Unit 17
A principal benefit gained by investing in physical real estate is... A) cash flow. B) low leverage. C) low volatility. D) low liquidity.
A) cash flow. **The term physical real estate means that the question is not dealing with a REIT. A significant proportion of real estate investors purchase rental properties. As a result, a major benefit is the cash flow generated from the rental income. We only have to look at the real estate market from 2006 through 2012 to see the volatility of real estate prices. Relative to securities, real estate has low liquidity and most consider that to be a risk rather than a benefit. One benefit of real estate is high leverage, not low leverage.**
When a client is interested in investing in commodities, you would expect to discuss... A) soybeans, wheat, and corn B) museum-quality art C) oil drilling programs D) investment-grade coins
A) soybeans, wheat, and corn **Agricultural products, including soybeans and other grains, are popular commodities.**
An agent must obtain written verification of an investor's net worth for which of the following investments? A) Unit investment trusts B) Direct participation programs C) Real estate investment trusts D) Variable contracts
B) Direct participation programs **DPPs require complete financial disclosure because of minimum suitability standards set by the states in which they are sold. REITs, unit investment trusts, and variable contracts do not have specific net worth suitability requirements for investors.**
Which of the following terms best describes ETNs and leveraged ETFs? A) Speculative investments B) Registered investment companies C) Alternative investments D) Forms of hedge funds
C) Alternative investments **These are two popular alternative investments. Are they speculative? Yes, but there are many other speculative investments that are not considered alternative investments. The question asks for the best description and, although it might seem like a "close call", these are "alts". The leveraged ETF is a registered investment company, but the ETN is not.**
It would be correct to state that an inverse ETF... A) is suitable for sophisticated investors with a long time horizon. B) moves in tandem with the index being tracked. C) utilizes derivatives to achieve its objectives. D) is a form of private equity fund.
C) utilizes derivatives to achieve its objectives. **Inverse, or short, ETFs move in the opposite direction of the index being tracked. To achieve their goals, various types of derivatives are used. This type of ETF is used only for short-term investments, rarely as long as a single month. These are registered investment companies, not private.**
The alternative asset investments class is least associated with which of the following characteristics? A) Illiquidity B) Nonnormal returns C) Diversification D) Efficient pricing
D) Efficient pricing **Alternative assets are most often characterized by inefficient pricing, providing potential abnormal returns or alpha returns. That is the prime reason for their popularity, especially with institutional investors.**
An investor in a high tax bracket who invested in a DPP should have which of the following characteristics? i. Need for tax benefits ii. Substantial liquid assets iii. Ability to identify both risks and merits of the program iv. Ability to commit money for a long time
i, ii, iii, and iv **DPPs are appropriate for investors who can benefit from substantial tax deductions or credits, are not bothered by illiquidity, understand the business risks and benefits involved, and can stay in the program until completion.**
One of your clients is 10 years away from retirement and is trying to decide what would be a suitable investment for this year's IRA contribution. You would probably NOT recommend... A) conservative growth mutual funds B) leveraged ETFs C) target date mutual funds D) broad market ETFs
B) leveraged ETFs **Because most leveraged funds reset daily, they are best utilized by investors with a very short time horizon.**
A number of different pooled investment vehicles are included in the term "alternative investment." One of them, a synthetic investment instrument that has been created to meet a specific need that cannot be met by a standardized financial instrument, is known as A) an inverse fund B) a z-tranche CMO C) a structured product D) an arbitrage
C) a structured product **Structured products are created as a tool to meet the issuer's debt financing needs when they will result in a lower cost than a standardized financial instrument available in the market place.**
An investor bought a parcel of raw land for $50,000 several years ago. A developer has offered to exchange another property, currently valued at $100,000, with this investor. Under Section 1031 of the Internal Revenue Code, the investor's tax consequences would be... A) $0.00. B) $50,000 long-term capital gain. C) $50,000 ordinary income. D) $50,000 short-term capital gain.
A) $0.00. **Section 1031 permits a tax-free exchange of one property for another. This has the effect of deferring any gain until final disposition of the property. This is a parallel to Section 1035 for annuity products.**
Which of the following statements is NOT true? A) Management of the enterprise is solely within the jurisdiction of the general partner(s). B) Limited partners have the option of actively managing the business operations. C) Limited partners are not liable for funds in excess of the amounts they have invested or otherwise committed for. D) It is the general partners rather than the limited partners who bear the liability for partnership debt.
