Final Exam 6

Question 1

A client of an IA has over 20% of his assets invested in a coal mining company's stock. The IA recommends greater diversification and indicates that stocks in this sector have been continually declining in value over the last 10 years. The client believes that the stock will eventually recover and refuses to sell it. The client's behavior may be described as:
QID: 1507556Mark For Review
A
Regret aversion
B   
Anchoring
C
Conservationism
D
Overconfidence

Answer 1

Anchoring

Anchoring involves a client being attached to the belief in an investment’s potential upside despite indications to the contrary.

Question 2

In which of the following situations is an adviser required to provide a customer with an annual audited balance sheet?
The IA has custody of client assets
The IA receives substantial prepayment of advisory fees
The IA has limited discretionary authorization over a client's account
QID: 1506748Mark For Review
A
I only
B   
I and II only
C
II and III only
D   
I, II, and III

Answer 2

I and II only

An investment adviser is required to provide a customer with an annual audited balance sheet if it has custody of the client’s assets or if it receives substantial prepayment of advisory fees. Under the USA (state law), substantial prepayment of fees is considered more than $500 dollars, six months or more in advance. However, under the Investment Advisers Act of 1940 (federal law), substantial prepayment of fees is considered more than $1,200 dollars, six months or more in advance.

Question 3

A wealthy, married couple, who are both in their 40s, have money that they would like to invest. If their objective is long-term growth with minimum tax liability upon liquidation in 25 years, which of the following investments is the most appropriate?
QID: 1507561Mark For Review
A
Municipal bonds
B   
A variable annuity
C   
Individual equity securities
D
An equity-indexed annuity

Answer 3

Individual equity securities

Of the given choices, investing in individual equities is likely the most appropriate. If the equities rise in value and are then, years later, liquidated, the gains will be taxed at the long-term capital gains rate. Historically, the long-term capital gains tax rate is lower than the highest rate at which ordinary income is taxed. A variable annuity and an equity-indexed annuity may provide growth potential, but that growth is taxed as ordinary income when it is withdrawn from the annuity.

Question 4

David is the owner of a private company and his firm needs to raise capital in order to expand its e-commerce business. David’s company will issue debt securities and has decided to avoid hiring an investment bank. Under the USA, in which situation will David’s salespersons be exempt from registration as agents?
QID: 1507567Mark For Review
A
If the company wants to raise capital and issues debt in minimum denominations of $100,000 that matures in two years
B
If the company wants to raise capital and issues debt in minimum denominations of $100,000 that matures in four months
C
If the company wants to raise capital and issues debt in minimum denominations of $25,000 that matures in 270 days
D
If the company wants to raise capital and issues debt in minimum denominations of $100,000 that matures in less than one year

Answer 4

If the company wants to raise capital and issues debt in minimum denominations of $100,000 that matures in four months

For this provision to apply, the debt securities must have a maximum maturity of nine months, must be issued in minimum denominations of $50,000, and be rated in one of the three highest rating categories of a nationally recognized statistical rating organization (NRSRO).

Question 5

When acting as the trustee for a family trust, who does an investment adviser consider for termination benefits?
QID: 1507237Mark For Review
A
The grantor
B   
An income beneficiary
C   
A contingent remainder beneficiary
D
The trustee

Answer 5

A contingent remainder beneficiary

Trust accounts can have different types of beneficiaries. An income beneficiary is one who only has claims on the income, but not the property (i.e., corpus) in the trust. Remainder beneficiaries have the right to receive property if a trust is being dissolved (i.e., terminated). Typically, primary beneficiaries have the first claim to assets if a trust is broken up. Contingent beneficiaries are given property only after the primary beneficiary cannot accept the assets (e.g., the primary beneficiary passed away). Since this question didn’t mention a primary beneficiary, the best answer is a contingent remainder beneficiary.

