Chapter 3: Client Investment Recommendations Flashcards
For Sole Proprietor, name the:
- Advantages
- Disadvantages
- Taxation
- Personal Liability
Advantages: (1) Fast, cheap, easy set up; (2) no meetings; (3) easy tax prep, (4) income direct to owner
Disadvantages: (1) Personal liability; (2) harder to obtain loans or attract investment capital
Taxation: Personal Income
Personal Liability: Yes
For General Partnerships, name the:
- Advantages
- Disadvantages
- Taxation
- Personal Liability
Advantages: (1) Flow through of income and expenses; (2) Equal ownership, returns, and costs;
Disadvantages: (1) Personal liability; (2) Equal responsibilities if one partner creates issue/defaults
Taxation: Flow through to owners
Personal Liability: Yes
For Limited Partnerships, name the:
- Advantages
- Disadvantages
- Taxation
- Personal Liability
Advantages: (1) Flow through of income and expenses; (2) Un-equal ownership whereas limited partners can only lose what they put in with recourse note allowing creditors to only come after personally invested or guaranteed debts (3) allows for partnership democracy which gives limited partner vote for dissolving partnership, suing GP for negligence//breach of duty and inspecting record
Disadvantages: (1) Personal liability: Requires min 1 General Partner that has unlimited liability; (2) Distribution of profits not as flexible
Taxation: Flow through to owners
Personal Liability: Yes for GP, Not for Limited
For Limited Partnership Company (LLC), name the:
- Advantages
- Disadvantages
- Taxation
- Personal Liability
Advantages: (1) Flow through of income and expenses; (2) Limited liability as owners are protected (3) More flexible distribution of profits (4) Unlimited number of members own LLC with both managing and non managing owners (similar to general and limited except all are protected from creditors) (5) No minutes or formal corp reporting required (6) avoids double taxation of income given flow thru of profits
Disadvantages: (1) Not good for attracting VC financing with direct flow of income/expense (2) More complexity in structure (3) Limited life based on filing with state and signed operating agreement
Taxation: Flow through to owners
Personal Liability: No, not even for negligence running business
For S-Corporation, name the:
- Advantages
- Disadvantages
- Taxation
- Personal Liability
Advantages: (1) Flow through of income and expenses via Schedule K-1; (2) No corporate tax (3) Liability protection from creditors due to corporate structure (4) Limit of 100 US resident individual, trust of estate shareholders own the corporation but are protected from personal liability (5) Protection against debts/lawsuits for owners but avoids double taxation (6) allows for business write offs and avoids being taxed as a legal entity
Disadvantages: (1) Not good for attracting VC financing with direct flow of income/expense (2) More complexity in structure and requires annual meetings and minutes of voting from each as org is filed with 3) One class of stock and limited to 100 stockholders residing in US with company located in US
Taxation: Flow through to owners
Personal Liability: No
For C-Corporation, name the:
- Advantages
- Disadvantages
- Taxation
- Personal Liability
Advantages: (1) Ability to attract capital investments and issue debenture (2)protects shareholders/owners from personal liability (3) not limited to # or classes of shareholders
Disadvantages: (1) Double taxation of corporate income on NI and personal income on dividends (2) More complexity in structure and requires annual meetings and minutes of voting from each as org is filed
Taxation: Taxed as business entity at flat corp rates
Personal Liability: No
What must first be determined before working with a client on investment recommendations
Income sources, Current expenses, Discretionary Income, Assets, Net Worth, Tax Bracket
Also good to know risk tolerance and time horizon
What 3 factors relative to investor situation must be assessed before / in making an investment recommendation
Investment Objective: income, appreciation, purchasing power protection..
Investment Time Horizon: Short, Intermediate, Long
Risk Tolerance: High, Medium, Low
What are exempt accounts (not allowed) for purposes of establishing margin accounts
Retirement Accounts
Open End Mutual Funds
Options
Primarily for stock traded on national exchanges
What are exempt securities for purposes of registering with state
Any security excused from registration requirements based on Uniform Security Act, such as
- US Treasuries,
- Munis,
- Canadian Govt or other foreign govt with
diplomatic ties
- Banks, S&Ls, Credit Union, Trust company
- Insurance company debt
- Railroad or Public Utility
- Federal covered
- Non Proft
- Pension/employee benefit program investment
What is CAPM and how calculated
Capital Asset Pricing Model that states the expected return on a stock is equal to the risk free rate an investor could get on 3 mo T-Bill plus the potential return on stock above risk free rate based on formula
Rf + B(Rm-Rf)
where Rf = risk free, B= Beta of stock, Rm= market return
What are key elements of Modern Portfolio Theory
Assesses how an investment affects the risk reward ratio of entire formula such that based on level of risk, any portfolio with risk adjusted returns landing on the curve is equally efficient, where as those inside the efficient frontier, with similar risks may different levels of efficiency based on returns and opposite for those with similar returns relative to different risks
What is:
- Recency Bias
- Mental Accounting
- Framing
- Primacy Effect
- Overconfidence/Dunning Kruger
- Loss Aversion
- Recency Bias: placing a higher weigh on recent information, often leading to mistiming on market (buy in when market hot, sell when not)
- Mental Accounting: Using rules of thumb or break even on losses to make decisions
- Framing: Based on way information is presented can confirm /reinforce behaviors
- Primacy Effect: First experience is given overweight to future decisions….ie..if made huge profits initially will expect to continue to do same
- Overconfidence/Dunning Kruger - Belief that know information, and overrate ability to make sound decisions even when really no nothing leading to overtrading as dont realize impact on portfolio
- Loss Aversion - avoiding losses more painful that potentials for gain by 2:1 (ie…50/50 chance of gaining $2500 or losing $1000 before proceeding)
What are 3 types of stock and investment styles for equity investing and examples from highest risk / volatility for each
Growth: Low to no dividend, high P/E, capital appreciation: - Large Cap is least volatile, Mid Cap, Small Cap is most volatile of all
Value: Higher dividend, low P/E - undervalued, some capital appreciation: Large Cap is least volatile of all equity, Mid Cap, Small Cap
Blend: Mix of growth and income; Mid range P/E - with some dividend and some capital appreciation: Large Cap is least volatile of blend, Mid Cap, Small Cap is more volatile
Reference Equity Mutual Fund chart; Determination of $ cut off between small and large is fluid
Name 2 investment styles and associated charcteristing
Passive - Efficient market theory, uses indexes and associated with asset allocation and rebalancing, more buy and hold strategies
Active - Weak to inefficient market theory, market timing and technical trading are associated with these investors
What are 2 types of asset allocation and how used
Strategic - Rebalancing, focused on individual investor age, time horizon, risk levels
Tactical - Market timing based on movements in market, Portfolio manager managing basket of stocks to beat market
Name the different portfolio management techniques and key characteristic
Buy and hold - low transaction costs, long term , lower tax impact - individual / retail investor
Sector Rotating - Buy and sell different class groups based on market movement to under or over weight the particular class via fundamental or technical analysis - portfolio mgr/active investor
Dollar Cost Averaging - buying fixed amount of security over regular schedule of time (ie..1/3 each mo) to take advantage of price fluctuations causing investors average cost to be lower than average share price. Used in determining cost basis when selling stock as opposed to FIFO (avg cost basis for Mutual Fund reporting by investor as part of NAV..long term cap gain).
