Ch 11 Investment Vehicles

Question 1

True or False: A Section 3(c)(7) hedge fund may contain performance-based fees.

Answer 1

True. However, investors should understand the fee structure of a hedge fund.

Question 2

Who assumes the investment risk in a variable insurance contract?

Answer 2

The client

Question 3

An investor writes 1 DEF May 55 Call at 6. What is the investor’s strategy?

Answer 3

Bearish

Question 4

Which annuity payout option provides for the greatest monthly payment?

Answer 4

Straight-life

Question 5

Identify the risk of existing bond prices declining while interest rates are rising.

Answer 5

Interest rate risk

Question 6

An investor buys 1 XYZ Dec 70 call at 4 and buys 1 XYZ Dec 70 put at 4. What is the investor’s strategy?

Answer 6

Volatility

Question 7

Describe inflation or purchasing power risk.

Answer 7

The risk that today’s investment will not be worth as much when the money is received in the future.

Question 8

May hedge funds sell stocks short and use margin?

Answer 8

Yes

Question 9

If exercised against, the writer of an equity call option is obligated to _____ the underlying stock.

Answer 9

sell

Question 10

A _____________ plan has no contribution limit.

Answer 10

non-qualified

Question 11

What is a derivative?

Answer 11

A financial product that derives its value from the value of underlying assets such as stocks, bonds, or mortgages

Question 12

Copper, lead, tin, and zinc are considered ___________________.

Answer 12

non-precious metals.

Question 13

An investor buys a March corn contract at $6.00. If the contract is later closed out at $6.05, what is the profit/loss?

Answer 13

$250 ($.05 x 5,000).

Question 14

Identify the acronym: TSA

Answer 14

Tax-Sheltered Annuity (a qualified contract)

Question 15

Identify the position: An investor sells 1 ELG May 75 call at 6 and sells 1 ELG May 75 put at 6

Answer 15

A straddle, which is the purchase or sale of both a call and a put with the same stock, expiration, and strike price

Question 16

True or False: Cash forwards can be for any amount of a commodity.

Answer 16

True. Cash forward transactions are negotiated between a buyer and seller and can be for any amount.

Question 17

Traditional contract assets are placed in the insurance company’s __________ account.

Answer 17

general account.

Question 18

To invest in a limited partnership, an investor must complete the _____________ __________.

Answer 18

Subscription Agreement.

Question 19

What is not considered a derivative?

Answer 19

Mutual funds, stocks, bonds, and notes

Question 20

True or False: Limited partners are taxed when they receive a distribution from the partnership.

Answer 20

False. Partners are taxed in the year in which the income is reported, not in the year in which it is received.

Question 21

An investor buys 100 shares of IBM at 91 and also 1 IBM Nov 90 put at 2. Is the investor bullish or bearish on IBM?

Answer 21

Bullish since they are long the stock. The put is purchased to protect downside risk.

Question 22

Bill shorts July soybeans at $15.00. If he later covers the sale at $15.25, what is his profit/loss?

Answer 22

Since soybean futures have 5,000 bushels/contract and Bill lost $.25/bushel, his total loss is $1,250 ($.25 x 5,000).

Question 23

Do long-term bonds have higher or lower interest-rate risk?

Answer 23

Higher

Question 24

Which of the following is not a security: an equity-indexed annuity, variable life policy, bank stock, or swap contract?

Answer 24

Equity-indexed annuities are a type of fixed annuity and are therefore not securities.

Question 25

A put option gives the owner the right to ______.

Answer 25

sell.

Question 26

The money invested in a variable annuity is used to buy _____________ _____.

Answer 26

accumulation units (similar to mutual fund shares).

Question 27

An investor wants to invest in bonds so she can buy a car in two years. What is an appropriate recommendation?

Answer 27

Buying bonds with less than two years to maturity would be best. Money-market securities would also be suitable.

Question 28

At annuitization (payout), accumulation units are exchanged for __________ units.

Answer 28

annuity units.

Question 29

An investor holds 1 XYZ January 80 Put at 5. What is her breakeven point?

Answer 29

80 - 5 = 75 (strike price minus premium or PUT DOWN)

Question 30

True or False: LEAPS and interest rate swaps are derivatives.

Answer 30

True. Both LEAPS and swaps are derivatives.

Question 31

Define duration.

Answer 31

The measure, expressed in years, of a bond's price sensitivity to interest rate changes

Question 32

Identify the acronym: AIR

Answer 32

Assumed Interest Rate

Question 33

True or False: An investor may lose money when investing in an equity-indexed annuity.

Answer 33

False. Equity-index annuities have a guaranteed minimum rate of return.

Question 34

What are the two main uses of futures?

Answer 34

The two main uses are hedging and speculation.