Question 6

Shares of which type of investment company are redeemable?
QID: 1507226Mark For Review
A
A closed-end management company
B
An open-end management company
C
A fund that’s exempt from registration under the Investment Company Act of 1940
D
An investment company that has registered with the SEC

Answer 6

An open-end management company

Question 7

Mammoth Investments is a federal covered investment adviser with offices in 42 states. Which of the following statements concerning the firm’s registration is TRUE?
QID: 1506435Mark For Review
A
Mammoth’s federal registration is sufficient to do business in all states and state registration of the firm is not required
B
Mammoth must also register as an adviser in each state in which it has an office
C
Mammoth must maintain dual federal and state registrations in all states in which it does business
D
Mammoth must maintain both federal and state registrations in all states in which it does business with noninstitutional customers

Answer 7

Mammoth’s federal registration is sufficient to do business in all states and state registration of the firm is not required

The federal government and the states have divided the responsibility for regulating investment advisers. In general, an adviser must be registered with either the SEC or with one or more states. There is no requirement to register at both the federal and state levels. The basis for the federal/state division is usually the amount of assets under management. If an investment adviser has $110 million or more under management, registration with the SEC as a federal covered adviser is mandatory. Smaller advisers generally register with one or more states. (Note: An IA may also choose to register with the SEC if it has AUM of $100 million up to $110 million.)

Question 8

Which of the following choices describes a hedge fund?
QID: 1506993Mark For Review
A
An investment trust formed to buy, develop, and manage real estate
B
A limited partnership whose primary objective is an absolute positive performance
C
A popular subaccount investment option in a variable annuity
D
A registered investment company that employs short selling

Answer 8

A limited partnership whose primary objective is an absolute positive performance

There is no uniform definition of a hedge fund. However, most hedge funds are formed as limited liability companies or limited partnerships, and they typically seek absolute investment performance. This means they set a definite performance goal (such as 8%) instead of measuring their performance against an index.

Question 9

Zemo, a new company engaged in green technologies, has announced its IPO will trade on the NYSE. Frank, an adviser with Einstein Advisory Services, plans to purchase a large block of the stock and allocate shares only to his largest discretionary clients. One regulatory concern would be:
QID: 1507004Mark For Review
A   
Breach of fiduciary duty
B
Liquidity
C
Diversification
D   
Front-running

Answer 9

Breach of fiduciary duty

Question 10

According to NASAA’s model rules, which of the following is NOT required to be disclosed to a client when an investment adviser renews or extends its contract?
QID: 1507009Mark For Review
A
The formula used to calculate its investment advisory fee
B
The length of the contract
C
Any prepaid fees or penalties assessed to clients who elect to cancel the contract
D
The investment adviser’s level of experience

Answer 10

The investment adviser’s level of experience

When renewing an advisory contract, a firm is required to disclose the formula used to calculate its advisory fee, the amount of the fees, and the length of the contract. The adviser’s experience level is not required to be disclosed.

Question 11

Which TWO of the following choices are not considered an asset class?
Annuities
Stocks
Cash
The S&P 500 Index
Real estate
QID: 1507010Mark For Review
A
I and III
B   
I and IV
C
III and V
D
II and V

Answer 11

I and IV

Asset classes include stocks, bonds, cash (money-market instruments), commodities, and real estate, but not annuities or indexes.

Question 12

Claire, an agent for a broker-dealer, receives a call from a client who submits an order to sell 500 shares of stock at the market. After hanging up the phone, the agent notices the stock has begun to rebound and decides to hold the order for awhile. After half an hour, the market suddenly reverses and Claire executes the customer’s order at a loss. Which of the following statements is TRUE?
QID: 1507558Mark For Review
A
This is an unethical practice because the agent did not follow the client’s instructions
B
This is an unethical practice because the client lost money, but would have been acceptable if she had turned a profit for the client
C
This is an acceptable practice, since the agent was acting in good faith in attempting to obtain the best price for the customer
D
This is not an unethical practice because the determination of the price and time of a trade does not require discretionary authorization from the client

Answer 12

This is an unethical practice because the agent did not follow the client’s instructions

The agent failed to follow the client’s instructions. This is an unethical practice under the USA even if the agent believes in good faith that she was acting in her client’s best interests.

