Investment Planning

Question 1

Margin Call Calculation

Answer 1

Margin Call = Loan / 1- Maintenance Margin

*an investor must restore their equity position to the maintenance margin

Question 2

Value Line & Morningstar

Answer 2

Value Line

• Ranks stocks on a 1-5 scale
• 1 being the best (buy), 5 being the worst (sell)

Morningstar

• Ranks stocks on a 1-5 scale
• 1 being the worst (sell), 5 being the best (buy)

Question 3

Ex-Dividend Date

Answer 3

An investor must purchase the stock prior to the ex-dividend date or 2 business days before the date of record.

Question 4

Securities act of 1933

Answer 4

• Regulates the issuance of new securities (primary market)

- Requires new issues are accompanied with a prospectus.

Question 5

Securities act of 1934

Answer 5

• Regulates the secondary market and trading of securities

- Created the SEC

Question 6

Investment Company act of 1940

Answer 6

• Authorized the SEC to regulate investment companies

- Three types of investment companies: Open, Closed, UITs

Question 7

Investment Advisers act of 1940

Answer 7

• Required investment advisors to register with the SEC or state

Question 8

Securities Investors Protection Act of 1970

Answer 8

• Established SIPC to protect investors for losses resulting from brokerage firm failures
• Does not protect investors from incompetence or bad investment decisions

Question 9

Insider Trading & Securities Fraud Enforcement Act of 1988

Answer 9

• Defines an insider as anyone with information that is not available to the public.
• Insiders cannot trade on non-public information

Question 10

Treasury Bills

Answer 10

• Issued in varying maturities UP TO 52 weeks
• Denominations in $100 increments through Treasury Direct up to $5m per auction.
• Larger amounts available through a competitive bid

Question 11

Commercial Paper

Answer 11

• Short term loans between corporations
• Maturities of 270 days or LESS and it does NOT have to register with the SEC
• Commercial paper has denominations of $100,000 and are sold at a discount

Question 12

Bankers Acceptance

Answer 12

• Facilitates imports/exports
• Maturities of 9 months or LESS
• Can be held until maturity or traded

Question 13

Eurodollars

Answer 13

• Deposits in foreign banks that are denominated in US dollars.

Question 14

Investment Policy Statement establishes what?

Answer 14

LLURRTT

• Liquidity
• Legal
• Unique Circumstances
• Risk
• Return
• Taxes
• Timeline

(DOES NOT INCLUDE INVESTMENT SELECTION)

Question 15

Price-Weighted VS Value-Weighted Indices

Answer 15

Price-Weighted (doesn’t incorporate market cap)
- DJIA

Value-Weighted (incorporates market cap)

• S&P
• Russell 2000
• Wilshire 5000
• EAFE

Question 16

Eddie Bauer bought a tax-exempt Original Issue Discount (OID) bond in November of 1998. Which of the following statements is/are true?

I. The bond basis increases at a set rate each year.

II. The difference between maturity value and the original issue discount price is known as the OID.

III. The bond’s earnings are treated as exempt interest income.

IV. The bond was issued at a discount to its par value.

II and III only.
I and IV only.
I, II and IV only.
I, II, III and IV.

Answer 16

Solution: The correct answer is D.

All of the above statements are descriptions of the Original Issue Discount bond.

Question 17

Your client owns the following two corporate bonds:

Bond Rating Coupon Maturity
ABC AA 5.25% 16
RST BBB 8.50% 9
Which of the following statements are true about the relationship between the bond prices and bond features? (Consider each statement with respect to only the single feature stated; do not attempt to integrate the impact of all features simultaneously).

I. The lower coupon makes ABC’s bond more volatile than RST’s bond.

II. The longer maturity makes ABC’s bond more volatile than RST’s bond.

III. The higher coupon makes RST’s bond more volatile than ABC’s bond.

IV. RST’s lower rating does not make its volatility higher or lower than ABC’s volatility.

I and II only.
I and IV only.
II and III only.
II and IV only.

Answer 17

Solution: The correct answer is A.

Choice “I” - The lower the coupon, the more volatile the bond. Choice “II” - The longer the maturity, the more volatile the bond. The greater the volatility, the greater the risk to the investor.

Question 18

Mortgage-backed securities may contain which of the following risks:

Purchasing power risk.
Interest rate risk.
Prepayment risk.

II only.
I and II only.
I and III only.
I, II and III.

Answer 18

Solution: The correct answer is D.

If rates on the mortgage backed securities do not keep up with inflation and rising rates, their purchasing power will be reduced, as will their value (interest rate risk). If interest rates fall, the mortgagees may seek refinancing and prepay their obligations early.

Question 19

You are faced with several fixed income investment options. Which of these bonds has the greatest reinvestment rate risk?

A U.S. Treasury bond with an 11.625% coupon, due in five years with a price of $1,225.39 and a yield to maturity of 6.3%.
A U. S. Treasury strip bond (zero-coupon) due in five years with a price of $735.12 and a yield to maturity of 6.25%.
A corporate B-rated bond with a 9.75% coupon, due in five years with a price of $1,038.18 and a yield to maturity of 8.79%.
A corporate zero coupon bond due in 5 years with a price of $750 and a yield to maturity of 5.9%.

Answer 19

Solution: The correct answer is A.

This is due to the high coupon and lack of similar rates currently.

Question 20

Which of the following can be eliminated using a “buy and hold” strategy with regard to fixed income securities?

Future value risk.
Interest rate risk.
Stand alone risk.
Reinvestment rate risk.

Answer 20

Solution: The correct answer is B.

The price changes when interest rates change but if you don’t sell the bond (buy and hold) then the price change doesn’t really matter. You still get the $1,000 par value at maturity.

Option “A” - Future value risk does not exist as a term.

Option “C” - Stand alone risk refers to single assets ownership.

Option “D” will still require the investor to reinvest interest paid, thus not eliminating such risk.

Question 21

Jack Rich has an investment portfolio equally divided among the following funds: Energy sector fund, Bond Unit Investment Trust (25-year average maturity), and a Money Market fund. He is a buy-and-hold investor. Which of the following risks is his portfolio exposed to?

Business risk.
Interest rate risk.
Political risk
Purchasing power risk.

I and III only.
II and IV only.
I, II and III only.
III and IV only.

Answer 21

Solution: The correct answer is D.

Interest rate risk does not affect a bond investor if he or she holds the securities to maturity. This is how unit investment trusts are structured. The energy sector will be directly impacted by regulatory influences of a political nature.

Question 22

An investor who searches for stocks selling at a low price to earnings (P/E) ratio believes that:

Anomalies to the Efficient Market Hypothesis exist.
The strong form of the Efficient Market Hypothesis is valid.
Such stocks have low betas.
The semi-strong form of the Efficient Market Hypothesis is valid.

Answer 22

Solution: The correct answer is A.

The low P/E ratio stocks are an anomaly to the EMH. Choice “B” is incorrect and the strong form of EMH is often thought to be invalid because it presumes markets are completely efficient and historical, public and private information will not help you achieve above average market returns. Choice “C” is incorrect as the stocks could have either high or low betas. Choice “D” is incorrect because the evaluation of P/E ratios is fundamental analysis, and the semi-strong theory rejects fundamental analysis (and technical analysis).

