Final Exam 8

Question 1

A client is in the 35% tax bracket. She has three children, ages 8, 12, and 16 and would like to invest in a 529 plan for the two oldest children. The client has $20,000 that she can invest in each account. If she anticipates her children will enter college at age 19, and will need $75,000 each for their college expenses over four years, an adviser would determine the future value of each account by inputting all of the following factors, EXCEPT the:
QID: 1506535Mark For Review
A
Principal amount invested
B   
Rate of inflation
C
Number of compounding periods
D   
Expected rate of interest

Answer 1

Rate of inflation

The inflation rate is not a factor in the calculation of the future value of an investment.
Future value calculation:

Pn = P0(1 + r)n

Pn = Future Value
n = Number of compounding periods
r = Rate of Interest
P0 = Original Principal

Question 2

A publicly traded corporation has 20,000,000 shares of common stock outstanding and an investor buys 1,400,000 of the shares in the open market. Which of the following forms is the investor required to file with the SEC?
QID: 1507487Mark For Review
A
None, since the client has not purchased more than 10% of the shares.
B
Form 13F
C   
Form 13D
D
Form 144

Answer 2

Form 13D

Question 3

An investor is evaluating two different bonds-one that matures in three years and another that matures in 25 years. Both bonds have a high credit rating. The 3-year bond has a 4% coupon and the 25-year bond has a 7% coupon. If interest rates are expected to decrease, how will the bonds’ prices be affected?
QID: 1506545Mark For Review
A
Both bonds will lose value.
B
The bonds will not lose or gain value since they have already been issued.
C
Both bonds will gain value.
D
The short-term bond will increase significantly more than the long-term bond.

Answer 3

Both bonds will gain value.

Question 4

Under the Investment Advisers Act of 1940, if an individual wants to create her own investment advisory firm, with which authority would she need to file the application?
QID: 1506734Mark For Review
A
The Administrator
B
The North American Securities Administrators Association (NASAA)
C
The Financial Industry Regulatory Authority (FINRA)
D
The Securities and Exchange Commission (SEC)

Answer 4

The Securities and Exchange Commission (SEC)

An investment adviser registering under the Investment Advisers Act of 1940 would register with the SEC. In this question, if the advisory firm is required to register in a state, it would do so with an Administrator under the provisions of the Uniform Securities Act.

Question 5

According to the Uniform Securities Act, an entity can avoid meeting the definition of a broker-dealer if it:
Has no office in the state
Only deals with institutional clients
Does not hold customer funds or securities
QID: 1506721Mark For Review
A
I only
B   
II only
C   
I and II only
D
II and III only

Answer 5

I and II only

If a broker-dealer has no office in a state and effects transactions only with institutional clients, it would be exempt from the definition of a broker-dealer. An institutional broker-dealer cannot qualify for this exemption if it has an office in the state, even if it avoids holding customer funds and securities.

Question 6

The prices of which of the following bonds would change the LEAST if interest rates rose?
QID: 1506526Mark For Review
A   
Short-term municipal notes
B
Treasury securities
C
AAA-rated corporate bonds
D   
Zero-coupon bonds

Answer 6

Short-term municipal notes

The prices of short-term bonds tend to decline less when interest rates rise than bonds with longer maturities. Zero-coupon bonds also tend to be particularly vulnerable to increases in interest rates.

Question 7

An investor wants to know how much money he will have in 10 years if he invests $100,000 in a variable annuity today, assuming an annual average return of 6%. This investor needs to calculate the:
QID: 1506528Mark For Review
A
Dollar-weighted return
B
Time-weighted return
C   
Present value of money
D   
Future value of money

Answer 7

Future value of money

Question 8

A federal covered investment adviser currently has five clients in State A. The IA would be required to make a notice filing with the Administrator in State A if it now enters into an advisory contract with which of the following?
QID: 1506735Mark For Review
A
A mutual fund with assets of $1 million and 250 clients
B
A bank’s trust department using the adviser to manage $250,000 of account assets
C
An inter vivos trust account set up for a relative
D
A government-authorized investment authority created to manage state funds

Answer 8

An inter vivos trust account set up for a relative

If a federal covered investment adviser has more than five individual clients in any one state, notice filing is required by the adviser. Adding the trust would bring the IA to six clients and would trigger the notice filing requirement. Financial institutions, regulated investment companies, and other investment advisers are excluded for the purposes of counting clients. Inter vivos is a legal term referring to a transfer or gift made during a person’s lifetime, as opposed to a testamentary transfer (a gift that takes effect on death).

