Unit 5 Quizzes
Your client who owns a DPP that generated a $10,000 passive loss for the year could A) only deduct the passive loss against passive income. B) deduct $10,000 against capital gains. C) deduct $3,000 against ordinary income and carry over the rest. D) deduct $10,000 against ordinary income.
A Passive losses, such as those generated by limited partnership investments (DPPs), are only deductible against passive income. LO 5.a
One of the benefits of adding precious metals to an investor's portfolio is A) a potential inflation hedge. B) generous income. C) low transaction costs. D) a high correlation to the stock market.
A Precious metals are traditionally viewed as a hedge against inflation. One of their benefits is that they have a low correlation with the stock market. Transaction costs for precious metals tend to be higher than securities—the dealer spreads can be relatively high. One significant negative is that these investments generate no income. LO 5.f
Which of the following is not a feature of owning a limited partnership? A) Tax-free income B) An investment managed by others C) Flow-through of income and expenses of a business to the individual limited partner D) Legislative risk
A The income from limited partnerships is not tax exempt. An investor, however, may use a tax loss from a partnership to offset the income from another passive investment. In limited partnerships, the investor enjoys the advantages and disadvantages of owning a business without actually having actually manage one. Limited partnerships are vulnerable to legislative changes that adversely impact ownership of such investments. LO 5.a
What is the maximum amount of bitcoin that will ever be in circulation? A) 21 million coins B) Indefinite number of coins C) 21 billion coins D) 194,425 coins
A The maximum amount of bitcoin that will ever be in circulation is 21 million coins. This is a feature of the bitcoin protocol, which is designed to create a finite supply of the cryptocurrency, which will prevent inflation on BTC. LO 5.h
Commodity futures contracts are available on all of the following except A) single-family homes. B) industrial metals. C) soybeans. D) eggs.
A Commodity futures contracts are available on metals, both precious and industrial; animal products, such as eggs; and agricultural crops, such as soybeans. Single-family homes are not a tradable commodity. LO 5.f
All of the following would flow through as a loss to limited partners except A) principal repayment on partnership debt. B) depletion. C) accelerated depreciation. D) interest payments on partnership debt.
A Principal repayments are not an expense for tax purposes. The interest on the debt is an expense and, along with depletion and depreciation expenses, does flow through to the limited partners as passive loss. LO 5.a
A number of different pooled investment vehicles are included in the term alternative investment. One of them, a synthetic investment instrument that has been created to meet a specific need that cannot be met by a standardized financial instrument, is known as A) a structured product. B) a z-tranche CMO. C) an arbitrage. D) an inverse fund.
A. Structured products are created as a tool to meet the issuer's debt financing needs when they will result in a lower cost than a standardized financial instrument available in the market place. LO 5.c
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) Neutral B) Bullish C) Bearish D) Bullish or bearish
B 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
One of your clients approaches you and is looking for an investment that will provide ready marketability and income. Which of the following would be the least appropriate recommendation? A) A money market mutual fund B) A limited partnership in rental real estate C) NYSE-listed preferred stock D) U.S. Treasury notes
B The key is meeting both needs—marketability and income; each of the choices supplies both except the limited partnership. The client could expect income from a direct participation program (DPP) investing in rental real estate, but the liquidity would be missing. LO 5.g
The alternative asset investments class is least associated with which of the following characteristics? A) Nonnormal returns B) Illiquidity C) Efficient pricing D) Diversification
C Alternative assets are most often characterized by inefficient pricing, providing potential abnormal returns or alpha returns. That is the prime reason for their popularity, especially with institutional investors. LO 5.c
The price of which of the following commodities is most likely to be impacted by weather? A) Lead B) Gold C) Orange juice D) Livestock
C If you ever saw the movie Trading Places with Eddie Murphy and Dan Aykroyd, you would certainly know that weather can have a major impact on the orange crop. Metals are not affected by heat, cold, rain, or snow. Years ago, before heated/air-conditioned barns and other protective devices, livestock would freeze in a bad winter, but that is no longer much of an issue. LO 5.g
In general, an investor wishing to gain economic exposure to commodities would find it easiest to do so by A) investing in forwards contracts. B) growing the commodity. C) investing in futures contracts. D) buying the commodity directly.
C It is generally agreed that using commodity futures is the easiest and most common way to gain economic exposure to commodities. Forwards are more commonly used by producers or users because, unlike futures, most forwards contracts result in the delivery of the actual commodity. Only about 1% of all futures contract positions involve the delivery of the underlying commodity. LO 5.g
Among the differences between an investment in a limited partnership offering and in a corporation is that A) only corporations issue securities. B) limited partners take a more active role in the management of the enterprise than do stockholders of a corporation. C) limited partnership offerings do not pay dividends; corporations do. D) only corporations are organized to run a business.