Question 13

Which of the following statements is TRUE regarding Roth IRAs and Coverdell Education Savings Accounts?
QID: 1507252Mark For Review
A
Both are only permitted for individuals whose income is below a certain amount.
B
Both allow tax-deductible contributions.
C
Both allow a catch-up provision if the contribution is made by a person who is over a certain age.
D
Both have the same maximum annual contribution amount.

Answer 13

Both are only permitted for individuals whose income is below a certain amount.

Question 14

If a broker-dealer has written procedures that allow for the borrowing and lending of money between agents and customers, in which of the following situations is an agent NOT allowed to borrow money from a customer?
QID: 1506741Mark For Review
A
If the customer and the agent are both registered with the same firm
B
If the customer is a member of the agents immediate family
C
If a loan is based on a written agreement with the customer and the agent repays the loan in full plus interest
D
If the lending arrangement is based on a business relationship that exists outside of the agent-customer relationship

Answer 14

If a loan is based on a written agreement with the customer and the agent repays the loan in full plus interest

An agent is allowed to borrow money from or loan money to a client, if the agent’s broker-dealer has written procedures in place allowing for the arrangement, plus one of the following situations.
The customer and agent are both registered with the same firm,
The customer is a member of the agent’s immediate family
The customer and the agent have either a business or personal relationship that exists outside the brokerage relationship
To loan money to a client based on a written agreement is not allowed.

Question 15

Which of the following are characteristics of zero-coupon bonds?
They can be purchased at a deep discount
There is no reinvestment risk
Tax consequences occur only at maturity
The investor is taxed annually
QID: 1507253Mark For Review
A   
I and III only
B
I and II only
C
I, II, and III only
D   
I, II, and IV only

Answer 15

I, II, and IV only

Zero-coupon bonds are issued at a deep discount and mature at par value; therefore, they require a minimal capital outlay. Also, due to the fact that zeros do not pay interest on a semiannual basis, they have no reinvestment risk (there is nothing to reinvest). For tax purposes, the IRS requires zero coupon investors to accrete (upwardly adjust) their basis. The result of accretion is that each year a portion of the discount is reported as taxable interest income.

Question 16

According to the Investment Advisers Act of 1940, if an investment adviser utilizes a solicitor, the solicitor must provide clients with written disclosure of all of the following, EXCEPT:
QID: 1506755Mark For Review
A
Contract terms between itself and the IA
B
Compensation agreements between itself and the IA
C
The name of the broker-dealer that will be executing client trades
D
The name of the investment adviser providing the advisory services

Answer 16

The name of the broker-dealer that will be executing client trades

Under the Investment Advisers Act of 1940, a solicitor must disclose the name of the adviser for whom it is soliciting as well as the contract terms and compensation agreement. There is no requirement for a solicitor to disclose the name of the broker-dealer executing the trades. However, before a client signs an advisory contract, the investment adviser (not the solicitor) must disclose the executing broker-dealer’s name.

Question 17

The results of discounted cash flow analysis would identify a potential purchasing opportunity when the value arrived at:
QID: 1506999Mark For Review
A
Is equal to the current cost of the investment
B
Is higher than the current cost of the investment
C
Would not be effective under any circumstances
D
Is lower than the current cost of the investment

Answer 17

Is higher than the current cost of the investment

When the results of a discounted cash flow calculation are higher than the market value of a potential investment, this signifies that the investment may be undervalued. This would lead to a potential purchasing opportunity.

