Section 3 Series 65

3(c)(7)

1) not make, or propose to make, a public offering of its securities and (2) limit the fund to "qualified purchasers"

Which of the following would be most likely to increase a bond's liquidity? A) A higher rating B) No call protection C) A longer maturity D) A lower rating

A) A higher rating

You have a client who has sold short 100 shares of RIF, a stock listed on the NYSE. If the client wished to use options to protect against unlimited loss, you would suggest the client A) buy 1 RIF call B) buy 1 RIF put C) sell 1 RIF put D) sell 1 RIF call

A) buy 1 RIF call Buying a call option on a stock you are short will give you a guaranteed covering cost, thus preventing against unlimited loss. This is the best way to hedge a short position.

In general, an investor wishing to gain economic exposure to commodities would find it easiest to do so by A) investing in futures contracts B) investing in forwards contracts C) buying the commodity directly D) growing the commodity

A) investing in futures contracts

The current yield on a bond with a coupon rate of 7.5% currently selling at 105½ is approximately A) 8.00% B) 7.50% C) 7.11% D) 6.50%

C) 7.11% A bond with a coupon rate of 7.5% pays $75 of interest annually. Current yield equals annual interest amount divided by bond market price, or $75 ÷ $1,055 = 7.109%, or approximately 7.11%.

Hedge funds are issued by A) investment companies B) portfolio advisers C) limited partnerships D) Administrators

C) limited partnerships Almost all hedge funds are issued as limited partnerships with the investment adviser (portfolio manager) having an investment in the fund.

If your customer owns 100 shares of a volatile stock and wants to limit downside risk, you may recommend A) buying calls B) writing calls and selling puts C) shorting the same stock D) buying puts

D) buying puts Downside risk is reduced by purchasing a put with a strike price at or close to the stock's purchase price. Should the stock decline below the strike price, the investor can exercise the put at the strike price. Selling put options will increase the downside risk. Buying calls is a bullish strategy that increases downside risk. Shorting stock will lock in the current price but will limit upside potential.

By investing in a REIT, you are provided all of the following EXCEPT A) pass-through tax treatment of income B) ownership of real property without management responsibilities C) diversification of real estate investment capital D) pass-through tax treatment of operating losses

D) pass-through tax treatment of operating losses REITs cannot pass through losses to investors. It is important to remember that they are not DPPs.

An investor is studying the prospectus received from the Abundant Returns Asset Allocation Fund. In a section titled Tenure, the discussion would be dealing with A) the average period of time the investors remain in the fund B) the length of time that asset allocations are maintained before changes are made C) the length of time that the fund has been in operation D) the number of years the portfolio manager has been managing the fund

D) the number of years the portfolio manager has been managing the fund Tenure always refers to management tenure, the length of time the portfolio manager has been at the helm of the fund.

In a mutual fund portfolio, you might find all of the following EXCEPT A) short stock B) junk bonds C) covered calls D) index options

A) short stock A mutual fund is generally prohibited by the Investment Company Act of 1940 from taking short stock positions. There are exceptions to this rule, such as in the case of hedge funds. Index options are permissible if they are consistent with the fund's stated objectives. Junk bonds or high-yield bonds are permissible in those high income funds that authorize such an investment. Some funds may use covered calls to generate income.

Which of the following debt instruments generally present the least amount of default risk? A) Municipal general obligation bonds B) Convertible senior debentures C) Municipal revenue bonds D) High-yield corporate bonds

A. Municipal general obligation bonds Because the full taxing power of the municipality backs a general obligation municipal bond, it will exhibit the least amount of default risk. A corporate debenture is an unsecured bond with a greater degree of risk, as is a junk or high-yield corporate bond.