C One of the key features of a limited partnership investment is the concept of flow-through of operating results. If the business operates at a loss, the limited partner's share of that loss is treated as a passive loss on the investor's tax return. If the business is profitable, the limited partner's share of the profit is treated as passive income. Corporations issue securities, primarily stocks and bonds, while limited partnerships issue units representing the limited partner's interest in the venture. Those units are investment contracts and, as taught in Unit 4, LO4, securities. Limited partners who take an active role in the partnership lose their limited status. LO 5.a
Which of the following must be considered in evaluating the suitability of a DPP investment for a customer? I. Risk tolerance II. Other holdings III. Financial situation IV. Age A) II and III B) I and II C) I, II, III, and IV D) I and IV
C The key here is to recognize that with DPPs, the customer's age is a relevant consideration in determining suitability. DPPs are long-term, illiquid, high-risk investments. It is unlikely that DPPs would be suitable for a customer near retirement age, regardless of the customer's financial situation. LO 5.a
Investing in commodities could involve investing in any of these except A) agricultural items. B) industrial metals. C) animals. D) consumer durables.
D 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
One of the benefits of being a limited partner in a direct participation program is that A) any losses generated by the partnership flow through to the limited partner and can be used against ordinary income in an amount up to $3,000 per year. B) the limited partner can make certain management decisions. C) any income generated by the partnership flows through to the limited partner and is treated as a long-term capital gain. D) the general partner is the only person liable for the debts of the business.
D In a DPP, it is only the general partners who have full liability; limited partners are liable only to the extent of their investment plus any future commitments. Limited partners lose their status if they undertake any management responsibility. Losses are passive losses and can be deducted only against passive income, not ordinary income. It is capital losses that are subject to the $3,000 limit. Any income is treated as passive income, and that is taxed at ordinary income tax rates, not the lower capital gains rate. LO 5.b
A 3x leveraged fund priced at $42 tracks an index that is up 2% one day and then down 3% on the next day. What should this fund be approximately priced at following these two volatile days? A) $43.18 B) $41.55 C) $45.86 D) $40.50
D Starting with the $42 purchase price, a 2% increase to the index on Day 1 equals $0.84 up (0.02 × $42 = $0.84). Given the 3x leverage, this would equate to a $2.52 increase on Day 1 (3 × $0.84 = $2.52). At the start of Day 2, the fund would be priced at $44.52 ($42 + $2.52 = $44.52). On Day 2, the index falls by 3%. A 3% decrease in the fund equals $1.34 [0.03 × $44.52 ($1.3356 rounds up to 1.34)]. Again due to the 3x leverage structure of the fund, the $1.34 decrease equates to a $4.02 drop in the fund price (3 × $1.34 = $4.02). Therefore, after the two volatile days, the fund should be priced at approximately $40.50. LO 5.c
Your customer is asking if either exchange-traded funds (ETFs) or exchange-traded notes (ETNs) might be suitable investments for his portfolio. The customer makes several statements regarding his understanding of the products, but only one of them is accurate. Which is it? A) If I want to sell my shares of an ETF, I have to wait until the next price is calculated to value the portfolio of securities. B) ETFs have a fixed coupon rate that I should expect to realize when they mature. C) ETNs are equity securities because they trade on exchanges. D) ETNs are issued by financial institutions; therefore, I should be concerned about the credit worthiness of the issuer.
D The only accurate statement is the one expressing that ETNs are issued by financial institutions and, therefore, the credit worthiness of the issuer should be a concerning factor. ETNs are debt instruments, not equity instruments. ETNs have a final payment at maturity based on the return of a single stock, a basket of stocks, or an equity index. Although ETF prices fluctuate based on the value of the securities within the fund portfolio throughout the trading day, they are priced by supply and demand, like all exchange-traded products. They are not forward priced like open-end mutual fund shares are. LO 5.c
A client was reading an offering document for an oil and gas drilling limited partnership program and noticed that one of the features was flow-through benefits. How would you explain this? A) Losses generated by the program pass-through to the investor and may be deducted in full against ordinary income. B) Once the program has paid taxes on its income, the entire remaining balance passes-through to the investors. C) Investors in the program are assured of a steady flow of income if the drilling is successful. D) Rather than being a separate taxable entity, the program's income or losses pass-through directly to the investors.
D The philosophy behind flow-through is that any income or losses generated by a program of this type (a direct participation program or DPP) flow directly to the investors; there is no tax at the entity level. If there are losses, they may be deducted only against passive income (e.g., income from other partnerships). No assurances can ever be given. LO 5.a
