Part 4

Question 1

Opening an Account
A. New account agreement
1. Basic customer information

• a. _, of legal _, _
  2. Customer _ program (CIP) - Bank _ Act
• a. From USA _ Act—anti-terrorism
• b. DOB, physical _, and _

3. Financial information and objectives

B. Suitability—applies to all

1. Understanding of customer objectives required
2. Adviser acts in _ capacity

Answer 1

Opening an Account
A. New account agreement
1. Basic customer information

• a. Name, of legal age, employment
  2. Customer identification program (CIP)
• a. From USA Patriot Act—anti-terrorism
• b. DOB, physical address, and TIN

3. Financial information and objectives

B. Suitability—applies to all

1. Understanding of customer objectives required
2. Adviser acts in fiduciary capacity

Question 2

Ownership Categories
C. Different client accounts
1. Individual—one beneficial owner

• a. Includes a sole-proprietorship
  2. Joint—two or more legal persons with control
• a. JTWROS—equal ownership, passes to survivor
• b. Tenants in common (TIC)—can be unequal, passes to estate
  
  • 1) Does not avoid _
• c. Tenancy by the entirety (TBE)
  
  • 1) Limited to spouses
  • 2) _ of spouse needed sale or gift of interest
  • 3) Primarily for real estate
• d. Checks must be made out in the names of all owners
• e. Distribution of money or certificate must be endorsed by all owners—may be sent to one address.
• f. Any owner whose name is on the account has control over the assets (except TBE)

Answer 2

Ownership Categories
C. Different client accounts
1. Individual—one beneficial owner

• a. Includes a sole-proprietorship
  2. Joint—two or more legal persons with control
• a. JTWROS—equal ownership, passes to survivor
• b. Tenants in common (TIC)—can be unequal, passes to estate
  
  • 1) Does not avoid probate
• c. Tenancy by the entirety (TBE)
  
  • 1) Limited to spouses
  • 2) Permission of spouse needed sale or gift of interest
  • 3) Primarily for real estate
• d. Checks must be made out in the names of all owners
• e. Distribution of money or certificate must be endorsed by all owners—may be sent to one address.
• f. Any owner whose name is on the account has control over the assets (except TBE)

Question 3

Non-Community Property Interest

• Income earned by spouses _ to marriage
• Property received as a _ by one spouse
• Property _ by one spouse
• Interest earned on _ assets held by one spouse as a _ owner

Answer 3

Non-Community Property Interest

• Income earned by spouses prior to marriage
• Property received as a gift by one spouse
• Property inherited by one spouse
• Interest earned on separate assets held by one spouse as a sole owner

Question 4

Joint Tenancy with Rights of Survivorship (JTWROS)

• Property can be held by who?
• Control, ownership, and enjoyment shared _ by all joint tenants
• Upon death of each tenant, property immediately passes to _ joint tenants in _ shares.
• Property controlled by terms of the will?
• Subject to probate?
• Gift of property is contribution/consideration?
• Can be disclaimed?

Answer 4

Joint Tenancy with Rights of Survivorship (JTWROS)

• Property can be held by husband and wife, parent and child or children, siblings, and business partners
• Control, ownership, and enjoyment shared equally by all joint tenants
• Upon death of each tenant, property immediately passes to surviving joint tenants in equal shares.
• Property NOT controlled by terms of the will
• NOT subject to probate
• No, gift of property is not contribution/consideration
• Can be disclaimed

Question 5

Tenancy by the Entirety

• Ownership can only be held by _
• Transfer of property can only occur with the _ of both parties
• In most states, property is protected from the claims _ creditors, but NOT protected from the claims of _ creditors
• Can be disclaimed?
• Available in community property states?

What are the 3 ways a TBE can be terminated?

Answer 5

Tenancy by the Entirety

• Ownership can only be held by a husband and wife
• Transfer of property can only occur with the mutual consent of both parties
• In most states, property is protected from the claims of each spouse’s separate creditors, but NOT protected from the claims of both spouse’s joint creditors
• Cannot be disclaimed
• Not available in community prop states, think about why.

TBE can be terminated by:

• Divorce
• Death
• Mutual agreement by both spouses

Question 6

Tenancy in Common

• Two or more owners each own an _ interest in the property
• Any Income is distributed according to each owner’s respective share in the property
• Are owners free to transfer their respective share of the property to other individuals?
• Goes to probate?
• Can be disclaimed?

Answer 6

Tenancy in Common

• Two or more owners each own an undivided interest in the property
• Any Income is distributed according to each owner’s respective share in the property
• Owners are free to transfer their respective share of the property to other individuals
• Ownership stake goes through probate upon death
• Can be disclaimed

Question 7

Business accounts
1. Sole proprietorship

• a. Unlimited _
• b. Suitability of the individual
• c. Simplest business to form and dissolve

2. Partnerships

• a. An _ association of two or more people
• b. Income and losses _
  
  • 1) General partnership
    
    • a) All partners assume full liability
  • 2) Limited partnership
    
    • a) Limited partners have limited liability
• c. Easy to form and easy to dissolve
  
  • 1) Suitability combined/collective objectives of all of the partners

3. Limited liability company (LLC)

• a. Limited liability, taxed like a _. Single member LLC taxed like _.
• b. _ number of members (rather than shareholders)
• c. Easy to form, easy to dissolve
• d. Suitability similar to _

4. S corporations

• a. Limited liability, taxed like a _
• b. Limited to _ shareholders
• c. No _ shareholders (resident alien ok)

5. C corporations

• a. Shareholders’ risk limited to _
• b. Corporation is taxable entity
• c. Best for raising large amounts of _
• d. Suitability of the entity, not the _

Answer 7

Business accounts
1. Sole proprietorship

• a. Unlimited liability
• b. Suitability of the individual
• c. Simplest business to form and dissolve

2. Partnerships

• a. An unincorporated association oftwo or more people
• b. Income and losses flow through
  
  • 1) General partnership
    
    • a) All partners assume full liability
  • 2) Limited partnership
    
    • a) Limited partners have limited liability
• c. Easy to form and easy to dissolve
  
  • 1) Suitability combined/collective objectives of all of the partners

3. Limited liability company (LLC)

• a. Limited liability, taxed like a partnership. Single member LLC taxed like sole proprietorship.
• b. Unlimited number of members (rather than shareholders)
• c. Easy to form, easy to dissolve
• d. Suitability similar to partnerships

4. S corporations

• a. Limited liability, taxed like a partnership (Unit 21)
• b. Limited to 100 shareholders
• c. No non-resident alien shareholders

5. C corporations

• a. Shareholders’ risk limited to investment
• b. Corporation is taxable entity
• c. Best for raising large amounts of capital
• d. Suitability of the entity, not the shareholders

Question 8

Fiduciary Accounts
A. All trusts
1. Trustee follows the terms of the trust

• a. Adhere to Uniform _ Act (UPIA)

B. Living trusts
1. Grantor (_) transfers assets (_/_) to trust while the grantor is alive

• a. Grantor may also be _
  2. May be a simple trust or a complex trust
• a. Simple trust must distribute _ each year
  
  • 1) Income from dividends and interest
  • 2) Rents
  • 3) Realized capital gains not reinvested in the corpus
  • 4) Less: trust _
• b. Simple trust may not distribute _
• Simple trusts may not make _ contributions, but complex trust may do so.
• c. Complex trust may retain _
• d. Complex trust may distribute _

Answer 8

Fiduciary Accounts
A. All trusts
1. Trustee follows the terms of the trust

• a. Adhere to Uniform Prudent Investor Act (UPIA)

B. Living trusts
1. Grantor (settlor) transfers assets (corpus/principle) to trust while the grantor is alive

• a. Grantor may also be trustee
  2. May be a simple trust or a complex trust
• a. Simple trust must distribute DNI each year
  
  • 1) Income from dividends and interest
  • 2) Rents
  • 3) Realized capital gains not reinvested in the corpus
  • 4) Less: trust expenses
• b. Simple trust may not distribute corpus
• Simple trusts may not make charitable contributions, but complex trust may do so.
• c. Complex trust may retain income
• d. Complex trust may distribute corpus

Question 9

Fiduciary Accounts
C. Testamentary trust
1. Settlor retains control over assets until _
2. Trust is irrevocable (can’t change things after death)

• a. Property passes into the trust by way of the _ and must go through the _
• b. Does not reduce grantor’s _ or _ tax liability

3. Trustee is responsible for managing the trust until termination

D. Powers of attorney
1. Limited versus full

• Limited - can _ and _
• Full - can _

2. Durable
   * a. Terminates with _ of principal
3. Living will (health or advance _)
   * a. End of _ medical care

Answer 9

Fiduciary Accounts
C. Testamentary trust
1. Settlor retains control over assets until death
2. Trust is irrevocable (can’t change things after death)

• a. Property passes into the trust by way of the will and must go through the probate court process
• b. Does not reduce grantor’s income or estate tax liability

3. Trustee is responsible for managing the trust until termination

D. Powers of attorney
1. Limited versus full

• Limited - can buy and sell
• Full - can send funds

2. Durable
   * a. Terminates with death of principal
3. Living will (health or advance directive)
   * a. End of life medical care

Question 10

Estate Planning
A. _ (TOD) avoids probate on first to die, but not _ tax. It is used for all except TIC.

• Same as _ and _ Trust

B. Trusts can be revocable or irrevocable.
1. Revocable living trusts (_ trust)

• a. Grantor can be trustee, beneficiary, or _.
• b. Income or corpus can go to grantor(s) or beneficiaries.
• c. Terms of trust may be _; grantor may amend or revoke the trust.
• d. Grantor is responsible for _ on trust income.
• e. Assets remain in grantor’s taxable _.

2. Irrevocable living trust

• a. Grantor cannot be _ and/or _.
• b. Terms of the trust cannot be _
• c. Grantor may avoid income and estate tax. Income is taxed to the beneficiaries if _, otherwise to the _
• d. Irrevocable Life Insurance Trust (ILIT) is a popular example

Answer 10

Estate Planning
A. Transfer on death (TOD) avoids probate on first to die, but not estate tax. It is used for all except TIC.

• Same as POD and Totten Trust

B. Trusts can be revocable or irrevocable.
1. Revocable living trusts (grantor trust)

• a. Grantor can be trustee, beneficiary, or both.
• b. Income or corpus can go to grantor(s) or beneficiaries.
• c. Terms of trust may be altered; grantor may amend or revoke
• the trust.
• d. Grantor is responsible for tax on trust income.
• e. Assets remain in grantor’s taxable estate.

2. Irrevocable living trust

• a. Grantor cannot be trustee and/or beneficiary.
• b. Terms of the trust cannot be altered
• c. Grantor may avoid income and estate tax. Income is taxed to the beneficiaries if distributed, otherwise to the trust
• d. Irrevocable Life Insurance Trust (ILIT) is a popular example

Question 11

Estate Planning
C. Estate account—custodial account directed by an executor(_ exists) or administrator (_ doesn’t exist/_) on behalf of beneficiaries
1. Fiduciary relationship
2. Suitability in accordance with UPIA
3. Tax considerations covered in Unit 21

4. Per stirpes—assets pass to descendants of deceased beneficiary
5. Per capita—assets are divided among surviving beneficiaries only
6. Intestate—If the deceased died intestate (without a will), the personal representative is an _(_appointed), rather than an executor.

