Seires 65 Checkpoint 2

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 A) future value of the par value repaid at maturity plus the future value of the coupon payments B) present value of the par value repaid at maturity plus the present value of the coupon payments C) future value of the par value repaid at maturity plus the present value of the coupon payments D) present value of the par value repaid at maturity plus the future value of the coupon payments

b (A bond's price can be calculated using the present value approach. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. Therefore, the value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate. The two choices using future value of the par value at maturity make no sense because we already know that is $1,000 (or whatever the par value might happen to be).)

When preparing a client's personal profile, it is generally accepted that there are both financial and non-financial considerations evaluated in order to issue appropriately suitable recommendations. Which of the following would not be included in the list of financial considerations? A) The client's marginal tax bracket B) Income from rental properties C) Risk tolerance D) Vested interest in the employer's 401(k) plan

c (A client's risk tolerance is a non-financial consideration; it is an attitude. Income from a rental property, tax obligations, and available retirement funds are all financial considerations that contribute to determining suitability.)

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

c (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.)

When a bond is selling at a premium, a bond callable at par will A) have a YTC that is more than the coupon B) have a current yield that is less than the YTM C) have a YTC that is less than the YTM D) have a YTM that is more than the coupon

c (A bond selling at a premium will always have a yield that is lower than the coupon. Highest of the computed yields will be the current yield because, unlike the YTM or the YTC, the loss at payoff of the principal is not included. Comparing YTM and YTC, because in both cases the investor is getting back the same par value, the YTC is lower because the loss is occurring sooner (bonds are always called prior to maturity).)

Which of the following would be considered an investment constraint rather than an investment goal? A) Current income B) Growth of capital C) Liquidity D) Capital preservation

C (Investment constraints are those things that limit our ability to reach our goals. If the investor needs high liquidity, that factor will affect the investment selection process and place a limit on the available investment options.)

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) Purchasing a call C) Selling a call D) 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 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) $126,500 C) $125,350 D) $117,829

C (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.)

An investment advisory firm tracks its performance against the S&P 400. From this, you could determine that this firm concentrates on A) mid-cap securities B) Nasdaq securities C) large-cap securities D) small-cap securities

a

GHI common stock has a $10 par value and is selling in the market for $60 per share. If the current quarterly dividend is $1, the current yield is A) 6.7% B) 1.7% C) 10% D) 1%

a

One of the advantages of owning a corporation's debentures is that you have prior claim over A) preferred stockholders B) general creditors C) employees D) secured creditors

a

The term sweetener would most often apply to A) warrants B) derivatives C) rights D) convertibles

a (A warrant is a derivative which gives the holder the ability to acquire shares of common stock at a fixed price. At issuance, that price is always higher than the current market value of the stock, but warrants generally have a long expiry date which gives them great time value. When an issuer attaches warrants to a bond or preferred stock issue, they serve to sweeten the offering resulting in lower interest rates or dividends.)

When giving advice to a large pension plan invested heavily in large-cap stocks on how to reduce their systematic risk, you would probably recommend that they A) hedge by purchasing broad index puts B) increase the standard deviation of the portfolio C) increase their portfolio diversification D) raise the correlation coefficient of the securities in the portfolio

a (Buying broad index put options, such as on the S&P 500, gives an effective hedge against the downside movement in the market. Another choice, although not necessarily as effective, would be to lower the standard deviation of the portfolio by switching into securities with a lower volatility. Diversification does not protect against systematic (market) risk and reducing the correlation would work, not increasing it.)

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) a majority of the outstanding shares B) a majority of the board of directors C) the fund's investment adviser D) none of these; no need for approval

a (Changes in investment policy require a vote of the majority of outstanding shares for approval.)

When are estate taxes due? A) 9 months after death B) 9 months after valuation C) 6 months after death D) 6 months after valuation

a (Estate taxes are due 9 months after death. The taxes are based on either the value at death or the alternative valuation 6 months after death.)

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

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

Each of the following could cause an investor to be subject to the alternative minimum tax EXCEPT A) interest received on school district GO bonds B) interest received on private activity municipal bonds C) excess intangible drilling costs D) accelerated depreciation taken on certain property

a (General obligation GO bonds are not subject to the AMT.)

An investment adviser (IA) explaining modern portfolio theory (MPT) to a client might make all of the following statements EXCEPT A) if one security has a higher return than another, and, at the same time has a higher risk, choose it B) if two securities offer the same risk, choose the one with the higher return C) if two securities offer the same rate of return, choose the one with the lower risk D) if one security has a higher return than another and, at the same time has a lower risk, choose it

a (Higher returns are only justified if they bear a relationship to the added risk. The goal of MPT is to maximize the return for any given amount of risk.)

An optimal portfolio is one which A) lies on the efficient frontier B) is diversified in such manner as to nearly eliminate systematic risk C) works well in bull markets, but suffers when there is a market reversal D) offers the greatest reward for the highest risk

a (In portfolio design, the collection of efficient portfolios is called the efficient set or the efficient frontier. This efficient frontier is plotted as a curve. The objective is for the portfolio to lie on the curve. Then, by being on the efficient frontier, the optimal portfolio has been created; one in which there is the highest return for the least risk.)

Which of the following describes an investment management style? A) Large capitalization B) Rebalancing C) Margin D) Current income

a (Large capitalization style distinguishes between investing in a small cap company versus a large capitalization company. Current income is an investment objective and not an investment management style. Rebalancing is used to bring asset allocations back to their desired weightings. Margin can be used in a number of investment management styles.)

Your client's child is entering college next year. Which of the following would be the most appropriate recommendation? A) A 5-year laddered portfolio of U.S. Treasury notes B) A large-cap growth fund C) A zero-coupon bond maturing in 5 years D) A U.S. Treasury note mutual fund

a (Most would agree that with a regularly scheduled commitment for tuition and other expenses associated with a college education, there is a need for not only income, but also (and perhaps more importantly) assurance that when the bills are due, the principal will not have fluctuated. That would be best accomplished through a laddered portfolio where each year there are T-notes maturing.)

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

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

Sector rotation would most likely be employed by an investment adviser using which of the following investment styles? A) Tactical B) Buy and hold C) Strategic D) Contrarian

a (Sector rotation is the practice of moving portfolio assets from those industries that have reached their peak in the current economic cycle to those that are now on the upswing. Buy and hold, as the name implies, does not involve constant trading and strategic is a passive technique as well. Contrarian investors go opposite the trend which is not the case here.)

Using industry jargon, the tax on the last dollar of income is at A) the marginal rate B) the effective rate C) the average rate D) the final rate

a (The IRS defines marginal tax rate as "the highest rate that you will pay on your income." Basically, as you make more money, you pay tax at a higher rate incrementally. The effective tax rate is the average that you pay on all of your income.)