How are governments securities taxed
US Treasuries and US Govt Securities - Fed only
Municipal : out of state - State/Local only
Municipal: in state/local - Tax exempt
Corporate/Govt Agency (GNMA,FMLA) - Fed,
State, Local
See notes - chart
How are OIDs taxed
Zero Coupons/STRIP discounts realized at maturity are amortized over life of bond and taxed as ordinary income - phantom tax; however as each year tax amount is paid the amount is added to cost basis so at maturity principal and basis are same so no cap gains, and if sold sooner reduced by this “accretion”
Munis are tax exempt so accretes the cost basis but does not pay taxes
For Premium bonds, the amount accreted is a loss that can be used to offset ordinary income received through interest payments
Bonds purchased on secondary market at a lower than par price are market discount bonds and are not tax exempt, but any gain is recognized as ordinary income
How are cost basis determined for cap gains tax purposes
FIFO is default
Average Cost can be used especially with dollar cost averaging
Specific share is used when shares can be tracked via CUSIP number
What are wash sale rules
Losses can not be claimed if same security (or derivative) is sold then repurchased within 30 days before and 30 days after purchase date (61 days), and loss amount is added back to cost basis of security
How are convertible securities taxed
Interest payments taxed as ordinary income when received plus if the bond is converted then sold, any gain is also taxed based on proceeds from sale minus the cost basis equivalent to original purchase price of the bond . (ie..if paid $1000 for convertible, then when converted, cost basis for sale = $1000) Only if sold, otherwise no capital gain
What is AMT and how used
Alternate Minimum is separate calculation that excludes certain deductible items (such as accelerated depreciation and other tax preferences to ensure that everyone who benefits from these pays minimum amount of taxes
What are common tax deferred individual retirement plans and key characteristics of each
Individual:
- Traditional IRA - 100% earned (now allowed past age 72 before Secure Act 2.0) only up to $7500 in 2023 ($6500+$1000) can be deducted, 6% Overfunding penalty and 10% penalty for early withdrawal before 59 1/2 except for death, perm disability, first home purchase, substantially equal payments, medical and higher education expenses; Taxed as ordinary income and subject to RMD beginning at 72 with 50% penalty on amount not taken. Collectibles can not be purchased and used in IRA without 59 1/2 10% penalty, except US minted gold or silver bullion; Income limits do not apply unless self or spouse covered by company plan.
- Roth IRA - 100% earned only up to $7500 in 2023 ($6500+$1000) CAN NOT be deducted (after tax contribution), No overfunding penalty, or limit to tax deferred growth (ie..Roth Conversions) and no RMD required but income limits apply for amount of after tax deferred growth benefit. Penalties on early withdrawal if not held Roth for 5 years or under age 59 1/2.
If make equal distributions under Rule of 72, must withdraw for 5 yrs or until age 59 1/2, whichever is longer
What are defined contribution employer based qualified retirement plans and key characteristics of each
Defined Contribution - employer not required to make regular contributions, employee bears risk of investments, higher limits of contributions, covered by ERISA:
401K/403B/457 Plans - Elective deferrals of paycheck tax free into self directed separate accounts of employee with min of 3 investment choices, including company stock; Vests over time; May include company match but not required; Must meet safe harbor (and top heavy test requirements; May also offer Roth 401k/403b for after tax/matching contributions
Profit Sharing - Contributions from company not required every year but must be made for all eligible employees based on predetermined formula and must be made often and substantial when made
Money Purchase - Requires employer to make annual contributions to each employees account based on salary; Are discretionary contributions for employee
Keogh -Qualified plan for self employed individuals or those working for sole proprietor with Keogh (not suitable for S/C-Corp, LLC); Contributions limited to 20% of self comp and 25% of employee comp annually.
SEP-IRA - Also Qualified plan for self employed individuals or small business allowing pretax contributions up to 25% of employee compensation (same for all employees); Employees can not make elective deferral as this is a Defined benefit type plan (Simplified Employee Pension-IRA). Requires model agreement, not filed and business must be making a profit
SIMPLE - For business with less than 100 employees and offering no other plan, consisting of IRA or 401K; Requires employer match up to 3% or contribution at 2% salary if not elective deferral; Immediate vesting
What are defined benefits employer based qualified retirement plans and key characteristics of each
Defined Benefits - employer required to make regular contributions to ensure guaranteed retirement income/payout; Holds account as part of general liability of business; , Employer bears risk of investments, set limits of contributions based on actuary, covered by PBGC:
Traditional Pension Plan
Cash Balance Pension Plan
What are common employer based non qualified retirement plans and key characteristics of each
Employee Stock Options - allows for 100% of stock options to be converted into stock as incentive
ESOP - allows all employees to purchase 100% company stock at discount to market price on date of exercise; all stock and dividends/cap gains on cumulative share grow tax deferred
Deferred Compensation - For highly compensated employees, allows for deferral of % of salary to be invested tax free and distributed at a later date as ordinary income
What are 2 key provisions of Secure Act
RMDs are delayed to age 72 (age 75 under Secure 2.0)
Individuals with earned income may continue to to contribute to a traditional IRA indefinitely (but still must take RMD after age 72/75)
Name 3 key requirements of a plan to meet fiduciary duties under Safe Harbor, 404(c)
Plan must:
1) Offer at least 3 investment choices with different risk and return characteristics, and no more than 10% of company stock
2) Provide ability to change investment allocation at least quarterly
3) Provide sufficient education and information on the plan and investment choices to allow participants to make informed decisions
What are requirements of company offering investment in company stock
Stock is:
- Publicly traded
- Traded with frequency and volume to make a market
- Shareholder info is also made available
- Same voting, tendering and other rights as common shareholder
-Fiduciary is designated to ensure all stockholder rights are maintained with procedures to keep trades confidential and no undue influence on votes or tender of shares
How are donations given to a 529 plan categorized for tax purposes
Donations are considered gifts (tax free up to gift tax exclusion) and can be made to any beneficiary, whether related or not. Any unused amount in 529 can be moved to another beneficiary that must be owner or blood relative, otherwise will lead to taxation on any gains in the account and based on Secure 2.0, starting in 2024, Americans can roll over unused 529 funds into a beneficiary’s Roth IRA with no penalty.
Donations are given with after tax dollars, but if used for qualified expenses (tuition, room board, supplies, IT for college and room and board up to $10k for primary/secondary and student loans) are withdrawn (principle plus gains) tax free, unless out of state programs charging state tax
Asset allocations can be adjusted max of 2x per year
Assets not counted as belonging to student, unlike UTMA/UGMA
Can be considered a defined contribution plan
What are other options for tax deferred college savings
Prepaid Tuition credits - Purchase of state tuition and fees only now for use when beneficiary ready. Must be used for in state schools but some accept out of state and can be refunded if beneficiary gets a scholarship; Can be considered a defined benefit plan
Coverdell Education Savings Account - Tax free contributions up to max of $2k per beneficiary who must be under 18 and who must withdraw funds tax free for qualified expenses in elementary, secondary, higher education before age 30; Has income limits for donors similar to funding Roth IRA; Custodian is the bank holding the account, not account owner; All payments must go to beneficiary; Assets not counted as belonging to student, unlike UTMA/UGMA
What information is needed to calculate education funding needs
Current annual cost of tuition
Current rate of tuition inflation
# Years student will attend
# Years until student starts college
Expected annual return on investment
What is a Grantor Trust
A revocable or irrevocable trust where the grantor or spouse benefit from the income and grantor is subject to tax while alive - there is no separation between grantor and trust
What is difference between simple and complex trust
Simple - income generated over the year is distributed to beneficiaries only as DNI-Distributable Net Income’ Charitable contributions and distributions from principle - corpus are not regularly made.