Answer 11

Estate Planning
C. Estate account—custodial account directed by an executor(Will exists) or administrator (Will doesn’t exist/intestate) on behalf of beneficiaries
1. Fiduciary relationship
2. Suitability in accordance with UPIA
3. Tax considerations covered in Unit 21

4. Per stirpes—assets pass to descendants of deceased beneficiary
5. Per capita—assets are divided among surviving beneficiaries only
6. Intestate—If the deceased died intestate (without a will), the personal representative is an administrator (state appointed), rather than an executor.

Question 12

Nonfinancial Considerations
A. Nonfinancial considerations

• 1. Attitudes
• 2. Demographics
• 3. Experience
• 4. Values

B. Behavioral finance

1. Behavioral biases can cause investors to make financial decisions that are irrational.
2. Examples:
   a. _ (investors overestimate their ability)
   b. _ (investor fails to react to new evidence as a rational person would)
   c. _ behavior (market drop—panic selling)
   d. _ (maintaining the status quo—typical with inherited position)

Answer 12

Nonfinancial Considerations
A. Nonfinancial considerations

• 1. Attitudes
• 2. Demographics
• 3. Experience
• 4. Values

B. Behavioral finance

1. Behavioral biases can cause investors to make financial decisions that are irrational.
2. Examples:
   a. Overconfidence (investors overestimate their ability)
   b. Conservatism (investor fails to react to new evidence as a rational person would)
   c. Herd behavior (market drop—panic selling)
   d. Anchoring (maintaining the status quo—typical with inherited position)

Question 13

Risk Tolerance
A. Elements of risk tolerance
1. Liquidity requirements
2. Investment time horizon: short or long
3. Current investment holdings
4. Attitude toward volatility

5. Type of client
   * a. Individual/business/trust/institution
6. Client characteristics

• a. Conservative (low risk)
• b. Aggressive (high risk)
• c. Moderate risk

Question 14

Objectives and Constraints
A. Objectives = desired outcomes
1. Preservation of capital
2. Current income
3. Growth of capital
4. Speculation
5. Education
6. Retirement
7. Tax planning

B. Constraints = obstacles in the way

1. Risk tolerance
2. Time horizon
3. Need for liquidity
4. Tax bracket
5. Personal values
6. Health changes

Question 15

Goals and Objectives
A. How to meet financial goals and objectives
1. Preservation of capital

• a. Client cannot afford loss of principal
• b. Appropriate investments include bank insured CDs and money market funds
• c. Client risks loss of _ power

2. Current income

• a. Government, agency, municipal, corporate bonds
• b. Preferred stocks
• c. Common stocks
  
  • 1) Public _
• d. Bond funds
• e. Equity _ funds

3. Capital appreciation

• a. Common stock
• b. Equity mutual funds or ETFs

4. Speculation

• a. Options
• b. High-yield bonds
• c. Commodities

5. Diversification

• a. Asset allocation
  
  • 1) Foreign stock funds
  • 2) _ assets for inflation protection

6. Passive investing

• a. Index funds; ETFs
  
  • 1) Low cost

7. College tuition

• a. _ bonds (STRIPS) maturing when tuition is due
• b. Coverdell ESA, Section 529 plans

8. Retirement planning

• a. Pensions/401(k)
• b. Annuity, IRA, etc.
• c. Social Security
  
  • 1) _ quarters—full coverage
  • 2) Age 70—_% per year more after full retirement age. (FRA 66, wait till 70 -> 4*_%=_% -> total of _% of benefit.
  • 3) Ex-spouse
    
    • a) Married _years
    • b) _now

9. Life insurance

• a. Capital needs analysis
  
  • 1) Calculate life insurance to meet future financial goals
    
    • a) Assets and liabilities
    • b) Future earnings
    • c) Inflation
  • 2) Market _ is not a consideration

10.Tax planning

• a. Tax deferral
• b. Tax-free income

11. Time horizon
    * a. Longer time horizon enables greater risk
12. Disability insurance
    * a. Can be denied for hazardous occupation

Answer 15

Goals and Objectives
A. How to meet financial goals and objectives
1. Preservation of capital

• a. Client cannot afford loss of principal
• b. Appropriate investments include bank insured CDs and money market funds
• c. Client risks loss of purchasing power

2. Current income

• a. Government, agency, municipal, corporate bonds
• b. Preferred stocks
• c. Common stocks
  
  • 1) Public utilities
• d. Bond funds
• e. Equity income funds

3. Capital appreciation

• a. Common stock
• b. Equity mutual funds or ETFs

4. Speculation

• a. Options
• b. High-yield bonds
• c. Commodities

5. Diversification

• a. Asset allocation
  
  • 1) Foreign stock funds
  • 2) Tangible assets for inflation protection

6. Passive investing

• a. Index funds; ETFs
  
  • 1) Low cost

7. College tuition

• a. Zero-coupon bonds (STRIPS) maturing when tuition is due
• b. Coverdell ESA, Section 529 plans

8. Retirement planning

• a. Pensions/401(k)
• b. Annuity, IRA, etc.
• c. Social Security
  
  • 1) 40 quarters—full coverage
  • 2) Age 70—8% per year more after full retirement age. (FRA 66, wait till 70 -> 4*8%=32% -> 132% of benefit.
  • 3) Ex-spouse
    
    • a) Married 10 years
    • b) Unmarried now

9. Life insurance

• a. Capital needs analysis
  
  • 1) Calculate life insurance to meet future financial goals
    
    • a) Assets and liabilities
    • b) Future earnings
    • c) Inflation
  • 2) Market volatility is not a consideration

10.Tax planning

• a. Tax deferral
• b. Tax-free income

11. Time horizon
    * a. Longer time horizon enables greater risk
12. Disability insurance
    * a. Can be denied for hazardous occupation

Question 16

Money market funds

• no-_, _-end investment companies (mutual funds)
• consists of money market instruments having a maximum maturity of 397 days
• The net asset value (NAV) of money market funds is generally _ at $1 per share.
• the price of money market shares does not fluctuate in response to changing interest rates.

Be aware that an investment in a money market fund is not insured or guaranteed by the _ or any other government agency. Although a money market fund seeks to preserve the value of the investment at $1.00 per share, it is possible to lose money by investing in a money market fund.

The interest these funds earn and distribute as dividends is computed daily and credited to customer accounts _. In general, money market mutual funds offer check-writing privileges making for extraordinary liquidity.

Answer 16

Money market funds

• no-load, open-end investment companies (mutual funds)
• consists of money market instruments having a maximum maturity of 397 days
• The net asset value (NAY) of money market funds is generally fixed at $1 per share.
• the price of money market shares does not fluctuate in response to changing interest rates.

Be aware that an investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although a money market fund seeks to preserve the value of the investment at $1.00 per share, it is possible to lose money by investing in a money market fund.

The interest these funds earn and distribute as dividends is computed daily and credited to customer accounts monthly. In general, money market mutual funds offer check-writing privileges making for extraordinary liquidity.

Question 17

Asset Class Allocation
A. Spreading portfolio funds among different asset classes based on IPS
1. Cash and cash equivalents
2. Fixed-income investments
3. Equities

• a. Domestic
• b. Foreign

4. Tangible assets

• a. Real estate
• b. Precious metals

5. Diversification can lower risk and increase returns.

Question 18

Active and Passive
A. Strategic asset allocation—_ term
1. Passive investment strategy
2. Percentages determined based on client

• a. 60% equity/40% debt—very common
• b. 70% debt/30% equity—retiree

3. Periodic _
4. Frequently use index funds or ETFs
5. Lower investor costs

B. Tactical asset allocation—_ term

1. Active management strategy—looking for _
2. Undervalued purchased/overvalued sold
3. Current market conditions
4. Market timing
5. Higher investor costs

• a. Trading costs (commissions)
• b. Capital gains taxes

Answer 18

Active and Passive
A. Strategic asset allocation—long term
1. Passive investment strategy
2. Percentages determined based on client

• a. 60% equity/40% debt—very common
• b. 70% debt/30% equity—retiree

3. Periodic rebalancing
4. Frequently use index funds or ETFs
5. Lower investor costs

B. Tactical asset allocation—short term

1. Active management strategy—looking for alpha
2. Undervalued purchased/overvalued sold
3. Current market conditions
4. Market timing
5. Higher investor costs

• a. Trading costs (commissions)
• b. Capital gains taxes

Question 19

Portfolio Management
A. Buy and hold
1. Can be used with many different styles (results in lower maintenance costs)
2. Lower capital gains taxes

B. Indexing

1. Low transaction costs
2. Lower management fees

C. Growth strategy
1. Earnings grow faster than similar companies/overall market

• a. Generally high P/E ratios
• b. Looking for _ momentum
• c. Low _ payout ratio
• d. Likely to trade at _ end of 52-week trading range

D. Value strategy
1. Undervalued or out-of-favor securities

• a. Generally low P/E ratios
• b. Higher dividend payout ratio
• c. Focus on _ statements
  
  • 1) Hidden value may include “rainy day” fund
• d. Likely to trade at the _ end of 52-week trading range

Answer 19

Portfolio Management
A. Buy and hold
1. Can be used with many different styles (results in lower maintenance costs)
2. Lower capital gains taxes

B. Indexing

1. Low transaction costs
2. Lower management fees

C. Growth strategy
1. Earnings grow faster than similar companies/overall market

• a. Generally high P/E ratios
• b. Looking for earnings momentum
• c. Low dividend payout ratio
• d. Likely to trade at higher end of 52-week trading range

D. Value strategy
1. Undervalued or out-of-favor securities

• a. Generally low P/E ratios
• b. Higher dividend payout ratio
• c. Focus on financial statements
  
  • 1) Hidden value may include “rainy day” fund
• d. Likely to trade at the lower end of 52-week trading range

Question 20

Portfolio Management
E. Contrarian
1. Buys when others are selling; sells when others arebuying

F. Monte Carlo Simulation
1. Runs hundreds or thousands of trials based on varying factors such as:

• a. rates of return on investments;
• b. inflation rates; and
• c. interest rates.

2. Measures probabilities of meeting specific objectives and goals under varying conditions and circumstances

G. Diversification

1. Between asset categories
2. Within the asset category

H. Sector rotating

1. Business cycle
2. Sector fund

Question 21

Micro Cap $_million–$_million N/A
Small Cap >$_million–$_ billion - _
Mid Cap >$_billion–$_billion - _
Large Cap >$_billion - _

Answer 21

Micro Cap $50 million–$300 million N/A
Small Cap >$300 million–$2 billion - Russell 2000
Mid Cap >$2 billion–$10 billion - S&P 400
Large Cap >$10 billion - S&P 500

Question 22

Income Strategies
A. Active strategies
1. Barbells

• a. Short- and long-term bonds
  2. Bullets
• a. All bonds mature _
  3. Ladders
• a. Bonds maturing _
• b. _ over as each matures

Answer 22

Income Strategies
A. Active strategies
1. Barbells

• a. Short- and long-term bonds
  2. Bullets
• a. All bonds mature same date—target
  3. Ladders
• a. Bonds maturing each year
• b. Rolled over as each matures

Question 23

Capital Market Theory
A. Capital market theory components
1. All investors can _ or lend money at the risk-free rate of return.
2. All investors are rational and evaluate investments in terms of expected return and variability (standard deviation).
3. The time horizon is equal for all investors.
4. There are no _ costs or personal income _.