One measure of an investor's total return is called holding period return. The computation includes both income and appreciation and is used for both debt and equity securities. An investor's holding period return would exceed the bond's yield to maturity if A) the coupons were reinvested at a rate exceeding the yield to maturity B) the investor purchased a put option on the bond C) the bond was redeemed at a discount D) the bond was called at a premium

a (The calculation of yield to maturity assumes reinvestment of the bond's interest at the coupon rate. Therefore, if the investor were able to do better than that, the holding period return would be increased. This is part of the concept of internal rate of return (IRR) which takes into consideration the time value of money (compounding). It is tempting to answer a call at a premium and that might, in fact, increase the total return, but we have no idea when the call takes place, at what price and the original purchase price of the bond. Just keep it simple—if the question says you can earn more than the YTM, your return will be higher than the quoted YTM.)

If the expected return on the market is 20% and the risk-free rate is 4%, a stock with a beta coefficient of 0.8 would have an expected rate of return under CAPM of A) 16.8% B) 12.8% C) 19.2% D) 16.0%

a (The formula is the risk-free rate (.04) plus the product of the stock's beta (.8) and the difference between the expected return on the market and the risk-free rate(.20 - .04). In this case, it would be .04 + .8(.16) or .04 +.128 = .168)

An investor is long 100 shares of XUZ common stock. If the investor wishes to generate some additional income while also creating a partial hedge, the recommended strategy would be to A) go short an XUZ call B) go short an XUZ put C) go long an XUZ call D) buy additional XUZ stock

a (The only way to generate income with options is to sell them (take a short position). Selling the call brings in a premium which creates a partial hedge.)

The owner of a convertible debt issue A) is a creditor of the issuer B) is generally in a senior position to other bondholders C) has the choice of receiving the bond's interest or dividends on the underlying stock, whichever is higher D) generally expects a higher current return than with a nonconvertible bond of the same quality and maturity

a (The owner of any bond is a creditor of the issuer. Dividends are only paid on stock and the investor will have to convert in order to be a stockholder. Because of the growth potential of the common stock, holders of convertible securities invariably accept a lower coupon rate. In almost all cases, convertible debt securities are debentures and, therefore, junior to secured bonds.)

An investor purchases 100 shares of ABCE common stock at $70 per share. Thirteen months later, the stock is sold when the market price is $50 per share. Which of the following activities made 20 days after the sale of the stock at $50 per share, would NOT violate the wash sale rule? A) Purchasing an ABCE put option B) Purchasing 100 shares of ABCE common stock C) Purchasing 5 ABCE convertible bonds with a conversion price of $50 D) Purchasing an ABCE call option

a (The wash sale rule applies when the same or substantially identical security as a stock sold at a loss is acquired within the 30 day period prior to and after the sale. Buying a put is not a problem because the put only allows the holder to sell the stock, not buy it. Please note that a bond convertible at $50 is convertible into 20 shares, so 5 bonds will enable the investor to convert into 100 shares.)

An investor does not wish to attempt to time the market, so she invests $300 each month into the GEMCO Growth Fund. Over the past 5 months, her purchase prices have been $10, $12, $15, $20, and $25. On the basis of this information, if she were to stop investing at this point and sell her shares 2 months from now when the NAV is $15 per share and the public offering price is $15.79, it would be CORRECT to state that her A) cost basis for tax purposes was $14.71 B) realized loss would be $1.40 per share C) proceeds were $15.79 per share D) average cost per share was $16.40

a (This client is taking advantage of dollar cost averaging. Each month, the $300 investment acquires a different number of shares. Take a look at the math below: Month 1: $300 @ $10 per share = 30 shares Month 2: $300 @ $12 per share = 25 shares Month 3: $300 @ $15 per share = 20 shares Month 4: $300 @ $20 per share = 15 shares Month 5: $300 @ $25 per share = 12 shares Total cost is $1,500. Total number of shares is 102. She spent $1,500 and bought a total of 102 shares. Dividing her cost ($1,500) by the number of shares (102) results in a cost per share of $14.71 and that is her cost basis for tax purposes. When redeeming, she would receive the NAV of $15 per share, not the POP. There is no loss here because the proceeds of $15 per share exceed the cost of $14.71.)

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) issue more than 1 class of stock B) be listed on an exchange C) continuously offer additional shares D) permit reinvestment of dividends

a (Unlike open-end companies, which can only issue 1 class of stock (don't confuse this with different sales charge classes), closed-end companies can issue preferred stock. It is only the open-end company that continuously offers new shares, and both permit reinvestment of dividends. The fact that closed-end companies can be listed on an exchange is not a method of capitalization.)

One of the asset allocation classes is fixed income securities. When an IAR is determining which securities to fill that portion of the client's portfolio, which of the following would NOT be included? A) Preferred stock B) Treasury bonds C) Municipal bonds D) Mortgage-backed securities

a (Although generally referred to as a fixed income security due to its fixed dividend, for asset allocation purposes, preferred stock is included in the equity class. Historically, Treasury bonds have a negative correlation to preferred stock (about ‒.20), while the S&P 500 has a correlation of about +.60.)

Many different investments offer the opportunity to reinvest income. If one were to compare the difference between interest-on-interest reinvestment plans and dividend and capital gain reinvestment plans, A) in both plans, all income is taxable in the year received, whether reinvested or not B) in the case of dividend and capital gains reinvestment plans, taxes are deferred until liquidation C) in the case of interest on interest plans, taxes are deferred until liquidation D) in both cases, all income is deferred until liquidation

a (Regardless of the type of plan, any income, whether reinvested or not, is always taxed in the current year. Think of an interest-on-interest plan as a passbook savings account where the interest is credited and compounded. Whether taken out or not, the earnings are reported on an annual basis. On the exam, the question may ask for a difference as we have here, but, as you can see, there is no difference.)

One of your customers purchased a variable life insurance contract through your firm. After 14 years, he had deposited $15,000 in premiums, and his death benefit had grown to $80,000. Shortly after taking out a loan against cash value of $10,000, he was killed in an automobile accident. What will be the tax consequences of this situation to the death benefit? A) His beneficiary must pay taxes on the amount of the death benefit that is over and above the cost base of $15,000. B) His beneficiary need not pay taxes on the death benefit. C) His beneficiary must pay taxes on the amount of the death benefit that is over and above the cost base of $15,000 plus the unpaid loan. D) The first $15,000 is tax-free with the excess being treated as a long-term capital gain

b (A death benefit payable on a life insurance policy or contract is not subject to taxation. The insurance company will deduct the balance of the $10,000 loan before it releases the death benefit to the beneficiary, but that does not affect the tax consequences.)

All of the following are advantages of universal life insurance EXCEPT A) when the cash value is sufficient, no premium payment is required B) the policy is guaranteed never to lapse C) ability to adjust the amount of premium payments D) ability to change death benefit amount

b (A universal life policy may lapse if the accumulation fund drops below a specified level and an additional premium is not paid.)

A client purchases a fixed annuity that will immediately begin paying $2,000 a month for life. What is the annuitant's greatest risk? A) Market risk B) Inflation risk C) Capital risk D) Interest rate risk

b (Also known as purchasing power risk, inflation risk is the effect of continually rising prices on investments. A client who annuitizes a fixed annuity, receiving $2,000 per month, will likely find the monthly check has less purchasing power as time goes on.)