Complex - Income is donated to charities and/or regular distributions from corpus is made to beneficiaries, as well as retains some income from the trust
What is inter vivos vs testamentary trusts
Inter-vivos: Trust established while grantor is alive; Living trust and can be revocable or irrevocable while alive, then irrevocable. Avoid probate but are included in grantors estate
Testamentary: “Will” Trust established at death of grantor and can only be irrevocable, but removed from grantors estate; Must go through probate
What are types of split trusts and key elements of each
Charitable / Grantor Remainder (Annuity/Uni) Trust (CRAT/GRAT; CRUT/GRUT) - Trust whereby Income is provided to beneficiary or grantor on fixed or % of account base until death, then remaining balance goes to charity or named beneficiary
Charitable / Grantor Lead (Annuity/Uni) Trust
(CLAT/GLAT; CLUT/GLUT) Trust whereby Income is provided to charity or beneficiary on fixed or % of account base for named period or until death, then remaining balance goes to named beneficiary
Pooled Income Fund - Trust that allows donors to pool donations into single fund owned by charity that benefits from it, while donors receive distributions from income generated until their death, when share of fund is distributed to charity
What is the name and benefits of a payable on death (POD) bank account
Totten Trust; Allows assets to pass to named beneficiary without going through probate; No rights by beneficiary when grantor is alive and is revocable
What are QPRT, and Q-TIP trusts
QPRT (Qualified Personal Residence Trust) is one that allows grantor to transfer title of primary residence to beneficiary but remain living in home over specified (10 yr) period of time and remain responsible for maintaining home and mortgage payments if any and protected from creditors If grantor still alive after period of time, then must pay market rent to beneficiary.
Q-TIP (Qualified Terminable Interest Trust) is set up by grantor wishing to direct where assets will go, often to children of earlier marriages, but allow for lifetime income stream for surviving spouse - qualifies for marital deduction if income is used only for surviving spouse
What is a Crummey Trust and why created
An irrevocable life insurance trust designed to pay premiums on a life insurance policy owned by a trust , avoiding the annual gift tax exclusion amount, thereby excluding the value of life insurance policy from gross estate. Gifts to trust are used to pay premiums on the policy which is owned by the trust and therefore not the estate of the deceased
This act covers guidance for trustees in order to avoid legal action when acted as a fiduciary
Uniform Prudent Investor Act provides that professional trustees can be held to higher fiduciary standards (to degree based on actions of reasonable person) as well as allows for delegation of trustee responsibilities
Requirements for disclaiming an inheritance
Irrevocable decision to formally disclaim the inheritance in writing and within 9 months of death of grantor) without ever touching or benefitting from the assets,
What is skip person
For purposes of determining if Generation Skipping Tax applies, person who is more than 1 generation below (2 generations younger) or if not related 37.5 yrs younger will create additional taxes for donor of large gifts unless a specific GST trust is established
What is a QDRO
QDRO (Qualified Domestic Relations Order) is a judgement or court order authorizing rights of divorcee to receive benefits from spouses retirement plan, usually up to 50% of value of assets gained, as long as ex-spouse has not remarried and.or is being carried on another’s plan. Intended for spouse to be able to rollover amount to own IRA tax free, otherwise a distribution is subject to income tax and 10% penalty if under 59 1/2
What are requirements of short /margin sales
Trades must be done in a margin account only (not Cash account); Not allowed for open end mutual funds, options..
Initial margin requirement is 50% FMV then Account Maintenance or Margin Call at 25% of margin account and 30% of short sell
For options, what are limited and unlimited risk positions
Buying Calls or Selling Puts represent bullish positions
Selling/Writing Calls or Buying Puts represent bearish positions
Buying Puts or Calls have downside risk limited to cost of premium only and unlimited upside on calls and strike price upside on puts
Selling Puts and Calls have unlimited downside risk on (naked) calls and strike price on puts, and upside of premiums only on both puts or calls
Covered calls or puts protect risk to cost of underlying shares only
Selling short also (like naked call) has unlimited risk
What are Bid-Ask/Offer and Spreads and how used
Bid is the purchase price a broker-dealer is willing to pay, and what investor must sell for
Ask is the amount broker-dealer is willing to sell or the security offered price and what investor must pay to buy the security
Spread is the delta between bid and ask/offer and is amount market makers - Supplemental Liquidity Providers - earn from trading
What are different types of orders and how used
Market - Order is fulfilled as soon as possible with best available price at time of sell or buy. These orders guarantee a fill not a price
Limit - Order is filled at stated price or not at all; maximum price investor is willing to buy or lowest price willing to sell the security. Buy orders can be executed at or below limit, while sell at or above limit (or better). These orders guarantee a price not a fill
Stop - Order is filled at next available price by triggering a buy or sell market order when the price stated point is reached ; minimum price investor is willing to buy or maximum price investor is willing to sell the security. These orders do not guarantee a price for execution nor a fill
Stop-Limit - Names most investors will pay or least they will accept for a stock up to specified price point before order is transacted
Also all orders open for just day unless GTC - Good till Cancelled
What are the different securities markets
1st - Auction market - NYSE listed securities;
2nd - Negotiated Market - OTC: NASDAQ and Non-NASDAQ OTC stocks on OTCBB or OTC Market Group
3rd - Consolidated Quotation System (CQS) Markets for NYSE listed stocks traded within the OTC Market.
4th - ECN (Electronic Communications Networks) markets of electronic trading, ie…INSTINET, that are part of Alternative Trading System (ATS)
What are the key characteristics of 1st Market
1st - Auction market via matching of buyers and sellers based on negotiated price: NYSE listed securities; Manual and electronic auction between Designated Market Makers and Supplemental Liquidity Providers (SLP)
What are the key characteristics of 2nd Market
2nd - Negotiated Market via negotiation through bid and ask process OTC: NASDAQ - 3 levels:
1) Inside Market showing highest bid/lowest ask
2) Subscription showing all activity of quotes
3) Market Makers access to place quotes
3 markets in NASDAQ based on requirements
- Global Select: highest standard
- Global
- Capital: lower standards to help companies raise $
Min $4 to list initially with delist at <$1
Also includes Non-NASDAQ OTC stocks that trade on OTCBB - over the counter bulletin board, which is based on set market pricing by MMs. Do need to meet stringent requirements or regulated/monitored by exchange except timely annual or quarterly report filings and not removed from OTCBB
If delisted from OTCBB, then can trade in OTC Markets Group-3 tiers:
- OTCQX - highest financial standards and info available
-OTCQB - current in reporting with US regulator, but not financial or qualitative standards to adhere to
OTC Pink - highly speculative companies without audited financials, shell or development stage companies
What are the key characteristics of 3rd Market
3rd - Markets for NYSE listed stocks within the OTC Market, ie…GE stock trading over the counter (vs purchased from NYSE = 1st market);
Traded via Consolidated Quotation System (CQS); Market makers can withdraw quotes from CS temp or perm, with 2 day min wait time to re-list
What are the key characteristics of 4th Market
4th - ECN (Electronic Communications Networks) markets of electronic trading, ie…INSTINET, that are part of Alternative Trading System (ATS) by matching buyers and sellers electronically, primarily institutional investors; Orders are executed on agency basis and therefore do not require negotiated or auctioned buyers and sellers to complete transaction since buying for own account. The Alternate Display Facility (ADF) is vehicle for displaying (not executing) quotes while ADF Trading Centers allow broker dealers and investors to trade in non exchanges
What is SRO and NMS
Self Regulating Organization, such as FINRA, NYSE, CBOE,..
National Market Securities, which are sold not on a national securities exchange (such as via ECN) and utilize Alternate Display Facility to display trades routed thru Alternate Trading Centers (part of Alternative Trading Systems-ATS
What is risk profile of short sellers and what regulation governs sales
limited upside (to sale price) and unlimited risk/downside (unlimited price increase)
Reg SHO ensures that there broker dealers locate physical securities to cover naked short positions and imposes cross market stop trading levels (1@7%, 2@13%, 3@20%) based on daily “circuit beakers”, with priority to long traders over short sellers; After 13 days of failure to close out position, broker dealer must cover position by buying securities of like kind and quantity
What are dark pools of liquidity
Large institutional orders traded off any public market such NYSE, between 2 parties alone
What regulation governs margin accounts and what infractions can be sanctioned by it
Reg T covers broker dealer requirements for establishing a margin account and can impose 90 day account freezes on
1) slow to pay customers when margin mtce levels are not maintained
2) customers who freeride by selling on 1 day and buying back to fulfill order on 2nd day
FINRA covers margin maintenance for all margin securities including US Treasuries and Munis (not regulated by Reg T)
What are the margin requirements for Margin Accounts
Long investor must make initial margin outlay of 50% Long Market Value as initial equity under Reg T Any increase in LMV will increase equity (as borrowed DR balance remains same) and becomes excess equity or Special Memorandum Account (SMA) that can be used as cash or used to buy back more stock with additional 50% leverage.
