Part 2: Economic Factors and Business Information
A 45-year-old investor takes a lump-sum distribution from a nonqualified variable annuity. How is the distribution taxed? 1The entire amount is taxed as ordinary income. 2The growth portion is taxed as ordinary income. 3The growth portion is taxed as a capital gain. 4The growth portion is subject to a 10% penalty. A) II and IV B) II and III C) III and IV D) I and IV
A.....On withdrawals from a nonqualified annuity, taxes are paid only on the amount that exceeds cost basis (the amount paid into the annuity). In this case, the investor is taking a lump-sum distribution before reaching age 59½ and must pay an additional 10% penalty on the taxable amount.
An investor concerned about liquidity would be least likely to invest in A) stock subject to Rule 144 B) ADRs C) common stock listed on the New York Stock Exchange D) cumulative preferred stock
A...Stock subject to Rule 144 is stock that cannot be immediately resold.
If an investment can be expected to return 8%, using the rule of 72, what is the present value needed to have $50,000 for a child's education in 18 years? A) $12,500 B) $6,250 C) $2,777 D) $25,000
A...Under the rule of 72, dividing 72 by the expected return shows the number of years it will take for a deposited sum to double. 72 divided by 8 equals 9 years. Over an 18-year period, there will be 2 doublings. So, dividing the future value ($50,000) by 4 solves for the present value required.
The business cycle has expanded, peaked, and contracted. The current economic activity could best be described as a trough. Which of the following would most likely be found in the trough? A high rate of inflation A low rate of inflation A high rate of unemployment A low rate of unemployment A) I and IV B) II and III C) II and IV D) I and III
B...A trough is the latter stage of a recession. Unemployment is higher than normal, and with a lesser demand for goods and services, the inflation rate is low.
If having discretion over $100 million or more in 13(f) securities, which of the following would be exempt from filing a Form 13F? A) A natural person who exercises investment discretion over the account of any other natural person or entity B) A natural person who exercises investment discretion over her own account C) A trustee D) An investment adviser that manages mutual fund assets
B...An institutional investment manager is also a natural person or an entity that exercises investment discretion over the account of any other natural person or entity. For example, an investment adviser that manages private accounts, mutual fund assets, or pension plan assets is an institutional investment manager; so is the trust department of a bank. A trustee is an institutional investment manager, but a natural person who exercises investment discretion over her own account is not an institutional investment manager.
An investment adviser representative is required to make disclosure to the client when the IAR, in preparing a recommendation, uses research provided by a third party with whom the IAR is not affiliated the IAR recommends a specific insurance policy for the client's overall financial plan, where a commission will be received on that sale transactions recommended to a specific client are inconsistent with those for other clients with objectives that are similar to that particular client transactions recommended to the client are inconsistent with those for the IAR's own account A) I, II, and III B) II and IV C) II, III, and IV D) I and III
B...An investment adviser must provide full disclosure to his client if there would be even a hint of conflict of interest. This will include the case where a recommended product will generate a commission or other source of income to the adviser, as well as full disclosure if a recommendation is not consistent with the adviser's own activity in his own account. The adviser can use any source of information to create his own analysis, with disclosure of source only being required if the adviser uses the product of a third party as the presentation to the client. It would be unusual that all clients with the same or similar objectives would purchase or have recommended for purchase the same securities.
The Conference Board releases information about the economy on a monthly basis. Included are a number of different indicators. Economic indicators can be leading, lagging, or coincidental, which indicates the timing of their changes relative to how the economy as a whole changes. Which of the following is a lagging economic indicator? A) Building permits (housing starts) B) Average prime rate C) Nonagricultural employment D) Manufacturers' new orders for consumer goods
B...Both the S&P 500 and housing permits are leading economic indicators, as is the measure of hours worked because it reflects changes in the average workweek during the current period. The average prime rate is a lagging indicator because, in an economic downturn, the longer rates stay low, the quicker the recovery should be.
If a company with 10 million shares outstanding with total earnings of $50 million pays a $2 dividend, the dividend payout ratio is A) 4% B) 40% C) 20% D) 25%
B...Dividend payout ratio is determined by dividends paid per share divided by earnings per share. In this case, earnings per share (EPS) is $50 million ÷ 10 million shares = $5 per share. The company paid out in dividends $2 for each $5 earned for a 40% payout ratio ($2 ÷ $5).
The Conference Board releases information about the economy on a monthly basis. Included are a number of different indicators. Economic indicators can be leading, lagging, or coincidental, which indicates the timing of their changes relative to how the economy as a whole changes. Which of the following is a lagging economic indicator? A) Building permits (housing starts) B) Prime interest rate C) Nonagricultural employment D) Manufacturers' new orders for consumer goods
B...The prime interest rate is a lagging indicator. Nonagricultural employment is a coincident indicator. The other two choices are leading indicators.
Which of the following would probably be the best indicator of where the economy is headed? A) Industrial production B) Permits for construction of new housing units C) Average duration of unemployment D) Average prime rate
B...The question is looking for a leading indicator and, of the list, only new building permits fits. Industrial production is a coincident indicator, while the other two choices are lagging.