A bond issued by the GEMCO Corporation has been rated BBB by a major bond rating organization. This bond would be considered A) callable B) an investment-grade corporate bond C) a high-yield corporate bond D) secured

b (An investment-grade bond has a bond rating between AAA and BBB. Lower-rated bonds are considered high-yield bonds and are often referred to as junk bonds. The bond may or may not be secured—the rating does not indicate that fact.)

Your customer is interested in a leveraged fund and makes the following statements about leveraged funds to you. All of the statements regarding leveraged funds are true EXCEPT A) some leveraged funds are exchange-traded products B) there are no unusual risks associated with these funds other than those one would incur with any index tracking fund C) the funds attempt to return a multiple of the return of a benchmark index they are tracking, perhaps 2 or 3 times D) these funds sometimes use derivatives products to achieve their stated goals

b (Because the fund objective is to achieve returns that are a multiple of the returns of the benchmark index, the result could be a multiple of any loss incurred by the benchmark index as well. In addition, because these funds utilize derivatives products to achieve their stated objectives, they may not be suitable for anyone that derivatives products are not suitable for, given the additional risks associated with those products.)

When comparing mutual funds and ETFs, the disadvantages of investing in ETFs include which of the following? A) A price not set by supply and demand B) Commissions both when purchasing and liquidating shares C) An expense ratio that is generally lower D) The ability to avoid tax consequences

b (Because the shares of ETFs are traded like any other stock, commissions are paid both to buy and to sell, and the price is determined by supply and demand, not NAV. ETFs are generally more tax efficient than mutual funds and their expense ratios tend to be lower as well.)

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) sell 1 RIF put B) buy 1 RIF call C) buy 1 RIF put D) sell 1 RIF call

b (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.)

Flow-through is one of the features of A) REITs B) direct participation plans C) open-end investment companies D) variable annuities

b (Flow-through is the term commonly used to describe that any income or loss generated by a direct participation program flows through to the owner(s). In the case of a REIT, the only thing that passes through is income or gains, never losses.)

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) decline the transaction because short-term trading of funds is not allowed B) buy the XYZ Aggressive Growth Class C shares with a 1% CDSC expiring in 1 year and 0.75% 12b-1 fee C) buy the XYZ Aggressive Growth Class A shares with a 4% load and 0.25% 12b-1 fee D) buy the XYZ Aggressive Growth Class B shares with a declining CDSC and 0.75% 12b-1 fee

b (If the client insists on making this type of investment, then the Class C shares are most appropriate for this customer's objectives; the sales load would be lower than that of either Class A or Class B shares. But, you ask, we don't know what the CDSC is for the Class B shares - it isn't given. It doesn't have to be because the CDSC for redemptions in the first year would never be lower than the Class A front-end load (4% in this question and certainly higher than the 1% on the Class C shares).)

MNO is planning to raise capital through an offering of 30-year bonds. Which call price would be most beneficial to MNO? A) 106 B) 102 C) 104 D) 110

b (MNO would benefit most from the ability to call bonds at the lowest possible price. The call feature enables MNO to buy the bonds before maturity to reduce their fixed interest costs. A call price of 102 requires the lowest call premium of the options shown.)

Probably the most significant characteristic of municipal bonds for investors is A) that their coupon yields are higher than comparably rated corporate issues B) their exemption from federal income tax C) their exemption from registration on the state and federal level D) their safety

b (Municipal bonds are unique in that their interest is not subject to federal income tax. As a result, their coupon yields are generally lower than corporate bonds with a similar rating—you get to keep all of the interest instead of paying taxes on it. The fact that they are exempt from registration with state and federal agencies is of little, if any, consequence to the typical investor. Although they tend to be quite safe, if safety is the primary concern, the investor would turn to Treasuries or government agency securities.)

One reason that a private equity fund may operate under the Section 3(c)(7) exemption of the Investment Company Act of 1940 is that A) investors would only need to be accredited rather than qualified B) it would be able to have more than 100 investors C) registration would not be required of the investment adviser D) greater liquidity would be assured

b (Private equity funds operate under two exemptions found in the Investment Company Act of 1940. The 3(c)(1) exemption limits the number of investors to 100 while no such limit applies to the 3(c)(7) exemption. Under the 3(c)(7) exemption, all investors must be qualified, a significantly higher standard than accredited. Investment advisers to private funds generally have to register and the selection of which exemption to use doesn't impact that. As private investments, liquidity is very limited.)

One of the benefits of adding foreign debt securities to an investor's portfolio is A) receiving income in foreign currency B) potentially higher yields C) potentially higher risk D) reduced taxation

b (The interest rates paid on debt in many foreign countries, especially those in emerging economies, is higher than that available domestically. The trade-off is higher risk. Receiving interest payments in foreign currency involves not only currency risk, but the added expense of conversion into U.S. dollars (ADRs are for equity, not debt securities). In many cases, investors pay foreign and U.S. tax on the interest.)

Which of the following indices or averages is based on the prices of only 65 stocks (30 industrial, 20 transportation, and 15 utility)? A) S&P Composite B) Dow Jones Composite Average C) Wilshire 5,000 D) Value Line

b (The most widely quoted and oldest measures of changes in stock prices are the Dow Jones averages. They are also the smallest in terms of the number of stocks included in the averages with only 65 stocks. It is the only price-weighted index on the exam; all of the others are cap-weighted.)

When reading a research report about an investment company, you read that, in addition to common stock, the company also has a preferred stock issue outstanding. From this, you could conclude that this is A) an open-end investment company B) a closed-end investment company C) a unit investment trust D) a blended investment company

b (The only investment company that can legally issue preferred stock is a closed-end investment company. Open-end companies can only issue 1 class of stock (common stock or its equivalent). UITs issue units and term blended investment company makes no sense here.)

A deceased individual with 2 surviving children and a spouse, had established a trust for his family. The trust document appointed both children as co-trustees. The surviving spouse is to receive current income, and his 2 children will receive equal shares of the remaining principal upon the spouse's death. As the adviser to the account, you A) focus on increasing principal for the children B) follow the instructions of the trustees C) focus on generating income for the spouse D) attempt to generate reasonable income while keeping the principal intact for the children

b (The responsibility of following the trust's instructions is that of the trustee(s). Should they attempt to deviate from that, the adviser should inform them that they face potential liability under trust law. However, in all cases, the adviser must follow the direction of the trustees. As a practical matter (not tested), if the trustees appear to violate the trust's instructions, many advisers would terminate their relationship to avoid any potential liability.)

One respect in which an investment adviser differs from an agent for a broker-dealer is that of fiduciary responsibility to the client. Therefore, the IA will have greater concerns about various non-financial needs and attitudes of the client when making recommendations. Included in those concerns would be all of these EXCEPT A) the client's attitudes toward the environment B) the client's retirement plan vested balance C) the client's time horizon number and age of dependents D) the client's marital status

b (The vested balance in the client's retirement plan is a critical factor in determining what additional (if necessary) will be necessary to meet retirement goals, but is a financial rather than non-financial consideration. The other choices can't be measured in terms of dollars and cents.)

