Series 66 Chapter 9 Exam Questions
An individual using which risk perspective would use modern portfolio theory to select an investment? [A]Risk Neutral [B]Risk Averse [C]Risk Seeking [D]Risk Indifferent
B Modern Portfolio Theory attempts to optimize expected returns for a portfolio for a given level of risk. Modern Portfolio Theory can also work with opposite directions attempting to minimize risk for a given amount of return. An individual who seeks to minimize risk is generally risk averse.
When a portfolio is spread among U. S. Equity securities, which two of the following types of risk are not reduced? I. System Risk II. Business Risk III. Market Risk IV. Liquidity Risk [A]I & III only [B]II & IV only [C]I & IV only [D]II & III only
A Both Business and Liquidity risk would be reduced with diversification in domestic equity securities. System risk and Market risk are the same thing and would not be reduced with diversification within the SAME asset class (U.S. Equity stocks).
Which of the following measures the relationship between expected risk and expected return? [A]Capital Asset Price Theory [B]Dollar Cost Averaging [C]Keynesian Theory [D]Time Value of Money
A Capital Asset Price Theory measures the relationship between expected risk and expected return, knowing that investors demand greater return for greater risk.
When using DCF to evaluate the impact of increasing interest rates in the market, what effect would it have on new bonds in the market? [A]The DCF on new bond will increase. [B]The DCF on new bond will decrease. [C]The DCF on new bond will stay the same. [D]The DCF is not used to evaluate the interest rates on new bonds.
A If interest rates are increasing, then it is expected that the returns on new bonds will increase due to the increase in interest rates.
Which of the following would be LEAST susceptible to risks associated with inflation and interest rate movements? [A]Common stocks [B]Municipal bonds [C]Corporation bonds [D]Government bonds
A Investments in any bond type, especially Treasury Securities would carry risks associated with inflation and interest rate movements. Common stock is not exposed to the same level of those risks as fixed-income investments. The biggest risk when investing in common stock is Capital Risk, which is the risk of losing all the money you invested. Other risks that could impact both stocks and bonds would include liquidity risk, market risk, business risk, and opportunity risk.
An IAR is evaluating a client's portfolio. The IAR is looking at each of the various aspects of the portfolio, determining the return on each aspect, and then weighting each aspect according to its proportion of the portfolio as a whole. These numbers will be used to find a projection of what the IAR and investor can expect in the year to come. What is the IAR looking for? [A]The IAR is looking for the expected rate of return of the portfolio. [B]The IAR is looking for the internal rate of return of the portfolio. [C]The IAR is looking for the risk-adjusted rate of return of the portfolio. [D]The IAR is looking for the inflation-adjusted rate of return of the portfolio.
A The expected rate of return on a portfolio is the weighted average of the expected annual returns for all of the components of the portfolio.
Fixed annuity payouts are primarily subject to which of the following risks: [A]Inflation Risk [B]Market Risk [C]Regulatory Risk [D]Capital Risk
A The inflation risk is the purchasing power risk. Since fixed annuity payments are of a fixed amount, inflation will diminish the purchasing power of the payments. (Ex - $1000 today will be worth less than $1000 in 10 years)
The "inflation-adjusted return" is also known as: [A]The real return [B]The internal rate of return [C]The risk free rate of return [D]The risk adjusted rate of return
A The inflation-adjusted return is also known as the real return and equals the rate of return less the rate of inflation.
An investor decides to invest in both domestic equity securities, international equity securities, and some emerging markets. Why would an investor set-up their portfolio in this manner? [A]To lower risk and increase diversification [B]To increase risk and increase profit potential without diversification [C]To take advantage of decreasing domestic values and increasing foreign values. [D]To take advantage of increasing domestic values and decreasing foreign values.
A The investor has securities in both foreign and domestic securities and would want all securities to increase in value. Market diversification reduces risk therefore the best answer is A.
