Investment Vehicles
A corporation has issued $10,000,000 of 7 1/4%, 20 year, $1,000 par, convertible debentures, convertible at a ratio of 40:1. The bond is currently trading at 120, while the company's common stock is at 24. The conversion price per share is: A. $24 B. $25 C. $30 D. $40
Bonds are convertible based on their par value - not the current market price. The conversion price formula is: $1000/40 = $25
Which of the following municipal issues would NOT be exempt from taxation of interest by the Federal Government? A. San Francisco, California - Convention Center Revenue Bond B. Miami, Florida - Sewer and Water Revenue Bond C. Nassau County, New York - Pollution Control Bond D. Des Moines, Iowa - School District Bond
The best answer is A. "Non essential use" private purpose municipal issues are subject to Federal Income tax, via the Alternative Minimum Tax computation (AMT). The building of a convention center constitutes such a use. Sewers, water, pollution control, and schools are all essential public uses and these issues qualify for the Federal Income Tax exemption on interest income received.
A Prime Banker's Acceptance is: I eligible for trading with the Federal Reserve II ineligible for trading with the Federal Reserve III negotiable IV non-negotiable A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. A Prime BA is of sufficient quality to be an eligible security for Fed trading. All BAs are negotiable (tradeable) and the securities trade on a yield basis (at a discount to face value).
A client is short stock and wants to protect his position. The option strategy that should be used is: A. buy a call B. sell a call C. buy a put D. sell a put
The best answer is A. A customer loses on a short stock position if the market rises. If the customer buys a call, he or she buys the right to buy the underlying stock at a fixed price. Thus, in a rising market, the stock can be purchased at a fixed price by exercising the call and the purchased shares used to cover the short stock position.
Which of the following statements are TRUE when comparing bonds and preferred stock? I Both bonds and preferred stock have a fixed payout rate II Bonds have a fixed payout rate; preferred stock does not III Both bonds and preferred stock can be convertible into shares of common stock IV Bonds can be convertible; preferred stock cannot A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. Both bonds and preferred stock can be convertible and both have a fixed payout rate. Think of preferred stock as a "bond" designed for corporate investment, so that a corporate investor can take advantage of the dividend exclusion from taxation (this tax benefit is not available to individual investors).
A customer sells short 100 shares of ABC stock at 38 and buys 1 ABC Mar 40 Call @ 5. The maximum potential gain is: A. $3,300 B. $3,500 C. $4,200 D. unlimited
The best answer is A. If the stock falls, the customer gains on the short stock position. He sold the stock for $38. If it falls to "0", he can buy the shares for "nothing" to replace the borrowed shares sold and make 38 points. He lets the call expire "out the money" losing 5 points, so the maximum potential gain is 33 points.
A customer buys 1 ABC Feb 50 Call @ $7 when the market price of ABC is $52. The customer's maximum potential loss is: A. $700 B. $4,300 C. $5,700 D. unlimited
The best answer is A. In a falling market, a long call position will expire "out the money" and the holder loses the premium paid. This is the maximum potential loss.
Municipal bonds would not be an appropriate investment for which of the following? A. Individual Retirement Accounts B. Individuals C. Casualty Companies D. Bank Holding Companies
The best answer is A. It makes no sense to place "federally tax exempt" municipal bonds into a "tax deferred vehicle" such as an IRA or Keogh account. Since the account is tax deferred, one would place securities earning the highest "before tax" return, such as corporates or governments, into the account. Tax is due only when the positions are liquidated and the funds withdrawn from the account. Individuals in high tax brackets buy municipal bonds for their federal income tax exemption; insurance companies buy municipal issues as part of their portfolios; and banks buy municipals as part of their investment portfolio (for example, they purchase "bank qualified" municipal issues that give the bank a large tax advantage).
The MINIMUM price at which an open-end fund share can be purchased is: A. NAV B. NAV plus a commission C. POP plus a commission D. Any price because the price is negotiated between buyer and seller
The best answer is A. No-Load mutual funds do not have a sales charge. In this case, the NAV (Net Asset Value) and the POP (Public Offering Price) are the same. Any shares are purchased at NAV, with no additional commissions charged because each share is newly issued.
Which statements are TRUE regarding Treasury STRIPS? I Interest is accreted annually II Interest is not accreted annually III Interest is subject to Federal income tax annually IV Interest is not subject to Federal income tax annually A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. The accretion of the discount over the bond's life represents the interest earned. Even though no payments of interest are made annually, the discount must be accreted annually and is taxable as interest income earned.