When price declines equity levels must meet minimum maintenance requirements of 25% or $2000 of equity (whichever higher) before Margin Call under FINRA, at which time additional cash must be added. If cash not added, then broker dealer will sell 4 times margin call amount
Can not have negative SMA as only a cash advance account
What are the margin requirements for Short Selling Accounts
Short investor must make initial margin outlay of 50% Short Market Value as initial equity under Reg T Any increase in LMV will increase equity (as borrowed CR balance remains same) and becomes excess equity or Special Memorandum Account (SMA) that can be used as cash or used to buy back more stock with additional 50% leverage.
When price declines equity levels must meet minimum maintenance requirements of 25% or $2000 of equity (whichever higher) before Margin Call under FINRA, at which time additional cash must be added. If cash not added, then broker dealer will sell 4 times margin call amount
Can not have negative SMA as only a cash advance account
How do you determine value for account at maintenance
- If investor borrows $7500 on $15000 placed in margin account, at what amount of equity will they receive a margin call
- If investor borrows 7500 on 15000 to sell short, at what amount of equity will they receive a margin call
If buying long position on margin, divide debit or borrowed amount by 1-margin call of 25% or 0.75
So investor borrowing $7500 would receive mtce call at $7500 / (1-.25 = .75) = $10,000 account level
If selling short, divide credit by 1+ margin call of 30% or 1.3
So investor borrowing $7500 would receive mtce call at $7500 / (1+.3 = 1.3) = $5,769 account level
How do you determine combined equity for account with long margin and short positions
Long Market Value + Credit amount from short sales - Debit amount borrowed for long sale - Short Market Value
(LMV + CR - DR - SMV)
What types of accounts can be purchased using margin and which type can not be purchased but can be held in a margin account
Marginable securites (purchased on margin)
- NYSE, NASDAQ, OTC on Fed Reserve Board list
Purchased from a Margin account, but paid in full
- Non-NASDAQ OTC, Options, IPOs, Open End Funds
Retirement and UTMA/UGMA can not be set up as margin accounts
What is prime brokerage
bundled services that clearing firms offer to active traders, such as hedge funds
What is difference between holding period and annualized rate of return
Holding period take difference between current value and cost basis regardless of time in between
annualize return takes total return over period then annualizes it
What are different yields and total return on bonds
Total return is total amount of interest earned plus/minus gain or loss as % of bond price and any cap gains earned
Nominal yield is coupon rate
Current Yield is total income stream divided by price
Yield to Maturity is total income stream thru maturity plus/minus discount or gain
Yield to Call is total income stream thru 1st call date plus/minus gain or loss; Also called yield to worst for 1st call date
For Discount bonds: CY - YTM - YTC (lowest to highest yields)..realize discount gains sooner
For Premium: CY - YTM - YTC (most to lowest yields)…realize premium losses later
What are yields and total return on mutual funds, UITs and closed end fund investors
Yields are the income stream divided by price
Total return is total amount of income plus/minus gain or loss as % of investment (then annualized)
Name 3 ways of tracking portfolio returns
Inflation adjusted - real vs nominal return: reduces nominal by inflation rate
After tax return - reduces nominal return by inflation based on multiplying real time (1-investor tax rate)
Risk Adjusted returns - nominal returns adjusted by Beta or Alpha based on expected returns given level of risk involved
How are taxable yield and tax equivalent yields determined
Taxable yield = Nominal yield times (100- investor tax rate); to determine value of equivalent tax free security
Tax Equivalent yield = Tax free nominal yield divided by (100- investor tax rate) to determine equivalent value of
What are different ways for measuring risk-adjusted returns
Expected Return measures return based on probability of achieving different levels of return based on different outcomes (can also be calculated from CAPM: Rf + B(Rm-Rf), or adjusted returns based on standard deviations (ie…67% time = +/- 1 std dev)
Sharpe Ratio compares portfolio returns based on returns achieved above risk free/less rate of return adjusted by standard deviation of portfolio: (R - Rf) / std dev.
Alpha compares actual return to risk adjusted expected return
Time Weighted measures average of the total return percentages for all years
Dollar Weighted measures returns based on dollars invested
How are 2 major key benchmark market indices weighted
Based on Market Cap or Price Weighted
S&P 500, Russell 2000 use Market Cap
DJIA uses price weighting
Which of the following is a true statement concerning trading terminology?
- a broker-dealer customer pays the BID price when purchasing the security
- the market maker pays the BID price to a broker-dealer customer who is selling the security
the BID represents both what the market maker will pay and the customer will receive if the customer wants to sell the security. The ASK/OFFER represents both what the customer will pay and the market maker will recieve if the customer wants to buy the security.
What are different types of mutual fund shares sold
A-Shares: Sold with front end sales load/charge; Can be no load if less than 0.25% 12b-1 fees; Lower annual expenses; Most suitable for long term, high $ investors
B-Shares: Sold with only a sales load when shares are redeemed/sold and incur contingent deferred sales charge, reduced annually until convert to A shares; Have higher operating expenses than A shares; most suitable for intermediate /long term low $ investors
C-Shares: Sold as level load fund because of high 12b-1 fees and are appropriate for short term investing and less than $500K
Options. Open-end funds. Initial Public Offerings. Which of these can be purchased on margin?
None all of these must be paid in full, even if bought within a margin account
The term “operating agreement” is associated with which of the following?
Limited Liability Company
Limited Partnership
LLC
a limited partnership operates according to a partnership agreement.
Compare strategic vs tactical asset allocation
if the investment allocation is based on the investor, that is strategic asset allocation. If the allocation is based on market timing, that is tactical asset allocation.
Which type of stock investor is more interested in turnaround opportunities?
growth
value
A value investor likes to buy companies currently in trouble, who are likely to turn themselves around and become more valuable.
The ABC Corporation owns common stock and bonds in two unrelated entities. Therefore, ABC will receive favorable tax treatment on
- any dividends paid on the common stock
- any dividends paid on the common stock or interest paid on the bonds
The issuer receives a tax break when paying bond interest, so the recipient does not.
Corporations can exclude 70% of the dividends they receive from other company’s stock when figuring their tax liability.
An investor using strategic asset allocation annually sells some securities and uses the proceeds to purchase others in order to return the allocation to prescribed targets. This is known as which of the following?
Portfolio Optimization or
Rebalancing
If the allocation ends up out of line, the investor rebalances.
Portfolio optimization is associated with the Efficient Frontier.
An open-end municipal bond fund distributes income dividends and year-end capital gains distributions. Which are taxable to investors in the fund?
neither type of distribution
or
capital gains distributions
the dividends = tax-exempt municipal bond interest, but capital gains are always taxable on municipal bonds.
If an investor following charts wanted to buy only if the stock broke through resistance and sell only if the stock lost support, he would use which type of order?
stop orders
or
limit orders
he would place buy-stops above resistance and sell-stops below support.
Which of the following orders are placed at a price that is less than the last-traded price for a stock?
sell limit, buy-stop
or
buy limit, sell-stop
Buy limit, sell-stop
Sell limit and Buy-stop orders are placed above the current market price.
On the secondary market a market maker will purchase a security from a willing seller at which of the following?
- the offer
- the ask or asked price
- the bid
- the spread
- the bid
a customer can sell at the bid because a market maker is willing to buy the security at that price.
Jerry Barry is a 46-year-old investor who likes to win frequently more than waiting for one or two large investment profits over time. He likes to be in control of his investment returns rather than relying on the dividend-paying policies of a public company’s board of directors. He seeks income and, secondarily, capital appreciation. You would recommend which of the following to Jerry Barry?
