Final Exam 4 Flashcards
A customer who’s in his early 50s recently received a sizeable bonus and his investment objective is to maximize his tax-free income. He has two children who are already attending college. Which of the following choices is the BEST method of investing the funds?
QID: 1892421Mark For Review
A
Contribute the maximum amount allowable to a 529 plan
B
50% equities, 20% general obligation bonds, 15% utility revenue bonds, and 15% Treasury Inflation-Protected Securities (TIPS)
C
20% high-yield corporate bonds, 20% airport revenue bonds, 20% general obligation bonds, 20% Treasury bonds, and 20% tax anticipation notes
D
30% general obligation bonds, 20% high-yield municipal bonds, 20% hospital revenue bonds, 20% special tax bonds, and 10% housing revenue bonds
30% general obligation bonds, 20% high-yield municipal bonds, 20% hospital revenue bonds, 20% special tax bonds, and 10% housing revenue bonds
Since this customer is seeking to maximize his tax-free income, he needs to invest in different types of municipal securities.
A corporation's long-term debt would most likely be called when interest rates: QID: 1892340Mark For Review A Rise above the bond's nominal yield B Rise above the bond's yield to maturity C Fall below the bond's nominal yield D Fall below the bond's yield to maturity
Fall below the bond’s nominal yield
The indenture between the issuer and bondholder for long-term debt often contains a call provision that allows the issuer, at its option, to redeem the bonds before maturity. Call provisions usually benefit the issuer, which has the option of calling in the bonds when interest rates decline. The issuer may then refinance the debt at a lower rate of interest. For instance, if an issuer’s outstanding bond is paying a coupon rate (nominal yield) of 9% at a time when similar bonds are paying only 5%, it can reduce its interest costs by calling in the 9% bonds and issuing new ones at 5%. As rates decline, the bond’s yield to maturity, or yield to call, also would decline.
The call premium of a bond refers to the amount:
QID: 1892365Mark For Review
A
An investor must pay above par to buy a callable bond
B
Over par value that the issuer must pay to exercise the call privilege
C
The issuer must add to the semiannual interest payments to offset the call feature
D
Added to the price at issuance to compensate for the call privilege
Over par value that the issuer must pay to exercise the call privilege
The call premium of a bond refers to the amount the issuer must pay in excess of par value to exercise the call privilege. The call privilege is the issuer’s right to buy the bond from the holder prior to maturity. For example, if a bond is callable at 102, it has a two-point ($20) call premium. The issuer must pay $1,020 ($20 more than par) if it wishes to call in the bond.
Which of the following information does NOT have an effect on the credit quality of an airport revenue bond? QID: 1892408Mark For Review A Tourism B Debt per capita C Airport traffic D Energy costs
Debt per capita
Debt per capita is used when analyzing a general obligation bond and would not be considered for a revenue issue.
An investment banking representative would require an authorized person of an institutional investor to sign which of the following documents to attest to, or determine, whether the institution has the status of an accredited investor? QID: 1892361Mark For Review A The private placement memorandum B The subscription agreement C The confidentiality agreement D The engagement agreement
The subscription agreement
The subscription agreement is a sales contract for the sale of securities in a private placement. It sets forth the terms and conditions of the securities. The client, or an authorized person of an institutional investor, will sign the agreement attesting to the status of an accredited investor.
Within how many days of receipt must a principal approve or disapprove an application to purchase a variable annuity? QID: 1892369Mark For Review A 3 business days B 5 business days C 7 business days D 10 business days
7 business days
An application to purchase a variable annuity received by a broker-dealer must be approved or disapproved by a principal no later than 7 business days after receipt. Should an insurance company receive an application without a principal’s approval, the application must be rejected.
A variable annuity contract holder dies during the accumulation period. In this situation, which of the following statements is TRUE regarding the tax consequences?
QID: 1892390Mark For Review
A
All proceeds pass to the beneficiary tax-free
B
Proceeds in excess of cost are taxable as capital gains to the beneficiary
C
Proceeds in excess of cost are taxable as ordinary income to the beneficiary
D
Proceeds are not taxable if the beneficiary rolls them over into an IRA
Proceeds in excess of cost are taxable as ordinary income to the beneficiary
When a variable annuity contract holder dies during the accumulation period, the proceeds in excess of cost are taxable to the beneficiary as ordinary income.
Series K preferred stock is suitable for which of the following investors?