Ford Motor Company has issued 8% convertible debentures, convertible at a 50:1 ratio. Currently the debenture is trading at 110. The stock is trading at 21. What is the conversion price of the stock? A. $20 B. $21 C. $22 D. $50
The best answer is A. The bond is convertible into common at a 50:1 ratio, based on the par value of the bond. The conversion price formula is: $1000/50 = $20
The dividend discount model can be used to determine an approximate market price for: A. common stock B. preferred stock C. bonds D. all of the above
The best answer is A. The dividend discount model takes the projected future dividend stream that a company will pay and "discounts" it back to its net present value, using a discount rate that is adjusted for the risk premium of investing in that company. This net present value gives an indication of what the current market price of the stock should be. It factors in expected growth of dividends over time. In contrast, preferred stock and bonds are "fixed income" securities - the payments made to investors do not grow over time. Their valuation is done by discounting the fixed income stream by the market rate of interest and adding up the present value of all of these cash flows (which for preferred stock, is a perpetuity, since there is no maturity).
The market price of common stock will be influenced by which of the following? I Expectations for future earnings of the company II Expectations for future dividends to be paid by the company III Book value per share IV Par value per share A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV
The best answer is A. The market price of common stock is determined by investor expectations about the future of the company. Par value and book value have no bearing on the market price of the common.
The purchase of a put has all of the same characteristics as selling stock short EXCEPT: A. unlimited loss potential in a rising market B. limited gain potential in a falling market C. low liquidity risk if the position is to be liquidated D. both are bear market strategies
The best answer is A. The purchase of a put has limited loss potential in a rising market - the maximum that can be lost is the premium paid. In a rising market, the loss potential on a short sale of stock is unlimited, since the stock must be purchased at the higher market price and replaced. The maximum gain for both a long put and a short sale of stock occurs if the market falls to "0". Both have increasing gain as the market falls, all the way to a maximum gain at "0". Because both are profitable in falling markets, they are bear market strategies. Thus, the maximum gain is limited for both, since the market can only fall as far as to "0". Both options and stocks are actively traded on exchanges, so there is little liquidity risk for either.
Which of the following options strategies provides the greatest profit potential in a bull market? A. Long Call B. Short Call C. Long Put D. Short Put
The best answer is A. The purchaser of a call (long call) has the right to buy stock at a fixed price, no matter how high the market price of the stock may go. This strategy has unlimited gain potential.
A speculator that initiates a short futures position in Swiss Francs: I believes that the Swiss Franc will decline II believes that the Swiss Franc will increase III will need to buy Swiss Franc futures to close his position if he wants to avoid making delivery in the future IV can only satisfy the terms of the contract by making delivery of Swiss Francs on the delivery date A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. When one goes short a futures contact, this is a "bet" that the price of the reference asset will decline. Futures contracts can be offset at anytime by trading, so the contract can be closed with an offsetting purchase. If the contract is not closed with an offsetting purchase, then the seller is required to deliver Swiss Francs on the delivery date.
Which of the following is NOT considered to be a derivative? A. Warrant B. Unit Investment Trust C. Credit Default Swap D. Option Contract
The best answer is B. A derivative security has a value that is "derived" from another investment, but it is not a directly proportional piece of an investment, which is the case with an investment company product such as a unit investment trust. Options are derivative because their premium movement (price) is based on the price movements of the underlying security. A warrant is a long-term issuer created call option that can be attached to stock and bond offerings to make them more attractive. A credit default swap (CDS) is a contract where the holder of a debt instrument makes a series of payments to a seller in return for a payoff if the credit quality of the issue deteriorates below a stated level. Thus, the contract becomes more valuable as an issuer's credit quality declines, since the seller is then obligated to make the payoff. CDSs are issued and traded OTC - there is no listed exchange for these.
Which of the following statements are TRUE about a Life Annuity? I A Life Annuity will cease when the person dies II A Life Annuity will continue to pay to a beneficiary if the person dies before a stated date III The periodic payment for a Life Annuity will be lower than the periodic payment for a Period Certain annuity IV The periodic payment for a Life Annuity will be higher than the periodic payment for a Period Certain annuity A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. A life annuity ceases when that person dies. A life annuity-period certain continues to a beneficiary if the person dies prior to the end of the "certain period." For example, if a life annuity-10 year period certain is purchased, and the purchaser dies after the 3rd year, the annuity continues to pay to a beneficiary for another 7 years. Because of the minimum guaranteed payment period, the periodic payment amount is lower than a simple life annuity (since the insurance company must pay for a longer guaranteed time period).
Interest income from which of the following securities is subject to State and Local tax? A. Treasury Bonds B. Federal National Mortgage Association Bonds C. Federal Home Loan Bank Bonds D. Puerto Rico Bonds
The best answer is B. As a rule, interest income from U.S. Government securities is subject to Federal tax and exempt from State and Local tax. As a general rule, interest income from agency securities is subject to Federal tax and exempt from State and Local tax. However, the interest income from securities issued by the housing agencies that sell pass through certificates is fully taxable. These are: Federal National Mortgage Association ("Fannie Mae") Government National Mortgage Association ("Ginnie Mae") Federal Home Loan Mortgage Corporation ("Freddie Mac") Interest income received from bonds issued by territories or possessions is always triple exempt.