5. There is no _.
6. The markets are efficient.

Modern portfolio theory

• holds that specific risk can be _ away by building portfolios of assets whose returns are not correlated.
• diversification allows investors to reduce the risk in a portfolio while simultaneously _ expected returns.
• all factors being equal, the portfolio with the least amount of _ would do better than one with a greater amount of _.

B. Modern portfolio theory
1. Diversify by using securities with a low or negative correlation, thereby reducing portfolio volatility

C. Efficient frontier
1. The feasible set of portfolios

• a. represents all portfolios that can be constructed from a given set of stocks.
  2. An efficient portfolio is one that offers
• a. the most return for a given amount of risk, or
• b. the least risk for a given amount of return.

3. The collection of efficient portfolios is called the efficient set or efficient frontier.
4. The optimal portfolio is the point where the efficient set (portfolio) and the investor’s risk tolerance meet.

Answer 23

Capital Market Theory
A. Capital market theory components
1. All investors can borrow or lend money at the risk-free rate of return.
2. All investors are rational and evaluate investments in terms of expected return and variability (standard deviation).
3. The time horizon is equal for all investors.
4. There are no transaction costs or personal income taxes.

5. There is no inflation.
6. The markets are efficient.

Modern portfolio theory

• holds that specific risk can be diversified away by building portfolios of assets whose returns are not correlated.
• diversification allows investors to reduce the risk in a portfolio while simultaneously increasing expected returns.
• all factors being equal, the portfolio with the least amount of volatility would do better than one with a greater amount of volatility.

B. Modern portfolio theory
1. Diversify by using securities with a low or negative correlation, thereby reducing portfolio volatility

C. Efficient frontier
1. The feasible set of portfolios

• a. represents all portfolios that can be constructed from a given set of stocks.
  2. An efficient portfolio is one that offers
• a. the most return for a given amount of risk, or
• b. the least risk for a given amount of return.

3. The collection of efficient portfolios is called the efficient set or efficient frontier.
4. The optimal portfolio is the point where the efficient set (portfolio) and the investor’s risk tolerance meet.

Question 24

The ___ becomes the new Efficient Frontier, because of the risk free rate of return.

Point B is the ___ risky portfolio, a portportional percentage of _______ assets.

If the investor is selling risky assets(long term bonds, stocks) he is moving from point ___ towards point ____ and the ____.

He moves from point B to point C by ________.

Answer 24

The CML(capital market line) becomes the new Efficient Frontier, because of the risk free rate of return.

Point B is the optimal risky portfolio, a portportional percentage of all risky assets.

If the investor is selling risky assets(long term bonds, stocks) he is moving from point B towards point A and the risk free return.

He moves from point B to point C by leveraging with margin.

Question 25

The macro aspect of moder portfolio theory (CAPM) is expressed by ______. It uses ______ for risk.

The micro aspect of moder portfolio theory (CAPM) is expressed by ______. It uses ______ for risk.

Answer 25

The macro aspect of moder portfolio theory (CAPM) is expressed by CML (capital market line). It uses standard deviation for risk.

The micro aspect of moder portfolio theory (CAPM) is expressed by SML (Security market line). It uses beta for risk.

Question 26

The SML represents the client’s ___.

What’s the formula for SML?

Which part is the market risk premium?

Which part is the stock risk premium?

Answer 26

The SML represents the client’s required rate of return

r = Rf + ( Rm - Rf) B

( Rm - Rf), it’s the slope of the SML

( Rm - Rf) B

Question 27

If the security markets are in equilibrium, all individual assets should plot along the SML. An asset is considered undervalued if it plots __ the line and overvalued if plots __ the line.

Answer 27

If the security markets are in equilibrium, all individual assets should plot along the SML. An asset is considered undervalued if it plots above the line and overvalued if plots below the line.

Question 28

CAPM
A. Capital Asset Pricing Model (CAPM)
1. Used to determine the required rate of return

• a. Must be compensated for time value
• b. Use risk-free rate

2. Must be compensated for systematic risk
   * a. Compare beta to market return
3. required rate of return= ?
   Example: RF = 4%, MR = 12%, β = .8

Answer 28

CAPM
A. Capital Asset Pricing Model (CAPM)
1. Used to determine the required rate of return

• a. Must be compensated for time value
• b. Use risk-free rate

2. Must be compensated for systematic risk
   * a. Compare beta to market return
3. required rate of return= risk-free rate (RF) plus [market return (MR) minus RF] times beta (β)
   Example: RF = 4%, MR = 12%, β = .8
   4% + (12% – 4%) × .8 = 4% + 6.4% = 10.4% required rate of return

Question 29

What are three types of Efficient Market Hypothesis (EMH)?

Answer 29

Strong Form: Asserts that stock prices fully reflect all information, public and private. Not even access to inside info can be expected to result in superior investment performance over time. Neither fundamental analysis nor technical analysis can produce superior results over time on a risk-adjusted basis.

Semi-Strong Form: Asserts that all publicly known information is reflected in stock prices. Neither technical analysis nor fundamental analysis can produce superior results over time on a risk-adjusted basis. Only an investor with access to inside information may consistently achieve superior results (but such access is illegal)

Weak Form: Suggests that historical price data is already reflected in current stock prices and is of no value in predicting future price changes.

Technical analysis will not produce superior results. Fundamental Analysis may produce superior results.

Question 30

EMH

Weak

• Won’t work:
• Work:

Semi-Strong

• Won’t work:
• Work:

Strong

• Won’t work:
• Work: _ walk

Answer 30

EMH

Weak

• Won’t work: Technical analysis
• Work: Fundamental analysis and insider information

Semi-Strong

• Won’t work: Technical analysis and Fundamental analysis
• Work: insider information

Strong

• Won’t work: Technical analysis, Fundamental analysis, insider information
• Work: Random walk

Question 31

Dollar Cost Averaging

By investing a constant amount of dollars at regular intervals, the investor buys fewer shares when the fund’s price rises and more shares when the share price drops, thereby _ the average cost.

$ Invested Price/Share No. of Shares
$100 $5 20
$100 $4 25
$100 $2 50
$100 $10 10

total $ invested ÷ # of shares = average cost per share

total share prices ÷ # of investment periods = average price per trade

Answer 31

Dollar Cost Averaging

By investing a constant amount of dollars at regular intervals, the investor buys fewer shares when the fund’s price rises and more shares when the share price drops, thereby lowering the average cost.

$ Invested Price/Share No. of Shares
$100 $5 20
$100 $4 25
$100 $2 50
$100 $10 10

total $ invested ÷ # of shares = average cost per share

$400 ÷ 105 = $3.81
total share prices ÷ # of investment periods = average price per trade
21 ÷ 4 = $5.25

Question 32

Hedging With Options

Because trading options (puts and calls) generally involves a _ degree of risk than stocks, bonds, or mutual funds, a _ _ person with knowledge about options must _ the account opening.

A. Hedging: stock position plus option position

1. Always let stock position control
2. Always hedge with opposite market attitude of stock position
3. You “buy” protection (insurance)

B. Long stock

1. Price risk = down (stock price declines)
2. Appropriate option position to hedge

• a. Buy _(most protection)
• b. Write _(limited protection – premium income)

3. Protect against big price decline
4. Enjoy big price increase

C. Short stock

1. Price risk = up
2. Appropriate option position to hedge

• a. Buy _(most protection)

3. Protect against big price increase
4. Enjoy big price decline

Answer 32

Hedging With Options

Because trading options (puts and calls) generally involves a higher degree of risk than stocks, bonds, or mutual funds, a designated supervisory person with knowledge about options must approve the account opening.

A. Hedging: stock position plus option position

1. Always let stock position control
2. Always hedge with opposite market attitude of stock position
3. You “buy” protection (insurance)

B. Long stock

1. Price risk = down (stock price declines)
2. Appropriate option position to hedge

• a. Buy put (most protection)
• b. Write call (limited protection – premium income)

3. Protect against big price decline
4. Enjoy big price increase

C. Short stock

1. Price risk = up
2. Appropriate option position to hedge

• a. Buy call (most protection)

3. Protect against big price increase
4. Enjoy big price decline

Question 33

Individual Income Tax
A. Tax on income—progressive
1. Rate increases as income increases
2. Marginal tax rate
3. Factors

• a. Filing status
  
  • 1) Head of household best for single with children
• b. Citizenship
  
  • 1) Tax treaties
• c. Age
  
  • 1) 65 and over
• d. State of residence
  
  • 1) State income tax

Question 34

What is taxed as income?
1. Earned income

• a. Ordinary income rates
  2. _ income
• a. Ordinary income rates
• b. Can offset passive loss (DPPs)

3. _ income

• a. _ at 15%–20%
• b. Non-_ - ordinary income
• c. _—ordinary income rates
• d. Municipal bonds—interest is tax free on federal; sometimes state as well

4. Retirement plan distributions

Answer 34

What is taxed as income?
1. Earned income

• a. Ordinary income rates
  2. Passive income
• a. Ordinary income rates
• b. Can offset passive loss (DPPs)

3. Portfolio income

• a. Qualifying dividends at 15%–20%
• b. Non-qualifying dividends - ordinary income
• c. Bond interest—ordinary income rates
• d. Municipal bonds—interest is tax free on federal; sometimes state as well

4. Retirement plan distributions

Question 35

Income reinvestment
1. Mutual fund dividend and capital gains distributions

• a. Benefit is compounding effect
  2. Dividend reinvestment plans (DRIPs)
• a. Offered from issuers to shareholders
• b. Discounted price
• c. Reduced or no commissions
• a. Can usually invest additional sums

3. Interest on interest (e.g., savings accounts)
4. Taxation

• a. Taxable in the year paid
• b. Form 1099 required

Question 36

Income and Capital Gain/Loss
A. Income
1. Taxed at ordinary rates
2. Qualifying dividends lower 15% (20%)

B. Capital gains and losses

1. Proceeds minus cost basis
2. Stock splits and stock dividends change cost basis (adjusted and taxed when sold)
3. Short term versus long term

• a. Short term is 12 months or less
  
  • 1) Taxed at ordinary income rates
• b. Long-term is more than 12 months
  
  • 1) Maximum tax of 15% (20%)

4. Deducting net capital losses

• a. Capital losses offset capital gains with no limit
• b. Net capital losses—maximum $3,000 per year deductible against ordinary income
• c. Balance may be carried forward indefinitely

Question 37

30-day wash sale rule

• a. Substantially _ securities—rights, calls, warrants, and convertibles

Sale versus several purchases

• a. _ (IRS default)
• b. Identified
• c. Average cost (_ funds)

Exemption on sale of primary residence

• a. _ of the past five years rule
• b. $500,000 for married
• c. $250,000 for single

Answer 37

30-day wash sale rule

• a. Substantially identical securities—rights, calls, warrants, and convertibles

Sale versus several purchases

• a. FIFO (IRS default)
• b. Identified
• c. Average cost (mutual funds)

Exemption on sale of primary residence

• a. 2 of the past five years rule
• b. $500,000 for married
• c. $250,000 for single

Question 38

AMT Preference Items (prefer you pay these)

AMT Add-Back Items (itemized deductions that must be added back)

Answer 38

• Excess Intangible Drilling Costs (IDC)
• Private Activity Municipal Bond
• Oil and Gas Percentage Depletion - NOT cost depletion
• Depreciation (ACRS/MACRS) but not straight line

Remember: I.P.O.D.