Question 18

While making cold calls on behalf of an investment adviser, an IAR speaks with a prospect who has invested a significant amount of his available funds into one mutual fund. After the client enters into a contract with the advisory firm, the IAR finds another fund with the same risk profile as the client's current investment, but it provides a higher return. What form of risk is presented in this scenario?
QID: 1507002Mark For Review
A   
Opportunity risk
B
Financial risk
C   
Market risk
D
Liquidity risk

Answer 18

Opportunity risk

Question 19

If the net present value of an investment is greater than 0:
QID: 1506747Mark For Review
A
The current market value is more than the discounted cash flows
B
The current market value is less than the discounted cash flows
C
The discount rate used to calculate the present value is the internal rate of return
D
The investment is overvalued

Answer 19

The current market value is less than the discounted cash flows

Net present value is the difference between the present value of an investment’s cash flows (e.g., interest payments), MINUS the market value of the investment (i.e., NPV = PV Cash Flows - Market Price). If the net present value is greater than 0, the present value of the cash flows is worth more than the purchase price and, therefore, the investment is undervalued (i.e., NPV is greater than 0 if PV of Cash Flows is more than the Market Price).

Question 20

Which of the following is NOT included on a trade confirmation?
QID: 1507020Mark For Review
A
The commission, markup, or markdown
B   
The customer's account number
C   
The exchange and bond's rating
D
The execution price

Answer 20

The exchange and bond’s rating

Trade confirmations are sent to customers after the execution of a transaction. Confirmations must include account information, execution price, and transaction fees. Although confirmations also include information on a bond’s yield, they don’t include a bond’s rating or the exchange on which the trade was executed.

Question 21

A bank is effecting corporate securities transactions with investors. The securities being bought and sold are not issued by the bank and the bank is not currently issuing securities. Under the Uniform Securities Act, how must the bank be registered?
QID: 1507576Mark For Review
A
As an agent of a corporation
B   
As an agent of an issuer
C
As an investment adviser
D   
As a broker-dealer

Answer 21

As a broker-dealer

Although banks are often excluded from the definition of a broker-dealer, if a bank sells corporate securities of a different issuer, it must register with the Administrator as a broker-dealer. In this example, the bank is selling the securities of another issuer and must register as a broker-dealer. On the other hand, if a bank does not carry securities accounts and is only selling certificates of deposit, the bank is not required to register as a broker-dealer.

Question 22

Which statement about an investment adviser’s annual renewal is TRUE?
QID: 1507578Mark For Review
A
Both state and federal covered advisers are required to renew their registrations by filing Form ADV within 90 days of the calendar year end.
B
Form ADV is filed with the SEC within 90 days of the calendar year end, or with the state Administrator(s) within 90 days of the investment adviser’s fiscal year end.
C
Form ADV is filed with the SEC within 45 days of a federal covered adviser’s fiscal year end, or with the state Administrator(s) within 90 days of investment adviser’s fiscal year end.
D
Form ADV is filed with the SEC within 90 days of a federal covered adviser’s fiscal year end, or with the state Administrator(s) within 90 days of the calendar year end.

Answer 22

Form ADV is filed with the SEC within 90 days of a federal covered adviser’s fiscal year end, or with the state Administrator(s) within 90 days of the calendar year end.

Federal covered advisers are required to renew their registration by filing Form ADV with the SEC within 90 days of their fiscal year end. On the other hand, state registered investment advisers are required to file Form ADV within 90 days of the calendar year end.

Question 23

Under the Uniform Securities Act, which individual is considered to be an agent?
QID: 1507007Mark For Review
A
A secretary who accepts customers’ securities orders
B
A principal of a broker-dealer
C
A person who solely performs clerical functions
D
A silent partner of a broker-dealer

Answer 23

A secretary who accepts customers’ securities orders

An agent is defined as a person who represents either a broker-dealer or an issuer in effecting securities transactions. The definition excludes principals of broker-dealers, clerical employees who do not accept customer orders, and silent partners.