Question 9

Which TWO of the following statements are NOT TRUE regarding TIPS?
During a period of inflation, the interest rate is adjusted upward.
During a period of deflation, the principal is adjusted downward.
During a period of inflation, the principal is adjusted upward.
During a period of deflation, the interest rate is adjusted downward.
QID: 1506720Mark For Review
A
I and III
B
I and IV
C
II and III
D
II and IV

Answer 9

I and IV

Treasury Inflation-Protected Securities (TIPS) pay a fixed rate of interest, based on inflation-adjusted principal. During an inflationary period, the principal of the TIPS increases. During a deflationary period, the principal decreases. When the security matures, the amount paid will be the greater of the original principal or the adjusted principal.

Question 10

While examining a client’s investment profile, an IAR determines that the client is able to tolerate a high degree of risk and does not anticipate the need to access invested funds for the next 25 years. What would be the best investment allocation for the client’s portfolio?
QID: 1507484Mark For Review
A
40% debt, 50% equities, and 10% money-market instruments
B
95% equities and 5% money-market instruments
C
25% bonds, 25% equities, 25% money-market instruments, and 25% real estate
D
65% bonds and 35% equities

Answer 10

95% equities and 5% money-market instruments

An investor who has a long time horizon and is willing to tolerate high levels of risk may allocate a large percentage of her portfolio to stocks (equities). The only answer that has a more than 50% of the portfolio allocated to equities is the one that suggest 95% equities and 5% money-market instruments

Question 11

A client deposits $20,000 and has expectations of an investment's future value including both income and expenses. What rate will the client's IAR use to calculate a net present value of zero?
QID: 1506518Mark For Review
A
The expected rate of return
B   
The internal rate of return
C
The holding period rate of return
D
The risk-adjusted rate of return

Answer 11

The internal rate of return

Question 12

A broker-dealer receives an order from a client to purchase 1,000 shares of ABC stock. Before executing the order, the broker-dealer purchases the same security for its own account at a price that would have satisfied the client's order. The broker-dealer's transaction is considered:
QID: 1506538Mark For Review
A   
Unethical
B
Fraudulent
C   
Trading ahead
D
A conflict of interest

Answer 12

Trading ahead

Question 13

Which of the following records must be kept for the lifetime of an investment adviser plus three years after the termination of the business?
QID: 1507489Mark For Review
A
Partnership agreements
B
Powers of attorney
C
Journals of purchases, sales, receipts, and deliveries of securities
D
The names and addresses of the recipients of each notice, circular, advertisement, or other communication that’s sent to 10 or fewer persons

Answer 13

Partnership agreements

Question 14

An insurance company is considering raising capital by issuing bonds. Under the Securities Act of 1933, the bonds are considered:
QID: 1506711Mark For Review
A   
Exempt from registration
B   
Subject to registration with the SEC
C
Exempt from the prospectus delivery requirements
D
Exempt from the antifraud provisions

Answer 14

Subject to registration with the SEC

Under the Securities Act of 1933, securities that are issued by insurance companies are subject to both the SEC’s registration requirements and its prospectus delivery requirements. However, the bonds are exempt from registration with the state Administrator. Keep in mind, no securities are exempt from the antifraud provisions of the Securities Act of 1933.

Question 15

The trustee is responsible for reporting all income, gains, and losses of a trust to the IRS on Form:
QID: 1506512Mark For Review
A
1040
B
1065
C   
1041
D
1040EZ

Answer 15

1041

On an annual basis, a trustee must report the trust’s income, gains, and losses to the IRS on Form 1041. Regarding the other forms, Form 1040 is used for personal tax returns, Form 1065 is an informational return that is filed by partnerships, and Form 1040EZ is used by single person or those who are married, filing jointly with less than $100,000 of taxable income.

Question 16

When a client purchases mutual fund shares from a broker-dealer, she receives a summary prospectus. When will the broker-dealer send the client a statutory (final) prospectus?
QID: 1506723Mark For Review
A
Within seven days of the settlement date
B
The day following settlement
C   
After the purchase has been completed, if requested
D   
Prior to confirmation of the purchase

Answer 16

After the purchase has been completed, if requested

According to the Investment Company Act of 1940, a client who purchases mutual fund shares must receive a statutory prospectus after the purchase has been completed. Therefore, if a summary prospectus is delivered first, a client must receive or be given access to the statutory prospectus, if requested.

