Chapter 1-5 Missed Q Bank Questions

Question 1

With respect to the specific commodity that is the subject of the contract, all of the following are standardized parts to an exchange-traded futures contract

Answer 1

It is the delivery price that is standardized, not the market price (which is continuously fluctuating). Exchange-traded futures contracts offer standardized quantities and qualities (grade of the commodity), as well as a standardized time for delivery.

Question 2

When contrasting preemptive rights and warrants, it would be correct to state that, at issuance,

Answer 2

rights have intrinsic and time value while warrants only have time value.

At the time of issuance, preemptive rights always offer the stock at a price below the current market, thus creating intrinsic value. Although rights rarely are effective for longer than 45–60 days, that does represent time value. On the other hand, warrants are always issued with an exercise price above the current market (no intrinsic value) but do have time value.

Question 3

3 statements about mutual funds

Answer 3

1- The sale of open-end investment company shares is a continuous public offering and must be accompanied by a prospectus.

2- Mutual fund shares may not be purchased on margin because their shares are always public offerings of new shares.

3- Mutual funds may be used as collateral in a margin account if they have been owned for more than 30 days.

4- Minimum assets to have public offering is $100k

Question 4

Which type of risk is a mortgage-backed security most likely to experience?

Answer 4

A mortgage-backed security, such as a Ginnie Mae, is most likely to experience reinvestment-rate risk. As mortgages are paid off early and refinanced in the event of declining interest rates, the interim cash flows received from the obligation must be reinvested in lower-yielding securities. This is the practical effect of prepayment risk.

Question 5

Which of the following is correct regarding zero-coupon bonds?

Answer 5

Zero-coupon bonds are sold at a deep discount from par value and have no coupon payments. Because there is nothing to reinvest, there is no reinvestment risk. That is why many investors prefer zero-coupon bonds for specific goals, such as college education for children. The tradeoff is that no coupon also means higher interest rate risk. These bonds have maximum price volatility and respond sharply to interest rate changes.

Question 6

Which of the following is a direct obligation of the U.S. government?

Answer 6

Ginnie Maes are backed by the full faith and credit of the United States. Other agencies have a moral, but not direct, government backing. Government bond mutual funds are not backed by the U.S. government.

Question 7

The fee charged by some mutual fund companies if shares are redeemed within a specified time after being purchased is known as

Answer 7

a contingent-deferred sales charge.

Some mutual funds impose contingent-deferred sales charges (CDSC) on investors who redeem their shares within a specified period after purchasing them. These fees are designed to encourage investors to leave their money in the fund for longer periods. Typically, the amount of the contingent-deferred sales charge decreases the longer the investor owns the shares.

Question 8

When a corporation domiciled in the United Kingdom issues U.S. dollar–denominated bonds in the United States, it is issuing

Answer 8

Yankee bonds are foreign bonds, denominated in U.S. dollars and issued in the United States by foreign banks and corporations.

ADRs are issued in the United States by domestic banks and represent receipts for securities traded on foreign exchanges.

Eurobonds are issued by a borrower in a foreign country, denominated in a currency other than one native to the issuer’s country.

Aren’t Yankee bonds a form of eurobond? Yes they are, but when given a choice like this, the exam will always be looking for the more specific response. In this question, the specific type of eurobond is the Yankee bond and that is why it is the correct choice.

Question 9

Net asset value per share for a mutual fund can be expected to decrease if

Answer 9

The fund has made dividend distributions to shareholders. Net redemptions have no effect on the net asset value, because the money paid out is offset by a reduced number of shares outstanding.

Question 10

Which of the following investments is not registered under the Investment Company Act of 1940?

Answer 10

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.

Question 11

It would be correct to state that an inverse ETF

Answer 11

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.

Question 12

Which of the following strategies would be considered most risky in a bull market?

Answer 12

Writing naked calls provides unlimited liability and the most risk. Buying a call would be an attractive strategy in a bull market with risk limited to calls paid. Writing naked puts risks only the difference between the strike price and zero, less any premium received. Buying a put is a bearish strategy with risk limited to the amount paid for the put.