Question 24

A mutual fund owns stocks with a total market capitalization of $50 million, but also has $3 million in liabilities, and $2 million in cash from dividends paid by stocks that the fund owns. If the mutual fund has 10 million shares outstanding, what's the net asset value?
QID: 1507247Mark For Review
A
$4.50 per share
B   
$4.90 per share
C
$5.10 per share
D
$1.00 per share

Answer 24

$4.90 per share

The net asset value (NAV) of a fund is the total assets, minus liabilities, divided by the number of shares the fund has issued. The fund’s assets include the $50 million market value of the stocks in the portfolio, plus the $2 million of cash, for a total of $52 million. The liabilities are $3 million; therefore, the net assets are $49 million ($52 million assets - $3 million liabilities). After dividing the net assets by the liabilities, the net asset value (NAV) per share is $4.90 ($49 million net assets ÷ 10 million shares).

Question 25

A customer of a broker-dealer has purchased stock in a margin account. The customer's exposure in the account is 50%. If the stock falls by 10%, what's the customer's percentage of loss in the account?
QID: 1507563Mark For Review
A   
20%
B
50%
C   
5%
D
10%

Answer 25

20%

If a customer has 50% exposure in a margin account, it means they’ve only paid for 50% of an investment and borrowed the other 50%. When a customer has 50% exposure, the easiest way to determine the client’s percentage loss due to the decline in the stock’s value is to double the percentage of decline. In this question, since the stock declined by 10%, the customer has a resulting loss of 20% (i.e., 2 x 10% = 20%).

Question 26

Which of the following choices is considered an offer or an offer to sell securities under the Uniform Securities Act?
QID: 1506754Mark For Review
A
A group of creditors receives stock in a bankrupt company as part of a court-approved reorganization plan
B
A corporation’s current shareholders receive the right to purchase additional shares at a predetermined price
C
A corporation’s current shareholders receive a stock dividend, rather than a cash dividend
D
A used car dealer offers a free bank-issued certificate of deposit (CD) to every person who purchases a car

Answer 26

A corporation’s current shareholders receive the right to purchase additional shares at a predetermined price

Question 27

What’s an exchange-traded fund (ETF)?
QID: 1507257Mark For Review
A
An unsecured bond that’s issued by a financial institution and offers a rate of return which is based on a basket of securities.
B
A portfolio of securities that’s registered as an investment company and can be bought and sold on an exchange.
C
A registered investment company that invests in a fixed portfolio of securities.
D
An exchange-traded portfolio that must derive 75% of its gross income from investments in real property.

Answer 27

A portfolio of securities that’s registered as an investment company and can be bought and sold on an exchange.

Question 28

Regarding equity-indexed annuities, which of the following statements is TRUE?
QID: 1507241Mark For Review
A
If the index declines in value, there’s no floor as to how much an investor may lose.
B
If the index increases in value, there’s no limit as to how much an investor may gain.
C
Since equity-indexed annuities are not securities, they’re considered risk-free securities.
D
If the annuitant withdraws money before the surrender period is over, she’s required to pay a surrender fee.

Answer 28

If the annuitant withdraws money before the surrender period is over, she’s required to pay a surrender fee.

Although equity-indexed annuities (EIAs) are insurance products, they’re subject to many FINRA rules. Broker-dealers must always have adequate controls in place to supervise the sales activities of their RRs. EIAs are generally issued with both a floor (that limits loss on the downside) and a cap (that limits the gain on the upside).

Question 29

An Administrator receives a written notice indicating that an IA has just violated the net capital rule and is currently below the minimum requirement. Which of the following reports would the Administrator demand?
A current balance sheet
Contact information for the qualified custodian that handles the clients' funds
A client ledger
A list of all client-owned securities and nonsegregated funds
QID: 1507557Mark For Review
A
I and II only
B
I, II, and III only
C   
I, III, and IV only
D   
I, II, III, and IV

Answer 29

I, III, and IV only

According to NASAA rules, if an IA violates the net capital rule, the Administrator may require the adviser to provide its balance sheet, client ledger, and a list of all customer-owned securities and nonsegregated funds. However, the Administrator would not require the qualified custodian’s name since that information is already disclosed in the investment adviser’s Form ADV.

