Series 65 Question 2

A member of the investment banking department of ABC Securities is explaining some of the advantages and disadvantages of rights and warrants to the board of directors of XYZ Corporation. Which of the following statements could he make? I) The exercise prices of stock rights are usually below the current market price of the underlying security at time of issue. II) The exercise prices of warrants are usually above the current market price of the underlying security at time of issue. III) Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. IV) Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer. A) I, II, and III B) I, II, III, and IV C) I and II D) I only

B All are true statements. The exercise prices of stock rights are usually below the current market price of the underlying security at time of issue. The exercise prices of warrants are usually above the current market price of the underlying security at time of issue. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer. LO 4.c

Which of the following statements is true regarding the civil liability provisions of the Uniform Securities Act? A) Only those who actually signed the registration statement are exposed to potential liability. B) Purchasers may waive their rights to suit under the civil liability provisions if done so by the purchase contract. C) If the registration statement contains misrepresentations that were made deliberately, criminal penalties, in addition to civil ones, may be levied. D) The statute of limitations for civil suits is three years from the date of discovery.

C Under state law, civil suits must be filed within two years of the date of discovery of the improper action or three years after the sale, whichever comes sooner. Purchasers may not waive their rights under the act for any provision. Although those who signed are liable, there is a list of others who also might be, including members of the board of directors, legal counsel, accountants, et cetera. LO 12.e

Municipal bonds are often called tax-exempts. This refers to the exemption of their income from A) federal income taxes. B) federal estate taxes. C) state income taxes. D) state, federal, and inheritance taxes.

A Although municipal bonds are sometimes exempt from state income tax (if issued in the state of residence of the taxpayer), all references to tax exemption refer to their exemption from federal income taxes. LO 2.h

Under the Uniform Securities Act, registration by coordination becomes effective A) immediately. B) when the registration with the SEC becomes effective. C) in 30 days. D) in 10 days.

B The registration by coordination becomes effective at the same time it is released (made effective) by the SEC, provided it was filed with the Administrator, in most states at least 10 days before the SEC effective date. LO 8.g

You recently took a trip to Warsaw, Poland, and when you received your credit card statement, you noticed that your vodka purchase for 100 Polish Zlotys resulted in a $30 charge on your statement. Based on this exchange rate, each dollar was worth approximately A) $3.33 B) 3 Zlotys C) 3.33 Zlotys D) $.33

C When making an investment (or a transaction) in a foreign currency, it is important to be able to translate that into the exchange rate for your home currency. To do so, we divide the purchase in the foreign currency by the charge in U.S. dollars. In this case, 100 Zlotys only cost us $30, so that makes each dollar worth 3.3 Zlotys. LO 19.b

Which of the following statements pertaining to the types of risk is not correct? A) Reinvestment rate risk is the uncertainty that surrounds the rate of return that can be earned on reinvested coupon income. B) Exchange rate risk is the variability in returns on securities caused by currency fluctuations. C) Interest rate risk is the risk that the market price of an investment will decline as the result of changes in market interest rates. D) Business risk is the uncertainty of price fluctuations in the stock market.

D Business risk is the uncertainty of operating income. It is market risk that is the uncertainty of stock market price fluctuations. LO 19.b

Which of the following are characteristics of newly issued warrants? A) No intrinsic value and no time value B) Intrinsic value but no time value C) Time value and intrinsic value D) Time value but no intrinsic value

D Warrants can be thought of as call options with a long expiration period. They are always issued with a strike price in excess of the current market value, so there is no intrinsic value. One could say that, on issuance, they are always out of the money. The only value is in the time to expiration—usually several years or longer. LO 4.c

Section 28(e) of the Securities Exchange Act provides a safe harbor for certain soft dollar compensation extended from broker-dealers to investment advisers. Which of the following is most likely to be included in that safe harbor? A) Bespoke software designed to give clients access to asset allocation programs B) Meal expenses to attend an investment seminar sponsored by the broker-dealer C) Use of vacant office space in the broker-dealer's facilities D) Desks remaining after the broker-dealer redesigned its office

A Among the items generally in the safe harbor are those items designed to assist the firm's customers. Customized software that helps clients would be acceptable. Although seminar registration expenses are in the safe harbor, travel and transportation expenses, such as meals and lodging, are not. Rent and office furniture are specifically listed as out of the safe harbor. LO 14.c

Which one, if any, of these transactions will be treated as a prohibited transaction under the provisions of the ERISA legislation? A) A loan between a 401(k) plan and plan participant B) An investment adviser using the interest from plan assets to cover the adviser's office expenses C) None of these transactions constitute a prohibited transaction under the provisions of the legislation D) The furnishing of office space to a plan trustee for reasonable compensation and fair rental value

B An investment adviser, as a fiduciary and disqualified person under the plan, is prohibited from using plan assets in payment of personal obligations (such as outstanding office expenses). Loans from a 401(k) plan to a participant are not prohibited transactions. The plan trustee may rent space from the plan (one of the plan's assets is an office building). LO 18.g

Under the NSMIA, state securities Administrators retain authority to A) forward all filing fees received from issuers, broker-dealers, and agents to the SEC. B) enforce antifraud provisions. C) regulate the securities registration and offering process for registered investment companies. D) impose state registration requirements on all investment advisers.

B Under the NSMIA, state Administrators are not prohibited from enforcing the antifraud provisions of state and federal securities laws. Investment companies and SEC-registered advisers are exempt from state registration, but they may be required to pay state filing fees. LO 8.g

Which of the following statements about 401(k) plans are correct? I) 401(k) plans are a type of defined benefit retirement plan. II) An employee's elective deferrals are made with pre-tax dollars. III) Earnings on the contributions to a 401(k) accumulate on a tax-deferred basis. A) I and II B) I and III C) II and III D) I, II, and III

C A 401(k) plan is a type of defined contribution plan rather than a defined benefit plan. A participating employee is not guaranteed a specific retirement benefit from the plan; instead, the retirement benefits depend on how much is contributed to the plan and how much the contributions earn. A 401(k) plan allows employees to make elective deferrals from their pay which results in those funds being contributed on a pre-tax basis. Plan earnings accumulate on a tax-deferred basis. This means that plan participants do not pay income tax on the earnings until they are withdrawn. LO 18.f

Open- and closed-end investment companies have all of the following in common except A) they have stated investment objectives. B) they compute their net asset values. 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. LO 3.b

If you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning −20%, and a 20% chance of earning −10%, the return would be equal to A) 14% B) −10% C) −6% D) 10%

C The return is computed by taking the probability of each possible return outcome, multiplying it by the return outcome itself, and then adding them all together. In this case, the math is as follows: (0.4 × 10%) + (0.4 × −20%) + (0.2 × −10%), or +4% − 8% − 2%, which equals -6%. Part of the trick here is catching the probable negative returns and the ridiculous assumption that an investor would consider looking at a stock with this kind of expected return. You can always count on NASAA to surprise you. LO 22.a

When a bank's reserve account is running low, it might choose to borrow from the Fed. When doing so, the bank will be charged A) the prime rate. B) the federal funds rate. C) the discount rate. D) the call loan rate.

C When a bank borrows from the Federal Reserve, it does so at the discount rate. When borrowing from another bank, it is at the federal funds rate. The prime rate is charged by the banks to their stronger borrowers, and the call loan rate is what broker-dealers pay on stock market collateral pledged for margin accounts. LO 6.c

Over the past year, the market, with a beta of 1.0, has returned 15%. Under CAPM, which of the following stocks would be considered overvalued? A) ACR, beta 0.9, return 13.6% B) RJP, beta 1.2, return 17.5% C) BED, beta 1.5, return 23.5% D) LQR, beta 0.7, return 11%

B We compare the expected return to the actual return to determine if the security outperformed (making it undervalued) or underperformed (making it overvalued). RJP's beta of 1.2 would have led to an expected return of 120% of that of the market. That would be 15% x 120% = 18%. With an actual return of 17.5%, the stock did not perform relative to the additional risk taken. The actual return for all of the others exceeded the expected return. LQR was 11% compared to 10.5%; BED was 23.5% compared to 22.5%; and ACR was 13.6% compared to 13.5%. LO 21.h

Mitch purchased a 30-year bond for 97¾ with a stated coupon rate of 8.5%. What is the approximate yield to maturity for this investment if Mitch receives semiannual coupon payments and expects to hold the bond to maturity? A) 8.50% B) 5.68% C) 8.67% D) 4.36%

C No calculation is necessary here. Why not? Because anytime a bond is purchased at a discount from par (97¾% is a discount), the YTM must be greater than the nominal (coupon) rate. There is only one choice greater than 8.5%. It isn't about your computational skills; it is about your understanding of the relationship between prices and yields. LO 2.e

When the market interest rate is 8%, which of the following equally-rated bonds will have the potential for the greatest relative price volatility to changes in interest rates? A) 12% coupon bond with 12 years to maturity B) 12% coupon bond with 6 years to maturity C) 8% coupon bond with 6 years to maturity D) 8% coupon bond with 12 years to maturity

D want lowest coupon and longest maturity for more volatility - if it was asking for least price volatility it would be B The question is all about the effects of a bond's duration on its price volatility. As the duration increases, so does the price volatility. When comparing bonds, generally, a low coupon bond is more susceptible to price fluctuations than a high coupon bond and a long-term bond is more susceptible to price fluctuations than a short-term bond. The bond with the lowest coupon (8%) and longest maturity (12 years) is subject to the greatest price volatility. The bond with the shortest duration, and least price volatility, would be the one with the highest coupon (12%) and the nearest maturity (6 years). LO 20.b

Which of the following would lead to a debit to our foreign account balance? A) Residents of other countries buying apartments here B) U.S. residents taking vacations abroad C) An increase in exports D) Foreign governments repaying loans to U.S. banks

B When our foreign account balance is debited, that creates a negative action. It is like a charge on your credit card—your account is debited. On the other hand, a credit to your card account is money coming to you. Our foreign-accounts balance will be debited whenever our money goes out rather than coming in. When U.S. residents take vacations abroad, our money is being spent on hotels, restaurants, and other items in foreign countries. The other choices represent a credit to our foreign account balance. When exports increase, more foreign money comes in. When foreigners buy property here, we get their money, and when loans are repaid here, once again, foreign money comes into the United States. LO 6.c

Julian and Jane are discussing risk-return measures. Julian states that "beta is used when looking at the performance of a fund or portfolio and refers to the extent of any outperformance against its benchmark." Jane disagrees and says that "outperformance of a fund or portfolio is actually measured by standard deviation." Which of the following statement is correct? A) Only Jane is correct. B) Both Julian and Jane are correct. C) Only Julian is correct. D) Both are incorrect.

