains. B) cash distributions of earning. C) participate in the management of the business. D) deductions for business expenses.

C) participate in the management of the business. Limited partners who take on a management role lose their limited liability protection.

Obtaining the financial status of the customer, and whether or not they meet income and net worth criteria, could be required for all of the following except A) oil and gas limited partnerships. B) real estate limited partnerships. C) real estate investment trusts (REITs). D) equipment leasing limited partnerships.

C) real estate investment trusts (REITs). Real estate investment trusts (REITs) do not require proof of financial status for investment. Limited partnerships and other DPPs can, particularly those that are offered privately (as private placements) as opposed to those that are offered publicly (by public offering).

A hedge fund portfolio has been characterized as being highly leveraged. This means that A) there are substantial investments in international markets. B) commodities and currencies are included in the portfolio. C) there is substantial borrowing or purchasing on margin. D) derivative products such as options are utilized.

C) there is substantial borrowing or purchasing on margin. While hedge funds can employ all these investment types and strategies, being highly leveraged means borrowing to purchase. Borrowing to purchase securities is typically known as buying on margin.

Investors in hedge funds should know that the funds are A) highly regulated, including having to abide by laws that investors be accredited. B) highly regulated, which is why there are no laws needed for investors to be accredited. C) unregulated but must abide by laws that investors be accredited. D) unregulated and, therefore, have no requirements for those who invest in them.

C) unregulated but must abide by laws that investors be accredited. Although hedge funds are unregulated (no Securities and Exchange Commission (SEC) registration is required), there are laws requiring that those who purchase shares of hedge funds be accredited investors. That is, they must meet minimum annual income and net worth criteria, as well as have considerable investment knowledge.

Which of these trading strategies are employed by hedge funds but are generally prohibited to mutual funds? I. The act of limiting investments to a narrow group of securities II. The use of borrowed money to purchase portfolio securities III. The act of taking long positions in speculative stocks IV. The act of taking short positions in NYSE listed stocks A) I and III B) II and III C) I and IV D) II and IV

D) II and IV Under most conditions, mutual funds are prohibited from purchasing securities on margin (i.e., using leverage—borrowed money) and from selling short. However, both of those strategies are commonly employed by hedge funds.

For a real estate DPP, which of the following is true? A) Capital growth can be derived from rents received. B) Neither income nor capital growth would come from rents received. C) Income will come from appreciation of the portfolio properties. D) Income can be derived from rents received for the properties.

D) Income can be derived from rents received for the properties. For real estate DPPs, both income and capital growth are possible. Income comes from the property rents received, and capital growth would come from the appreciation of the properties.

Which of these statements regarding a 529 plan is correct? A) Contributions are limited to $2,000 annually B) The beneficiary must be below age 18 C) The assets in the plan belong to the beneficiary D) One person can be both the beneficiary and owner

D) One person can be both the beneficiary and owner Anyone can establish and contribute to a 529 plan. This means parents, other family members, friends, and even the designated beneficiary can establish a 529 plan. A Section 529 College Savings Plan is a type of tax advantaged account used to save for education expenses. The person who opens the 529 plan is the account owner and the beneficiary is the future student. Most 529 plans are set up for children by parents or other family members, but there is no requirement that the owner and beneficiary have to be related. Plan assets belong to the account owner, not the beneficiary. The account owner has the right to change the plan's beneficiary. For example, if a parent had two children and one received a full scholarship, assets could be shifted for the benefit of the other child. Coverdell Education Savings Account (ESA) plans limits contributions to $2,000 annually.

For ETFs, the phrase "tax efficiency" can best be described by which of the following concepts? A) These exchange-traded products can be purchased on margin, allowing for a smaller initial investment. B) All transactions in ETFs are commissionable, and sales charges do not apply. C) ETFs generally have reportable tax gains passed on annually. D) Usually, for ETFs, there are no tax consequences for investors until the shares are sold.

D) Usually, for ETFs, there are no tax consequences for investors until the shares are sold. The single greatest advantage associated with ETFs is the fact that while they can pass on capital gains from time to time, creating tax consequences in that year, they rarely do. Therefore, there would be no expected tax consequences until the shares are sold. This is the tax efficiency generally associated with ETFs.

Hedge funds A) are highly regulated, starting with the requirement to be registered with the SEC. B) are regulated under the Investment Company Act of 1940 with no SEC registration required. C) are nonregulated but still require SEC registration. D) are not regulated under the Investment Company Act and no Securities and Exchange Commission (SEC) registration is required.

D) are not regulated under the Investment Company Act and no Securities and Exchange Commission (SEC) registration is required. Hedge funds normally do not require registration with the SEC as they are often sold under Reg D. Furthermore, they do not come under the Investment Company Act of 1940.

All of these are risks associated with limited partnerships except A) audit and recapture risk. B) business risk. C) liquidity risk. D) limited liability risk.

D) limited liability risk. One of the primary benefits to an investor is the limited liability of an LP. An audit by the IRA may result in a recapture of prior tax benefits. All businesses are subject to business risk, and limited partnerships are famous for their lack of liquidity.

All of these are true for an Achieving a Better Life Experience account except that A) the income is tax-free. B) the onset of the disability must have occurred before the owner turns 26. C) the account owner and beneficiary must be disabled. D) the account must be opened before the beneficiary turns 26.

D) the account must be opened before the beneficiary turns 26. The account does not need to be opened before the owner turns 26, but the qualifying disability does need to have begun before that age. Income from an ABLE account is received tax-free.

An investor in a direct participation program wishes to divest of a partnership interest purchased some time ago. You would correctly advise that A) the interest in the business once purchased, can never be sold. B) they trade in the secondary market and entering an order to sell should suffice. C) there is ample secondary market trading making them highly liquid. D) there is no secondary market making them highly illiquid.

D) there is no secondary market making them highly illiquid.

All of the following are true of REITs except A) they can pass through gains but not losses. B) listed REITS are liquid investments. C) they can be registered under subchapter M. D) they are registered as investment companies.

D) they are registered as investment companies. REITs have many similarities to investment companies but are not classified as an investment company under the Investment Company Act of 1940.