XYZ Aircraft Manufacturing Corporation, based in the United States, announces a multibillion dollar order for its new jumbo jet from Fly Airlines, a Japanese-based carrier. When the sale is completed, there will be A) a debit to the current account of the United States B) a credit to the current account of the United States C) a credit to the current account of Japan D) no effect on the balance of trade
B...Whenever money from a foreign source enters the United States, it becomes a credit item in the U.S. balance of payments.
An agent for a well-known broker-dealer has taken it upon herself to look for investment opportunities for her clients. Her research indicates that, in spite of record earnings, the stock of GEMCO, Inc., is poised for a price reversal. Should this analysis prove correct, this would be an example of A) financial risk B) reinvestment risk C) market risk D) regulatory risk
C.....Market risk is the uncertainty that the market price of a stock will drop even when earnings are strong. Most stocks follow the "market" and this would appear to be no exception. Financial risk concerns itself with financing, particularly debt, so it is related to credit risk. Nothing in this question infers anything about financing difficulties.
Securities analysts would agree that it makes sense to purchase a fixed-income security when its net present value (NPV) is A) variable B) negative C) positive D) zero
C....A positive NPV means the security is available for a price below its present value—it is a good buy. With a negative NPV, the price is too high. With a zero NPV, it is accurately priced.
Which of the following has the least exposure to inflation risk? A) Fixed annuity B) Preferred stock C) Common stock D) Cash
C...The returns on common stock have historically outperformed inflation, making them less vulnerable to loss of purchasing power among the choices presented. Cash is a store of present purchasing power that inflation will erode. Fixed annuities have more exposure to inflation than common stock because their payments are fixed in nominal dollars. Preferred stock has the same exposure to inflation risk as do all fixed income instruments.
A support level is the price range at which a technical analyst would expect the A) demand for a stock to decrease substantially B) demand for a stock to remain constant C) demand for a stock to increase substantially D) supply of a stock to increase substantially
C...This question is about comparing support and resistance levels. Most stock prices remain relatively stable and fluctuate up and down within a narrow range. The lower limit to these fluctuations is called a support level - the price point where a stock appears cheap and attracts buyers. The upper limit is called a resistance level - the price point where a stock appears expensive and initiates selling. Generally, a support level will develop after a stock has experienced a steady decline from a higher price level. Technicians believe that, at some price below the recent peak, other investors will buy who did not buy prior to the first price increase and have been waiting for a small reversal to get into the stock. When the price reaches this support level, demand surges and price and volume begin to increase again.
Interest rates are rising. An analyst would be most likely to state that the business cycle is in which stage? A) Trough B) Peak C) Contraction D) Expansion
D....It is during periods of economic expansion that interest rates tend to increase. They tend to fall during contractions.
Charlie Mindel is the portfolio manager for the Steady Yield Bond Fund. If Charlie was of the opinion that interest rates were going to fall, he would A) move more of the portfolio into cash. B) keep the average duration the same. C) decrease the average duration of the portfolio. D) increase the average duration of the portfolio
D...As interest rates go down, prices of bonds rise. Those with the longest duration will have the greatest price increase. To benefit from this move, managers of bond portfolios will lengthen the average duration of the portfolio. The reverse action would be taken if Charlie thought that interest rates were going to rise. Of course, if interest rates move in the opposite direction of that the manager expects, the fund might start looking for a new manager.
If the Consumer Price Index (CPI) is down but consumer demand is up, the economy is likely in which stage of the business cycle? A) Contraction to trough B) Peak to contraction C) Recovery to trough D) Recovery to expansion
D...As prices trend downward and consumer demand increases, the economy is moving from recovery to expansion. As demand continues to increase, assuming supply remains constant, upward pressure will be put on prices through the expansion to the peak. DUPLICATE
When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) net value of fixed assets. B) earnings per share. C) cash flow from investments. D) cash flow from operations.
D...Cash flow from operations is computed by adding the year's depreciation deduction to the net income.
An investor is analyzing the impact of the specific type of risk affecting bonds because the fixed cash payments that they deliver may become less valuable. What risk is this? A) Interest rate risk B) Systematic risk C) Credit risk D) Inflation risk
D...This is an example of a question where careful reading is necessary. Indeed, every one of the choices is a risk faced by bond investors, but only one specifically answers the question. When the semiannual interest payments 10 or 20 years from now don't buy as much as they would today, that is inflation or purchasing power risk. That falls into the category of systematic risk. On the exam, when one choice is specific and the other is broad, go with the specific one. Interest rate risk is another systematic risk, but it indirectly relates to the question. Credit risk is an unsystematic risk and has nothing to do with the issue raised here.
Under which of the following circumstances can an agent conduct customer transactions without the activity being recorded on the books and records of his broker-dealer employer? A) The customer is a member of the agent's immediate family. B) The securities are exempt under the Uniform Securities Act. C) The agent will receive no compensation. D) The transactions are authorized in writing by the broker-dealer before execution of the transactions.