D Both Julian and Jane are incorrect. It is alpha, not beta, that is used when looking at the performance of a fund or portfolio. Alpha refers to the extent of any outperformance of a portfolio against its benchmark. Standard deviation is used for measuring volatility, not performance. LO 20.f

An investor begins contributing $600 on the third day of each month to a purchase plan for the KAPCO Total Return Fund. For the first six months, the per share prices were: $10 $12 $15 $20 $12 $8 What is this investor's breakeven point? A) $8.00 per share B) $12.50 per share C) $12.83 per share D) $11.80 per share

D This is a dollar cost averaging question. This investor has purchased a total of 305 shares with a total cost of $3,600. Here's the math: Month 1- $600 divided by $10 = 60 shares Month 2 - $600 divided by $12 = 50 shares Month 3 - $600 divided by $15 = 40 shares Month 4 - $600 divided by $20 = 30 shares Month 5 - $600 divided by $12 = 50 shares Month 6 - $600 divided by $8 = 75 shares The total expenditure was $3,600 (6 months××$600) and the total number of shares purchased was 305. That makes the average cost per share $11.80 ($3,600 divided by 305). With the investor's average cost per share being $11.80, a sale of the shares at that price will cause the investor to break even. LO 21.j

All of the following permit investments into various securities, such as stocks, bonds, and mutual funds except A) an FSA. B) a traditional IRA. C) an HSA. D) a Roth IRA.

A Flexible spending accounts (FSAs) allow deductions from an employee's paycheck. That money is held by the company and is used to pay allowable claims by the employee. A health savings account (HSA) permits the employee to invest in a wide variety of securities. IRAs, traditional and Roth, have always permitted investment flexibility. LO 18.j

A registered investment company whose capitalization may include preferred stock and/or bonds is A) the closed-end management investment company. B) the unit investment trust. C) the open-end management investment company. D) the face-amount certificate company.

A Only the closed-end company is legally permitted to issue senior securities (preferred stock and bonds). LO 3.b

An investor would enter a buy stop order to hedge against a loss in A) a short stock position B) a margin account C) a variable annuity wrapper D) a long stock position

A When an investor sells short, stock is borrowed and sold with the anticipation that it will later be replaced at a lower price. However, the investor will lose money if the stock goes up instead of down. Because there is no limit to how high the stock's price can go, one can protect against that unlimited loss by entering a buy stop order at a specified price above the current market. It is true that all short sales must be made in margin accounts, but that is not nearly a descriptive enough answer because there are both long and short margin accounts and a long position cannot be hedged with a buy stop order. LO 23.f

Under the Uniform Securities Act, which of the following is true regarding the registration of securities? A) State registration by coordination is available only if a federal registration statement has been filed under the Securities Act of 1933 in connection with the same offering. B) The Administrator may require that a prospectus be delivered to every purchaser of a registered security no sooner than the time at which the security is delivered. C) Registration by coordination becomes effective on a date ordered by the Administrator. D) The effectiveness of a registration statement assures the accuracy of the information contained in the statement.

A Registration by coordination becomes effective simultaneously with the federal registration. A prospectus may be delivered at or prior to the time actual delivery of the security is made. The act prohibits any statement or implication that registration involves approval of accuracy of facts by the Administrator. The federal registration statement is what the state registration is being coordinated with. LO 8.g

All of the following are characteristics of a rights offering except A) the subscription period is up to two years. B) the subscription price is below the current market value. C) it is issued to current stockholders. D) the rights are marketable.

A Rights offerings are usually very short-lived (30 to 45 days). LO 4.c

Serenity Strategic Investments (SSI) is an investment adviser registered in four states. SSI's most previous annual updating amendment showed AUM of $108 million. Six months later, a favorable market resulted in SSI's AUM growing to $120 million. Unfortunately, several large clients left, so at the end of SSI's year, its AUM was down to $94 million. Which of the following statements is correct? A) SSI remains state registered because its AUM is less than $100 million. B) SSI may remain SEC registered as long as AUM is at $90 million or more. C) SSI has the choice of remaining state-registered or registering with the SEC. D) SSI must become registered with SEC within 90 days of exceeding $110 million.

A The key to answering this question is remembering that, for purposes of SEC registration, it is the AUM (technically known as the RAUM—regulatory AUM) shown on the annual updating amendment to Form ADV that is the determining factor. We are told that SSI is state registered, something permitted when reported AUM is $108 million, although it was eligible to register with the SEC. The midyearincrease has no effect on registration, only that at the end of the year. Because SSI will report $94 million on the next annual update, it will remain state registered and does not have the option to register with the SEC because its AUM is below $100 million. The only time the $20 million buffer down to $90 million enables an investment adviser to remain registered with the SEC is just that—the IA is already registered with the SEC and can stay there. LO 9.d

An investment adviser making investment decisions within parameters agreed upon with the client is managing the portfolio on A) a discretionary basis. B) a nondiscretionary basis. C) a best-efforts basis. D) an advisory basis.

A When the investment adviser makes investment decisions within parameters agreed upon with the client, the arrangement is best described as being on a discretionary basis. LO 14.f

An investor would have to pay the alternative minimum tax when A) there are tax-preference items reported on the tax return. B) it exceeds the investor's regular income tax. C) the investor's capital gains exceed 10% of total income. D) the investor has received income from a limited partnership.

B A taxpayer must pay the alternative minimum tax (AMT) in any year that it exceeds regular tax liability. Tax-preference items are re-input in figuring the AMT, but the AMT is paid only if that amount is higher than the regular income tax. LO 15.d

Early in the year, an investor purchased shares of the GEMCO Fund at $10.40 per share when the net asset value per share was $9.53. Just before the last trading day of the year, this investor liquidated the position at $10.60 per share when the net asset value per share was $10.77. From this, you can discern that GEMCO Fund is A) an open-end investment company. B) a closed-end investment company. C) a unit investment trust. D) a face-amount certificate company.

B It is only the closed-end investment company where shares trade at a premium or discount to the NAV per share. LO 3.b

The firm engaged to manage the portfolio of an investment company registered under the Investment Company Act of 1940 must: A) provide notice to SEC. B) register with SEC. C) offer to provide a brochure to the investment company no less frequently than annually. D) register with the Administrator in each state in which the fund's shares will be offered.

B Managers of registered investment companies are federal covered investment advisers and must register with SEC. There is an exemption from the brochure delivery requirements to investment company clients. LO 9.b

Which of the following is price-weighted rather than cap-weighted? A) Wilshire 5000 B) Dow Jones Industrial Average C) Standard & Poor's 500 D) Russell 2000

B Of the major averages/indexes, the DJI is the only one which is price-weighted. All of the others are weighted based on market capitalization. LO 22.b

Which of the following statements regarding advisers who maintain custody over client accounts is not true? A) Advisers must send clients quarterly statements that itemize the funds and securities in the adviser's possession. B) The adviser must arrange for the audit of client accounts by an independent public accountant on a systematic basis at least once a year. C) The adviser must maintain complete and accurate records of all accounts and ensure that the funds and securities are segregated by client. D) If customer funds and securities are deposited in a bank, the bank account must only contain customer funds and identify the adviser who is acting as an agent for the customers.

B The adviser must arrange for the audit of client accounts by an independent public accountant without prior notice to the adviser and not on a systematic basis (hence the surprise audit). The adviser must send quarterly statements to clients, itemizing the funds, securities, and transactions that have occurred. The adviser must maintain accurate records of all accounts and ensure that the funds and securities are segregated by client. LO 14.e

An investor who resides in New York reads a newspaper ad for advisory services in a newspaper published in New Jersey. More than 80% of the newspaper's circulation is in the state of New York. According to the Uniform Securities Act, an offer has been made in A) New York. B) New Jersey and New York. C) neither New Jersey nor New York. D) New Jersey.

C An offer is made neither when a newspaper is circulated but not published in the state nor if it is published in the state but has more than 2/3 of its circulation outside of the state. LO 12.a

If a bond has a long duration, it will A) continue paying interest into perpetuity B) be relatively unaffected by small changes in interest rates C) be more sensitive to small changes in interest rates than a bond with a shorter duration D) be less sensitive to small changes in interest rates than a bond with a shorter duration

C Duration measures how sensitive a bond will be to a small change in interest rates. The longer the duration of a bond, the more volatile (sensitive to interest rate changes) it will be. LO 20.b

Many investors consider purchasing an equity exchange-traded fund (ETF) to increase portfolio diversification. All of the following are reasons for investors to purchase this investment except A) shares may be purchased and sold throughout the day. B) they have lower taxable distributions than most mutual funds. C) ETFs offer tax benefits similar to a limited partnership. D) they have lower annual expenses than those of mutual funds.

C Equity ETFs are often organized as regulated open-end investment companies and rarely as limited partnerships (never on the exam). Therefore, they must distribute at least 90% of their net investment income and capital gains. However, the method by which those capital gains are realized by the ETF is different from that of a mutual fund and, in almost all cases, results in lower taxable capital gains distributions. Unlike limited partnerships, there is no flow-through of losses. Expenses are generally lower as well, and ETFs trade during the day just like any stock. LO 3.g

Profit Partners, LLC (PPL), a federal covered investment adviser, sends correspondence regarding its past performance to prospective retail clients in State A. PPL does not maintain a place of business and is not registered in State A. Because PPL is soliciting for new business there, the Administrator of State A A) would have no jurisdiction over PPL because the firm is a federal covered investment adviser. B) would be able to bring a claim against PPL for showing past performance in a communication with prospective clients. C) would be able to bring a claim against PPL if it was discovered that the antifraud provisions of the Uniform Securities Act had been violated. D) would be able to bring a claim against PPL for soliciting without being properly registered in the state.

C In general, Administrators have no jurisdiction over the activities of federal covered investment advisers. The situation is different, however, when a covered adviser pursues an activity in the Administrator's state that violates the antifraud provisions of the Uniform Securities Act. In that case, the Administrator can take action against the covered adviser. The showing of past performance is permitted as long as the required conditions are met; nothing in the answer choice indicates that the communication is not in compliance. LO 12.a

Investors looking to minimize the effects of taxation on their investments would probably receive the least benefit from A) an apartment building. B) a growth stock. C) a corporate bond. D) an S&P 500 Index fund.

