Series 66 part 1 units 7/8
Present value is a computation frequently used to determine the amount of deposit needed now to meet a future need, such as a college education. If an investor uses an expected return of 8%, but the actual return over the period is 6%, A) the present value was insufficient to meet the objective B) the yield to maturity will be lower than anticipated C) the accumulated value will meet the objectives D) the future value will not be able to be computed
A Explanation Present value is the amount deposited to meet a future goal based on an expected rate of return. If the return is lower than expected, the amount deposited will not grow to the required amount (a bad thing).
If an agent thinks that a technology stock is undervalued and actively solicits all customers, which of the following is TRUE of the agent? A) He committed the unethical business practice of blanket recommendations. B) He did not violate the Uniform Securities Act if all material facts are disclosed. C) He did not commit a violation if all clients are accurately informed of the price of the stock. D) He committed an unethical sales practice because the firm has not recommended this technology stock.
A Explanation Agents must always determine suitability before soliciting purchases or sales. An investment cannot be suitable for all your clients; therefore, the practice of blanket recommendation is unethical.
Under which of the following circumstances may an agent borrow money from a customer? A) If the customer is a bank B) Under no circumstances C) Upon notification to his firm D) With written permission from NASAA
A Explanation An agent may borrow funds from a client who is in the business of lending money.
What is her portfolio's alpha? Did her portfolio outperform the market on a risk-adjusted basis? A) With an alpha of 0.15%, her portfolio outperformed the market. B) With an alpha of -0.15%, her portfolio underperformed the market. C) With an alpha of -5.10%, her portfolio underperformed the market. D) With an alpha of 5.10%, her portfolio outperformed the market.
A Explanation As with most computation questions, there is more than one way to arrive at the answer. Using the steps in the LEM (U10LO4), Alpha - (total portfolio return minus risk-free rate) minus (portfolio beta times [market return minus risk-free rate]). Plugging in the numbers, we have (9% - 3%) - (.65 times [12% minus 3%]) = 6% - (.65 x 9%) = (6% - 5.85% = 0.15%
Which of the following items would be included in a current ratio computation? A) Accounts payable, wages payable, and short-term debt B) Accounts receivable, inventory, and long-term debt C) Cash, dividends payable, and shareholders' equity D) Inventory, equipment, and cash
A Explanation Current ratio is computed by dividing current assets by current liabilities. Current assets include cash, accounts receivable, and inventory. Current liabilities include accounts payable, wages payable, dividends payable, and short-term debt. Equipment is a fixed asset, and shareholders' equity is net worth.
When does a deliberate omission of a fact in a securities sale constitute fraud? A) If a reasonable person would base an investment decision on the omitted information B) Only if the information was known to be true C) Only when a new issue of securities is being offered D) Anytime the information is known by more than 15 people
A Explanation Deliberate omission of a fact constitutes fraud if the omitted information is material in nature (i.e., if a reasonable investor would use the information in making an investment decision). This is true whether the information is made in connection with a primary offering or a secondary market transaction.
All of the following activities could result in the revocation of an agent's registration EXCEPT A) failing to state all known facts about an investment when presenting it to a client B) borrowing from retail customers C) making recommendations based on material nonpublic inside information D) excessively trading for the purpose of generating commissions
A Explanation Failure to state all known facts about an investment is not a violation of the Uniform Securities Act; omitting material facts, however, would be a violation of the act. Excessive trading, making recommendations on material nonpublic information, and borrowing from retail customers are prohibited business practices that could result in revocation of a registration
Under the NASAA Model Rule on Custody Requirements for Investment Advisers, an investment adviser would be permitted to maintain custody of customer cash and/or securities if A) notification was given to the Administrator and custody was not prohibited by that state's rules B) permission was obtained from the Administrator and custody was not prohibited by that state's rules C) the IA maintained net worth of at least $10,000 D) customer permission was obtained prior to entering into the contract
A Explanation In order to maintain custody, notification must be given to the Administrator and, obviously, the state must not have a rule forbidding custody. Does the customer have to approve of the custody arrangement? Yes, but that is done AT the time of entering into the contract, not before. What about net worth? Under the USA, in order to maintain custody, an IA must have net worth in the amount of no less than $35,000, or provide a suitable surety bond.