B) Limited partners have the option of actively managing the business operations. **Limited partners are passive investors in a partnership whose liability is limited to the amount of funds they have invested and committed to, but have not yet contributed. They do not manage the funds in the partnership; the general partner has that responsibility.**
In a life settlement, the seller receives more than the premiums paid into the policy but less than... A) the future premiums payable. B) the face amount. C) the cash value. D) the accumulated dividends.
B) the face amount. **The sale price of a life settlement is always more than the cash value and less than the face value.**
Which of the following most accurately identifies a private equity investment in income-producing real estate? A) Investment in a real estate investment trust (REIT) B) Private market mortgage lending by an insurance company C) Direct ownership of real estate properties D) Investment in a real estate mutual fund
C) Direct ownership of real estate properties **Real estate investments take four major forms: private equity, publicly-traded equity, private debt, and publicly-traded debt. Private equity investment in real estate refers to direct ownership of real estate properties. Mortgage lending by banks or insurance companies is best described as private debt. Indirect ownership of real estate through equity securities such as REITs is an example of publicly-traded equity.**
Which of the following investments is least appropriate for a client primarily concerned with liquidity? A) Municipal bond mutual fund B) Bank savings account C) Direct participation program D) Preferred stock
C) Direct participation program **There is little secondary market liquidity for direct participation programs (DPPs); of those securities listed, they are the least appropriate for a client seeking liquidity.**
Which of the following investments is not registered under the Investment Company Act of 1940? A) ETFs B) UITs C) ETNs D) FACCs
C) ETNs **Exchange-traded notes, sometimes called equity-linked notes, are registered under the Securities Act of 1933 as debt instruments. All of the other choices are registered as investment companies under the Investment Company Act of 1940.**
A REIT and a direct participation program are similar because they both... A) can be described as a limited partnership B) are traded actively in the secondary market C) are operated by a centralized management D) pass through losses to investors
C) are operated by a centralized management **Both a REIT and a DPP are run by centralized management. A REIT may not pass through losses to its investors, and it is not a limited partnership. A DPP cannot be easily traded in the secondary market.**
Many investment advisers follow a program of asset allocation. Which of the following categories of assets is most likely classified as an alternative asset? A) Cash B) Preferred stocks C) Callable bonds D) Real assets
D) Real assets **Traditional assets in an allocation program include cash, bonds, and stocks, regardless of the adjective used. Alternative assets include 4 major categories: real assets, hedge funds, private equity, and structured products.**
An investment adviser who is discussing forward contracts with a client would most likely be referring to an investment in... A) an agricultural commodity B) puts and calls C) an equity index annuity D) a diversified portfolio
A) an agricultural commodity **Forward contracts are available on commodities, such as agricultural products (e.g., corn, wheat, and soybeans). Puts and calls are options, not forward contracts; although this could be a way to diversify the portfolio, that does not directly answer the question.**
Someone who wishes to invest in precious metals would consider any of the following EXCEPT... A) gold B) silver C) lead D) platinum
C) lead **Lead is not considered a precious metal.**
One reason for including commodities in an investment portfolio is because they have a high correlation to... A) the bond market. B) the U.S. dollar. C) the inflation rate. D) the stock market.
C) the inflation rate. **Commodity prices tend to have a high correlation with the inflation rate. As inflation goes up, the value of the dollar generally falls. The relationship is inverse, a characteristic of negative correlation. As inflation increases, interest rates invariably do the same leading to a decrease in bond prices. Stock prices have a random correlation to commodities, generally negative.**
You have a 70-year-old client who owns a whole life insurance policy. The face amount of the policy is $1 million and it currently has a cash value of $400,000. The client is interested in a life settlement. If the policy is accepted, the client would expect to receive... A) the $1 million face amount. B) the face amount plus the cash value. C) more than $400,000, but less than $1 million. D) less than $400,000.
C) more than $400,000, but less than $1 million.
