Final Exam 7

Question 1

David has annual income of $482,000 and is contributing the maximum allowable amount to his 401(k) plan. If he wants to fund another retirement account, which of the following is the MOST suitable account?
QID: 1507190Mark For Review
A
Roth IRA
B
Education IRA
C   
Traditional IRA
D   
Non-deductible IRA

Answer 1

Non-deductible IRA

Investors with a high level of income are not eligible to contribute to Roth IRAs and may not be able to deduct the contributions they make to traditional IRAs. Since this investor is covered by an employer plan and he has a high income, his IRA contributions will be non-deductible (i.e., after-tax). Education IRAs (i.e., Coverdell Education Savings Accounts) are suitable for saving for college, but not appropriate for retirement savings.

Question 2

If an advisory client is most concerned with minimizing her tax liability, common stocks may provide a greater benefit than corporate bonds because:
QID: 1507323Mark For Review
A
Stocks tend to offer a lower yield than corporate bonds
B
Qualified cash dividends are taxed at a maximum rate that is less than the rate at which the interest on corporate bonds is taxed
C
The unrealized capital gains on some bonds is taxed each year as ordinary income
D
Capital gains on stocks are taxed at a lower rate than the capital gains on corporate bonds to encourage investments in stocks

Answer 2

Qualified cash dividends are taxed at a maximum rate that is less than the rate at which the interest on corporate bonds is taxed

If an investor owns stock of a domestic corporation (or shares of a fund that contains these types of stocks) and has satisfied a holding period, any dividends that are distributed by the company (or fund) are considered a qualified cash dividends and are taxed at a maximum rate of 20%. On the other hand, the interest on corporate bonds is taxed as ordinary income (possibly as high as 39.6%). Capital gains are only taxable if they are realized (i.e., the investor sells the asset at a price that is higher than what he originally paid).

Question 3

A sector rotation strategy would include investing in which of the following?
QID: 1507184Mark For Review
A
Industrial stocks in an expanding economy
B
Precious metals at the peak of the economy
C
Consumer goods stocks in an expanding economy
D
Technology stocks in a contracting economy

Answer 3

Industrial stocks in an expanding economy

A sector rotation strategy involves investing in businesses that will grow along with the economy. Industrial stocks are cyclical and will rise and fall with the economy. The best time to buy technology stocks is right before an expansion, not during a contraction. Commodities help protect against inflation, but inflation is generally not anticipated if the market is peaking. Consumer goods companies make staples (e.g., groceries and household products) and would generally perform well during a recession.

Question 4

All of the following are characteristics of an irrevocable trust, EXCEPT:
QID: 1506701Mark For Review
A
Assets are often excluded from the grantor’s estate
B
The grantor may not benefit from the assets in the trust after they have been placed in the trust
C
The trust avoids probate
D
During the grantor’s lifetime, any income taxes are paid by the grantor

Answer 4

During the grantor’s lifetime, any income taxes are paid by the grantor

Unlike revocable trusts, income that’s generated in an irrevocable trust is taxable to the trust, not the grantor. Irrevocable trust assets are excluded from the grantor’s estate, which minimizes the estate tax liability. Both revocable and irrevocable trusts avoid probate, and this is often a main reason that trust accounts are established.

Question 5

In what type of investing would an active or tactical asset manager engage?
QID: 1507179Mark For Review
A
Indexing
B   
Day trading
C
Buy-and-hold
D   
Systematic rebalancing

Answer 5

Day trading

Active investment strategies stress that markets are inefficient. Day trading, which involves attempting to time the market, is a type of tactical investment approach. On the other hand, systematic rebalancing, buy-and-hold, and indexing are all types of passive strategies.

Question 6

Which TWO of the following statements are TRUE regarding Subchapter S Corporations?
Their status is terminated if there are more than 100 shareholders.
They have a federal charter.
Shareholders have unlimited liability.
Income and losses flow through to shareholders.
QID: 1507306Mark For Review
A   
I and III
B   
I and IV
C
II and III
D
II and IV

Answer 6

I and IV

Subchapter S status is revoked if there are more than 100 shareholders. As with limited partners, shareholders have limited liability, and income and losses flow through to shareholders. Subchapter S Corporations have state charters.

