investment Planning Review Questions

Question 1

Which of the following would you use to ascertain the chairman’s perspective for progress completed and expected for the coming year?

a) 10K report.
b) Annual report.
c) 10Q report.
d) Quarterly report.

Answer 1

b) Annual Report

- The chairman’s statement is included in the company’s annual report

Question 2

You own 1,000 shares of ePlace stock. You purchased these shares for $25 per share on margin with a 50% initial margin requirement and a 25% maintenance margin requirement. ePlace has experienced some rever-sals in the pummeling that tech stocks have received recently. The price has dropped to $13 per share. Will there be a margin call? If so, how much?

a) $1,500.
b) $2,750.
c) $3,250.
d) No margin call required.

Answer 2

b) $2,750
- Debt of $12,500 and new portfolio value of $13,000 requires a 25% or $3,250 margin. With only $500 [($13 - 12.50) x 1,000] remaining, there is a required call for $2,750

Question 3

How do the stock split and the stock dividend impact the shareholders without bringing about any changes in the value of the company on the balance sheet?

a) The value of the stock split and value of the stock dividend are generally small enough that the impact on the balance sheet is minimal
b) The value of the stock split and the value of the stock dividend increase the number of shares but not the total value of those shares
c) The value of the stock split and the value of the stock dividend cause dilution, which keeps the value of the stock up, but without increasing the overall value on the balance sheet
d) The value of the stock split and the value of the stock dividend offset one another, thereby eliminating any change that might occur to the balance sheet of the company

Answer 3

b) The value of the stock split and the value of the stock dividend increase the number of shares but not the total value of those shares
- Only option B, which states that the value of the stock split and the value of the stock dividend increase the number of shares but not the value of those shares is correct. These options are sometimes used when a firm wishes to reward shareholders without expending cash that it prefers to use for other activities or opportuni-ties

Question 4

Sydney buys a stock for $50 using an initial margin of 75% and a maintenance margin of 40%. At what price will she receive a margin call?

a) $13.12
b) $20.83.
c) $25.25.
d) $66.67

Answer 4

b) $20.83.

- ($50 x 0.25) ÷ (1 - 0.40) = $20.83

Question 5

Your best friend Alex came to your house party for the football game. During the game he starts telling you about his amazing portfolio performance. He tells you about several positions that experienced double digit returns in a matter of days. He says that he lost on a few but not very much. Impressed you decide to invest some money with him. What behavioral finance bias does your friend Alex portray?

a) Overconfidence
b) Anchoring
c) Cognitive dissonance
d) Belief perseverance

Answer 5

c) Cognitive dissonance
- Alex is, most likely, exaggerating his gains and minimizing or forgetting about his losses. He doesn’t want the blow to his ego or pride associated with making bad decisions that lost money. This is an example of cognitive dissonance

Question 6

Your company has a portfolio made up of two assets, one from the US and the other from Swaziland. Their information is as follows: 
Return Deviation Weight 
US 12.2% 10.5% 60%
Swaziland  18.4% 23.8% 40% 
The company has asked you to estimate risk involved in the existing portfolio (the correlation is .30). After calculating, you tell them that the portfolio deviation is: a) 20.6%. 
b) 12.9%. 
c) 8.5%. 
d) 18.9%

Answer 6

b) 12.9%
- Standard deviation formula
- must calculate covariance given correlation of 0.3

Question 7

Your client is considering purchasing stocks. The actual return of one of his choices follows here. Assist him by calculating the standard deviation and advise him what the risk is.
Stock A Actual Returns: 6%, 12%, 8%, 10%
a) 0.0164.
b) 0.0258.
c) 0.0542.
d) 0.1072.

Answer 7

b) 0.0258
10 BII
6 E+
12 E+
8 E+
10E+
Sx,Sy = 2.5820 or 0.0258

Question 8

A mutual fund has a correlation coefficient of 0.80. What percent of return is due to unsystematic risk?

a) 36%.
b) 64%.
c) 80%.
d) 100%

Answer 8

a) 36%
- Correlation coefficient = 0.80
- r-squared = 0.64
- Therefore, 64% of the mutual funds return is due to systematic risk or market risk and 36% is due to unsystematic risk

Question 9

Which of the following returns do mutual funds use when reporting a five-year historical return?

a) Time-Weighted Return.
b) Dollar-Weighted.
c) Arithmetic Mean.
d) Holding Period Return.

Answer 9

a) Time-Weighted Return
- Mutual funds use the security’s cash flow, which is a time-weighted return. An investor is concerned about a dollar-weighted return

Question 10

Which form of the Efficient Market Hypothesis directly refutes Technical Analysis?

a) Strong form.
b) Semi-strong form.
c) Weak form.
d) All of the above.

Answer 10

c) Weak form
- The weak form of the EMH refutes technical analysis
- Although all three forms refute technical analysis, the weak form is in direct contradiction with technical analysis

Question 11

Which of the following are tools of the Technical Analysts?

1. Market Indicators.
2. Price Indicators.
3. Volume Indicators.
4. Charting.

a) 1 and 3.
b) 2 and 4.
c) 2, 3, and 4.
d) 1, 2, 3, and 4.

Answer 11

d) 1, 2, 3, and 4.
- All of the listed tools are used by technicians in the process of trying to recognize patterns in stocks in order to anticipate future prices.

Question 12

How does the user of the “Intrinsic Value” formula arrive at the appropriate rate of return (the r or the k) used in this model?

a) By using the Capital Asset Pricing Model.
b) By using the Arbitrage Pricing Model.
c) By using the Jensen Model.
d) By using the Expected Rate of Return Model.

Answer 12

a) By using the Capital Asset Pricing Model
- The “r” or “k” in the bottom of the Intrinsic Value Model is the required rate of return, and it is calculated using the Capital Asset Pricing Model, or CAPM

Question 13

Your client has expressed a desire to completely minimize risk exposure. Under the time classification of markets listed in the reading, which instrument would best meet her requirements?

a) A 30-day call option.
b) A treasury bond with 60 days to maturity.
c) A treasury bill with 1-year maturity.
d) A 180-day commercial paper

Answer 13

c) A treasury bill with 1-year maturity.
- The US T-Bill is the investment listed with the least risk exposure. The treasury bond with 60 days to matu-rity may seem like a good choice, but they are a long term investments subject to purchasing power risk.