Question 23

A $1,000 bond originally issued at par maturing in exactly 10 years bears a coupon rate of 8% compounded semi-annually and a market price of $1,147.20. The indenture agreement provides the bond may be called after five years at $1,050. Which of the following statements is/are true?

The yield to maturity is 6%.
The yield to call is 5.5%.
The bond is currently selling at a premium, indicating that market interest rates have fallen since the issue date.
The yield to maturity is less than the yield to call.

I, II and III only.
I and III only.
II and III only.
IV only.

Answer 23

Solution: The correct answer is A.

YTM N=10 × 2=20 I=? PV=<1,147.20> PMT=.08 × 1000 × .50=40 FV=1,000 I=3.0097 × 2=6.01%

YTC N=5 × 2=10 I=? PV=<1147.20> PMT=.08 × 1000 × .50=40 FV=1,050 I=2.7387 × 2=5.5%

Question 24

Margin accounts involve security transactions performed using some amount of capital borrowed from the brokerage firm as well as some of the investor’s own capital. The entity that establishes the initial margin requirement is the:

Securities and Exchange Commission.
Federal Reserve.
National Association of Securities Dealers.
Brokerage firm with which an investor is dealing.

Answer 24

Solution: The correct answer is B.

The Federal Reserve sets margin requirements for all security transactions.

Question 25

Jong Mae is optimistic about the long-term growth of her Matsushita stock. However, the stock, currently priced at $128 per share, has made a sharp advance in the last week and she wants to lock in a minimum price in case the shares drop. What should Jong Mae do?

Buy $125 call options.
Sell $125 call options.
Buy $125 put options.
Sell $125 put options.

Answer 25

Solution: The correct answer is C.

Buying a put option is like insurance against a drop in price. Remember, from the buyer’s perspective, “Call up” . . . “Put down”!! (This may be a helpful mnemonic device.) The opposite is true for option sellers.

Question 26

You purchase one put contract and pay a $3 premium that allows you to sell the stock at $50. The stock is currently trading at $48. What is the intrinsic value of your situation?

-$5
-$2
$0
$2

Answer 26

Solution: The correct answer is D.

Intrinsic Value of Put = Strike Price - Stock Price, therefore IV = $50 - $48 = $2.

Question 27

If one of your clients has a profitable long position in an oranges futures contract and does nothing as the contract expires, what should she expect to occur?

The oranges will be delivered to her.

She will receive a substantial check as soon as the account is settled.

Her contract will expire worthless unless she takes some action.

Her broker will arrange for sale of the oranges in an appropriate market.

Answer 27

Solution: The correct answer is A.

Positions in futures contracts are closed by taking an equal and opposite position. One who is long on a contract at the expiration should expect delivery of the commodities at the stated contract price. It is the buyers responsibility, but in this case, we could say the broker was remiss in his or her duties!

Question 28

Jasmine has a large paper profit in her Amalgamated Corporation shares, currently at $46 per share. She is happy with the stock, but realizes that a good thing CANNOT go on forever. She bought the stock so inexpensively that she is not worried about the downside. If she is willing to sell at $50, what strategy could you recommend to her?

Buy $50 call options.
Sell $50 call options.
Buy $50 put options.
Sell $50 put options.

Answer 28

Solution: The correct answer is B.

She gains the premium from selling the call, and if the price rises, at or above the strike price of $50, her stock will be called away at $50. “C” would be a good choice, but she is not worried about the downside risk.

Question 29

Your clients, Dan & Mary both work for Terra Corporation. They have asked you, as their personal financial planner, to explain to them exactly what their human resources department was referring to in a session last week when they discussed “out-of-the-money” positions in the stock option investment plan they have at work. Of the following, which would meet that description given the current $51 per share market price of the stock?

Dan holds 100 shares of company stock which he purchased through his broker at $56 per share.

A portion of Mary Jo’s shares were given to her at the program’s inception 18 months ago and are currently exercisable at $47 per share.

Dan’s most recent award has an exercise price of $55 per share.

Mary Jo has 225 shares of Terra, awarded with an exercise price of $51 per share.

Answer 29

Solution: The correct answer is C.

Option “A” is out-of-the-money but has nothing to do with his option through his work. Option “B” is in-the-money. Option “D” is at-the-money, meaning price of exercise and stock price are the same. Only Option “C” is out-of-the-money and addresses our client’s concerns.

Question 30

Put option sellers do best if the market price of the stock:

Falls.
Rises.
Falls or remains at the same price.
Rises or remains at the same price.

Answer 30

Solution: The correct answer is D.

The put option seller looks for the security price to rise and opposites the position of the put buyer who looks for a falling security price. If the price rises or stays the same, the put seller keeps the premium.

Question 31

The duration of a bond is a function of its:

Current price.
Time to maturity.
Yield to maturity.
Coupon rate.

I and III only.
II and III only.
II and IV only.
I, II, III and IV.

Answer 31

Solution: The correct answer is D.

Duration is used to estimate the price of a bond, given a change in interest rates.

Question 32

You are faced with several fixed income investment options. Which of these bonds has the greatest interest rate risk?

A U.S. Treasury bond with an 11.625% coupon, due in five years with a price of $1,225.39 and a yield to maturity of 6.3%.

A U.S. Treasury strip bond (zero-coupon) due in five years with a price of $735.12 and a yield to maturity of 6.25%.

A corporate B-rated bond with a 9.75% coupon, due in five years with a price of $1,038.18 and a yield to maturity of 8.79%.

A U.S. T-bill selling for $950 due in six months.

Answer 32

Solution: The correct answer is B.

With the term being equal, the bond with the lowest coupon will have the biggest duration. The bigger the duration, the more price sensitive the bond is to interest rate changes. Bond B has the lowest coupon, zero.

Question 33

Which of the following is not an appropriate match?

Classification by time: Spot markets.
Classification by type of claim: Equity markets.
Classification by participants: Mortgage markets.
Classification by products: Money markets.

Answer 33

Solution: The correct answer is D.

Money market securities are short-term instruments categorized by time considerations, not product.

Look at this from the product to determine the classification. For example, money markets and spot markets are classified as according timing because they are either short term maturities or current price.
The common component when classifying these type of securities is timing.

Equity and debt markets can be classified as to the order of claims in the event of liquidation. “Type of claims” simply refers to debt vs. equity and which is more senior.

Bond markets, which include mortgage bonds, are divided into short, intermediate and long term markets. Each market has participants that prefer different segments of the yield curve. A participant in this case is an insurance company, bank, manufacturing company, etc. Different participants will prefer mortgage bonds over shorter term maturities.

Question 34

As your client, Joe Stockhill has built an impressive portfolio of aggressive growth stocks. Recently, he expressed an interest in purchasing gold for his portfolio, but he does not fully understand the concepts surrounding its relationship to the stock market. How would you explain it to him?

Due to its extremely volatile nature, gold should not be purchased in conjunction with an aggressive growth stock portfolio.

Gold should only be purchased when inflation is low, otherwise one runs the risk of losing portfolio value.

Gold has an inverse relationship to the market and should only be purchased when stock prices are rising.