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

b (This is an example of a protective put; that is, purchasing a put option on a stock the investor already owns. This allows the stockholder to lock in a sale price (the strike price of the put). If the market price of the stock continues to rise, the investor would not exercise the put. The put would expire, and the long stock remains in the account at the higher market price. The investor could hold the stock or sell it at the higher market price and in either case, the investor continues to participate in the additional gains. The protection (the hedge) occurs if the price of the stock falls. Then, the investor would be able to exercise the right to sell the stock at the strike price. That would 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. Perhaps viewing an example will help. The investor owns 100 shares of ABC stock currently trading at $50 per share. Wanting to protect against a drop in price, the investor purchases an ABC put option with a strike price of 50 and pays a premium of 3. If the stock's price rises to $60 per share by the expiration date, the put option will expire worthless (who wants to put [sell] stock at $50 when it is selling for $60?). In this case, the investor has paid a premium of 3 points to insure that the stock can always be sold (during the life of the option) for a price of $50 while still having the opportunity to participate in future price increases of the stock. In our example, the investor has gained $7 per share (the difference between the increase from $50 to $60 less the premium paid for the option).)

If an investor pays 95.28 for a Treasury bond, how much did the bond cost? A) $9,528 B) $958.75 C) $95.28 D) $950.28

b (Treasury bonds are quoted as a percentage of par, ($1,000), plus 32nds. In this case, the price is $950 plus 28/32 (i.e., 7/8) of $10, for a total of $958.75.)

When opening an account for a trust, which of the following sets of terms are synonymous? A) Beneficiary—trustee B) Settlor—grantor C) Trustee—settlor D) Grantor—trustee

b (The settlor, sometimes referred to as the grantor, is the person who establishes the trust. The trustee administers the trust and could be the grantor but does not have to be.)

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) When investors redeem their open-end fund shares, they receive the net asset value (NAV) per share next computed after the redemption order was received. C) 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) The Investment Company Act of 1940 classifies investment companies into 3 types: face-amount certificate companies, unit investment trusts, and management investment companies.

c (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. Redemption (or purchase) of open-end investment company shares is based on the forward pricing rule. Because the offering of open-end investment shares is continuous, it is impractical to specify the exact number that will be issued.)

Your client has heard about investment opportunities in life settlements. Among the risks involved with this investment is A) the insured may change the beneficiary without notifying the investor B) the insured may cease paying premiums, leading to a policy lapse C) the insured may live well past the expected mortality date D) the insurance company may not have the funds to pay the death benefit

c (Although it is always possible that the insurance company could default, that is so rare, it is not usually a consideration. Life settlements are priced based on providing a stated return assuming normal mortality. If the insured lives far past that, the rate of return to the investor goes way down. The insured does not pay the premiums (the investor does) and the insured no longer has the rights to change the beneficiary (the investor does).)

An individual who is a proponent of the efficient market hypothesis (EMH) will likely invest in which of the following? A) Growth mutual funds B) Balanced mutual fund C) Index funds D) Sector mutual funds

c (An individual who believes in the EMH will likely invest in index funds. Inherent in this strategy is a belief that an investor cannot outperform the market with active portfolio management techniques. The remaining choices all incorporate an active portfolio management philosophy.)

In the past 20 years, 55-year-old James has put $27,000 into accumulation units in his nonqualified variable annuity. The current value of his units is $36,000. He wishes to withdraw $16,000 to assist with his grandchild's college education. If he is in the 28% tax bracket, what is his tax consequence on the withdrawal? A) $2,520.00 B) $0.00 C) $3,420.00 D) $4,480.00

c (Because this is nonqualified, the investments are in after-tax dollars. Therefore, any value of the account over the investment is growth. Withdrawals from tax-deferred plans treat the growth as ordinary income for tax purposes. The portion attributable to growth is considered to be withdrawn first under the Tax Code. Here, we have $9,000 worth of growth taxable at 38% (28% + 10% penalty) because James is younger than 59½. Yes, the earnings on a non-qualified annuity are subject to the 10% penalty; it is only the principal that escapes the tax and penalty. The remaining $7,000 withdrawn is considered a withdrawal of principal and is therefore nontaxable.)

Which of the following is NOT a money market instrument? A) Treasury bills B) Banker's acceptances C) Newly issued Treasury notes D) Commercial paper

c (Commercial paper, Treasury bills, and banker's acceptances are debt instruments with maturities of 1 year or less and are therefore money market instruments. A newly issued Treasury note would have a maturity of 2 to 10 years and therefore would not be a money market instrument.)

Investing in commodities could involve investing in any of these EXCEPT A) industrial items B) animals C) consumer durables D) agricultural items

c (Commodity contracts are not available on consumer durables such as refrigerators and washing machines. They are available on agricultural items, such as corn, wheat, and soybeans. Likewise, investing in animal items such as cattle and pork bellies is possible. Finally, industrial items, primarily metals such as lead, zinc, and aluminum, are popular investments.)

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

c (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.)

All of the following are characteristics of exchange-traded funds EXCEPT A) they generally have a lower expense ratio than comparable mutual funds B) they are typically designed to track an index C) they are redeemable securities D) they are priced by supply and demand continuously during the trading day

c (Exchange-traded funds have many similarities to closed-end investment companies. They are traded based on supply and demand rather than redeemed and are typically designed to track a particular index, such as the S&P 500. In most cases, ETFs have lower operating expense ratios than mutual funds with similar objectives.)

Which of the following statements is TRUE? A) A futures contract does not involve obligations to buy or sell an asset. B) A futures contract always requires delivery of an asset. C) A futures contract has standardized terms. D) Unlike forwards, futures are not traded on an exchange.

c (Futures contracts are traded on exchanges and, therefore, have standardized terms. In forwards, the terms of each contract are separately negotiated.)

Which of the following projects is most likely to be financed by a general obligation rather than a revenue bond? A) Municipal hospital B) Expansion of an airport C) Public library D) Public golf course

c (Hospitals, airports, and golf courses all generate revenue and can be financed with revenue bond issues. Public libraries are financed through GO bond sales with the backing of taxes.)

A bank is advertising a no-cost DDA. Your client asks you to describe what that is. You would respond that DDA stands for A) deferred deposit account B) direct deposit account C) demand deposit account D) digital deposit account

c (In the banking industry, the most common definition of DDA is demand deposit account, better known as a checking account.)

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

c (It is generally agreed that using commodity futures is the easiest and most common way to gain economic exposure to commodities. Forwards are more commonly used by producers or users because, unlike futures, most forward contracts result in the delivery of the actual commodity. Only about 1% of all futures contract positions involve the delivery of the underlying commodity.)