Question 14

If a municipal bond fund is designed to be federal and state-tax-free by investing in municipal and state issues where a participant lives, how would it occur that this same municipal bond mutual fund could gener-ate taxable capital gains?

a) Municipal bond mutual fund interest is not given the same tax-exempt status as bonds held by individ-ual bondholders.
b) Municipal bond mutual fund profits generated through sale of fund units to new fund participants do not qualify for the tax exemption.
c) Municipal bond mutual fund income generated through bond sales is a taxable gain to the fund holders.
d) Municipal bond mutual funds are taxable if they are not issued by the state in which a participant resides.

Answer 14

d) Municipal bond mutual funds are taxable if they are not issued by the state in which a participant resides.
- Fund managers often seek to generate additional profits for stakeholders by selling various bonds when there is an opportunity to profit from interest rate movements. Profits generated for the fund in this manner, how-ever, are not distributed on a tax-free basis

Question 15

Which of the following best explains what it means to a firm to have their bond issues downgraded by their rating agency?

a) Bonds are downgraded periodically to ensure that corporate performance is kept at its peak at all times.
b) Bonds are downgraded when a corporation engages in riskier financial positions than the bond rating agency deems appropriate for a specific rating.
c) Bonds are downgraded when a corporation engages in riskier projects than the bond rating agency approves of for a certain level of bond rating.
d) Bonds are seldom, if ever, downgraded.

Answer 15

b) Bonds are downgraded when a corporation engages in riskier financial positions than the bond rating agency deems appropriate for a specific rating
- A corporation that is not performing well with regard to reductions in earnings and increases in reliance on debt may find the rating of its debt issues downgraded which will mean an increase in the cost of borrowing. A highly leveraged company that takes on riskier projects could see a further down grade. A risky project on its own is not necessarily indicative of a down grade as the corporation may be in a healthy financial position

Question 16

Calculate the new price of the following bond when interest rates change: A 10-year bond was selling in the marketplace for $1,071. It pays investors $80 annually with a $1,000 maturity value. If interest rates in the marketplace fall 100 basis points, the new price of this bond will:

a) Fall $40.
b) Rise $68.
c) Fall $71.
d) Rise $74

Answer 16

d) Rise $74
- Duration formula
- YTM (y) = 7%
- Periods to Maturity (t) = 10
- Coupon rate (c) = 8%
- By solving, duration = 7.34
- Estimating bond price formula
- Delta y = 0.1
- YTM (y) = 7%
- .0686 = 6.86% increase in price
- $1,071 x 0.0686 = 73.47

Question 17

You are contemplating the purchase of a 10-unit building and plan on renting each unit out at $700 per month. After looking at the owner’s books, you have determined that the annual vacancy rate is 10%. There is additional revenue from vending and parking of $500 per month. Expenses on operations, maintenance, cleaning, and up-keep average about $15,000 annually. With all of this in mind, and the fact that similar properties in the area are selling using an equity capitalization rate of 8%, how much should you offer on the building?

a) $750,000.
b) $765,000.
c) $820,000.
d) $825,000

Answer 17

d) $825,000
- As follows: 10 units x $700 = $7,000 x 12 mos. = $84,000 + $6,000 other income = $90,000 – ($90,000 x 10%) = $81,000 – $15,000 = $66,000 = $66,000/0.08 = $825,000

Question 18

Which of the following terms captures the difference between duration’s estimate of a bond’s price change and the actual price change of a bond based upon changes in interest rates?

a) Modified Duration.
b) Skewness.
c) Yield Curve.
d) Convexity

Answer 18

d) Convexity
- Convexity measures the difference between duration’s estimate of a bond’s price change and the actual price change of a bond

Question 19

All of the following statements regarding a UIT are true except?

a) Investors redeem shares directly with the trust.
b) They are self-liquidating investments.
c) They are passively managed.
d) UITs can invest in equities or bonds

Answer 19

a) Investors redeem shares directly with the trust

- Investors in a UIT redeem UNITS not shares. All other statements regarding UITs are correct

Question 20

Your client has expressed an interest in the possibility of writing and selling option contracts in several stocks in his portfolio. Which of the following is your client’s primary reason for taking the selling position in the option transaction?

a) Income.
b) Hedging.
c) Speculation.
d) Coverage.

Answer 20

a) Income

- Most option writers (sellers) are seeking additional portfolio income.

Question 21

What are the differences between option contracts and futures contracts?

1. Options contracts are custom designed to fit the transaction.
2. Futures contracts specify price and options do not.
3. Options contracts give the buyer a right to do something, whereas futures contracts the buyer is obli-gated to take delivery.
4. Futures are marked to market on a daily basis and options are not.

a) 1 and 2.
b) 2 and 3.
c) 3 and 4.
d) 1 and 4

Answer 21

c) 3 and 4

- Options contracts are standardized. Options specify price, futures do not.

Question 22

Mike buys a call option with a strike price of $50 and an option premium of $5, when the stock is trading at $48. Which of the following statements is true?

a) The call option is in the money.
b) The time premium is $3.
c) The time premium is $5.
d) The intrinsic value is $2.

Answer 22

c) The time premium is $5
- The intrinsic value formula for a call option is Stock Price - Strike Price. $48 - $50 = -$2, however, intrinsic value cannot be less than zero. Therefore, the entire premium is due to the time component. The call option is out of the money because the intrinsic value is zero

Question 23

Kevin buys a put option with a strike price of $30 and an option premium of $5 when the stock is trading at $27. Which of the following statements is true?

a) The put option is out of the money.
b) The time premium is $3.
c) The time premium is $5.
d) The intrinsic value is $3.

Answer 23

d) The intrinsic value is $3
- The intrinsic value formula for a put option is Strike Price - Stock Price. $30 - $27 = $3. The time premium is $5 - $3 = $2. The put option is in the money because it has an intrinsic value greater than zero.

Question 24

Hector is a tree farmer who sells his trees to lumber manufacturers. Hector is concerned about hedging his risk associated with price fluctuations for his timber. Which of the following strategies would you recom-mend that Hector use to hedge his risk?

a) Buy a futures contract.
b) Sell a futures contract.
c) Short straddle.
d) Long straddle

Answer 24

b) Sell a futures contract
- The best answer is for Hector to sell a futures contract. He is already inherently long on the price of timber, so to hedge his risk, he needs to short timber. To short the price of timber, he should sell a futures contract. Recall that to hedge risk, an investor needs to enter into a futures contract that is opposite of his inherent position. Growers are always inherently long and manufacturers are always inherently short.