You recently took a trip to Warsaw, Poland, and when you received your credit card statement, you noticed that your vodka purchase for 100 Polish Zlotys resulted in a $30 charge on your statement. Based on this exchange rate, each dollar was worth approximately A) 3.33 Zlotys B) $3.33 C) 3 Zlotys D) $.33
A Explanation When making an investment (or a transaction) in a foreign currency, it is important to be able to translate that into the exchange rate for your home currency. To do so, we divide the purchase in the foreign currency by the charge in U.S. dollars. In this case, 100 Zlotys only cost us $30, so that makes each dollar worth 3.3 Zlotys.
If an investor wanted to verify a company's working capital, she would do so by reviewing their A) balance sheet B) income statement C) cash flow statement D) footnotes
A Explanation Working capital, current assets minus current liabilities, is determined from numbers found on the balance sheet.
Which of the following statements are TRUE of a discretionary account at a broker-dealer's? The opening must be approved by a supervisory person of the firm. It must be reviewed frequently. A discretionary order may be placed once the customer has placed a power of attorney in the mail. It must be approved by the SEC. A) III and IV B) I and II C) II and IV D) I and III
B Explanation A new discretionary account must first be approved by the appropriate supervisory person, orders must be approved on the day of the trade, and the account must be reviewed frequently for suitable activity. The written authorization must be in hand before any discretion may be exercised.
Plymouth Standard's common stock has an average return of 12%; its returns fall within a range of -2% to +26% approximately 68% of the time. Which one of the following numbers is closest to the standard deviation of returns of Plymouth Standard's stock? A) 8% B) 14% C) 19% D) 28%
B Explanation A standard deviation of 14% means an investor can expect a return on an investment to vary ±14 from the average return approximately 68% of the time. A return of +26% minus the 12% average return equals 14%. Likewise, the difference between the -2% return and the average of 12% is also 14%.
When referring to a federal covered investment adviser, all of the following are supervised persons EXCEPT A) the chief securities analyst B) an individual contracted to solicit for new advisory clients C) an investment adviser representative D) the receptionist who works for the investment adviser and analyzes client financial profiles
B Explanation All individuals working for an investment adviser who provide investment advice or management are considered supervised persons. Whether analyzing securities or customer profiles, one would be a supervised employee. Contracted solicitors are not employees of the adviser and, therefore, under the Investment Advisers Act of 1940, the adviser is only required to make a bona fide effort to determine that the solicitor complies with the solicitor agreement. Please be careful because this is not so under the USA. That act considers solicitors to be supervised persons, whether employed by the adviser or not, and requires IAR registration.
A portfolio manager considers adding an asset to the portfolio. The manager decides between 4 equally-risky assets: W, X, Y, and Z. The correlations of each asset with the portfolio are: Asset W +0.90 Asset X +0.80 Asset Y +0.40 Asset Z +0.20 To achieve the optimal diversification benefits, which of the assets should be selected by the manager? A) Asset W B) Asset Z C) Asset Y D) Asset X
B Explanation Correlation runs from + 1.0 to - 1.0. A the higher the correlation, the more the securities move in tandem. That lessens the diversification. The reverse is true when the correlation is low or negative. Asset Z has the lowest correlation with the portfolio and will therefore provide the largest reduction in portfolio risk. Even better diversification would be obtained if there was a choice with a negative correlation.
The time value of money is part of the computation for A) the real rate of return B) the internal rate of return C) the risk-adjusted return D) the after-tax return
B Explanation One of the unique features of IRR is that it is a compounded rate using the time value of money.
Moonglow Specialties, Inc., is currently trading at $20 per share. Recently, the company reported net income of $1 million. The company is capitalized with 200,000 common shares and $5 million of 20-year debentures with a coupon of 4%. Given the data, Moonglow's price-to-earnings (P/E) ratio is closest to A) 2 times. B) 4 times. C) 3 times. D) 5 times.
B Explanation P/E ratio = market price per share ÷ earnings per share. Earnings per share = net income ÷ shares = $1 million ÷ 200,000 shares = $5. P/E = 20 ÷ 5 = 4. The net income is after all expenses including the interest on the debentures. As is frequently the case, the question includes information irrelevant to the answer.