Question 17

Several years ago, a person received a gift of 300 shares of stock that were originally purchased for $10 per share. After the gift, the person then inherited 700 shares of the stock when the price was $20 per share. This year, the person sold all of the shares for $40 per share. What are the tax consequences?
QID: 1506534Mark For Review
A
$23,000 long-term capital gain
B
$14,000 short-term capital gain and a $9,000 long-term capital gain
C
$14,000 long-term capital gain and a $9,000 short-term capital gain
D
$30,000 long-term capital gain

Answer 17

$23,000 long-term capital gain

Question 18

An individual represents an issuer in the sale of the issuer's securities to its employees, but does not earn commissions on the transactions. The individual is:
QID: 1506716Mark For Review
A   
Not considered to be an agent of the issuer
B   
Considered to be an agent of the issuer
C
Considered to be a broker-dealer
D
Considered to be the issuer

Answer 18

Not considered to be an agent of the issuer

An agent is an individual who represents a broker-dealer or an issuer in effecting securities transactions. However, an individual who represents an issuer in a transaction with existing employees and does not receive commissions is NOT considered to be an agent. In this question, the individual does not fall under the definition of either a broker-dealer or an issuer.

Question 19

Which of the following would NOT be considered an income strategy?
QID: 1507471Mark For Review
A
One that always excludes covered call writing
B
One that sacrifices growth
C
One that includes mostly bonds and preferred stocks in a portfolio
D
One that minimizes risk while seeking steady income

Answer 19

One that always excludes covered call writing

Eliminating covered call writing would not be appropriate for an income strategy. Writing covered calls is a conservative method of generating additional income in a portfolio. All of the other choices are consistent with an income strategy.

Question 20

Under SEC Release 1092, which of the following persons meets the definition of an investment adviser?
QID: 1506717Mark For Review
A
A person that limits its advice to U.S. government securities
B
Broker-dealers, registered representatives, and investment adviser representatives
C
Lawyers, accountants, teachers, and engineers
D
Pension consultants, financial planners, and sports and entertainment representatives

Answer 20

Pension consultants, financial planners, and sports and entertainment representatives

Question 21

Which of the following would NOT be important when analyzing the issuer and price of a fixed-income security?
QID: 1507483Mark For Review
A
The current and anticipated rate of inflation
B
The investor’s age
C
The issuer’s balance sheet
D
The prevailing interest rate set by the Federal Reserve Board

Answer 21

The investor’s age

An investor’s age has no effect on the price of a bond. All of the other items listed would impact the value of a bond that trades in the market. For instance, the issuer’s balance sheet gives insight into what it owns compared to what it owes at a specific point in time.

Question 22

A broker-dealer advertises on a radio program that is broadcast from a bank. Which of the following would be prohibited by the Administrator?
QID: 1507460Mark For Review
A
Mentioning that the broker-dealer that sponsored this show is affiliated with the bank
B
Mentioning the advantages of investing in mutual funds without sending a prospectus
C
Omitting the name of the broker-dealer in any 30-second ads during the show
D
Omitting the name of the bank during any 30-second ads during the show

Answer 22

Omitting the name of the broker-dealer in any 30-second ads during the show

Broker-dealers and agents are not allowed to publish a blind ad unless it is a recruiting advertisement for a new hire. The name of the broker-dealer that approved the ad is generally required on all advertisements. Broker-dealers are allowed to mention that they are affiliated with or subsidiaries of banks. They must make the distinction that the products they offer are neither deposits nor are they guaranteed.

Question 23

An efficient market is one with:
QID: 1506554Mark For Review
A   
Narrow or small spreads between the bid and ask prices
B
Computerized trading and reporting
C
A trading floor
D   
Uniform rules and procedures

Answer 23

Narrow or small spreads between the bid and ask prices

Question 24

Which of the following events would increase a partner's basis in a limited partnership?
QID: 1507468Mark For Review
A   
An assessment
B   
A cash distribution
C
A depletion allowance
D
Alternative energy tax credits

Answer 24

An assessment

A partner’s basis for tax purposes is generally composed of all his contributions to the partnership (both cash and property). An assessment requires the partner to give additional cash to the partnership, which would increase his basis.