Question 7

Which of the following would most likely be registered with the state Administrator?
QID: 1506988Mark For Review
A
A municipal revenue bond
B   
A mutual fund
C
An NYSE-listed company's common stock
D   
A distribution of an interest in a mining or real estate venture

Answer 7

A distribution of an interest in a mining or real estate venture

Interests in mining or real estate ventures are examples of partnership offerings. General and limited partnerships are often registered with the Administrator in the state in which they are offered. Municipal bonds are not subject to registration requirements since they are categorized as exempt securities under the Uniform Securities Act. Also, mutual fund shares and securities listed on the NYSE are federal covered securities, since these issues are only required to be registered with the SEC.

Question 8

Net asset value is:
QID: 1507183Mark For Review
A
The assets of a fund, plus the fund’s liabilities, multiplied by the number of shares issued
B
The assets of a fund, minus the fund’s liabilities, divided by the number of shares issued
C
The value an insurance company guarantees to an annuitant in a fixed annuity contract
D
The proceeds exceeding the cost basis which is payable to the beneficiary after an annuitant dies

Answer 8

The assets of a fund, minus the fund’s liabilities, divided by the number of shares issued

NAV = (Assets - Liabilities) ÷ Shares Issued

Question 9

All of the following maturities are offered for TIPS, EXCEPT:
QID: 1507173Mark For Review
A   
1 year
B
5 years
C
10 years
D   
30 years

Answer 9

1 year

Treasury Inflation-Protected Securities (TIPS) are offered in 5-year, 10-year, and 30-year maturities. Maturities of one year are not available for TIPS.

Question 10

The Uniform Securities Act prohibits:
QID: 1507308Mark For Review
A   
Soliciting orders for unregistered, non-exempt securities
B
Maintaining discretionary accounts
C   
Charging extraordinary commissions on certain transactions
D
Accepting unsolicited orders

Answer 10

Soliciting orders for unregistered, non-exempt securities

Soliciting orders for unregistered, non-exempt securities is prohibited by the Uniform Securities Act. The Act permits broker-dealers to maintain discretionary accounts for customers, to charge fees for services performed in customer accounts, and to accept unsolicited orders.

Question 11

An investment adviser is also registered as a broker-dealer. According to the Investment Advisers Act of 1940, which of the following statements regarding contracts for impersonal advisory services is/are TRUE?
These services may be provided orally.
These services may contain statistical information as long as the IA expresses no opinions about the statistics.
These services may be distributed in writing.
These services cannot claim to meet any specific investment goals of any particular investor.
QID: 1507199Mark For Review
A
I only
B
I and II only
C
I, II, and IV only
D
I, II, III, and IV

Answer 11

I, II, III, and IV

If an investment adviser offers an impersonal advisory service, it may be offered verbally or in written form and may contain statistics. Impersonal advisory service is defined as service that does not purport to meet the objectives or needs of specific individuals or accounts. When an investment adviser also acts in the capacity of a broker-dealer, it must provide its advisory clients with written disclosure.

Question 12

Which of the following would be considered a sale of securities?
A car dealership gives each customer a gift of one free share of stock for buying a new car.
An investor converts a bond into 50 shares of common stock.
A minor is named as a beneficiary of a trust containing common stock.
An individual inherits a security from the estate of a deceased parent.
QID: 1507172Mark For Review
A
I only
B
I and II only
C
II, III, and IV only
D
I, II, III, and IV

Answer 12

I only

If an individual is required to pay for an item in order to receive a free security, then the security investment is not actually free. The required payment would constitute a sale of the security. The other examples involve either the gift or transfer of securities and would not be considered a sale.

Question 13

Which of the following is a benefit of a transfer on death (TOD) account designation?
QID: 1507194Mark For Review
A
The beneficiary avoids the estate tax.
B
The beneficiary is required to pay the estate tax.
C
The beneficiary has discretionary authority during the owner’s lifetime.
D
The beneficiary avoids probate.

Answer 13

The beneficiary avoids probate.

A transfer on death (TOD) account will pass to the beneficiary (or beneficiaries) upon the death of the account owner. The benefit of a TOD designation is that the transfer of ownership of the account’s assets avoids probate. However, assets in a TOD account are still subject to the estate tax. This form of account is not considered a joint account since the beneficiary only receives control of the account after the death of the original owner.