C Investors receive interest income from corporate bonds. That income is fully taxable at ordinary income rates. Real estate ownership has certain tax benefits, such as depreciation and a deduction for operating expenses. Index funds are known for their high tax efficiency, and investors in growth stocks anticipate long-term capital gains, which are taxed at a lower rate than ordinary income. LO 15.b

The statistical measurement that indicates how much an investment's returns have fluctuated, compared to its average return, over a given period of time is known as A) convexity B) beta C) standard deviation D) R-squared

C Standard deviation measures how much an investment's returns have fluctuated over a given period of time. The higher the investment's standard deviation, the higher the risk. LO 20.f

Which efficient market hypothesis suggests that an investor can achieve above-market returns only by utilizing insider information? A) Super-strong B) Strong C) Semi-strong D) Weak

C The semi-strong form suggests that fundamental analysis is of no value, and only through the use of insider information can an investor achieve above-market returns. The weak form suggests that technical analysis is of no value, and the strong form suggests that nothing has any value, that efficient markets are totally random. LO 21.i

A client is in the 28% marginal federal income tax bracket and the 3% state income tax bracket. Which of the following investments would produce the highest after-tax yield for the client? A) A AAA rated debenture yielding 7.75% B) An A-rated corporate mortgage bond yielding 8% C) A U.S. Treasury note yielding 7% D) A public-purpose municipal bond yielding 6%

D Because your client is in the 28% tax bracket, she has to earn more than the 6% on a taxable bond for the yield to be equal to, or higher than, the tax-free bond. That number can easily be calculated because 72% of the taxable amount must be equal to or greater than the 6% return (6% ÷ 72% = 8.33%). The 8.33% is higher than the return on the other bonds listed, so the public-purpose municipal bond would produce the highest retained return. This would be even more appropriate if the issue was tax exempt in the client's state. LO 2.h

A fundamental analyst would be most interested in which of the following? A) A 200-day moving average B) The outstanding short interest in the market C) Resistance and support levels D) A P/E analysis of the stocks included in the Dow Jones Industrial Average

D Fundamentalists look at P/E ratios; the other tools mentioned are technical. LO 21.d

At his death, on January 1, 2017, Morris owned shares of ABC Corporation common stock, with a fair market value of $50 per share, which he had purchased in 2001 for $25 per share. If Morris's executor elected to value the estate by using the alternate valuation date, but then sold the shares through a broker-dealer on May 15, 2017, at $40 per share, what is the estate's basis per share for estate tax purposes? A) $15 B) $125 C) $50 D) $40

D If the executor elects to value the decedent's estate by using the alternate valuation date, the value per share is the value at the date six months after death, unless the property is sold prior. In this case, the value per share is the FMV on the date of sale, $40 in this example. LO 16.g

The Administrator in Texas has jurisdiction over an offer of securities made where? On a radio program originating in Texas On a radio program originating in Oklahoma In a newspaper circulated in Texas but published in Oklahoma A) I and II B) I, II, and III C) III only D) I only

D The Administrator does not have jurisdiction over an offer made in a TV or radio broadcast that originated outside of the state. The same is true for a newspaper published outside of the state. LO 12.a

The economy has gone through three consecutive quarters of economic decline with no immediate end in sight; therefore, it could be said to be A) in a depression. B) lagging. C) in a recovery. D) in a recession.

D Recession is defined as two or more consecutive quarters of economic decline. It would have to be at least six quarters to be considered a depression. LO 6.a

An agent has a new client who is prone to tergiversation. As such, it would probably make sense to A) make recommendations on a frequent basis. B) open a discretionary account. C) obtain permission from both the client and the broker-dealer before sharing in the profits and losses in the account. D) accept unsolicited orders only.

D Those who tergiversate repeatedly change their attitude or opinions. As a consequence, the client who likes an agent's recommendation one day may quickly change his mind the next. Therefore, the agent could be placed in an untenable position, being unable to satisfy the client. To avoid this possibility, it would be most sensible to leave all the decisions to the client and only accept unsolicited orders. LO 14.g

Under which of the following circumstances can an agent conduct customer transactions without the activity being recorded on the books and records of the broker-dealer employer? A) The securities are exempt under the Uniform Securities Act. B) The customer is a member of the agent's immediate family. C) The agent will receive no compensation. D) The transactions are authorized in writing by the broker-dealer before execution of the transactions.

D Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, it would be considered contrary to the standards imposed for an agent to effect securities transactions not recorded on the regular books or records of the broker-dealer that the agent represents, unless the transactions are authorized in writing by the broker-dealer before execution of the transaction. LO 14.g

A client of your broker-dealer, currently long 1,000 shares of DEF Corporation common stock, wishes to liquidate the position. Based on the following market maker quotes, it would be expected that the firm's trader would direct a market order to A) MMC: 9.75 - 9.85, 20 x 20. B) MMB: 9.65 - 9.75, 10 x 10. C) MMD: 9.75 - 9.90, 5 x 10. D MMA: 9.65 - 9.85, 5 x 5.

A A market order to sell 1,000 shares should be directed to the market maker with the highest bid price that is firm for at least 1,000 shares. The highest bid price is $9.75 by both MMC and MMD, but MMD's quote is only firm for 500 shares. LO 23.d

When does a customer have to receive the OCC Options Disclosure Document? A) At or prior to the time the account is approved for options trading B) Within 15 days of account approval C) With the confirmation of his first options transaction D) Within 5 business days of the first options trade

A Before opening an account to trade options, the owner must be told about the risks involved with trading options. By providing the owner with an options disclosure document titled Understanding the Risks and Uses of Options at or prior to the time of account approval, the broker-dealer satisfies the risk disclosure requirements. LO 16.a

Under the Uniform Securities Act, a person who is in the business of providing advice on trading futures contracts and advising clients on securities issued or guaranteed by the U.S. government is A) not required to be a registered investment adviser in the state. B) required to be a registered agent in the state. C) required to be a registered investment adviser representative in the state. D) required to be a registered investment adviser in the state.

A The Uniform Securities Act excludes futures contracts from the definition of security. To be defined as an investment adviser, the advice must be on securities. That brings us to the U.S. government securities. A person whose securities advice is limited to those issued or guaranteed by the U.S. government is included in the definition of a federal covered adviser. Federal covered advisers are included in the list of persons who are not deemed to be investment advisers under the USA. Therefore, this person is not considered an investment adviser in a state and is not required to register as one. LO 9.b

The issuance of a long-term debt instrument, such as a bond, by a company would have an immediate effect on which of the following balance sheet items? I) Total assets II) Total liabilities III) Working capital IV) Shareholders' equity A) I, II, and III B) I, II, and IV C) I, III, and IV D) II, III, and IV

A The cash received from the sale of the bonds is a current asset of the company and, as such, would increase assets and working capital on the balance sheet. The bonds are debt of the company and would increase the liabilities of the company. Shareholders' equity is only affected by gains, losses, new invested capital, and the declaration of cash distributions (dividends) to shareholders. LO 7.c

Owners of private activity municipal bonds might find themselves A) subject to the alternative minimum tax. B) receiving less interest than with a similar GO bond. C) in violation of MSRB rules if proper disclosures are not made. D) taking an extraordinarily high risk.

A The interest on private activity municipal bonds (used for things like airports, student housing, etc.) is exempt from federal taxation but is considered a preference item for the AMT. LO 15.d

A client needs funds for an unexpected medical emergency. If the client takes out a loan against the cash value of his life insurance policy and does not pay it back, the insurance company can do which of the following? A) Reduce the death benefit when the client dies B) Cancel the policy C) Increase the premium amortized over the life of the policy D) Reduce the cash value at the next anniversary

A Unpaid cash value loans reduce the death benefit. LO 24.f

Hexagon Portfolio Advisors (HPA) believes that the market is semi-strong efficient. The firm's portfolio managers most likely will use A) passive portfolio management strategies. B) active portfolio management strategies. C) technical analysis to create portfolio management strategies. D) an enhanced indexing strategy that relies on trading patterns.

A f the market is semi-strong efficient, portfolio managers should use passive management because they believe neither technical analysis nor fundamental analysis will generate positive abnormal returns on average over time. A semi-strong proponent opines that private (inside) information can work (beat the market), but because that information is generally prohibited from use, portfolio managers can't claim that as their investment strategy. LO 21.i

Which of the following statements about capital gains are true? I) The minimum holding period required to qualify for long-term capital gains treatment is 1 day longer than 12 months. II) The highest federal income tax rate on long-term capital gains is less than the highest federal income tax rate on ordinary income. III) If an investor holds stock for 12 months or less and has no other transactions, any gain on the sale of the stock is taxed at the same rate as ordinary income. A) I and III B) I, II, and III C) II and III D) I and II

B If an investor holds stock for more than 12 months and sells it for a gain, the gain will be treated as a long-term capital gain. The advantage of long-term capital gains is that the maximum tax rate on long-term capital gains is lower than the maximum rate on ordinary income. If an investor holds stock for 12 months or less, though, any gain will be considered a short-term capital gain and will be taxed at the same rate as ordinary income. LO 15.c

A 45-year-old investor takes a lump-sum distribution from a nonqualified variable annuity. How is the distribution taxed? I) The entire amount is taxed as ordinary income. II) The growth portion is taxed as ordinary income. III) The growth portion is taxed as a capital gain. IV) The growth portion is subject to a 10% penalty. A) II and III B) II and IV C) I and IV D) III and IV

B On withdrawals from a nonqualified annuity, taxes are paid only on the amount that exceeds cost basis (the amount paid into the annuity). In this case, the investor is taking a lump-sum distribution before reaching age 59½ and must pay an additional 10% penalty on the taxable amount. LO 24.e

With regard to an SEC-registered investment adviser employing the services of a promoter to solicit business, it would be correct to state that A) referral fees may be paid only if the solicitor is also registered with the SEC. B) the investment adviser may not compensate a solicitor who is subject to a statutory disqualification. C) cash referral fees may be paid pursuant to a written or oral agreement to which the investment adviser is a party. D) delivery of the solicitor's brochure must take place within five days after entry into the advisory contract.

B One of the important requirements when hiring a solicitor is making sure that the person is not statutorily disqualified from registration. The rule gives as an example a person considered to be a bad actor under Rule 506 of Regulation D. That is, any person who would be unable to register as a securities professional because of prior conduct cannot act as a solicitor for a registered investment adviser. Promoters do not have to prepare (much less deliver) a brochure. If the promoter is to be compensated more than the de minimis amount, there must be a written, not oral, agreement. LO 13.i

Under the Uniform Securities Act, which of the following statements regarding private placements is true? A) Being an exempt transaction, the antifraud provisions do not apply. B) The security ​that is the subject of the private placement ​need not be registered. C) A prospectus must be provided before the offering. D) The offering must be made to fewer than 15 noninstitutional persons.