A man invested $20,000 in a variable annuity purchased in a non-qualified account. At age 62, the account has grown to $35,000 and the man withdraws $3,000. The amount of the withdrawal is: A. tax-free B. subject to ordinary income tax but no penalty tax C. subject to penalty tax but not to ordinary income tax D. permitted to be rolled over to an IRA is completed within 60 days
The best answer is B. Contributions to variable annuities are not deductible. Earnings build tax-deferred. When distributions are taken, they are taxed on a LIFO basis. The first monies to be withdrawn represent the never-taxed build up. These are 100% taxable. This client invested $20,000, which has now grown to $35,000. At age 62, he withdraws $3,000 - all of which represents taxable build-up. However, there is no penalty tax because the client is over age 59 1/2.
A portfolio manager would sell calls against the securities in the managed portfolio in order to: A. protect the positions against a bear market B. increase income and cash flow C. increase the diversification of the portfolio D. speculate on the direction of the market
The best answer is B. Covered call writing is one of the most conservative and popular strategies used by portfolio managers to increase income (and hence return) from the investments. In addition to the dividend income from the stocks, if the market stays flat, the calls will expire and the premium income will be earned. To protect the stock positions, puts would be purchased. Diversification would be increased by purchasing stocks or call options on other companies than those held in the portfolio. To speculate on the direction of the market, long calls (speculating on a bull market) or long puts (speculating on a bear market) would be used.
Which statements are TRUE when comparing Equity Indexed Annuities to Variable Annuities? I In a year of sharply rising stock prices, variable annuities will outperform equity indexed annuities II In a year of sharply rising stock prices, equity indexed annuities will outperform variable annuities III In a year of sharply falling stock prices, variable annuities will outperform equity indexed annuities IV In a year of sharply falling stock prices, equity indexed annuities will outperform variable annuities A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. Equity indexed annuities have a cap on their maximum annual return, while variable annuities do not. Thus, in a year of sharply rising stock prices, variable annuities will outperform equity indexed annuities. In a year of sharply falling stock prices, equity indexed annuities will do better, because they protect their positions with put options. This is one of the reasons they have higher annual expenses than variable annuities. In contrast, variable annuity separate accounts can lose sharply in a bear market, unless they offer a principal protection feature, which would increase expenses.
A principal difference between a forward contract and a futures contract is that: A. futures contracts may not be offset without permission B. forward contracts may not be offset without permission C. short positions cannot be taken with a futures contract D. short positions cannot be taken with a forward contract
The best answer is B. Futures contracts are negotiable - they trade in the market and can be offset at any time by doing a closing trade. In contrast, forward contracts are custom contracts between buyer and seller that do not trade. They can only be closed (offset) if both parties agree. Any contract has 2 parties - the buyer (long) and seller (short). Thus, parties to both futures contracts and forward contracts can take either long or short positions.
A customer buys 100 shares of ABC stock at 40 and sells 1 ABC Jan 45 Call @ 2 on the same day in a cash account. The customer's maximum potential loss is: A. $200 B. $3,800 C. $4,500 D. unlimited
The best answer is B. If the stock drops, the call expires "out the money". As the stock keeps dropping, the customer loses more and more on the stock position. Because he effectively paid $3,800 ($40 price - $2 premium collected) for the stock, this is his maximum potential loss.
The Federal Intermediate Credit Banks make loans to, and buys the agricultural and livestock paper of all of the following EXCEPT: A. Commercial Banks B. Federal Reserve Banks C. Agricultural Credit Corporations D. Incorporated Livestock Loan Companies
The best answer is B. The Federal Reserve only deals with member banks - it does not issue loans, bonds, or notes to the public to support activities such as housing or farming. The Federal Intermediate Credit Bank is an "intermediary" providing short term loans to farmers. This is accomplished by purchasing the loans that have already been made to farmers by their "direct" lenders, which injects new monies into the direct lenders to make more loans. The FICB buys the "farm" paper of commercial banks, production credit associations, agricultural credit associations and incorporated livestock loan companies. The FICB gets the monies to buy the "direct" lender paper by selling notes through the Federal Farm Credit System. These notes are Federal Agency obligations.
A customer bought a $1,000 par convertible subordinated debenture at par, convertible into common at $25 per share. If the bond's market price increases by 20%, the parity price of the stock will be: A. 25 B. 30 C. 40 D. 48
The best answer is B. The conversion price (and hence the conversion ratio) are fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $25, based upon converting each bond at par. $1,000 par / $25 conversion price = 40:1 conversion ratio. Thus, for every bond that is converted, the holder receives 40 shares. To be at parity, since the bond is now trading at $1,200 (1.20 % X $1,000), the stock which is convertible into 40 shares, must have a parity price of $30 ($1,200 / 40).
