Series 66: Analysis

Years ago, a bond was issued at par with a 7% coupon. This year, new issue bonds of similar credit quality are being issued at 10%. Which statement is TRUE? A. The new bonds will be issued at a premium to the current price of the 7% bonds B. The new bonds will be issued at a discount to the current price of the 7% bonds C. The new bonds will be issued at the same price as the current price of the 7% bonds D. There is no relationship between the prices of the 2 bond issues

The best answer is A. Because interest rates have risen from 7% to 10%, any new issue bonds will come out at par with a 10% coupon; while the prices of outstanding bonds with lower coupons will drop in the market. Thus, new bonds will be selling at a premium to the current price of existing bonds that have lower coupons.

The difference between a C Corporation and an S Corporation is: A. flow-through tax status B. enterprise life C. limited liability D. business intent

The best answer is A. C Corporations are taxable while S Corporations are not. Thus, S Corporations permit income and loss to flow through directly to the shareholders. Both have an unlimited life; both limit liability for shareholders to the amount invested; and both are formed for a business purpose (as opposed to a not-for-profit purpose).

Time Weighted Return will be the same as Dollar Weighted Return for an individual customer that has a mutual fund holding if: A. actual cash deposits into the mutual fund and actual withdrawals out of the mutual fund are ignored B. cash deposits into the mutual fund are ignored C. cash withdrawals out of the mutual fund are ignored D. the customer takes all distributions from the fund as a checks and does not reinvest them

The best answer is A. Dollar weighted average return is most often used when evaluating a specific investor's mutual fund return. It is the return achieved, accounting for the timing of all cash flows (deposits) into the fund and all cash redemptions from the fund made by that investor. It is the same as the Internal Rate of Return, and will vary with the timing of each investor's deposits and withdrawals. Because investors often "chase" past performance, they will buy a fund "too late" (after the fund has posted its best performance and now enters a period of lesser performance) and will sell "too soon." Thus, for the individual investor, dollar weighted average return is often lower than time weighted average return. In contrast, time weighted average return is the measure used for mutual fund performance charts (Total Return, which shows dividends and capital gains as continually reinvested). It reflects the growth that would be achieved from a 1-time investment into the fund and then holding that investment over time - this is a buy and hold strategy. This method is consistent when comparing one fund's performance to another fund's performance. Time Weighted Average Return and Dollar Weighted Average Return are the same as long as the customer makes a 1-time investment and then automatically reinvests fund distributions, removing the effect on return of additional cash payments into the fund; or cash redemptions out of the fund.

All of the following statements concerning dollar cost averaging (DCA) are correct EXCEPT: A. DCA reduces the cost of purchasing shares below current market price B. the investor using DCA makes no attempt to adjust the amounts of investment by market trends C. an investor using DCA makes fixed dollar investments at regular intervals D. an investor using DCA will buy fewer shares when the price of shares is high

The best answer is A. Dollar-cost averaging is a way to reduce the investor's average cost of shares below the average price per share over the same period. The average cost will not be below the market price, and may actually be above the current market price in a steadily decreasing market. DCA requires an investor to make fixed dollar investments at regular intervals without regard to market trends. The result will be that the investor will buy more shares when the price falls and fewer shares when the price for shares is high.

The weak form of efficient market theory states that: I historical stock prices have no validity for predicting future stock price movements II historical stock prices have a strong correlation to future stock price movements III technical analysis cannot be used to improve investment returns IV fundamental analysis cannot be used to improve investment returns A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Efficient market theory basically states that markets are efficient at pricing stocks, and that over a long time frame, an investor cannot outperform the market. It is the economic argument used for index funds. There are 3 "forms" of efficient market theory: Weak Form: States that prices reflect all past publicly available information, but that this has no validity for predicting future price movements. It essentially states that price movements are random. This implies that technical analysis is basically useless to improve returns, but fundamental analysis still has potential value. Semi-Strong Form: States that prices respond rapidly to publicly available information, so that no potential gains can be made by trading on that information. This implies that anyone with inside information has an inherent advantage and can profit by trading on it. Strong Form: States that prices respond rapidly to both publicly available and private information, so that no one can profit by trading on this information. Most people subscribe to the "semi-strong" version of this theory.

Which statements are TRUE regarding variable annuities during the annuity phase? I The annuity unit value fluctuates II The annuity unit value remains the same III The annuity check received may be for a different amount at each payment IV The annuity check received will be for the same amount at each payment A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Once the separate account interest is "annuitized," the accumulation units are turned into a fixed number of annuity units. Since the earnings in the account vary, each payment based on a fixed number of annuity units also varies (hence the term variable annuity). So, when the investor receives proceeds from the account each month as an annuity payment, the annuity check can be for a different amount, all depending on the performance of the securities in the separate account.

Which statement is TRUE? A. Once a strategy has been set for an asset allocation scheme, then tactical asset allocation can be considered B. Once the tactics have been set for an asset allocation scheme, then the strategic asset allocation percentages can be considered C. Strategic asset allocation does not permit the use of tactical asset allocation schemes D. Tactical asset allocation does not permit the use of a strategic asset allocation scheme

The best answer is A. Strategic portfolio management is the determination of the percentage allocation to be given to each investment vehicle within an asset class - for example a portfolio might be strategically allocated as follows: Money Market Instruments 10% Corporate Bonds 30% Large Cap Equities 50% Small Cap Equities 10% Such a basic strategy must be set before taking into account any "timing tactics." Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will under-perform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.

Which statement is TRUE for both Roth IRAs and Traditional IRAs? A. The same investments are permitted for Roth IRAs and Traditional IRAs B. Distributions from both Roth IRAs and the Traditional IRAs after age 59 ½ are tax-free C. For individuals who are not covered by another qualified retirement plan, contributions to both Traditional IRAs and Roth IRAs are deductible D. Contributions can be made by persons in any income tax bracket to both Roth IRAs and Traditional IRAs

The best answer is A. The permitted investments for IRAs (bank certificates of deposit, securities, real estate, U.S. minted gold and pure silver coins, and precious metals bullion) are the same for both Traditional and Roth IRAs. Distributions after age 59 1/2 from Traditional IRAs are taxable; qualified distributions from Roth IRAs after age 59 1/2 are tax-free. If an individual is not covered by another qualified retirement plan, contributions to a Traditional IRA are tax-deductible while contributions to a Roth IRA are not deductible. High-earning individuals cannot contribute to Roth IRAs - only to Traditional IRAs.

A customer with no stock position sells 1 ABC Call and sells 1 ABC Put. The customer would do this to maximize potential profit if the market: A. stays flat B. rises C. falls D. is volatile

The best answer is A. The seller of an option receives a premium, hoping that the contract expires worthless. If a call is sold, the contract expires if the market stays flat (or if the market falls). If a put is sold, the contract expires if the market stays flat (or if the market rises). Maximum profit occurs if the market stays flat and both contracts expire "at the money." Then the seller keeps the 2 collected premiums. If the market rises, the seller starts to lose on the short naked call. If the market falls, the seller starts to lose on the short naked put.