D...Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, it would be considered contrary to the standards imposed for an agent to effect securities transactions not recorded on the regular books or records of the broker-dealer that the agent represents, unless the transactions are authorized in writing by the broker-dealer before execution of the transaction.
Although there may be some slight differences in methodology, when S&P or Moody's evaluate a security in order to assign a rating, they would be least likely to consider the issuer's A) liquidity ratio B) profitability ratio C) cash flow to debt ratio D) asset turnover ratio
D...What is the purpose of a security's rating? To inform investors of the financial risk of the investment. The higher the rating, the lower the risk. This is one of those questions that students answer correctly because all of the other choices are incorrect (they are important factors). Remember, this is a negative question: "least likely." Certainly profitability of the issuer is a key factor in assessing the safety of the issue. Liquidity and cash flow are important factors as well. The rate at which assets are turned over is not nearly as important to determining a rating as the other three.
One measure of a corporation's liquidation value is its book value per share. When performing this computation, which of the following must be taken into consideration? Goodwill Long-term debt Retained earnings Par value of the preferred stock A) I, II, III, and IV B) II, III, and IV C) II and III D) I and II
A....The computation of book value per share is basically net tangible worth per share of common stock. Included in the net worth are all assets and liabilities (such as long-term debt), as well as the stockholders equity (par value of the preferred stock and par + paid in surplus of the common stock and retained earnings). Subtracted from this to get tangible book value would be the par value of the preferred stock and the value of intangible assets such as goodwill.
Which of the following would lead to a debit to our foreign account balance? A) U.S. residents taking vacations abroad B) Foreign governments repaying loans to U.S. banks C) An increase in exports D) Residents of other countries buying apartments here
A....When our foreign account balance is debited, that creates a negative action. It is like a charge on your credit card - your account is debited. On the other hand, a credit to your card account is money coming to you. Our foreign accounts balance will be debited whenever our money goes out rather than coming in. When U.S. residents take vacations abroad, our money is being spent on hotel, restaurants, and other items in foreign countries. The other choices represent a credit to our foreign account balance. When exports increase, more foreign money comes in. When foreigners buy property here, we get their money, and when loans are repaid here, once again, foreign money comes into the U.S.
ABC Manufacturing Company is in the business of making high quality machine tools. Which of the following would be included in ABC's cash flow from financing activities? A) Payment of cash dividends B) The sale of XYZ Lathe Manufacturing bonds C) The purchase of a new computer-driven lathe D) The purchase of a new building to store inventory
A...All financing activities deal with the flow of cash to or from the business owners. Who do dividends go to? The company's shareholders and that is why they are included in financing activities. The other choices are part of cash flow from investing activities.
All of the following would decrease the U.S. balance of payments deficit EXCEPT A) a decrease in purchases of U.S. securities by foreign investors B) a decrease in dividend payments by U.S. companies to foreign investors C) a decrease in imports of foreign goods into the U.S. D) an increase in exports of domestic goods from the U.S.
A...Anything that will bring foreign money to the U.S. will decrease the balance of payments. Foreign investors pulling their money out of the U.S. or investing less in the U.S. will increase the deficit.
Patrice has an investment portfolio with the following characteristics: Portfolio actual return: 9% Market actual return: 12% Portfolio standard deviation: 4% Market standard deviation: 7% Portfolio beta: 0.65 Risk-free rate of return: 3% What is her portfolio's alpha? Did her portfolio outperform the market on a risk-adjusted basis? A) With an alpha of 0.15%, her portfolio outperformed the market. B) With an alpha of -5.10%, her portfolio underperformed the market. C) With an alpha of 5.10%, her portfolio outperformed the market. D) With an alpha of -0.15%, her portfolio underperformed the market.
A...As with most computation questions, there is more than one way to arrive at the answer. Using the steps in the LEM (U10LO4), Alpha - (total portfolio return minus risk-free rate) minus (portfolio beta times [market return minus risk-free rate]). Plugging in the numbers, we have (9% - 3%) - (.65 times [12% minus 3%]) = 6% - (.65 x 9%) = (6% - 5.85% = 0.15% An alternative method simply moves the parentheses a bit. If this is easier for you, use it. Alpha = 9% − [3% + 0.65 (12% − 3%)] = 9% - [3% + .65 (9)] = 9% - (3% + 5.85) = 9% - 8.85 = 0.15%. A positive alpha indicates that the portfolio outperformed the market on a risk-adjusted basis. Did you notice that the standard deviation was irrelevant to our computation? It is not unusual for the exam to include information that is extraneous to the question just to confuse you.
Your client calls you after reading a story in the business section of his local newspaper. It seems that the article focused on changes to the core CPI and the client wants to know how that is different from the normal CPI. You should explain that it is A) the Consumer Price Index excluding energy and food prices B) the total of the leading indicators, excluding stock prices C) the Consumer Price Index excluding housing and automobiles D) the figure used to determine annual increases, if any, to Social Security benefits
A...Because of their high volatility, economists exclude energy and food prices from core inflation figures. Social Security adjustments (and many others as well) are based upon the CPI itself, not the core.