Add Back:

• Incentive Stock Option Bargain Element
• Property and State, City Income Taxes

Question 39

Insurance Taxation
A. Life insurance
1. Death benefit proceeds

• a. Not subject to income tax
• b. Included in estate unless owned by _

B. Social Security

• 1. _% of benefit is taxed, _
• 2. _% of benefit is taxed, _

C. Cost basis of gifted and inherited securities
1. Gifts of securities

• a. Donor’s _ cost basis (_ and _ period) passes to recipient (the donee)
  2. Inherited securities—cost basis to heirs market value on date of death
• Stepped-up basis
• _ if sold after inheritance, even if decedent bought less than 1 year.

D. Trust taxation

1. Trust income reported on Form _
2. Retained income taxed at _ rates (over $12,500 at 37%—2018)

Answer 39

Insurance Taxation
A. Life insurance
1. Death benefit proceeds

• a. Not subject to income tax
• b. Included in estate unless owned by other than insured

B. Social Security

• 1. 50% of benefit is taxed, $25,000(single)–$34,000(joint)
• 2. 85% of benefit is taxed, $32,000(single)–$44,000(joint)

C. Cost basis of gifted and inherited securities
1. Gifts of securities

• a. Donor’s original cost basis (cost and holding period) passes to recipient (the donee)
  2. Inherited securities—cost basis to heirs market value on date of death
• Stepped-up basis
• LTCG if sold after inheritance, even if decedent bought less than 1 year.

D. Trust taxation

1. Trust income reported on Form 1041
2. Retained income taxed at compressed rates (over $12,500 at 37%—2018)

Question 40

Estate tax

1. Gross Estate includes the following:
   a. Cash, securities, real estate
   b. Insurance (if policy owned by the _)
   c. Property in revocable trusts, IRAs, annuities, business interests
   d. All other assets owned by or in which the deceased has an ownership interest
   e. Assets valued as of date of _ or alternative valuation date (_ months later)
2. Subtract deductions from the Grross Estate to get to _
3. Mortgages and other _
4. _
5. Casualty _
6. _ expenses
7. _ expenses
8. Subtract deductions from the _ to get to _ Estate

c. Property passing to _
d. Property passing to _

• 1) If U.S. citizen, spousal deduction is _
  4. Result is taxable estate
• a. Calculate estate tax (progressive rate from 18% to 40%)
• b. Apply uniform credit (equivalent to $11.2 million of assets in 2018)
• c. The estate tax is due _ months after death on IRS Form _

Answer 40

Estate tax

1. Gross Estate includes the following:
   a. Cash, securities, real estate
   b. Insurance (if policy owned by the insured)
   c. Property in revocable trusts, IRAs, annuities, business interests
   d. All other assets owned by or in which the deceased has an ownership interest
   e. Assets valued as of date of death or alternative valuation date (six months later)
2. Subtract deductions from the Grross Estate to get to Adjusted Gross Estate
3. Mortgages and other debts
4. Taxes
5. Casualty losses
6. Funeral expenses
7. Estate administrative expenses
8. Subtract deductions from the Adjusted Gross Estate to get to Taxable Estate

c. Property passing to qualified charities
d. Property passing to a surviving spouse

• 1) If U.S. citizen, spousal deduction is unlimited
  4. Result is taxable estate
• a. Calculate estate tax (progressive rate from 18% to 40%)
• b. Apply uniform credit (equivalent to $11.2 million of assets in 2018)
• c. The estate tax is due nine months after death on IRS Form 706

Question 41

Gift tax
1. Donor liability based on fair market value (FMV)

2. $15,000 exclusion

• a. $30,000 for married couple
• b. Unlimited gift between spouses
• c. Non-citizen spouse limited to $_ per year (2021)
• d. Form _ used to file gift tax returns
• e. Progressive with same rates as estate tax _-_%

Answer 41

Gift tax
1. Donor liability based on fair market value (FMV)

2. $15,000 exclusion

• a. $30,000 for married couple
• b. Unlimited gift between spouses
• c. Non-citizen spouse limited to $159,000 per year (2021)
• d. Form 709 used to file gift tax returns
• e. Progressive with same rates as estate tax 18-40%

Question 42

Business Taxation
A. Business taxation
1. Sole proprietor

• a. Taxed on Schedule _ of Form _
  2. Partnership
• a. Partnership files Form _, _ return
  • 1) Due _
  • 2) Partners receive Schedule _

3. LLC

• a. Single member LLC files like a _
• b. Multiple member files like a partnership. Use schedule _

4. S Corporation

• a. Filed on Form _
• b. Due 15th day of _ month after year-end
• c. Schedule _ to shareholders

5. C Corporations

• a. Filed on Form _
• b. Due 15th day of _ month after year-end, e.g., _ for calendar year reporting corporation
• c. _ to shareholders—corporation pays tax

B. Corporate dividend exclusion rule—_%

Answer 42

Business Taxation
A. Business taxation
1. Sole proprietor

• a. Taxed on Schedule C of Form 1040
  2. Partnership
• a. Partnership files Form 1065 information return
  • 1) Due March 15
  • 2) Partners receive Schedule K-1

3. LLC

• a. Single member LLC files like a sole proprietorship
• b. Multiple member files like a partnership. Use schedule K-1

4. S Corporation

• a. Filed on Form 1120S
• b. Due 15th day of 3rd month after year-end
• c. Schedule K-1 to shareholders

5. C Corporations

• a. Filed on Form 1120
• b. Due 15th day of 4th month after year-end, e.g., April 15 for calendar year reporting corporation
• c. No forms to shareholders—corporation pays tax

B. Corporate dividend exclusion rule—50%

Question 43

Cash and Margin Accounts

Customer can have cash or margin account

A. Cash

1. Payment in full (no borrowing) within specified time
2. _ and _ accounts may only be cash

B. Margin

• A margin account uses leverage. It allows an investor to use some cash and some credit to purchase securities.
• The _ Board regulates the extension of credit in the securities industry.

Answer 43

Cash and Margin Accounts

Customer can have cash or margin account

A. Cash

1. Payment in full (no borrowing) within specified time
2. Retirement and custodial accounts may only be cash

B. Margin

• A margin account uses leverage. It allows an investor to use some cash and some credit to purchase securities.
• The Federal Reserve Board regulates the extension of credit in the securities industry.

Question 44

Cash and Margin Accounts

1. Customer meets initial margin call; broker-dealer lends the balance
2. Considered a leveraged position
3. Greater returns or losses on percentage basis

• a. _ securities—securities are used as collateral for loan
• b. Drop in market value could lead to _ call for more money (House call then SRO requirement)
  
  • SRO - _ (eg, FINRA and NYSE) rather than Fed through Regulation _, establishes minimum levels of equity for margin accounts. Currently at _%
  • _ maintenance - _ limits imposed by the BD, might require 35% or higher. This is first call.

Answer 44

Cash and Margin Accounts

1. Customer meets initial margin call; broker-dealer lends the balance
2. Considered a leveraged position
3. Greater returns or losses on percentage basis

• a. Marginable securities—securities are used as collateral for loan
• b. Drop in market value could lead to maintenance call for more money (House call then SRO requirement)
  
  • SRO - self-regulatory organizations (eg, FINRA and NYSE) rather than Fed through Regulation T, establishes minimum levels of equity for margin accounts. Currently at 25%
  • House maintenance - stricter limits imposed by the BD, might require 35% or higher.

Question 45

Margin account forms

1. _ Agreement - establishes the _/_relationship, disclose the method of computing _ fees.
2. _ Agreement - Gives permission to use client securities as _ for margin loan and pledge securities(re-_) held on margin to a lending institution.
3. _-to-loan Agreement - Only one that is _. Agree to _ your securities out, usually for short sales.

Answer 45

Margin account forms

1. Credit Agreement - establishes the debtor/creditor relationship, disclose the method of computing interest fees.
2. Hypothecation Agreement - Gives permission to use client securities as collateral for margin loan and pledge securities(re-hypothecate) held on margin to a lending institution.
3. Consent-to-loan Agreement - Only one that is optional. Agree to lend your securities out, usually for short sales.

Question 46

Cash and Margin Accounts

_ policy—received promptly _ first margin trade

Risk _ document

• a. Delivered prior to or at account _ (FINRA)

Answer 46

Cash and Margin Accounts

NASAA policy—received promptly after first margin trade

Risk disclosure document

• a. Delivered prior to or at account opening (FINRA)

Question 47

Margin Call: Set by the Federal _ Board under Regulation _. This is the initial deposit required when purchase securities on margin (the broker-dealer lends the balance of the purchase price). For equity securities, the initial margin requirement is _% of the purchase price.

Minimum Maintenance: Set by the _. This is the minimum equity that must be maintained in a margin account. Should the equity fall below the minimum required, a maintenance _ (sometimes called maintenance margin) will go out demanding an immediate deposit of enough equity to bring the account _ the required level. Currently, the minimum maintenance level for long positions is _% and for short positions is _%.

House Maintenance: Set by the_. As a cushion, and to reduce the possible sellout caused by failure to meet a maintenance call, most firms set a minimum equity level _ the SRO minimum. A common house requirement is _%. Falling below triggers a house call.

Answer 47

Margin Call: Set by the Federal Reserve Board under Regulation T. This is the initial deposit required when purchase securities on margin (the broker-dealer lends the balance of the purchase price). For equity securities, the initial margin requirement is 50% of the purchase price.

Minimum Maintenance: Set by the SROs. This is the minimum equity that must be maintained in a margin account. Should the equity fall below the minimum required, a maintenance call (sometimes called maintenance margin) will go out demanding an immediate deposit of enough equity to bring the account above the required level. Currently, the minimum maintenance level for long positions is 25% and for short positions is 30%.

House Maintenance: Set by the individual broker-dealer firm. As a cushion, and to reduce the possible sellout caused by failure to meet a maintenance call, most firms set a minimum equity level above the SRO minimum. A common house requirement is 35%. Falling below triggers a house call.

Question 48

Mixed Margin Account

In a long account, the equity is what you own, minus what you owe. In the case of the short position, it is basically the same, except the terms are different. What you owe in a short position is the cost to buy back the stock you’ve borrowed. What you own is the credit balance representing what you received when you sold the stock in the first place. So, the equity in a short account is the credit balance minus the current market value of the short stock.

• Long account: CMV _ - _ balance = long equity
• Short account: _ balance - CMV _ = short equity

EXAMPLE
A client’s mixed margin account shows the following. Current market value of the long positions is $50,000, while the current market value of the short positions is
$25,000. There is a debit balance of $20,000 and a credit balance of $40,000. What is the combined, or net equity in the account?

Answer 48

Mixed Margin Account

In a long account, the equity is what you own, minus what you owe. In the case of the short position, it is basically the same, except the terms are different. What you owe in a short position is the cost to buy back the stock you’ve borrowed. What you own is the credit balance representing what you received when you sold the stock in the first place. So, the equity in a short account is the credit balance minus the current market value of the short stock.

• Long account: CMV long - debit balance = long equity
• Short account: credit balance - CMV short= short equity

EXAMPLE
A client’s mixed margin account shows the following. Current market value of the long positions is $50,000, while the current market value of the short positions is
$25,000. There is a debit balance of $20,000 and a credit balance of $40,000. What is the combined, or net equity in the account?