QID: 1892418Mark For Review
A
An investor who is seeking a fixed rate dividend for the life of the security
B
An investor who is seeking a floating rate dividend for the life of the security
C
An investor who is seeking capital appreciation if the value of the common stock increases
D
An investor who is seeking a high fixed dividend for a period of time followed by a floating rate dividend
An investor who is seeking a high fixed dividend for a period of time followed by a floating rate dividend
Series K preferred stock has the following characteristics:
It is issued by a financial service company
It has no maturity date
It pays a fixed rate for a period and then switches to a floating rate (usually based on LIBOR)
It’s dividend is non-cumulative and it may not carry voting rights
It is callable at the option of the issuer
Series K preferred stock is suitable for an investor who is seeking a high fixed dividend for a period followed by a floating rate dividend. An investor who is seeking capital appreciation based on the increasing value of the common stock should consider convertible preferred stock, not K shares.
When analyzing the credit risk of an issuer of general obligation bonds, which of the following is NOT a concern?
QID: 1892351Mark For Review
A
The diversification of economic activity
B
The budgetary pictures and legislative climate
C
Any pending litigation against the issuer
D
Existing or potential competitive facilities
Existing or potential competitive facilities
The credit analysis of a general obligation bond is based on the issuer’s ability to levy and collect taxes in an amount that’s sufficient to cover the debt service of the issue. The main considerations are as follows:
Demographics, such as the diversification of economic activity
Factors affecting the issuer’s ability to pay, such as the budgetary pictures and legislative climate
The credit analysis of a revenue bond is based on the project’s ability to generate enough revenue to pay the debt service of the issuer. One consideration is whether there are existing or potential competitive facilities (e.g., if a new airport is being financed by an issuer, determination must be made as to whether there’s another airport in the same geographical area).
A client buys 100 shares of MTB at $58 per share and writes 2 MTB October 60 calls at 3. Which of the following statements is TRUE? QID: 1892397Mark For Review A The breakeven point is $56 B The maximum profit is $600 C The maximum loss is $5,200 D The maximum loss is unlimited
The maximum loss is unlimited
This position, which is referred to as ratio writing or a variable hedge, has an objective to increase the income from writing more calls than stock owned. However, this is an extremely risky position and the client’s maximum loss is unlimited since two calls were written against a long stock position of only 100 shares. This client is covered on one short call, but uncovered on the second short call, which results in the maximum loss being unlimited. If the market price trades at or below $60 and the options expire, the client will have a $600 profit since two calls were written. The breakeven point is found by taking the purchase price of $58 and subtracting the total premiums of 6, which equals $52. The maximum profit is $800, which is found by taking the difference between the purchase price and the strike price and adding the premiums received from writing the call options (60 - 58 + 3 + 3). A popular answer choice is a maximum loss of $5,200, since students simply subtract the total premiums received ($600) from the total cost of the stock ($5,800). It is important in these questions to examine the entire position and to remember that the maximum loss on an uncovered call is unlimited.
Which TWO of the following securities would be MOST suitable if interest rates are expected to rise? Collateralized Mortgage Obligations A bond with short-term maturities Preferred stock with a fixed dividend Adjustable-rate preferred stock QID: 1892468Mark For Review A I and III B I and IV C II and III D II and IV
II and IV
If interest rates are expected to rise, the most suitable investments would be those that can be reinvested quickly to take advantage of rising rates, or variable or adjustable-rate securities. Bonds with short-term maturities can be reinvested in bonds quickly with higher rates, and the dividend on adjustment-rate preferred stock would increase since the dividend paid is based on LIBOR or another rate that quickly reacts to changing interest rates.
If an equity option is exercised, when is the settlement date for the stock transaction? QID: 1892358Mark For Review A On the same business day B On the next business day C Within two business days D Within seven business days
Within two business days
When an equity (stock) option is exercised, delivery of the underlying stock and payment for the stock is expected within 2 business days (regular-way settlement for stock).
A RR should update a client’s financial condition or status:
QID: 1892443Mark For Review
A
When there is an obvious change in the economy of the client’s hometown
B
When there is a change in the clients purchases or sales that might indicate a different financial situation
C
When informed by a friend or relative
D
Only after any meeting with the client
When there is a change in the clients purchases or sales that might indicate a different financial situation
A client is reading a financial publication that contains an advertisement for a mutual fund. Under the “omitting prospectus regulations” of the Securities Act of 1933, which of the following statements is FALSE?
QID: 1892449Mark For Review
A
This advertisement can list past performance of the mutual fund.