The advantage of a custodian account opened under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) is: A. there is relatively little paperwork to complete as compared to that required for opening a trust account B. only the custodian can deposit funds to the account and can withdraw funds from the account C. the donor has full control of the account assets even after the child reaches the age of majority or transfer set by the State D. withdrawals of funds can be used for any purpose that benefits the child and other direct family members

The best answer is A. There is no special paperwork to open a custodian account - one can be opened by any adult for any minor, using the social security number of the minor. In comparison, to open a trust account requires a copy of the lawyer-prepared trust document, which must have its own tax identification number. Any adult can deposit funds to a custodian account - it does not have to be the custodian, making Choice B false. Once the child reaches legal age under UGMA or the transfer age under UTMA, the assets transfer to the new adult and the custodian has no more control over the account, making Choice C false. Withdrawals can only be used for the benefit of the minor, not other direct family members, making Choice D false.

A customer wishes to make an investment that provides liquidity, marketability and current income. The BEST recommendation is: A. Treasury Note B. Bank CD C. Preferred Stock D. Growth stock

The best answer is A. This customer is looking for current income, so growth stocks are inappropriate. This customer is looking for ready marketability and CDs are not very marketable - they are typically held to maturity. Both preferred stock and Treasury notes provide current income, but Treasuries are more marketable and more liquid. This is the best of the choices offered.

A customer has $20,000 to invest, but needs immediate access to the funds to pay a variety of bills that will arrive over the next 3 months. The BEST recommendation is for the customer to deposit the funds to a: A. Money market checking account B. Money market mutual fund C. Money market instrument D. Treasury Direct account

The best answer is A. This customer needs immediate access to the funds to pay bills as they come due - so a checking account paying money market interest rates is the best recommendation. Money market mutual fund shares must be redeemed to get access to the funds, and this takes time. Money market instruments must be sold to get access to the funds and this takes time as well. A Treasury Direct account allows an investor to buy Treasury securities directly from the U.S. Government without a broker. However, these do not have a checking account feature and are not an appropriate recommendation.

Which statement about variable life insurance is FALSE? A. The policy value may be reduced to zero by poor performance of the separate account B. The policy value is included in the estate of the deceased individual C. The policy value is not taxable to the beneficiary D. In lieu of taking the death benefit as a lump sum, the beneficiary can choose to take it as an annuity

The best answer is A. Variable life gives a guaranteed minimum insurance coverage, regardless of performance in the separate account, making Choice A false. With any life insurance, the policy value is included in the deceased's estate (the only way to remove it is for the individual to put the policy into a non-revocable trust prior to death). With any life insurance, the proceeds go to the beneficiary without tax due. With a variable life policy, the beneficiary can choose to take the death benefit as annuity payments instead of as a lump sum.

For bonds trading at a discount, rank the yield measures from lowest to highest? I Nominal II Current III Basis IV Yield to Call Basis A. I, II, III, IV B. IV, III, II, I C. II, I, III, IV D. I, III, II, IV

The best answer is A. When bonds are trading at a discount, the stated (nominal) yield will be lowest. The current yield will be higher, since it is based on the discounted market price - not par value. The yield to maturity will be the next highest, since it includes the portion of the discount earned annually as part of the annual return in addition to the interest received. Finally, yield to call will be highest, since the discount would be earned over a shorter period of time, increasing the annual yield on the security.

All of the following are advantages of "DRIPs" EXCEPT: A. additional shares of the issuer are purchased with no commission charges B. the investor gets to decide the timing of additional stock purchases in that issuer C. the investor can add to an existing position in that issuer without having to place an order through a broker D. the process of buying additional shares via a DRIP allows for dollar cost averaging

The best answer is B. "DRIP" stands for "Dividend Re-Investment Plan." These are plans offered by corporate issuers that give shareholders the ability to reinvest cash dividends paid by the company in additional shares of that company. This is a feature similar to automatic reinvestment of dividends at NAV in a mutual fund. There are no commission charges on reinvested dividends and fractional shares can be purchased. The issuer's DRIP allows the shareholder to build an increasing position in that issuer's stock over time in a passive fashion. Because additional shares are purchased periodically with the reinvested dividends, this is a form of dollar cost averaging. The disadvantage of a DRIP is that the investor cannot determine the timing of these incremental purchases.

A new investment adviser that will use a passive management approach opens its first account with a customer that is placing $10,000,000 under management. The customer states that he wants the portfolio invested aggressively in selected speculative stocks. The investment adviser should: A. create a model portfolio to present to the customer using the adviser's existing range of index fund investments B. recognize that the customer's request is not within the scope of the adviser's expertise and retain an outside investment counsel C. research micro cap stocks that appear to be undervalued and create a model portfolio for the customer D. assign the advisory contract to another investment adviser that specializes in large cap stocks

The best answer is B. A "passive" manager does not believe in selecting individual stocks, under the concept that over the long haul, individual stock selection cannot improve results over and above that generated by a diversified portfolio. Instead, he believes in using "index funds" as investments, so there is no changing of the stocks in the portfolio (a passive approach). Since this customer wants the adviser to pick good individual speculative stocks for his investments, the adviser should recognize that he does not have the expertise to do so, and should retain another investment adviser with the expertise to select the portfolio (and the use of a third party adviser must be disclosed to the customer).

When the market price of ABCD stock is at $48, a customer places a buy stop limit order at $50. The next trades in the stock occur in sequence at: 51...52....53....49....48 The first trade where execution could occur is: A. 48 B. 49 C. 52 D. 53

The best answer is B. A buy stop limit order is triggered in a rising market. It is most often used to stop a loss on an existing short stock position. Once the market trades up to 50 or higher, the order is triggered and becomes a limit order to buy at $50, meaning buy at $50 or lower. The very first reported trade of $51 elects the order because the market moved from $48 to $51 and went right through the stop price of $50. The order now becomes a limit order to buy at $50, meaning that the customer does not want to pay more than $50 to buy. The next trade of $52 is too high; the following trade of $53 is too high; and the next trade of $49 is the first one that meets the customer's limit (buy at $50 or lower). This is the first trade where the order could be filled.

Which statements are TRUE about ETNs? I ETNs are a structured product II ETNs are an investment company product III ETNs are suitable for investors seeking income IV ETNs are suitable for investors seeking long-term capital gains A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. ETNs make no interest or dividend payments, so they are not suitable for an investor seeking income. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to conventional debt instruments.