Which of the following would offer your client check-writing privileges and FDIC insurance coverage? A) DDA B) GIC C) Government securities money market fund D) Negotiable CD
A...DDA stands for demand deposit account, most commonly, a bank checking account. It, like all other bank accounts, carries FDIC insurance. GICs offer neither. Money market funds offer check-writing, but no FDIC coverage; negotiable CDs offer FDIC coverage, but no check-writing.
An upward sloping yield curve represents all of the following EXCEPT A) foreign interest rate differentials B) increased risk of default over time C) inflation expectations D) time value of money
A...Foreign interest rate differentials are not reflected in an upward sloping yield curve. Interest rate differentials between countries reflect differences in domestic monetary and fiscal conditions. The time value of money is reflected in the upward sloping yield curve. Longer-term rates require higher rates to compensate for loss of current buying power and liquidity. Longer-term funds bear a higher risk of default than do shorter-term funds and, as a result, command higher rates. Increasing inflation expectations cause the yield curve to slope upward to compensate lenders for the loss of future buying power. This is an example of how you get a question correct by process of elimination.
The net asset value of an international bond fund can be expected to increase if interest rates rise abroad interest rates fall abroad the U.S. dollar strengthens the U.S. dollar weakens A) II and IV B) I and IV C) I and III D) II and III
A...If interest rates fall, bond prices will rise, thus increasing the NAV of a bond portfolio. If the U.S. dollar weakens, the value of other currencies will rise. This would also increase the NAV for a portfolio of international bonds.
Which of the following statements concerning international investing is correct? A) Information is not as readily available on foreign investments as on domestic ones. B) The rates of return on foreign securities are generally less than those available from U.S. markets. C) Foreign markets are usually mature and offer no growth advantages. D) The addition of foreign securities to a portfolio may result in increased portfolio risk due to the different movements of foreign markets and U.S. markets.
A...In general, foreign investments don't have the transparency of domestic ones. Investors may earn higher returns in foreign markets and including foreign securities in an investment portfolio may lower risk through greater diversification. This is because there may be a low correlation with U.S. markets. Although securities markets in most developed economies are mature, that doesn't mean they can't grow and the markets in emerging economies offer great potential growth commensurate with their greater risk.
The Conference Board releases information about the economy on a monthly basis. Included are a number of different indicators. Economic indicators can be leading, lagging, or coincidental, which indicates the timing of their changes relative to how the economy as a whole changes. Which of the following is a coincident economic indicator? A) Industrial production B) Machine tool orders C) Agricultural employment D) Stock market prices as measured by the S&P 500
A...Industrial production is a coincident indicator. The stock indices and manufacturing orders are leading indicators; economists do not use agricultural employment as an indicator.
Which of the following would be considered unethical under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers? A) A loan is made to an investment adviser representative by one of her clients who happens to be the chief loan officer where she maintains her principal banking relationship. B) An investment adviser varies the annual fee based upon each client's assets under management, charging less for those with higher balances and more for those meeting the account minimum. C) An investment adviser representative receives an order to buy XYZ stock from an advisory client and simultaneously recommends that another advisory client sell that stock in an agency cross transaction. D) An investment adviser discloses in its brochure that, from time to time, it may sell securities recommended to clients directly out of the firm's inventory.
A...It is an unethical and prohibited business practice for investment advisers and their representatives to borrow money from clients who are not in the business of lending money. In this case, the loan officer is the one who is doing the lending, not the bank. IAs are permitted to base their fees on the amount of assets under management, generally charging a lower percentage to those with higher balances. IAs are permitted to act as principals in recommended trades, but appropriate disclosure must be made. In an agency cross transaction, a recommendation may be made to either, but not both, parties to the trade.
The Federal Reserve Board foresees the probability of an overheated economy and the resumption of double-digit inflation. Therefore, the FRB takes actions to slow down the economy, including increasing the discount rate. Which of the following are likely effects of these moves? 1An increase in the prime rate 2An increase in bond yields and an accompanying decrease in bond prices 3A slowdown in corporate growth 4A decrease in corporate earnings A) I, II, III, and IV B) I and II C) III and IV D) I, III, and IV
A...The FRB attempts to slow the economy and decrease the money supply with a corresponding increase in interest rates. When interest rates rise, the prime rate increases, bond yields rise, and bond prices drop. Higher interest rates have a tendency to slow corporate growth, with a resulting slowdown in earnings; these events occur in this approximate sequence.
One way in which internal rate of return (IRR) differs from most return computations is that A) it takes into consideration the time value of money B) it takes into consideration the rate of inflation C) it is always an annualized rate of return D) its application to debt securities is limited
A...The internal rate of return compounds returns and takes into consideration the time value of money. Real rate of return considers the inflation rate.