Question 25

Ivan owns Microsoft stock, which has been trading in a narrow range recently. Ivan is interested in keeping his Microsoft stock, but would like to generate some income. What would you recommend?

a) Buy a call that’s out of the money
b) Sell a call that’s in the money.
c) Sell a call that’s out of the money.
d) Buy a call that’s in the money.

Answer 25

c) Sell a call that’s out of the money
- The best answer is to sell a call that is out of the money. It’s less likely that Ivan will be called out of his stock if he sells a call that is “significantly” out of the money. By selling a call that is in the money, there is a higher probability that he will be called out of his stock and forced to sell it.

Question 26

Two defense contractors are competing for the Army’s newest contract for tanks. The Army has decided they are going to announce who wins the contract on Friday, April 18th. Joe knows that the company that wins the contract, their stock is going to appreciate. The company that loses the contract, their stock will go down. Which of the following strategies would allow Joe to take advantage of these price movements?

a) Long straddle.
b) Short straddle.
c) Covered call.
d) Married put

Answer 26

a) Long straddle
- A long straddle involves buying a put and call option on both companies. Joe’s not sure which stock is going up or down, so a long straddle will be the appropriate strategy, as long as there is price volatility. A short straddle is appropriate if there is little to no volatility. A covered call is appropriate to generate income, and a married put locks in profit.

Question 27

In May, 1993, Joe Edd bought a tax-exempt original issue discount (OID) bond. Which of the following statements apply?

1. The bond basis increases at a set rate each year.
2. The difference between the maturity value and the original issue discount price is known as the OID.
3. The bond’s earnings are treated as exempt-interest income.
4. The bond was issued at a discount to its par value.

a) 2 and 3.
b) 1 and 4.
c) 1, 2 and 4.
d) 3 only.
e) 1, 2, 3 and 4.

Answer 27

e) 1, 2, 3 and 4.
- An original issue discount bond is sold at a discount to par value. As it matures, the price of the bond increases until the price reaches the par value. The OID is the difference between its maturity value and original issue discount price. Since this bond is tax-exempt, the earnings are treated as tax-exempt interest income.

Question 28

Harry Ingram purchased ten listed bonds (Widget Corp 8.00s 10/1/99) on June 30, 1995, at a market-asked price of 95. His transaction cost from the trade was $100. He paid his broker $9,800 as a consequence of the trade. He asks you to explain the details of his purchase. You reply that:

1. His purchase cost included $9,500 for the bonds, $100 for broker commission and $200 as mark-up by the trade specialist.
2. His broker will report $400 on Form 1099-INT as 1995 taxable interest on these bonds. His taxable interest income from the bonds for 1995 was $400.
3. His purchase cost included $9,500 for the bonds, $100 for broker commission and $200 as accrued interest.
4. His broker reported $400 on Form 1099-INT as 1995 taxable interest on these bonds. His taxable inter-est income from the bonds for 1995 was $200.
5. His purchase cost included $9,500 for the bonds, $100 for broker commission and $200 charged in error by the brokerage house.

a) 3 and 4.
b) 1 and 2.
c) 1 and 4.
d) 2 and 3.
e) 2 and 5.

Answer 28

a) 3 and 4.
$9,500 Price of Bonds
$100 Commission
200 ($9,800 - $9,500 - $200) Accrd Intrst Entitled to Ded
= $9,800 Interest for 6-month period will be 8% x $1,000 x (6/12) = $400

Question 29

The standard deviation of the returns of a portfolio of securities will be ____________ the weighted average of the standard deviation of returns of the individual component securities.

a) Equal to.
b) Less than.
c) Greater than.
d) Less than or equal to (depending upon the correlation between securities).
e) Less than, equal to, or greater than (depending upon the correlation between securities).

Answer 29

d) Less than or equal to (depending upon the correlation between securities).
- The standard deviation of the returns of a portfolio will equal the weighted average of the standard deviation of returns when correlation is equal to one. Anytime correlation is less than one, then the standard deviation of the returns will be less than the weighted average of the standard deviation of returns.

Question 30

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

a) Not change because this does not affect stock values.
b) Increase in order to compensate the investor for increased risk.
c) Increase due to higher risk-free rates.
d) Decrease in order to compensate the investor for increased risk.
e) Decrease due to lower risk-free rates.

Answer 30

d) Decrease in order to compensate the investor for increased risk.
- If the market risk premium increases, stock prices will decrease to provide investors with compensation for the increased risk associated with the market risk premium increasing.

Question 31

Which of the following is/are characteristics of a municipal bond unit investment trust?

1. Additional securities are not added to the trust.
2. Shares may be sold at a premium or discount to net asset value.
3. Shares are normally traded on the open market (exchanges).
4. The portfolio is self-liquidating.

a) 1 only.
b) 1 and 4.
c) 2 and 3.
d) 2 and 4.
e) 1, 2, 3 and 4.

Answer 31

b) 1 and 4.
- Municipal bond unit investment trusts are passively managed and self liquidating. The bonds are held until maturity and the proceeds are then dispersed to the investors. Once the assets are purchased, no other assets are added to the trust

Question 32

American depository receipts (ADRs) are used to:

1. Finance foreign exports.
2. Eliminate currency risk.
3. Sell US securities in overseas markets.
4. Trade foreign securities in US markets.

a) 1 and 3.
b) 1 and 4.
c) 2 and 4.
d) 4 only.
e) 1, 2 and 4

Answer 32

d) 4 only.
- Bankers acceptance is used to finance exports and imports. ADRs do not eliminate currency or exchange rate risk. ADRs represent foreign securities and ADRs are traded in the US ADRs are also denominated in US dollars.

Question 33

Which combination of the following statements about bond swaps is true?

1. A substitution swap is designed to take advantage of a perceived yield differential between bonds that are similar with respect to coupons, ratings, maturities, and industry.
2. Rate anticipation swaps are based on forecasts of general interest rate changes.
3. The yield pickup swap is designed to change the cash flow of the portfolio by exchanging similar bonds that have different coupon rates.
4. The tax swap is made in order to substitute capital gains for current yield.

a) 1, 2 and 3.
b) 1 and 3.
c) 2 and 4.
d) 4 only.
e) 1, 2, 3 and 4.