Gold has a negative correlation to the market and can be used when interest rates are rising as a hedge against inflation.

Answer 34

Solution: The correct answer is D.

Gold’s volatility has nothing to do with adding it or not adding it to a portfolio. Gold has tended to act as a hedge against inflation due to its negative correlation to the market. It is best purchased at the onset inflationary times, but a portfolio will not necessarily lose value by its purchase. Rising stock prices generally have meant stationary or decreasing gold prices.

Question 35

Physical assets might be suitable as an investment in the portfolio of an investor looking for:

Deflationary hedges.
Stability of periodic cash flows.
Short-term investments.
Long-term capital gains.

Answer 35

Solution: The correct answer is D.

Hard assets are generally considered a hedge against inflation, which will lead to price appreciation and potential capital gains.

Question 36

Which of the following statement(s) regarding bond swaps is/are true?

A substitution swap is designed to take advantage of anticipated and potential yield differentials between bonds that are similar with regard to coupons, rating, maturities, and industry.

Rate anticipation swaps utilize forecasts of general interest rate changes.

The yield pickup swap is designed to alter the cash flow of the portfolio by exchanging similar bonds having different coupon rates.

The tax swap is made to substitute current yield in place of capital gains.

I, II and III only.
I and III only.
II and IV only.
IV only.

Answer 36

Solution: The correct answer is A.

All statements are correct except for IV. The tax swap replaces bonds with offsetting capital gains and losses.

Question 37

Which of the following investment vehicles are most appropriate for an emergency fund for a family with $12,000-a-year discretionary income?

Balanced mutual fund.

Line of credit.

Money market mutual funds.

Laddered CDs set to mature every 6 months.

I and II only.
II and IV only.
III and IV only.
I, II and III only.

Answer 37

Solution: The correct answer is C.

Though a line of credit might make a reasonably good emergency fund, the question asks for “investment vehicles” (which make Options “III” and “IV” correct.)

Question 38

Of the following investment, which is designed to provide growth and income?

Raw land.
Fixed premium annuity.
Non-participating mortgage Real Estate Investment Trust (REIT.)
Convertible bond.

Answer 38

Solution: The correct answer is D.

Raw land may appreciate, but provides no income. A fixed premium annuity provides income, but no growth. Mortgage REITs offer income but no growth. Convertible bonds offer income as a bond and growth potential when converted to a stock.

Question 39

You are currently reviewing Shanda’s Roth IRA investment portfolio. She is 35 years of age with a moderate risk tolerance. She is single and has no children. Which of the following investments are you likely to recommend she remove from the existing portfolio?

Large Cap Mutual Fund
International Mutual Fund
Corporate Bond Mutual Fund
Municipal Bond Mutual Fund

Answer 39

Solution: The correct answer is D.

Municipal bonds are not generally suitable investments in a Roth IRA because of the tax deferral that is already built into the Roth IRA and the potential for tax free distributions if you meet the qualifying rules.

Question 40

Which of the following best describes a long hedge position?

The investor is short the underlying commodity and short the futures contract.

The investor is long the underlying commodity and long the futures contract.

The investor is short the underlying commodity and long the futures contract.

The investor is long the underlying commodity and short the futures contract.

Answer 40

Solution: The correct answer is C.

A long hedge means that the investor owns (buys) the futures contract to insure a certain price of a commodity that he or she does not yet own.

Hedging is taking an opposite futures position than the investor’s inherent underlying position.

A long position in a futures contract is when the investor buys a futures contract. A short position in a futures contract is when the investor sells a futures contract.

Question 41

Which method of portfolio evaluation allows the comparison of a portfolio manager’s performance to that of the over-all market using just one calculation?

The Treynor Model.
The Jensen Model.
The APT Model.
The Sharpe Model.

Answer 41

B. The Jensen Model

Solution: The correct answer is B.

Only Options “A,” “B” and “D” are models used to examine portfolio manager’s performance. Treynor and Sharpe require that one calculate the performance of the market to make a valid comparison.

Question 42

Which of the following terms would be used to describe a municipal bond issued with a restricted revenue base?

Limited general obligation bonds.
Limited revenue bonds.
Full faith and credit bonds.
Revenue bonds.

Answer 42

Solution: The correct answer is A.

The limited general obligation bond is a bond issued by an entity that has some ability to levy taxes to support itself (for example, a school district). However, this ability is limited when compared to that of the general taxing power of the state.

Question 43

Which of the following best describes the investment characteristics of a high-quality long-term municipal bond?

High inflation risk; low default risk.
Low inflation risk; high market risk.
Low inflation risk; low default risk.
High inflation risk; high market risk.

Answer 43

Solution: The correct answer is A.

The rate of the high-quality municipal bond will be low, thus exposing it to potentially higher levels of inflation risk. These same instruments are very safe and represent low default risk.

Question 44

American Depository Receipts (ADRs) are for the following purpose(s):

Finance foreign exports.
Eliminate currency risk.
Sell U.S. Securities in overseas markets.
Trade foreign securities in U.S. markets.

I and III only.
I and IV only.
II and IV only.
IV only.

Answer 44

Solution: The correct answer is D.

ADRs provide an opportunity for Americans to purchase foreign securities.

Question 45

The Federal Reserve Board is expected to sell large quantities of Treasury securities in the near future. What impact will these sales likely have on stock prices?

Stock prices will decrease because the dividend growth rate of stocks will increase.

Stock prices will decrease because the required rate of return for investors will increase.

Stock prices will increase because interest rates will decrease as investors compete to purchase the Treasury securities.

Stock prices will increase because the growth rate in dividends and earnings will increase.

Answer 45

Solution: The correct answer is B.

The sale of Treasury securities results in a reduction of cash in the market place, thus a decrease in supply causing an increase in demand. This will lead to an increase in the cost of money and a lessening of funds for investment, thus a reduction in stock prices.

Question 46

The market where exchange and broker dealer services are eliminated entirely is:

The primary market.
The secondary market.
The third market.
The fourth market.

Answer 46

Solution: The correct answer is D.

The fourth market is the market where corporation and institutional investors deal directly with one another. Primary market is where investment bankers and corporations meet to arrange offerings to the public. Secondary markets are where previously issued securities are sold (exchanges, etc.).

Question 47

Given the following diversified mutual fund performance data, which fund had the best risk-adjusted performance if the risk-free rate of return is 5.7%?

Fund A: Average rate of return = .0782, Standard deviation of annual return = .0760 and Beta = 0.950

Fund B: Average annual return = .1287, Standard deviation of annual return = .1575 and Beta = 1.250

Fund C: Average annual return = .1034, Standard deviation of annual return = .1874 and Beta = 0.857

Fund D: Average annual return = .0750, Standard deviation of annual return = .0810 and Beta = 0.300

Fund B, because the annual return is highest.
Fund C, because the Sharpe ratio is lowest.
Fund D, because the Treynor ratio is highest.
Fund A, because the Treynor ratio is lowest.

Answer 47

Solution: The correct answer is C.

If a fund is diversified, use the Treynor model and the result there is arrived at by dividing the return by the beta. In this case, fund D has the highest risk adjusted rate of return. Treynor = [(rp - rf) / (Bp)]. In this case, the result is (.0750 - 0.057) ÷ .3000 = .06.