Claude is an investment adviser representative. One of his clients has recently bought and sold into and out of several investments. None of the investments were held for more than 6 months, and the investor is now asking Claude how to best compare the returns. Claude tells the client to annualize the returns. Why is annualizing the returns a good idea? [A]Annualizing the returns would give the client the best representation of each individual investment and allow a better comparison of the performance of all of the investments side-by-side. [B]Annualizing the returns would give the client the exact amount that they would have received if they held the investment for a year. [C]Annualizing the returns would be the same as comparing the holding period returns to a benchmark. [D]Annualizing the returns would give the investor exact representations of the returns which were realized on each investment.
A When an investor has varying holding periods, the investor is best suited to annualize the returns so that an accurate picture of returns can be viewed. By looking at holding period return for only short periods of time without annualizing, the investor may not get the best picture on short-term investments. With holding periods of less than a year (in this case, less than 6 months), adjustments should be made to give an accurate means of comparison, rather than just looking at short-term returns. Annualizing short-term returns does not give an exact representation of realized returns or an exact idea of what the investment may have returned over a longer period of time, it merely puts holding period returns into the context of the year as a whole. Annualizing is not the same as comparing a holding period return to a benchmark.
An IAR at your firm has a client in the 25% federal tax bracket who has a large portfolio of long-term Treasury Bonds with an overall nominal yield on the portfolio of 4%. In reviewing the account, the IAR discovers that the transaction costs associated with the portfolio total roughly 1% and the anticipated rate of inflation for the foreseeable future is 2%. In a meeting with the client, it would be MOST important for the IAR to discuss [A]the fact that the inflation-adjusted return is only 2% after subtracting the 2% rate of inflation and that it is likely to remain at that level for the foreseeable future. [B]a transition to municipal securities to avoid all taxation related to the bond portfolio. [C]the fact that the expected return on the portfolio would be higher than 4% as rates should only really increase from the 4% level. [D]the potential for a transition to an actively-managed bond fund, where sales loads and annual expenses would be lower than 1%.
A With the information provided, the IAR's main concern should be the fact that the rate of inflation (2%) is going to have a significant impact on the inflation-adjusted or real return, which is calculated by subtracting the rate of inflation from the nominal yield of the portfolio.There is no indication that the client is seeking to avoid taxation or seeking to transition to municipal securities from government securities.Expected Return is a projected estimate of return based on various potential market conditions/outcomes. It would not dictate that the return on the portfolio should be exceeding 4%.Though an actively-managed bond fund may provide diversification for the client, there is no indication that the client is seeking higher returns. As well, an actively-managed bond fund will have sales loads and annual expenses that are likely to exceed 1%, which is what the question specifies as the rough transaction cost percentage.
Which of the following measures is used to compare a security's volatility to the market as a whole? [A]R-Squared [B]Beta [C]Alpha [D]Standard Deviation
B A stock's beta measures the security's volatility relative to the market as a whole or relative to a specific benchmark (such as the S&P 500).Alpha measures returns based on fundamentals of a specific company. Standard deviation measures the variance of a portfolio from an expected return (e.g., +/- 3%). R-squared measures a portfolio relative to the overall market.
In the event that a company fails, the preferred stockholders will be paid after all of the following EXCEPT [A]taxes. [B]common stockholders. [C]unsecured debt. [D]secured debt.
B Common stockholders are paid last. They have a "residual" claim on the assets.
A valuation model utilized to anticipate a portfolio's performance is: [A]net present value [B]expected return [C]internal rate of return [D]inflation adjusted rate of return
B Expected return is used to "anticipate" what a portfolios performance will be in the future whereas 'A' and 'C' measure present value and the portfolio's existing return. Inflation adjusted return compares the return on a security to the current rate of inflation.
During the first years after the purchase of a long term investment grade bond, the bond would be most affected by which of the following types of risks? [A]Purchasing Power [B]Interest Rate [C]Market [D]Inflationary
B In the early years of owning a long term bond, the bond would be most sensitive to Interest Rate Risk. As the bond approaches maturity, the Interest Rate Risk diminishes.
A trader has a sizable position in a small capitalization stock with low trading volume. The trader is subject to which of the following types of risk? [A]Market [B]Liquidity [C]Business [D]Inflation
B Liquidity risk would be a major concern for anyone holding a small cap stock with low trading volume.