The sale of a life insurance policy in the secondary market by a terminally ill individual is known as... A) a viatical settlement B) an unethical trade practice C) a vertical settlement D) a trade in the OTC market
A) a viatical settlement **A viatical settlement is the sale of a life insurance policy to a third party (the investor). The owner (viator) of the life insurance policy sells the policy for an immediate cash benefit. The buyer becomes the new owner of the life insurance policy, pays future premiums, and collects the death benefit when the insured dies. At one time, most viatical settlements were from people with a life-threatening illness. Now, individuals who are not facing a health crisis may sell their life insurance policies to get cash.**
An investor owns an inverse ETF. If the underlying index should decrease in value, A) the fund shares will increase in value B) the fund shares will increase by a factor of 2 C) the fund shares will also decrease in value D) there is no correlation between the fund and the value of the index
A) the fund shares will increase in value **An inverse, or short fund, will move in the opposite direction of the underlying index. If it were leveraged, then it could move at a rate of 2x or 3x, but nothing in the question mentioned leverage.**
You have a client who wishes to allocate a portion of his funds to investment real estate in an attempt to generate additional income. That goal could be reached by investing in any of the following EXCEPT... A) real estate limited partnerships B) rental real estate C) raw land D) REITs
C) raw land **Raw land does not generate income; it is most often held for future capital appreciation.**
An exchange-traded fund whose strategy is to generate performance opposite that of the designated index is called... A) a reverse fund. B) a hedge fund. C) a leveraged fund. D) an inverse fund.
D) an inverse fund. **Inverse ETFs (also called "short" funds) seek to deliver the opposite of the performance of the index or benchmark they track. There are some who call these reverse funds, but the SEC, FINRA, and NASAA do not use that term. Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. There are leveraged inverse funds, but the term "inverse" would have to be in the description. Hedge funds are not exchange-traded.**
Among the differences between an investment in a limited partnership offering and in a corporation is that... A) only corporations are organized to run a business. B) limited partnership offerings do not pay dividends; corporations do. C) only corporations issue securities. D) limited partners take a more active role in the management of the enterprise than do stockholders of a corporation.
B) limited partnership offerings do not pay dividends; corporations do. **One of the key features of a limited partnership investment is the concept of flow-through of operating results. If the business operates at a loss, the limited partner's share of that loss is treated as a passive loss on the investor's tax return. If the business is profitable, the limited partner's share of the profit is treated as passive income. Corporations issue securities, primarily stocks and bonds, while limited partnerships issue units representing the limited partner's interest in the venture. Those units are investment contracts and, as taught in Unit 4, LO4, securities. Limited partners who take an active role in the partnership lose their limited status.**
Which of the following is NOT a characteristic of owning a limited partnership? A) An investment managed by others B) Legislative risk C) Flow-through of income and expenses of a business to the individual limited partner D) Tax-free income
D) Tax-free income **The income from limited partnerships is not tax exempt. An investor, however, may use a tax loss from a partnership to offset the income from another passive investment. In limited partnerships, the investor enjoys the advantages and disadvantages of owning a business without having to actually manage one. Limited partnerships are vulnerable to legislative changes that adversely affect ownership of such investments.**
An alternative investment vehicle that is managed to perform contrary to a benchmark market index such as the S&P 500 is... A) an inverse exchange-traded fund. B) an equity-linked note. C) a leveraged exchange-traded fund. D) a long put on the index.
A) an inverse exchange-traded fund. **Inverse exchange-traded funds are designed to move in the opposite direction of the index they are tracking. They can be leveraged, but the term leveraged can also apply to an ETF that goes in the same direction as the index. A put option on an index will go up in value when the index falls, but it will not rise when the index increases.**
One of the benefits of adding precious metals to an investor's portfolio is... A) generous income. B) low transaction costs. C) a potential inflation hedge. D) a high correlation to the stock market.
C) a potential inflation hedge. **Precious metals are traditionally viewed as a hedge against inflation. One of their benefits is that they have a low correlation with the stock market. Transaction costs for precious metals tend to be higher than securities—the dealer spreads can be relatively high. One significant negative is that these investments generate no income.**
It would not be considered passive real estate investing when buying... A) hybrid REITs. B) mortgage REITs. C) homes and flipping them. D) ABC Home Builders common stock.
C) homes and flipping them. **Real estate investing where the investor works with the property is active rather than passive. In a passive real estate investment, as with any other passive investment, the work is done by others, not the investor. Examples are REITs and stock in real estate companies, such as those who build homes.**
Commodity futures contracts are available on all of the following except... A) soybeans. B) industrial metals. C) single family homes. D) eggs.
C) single family homes. **Commodity futures contracts are available on metals, both precious and industrial, animal products, such as eggs, and agricultural crops, such as soybeans. Single family homes are not a tradeable commodity.**
Which of the following statements regarding the general partner in a direct participation program (DPP) is NOT true? A) A GP has a fiduciary relationship to the limited partners (LPs). B) The general partner (GP) is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations. C) The GP, as the active manager of the partnership, does not maintain a financial interest in the partnership and only receives income distributions from profits on the business prior to the limited partners. D) The GP cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds.