A customer bought a $1,000 par convertible subordinated debenture at par, convertible into common at $31.25 per share. If the bond's market price increases by 20%, the conversion ratio will be: A. 31.25:1 B. 32.00:1 C. 37.50:1 D. 38.40:1
The best answer is B. The conversion price (and hence the conversion ratio) is fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $31.25, based upon converting each bond at par. $1,000 par / $31.25 conversion price = 32:1 conversion ratio. Thus, for every bond that is converted, the holder receives 32 shares.
A convertible debenture is convertible into common at $50 per share. If the market price of the bond rises to a 25 point premium over par, which statements are true? I The conversion ratio is 20:1 II The conversion ratio is 25:1 III The parity price of the stock is $50.00 IV The parity price of the stock is $62.50 A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. The conversion ratio is established when the bond is issued, and is par value divided by the conversion price. In this case, the conversion price is set at $50 per share, so the conversion ratio is $1,000 par / $50 conversion price = 20:1 (20 shares per bond). If the bond moves to a 25 point premium over par, its new price will be 125, or $1,250 per bond. For the common stock to be valued at parity to the bond, the price per share must be $1,250 / 20 shares per bond = $62.50 per share parity price.
Interest income from municipal bonds is: A. exempt from Federal, State and Local tax B. exempt from Federal tax and subject to State and Local tax C. subject to Federal tax and exempt from State and Local tax D. subject to Federal, State and Local tax
The best answer is B. The interest income from municipal bonds is exempt from Federal income tax; but is subject to State and Local tax. However, if a bond is purchased by a State resident, then the State exempts that issue from taxation as well.
Treasury Inflation Protection Securities (TIPS) are subject to: A. Credit Risk B. Market Risk C. Marketability Risk D. Purchasing Power Risk
The best answer is B. The principal amount of Treasury Inflation Protection Securities is adjusted upwards annually if there is inflation - thus these securities are protected against purchasing power risk. Because these are U.S. Government issues, they have the highest credit rating (AAA) and thus have minimal credit risk. Again, because they are U.S. Government issues, the trading market is extremely active, so there is minimal marketability risk. The risk that TIPS have is market risk - if interest rates rise (say due to Fed actions), their value will fall.
An investment adviser has determined that writing call options is a strategy that he wishes to employ for his clients. He does this in order to: A. hedge against a price decline of the securities held in the client portfolio B. increase the income earned from the securities held in the client portfolio C. guarantee a price at which the securities held in the portfolio can be purchased in the future D. speculate that the securities held in the portfolio will become more volatile over time
The best answer is B. The writing of call options (the sale of call options against a long stock position) is a fairly conservative strategy used to increase income when prices are expected to be stable. The options sold will expire "at the money" and the investment adviser will earn the premiums, increasing income. If prices move down, the calls expire worthless, but there will be a loss on the underlying stock position. If prices rise, the stock is called away, and no further gain is enjoyed on the stock. To hedge against a price decline on the stock portfolio, puts would be purchased. To guarantee a price at which securities can be purchased in the future, calls would be purchased. To speculate on volatility, straddles would be purchased (buy a call and buy a put).
Which of the following are issued with a fixed coupon rate? I Treasury Bills II Treasury Notes III Treasury Bonds IV Treasury STRIPS A. I and IV only B. II and III only C. II, III, IV D. I, II, III, IV
The best answer is B. Treasury Notes and Bonds are issued at par with a stated interest rate. Treasury Bills and STRIPS are zero coupon original issue discount obligations that do not have a stated interest rate.
Which statement is true regarding a corporation that has adopted cumulative voting? A. Each stockholder must accumulate his votes and cast them for one director B. Minority stockholders have the ability to elect the director of their choice C. Each director must be elected by a majority of the shareholders D. Minority stockholders are given proportionately more votes than majority stockholders
The best answer is B. Under "cumulative" voting, shareholders can accumulate their votes and place them on any directorship (or combination of directorships). Thus, minority shareholders who place all of their accumulated votes on 1 director have a reasonable chance of electing that person. The statement that each shareholder must accumulate his votes and cast them for 1 director is false - the votes are accumulated and can be cast as the stockholder sees fit. The statement that each director must be elected by a majority of the shareholders is incorrect - each director must be elected by a majority of the outstanding shares. The statement that minority shareholders are given proportionately more votes than majority shareholders is incorrect - the benefit of cumulative voting is that the minority shareholder can vote all of his votes for 1 (or for a few) director(s), and by virtue of the extra weight of those votes, get the director(s) elected.