When an investment adviser structures a portfolio utilizing different asset classes, this primarily reduces the portfolio's: [A]regulatory risk [B]market risk [C]interest rate risk [D]purchasing power risk
B Portfolio management based on reducing market risk generally refers to structuring the portfolio by utilizing different assets to reduce risks in the daily activity in security prices.
An investor holding a block of 30-year Treasury Bonds would be most concerned with which of the following types of risk? [A]credit [B]purchasing power [C]marketability [D]call
B Since the investor has purchased a fixed income security, they would be subject to Purchasing Power risk which is also called Inflationary Risk. This risk considers what the buying power of money invested for long periods of time will be able to buy when it is repaid to the investor at maturity. The longer the maturity, the greater the Purchasing Power Risk.
Which of the following is an example of systematic risk? [A]The price of a corporation's common stock goes down because of changes to regulations for a specific sector. [B]A world-wide economic downturn brings the prices of almost all securities down. [C]A corporation's earnings fall substantially over a business year, leading to a substantial reduction in the price of the corporation's common stock. [D]A corporation goes out of business due to mismanagement.
B Systematic risk is risk that is common to all types of securities and cannot be eliminated by diversification. The only example here that would have an effect on all securities is the world-wide economic downturn, which would negatively affect all securities. Each of the other types of risk is more closely related to a specific company or sector.
Which of the following is FALSE about the current yield on a bond? [A]It is calculated by dividing the annual interest by the current market price of the bond. [B]It is also known as the coupon on a bond. [C]It measures an investor's actual return on investment. [D]It may be different from the yield to maturity of the bond.
B The "coupon" on a bond is the stated interest rate on the bond that is paid annually regardless of the purchase price of the bond.
An investment's performance is best measured by: [A]The investment's yield [B]The investment's total Return [C]The investment's benchmark return [D]The investment's capital appreciation
B The best measure of an investment's performance is the sum of income and capital appreciation, known as total return.
What is the primary difference between current yield and yield to maturity? [A]The yield to maturity is a snapshot of the yield on a bond, while the current yield takes into consideration the time value of money. [B]The current yield is a snapshot of the yield on a bond, while the yield to maturity takes into consideration the time value of money. [C]Yield to maturity should be used by investors who are near retirement, while current yield should be used by investors who have many years until retirement. [D]The two are used to evaluate two different types of investments.
B The current yield of a bond is a snapshot of the bond's yield in relation to the annual interest received on the bond and the current market price. The yield to maturity takes into consideration the time value of money and evaluates the bond's long-term yield considering the bond's price, redemption value, coupon rate, and time to maturity.
Put the following in the proper order of asset distribution upon the liquidation of a corporation: I. Common Stockholders II. Secured Debt III. Unsecured Debt IV. Preferred stockholders [A]II, III, I, IV [B]II, III, IV, I [C]I, II, III, IV [D]III, IV, II, I
B The proper sequence of asset distribution upon the liquidation of a corporation is:1. Secured Debt2. Unsecured Debt3. Preferred Stockholders4. Common Stockholders
In a simplified formula, if a client wants to have a specific payout on a monthly basis for the rest of their lives based on a specific investment and anticipated rate of return, which two of the following would be appropriate formulas to use to find the initial amount that must be invested? I. Investment Amount Required = Monthly Payout / Monthly Expected Return II. Investment Amount Required = Monthly Payout / Annual Expected Return III. Investment Amount Required = Annual Payout / Monthly Expected Return IV. Investment Amount Required = Annual Payout / Annual Expected Return [A]I and III [B]I and IV [C]II and III [D]II and IV
B To find the required investment, you can take the monthly payout and divide by the monthly expected return, or you can take the annual payout and divide by the annual expected return.For example, using the monthly payout and monthly expected return:x = $2,500 / (6%/12)x = $2,500 / 0.005x = $500,000OR the annual payout and annual expected return:x = ($2,500 x 12) / 6%x = $30,000 / 0.06x = $500,000
According to Modern Portfolio Theory, the efficient frontier represents [A]the portfolio with the highest returns over the past twelve months. [B]the portfolio with the highest return for a given level of risk. [C]the asset class with the lowest risk profile. [D]the asset class with the highest risk profile.