The use of futures to hedge against a price increase is best referred to as A) a neutral hedge B) a trimmed hedge C) a long hedge D) a short hedge

c (Just as with stock options, the strongest hedge is always accomplished by buying (going long) on the opposite side.)

Larry purchased a deferred annuity and, on his 65th birthday, annuitized the product under a life with 15-year certain option. His spouse, Linda, is the beneficiary. Which of the following statements is CORRECT? A) Payments would be made to Larry until he is 80, then to Linda for the remainder of her life. B) Payments would be made to Larry until he is 80, then cease. C) Payments would be made to Larry as long as he lives, but should he die prior to reaching age 80, Linda will receive payments until Larry's 80th birthday. D) Payments would be made to Larry until his death, then to Linda for another 15 years.

c (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.)

All of the following are examples of non-diversifiable risks EXCEPT A) market risk B) purchasing power risk C) liquidity risk D) interest rate risk

c (Liquidity risk is a type of unsystematic, or diversifiable, risk. All of the other choices are systematic risk, which is considered to be non-diversifiable.)

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

c (Liquidity risk is the risk that when an investor wishes to dispose of an investment, no one will be willing to buy it, or that a very large purchase or sale would not be possible at the current price. The available pool of purchasers for bonds with a low credit rating is much smaller than for those with investment grade ratings (many institutions are only able to purchase bonds with higher credit ratings). As a result, the lower the credit rating, the greater chance of the bond having liquidity issues. Similarly, bonds with short-term maturities attract many more investors than those with long-term maturities causing the long-term bonds to be less liquid. The absence of call protection is negative to many investors thus limiting the number of potential investors.)

If an investor is in the highest federal income tax bracket and is subject to the alternative minimum tax, which of the following securities should an agent recommend? A) Industrial revenue bond B) Treasury bond C) General obligation bond D) Corporate bond

c (Municipal bonds are suitable for the portfolio of an investor who is in a high tax bracket because the interest is exempt from federal income tax. A general obligation (GO) bond is a better recommendation than an industrial revenue bond because the interest on industrial revenue bonds is likely subject to the AMT.)

Although investing in managed investment companies can provide many benefits, investors should be aware that disadvantages could include all of these EXCEPT A) unpredictability of tax consequences B) high expenses C) limited liquidity D) poor management performance

c (Open-end and closed-end are the 2 categories of managed investment companies. Liquidity is never a problem with open-end companies with the federal law requiring redemption at NAV within 7 days and, because almost all CEFs are traded on exchanges, they have a ready market as well. Management fees can be high and, because performance is due to the efforts of the portfolio managers, some just don't do very well. Finally, the investor has no say in when the fund elects to take gains or losses and that can have an impact on the investor's personal return.)

Examples of private funds include A) ETNs and private equity funds B) open-end and closed-end investment companies C) hedge funds and private equity funds D) hedge funds and private placements

c (Private funds, such as hedge funds and private equity funds, are excluded from the definition of investment company under the Investment Company Act of 1940. As a result, they do not register with the SEC as do open-end and closed-end companies. Although these are generally sold as private placements under Regulation D of the Securities Act of 1933, there are many private placements that are not private funds.)

Which of the following statements about S corporations is NOT correct? A) Stockholders of S corporations are taxed on the net profits of the corporation, even if they do not receive taxable dividends. B) An S corporation may have no more than 100 shareholders. C) S corporation status offers greater opportunity for raising additional capital than do other forms of business structure. D) An S corporation may have only 1 class of stock

c (S corporations are flow-through vehicles, so any earnings are taxable to shareholders, whether or not they are paid out as dividends. An S corporation may have no more than 100 shareholders and may issue only 1 class of stock so its ability to raise large amounts of capital is rather limited.)

A Schedule K-1 would NOT be used for tax reporting to the owners by which of the following business entities? A) LLC B) Limited partnership C) Sole proprietorship D) S corporation

c (Sole proprietorships generally complete Schedule C of the individual Form 1040. Legal entities that pass through income or loss use the Schedule K-1 to indicate the amount of that income or loss attributable to the individual shareholder/member/partner.)

The amount of federal income tax a U.S. citizen residing in the country will pay is dependent on all of these EXCEPT A) age B) state of residence C) gender D) filing status

c (Tax rates are not dependent upon one's gender. Age has an impact because there is an extra exemption for those at age 65. State of residence is a factor because certain state taxes are deductible on your Form 1040. Filing status is very important because in most cases, married filing jointly results in the lowest taxes.)

An investor has made the following purchases, all in the same calendar year: 100 ABC at $20 on January 15; 200 ABC at $25 on April 4; and 100 ABC at $30 on July 23. With ABC currently selling at $22, if this investor needed to sell 200 ABC, the best decision from a tax standpoint would probably be to A) hold the stock until the price reaches $25 B) use average cost C) use LIFO D) use FIFO

c (The best decision from a tax standpoint is to arrange things to show the largest loss. Remember, losses can be used against gains and, if there are more losses than gains, up to $3,000 of that loss can reduce taxable income. Using a form of share identification known as LIFO (last in first out), enables the investor to designate the 100 shares purchased at $30 in July and 100 of the shares purchased at $25 in April. That will result in a short-term capital loss of $1,100 ($800 on the July shares purchased at $30 plus $300 on the April shares purchased at $25.) That loss may be used either against realized gains or, if this is the investor's only transactions, deducted in full against ordinary income. The average cost method is only available for mutual funds. If this investor used FIFO, the sale would be of the 100 shares bought in January at $20 per share and 100 of the shares bought in April at $25 per share. The sale of the January purchase results in a $200 gain ($22 - $20 × 100 shares). The sale of the April purchase results in a $300 loss ($22 - $25) = -$3 times 100 shares. Combining them generates a net loss of $100. From a tax standpoint, declaring a loss of $1,100 is preferable to a loss of $100.)

When comparing a time deposit account and a demand deposit account, you would expect A) FDIC insurance on the time deposit account but not on the demand deposit account B) lower penalties for withdrawing funds from a time deposit account C) a higher rate of interest paid on the time deposit account D) easier access to the funds in a time deposit account

c (The best example of a time deposit accounts is a CD. Money is deposited for a fixed length of time, generally at a fixed interest rate. Demand deposit accounts are checking accounts. Because the bank expects to have longer use of time deposit funds, interest rates are generally higher. DDAs offer the instant access of check-writing (or online payments). Typically CDs, have penalties for early withdrawal; there is no such charge on a checking account. Both are covered by FDIC up to the applicable limit.)

According to the efficient market hypothesis, information found when reading the Wall Street Journal would be considered A) random walk B) semi-strong form market efficiency C) weak-form market efficiency D) strong-form market efficiency

c (The closer to inside information, the stronger the information. Anything published in widely read media would be considered very weak.)