The Smiths are saving money for a down payment on a house. The Smiths have $25,000 in cash, and they estimate that in 5 years they will have approximately $31,000 if they deposit their cash in a savings account that compounds interest yearly. To calculate the $31,000 amount, the Smiths determined A) the future value of the $25,000 B) the present value of $25,000 C) the internal rate of the return on the $25,000 D) the net present value of the $25,000
A...To determine the money's worth at a future date (in this case, 5 years), the Smiths calculated the future value of the funds. Future value is a compounded rate of return, and in this case, the $25,000 was compounded at 5% per year for 5 years. The present value of an investment is the opposite of future value.
If a corporation issues mortgage bonds, all of the following would be affected EXCEPT A) shareholder's equity B) total assets C) total liabilities D) working capital
A...When issued, the corporation receives the net proceeds in cash, increasing current assets (and thus total assets). Simultaneously, the corporation's long-term liabilities increase reflecting the debt (and thus total liabilities). Working capital increases because of the increase in current assets. Shareholder's equity, or net worth, is only affected by the sale of new equity securities or by any profit or loss generated by the corporation.
You recently took a trip to Warsaw, Poland, and when you received your credit card statement, you noticed that your vodka purchase for 100 Polish Zlotys resulted in a $30 charge on your statement. Based on this exchange rate, each dollar was worth approximately A) 3.33 Zlotys B) $3.33 C) 3 Zlotys D) $.33
A...You recently took a trip to Warsaw, Poland, and when you received your credit card statement, you noticed that your vodka purchase for 100 Polish Zlotys resulted in a $30 charge on your statement. Based on this exchange rate, each dollar was worth approximately A) 3.33 Zlotys B) $3.33 C) 3 Zlotys D) $.33
ALFA Enterprises pays a quarterly dividend of $0.15 and has earnings per share of $2.40. Assuming that payout rate is continued, what is the dividend payout ratio? A) 30% B) 25% C) 6.25% D) 14.4%
B...Earnings per share are typically calculated for a year. If the quarterly dividend rate of $0.15 is continued, that will be an annual payout of $0.60 ($0.15 × 4). So the annual dividend of $0.60 is divided by $2.40 to calculate what percentage of earnings is paid as a dividend; or rather, the dividend payout ratio (0.60 ÷ 2.40 = 25%).
Which of the following is a direct obligation of the U.S. government? A) Fannie Maes B) Ginnie Maes C) Bank for Cooperatives bonds D) Government bond mutual funds
B...Ginnie Maes are backed by the full faith and credit of the United States. Other agencies have a moral, but not direct, government backing. Government bond mutual funds are not backed by the U.S. government.
An IAR is attempting to develop an investment plan for a client. The IAR decides to use two different mutual funds in an effort to provide appropriate diversification. Of the four pairs given below, which one would offer the most diversification? A) Portfolio 5 and 6, with a correlation coefficient of -.05 B) Portfolio 7 and 8, with a correlation coefficient of -.20 C) Portfolio 3 and 4, with a correlation coefficient of +.20 D) Portfolio 1 and 2, with a correlation coefficient of +.90
B...If two portfolios have a high correlation coefficient, it means that their performance will be very similar. The purpose of diversification is to have some negative correlation so that losses in one portfolio are offset by gains in the other.
As appropriate to the scale and complexity of a firm's business, elements of an effective practice framework for managing conflicts of interest include all of the following EXCEPT A) avoiding severe conflicts, even if that avoidance means foregoing an otherwise attractive business opportunity B) ensuring that the firm remains solvent for protection of customers and employees alike C) establishing mechanisms to identify conflicts in a firm's business as it evolves D) training staff to identify and manage conflicts in accordance with firm policies and procedures
B...Managing conflicts of interest does not take into consideration making enough money to remain solvent.
With regard to an SEC-registered investment adviser employing the services of a promoter to solicit business, it would be correct to state that A) cash referral fees may be paid pursuant to a written or oral agreement to which the investment adviser is a party. B) the investment adviser may not compensate a solicitor who is subject to a statutory disqualification. C) referral fees may be paid only if the solicitor is also registered with the SEC. D) delivery of the solicitor's brochure must take place within five days after the entry into the advisory contract.
B...One of the important requirements when hiring a solicitor is making sure that the person is not statutorily disqualified from registration. That is, any person who would be unable to register as a securities professional because of prior conduct cannot act as a solicitor for a registered investment adviser. Promoters do not have to prepare (much less deliver) a brochure. If the promoter is to be compensated more than the de minimis amount, there must be a written, not oral, agreement.
Discounted cash flow is commonly thought of as applying solely to fixed-income securities. However, forms of DCF used for the valuation of common stock also include 1the price-to-earnings ratio 2the dividend discount model 3the discounted book value model 4the dividend growth model A) II and III B) II and IV C) I and II D) I and IV
B...The 2 most common forms of DCF used in the valuation of common stock are the dividend discount and dividend growth models.