Either find the equity in each account, Long: $50,000 - $20,000 = $30,000 and short: $40,000 - $25,000 = $15,000, so the total is $45,000. Or, take the two positive numbers, $50,000 + $40,000, which equal $90,000 and subtract the two negative numbers, $20,000 + $25,000, which equal $45,000 and you get the same $45,000.

Question 49

Margin interest is a tax-_expense. The one exception is interest expense incurred in the purchase of _ securities. Because _ interest income is federally tax exempt, the IRS does not allow taxpayers to deduct the margin interest expenses these.

Investors can deduct interest expenses incurred when borrowing money to purchase other securities to the extent those interest expenses do not exceed their portfolio income, which includes _ income, _ , and all _.

Answer 49

Margin interest is a tax-deductible expense. The one exception is interest expense incurred in the purchase of municipal securities. Because municipal interest income is federally tax exempt, the IRS does not allow taxpayers to deduct the margin interest expenses for municipal securities.

Investors can deduct interest expenses incurred when borrowing money to purchase other securities to the extent those interest expenses do not exceed their portfolio income, which includes interest income, dividends, and all capital gains.

Question 50

Securities Markets
A. Exchanges (listed)
1. _ location
2. _ market

B. Over-the-counter (OTC) unlisted

1. Between _ (not on exchange)
2. _ and _ bonds and unlisted _ stocks and bonds trade in the OTC market.
3. _ market

NYSE

• Securities prices determined through _ bidding
• Regulated by the NYSE
• Traded on the NYSE floor on Wall Street

OTC

• Securities prices determined through _
• Regulated by _
• Traded at _ the country

Answer 50

Securities Markets
A. Exchanges (listed)
1. Physical location
2. Auction market

B. Over-the-counter (OTC) unlisted

1. Between broker-dealers (not on exchange)
2. Government and municipal bonds and unlisted corporate stocks and bonds trade in the OTC market.
3. Negotiated market

NYSE

• Securities prices determined through auction bidding
• Regulated by the NYSE
• Traded on the NYSE floor on Wall Street

OTC

• Securities prices determined through negotiation
• Regulated by FINRA
• Traded at many locations across the country

Question 51

Broker vs. Dealer
A. Roles of the broker-dealer
1. _ makers (dealers)

• a. Broker-dealer with position (_) in security
  1) Maintain bid and ask minimum of _ shares
• a) Firm quote

2) Market makers provide liquidity as available _ parties
3) No compensation from _ to make a market
4) Inside _ (inside market) - Client would sell to the _ bid and buy the _ offer.

Bid Offer Size

MMA 17.50 17.95 5×8
MMB 17.58 17.99 10×10
MMC 17.62 18.01 6×4

5) Charges a _ or _

Brokers

a. Broker-dealer acting in _ capacity
1) Calls market maker (dealer/principal)
2) Purchases/sells at inside market
3) Charges _

Answer 51

Broker vs. Dealer
A. Roles of the broker-dealer
1. Market makers (dealers)

• a. Broker-dealer with position (inventory) in security
  1) Maintain bid and ask minimum of 100 shares
• a) Firm quote

2) Market makers provide liquidity as available contra parties
3) No compensation from issuer to make a market
4) Inside quotes (inside market) - Client would sell to the highest bid and buy the lowest offer.

Bid Offer Size

MMA 17.50 17.95 5×8
MMB 17.58 17.99 10×10
MMC 17.62 18.01 6×4

5) Charges a markup or markdown

Brokers

a. Broker-dealer acting in agency capacity
1) Calls market maker (dealer/principal)
2) Purchases/sells at inside market
3) Charges commission

Question 52

Disclosures on trade _

Broker - Must disclose its _ and the amount of its _ to the client

Dealer - Must disclose its _ to the client, but not necessarily the _ or _ of the markup or markdown

Answer 52

Disclosures on trade confimation

Broker - Must disclose its role and the amount of its commission to the client

Dealer - Must disclose its role to the client, but not necessarily the amount or source of the markup or markdown

Question 53

Trading Costs
A. Dealer (_ capacity)
1. Markup or markdown
2. Thinly traded—_ spread

B. Broker (_ capacity)

1. Commissions
2. Disclosed on confirmation

Answer 53

Trading Costs
A. Dealer (principal capacity)
1. Markup or markdown
2. Thinly traded—wider spread

B. Broker (agency capacity)

1. Commissions
2. Disclosed on confirmation

Question 54

Types of Orders
A. Order ticket
1. Account number
2. Solicited or unsolicited
3. Long or short sale
4. BD and agent identifier
5. No _/_, current _ price, _ rating
6. Type of order

Answer 54

Types of Orders
A. Order ticket
1. Account number
2. Solicited or unsolicited
3. Long or short sale
4. BD and agent identifier
5. No client name/address, current market price, bond rating
6. Type of order

Question 55

Types of orders
Market orders—executed immediately at best available price

• a. Time priority applies

Limit orders are stated prices at which customers are willing to buy or sell
1. Guaranteed price, not fill

• a. Buy limit order
  
  • 1) Entered _ CMV
• b. Sell limit order
  
  • 1) Entered _ CMV
• c. Time priority applies

Types of Orders
Example: Market and limit orders
Market order: Buy (or sell) 1000 shares XYZ @ market
Instruction: Execute at any (best) available price
Sell limit: Sell 1000 shares XYZ @ 35 (cmv = 33)
Instruction: Execute at $35 or better (_)
Buy limit: Buy 1000 shares XYZ @ 30 (cmv = 33)
Instruction: Execute at $30 or better (_)

Answer 55

Types of orders
Market orders—executed immediately at best available price

• a. Time priority applies

Limit orders are stated prices at which customers are willing to buy or sell
1. Guaranteed price, not fill

• a. Buy limit order
  
  • 1) Entered below CMV
• b. Sell limit order
  
  • 1) Entered above CMV
• c. Time priority applies

Types of Orders
Example: Market and limit orders
Market order: Buy (or sell) 1000 shares XYZ @ market
Instruction: Execute at any (best) available price
Sell limit: Sell 1000 shares XYZ @ 35 (cmv = 33)
Instruction: Execute at $35 or better (higher)
Buy limit: Buy 1000 shares XYZ @ 30 (cmv = 33)
Instruction: Execute at $30 or better (lower)

Question 56

Short sales—must be in a short _ account

• a. Selling short is _ strategy
• b. Deliver stock _ from the broker-dealer
• c. Return borrowed stock to close out (cover) position
  
  • 1) Purchase at _ price = profit
  • 2) Purchase _ price = loss (potentially unlimited)

Answer 56

Short sales—must be in a short margin account

• a. Selling short is bearish strategy
• b. Deliver stock borrowed from the broker-dealer
• c. Return borrowed stock to close out (cover) position
  
  • 1) Purchase at lower price = profit
  • 2) Purchase higher price = loss (potentially unlimited)

Question 57

Stop orders (stop loss)

a. Buy stop

• 1) Can protect _ position in _ market
• 2) Investor benefits if stock falls
• 3) Entered _ CMV
• 4) Becomes a market order when triggered - after trigger, buy the next _ order.

Example: Buy stop

• An investor sells 100 ABC short at $33 but does not want to be at risk of losing money if the stock goes up.
• Buy stop: Buy 100 shares ABC @ 35 stop
• Instruction: Triggered at $35 or better (higher)
• Becomes a market order
• Buy stops are always placed above CMV

b. Sell stop

• 1) Can protect _ position in _ market
• 2) Investor benefits if stock rises
• 3) Entered _ CMV
• 4) Becomes a market order when triggered
• 5) Can accelerate a decline in a falling market - Snowballing- Multiple sell stop orders can snowball and accerlerate sell price.

Example: Sell stop

• An investor buys 100 ABC at $33 but does not want to be at risk of losing money if the stock goes down.
• Sell stop: Sell 100 shares ABC @ 30 Stop
• Instruction: Triggered at $30 or better (lower)
• Becomes a market order
• Sell stops are always placed below CMV

Answer 57

Stop orders (stop loss)

a. Buy stop

• 1) Can protect short position in rising market
• 2) Investor benefits if stock falls
• 3) Entered above CMV
• 4) Becomes a market order when triggered - after trigger, buy the next market order.

Example: Buy stop

• An investor sells 100 ABC short at $33 but does not want to be at risk of losing money if the stock goes up.
• Buy stop: Buy 100 shares ABC @ 35 stop
• Instruction: Triggered at $35 or better (higher)
• Becomes a market order
• Buy stops are always placed above CMV

b. Sell stop

• 1) Can protect long position in falling market
• 2) Investor benefits if stock rises
• 3) Entered below CMV
• 4) Becomes a market order when triggered
• 5) Can accelerate a decline in a falling market

Example: Sell stop

• An investor buys 100 ABC at $33 but does not want to be at risk of losing money if the stock goes down.
• Sell stop: Sell 100 shares ABC @ 30 Stop
• Instruction: Triggered at $30 or better (lower)
• Becomes a market order
• Sell stops are always placed below CMV

Question 58

Stop limit orders—become limit orders when triggered
a. Trigger—first trade at or through _ price

• 2 prices, _ price and _ price
  b. Like any other limit order, execution is _

Example: Sell stop limit order
An investor wants to sell the stock if it falls to $25 but wants at least $24

S 100 ABC @ 25 STOP LIMIT 24

Might not _ if skip to _ 24

Answer 58

Stop limit orders—become limit orders when triggered
a. Trigger—first trade at or through stop price

• 2 prices, stop price and limit price
  b. Like any other limit order, execution is not guaranteed

Example: Sell stop limit order
An investor wants to sell the stock if it falls to $25 but wants at least $24

S 100 ABC @ 25 STOP LIMIT 24

Might not execute if skip to below 24

Question 59

Types of Orders
5. Time

• a. Day
  
  • A partial fill means that you have asked your broker to buy or sell stock, but the broker can’t buy or sell as much as you would like, and a portion of the order remains unfulfilled. Every time you trade stocks, you’re charged a full _ even if it’s partially fulfilled. If a day order is partially filled, remainder of the order is _ after the close.
• b. Good until _ (GTC)

6. Block trade—_ shares or more

Answer 59

Types of Orders
5. Time

• a. Day
  
  • A partial fill means that you have asked your broker to buy or sell stock, but the broker can’t buy or sell as much as you would like, and a portion of the order remains unfulfilled. Every time you trade stocks, you’re charged a full commission even if it’s partially fulfilled. If a day order is partially filled, remainder of the order is cancelled after the close.
• b. Good until canceled (GTC)

6. Block trade—10,000 shares or more

Question 60

SL o BS

———————– CMV

BL i SS

Answer 60

With sell limits above the line, this tells you they execute when the market price is at or above the limit price. With buy limits below the line, they execute when the market price is at or below the limit price.

Stop orders don’t execute immediately, but they trigger at specific market prices. Utilizing the SLOBS/BLISS visual, sell stops trigger when the market price is at or below the stop price. Buy stops trigger when the market price is at or above the stop price.

Question 61

High Frequency Trading
A. Proprietary trading using high _ systems to monitor and submit _ number of orders to the markets
1. Use algorithms to maximize speed.
2. Computers take advantage of minute discrepancies in price.