Some analysts use the discounted cash flow to determine the theoretical value of a debt security. Under DCF, the bond price can be summarized as the sum of the

present value of the par value repaid at maturity plus the present value of the coupon payments

Types of Investment Companies

1. Face Amount Certificate Companies 2. Unit Investment Trusts (UIT's) 3. Management Investment Companies A. Closed End B. Open End

For a customer interested in buying an inverse exchange-traded fund (ETF) tracking the performance of the Standard & Poor's 500 Index, which of the following market views would make that purchase most inappropriate? A) Bullish B) Bearish C) Neutral D) Bullish or bearish

A) Bullish

A customer has been following several investment company quotes in the newspaper. She notices that the GEM Fund has an net asset value (NAV) of $12 and an ask price of $12.50, and that the ABC Fund has an NAV of $11.50 and an ask price of $10.98. The customer should conclude that A) GEM may be an open- or closed-end fund and ABC is a closed-end fund B) both are open-end funds C) ABC is an open-end fund and GEM is a closed-end fund D) ABC and GEM are both unit investment trusts

A) GEM may be an open- or closed-end fund and ABC is a closed-end fund The price for open-end funds is determined by adding the sales charge to the NAV. An open-end fund can never have an ask (or offering) price less than its NAV, therefore ABC cannot be an open-end fund.

A client purchased an index annuity from you 3 years ago and made an initial deposit of $100,000. The contract calls for a 90% participation rate with a 15% cap. The index had a return of +20% in the 1st year, -5% the 2nd year, and +10% the 3rd year. The investor's current value is approximately A) $128,620 B) $125,350 C) $126,500 D) $117,829

$125,350 In the 1st year, the index gained 20%. With a 90% participation rate, the investor might have earned 18%, but was limited by the 15% cap. So, after 1 year, the value was $115,000. In the 2nd year, the index lost money. However, with an index annuity there are never any reductions in a down market, so the account remained at $115,000. In the 3rd year, the investor received 90% of the 10% growth and that increased the account value to $125,350. This resulted in an overall gain of 25.35%, or an average return of almost 8.5% per year.

A mutual fund must redeem its tendered shares within how many days after receiving a request for their redemption?

7 days

A commodities speculator purchases a 1,000 bushel wheat futures contract at $.50 per bushel. At expiration, the settlement price is $.45 per bushel. This individual A) has a $50 loss B) must make delivery of the wheat C) has a $50 gain D) effectively hedged the long wheat position

A) has a $50 loss The simple math is, the individual bought at $.50 and sold at $.45, losing $.05 per bushel. Multiply $.05 times 1,000 bushels and the loss is $50. It is the seller who is obligated to deliver; the buyer of the contract must accept delivery (unless there was an offsetting transaction prior to expiration). This individual was long the futures contract, not long (the owner of) the wheat.

Although the terms are frequently used synonymously, historically, viatical settlements differed from life settlements in that A) the seller of the viatical policy was someone with a life expectancy of up to 15 years B) the seller of the viatical policy was someone who was terminally ill C) the buyer of the viatical policy was someone who was terminally ill D) the buyer of the viatical policy did not know the identity of the seller

B) the seller of the viatical policy was someone who was terminally ill

Your client is interested in investing in preferred stocks in an effort to receive dividend income. The client's target goal is a 6% current return on investment (ROI). If the RIF Series B preferred stock is paying a quarterly dividend of $.53, your client's goal will be achieved if the RIF can be purchased at A) $22.55 B) $50.00 C) $35.33 D) $8.83

C) $35.33 First, take the quarterly dividend and annualize it (4 × $.53 = $2.12). Then, divide that number by 6% and you get $35.3333, which rounds down to $35.33. Or, if you wish, but it takes more time, multiply each of the choices by 6% to see which of them equals $2.12.

Which of the following would you NOT expect to see issued at a discount? A) Zero-coupon bond B) Treasury Bill C) Bank jumbo CD D) Commercial paper

C) Bank jumbo CD Of these securities, only the bank jumbo (negotiable) CDs are always interest bearing and issued at par or face value.

Which of the following statements regarding investment companies is NOT true? A) When an open-end investment company, or mutual fund, registers its offering with the SEC, it does not specify the exact number of shares it intends to issue. B) The Investment Company Act of 1940 classifies investment companies into 3 types: face-amount certificate companies, unit investment trusts, and management investment companies. C) When investors sell or redeem their open-end fund shares, they receive the net asset value (NAV) as of the close of the day the order was issued. D) A management investment company can offer investors two ways of participating in the fund under management through the purchase of closed-end shares or, if the investor prefers, open-end redeemable shares.