1) a portfolio of 10 large cap stocks against which covered calls will be written
2) an S&P 500 index fund
3) a portfolio of preferred stock issued primarily by financial companies
4) a portfolio of 10 large cap stocks on which protective puts will be purchased
1) a portfolio of 10 large cap stocks against which covered calls will be written
Buying stock and then buying puts does not sound like a strategy to produce income and, perhaps, growth. Buying stock and then receiving call premiums against that stock seems to match up best with what Jerry Barry is all about. Preferred stock still relies on company board of directors to declare dividend payout
Which of the following statements is FALSE concerning a Transfer on Death (TOD) investment account?
1) such accounts allow assets to transfer outside of the probate process
2) such accounts allow assets to transfer outside the estate for purposes of estate tax liability
3) the account owner maintains complete control over the assets during his lifetime
4) the named beneficiaries can be changed at any time during the account owner’s lifetime
2) Such accounts allow assets to transfer outside the estate for purposes of estate tax liability
TOD accounts make the transfer of assets to the beneficiaries easy, but they do not avoid estate tax liability. Because TOD accounts are still part of the decedent’s estate (although not the probate estate that the Last Will establishes), they may be subject to income, estate and/or inheritance tax. TOD accounts are also not out of reach for the decedent’s creditors or other relatives.
How are 1, 5, 10-year, and life-of-fund investment results typically shown in the summary and statutory prospectuses for an open-end fund?
1) as risk-adjusted returns
2) as dollar-weighted returns
3) as time-weighted returns
4) as inflation-adjusted returns
3) as time-weighted returns
the total returns shown do not weight the returns for the dollars invested into the fund, or for risk or inflation. They are time-weighted returns showing what percentage the fund went up or down over each period.
Mason Jarr purchased 1,000 shares of MMM last year on January 1st. On December 31st, Mason sells the shares for a $300 capital gain. If the trade settles on January 4th, which of the following accurately describes the tax consequences?
1) The gain will be treated as dividend income.
2) The gain will be considered long-term.
3) The gain will be considered short-term.
4) Not enough information given.
3) The gain will be considered short-term.
The settlement date has nothing to do with holding period. The holding period stops the day you sell the stock and includes that day. Mason had held the stock < 1 year in this question.
According to Modern Portfolio Theory, investors should construct portfolios in which
1) the securities have a strong positive correlation
2) the securities have a strong negative correlation
3) the securities have a slightly negative correlation
4) the securities have no correlation to anything
3) the securities have a slightly negative correlation
a slightly negative correlation between parts of the portfolio can help to balance the portfolio as a whole.
Your grandmother bought shares of a growth fund when the NAV was $9.75 and the POP $10. On the day she dies the NAV is $15 and the POP $15.20. If you inherit all 1,000 shares, what is your gain or loss if you redeem the shares 5 months later when the NAV is $16 and the POP $16.18?
1) short-term gain of $6.00 per share
2) long-term gain of $1.00 per share
3) long-term gain of $.80 per share
4) short-term gain of $1.00 per share
2) long-term gain of $1.00 per share
take the NAV on the date of death as your cost basis; all gains FROM INHERITED ASSETS ? are LONG-term here BASED ON ORIGINAL HOLDING PERIOD: (Inherited Shares Any capital gain or loss that is the result of selling inherited stock is always long-term. This rule applies regardless of how long you or the original owner owned the shares. You are not responsible for taxes on any gain that occurred while the original owner was alive.)
Which of the following investments has improperly addressed the investor’s time horizon?
1) an investor with a 10-year time horizon holding large cap value funds
2) an investor with a 10-year time horizon investing in a newly issued U.S. Treasury Bond
3) an investor with a 1-year time horizon with 100% of the portfolio in a money market mutual fund
4) an investor with a 5-year time horizon holding U. S. Treasury Notes exclusively
2) An investor with a 10-year time horizon investing in a newly issued U.S. Treasury Bond
Never buy a bond with a maturity longer than the investor’s time horizon. If you do that, the investor might end up selling at a loss that could easily have been avoided.
Bills = < 1 yr
Notes = 2-10 yrs
Bonds = 20, 30 yrs
ERISA defines which of the following as a fiduciary to a qualified plan?
1) accountants performing auditing services
2) actuaries attesting to the sufficiency of current funding levels
3) attorneys performing legal services to the plan
4) individuals who merely select plan committee officials
4) individuals who merely select plan committee officials
fiduciaries include:
Trustee
Investment advisers
All individuals exercising discretion
All members of the plan’s administrative committee
Those who select committee officials
If an investor wants to sell stock at a set price–or better–which of the following orders could be entered?
1) sell-stop
2) sell-limit
3) neither
4) either
2) sell-limit
limit orders name the price at which the order must be executed–or better. Stop orders become market orders once they’re activated.
An S-corporation is different from an LLC in which of the following ways?
1) limited term of operation
2) inflexibility of profit distributions
3) owners are personally liable for debts incurred by the business
4) owners enjoy more protection from lawsuits
2) inflexibility of profit distributions
The owners of an S-corp are shareholders, and they have a right to their % of the profits. An LLC has more flexibility in how (if, when) it distributes profits to the owners, called “members.” Members can vote not to distribute any profits, for example, in an LLC. LLCs have more flexibility in this regard than limited partnerships, too.
Which of the following best exemplifies the portfolio management technique known as diversification?
1) buying put and call options on the same blue chip stock
2) maintaining both long and short positions in three pharmaceutical company stocks
3) maintaining an equity portfolio mix of 33.3% pharmaceutical stocks, 33.3% consumer staples stocks and 33.3% financial stocks
4) maintaining a portfolio mix of 50% stocks, 50% bonds
3) Maintaining an equity portfolio mix of 33.3% pharmaceutical stocks, 33.3% consumer staples stocks and 33.3% financial stocks
50% stocks/50% bonds is a better example of ASSET ALLOCATION From there, the investor could diversify DIVERSIFICATION among industry groups and issuers.
An investment of $15,000 that compounds at 9% would be worth $60,000 in approximately how many years?
1) 11.7 years
2) no legal investments that compound@ 9%
3) 8 years
4) 16 years
4) 16 years
the test has been known to use the “rule of 72” method of approximating future value, and then–of course–add some spin to it. Take 9 and divide it into 72 to get 8 years. The account is worth $30,000 at that point and would double again in another 8 years (16 years total).
Common stock trading on which of the following trades with the widest spreads?
1) NASDAQ
2) NYSE
3) OTC Bulletin Board
4) The Fourth Market
3) OTC Bulletin Board
On the OTCBB market makers enjoy very wide spreads between their Bid and Ask prices due to more thinly traded
Fourth Markets are between institutional investors in alternate markets that trade on agency basis therefore not obligated to maintain two sided quotes, so not concerned with spreads.
An investor sees that ABC Energy Solutions is trading for just $1.75 per share. Afraid that the stock could continue to drop, the investor would like to purchase 500 shares only if they rise to at least $5 and not for more than $5. Therefore, he should enter which of the following?
1) buy 500 ABC @5
2) buy 500 ABC @5, stop, limit $5
3) buy 500 ABC @5, stop
4) buy 500 ABC
3) buy 500 ABC @5, stop, limit $5
a buy-stop is activated if the stock goes up to a certain price; a buy-stop-limit would then have to also be filled at the stated limit price, while a buy-stop order would be filled at the next available market price.
Which of the following presents a situation in which the yield of a mutual fund is positive while the total return decreases?
1) the NAV is unchanged, the dividend is $1, and the capital gains distribution is $2
2) the NAV rises $2, the dividend is $1, and the capital gains distribution is 50 cents
3) the NAV drops $2, the dividend is $1, and the capital gains distribution is 50 cents
4) the NAV rises $1, the dividend is $1, and the capital gains distribution is 50 cents
3) The NAV drops $2, the dividend is $1, and the capital gains distribution is 50 cents
solving this question involves trial and error–try the answer choices out until you find a case where the total return is negative. This happens WHEN THE NAV DROPS BY MORE THAN THE DIVIDEND AND CAPITAL GAINS DISTRIBUTION COMBINED
An investor in the 33% marginal tax bracket would achieve the highest after-tax return on which of the following securities investments held within a taxable account?