Wealth Creation Advisers (WCA) is a federal covered investment adviser specializing in consulting to pension plans. WCA's principal office is located in State L. The governor of State L is running for re-election. If WCA were to make a $350 contribution to the campaign, under the SEC's pay-to-play rule, A) WCA's contribution is within the de minimis limitation because their principal office is located in State L B) WCA would be prohibited from receiving compensation for advisory services rendered to any agency of State L for 2 years C) WCA would be prohibited from rendering any advisory services to any agency of State L for 2 years D) WCA could be subject to disciplinary action
B...The SEC's pay-to-play rule prohibits investment advisers from receiving compensation for advisory services to a government entity (any agency, authority, or instrumentality of a state or political subdivision), for 2 years after the advisory firm or any covered employee makes a political contribution to a public official or candidate who is or would be in a position to influence the award of investment advisory business by public retirement funds. Please note that the advisory relationship can continue, just without any compensation. The de minimis exemption of $350 applies to an individual, as long as that person is eligible to vote for the candidate ($150 if he is not), but it never applies to the firm.
All of the following are leading indicators for economic growth EXCEPT A) stock prices as measured by the S&P 500 index B) average prime rate C) orders for durable goods D) average weekly initial claims for state unemployment compensation
B...The average prime rate is a lagging indicator. The duration of unemployment is also a lagging indicator, but the number of initial unemployment claims is a leading indicator. The S&P 500 index and orders for durable goods are leading economic indicators.
An inverted yield curve results in part by A) rising interest rates B) investors buying long-term bonds and selling short-term bonds C) investors buying short-term bonds and selling long-term bonds D) declining interest rates
B...The demand for longer-term bonds is higher than that of short-term bonds and causes a negative slope in the yield curve. If investors were buying short-term bonds in greater demand, the rates of short-term bonds would decline rather than rise.
Under the Investment Advisers Act of 1940, cash payment to a broker-dealer from an investment adviser in return for client referrals is A) not permitted under any circumstances B) permitted only if the investment adviser and broker-dealer are affiliated C) permitted if the investment adviser makes certain disclosures to the clients and meets other requirements D) permitted with no restrictions
C....Cash payments by investment advisers for referrals from broker-dealers are permitted whether or not the BD is affiliated with the IA. In all cases, such compensation must be disclosed to affected clients.
A corporation calls in a portion of its long-term debt at 101. This will have the effect of 1decreasing working capital 2increasing working capital 3decreasing net worth 4increasing net worth A) II and IV B) I and IV C) I and III D) II and III
C....Working capital is computed by subtracting current liabilities from current assets. Using a current asset, like cash, to call in the bonds, reduces those assets with no corresponding reduction to current liabilities. Whenever a bond is called at a premium, net worth is reduced by that premium.
Which of the following statements regarding convertible debentures is TRUE? A) The debenture holders receive a variable rate of interest. B) The issuer has the right to convert the debentures during the time period specified in the indenture. C) The issuer pays a higher rate of interest, compared with a comparable nonconvertible debenture. D) When compared with similar nonconvertible debentures, convertible debentures are issued with a lower coupon rate.
C...A conversion feature is a benefit to the debtholder. It allows the debtholder a choice to either continue holding the debt represented by the debenture or to convert it into shares of common stock of the underlying issuer. Everything that is done in the securities industry has to be a win/win situation. The win for the debtholder in this instance is the ability to take advantage of the capital appreciation potential the common stock may offer, and the win for the issuer is that by offering something extra to the debenture purchaser, that purchaser is willing to accept a lower interest rate on the debt (as compared to a nonconvertible debenture) and therefore giving the issuer a lower cost of capital. It is the debtholder, not the issuer who determines when and if to convert.
Looking at the balance sheet, a corporation builds its capital structure with all of the following except A) capital stock. B) long-term debt. C) cash. D) retained earnings.
C...A corporation's capital structure consists of its long-term debt plus shareholders' equity. Included in shareholders' equity are the equity capital (stock) and the retained earnings.
Which of the following activities might result in a positive yield curve in the bond market? A) A parallel upward shift in interest rates B) A parallel downward shift in interest rates C) Investors buying short-term bonds and selling long-term bonds D) Investors buying long-term bonds and selling short-term bonds
C...A positive yield curve is the normal condition and occurs when long-term rates are higher than short-term rates. Buying short-term bonds tends to drive their prices up and their yields down, while selling long-term bonds has the opposite effect.
The terms mean, median, and mode are all measures of A) standard deviation B) correlation coefficient C) central tendency D) beta coefficient
C...Central tendency is usually defined as the center or middle of a distribution. The three most common tools used are mean, median, and mode.
Current liabilities on a company's balance sheet would include A) accounts receivable. B) mortgage payable. C) accounts payable. D) prepaid rent.
C...Current liabilities are those which are expected to be paid within a normal operating cycle and would include accounts payable. A mortgage payable is a liability, but it is a long-term debt and would be included in fixed or long-term liabilities. Accounts receivable and prepaid expenses are current assets.