Question 48

Sue Todd began purchasing BLT, Inc. mutual fund shares several years ago. She has followed a dollar-cost averaging approach by investing $1,000 each year for 5 years. The following describes Sue’s purchases: Year 1 - $1,000 investment at $120 per share Year 2 - $1,000 investment at $100 per share Year 3 - $1,000 investment at $118 per share Year 4 - $1,000 investment at $97 share Year 5 - $1,000 investment at $130 per share What is Sue’s average cost per share?

$100
$111.58
$113
$118.23

Answer 48

Solution: The correct answer is B.

Calculate the number of shares purchased over time (44.8 shares) and divide this figure into the total amount invested over that time ($5,000). The result is an average share price of $111.58 per share.

Year 1 - $1,000 investment at $120 per share = 8.33 shares

Year 2 - $1,000 investment at $100 per share = 10 shares

Year 3 - $1,000 investment at $118 per share = 8.47 shares

Year 4 - $1,000 investment at $97 share = 10.30 shares

Year 5 - $1,000 investment at $130 per share = 7.69 shares

$5,000/44.79 = 111.63 (give or take for rounding)

Question 49

Which of the following represent the minimum information needed to calculate the weighted average rate of return for a portfolio?

Current market price of each security.
Price paid for each security.
Number of shares of each security.
Total portfolio value.
Percent return of each security.
I, III and V only.
II, III and IV only.
III, IV and V only.
I, IV and V only.

Answer 49

Solution: The correct answer is A.

Current market price times number of shares gives the total value of each investment. These can be summed to calculate the total portfolio value. Then, the total value of each investment is divided by the total portfolio value and multiplied by the percent return of each security to calculate the weighted return. These weighted returns added together give the weighted average portfolio rate of return.

Question 50

If the market risk premium were to increase, the value of common stock (everything else being equal) would:

NOT change because this does NOT affect stock values.

Increase in order to compensate the investor for increased risk.

Increase due to higher risk-free rates.

Decrease in order to compensate the investor for increased risk.

Answer 50

Solution: The correct answer is D.

A need for higher return to meet the onset of higher risk would drive the price of a security down (all other things being equal).

Using an example where rm is 14% and rf is 3%, and a beta of 1.1, the required return under the SML is:

r = .03 + (.14-.03)1.1 = 15.10%

Then let’s assume the most recent dividend is $2 and the growth rate is 7%. The price of the stock using the constant growth model is

V= (2 x 1.07)/(.1510 - .07) = $26.42

Now let’s increase the rm to 15%. Using the SML:

r = .03 + (.15-.03)1.1 = 16.20%

The new price under the constant growth model is:

V = (2x1.07)/(.1620 - .07) = $23.26

Question 51

Which of the following statements concerning the S&P 500 is incorrect?

It has less dramatic fluctuations than the Dow Jones Industrial Average.

It is a reflection of broad sectors of the market.

It is a value-weighted index.

It is a broader base measure of the stock market than the Wilshire 5000 Index.

Answer 51

Solution: The correct answer is D.

The DJIA tracks 30 stocks, the S&P 500 tracks 500 stocks, and the Wilshire 5,000 tracks slightly more than 6,500 stocks. The broader the stock base (or larger number of stocks), the less the fluctuation of the index.

Question 52

Which of the following have been repurchased by the corporation?

Unissued shares.
Repurchased shares.
Authorized shares.
Treasury shares.

Answer 52

Solution: The correct answer is D.

Unissued shares have never been held by investors to be repurchased. There is no such thing as “repurchased” shares. Authorized shares may be unissued or outstanding shares, but not necessarily Treasury shares (which are those the company has repurchased).

Question 53

A convertible bond has the following terms:

Maturity value = $1,000

Time to maturity = 20 years

Coupon rate = 8%

Call penalty = One year’s interest

Exercise price = $10 per share.

Given this information, you will inform your client as to how many shares of stock that the bond may be converted.

100 shares
80 shares
50 shares
20 shares

Answer 53

Solution: The correct answer is A.

The conversion ratio is used here (PAR/Conversion Price) to determine how many shares are available upon conversion. $1,000 / $10 = 100 shares.

Question 54

Your client owns a DGL Corporation convertible bond that has a coupon rate of 8% paid semiannually and matures in five years. Comparable debt yields 7% currently. The GGL bond is convertible into 22 shares of common stock. The current market price of the underlying stock is $52. What is the conversion value of this convertible bond?

$925
$1,000
$1,042
$1,144

Answer 54

Solution: The correct answer is D.

Use the formula for calculating conversion value of a bond. Keep in mind the conversion value may be different from the intrinsic value of the bond (which in equilibrium is the market price of the bond).

CV = (PAR ÷ Cp) x Ps 
CV = (1,000 ÷ 45.45) x Ps
CV = $22 x $52 
CV = 1,144​

Cp = conversion price: PAR / shares (1,000 / 22 = 45.45)
Ps = Price of the stock

Question 55

The value of the convertible bond as a debt instrument does not depend on which of the following?

The bond’s coupon.
Current interest rates.
The conversion price of the bond.
The term of the bond.

Answer 55

Solution: The correct answer is C.

The value of the bond as a debt instrument is considered separately from its convertibility and is calculated using the bond formula or the present value methodology on the calculator. However, should the conversion value be greater than the “debt value” of the bond, it will sell for the higher price.

Question 56

Jenny bought 250 shares of XYZ stock at $30 per share, with an initial margin of 60%. She paid 8% margin interest annually. One year later she sold all of the stock for $10,500. Jenny is in the 35% marginal tax bracket, 15% for capital gains, and itemizes her deductions. What is Jenny’s holding period return?

61.33%
40%
51.47%
34%

Answer 56

Solution: The correct answer is A.

To calculate the holding period return, use the following:

HPR = [ (Sale price - purchase price) +/- cashflows* ] / purchase price or equity invested

HPR = [ ((10,500 - (7,500 x .40)) - (7,500 x .60)) - (7,500 x .40 x .08) ] / (7,500 x .60)

HPR = [ ((10,500 - (3,000)) - (4,500)) - (240) ] / (4,500)

HPR = [ 2,760 ] / 4,500

HPR = .61333 or 61.33%

*cashflow in this problem is the margin interest.

Choice B is not correct because it does not factor in cashflows or the margin purchase.

Choice C is not correct because that is the calculation for the after-tax holding period return.

Choice D is not correct because that is the calculation for the after-tax holding period return without the margins.

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Question 57

Holly bought a stock at the minimum margin, when the stock was trading at $10. The stock paid quarterly dividends of $.25. Holly held the stock for one year and sold the stock when it was trading at $11. What was Holly’s holding period return?

10%.
20%.
30%
40%.

Answer 57

Solution: The correct answer is D.