B
This advertisement should disclose to investors that it is important to read the prospectus before investing.
C
This advertisement can be accompanied by an application to receive a prospectus.
D
This advertisement can be accompanied by an application to invest.
This advertisement can be accompanied by an application to invest.
According to the SEC Rule 482, an offer to sell securities can only be made through a prospectus. An application to receive a prospectus can be placed in the advertisement but not an application to invest.
A business development company (BDC) is MOST suitable for which of the following investors?
QID: 1892416Mark For Review
A
An investor who is seeking a liquid investment in a portfolio of established companies
B
An investor who is seeking a non-speculative investment in a portfolio of companies that are privately held
C
An investor who is seeking a speculative investment in a portfolio of distressed companies and understands that the investment will not offer liquidity
D
An investor who is seeking a speculative investment in a portfolio of distressed companies and is interested in liquidity
An investor who is seeking a speculative investment in a portfolio of distressed companies and is interested in liquidity
A business development company (BDC) raises capital by selling securities to investors, has a structure that is similar to a closed-end investment company, and provides the investor with access to their capital (liquidity). A BDC will use the money it raises to invest in private companies, small and developing businesses, and financially troubled companies that have difficulty raising capital in public markets. Since some of the funds are invested in the equity of non-public companies, purchasing shares of a BDC is similar to buying a publicly traded investment in a private equity firm. Due to the speculative nature of BDC investments, RR’s should inform investors of all of the potential risks before making the investment.
A 3-month Treasury bill is issued at a discount to yield 9.5%, and a corporate bond is issued to yield 9.5%. The bond is to mature in 10 years. If both are offered on the same day on a bond equivalent yield basis, which of the following statements is TRUE?
QID: 1892430Mark For Review
A
The bill has a greater yield than the bond
B
The bond has a greater yield than the bill
C
The yield is the same for both
D
The bond equivalent yield and tax equivalent yield are equal
The bill has a greater yield than the bond
T-bills are issued and quoted on a discount yield basis, whereas corporate bonds are quoted on a yield-to-maturity basis. These yields are calculated in different manners. The bond equivalent yield of a T-bill is always higher than its discount yield.
A corporation with an excellent earnings record has several issues of bonds outstanding. During a period of stable interest rates, which of the following securities are expected to fluctuate the most? QID: 1892455Mark For Review A Mortgage bonds B Commercial paper C Debenture bonds D Convertible bonds
Convertible bonds
The convertible bonds will fluctuate the most because they are convertible into common stock. The price fluctuates with the price movements of the common stock. The fact that interest rates are stable is another reason why convertible bonds is the best answer. If the question had stated that interest rates were moving sharply upward or downward, then all other bonds would fluctuate sharply in price to bring yields in line with interest rates. However, the question asks what will happen in a period of stable interest rates. Given that statement, the best answer is that convertible bonds will fluctuate the most.
A mutual fund that invests in stocks that are currently trading below their intrinsic market value is a(n): QID: 1892447Mark For Review A Value fund B Growth fund C Index fund D Exchange-traded fund
Value fund
Value funds invest in stocks that their managers believe are currently undervalued – selling for less than they are really worth.
A customer has a net worth of $2 million and has $475,000 in a brokerage account. The customer wants to use some of the funds to purchase a vacation property near a beach, but has not yet found the right property. If the customer is subject to the highest marginal tax rate, wants preservation of capital, and access to her funds, what should her registered representative recommend? QID: 1892346Mark For Review A Short-term corporate debt B Treasury bills C Treasury notes D Short-term U.S. government agency debt
Treasury bills
For this customer, the best choice is Treasury bills since they have the lowest interest-rate and credit risk and offer safety of principal. Also, they’re the most liquid securities which provides quick access to the funds.
An investor owns stock that has increased in value. Which of the following is the most suitable recommendation for an RR to make if the investor wants to protect her profit?
QID: 1892380Mark For Review
A
A sell stop order that’s placed below the current market price or a long put position
B
A sell limit order that’s placed above the market or a short put option
C
A sell stop order that’s entered above the current market price or a short call position
D
A sell limit order that’s placed above the market or a long call position
A sell stop order that’s placed below the current market price or a long put position
A sell stop order that’s placed below the current market price can be used to protect a profit or limit a loss on an existing long position. The stop order will not be activated until the market declines to or below the stop price. By purchasing put options, the investor will have the right to sell his stock at a specific price (the strike price); thereby limiting any greater downside risk.