Question 25

A court has appointed a person to be the guardian for an incompetent individual. To open a guardianship account with a broker-dealer, which of the following court-issued documents is required?
QID: 1506737Mark For Review
A   
A guardianship agreement
B   
A certificate of incumbency
C
A durable power of attorney
D
A power of attorney

Answer 25

A certificate of incumbency

A certificate of incumbency is a court-issued document that provides the legal authority of a court-appointed guardian to act on behalf of another person. The certificate serves as evidence that the listed person is authorized to act as a fiduciary for another person (the account holder) or any unincorporated entity (i.e., business, club, association, or organization). On the other hand, a durable power of attorney authorizes a person to manage the affairs of an individual who is in good health and remains in force if the individual is declared incompetent or becomes incapacitated. It is important to note that a power attorney is not issued by a court; instead, it is issued by one person to another person.

Question 26

A client, age 61, has invested $200,000 in after-tax dollars in a variable annuity. His annuity is currently worth $380,000. The client decides to draw down $50,000 from the contract. How will the distribution be taxed?
QID: 1507472Mark For Review
A
The distribution will be 25% tax-free and 75% taxable at long-term capital gains rates
B
The distribution will be 25% tax-free and 75% taxable at Pete’s statutory income rate
C
The entire distribution is tax-free since Pete is older than 59 1/2
D
The entire distribution will be taxable at ordinary income rates

Answer 26

The entire distribution will be taxable at ordinary income rates

This question discusses a nonqualified annuity. In a nonqualified annuity, the investment is made with after-tax dollars. When a client makes a single (irregular) withdrawal from a contract, the IRS requires that a last in, first out (LIFO) method be used when calculating tax liability. This means earnings (the last in) come out first. In this case, the $50,000 is taken out of the $180,000 of earnings and would be fully taxable as ordinary income. Annuities never generate long-term capital gains.

Question 27

As the result of a legislative change, municipal bonds have increased in value. Which of the following BEST describes the reason for this occurrence?
QID: 1506542Mark For Review
A
Income tax rates have increased
B
The number of corporate IPOs has increased
C
There is a general increase in interest rates
D
S&P has slightly downgraded the rating of all municipalities

Answer 27

Income tax rates have increased

Legislative risk is the risk that changes in legislation will materially impact investment returns. When income tax rates increase, investors are required to pay taxes at a higher rate. If this happens, investors will seek investments that provide tax-free returns (e.g., municipal bonds). Therefore, as the demand for municipal bonds increases, so too will the value of these investments.

Question 28

When considering estate planning needs, what can be said regarding Section 529 plans?
QID: 1507475Mark For Review
A
The plan participant gives up ownership of the account
B
The plan participant maintains control of how the funds are distributed
C
The beneficiary will pay federal gift taxes on any distributions
D
Assets in the plan will be considered as part of the owner’s estate for federal estate tax purposes

Answer 28

The plan participant maintains control of how the funds are distributed

One of the advantages of a Section 529 plan is that the plan participant, the parent, etc. is the account owner and maintains control of how the funds in the plan are distributed and to whom. The beneficiary does not have to pay federal taxes on qualified withdrawals and the assets in the plan are generally not considered part of the participant’s estate for federal estate tax purposes.

Question 29

Which of the following statements is FALSE?
QID: 1507467Mark For Review
A
For inherited securities, the recipient’s cost basis is the market value at the time of death.
B
When securities are gifted, the donor may claim a deduction that is equal to his original cost basis.
C
For gifted securities that have appreciated, the recipient’s cost basis is the donor’s original purchase price.
D
For gifted securities that have depreciated, the recipient’s cost basis is the market value at the time of the gift.

Answer 29

When securities are gifted, the donor may claim a deduction that is equal to his original cost basis.

When securities are gifted, the deduction that a donor may claim is equal to the market value of the securities at the time of the gift. The donor will benefit if the stock price has risen, since he will avoid paying capital gains tax. If the shares are gifted to an individual, the recipient’s cost basis is the original purchase price or the current market price, whichever is less. On the other hand, if shares are inherited by an individual, the beneficiary’s cost basis is the market value of the shares on the date of the decedent’s death.