1) a corporate bond with a 4.5% yield to maturity
2) a REIT offering a dividend yield of 5.5%
3) a 5% preferred stock
4) a U.S. Treasury Bond with a yield to maturity of 2.75%
3) a 5% preferred stock
The investor would keep 85% of the 5% (80% of 5% for highest taxpayers) offered on the preferred stock. The other investments pay income taxed at 33%, meaning the investor would keep just 67% of 4.5%, 5.5%, or 2.75% (NOT A MUNI-US Treasuries Taxed at Fed not state)
Although the dividends are received similarly to that of a bond, this source of income is taxed not as interest but as qualified dividends.
That means that preferred dividends are taxed at between 15%-20%, rather than at the marginal income tax rate.
What are allowable reasons for refunding prepaid tuition credits?
if the child gets a scholarship, dies, or becomes disabled, not only is the money refunded, but also interest is typically added to the payment (at a low rate, of course).
If the child decides not to go to college at all, the account owner—typically the student’s parent—can change the beneficiary to another relative, or withdraw the money and pay income tax plus a 10% penalty on the account’s earnings. It may also be possible to change the beneficiary or to receive a refund of your contributions, but not their earnings, with a prepaid tuition plan.
What are some common items adjusted for AMT
When partnerships use accelerated depreciation, the cost is compressed over a shorter time frame, giving the partners extra deductions.
Depletion allowances on limited partnership interests are also AMT adjusted;
Associate “private purpose municipal bonds” with “AMT, “ in case you don’t have enough word association to do at this point.
Active portfolio management
1) is considered imprudent based on conclusions arrived via the Uniform Prudent Investor Act
2) is the typical technique employed by those who follow the efficient market hypothesis
3) is associated with tactical asset allocation
4) is inconsistent with a buy-and-hold management style
3) is associated with tactical asset allocation
An active manager, like Warren Buffett, can also be a long-term, buy-and-hold investor. The “active” part has to do with determining that a particular stock is a superior investment to another alternative, as opposed to just buying low-cost index-based investments, as the passive portfolio managers do. Efficient market people are the opposite of active portfolio managers. They are passive by definition.
When calculating the taxable estate, which of the following items is not subtracted from the gross estate?
funeral expenses
charitable gifts made after death
tax-exempt municipal bonds
debts owed at the time of death
tax-exempt municipal bonds
the following are subtracted from the gross estate value: funeral expenses, debts owed by the decedent, and charitable donations specified in the will with pre-tax money.
Which of the following business entities would have General Partners?
a general partnership
a limited partnership
both a general and a limited partnership
an S-Corporation
Both a general and a limited partnership
in a GP all owners are GPs; in an LP, there has to be at least one GP running the business.
Which of the following orders could best be used to protect capital appreciation on a long stock position?
sell-limit
buy-limit
buy-stop
sell-stop
sell-stop
this is also called a “stop loss” order because it is designed to leave the investor’s upside unimpeded but to stop a loss if the stock begins to fall. Sell-limit orders are executed only if the stock rises–if the stock drops, it just keeps dropping.
When a customer of a broker-dealer wants to sell half her shares of ABC if and only if she can receive at least $29.75 per share, which of the following orders should her registered representative (securities agent) enter?
Sell-stop
Sell-stop-limit
Sell-limit
Market order
Sell-limit
the only way to name the price for the execution is to enter a limit order. A market order, or a stop order, is executed at the best available price.
XYZ Growth Fund had a NAV of $10 at the beginning of the year, ending with a NAV of $12. The fund also paid dividends of $1 and capital gains of $1. The total return is, therefore:
25%
40%
10%
20%
40%
total return is found by, first, adding the annual dividend, the capital gains distribution and then adding, or subtracting, the change in NAV. In this case, we add a $1 dividend, to a $1 capital gains distribution, to a $2 increase in NAV. That $4 divided by the starting NAV of $10 gives us a total return of 40%.
What is the primary concern of a fiduciary managing pension fund assets?
minimizing risk
achieving the highest yield possible
achieving maximum growth
managing the tradeoffs between risk and reward
Managing the tradeoffs between risk and reward
risk is not something to be avoided; it’s something to be managed, prudently.
You have an investing client who has done some homework on covered call writing. He has invested in stocks for five years at this point and has a steady job. Which of the following would you bring to his attention FIRST?
if the market price of the stock drops, you could suffer a total loss on that stock position
you will receive the premium upfront, regardless of the outcome
you will achieve leveraged returns with long options positions
covered call writing is probably the most conservative of all options strategies
if the market price of the stock drops, you could suffer a total loss on that stock position
make it clear that although he does receive the premium when writing the covered calls, the stock he bought could still drop to zero.
Which of the following limited partnership interests would be LEAST suitable for an investor seeking tax shelter?
raw land program
new construction real estate program
oil exploration program
oil production/income program
raw land program
oil exploration and new construction programs probably offer the most tax shelter from depreciation and wildcat risks. Oil income programs offer depletion allowances. But, since raw land offers no depreciation or depletion, you have to choose that answer here.
One of your investing clients held a real estate limited partnership interest before signing up with your brokerage firm with you as his agent. The partnership files for bankruptcy protection, and some of the properties are actually sold for more than cost. What must happen with the profits on these transactions?
They must be distributed equally to all creditors
They may be retained by the General Partner(s)
They must be distributed first to secured creditors
They may be retained by the partnership
They must be distributed first to secured creditors
Secured creditors always have highest priority if the company has to be liquidated. The GP’s are last in line, right after the LP’s. The LP’s are below the secured and the unsecured creditors.
Which of the following represents a major point of the Uniform Prudent Investors Act?
penny stocks are inherently too risky for pension funds
bonds rated below BBB/Baa may not be purchased by fiduciaries
no individual investment can be accurately labeled “risky, “ but, rather, the risk of the overall portfolio is to be considered when selecting investment opportunities
an executor of an estate is held to the same standards as a pension fund manager
No individual investment can be accurately labeled “risky, “ but, rather, the risk of the overall portfolio is to be considered when selecting investment opportunities
modern portfolio theory says that risks on one stock can be reduced by investing in others. The Uniform Prudent Investor Act even mentions that in 1973 an investor could have offset the losses in international oil stocks by purchasing domestic oil stocks—which actually benefited from a rise in oil prices. Therefore, no one stock or bond is considered “too risky” for a fiduciary to buy. The risk is looked at in terms of the portfolio as a whole.
Whose tax ID is used when opening an UTMA or UGMA (Custodial) account?
none, as the account is not taxable
the custodian’s
the minor’s
the donor’s
the minor’s
UTMA/UGMA accounts receive special tax treatment but are neither tax-free nor tax-deferred. These are considered owned by the minor therefore use minor’s tax id
The longer an investor’s time horizon, the greater the danger of:
Volatility
Investment loss
Inflation
Stagnation
Inflation
inflation reduces purchasing power over time, even if increasing at relatively low rates each year.
When are warrants used and how issued
Warrants are long term derivative securities which are issued by corp giving owner the right to purchase stock at a set price and most often used as sweetner to debt/bond offerings making these more attractive or with lower coupon rate / yields
What happens to UTAM/UGMA accounts when minor dies
The account is part of minor estate and passes to beneficiary or if intestate, likely back to parents
Which of the following plans requires the employer to make a stated, mandatory contribution to the employee’s account?
defined benefit pension plan
money purchase plan
profit sharing plan
401(K) plan
money purchase plan
only the money-purchase plan requires a mandatory contribution from the employer. Defined benefit plans must be certified annually by an actuary as to being sufficiently funded.
rank & Emma’s Fruit Pies currently has 50 employees. Only four of the employees want to maximize their retirement savings. Which of the following plans would allow the employees to accomplish this goal?