B Private placements are offers to no more than 10 noninstitutional persons in a 12-month period for investment purposes (not immediate resale), where no commissions are paid, directly or indirectly. Such transactions are exempt from registration requirements. The fraud provisions apply to any person involved with the purchase or sale of a security, whether registered or exempt, and the prospectus delivery requirements apply to registered securities. Please note that when it comes to institutional clients, there are no numerical limitations on offers, no required holding periods, and no restrictions on payment of commissions. LO 8.d

An investment adviser would be most likely to be the contra-party to a trade when acting as A) a broker. B) a principal. C) an agent. D) an investment counsel.

B The term contra-party means the other side of the trade. There are always two parties (the principals) to any transaction: the buyer and the seller. When an investment adviser is selling a security out of, or purchasing a security for its proprietary account, it is one of the principals. LO 13.b

The yield to maturity of a bond represents the bond's A) real rate of return. B) internal rate of return (IRR). C) annualized rate of return. D) net present value (NPV).

B The yield to maturity (YTM), or internal rate of return, of a bond is the total return earned on a bond that is held to maturity. A major assumption when calculating YTM is that all interest payments on the bond are reinvested at the calculated YTM. For example, if the calculated YTM is 7%, any interest payments generated from the bond are also assumed to be reinvested at 7%. The NPV indicates how the market price of the bond compares to its present value. The real rate of return, often called the inflation-adjusted return, compares the actual return with the inflation rate. The annualized return is the return an investor would have received had he held an investment for one year. LO 22.a

Which one of the following statements regarding a characteristic or use of a Roth IRA is correct? A) Roth IRA withdrawals are tax-deferred in their entirety regardless of the participant's age at withdrawal. B) Roth IRAs are not subject to the minimum distribution rules until the death of the owner-participant of the plan. C) Like traditional IRAs, Roth contribution eligibility is restricted by active participation in an employer's retirement plan. D) Unlike traditional IRAs, Roth IRA contributions may not be made after the participant attains age 73.

B Unlike the traditional IRA, Roth IRAs are not subject to the minimum distribution rules upon the participant attaining age 73. Rather, distributions need not be made until the death of the owner/participant. For a Roth IRA withdrawal to be entirely tax free, it must be made after a five-year holding period and after the participant reaches age 59½. Like traditional IRAs, contributions may be made at any ages (as long as there is earned income). Roth eligibility is restricted by adjusted gross income, not participation in an employer-sponsored plan. Under the SECURE Act, there is no longer an age limitation for contributions to any retirement plan. LO 18.a

The Investment Advisers Act of 1940 would consider each of the following investment advisers to be exempt from registration except A) an adviser whose only clients are insurance companies. B) an adviser who maintains an office in only one state, advises only residents of that state (none of whom is a private fund), and gives advice relating solely to securities not traded on any national exchange. C) an adviser whose only clients are banks. D) an adviser whose only clients are venture capital funds.

C Advising only banks does not qualify one for the exemption. Advisers who only service insurance companies or venture capital funds are exempt, as are advisers performing intrastate who do not give advice to private funds or on listed securities. LO 9.c

Which of the following is not included in Form ADV Part 2A? A) Types of investments made by the adviser B) Investment policy of the adviser C) States in which the investment adviser is registered or intends to register D) A description of how the adviser is compensated

C Form ADV Part 2A is the brochure that investment advisers must deliver to clients; it describes the investment adviser's fees, investment policies, and types of investments made. The states in which the adviser is registered or intends to be registered are not contained in Form ADV Part 2A. If the investment adviser is registering with the SEC, on Part 1A, it lists only the largest five offices (in terms of numbers of employees). If state-registered, it lists each state it will be registering in or is already registered in. LO 9.e

An Administrator may suspend the registration of a broker-dealer if the broker-dealer has: I) liabilities that exceed assets. II) an officer who has been recently convicted of committing fraud. III) terminated all agents without cause. A) I and III. B) I, II and III. C) I and II. D) II and III.

C If an investigation determines that a firm is insolvent or an officer or partner has been convicted of a felony, the Administrator may suspend or revoke the firm's registration. Termination of agents is a decision in the hands of the employer. LO 12.c

A third-party post has been made on a broker-dealer's Facebook page. If the firm has involved itself in the preparation of the content, this would be known as A) replacement. B) misrepresentation. C) entanglement. D) disgorgement.

C The entanglement theory means the firm is or its personnel are entangled with the preparation of the third-party post. A similar concept is that of adoption. This is when the broker-dealer explicitly or implicitly endorsed or approved the content posted by the third party. LO 13.h

Which of the following statements about the federal government's fiscal policy are true? I) The federal government's fiscal policy is its policy for managing taxation, spending, and debts. II) The federal government's fiscal policy can have a great impact on the securities markets. III) The federal government finances its deficit spending by selling bonds. A) I and III B) I and II C) I, II, and III D) II and III

C The federal government's fiscal policy establishes the government's taxation, spending, and debt practices. Fiscal policy can affect the securities markets because it can be used to regulate prices, employment, and economic growth. If fiscal policy includes deficit spending, the government sells bonds to make up the deficit. LO 6.c

Which of the following factors has an inverse relationship to a bond's duration? A) Time to maturity B) Par value C) Yield to maturity D) Rating

C Yield to maturity has an inverse relationship to duration. That is, the higher the YTM, the lower (shorter) the duration. The longer the time to maturity, the higher (longer) the duration; it is a direct relationship. The bond's rating and par value are irrelevant. LO 20.b

Jasper Quartermaine is interested in using the options market to create "insurance" against a severe drop in the value of a stock portfolio that he owns. How could he best accomplish this goal and what is this type of strategy called? Type of option/ Strategy A) Buy call options/ Protective call B) Write call options/ Protective call C) Write call options/ Covered call D) Buy put options/ Protective put

D An investor who is long securities can obtain portfolio insurance by purchasing put options. Losses in the underlying portfolio are offset by gains in the put position. This is known as a protective put strategy. Buying calls would be "insurance" when having a short position and would be considered protective calls. Writing covered calls provides downside protection to the extent of the premium received, but if you want real insurance, you have to buy it. LO 21.k

If an investor received a lump-sum distribution from a 401(k) plan when he left his job, he may I) roll over his account into an IRA within 60 days II) transfer his account without taking possession of the money III) keep the funds and pay ordinary income tax IV) invest in a tax-exempt municipal bond fund to avoid paying tax A) III and IV B) I and II C) II and IV D) I and III

D Because the client has already received the lump sum, he may either roll the money into an IRA account within 60 days, or retain the money and pay income tax (and possibly a penalty) on it. Any amount the client does not roll over will be taxed as income, even if invested in tax-exempt bonds. A direct custodian-to-custodian transfer is not permitted because the client has already received the distribution. LO 18.f

A customer is interested in an exchange-traded fund (ETF). With regard to the trading of ETFs, the customer should be aware of which of these? I) ETFs can be purchased throughout the trading day. II) ETFs use forward pricing, as all mutual funds do. III) Real-time quotes are available for ETFs. IV) The NAV calculated at the end of the day, plus a sales charge, will equal the trading price. A) I and IV B) II and III C) II and IV D) I and III

D ETFs can be traded throughout the trading day. Changing price quotes are available in real time as investors buy and sell. Although ETFs have a NAV that is calculated on the basis of the portfolio holdings, the trading price is determined by supply and demand in the open market, with customers paying commissions. LO 3.g

You are an agent for a fully licensed broker-dealer, and one of your clients is the chairman of a drug company who tells you that the government will shortly disapprove a patent for a new drug. According to the Uniform Securities Act, you should A) sell the company's shares short for your discretionary customer accounts B) contact the SEC because you have inside information C) tell your best customers to sell their holdings of the corporation immediately D) promptly inform your supervisor

D If you receive inside information, you should inform your supervisor immediately so that he may take the appropriate steps to avoid any transaction that may be construed to violate the Uniform Securities Act. An agent cannot lawfully trade on inside information and is not obligated to inform the SEC. LO 14.k

Although generally prohibited, there are conditions under which a state-registered investment adviser is permitted to charge performance-based fees. Which of the following meets the necessary criteria? A) Charging a performance-based fee to an aggressive entrepreneur whose net worth, excluding the equity in the principal residence, is $1.8 million and who has $500,000 under the adviser's management B) Charging a performance-based fee to an individual with a qualifying net worth in excess of $10 million without describing that there is an incentive for the adviser to take greater risks C) Charging a performance-based fee to an individual who meets the definition of an accredited investor D) Charging a performance-based fee to an elderly client whose net worth, excluding the equity in the principal residence, is $2.3 million, with only $150,000 under the adviser's management

D Performance fees may be charged, regardless of the client's age, to anyone with a qualifying net worth in excess of $2.2 million or with at least $1.1 million under management with the firm. This client with $2.3 million, exclusive of the equity in the principal residence, in net worth meets the qualification. An individual reaches accredited investor status with a qualifying net worth of at least $1 million, not enough to qualify. Additionally, one way in which the states differ from federal law is the requirement to disclose the incentive to take greater risks.

Registration statements for securities A) expire on December 31 of each year and must be renewed if further sales are to be continued. B) need not be filed with the Administrator if the securities are only sold in one state. C) are effective for at least two years from their effective dates, or longer if the securities are still under distribution by the underwriters. D) may be amended after their effective dates as to the amount of securities issued, provided that underwriting fees and the initial offering price have not changed.

D Registration of securities under the USA may be amended after their effective dates as to the amount of securities issued, provided that underwriting fees and initial offering prices have not changed. Securities registration statements remain effective for one year from their effective date and do not expire on December 31 of each year. Registration statements are effective for one year from their effective dates (or longer if the securities are still under distribution by the underwriters). LO 8.g

During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share (EPS) have increased from $2.00 to $2.50 per share, and their dividend payout ratio has decreased from 50% to 40%. Based on this information, the current yield on Kapco common stock is A) 2.13%. B) 6.34%. C) 4.26%. D) 2.00%.

D The current yield on a stock is computed by dividing the annual dividend rate by the current market price. With EPS of $2.50 and a 40% payout ratio, the annual dividend is $1.00. This dollar divided by the current market price of $50.00 results in a current return of 2%. LO 2.e

Which of the following are subject to the holding period requirements of Rule 144 of the Securities Exchange Act of 1934? I) Registered securities held by a control person II) Unregistered securities held by a noncontrol person III) Registered securities held by a noncontrol person IV) Unregistered securities held by a control person A) I and IV B) II and III C) I and III D) II and IV

D The holding period requirement of Rule 144 applies to unregistered securities, no matter who the owner is. LO 1.e

Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of his state, his total tax-equivalent yield would be A) 4.00%. B) slightly less than 5.33%. C) approximately 12.90%. D) slightly more than 5.33%.