Question 14

Under the Uniform Securities Act, which of the following choices is a nonexempt transaction?
QID: 1506698Mark For Review
A
Selling U.S. federal agency securities to a bank
B
Selling U.S. Treasury bills to a mutual fund
C
Selling unregistered nonexempt securities
D
Selling unregistered exempt securities on an unsolicited basis

Answer 14

Selling unregistered nonexempt securities

The only nonexempt transaction in this question is selling unregistered, nonexempt securities. This would actually be a violation of the Uniform Securities Act.

Question 15

If an adviser wants to evaluate a publicly traded firm's ability to pay down its short-term debt, which ratio would be most appropriate?
QID: 1507176Mark For Review
A
P/E Ratio
B
Sharpe Ratio
C   
Debt Coverage Ratio
D   
Current Ratio

Answer 15

Current Ratio

The best measure of short-term liquidity is the current ratio, which is calculated by dividing current assets by current liabilities. Although the debt coverage ratio also measures liquidity, it actually includes all debt-both short-term and long-term.

Question 16

What formula is used to find the present value of an investment by using a future value that is decreased at a compound rate over time?
QID: 1507200Mark For Review
A   
A discounting formula
B
An adjusting formula
C
Accretion
D
Beta

Answer 16

A discounting formula

Question 17

According to the Securities Act of 1933, a pooled investment fund is considered a federal covered security when it:
QID: 1507307Mark For Review
A
Registers as a hedge fund
B
Is managed by a federal covered adviser
C
Registers with the SEC under the Investment Company Act of 1940
D
Files an application with an Administrator seeking an exemption

Answer 17

Registers with the SEC under the Investment Company Act of 1940

An investment pool is considered a federal covered security when recognized as an investment company under the Investment Company Act of 1940 and when its offering is registered with the SEC. Requesting an exemption or employing a federal covered adviser does not make an investment pool an investment company.

Question 18

A sole proprietor desires to set up their business as a separate entity, but retain the same flow-through tax treatment with full ownership. Which of the following business entities would be BEST?
QID: 1507315Mark For Review
A
A limited partnership
B   
A general partnership
C
A C Corporation
D   
A Subchapter S Corporation

Answer 18

A Subchapter S Corporation

By establishing a Subchapter S Corporation, the business is not taxed. Instead, income and losses flow through to the shareholders, which in this case is one person. While partnerships also provide flow-through of tax treatment, they require more than one owner or investor. A C Corporation is a taxable entity that lacks flow-through tax treatment.

Question 19

An Administrator from State A has jurisdiction over an offer made:
On a radio or television program that originated in State A
On a radio or television program broadcast in State A where the communication originated outside the state
In a newspaper circulated in State A, but published in State B
In a newspaper published in State A, but with more than two-thirds of its circulation outside the state in the last year
QID: 1506984Mark For Review
A
I only
B
I and II only
C
I and III only
D
I, II, III, and IV

Answer 19

I only

Question 20

Open-end funds:
QID: 1507302Mark For Review
A
Trade in the secondary market
B
Only issue full shares
C   
Have a fluctuating capitalization
D
Issue non-redeemable shares

Answer 20

Have a fluctuating capitalization

Question 21

Which of the following may be advertised as a no-load fund?
QID: 1506983Mark For Review
A
A fund that assesses a front-end sales charge
B
A fund that assesses a back-end sales charge
C
A fund that assesses a 12b-1 fee of 0.25% of average total assets per year
D
A fund that assesses a 12b-1 fee of 0.25% of average net assets per year

Answer 21

A fund that assesses a 12b-1 fee of 0.25% of average net assets per year

Question 22

Which of the following is NOT an option exercise style?
QID: 1507177Mark For Review
A
American
B   
Capped
C
European
D   
Uncovered

Answer 22

Uncovered

Uncovered is a term that relates to an option position or strategy that investors may employ and it’s in no way connected to an option exercise style. American, European, and Capped are option exercise styles. American style options allow the owners to exercise their contracts any time prior to expiration. European style options allow the owners to exercise their contracts only during a specified period, typically on the business day of expiration. Capped style options will be exercised automatically if the value of the underlying security hits or exceeds a specified capped price.

Question 23

A customer invested $25,000. After 20 years the investment is now valued at $100,000. How many years did it take to double in value?
QID: 1507316Mark For Review
A
4
B
5
C   
7
D   
10

Answer 23

10

The $25,000 investment doubled twice, from $25,000 to $50,000, then to $100,000, over 20 years, or it doubled every 10 years.