Which business form has a limited life? A. S corporation B. General partnership C. Limited liability company D. C Corporation

The best answer is B. Any partnership has a limited life; if there is not a fixed life stated in the partnership agreement; then the life of the partnership ends when the partnership composition changes. If a partner leaves, or a new partner is added; the old partnership is dissolved and a new partnership is formed. All corporations have an unlimited life; a change in ownership does not dissolve the corporation. Also, limited liability companies have an unlimited life.

The rate of return that an individual investor earns over time in a mutual fund, including the timing of cash inflows and outflows, is the: A. Annualized Rate of Return B. Dollar Weighted Average Return C. Time Weighted Average Return D. Expected Rate of Return

The best answer is B. Dollar weighted average return is most often used when evaluating a specific investor's mutual fund return. It is the return achieved, accounting for the timing of all cash flows (deposits) into the fund and all cash redemptions from the fund made by that investor. It is the same as the Internal Rate of Return, and will vary with the timing of each investor's deposits and withdrawals. Because investors often "chase" past performance, they will buy a fund "too late" (after the fund has posted its best performance and now enters a period of lesser performance) and will sell "too soon." Thus, for the individual investor, dollar weighted average return is often lower than time weighted average return. In contrast, time weighted average return is the measure used for mutual fund performance charts (Total Return, which shows dividends and capital gains as continually reinvested). It reflects the growth that would be achieved from a 1-time investment into the fund and then holding that investment over time - this is a buy and hold strategy. This method is consistent when comparing one fund's performance to another fund's performance.

Which of the following would be defined as "earned income" under IRS regulations? I Social Security payments II Alimony payments III Royalty payments IV Bonus payments A. I and II B. III and IV C. II, III, IV D. I, II, III, and IV

The best answer is B. Earned income includes wages, salaries, tips, bonuses, royalties for books and self-employment income. Social security payments and alimony payments are "transfer payments" that are taxed at the same rate as earned income, but they are not defined as such.

A customer sells short 100 shares of PDQ at $47 and sells 1 PDQ Sep 50 Put @ $6. The maximum potential gain while both positions are in place is: A. 0 B. $300 C. $600 D. unlimited

The best answer is B. If the market falls, the short put is exercised and the stock must be bought at $50. Since it was already "sold" at $47, there is a loss of $3 per share ($300 total). But the customer collected $600 in premiums; so the end result is a net gain or $300. This is the maximum potential gain. Conversely, if the market rises, the short put expires, leaving a short stock position that has potentially unlimited loss.

An investor has a broadly diversified portfolio of blue chip stocks. The use of index options to hedge the portfolio: A. reduces non-systematic risk B. reduces systematic risk C. reduces both systematic and non-systematic risk D. cannot be used to reduce any risk since the portfolio is fully diversified

The best answer is B. Index options can be used to hedge a portfolio. If index puts are bought, then a drop in the market lowering the portfolio's value will be offset by a gain in the value of the index puts. This strategy hedges against market risk, also known as systematic risk. Non-systematic risk is the risk that any one security will perform poorly. The larger the portfolio, the lower the effect of non-systematic risk.

Investment "A" is purchased in May and sold at a gain in the July following. Investment "B" is purchased in June and sold at a gain in the October following. In order to compare the return of investment "A" to investment "B," which measure should be used? A. Dollar weighted return B. Annualized return C. Holding period return D. Total return

The best answer is B. Investment A has been held for 2 months and then sold at a gain; while Investment B has been held for 4 months and then sold at a gain. To compare them, their returns must be annualized. Dollar weighted return is another name for Internal Rate of Return. Holding period return is a non-annualized rate of return that is earned over the life of the investment. Total return includes the "total" of both dividends and capital gains as the components of investment return.

A business form that gives a "flow-through" tax benefit and limited liability to owners is a(n): A. C Corporation B. S Corporation C. Sole Proprietorship D. General Partnership

The best answer is B. Limited liability is only provided by limited partnerships; corporations (whether S or C); and limited liability companies. Sole proprietorships and general partnerships have unlimited liability. Flow-through taxation is provided by S corporations, partnerships, sole proprietorships, and limited liability companies. Thus, the only business entities that provide both limited liability and flow-through taxation are limited partnerships, limited liability companies, and S corporations.

Monte Carlo simulation: A. is used to determine the expected value of an investment's return based on the probability of a specific result occurring B. establishes a frequency distribution of investment returns over a range of different conditions C. predicts the variability of return that can occur relative to the mean or median return D. establishes the asset allocation percentages applied to each asset class based upon an investor's objectives, risk tolerance, and time horizon

The best answer is B. Monte Carlo simulation is a computer simulation methodology that is used to determine the most probable outcome of an investment decision. Instead of using a formula, this method assesses the outcome of the investment's return under an extremely broad range of varying conditions, creating thousands of computer calculated scenarios to converge on the most probable outcome. Thus, it creates a frequency distribution of investment returns, with the most likely result being the investment returns that are generated with the greatest frequency.

Over a period of time, a portfolio needs to be "rebalanced." This means that: A. the percentages assigned to each asset class must be strategically reset based on the relative performance of each asset class B. securities must be bought and sold to maintain the asset allocation at the initial percentage targets C. securities must be bought and sold to take advantage of market price fluctuations D. the portfolio must be liquidated and the proceeds reinvested with another independent investment adviser

The best answer is B. Over time, securities values in each asset class will shift at differing rates, moving the allocations away from their initial set percentages. Periodic portfolio rebalancing (selling appreciated positions and using the proceeds to buy depreciated positions) brings the asset allocations back to their initial set percentages, established up-front as part of the portfolio strategy.

Which security is MOST affected by interest rate risk? A. Common stock B. Preferred stock C. Treasury bill D. Commercial paper

The best answer is B. Preferred stock is a fixed income security, with a perpetual life - there is no stated maturity. Thus, this is the longest term fixed income security available, and its price is greatly affected by interest rate risk (remember, longer maturities and lower coupon rate issues are most susceptible to interest rate risk). Common stock prices are not directly influenced by interest rate movements - the connection is indirect at best. Common stock prices are directly influenced by expectations regarding future earnings, sales, dividends, etc. Treasury bills and commercial paper are money market instruments with very short maturities - interest rate risk has little impact on these issues.

What investment held in an investment portfolio would be subject to the greatest negative impact from an increase in market interest rates? A. Common stock B. Preferred stock C. Mutual fund D. REITs

The best answer is B. Preferred stock pays a fixed dividend rate without any stated maturity, so it is a fixed income security that is directly interest rate sensitive. As market interest rates rise, preferred stock prices fall in a similar manner to that of a long-term bond. In contrast, equity security prices are not directly interest rate sensitive. Rather, their price movements are mainly driven by the company's earnings and dividends. Regarding mutual funds, we don't know if the choice offered is an equity fund or a bond fund, but preferred stock is still the better answer. Regarding the REIT, we don't know if it is an Equity REIT or a Mortgage REIT, but preferred stock is still the better answer.