B When evaluating portfolio returns, investors will choose the highest return for a given level of risk. This is commonly referred to as the efficient frontier because it represents the best (or optimal) combination of assets that can produce the highest or maximum return for a given level of risk. The efficient frontier is the founding principle of Modern Portfolio Theory. Keep in mind that returns have to be evaluated with the risk level in mind.
A client comes into an IAR's office seeking advice about investing. The client wishes to be able to liquidate investments quickly in order to meet varying cash flow needs on a month to month basis. The client currently has their portfolio centered around large-cap stocks that trade on an exchange or on NASDAQ. Which of the following is true of this scenario? [A]The advisor should inform the client that large-cap stocks on an exchange or on NASDAQ are not thought of as liquid investments. [B]The advisor should inform the client that large-cap stocks on an exchange or on NASDAQ are thought of as liquid investments, and if the investor wished to diversify but keep liquidity, they could do so with investments in Treasury Securities, etc. [C]The advisor should inform the client that large-cap stocks on an exchange or on NASDAQ are not as liquid as other types of investments such as interests in limited partnerships. [D]The advisor should inform the client that they likely do not need the assistance of an investment adviser, because they made the right decision when it came to this particular need for liquidity.
B When it comes to large-cap stocks listed on an exchange or listed on an exchange or on NASDAQ, these stocks are typically thought of as highly liquid. This would suit this investor's needs. These listed or NASDAQ large-cap stocks would be more liquid than other investments such as limited partnership interests. Just because the investor got one investment decision right, it does not mean that they couldn't benefit from the assistance of the IAR, who may be able to help this client maximize returns for their given objectives, etc.
A client buys one share of ABC on January 1st for $200 and sells it for $230 on December 31st. During the year, he receives a dividend of $6 on the share. His total return for the year is: [A]3% [B]15% [C]18% [D]21%
C $230 (sold on 12/31) - $200 (bought on 1/1) = $30 gain + $6 dividend = $36/200 = .180 or 18%
All of the following are a measurement of risk except: [A]Beta coefficient [B]Standard deviation [C]Current yield [D]Sharpe ratio
C Choices 'A', 'B', and 'D' measure the risk factor of an investment whereas Current Yield measures an investment's income.
The process of calculating future value is also called [A]Annualizing [B]Discounting [C]Compounding [D]Amortization
C Compounding is known as the process of calculating future value.
Suzanne is an IA who handles Bobby's account. Bobby is heavily invested in bonds and regularly reviews and calculates the current yield on his bonds. Which of the following would be of greatest concern to Suzanne in relation to Bobby's view of the bonds? [A]Bobby isn't getting an accurate idea of the market value of the bonds. [B]Bobby isn't getting an accurate idea of the nominal yield of the bonds. [C]Bobby isn't getting an accurate idea of the yield to maturity of the bonds. [D]Bobby isn't viewing a valid number when calculating current yield on any bond.
C Current yield is a great snapshot of a bond considering the bond's nominal yield (coupon rate) divided by the bond's current market price. It is a valid tool in analyzing bonds but does NOT give an accurate assessment of a bond's YTM - Yield to Maturity.
When utilizing Net Present Value and/or Internal Rate of Return to evaluate a project or investment, which of the following is primarily used? [A]Amortization [B]Compounding [C]Discounting [D]Accretion
C Discounting and compounding are very similar in nature, but discounting is the primary means of evaluation that is used when discussing Net Present Value (NPV) and Internal Rate of Return (IRR), both forms of Discounted Cash Flow Methodology (DCF).
A client of an investment adviser intends to purchase an RV in order to tour the country. The client is 55 years old and recently retired. He and his wife can afford a monthly payment of $750 per month. The going interest rate on RVs is 7.5% for a 12-year loan. With a monthly payment of $750 on a 12-year loan with an interest rate of 7.5%, approximately how much can this client afford to borrow when buying the RV? [A]With the terms specified, the client can afford a loan amount of approximately $9,000. [B]With the terms specified, the client can afford a loan amount of approximately $9,675. [C]With the terms specified, the client can afford a loan amount of approximately $71,000. [D]With the terms specified, the client can afford a loan amount of approximately $108,000.