Answer 33

a) 1, 2 and 3.

- All statements are true except that a tax swap is meant to offset bonds with capital gains and losses.

Question 34

Modern “asset allocation” is based upon the model developed by Harry Markowitz. Which of the following statements is/are correctly identified with this model?

1. The risk, return and covariance of assets are important input variables in creating portfolios.
2. Negatively correlated assets are necessary to reduce the risk of portfolios.
3. In creating a portfolio, diversifying across asset types (e.g., stocks and bonds) is less effective than diversifying within an asset type.
4. The efficient frontier is relatively insensitive to the input variable.

a) 1 and 2.
b) 1, 2 and 3.
c) 1 only.
d) 2 and 4.
e) 1, 2 and 4.

Answer 34

c) 1 only.
- Statement 1 is true. Statement 2 is incorrect because a correlation of of anything less than 1 helps to reduce the risk of a portfolio. Diversifying across asset types is more effective than diversifying within an asset type. The efficient frontier is sensitive to input variables

Question 35

When the couple is able to begin an investment program, they want to begin making investments for their retirement and their children’s education. All of the following actions will help accomplish their goals in a tax-efficient manner except:

a) Investing in individual Roth IRAs.
b) Investing through a 403 (b) program for the wife.
c) Investing in a growth and income mutual fund.
d) Investing in education IRAs for each child

Answer 35

c) Investing in a growth and income mutual fund.
- The couple is too young to invest in a growth and income fund. They have more of a need for growth and not a need for income. All of the other options are appropriate.

Question 36

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

a) High inflation risk; low default risk.
b) Low inflation risk; high market risk.
c) Low inflation risk; low default risk.
d) High inflation risk; high market risk.

Answer 36

a) High inflation risk; low default risk.
- All bonds are subject to inflation risk, which is in the form of purchasing power risk. Long-term bonds are subject to more inflation/purchasing power risk than shorter term bonds. There is no inflation protection because the coupon payments remain constant throughout the term of the bond. As inflation increases, the investor has less purchasing power. Municipal bonds are considered to have a low default risk because the issuing municipality may raise taxes to repay the bond holders.

Question 37

To immunize a bond portfolio over a specific investment horizon, an investor would do which of the following?

a) Match the maturity of each bond to the investment horizon.
b) Match the duration of each bond to the investment horizon.
c) Match the average weighted maturity of the portfolio to the investment horizon.
d) Match the average weighted duration of the bond portfolio to the investment horizon.

Answer 37

d) Match the average weighted duration of the bond portfolio to the investment horizon.
- In order to immunize a bond portfolio, the weighted average duration of the portfolio needs to equal the investor’s time horizon.

Question 38

You are faced with the following alternative fixed income investments:
• A - US Treasury bond with an 11.625% coupon, due in 2004 with a price of $142.50 and a yield to maturity of 6.3%.
• B - US Treasury strip bond (zero coupon) due in 2004 with a price of $46.75 and a yield to maturity of 6.25%.
• C - Corporate B-rated bond with a 9.75% coupon, due in 2004 with a price of $104.75 and a yield to maturity of 8.79%
Which of these bonds has the greatest reinvestment rate risk?

Answer 38

A - US Treasury bond with an 11.625% coupon, due in 2004 with a price of $142.50 and a yield to maturity of 6.3%.
- The higher the coupon rate, the greater the reinvestment rate risk.

Question 39

You are faced with the following alternative fixed income investments:
• A - US Treasury bond with an 11.625% coupon, due in 2004 with a price of $142.50 and a yield to maturity of 6.3%.
• B - US Treasury strip bond (zero coupon) due in 2004 with a price of $46.75 and a yield to maturity of 6.25%.
• C - Corporate B-rated bond with a 9.75% coupon, due in 2004 with a price of $104.75 and a yield to maturity of 8.79%
Which of these bonds has the greatest interest rate risk?

Answer 39

B - US Treasury strip bond (zero coupon) due in 2004 with a price of $46.75 and a yield to maturity of 6.25%.
- The bond with the highest duration has the greatest interest rate risk. Since all three bonds mature in exactly 5 years, the zero-coupon bond will have the highest duration

Question 40

You are faced with the following alternative fixed income investments:
• A - US Treasury bond with an 11.625% coupon, due in 2004 with a price of $142.50 and a yield to maturity of 6.3%.
• B - US Treasury strip bond (zero coupon) due in 2004 with a price of $46.75 and a yield to maturity of 6.25%.
• C - Corporate B-rated bond with a 9.75% coupon, due in 2004 with a price of $104.75 and a yield to maturity of 8.79%
Which of these bonds has the longest duration?

Answer 40

B - US Treasury strip bond (zero coupon) due in 2004 with a price of $46.75 and a yield to maturity of 6.25%.
- Again, since bond B is a zero-coupon bond and all three bonds mature in five years, bond B has the longest duration.

Question 41

Match the investment characteristics listed below with the appropriate type of investment company in the items that follow.

a) Passive management of the portfolios.
b) Shares of the fund are normally traded in major secondary markets.
c) Both A and B.
d) Neither A nor B.
48. Closed-end investment companies ______

Answer 41

b) Shares of the fund are normally traded in major secondary markets.
- Closed end investment companies are traded on exchanges with the assistance of brokers.

Question 42

Match the investment characteristics listed below with the appropriate type of investment company in the items that follow.

a) Passive management of the portfolios.
b) Shares of the fund are normally traded in major secondary markets.
c) Both A and B.
d) Neither A nor B.
49. Open-end investment company_______

Answer 42

d) Neither A nor B.
- Open end investment companies have active management, and shares are purchased and redeemed directly with the fund family.

Question 43

Match the investment characteristics listed below with the appropriate type of investment company in the items that follow.

a) Passive management of the portfolios.
b) Shares of the fund are normally traded in major secondary markets.
c) Both A and B.
d) Neither A nor B.
50. Unit investment trust_________

Answer 43

a) Passive management of the portfolios.

- A Unit investment trusts are passively managed and self-liquidating.

Question 44

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.
a) I and II only.
b) I and IV only.
c) II and III only.
d) II and IV only.