D) A management investment company can offer investors two ways of participating in the fund under management through the purchase of closed-end shares or, if the investor prefers, open-end redeemable shares. A management investment company cannot offer investors two ways of participating in the fund under management. The fund must either be a closed-end fund with shares traded in the marketplace or an open-end fund with redeemable shares. The Investment Company Act of 1940 classifies investment companies into 3 types: FACs, UITs, and management investment companies.

Larry purchased a deferred annuity and, at age 65, annuitized the product under a life with 15-year certain option. His spouse, Linda, is the beneficiary. Which of the following statements is CORRECT?

Larry selected the life with 15-year certain option. This pays Larry for his life, regardless of how long, but continues to pay his beneficiary (Linda) if he dies before the end of 15 years. That is the 15-year certain part.

One way in which active and passive real estate investing differ is that A) there are circumstances under which losses from active real estate investing can be deducted against ordinary income B) only real estate professionals can deduct losses from active real estate investing. C) losses from active real estate investing can only be deducted against income from other active investing projects D) there are circumstances under which losses from passive real estate investing can be deducted against ordinary income

A) there are circumstances under which losses from active real estate investing can be deducted against ordinary income There are certain conditions under which active real estate investors can deduct as much as $25,000 in losses from ordinary income. Those conditions are likely to be far more complex than the exam will delve, but it can be important to know that this is possible. Passive real estate losses can only be deducted against passive income.

Buying a put option on a security he holds allows an investor to A) increase his profit if the security declines in price B) receive the premium for the purchase of the put C) participate in additional gains if the security continues to increase in price D) buy more stock if he exercises the put

C) participate in additional gains if the security continues to increase in price Purchasing a put allows the stockholder to lock in a sale price. If the price continued to rise, the investor would not exercise the put. He would let it expire and sell the stock at the higher market price thus continuing to participate in the additional gains. If the stock fell the investor would be able to exercise the right to sell the stock at the strike price but that would only offset the loss on the long position, not generate additional profit. Remember that options buyers pay the premium, they do not receive it, and exercising a put gives the holder the right to sell the stock, not buy it.

You are meeting with a relatively unsophisticated investor who doesn't understand very much about stocks and bonds. When asked, "can you list the advantages of owning common stock as compared to bonds?" among other reasons, you could reply A) there is limited liability B) bonds must be surrendered at maturity or at a call while the owner of common stock can hold the investment as long as desired C) income payments are more reliable D) bonds have priority over any equity security in the event of liquidation

B) bonds must be surrendered at maturity or at a call while the owner of common stock can hold the investment as long as desired One negative of owning bonds is that the bond will ultimately mature or be called and the bondholder has no choice but to surrender the security. With common stock, the investor has total control over the length of the holding period. Although there are many positive benefits to owning bonds compared to common stock, among them is priority in the event of liquidation and regular payment of interest. Yes, common stock has limited liability, but the same is true of the bondholder—if the company goes under, the bondholder's maximum loss is the investment. Even then, because of its seniority, it is less likely that the entire investment will be lost.

Straddle (option strategy)

An investor who was sure that a stock's price was going to move substantially, but wasn't sure in which direction, would be able to benefit by buying a call and put at the same time for the same strike price and expiration

When comparing exchange-traded funds (ETFs) to mutual funds, a feature available in ETFs that is NOT found in the mutual funds would include the ability to A) reinvest dividend distributions B) be bought and sold at a profit the same day C) represent an entire portfolio, or basket of securities. D) correlate to a specific index.

B) be bought and sold at a profit the same day

DDA

"Demand Deposit Account"- a checking account

A TIPS bond is issued in the principal amount of $1,000, paying 3.5%. Over the security's 5-year term, the annual inflation rate is 6%. What is the principal value of the bond at the end of 4 years?

$1,267 1,000*(1.06%/2) due to interest paid semi annually do that 8 times for the 4 years

Leveraged Funds

Attempt to deliver a multiple of the return of the benchmark index they are designated to track; there are no limits by rule or regulation as to the amount of leverage that could be applied to a portfolio

One way in which the method of capitalization of closed-end companies differs from that of open-end companies is that the closed-end company can A) permit reinvestment of dividends B) be listed on an exchange C) issue more than 1 class of stock D) continuously offer additional shares

C) issue more than 1 class of stock can issue preferred and common Stock

ETNs (Exchange-traded notes)

Carry issuer risk tied to the creditworthiness of the institution backing the note. They typically do not pay interest. Returns are linked to the performance of an index, currency, or commodity and suitable for investors looking to speculate on an index.