Question 30

A broker-dealer owns 100 shares of ABCO stock which it purchased at 28. If the stock is sold to a customer, the broker-dealer will base the markup on:
QID: 1507245Mark For Review
A
The inventory cost of 28
B
The highest bid on the Nasdaq system
C   
The lowest offer on the Nasdaq system
D   
A price that is fair and reasonable

Answer 30

The lowest offer on the Nasdaq system

When selling stock to a customer, a markup should be based on the lowest offer on the Nasdaq system, not the price the dealer paid to purchase the stock (dealer’s inventory cost).

Question 31

In which of the following circumstances is an investment adviser required to obtain a client’s permission before assigning her contract?
QID: 1506998Mark For Review
A
A sole proprietor decides to take on seven partners, while still retaining a 30% ownership stake in the advisory firm
B
The owner of 80% of an advisory firm pledges his home as collateral for a loan he has made to the firm
C
The owner of 40% of an advisory firm dies
D
The owner of 25% of an advisory firm leaves to start another firm as a sole proprietorship

Answer 31

A sole proprietor decides to take on seven partners, while still retaining a 30% ownership stake in the advisory firm

Assignment is defined as the direct or indirect transfer of a client’s advisory contract by an investment adviser. Assignment typically occurs when an adviser is sold or acquired by new ownership. If an adviser is a corporation, the acquisition of a majority of the adviser’s shares by another entity is considered assignment and requires client consent (i.e., the client’s signature). If an adviser is organized as a partnership, the death or resignation of a majority of the partners is considered assignment and client consent is required. Client consent is also required if a sole proprietor sells 70% of his ownership to new partners (i.e., a majority change). If an owner of 40% of an advisory firm dies or if a 25% owner of an advisory firm leaves, it doesn’t constitute assignment since it’s not majority change. The owner of an advisory firm pledging his home as collateral doesn’t constitute assignment.

Question 32

Patrick invests in a diversified portfolio of income-producing equity investments. Patrick is investing to achieve the goal of early retirement. He takes all his dividend income and uses it to pay bills. What is the main problem with this type of strategy?
QID: 1507259Mark For Review
A
By spending the dividends, Patrick incurs a current tax liability each year
B
Patrick does not take advantage of compounding (reinvestment of dividends) to increase earnings
C
Bills should always be paid from earnings, not investment income
D
Patrick should definitely balance his portfolio with some mutual fund investments

Answer 32

Patrick does not take advantage of compounding (reinvestment of dividends) to increase earnings

Question 33

A broker-dealer is about to launch a marketing campaign to promote the knowledge and expertise of their employees. The broker-dealer has decided to establish a website on which it will include a significant amount of information regarding securities. According to the Uniform Securities Act, what step(s) should the broker-dealer take to launch its website while also avoiding registration as a broker-dealer in every state?
QID: 1507249Mark For Review
A
The broker-dealer should include a disclaimer on the website to indicate the only state(s) in which its registered to do business.
B
The broker-dealer is permitted to launch the website without registering in every state.
C
The broker-dealer should only register in the state that hosts the website.
D
The broker-dealer has no choice and must register in every state.

Answer 33

The broker-dealer is permitted to launch the website without registering in every state.

The Uniform Securities Act defines a broker-dealer as a person that effects securities transactions for the accounts of others or its own account. Since the website does not permit individuals to buy and sell securities, the broker-dealer is not required to register in every state. The broker-dealer is only required to register in the state(s) in which it effects transactions. This typically means the state(s) in which the broker-dealer has an office and the state(s) in which its customers reside.

Question 34

ABC Investment Adviser is a federal covered adviser and requires its IARs to have an MBA degree before they are able to provide advice to its clients. For any of the firm's IARs who provides advice, in what document(s) must their education be disclosed?
ADV Part 1
ADV Part 2
Schedule E
The adviser's brochure
QID: 1507577Mark For Review
A   
I only
B
I and II only
C
II and III only
D   
II and IV only

Answer 34

II and IV only

If an investment adviser requires a specific level of education or business experience for its IARs to be able to provide advice, it must be disclosed in its ADV Part 2, which may also be used as the adviser’s brochure.