Answer 44

a) I and II only.
- 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 45

These bonds are considered to be owned by whoever possesses them:

a) Serial bonds.
b) Registered bonds.
c) Bearer bonds.
d) Reset bonds.

Answer 45

c) Bearer bonds.
- Serial bonds are issued in series and mature in series. Registered bonds are paid interest based on to whom the bonds are registered. Bearer bonds pay interest to the holder of the bond. Interest rates can be reset on Reset bonds, and the U.S. government issues Treasury bonds; and both are registered.

Question 46

An increasing inflation rate can have a negative effect on the value of common stock and bonds due to:

a) The U.S. Treasury having to increase the supply of money to try to reduce inflation.
b) A reduction in interest rates, which will reduce the value of stocks.
c) An increase in the investor’s required rate of return.
d) An increase in the international transfer of funds.

Answer 46

c) An increase in the investor’s required rate of return.
- Because of the upward pressure of inflation on interest rates, the demand by investors for increased returns puts pressure on companies to perform at a time when the increased cost of borrowing may make that impossible. The company will be seen as less valuable, stock may be sold, and stock prices will fall as a result

Question 47

Which of the following elements of risk in mortgage-backed securities can be difficult to determine?

I. Actual maturity is not known with certainty.
II. Mortgage rates vary between the different investment pools.
III. Actual cash flows are not known with certainty.
IV. Government guarantees make the determination of an appropriate discount rate for calculating their present value difficult.
a) I and III only.
b) I and IV only.
c) II and III only.
d) II and IV only.

Answer 47

a) I and III only.

- Lack of a definite maturity date and uncertain cash flows are the elements of risk in mortgage-backed securities.

Question 48

The type of risk which CANNOT be eliminated through diversification is:

a) Unsystematic Risk.
b) Company Specific Risk.
c) Systematic Risk.
d) Business Risk

Answer 48

c) Systematic Risk.

- Unsystematic risk, company specific risk and business risk can all be eliminated through diversification.

Question 49

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

a) 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%.
b) 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%.
c) 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%.
d) A corporate zero coupon bond due in 5 years with a price of $750 and a yield to maturity of 5.9%.

Answer 49

a) 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%.
- This is due to the high coupon and lack of similar rates currently.

Question 50

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

a) Future value risk.
b) Interest rate risk.
c) Stand alone risk.
d) Reinvestment rate risk.

Answer 50

b) Interest rate risk.
- 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 51

Which of the following is NOT a premium factor that would be considered part of the nominal rate of interest?

a) Economic premium.
b) Default premium.
c) Liquidity premium.
d) Risk free rate of interest.

Answer 51

a) Economic premium.
- There is no such thing as an economic premium. All of the other premiums added to the risk free rate equal the nominal (or stated) rate.

Question 52

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

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

Answer 52

a) Anomalies to the Efficient Market Hypothesis exist.
- 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 53

“Stock prices adjust rapidly to the release of all new public information.” This statement is an expression of which one of the following ideas?

a) Random walk hypothesis.
b) Arbitrage price theory.
c) Semi-strong form of the Efficient Market Hypothesis.
d) Technical analysis

Answer 53

c) Semi-strong form of the Efficient Market Hypothesis.
- The Efficient Market Hypothesis weak form states that prices reflect historical information. The Efficient Market Hypothesis strong form states that stock prices reflect all information including insider information.

Question 54

What is one implication of the efficient market hypothesis?

a) Consistently superior performance is rare.
b) The weak form suggests that security prices do NOT adjust to new information.
c) The random walk hypothesis is invalidated.
d) Anomalies are perceptions but do NOT actually exist.

Answer 54

a) Consistently superior performance is rare.
- One cannot consistently earn abnormal returns. Over time, these superior returns will be reversed and overall gain is consistent with the general market.

Question 55

Kimberly Thurman is a private investor who researches individual stock purchases thoroughly. She studies company annual reports and 10k reports, computes comparative financial ratios from the reports, and compares company financial information to industry statistics to find undervalued stocks. Kim believes in:

a) The weak form of the efficient market hypothesis.
b) The neglected firm effect.
c) The random walk hypothesis.
d) The semi-strong form of the efficient market hypothesis.

Answer 55

a) The weak form of the efficient market hypothesis.
- Kimberly believes fundamental analysis will help her achieve above average market returns. The weak form of the EMH states that “the current price of a security reflects all historical information available on that security and does not reject fundamental analysis.”

Question 56

Your client has purchased stock with a margin position that required 50% initial margin and a 35% maintenance margin. The stock was originally valued at $23 per share when the transaction was undertaken and your client bought 1,000 shares. What stock price will trigger a margin call?

a) $13.04
b) $17.69
c) $26.45
d) $32.86

Answer 56

b) $17.69

- Price = Loan ÷ (1 - MM) = (23 × . 50) ÷ (1 - .35) = 17.69

Question 57

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:

a) Securities and Exchange Commission.
b) Federal Reserve.
c) National Association of Securities Dealers.
d) Brokerage firm with which an investor is dealing.

Answer 57

b) Federal Reserve.

- The Federal Reserve sets margin requirements for all security transactions.

Question 58

My margin requirements are 50% initial margin and 25% maintenance margin. I purchase a total of 200 shares at $100 per share using full margin amount for the 200 share purchase. Shortly thereafter, share prices fall to $50 per share. What will my margin call be?

a) $1,000
b) $1,500
c) $2,500
d) $5,000

Answer 58

c) $2,500
- Required equity: $50 × .25 = 12.50 per share
- Actual equity: $50 - $50 = 0 (current price- loan amount)
- To meet required equity: $12.50 per share × 200 shares = $2,500

Question 59

Which of the following option strategies would be considered the most risk?

a) Buying a call.
b) Buying a put.
c) Selling a covered call.
d) Selling a put.

Answer 59

d) Selling a put.
- Buying a put or call option limits the investor’s loss to the premium paid. With a covered call, the investor owns the underlying stock, which offsets any loss associated with selling the call. Selling a put is the most risky of the strategies listed because the stock could fall to zero.

Question 60

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?

a) Buy $50 call options.
b) Sell $50 call options.
c) Buy $50 put options.
d) Sell $50 put options.

Answer 60

b) Sell $50 call options.
- 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 61

Whenever there is a cash dividend issued on an underlying stock, the price (or premium) for a call option available on that stock tend to be:

a) Unaffected.
b) Higher.
c) Volatile.
d) Lower.

