PASSING 82

Question 1

Sharpe ratio

Answer 1

The formula for the Sharpe ratio is: (actual rate of return minus the risk-free rate of return) divided by the standard deviation of the security. Beta is not a component.
The Sharpe ratio is used to measure risk-adjusted performance of either a portfolio or an individual security. The Sharpe ratio uses standard deviation as the denominator in its formula: the higher the Sharpe ratio, the better the portfolio or security has performed on a risk-adjusted basis.

Question 2

Capital asset pricing model (CAPM) is used by many to assess the expected return of a security.

Answer 2

The formula for this computation is as follows: 10% (the return on the market is a beta of 1.0) minus the risk-free rate of 2% or 8%. Then, multiply that by the beta of this stock (1.5) to arrive at 12%. That is, the stock should return 12% above the risk-free rate, or 14%. The standard deviation is not relevant to this computation.

Question 3

Current yield

Answer 3

Current yield is determined by dividing the annual dividend of $4 ($1 per quarter × 4 = $4) by the current stock price of $60 ($4 ÷ $60 = 6.7%).

Question 4

Keynesians

Answer 4

Keynesians advocate government intervention in the workings of the economy through increased government spending, which in turn increases aggregate demand.

Question 5

Marginal tax rate

Answer 5

The IRA defines marginal tax rate as “the highest rate that you will pay on your income.” Basically, as you make more money, you pay tax at a higher rate incrementally. The effective tax rate is the average that you pay on all of your income.

Question 6

Customer pays

Answer 6

In an agency trade, the customer–buyer or seller–pays a commission. In a principal trade the buying customer pays a markup, the seller a markdown. The acquisition cost of a mutual fund is the sales load.

Question 7

Margin account

Answer 7

The original call for funds is the Reg. T or margin call. But, when the call is for additional money, it is known as maintenance margin.

Question 8

Monetarists

Answer 8

Monetarists believe that the economy and inflation are best controlled through the management of the money supply rather than through fiscal policy stimulation.

Question 9

Structured products. complex instruments

Answer 9

As unsecured obligations, their safety is only as good as the financial strength of the issuer and because these tend to be one-of-a-kind products, they do not have liquidity. A particular hazard of investing in these is that there is a low level of pricing transparency; another concern is that the returns are generally not fully realized until the maturity date.

Question 10

Under the CAPM, using the SML

Answer 10

We can determine the expected return of any given stock by taking the risk-free rate and adding to that the product of that stock’s beta coefficient and the difference between the expected return on the market and the risk-free rate.

Question 11

Tactical approach.

Answer 11

The approach to asset review that intentionally deviates from the normal asset mix to take advantage of market opportunities is the tactical approach. Investors using this approach try to use market timing to beat the market, so this approach requires a great deal of predictive ability.

Question 12

The Consumer Price Index (CPI)

Answer 12

Is the average cost of goods and services (market basket) purchased by consumers as compared to those same goods and services purchased during a base period.

Question 13

Net present value NPV

Answer 13

Net present value is a computation taking into consideration future cash flows, discounted to the present, and comparing that to the capital investment necessary to obtain those flows. It is always expressed in monetary units and, if positive, indicates a potentially worthwhile investment.

Question 14

Positive margin

Answer 14

The rate of return on the investment exceeds the interest cost on the borrowed money.

Question 15

Long call option

Answer 15

Those who are bullish on a stock, but don’t have sufficient funds at this time to purchase the stock, can “lock-in” their future cost by going long a call. Income is generated only through selling options. Since a long call is on the same side of the market as long stock, there is no hedge. A spread involves a long and short option.
Lock in future cost.

Question 16

Exempt security

Answer 16

Several types of securities are specifically exempt under the act, including equipment trust certificates issued by a state-regulated or federally regulated railroad. High-quality (receives a rating in one of the three highest rating categories from a nationally recognized statistical rating organization) commercial paper is exempt if the term is nine months or less and it is issued in denominations of $50,000 or more.