An investor has $10,000 invested in an account that earns 5% annually. The investor wishes to withdraw $2,000 per year. If the investor withdraws $2,000 annually, the account will be fully depleted in: A. 3 years B. 6 years C. 9 years D. 12 years

The best answer is B. Since an advanced function calculator is not provided in the exam, the answer to this question must be approximated manually. Beg Bal. Int. 5% Withdrawal Ending Bal. 1 $10,000 $10,500 $2,000 $8,500 2 $8,500 $8,925 $2,000 $6,925 3 $6,925 $7,271 $2,000 $5,271 4 $5,271 $5,535 $2,000 $3,535 5 $3,535 $3,712 $2,000 $1,712 6 $1,712 $1,797 $1,797 $0 Another way to deal with this is the "eyeball" approach. If $10,000 is invested at no interest and $2,000 is withdrawn each year, it would take $10,000/$2,000 = 5 years to deplete the money. The average balance over this time frame is $5,000 (starting balance is $10,000 and ending balance is 0) x 5% interest = $250 annual interest earned x 5 years = $1,250 interest earned total. Thus, there is a total of about $11,250 being depleted at the rate of $2,000 per year = about 5.6 years to deplete the balance. 6 years is the closest answer to this.

Which of the following BEST describes S corporations? S corporations are: I limited to 100 investors or less II not limited as to the number of investors III taxable entities IV not taxable entities A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Subchapter S corporations are limited to 100 shareholders. They are not taxable entities - income and loss flows through to the shareholders and any net income is only taxed at the shareholder level - not the corporate level.

A client purchases 1,000 shares of ACME Growth Fund in July of a 20XX. In December of 20XX, the fund distributes a capital gain to its shareholders. This distribution is: A. taxable as a short-term capital gain based on the length of time that the client held the fund shares B. taxable as a long-term capital gain based on the length of time that the fund held underlying securities C. a tax-free return of invested capital D. exempt from taxation at the State level but not at the Federal level

The best answer is B. Taxation of mutual fund distributions is based on the length of time that the fund held the underlying securities. All fund distributions, whether they are dividends, short term capital gains or long term capital gains, are reported to shareholders and to the IRS on Form 1099-DIV. If a fund has held securities for more than 1 year and sells them at a profit, the resulting gain is reported on Form 1099-DIV in the box titled "Total Capital Gains Distribution." Long-term capital gains are taxed at a preferential maximum 15% rate (this increases to 20% for individuals earning over $400,000 per year). If the fund distributes a dividend where the source of the distribution is dividends received from a portfolio of equity securities, these are reported on Form 1099-DIV in the box titled "Qualified Dividends" and are taxed at a preferential maximum 15% rate (this increases to 20% for individuals earning over $400,000 per year). If the fund distributes a dividend where the source of the distribution is dividends received from a portfolio of debt instruments or short term capital gains from securities sold at a profit, these are reported on Form 1099-DIV as ordinary dividends ("non-qualified") and are taxed at ordinary income tax rates of up to 39.6%.

The target allocation for a specific asset class has been set at 20% of total assets under an asset allocation scheme. The manager is permitted to reduce this percentage to 15%; and can increase it to 25%; as he or she sees fit. The setting of the 20% target allocation is called: A. portfolio rebalancing B. strategic asset management C. tactical asset management D. active asset management

The best answer is B. The selection of the percentage of total assets to be allocated to a given asset class is called "strategic asset management" - that is, setting the investment strategy. The permitted variation from this percentage that is given to the asset manager, so that the manager can take advantage of market opportunities, is called "tactical asset management".

A trader who places an order to sell 100 shares of ABC at $68 when the market price of ABC stock is at $64 has placed a(n): A. market order B. limit order C. stop loss order D. open order

The best answer is B. The trader wants to sell the stock at $68 when the market is at $64. This trader does not want to sell for less than $68 per share, so he has placed a limit on the price. The order cannot be filled unless the market rises to $68 or higher. This order will remain "open" until it is filled, but limit order is the better answer to the question.

Many years ago, a trust was set up for the benefit of a client. The client passes away. The trustee is notified by the IRS of possible tax problems and is separately notified that a family member is protesting the trustee's actions. Based on this information, what should be the most heavily weighted factor when recommending a portfolio investment to the trust? A. Liquidity B. Taxes C. Best interests of beneficiary D. Long-term growth

The best answer is B. There is not a lot of information to go on here, but the primary concern is the tax issue. If there are "tax problems" with the trust, the IRS issues must be settled first. Liquidity is also a good choice, because when an individual dies, federal estate tax is payable 9 months from the date of death. However, having enough immediate funds to settle any issues is the number #1 concern. Acting in the best interests of the beneficiary is a long-term concern of any trustee, however since this beneficiary is dead, this is no longer a consideration! Finally, investing for long-term growth is not a good choice, since the question gives no information leading to this answer.

An 80-year old client lives on his social security payments that total $25,000 per year. 3 years ago, on the advice of the broker, he invested in a technology fund where he lost most of his assets. The remaining balance in his brokerage account is $17,000. The client has annual living expenses of $30,000 and a net worth of $128,000. The customer approaches a new broker to take over management of his account. The representative that receives the account should: A. do nothing B. sell the holding in the account and invest the proceeds in a more conservative fund within the same family of funds C. sell the holding in the account and invest the proceeds in a more conservative fund outside the family of funds D. sell the holding in the account and invest the proceeds in a more conservative fund that has a deferred sales charge

The best answer is B. This customer should be invested in a safe income fund that will provide the "extra" $5,000 in annual income needed to meet this customer's income shortfall (the customer is living on $25,000 of social security but has $30,000 of annual living expenses). The question does not give an option of selling the tech fund and investing the proceeds in an income fund! Of the choices offered, Choice B is best because there will be no (or a lower) sales charge for moving assets within a family of funds, as opposed to investing the proceeds in a new fund family. Choice D is not correct because this customer is elderly and has a high probability of dying before the contingent deferred sales charge would be depleted to "0" (this usually occurs over a 7-year time frame, and this customer is now 80 years old). If the customer died, say 2 years later, and the estate liquidated the holding, then the CDSC (Contingent Deferred Sales Charge) would have to be paid.

When describing a mutual fund manager, the term management tenure is the: A. length of time that the individual has been in the securities industry B. length of time that the individual has been managing that mutual fund C. length of time that the mutual fund has been in existence D. length of time that the mutual fund has been managed by a registered investment adviser

The best answer is B. When looking at the performance of a mutual fund over many years, a key factor is the length of time that the investment adviser has been managing that fund. Typically, a long-tenured adviser who has produced good investment returns can be expected to do so in the future. Investment advisers with a short tenure do not have a proven track record; and if there is a change of investment adviser, this can be a red flag to potential investors, because the new adviser does not yet have a track record.