Answer 61

d) Lower.
- Cash dividends will generally tend to drive the price of the underlying security lower and along with it, the call option prices.

Question 62

Which of the following statements about call options and warrants are true?

I. Call options are created by individuals; warrants are issued by corporations.
II. Call options generally have shorter durations than warrants.
III. When an investor exercises either a call option or a warrant, he or she receives the stock shares from a writer of the option or warrant.
IV. The call option or warrant writer uses this strategy to increase investment income from relatively stable underlying stocks.

a) I and II only.
b) II and III only.
c) II and IV only.
d) I, II and III only.

Answer 62

d) I, II and III only.
- Choice “IV” - An option premium is paid to the writer upon purchase, where as a warrant does not increase company profit until it is exercised.

Question 63

Your client has asked you to assist her in examining possible additions to her bond portfolio. She has expressed a desire to minimize risk at this stage in her planning process, and to assure income beginning at the point of her retirement, and lasting throughout. She has a tentative retirement date in seven years at age 65. She will then have an eighteen year life expectancy. Which of the following is an appropriate addition to her current portfolio?

25-year AAA-rated corporate bonds with a seven-year maturity.
20 year AAA-rated municipal bonds with a seven-year duration.
25-year AAA-rated corporate zeroes with a seven-year duration.
20-year US Treasury zeroes with a seven-year maturity.
25-year AAA-rated corporate bonds with a seven-year duration.

a) I, III and V only.
b) II, III and V only.
c) III and IV only.
d) V only.

Answer 63

d) V only.
- The client is looking for income to begin in 7 years. Therefore anything maturing in 7 years will not provide that income. Zeroes provide no income. She wants something out 25 years, not 20 years. Thus, option “V” is the only appropriate answer.

Question 64

Which of the following is not an appropriate match?

a) Classification by time: Spot markets.
b) Classification by type of claim: Equity markets.
c) Classification by participants: Mortgage markets.
d) Classification by products: Money markets.

Answer 64

d) Classification by products: Money markets.
- 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 65

Bob and Betty have approached you looking for the right hedge against possible, expected future inflation. You suggest to them that they:

Invest in technology stocks.
Invest in commodity futures.
Invest in long-term U.S. Treasury issues.
Invest in precious metals.

Answer 65

Invest in precious metals.
- None of the choices are necessarily stellar, but in contrast to the other choices, Option “D” makes far more sense, as metals have generally performed well as inflation hedges over time.

Question 66

A child is 8 years old and the parents want to invest today for the child’s education. The parents have AGI of $210,000. Which investment vehicle would you recommend?

Series EE savings bonds.
S&P 500 index fund.
Laddered CDs
Money market mutual fund.

Answer 66

S&P 500 index fund.
- The S&P 500 index fund is the best answer because the time horizon is long term (10 years). The parents are currently phased-out of the interest income tax exclusion benefit on the series EE savings bonds. The CDs and money market mutual fund are too conservative.

Question 67

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 67

Municipal Bond Mutual Fund
- 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 68

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 68

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

Question 69

In his search for better ways to invest, your client, John Galt, hears of the barbell bond strategy. He asks you what this investment strategy is, and if you would recommend it for him. You advise John that for the barbell bond strategy to be undertaken correctly, the portfolio must be structured as follows:

Bonds with maturities staggered every few years apart are purchased for inclusion in the portfolio.
Bonds are purchased for the portfolio based on their duration, not on their maturity.
Bonds for the portfolio are purchased with both long and short periods of time to maturity, with little in between.
Bonds purchased for the portfolio are either very high risk, or they are very safe and secure offerings.

Answer 69

Bonds for the portfolio are purchased with both long and short periods of time to maturity, with little in between.
- Barbell bond strategy has to do with long and short maturities in the portfolio . Option “A” is the bond-ladder strategy, and Option “B” describes immunization.

Question 70

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 70

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

Question 71

Gary Garnet is a client. He works for Amalgamated Audio Company and has about 20 years before he retires. He has a wide selection of investment funds in his 401(k) plan. He has approached you with a question about the best way to make money in the stock market for someone in his position putting the money into his 401(k). As his planner, you tell him that:

Most profits are made through proper asset allocation.
Most profits in the market are made through market-timing.
He will do best to stay away from the stock market unless he knows what he is doing.
Concentrated investments are ideal given his age.

Answer 71

Most profits are made through proper asset allocation.
- Although all of the other choices may look good, the truth of the matter is that the majority (91%) of profits realized in the market place, over the long haul, are made from proper asset allocation. Concentrated investments are too risky to recommend for a 401(k) and is not the best answer.

Question 72

An investor may use options on debt instruments to protect against:

Interest rate risk.
Reinvestment rate risk.
Default risk.
Call risk.

Answer 72

Interest rate risk.
- Put options that lock in the price at which the security may be sold may be used to protect an investor from a drop in bond prices caused by rising interest rates.

Question 73

During the peak of the economic cycle, which of the following should one undertake?

Sell debt instruments
Begin allocations to cash positions
Buy debt instruments
Sell gold and real assets
a) I and II only.
b) II and III only.
c) III and IV only.
d) I and IV only.

Answer 73

a) I and II only.
- At the peak of the cycle, as the economy has reached full steam, it is an excellent time to sell not buy fixed (and generally lower return) instruments. It is also an excellent time to begin appropriations to cash in preparation for opportunities that may arise. Since inflation is still on (and rising after the peak), it often proves to be a good time to acquire metals rather than sell them.

Question 74

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 74

Limited general obligation bonds.
- 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 75

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

I. Current market price of each security.
II. Price paid for each security.
III. Number of shares of each security.
IV. Total portfolio value.
V. 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 75

I, III and V only.
- 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 76

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 76

It is a broader base measure of the stock market than the Wilshire 5000 Index.
- 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 77

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 77

Stock prices will decrease because the required rate of return for investors will increase.
- 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 78

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 78

The fourth market.
- 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 79

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.
a) I and III only.
b) I and IV only.
c) II and IV only.
d) IV only.

Answer 79

d) IV only.

- ADRs provide an opportunity for Americans to purchase foreign securities.

Question 80

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 80

The conversion price of the bond
- 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 81

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 30%. The tax on LTCG is 15%. What is his after-tax holding period return?