The first key to this question is knowing that the “minimum margin” is 50%, which is established by the Federal Reserve. So, Holly is required to pay $10 × .50 = $5 in cash and borrow the other $5 per share to make the investment. The question does not reference any margin interest, so it’s excluded from the calculation. The second key to this problem is that the Purchase Price in the numerator reflects both the equity contribution of $5 per share and the $5 per share that must be repaid to the broker. The Purchase Price in the denominator only needs to reflect the $5 in equity paid. HPR = (SP - PP +/- CF) ÷ PP HPR = ($11 - $10 + ($.25 × 4) ÷ ($10 × .5) HPR = 40%

Question 58

An investor in the 30% marginal tax bracket purchased a bond for $980, received $75 in interest, and then sold the bond for $950 after holding it for seven months. The LTCG rate is 15%. What are the pre-tax and post-tax holding period returns?

4.6%, 4.6%
4.6%, 3.2%
11%, 4.6%
11%, 3.2%

Answer 58

Solution: The correct answer is B.

Pre-tax Holding Period Return = ($950 - $980 + $75) / $980 = 4.6% Since the holding period is ST, use the marginal tax rate: After-tax Holding Period Return = [($950 - $980 + $75) × (1 - .30)] / $980 = 3.2% Answer: 4.6%, 3.2%

Question 59

Robin purchased a mutual fund at NAV of $20.00 and sold it 8 months later at $21.00. During the time he owned the fund, he received a LTCG of $1.00/share and a qualified dividend distribution of $.75/share from the mutual fund. He has a marginal tax rate of 32%. The tax on LTCG is 15%. What is his after-tax holding period return?

10. 84%
11. 5%
12. 8%
13. 3%

Answer 59

Solution: The correct answer is A.

Since this is a ST holding period, it’s ordinary income at the marginal tax rate for the price increase. Since the dividend distribution is a qualified dividend, it receives capital gians tax treatment.

HPR = (SP - PP +/- CF) × (1-TR) / PP

[($21.00 - $20.00) × (1 - .32)] + [($1.00 + $.75) × (1 - .15)] / $20.00

Answer: 10.84%

(remember to follow order of operations: Parenthesis, exponents, multiplication, division, addition, subtraction)

Based on Subchapter M or pipeline theory, investment companies must payout at least 90% of their portfolio earnings. If a mutual fund sells a position they hold at a gain, it passes the gain, like-kind, to its investors.

Question 60

What is one reason a company may call bonds that were previously issued?

The bonds are currently selling at a premium.
The bonds are currently selling at a discount.
The company expects interest rates to decrease.
The bonds are selling at par.

Answer 60

Solution: The correct answer is A.

If the bonds are selling at a premium, then interest rates have decreased since the bonds were issued. The company would be motivated to retire the higher yield bonds and issue new bonds at lower market interest rates. A discount bond would indicate that interest rates of increased and the bond is paying a lower rate than current market interest rates.

Question 61

David has $20,000 that is earmarked for a down payment on a house in two years. If David is in the 28% tax bracket, what should he invest the $20,000 in?

A 4% tax free money market mutual fund.
A 5.4% corporate bond.
A well diversified growth mutual fund.
An intermediate muni-bond fund paying 4.5%

Answer 61

Solution: The correct answer is A.

The taxable equivalent yield for the tax free money market fund is 5.56%. TEY = .04 / (1 - .28) TEY = .0556 The taxable equivalent yield is greater than the taxable corporate bond paying 5.4%. The mutual fund and intermediate muni-bond fund are not appropriate given the investor’s time horizon.

Question 62

Your client’s federal marginal tax rate is 36%, and the state marginal rate is 7%. The client does not itemize deductions on his federal return and is considering investing in a municipal bond which yields 5% issued in his state of residence. What is the taxable equivalent yield?

3. 20%
4. 65%
5. 38%
6. 77%

Answer 62

Solution: The correct answer is D.

Use the tax equivalent yield formula of the taxable security return divided by one minus the client’s tax rate to arrive at the correct answer to this problem.

TEY= (Tax Exempt Security) ÷ (1 - the investor’s marginal tax rate).

This should include the state rate in the calculation of marginal rates as the municipal security is state tax-free in the state of issue if one is a resident of that state.

= .05 ÷ (1 - .36 - .07)

= .0877

Question 63

Which of the following statements best describes an investment where standard deviation serves as the best measure of a portfolio’s risk level?

When a portfolio is well diversified.
When a portfolio is not well diversified.
When portfolio is identified as being above the Capital Market Line.
When correlation coefficient is .85 or greater.

Answer 63

Solution: The correct answer is B.

Option “A” - In a well diversified portfolio, beta can be used to measure risk. Option “C” - Securities above the CML refers to alphas, not measures of risk. Option “D” - If correlation is .85, then r-squared is .72. When r-squared is greater than or equal to .70, then the portfolio is well diversified and Beta is an appropriate measure of total risk.

Question 64

Mutual fund XYZ has a beta of 1.5, standard deviation of 12% and a correlation to the S&P 500 of .80. How much return of fund XYZ is due to the S&P 500?

20%.
64%.
80%.
100%

Answer 64

Solution: The correct answer is B.

Correlation is .80, therefore r-squared is .64 (R-squared = correlation coefficient squared). Therefore 64% of mutual fund’s return is due to the S&P 500. Remember, r-squared measures the percentage of return due to the market.

Question 65

Sylvia has a two assets in her portfolio, asset A and asset B. Asset A has a standard deviation of 40% and asset B has a standard deviation of 20%. 50% of her portfolio is invested in asset A and 50% is invested in asset B. The correlation for asset A and asset B is .90. What is the standard deviation of her portfolio?

Greater than 30%.
Less than 30%.
Equal to 30%.
Not enough information to determine.

Answer 65

Solution: The correct answer is B.

It’s not necessary to use the standard deviation of a two asset portfolio formula to answer this question. Since there’s a 50/50 weighting for each asset, simply take a simple average of the standard deviations (.40 + .20) / 2 = .30. Since the correlation is less than 1, the standard deviation for the portfolio will be less than the simple average. If correlation was equal to 1, then the standard deviation would be equal to 30%.

Question 66

As a measure for risk, the Capital Market Line (CML) uses the:

Risk free rate of return.
Beta of the market.
Standard deviation of the market.
Portfolio weighted beta.

Answer 66

Solution: The correct answer is C.

The CML (Capital Market Line) uses standard deviation, while the SML (Security Market Line) uses the beta as its “risk” measurement.

Question 67

Use the following information to answer the question:

Stock	Beta	ERR	     Amt Invested
A	         1.4	         15%	     $10,000
B	         1.2	         12%     $15,000
C	         0.9	         9%	     $11,000
Your client has expressed a desire to reduce the risk in her portfolio without reducing the expected rate of return. Your recommendation would be as follows:

Increase the amount of stock A and decrease the amount of stock C.
Increase the amount of stock B and decrease the amount of stock C.
Increase the amount of stock C and decrease the amount of stock A.

III only.
I and II only.
I and III only.
None of the above.

Answer 67

Solution: The correct answer is D.

The risk in this portfolio cannot be reduced without a commensurate reduction in return based on the information given.

To reduce risk, you need a lower weighted average beta, than the current portfolio allocation. To accomplish this, you must increase the amount invested in C (or maybe B too), but the point is you are increasing the amount invested in a security with a lower expected return thereby decreasing the expected return of the portfolio.