Question 30

Zack is employed at Indiana Trust Company, a federally chartered bank. The CFO of the company asks Zack to help sell the bank’s securities to some potential institutional clients as well as some select few retail investors who do not have accounts with the bank. Under the USA, Zack:
QID: 1507478Mark For Review
A
Does not meet the definition of an agent if he sells the securities only to institutional investors
B
Meets the definition of an agent if he sells the securities to any retail investors
C
Meets the definition of an agent since he is selling the bank’s securities to individuals who do not have an account with the bank
D
Does not meet the definition of an agent under any circumstances

Answer 30

Does not meet the definition of an agent under any circumstances

Zack is not considered an agent under any circumstances since he is representing an issuer and is selling securities that are exempt from registration (bank-issued securities). Regardless of whether the securities are being sold to institutional and/or retail investors, Zack does not meet the definition of agent.

Question 31

After years of managing his own money, a client approaches an investment adviser representative seeking some financial advice regarding his IRA account. The IAR notices that the client's current investments include stocks, bonds, Treasury inflation-protected securities (TIPS), and a municipal bond fund. Also, the client is holding a small amount of cash that has not been invested. Which of the instruments in this client's IRA would be the biggest concern for the IAR?
QID: 1506548Mark For Review
A   
The cash position
B
The TIPS
C   
The municipal bond fund
D
The stock position

Answer 31

The municipal bond fund

In an IRA, the investment creating the greatest concern would be the municipal bond fund. Interest earned in an IRA is deferred, so, there is no need to purchase a tax-free security. Including municipal securities in an IRA is not advisable since the tax-free income received from the municipal bond fund becomes taxable if purchased in an IRA and later distributed.

Question 32

All of the following choices are maintained for five years by an IA, EXCEPT:
Partnership agreements
Articles of incorporation
A copy of audited financial statements
Written complaints
A copy of a solicitor's written disclosure documents
QID: 1506714Mark For Review
A   
I and II only
B
I and V only
C
III and IV only
D
II, III, and IV only

Answer 32

I and II only

Partnership agreements, articles of incorporation, minute books from board meetings, and stock certificate books are preserved

Question 33

With a simple trust, the trust:
QID: 1506537Mark For Review
A
Allows only for a single beneficiary
B
Is only allowed to invest in a single asset class
C
Has a predetermined asset allocation
D   
Must distribute its annual investment earnings

Answer 33

Must distribute its annual investment earnings

Question 34

Which of the following activities are considered fraudulent, rather than being simply unethical?
QID: 1507485Mark For Review
A
An investment adviser representative describes himself to clients as an expert in senior citizen retirement planning and, although no such designation exists, he displays a certificate in his office from a fictitious institution conferring the designation.
B
An agent solicits sales in securities that are exempt and the issuer has not filed a registration statement in the state.
C
An IAR notifies her superior of a letter that she received from a client which alleges fraudulent activities on the part of the IAR.
D
An agent of a broker-dealer knowingly provides material, public information to her largest client, with the client ultimately acting on the information.

Answer 34

An investment adviser representative describes himself to clients as an expert in senior citizen retirement planning and, although no such designation exists, he displays a certificate in his office from a fictitious institution conferring the designation.

Fraudulent actions always include a misrepresentation of material facts, with the intent to mislead.

Question 35

ABC Farms, a regional farm, is seeking to expand its product line through the acquisition of another regional farm and has targeted XYZ Farm, which is listed on Nasdaq. XYZ Farms has established a powerful West Coast presence over the last two decades. ABC Farms has not yet contacted XYZ Farms and is in the process of formulating an initial price range for its offer. What methodology is ABC Farms most likely use to formulate its bid?
QID: 1507461Mark For Review
A
Efficient market hypothesis
B
Duration analysis
C
Future value calculation
D   
Discounted cash flow analysis

Answer 35

Discounted cash flow analysis

Discounted cash flow analysis is used to determine a company’s value based on its projected future cash flows.

Question 36

Under the Investment Advisers Act, all of the following statements are TRUE concerning agency cross transactions, EXCEPT:
QID: 1506738Mark For Review
A
The transaction must be conducted on an exchange
B
The client must give written consent and such consent can be withdrawn at any time
C
A written confirmation may be sent no later than the completion of the transaction
D
The adviser may not recommend the transaction to both buyer and seller

Answer 36

The transaction must be conducted on an exchange

An agency cross transaction is one in which the adviser acts as broker for both sides of the trade. All of the statements listed are true except the statement which indicates that they must be conducted on an exchange.