An investor in the 25% federal income tax bracket is considering the purchase of some fixed-income instruments. Which of the following would provide the investor with the greatest after-tax return? A) 6% FDIC-insured CD B) 4.8% AAA rated insured municipal bond C) 7% Ba rated corporate bond D) 5% U.S. Treasury bond

c (The greatest after-tax return is provided by the instrument listed that, after subtracting 25% for income tax, leaves the investor with the greatest amount. Because the Treasury bond, the CD, and the corporate bond are all taxable at the same rate, the 7% bond must be the best deal. Even though the municipal bond is not taxed, its 4.8% net yield is far lower than the 5.25% ($70 − 25% tax) return on the corporate bond.)

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) both are open-end funds B) ABC and GEM are both unit investment trusts C) GEM may be an open- or closed-end fund and ABC is a closed-end fund D) ABC is an open-end fund and GEM is a closed-end fund

c (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 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? A) $1,300 B) $1,240 C) $1,267 D) $1,344

c (The unique feature of a TIPS bonds is its semi-annual adjustment to principal based on the inflation rate. With an annual inflation rate of 6%, there is a 3% increase to the principal value every 6 months. The arithmetic is $1,000 multiplied by 103% consecutively 8 times (there are 8 semi-annual periods in 4 years). Be sure to stop at 4 years—the question doesn't ask for the ending value for the 5th year.)

A 57 year-old client has $100,000 in a non-qualified variable annuity and $100,000 in a mutual fund with a dividend reinvestment plan. Coincidently, each was purchased 10 years ago with a deposit of $50,000. If the client needs $50,000 to use as a down payment for a vacation home, which would have the most severe tax consequences? A) The tax consequences would be the same B) The mutual fund C) The variable annuity D) Not enough information to tell

c (There are several differences involved here. First of all, withdrawals from a variable annuity are treated on a LIFO basis. That is, the earnings are considered to be withdrawn first. In that case, all $50,000 taken from the VA are taxed as ordinary income. In addition, because the client is not yet 59 ½, there is the 10% tax penalty tacked on. The mutual funds are part of a dividend reinvestment program which means that a good portion of the $50,000 in gain has already been taxed and, in any event, there is no early withdrawal tax penalty. Finally, profits from the sale of mutual fund shares held this long would be taxed at the long-term gains rate, always lower than ordinary income.)

An investment adviser is doing some research on a company and notices that the current market price is $21 per share. The most recently reported EPS is $3 and the company is paying a $.19 quarterly dividend. On the balance sheet, the company is carrying a significant amount of cash. This company would probably be attractive to this adviser if his investment style was A) growth B) passive C) value D) contrarian

c (This is an example of the kind of company appealing to those who follow a value style of portfolio management. The company is selling at a low P/E ratio of 7 to 1 ($21/$3) with a liberal dividend yield of 3.62% (.76/$21). The high cash balance only adds to the value.)

A securities analyst does not believe that markets are highly efficient. This analyst most likely follows which of the following investing strategies? A) Passive B) Strategic C) Tactical D) Indexing

c (Those who believe that stock markets are not efficient believe that they can "beat the market." That is the style followed by active or tactical managers. Those who believe in efficient markets would be passive or strategic investors such as those who buy index funds.)

As a technique in portfolio management, portfolio diversification reduces A) returns B) interest rate risk C) unsystematic risk D) systematic risk

c (Unsystematic risk, such as business risk, can be almost eliminated with a well-diversified portfolio. Systematic risks, such as interest rate risk, are not helped by diversification. For example, no matter how many bonds you hold in your portfolio, if interest rates go up, they'll all drop in price. On the other hand, holding many bonds limits the overall loss should 1 or 2 issuers default.)

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 buyer of the viatical policy was someone who was terminally ill C) the seller 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

c (Viatical settlements came of age during the AIDs crisis of the 1980s. They provide cash in exchange for the sale of a life insurance policy to those who were racking up substantial medical bills and had a short (generally less than 2 years) life expectancy. As medical advances changed the "death sentence" for an AIDS diagnosis (and many cancers as well), the life settlement became the more popular option when the policy owner was healthy but had reached an age (generally at least 70), and the need for life insurance was not as important as having the cash for personal use.)

The alternative minimum tax becomes a consideration when a taxpayer has so-called tax preference items. Included in that definition is A) interest from U.S. Treasury bonds B) tips received while working at a restaurant C) interest from private activity bonds D) overtime pay from a job

c (When an individual has tax preference items, AMT becomes an issue. One of the securities that generates preference income is a private activity bond, a revenue bond that is issued to benefit certain facilities such as airports, sports facilities and hospitals. Interest on Treasury securities is never a preference item and earned income, such as wages, salary, and tips, is not considered a preference item.)

If a new client has $200,000 to invest and wants to retire in 15 years, which of the following client information is least necessary for an adviser to recommend a suitable investment program? A) The amount of income he requires for his retirement years B) The age of the client C) Current income and cash flow requirements D) Tolerance toward risk

c (While current income and cash flow requirements are ordinarily important considerations, in this question we are being asked about the investment of a lump sum, not periodic additional investments. The amount of income required will determine the types of investments and how they must be structured in order to achieve the retirement income desired. The client's age is necessary to determine the time horizon. That is, if the client is currently 35 and wishes to retire at age 50, the money will have to last a lot longer than if we are dealing with a 55-year-old who wishes to retire in 15 years at 70. A client's tolerance toward risk is among the most important non-financial considerations in determining investment suitability.)

An investor buys 100 shares of KAPCO stock for $120 per share. During the year, he receives $260 in dividends and, at the end of the year, the stock is worth $13,000. The investor's holding period return is A) 2.17% B) 9.69% C) 10.50% D) 8.33%

c (Holding period return is computed by dividing the total return from income (dividends or interest) plus appreciation (or minus depreciation), by the original cost. In this example, the investor received $260 in income and has $1,000 of appreciation. That is a total return of $1,260 divided by $12,000 or 10.50%)

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 A) purchasing the stock and a put on the stock B) writing a straddle on that stock C) purchasing a straddle on that stock D) selling the stock short and purchasing a call on the stock

c (Purchasing a straddle on a stock means going long a put and a call at the same strike price with the same exercise date. If the stock goes up, the investor profits on the call; if the stock goes down, the investor profits on the put. When an investor writes a straddle, a put and a call are sold at the same exercise price and expiration date. Short straddles profit when the stock price remains stable (the opposite of what is presented in this question). Taking a long position in a stock with a long put offers protection to the downside, but no profit. Likewise, shorting a stock and taking a long position in a call offers protection to the upside, but no profit.)

Using the following information, compute the inflation-adjusted rate of return for an investor holding the ABC Corporation's 20-year bond: Coupon rate 5%, paid semi-annually Rating Aa Maturity date December 1, 2046 CPI 2% Par value $1,000 Purchase price 90 Call date December 1, 2033 Call price 101 A) 5.00% B) 2.50% C) 3.56% D) 4.50%

c (The inflation-adjusted rate of return is the actual return (income received divided by the purchase price) less the inflation rate as measured by the CPI. In this example, the bond pays $50 per year on an investment of $900. That is an actual return of 5.56%. Subtracting the CPI of 2% gives us an inflation-adjusted, or real, rate of return of 3.56%.)