Question 68

Which of the following reveals the relationship of a given security’s movement relative to that of the market?

Beta.
Correlation coefficient.
Covariance.
Standard deviation.

Answer 68

Solution: The correct answer is A.

Correlation coefficient and covariance measure two stocks movements relative to one another. Standard deviation measures a security’s performance relative to expectations of performance. Beta reveals the level of over or underperformance of the security relative to market expectations.

Question 69

Which of the following statements regarding federal law is correct?

The Securities Act of 1933 provides for protection from misrepresentation, deceit, and other fraud in previously issued securities.

The Securities Investor Protection Act of 1970 is designed to protect individual investors from losses as a result of brokerage house failures.

The Investment Advisers Act of 1940 requires that person or firms advising others about securities investment must register with the Securities and Exchange Commission.

The Investment Advisers Act of 1940 assures the investor’s safety of investment in companies engaged primarily in investing, reinvesting, and trading in securities.

I, II and III only.
I and III only.
II and IV only.
II and III only.

Answer 69

Solution: The correct answer is D.

Options “II” and “III” are correct statements. Option “I” is incorrect because the Security Act of 1933 pertains to new securities. Option “IV” is untrue because the Investment Advisers Act of 1940 addresses registration requirements and conduct of advisers, but does not deal with investment safety.

Question 70

What is the geometric rate of return for a stock that has experienced the following prices over a four-year period? Year 1 = $20 Year 2 = $32 Year 3 = $24 Year 4 = $28

17. 23%
18. 78%
19. 82%
20. 88%

Answer 70

Solution: The correct answer is D.

There are many ways to solve this, but here is the quickest: N=3 i=? PV=<20> PMT=0 FV=28 Assume you paid $20 for the stock today and three years later, it is trading at $28.

Question 71

Of the following indexes, which is the only one that uses the geometric average to compute its daily value?

NASDAQ Index.
Wilshire 5000 Index.
Value Line Average.
Dow Jones Industrial Average.

Answer 71

Solution: The correct answer is C.

The NASDAQ, the NYSE Composite, and the Wilshire all use value weighted average, while the Dow Jones Industrial is a simple price weighted average. Only Value Line uses the geometric average.

Question 72

Mark is the 100% owner of Widget Manufacturing, Inc. (WMI). The WMI 401(k) plan covers 35 employees with 70% of the employees under age 40. Employee turnover is high. Mark wants to retire in 20 years at age 65. Mark has a medium tolerance for volatility within his investments. The market value of the 401(k) is $4,000,000 and Mark is the trustee and manages the investments. The portfolio consists of the following assets: - 10% short-term CDs with staggered maturity date. - 20% limited partnership interest in a private commercial real estate project which generates a high income yield. - 40% in a brokerage account invested in four stocks. - 30% in long-term government bonds with staggered maturity dates. You have been retained to evaluate the appropriateness of the portfolio. Which of the following statements best describes the portfolio?

Short-term certificates of deposit have a fixed maturity date and therefore are not appropriate for liquidity purposes.

The brokerage account investments are not adequately diversified.

The investment in the limited partnership may be subject to unrelated business taxable income and therefore is inappropriate.

Overall, the asset classes selected by the plan are sufficiently diversified and therefore minimize overall portfolio volatility.

I and II only.
II and III only.
I, II and III only.
II, III and IV only.

Answer 72

Solution: The correct answer is D.

Statement “I” - Short-term CDs are an appropriate choice for liquidity needs due to fixed value of the vehicle and short maturity periods. Statement “IV” - Even though the current investments within the asset classes are not properly positioned, the asset class allocation would, under Modern Portfolio Theory, reduce overall volatility to the plan.

Question 73

Developing cash flow projections and valuations for real estate can be difficult due to:

A lack of comparable figures for other properties in the area.

Changes in demographic and economic variables.

Different financing methods amongst prospective purchasers.

A lack of standardized methods for objectively evaluating an investment in a market that is considered inefficient

Answer 73

Solution: The correct answer is B.

Cash flow projections and comparable equity capitalization rates are easily obtained for a valid comparison. The difficulty is one of the unpredictability of changes in economics and demographics which directly impact values. Real estate valuation models such as one using net operating income, adjust for variations in real estate financing.

Question 74

The Chesapeake Bay apartment complex contains 60 one-bedroom apartments renting for $650 per month. In addition, the complex generates $625 per month from laundry, parking, and vending machines. Vacancy and collection losses have averaged 8% of Potential Gross Income (PGI) and are expected to continue at about the same rate in the future.

Annual expenses totaling $117,000 include:

Property taxes = $2,000

Property management = $7,000

Interest expense = $72,000

Swimming pool = $5,000

Professional fees = $8,000

Other expenses = $23,000

There is a monthly mortgage payment of $10,000 per month. Out of the $10,000 mortgage, $6,000 is interest expense and $4,000 is repayment of principal. Assuming a capitalization rate of 9%, what is the market value of the Chesapeake Bay complex?

$1,941,422
$2,884,140
$3,560,667
$4,360,667

Answer 74

Solution: The correct answer is D.

Gross rental receipts ($650 × 60 × 12) = $468,000 plus non-rental income ($625 × 12) = $7,500 equals potential gross income (PGI) ($468,000 + $7,500) = $475,500. PGI minus vacancy and collection losses [$475,500 - (.08 × $475,500)] = $437,460 equals Effective Gross Income (EGI). EGI minus expenses equals net income $437,460 - $117,000 = $320,460. Next, determine net operating income by adding interest and depreciation expense back to net income.

NOI = $320,460 + $72,000 interest + $0 depreciation = $392,460.

Market value = $392,460 ÷ .09 = $4,360,667

Question 75

In comparing the performance of two mutual funds over the previous five-year period, you note that the annual returns of the funds are quite similar year-to-year. You also note that one of the funds has a portfolio turnover that averages 12 times the value of the portfolio (i.e., the dollar amount of trades the fund made for the year is 12 times the average dollar value of the portfolio) For one year, turnover was as high as 26. The comparison fund’s portfolio turnover never exceeded 0.8 and averaged 0.4 for the five year period. From a behavioral finance point of view, the high turnover fund’s management most likely exhibits:

anchoring.
overconfidence.
regret avoidance.
representativeness.

Answer 75

Solution: The correct answer is B.

Overconfidence leads to overtrading.

Question 76

A mutual fund investor who is looking for the opportunity to buy investments at a discount, so as to capture a greater portion of any capital gains, would probably decide to invest in a(n):

Open-end fund.
Closed-end fund.
Unit investment trust.
Exchange Traded Fund (ETF).

Answer 76

Solution: The correct answer is B.

Closed-end funds generally sell at either a premium or a discount to par value. When purchased at a discount, they afford investors an opportunity to realize up-side capital appreciation.

Question 77

Match the investment characteristic(s) listed below which describe(s) a unit investment trust.

Passive management of the portfolios.
Self-liquidating investments usually holding bonds.
Both “A” and “B.”
Neither “A” nor “B.”

Answer 77

Solution: The correct answer is C.

Both statements are correct because a UIT typically holds municipal bonds until maturity. UITs can also own equities.

Question 78

Which of the following are factors to consider when investing in a mutual fund?