All of the following statements are true regarding repurchase or reverse repurchase agreements EXCEPT: A. Under a reverse repurchase agreement, the dealer is buying securities from the Federal Reserve B. If a repurchase agreement extends for longer than overnight, the agreement is known as a "Due Bill" repurchase agreement C. Repurchase agreements are used by dealers to reduce the carrying cost of Government securities held in their inventory D. Repurchase agreements are initiated by the Federal Reserve to loosen the money supply
The best answer is B. Under a "repurchase agreement", a government securities dealer sells some of its inventory to another dealer or to the Federal Reserve, with an agreement to buy back the securities at a later date for a pre-established price. In this manner, the dealer gets a temporary inflow of cash. Since government dealers finance their inventory, by reducing the amount of inventory on hand, they are reducing inventory finance charges when such an agreement is employed. Under a "reverse repurchase agreement", the dealer is buying securities from the Federal Reserve, draining the dealer of cash. Choice B is false. Under any repurchase agreement, the underlying government securities are the collateral. The collateral that underlies the agreement must be transferred from seller to buyer to support the transaction. In previous years, dealers could do repurchase agreements that were backed by a promise to deliver the underlying securities (a "due bill" for the securities) instead of making physical delivery. Due bill repurchase agreements are no longer permitted.
A fund that distributes at least 90% of its Net Investment Income to shareholders is termed a(n): A. income fund B. registered fund C. regulated fund D. tax exempt fund
The best answer is C. A fund that distributes at least 90% of Net Investment Income to shareholders is "regulated" under Subchapter M of the Internal Revenue Code and pays no tax on the distributed amount.
A customer owns a perpetuity that pays $400 per month. Assuming that the market rate of return is 6%, the value of the contract is: A. $6,666 B. $66,666 C. $80,000 D. $100,000
The best answer is C. A perpetuity makes payments forever. To calculate the value of the contract, you take the annual (not monthly) payment received and divide it by the market rate of interest. $4,800 annual payment received / .06 = $80,000
Banker's Acceptances are: I overnight loans available to member institutions of the Federal Reserve System II drafts on banks used to finance imports and exports III negotiable securities IV non-negotiable securities A. I and III B. I and IV C. II and III D. II and IV
The best answer is C. Banker's Acceptances are drafts on banks used to finance imports and exports. They can be held to maturity or can be traded (are negotiable).
Common stockholders have all of the following rights EXCEPT: A. voting for the Board of Directors B. transferring share ownership without restriction by the issuer C. inspecting minutes of executive meetings D. maintaining proportionate ownership in the company
The best answer is C. Common stockholders do not get to inspect the minutes of executive meetings. They do have the right to vote; to sell their shares without issuer restriction; and to maintain proportionate ownership in the company.
Common shareholders have all of the following rights EXCEPT the right to: A. receive a dividend if one is declared by the Board of Directors B. remaining assets in a liquidation of the company after all other claimants C. inspect the minutes of meetings of the Board of Directors D. vote for each individual proposed for election to the Board of Directors
The best answer is C. Common stockholders have the right to vote for the Board of Directors, but they do not have the right to inspect the minutes of Board of Directors meetings. They do have the right to "inspect the books and records" of the company - but this right is limited to inspection of financial reports. The shareholder has the right to receive a dividend if declared by the Board; and is last in line for receiving remaining assets of the company if it liquidates.
A customer, age 65, is in the 30% tax bracket. The customer has a non-tax qualified variable annuity separate account to which he contributed $12,000 that has a current market value of $30,000. The customer takes a distribution of $10,000 from the account. The tax that will be due on this distribution is: A. 0 B. $1,000 C. $3,000 D. $4,000
The best answer is C. Distributions from non-tax qualified variable annuity separate accounts are taxed on a LIFO (Last In First Out) basis. The original non-tax deductible contribution of $12,000 was the first in. The tax-deferred build up of $18,000 occurred second. When distributions are taken, the "build-up" portion comes out of the account first and is taxed at regular tax rates. After the build-up is depleted, the original investment of $12,000 comes out of the account and is not subject to tax. The customer is withdrawing $10,000 - which is all counted as "build-up" for tax purposes (last in - first out). This is taxable at 30% without any penalty tax due since the customer is older than 59 1/2. The total tax due is 30% of $10,000 = $3,000.
Equipment trust certificates would most likely be issued by a(n): A. manufacturer B. utility C. airline D. bank
The best answer is C. Equipment trust certificates are issued by common carriers such as airlines, railroads, and trucking companies. The rolling (or flying) stock is the collateral for the debt.
A 65-year old retired teacher living on a pension has $200,000 invested in 2 year certificates of deposit that are yielding 4%. $20,000 of the CDs are maturing and the customer wants to diversify into an investment that gives a higher return and a moderate level of risk. The BEST recommendation would be: A. High yield corporate bonds B. Treasury strips C. Equity REITs D. Income bonds
The best answer is C. Equity REITs tend to pay a high dividend yield, since they are structured to generate net rental income. Because the underlying real estate investments are diversified, the risk level is moderate. This is the best of the choices offered. High yield bonds (junk bonds) have a very high risk of default and thus are unsuitable. Treasury Strips are zero-coupon Treasuries that do not provide current income and thus are unsuitable. Finally, Income bonds only pay interest if the issuer has high enough net income, so there may not be any "income".