Question 35

Identify the acronym: EIA

Answer 35

Equity-Indexed Annuity (also known as an Equity-Indexed Contract or EIC)

Question 36

An investor writes 1 DEF May 55 Call at 6. Later at expiration, if DEF has fallen to 53, is there a gain or loss?

Answer 36

A $600 gain on the premium

Question 37

True or False: A registered representative (RR) may present variable annuity performance projections.

Answer 37

False. Projecting variable annuity performance is prohibited.

Question 38

True or False: Investors sell covered options in order to generate income.

Answer 38

True. By selling the option, the seller is immediately credited with the premium.

Question 39

In a limited partnership, when is a limited partner taxed on any generated income?

Answer 39

In the year in which the income is reported (declared)

Question 40

Is registration required for a Section 3(c)(1) hedge fund?

Answer 40

No. Section 3(c)(1) hedge funds are exempt from registration under the Investment Company Act of 1940.

Question 41

True or False: The market price of closed-end shares could be higher, lower, or equal to the NAV.

Answer 41

True. Shares can trade at a premium or discount to NAV based on supply and demand forces.

Question 42

Define futures contract.

Answer 42

An agreement to buy or sell a specific amount of a commodity on a stipulated date in the future

Question 43

True or False: Variable annuities are subject to registration requirements of the Act of 1933 and sold by prospectus.

Answer 43

True

Question 44

Who assumes the investment risk in a traditional insurance contract?

Answer 44

The insurance company

Question 45

An investor writes 1 DEF May 55 Call at 6. What is the breakeven point?

Answer 45

55 + 6 = 61 (strike price + premium or CALL UP)

Question 46

True or False: Income Programs purchase already producing wells, but offer few intangible drilling costs.

Answer 46

True

Question 47

Define insured.

Answer 47

The person whose life is covered by an insurance contract

Question 48

True or False: An investor who has already annuitized a variable annuity may roll it over into an IRA.

Answer 48

False. Once annuitization begins, a rollover is no longer permitted.

Question 49

Which interest rates are generally more volatile?

Answer 49

Short-term rates

Question 50

True or False: Closed-end fund shares are valued at their NAV at the close of the market each day.

Answer 50

False. Closed-end shares are priced intraday. They trade constantly at a prices that may be discounts or premiums to NAV.

Question 51

An investor holds 1 XYZ January 80 Put at 5. What is her strategy?

Answer 51

Bearish (to find strategy for put buyers, use the phrase PUT DOWN)

Question 52

Describe a whole life policy.

Answer 52

A policy providing death benefit protection for life or to age 100, cash value, level death benefit, and level premium

Question 53

Does a term life policy have cash value?

Answer 53

No. Term life is pure insurance.

Question 54

What is a fund of funds?

Answer 54

A mutual fund that invests in other multiple hedge funds

Question 55

The ________________ the duration, the greater the bond's price sensitivity.

Answer 55

longer/greater

Question 56

May a firm advertise a hedge fund being offered through a Reg. D private placement to the general public?

Answer 56

Yes. Under Rule 506(c), general advertising is permitted; however, sales are limited to accredited investors.

Question 57

What is a 1035 Exchange?

Answer 57

A tax-free exchange of one annuity for another. These exchanges are allowed under Section 1035 of the Tax Code.

Question 58

Does an equity-indexed annuity transaction require the delivery of a prospectus?

Answer 58

No, these contracts are not considered securities by the SEC.

Question 59

True or False: To hedge a stock position, buying options provides more protection than writing options.

Answer 59

True. When long stock, investors may buy a put. When short stock, investors may buy a call.

Question 60

If a client's goal is preservation of principal, what fund would be most appropriate?

Answer 60

Money-market fund

Question 61

Describe whole life insurance.

Answer 61

A life insurance policy that has a fixed death benefit, fixed premium payments, and builds cash value over time

Question 62

What is the primary benefit of including insurance in a financial plan?

Answer 62

To transfer to an insurance company the risk of losing a person's wages due to death

Question 63

What payout option requires the insurance company to provide payments for as long as one of two people remain alive?

Answer 63

Joint and Last Survivor

Question 64

What type of oil and gas program drills for new oil reserves in unproven areas?

Answer 64

Exploratory (wildcatting)

Question 65

Is a person who invests in a variable annuity more susceptible to legislative risk or investment risk?

Answer 65

Investment risk, since the separate account of a variable annuity fluctuates with the overall performance of the market

Question 66

What is easier to offset, a futures contract or a cash forward?

Answer 66

Futures contracts are easier to offset; forwards are generally non-transferrable.

Question 67

A 62-year-old investor makes a full withdrawal from her non-qualified fixed annuity. What is the tax consequence?

Answer 67

She is taxed on the earnings at her ordinary income rate.

Question 68

Which contracts trade on centralized exchanges—futures or forwards?

Answer 68

Futures