Quiz Flashcards
Which of the following statements comparing fixed and variable annuities is TRUE?
A. The amount of the payout will be level with a fixed annuity but may increase or decrease with a variable annuity
B. The number of years of benefit payments is specified with a fixed annuity but is not specified with a variable annuity
C. The rate of return must increase for a variable annuity but remains level for a fixed annuity
D. Variable annuities make periodic payments to an annuitant but fixed annuities make lump sum payments to an annuitant
The best answer is A.
The amount of the payout will be level with a fixed, but may increase or decrease with a variable annuity. Both fixed and variable annuities promise payments for the lifetime of the annuitant. The rate of return remains level for a fixed annuity, but can increase or decrease for a variable annuity. Both fixed and variable annuities make periodic payments (typically monthly) to annuitants.
As the economy fluctuates, the holder of a fixed annuity contract should know that:
A. payments will fluctuate based upon the actual return that the separate account earns
B. payments will not fluctuate over time
C. during periods of negative economic growth, annuity payments are subject to reduction
D. during periods of negative economic growth, it is likely that annuity payments will increase
The best answer is B.
Fixed annuities are just that - fixed. No matter how well or poorly the insurance company’s general account performs, or how much the economy fluctuates, the annuitant receives a fixed monthly amount.
Which of the following investments trade in the market?
I Limited partnership
II Closed-end fund
III Variable annuity
IV Listed option
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
Limited partnerships are illiquid - they do not trade because partnership units are not transferable unless the general partner approves. Closed-end funds are listed and trade like any other stock; in contrast, open end funds do not trade - they are redeemable, not negotiable. Variable annuities use a mutual fund held in a separate account to fund the annuity - they are also not negotiable. Listed options trade, so they are negotiable.
Which of the following is MOST likely to fluctuate for an annuitant during the payout period of a variable annuity?
A. Death benefit
B. Mortality risk
C. Investment return
D. Expense risk
The best answer is C.
With a variable annuity, the investment return and benefit payments will vary based on the performance of the underlying securities held in the separate account. During the payout period, there is no death benefit - the insurance company simply promises to make the fixed monthly payments until the annuitant dies. The mortality risk and expense risk are carried by the insurance company and are not subject to market fluctuation.
Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company’s expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company’s problem.
A customer who is short stock will buy a call to:
A. hedge the short stock position in a falling market
B. protect the short stock position from a falling market
C. protect the short stock position from a rising market
D. generate additional income in a stable market
The best answer is C.
A customer who has shorted stock is bearish on the market. However, the potential loss for a short seller of stock is unlimited if the market should rise, forcing the customer to replace the borrowed shares at a much higher price. To limit this risk, the purchase of a call allows the stock position to be bought at a fixed price (by exercising the call), if needed, in a rising market.
For an investor seeking a tax sheltered investment, the primary advantage of a real estate direct participation program is the:
A. high level of liquidity provided by the investment
B. ability of the program to generate losses for tax purposes but provide positive cash flow
C. ability to offset passive losses generated by the program against the investor’s earned income
D. ability of the program to generate increasing losses until liquidation
The best answer is B.
Limited partnership interests are not liquid. To avoid the corporate characteristic of “free transferability of shares,” most partnership agreements place restrictions on transfer. The ideal structure for a partnership is to generate losses for tax purposes (in a real estate program, through mortgage interest and depreciation deductions), yet show positive cash flow (since depreciation is a “paper” write-off). Since real estate is considered a passive investment, any losses can only be offset against passive income - not earned income. The structure of partnerships generates higher losses in the early years, and lower losses in the later years. This gives people with “tax problems” the incentive to buy such a program, since the deductions are “front loaded,” and the potential purchaser needs those deductions today.
Which of the following options strategies provides a gain equal to the premium in a bull market?
A. Long Call
B. Short Call
C. Long Put
D. Short Put
The best answer is D.
The writer of a put (short put) collects a premium in return for agreeing to buy stock at a fixed price, no matter how low the market price of the stock may go. If the market price rises, the put expires “out the money” and the writer keeps the collected premium. This is the maximum potential gain.
An individual, for a fee, prepares a custom financial plan for a client that includes a section covering life insurance needs. In order to do so, the individual:
I must be a licensed insurance agent in the State
II is not required to be a licensed insurance agent in the State
III must be a licensed investment adviser representative in the State
IV is not required to be a licensed investment adviser representative in the State
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.
To prepare customer financial plans for a fee, the individual must be licensed as an investment adviser representative in the State, but this does not cover life insurance! To sell life insurance, a separate State life insurance license is needed.
A customer sells short 100 shares of PDQ at $49 and sells 1 PDQ Sep 50 Put @ $6. The maximum potential loss is:
A. $4,300
B. $4,400
C. $5,500
D. unlimited
The best answer is D.