Question 35

At the beginning of the year, the price-to-earnings (P/E) ratio of ABC stock was 30, but three months later it fell to 15 because of bad news about the company's future earnings projections. Which of the following explains the company's lower PE ratio?
QID: 1507559Mark For Review
A
The stock price increased.
B
Earnings per share increased.
C   
The stock price decreased.
D   
Earnings per share decreased.

Answer 35

The stock price decreased.

The price to earnings (PE) ratio is typically calculated by taking the current market price of the company’s stock and dividing it by the earnings per share (EPS) from the last fiscal year. In this question, downgrading the future projections for the company’s earnings will not have any impact on last year’s EPS. However, the market price of the stock will fall due to the lower earnings projections, which explains how the P/E ratio fell from 30 to 15.

Question 36

Susan is registered as an investment adviser representative (IAR). Susan asks one of her clients to write positive comments about her firm’s services and then post them on a social media site. Is Susan’s request considered a violation of the communication rules?
QID: 1507005Mark For Review
A
No, provided the posts have been preapproved by a supervisor of the IA.
B
Yes, because investment advisers are never permitted to post content that’s created by third parties.
C
No, provided the content is not misleading and appropriate disclosures are made.
D
Yes, because testimonials are prohibited under the Investment Advisers Act of 1940.

Answer 36

No, provided the content is not misleading and appropriate disclosures are made.

Investment advisers that encourage or pay a person to promote their services are using testimonials. Traditionally, testimonials were prohibited under the IA Act of 1940. However, in 2020, the SEC updated its rules and now permit IAs to use testimonials. Keep in mind, IAs that use testimonials are responsible for ensuring that the testimonials are accurate and not materially misleading. In addition, IAs need to provide disclosures about the relationship between the adviser and the person making the testimonial.

Question 37

What are the advantages of a limited liability company (LLC) compared to an S Corporation?
QID: 1506756Mark For Review
A
Limited liability
B
Lower corporate tax rates
C   
A simpler managerial structure
D   
Continuity of life

Answer 37

Continuity of life

Owners of S Corporations and limited liability companies have limited liability. Both entities also have a flow-through tax structure. Income, capital gains, and capital losses are passed directly on to the investors and reported on their personal income tax returns. Neither entity pays federal corporate taxes on income earned. The advantage of a limited liability company is that its managerial structure is much simpler. There is no need for a board of directors or annual meetings or the other formalities of a corporation. However, unlike an S Corporation that has continuity of life, LLCs are dissolved after an event (e.g., owner dies) or a specific period passes.

Question 38

In the past year, a client reported earnings of $3,000 in dividends, $6,000 in long-term capital gains, and salary of $190,000. The client also had a loss of $8,000 from a limited partnership investment. For tax purposes, how is the limited partnership loss treated?
QID: 1507242Mark For Review
A
The partnership loss is only deductible against the $6,000 long-term capital gain
B
The partnership loss is only deductible against the salary of $190,000
C
The partnership loss is only deductible against other income, up to $3,000
D
The partnership loss is only deductible against passive income

Answer 38

The partnership loss is only deductible against passive income

A limited partner’s share of profits from a limited partnership are considered a form of passive income and taxed as ordinary income. A partner’s share of the partnership’s losses are considered passive losses (not capital losses), which are deductible against passive income only. Since the client did not report any passive income, the loss is suspended and carried forward.