D When an individual owns a municipal bond issued in his state of residence, not only is the interest tax free on a federal basis but (at least in all cases on the exam) also it is nontaxed in that state. Therefore, the tax-equivalent yield here is slightly higher than it would be if we only computed using the federal tax rate. Because that would be 4.0% divided by 0.75 (100% minus the 25% tax bracket) or 5.33%, saving on state income taxes would increase the yield slightly. LO 2.h

All of the following would be reasons for an employer to choose a nonqualified plan over a qualified plan except A) the nonqualified plan is not subject to ERISA reporting and disclosure requirements. B) the nonqualified plan provides an immediate income tax deduction for the employer. C) the nonqualified plan provides greater flexibility. D) the nonqualified plan can discriminate in favor of highly-compensated employees.

B The answer is the nonqualified plan provides an immediate income tax deduction for the employer. Nonqualified plans do not provide a tax deduction to the employer until the employee receives the economic benefit as income at some point in the future. They are, however, more flexible because they do not have to comply with ERISA reporting and non-discrimination requirements. LO 18.e

Pontourny Advisory and Investment Services (PAIS) is a federal covered investment adviser. Its principal office is in State X. PAIS also maintains branch offices in States Y and Z. Brenda is the manager of the branch office in State Y. Some of the individuals being supervised by Brenda have clients in States X and Y, and others have clients in States Y and Z. Brenda must register as an IAR in A) States X and Y. B) State Y. C) States Y and Z. D) States X, Y, and Z.

B Those who supervise the activities of investment adviser representatives (IARs) are themselves defined as IARs. An IAR representing a federal covered investment adviser need only register in the state or states in which she (the IAR) has a place of business. There is nothing in this question to suggest that Brenda has a place of business anywhere other than in State Y, where her branch office is located. Remember, when it comes to federal covered advisers, registration of their IARs is dependent on the IAR's place of business, not the location of their clients. LO 10.b

Under the Investment Company Act of 1940, which of the following statements about advisory contracts between an investment company and an outside adviser is true? A) The contract may not be unilaterally assigned to another adviser. B) The initial contract is effective once approved by the board of directors. C) The contract must be established for a one-year period and renewed annually thereafter. D) The contract may be in writing, or it may be oral if there are at least two witnesses to the agreement.

A All contracts between an investment company and an outside adviser must be in writing and must contain certain provisions; these include that the contract may not be unilaterally assigned to another adviser. The initial contract may be for two years, but it is subject to annual renewal by a majority vote of the outstanding shares or the board of directors, as well as a majority of the directors who are considered to be noninterested parties. LO 3.a

A corporate bond that pays interest semiannually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%. What is the value of the bond today if the coupon rate is 8%? A) $1,051.23 B) $922.78 C) $1,221.17 D) $1,144.31

B USE YOUR BRAIN How did we calculate that? We used a tool that you won't have available at the test center (a financial calculator), but there is a great tool you will have—common sense. When a bond has a yield to maturity that is greater than its coupon rate, the bond must be selling at a discount, and that only leaves one possible answer. The only way to get a 10% return on an 8% bond is to buy it at a price below par. LO 2.e

If a corporation issues mortgage bonds, all of the following would be affected except A) total assets. B) shareholders' equity. C) total liabilities. D) working capital.

B When issued, the corporation receives the net proceeds in cash, increasing current assets (and thus total assets). Simultaneously, the corporation's long-term liabilities increase, reflecting the debt (and thus total liabilities). Working capital increases because of the increase in current assets. Shareholders' equity, or net worth, is only affected by the sale of new equity securities or by any profit or loss generated by the corporation. LO 7.b

John owns a nonqualified, tax-deferred annuity. When he retires, what will be the tax consequences of his annuity payments? A) His annuity payments are partly taxable as capital gain and partly taxable as ordinary income. B) His annuity payments are all taxable as ordinary income. C) His annuity payments are partly taxable and partly tax-free return of capital. D) His annuity payments are tax free.

C The key word here is nonqualified! The investment John made was with after-tax dollars, the money grows tax-deferred, and only the earnings are taxed at distribution. A computation will be made at John's retirement called the exclusion ratio to determine how much of each retirement payment will be treated as a return of cost basis and how much as taxable ordinary income. No annuity payment is ever treated as a distribution of capital gains. LO 24.e

A manager of a venture capital fund would be most interested in investing in A) a well-established company going through management changes. B) a company interested in going private. C) a young, promising company. D) a company listed on a major stock exchange.

C Venture capitalists prefer to get involved in the earlier stages of a company's development. This would certainly not be a company listed, nor would it be likely that the company is already publicly traded. LO 3.d

Mark is a client of Gibraltar Investment Advisers. Gibraltar sells its investment advisory business to Alpha Advisers. Which of the following best describes Mark's relationship to Alpha? A) Mark is automatically a client of Alpha. B) Mark may not become a client of Alpha. C) The investment advisory contract Mark made with Gibraltar continues with Alpha. D) Mark may become a client of Alpha if he chooses to do so.

D An investment advisory relationship may not be assigned without the consent of the client. The client may choose to enter into a contract with the new firm. The contract with the old firm becomes void when it sells its business. LO 13.e

This is the performance of your portfolio over the previous 4 years: I) Year 1 - 10% II) Year 2 - 45% III) Year 3 + 20% IV) Year 4 + 35% n order for the portfolio to be equal to the starting investment, the return in Year 5 must be nearest to A) 20%. B) 0%. C) 33%. D) 25%.

D Suppose the initial value of your portfolio is $1,000. In Year 1, you lose 10%. Your portfolio is now worth $1,000 x (1 - 0.1) = $1,000 x 0.9 = $900. In Year 2, you lose 45%. Your portfolio is now worth $900 x (1 - 0.45) = $900 x 0.55 = $495. In Year 3, you gain 20%. Your portfolio is now worth $495 x (1 + 0.2) = $495 x 1.2 = $594. In Year 4, you gain 35%. Your portfolio is now worth $594 x (1 + 0.35) = $594 x 1.35 = $801.9. You would like to know by how much your portfolio needs to appreciate in Year 5 to be worth its original value of $1,000. Let's set "y" to be this number. Then we have: $801.9 x (1 + y) = $1,000. Solving this equation for "y" gives: y = ($1,000 ÷ $801.9) - 1 = 0.247 = 24.7%. Rounding this answer in percentage terms (24.7%) to the nearest integer yields the desired answer of 25%. Your portfolio thus needs to increase by nearly 25% in Year 5 for it to be worth its original value of $1,000. Some might find it easier to look at the shortfall ($1,000 - $801.90) = $198.10. Divide that by the current value and you have 198.10 ÷ 801.90 = 24.7%. Some might just look at the number and recognize that you are about $200 short on a value of $800 and that is 25%. LO 22.a

Adell, a retiring social worker, has some money to invest. An agent suggests she look into investing in a private placement security that is raising money to build apartment buildings in Puerto Rico. According to the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, which of these are true? I) Building projects are not appropriate for retirees who typically need immediate income. II) Private placements are not usually appropriate for retiring individuals because they are not liquid. III) No rule has been violated because the customer has only been offered the product. IV) If the customer lives in Puerto Rico, the proposed investment may be suitable because there may be a ready market. A) I and II B) II and IV C) I and III D) II and III

A This is not a suitable recommendation for a social worker about to retire. Based on the information given, one would expect that her objectives would be income with a high degree of safety, yet this building project will give her neither. Additionally, the private placement suffers from a lack of liquidity, something that could be an important factor in Adell's future. LO 14.g

It would be considered a prohibited activity for an agent to engage in any of the following activities except A) sharing in profits of an account as a reward for the agent's recommendations exceeding the S&P 500. B) executing a transaction in a nonexempt security in a discretionary account. C) trading in the account of a conservative client exclusively in initial public offerings with proper trading authorization from the client. D) failing to record exempt transactions on the broker-dealer's books and records.

B Once a discretionary account has been properly documented, the agent handling the account can trade exempt and nonexempt securities. Nothing in this answer choice implies that the nonexempt security is unregistered. All transactions, no matter in exempt or nonexempt securities, must be recorded on the books of the broker-dealer. As a rule, initial public offerings tend to be on the speculative side, suitable for aggressive, not conservative, investors. Therefore, even with the client's authorization, this trading profile would be unsuitable and, as a result, a prohibited activity. Sharing in profits of an account as a reward for exceeding the S&P 500 (or any other benchmark) is prohibited under any circumstance. This is not the same as sharing in the profits of an account with consent of the client and the employing broker-dealer, because this is based on the performance of the agent's recommendations and not on a mutually agreed-upon sharing arrangement.​ LO 14.g

An investment adviser new to the business is engaged by an elderly client who, on the grounds of privacy, refuses to disclose his annual income or net worth. The client merely asks the adviser to establish and manage a $50,000 portfolio. If the client brings a cashier's check for $50,000 to the initial meeting, which choice reflects the best action on the part of the adviser? A) Accept the client but acknowledge in writing the client's refusal to provide financial information. B) Decline the client, recognizing that you cannot effectively determine suitability in the absence of financial information. C) Accept the client but only allocate his funds to money market-type securities. D) Decline the client because he is difficult to work with.

A The first step in finding the NPV is to compute the present value (PV). The PV is computed by taking the future cash flows and discounting them by a "discount" rate. That rate is the current market interest rate. So, if NPV is based on PV and PV assumes reinvestment at the discount rate, that assumption must hold true for figuring NPV. In the case of the IRR, that is the yield to maturity of a bond and assumes that the cash flows are reinvested at that IRR. For example, a bond with a YTM of 7% assumes that all reinvestments will be made at that 7% rate. The periodic cash flow on a bond comes from the semiannual interest payments making reinvestments semiannually, not annually. LO 20.a

Walter and Wanda Willingham are new client's. While reviewing their holdings, you notice an account at a local bank titled, "Walter Willingham, in Trust for Walter Willingham, Jr." The account provides that, upon Walter's death, the assets in the account will pass to his son. This is an example of A) an account opened JTWROS. B) a testamentary trust. C) a Totten trust. D) an UTMA account.

