Readiness Exam #1 Flashcards

Question

Under Prudent Investor Rules, the trustee must do which of the following? (A) Manage the trust for the benefit of the beneficiaries (B) Disclose all transactions that present a conflict of interest to the beneficiaries (C) Maintain a fixed list of securities in the portfolio (D) Give preference to securities with special meaning to the beneficiaries

Answer 1

A SIMPLE IRA is a retirement savings plan that most small businesses with 100 or fewer employees can use. "SIMPLE" stands for "Savings Incentive Match Plan for Employees," and "IRA" stands for "Individual Retirement Account." Employers can choose to make a 2% retirement account contribution to all employees or an optional matching contribution of up to 3%. Employees can contribute a maximum of $13,500 annually in 2020; the maximum is increased periodically to account for inflation. Retirement savers age 50 and older may make an additional catch-up contribution of $3,000, bringing their annual maximum to $16,000. KEY TAKEAWAYS A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a type of tax-deferred retirement savings plan. SIMPLE IRAs are easy to set up, and they can be a good option for small businesses. They have some drawbacks, and businesses that can afford to set up other plans might consider it.

Answer 2

A Beta is a measure of a portfolio's volatility as compared to the volatility of the overall market. Since systematic risk is risk associated with the overall market, lowering the client's beta relative to that of the market should lower his or her exposure to market risk. Diversification, safety ratings, and price/earnings ratios should be considered when evaluating unsystematic risk, which is the risk associated with a particular issuer's securities.

Answer 3

D If interest rates in the economy go down, bond prices will go up in the secondary market. This causes their yields to go down. On a premium bond (one selling for more than par), the yield to maturity will be lower than both the current yield and the nominal yield.

Answer 4

C Although an agent may represent an issuer or a broker/dealer, if it is the broker/dealer who hires the agent to sell the securities, the agent represents the broker/dealer. An issuer who hires an agent to sell its own securities would not need to hire a broker/dealer since an agent may represent an issuer as well.

Answer 5

C Since all contributions to a 403(b) tax-sheltered annuity are made with before-tax dollars, the participant has a zero cost basis in the plan. Upon distribution, both the contributions and the earnings will be taxable as ordinary income. All of the other choices present in this question are funded with after-tax dollars and there are either no taxes due upon qualified distribution (Roth IRA) or only the earnings will be taxable (nonqualified deferred annuities and traditional IRAs funded with after-tax dollars).

Answer 6

D Holding period return is the total return on an investment over a variable time period. Converting holding period return to annualized return makes rates of return easier to compare.

Answer 7

The balance of payments (BOP) is a statement of all transactions made between entities in one country and the rest of the world over a defined period of time, such as a quarter or a year. The balance of payments (BOP), also known as balance of international payments, summarizes all transactions that a country's individuals, companies and government bodies complete with individuals, companies and government bodies outside the country. These transactions consist of imports and exports of goods, services and capital, as well as transfer payments, such as foreign aid and remittances.

Answer 8

A Federal covered advisers are those who must register with the SEC (such as those who advise mutual funds). They must renew their registration by filing an annual updating amendment with the SEC within 90 days after the end of their fiscal year. The adviser is required to send it out to investors within 120 days if there are any changes and provide a summary of the changes.

Answer 9

B The SEC exemption that allows advisers to charge performance-based fees for certain clients does not extend to accredited investors, a term associated only with the private placement of securities under SEC Regulation D.

Answer 10

A While common stocks and mutual funds may do well over a period of time, this investor only has money to invest for 2 years and wants minimal risk. While municipal bonds are safe, they also have low yields and without knowing the client's tax bracket, it cannot be assumed that the client would maximize returns. In this case, it appears that T-bills would be most suitable since they are safe and short-term.