Question 39

A group of investors are forming a start-up company. The business will have approximately five investors. The investors want the most tax efficient business structure and to avoid paying taxes twice on company profits. Which business structure would allow them to protect their personal assets and also avoid double taxation?
An S Corporation
A C Corporation
A limited liability company
A closed corporation
QID: 1507013Mark For Review
A   
I only
B   
I and III only
C
II and III only
D
I, II, III, and IV

Answer 39

I and III only

S Corporations and limited liability companies (LLCs) are flow-through entities. Therefore, profits are passed through to the owners and reported on their individual tax returns. C Corporations, however, are subject to two levels of taxation, since they are considered separate entities for tax purposes. They must pay corporate income taxes and their shareholders must also pay individual income taxes on dividends that they receive. Closed corporations (also termed privately held corporations) are companies whose shares do not trade publicly. A closed corporation could be organized as either an S Corporation or a C Corporation. (Note, however, that S Corporations are almost always closed corporations since they may only have a maximum of 100 shareholders.)

Question 40

According to the Uniform Securities Act, all the following transactions would be considered exempt, EXCEPT:
QID: 1506995Mark For Review
A
A transaction that is executed by a bona fide pledge that is not intended to evade the USA
B
A nonissuer transaction of a security that is regularly quoted on the OTC Bulletin Board
C
A nonissuer transaction of a security that is quoted on Nasdaq
D
A transaction executed by a guardian appointed by a state court

Answer 40

A nonissuer transaction of a security that is regularly quoted on the OTC Bulletin Board

A nonissuer transaction of a security that is regularly quoted on the OTC Bulletin Board would not qualify as an exempt transaction. The OTCBB does not have specific listing criteria, whereas national exchanges such as the NYSE and Nasdaq have minimum standards to which issuers must adhere. All the other choices are specifically defined under the USA as exempt transactions.

Question 41

Paul works as a registered representative for Broker-Dealer X and also works as a financial planner under Broker-Dealer X’s control. Paul’s only source of compensation are commissions for trades that are executed. According to the Investment Advisers Act:
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A
Paul must be registered as an investment adviser
B
Broker-Dealer X must be registered as an investment adviser
C
Paul does not need to be registered as an investment adviser
D
Neither Paul nor Broker-Dealer X are required to registration as an investment adviser

Answer 41

Neither Paul nor Broker-Dealer X are required to registration as an investment adviser

According to SEC Release 1092, broker-dealers are not required to register as investment advisers if their advisory service is solely incidental to the conduct of their business as broker-dealers and if they do not receive any special compensation for their advice. This exclusion is also available to a registered representative who acts as a financial planner under the knowledge and control of his broker-dealer.

Question 42

Which TWO of the following items does the IRS consider earned income?
Royalties
Dividends
Long-term disability benefits received prior to minimum retirement age
Social Security
QID: 1507236Mark For Review
A   
I and III
B
I and IV
C   
II and III
D
II and IV

Answer 42

I and III

The IRS defines earned income as compensation received for personal services actually rendered. Royalties and long-term disability benefits received prior to the minimum retirement age come under the IRS’s definition. Dividends and Social Security are not considered earned income. They are still taxable, however.

Question 43

The original asset allocation of an investment portfolio was 10% cash, 40% bonds, and 50% stocks. A recent bear market, however, has altered this allocation to 10% cash, 50% bonds, and 40% stocks. The client’s investment objectives and risk tolerance have not changed. The adviser recommends that the portfolio be systematically rebalanced by selling:
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A
Stocks and buying bonds with the proceeds
B
Bonds and buying stocks with the proceeds
C
Stocks and bonds and placing the proceeds in cash until market conditions stabilize
D
Stocks and bonds and allocating 10% of the portfolio to alternative investments

Answer 43

Bonds and buying stocks with the proceeds

Systematic rebalancing is the process of buying and selling securities within a portfolio to restore its original asset allocation. Systematic rebalancing may be done either periodically (annually, quarterly, or monthly) or whenever market forces or different rates of return cause a significant change in the original asset allocation.

In this case, a bear market has caused the value of the stocks in the portfolio to shrink so that this asset class now represents only 40% of the total portfolio. The adviser would rebalance the portfolio by selling bonds and buying stocks with the proceeds.