A growth fund would likely invest in which of the following securities? A. Non-convertible corporate bonds B. Government bonds C. Convertible bonds D. Preferred stocks
The best answer is C. Growth funds would likely invest in common stocks for capital gains; they could also invest in convertible bonds, since they are an "equivalent" to the common stock; and if the common stock price rises substantially, their price will rise as well (because the market will force them to trade at parity with each other). Preferred stocks and non-convertible bonds give a higher rate of current income; but little in the way of capital gains potential (unless interest rates fall by a large amount). In this case, the fund manager is not attempting to profit from market interest rate moves - he or she is simply attempting to select stocks that have excellent growth potential.
If interest rates fall, issuers most likely will call: I low dividend rate preferred issues II high dividend rate preferred issues III preferred issues trading at a premium IV preferred issues trading at a discount A. I and III B. I and IV C. II and III D. II and IV
The best answer is C. If interest rates fall, issuers most likely will "call in" old high rate preferred and replace it by selling new preferred at the lower current rates. High rate preferred will sell at a premium if market interest rates are dropping.
Which of the following are risks of investing in a Real Estate Limited Partnership (RELP)? I Business risk II Liquidity risk III Regulatory risk IV Reinvestment risk A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV
The best answer is C. Limited partnerships are illiquid - they do not trade and a limited partner can only sell his or her unit with general partner approval. So liquidity risk is a major issue. Because these are tax shelters that use provisions of the tax code to reduce tax liability, owners of limited partnerships face increased risk of tax audit; and also are subject to regulatory risk, which is the risk of tax law change. There are no dividends or interest payments received that must be reinvested, so there is no reinvestment risk. However, business risk is another big issue here - because the business venture may fail.
Constitutional debt limits are imposed on the issuance of: A. revenue bonds B. moral obligation bonds C. general obligation bonds D. industrial development bonds
The best answer is C. Municipalities impose debt ceilings on the dollar amount of bonds that can be issued backed by ad valorem taxing power (G.O. bonds). To raise this limit requires a public referendum. Debt limits do not apply to self supporting debt such as revenue bonds or industrial revenue bonds. They also do not apply to moral obligation bonds, which the issuer does not legally have to pay (though the issuer is "morally" obligated to pay).
Which of the following municipal issues would be exempt from taxation of interest by the Federal Government? I San Francisco, California - Convention Center Revenue Bond II Miami, Florida - Sewer and Water Revenue Bond III Nassau County, New York - Pollution Control Bond IV Des Moines, Iowa - Baseball Stadium Revenue Bond A. I only B. I and IV C. II and III D. I, II, III, IV
The best answer is C. Non-essential use, private purpose municipal issues are subject to Federal Income tax, via the Alternative Minimum Tax computation (AMT). The building of a convention center constitutes such a use, as does the building of a baseball stadium. Sewers, water, pollution control, and schools are all essential public uses and these issues qualify for the Federal Income Tax exemption on interest.
Which actions taken regarding a universal variable life insurance policy could result in tax liability? I Cash surrender II Partial withdrawal III Loan of up to 95% IV Payout of death benefit A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV
The best answer is C. Proceeds distributed from a variable life insurance policy are taxable income if there is a distribution of benefits above the amount invested (tax basis) in the separate account. This would include a cash surrender (surrender of the entire policy for its current cash value, terminating the policy) or making a partial withdrawal from the policy. The payment of a death benefit from the policy, while not taxable income to the recipient, is included in the taxable estate of the deceased individual. If the aggregate value of the estate exceeds the estate tax exclusion, there will be estate tax liability. The only way to get cash out of a variable policy without a potential tax consequence is to borrow against the policy. In general, most "cash value" policies only permit a loan of up to 75% of cash value; but if the policy is fully paid, often the loan amount is raised to 95%.
Federal Farm Credit System bonds include which of the following? I Federal Land Banks II Federal Intermediate Credit Banks III Banks for Cooperatives IV Federal Home Loan Banks A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV
The best answer is C. The Federal Farm Credit System consists of the Federal Land Banks (making long term mortgage loans to farmers), Federal Intermediate Credit Banks (making short term - up to 5 years - agricultural loans to farmers) and the Banks for Cooperatives (making loans to farmer's cooperatives). Obviously, the Federal Home Loan Bank is not part of the Farm Credit System. It buys conventional mortgages from savings and loans and finances its activities by issuing conventional bonds.