Answer 11

The accounts receivable turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its receivables or money owed by clients. The ratio shows how well a company uses and manages the credit it extends to customers and how quickly that short-term debt is collected or is paid. The receivables turnover ratio is also called the accounts receivable turnover ratio. KEY TAKEAWAYS The accounts receivable turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its receivables or money owed by clients. A high receivables turnover ratio can indicate that a company’s collection of accounts receivable is efficient and that the company has a high proportion of quality customers that pay their debts quickly. A low receivables turnover ratio might be due to a company having a poor collection process, bad credit policies, or customers that are not financially viable or creditworthy. A company’s receivables turnover ratio should be monitored and tracked to determine if a trend or pattern is developing over time.

Answer 12

Inventory turnover is a ratio showing how many times a company has sold and replaced inventory during a given period. A company can then divide the days in the period by the inventory turnover formula to calculate the days it takes to sell the inventory on hand. Calculating inventory turnover can help businesses make better decisions on pricing, manufacturing, marketing and purchasing new inventory.

Answer 13

B The price-to-book ratio is a valuation ratio, not a liquidity ratio.

Answer 14

A real rate of return is the annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external factors. This method expresses the nominal rate of return in real terms, which keeps the purchasing power of a given level of capital constant over time. Adjusting the nominal return to compensate for factors such as inflation allows you to determine how much of your nominal return is real return. The Formula for the Real Rate of Return Is \text{Real rate of return} = \text{Nominal interest rate} - \text{Inflation rate}Real rate of return=Nominal interest rate−Inflation rate

Answer 15

C The Investment Advisers Act of 1940 excludes from the definition of investment adviser anyone who advises only on government or agency securities. A lawyer who gives investment advice falls within the definition of investment adviser if he or she offers the advice as part of his or her practice and receives compensation for it. A person who is paid to give advice on bank stocks and a publisher of a newsletter that gives specific securities recommendations both fall within the definition of an investment adviser under the Act.

Answer 16

D Advertising does not have to be filed on U.S. government securities, private placements, or federal covered securities since they are all either exempt securities or exempt transactions. However, it is best to assume that corporate stock is nonexempt.

Answer 17

A A premium bond is one that is selling in the secondary market for more than par, which means that interest rates have gone down since the bond was issued. If interest rates go down, bond prices in the secondary market go up, causing both the current yield and the yield to maturity to go down.

Answer 18

The balance of payments divides transactions in two accounts: the current account and the capital account. Sometimes the capital account is called the financial account, with a separate, usually very small, capital account listed separately. The current account includes transactions in goods, services, investment income and current transfers. The capital account, broadly defined, includes transactions in financial instruments and central bank reserves. Narrowly defined, it includes only transactions in financial instruments. The current account is included in calculations of national output, while the capital account is not. The sum of all transactions recorded in the balance of payments must be zero, as long as the capital account is defined broadly. The reason is that every credit appearing in the current account has a corresponding debit in the capital account, and vice-versa. If a country exports an item (a current account credit), it effectively imports foreign capital when that item is paid for (a capital account debit).

Answer 19

C The U.S. balance of payments system records all of the country’s economic transactions with the rest of the world during a particular time period by using a system of debits and credits to help the country evaluate its competitive strengths and weaknesses and forecast the strength of its currency. Any transaction that causes money to flow into a country is a credit to its balance of payments account and any transaction that causes money to flow out is a debit.

Answer 20

A company's financial statements offer investors and analysts a portrait of all the transactions that go through the business, where every transaction contributes to its success. The cash flow statement is believed to be the most intuitive of all the financial statements because it follows the cash made by the business in three main ways—through operations, investment, and financing. The sum of these three segments is called net cash flow.

Answer 21

B Inflation-adjusted return (real return) may be found by reducing the nominal rate of return on an investment by the rate of inflation as indicated by the consumer price index (CPI).

Answer 22

C Market makers are not underwriters. Market makers are the dealer side of broker/dealer. Market makers take an inventory position in a stock in order to make the market. Market makers make money on their inventory positions. Municipal bond interest does not appear in a client's AGI on his or her federal tax return because municipal bond interest is exempt from federal income taxes. Advertising does not have to be filed on an exempt security but must be filed on all nonexempt securities. A federal covered security is not registered at the state level; instead, it is registered federally with the SEC.

Answer 23

B Money in a 5-year certificate of deposit at the bank is tied up in this product for 5 years. At maturity, purchasing power risk and reinvestment risk will be present.