Question 17

SEC adviser’s registration

Answer 17

Under the Investment Advisers Act of 1940, registrations become effective 45 days after filing, unless delayed by the SEC, and remain effective until withdrawn by the adviser or canceled, suspended, or revoked by the SEC. The SEC will cancel a registration if the adviser is no longer in existence or in the business. Although the ADV-W is the form for withdrawal, it becomes effective upon acceptance by the IARD, provided however that the investment adviser’s registration continues for a period of 60 days after acceptance solely for the purpose of commencing a proceeding regarding any violation of the Act.

Question 18

Capital Asset Pricing Model (CAPM)

Answer 18

CAPM is built on the theory that investors must receive a return commensurate with the amount of risk taken over a specified period of time.

Question 19

Private placement & preorganization

Answer 19

No money changes hands in the sale of a preorganization certificate or subscription, while the seller receives payment in the case of a private placement. The state will consider a private placement an exempt transaction if it is anticipated that individual (noninstitutional) investors are purchasing for investment only, not immediate resale.
No holding period restrictions are placed on preorganization certificates. Only in the case of a sale of a private placement to an institutional client is it permissible to pay commissions. Finally, choice I has it backwards. When referring to retail (noninstitutional) investors, there is a limit to the number of offers (10), while in the preorganization certificate, the number of sales (subscribers) is limited to 10 regardless of whether they are retail or institutional.

Question 20

investment policy statement (IPS),

Answer 20

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.

Question 21

Dividend discount model (DDM

Answer 21

The dividend discount model (DDM) calculates the present value of the future dividends that a company is expected to pay its shareholders. It uses that calculation to arrive at a projected market value of the common stock.

Question 22

Treasury Bills T-Bill

Answer 22

Treasury Bills are always issued at a discount from their face value. At maturity, the investor receives par. No interest

Question 23

Filing dates

Answer 23

For S corporations, the filing date is March 15 (assuming it is a weekday). For partnership returns (including LLCs with more than one member), the due date is also March 15. For C corporations, the due date is the 15th day of the fourth month following the close of the corporation’s year; this date is April 15th for a calendar-year filer. One effect of this is that LLCs, partnerships, and S corporations all have the same filing​ deadline.

Question 24

Shareholders’ equity

Answer 24

Total assets minus total liabilities equals shareholders’ equity ($780,000 − $370,000 = $410,000).

Question 25

Net present value

Answer 25

Anytime the present value is higher than the cost of the investment, the NPV is positive and you will have made a profitable investment. Therefore, purchasing choice A would result in an increase to the investor’s present wealth because buying something for $20,000 that has a present value of $21,223 gives the investor that added value.

Question 26

Buy Stop

Answer 26

When an investor sells short, stock is borrowed and sold with the anticipation that it will later be replaced at a lower price. However, the investor will lose money if the stock goes up instead of down. Since there is no limit to how high the stock’s price can go, one can protect against that unlimited loss by entering a buy stop order at a specified price above the current market. It is true that all short sales must be made in margin accounts, but that is not nearly a descriptive enough answer because there are both long and short margin accounts and a long position cannot be hedged with a buy stop order.

Question 27

CDSC

Answer 27

Class B shares are known for their back-end load. Class C shares usually only have one for 1 year; but, if the investor redeems within that period, there will be a CDSC. Class A shares do not carry a back-end load, except under conditions that are beyond the scope of this exam.

Question 28

LEAPS,

Answer 28

LEAPS, the acronym for Long-term Equity Anticipation Securities, have expiration dates that can run more than 3 years compared to the 9 months for standard option contracts. Because time value is a direct function of the length of the option, the longer the time until expiry, the greater the potential time value.

Question 29

Look these up

Answer 29

the beta for the subject security.
B)
the actual rate of return for the subject security.
C)
the risk-free return available in the market.
D)
the standard deviation of the subject security.

Question 30

Real rate of return RRR

Answer 30

The real rate of return is the actual return less the inflation rate as measured by the CPI.