Which statement describes a variable life insurance policy? A. A policy owner has flexibility in skipping some premium payments B. The cash value increases based on equity investments C. The death benefit is fixed and guaranteed for the insured's entire life D. Premium payments are low for a young insured individual and increase with age

The best answer is B. Whole life insurance protects the purchaser from increasing premiums as that person ages, and there are no renewals - the policy is good for that person's "whole" life. With a whole life policy, the annual premium is level, and will start out higher than a term life policy. Part of the premium is invested in the insurance company's general account and is guaranteed to grow at a fixed, guaranteed rate. As the general account investment portion grows, the policy builds "cash value" that can be borrowed. Variable life is a variation on whole life where a level annual premium is invested in a separate account, typically invested in equities. Better performance of the securities in the separate account will increase the death benefit, hence the term "variable life," - so the death benefit is not fixed. The policy builds cash value similar to whole life, but the amount of cash value depends on the performance of the separate account. Part (but not all) of this value can be borrowed, since the separate account performance will vary. Any borrowed funds reduce the benefit payment upon death. Universal life gives the policyholder the flexibility to skip some premium payments. Variable life invests premiums in a separate account and typically invests in equities, whereas both whole life and universal life invest premiums in the general account, which must be heavily invested in fixed income securities. Term life has low premiums for a young insured individual, but the premiums increase with each renewal as that person ages.

A nonqualified retirement plan that is established by a non-profit organization is a: A. 401(k) plan B. 403(b) plan C. 457 plan D. 529 plan

The best answer is C. 457 plans are "add on" plans to government sponsored defined benefit plans and 403(b) plans. 403(b) plans are similar to 401(k)s - they are salary reduction plans that allow employees to contribute up to $18,000 in 2017. 401(k)s are for the corporate sector, while 403(b)s are for the not-for-profit government sector. As an added benefit for higher level employees, not-for-profit employers can establish a 457 plan. This is not a qualified plan because it is discriminatory. An additional $18,000 can be contributed in 2017 as a salary reduction by these higher level employees. 529 plans are college savings plans and are not retirement plans.

A father and mother established a 529 plan for their son when he was age 12. The son has just turned 18 and is entering college. The father gets the first tuition and boarding bill from the college for $22,000. Since the son will be commuting home every other weekend, the father withdraws $25,000 from the 529 plan to pay for the college bill and the commuting expenses. Which statement is TRUE? A. There is no tax consequence to the $25,000 withdrawal B. $3,000 of the distribution is subject to regular income tax C. $3,000 of the distribution is subject to both regular income tax and a penalty tax D. The entire distribution is subject to regular income tax

The best answer is C. 529 plan distributions can only be used to pay for "qualifying" higher education expenses - tuition, books, and room and board, in the amount that would be paid under tuition assistance plans. So the $22,000 tuition and boarding bill from the college is "qualified," and is not taxable. However, the extra $3,000 withdrawn to pay for commuting is not qualified and is taxable and, in addition, is subject to penalty tax.

The holder of a variable annuity contract elects the settlement option of Life Annuity - 10 Year Period Certain. This individual annuitizes at age 66 and recently died at age 78. Which statement is TRUE? A. Annuity payments to this individual would have stopped at age 76 B. Annuity payments to this individual will continue to be made to the individual's beneficiary C. Annuity payments to this individual will stop D. Annuity payments to this individual will continue for another 2 years

The best answer is C. A life annuity with a 10 year period certain guarantees to make payments for life, but if that individual dies prior to the "10 year period certain," then payments will continue to a beneficiary until a minimum of 10 years' payments have been made. Since this individual has received payments for 12 years at the time of his death, no more payments will be made.

A 25-year old man receives $50,000 and wants to retire at age 65 with an income of $1,500 per month from his investment portfolio. The adviser should invest: A. 100% in bonds and 0% in stocks B. 65% in bonds and 35% in stocks C. 25% in bonds and 75% in stocks D. 0% in bonds and 100% in stocks

The best answer is C. As a "rule of thumb," when balancing investments between stocks and bonds, the portion of the portfolio that should be invested in equities is "100% minus that person's age." Since this individual is age 25, 75% should be invested in equities for growth; with the other 25% invested in safe bonds.

A major disadvantage of forming a C Corporation as compared to other business forms is: A. unlimited liability B. a limit on the number of shareholders C. double taxation of dividends received by shareholders D. an inability to issue senior securities

The best answer is C. C Corporations place a limit on liability of shareholders; can have an unlimited number of shareholders; and can issue preferred stock and bonds (senior securities). These are all advantages. The disadvantage is that a C Corporation is a taxable entity. The corporation pays tax on its net income and can distribute part of its after-tax income to shareholders as a dividend. The shareholder must pay tax on the dividend received, so it is said to be "double taxed." By the way, the preferential 15% tax rate on corporate dividends is intended to partially offset this negative factor.

Roth IRAs allow for: A. greater annual contributions than a Traditional IRA B. the contribution to be deducted from taxable income in that year C. no tax on distributions if the funds have been held in the account for at least 5 years D. no penalty tax on distributions taken prior to age 59 1/2

The best answer is C. Contribution amounts to a Roth IRA are the same as for Traditional IRAs - $5,500 for an individual and $11,000 for a couple (for 2017). Unlike regular IRAs where the contribution is usually deductible (unless the contributor is covered by another qualified retirement plan and earns too much); contributions to a Roth IRA are not deductible. As long as the monies are kept in the Roth IRA for at least 5 years, distributions from the Roth IRA are not taxable (in contrast, distributions from Traditional IRAs are taxable since the contribution was deductible.) Premature distributions (prior to age 59 1/2) from both a Traditional and a Roth IRA subject that person to a 10% penalty tax.

The yield to maturity on a bond is lower than the current yield. This bond is trading: A. at par B. at a discount C. at a premium D. in the money

The best answer is C. Current yield only takes into account the income from an investment, whereas yield to maturity also factors in the additional return earned when a bond is purchased at a discount and held to maturity; or the loss that will be suffered when a bond is purchased at a premium and held to maturity. If a bond is purchased at a discount, the yield to maturity will be more than the current yield because of the earning of the discount in addition to interest received. If a bond is purchased at a premium, the yield to maturity will be less than the current yield because of the loss of the premium offsetting interest received.

Duration would NOT be an appropriate measure for: A. Treasury bonds B. Corporate bonds C. Corporate common stock D. Corporate preferred stock

The best answer is C. Duration measures the anticipated price movement of a fixed income security for a given change in market interest rate levels. Bonds and preferred stocks are fixed income securities. Common stock is not a fixed income security.