The size of the fund.
The amount of time until a distribution is made.
The amount of time the current portfolio manager has managed the fund.
The availability of a third-party analysis of the fund.

I and III only.
II and IV only.
I, II and III only.
I, III and IV only.

Answer 78

Solution: The correct answer is C.

If an investor can find out I, II and III, he or she will not likely require IV. Though it may reinforce the investor’s findings, the third party analysis is unnecessary at that point.

Question 79

Match the investment characteristic(s) listed below which describe(s) closed-end investment companies.

Passive management of the portfolios.
Shares of the fund are normally traded in major secondary markets.
Both “A” and “B.”
Neither “A” nor “B.”

Answer 79

Solution: The correct answer is B.

Close-end funds are traded on the secondary markets but are not passively managed.

Question 80

In the mutual fund industry, 12b-1 fees are charged as part of:

Fund management fees.
Distribution fees.
Commissions for sales.
Legal fees and expenses.

I only.
II only.
I and III only.
I, II and IV only.

Answer 80

Solution: The correct answer is B.

12b1 fees are used for marketing and distribution costs. All other costs, such as legal, accounting and analysis are paid through management fees. Commissions are paid using either a front load or a back load.

Question 81

Company A has 60% debt and 40% equity; Company B has 20% debt and 80% equity. Assume both companies have the same dollar amount of assets and net income before interest and taxes. Which one of the following statements is true?

The unsystematic risk for the two companies is about equal.

Company A’s tax obligation will exceed Company B’s.

The company with the higher return on equity should be purchased by a risk-averse investor.

The return on equity for Company A can be expected to exceed the return on equity for Company B.

Answer 81

Solution: The correct answer is D.

Company A has a smaller amount of its assets financed by equity, therefore, with the same earnings in net income as Company B, the level of return on the equity of Company A would be greater.

Purely for EXAMPLE (net income is provided, not calculated):

A: Assets $10M; Liabilities $6M; Equity $4M; EBIDTA = $1M; I/Y = 5% Net Income = $700K; ROE = $700,000 ÷ $4M = 17.5%

B: Assets $10M; Liabilities $2M; Equity $8M; EBIDTA = $1M; I/Y = 5% Net Income = $900K; ROE = $900,000 ÷ $8M = 11.25%

Question 82

Specific companies are researched and chosen as investments based on their outstanding investment possibilities by analysts who practice:

The Dow theory analysis.
Top-down analysis.
Bottom-up analysis.
Random Walk analysis.

Answer 82

Solution: The correct answer is C.

Bottom up analysts are looking for the next big, but as yet, undiscovered stock that will break onto the scene. Bottom up analysts start with the company, then the industry and finally the economic climate. Top-down starts with the economic climate, moves to the industry and then the company.

Question 83

According to fundamental analysis, which phrase best defines the intrinsic value of a share of common stock?

The par value of the common stock.
The book value of the common stock.
The liquidating value of the firm on a per share basis.
The discounted value of all future dividends

Answer 83

Solution: The correct answer is D.

Intrinsic value is the discounted value of a future stream of cash flows. In the case of a stock, its dividends.

Question 84

Bottom-up equity managers include:

Group rotation managers.
Value managers.
Market timers.
Technicians.

I only.
II only.
I and III only.
II and IV only.

Answer 84

Solution: The correct answer is D.

Options “I” and “III” are both “top down” style managers.

Question 85

The form of technical analysis that utilizes Advances and Declines (also known as Breadth of the Market) as an indicator is known as:

Price Indicator.
Volume Indicator.
Market Indicator.
Charting Indicator.

Answer 85

Solution: The correct answer is A.

Advances and declines deal with price. Volume indicates the number of shares traded. Market indicators deal with directions of the market and related averages. Charts are used as indicators and in some instances, do not use price but rather movements.

Question 86

Which of the following are true statements about the Capital Asset Pricing Model (CAPM)?

The Security Market Line (SML) by itself does NOT determine the optimal portfolio for an investor.

Beta is used as a measure of risk on the Security Market Line (SML).

The required return is beta times the market return.

As investors replace risk-free assets with risky assets, the required return will rise.

I and III only.
II and IV only.
I, II, and IV only.
II, III, and IV only.

Answer 86

Solution: The correct answer is C.

Choice “III” - The required rate of return is determined by adding the risk premium (which is the market rate of return minus the risk free rate) times the beta to the risk free rate of return.

Question 87

Camping the US, Inc. is currently trading at $25 a share and will pay dividends of $1, $0, $2 respectively, at the end of this year and the following 2 years. They expect dividends to level out at a 3% growth rate after that. Your client is interested in purchasing some shares and would like to know the current value of the shares. Your client has a 7% required rate of return. What is the value per share of Camping the US, Inc. if you use the dividend growth model?

$23.25
$25.75
$22.21
$44.61

Answer 87

Solution: The correct answer is D.

For uneven dividend cash flow, you will need two steps. First use the dividend growth model for the 3% consistent growth.

D1/r-g D1 is next year’s dividend, which we don’t have so we substitute with D0(1+g)
2 (1+.03) / .07-.03 = 51.50

Then do the cash flows to account for the uneven growth
CFj 0
CFj 1
CFj 0
CFj 2 + 51.50
I = 7
NPV = ?
NPV = 44.6065

Question 88

Which one of the following types of investor benefits most from the tax advantage of preferred stocks?

Government.
Individual.
Corporate.
Mutual funds.

Answer 88

Solution: The correct answer is C.

The corporate dividend-received deductions are based on ownership.

Question 89

Which of the following is NOT a similarity between preferred stock and debt instruments?

Preferred stock represents the same level of risk as debt to the buyer.
Preferred stock pays a fixed income in its dividend.
Preferreds are purchased for their income stream.
Preferred stock is subject to interest rate and purchasing power risks.

Answer 89

Solution: The correct answer is A.

Preferred stocks are riskier than debt due to the lack of a maturity date on preferred issues.

Question 90

The cumulative feature on a preferred stock is best described in the following:

The preferred stock gets to cast its entire total of votes in a grouping for one seat on the board of directors if the shareholders so desire.

The preferred shareholder has the option of accruing a certain number of shares and then converting them to common stock.

If there are additional or extra dividends declared, the preferred shareholders have the right to share in the profits.

If dividends are not paid in a given cycle, they cannot be paid to anyone else until they are paid to preferred shareholders.

Answer 90

Solution: The correct answer is D.

Preferred stocks are non-voting shares. The description of Option “A” is of common stocks’ cumulative voting rights. Option “B” refers to convertibility, while Option “C” addresses participating preferred stocks.

Question 91

Bristol-Buyers Company has a market price of $36.00 per share with earnings of $3.00 per share, a beta of 1.1 and a dividend of $1.20, which means a dividend payout ratio of 40%. Earnings for next year are projected to increase by 25%, and the retention ratio is projected to remain at 60%. Using the price/earnings multiplier, to what level might your client expect to see market prices move in a year?

$39.60
$45.00
$50.40
$57.60

Answer 91

Solution: The correct answer is B.