C) The GP, as the active manager of the partnership, does not maintain a financial interest in the partnership and only receives income distributions from profits on the business prior to the limited partners. **General partners (GPs) must maintain a financial interest in the partnership and generally do not receive distributions from profits before those paid to the limited partners. The GP is the active investor in a limited partnership and assumes responsibility for all aspects of the partnership's operations and has a fiduciary relationship to the LPs. The GP, as a fiduciary, cannot borrow from the partnership, compete with the partnership, or commingle personal funds with partnership funds.**
One of your clients is considering allocating about 10% of her portfolio to commodities. Her current portfolio is a mix of stocks, bonds, and broad market index ETFs. Relative to her existing portfolio, you would explain to her that the primary benefit of the commodity investment is most likely.. A) commodity returns have a low or negative correlation to the other assets in her portfolio. B) increased short-term performance. C) lower trading costs. D) an increase in the reliability of income generated in the portfolio.
A) commodity returns have a low or negative correlation to the other assets in her portfolio. **The returns on commodities exhibit low or even negative correlation with stock and bond returns. This is generally cited as a major advantage to investing in commodities. Commodities do not generate income; there are no dividends or interest paid on them - the investor recognizes a gain or a loss, but no income. In general, allocating a small percentage of the portfolio to commodities should be viewed as a long-term strategy, not short-term. There is no evidence that trading costs on commodities are lower than on traditional investments. In fact, it seems likely the opposite is true.**
Among the characteristics of leveraged exchange-traded funds is that.. A) they are generally suitable for investors with a long time horizon B) leveraged ETFs may be purchased on margin C) they can only be sold to accredited investors D) leveraged ETFs generally obtain the leverage through bank borrowing
B) leveraged ETFs may be purchased on margin **Because an exchange-traded fund is purchased and sold on an exchange, the rules generally applying to all exchange products, such as purchasing them on margin, would apply. Leveraged funds use derivative products to generate the leverage, not bank borrowing. When it comes to suitability, they are for aggressive investors, but there is no requirement that they meet the accredited investor standard. However, the very nature of the product is that it is designed for short-term trading, not long-term.**
A feature common to all passive real estate investing is... A) someone other than the investor is doing the management. B) flow-through of operating losses. C) low initial investment requirements. D) high liquidity.
A) someone other than the investor is doing the management. **The concept of passive investing is that, in all cases, someone else is "running the show". Although some passive real estate investments, such as the exchange-traded REIT, are very liquid, others, such as DPPs, are generally not. In the same vein, while one can purchase a REIT for as little as the price of 1 share, a unit in a RELP (real estate limited partnership) can be $25,000 or more. Finally, although DPPs are flow-through vehicles, REITs and ownership of stock in real estate companies are not.**
All of the following are features of limited partnership direct participation programs except... A) the limited partners have limited liability. B) the limited partners may participate in the management of the partnership. C) the general partner controls the business activities of the partnership. D) the general partner determines when distributions are made to the limited partners.
B) the limited partners may participate in the management of the partnership. **Should a limited partner assume a management role, there is the danger that the limited liability protection would be lost and that partner would now have the same unlimited liability of a general partner. It is the general partner who manages the program; the limited partner is a passive investor.**
Many sophisticated investors have added alternative investments to their portfolios. Benefits in doing so would include A) lower expenses than traditional stock and bond investments B) greater regulation than traditional investments such as stocks and bonds C) portfolio diversification D) returns that generally exceed those of traditional stock and bond investments
C) portfolio diversification **Alternative investments, such as limited partnership vehicles and hedge funds, have a tendency to add diversification to a traditional stock and bond portfolio. Many alternative investments have little or no regulation and their expenses are typically high.**
When comparing active to passive real estate investing, the primary benefit to active is... A) a smaller capital commitment. B) liquidity. C) lower risk. D) control.
D) control. **The main benefit of active investing is control. The investor determines what type of projects (e.g., single family home, apartment building, or commercial property) and then selects the specific property or properties. In addition, the management of the property is under the investor's control, even when the decision is to employ third-party management. In some, but not all, passive investments, there is high liquidity. The best example of that is an exchange-traded REIT. A house or apartment building is not usually very liquid. Many passive real estate investments can be made with a small sum; that is usually not the case with active. Finally, because the results of active investing rely greatly on the individual investor rather than with professional management, active real estate investing generally carries higher risk than is the case with passive investing.**