Question 24

Which of the following factors is a disadvantage of a buy/hold strategy?
QID: 1506977Mark For Review
A   
Low transaction costs
B   
Changing portfolio risk levels
C
Higher management fees
D
Increased tax risk

Answer 24

Changing portfolio risk levels

While a buy/hold strategy has the advantage of minimizing capital gains taxes and transaction costs, the mix of assets can drift substantially from the original asset allocation, changing the risk levels of the portfolio. The risk level may eventually be outside the client’s risk tolerance.

Question 25

Under the USA, which of the following entities could be considered an investment adviser?
QID: 1507313Mark For Review
A   
A bank
B
A trust company
C
A savings institution
D   
An insurance company

Answer 25

An insurance company

Under the Uniform Securities Act, banks, trust companies, and saving institutions are specifically exempt from the definition of investment adviser. There is no specific exemption for insurance companies.

Question 26

All of the following securities prices are quoted based on the market price, rather than NAV, EXCEPT:
QID: 1507325Mark For Review
A   
Open-end management companies
B   
Closed-end management companies
C
Exchange-traded funds
D
Hedge funds

Answer 26

Open-end management companies

Open-end management companies (mutual funds) and unit investment trusts (UITs) are valued each day, at the close of market, based on their net asset value. Closed-end management companies and ETFs trade in the market at either a premium or discount to their NAV, or they are quoted at their market value. Since hedge funds do not trade, their value is not transparent.

Question 27

An adviser is comparing two bonds of similar credit quality and duration for a client. The client is seeking a yield of 7.2%. After performing discounted cash flow analysis on each bond, the adviser has determined that Bond A is trading at a premium to its present value, while Bond B is trading at a discount to its present value. Which TWO of the following statements are TRUE?
Bond A is priced attractively and should be purchased.
Bond B is priced attractively and should be purchased.
The investor will earn an annual interest rate greater than 7.2% with Bond A.
The investor will earn an annual interest rate greater than 7.2% with Bond B.
QID: 1506700Mark For Review
A
I and III
B
I and IV
C
II and III
D
II and IV

Answer 27

II and IV

Question 28

Which of the following statements is TRUE according to ERISA section 404(b)?
QID: 1507303Mark For Review
A
The fiduciary may maintain plan assets in any foreign jurisdiction
B
Any plan participant may be considered a fiduciary
C
The fiduciary may not maintain the indicia of ownership of assets of the plan outside the jurisdiction of the district courts of the U.S.
D
The fiduciary may maintain the indicia of ownership of assets of the plan outside the jurisdiction of the district courts of the U.S. if authorized by the Secretary of the Department of Labor

Answer 28

The fiduciary may maintain the indicia of ownership of assets of the plan outside the jurisdiction of the district courts of the U.S. if authorized by the Secretary of the Department of Labor

Question 29

Which TWO of the following statements are TRUE of stop orders?
A stop order may be described as a suspended market order
A stop order may be executed only at the stop price or better
A stop order, when triggered, guarantees an execution
A stop order, when triggered, becomes a limit order and needs its limit price to be satisfied for execution
QID: 1507169Mark For Review
A
I and III
B
I and IV
C
II and III
D
II and IV

Answer 29

I and III

A stop order becomes a market order (in turn receiving immediate execution) when a round-lot trades at or through its stop price. A stop-limit order becomes a limit order when a round-lot trades at or through its stop price, and requires that its limit price be satisfied to receive an execution. A stop order is sometimes described as a suspended market order since execution depends on the stop price being triggered first.

Question 30

Which of the following is an example of an exempt transaction under the Securities Act of 1933?
QID: 1507189Mark For Review
A
U.S. Treasury securities
B
Municipal securities
C   
Reg. D
D   
Railroad equipment trusts

Answer 30

Reg. D

Since this question is asking about an exempt transaction at the federal level (Act of 1933), the only appropriate answer is Regulation D. A Regulation D offering is also considered private placement and represents a federal exempt transaction. Under the Securities Act of 1933, U.S. Treasuries, municipal securities, and railroad equipment trusts are all exempt securities (not transactions).