The Conference Board releases information about the economy on a monthly basis. Included are a number of different indicators. Economic indicators can be leading, lagging, or coincidental, which indicates the timing of their changes relative to how the economy as a whole changes. Which of the following is a coincident economic indicator? A) Agricultural employment B) Stock market prices as measured by the S&P 500 C) Industrial production D) Machine tool orders
C...Industrial production is a coincident indicator. The stock indices and manufacturing orders are leading indicators; economists do not use agricultural employment as an indicator.
All the pundits are predicting bad times ahead—not only a recession but a period where prices actually fall (deflation). If they are right, the best place for your client would probably be A) common stock B) gold C) U.S. Treasury securities D) real estate
C...It is times like this that the flight to safety has investors commit their funds to U.S. government securities. Gold (and other commodities) tends to increase in price during inflationary, not deflationary, periods. Both real estate and equities tend to rise when things are good, not during recessionsIt is times like this that the flight to safety has investors commit their funds to U.S. government securities. Gold (and other commodities) tends to increase in price during inflationary, not deflationary, periods. Both real estate and equities tend to rise when things are good, not during recessions.
An inverted yield curve results in part by A) rising interest rates B) declining interest rates C) investors buying long-term bonds and selling short-term bonds D) investors buying short-term bonds and selling long-term bonds
C...The demand for longer-term bonds is higher than that of short-term bonds and causes a negative slope in the yield curve. If investors were buying short-term bonds in greater demand, the rates of short-term bonds would decline rather than rise.
Among the responsibilities of the Federal Reserve (the Fed) is influencing the supply of money and credit in the economy. When performing this function, adjusting which of the following is not a tool at its disposal? A) The activities of the Federal Open Market Committee B) The reserve requirements C) The prime rate D) The discount rate
C...The prime rate is set by the banks. All of the others are under the control of the Fed.
Among the responsibilities of the Federal Reserve (the Fed) is influencing the supply of money and credit in the economy. When performing this function, adjusting which of the following is not a tool at its disposal? A) The discount rate B) The reserve requirements C) The prime rate D) The activities of the Federal Open Market Committee
C...The prime rate is set by the banks. All of the others are under the control of the Fed.
Bond X has an internal rate of return (IRR) of 7%. Bond Y has an IRR of 9%. Both bonds pay interest semiannually. If the required rate of return is A) 7%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. B) 9%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. C) 7%, the net present value (NPV) of Bond Y will exceed the NPV of Bond X. D) 9%, both bonds will have a positive NPV.
C...We know that when a bond's IRR equals the required rate of return (the discount rate), the NPV of that bond is zero. That is the case with Bond X when the required rate of return is 7%. When the bond's IRR is above the required rate of return, it has a positive NPV. That is the case with Bond Y whose IRR is higher than the 7% required return. With a required return of 9%, Bond X has a negative NPV and Bond Y's NPV is zero. That is the technical explanation. The simple explanation is to compare the IRR with the required rate of return. Anytime the IRR is above the required rate, you've got a good deal (and that is what a positive NPV tells us).
An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 6%, then the NPV is A) positive B) negative C) zero D) 6%
C...When an investment's IRR equals the required rated of return, the NPV is zero. If the IRR is higher than the required rate of return, the NPV is positive; if the IRR is lower than the rate of return, the NPV is negative.
If a corporation issues mortgage bonds, all of the following would be affected EXCEPT A) working capital B) total assets C) shareholder's equity D) total liabilities
C...When issued, the corporation receives the net proceeds in cash, increasing current assets (and thus total assets). Simultaneously, the corporation's long-term liabilities increase reflecting the debt (and thus total liabilities). Working capital increases because of the increase in current assets. Shareholder's equity, or net worth, is only affected by the sale of new equity securities or by any profit or loss generated by the corporation.
A client is considering the purchase of American depositary receipts (ADRs). She is looking to further diversify her portfolio. Which of the following is NOT a feature of this type of investment vehicle? A) ADRs are traded on exchanges and the OTC markets. B) Information regarding the foreign company is easily attainable. C) ADRs are denominated in and pay dividends in U.S. dollars. D) They are not subject to exchange rate, or currency, risk.
D...Even though ADRs are denominated in U.S. dollars, they are subject to exchange rate, or currency, risk. In order to trade in the U.S. markets, information about the foreign company must be available to investors. ADRs representing the best known companies typically trade on the NYSE or the Nasdaq Stock Market, while lesser companies trade OTC.
Which of the following is a coincident economic indicator? A) Stock market prices as measured by the S&P 500 B) Machine tool orders C) Agricultural employment D) Industrial production
D...Industrial production is a coincident indicator. The stock indexes and manufacturing orders are leading indicators. Economists do not use agricultural employment as an indicator.
Which of the following statements regarding internal rate of return (IRR) is TRUE? A) IRR ignores the time value of money. B) IRR cannot be used effectively to measure return on investments with even cash flows, such as bonds. C) If the IRR is higher than the cost of borrowing to fund an investment, the investment is likely to be unprofitable. D) IRR is a discount rate at which the net present value (NPV) of an investment is equal to zero.