Answer 24

D Although advisers do not have to disclose all of their personal trades to customers, they must disclose the trades that they make that are inconsistent with their advice and trades that they make that take advantage of their recommendations.

Answer 25

A Net capital gains and capital losses dollar-for-dollar to find the final position, a $3,500 net long-term capital loss. Of this, the investor may write off (deduct) $3,000 (which is the maximum annual limit) from her other income on the tax return for the year. The remaining $500 net capital loss may be carried over and used to offset $500 in capital gains next year.

Answer 26

D The management consultant's advice to clients is more personal opinion than providing investment advice as a business. In the other three choices, investment advice is offered as part of the individual's regular business. Lawyers, accountants, engineers, and teachers are generally not considered investment advisers provided the advice is incidental to their regular profession.

Answer 27

The record date, or date of record, is the cut-off date established by a company in order to determine which shareholders are eligible to receive a dividend or distribution. The determination of a record date is required to ascertain who exactly a company's shareholders are as of that date, since shareholders of an actively traded stock are continually changing. The shareholders of record as of the record date will be entitled to receive the dividend or distribution, declared by the company.

Answer 28

A If a client provides verbal discretion, the IAR may make discretionary trades on the same day. The IAR will need to obtain written discretionary authority from the client within 10 days. If the client specifies the type and quantity, the IAR is always given automatic discretion over timing and price; this does not need to be in writing.

Answer 29

A The Administrator must provide appropriate prior notice, opportunity for a hearing, and written findings of facts and conclusions of law. Even if an order is issued summarily, that is, made effective upon issue without prior notice, a registrant must be notified upon issue of the order and must be given the opportunity to request a hearing.

Answer 30

A The Administrator has broad powers, including the issuance of stop orders, cease and desist orders, and the revocation of previously allowed exemptions. For example, the state's private placement rule states that new securities sold privately are exempt transactions if no more than 10 offers are made. If the issuer makes 11 offers, the Administrator could revoke the exemption. However, only a judge can hold a witness in contempt.

Answer 31

B Price/earnings ratio is a valuation ratio, not a financial ratio. Price/earnings ratios are used to determine if a stock is under- or overvalued. Financial ratios measure a corporation's liquidity (current ratio and quick ratio) or the amount of leverage (bonds) in its capital structure (debt-to-equity ratio).

Answer 32

D An accredited investor is a person or organization that has a significant level of net worth, financial knowledge, and investment experience. Accredited investors include individuals with a minimum net worth of $1,000,000, a minimum annual income exceeding $200,000 in each of the previous 2 years and expected this year, or $300,000 in joint income. Accredited investors do not include investment advisers or investment advisory companies. While many institutional investors (such as banks, insurance companies, and investment companies) are considered to be accredited investors, an accredited investor need not be an institutional investor.

Answer 33

C There are two fiduciary standards governing the prudence of the individual investments selected by a fiduciary – the Prudent Investor Act and the Prudent Man Rule. The Prudent Investor Act, which was adopted in 1990, reflects a modern portfolio theory and total return approach to the exercise of fiduciary investment discretion. This approach allows fiduciaries to utilize modern portfolio theory to guide investment decisions and requires risk versus return analysis. Therefore, a fiduciary’s performance is measured on the performance of the entire portfolio rather than on individual investments.

Answer 34

A Standard deviation is a quantitative descriptive statistic that measures the risk associated with price fluctuations of a given asset, such as stocks or bonds. When evaluating investments, investors should estimate both the expected return and the uncertainty of future returns. Standard deviation provides a quantified estimate of the uncertainty of future returns.

Answer 35

D The question asks for clients to whom it would be unethical for the adviser to lend money. An adviser who is not a lending institution may lend money to a client only if the client is an affiliate of the adviser.

Answer 36

B Return on assets tells an investor how much profit a company generated for each $1 in assets. Often, a company will do an analysis to determine whether to invest additional capital into the purchase of a new asset. If the expected return of assets should decrease, then the net present value will increase. At a discount rate of zero, the net present value of an investment is just the total cash inflows minus the cash outflows of a project. Thus, the highest net present value will occur when the discount rate is zero. As the discount rate increases, the net present value decreases.