C For a question such as this one, you must review the terms of the loan and make an educated guess with relation to the numbers provided. With a monthly payment of $750 per month, the client would pay $9000 in payments per year, so the answers of $9,000 and $9,675 don't make sense and are too low for a loan that spans 12 years. As well, over a 12-year term, at $750 per month, the client would pay a total of $108,000, but remember that this includes paying back the loan PLUS interest. So the loan amount will be less. Because of this, we can reasonably assume that the loan value lies somewhere between the numbers that are far too low, and the overall payout over the life of the loan. The only answer that falls into that category is the $71,000. Using a loan calculator (not available on the exam), the actual payment with the terms specified on a $71,000 loan is $749.21.
Mr. Perfect is heavily invested in municipal bonds. He would be primarily concerned with which of the following types of risk? [A]market risk [B]business risk [C]regulatory risk [D]systematic risk
C If investing heavily in municipal bonds, one would be primarily concerned with regulatory risk. Regulatory risk is the risk that changes in laws, regulations, and tax rates will have a negative effect on investments.
An analyst on a financial television program reports that despite strong performance, personnel at technology companies expect a downturn in that sector. Which of the following risks explain this situation? [A]interest rate [B]business risk [C]market risk [D]liquidity risk
C In this scenario, the fluctuations in pricing of stocks throughout an entire industry would most likely be attributed to market risk for that industry. It is unlikely that all businesses in an industry would have substantial business risk or be thinly-traded. Interest-rate risk would not cause an industry-wide fall in stock prices.
A portfolio which is heavily invested in only a few domestic equity securities would be primarily subject to which of the following types of risk? I. Market risk II. Systematic risk III. Business risk IV. Reinvestment risk [A]I & II only [B]I & IV only [C]I, II, III only [D]I, II, III, IV
C Of the choices offered, the primary risks would include Market or Systematic as well as Business (unsystematic) risk. The least relevant risk offered would be reinvestment risk.
Standard deviation is a measure of which of the following? [A]duration [B]growth [C]return variance [D]total return
C Standard Deviation measures a security's variance from its expected return.
Which of the following investments would have the highest degree of interest rate risk? [A]7% corporate bond maturing in 2010 [B]5% municipal bond maturing in 2010 [C]0 coupon bond maturing in 2010 [D]6% government bond maturing in 2010
C The lower the coupon rate on a bond the more sensitive the price becomes (the duration is higher). Therefore, a zero coupon bond would have the greatest degree of risk or sensitivity.
Which of the following are pieces of the formula which determine the real rate of return on an investment? I. The investment's risk level II. The investment's total return III. The current rate of inflation IV. The investment's internal rate of return [A]I and III only [B]I and IV only [C]II and III only [D]II and IV only
C The real rate of return is the total return of an investment minus the current rate of inflation. It attempts to give investors a picture of their return in relation to the current rate of inflation, showing the investor how inflation is affecting their overall returns.
Which of the following statements are TRUE regarding Dollar-Weighted Return and Time-Weighted Return? I. Dollar-weighted return allows investors to compare the performance of one manager to the performance of another manager. II. Time-weighted return allows investors to compare the performance of one manager to the performance of another manager. III. Dollar-weighted return allows investors to see a snapshot of their overall investments in relation to their financial goals. IV. Time-weighted return allows investors to see a snapshot of their overall investments in relation to their financial goals. [A]I and III [B]I and IV [C]II and III [D]II and IV
C Time-weighted return eliminates the effect of cash flows to give an idea of performance. It is an effective way to measure the performance of portfolio managers to one another as well as to a benchmark. Dollar-weighted return includes cash flows so that the investor can get an idea of the returns and growth of their portfolio in relation to their financial goals. It is not an effective way to compare managers.