10. 9%
11. 5%
12. 8%
13. 3%

Answer 81

10. 9%
    - 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 gains tax treatment.

HPR = (SP - PP +/- CF) × (1-TR) / PP

Question 82

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

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

Answer 82

a) The bonds are currently selling at a premium.
- 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 83

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 83

A 4% tax free money market mutual fund.
- 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 84

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 84

Less than 30%.
- 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 85

After examining several funds and calculating the correlation coefficient relative to the client’s existing portfolio, which fund would provide the most diversification benefits?

Fund LMNO: with a correlation coefficient of +0.75.
Fund XYZ: with a correlative coefficient of +0.15.
Fund MYOB: with a correlation coefficient of 0.00.
Fund PDQ: with a correlation coefficient of -0.17.

Answer 85

Fund PDQ: with a correlation coefficient of -0.17
- The most favorable correlation between two securities would always be -1 (negative one). That is they move against each other. Therefore, the most negative choice available here would be the best choice.

Question 86

Modern “asset allocation” is based upon the portfolio theory model developed by Markowitz. Of the following statements, which correctly identify the model?

I. Negatively correlated assets are necessary to reduce the risk of portfolios.
II. In creating a portfolio, diversifying across asset types (e.g., stocks and bonds) is less effective than diversifying within an asset type.
III. The efficient frontier is relatively insensitive to the input variable.
IV. The risk, return and covariance of assets are important input variables in creating portfolios.

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

Answer 86

IV only.
- Option “I” is not correct. Although negative correlation of assets reduces risk, it is not NECESSARY that assets be negatively correlated. As long as assets are not perfectly positively correlated, risk will be reduced. Option “II” is also a false statement, diversifying across asset types is MORE effective. Option “III” is incorrect in that the efficient frontier IS sensitive to input variables.

Question 87

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 87

II and III only.
- 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 88

Which of the following statements is correct with regard to the use of an arbitration clause in an investment advisory agreement?

The SEC and FINRA require arbitration if voluntary negotiation fails.
The SEC requires that such a clause be contained in any investment advisory agreement.
The FINRA requires that such a clause stipulate that arbitration must be conducted by non-industry organizations.
The clause must allow state regulations to take precedence over federal regulation.

Answer 88

The SEC and FINRA require arbitration if voluntary negotiation fails.
- Both SEC and FINRA call for voluntary negotiations first. Barring success with this level of contact both SEC and FINRA require arbitration.

Question 89

Which of the following requires registration under disclosure rules with the Securities and Exchange Commission?

Sale of an entire issue of securities in an IPO.
Sale of securities in a single block to a public pension fund.
Sale of an entire issue of securities to a single investor.
Sale of securities in a single block to a publicly-traded mutual fund.

Answer 89

Sale of an entire issue of securities in an IPO.

- All answers except “A” constitute private placement.

Question 90

The Securities Act of 1933 is best summarized by the following statement:

Requires the registration and provides for regulation of investment advisors.
The Act regulates securities in the secondary markets.
Regulates both initial public offerings and subsequent secondary offerings by a public company.
Established the organized securities exchanges.

Answer 90

Regulates both initial public offerings and subsequent secondary offerings by a public company.
- Option “A” - The Investment Advisors Act of 1940 regulates advisors. Option “B” is incorrect because the Act of 1934 regulates the secondary market. Option “C” - The Act of 1933 regulates both IPOs and secondary offerings. Option “D” - The organized exchanges and previously issued securities are governed by the Securities and Exchange Act of 1934.

Question 91

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 91

11. 88%
    - 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 92

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 92

Value Line Average
- 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 93

An investor who rebalances her portfolio frequently to take advantage of perceived opportunities in other market sectors is using which one of the following types of asset allocation?

Tactical.
Strategic.
Passive.
Hybrid.

Answer 93

Tactical.
- Strategic asset allocation is concerned with allocating the wealth of a client among various asset classes, consistent with the clients’ investment objectives, time horizons and risk preferences. Tactical asset allocation is concerned with shifting wealth between asset classes to take advantage of expected price level changes (timing) arising from broad movements in the business cycle.

Question 94

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?

I. Short-term certificates of deposit have a fixed maturity date and therefore are not appropriate for liquidity purposes.
II. The brokerage account investments are not adequately diversified.
III. The investment in the limited partnership may be subject to unrelated business taxable income and therefore is inappropriate.
IV. 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 94

II, III and IV only.
- 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 95

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 95

Changes in demographic and economic variables.
- 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 96

An investor in improved land (with an office building) is concerned most with which one of the following factors?

Net income of investment.
Reselling the property within three years.
Real estate taxes.
Cash flow expected to be generated by the property.

Answer 96

Cash flow expected to be generated by the property.
- An office building is purchased to rent space; therefore, cash flow is of paramount importance. Net income without the information that leads up to this final figure is not as valuable as cash flow information. Resale, commissions and taxes are secondary concerns if the property is purchased (with an office building) for cash flow.

Question 97

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 97

overconfidence.
- Overconfidence leads to overtrading.

A is incorrect. Anchoring results in buying securities that have fallen in value because it “must” get back up to that recent high.

C is incorrect. Regret avoidance, also known as the disposition effect, causes investors to take action (or inaction) in hopes of minimizing any regret.

D is incorrect. Representativeness is thinking that a good company is a good investment without regard to an analysis of the investment

Question 98

John was the editor of his campus conservative newspaper. He was a member of the National Guard and was on the university’s precision rifle shooting team. He was a vocal supporter of U.S. military actions in Iraq and Afghanistan. You knew John was interested in becoming a financial analyst, but you have lost touch with him after you both graduated from college. Which of the following statements is more likely to be true?

1. John is employed as an analyst with Second National Securities.
2. John is employed as an analyst with Second National Securities and is a member of the National Rifle Association (NRA).

Statement 1
Statement 2
They are equally likely to be true.
The answer can’t be determined with the information provided.

Answer 98

Statement 1
- However likely it is that John works for Second National Securities, the likelihood that he works for Second National and also is a member of the NRA cannot exceed the stand-alone probability of working for Second National. Furthermore, they could only be equally probable if each and every analyst employed by Second National is also a member of the NRA, which is itself an improbable event. Representativeness takes you towards Statement 2 as your mind views it as “completing the story.” However, the hard cold logic of mathematical probability confirms that Statement 1 is indeed more likely to be correct.