D...Internal rate of return (IRR) is a discount rate at which the net present value (NPV) of an investment is equal to zero. IRR can be used to measure return on bonds because of their even cash flows and on those stocks that pay stable dividends for the same reason. IRR accounts for the time value of money. If the IRR is higher than the cost of borrowing to fund the investment, the investment should be profitable.
With regard to nonqualified stock options (NSO) and incentive stock options (ISO), which of the following statements is incorrect? A) AMT is only an issue for those exercising ISOs. B) Board of director approval is required for both NSOs and ISOs. C) A tax deduction for the employer is generally only available with NSOs. D) Capital gain treatment is only available with NSOs.
D...It is only the ISO where the employee can possibly receive capital gain treatment
An economic indicator that has turning points which tend to occur after the turning points in the business cycle is classified as a A) leading indicator. B) coincident indicator. C) trailing indicator. D) lagging indicator.
D...Lagging indicators have turning points that occur after business cycle turning points. That is why they are called lagging indicators. Leading indicators are ahead of the cycle and coincident indicators parallel the cycle.
The Conference Board, a nongovernmental nonprofit organization, regularly publishes a list of economic indicators. Which of the following would be included in their list of leading indicators? A) Average prime rate B) Manufacturing and trade sales (in constant dollars) C) Average duration of unemployment D) Average weekly initial claims for unemployment insurance
D...Of these, the only one that is included in the list of leading indicators is the average weekly initial claims for unemployment insurance. Manufacturing and trade sales is a coincident indicator, and average duration of unemployment and average prime rate are lagging indicators.
Current market interest rates are 6%. Using the discounted cash flow method of valuation, you would expect to arrive at the highest valuation for which of the following? A) Zero-coupon bond maturing in 11 years B) 5% coupon maturing in 20 years C) 7% coupon maturing in 9 years D) 10% coupon maturing in 10 years
D...The discounted cash flow method considers the future expected free cash flow (the interest payments plus the eventual return of the principal) and discounting it to arrive at a present value. In its simplest iteration, this is nothing more than taking all the money you are scheduled to receive over a given future period and adjusting that for the time value of money. In general, bonds with higher coupons will have the greatest value because they will clearly produce the most cash flow, and zero-coupon bonds will produce the lowest because they have no cash flow other than the return of the face value at maturity.
Which of the following statements is most accurate regarding the net present value (NPV) and internal rate of return (IRR) on a bond? A) IRR assumes the cash flows are reinvested annually. B) NPV assumes that cash flows can be reinvested at the bond's IRR. C) IRR assumes the cash flows are reinvested at market interest rates. D) NPV assumes the cash flows can be reinvested at market interest rates.
D...The first step in finding the NPV is to compute the present value (PV). The PV is computed by taking the future cash flows and discounting them by a "discount" rate. That rate is the current market interest rate. So, if NPV is based on PV and PV assumes reinvestment at the discount rate, that assumption must hold true for figuring NPV. In the case of the IRR, that is the yield to maturity of a bond and assumes that the cash flows are reinvested at that IRR. For example, a bond with a YTM of 7% assumes that all reinvestments will be made at that 7% rate. The periodic cash flow on a bond comes from the semiannual interest payments making reinvestments semiannually, not annually.
A state-registered investment adviser would like to employ the services of an individual as a solicitor to help bring in more business. The solicitor will be compensated by receiving a percentage on all assets placed under management. In order to do this, all of the following must be complied with except A) the solicitor must be registered as an investment adviser representative in order to receive compensation based upon advice B) disclosure of the arrangement must be made to the clients C) the terms of the compensation must be spelled out D) the clients must sign the contract at the same time that they receive the investment adviser's brochure
D...The investment adviser's brochure must be delivered no later than at the time the advisory contract is signed. In most cases, especially with state-registered advisers, the brochure is delivered in advance. In fact, because of the USA's 48-hour rule dealing with a penalty-free withdrawal, the brochure is typically delivered well ahead of signing. As a practical matter, signing of the contract won't take place until the prospective client decides to engage the services of the IA.
Which of the following might be used by an analyst to approximate a reasonable price for a common stock? A) Book value per share B) Yield to maturity C) Par value D) The dividend discount model
D...The simplest model for valuing equity is the dividend discount model—the value of a stock is the present value of expected divi¬dends on it. Yield to maturity only applies to debt securities with a fixed maturity date. The par value of a common stock has nothing to do with its market price. Although fundamental analysts will examine a company's book value per share, it generally has little or no bearing on the current market price of the stock.
Selmer Jones has just inherited some money and wants to set some of it aside for a vacation in Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In order to determine how much of the money must be set aside now and held for the trip, he should use the 5% as a A) nominal rate of return. B) required rate of return. C) opportunity cost. D) discount rate.
D...This is a present value question. Selmer needs to figure out how much the trip will cost in one year, and use the 5% as a discount rate to convert the future cost to a present value. Thus, in this context the rate is best viewed as a discount rate. Although you would never have to compute it, for each $1,000 Selmer needs, he would have to put away $952.38 (the present value of $1,000 at 5% in 1 year).