One of your clients purchased 100 shares of XYZ common stock at $30 per share. The client sells the shares one year later at $35 per share. Throughout the year, your client received quarterly cash dividends of $0.25 for a total of $1 in dividends. The client's total return on the stock was [A]16.67% [B]17.5%. [C]20%. [D]3.3%.
C Total Return equals all cash distributions during the period that the investment is held. It is the best measure of an investment's performance. In this situation, the cash dividend of $1 per share is added to the capital gains of $5 per share for a total return of $6 per share. To get the rate of return, the $6 is divided by the original cost of the security which was $30 per share. $6 return / $30 investment = 0.20 or 20%
An investor buys 100 shares of ABC at $40 per share. At the end of one year, the investor has received $3.00 in dividends per share and sells the stock at $35. What was the investor's total return? [A](-12.5%) [B]5% [C](-5%) [D]12.5%
C Total return is calculated by taking the increased (or decreased) value dividend by the value at the beginning of the year. $35 - $40 = -$5 + $3 = -$2 or a $2.00 dollar loss. (-$2.00)/40 = -.05 or a 5% loss.
An analyst is attempting to optimize a balanced portfolio for maximum returns with a specified level of risk. Which of the following is TRUE in this scenario? [A]The analyst cannot optimize a portfolio for a specified level of risk. [B]The analyst should only look at company fundamentals for specific stocks found within the portfolio. [C]The analyst should incorporate the expected or mean returns of securities in the portfolio into their optimization strategy. [D]The analyst should focus most of their attention on the maturities of bonds within the portfolio, the yield to maturity of these bonds, and the bonds total return to date.
C When optimizing a portfolio, the expected or mean returns of all securities within the portfolio should be considered. It would be irresponsible to only focus on stocks or bonds.
Which of the following investments are considered to be "liquid"? I. The common stock of a company traded on the NYSE II. Bills and Notes issued by the US Treasury Department III. The common stock of a company traded on NASDAQ IV. Mutual fund shares [A]I and III only [B]II and III only [C]I, II, and IV only [D]I, II, III, and IV
D All of the items listed would be considered liquid investments. Liquidity refers to the ease with which capital invested can be recovered. If an investment is highly liquid, the investor shouldn't have trouble selling it or redeeming it. All of the items listed are considered liquid. If the investment carries high liquidity risk, then the investor may have trouble selling it or redeeming it. Examples of illiquid investments would be limited partnership interests, raw land, thinly traded stocks, etc.
All of the following statements about the "efficient market" theory are TRUE EXCEPT: [A]Prices reflect the combined knowledge and expectations of all investors. [B]It is impossible to "beat the market." [C]It is impossible to find undervalued or overvalued stock. [D]Efficient fundamental and technical research can produce superior investment results.
D The "efficient market" theory is also known as the "random walk" theory and believes that throwing darts will produce as good results as using a professional investment adviser. Therefore, using fundamental or technical research would unlikely produce results as the efficient market hypothesis states that all stocks are appropriately priced and fully reflect their value.
The yield that a saver earns on a bank certificate of deposit and the annualized percentage rate that an auto dealer earns on a car loan are both examples of which types of rate of return? [A]Risk-free Return [B]Expected Return [C]Internal Rate of Return [D]Holding Period Return
D The Holding Period return measures the return on an investment while the investment was held. The length of time held can vary and is not known upon purchase. Here, the length of time that the CD is outstanding and the length of time that the auto loan is outstanding are not specified, but if we are looking for the overall return while either was outstanding, we are looking for the Holding Period Return.
When calculating a stock's value using the dividend discount model, an investor would discount the [A]average dividend amount paid over the past five years. [B]average dividend amount paid over the past five years. [C]the forecasted net income for the company. [D]the forecasted dividend for the company for a stated timeframe.
D The dividend discount model (DDM) is a financial analysis tool that is used to determine the price of a common stock based on potential future dividends. An investor wouldn't plug in historical dividend figures in the model. If the value based on DDM is below the current market price of the stock the investor could conclude the stock is currently overvalued. However, if the DDM value is above the current market price, the investor could conclude the stock is undervalued.