Question 31

Ted set up a 529 plan for his daughter Nicky in 2004. Performance in the account has been mediocre. Which TWO of the following options does Ted have with respect to making changes in the account?
Roll over the funds into a Coverdell Education Savings Account
Set up a new and separate 529 plan
Roll over the funds into another 529 plan
Maintain the same 529 plan as required
QID: 1506702Mark For Review
A
I and II
B   
I and IV
C   
II and III
D
II and IV

Answer 31

II and III

A rollover of a 529 plan is permitted every 12 months. In rolling over funds from this type of plan an investor would be moving the funds to another state’s plan. Generally, there are no residency requirements for a 529 plan. A 529 plan may not be rolled over to a Coverdell Education Savings Account.

Question 32

An investment adviser is attempting to determine whether a fixed-income security is priced attractively relative to a client's desired annual interest rate. Which of the following methods would BEST determine a bond's fair value?
QID: 1506991Mark For Review
A   
Calculating the bond's duration
B
Determining the future value of the bond
C
Confirming the yield to maturity
D   
Discounted cash flows

Answer 32

Discounted cash flows

Discounted cash flow evaluates each coupon payment and the repayment of a bond’s principal at a present value, based on a rate of return. This makes it possible to evaluate a bond’s value against the investor’s desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond’s principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for her client.

Question 33

According to the Securities Exchange Act of 1934, which of the following is NOT required to be included on the confirmation for a bond trade?
QID: 1507191Mark For Review
A
Disclosure of the bond's coupon rate
B   
Disclosure of the bond's yield-to-maturity
C   
Disclosure of the bond's rating
D
Disclosure of the bond's purchase price

Answer 33

Disclosure of the bond’s rating

Although a bond’s rating is not required to be included on a confirmation, if the bond is unrated, this fact must be disclosed. A bond’s price and its yield-to-maturity at the time of the trade must be disclosed on a confirmation.

Question 34

According to the Capital Asset Pricing Model (CAPM), all of the following statements are TRUE, EXCEPT:
QID: 1506980Mark For Review
A
In an efficient market, all securities are priced fairly in relation to their risks and returns.
B
In an inefficient market, it may be possible to find securities that are selling for less than their “true” value.
C
Given a choice of two investments that offer the same return, investors will choose the investment with greater variability.
D
Most investors are able to borrow or invest money easily at the same rate as three-month T-bills.

Answer 34

Given a choice of two investments that offer the same return, investors will choose the investment with greater variability.

CAPM makes the assumption that all investors are risk-averse. Therefore, when given a choice between two investments that offer the same return, a risk-averse investor will choose the one with less variability (less risk). Likewise, when given a choice between two investments with the same variability (risk), risk-averse investors will choose the one with the higher return.

Question 35

Which of the following asset management techniques would NOT be used to identify a security that is either undervalued or overvalued?
QID: 1507320Mark For Review
A
Fundamental analysis
B   
Indexing
C   
Technical analysis
D
Tactical management

Answer 35

Indexing

When a portfolio is indexed, the manager is attempting to match the performance of the market. An indexed portfolio is one with a composition that mirrors a benchmark index. Fundamental, technical, and tactical approaches all attempt to identify securities that are either overvalued or undervalued and use this information in an attempt to outperform the market.

Question 36

When does a person become eligible for Social Security benefits?
QID: 1506965Mark For Review
A   
When she reaches the age of 62
B   
After she's worked 40 quarters
C
After she's worked for the same employer for more than 10 years
D
When she reaches the age of 65

Answer 36

After she’s worked 40 quarters

Social Security eligibility is based on credits that taxpayers earn by working. Individuals become eligible for Social Security benefits if they have earned 40 credits. Taxpayers can earn up to four credits for every year they work (i.e., one per quarter) and taxpayers become eligible by earning 40 credits. If an individual is earning the maximum credits per year, she can become eligible after 10 years (4 credits per year x 10 years = 40 credits). Be careful, even if a person has earned enough credits, she cannot take benefits until she turns age 62.

Question 37

Which right is NOT granted to shareholders under the Investment Company Act of 1940?
QID: 1507168Mark For Review
A
The right to approve changes to the firm’s investment policy
B
The right to approve the investment adviser’s contract
C
The right to receive real-time updates of changes in the firm’s portfolio
D
The right to vote for or elect the firm’s board of directors

Answer 37

The right to receive real-time updates of changes in the firm’s portfolio

Under the Investment Company Act of 1940, shareholders are not entitled to current information about the composition of the fund’s portfolio. This information is considered to be proprietary and is not released in real-time. All of the other statements are true. On a semiannual basis, shareholders will receive reports which contain updated financial information about the fund as well as a list of the securities in the fund’s portfolio. (