Question 13

mutual fund’s expense ratio

Answer 13

A mutual fund’s expense ratio is calculated by dividing its expenses by its average annual net assets. For example, if the fund had net assets of $100 million and its annual expenses are $1 million, the expense ratio is $1 million divided by $100 million = 1%.

Question 14

An investor owns five DEF call options with a strike price of $40. The options are European style. If the holder exercises, the cost will be

Answer 14

20k - Each option contract represents 100 shares. Exercising five call options means buying 500 shares at a price of $40 each, which equals $20,000. Although it is true that European-style options are exercisable only at expiration, nothing in the question indicates the investor tried to exercise before then.

Question 15

A mutual fund must redeem its tendered shares within how many days after receiving a request for their redemption?

Answer 15

The seven-day redemption rule is required by the Investment Company Act of 1940.

Question 16

A mutual fund’s computed NAV on April 24 was $100 per share. On April 25, the portfolio realized gains of $2 per share and enjoyed $1 per share in unrealized appreciation. What would the NAV be on April 26 assuming an unchanged market?

Answer 16

A mutual fund’s net asset value (NAV) per share is the fund’s total assets minus total liabilities (net asset) divided by the number of shares outstanding.

Therefore, when that gain (or loss) is realized, paper profit (or loss) is now real and there is no change to total assets. In the subject question, the realization of the $2-per-share gain has no effect, but the new $1 in unrealized appreciation increases the NAV by that amount.

Question 17

The Alpha-Gamma Mutual Fund reports a large number of their investors liquidating shares of the fund, so much so that the dollar amount of liquidations exceeds the incoming cash for new purchases. This would lead to a condition known as

Answer 17

Net redemption - One of the main features of open-end investment management companies (mutual funds) is that there is a continuous offer of new shares and ready redemption of old ones. When redemptions exceed new purchases, the fund suffers from net redemptions.

Question 18

A bank is advertising a no-cost DDA. Your client asks you to describe what that is. You would respond that DDA stands for

Answer 18

demand deposit account. (I.e. checking account)

Question 19

Which of the following U.S. government securities do not bear a stated interest rate but are sold at a discount through weekly auctions?

Answer 19

Treasury bills bear no stated interest rate. They are sold at a discount through weekly auctions and are actively traded in the money market. Treasury notes and Treasury bonds both carry stated interest rates.

Question 20

Your customer owns 1,000 shares of the XYZ $100 par 5½% callable convertible preferred stock convertible into four shares of XYZ common stock at $25. What should she be advised to do if the board of directors were to call all the preferred at 106 when the XYZ common stock is trading at $25.50?

Answer 20

If the preferred stock is called, the client will receive $106 per share or $106,000. Tendering the preferred stock will provide the highest value. The value of converting the preferred stock into four shares of common is worth $102 (4 × $25.50 = $102), which is less than the call value of $106. On the 1,000 shares, this is a $4,000 difference. The dividends will cease on the call date if the preferred stock is held beyond the call date.

Question 21

Asset-based sales charges will generally be lowest when holding which of the following mutual fund share classes?

Answer 21

Class A shares have a front-end load, but a low- or no asset-based sales charge. Class B and C shares don’t have a front-end load but do have a higher asset-based sales charge. Class R shares can have a 12b-1 charge as high as 0.60%, more than Class A, but less than Classes B and C.

Question 22

A management investment company owns portfolio securities with a current market value of $100 million. The company owes $10 million for securities purchased but not yet paid for and accrued management fees of $5 million. If there are 2,611,437 shares outstanding and the current asking price of the shares is $36.38 per share, it would be correct to state that this investment company is

Answer 22

When a closed-end investment company is selling at a price in excess of its net asset value, it is said to be selling at a premium. The net asset value per share of a management investment company (either open-end or closed-end) is computed by dividing the net assets (assets minus liabilities) by the number of outstanding shares.

he assets are the $100 million portfolio value and the liabilities are $10 million for the unpaid securities plus the $5 million in accrued management fees. Subtracting the $15 million in liabilities from the $100 million in assets leaves $85 million. Divide that by the 2,611,437 shares outstanding, and the quotient is approximately $32.55. Once we know the NAV, it is clear that the price of $36.38 is a premium over the NAV.