The $36.00 per share price is divided by the $3.00 earnings per share resulting in a price/earnings multiplier of 12. The increase of earnings by 25% results in a projected earnings of $3.75 next year. This new earnings times the P/E multiplier of 12 (assuming the P/E ratio remains constant) results in a price of $45.00. The dividend information provided is unnecessary in answering the question.

Question 92

Which one of the following factors would be the strongest indication that interest rates might rise?

Selling of dollar-denominated assets by foreign investors.
Decreasing United States government deficits.
Decreasing rates of inflation.
Weak credit demand by the private sector of the United States economy.

Answer 92

Solution: The correct answer is A.

Foreigners selling dollar-denominated assets are preparing to take advantage of higher rates by increasing their liquidity. The rest signal a decrease in rates.

Question 93

The bond investment strategy of “riding the yield curve” involves:

Investing equal amounts in short-term and long-term bonds.
Investing equal amounts in each of several maturity periods.
Investing either short-term or long-term to take advantage of anticipated interest rate changes.
Selling bonds with unrealized losses and replacing them with similar bonds.

Answer 93

Solution: The correct answer is C.

Riding the yield curve refers to the purchase of debt instruments in anticipation of fluctuations in the rates of return on both long and short-term instruments. Rising rates of interest require repositioning a portfolio in advance of the rise in order to avoid significant price drops. These moves are based on anticipated changes in the yield curve.

Question 94

A yield curve can be described as a curve that:

Depicts the current yield on government debt.
Slopes upward as the years to maturity increase.
Shows the term structure of interest rates on government debt.
Offers greater potential yield as the maturity approaches the present.

Answer 94

Solution: The correct answer is C.

The yield curve demonstrates graphically the relationship between long-term and short-term government debt.

Question 95

An investor buys a share of stock for $50. At the end of the first year, he purchases a second share for $55. At the end of the second year, the stock is worth $62 per share and the investor sells both shares. (The investor received a cash dividend of $2 per share each year.) What is the time-weighted return on this investment?

13. 6%
14. 2%
15. 5%
16. 3%

Answer 95

Solution: The correct answer is B.

CFo = <50>, CFj = 2, CFj = 64 (62 + 2) then solve for IRR. Remember, time-weighted return is only concerned about the security’s cash flow, not the investors.

Question 96

Which of the following are characteristics of the payout ratio?

The percentage of compensation paid to the top 10 executives of a company as a percentage of net income.

The percentage of net income paid out as dividends.

A measure of a company’s earnings retention philosophy.

A measure of a company’s attitude toward compensation of top executives on the basis of performance.

I only.
II only.
I and IV only.
II and III only.

Answer 96

Solution: The correct answer is D.

The dividend payout ratio is the portion of earnings which a company pays its investors. The balance of earning retained by the company comprises its retention ratio. The dividend payout ratio is:

Dividend Per Share ÷ Earnings Per Share

Question 97

Which of the following represents an advantage of an index mutual fund over an exchange traded fund (ETF)?

A. Index fund shares can be purchased at any time during the day, while ETF shares can only be purchased at the end of the trading day.

B. Index funds always trade at net asset value, while ETFs can trade at a discount to their net asset value.

C. Index funds can be purchased on margin or shorted, whereas ETFs require the full purchase price and can’t be shorted.

D. Index funds more readily track the underlying index as compared to an ETF.

Answer 97

Solution: The correct answer is B.

A is incorrect. ETF shares can be purchased at any time during the day, while index fund shares can only be purchased at the end of the trading day.

C is incorrect. ETFs can be purchased on margin or shorted, whereas index funds require the full purchase price and can’t be shorted.

D is incorrect. ETFs more readily track the underlying index as compared to an index fund, because the index fund will incur transaction costs, fund cash flows, and changes to the index.

Question 98

Which of the following investments would be most appropriate for an investor wanting to maintain purchasing power while minimizing interest rate risk?

A. Laddered short-term CD portfolio.

B. Treasury bonds.

C. Conservative large-value mutual funds.

D. Collateralized mortgage obligations.

Answer 98

Solution: The correct answer is C.

CDs, Treasury bonds, and CMOs all have interest rate risk.

Question 99

A client is determining which of a series of projects to invest in. The products have a $100,000 cost of entry. The client is comfortable with the market risk necessary to generate a 12% rate of return in today’s economic environment. Given the expected cash flows, which of the following should a CFP® professional recommend for the client?

A. Project A, with a net present value of $500 using a 10% discount rate.

B. Project B, with a net present value of $600 using a 11% discount rate

C. Project C, with a net present value of $800 using a 12% discount rate

D. Project D, with a net present value of $0 using a 14% discount rate

Answer 99

Solution: The correct answer is C.

Look to the highest NPV and ensure the level of risk is acceptable. NPV of zero is a break even, meaning you are earning the IRR.

Question 100

Todd is an aggressive investor who invests exclusively in stocks. He studies odd-lot theory and head-and-shoulder charting patterns when selecting appropriate stocks for investment. He also knows several members of the board of directors of a publicly-traded company and believes inside information he obtains from them will help with his purchase and sell decisions. Todd’s use of odd-lot theory and head-and-shoulder charting patterns is consistent with:

A. The semi-strong form of the efficient market hypothesis.

B. The weak and semi-strong forms of the efficient market hypothesis.

C. The strong form of the efficient market hypothesis.

D. None of the forms of the efficient market hypothesis.

Answer 100

Solution: The correct answer is D.

Odd-lot theory and the January effect are both examples of technical analysis. No form of the efficient market hypothesis supports technical analysis.

Question 101

Greg buys 100 shares of ABC Company stock at a cost of $48 per share. He later purchases a put option on ABC Company stock with a strike price of $42. He paid a premium of $100 for the option. On the date of the put option expiration, ABC stock is trading at $35, and Greg exercises the option. What is Greg’s net gain or loss on this transaction?

A. $400 gain.

B. $700 loss.

C. $800 loss.

D. $1,300 loss.

Answer 101

​Solution: The correct answer is B.

A put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. He paid $100 for the put option. His security basis is $48 per share, and the sale price is the strike price of the option, $42, resulting in a $6 per share loss x 100 shares = $600, plus the purchase price of the option leaves a $700 loss.

Question 102

Holding Period Return Formula

Answer 102

HPR = [Selling Price - Purchase Price +/- Cash Flows] / Purchase Price

Question 103

Gabby, a CFP® professional, is working with Debby, a retiree. Debby has a concentrated position in a highly appreciated growth stock, which makes up the majority of her assets. Debby requires income from her portfolio but is hesitant to sell her stock position. Which of the following strategies should Gabby recommend that would provide the least amount of risk to the retiree?

A. Purchase put options on the stock.

B. Sell covered puts on the stock position.

C. Sell covered calls on the stock position.

D. Sell the stock position and purchase an immediate annuity.

Answer 103

Solution: The correct answer is C.

Selling covered call options will generate income for Gabby’s client. A “covered call” is an income-producing strategy where you sell, or “write”, call options against shares of stock you already own.

A is incorrect. Put options will not provide income.

B is incorrect. Covered puts would create additional portfolio risk if the position decreased in value.

D is incorrect. Purchasing an immediate annuity is inconsistent with the fact pattern presented.