The price-to-earnings ratio A) is higher for value stocks than for growth stocks B) shows how much investors value the stock as a function of earnings to the company's market price C) reflects how liberal the company's dividend policies are D) indicates current cash flows
B Explanation The 2 components of the price-to-earnings ratio are the current market price and the earnings per common share. When a company has a high P/E ratio, it means that investors are placing greater value on expected growth in earnings. That is one of the reasons why growth stocks carry higher P/E ratios than do value stocks.
If an analyst wished to determine the degree to which leverage was being employed by a subject company, she would most likely examine that issuer's A) debt-to-equity ratio B) current ratio C) sales-to-debt ratio D) price-to-book ratio
B Explanation The debt-to-equity ratio is computed by dividing the issuer's long-term debt by their total capitalization. The higher the ratio, the more leverage is being used by the company.
Steve and Haley, ages 48 and 45, respectively, invest in large-cap stocks, international stock mutual funds, and real estate. They consider themselves moderately aggressive investors. Their investment portfolio is subject to all of the following risks except A) currency risk. B) default risk. C) systematic risk. D) business risk.
B Explanation Their investment portfolio is subject to all of these risks except default risk. Default risk primarily applies when holding debt securities. A portfolio heavily concentrated in equity securities is going to have market (systematic) risk. Business risk is the risk that a company's managerial decisions or even factors out of its control, such as expiration of a patent, may negatively affect the value of an equity investment. By holding investments in international stock mutual funds, they are subject to exchange rate risk.
Lamar is an investment adviser representative for Southeast Retirement Advisers (SRA), a wholly owned subsidiary of Southeast Retirement Solutions (SRS), a broker-dealer registered in a number of southeastern states. Lamar is also a registered agent with SRS. If one of Lamar's advisory clients sends a check made payable to SRS for a stock purchase, under NASAA's Model Rule on Custody A) Lamar would have to post a surety bond in the amount of $35,000 B) SRA is considered to be maintaining custody of client funds and securities C) SRA would be in violation of the NASAA requirement to use a qualified custodian D) Lamar is considered to be maintaining custody of client funds and securities
B Explanation Under the NASAA Model Rule, when an investment adviser uses an affiliated broker-dealer as its qualified custodian, the adviser is considered to be maintaining custody. Therefore, receipt of a check made payable to the BD is acceptable (it does not have to be forwarded). IARs would never take custody, and there is no bonding requirement for IARs.
While searching for a suitable investment for your client, you narrow the choice to the following four companies. Company A with returns over the past 4 years of: 12%, 4%, 8%, 6% Company B with returns over the past 4 years of: 7%, 8%, 9%, 6% Company C with returns over the past 4 years of: 10%, 12%, −2%, 10% Company D with returns over the past 4 years of: 15%, 20%, −8%, 3% Which of these choices has the highest volatility? A) Company B B) Company C C) Company D D) Company A
C Explanation Although the exam will not ask you to compute standard deviation, you are required to know that it measures the deviation from the mean (average). In all 4 of these examples, the mean is 7.5% (30 divided by 4). In which of the choices do the returns occur furthest from that mean? In choice D, they range from 12.5% higher to 15.5% lower. In choice A, the range is from 4.5% higher to 3.5% lower; in choice B, from 1.5% higher to 1.5% lower; in choice C, from 4.5% higher to 9.5% lower. That should clearly point out that the greatest volatility, or dispersion from the mean is choice D while choice B would have the lowest standard deviation.
Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, which of the following practices is appropriate for an adviser who does not have custody or discretion over clients' assets? A) Vanessa discusses a security with a client who agrees it is a good buy. A short time later, she learns shares are available and purchases them for the client. B) Without authority, Shawna trades a security that is losing heavily for a similar security that she had recently discussed with her client. C) Tom manages 35 clients who suffer financial loss while he is trying to contact them for authorization to trade. D) Chris purchases shares of a stock without discussing it with his client. The client had previously agreed to buy another stock, but at the time of purchase, it was losing heavily. To spare his client from a loss, Chris purchased the stock.
C Explanation An investment adviser must have a client's authority before placing an order for a purchase or a sale. Discretionary authority must be in written form with two exceptions. First, if the client has determined the specific security and the amount to be transacted, leaving discretion as to price and timing only; and second, if the client has agreed to give the adviser written authority over the account within 10 business days by way of an advisory contract or discretionary agreement. Neither of these cases applies to Vanessa, Shawna, or Chris, who all traded without proper client authority. Only Tom acted properly.