A client, age 40, covered by a high-deductible health insurance plan, opens a Health Savings Account and contributes the maximum permitted. She is currently healthy, but intends to use the money to pay for medical expenses that are expected after age 65. The best investment option in the HSA for this individual is a: A. bank account B. money market fund C. target date fund D. growth fund

The best answer is C. Health Savings Accounts (HSAs) are only available to individuals who are covered by high-deductible health insurance plans. A deductible contribution is made to the HSA (in 2017, it is a maximum of $3,400 for an individual and $6,750 for a couple). Earnings build tax-deferred and distributions used to pay for qualified medical expenses are not taxable - so there are 3 tax benefits. Since this person wants to use the HSA to pay for medical expenses expected in 25 years (at age 65 and later), a target date fund with an end-date 25 years in the future is the best investment option.

An investor that purchases 10 year zero-coupon Treasury bonds with the intention of holding them to maturity should be MOST concerned with: A. market risk B. interest rate risk C. purchasing power risk D. reinvestment risk

The best answer is C. Market risk (which is the same as interest rate risk for bonds) is the risk that market interest rates rise, forcing bond prices down. This is a major issue for zero-coupon bonds, but it is not an issue if the investor is holding them to maturity. At maturity, the investor receives par, with almost no credit risk.

An IAR has been retained to manage the brokerage account of an estate. When examining the account statement, the IAR sees the following holdings: $9,000,000 ABC Corp. AA-rated long term bonds $1,000,000 XYZ Money Market Fund Over past year, the ABC bond position has appreciated by 30% due to falling interest rates. The IAR notes that the yield curve has steepened its positive slope and believes that the Federal Reserve will start tightening credit to reduce the risk of inflation. The BEST action for the IAR to take is to: A. do nothing because the account assets must be distributed to the heirs within 9 months B. sell the appreciated bond position and reinvest the proceeds in a growth mutual fund C. sell the appreciated bond position and reinvest the proceeds in the money market fund D. either hold or sell the appreciated bond position using the prudent investor rule as a guideline

The best answer is C. One of the advantages built into estate taxes is that the assets are valued at market value as of date of death, and if there was any asset appreciation, this is not taxed as capital gains (this is called a "stepped up" basis). The goal of the IAR is to maximize investment returns using a time horizon of a maximum of 9 months (which is when estate tax is due). Because the IAR believes that interest rates will start rising, he or she should sell the appreciated long-term bond position (it has risen a lot!), locking in the gain without any capital gains tax due. Choice B is not good, because if the Fed tightens credit, then the equities market is likely to perform poorly. Choice D seems good and it also mentions "prudent man" - but the fact is that the greatly appreciated long-term bond position should not be held if the IAR believes that interest rates are going to rise. If the position were to be held untouched, it could lose a lot of its value in a falling market, and this is hardly the action that a "prudent man" would take.

An elderly mother gives her daughter the gift of her wedding ring. It was purchased many years ago for $3,000. At the date that the wedding ring was gifted to the daughter, the ring was valued at $5,000. Many years later, the daughter sells the ring for $7,500. What is the tax consequence to the daughter? A. No capital gain or loss because the item sold was personal property B. $2,500 long term capital gain C. $4,500 long term capital gain D. $7,500 long term capital gain

The best answer is C. Personal property that is sold for a profit is subject to capital gains tax - and instead of the favorable 15% rate given to long-term holding of securities (this increases to 20% for individuals earnings over $400,000), the tax rate is 28%! When a gift is made, the recipient assumes the cost basis of the donor. Thus, the cost basis to the daughter is $3,000. Since the ring was sold for $7,500, there is a $4,500 long term capital gain. Also note in contrast that if an item is inherited (as opposed to being received as a gift), the cost basis to the recipient is the market value at date of death.

The settlor of a trust does which of the following? I Donates the assets to the trust II Appoints the trustee III Establishes the purpose of the trust IV Manages the assets of the trust A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. The "settlor" of a trust is the person who grants property to the trust for the benefit or one or more beneficiaries. The settlor is also called the grantor, donor or trustor. The trustee is appointed by the settlor to manage the assets of the trust in the best interest(s) of the beneficiaries. The settlor establishes the purpose of the trust and names the beneficiaries. The settlor does not manage the trust assets - this is done by the trustee (who is usually a third party, but in rare cases, the settlor can also act as trustee).

Which recommendation is appropriate for a client who is subject to the AMT (Alternative Minimum Tax)? A. "You should invest in an existing housing real estate limited partnership for stable income sheltered by depreciation deductions" B. "A private activity municipal bond investment is suitable for you because of its tax-free income" C. "Don't exercise any incentive stock options granted by your employer" D. "You should be making investments in foreign corporations"

The best answer is C. The AMT (Alternative Minimum Tax) applies a minimum flat tax rate under an alternative calculated income if an individual relies on too many "tax preferences" in the tax code to reduce regular taxable income. These tax preferences are added back to regular taxable income to arrive at AMT income, which is taxed at a flat 26-28% rate. Among the items added back are: Excess depreciation deductions from real estate investments. (The "add back" is the excess of accelerated depreciation deductions taken over straight line depreciation.) Private activity municipal bond interest income. (This is usually federally tax free, but it is added back as a tax preference and becomes taxable under the AMT. Since tax-free municipal bonds are typically purchased by high income individuals, this makes sure that they don't shelter "too much" of their income from some form of federal tax). The exercise of incentive stock options, where there is a "bargain element." (For example, if an employee has the option to buy that employer's stock at $20 and exercises when the stock is worth $50, the $30 per share discount is added into AMT, even though the employee has not sold that stock position.) Difference between the foreign tax credit claimed on an individual's regular tax return (for taxes withheld on income from a foreign investment in a foreign country) and the lesser amount of foreign tax credit allowed under the AMT. (Again, the "idea" is that wealthy individuals are the ones who will invest in foreign securities, so this increases their tax due.) Thus, the best recommendation is not to exercise incentive stock options.

Which item is used when computing a corporation's Current Ratio? A. Net Working Capital B. Net Worth C. Accounts Receivable D. Long-Term Debt

The best answer is C. The Current Ratio is: Current Assets / Current Liabilities. It is a measure of liquidity, because it looks at whether the company can pay its current bills as they come due. Cash, Accounts Receivable and Inventory are the primary "Current Assets." Net Working Capital is Current Assets - Liabilities. Net Worth is All Assets - All Liabilities. Long-Term Debt is not a current liability and is not included.

If stockholders' equity is subtracted from total assets, you are left with: A. current liabilities B. long term debt C. current liabilities and long term debt D. retained earnings

The best answer is C. The balance sheet formula is: Total Assets = Total Liabilities + Stockholders' Equity If Stockholders' Equity is subtracted from Total Assets, you are left with Total Liabilities - which consists of both Current Liabilities and Long-Term Liabilities.

A customer places an order on the NYSE to sell bonds. The order reads "Sell 5M ABC 9s M '42 @ 90 GTC." At which of the following prices may the order be executed? I 89 II 90 III 91 IV 92 A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is C. The customer places a limit order to sell 5M - or 5 $1,000 par bonds at 90% of par value or more, if possible. The order must be executed at 90% or more, so selling at 90, 91 and 92 are OK. Selling at 89 is not high enough to satisfy the customer's limit.