Open- and closed-end investment companies have all of the following in common EXCEPT A) they compute their net asset values B) they have stated investment objectives C) they trade their shares in the secondary market D) they actively manage their portfolios

c (Open-end companies do not trade shares in the secondary market. However, both open-end and closed-end companies compute their net asset values, actively manage their portfolios, and have stated investment objectives.)

Many investors with a long position in common stock employ the technique of writing call options on the underlying stock for the purpose of A) participating in the growth of the company B) increasing the dividend return C) protecting the premium D) generating income

d (A covered call option is one where the writer (seller) owns the stock on which the call is sold. There are two reasons to write covered calls. The primary one is that the sale generates income in the form of the premium received from the buyer. A secondary reason is that, at least to the extent of the premium received, there is some downside protection for the long stock. This action has no impact upon the amount of the dividends received. It is the uncovered (or naked) call option that has unlimited risk.)

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

d (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.)

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

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

Why do some mutual funds offer Class A and Class B share options? A) Class A shares have lower management fees, while Class B shares have lower administrative costs B) To differentiate between those shares sold directly from the fund's principal underwriter and those sold by broker-dealers C) To give investors the option of purchasing shares prior to or after 4:00 pm ET D) To give investors the option of choosing how they wish to be charged for the purchase of their funds

d (Class A shares have a front-end load while Class B shares have a back-end load. The operating and administrative expenses are always higher on the Class B shares, but management fees are generally the same.)

A high net worth client expresses an interest in adding a hedge fund to her portfolio and asks for your advice. Among the points you could make is that A) she is probably not eligible to purchase a hedge fund B) she should limit her purchase to a hedge fund that is registered with the SEC C) hedge funds offer higher returns with less risk than similar investments D) adding the hedge fund increases the portfolio's diversification

d (Diversification is increased by adding asset classes or, in this case, a sub-class. When we are told that she is a high net worth client, it means she meets the eligibility requirements for purchasing a hedge fund. Although many hedge fund advisers are registered with the SEC, the funds are not. Hedge funds carry a number of risks, so we can't refer to them as low-risk investments.)

An agent presenting a variable life insurance (VLI) policy proposal to a prospect must disclose which of the following about the insured's rights of exchange of the VLI policy? A) The insured may request that the insurance company exchange the VLI policy for a permanent form of life insurance policy, issued by the same company, within 2 years. The insurance company retains the right to have medical examinations for underwriting purposes. B) Within the first 18 months, the insured may exchange the VLI policy for either a permanent form of life insurance or universal variable policy, issued by the same company, with no additional evidence of insurability. C) The insurance company will allow the insured to exchange the VLI policy for a permanent form of life insurance policy within 45 days from the date of the application or 10 days from policy delivery, whichever is longer. D) Federal law requires the insurance company to allow the insured to exchange the VLI policy for a permanent form of life insurance policy, issued by the same company for 2 years with no additional evidence of insurability.

d (Federal law requires that issuers of variable life insurance policies allow exchange of these policies for a permanent form of life insurance policy, issued by the same company for a period of no less than 2 years. The exchange must be made without additional evidence of insurability.)

A client has indicated that his primary objective is maximizing current income regardless of the risk. Which of the following mutual funds would probably be most suitable for achieving that goal? A) JKL Municipal Bond Fund B) GHI Index Fund C) ABC Growth and Income Fund D) DEF High-Yield Bond Fund

d (High-yield (junk) bonds, although carrying more risk, produce higher current income than other funds.)

All of the following are true of REITs EXCEPT A) they must invest at least 75% of their assets in real estate-related activities B) they must distribute at least 90% of their net investment income for favorable tax treatment C) in most cases, their shares are publicly traded D) they must take equity or debt positions, never both

d (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.)

Which of the following statements regarding U.S. government agency securities is TRUE? A) Interest received on agency securities is exempt from federal income tax. B) They generally trade on the major stock exchanges. C) They are direct obligations of the U.S. government. D) They generally offer higher yields than direct U.S. obligations.

d (In most cases, securities issued by U.S. government agencies are obligations of that agency rather than the U.S. government. As such, they carry slightly higher risk and that means investors demand a higher return. The do not trade on any exchange and their interest, like that of all U.S. government securities, is taxable on the federal level.)

An example of an interest-on-interest reinvestment program is A) reinvesting the dividends distributed on a bond fund B) reinvesting the earnings on a bond UIT C) reinvesting the interest received on a bond D) interest left to compound on a bank-insured certificate of deposit

d (Interest-on-interest reinvestment is, as the term implies, the practice of compounding earnings by reinvesting them. This is traditionally the way a bank savings account or certificate of deposit builds in value. Reinvesting the dividends on a bond fund is dividend reinvestment, even though most, if not all, of the fund's income is generated by interest. Same with the UIT and there is no program for reinvesting bond interest similar to a DRIP for reinvesting dividends.)

The president of a business entity opens an account in the name of the business. When determining the suitability of recommendations to the account, knowing the president's personal financial condition is necessary for each of the following forms of business structure EXCEPT A) an LLC B) a sole proprietorship C) an S corporation D) a C corporation

d (Only in the case of the C corporation are the income and losses of the investment account taxed at the corporate level rather than passed through to the owners.)

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

d (REITs cannot pass through losses to investors. It is important to remember that they are not DPPs.)

Gloria wishes to set up a trust where income must be annually distributed to her daughter. She wants her daughter to pay any income taxes because she is in a lower tax bracket than Gloria is. What should Gloria do? A) Use a complex trust with her daughter as irrevocable beneficiary B) Use a complex trust with her daughter as revocable beneficiary C) Use a simple trust with her daughter as revocable beneficiary D) Use a simple trust with her daughter as irrevocable beneficiary

d (Simple trusts must annually distribute income to the beneficiaries. Complex trusts do not. If Gloria makes the beneficiary revocable, the trust is subject to grantor trust rules and the income will be taxed to Gloria.)

Variable annuities A) generally provide more security of principal than fixed annuities B) provide a guaranteed minimum annuity payout C) may invest only in money market mutual funds D) may have 20 or more subaccount investment options

d (Some variable annuity separate accounts have 50 or more subaccounts to choose from. There are no guarantees as far as the amount of payout; that is why it is called a variable annuity.)

An individual opens an account with your firm. She tells you that upon her death, she wants any assets in the account to be divided equally among her 3 children. She also wants the ability to change the allocation in the event that conditions change and 1 of the children is in greater need than the others, but she does not want to incur any significant legal expense. You would suggest that the account be opened A) under a discretionary power B) as a joint account with tenants in common C) as a joint account with right of survivorship D) as an individual TOD account

d (TOD, the term used for transfer on death, will allow this client to fulfill her wishes.)

As defined in the Investment Company Act, investment companies include A) mutual funds, closed-end companies, and unit investment trusts B) diversified companies, nondiversified companies, and face-amount certificate companies C) open-end companies, closed-end companies, and unit investment trusts D) face-amount certificate companies, management companies, and unit investment trusts

d (The act defines investment companies as being management companies, face-amount certificate companies, or unit investment trusts. Management companies are further categorized as being open-end or closed-end, diversified or nondiversified.)