SIMPLE IRA
Keogh plan
Profit sharing
SEP-IRA
SIMPLE IRA
the SIMPLE IRA is the only plan here that would let the employees contribute.
What are rules defining safe harbor and whether 401K is top heavy
Safe Harbor:
- Must offer min 3 options for investing
- Must disclose investing info on choices
- Investments must be tradable and can be updated at least quarterly
Top Heavy:
- No more than 60% of benefits can accrue to key employees (officers, 10% owners,)
For which type of account ownership is it mandatory that the owners are husband and wife?
Joint Tenants With Rights of Survivorship
Joint Tenants in Common
Tenancy By The Entirety
all choices listed
Tenancy By The Entirety
Rationale
a Tenancy By The Entirety is for husband and wife only. Neither one can sell or transfer his/her interest, and creditors of one spouse cannot attach the accounts held in this way.
Joint Tenants and JWROS can be anyone
An investor hopes to invest $10,000 today and liquidate the account at $20,000 in 6 years. In order to do this, the compounded rate of return would be approximately equal to
1%
9.5%
12%
10%
Solve without calculator..
12%
Using the “rule of 72,” you can take the number of years in which the money needs to double and divide that into 72. 6 divided into 72 = 12. If the account grows at 12% year-over-year for 6 years, the $10,000 will become $20,000.
A false statement concerning joint investment accounts is that
Orders may be accepted by either party
Mail may be sent to either party
Probate may be bypassed with a JTWROS account
Checks may be drawn out to either party
Checks may be drawn out to either party
if the account is entitled Joann Williams and Barbara Smith, JTIC, that is how the checks need to be cut. Don’t cut a check to Joann and tell her to settle up with Barbara next time they have lunch.
Marty Ryan is a resident of the State of Virginia. Marty is in the 30% federal tax bracket and the 10% state tax bracket. If Marty purchases a 5.5% Virginia General Obligation bond, his after-tax yield will be
9.2%
3.3%
7.9%
5.5%
5.5%
the investor avoids tax at the federal and state level in this question. His Tax Equivalent Yield is 9.2%!!
Which of the following equals the highest risk-adjusted return?
3% above riskless rate, standard deviation 5.5
4% above riskless rate, standard deviation 6.0
4% above riskless rate, standard deviation 5.0
3% above riskless rate, standard deviation 6.5
4% above riskless rate, standard deviation 5.0
the Sharpe Ratio looks good when the return is high above the riskless rate, with the standard deviation as low as possible.
CAPM will return higher expected returns the higher the Beta and higher the risk adjusted return
What are primary concerns of retirees with discretionary income to invest based on pension and ss benefits covering monthly expenses
With non inflation adjusted Defined Benefit Pension plans, purchasing power risk is primary concern to those on fixed income
With the market at 35 a customer places the following order: sell-stop @34, limit 34 The following prices are reported: 35.00,34.50,34.05,33.95,33.50,33.75,34.00.
At which price is the order triggered?
At which price is the order activated?
At which price is the order filled
34.50
34.05
34.00
33.95
Triggered/Activated- 33.95
Filled - 34.00
An investing client has a large brokerage account that is not tax-advantaged. He typically ends up in the top or second-highest marginal tax bracket. If he seeks growth and income, an IAR would best recommend which of the following?
Real Estate Investment Trusts (equity)
Investment-Grade Corporate Bond funds
A diversified portfolio of large-cap value stocks
A diversified portfolio of closed-end funds
A diversified portfolio of large-cap value stocks
REITs pay high dividend yields, but they are taxed at ordinary income rates, so for this investor, put the REITs in tax-advantaged accounts.
Corporate bonds don’t promise much growth and would be taxed at the same rate that REIT dividends would.
A portfolio of closed-end funds is too non-specific to use here.
Large-cap value is associated with high dividend yields, which would be qualified dividends, taxed at about half his ordinary income rate.
Which of the following is an accurate statement concerning 529 Savings Plans?
the maximum contributions to the account cannot exceed the amount necessary to provide for the qualified education expenses of the beneficiary
the maximum contributions to the account are $2,000 per year
there is no maximum contribution to the account
the U.S. Department of Education establishes the maximum contributions for each state
The maximum contributions to the account cannot exceed the amount necessary to provide for the qualified education expenses of the beneficiary
Their is a maximum contribution limit that is set by each state, but generally no more than $300K
An agent is employed by a broker-dealer properly registered in all 50 states. The agent receives an unsolicited order from a resident of Arizona, where the agent is not registered. What is true of this situation?
the agent may accept the order because it is unsolicited
the agent needs to be registered only if he has in excess of 5 customers in Arizona
the agent may accept the order because the firm is registered in Arizona
the agent may not accept the order
the agent may not accept the order
the agent needs to be registered. An unsolicited order might afford the security a transactional exemption, but agents need to be registered to deal with public/retail investors.
Which of the following assets are not counted as part of the decedent’s estate?
vacation home placed in a revocable trust 5 years prior to death
tax-exempt municipal securities owned for 5 or more years prior to death
vacation home placed in an irrevocable trust 5 years prior to death
vacation home placed in an irrevocable trust 2 years prior to death
vacation home placed in an irrevocable trust 5 years prior to death
assets placed in an irrevocable trust are not part of the estate–unless they go into the trust within 3 years of the decedent’s demise. Assets placed in revocable trusts remain a part of the decedent’s estate.
When making recommendations to a trust account, all recommendations should be suitable for the
grantor
beneficiary
trustee
executor
Incorrect
Correct Answer: beneficiary
Rationale
for whose benefit is the trust established? The beneficiary.
Which of the following represents the LEAST suitable recommendation for a single mother saving for the education of a 2-year-old and a 5-year-old child?
diversified common stock mutual fund
common stock
variable life insurance
STRIPS
variable life insurance (borrow against VLI for education??)
Rationale
do not present insurance primarily as an investment vehicle. Present it first as an insurance product, then one which has features of a securities investement.
Three sisters own an investment account that is a Joint Tenants With Rights of Survivorship Account . Therefore, if one sister dies,
1/3 of the account assets pass to her estate
her estate receives the stated % on the joint account agreement
the other two sisters remain as joint owners of the account
all assets must be liquidated within 6 months
the other two sisters remain as joint owners of the account (review ownership types and impact on estate)
in a JTWROS account, the deceased’s assets become the assets of the survivors.
Which type of mutual fund below probably involves the most volatility and highest risk tolerance?
sector
equity income
growth & income
junk bond
Sector
sector funds are concentrated on just one or a few industry groups, making them subject to boom and bust cycles.
Investments in which of the following would probably require the highest risk tolerance?
Corporate Bonds rated below BBB/Baa
Small Cap Stock
ADRs
Limited Partnerships
Limited Partnerships INTERESTS (REVISIT)
Rationale
LP interests are not liquid, and many are speculative (raw land, oil & gas exploration, etc.).
A widow, 84 years old, opens an advisory account with a deposit of $50,000. Her net worth, including her home, is $250,000. She tells her IAR that her objectives are preservation of capital and income. She may need to access the funds frequently on short notice to cover medical bills and home repairs. Therefore, the most suitable recommendation would be
Preferred Stock
Deferred Variable Annuity
Money Market Mutual Funds
Treasury Bills
WHY NOT T-BILL VS MM FUND
Money Market Mutual Funds
Rationale
this investor does not have a long enough time horizon for a deferred annuity, and does not have the risk tolerance for a variable annuity.
The income generated in a variable annuity through investing in the separate account’s subaccounts is
tax-deductible to the insurance company’s general account
guaranteed at a certain minimum rate by the insurance company’s general account
taxable for the year in which it is generated
taxable upon constructive receipt to the extent it is part of the amount exceeding cost basis
taxable upon constructive receipt to the extent it is part of the amount exceeding cost basis
Rationale
the account value grows tax-deferred in a variable annuity. But, the individual will pay ordinary income tax on that growth if and when he makes withdrawals from the account.