B. Benefits of HFT

1. Increased _, especially very active stocks
2. Arbitrage increases market _
3. Lower _ for institutional purchasers

C. Negatives of HFT

1. Phony trades can lead to market _.
2. It’s unfair to _ who don’t have such quick access to information.
3. “_” effect (Aug 24, 2015—DJI drops over 1,000 points in minutes)

Answer 61

High Frequency Trading
A. Proprietary trading using high speed systems to monitor and submit large number of orders to the markets
1. Use algorithms to maximize speed.
2. Computers take advantage of minute discrepancies in price.

B. Benefits of HFT

1. Increased liquidity, especially very active stocks
2. Arbitrage increases market efficiency
3. Lower costs for institutional purchasers

C. Negatives of HFT

1. Phony trades can lead to market manipulation.
2. It’s unfair to small investors who don’t have such quick access to information.
3. “Snowballing” effect (Aug 24, 2015—DJI drops over 1,000 points in minutes)

Question 62

Dark Pools
D. Known as dark pools of _
1. Used by _ traders
2. Execute large block trades without impact to public _ or _
3. Fund managers use to keep from _
4. Market transparency “darkened”

5. _ away from exchang markets

Answer 62

Dark Pools
D. Known as dark pools of liquidity
1. Used by institutional traders
2. Execute large block trades without impact to public quotes or prices
3. Fund managers use to keep from revealing strategies
4. Market transparency “darkened”

5. Trading desks away from exchang markets

Question 63

Compare Yields
A. Nominal yield (coupon rate )
1. Fixed rate stated on the face of the bond

B. Current yield (CY)
1. Annual coupon interest (debt) ÷ by CMV

• a. _ than coupon rate if CMV is below par (discount)
• b. _ than coupon rate if CMV is above par (premium)

2. Annual dividend (equity) divided by CMV

C. Yield to maturity (YTM)
1. Annual interest adjusted by annual gain/loss ÷ by average of CMV and face

• a. Generally the highest yield when bond at a discount

D. Yield to call (YTC)
1. Annual interest adjusted by annual gain/loss to call ÷ by average of CMV and call price

• a. Generally the lowest yield when bond at a premium

Answer 63

Compare Yields
A. Nominal yield (coupon rate )
1. Fixed rate stated on the face of the bond

B. Current yield (CY)
1. Annual coupon interest (debt) ÷ by CMV

• a. Higher than coupon rate if CMV is below par (discount)
• b. Lower than coupon rate if CMV is above par (premium)

2. Annual dividend (equity) divided by CMV

C. Yield to maturity (YTM)
1. Annual interest adjusted by annual gain/loss ÷ by average of CMV and face

• a. Generally the highest yield when bond at a discount

D. Yield to call (YTC)
1. Annual interest adjusted by annual gain/loss to call ÷ by average of CMV and call price

• a. Generally the lowest yield when bond at a premium

Question 64

Return Measurements
A. Total Return = Income ± Gains/Losses
Total Return ÷ Investment = Total Return %

• I bought my stock at $50 and sold it for $59 after holding it for one
  year. I received a $.25 quarterly dividend. What is my total return?

B. Holding period return = Total return as calculated, regardless of the holding period

• I bought my stock at $50 and sold it for $59 after holding it for two years. I received a $.25 quarterly dividend. What is my holding period return?

C. Annualized return = (1 year or 12 months ÷ Holding Period) × Holding Period Return

• I have held my stock for three months. I purchased it for $20 and sold it for $21. What is my annualized return?

D. After-tax return/yield = Pre-tax return × (1.00- marginal tax rate); or Pre-tax return – marginal tax rate

• I know I am receiving a 10% taxable return on my investment. I am in the 30% tax bracket. What is my after-tax rate of return?

E. Inflation-adjusted return = Unadjusted rate of return – inflation rate (CPI)

• I know I have received an 8% rate of return this year, but if inflation for the year is 3%, shouldn’t I take that into consideration to determine what my real rate of return is?

F. Probable return

• You keep telling me that my chances of receiving certain returns are 20%, 30%, and 50%. I just want to know what I should legitimately expect to receive as a return on the investment.
• 20% chance of 10%
  30% chance of 2%
  50% chance of 6%

Answer 64

Return Measurements
A. Total Return = Income ± Gains/Losses
Total Return ÷ Investment = Total Return %

• I bought my stock at $50 and sold it for $59 after holding it for one
  year. I received a $.25 quarterly dividend. What is my total return?
• 9+1 =10, 10/50=20%

B. Holding period return = Total return as calculated, regardless of the holding period

• I bought my stock at $50 and sold it for $59 after holding it for two years. I received a $.25 quarterly dividend. What is my holding period return?
• 9+2=11, 11/50 over 2 years, 22% over 2 years

C. Annualized return = (1 year or 12 months ÷ Holding Period) × Holding Period Return

• I have held my stock for three months. I purchased it for $20 and sold it for $21. What is my annualized return?
• 1/20=5% *4 = 20%

D. After-tax return/yield = Pre-tax return × (1.00- marginal tax rate); or Pre-tax return – marginal tax rate

• I know I am receiving a 10% taxable return on my investment. I am in the 30% tax bracket. What is my after-tax rate of return?
• 10-3 = 7%

E. Inflation-adjusted return = Unadjusted rate of return – inflation rate (CPI)

• I know I have received an 8% rate of return this year, but if inflation for the year is 3%, shouldn’t I take that into consideration to determine what my real rate of return is?
• 8-3= 5%

F. Probable return

• You keep telling me that my chances of receiving certain returns are 20%, 30%, and 50%. I just want to know what I should legitimately expect to receive as a return on the investment.
• 2+0.6+3 = 5.6%

20% chance of 10% 20 × 10%
30% chance of 2% 30 × 2%
50% chance of 6% 50 × 6%

Question 65

Return Measurements
Sharpe ratio—measures _ _ return

• 1. Measures amount of return per unit of risk taken
• 2. Formula?
• 3. _ Sharpe ratio is better.

H. Time-weighted returns

• 1. Used to evaluate the performance of _
• 2. Does not reflect cash in or out of the account

I. Dollar-weighted returns

• 1. Used to evaluate the _
• 2. Reflects that investor’s cash flow in and out of account

J. Current Return and Yield to Maturity

Answer 65

Return Measurements
Sharpe ratio—measures risk adjusted return

• 1. Measures amount of return per unit of risk taken
• 2. (Actual return minus RF rate) ÷ standard deviation
• 3. Higher Sharpe ratio is better.

H. Time-weighted returns

• 1. Used to evaluate the performance of portfolio managers
• 2. Does not reflect cash in or out of the account

I. Dollar-weighted returns

• 1. Used to evaluate the individual’s account performance
• 2. Reflects that investor’s cash flow in and out of account

J. Current Return and Yield to Maturity

Question 66

Benchmark Portfolios
A. Dow Jones _ Average (DJIA)
1. 30 large-cap stocks
2. _ weighted

Dow Jones _ Average

• based on the prices of only _ stocks (30 industrial, _transportation, and _ utility)

B. Standard and Poor’s 500 (S&P 500)

1. 500 large-cap stocks
2. Market value (_) weighted
3. Standard benchmark for large-cap equity

C. NYSE Composite Index (NYSE Composite)

1. All NYSE-listed stocks
2. Market value (_) weighted

Nasdaq

• 3000 _ companies
• _ weighted

D. Standard and Poor’s 400

1. 400 _ stocks
2. Market value (_) weighted
3. Standard benchmark for mid-cap equity

E. Russell 2000® Index

1. 2,000 _ stocks
2. Market value (_) weighted
3. Standard benchmark for small-cap equity

F. EAFE

1. Europe, _, and _
2. Market value (_) weighted
3. Standard benchmark for foreign equity

G. Wilshire 5000

1. Broadest indicator of _ equities market
2. Approximately _ securities

3.Market value (_) weighted

Answer 66

Benchmark Portfolios
A. Dow Jones Industrial Average (DJIA)
1. 30 large-cap stocks
2. Price weighted

Dow Jones Composite Average

• based on the prices of only 65 stocks (30 industrial, 20 transportation, and 15 utility)

B. Standard and Poor’s 500 (S&P 500)

1. 500 large-cap stocks
2. Market value (cap) weighted
3. Standard benchmark for large-cap equity

C. NYSE Composite Index (NYSE Composite)

1. All NYSE-listed stocks
2. Market value (cap) weighted

Nasdaq

• 3000 OTC companies
• cap weighted

D. Standard and Poor’s 400

1. 400 Mid-cap stocks
2. Market value (cap) weighted
3. Standard benchmark for mid-cap equity

E. Russell 2000® Index

1. 2,000 small-cap stocks
2. Market value (cap) weighted
3. Standard benchmark for small-cap equity

F. EAFE

1. Europe, Australasia, and Far East
2. Market value (cap) weighted
3. Standard benchmark for foreign equity

G. Wilshire 5000

1. Broadest indicator of U.S. equities market
2. Approximately 3,500 securities
3. Market value (cap) weighted

Question 67

IRAs
A. Traditional IRAs
1. Contribution limit

• a. 100% of _ income up to an allowable amount (plus catch-up for individuals age _ and older)

2. _ IRA: Additional contribution with same limits may be made for spouse with little or no earned income
3. Contributions may or may not be deductible

• a. Covered by employer-sponsored plan
  
  • 1) Above certain income limits

4. Contribution deadline is _ of the year _ the contribution year
   * Can continue to contriubte until?
5. Earnings grow tax deferred
6. Tax penalties

• a. Excess contribution = _%
• b. Premature distributions: before age 59½ = _% of taxable amount, with the following exceptions: 3D IRS MEAL at Home when 59 1/2
• c. Insufficient distribution = _%: Distribution must begin _
  of the year after turning age _

Answer 67

IRAs
A. Traditional IRAs
1. Contribution limit

• a. 100% of earned income up to an allowable amount (plus catch-up for individuals age 50 and older)

2. Spousal IRA: Additional contribution with same limits may be made for spouse with little or no earned income
3. Contributions may or may not be deductible

• a. Covered by employer-sponsored plan
  
  • 1) Above certain income limits

4. Contribution deadline is April 15 of the year following the contribution year
   * Can continue to contriubte at any age
5. Earnings grow tax deferred
6. Tax penalties

• a. Excess contribution = 6%
• b. Premature distributions: before age 59½ = 10% of taxable amount, with the following exceptions: 3D IRS MEAL at Home when 59 1/2
• c. Insufficient distribution = 50%: Distribution must begin April 1
  of the year after turning age 70 1/2 or 72(didn’t turn 70 1/2 until 2020)

Question 68

IRA Qualified Distributions

There will be no _ penalty, but still have to _.

Answer 68

There will be no 10% penalty, but still have to pay taxes.

IRA Qualified Distributions

3D IRS MEAL at Home when 59 1/2

Death

Disability

Divorce/marital separation (Not QDRO, only a divorce decree)

Insurance for health care when unemployed

Reservist/active duty

Sequentially equally periodic payment (SEPP or Section 72(t))

Medical expenses over 7.5% AGI

Education expenses for higher education

Annuitized distributions

Levy by IRS

Home - qualified first-time homeowner expenses up to $10K lifetime maximum

591/2 - Distributions after 591/2

Highlighted Home, Education, Insurance are not available for Employer Qualified Retirement Plans like 401k.

But ER Qualified retirement plans have 3 that IRA doesn’t have:

QDRO payments

55 and separation from employment

Public safety employees separation from service after age 50

SECURE ACT also added each birth/adoption can get $5k distribution for IRA and QP plans.