An investment of $100,000 is worth $105,000 after 3 months. If the investment keeps growing at the current rate, at the end of one year, the annualized rate of return will be: A. 5.00% B. 20.00% C. 21.55% D. 25.00%

The best answer is C. This investment grew at a 5% rate over 3 months, from $100,000 to $105,000. If this growth rate continues over the next 3 quarters, the investment will be worth: 2nd Quarter: $105,000.00 x 1.05 = $110,250.00 3rd Quarter: $110,250.00 x 1.05 = $115,762.50 4th Quarter: $115,762.50 x 1.05 = $121,550.63 Thus, an original $100,000 investment is worth $121,551 at the end of the year, for a growth rate of 21.55%.

A customer buys a TIPS at par with a 3½% coupon. Inflation stays at 4% over the life of the security. What is the total return on the investment? A. 3½% B. 4% C. 7½% D. This cannot be determined from the information presented

The best answer is C. Treasury Inflation Protection Securities (TIPS) give a fixed coupon rate (3½% in this example), but they also adjust the principal value of the bond up each year for inflation (4% per year in this example). At maturity, the investor gets the inflated principal amount. The Total Return on this TIPS would be 3½% annual income + 4% annual gain = 7½%.

A mother purchased 100 shares of DEFF stock for $40 per share. After holding the shares for 3 years, she gifts the stock to her minor son in a custodian account. At the time of the gift, the stock is worth $50 per share. Which statement is TRUE? A. The $1,000 gain on DEFF is taxable as a long-term capital gain as of the date of the gift B. The mother has a $5,000 tax deduction for the contribution to the custodian account C. The child's cost basis in the securities is $4,000 D. The child's cost basis in the securities is $5,000

The best answer is C. When a gift of securities is given, the recipient assumes the donor's cost basis, so the minor now owns the stock at a cost basis of $40 per share ($4,000 for 100 shares). When the stock is sold, there will be a capital gain or loss to the minor.

When comparing the Alternative Minimum Tax calculation to the Regular income tax calculation, which deductions are ONLY permitted in the Regular income tax calculation? I Personal exemption II State and local tax deduction III Miscellaneous itemized deductions IV Medical expense deduction A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. When calculating the Alternative Minimum Tax, aside from adding back "tax preferences," many of the basic deductions permitted when calculating Regular income tax are not allowed, increasing the amount of AMT income that is subject to tax. When calculating AMT, there is no deduction for the personal exemption; no deduction for state and local taxes paid (including property taxes paid); no deduction for miscellaneous items such as tax preparation fees; and no standard deduction; among other items. Medical expenses are deductible from Regular income tax to the extent they exceed 7.5% of Adjusted Gross Income (AGI). They are also deductible from the AMT computation, but for AMT, they are only deductible to the extent they exceed 10% of AGI.

An options strategy where the maximum potential loss is equal to the difference between the increase in value of the underlying short securities position and the premiums received is a: A. naked call writer B. covered call writer C. naked put writer D. covered put writer

The best answer is D. A covered put writer sells a put contract against the underlying short physical security position. If the market rises, the put expires unexercised and the writer keeps the premium. However, as the market rises, he loses on the short security position. Thus, the maximum potential loss is the rise in value of the short security position, net of collected premiums.

Which statement concerning the AIR of a variable annuity contract is TRUE? A. It is the insurer's best estimate of the future performance for accumulated income retained in the separate account B. It applies during the accumulation period C. It must be adjusted annually for inflation D. It applies only during the annuity period

The best answer is D. AIR refers to the assumed interest rate used to determine the initial monthly payment to the annuitant - it is set when the contract is annuitized and only applies during the annuity period. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases. The AIR has no meaning during the accumulation period. Also note that the prospectus has an "AIR Illustration" that is an estimate of the annuity to be paid based on a conservative growth estimate, but the actual AIR is not set until the contract is annuitized.

Bond A and Bond B both have an 8% coupon. Bond A matures in 2 years, while Bond B matures in 10 years. If market interest rates fall: A. the price of both bonds will fall at the same rate B. the price of Bond B will fall faster than the price of Bond A C. the price of both bonds will rise at the same rate D. the price of Bond B will rise faster than the price of Bond A

The best answer is D. As market interest rates fall, the prices of fixed income securities rise, but not at equal rates. As market interest rates fall, the longer the maturity of the bond, the faster the price will rise; and the lower the coupon rate, the faster the price of the bond will rise. Since the coupon is the same for both bonds, the price of the longer maturity bond (B) will rise faster as market interest rates fall.

All of the following investment company terms are synonymous EXCEPT: A. Bid B. Redemption Price C. Net Asset Value D. Offering Price

The best answer is D. Bid, Redemption Price, and Net Asset Value are all the same terms for investment company shares. This is the price at which a customer can sell (redeem) his or her shares.

For a single parent with two children, what is the maximum amount that can be contributed to 529 plans without gift tax consequences in 2017? A. $14,000 B. $28,000 C. $100,000 D. $140,000

The best answer is D. Contributions to a 529 plan above the Federal gift tax exclusion amount ($14,000 in 2017) will subject the donor to gift tax. A 1-time gift of 5 times the exclusion amount may be given without gift tax (5 x $14,000 = $70,000 in 2017) for each child. Thus, for 2 children, the maximum contribution without gift tax due is $140,000.

What is the maximum amount that an individual can contribute to a 529 plan without gift tax consequences in 2017? A. $5,500 B. $14,000 C. $52,000 D. $70,000

The best answer is D. Contributions to a 529 plan above the Federal gift tax exclusion amount ($14,000 in 2017) will subject the donor to gift tax. A 1-time gift of 5 times the exclusion amount may be given without gift tax (5 x $14,000 = $70,000 in 2017).

A customer, age 55, is in the 30% tax bracket. The customer has a non-tax qualified variable annuity separate account to which he contributed $12,000 that has a current market value of $30,000. The customer takes a distribution of $10,000 from the account. The tax that will be due on this distribution is: A. 0 B. $1,000 C. $3,000 D. $4,000

The best answer is D. Distributions from non-tax qualified variable annuity separate accounts are taxed on a LIFO (Last In First Out) basis. The original non-tax deductible contribution of $12,000 was the first in. The tax-deferred build up of $18,000 occurred second. When distributions are taken, the "build-up" portion comes out of the account first and is taxed at regular tax rates. After the build-up is depleted, the original investment of $12,000 comes out of the account and is not subject to tax. The customer is withdrawing $10,000 - which is all counted as "build-up" for tax purposes (last in - first out). This is taxable at 30%, plus the customer must pay a 10% penalty tax on a premature distribution (prior to age 59½). The total tax due is 40% of $10,000 = $4,000.