Question 99

LeAnn Wallace, CFP®, is discussing with her colleague an article she recently read in a behavioral finance academic journal. She comments that while behavioral finance is quite interesting, it is also confusing. She finds it difficult to separate one behavioral trait from another, and difficult to separate the consequences of the various traits. She starts to diagram the traits and their consequences. Her first two entries read:

Behavioral bias: Consequence:
Hindsight bias Belief that one has predicted an event that, in fact, they did not predict
Cognitive dissonance Minimizing or forgetting past losses
Exaggerating past gains
Which of the following behavioral biases is closest to the two identified in Ms. Wallace’s diagram?

Belief perseverance.
Overconfidence.
Regret avoidance.
Representativeness

Answer 99

Overconfidence.
- Hindsight bias and cognitive dissonance are each a type of overconfidence.

A is incorrect. Belief perseverance is similar to anchoring in that people are unlikely to change their views given new information.

C is incorrect. Regret avoidance, also known as the disposition effect, causes investors to take action (or inaction) in hopes of minimizing any regret.

D is incorrect. Representativeness is thinking that a good company is a good investment without regard to an analysis of the investment.

Question 100

In an after-dinner conversation, your neighbor states that Hot-Flow, Inc. must certainly be a good investment now that the stock has fallen from its recent high of $80 per share. The company currently trades for $65 per share. You ask your neighbor if she has any other information on which to base her buy recommendation. “Not really,” she replies, “but if the stock was $80 per share last month, surely it will return to that level in the near future. After all,” she continues, “how much can things change in just a few months of time?”

Your neighbor’s attitude is best described as:

anchoring.
hindsight bias.
regret avoidance.
representativeness.

Answer 100

anchoring.
- Anchoring results in buying securities that have fallen in value because it “must” get back up to that recent high.

B is incorrect. Hindsight bias is a form of overconfidence related to an investor’s belief that they had predicted an event that, in fact, they did not predict.

C is incorrect. Regret avoidance, also known as the disposition effect, causes investors to take action (or inaction) in hopes of minimizing any regret.

D is incorrect. Representativeness is thinking that a good company is a good investment without regard to an analysis of the investment.

Question 101

Which one of the following is an advantage of equity REITs over mortgage REITs?

Equity REITs can participate in the appreciation of the underlying properties.
Equity REITs participate in the capital gains of the mortgages, whereas mortgage REITs receive only the coupon payments.
Equity REITs retain the right to the potential appreciation of a property, but mortgage REITs retain the right to only the property’s rental income.
Equity REITs have the right to repossess the underlying property if the mortgage REIT fails to make its mortgage payments.

Answer 101

Equity REITs can participate in the appreciation of the underlying properties.
- Option “B” describes mortgage REITs, not equity REITs. Option “C” is incorrect as mortgage REITs have nothing to do with “rental income.” Option “D” is an incorrect statement.

Question 102

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 102

II only.
- 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 103

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 103

Closed-end fund.
- 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 104

Which of the following are advantages of dividend reinvestment plans?

Reinvested dividends currently are tax deferred.
They help firms raise new capital.
They give investors a systematic way to accumulate capital.
Companies build goodwill by offering these plans to shareholders.
I and II only.
II and IV only.
III and IV only.
II, III and IV only.

Answer 104

II, III and IV only.

- All are true with the exception of dividends paid on a mutual fund are taxable, even when reinvested.

Question 105

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 105

The return on equity for Company A can be expected to exceed the return on equity for Company B.
- 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 106

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 106

Bottom-up analysis.
- 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 107

Fundamental analysis includes which of the following?

I. Debt as a percent of total capital.
II. A 39 week moving average of a company's stock prices.
III. Interest rate trends.
IV. Growth rate of the industry of which a company is a part.
I and II only.
I and III only.
II and IV only.
I, III and IV only.

Answer 107

I, III and IV only.
- Choice “II” is a tool used by technicians to predict future prices. All the others choices are part of fundamental analysis.

Question 108

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 108

Price Indicator.
- 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 109

Bottom-up equity managers include:

I. Group rotation managers.
II. Value managers.
III. Market timers.
IV. Technicians.

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

Answer 109

II and IV only.

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

Question 110

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 110

$44.61
- 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 111

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 111

Preferred stock represents the same level of risk as debt to the buyer.
- Preferred stocks are riskier than debt due to the lack of a maturity date on preferred issues.

Question 112

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

Government.
Individual.
Corporate.
Mutual funds.

Answer 112

Corporate.
- The corporate dividend-received deductions are based on ownership. TCJA of 2017 updated the amounts. If a corporation owns 20% or less, the have a DRD of 50%. if 20% or more (and less than 80%) of the corporation paying the dividend is owned by the company receiving the dividends, then up to 65% of the dividend is tax free. If ownership is greater than 80% (affiliated corporations) the DRD is 100%.

Question 113

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 113

If dividends are not paid in a given cycle, they cannot be paid to anyone else until they are paid to preferred shareholders.
- 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 114

A rise in the price of the Japanese Yen in relation to the U.S. Dollar results in:

A devaluation of the Yen.
Excess reserves in the U.S. current account.
A revaluation of the Yen.
A negative balance of payments.

Answer 114

A revaluation of the Yen.
- Were the Yen to fall in value against the dollar, this would constitute a devaluation, but when it costs more dollars to buy a Yen, this is considered an appreciation or revaluation of the Yen.

Question 115

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 115

Selling of dollar-denominated assets by foreign investors.
- 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 116

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 116

Investing either short-term or long-term to take advantage of anticipated interest rate changes.
- 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 117

Which one of the following statements best describes a firm commitment?

The investment banker agrees to purchase the entire issue and resell the securities to the public.
The SEC registration process for an underwriting is NOT as extensive as for an initial public offering.
The investment banker agrees to sell a minimum number of shares before the offering closing date.
The corporation issuing shares bears the risks associated with a failure to market the entire issue.

Answer 117

The investment banker agrees to purchase the entire issue and resell the securities to the public.
- Choice “B” is an incorrect answer. Choice “C” is known as a best effort agreement. Choice “D” is not true. In a firm commitment, the issuing corporation does not bear the risks if an entire issue is not marketed.