The maximum potential loss for a customer with a short stock / short put position is unlimited. If the market rises, the put expires and the short stock position must be covered (bought in) in the market.
A customer buys 100 shares of ABC stock at 39 and sells 1 ABC Jan 45 Call @ 2 on the same day in a cash account. The customer’s maximum potential gain until the option expires is:
A. $200
B. $300
C. $700
D. $800
The best answer is D.
If the market rises above 45 the short call will be exercised. The customer must deliver the stock that he bought at 39 for the $45 strike price, resulting in a $600 gain. Since $200 was collected in premiums as well, the total gain is $800. This is the maximum potential gain while both positions are in place.
The very first option style used was:
A. American
B. European
C. Eastern
D. Western
The best answer is A.
The CBOE started in 1973 with single stock options only - and these were American style options (options that could be exercised at any time). When the CBOE introduced index options in the late 1970s, they found that portfolio managers who used them to hedge did not want to be hit with an unintended exercise - so they made them European style options - which can be exercised only at expiration. There is no such thing as an Eastern or Western option.
All of the following information is included in a (standardized) commodities futures contract EXCEPT the:
A. acceptable grades of the commodity
B. quantity of the commodity
C. delivery location of the commodity
D. price of the commodity
The best answer is D.
Commodities futures contracts are “standardized,” which makes them easier to trade. Each exchange has its own contract for a standard size (quantity) and quality of the commodity (the exchange sets the different varieties or grades that can be delivered at various price differentials to the contract price) and there are standardized future delivery dates for the underlying commodity, if the contract is not closed by trading as of that date. What is not standardized is the price of the commodity - this is determined in the marketplace.
Payments received by the owner of a tax qualified variable annuity are:
A. 100% taxable as investment income
B. only taxable to the extent of earnings above the holder’s cost basis
C. only taxable to the extent of the holder’s cost basis
D. non-taxable
The best answer is A.
Funds paid into “tax qualified” retirement plans were never subject to tax, since the contribution amount was deductible from income at the time it was made. Earnings build up tax deferred in the plan. When distributions are taken, since all of the dollars in the plan were never taxed, all of the distribution is taxable.
Funds paid into “non-tax qualified” retirement plans are not tax deductible. Any earnings build up tax deferred. When distributions are taken, the portion that represents the return of original after tax investment is not taxed, while the portion that represents the tax deferred earnings buildup is taxable.
When comparing the Alternative Minimum Tax calculation to the Regular income tax calculation, which deductions are ONLY permitted in the Regular income tax calculation?
I Personal exemption
II State and local tax deduction
III Miscellaneous itemized deductions
IV Medical expense deduction
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is C.
When calculating the Alternative Minimum Tax, aside from adding back “tax preferences,” many of the basic deductions permitted when calculating Regular income tax are not allowed, increasing the amount of AMT income that is subject to tax. When calculating AMT, there is no deduction for the personal exemption; no deduction for state and local taxes paid (including property taxes paid); no deduction for miscellaneous items such as tax preparation fees; and no standard deduction; among other items.
Medical expenses are deductible from Regular income tax to the extent they exceed 7.5% of Adjusted Gross Income (AGI). They are also deductible from the AMT computation, but for AMT, they are only deductible to the extent they exceed 10% of AGI.
A representative is making a presentation to a married couple, ages 77 and 81, about their need for continuing income as the expected life spans of the general population have increased. The representative is strongly recommending that the couple buy an equity indexed annuity (EIA). Which statements made by the representative would be misleading and fraudulent?
I “EIAs guarantee a minimum rate of return that is equal to the Standard and Poor’s 500 Index”
II “I do not earn any commissions when I sell you an EIA”
III “EIAs are tax qualified, allowing you to reduce your taxable income by deducting any contribution that you make”
IV “EIAs provide a minimum guaranteed rate of return that is guaranteed by the issuing insurance company”
A. I and III
B. I and II
C. I, II, III
D. I, II, III, IV
The best answer is C.
Equity indexed annuities (EIAs) are an insurance product that falls somewhere between a fixed annuity and a variable annuity. They give a return linked to a well-known index, such as the Standard and Poor’s 500 Index, but the return is typically capped to a maximum interest rate per year. Thus, if the cap is 10% and the S&P 500 Index grows by 15%, the customer only gets a 10% return for that year. Thus, Choice I is a misleading statement. Technically the salesperson does not earn a commission, but he or she does earn a very steep sales charge, so choice II is misleading. There is no deduction for contributions to the contract (these are non-qualified plans) making Choice III a misleading statement. Choice IV is true - the contracts have a minimum guaranteed rate of return (like around 4%) that is guaranteed by the insurance company. Of course, if the insurance company fails (which rarely happens, but it has happened), then the guarantee is worthless.