All of the following statements regarding an investment's internal rate of return (IRR) are true EXCEPT A) IRR expresses the rate of interest that matches the initial investment with the present value of future cash flows B) investments are acceptable when their internal rates of return exceed the investor's required rate of return C) IRR is most often used with growth stocks D) IRR is the one rate of return that results in an investment having a net present value (NPV) of 0
C Explanation It is possible, although very difficult, to calculate IRR for investments with uneven cash flows such as growth stocks where dividends are generally not reliable. IRR is the rate of interest that equates the initial investment with the present value of future cash flows; it is the rate of return that results in an investment having a net present value of 0.
The future value of an invested dollar is dependent on the exchange rate of the dollar at the beginning and end of the period interest rate at maturity the rate of return it earns the time period over which it is invested A) I and II B) I and III C) III and IV D) II and III
C Explanation The future value of a dollar reflects the interest rate it earns over a period of time. The rate of foreign exchange is not related to or used in the calculation of the future value of a dollar.
The financial ratio that shows the relationship between the price of a company's stock and the company's net worth (stockholders' equity) is A) the price-sales ratio B) the price-earnings (P/E) ratio C) the price-to-book-value ratio D) the dividend discount ratio
C Explanation The price-to-book-value ratio is calculated by dividing the price per share by the stockholders' equity per share. This ratio shows the relationship between a company's stock price and the company's book value.
Which of the following statements regarding an investment adviser's use of a full-service broker for an account over which the adviser has investment discretion is TRUE? A) Sales incentives, such as free vacations, may be taken into consideration by the adviser in determining whether to use a full-service broker. B) A full-service broker may be used only if the broker is not affiliated with the adviser. C) A full-service broker may be used if the charge is reasonable in relation to the advice, analyses, or other services provided. D) A full-service broker may not be used for any transaction that could be done by a discount broker.
C Explanation Use of a full-service broker to effect transactions, for an account over which an adviser has investment discretion, is not a breach of fiduciary duty, provided the full-service broker's commission is reasonable in view of the services he provides. Services include advice, analyses, research, and custodial services, but not sales incentives offered to the adviser; investment advisers are required to disclose this fact on the ADV Part 2A.
Bond X has an internal rate of return (IRR) of 7%. Bond Y has an IRR of 9%. Both bonds pay interest semiannually. If the required rate of return is A) 7%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. B) 9%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. C) 7%, the net present value (NPV) of Bond Y will exceed the NPV of Bond X. D) 9%, both bonds will have a positive NPV.
C Explanation We know that when a bond's IRR equals the required rate of return (the discount rate), the NPV of that bond is zero. That is the case with Bond X when the required rate of return is 7%. When the bond's IRR is above the required rate of return, it has a positive NPV. That is the case with Bond Y whose IRR is higher than the 7% required return. With a required return of 9%, Bond X has a negative NPV and Bond Y's NPV is zero. That is the technical explanation. The simple explanation is to compare the IRR with the required rate of return. Anytime the IRR is above the required rate, you've got a good deal (and that is what a positive NPV tells us).
Which of the following would justify an investment adviser's use of a full-service broker? Obtaining special reports dealing with economic projections from the broker Expense-paid business trips paid for by the broker The use of the research analysis provided by the broker A) II and III B) I, II, and III C) I and II D) I and III
D Explanation Full-service brokerage firms often provide research reports, securities and portfolio analysis, and special reports without specific charges, but are usually compensated by their higher commissions. Nothing in industry rules prevents an adviser from using a full-service broker to effect customer transactions. However, it would be unethical if the adviser were to benefit personally from the direction of the client business.
An investment adviser runs an advertisement in the business section of the local newspaper. The ad describes the nature of the firm's model portfolio and indicates that it has outperformed the overall market by 800% over the past 10 years, and the firm therefore guarantees that clients will more than keep pace with inflation. At the bottom of the ad, in smaller print, is the following statement: "Results are not guaranteed. Past performance is not indicative of future results. These results are not normal and cannot be expected to be repeated." This is an example of A) a violation of an investment adviser's fiduciary responsibility B) a properly worded disclaimer C) a wrap fee account D) an improper hedge clause
D Explanation Hedge clauses may not be used to disclaim statements that are inherently misleading.