Question 23

The Investment Company Act of 1940 requires certain types of investment companies to compute their net asset value on a regular basis. Excluded from this requirement are

Answer 23

Face amount certificate companies (FACC) because calculating a NAV wouldn’t make any sense.

Question 24

The board of directors

Answer 24

The board of directors sets policy and manages the administrative affairs of the investment company, but it does not manage the portfolio.

The board contracts with an outside investment manager to invest the funds.​

It is unlawful for any person to serve or act in the capacity of employee, officer, director, or investment adviser of any registered investment company, or principal underwriter for any registered open-end company, registered unit investment trust, or registered face-amount certificate company if that person, within the past 10 years, has been convicted of any felony or a misdemeanor involving the purchase or sale of any security.

Question 25

Which of the following are features of Class C mutual fund shares?

Answer 25

Class C shares generally have the following features: no front-end sales charge, lower CDSCs than Class B shares for a shorter period, and no conversion to Class A shares regardless of how long they are held. Because of these features, Class C shares may be less expensive for investors with shorter investment horizons. They may be more expensive for investors who plan to hold their shares for a long time, because the level load never discontinues.

Question 26

The primary defining characteristic of an equity security is

Answer 26

it represents ownership in a corporation.

What does the term equity mean? It means ownership and that is the single most significant fact about an equity security, whether common or preferred stock. Many pay dividends, but that is not at the core of being an equity security. Equity securities include preferred stock, which, with its fixed dividend, does not offer inflation protection and does not have voting rights.

Question 27

An option that may be exercised before its expiration date is said to be

Answer 27

There are two forms of option exercise—American and European. American style can be operationally exercised any day that the market is open before the expiration date. With European style, the only time you can operationally exercise your contract is the last trading day before expiration. Remember, even though there is only one day in which you can exercise your contract, you can always close out your option position in the secondary market any day prior to expiration.

Question 28

A speculator, believing that a drought in the Midwest will lead to a weak corn crop, would probably

Answer 28

take a long position in corn futures.

A weak corn crop means a shortage in the supply. That will lead to an increase in prices. When one is speculating that prices will go up, the best position is a long one. So, why not the long forwards? Those who purchase forward contracts anticipate accepting delivery of the asset. This individual is merely speculating and has no interest in taking physical possession of the commodity and paying for transportation, silage, and insurance until the commodity is sold. If the person in the question had been a user of corn (a cereal maker, for example), then the forward contract would have been a better choice.

Question 29

One of the ways in which U.S. government agency issues differ from those offered directly by the U.S. Treasury is that agency issues

Answer 29

typically carry higher returns than Treasury issues because of the lack of direct government backing.

Question 30

A REIT is able to pass-through which of the following?

Answer 30

Taxable income from operations

REITs are required to distribute a minimum of 90% of their taxable income from operations.

Unlike the traditional flow-through vehicle, they do not pass through losses. When a gain is unrealized, there is nothing to distribute.

Question 31

DERP Corporation’s 5% convertible debentures maturing in 2030 are currently selling for 120. The conversion price is $40. One would expect the DERP common stock to be selling

Answer 31

The first step here is to compute the parity price. A conversion price of $40 means the debenture is convertible into 25 shares of the common stock (par of $1,000 divided by $40 = 25 shares). With a current market price of $1,200, the parity price of the stock would be $48. Because convertible securities generally sell at a slight premium over their parity price, the stock should have a current market value a bit less than $48 per share.

Question 32

Which of the following rates of return is used by investment professionals as the risk-free rate?

Answer 32

The interest rate used as the basis for a risk-free rate of return is the 91-day Treasury bill rate. T-bills are U.S.-government guaranteed, the rate is short term, and the market risk is minimal.