Which of the following would be an asset on a client's personal balance sheet? A. dividends received from stock investments B. policy value of term insurance C. interest received from bond investments D. cash value of whole life insurance

The best answer is D. Dividends and interest received are income items on a client's income statement. Term insurance has no investment component - it only pays if the insured person dies. Thus, it only becomes an asset on death. The cash value that builds in a universal life or whole life policy is a client asset. It is cash that can be withdrawn if the policy is surrendered. Alternatively, the customer can maintain the policy and borrow against the cash value in the policy.

A dividend paid by a foreign corporation will be "qualified" in all of the following cases EXCEPT: A. The corporation is incorporated in a country that has a comprehensive tax treaty with the United States B. The corporation is incorporated in a U.S. possession C. The corporation has its shares listed on an established trading market in the United States D. The corporation has qualified for duty free shipments to the United States

The best answer is D. Dividends paid by U.S. corporations generally qualify for the lower 15% tax rate. Dividends paid by foreign corporations to U.S. security holders only qualify for the lower rate if: The corporation is incorporated in a country that has a comprehensive tax treaty with the United States; The corporation is incorporated in a U.S. possession; or The corporation has its shares listed on an established trading market in the United States.

A 62-year old man takes a distribution from a non-tax qualified variable annuity. The distribution is: A. tax free without any penalty imposed B. taxed at capital gains rates without any penalty imposed C. taxed as ordinary income without any penalty imposed D. taxed in accordance with federal tax law

The best answer is D. Is this one special or not!? Contributions to non-tax qualified annuities are not deductible. Dividends earned during the accumulation phase must be reinvested and build tax deferred. When distributions commence at retirement age (age 59½ or later), the portion attributable to the never-taxed build up is taxed at ordinary income tax rates, while the portion attributable to the already taxed contribution amounts is returned without tax due. Distributions are taxed on a LIFO basis. This results in the build-up (taxable dollars) coming out first; and once this is depleted, the original investment dollars are returned without tax due. Thus, the best answer to this question is that distributions are taxed "in accordance with Federal tax law."

A NASDAQ stock is quoted at $34 Bid / $35 Ask. A trader that places a sell order will most likely be filled at: A. $35 1/2 B. $35 C. $34 1/2 D. $34

The best answer is D. Market makers maintain a bid / ask quote in a security. Bid / Ask quotes are always from the standpoint of the dealer. The dealer is willing to sell at his "asking" price; and is willing to buy at his "bidding" price. The difference between the bid and ask is the spread - that is the market makers gross compensation for making a market in the security. Customers who wish to buy do so at the dealer's ask; customers who wish to sell do so at the dealer's bid. This customer who wishes to sell will do so at the dealer's bid price of $34 - the price at which the dealer will buy the stock from the customer.

All of the following terms relating to mortgage backed securities are synonymous EXCEPT: A. Call risk B. Contraction risk C. Prepayment risk D. Extension risk

The best answer is D. Mortgage backed securities pass through the monthly mortgage payments to the certificate holders. Because the homeowners have the right to prepay their mortgages without penalty, when market interest rates drop, the homeowners refinance their mortgages, and these early principal repayments are passed-through to the certificate holders. Thus, the certificates pay off much earlier than expected as the expected maturity shortens (this is also called contraction risk or call risk). The certificate holders that receive the early principal payments will now have to reinvest them in new MBSs, which will be yielding less because market interest rates have declined. Extension risk is an opposite risk. If market interest rates have risen after a mortgage pool is created, the homeowners sit tight and don't move. Thus, the anticipated rate of prepayments built into the security slows down and the maturity extends. The certificate holder winds up earning a lower than market rate of interest for much longer than he or she ever expected! All securities have credit risk (risk of default) with the possible exception of U.S. Government debt (the safest debt in the world and credit risk-free for test purposes). All fixed rate securities have interest rate risk (the risk of rising interest rates forcing the value of outstanding lower-rate issue downwards to bring their yields up to current market rates) and purchasing power risk (inflation risk, which will increase interest rates and depress bond prices).

To determine the present value of an investment, which of the following is NOT considered? A. The interest rate to be used to discount the annual payments received B. The amount of cash expected to be generated each year by the investment C. The time horizon of the expected investment returns D. The required sum needed at the end of the investment's life

The best answer is D. Present value takes the annual cash flows that are expected to be generated by an investment and discounts them at the market rate of interest to their "present value." Thus, the present value formula determines what those cash flows are worth today. In contrast, future value takes the cash flows generated by an investment and compounds them at the market rate of interest to their value at a set future date.

All of the following are objectives that a capital needs analysis would attempt to address EXCEPT: A. paying for a child's college 15 years from now B. the maturing of a medical resident's balloon loan 10 years from now C. having funds 20 years from now to enjoy a comfortable retirement D. borrowing 5 years from now using a home equity line to make a major home improvement

The best answer is D. Put simply, a "capital need" means that a specific sum of money is needed at a future date to meet an upcoming need or obligation. Thus, a capital need might be the need to pay for a kid's college; the need to accumulate enough money to make a down payment on a home purchase; the need to have the funds to pay off a maturing loan; the need to have enough funds for retirement, etc. Borrowing money is not a capital need, but it can be a way of meeting a capital need.

A customer is invested in a diversified portfolio of small-cap, mid-cap and large-cap stocks of companies based in the United States. Which index fund could the customer use to further diversify this portfolio? A. S&P 500 B. Russell 2000 C. DJIA D. EAFE

The best answer is D. The EAFE Index stands for Europe, Australasia, and the Far East. It consists of companies of developed countries in these areas - so these are all companies outside of North America. Investing in an EAFE ETF would give the customer international exposure and further diversify his or her U.S. based portfolio against market risk, since companies in international markets would typically be affected by different events than U.S. companies. The S&P 500, DJIA, and Russell 2000 all consist of U.S. companies.

A customer that is long ABC stock in his portfolio buys call options on that stock. Why would the customer do this? A. To protect the ABC stock position from an adverse market move B. To derive additional income from the ABC stock position C. To speculate on the price of the stock going down D. To lock in a price at which shares can be added to the portfolio

The best answer is D. The purchase of a call gives the customer the right to buy shares at the strike price. The only reason why a person who is already long that stock would buy calls on the stock would be to give the customer the ability to buy more shares at the strike price if the market price of the stock should move up.

A mutual fund is owned in a qualified retirement account. Dividends paid by the mutual fund will be taxable: A. annually B. if they are not automatically reinvested in additional fund shares C. if they are automatically reinvested in additional fund shares D. if they are taken as a distribution from the account

The best answer is D. The qualified retirement account is a tax-deferred vehicle. Contributions used to buy fund shares are deductible; and dividends must be retained in the account and build tax deferred. Usually, dividends are reinvested in shares of the same fund, but they could be reinvested in other securities held in the account. Only when distributions are taken is tax due.