Question 69

IRAs

Ineligible Investment Practices

1. _ of stock
2. Speculative _ strategies
3. _ account trading

Nonallowable investments

1. _
2. _

Inappropriate
1. _ bonds

Allowed

• _
• U.S. _ (American _) are allowed
• Investment _ is allowed (business purpose)
  
  • 1) Neither contributor nor _ family may derive immediate benefit (spouse, parents, _(also leagally _), or grandchildren), but _are ok.

Answer 69

IRAs

Ineligible Investment Practices

1. Short sales of stock
2. Speculative option strategies
3. Margin account trading

Nonallowable investments

1. Collectibles
2. Insurance

Inappropriate
1. Municipal bonds

Allowed

• Annuity
• U.S. gold and silver coins (American Eagles) are allowed
• Investment real estate is allowed (business purpose)
  
  • 1) Neither contributor nor lineal family may derive immediate benefit (spouse, parents, children(also leagally adopted), or grandchildren), but siblings are ok.

Question 70

IRAs
Rollover
1. Rollover of 100% of the amount distributed must occur within _ days of the distribution or the remainder will be taxed

• _ per year, among all of your IRAs
  2. Trustee to trustee transfer—no tax

Direct Rollover
1. Plan to plan, or plan to IRA—no tax

Taxation upon distribution

1. Ordinary income
2. _ if some contributions were after tax

Answer 70

IRAs
Rollover
1. Rollover of 100% of the amount distributed must occur within 60 days of the distribution or the remainder will be taxed

• Once per year, among all of your IRAs
  2. Trustee to trustee transfer—no tax

Direct Rollover
1. Plan to plan, or plan to IRA—no tax

Taxation upon distribution

1. Ordinary income
2. Proportionate if some contributions were after tax

Question 71

Roth IRA
1. Same contribution limits as a traditional IRA

• a. May have both—limit is not _

2. Contributions not allowed for those exceeding earnings limits
3. Contributions never tax deductible
4. Earnings may be withdrawn tax-free if a qualified distribution account:

• a. has been established for _ years; and
• b. one of the following applies:
  
  • 1) Age _
  • 2) _or _
  • 3)_

5. RMD?
6. Contributions after 72?
7. Minor may be named as a beneficiary

Answer 71

Roth IRA
1. Same contribution limits as a traditional IRA

• a. May have both—limit is not doubled

2. Contributions not allowed for those exceeding earnings limits
3. Contributions never tax deductible
4. Earnings may be withdrawn tax-free if a qualified distribution account:

• a. has been established for five years; and
• b. one of the following applies:
  
  • 1) Age 59½
  • 2) Death or disability
  • 3) First-time home purchase

5. No required minimum distributions at age 70½
6. Contributions may be made after age 70½
7. Minor may be named as a beneficiary

Question 72

Roth IRA

Ordering Rules for Distribution

Answer 72

• Any contributions (not conversions) are withdrawn first
• Conversions are withdrawn second
• Earnings are withdrawn last

Question 73

IRA Keys

(SIMPLE, SEP, SARSEP)

• Loans?
• Life Insurance?
• Annuity?
• Collectibles?
• Vesting?
• Protected from creditors?
• What’s the deadline for contribution for traditional and Roth IRA?

Answer 73

• No Loans
• No Life Insurance
• Annuity is allowed
• No Collectibles
• Immediate Vesting
• May not be creditor protected (state specific)
• 59½ not 55 for no 10% penalty
• Must take RMDs at 72 (even if not 5% owner)

Deadline for contribution for traditional and Roth IRA is 4/15 for the previous year.

Question 74

IRA and Roth IRA excess contribution penalty?

Qualified plan excess contribution penalty?

Answer 74

IRA and Roth IRA - 6% on the excess amt

Qualified plan - 10% on the excess amt

Question 75

SEP IRA

• _ and _ businesses
• _ contribute to the plans
• Eligibility: _years old, worked _ or last _ years, $650 earned in 2021
• Up to _% of compensation or a maximum of $_

Answer 75

SEP IRA

• Self employed and small businesses
• Employer contribute to the plans
• Eligibility 21 years old, worked 3 or last 5 years, $650 earned in 2021
• Up to 25% of compensation or a maximum of $58,000

Question 76

Qualified Employer Plans
A. Keogh (HR-10)—_ employed, _. Contribution limit $_

B. 403(b) plans _, _ (TDA)

1. Available for employees of 403(b) organizations (i.e., public schools) and 501(c)(3) organizations (i.e., qualified nonprofits such as churches and hospitals)
2. Funded through pretax salary reductions
3. Employer may make contributions

C. Defined benefit plan (traditional pension plan)
1. Provides defined benefit at retirement based on the following:

• a. Age
• b. Years of service
• c. Earnings

2. Sponsor (_) bears investment risk

D. Defined contribution plans
1. _ pension plan

• a. Annual employer contribution is _
• b. Employee bears investment risk

2. Profit-sharing plan—employer contribution may be decreased or _ on the basis of corporate _
3. 401(k) plan

• a. Reduces income tax for employees who contribute, but not _ (EE paid) and _(ER paid)
• b. Top-heavy testing for _ employees (not _ employees)
• c. Safe harbor plan avoids testing if contributing with immediate vesting, whether non-elective or matching
• d. Distribution may be rolled over into traditional IRA or into a Roth IRA
• e. Self-employed may use _ 401(k) to maximize contributions
• f. Participants may borrow
  
  • 1) Pay back with interest through payroll deduction

E. 457 plan

1. State, city, county employees
2. Certain non-profits (not _)
3. Can’t rollover, but no _ penalty
4. Can max contribution plus max to 403(b) or 401(k)

Answer 76

Qualified Employer Plans
A. Keogh (HR-10)—self employed, nonincorporated. Contribution limit $58,000

B. 403(b) plans [tax sheltered annuities Tax Sheltered Annuity (TSAs)] tax-deferred annuity (TDA)

1. Available for employees of 403(b) organizations (i.e., public schools) and 501(c)(3) organizations (i.e., qualified nonprofits such as churches and hospitals)
2. Funded through pretax salary reductions
3. Employer may make contributions

C. Defined benefit plan (traditional pension plan)
1. Provides defined benefit at retirement based on the following:

• a. Age
• b. Years of service
• c. Earnings

2. Sponsor (employer) bears investment risk

D. Defined contribution plans
1. Money purchase pension plan

• a. Annual employer contribution is fixed
• b. Employee bears investment risk

2. Profit-sharing plan—employer contribution may be decreased or skipped on the basis of corporate profits
3. 401(k) plan

• a. Reduces income tax for employees who contribute, but not FICA and FUTA
• b. Top-heavy testing for key employees (not highly compensated employees)
• c. Safe harbor plan avoids testing if contributing with immediate vesting, whether non-elective or matching
• d. Distribution may be rolled over into traditional IRA or into a Roth IRA
• e. Self-employed may use solo 401(k) to maximize contributions
• f. Participants may borrow
  
  • 1) Pay back with interest through payroll deduction

E. 457 plan

1. State, city, county employees
2. Certain non-profits (not churches)
3. Can’t rollover, but no 10% penalty
4. Can max contribution plus max to 403(b) or 401(k)

Question 77

Qualified/Nonqualified Plans
A. Individual—annuities
B. Business
1. Payroll deduction
2. Deferred compensation

nonqualified deferred compensation (NQDC) plan is a contractual agreement between a firm and an employee in which the employee agrees to defer receipt of current compensation in favor of a payout at retirement.

• a. Retain _ employees
• b. May _
• There are no current _
• no _ approval necessary

3. SERPs- A supplemental executive retirement plan (SERP) provides benefits to executives over and above the benefits available from a qualified plan and is funded entirely with employer funds. The plan can be either completely unfunded (like an excess benefit plan) or _ funded. The plan rewards an executive’s continued employment or encourages the early retirement of the executive. A SERP also may be established to protect the executive from involuntary termination if the company changes ownership by awarding her increased benefits from the plan. Often funded by _ value.

Unfunded is the same as __ funded. __ funded assets are __ from the ER’s general accounts, but still subject to company’s __.

In a Rabbi Trust (Nonqualified Deferred Compensation), the participant has the same rights as?

A. A secured creditor. B. An unsecured creditor. C. Any other employee. D. Any other officer of the company.

Answer 77

Qualified/Nonqualified Plans
A. Individual—annuities
B. Business
1. Payroll deduction
2. Deferred compensation

nonqualified deferred compensation (NQDC) plan is a contractual agreement between a firm and an employee in which the employee agrees to defer receipt of current compensation in favor of a payout at retirement.

• a. Retain key employees
• b. May discriminate
• There are no current tax deductions
• no IRS approval necessary

3. SERPs- A supplemental executive retirement plan (SERP) provides benefits to executives over and above the benefits available from a qualified plan and is funded entirely with employer funds. The plan can be either completely unfunded (like an excess benefit plan) or informally funded. The plan rewards an executive’s continued employment or encourages the early retirement of the executive. A SERP also may be established to protect the executive from involuntary termination if the company changes ownership by awarding her increased benefits from the plan. Often funded by life insurance cash value.

Unfunded is the same as informal funded. Informally funded assets are separate from the ER’s general accounts, but still subject to company’s creditors.

Answer: B The participant must not have greater rights than unsecured creditors.

Question 78

Tax on Plan Distributions
A. Excess over cost basis taxed as ordinary income
1. 401(k) loans

• a. Non-taxable distribution
• b. Limited to _% of vested amount or _, whichever is _
• c. Paid back in _ months via payroll deduction
  
  • 1) _ exception

B. RMDs

1. _ following 72
2. Not required if still _

NUA

ER stock portion of 401k

• basis is taxed as OI
• Gain is LTCG
• After triggering event, hold the stocks for 1 year, then the gain from event to sell date is also LTCG

Answer 78

Tax on Plan Distributions
A. Excess over cost basis taxed as ordinary income
1. 401(k) loans

• a. Non-taxable distribution
• b. Limited to 50% of vested amount or 50k, whichever is smaller
• c. Paid back in 60 months via payroll deduction
  
  • 1) Home mortgage exception

B. RMDs

1. April 1 following 72
2. Not required if still employed

Question 79

401k Early withdrawal

Answer 79

IRA Qualified Distributions

3D IRS MEAL at Home when 591/2

Death

Disability

Divorce/marital separation (Not QDRO, only a divorce decree)

Insurance for health care when unemployed

Reservist/active duty

Sequentially equally periodic payment (SEPP or Section 72(t))

Medical expenses over 7.5% AGI

Education expenses for higher education

Annuitized distributions

Levy by IRS

Home - qualified first-time homeowner expenses up to $10K lifetime maximum

591/2 - Distributions after 591/2

Highlighted Home, Education, Insurance are not available for Employer Qualified Retirement Plans like 401k.

But ER Qualified retirement plans have 3 that IRA doesn’t have:

QDRO payments

55 and separation from employment

Public safety employees separation from service after age 50

SECURE ACT also added each birth/adoption can get $5k distribution for IRA and QP plans.