Brady Bonds

Debt instruments, generally from third world countries, that may have a US Treasury bond as collateral.

Closed end Invest

Do not redeem their own shares like a MF it does sell at Market Price based supply and demand

All of the following characteristics are advantages of a REIT EXCEPT A) diversification B) professional management C) liquidity D) tax deferral

D) tax deferral income is pass through A REIT is a professionally managed company that invests in a diversified portfolio of real estate holdings. REITs are traded on exchanges and OTC, which provides liquidity. The IRS does not permit tax deferrals on REIT investments. Please note: Over the past few years, there has been an enormous growth in non-traded REITs (they don't trade; there is no liquidity). However, there has been no feedback about that issue and, unless something in the question refers to a non-traded REIT, assume that all REITs are publicly traded either on the stock exchanges or OTC.

REITs (Real Estate Investment Trusts)

Joint ventures, usually in the form of a limited partnership, through which real estate is purchased. A person must have a securities license to sell REITS. REITs avoid double taxation as they are taxed to the beneficiary. Hybrid REITs take both equity and debt (mortgage) positions. REITs engage in real estate activities and can qualify for favorable tax treatment if they pass through at least 90% of their net investment income to their shareholders. Although there has been an increase in non-traded REITS in recent years, unless the question specified them, assume they are publicly traded.

Face Amount Certificate Company

one of three types of ivnestment companies under the Investment Company Act of 1940. Issues face amount certicates. Not a unit investment trust or management company.

3(c)(1)

(1) not make, or propose to make, a public offering of its securities and (2) either (a) limit the fund to no more than 100 investors

private fund

A) a venture capital fund B) a hedge fund C) a unit investment trust

Jumbo CDs

issued for $100,000 to $1 million and trade secondary. Most jumbos issued mature at less than a year maturities. Being negotiable, there is no prepayment penalty. Pay int. semi-annual, not monthly.

The term sweetener would most often apply to

Warrants

10% penalty

applied to annuities if withdrawn prior to age 59 1/2

Flow-Through Taxation

the income and losses of partnership flow onto and have to be reported on the individual partners' personal income tax returns

Starflier Mutual Fund, regulated under the Investment Company Act of 1940, wishes to change its investment policy. It may do so with approval of

a majority of the outstanding shares

Viatical Settlement

the sale of a life insurance policy by a terminally ill insured to another party, typically to investors or investor groups, who hope to profit by the insured's early death

Derivatives can serve many purposes. However, investors should be aware that there are positions which can result in?

unlimited loss There are some derivative positions, such as an uncovered call, where the potential for loss is unlimited.

ETF (exchange traded fund)

a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund

A customer with an aggressive growth investment objective and short-term (6- to 12-month) time horizon wants to invest $50,000 in a mutual fund. He has a substantial net worth, but none of it is invested in mutual funds. You inform him that mutual fund investments are intended to be long-term investments, but he expresses his intention to make the short-term investment anyway. If the XYZ fund family (one you have dealt with in the past) offers an aggressive growth fund that has a respectable track record, your recommendation should be to A) buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee B) decline the transaction because short-term trading of funds is not allowed C) buy the XYZ Aggressive Growth Class B shares with a declining CDSC and 0.75% 12b-1 fee D) buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee

A) buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee

If an investor pays 95.28 for a Treasury bond, how much did the bond cost?

958.75 Gov notes and treasuries are measured on 32nds 28/32 =75

time deposit account

A savings account that requires money to be left in the account for a certain period of time

One popular method of determining the value of certain securities is discounted cash flow. Using the DCF with the current discount rate at 3%, which of the following would be expected to have the highest market value? A) XYZ Corporation mortgage bond maturing in 10 years with a coupon of 4.5% B) ABC Corporation debenture maturing in 25 years with a 5% coupon C) U.S. Treasury bond maturing in 20 years with a 4% coupon D) Bay Area Rapid Transit Authority 4% revenue bond maturing in 15 years

B) ABC Corporation debenture maturing in 25 years with a 5% coupon The current discount rate represents market interest rates. At 3%, each of these bonds should sell at a premium (their coupon rates are higher than 3%). When a bond is paying interest at a rate higher than the current market rate, the longer the investor will be receiving that higher rate, the higher the premium. Therefore, the 5% bond with 25 years to maturity will have the highest present value using the DCF.