Answer 37

A Beta is a measure of a portfolio's volatility as compared to the volatility of the overall market. Since systematic risk is risk associated with the overall market, lowering the client's beta relative to that of the market should lower his or her exposure to market risk. Diversification, safety ratings, and price/earnings ratios should be considered when evaluating unsystematic risk, which is the risk associated with a particular issuer's securities.

Answer 38

D If interest rates in the economy go down, bond prices will go up in the secondary market. This causes their yields to go down. On a premium bond (one selling for more than par), the yield to maturity will be lower than both the current yield and the nominal yield.

Answer 39

C Although an agent may represent an issuer or a broker/dealer, if it is the broker/dealer who hires the agent to sell the securities, the agent represents the broker/dealer. An issuer who hires an agent to sell its own securities would not need to hire a broker/dealer since an agent may represent an issuer as well.

Answer 40

C Since all contributions to a 403(b) tax-sheltered annuity are made with before-tax dollars, the participant has a zero cost basis in the plan. Upon distribution, both the contributions and the earnings will be taxable as ordinary income. All of the other choices present in this question are funded with after-tax dollars and there are either no taxes due upon qualified distribution (Roth IRA) or only the earnings will be taxable (nonqualified deferred annuities and traditional IRAs funded with after-tax dollars).

Answer 41

D Holding period return is the total return on an investment over a variable time period. Converting holding period return to annualized return makes rates of return easier to compare.

Answer 42

A Federal covered advisers are those who must register with the SEC (such as those who advise mutual funds). They must renew their registration by filing an annual updating amendment with the SEC within 90 days after the end of their fiscal year. The adviser is required to send it out to investors within 120 days if there are any changes and provide a summary of the changes.

Answer 43

B The SEC exemption that allows advisers to charge performance-based fees for certain clients does not extend to accredited investors, a term associated only with the private placement of securities under SEC Regulation D.

Answer 44

A While common stocks and mutual funds may do well over a period of time, this investor only has money to invest for 2 years and wants minimal risk. While municipal bonds are safe, they also have low yields and without knowing the client's tax bracket, it cannot be assumed that the client would maximize returns. In this case, it appears that T-bills would be most suitable since they are safe and short-term.

Answer 45

B The price-to-book ratio is a valuation ratio, not a liquidity ratio.

Answer 46

A Under NASAA's Model Rules regarding unethical business practices of investment advisers, investment adviser representatives, and federal covered advisers, an adviser is prohibited from guaranteeing a client that a specific result will be achieved (a gain or no loss) with the advice rendered.

Answer 47

B A low price-to-book ratio could mean that the stock is undervalued.

Answer 48

C The Investment Advisers Act of 1940 excludes from the definition of investment adviser anyone who advises only on government or agency securities. A lawyer who gives investment advice falls within the definition of investment adviser if he or she offers the advice as part of his or her practice and receives compensation for it. A person who is paid to give advice on bank stocks and a publisher of a newsletter that gives specific securities recommendations both fall within the definition of an investment adviser under the Act.

Answer 49

D Advertising does not have to be filed on U.S. government securities, private placements, or federal covered securities since they are all either exempt securities or exempt transactions. However, it is best to assume that corporate stock is nonexempt.

Answer 50

A A premium bond is one that is selling in the secondary market for more than par, which means that interest rates have gone down since the bond was issued. If interest rates go down, bond prices in the secondary market go up, causing both the current yield and the yield to maturity to go down.

Answer 51

C The U.S. balance of payments system records all of the country’s economic transactions with the rest of the world during a particular time period by using a system of debits and credits to help the country evaluate its competitive strengths and weaknesses and forecast the strength of its currency. Any transaction that causes money to flow into a country is a credit to its balance of payments account and any transaction that causes money to flow out is a debit.

Answer 52

B Inflation-adjusted return (real return) may be found by reducing the nominal rate of return on an investment by the rate of inflation as indicated by the consumer price index (CPI).