Treasury Bills are typically issued for which of the following maturities? I 4 weeks II 13 weeks III 26 weeks IV 78 weeks A. I and III only B. IV only C. I, II, III D. I, II, III, IV
The best answer is C. The U.S. Treasury issues 4 week, 13 week, 26 week, and 52 week T-Bills.
The client of a Registered Investment adviser is dependent upon the income from his portfolio. The client notices that a stock that is owned in the portfolio has declared a dividend and wants to know when he is entitled to that dividend. The RIA should respond that the client is entitled to the dividend as of the: A. Declaration Date B. Ex-Date C. Record Date D. Payable Date
The best answer is C. To receive the dividend, the customer must be on the shareholder list, which is taken on the Record Date. The actual checks are sent out on the Payable Date, which is typically 2 weeks after Record Date.
Which of the following actions by the Federal Reserve will tighten credit? I Repurchase Agreement II Reverse Repurchase Agreement III Matched Sale A. I only B. II only C. II and III D. I, II, III
The best answer is C. To tighten credit, the Federal Reserve will sell government securities to bank dealers (draining the dealers of cash that could be lent out) with an agreement to buy them back at a later date. The sale is being "matched" to a future purchase and is used to temporarily drain cash from the credit markets. This is called a reverse repo or matched sale.
The financial news media quote Goofy Fund with a bid price of $8.10 and an ask price of $8.75; and Chipmunk Fund at a net asset value per share of $11.05 and a market price of $10.20. Which of the following statements concerning these funds is most likely correct? A. Goofy Fund is a unit investment trust and Chipmunk Fund is a mutual fund B. Both funds are open-end investment companies but Chipmunk Fund is a no-load fund C. Goofy Fund is a closed-end investment company and Chipmunk Fund is a mutual fund D. Goofy Fund is an open-end investment company and Chipmunk Fund is a closed-end investment company
The best answer is D. An open-end management company (mutual fund) will have a higher ask price than bid price, unless it is a no-load fund, where the bid and ask price are the same. The bid price is the net asset value, and the ask price is the net asset value plus the sales charge. Remember that open-end funds do not trade - rather, they are purchased from the sponsor (at the Ask price, which is NAV plus a sales charge, if the fund is a load fund) and are redeemable with the sponsor (at the Bid price, which is NAV). Closed-end fund shares are listed on an exchange and trade like any other stock; therefore they have a market price than can be higher or lower than NAV. The only fund that can sell for less than NAV is a closed-end fund, if investors are bearish on that fund's prospects. Thus, Chipmunk Fund, with a market price of $10.20, but an NAV of $11.05, must be a closed-end fund.
Which of the following statements are true about commercial paper? I Commercial paper has a maximum maturity of 90 days II Commercial paper has a maximum maturity of 270 days III Commercial paper is quoted on a dollar price basis IV Commercial paper is quoted on a yield basis A. I and III B. I and IV C. II and III D. II and IV
The best answer is D. Commercial paper has a maximum maturity of 270 days. Commercial paper is quoted on a yield basis (as is all money market debt).
A customer, age 57, has made payments into a non-tax qualified variable annuity contract totaling $10,000. The investment in the separate account is now worth $16,000. The customer wishes to withdraw $5,000 from the account. The tax implications of the withdrawal are: A. $5,000 non-taxable return of capital and $0 penalty tax B. $5,000 taxable ordinary income and $0 penalty tax C. $5,000 taxable long-term capital gain and $0 penalty tax D. $5,000 taxable ordinary income and $500 penalty tax
The best answer is D. Distributions from non-tax qualified retirement plans are accounted for on a LIFO - Last-In; First-Out basis. The first item that went into the plan was the original non-tax deductible contribution. The next item than went into the plan was the reinvestment of dividends, interest, and capital gains over time - all of which have been building tax deferred. When distributions commence, the first dollars out of the plan are accounted for as the return of the "build-up" - which was never taxed. The last dollars out of the plan are the original investment (cost basis) which was made with after-tax dollars and hence is not taxed. Thus, in this plan $10,000 was invested; and it built up to $16,000. Thus, the first $6,000 out of the plan is taxable ordinary income; the remaining $10,000 is a non-taxable return of capital. In addition, since this customer is under age 59 1/2, a 10% penalty tax must be paid on any distribution, since this is a premature distribution. The customer withdrew $5,000, all of which is taxable as ordinary income, plus an additional 10% ($500) penalty tax is due on the distribution.
Forward contracts differ from futures contracts in all of the following ways EXCEPT forward contracts are: A. non-standardized B. non-regulated C. non-competitive D. non-derivative
The best answer is D. Forward contracts are custom contracts that are negotiated between buyer and seller. They are issued OTC and there is very limited trading - thus it may not be possible to do an offsetting trade with a forward contract. Forward contracts are not subject to federal regulation. In contrast, futures contracts are standardized, exchange traded contracts. They are regulated by the CFTC - the Commodities Futures Trading Commission. Because they are actively traded, it is easy to do an offsetting trade before the delivery date. Both futures and forwards are derivatives, because their price movements are based on the price movement of a reference asset.