Which of the following is a possible advantage of scheduled premium variable life insurance over whole life insurance? A) Flexibility of premium payments B) Possible inflation protection for the death benefit C) Less risk in the underlying investment instruments D) Greater guaranteed cash value

B) Possible inflation protection for the death benefit

Options positions can either create rights or obligations. In which option position has the investor created the possible obligation to purchase stock? A) Purchasing a put B) Selling a put C) Purchasing a call D) Selling a call

B) Selling a put When you sell (write, go short) an option, you create an obligation. In the case of a put, you are obligated to purchase stock that is "put" to you. In the case of a call, you are obligated to sell stock that is "called" away from you. Option buyers have rights, they can choose what they wish to do—there are no obligations.

A high net worth client of yours invested $250,000 into an oil and gas limited partnership drilling program for which she received a 10% interest in the project. Unfortunately, after 2 years of drilling without success, the project was foreclosed with outstanding debt of $4 million. Your client is liable for A) $250,000 B) $150,000 C) $0 D) $400,000

C) $0 An investor's liability in a limited partnership is generally limited to the original investment. If there are any funds that the investor has committed for, but not yet contributed to, there is a liability for that amount as well.

The DERP Corporation has an outstanding convertible bond issue with a conversion price of $125 per share. If the current market price of the bond is 80, the parity price of the stock is A) $125.00 per share B) $64.00 per share C) $156.25 per share D) $100.00 per share

C) $156.25 per share What does parity mean? It means that 2 things have equal value. What 2 things do we have here? We have the convertible bond and, because it is convertible, it can be "converted" into common stock. There is a number where the value of the bond and the value of the stock are the same—this price is the parity price. The bond is currently valued at $800 (80% of par). Anytime the investor wishes, he can exchange (convert) that bond into DERP's stock at $125 per share. But, that conversion is based not on a market price, which can fluctuate every day—it is based on the amount of the money initially borrowed—the $1,000 par value of the bond. DERP is saying that it will allow you to exchange the $1,000 they owe you for stock at $125 per share. Simple division results in the ability to convert into 8 shares. Now we have everything we need to compute the parity (equal) price. If the bond is currently valued at $800 and we can convert it into 8 shares, what does each of those shares have to be worth so that the stock is also valued at $800? Dividing 800 / 8 = $100 per share. That means that if the stock is selling for $100 per share, and we decide to convert the bond, we'll have the same $800 in value. Some students find the answer a quicker way. If the bond is selling at 80% of its par value, then, to be equal, the stock must be selling at 80% of the conversion value (80% × $125 = $100).

One of your clients approaches you looking for an investment that will provide ready marketability and income. Which of the following would be the least appropriate recommendation? A) U.S. Treasury notes B) A money market mutual fund C) NYSE-listed preferred stock D) A limited partnership in rental real estate

D) A limited partnership in rental real estate The key is meeting both needs—marketability and income—and each of them supply both except the limited partnership. The client could expect income from a DPP investing in rental real estate, but the liquidity is missing.

UITs

Fixed Portfolio Passive Investments "An investment company with a low expense ratio and a portfolio that doesn't change" would be a description of a (blank).

Which of the following is not traded on any exchange? A) Forward contracts B) Futures contracts C) ETFs D) Closed-end funds

Forward contracts are nonstandardized and, as such, do not trade on any exchange.

Yield to call calculation

To calculate a bond's yield to call, enter the face value (also known as "par value"), the coupon rate, the number of years to the call date, the frequency of payments, the call premium (if any) and the current price of the bond.

If the coupon rate on a bond increases, the duration of the bond will A) remain unchanged B) change in an unpredictable fashion C) increase D) decrease

The higher the coupon, the shorter the duration.

Money market instruments include

Treasury bills, commercial paper, repurchase agreement, bankers acceptances, tax anticipation notes

Eurodollar bonds

dollar-denominated bonds sold outside the United States

Under DCF, the bond price can be summarized as the sum of the

present value of the par value repaid at maturity plus the present value of the coupon payments

restricted stock units

shares awarded after time to defer taxes