To which of the following clients should an aggressive growth fund be recommended?
younger investor with solid employment, good income, and a moderate risk tolerance
an investor who is financially secure
an investor who is financially secure and has a high risk tolerance
younger investor
An investor who is financially secure and has a high risk tolerance
the perfect candidate for an aggressive growth fund would have all of these characteristics: long time horizon, high risk tolerance, financially secure, no immediate needs for income from the investment.
A customer’s market order to sell should be executed by the broker-dealer at the:
highest bid
highest ask
lowest ask
lowest bid
highest bid
Rationale
customers BUY at the ASK/OFFER, SELL at the BID
A trader just sold 500 XYZ short @50. Therefore, which of the following statements is true?
The trader will profit if XYZ rises to more than $50.
The trader executed the transaction within either a cash or margin account.
The trader is required to meet a Reg T requirement by making a deposit of cash collateral.
The trader is bullish on XYZ over the short-term only.
The trader is required to meet a Reg T requirement by making a deposit of cash collateral.
Rationale
short sellers are bearish. Short sales occur in margin accounts, NOT cash accounts, and require the short seller to deposit cash (typically 1/2 the amount of the short sale) under Regulation T.
For the current tax year the maximum gift that may be made to an UGMA or UTMA account is
an unlimited amount
$15,000
$14,000
$10,000 indexed for inflation
An unlimited amount
gifts over a certain amount are taxable, but there is no such thing as a “maximum gift.”
A technical analyst tells a radio host that shares of Windcomm have been “drastically oversold” at this point. Therefore, we can conclude that
The analyst is bearish on Windcomm
The stock is at the resistance point
The analyst is short the stock
Windcomm shares are trading at support
Windcomm shares are trading at support
Rationale
the stock has dropped to the point where buyers will step in and push the price back up.
An investor should be concerned about the issuer’s AM Best rating before investing his money in which of the following?
fixed annuity
technically, fixed annuities are not investments of money
Treasury Note
variable annuity
Fixed annuity
the safety and returns for fixed annuities are backed completely by the insurance company’s claims paying ability, measured by their AM Best rating.
If a customer enters an order to purchase 1,000 ART @33.50, at which of the following prices could the order be filled?
$33.45
$33.51
$33.55
$33.75
WHAT IS ART? OR BUY AT 33.50 OR BETTER..SO ANYTHING UNDER $33.50
$33.45
Rationale
we can’t execute a buy-limit order unless it is for the customer’s price or better (which means “lower” for a buyer). This order can be filled at $33.50 or less, but not one penny more.
When do investors typically write “covered calls”?
when they seek to “lock in” a profit on an existing stock position
when they feel a stock they currently hold will trade “sideways”
when they seek maximum downside protection on an existing stock position
when they are bullish on the underlying security
REVISIT RATIONALE OF ALL 3 CHOICES
when they feel a stock they currently hold will trade “sideways”
Rationale
if the stock isn’t going to go up, the investor will end up keeping the call premiums without doing anything.
For downside protection on an existing stock position, investors buy puts.
A covered call would not lock in a profit on the stock–it would merely cap the amount of profit the investor could make through expiration of the option.
Which of the following strategic allocations looks most appropriate for a 65-year-old retired investor?
30% bonds, 70% stock
100% United States Treasuries
90% cash, 10% bonds
55% bonds, 35% stock, 10% cash
55% bonds, 35% stock, 10% cash
a rule of thumb is to take 100% minus the investor’s age to arrive at the percentage he should put in stocks. A 65-year-old would, therefore, keep the equities/stocks to 35%.
WHAT IS ORDER OF BRINGING NEW ISSUE OF SECURITY TO MARKET PRIOR TO FILING DATE
1) Prepare the registration statement
2) Publish a tombstone
3) Deliver a preliminary prospectus
4) Accept indications of interest
Darla Jean originally invested $10,000 into the Argood Value Fund. She has since reinvested dividend distributions of $1,000 and capital gains distributions of $500. If Darla Jean currently holds 1,000 shares of the Argood Value Fund, her cost basis is
$10.50 per share
$10.00 per share
$11.50 per share
indeterminable given this information
$11.50 per share
Rationale
just take the amount she has invested and reinvested divided by the number of shares she now holds.
Any reinvestment of dividends or cap gains raises cost basis
An investment adviser charges “35 basis points” to manage large fixed-income portfolios. Thirty-five basis points is equal to which of the following?
.0035%
3.5%
35%
.35%
Correct
Correct Answer: .35%
Rationale
35 basis points = .0035 or .35%. (add 2 zeros then convert to pctg)
Which of the following retirement plans leaves the business owner with the least flexibility in terms of contributions to the plan?
profit sharing
SEP-IRA
defined benefit
money purchase
Imoney purchase
Rationale
a money purchase plan requires a fixed % contribution for each participant while SEP-IRA and profit sharing are NOT mandatory (but require same formula for all ees if do so)
Defined benefit requires predetermined amount to be funded based on actuarials but not annual contributions
An investor in his mid-30’s inherited a sizable stock portfolio comprised of large positions in 5 large-cap stocks. He struggles to be a long-term investor, but seems able to exhibit some patience if also receiving income. Therefore, the best recommendation below is for the investor to
liquidate at least half his holdings and place the proceeds in the same issuers’ fixed-income securities
seek counseling from a qualified therapist who works primarily with investors
sell covered calls against a percentage of the equity positions that he holds
sell puts against a percentage of the equity positions that he holds
Sell covered calls against a percentage of the equity positions that he holds
Rationale
covered calls allow this investor to hold the stock but also generate call premiums while he’s waiting for the stock to rise over the long-term. Selling puts would not be a good “hedge,” as it is also a bullish position, like holding the stock.
An investor with considerable income taxed at the top marginal rate holding a large portfolio of investment-grade municipal bonds should be most concerned with which of the following investment risks?
market risk
liquidity risk
default risk
legislative risk
Legislative risk
Rationale
if the tax code changes, that probably hurts this investor. The risk could come through the AMT, marginal tax rates, tax brackets themselves, or even the loss of the deduction for municipal bond interest earned by the investor.
One of your clients is a 53-year-old successful entrepreneur who owns a regional chain of convenience stores. He participates in his company’s 401(k) plan and draws an annual salary of about $550,000. If he seeks purchasing power protection, which recommendation below is most suitable?
maximize funding to his Roth IRA
purchase investment-grade corporate bonds within a taxable account
purchase a deferred variable annuity
maximize the tax-deductible contributions available within his Traditional IRA
purchase a deferred variable annuity
Rationale
purchasing power protection happens in the stock market. The variable annuity will allow him to invest in various stock/equity subaccounts. The Roth contribution is NOT available to him due to HIS INCOME. In a Traditional IRA he could make but NOT DEDUCT his contribution due to his income
Which of the following orders would be entered to protect a “paper gain” on a long stock position?
sell-stop
sell-limit
buy-stop
buy-limit
sell-stop
a sell-stop order (stop loss) protects a long stock position, while a buy-stop order protects a short stock position.
An investor purchases a zero coupon bond @90 maturing in 3 years. The investor’s annualized rate of return will be
zero
3.7%
11%
5%
Due to phantom income amoritization on zero coupon:
3.7%
Rationale
he will earn $100 out of (divided by) $900 for a holding period return of 11.11%. Divide that by the three years it took to get it for the annualized rate of return.
One of your investing clients is currently in a 20% marginal tax bracket. If she anticipates being in a higher tax bracket when she retires, the best recommendation would be to
- purchase municipal securities in a SEP-IRA
- purchase growth funds within an IRA or 401(k) in order to defer capital gains
-purchase small cap growth stocks within a taxable account
purchase small cap growth stocks within a taxable account
NEVER purchase municipal securities in a tax-advantaged account, since that would convert tax-exempt income to taxable income. There are no long-term capital gains in an IRA or 401(k) account, so “deferring” them would convert long-term capital gains rates to higher ordinary income rates.