An estate planning tool that may be used to take advantage of the lifetime estate tax exclusion is the A) complex trust B) testamentary trust C) living trust D) bypass trust

d (The bypass trust is most commonly used to maximize estate tax savings by having the first to die of a married couple leave the lifetime exclusion ($11.4 million for 2019) to their children with the balance taken against the unlimited marital deduction. This results in saving estate taxes on that $11.4 million. With the "portability" provisions of the tax law signed on December 17, 2010, this is of limited value.)

An analyst wishes to assess the value of a fixed income security by taking the income payments scheduled to be received over a given future period and adjusting that for the time value of money. This analytical tool is known as A) future value B) yield to maturity C) duration D) discounted cash flow

d (The discounted cash flow (DCF) for a fixed income security (bond) is a summary of the expected interest payments that has been adjusted to reflect the time value of money. With all other things being equal, the bond with the higher DCF is the better investment.)

Which of the following are asset classes? A) Large cap stock funds B) Forward contracts C) Options D) REITs

d (The general consensus is that the major classes, for purposes of an asset allocation program, are equity, debt, cash (or cash equivalents), real estate, and commodities. Large cap stock funds are not an asset class; they are a way to invest in the asset class known as equity. Derivatives, such as options, are not generally considered an asset class, and it is the actual commodity (precious metals, oil, and so forth), not a forward or futures contract, that is the asset class. Most agree that REITs are a proxy for real estate itself.)

"An investment company with a low expense ratio and a portfolio that doesn't change," is a description of A) an ETF B) an index fund C) a no-load fund D) a UIT

d (The key to this is that the portfolio does not change. Unit investment trusts (UITs) are characterized by a fixed portfolio; once put together, it remains until maturity of the bonds or liquidation of the equities. Index funds and ETFs do change their portfolios from time to time as the composition of the underlying index changes.)

A 45-year-old investor wants the greatest possible monthly income with the preservation and stability of capital as secondary objectives. Which of the following investments would you recommend? A) Growth and income fund B) Money market mutual fund C) Growth mutual fund D) Long-term bond fun

d (The only choice that provides stability of capital is the money market fund, but that is not one of the investor's objectives and the monthly income is quite low. Although the 2 other funds don't offer stability, they certainly don't provide a high income (even the growth and income fund). If you want income, you invest in bonds, especially those with longer maturities.)

which of the following accounts can only be opened by spouses? A) Tenants in common B) Tenants with right of survivorship C) TOD accounts D) Tenants in the entirety

d (The unique characteristic of a tenants in entirety account is that it can only be opened by spouses. Each of the others can be opened jointly by any legal persons.)

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

d (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.)

The term private fund would apply to all of the following EXCEPT A) a venture capital fund B) a hedge fund C) a liquidity fund D) a unit investment trust

d (Unit investment trusts are one of the types of investment companies defined in the Investment Company Act of 1940. They register with the SEC prior to offering their units to the public. The other choices are all types of private funds.)

Keisha has 3 married children, each with children of their own. She wishes to leave equal shares of her estate to each of her children. What happens if 1 of those children dies before Keisha? A) The estate is divided on a per capita basis B) The estate is divided equally among the 2 surviving children C) The estate is divided equally between the 2 surviving children and the children of the deceased child D) The share belonging to the deceased child is distributed per stirpes

d (Unless specified otherwise, assets in an estate are distributed per stirpes (sometimes called in stirpes). Stirpes is a Latin word meaning branches and, in this context, it is used to determine how the next generation receives a share in an estate when the parent predeceases the grandparent. As an example, if Keisha had child A, B, and C, and C died having 2 living children, the estate would be divided as follows: Child A gets ⅓, child B gets ⅓, and the 2 children of child C receive ¹⁄₆ each (sharing half of child C's portion). If you selected, "The estate is divided equally between the 2 surviving children and the children of the deceased child," that would mean that everyone would receive ¼ and that is not the way it is done.)

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) represent an entire portfolio, or basket of securities. C) correlate to a specific index. D) be bought and sold at a profit the same day

d (Unlike mutual fund shares, ETF shares can be traded on an intra-day basis. Mutual funds are generally only priced once per day, after the market closes, but, with an ETF, you can buy and then sell an hour or two later at a profit. They are similar in that they both represent an entire portfolio or basket of securities and both can have portfolios correlated to a specific index. Dividend reinvestment is available on ETFs and mutual funds, although the process tends to be more efficient with the funds.)

Exercise of which of the following would NOT result in the money going to the issuer? A) Warrants B) Rights C) Convertible preferred stock D) A call option

d (When a call option is exercised, the strike price is paid to the seller of the option, not the issuer.)

An investment adviser representative's client lost her father to lung cancer. Among the assets bequeathed to her were 2,000 shares of a tobacco stock. Which of the following is NOT a consideration when recommending to her what to do with the stock? A) Her financial goals B) The cause of her father's death C) Her employment situation D) Her father's years of investment experience

d (An adviser's recommendations to a client are not impacted by the degree of someone else's investment experience or knowledge. In this case, one could expect some resentment towards holding shares of a tobacco company when the cause of a loved one's death is lung cancer.)

Which of the following statements regarding convertible bonds is NOT true? A) Convertible bondholders are creditors of the corporation. B) The conversion rate is set at issuance and does not change. C) If there is no advantage to converting the bonds into common stock, they would sell at a price based on their market value without the convertible feature. D) Coupon rates are usually higher than nonconvertible bond rates of the same issuer.

d (Because convertible debentures offer investors the opportunity to gain from increases in the issuer's common stock, those investors are willing to accept a lower coupon (interest) rate than debt securities without the convertible feature. Debentures are debt securities making their holders creditors of the issuer. At the time the debenture is issued, the bond indenture indicates the conversion rate. That rate is fixed and does not change over the life of the security. In general, the conversion feature will be exercised only if the market price of the underlying stock has risen to the point where the investor is better off owning the stock than the debenture. One of the benefits of owning this security is that, as a debt instrument, if the stock price falls below the conversion price, the debenture will trade in the market like a comparable non-convertible issue. That is, it will trade at a market price offering a yield similar to non-convertible debt securities of the same quality and maturity.)

Which of the following bond strategies is the least active? A) Yield curve B) Barbell C) Ladder D) Bullet

d (The least active strategy is the one requiring the lowest level of activity on the part of the investor. The bullet strategy involves investing in bonds at various intervals with all of the bonds maturing at or about the same time (such as when a child is entering college). As such, the only activity is buying bonds every couple of years. Barbell and ladder strategies have bonds maturing at regular intervals requiring an active role in reinvesting the principal. All three of these require the investor to purchase bonds at different times, but the bullet strategy is the only one not concerned with the mechanics of collecting the matured principal and reinvesting it. Yield curve is not a specific strategy.)