Question 31

Alternative minimum tax

Answer 31

When an incentive stock option is exercised, the excess of the market price over the strike price is an AMT adjustment. It is only excess intangible drilling costs, interest from private activity municipal bonds, and accelerated depreciation where AMT comes into play.

Question 32

Under federal law

Answer 32

In the federal regulations, the statute of limitations for a civil action is the sooner of one year after discovery or three years after the action. Under the USA, it is the sooner of two years after discovery or three years after the action.

Question 33

Long Stock

Answer 33

Selling a call against a security will generate additional income (the premium). An investor who writes a put receives additional income from the position but must also be willing to increase his position should the put be exercised. An investor who buys a call is speculating that the stock will soon rise dramatically. An investor who buys a put is speculating the stock will soon fall, not stay steady in price.

Question 34

Eurodollar bonds

Answer 34

Because Eurodollar bonds are denominated in U.S. dollars, a U.S. corporate issuer will not be subject to foreign exchange risk, regardless of the country of issuance. In addition, because the bonds are issued outside the U.S., the issue is not registered with the SEC.

Question 35

Keynesian economic

Answer 35

Keynesian economics, so named for the noted British economist John Maynard Keynes, maintains that governments should manage the economy by adjusting levels of taxation and government spending. Monetarist economics maintains that the economy operates best when the Federal Reserve manages the money supply, not when the government stimulates economic activity through fiscal programs. Supply side economics states that reducing government and its claims on taxpayers’ income is the best way to keep a nation’s economy healthy. Free-market economists believe that government interference in business should be minimal in order for the invisible hand of the market to allocate goods and services in the most efficient manner.

Question 36

Form 8-K

Answer 36

Form 8-K is used to report newsworthy events to the SEC. The reporting time limit is four business days.

Question 37

Coverdell ESA & 529 QTP

Answer 37

)
If a portion or all of the withdrawal from a QTP is spent on anything other than qualified higher education expenses, the owner/contributor will be taxed at her own tax rate on the earnings portion of the withdrawal.

C)
Coverdell ESAs are designed to offer tax benefits to those individuals who wish to save money for a child/grandchild’s higher education expenses.
D)
QTPs are extremely useful tools that provide significant tax savings, allow for substantial investments for a child’s education and provide a tool for avoidance of gift and estate taxes if used correctly.

Question 38

An inverted yield curve results in part by

Answer 38

The demand for longer term bonds is higher than that of short-term bonds and causes a negative slope in the yield curve. If investors were buying short-term bonds in greater demand, the rates of short-term bonds would decline rather than rise.

Question 39

A Simplified Employee Pension (SEP IRA)

Answer 39

Participants in SEPs are vested immediately, not after 1 year in the plan. To be eligible, an employee must be 21 years of age and must have performed services for the employer during at least 3 of the previous 5 years. SEP rules require the employer to allow all eligible employees to participate in the plan.

Question 40

Market capitalization

Answer 40

A stock’s market capitalization is determined by multiplying the price per share times the number of outstanding common shares. For example, if a company had 1 billion shares outstanding and the market price was $20 per share, the company would be said to have a market cap of $20 billion. This would put it into the category of “large-cap” stocks.

Question 41

The minimum rate of return

Answer 41

Reasonable investors relate return to the level of risk assumed; on Treasury bills, this is considered the risk-free rate. An investor in other than risk-free Treasury bills would require a premium to compensate for the additional risk taken.
current risk-free rate of return plus the risk premium.

Question 42

Call option

Answer 42

Think about it—you bought something for $300 (the premium on an option is per 100 shares). What is the most you can ever lose with anything of any type that you pay $300 for? Your purchase price!

Question 43

The Federal Reserve Board foresees the probability of an overheated economy

Answer 43

The FRB attempts to slow down the economy and decrease the money supply with a corresponding increase in interest rates. When interest rates rise, the prime rate increases, bond yields rise, and bond prices drop. Higher interest rates have a tendency to slow down corporate growth, with a resulting slowdown in earnings; these events occur in this approximate sequence.