Lesson 5.4: Benefits and Risks of Alternative Investments Flashcards
Which of the following investments is least appropriate for a client primarily concerned with liquidity?
A) Municipal bond mutual fund
B) Bank savings account
C) Preferred stock
D) Direct participation program
D) Direct participation program
There is little secondary market liquidity for direct participation programs (DPPs). Compared to the other choices, they are the least appropriate for a client seeking liquidity.
The term digital assets would include all of the following except
A) nonfungible tokens.
B) cryptocurrency.
C) stablecoins.
D) electronic communications such as email.
D) electronic communications such as email.
Although email is a digital form of communication, there is nothing about it that makes it an asset. One cannot invest in someone’s emails. The other three items are included in the definition of a digital asset.
One of your clients is considering allocating about 10% of her portfolio to commodities. Her current portfolio is a mix of stocks, bonds, and broad market index ETFs. Relative to her existing portfolio, you would explain to her that the primary benefit of the commodity investment is most likely:
increased short-term performance.
The returns on commodities exhibit low or even negative correlation with stock and bond returns. This is generally cited as a major advantage to investing in commodities. Commodities do not generate income; there are no dividends or interest paid on them—the investor recognizes a gain or a loss, but no income. In general, allocating a small percentage of the portfolio to commodities should be viewed as a long-term, not short-term, strategy. There is no evidence that trading costs on commodities are lower than on traditional investments. In fact, it seems likely the opposite is true.
If near-term liquidity is the only objective for a client, which of the following pairs of investments represents the most/least liquid?
A) Common stock listed on the New York Stock Exchange/unit in a direct participation program (DPP)
B) 10-year corporate bonds/U.S. T-bills
C) Annuity units of a variable annuity/unit in a direct participation program (DPP)
D) Variable annuity accumulation unit/money market mutual fund shares
A) Common stock listed on the New York Stock Exchange/unit in a direct participation program (DPP)
Stock listed on the NYSE is considered highly liquid, while ownership units in a DPP are generally illiquid. Once a variable annuity’s accumulation units have been exchanged for annuity units (payout time), there is no liquidity. The corporate bonds and T-bills have the order reversed; it is the T-bills with high liquidity and corporate bonds have the lower liquidity. Variable annuity accumulation units are liquid and so are money market mutual fund shares. However, because the fund shares have check-writing privileges, they are the more liquid of the choices, so the order is reversed from what the question seeks.
The Canadian government is looking to create their own digital coin that will allow them to regulate digital assets safely and securely. What is the name of this developing stablecoin?
The key to the answer is that this is an official Canadian government action. A central bank digital currency (CBDC) is a digital currency that is issued and backed by a sovereign government’s central bank. Unlike decentralized cryptocurrencies like bitcoin, CBDCs are centrally controlled and regulated by the central bank, such as the Federal Reserve in the United States, which has the authority to issue, distribute, and regulate the supply of the digital currency.
n discussing a direct participation program with your customer, rank the following items in order of importance from most to least.
I. Tax write-offs
II. Liquidity and marketability
III. Potential for economic gain
III, I, II
The reason why the program’s economic viability is the first priority in the assessment of DPPs is that the IRS considers programs designed solely to generate tax benefits to be abusive tax shelters. This can lead to tax penalties. During an audit, the first thing the IRS agent will examine is if the program has a reasonable expectation of generating a profit. As the IAR recommending the program to your client, you want to do your best due diligence to make sure to limit the potential audit exposure. Assuming this program passes that test, you want to examine the potential tax benefits. Finally, because there is a very limited secondary market for DPPs, liquidity and marketability should be a low priority.
One of your clients calls to tell you that they overheard someone at work talking about investing in NFTs. What do those initials stand for?
One of your clients expresses interest in purchasing a unique piece of art in digital form. More than likely, the client is referring to:
—————————————————————–
An investor looking for liquidity would be least likely to consider:
Nonfungible tokens (NFTs) are digital assets that reside as code on a blockchain. The owner of an NFT buys ownership of that particular bit of alphanumeric code associated with whatever has been tokenized. NFTs can be digital representations of artwork, a video, music, or even a tweet. They are not cryptocurrency but are usually paid for with that currency. Each NFT is unique, a one of a kind, making the tokens nonfungible. That means investors can’t exchange one NFT for another just like it as they can with dollars or publicly traded securities. Artwork is a good example of something produced as an NFT; the digital copy owned by the investor is the only copy.
NFTs are nonfungible tokens and, because they are nonfungible, their liquidity is limited. CEFs (closed-end funds) and ETFs (exchange-traded funds) are highly liquid. Although there are nontraded REITS, for exam purposes, all REITs are considered to be publicly traded unless something in the question indicates otherwise.
With respect to liquidity and potential for diversification, in comparing alternative investments to exchange-traded stocks, the markets for alternative investments are generally:
less liquid and provide more opportunity for diversification.
Alternative investments can provide exposure to unique risks and trading strategies and thus provide good diversification to a stock and bond portfolio. The markets for alternative investments are generally less liquid than most listed stocks.
One reason for including commodities in an investment portfolio is because they have a high correlation to:
the inflation rate.
Commodity prices tend to have a high correlation with the inflation rate. As inflation goes up, the value of the dollar generally falls. The relationship is inverse, a characteristic of negative correlation. As inflation increases, interest rates invariably do the same, leading to a decrease in bond prices. Stock prices have a random correlation to commodities—generally negative.
What is the maximum amount of bitcoin that will ever be in circulation?
21 million coins
The maximum amount of bitcoin that will ever be in circulation is 21 million coins. This is a feature of the bitcoin protocol, which is designed to create a finite supply of the cryptocurrency, which will prevent inflation on BTC.