Under the Investment Advisers Act of 1940, a cash referral fee may be paid by an IA A) under no circumstances B) only if the referring party is registered as an IAR C) with no restrictions D) when a written agreement providing certain disclosures has been entered into between the IA and the third party
D Explanation Please note that the question refers to the Investment Advisers Act of 1940; this answer would not be appropriate under the Uniform Securities Act. A cash referral fee may be paid under the terms of a written agreement spelling out the terms and conditions of the arrangement and making the required disclosures.
The Administrator may, by rule, A) suspend the registration of a federal covered adviser because the contract did not meet the requirements for a state-sanctioned investment advisory contract B) allow an agent to waive provisions of the USA C) suspend federal law if the Administrator believes it to be in the public interest D) forbid investment advisers registered in that state from taking custody of client funds
D Explanation The Administrator has considerable discretion to make rules or issue orders. Specifically, the USA allows the Administrator to prohibit custody by rule. However, the USA does not allow the Administrator to waive provisions of the USA, nor can the Administrator suspend federal law. The NSMIA took away the power of the states to regulate federal covered advisers except in the case of a violation of the antifraud statutes.
Under the Insider Trading and Securities Fraud Enforcement Act of 1988, which of the following are insiders for purposes of insider trading? Attorney who writes an offering circular for a company An investor holding 4% of the company's stock The next-door neighbor of a board member of a company Brother of a company's president A) I and III B) II and IV C) II and III D) I and IV
D Explanation The Securities Exchange Act of 1934 defines an insider as an officer, director, or stockholder owning more than 10% of a company's outstanding voting equity. The definition also includes anyone else who has or could have access to insider information, such as immediate family members. Merely being someone's neighbor does not automatically classify someone as an insider. Any professional who takes part in preparing the registration statement is automatically considered to have insider information.
Assume Frank has a portfolio with an actual return of 10.50% for the past year. The portfolio beta equals 1.25, the return on the market equals 9.75%, and the risk-free rate of return equals 3%. Based on this information, what is the alpha for Frank's portfolio and did it outperform or underperform the market? A) +9.1875%, outperform B) +3.3750%, outperform C) −1.6875%, underperform D) -.9375%, underperform actual return - [risk-free rate + beta x(market return - RF)]
D Explanation The alpha for Frank's portfolio equals −.9375% indicating that his portfolio underperformed the market based on the level of assumed investment risk. Let's do the computation. Alternatively some might prefer this formula for alpha: alpha = actual return - [risk-free rate + beta x(market return - RF)]. If we plug in the numbers, we get .105 - [.03 +1.25 x(.0975 - .03)] = −.009375, or−.9375%.
The present value of a dollar A) cannot be calculated without knowing the level of inflation B) is the amount of goods and services the dollar will buy in the future at today's rate price level C) is equal to its future value if the level of interest rates stays the same D) indicates how much needs to be invested today at a given interest rate to equal a specific cash value in the future
D Explanation The present value of a dollar will indicate how much needs to be invested today at a given interest rate to equal a cash amount required in the future.
Which of the following is a stock valuation ratio? A) Operating profits to net sales B) Dividend payout ratio C) Revenues to assets D) Price-earnings
D Explanation The price-earnings (PE) ratio is a valuation ratio used to calculate the value of a stock. For example, if a stock has a PE of 20, it means that the security is priced at 20 times earnings.
The financial ratio that shows the relationship between the price of a company's stock and the company's net worth (stockholders' equity) is A) the price-earnings (PE) ratio. B) the dividend discount ratio C) the price-sales ratio D) the price-to-book-value ratio
D Explanation The price-to-book-value ratio is calculated by dividing the price per share by the stockholders' equity per share. This ratio shows the relationship between a company's stock price and the company's book value.
Which of the following actions by an agent would NOT constitute fraud as defined in the Uniform Securities Act? A) Executing a trade for a customer at a price that is unrelated to the current market B) Executing a trade for a customer without the customer's knowledge C) Purchasing a security on an exchange and simultaneously selling it on another exchange to create the impression of increased trading volume. D) Purchasing a security for the account of a client and then buying 100 shares of it for her own account
D Explanation There is nothing illegal about an agent purchasing stock for her own account after a trade in that security is made in a customer's account. Depending on the circumstances, it could be a problem if the agent bought first and then executed customer orders. The other activities are all fraudulent.