Question 80

ERISA
A. Eligibility
B. Funding
C. Reporting

• 1. Distributions on 1099R

D. Beneficiary

E. Fiduciary responsibility—comply with UPIA

• 1. No self-dealing
• 2. No acting with parties with adverse interests
• 3. No compensation on personal transactions
• 4. Act with skill and caution

F. Party in interest

• 1. Any fiduciary of the plan
• 2. The employer
• 3. An employee organization whose members are covered by the plan (unions)
• 4. Service providers (e.g., legal, accounting, trustee/custodial, recordkeeping)
• 5. A “control” person of any of the above
• 6. Lineal descendent of above (besides #3)

Question 81

ERISA
G. Investment policy statement—Section 404(A)
1. Recommended, not _, plan document detailing acceptable investments and investment strategies

• a. Investment objectives and policies
• b. Investment selection criteria (but not actual investments)
• c. Monitoring procedures and performance
• d. Determination for meeting future cash flow needs

2. Not the same as the DOL’s _ Description (SPD)
   * SPD - Under regulations of the U.S. Department of Labor (DOL), the plan administrator is legally obligated to provide to participants, free of charge, the SPD. The SPD is an important document that tells participants what the plan provides and how it _. It provides information on when an employee can _ to participate in the plan, how service and benefits are calculated, when benefits become _, when and in what form benefits are paid, and how to file a _ for benefits. Unlike the investment policy statement, it does not deal with the _ characteristics of the plan.

The investment policy statement (IPS), although not required under Department of Labor (DOL) rules, is generally found in corporate _ plans, such as the defined _ or defined _ plan. Because the investor manages the IRA, there is no need to prepare an _ for participants to review.

H. Safe harbor provisions (liability of the trustee)— Section 404(C)

• If all 3, then trustee avoids _ liability.
  1. _ selection
• a. At least _ investment alternatives. _ different asset classes, such as equity, debt, and cash equivalent. All _ or all _ won’t qualify.
  2. _ control
• a. Employees choose their own investments
• allow plan participants to change their investment options no less frequently than _

3. Communication

• a. Information available upon _
  
  • 1) _ and _ statements
  • 2) _ and _ characteristics of investments

Answer 81

ERISA
G. Investment policy statement—Section 404(A)
1. Recommended, not required, plan document detailing acceptable investments and investment strategies

• a. Investment objectives and policies
• b. Investment selection criteria (but not actual investments)
• c. Monitoring procedures and performance
• d. Determination for meeting future cash flow needs

2. Not the same as the DOL’s Summary Plan Description (SPD)

• SPD - Under regulations of the U.S. Department of Labor (DOL), the plan administrator is legally obligated to provide
  to participants, free of charge, the SPD. The SPD is an important document that tells participants what the plan provides and how it operates. It provides information on when an employee can begin to participate in the plan, how service and benefits are calculated, when benefits become vested, when and in what form benefits are paid, and how to file a claim for benefits. Unlike the investment policy statement, it does not deal with the investment characteristics of the plan.

The investment policy statement (IPS), although not required under Department of Labor (DOL) rules, is generally found in corporate qualified plans, such as the defined benefit or defined contribution plan. Because the investor manages the IRA, there is no need to prepare an IPS for participants to review.

H. Safe harbor provisions (liability of the trustee)— Section 404(C)

• If all 3, then trustee avoids performance liability.
  1. Investment selection
• a. At least three investment alternatives. 3 different asset classes, such as equity, debt, and cash equivalent. All equities or all debt won’t qualify.
  2. Independent control
• a. Employees choose their own investments
• allow plan participants to change their investment options no less frequently than quarterly

3. Communication

• a. Information available upon request
  
  • 1) Prospectuses and financial statements
  • 2) Risk and return characteristics of investments

Question 82

ERISA
I. Prohibited transactions
1. Transactions involving “parties in _”

• a. _ money from the plan
  2. Fiduciary self-dealing
• a. Acting on _ of a transaction involving the plan

J. Vesting

• _ % vest on EE contributions

Answer 82

ERISA
I. Prohibited transactions
1. Transactions involving “parties in interest”

• a. Borrowing money from the plan
  2. Fiduciary self-dealing
• a. Acting on both sides of a transaction involving the plan

J. Vesting

• 100% vest on EE contributions

Question 83

ESAs
A. Educational IRA/Coverdell ESA

• 1. _ contribution, but grows tax-_
• 2. Contributions may be made by _, including the _, but the total annual maximum contribution per child is $_
• 3. Contributions may be made until the child’s _ birthday
• 4. Contributors must fall under certain _ limits
• 5. Earnings withdrawn for qualified education expenses before beneficiary is age _ are tax-_; otherwise _ + _% tax penalty
• 6. works similar to a self-directed IRA where stocks, bond, mutual funds, ETFs, and other investment vehicles are options.

Qualified expenses for Coverdell ESA include:

Tuition, fees, academic tutoring, special needs services in the case of a special needs beneficiary, books, supplies, and other equipment which are incurred in connection with the enrollment or attendance of the designated beneficiary

Room and board, uniforms, transportation, and supplementary item and services (including extended day programs) which are required or provided by the school in connection with such enrollment or attendance

Any computer technology or equipment or Internet access and related services, if such technology, equipment, or services are to be used by the beneficiary and the beneficiary’s family during any of the years the beneficiary is in school.

Answer 83

ESAs
A. Educational IRA/Coverdell ESA

• 1. After-tax contribution, but grows tax-deferred
• 2. Contributions may be made by anyone, including the beneficiary, but the total annual maximum contribution per child is $2,000
• 3. Contributions may be made until the child’s 18th birthday
• 4. Contributors must fall under certain earnings limits
• 5. Earnings withdrawn for qualified education expenses before beneficiary is age 30 are tax-free; otherwise tax + 10% tax penalty
• 6. works similar to a self-directed IRA where stocks, bond, mutual funds, ETFs, and other investment vehicles are options.

Qualified expenses for Coverdell ESA include:

Tuition, fees, academic tutoring, special needs services in the case of a special needs beneficiary, books, supplies, and other equipment which are incurred in connection with the enrollment or attendance of the designated beneficiary

Room and board, uniforms, transportation, and supplementary item and services (including extended day programs) which are required or provided by the school in connection with such enrollment or attendance

Any computer technology or equipment or Internet access and related services, if such technology, equipment, or services are to be used by the beneficiary and the beneficiary’s family during any of the years the beneficiary is in school.

Question 84

529 Plans
B. Section 529 plans [_]—college savings plans
1. Contributions
2. No _ limit for contributions or withdrawals
3. Earnings accumulate tax deferred and are tax-free when withdrawn for qualified education expenses

• a. Maximum of $_ _ for K-12, _ and _ only
  4. No earnings limitations on contributors
• a. States may offer state income tax-free withdrawals or deductions for contributions or tax credits
  5. Non-qualified withdrawals subject earnings to _ plus a _% tax penalty

6. Prepaid tuition plans - most have age/grade limit
7. College savings plans

• a. States set maximum contribution limits—no _ limits
  
  • 1) Subject to gift tax rules
    
    • a) Five-year multiple gift tax exclusion
  • 2) Donor _ control

8. May be rolled over to another _ plan
   * a. Once per _ months
9. These are municipal fund securities and require delivery of an official statement or offering circular (not a prospectus)
10. Treated as _ assets when student applies for financial aid—better than if student’s asset
11. Assets under control of account owner (usually the donor)
12. May be used for certain _ educational institutions

Paying off up to $_ in student loans (lifetime) is a qualified expense

Qualified expenses:

• Tuition and fees
• Room and Board
• Technology Items
• Books and Supplies
• Student Loan Repayment

Answer 84

529 Plans
B. Section 529 plans [qualified tuition plans (QTPs)]—college savings plans
1. Contributions
2. No age limit for contributions or withdrawals
3. Earnings accumulate tax deferred and are tax-free when withdrawn for qualified education expenses

• a. Maximum of $10,000 annually for K-12, tuition and fees only
  4. No earnings limitations on contributors
• a. States may offer state income tax-free withdrawals or deductions for contributions or tax credits
  5. Non-qualified withdrawals subject earnings to tax plus a 10% tax penalty

6. Prepaid tuition plans - most have age/grade limit
7. College savings plans

• a. States set maximum contribution limits—no federal limits
  
  • 1) Subject to gift tax rules
    
    • a) Five-year multiple gift tax exclusion
  • 2) Donor retains control

8. May be rolled over to another state’s plan
   * a. Once per 12 months
9. These are municipal fund securities and require delivery of an official statement or offering circular (not a prospectus)
10. Treated as parental assets when student applies for financial aid—better than if student’s asset
11. Assets under control of account owner (usually the donor)
12. May be used for certain foreign educational institutions

Paying off up to $10,000 in student loans (lifetime) is a qualified expense

Question 85

UGMA/UTMA
A. Custodial accounts
1. Rules

• a. One child—beneficial owner
• b. _ custodian
  
  • 1) Adult
  • 2) Not necessarily the donor
  • 3) Fiduciary capacity
• c. Irrevocable?
  
  • 1) No limit to as to gift size
  • 2) Withdrawn only for benefit of minor, but not ?
• d. Donor is custodian—no management fee
• e. Names on account
  
  • 1) _
  • 2) _
  • 3) _where account is held

2. Taxation
   * a. Minor’s Social Security number
3. Types

• a. Uniform Gift to Minors Act (UGMA)
  
  • 1) Assets registered to individual at age of _
• b. Uniform Transfers to Minors Act (UTMA)
  
  • 1) Designate age for the transfer of the assets
  • 2) Maximum age?
  • 3) Offer greater investment choices
    
    • a) _

Answer 85

UGMA/UTMA
A. Custodial accounts
1. Rules

• a. One child—beneficial owner
• b. One custodian
  
  • 1) Adult
  • 2) Not necessarily the donor
  • 3) Fiduciary capacity
• c. Irrevocable
  
  • 1) No limit to as to gift size
  • 2) Withdrawn only for benefit of minor, but not basic necessities
• d. Donor is custodian—no management fee
• e. Names on account
  
  • 1) Custodian
  • 2) Minor’s name
  • 3) State where account is held

2. Taxation
   * a. Minor’s Social Security number
3. Types

• a. Uniform Gift to Minors Act (UGMA)
  
  • 1) Assets registered to individual at age of majority
• b. Uniform Transfers to Minors Act (UTMA)
  
  • 1) Designate age for the transfer of the assets
  • 2) Maximum 25 years of age
  • 3) Offer greater investment choices
    
    • a) Real estate

Question 86

HSAs
A. Health savings account
1. Tax-deductible contributions
2. No “use it or lose it” like _
3. Must have _ and no other insurance

Answer 86

HSAs
A. Health savings account
1. Tax-deductible contributions
2. No “use it or lose it” like FSA
3. Must have HDHP and no other insurance

Question 87

Funds in both ESA and 529 are counted as assets of parents at 5.64% if owner is a _ or _ student.

If a 529 plan is owned by an _ student, it is reported as a student asset on the FAFSA.

If a 529 plan is owned by anybody else, such as a grandparent, aunt, uncle, cousin or non-custodial parent, it is not reported as an asset on the FAFSA. Instead, distributions count as untaxed income to the beneficiary.

Are ESAs and 529 plans considered securities?

Answer 87

Funds in both ESA and 529 are counted as assets of parents at 5.64% if owner is a parent or dependent student.

If a 529 plan is owned by an independent student, it is reported as a student asset on the FAFSA.

The definition of security specifically excludes retirement plans (the Coverdell was originally known as the Education IRA). Section 529 plans are technically considered municipal fund securities.