C A Totten trust is an informal trust that is set up as a bank account. The person who sets up the Totten account is the trustee of the account and can name any person as the beneficiary of the account. Upon the death of the trustee, the money will immediately be made available to the named beneficiary. LO 16.f

Which of the following statements concerning the books and records of a state-registered investment adviser under the Uniform Securities Act is true? I) Books and records must be maintained in the principal office of the adviser for the first two years. II) Books and records must be maintained in an easily accessible place for no less than five years from the end of the last fiscal year in which an entry was made. III) Copies of all investment letters, advertisements, or communications to two or more persons must be preserved for five years from the end of the fiscal year of the publication date. IV) An adviser who ceases business continues to be responsible for the maintenance and preservation of certain records, such as corporate charters and minute books, for three years after termination of the enterprise. A) I, II, and III B) I, II, III, and IV C) II only D) I only

B All books and records required to be maintained by actively registered investment advisers—including investment letters, advertisements, or other communications to 2 or more persons (10 if the question dealt with federal law)—must be preserved in a readily accessible place for five years from the end of the fiscal year in which they were created or communicated. For the first two years, they must be maintained in the appropriate office of the adviser. The adviser remains responsible for the preservation of certain records, such as corporate charters and minute books or partnership agreements if operated in that business form, for three years after ceasing business. LO 9.g

Which of the following is not defined as a security under the Uniform Securities Act? A) An investment in a managed pool of rental condominiums B) A Roth IRA C) Unsecured debentures sold in a private placement only to accredited investors D) Bills, notes, and bonds issued by the U.S. Treasury

B An investment in an individual condominium used as a residence is not a security. However, an interest in the rental income from a group of condos, where the rent is pooled, is a security under the USA. While the sale of the debentures in this case is an exempt transaction, the debentures are securities. Treasury bills, notes, and bonds are securities, although they are exempt from registration under the USA. A Roth IRA is not a security. Securities may be put in an IRA, but the IRA is not a security. The key to questions like this is to remember those things that are not securities. LO 8.a

An investment adviser representative has a 78-year-old prospect living on $26,400 per year from Social Security plus investment income. The individual's net worth is $141, 000 including the equity in her primary residence. Her net worth was higher until recently, but the aggressive fund she owns in the KAPCO family of funds is down over $20,000 in value. Which of the following would you recommend to her? A) Liquidate the fund shares and put the proceeds in a bank CD B) Switch to a more conservative fund in the same family of funds C) Sell her fund shares and reinvest in a vehicle offering her deferred accumulation D) Invest in a municipal bond fund

B Clearly the municipal bond fund is inappropriate because this client's income does not put her into one of the higher tax brackets where the tax exemption on the bond's interest is beneficial. Just as obvious is the poor choice of moving her assets to a deferred accumulation vehicle, such as an annuity, where there would probably be surrender charges and no income. That leaves using the exchange privilege where she can move her investment to a more conservative fund without paying a sales charge or buying a bank CD. Because this is an exam for representatives of an investment adviser and one of the requirements to be defined as an investment adviser is that advice be given on securities, the answer on the exam should be a security (bank CDs are not securities). LO 17.d

Which of the following is not included in the definition of broker-dealer as found in the Uniform Securities Act? A) Investment advisers B) Banks C) Credit unions D) Attorneys

B In the Uniform Securities Act, it specifically states: "Broker-dealer" means any person engaged in the business of effecting transactions in securities for the account of others or for his own account. "Broker-dealer" does not include (1) an agent, (2) an issuer, (3) a bank, savings institution, or trust company. Attorneys are excluded from the definition of investment adviser, as long as their advice is incidental to their legal practice, but that exclusion does not apply to the term "broker-dealer". Even though credit unions engage in banking activity, they are not included in the exclusion. Being an investment adviser does not exclude a person from the need to register as a broker-dealer if that person is performing the functions of a BD. LO 11.b

Which of the following accurately describes a cease and desist order as authorized by the USA? A) An order from one brokerage firm to another brokerage firm to refrain from unfair business practices B) An order issued by a federal agency to a brokerage firm to stop an advertising campaign C) An order by the Administrator to refrain from a practice of business believed by that Administrator to be unfair D) An order issued by a court of competent jurisdiction in the state requiring a business to stop an unfair practice

C A cease and desist order is a directive from an administrative agency to immediately stop a particular action. The order can come from a federal, state, or judicial body; it is not exclusive to any single body. However, because this question is referring to the Uniform Securities Act, we focus on the actions of the Administrator, not a federal agency. Administrators may issue cease and desist orders with or without a hearing. Courts issue injunctions, usually when the cease and desist order is ignored. Brokerage houses cannot issue cease and desist orders to each other. LO 12.b

ADRs are used to facilitate A) the domestic trading of foreign securities. B) the foreign trading of U.S. government securities. C) the domestic trading of U.S. government securities. D) the foreign trading of domestic securities.

A An ADR is a negotiable security that represents an ownership interest in a non-U.S. company. Because they trade in the U.S. marketplace, ADRs allow investors convenient access to foreign securities. LO 1.f

Under the Uniform Securities Act, an example of a nonissuer transaction is A) the purchase and sale of shares of common stock on the NYSE. B) a Regulation D private placement sale of limited partnership interests. C) an initial public offering of common or preferred stock. D) the issuance of mutual fund shares.

A In a nonissuer transaction, the proceeds do not flow to the issuer; rather, the proceeds are credited to selling shareholders. A secondary market trade, such as a transaction executed on the floor of an exchange, is a nonissuer transaction. An IPO, the purchase of mutual fund shares, and the purchase of limited partnership interests all benefit the issuer and are called issuer transactions. LO 8.b

As used in the Uniform Securities Act, the term institutional investor would not include A) individuals qualifying as accredited investors. B) savings institutions. C) employee benefit plans with assets of at least $1 million. D) investment companies.

A Institutional investors include banks, savings institutions, insurance and investment companies, and employee benefit plans. Although each of these is included in the term accredited investor, that term, as used in federal law (the term is not found in the USA), also includes certain individuals, and they would never be considered institutional investors under the USA. LO 8.d

A registration of an investment adviser representative can be denied or revoked if it is in the public interest and which of these is true? I) The registrant failed to include the fact that he had been convicted of a non-securities-related misdemeanor within the last two years. II) The registrant has willfully violated the securities laws of a foreign jurisdiction. III) The registrant is qualified on the basis of knowledge and training but lacks experience. IV) The registrant has engaged in dishonest or unethical practices in the securities business. A) II and IV B) II and III C) III and IV D) I and II

A Just cause for denial, suspension, or revocation of an IAR's license would include engaging in dishonest or unethical practices in the securities business and willfully violating the securities laws of a foreign jurisdiction. Failure to include convictions for a securities-related misdemeanor (or any felony) constitutes filing an incomplete or misleading application, and that too would be just cause for taking action. Don't confuse this with the 10-year rule. These convictions must always be disclosed; 10 years is the time period during which it is almost a sure thing that the application will be denied. An Administrator may not deny a registration solely on the basis of lack of experience. LO 12.c

Rule 144 applies to the sale of all of the following except A) registered securities by a minority shareholder of the issuer. B) registered securities by an officer of the issuer. C) unregistered securities by an officer of the issuer. D) unregistered securities by a minority shareholder of the issuer.

A Rule 144 applies to the sale of unregistered securities owned by affiliates or nonaffiliates and the sale of control stock. It does not apply to the sale of registered securities by nonaffiliated persons. LO 1.e

Which of the following is not a market cap-weighted index? A) Dow Jones Industrial Average B) S&P 500 C) FTSE 100 and FTSE All-Share D) Morgan Stanley Capital International

A The Dow Jones Industrial Average is a price-weighted index. All other options are market cap-weighted indexes. LO 22.b

Which of the following bonds would most likely be exposed to the greatest amount of interest rate risk? A) ABC 5s of 2045 B) GHI 7s of 2047 C) DEF 6s of 2046 D) JKL 4s of 2025

A The bond with the longest duration is generally going to have the greatest exposure to interest rate risk. Because there is very little difference between maturity dates of 2045 through 2047, the bond with the lowest coupon will have the longest duration. The 4s of 2025 have a relatively short duration, even though their coupon is low. LO 20.b

Which form of the efficient market hypothesis (EMH) suggests that fundamental analysis and insider information may produce above-market returns? A) Weak B) Strong C) Semi-strong D) Semi-weak

A The weak form holds that current stock prices reflect all historical market data and that historical price trends are therefore of no value in predicting future prices. However, this form holds that credible fundamental analysis and insider information may produce above-market returns. Those who truly believe in the EMH are of the opinion that none of these will do any better than the market; random selection is as good as anything else. LO 21.i

Strategic Capital Asset Managers (SCAM) is an investment adviser registered with the SEC. Registration as an investment adviser representative would be required of an employee who A) provides recommendations on securities to the firm's bank clients. B) cleans the office on weekends. C) presents seminars on the benefits of whole life insurance. D) supervises the activities of clerical staff who file individual clients' transaction reports.

A Unless subject to an exemption, any employee of an investment adviser (SEC or state registered) who makes recommendations of securities, regardless of the client, must register as an IAR. Supervisors only need to register when those they supervise are IARs, and clerical staff members are generally exempt from registration. Someone who presents a seminar on a nonsecurities product is not an IAR (although the individual would probably need an insurance license). LO 10.b

Covered call writing is a strategy where an investor A) sells a call on an index that contains some of the securities that he has in his portfolio. B) sells a call on a security he owns to reduce the volatility of the stock's returns and to generate income with the premium. C) buys two calls on the same security he owns to leverage the position. D) buys a call on a security he has sold short.

B A covered call is simply defined as an investor owning 100 shares of the underlying stock for each option written (sold). The premium received is not only a source of income but also serves to provide downside protection to the extent of the amount received. LO 4.b

A client has invested $25,000 into a variable annuity which has grown to $150,000 over the accumulation period. At age 60, the account is liquidated. The tax treatment of the withdrawal would be A) partly ordinary income and partly capital gains depending on the length of time the variable annuity was in force. B) ordinary income tax on $125,000. C) ordinary income tax on $125,000 with a 10% tax penalty. D) capital gains tax on $125,000.