During the annuity period of a fixed annuity, the insurance company assumes which of the following risks? I Mortality Risk II Purchasing Power Risk III Expense Risk IV Investment Risk A. I and II B. II and III C. III and IV D. I, III, IV
The best answer is D. In a fixed annuity, the insurance company assumes mortality risk, expense risk and investment risk. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company's expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company's problem. Investment risk is the risk that the insurance company's return on its investments does not keep pace with its payment obligations to fixed annuity holders. If its investments fare poorly, the insurance company does not reduce the amount of the fixed annuity payments With a fixed annuity, the purchaser assumes purchasing power risk - the risk of inflation. If there is inflation, the monthly annuity payments do not increase, so the annuitant's purchasing power declines over time.
All of the following are risks of investing in a Real Estate Limited Partnership (RELP) EXCEPT: A. Business risk B. Liquidity risk C. Regulatory risk D. Reinvestment risk
The best answer is D. Limited partnerships are illiquid - they do not trade and a limited partner can only sell his or her unit with general partner approval. So liquidity risk is a major issue. Because these are tax shelters that use provisions of the tax code to reduce tax liability, owners of limited partnerships face increased risk of tax audit; and also are subject to regulatory risk, which is the risk of tax law change. There are no dividends or interest payments received that must be reinvested, so there is no reinvestment risk. However, business risk is another big issue here - because the business venture may fail.
Which statement is best regarding participating preferred stock? A. The dividend rate is fixed B. The dividend rate varies depending on the decision of the Board of Directors C. The dividend rate is fixed as to maximum but not as to minimum D. The dividend rate is fixed as to minimum but not as to maximum
The best answer is D. Participating preferred pays a fixed dividend rate but also participates with common in "extra" dividends declared by the Board of Directors. Therefore, the dividend rate is fixed as to minimum but not as to maximum.
Listed REITs offer all of the following benefits to purchasers EXCEPT: A. Diversification of investments B. Ready marketability of shares C. Capital gains potential D. Preferential taxation of dividends received
The best answer is D. REITs offer diversification of investments similar to investment companies, except that the investments are being made in various types of real estate. REIT shares are listed and trade on an exchange (like a closed-end fund), so they are readily marketable. If real estate does well as an investment, the shares will appreciate, giving the investor a capital gain. Finally, REIT dividend taxation is truly "not that great." While dividends received from common stock investments, including mutual funds, qualify for the lower 15%-20% tax rate, the tax law specifically denies this benefit to REIT dividend distributions. These are taxed at ordinary income tax rates of up to 39.6%.
The sponsor of a mutual fund is also known as the: A. Bank B. Manager C. Custodian D. Underwriter
The best answer is D. The fund underwriter is also known as the fund sponsor. The sponsor is responsible for establishing the fund in compliance with the requirements of the Investment Company Act of 1940.
Which of the following options strategies provides a gain equal to the premium in a bull market? A. Long Call B. Short Call C. Long Put D. Short Put
The best answer is D. The writer of a put (short put) collects a premium in return for agreeing to buy stock at a fixed price, no matter how low the market price of the stock may go. If the market price rises, the put expires "out the money" and the writer keeps the collected premium. This is the maximum potential gain.
Which of the following investments is issued with a stated coupon rate and with a maximum maturity of 30 years? A. Treasury Notes B. Treasury Stock C. Treasury Strips D. Treasury Bonds
The best answer is D. Treasury bonds are government obligations issued with initial 30 year maturities which pay interest semi-annually.
A premium corporate bond that is callable would be quoted on a yield basis based upon: A. yield to maturity B. coupon rate C. current yield D. yield to call
The best answer is D. When a yield is quoted on a bond, this yield is then converted to a dollar price. The actual yield that the bond will return is based on the expected redemption date of the bond. A premium bond will most likely be called by the issuer. The reason why it is trading at a premium is because market yields have fallen. If the issuer did call the bonds and wanted to issue new bonds to replace the old called issue, it would pay lower market rates. Thus, such a bond will be called and will not last until maturity. Thus, the price will be calculated based upon the nearest call date of the bond.
Revenue bonds are: I issued by municipalities II issued by municipal authorities III backed by an insurance pledge from a private municipal bond insurer IV backed by a pledge of revenues from a specific project A. I and III B. I and IV C. II and III D. II and IV
he best answer is D. Municipal revenue bonds are backed by a revenue pledge from a specific project. A municipality established an "authority" to build the facility (such as a bridge or tunnel), manage the facility's operations, and pay the bondholder's their interest and principal as due. Only the revenues from the facility back the issue. In contrast, municipal general obligation bonds are backed by the full faith, credit, and taxing power of the issuer.