B Any increase in the value of a variable annuity is taxed as ordinary income, never capital gain. In this case, there is no 10% penalty tax because the client is over 59½ years old. On the exam, all annuities are non-qualified unless the question says it is qualified or there is a clue, such as being part of a 403(b) plan. LO 24.e

Your married client has an AGI of $105,000 per year and is covered by his employer's defined benefit pension plan. When inquiring about opening a Roth IRA, you would respond that A) one cannot be a participant in a qualified plan and a Roth IRA at the same time B) the client could open the Roth IRA without any restriction C) the client could open a Roth but, depending on future earnings, might not be able to deduct all of the annual contribution D) the client's earnings exceed the Roth limits so the plan could not be opened

B As long as a married couple's AGI does not exceed 208,000 (for 2021), a Roth IRA can be opened without any restrictions. Contributions are never deductible. LO 18.a

One reason for including commodities in an investment portfolio is because they have a high correlation to A) the U.S. dollar. B) the inflation rate. C) the bond market. D) the stock market.

B Commodity prices tend to have a high correlation with the inflation rate. As inflation goes up, the value of the dollar generally falls. The relationship is inverse, a characteristic of negative correlation. As inflation increases, interest rates invariably do the same, leading to a decrease in bond prices. Stock prices have a random correlation to commodities—generally negative. LO 5.g

The final responsibility for ensuring that investment adviser representatives are adequately supervised is that of A) the managing principal. B) the chief compliance officer. C) the Administrator. D) each investment adviser representative's immediate supervisor.

B It is the CCO who has the ultimate responsibility for ensuring that the firm has, and properly implements, adequate supervisory procedures. The immediate supervisor has the "first-line" responsibility, but the "buck stops" with the CCO. LO 9.h

Broker-dealers provide a bid and offer price when functioning as market makers. In this context, A) the bid price represents market maker's selling price and the offer price is the price the market maker is willing to pay for the stock. B) the bid price represents the price the market maker is willing to pay for the stock and the offer price is the market maker's selling price. C) the bid and offer prices refer to the market maker's buying and selling prices including commissions. D) the bid and offer price refer to the price the market maker is willing to pay for the stock.

B Marker makers provide a two-sided quote. Because market makers stand ready to buy and sell the specific security, they provide a bid price, the price the firm is willing to pay for the stock, and the offer price, the price they are asking to receive when selling the stock. Market makers do not earn a commission; they charge a markup or markdown. LO 23.e

An issuer of federal covered securities, whose registration is effective under the Securities Act of 1933, would use which of the following procedures to permit sales of its securities in a specific state? A) Qualification B) Notice filing C) Coordination D) Registration

B Notice filing is the procedure by which federal covered securities, most commonly registered investment company securities, receive clearance for their securities to be sold in a specific state. No formal registration is required, but payment of fees and filing of certain documents may be. LO 8.g

Which of the following insurance company products is likely to have the longest time for which a surrender charge will be levied? A) Whole life insurance B) Bonus annuity C) Class B shares D) Variable annuity

B One of the characteristics of bonus annuities is that their surrender charges tend to be higher for a longer time than other insurance company products. When you see Class B shares on the exam, it will be referring to mutual funds, not insurance company products. LO 24.d

If a portfolio manager wished to reduce inflation risk, which of the following would be most appropriate to add to the portfolio? A) Preferred stock B) Tangible assets C) Fixed annuities issued by an insurance company with Best's highest rating D) AAA bonds

B Tangible assets, such as real estate, precious metals, and other commodities, tend to keep pace with inflation. Fixed dollar investments do not. LO 21.a

William died in 2019 with the following assets and liabilities: $200,000 in securities left to his wife, $650,000 home left to his wife (the home cost $150,000), $250,000 life insurance policy with his daughter named as beneficiary, and $75,000 in debts and estate expenses. What is William's net estate? A) $0; it is below the $11.4 million exemption equivalent B) $175,000 C) $625,000 D) $750,000

B The question is asking for the net estate, not the amount of estate tax due. The market value of all assets that William has an incident of ownership in will be included in the gross estate. All assets left to the spouse and the debts/expenses are allowable reductions to arrive at the net or taxable estate. The math goes like this. The $1.1 million gross estate (add together the assets ($200,000 + $650,000 + $250,000) is reduced by the $850,000 left to his wife. That brings the net estate down to $250,000 ($1,100,000 minus $850,000). The net estate is further reduced by the $75,000 in debt and expenses. Subtracting $75,000 from $250,000 leaves a net estate of $175,000. That is well below the estate tax exemption of $11.4 million in assets for 2019. LO 16.g

Which of the following bonds has the shortest duration? A bond with A) a 10-year maturity, 6% coupon rate. B) a 10-year maturity, 10% coupon rate. C) a 20-year maturity, 6% coupon rate. D) a 20-year maturity, 10% coupon rate.

B Two factors go into the computation of a bond's duration - the length to maturity and the coupon rate. When the maturities are the same, the bond with the highest coupon has the shortest duration. When the coupons are the same, the bond with the nearest maturity has the shortest duration. The 10% bond maturing in 10 years "wins" on both counts. It has the nearest maturity with the highest coupon. All else being equal, a bond with a longer duration will be more sensitive to changes in interest rates. LO 20.b

Ways in which offerings under Rule 506(c) of Regulation D of the Securities Act of 1933 differ from those under Rule 506(b) include each of these except A) general solicitation is permitted under Rule 506(c) offerings; no advertising is permitted under Rule 506(b). B) securities issued under Rule 506(c) are federal covered, while those under Rule 506(b) are not. C) the issuer must take "reasonable steps" to verify that all purchasers are accredited investors in a 506(c) offering, while no such obligation falls upon issuers in a 506(b) offering. D) all purchasers of the Rule 506(c) securities must be accredited investors as defined in Rule 501, whereas Rule 506(b) permits a limited number of sophisticated but not accredited investors.

B Under the NSMIA, any security issued under the federal transaction exemption offered under Rule 506, either (b) or (c), is considered a federal covered security. Rule 506(c) permits advertising (general solicitation) but requires that the issuer take reasonable steps to ensure all purchasers meet the accredited investor standard. In a Rule 506(b) offering, up to 35 nonaccredited investors are permitted with no limit placed on the number of accredited investors. LO 8.c

Which of the following is not an annuity purchase option? A) Periodic payment deferred annuity B) Periodic payment immediate annuity C) Single premium deferred annuity D) Single premium immediate annuity

B With an immediate annuity, payout begins immediately (generally within 30-60 days). As such, the concept of making purchases while receiving payout is illogical and is, therefore, not permitted as an option. LO 24.d

Many fixed-income investors are looking to avoid loss of principal. Which of the following would likely have the lowest degree of exposure to credit risk? A) A-rated general obligation municipal bond B) Aa-rated corporate debenture C) Baa-rated municipal revenue bond D) Ba-rated corporate mortgage bond

B look for the highest rating - nothing else A bond's rating takes into consideration all factors, including collateral and tax base. The higher the rating, the lower the credit risk. LO 2.b

An agent may open a joint account for which of the following? I) Lee and his 13-year-old son, Tom II) Mary and Kelley, 2 adult college roommates III) Jerry and Mark, friends and partners in business for more than 20 years IV) Melinda and her minor nephew, John, for whom she is guardian A) I and III B) I and IV C) II and III D) II and IV

C Joint account owners share ownership of the account and must be adults. A minor may not legally exercise control over an account and may not be an owner of record of an account. Remember that a joint account is owned by 2 or more persons and, under both state and federal law, a minor is not a person. LO 16.a

If a customer is in the 15% federal income tax bracket and his main investment objective is current income, which of the following securities should the agent recommend? A) City of Milwaukee GO bond. B) U.S. government bond. C) Investment-grade corporate bond. D) Zero-coupon bond.

C The investor is in a low tax bracket, so the tax-exempt municipal bond is not a suitable investment. To maximize income, the best recommendation is the corporate bond which offers a higher yield than a government bond with a similar maturity. LO 17.d

An investor originally purchased a debt security at par value. Unfortunately, the value has fallen to $920, even though the company has reported record earnings. This decline in value would be representative of what type of risk? A) Timing risk B) Credit risk C) Interest rate risk D) Purchasing power risk

C This decline in value is most likely due to interest rate risk, which indicates that as prevailing interest rates rise, the price of existing debt instruments declines. Purchasing power risk is essentially synonymous with inflation risk, and credit risk is the danger that the issuer may default on its debt service, something that seems unlikely considering the recent earnings reports. LO 19.a

Purchasers of options can have a number of different objectives. One of your clients who is a soft-drink fan already has a long position in KO. What would be a possible reason for this client to go long a KO call option? A) Owning a long call on stock you already own offers a hedge against a market decline. B) This would generate additional income. C) It fixes the cost of acquiring additional stock for the portfolio. D) It completes the other side of a spread.

C Those who are bullish on a stock but don't have sufficient funds at this time to purchase the stock can lock in their future cost by going long a call. Income is generated only through selling options. Because a long call is on the same side of the market as long stock, there is no hedge. A spread involves a long and short option. LO 4.b

According to the Investment Advisers Act of 1940, which of the following statements regarding Part 2 of Form ADV are true? I) It must be filed with the state Administrator. II) A balance sheet must be submitted if the adviser collects prepaid fees of more than $1,200, six or more months in advance. III) Certain minimum business and education qualifications must be met before an investment adviser can file. IV) It may be used to satisfy the brochure requirements of the act. A) I, II, and III B) I, II, and IV C) I and IV D)II and IV

D An investment adviser required to register with the SEC under the Investment Advisers Act of 1940 must submit its Form ADV to the SEC. In some cases, the Form ADV will also be filed with the state Administrator, but that is state law, not a federal requirement. A balance sheet must be submitted with Part 2 if the adviser receives "substantial" prepayments of fees. Part 2 may be used as an investment adviser's disclosure brochure to clients. LO 9.e

An exemption from state registration is granted under the specific authority of the Uniform Securities Act to securities issued by which of the following entities? I) State of Georgia II) City of London, Ontario III) City of London, England IV) Kapco Income Fund, an open-end investment company registered with the SEC A) I, II, and IV B) I, II, III, and IV C) I, II, and III D) I and II

D Any state, Canadian province, or political subdivision thereof is considered an issuer of exempt securities. The exemption also applies to securities issued by foreign governments with whom the United States has diplomatic relations—but not their political subdivisions, such as the City of London, England. Although securities issued by investment companies registered with the SEC are exempt from state registration, the authority for that exemption is found in the NSMIA of 1996 (federal covered securities) rather than the Uniform Securities Act. LO 8.c

Which of the following is generally believed to present a more accurate picture of a portfolio manager's performance? A) Dollar-weighted return B) Net present value C) Real rate of return D) Time-weighted return

D Because contributions and withdrawals by the investor are not under the control of the fund manager, time-weighted return is a more reliable measure of a portfolio manager's performance. Dollar-weighted is a more reliable measure of how the investor fared. Real rate of return and net present value are not relevant to this question. LO 22.a

Each of these would be considered an advantage of using a 529 plan rather than a Coverdell ESA to fund a child's future education except A) the 529 plan allows for higher contribution levels. B) the 529 plan has no age limits. C) the 529 plan has no earnings limitation on the donor. D) the 529 plan is counted at a lower percentage of assets when applying for financial aid.

D Funds in both plans are counted as assets of parents at 5.64% if owner is a parent or dependent student, so there is no difference. The 529 plan allows for far greater contribution levels and there is no income limitation on the donor as exists with the Coverdell ESA. The funds in the ESA must be used by the time the beneficiary is 30; no such age restrictions apply to the 529 plan. LO 18.h

The separate account subaccounts chosen by the purchaser of a variable life insurance policy have had outstanding performance over the past 15 years. There would generally be no tax implications in which of the following situations? A) The policy is surrendered B) The death benefit is paid C) There is a cash withdrawal in excess of the cost basis D) A loan is taken equal to 95% of the policy's cash value

D Funds obtained from a policy loan are not considered taxable income (same as any loan - you owe the money). If the amount received at policy surrender is greater than the cost basis, the excess is taxed as ordinary income. The same is true with the withdrawal. Although the death benefit will always be free of income tax, it could be subject to estate tax. LO 16.e

When a customer wants income from an annuity and chooses the option of life with 20-year period certain, how will distributions be taxed? A) As ordinary income based on LIFO accounting B) As capital gains based on an exclusion ratio C) As capital gains based on LIFO accounting D) As ordinary income based on an exclusion ratio

D Life with 20-year period certain is an annuitization option. When an annuity is annuitized, ordinary income taxes are paid based on an exclusion ratio (cost basis divided by expected return = how much of the distribution is a return of cost basis (the original principal invested), and not subject to income taxes). Testing note: Unless the question specifically mentions that the annuity is qualified, or gives you a clue, such as it is in a 403(b) plan, the annuity is always nonqualified. LO 24.e

An investment adviser representative of a federal covered investment adviser registers with A) NASAA. B) the SEC. C) FINRA. D) the Administrator.

D Registration of IARs is done solely on the state level. IARs register with the Administrator of each state in which they are required to be registered. LO 10.c

Which of the following acts requires publicly traded corporations to issue annual reports? A) Investment Company Act of 1940 B) Securities Act of 1933 C) Trust Indenture Act of 1939 D) Securities Exchange Act of 1934

D The Securities Exchange Act of 1934 mandates that public issuers file annual and quarterly reports with the SEC. LO 7.e

One measure of a corporation's liquidation value is its book value per share. When performing this computation, the value of which of the following would normally be subtracted from the corporation's net worth? I) Cash II) Wages payable III) Patents IV) Preferred stock A) I and II B) I and IV C) II and III D) III and IV

D The computation of book value per share is basically net tangible worth per share of common stock. Therefore, we subtract both the par value of the preferred stock and the value listed on the balance sheet for the intangible assets, such as patents. LO 20.h

An investor purchases $10,000 of A-rated debentures in early January. At the end of the year, $500 in interest has been received and the value of the investment is $9,500. If the investor is in the 25% tax bracket, the after-tax yield is A) 0.0%. B) -1.25%. C) 5.0%. D) 3.75%.

D The only return (as far as yield is concerned) is the $500 of interest. Subtracting 25% for taxes leaves $375 which, when divided by the $10,000 initial cost, is an after-tax yield of 3.75%. If the question had asked about total return, then the $500 unrealized loss would have been included, although there would have been no tax benefit to it because it is only a "paper" loss. LO 22.a

Your married customers are both 42 years old, have 2 children ages 14 and 12, and have spent the past 10 years accumulating money to provide for their children's education. Their oldest child will enter college in 4 years, and the customers are very cautious investors. If they need a safe investment that provides regular income to help them meet tuition payments, which of the following mutual funds is the most suitable for these customers? A) ABC Stock Index Fund B) RST Balanced Fund C) ATF Overseas Opportunities Fund D) LMN Investment-Grade Bond Fund

D These clients cannot afford a downturn in the stock market between now and the time they want to send their children to college. An investment-grade bond fund will provide the income and safety required for accumulating additional funds for college expenses. LO 17.d

An investor purchases a 30-year zero-coupon corporate bond. The bond was issued by a Fortune 500 company. Her investment is subject to all of the following risks except A) default risk. B) purchasing power risk. C) interest rate risk. D) reinvestment risk.

D Zero-coupon bonds are not subject to reinvestment risk because there is nothing to reinvest. However, they are subject to purchasing power, interest rate, and default risk. LO 2.j

One of your customers has a substantial savings account at the local S&L. The customer has several grandchildren and wants the flexibility of being able to change the beneficiary allocations as their financial conditions change. You should recommend that the customer investigate the use of A) a Totten trust. B) a durable power of attorney (POA). C) a Uniform Transfers to Minors Act (UTMA) account. D) an irrevocable trust.

A A Totten trust allows for the transfer of ownership of a bank account to a beneficiary or beneficiaries after the owner's death. It is the predecessor of today's POD (pay on death) and TOD (transfer on death) accounts. Beneficiary names and/or percentages can be changed at will. An irrevocable trust can't be changed; there is no flexibility. In an UTMA account, once the money is allocated, the decision is irrevocable (and who says the grandchildren are minors). The durable POA gives a designated person the authority to manage the affairs of the account, and this customer wants the control. LO 16.f

Nite Capital Group is a registered broker-dealer whose primary business model is providing quotations for OTC stocks in which they position trade. Nite would be known as A) a market maker B) a specialist C) an investment company D) a secondary market

A A market maker is a firm that stands ready to buy and sell a particular stock on a regular and continuous basis at a publicly quoted price. The term is most often used in the context of the over-the-counter (OTC) markets. Market makers trade for their own inventory (position trade). The term specialist historically referred to the person on the floor of a stock exchange who performed a similar function; the current term is designated market maker (DMM). LO 23.d

A corporation calls in a portion of its long-term debt at 101. This will have the effect of I) decreasing working capital II) increasing working capital III) decreasing net worth IV) increasing net worth A)I and III B) I and IV C) II and III D) II and IV

A Working capital is computed by subtracting current liabilities from current assets. Using a current asset, like cash, to call in the bonds, reduces those assets with no corresponding reduction to current liabilities. Whenever a bond is called at a premium, net worth is reduced by that premium. LO 20.h

An investor goes long one ABC May 45 Put @ 3 and short one ABC May 50 Put @ 6. This would be known as A) a debit spread B)\ a credit spread C) a combination D) a straddle

B A spread option position is a long and short position of the same type of option on the same stock with different strike prices or different expiration dates. In this case, the proceeds of $600 from the short position exceed the $300 cost of the long, giving the investor a credit of $300. LO 4.e

Under all of the following circumstances, the USA requires investment advisers with no place of business in the state to register except A) when an adviser has maintained assets of $100 million or more for 7 out of the last 10 years. B) when an adviser only provides investment advice to 401(k) plans with assets of $250,000 or more. C) when an adviser only provides advice to registered investment companies. D) when an adviser with numerous clients in the state has not been subject to disciplinary action within any state within the last 10 years.

C An adviser that only provides investment advice to investment companies registered under the Investment Company Act of 1940 is federal covered and does not have to register in a state, regardless of whether or not it has a place of business there. An adviser that provides advice only to 401(k) plans or other tax-qualified employee benefit plans with $1 million in assets (not $250,000) is not required to register in a state in which it does not have a place of business. The assets of the adviser is not what determines becoming a federal covered adviser; it is assets under management, and the determining factor is the AUM now, not the range over the previous 10 years. LO 9.b

Which of the following are required to provide a consent to service of process to the Administrator in a state in which registration is sought? I) An agent employed out of state but who seeks registration in a state in which business is conducted II) A federal covered investment company not required to be registered in a state in which business is conducted but required to supply notice filing materials by the state Administrator III) A broker-dealer registered in 14 states that seeks registration in a 15th state IV) An investment adviser with less than $25 million of assets under management who is not covered by federal legislation A) I and III B) II and IV C) I, II, III, and IV D) I, II, and IV

C Every legal or natural person seeking registration or making a notice filing must supply a consent to service of process with their registration applications. For example, a federal covered investment company, while covered under federal law, need not register with the state administrator but must submit notice filing materials that include a consent to service of process. It is investment advisers who can move from state to federal registration when needing to register in 15 or more states, not broker-dealers. LO 9.e

What information is required on an application for registration as an agent? I) The form of business (corporation, partnership, LLC, etc.) II) Felony convictions, whether securities related or not III) A statement of financial condition IV) Citizenship information A) I and II B) III and IV C) I and III D) II and IV

D Applicants for registration as agents must include any felony conviction (misdemeanors are limited to those that are securities related) and a statement of citizenship. Agents can only be individuals, not business entities, and it is only broker-dealers and investment advisers that must submit financial information. LO 11.f

An adviser has custody of a client's securities or funds if the adviser A) maintains the customer's funds and securities in a joint account with the registered investment adviser. B) accepts prepayment of advisory fees or has discretion over a customer's account. C) uses a broker-dealer to hold the customer's funds and securities and has limited trading authority over the account. D) has authority to withdraw funds from a client's account for the benefit of the adviser for the payment of the quarterly advisory fees.

D Custody is the physical possession of the asset. Discretion is the authority to make decisions independent of the authorization of the account holder on a trade-by-trade basis. Authorization is in a blanket form in the existence of either a limited trading authority or full trading authority. Acceptance of prepayment of adviser's fees or discretionary authority does not constitute custody. The ability to withdraw funds for the purpose of paying quarterly advisory fees from a customer's accounts is deemed to be custody of the funds. A broker-dealer holding a customer's funds and securities would have custody, but the adviser who has trading authority over the account would only have discretion. If the funds and securities of the client are held with the funds and securities of the adviser in a joint account, the adviser would be involved in commingling (or theft), not custody. LO 14.e

Which of the following statements referring to renewal of a broker-dealer's registration under the Uniform Securities Act are correct? I) Annual renewal takes place on the anniversary of the registrant's initial registration. II) Each renewal application must be accompanied by the appropriate fee. III) Each renewal application must be accompanied by a consent to service of process signed by an authorized supervisory person of the firm. IV) Registrations expire December 31 unless renewed or canceled. A) II and III B) I and IV C) I and III D) II and IV

D The consent to service of process is filed with the initial application for registration and becomes a permanent part of the registrant's file. The USA states that all registrations of persons expire on December 31 unless renewed, withdrawn, or canceled. LO 11.e