Answer 53

C Market makers are not underwriters. Market makers are the dealer side of broker/dealer. Market makers take an inventory position in a stock in order to make the market. Market makers make money on their inventory positions. Municipal bond interest does not appear in a client's AGI on his or her federal tax return because municipal bond interest is exempt from federal income taxes. Advertising does not have to be filed on an exempt security but must be filed on all nonexempt securities. A federal covered security is not registered at the state level; instead, it is registered federally with the SEC.

Answer 54

B Money in a 5-year certificate of deposit at the bank is tied up in this product for 5 years. At maturity, purchasing power risk and reinvestment risk will be present.

Answer 55

B Do not confuse yield with total return. Yield formulas are based upon earnings, not appreciation or capital gains. In this case, simply divide the annual dividends of $3 by the purchase price paid of $95 to find that the yield is about 3.2%.

Answer 56

D Although advisers do not have to disclose all of their personal trades to customers, they must disclose the trades that they make that are inconsistent with their advice and trades that they make that take advantage of their recommendations.

Answer 57

A Net capital gains and capital losses dollar-for-dollar to find the final position, a $3,500 net long-term capital loss. Of this, the investor may write off (deduct) $3,000 (which is the maximum annual limit) from her other income on the tax return for the year. The remaining $500 net capital loss may be carried over and used to offset $500 in capital gains next year.

Answer 58

D The management consultant's advice to clients is more personal opinion than providing investment advice as a business. In the other three choices, investment advice is offered as part of the individual's regular business. Lawyers, accountants, engineers, and teachers are generally not considered investment advisers provided the advice is incidental to their regular profession.

Answer 59

A Remember the teeter-totter: if interest rates go up, then yields go up and price goes down. When interest rates go up, any new bond being issued at that point would have to pay a higher coupon rate.

Answer 60

C Total return is defined as yield plus growth. Growth is also known as appreciation which can be realized or unrealized. In this question, the investor has $2 of growth (from $50 to $52) and $4 of yield (dividends), so the total return is $6. If the question asks for it as a percentage, divide $6 by $50, which is 12%.

Answer 61

Defined-Benefit Plans Employers guarantee a specific retirement benefit amount for each participant in a defined-benefit plan. The amount is based on factors such as the employee’s salary and years of service. Employees have little control over the funds until they are received in retirement. The company takes responsibility for the investment and for its distribution to the retired employee. That means the employer bears the risk that the returns on the investment will not cover the defined-benefit amount due to the retired employee. Because of this risk, defined-benefit plans require complex actuarial projections and insurance for guarantees, making the costs of administration very high. This has made defined-benefit plans all but obsolete.

Answer 62

Defined-contribution plans are funded primarily by the employee, called “the participant,” with the employer matching contributions to a certain amount. The most common type of defined-contribution plan is the 401(k) plan. Participants may elect to defer a portion of their gross salary via a pre-tax payroll deduction to the plan, and the company may match the contribution up to a limit it sets. The contributions are invested, at the participant’s direction, in select mutual funds, money market funds, annuities, or individual stocks offered by the plan. As the employer has no obligation toward the account’s performance after the funds are deposited, these plans require little work and are low risk to the employer. The employee is responsible for directing the contributions and investments.

Answer 63

CHOSE B (BUT KNOW ITS D)

Answer 64

A It is true that variable annuities have higher expenses than mutual funds. Variable annuities do not have a guaranteed rate of return. Performance-based fees are generally prohibited. Waivers are unenforceable in court.

Answer 65

B The par value of this T-note is $10,000. With a 5% nominal interest rate, it will pay $500 a year in interest. Since current yield measures what the note will yield an investor who buys it today, the $500 interest that it will pay must be divided by its present market price of $10,200, which is 4.9%. Because the note is trading at a premium, the current yield will be less than the nominal yield. It is trading at a premium because interest rates in the economy must have gone down slightly since the note was issued.

Answer 66

B Beta is a measure of a portfolio's volatility as compared to the volatility of the overall market. Since systematic risk is risk associated with the overall market, lowering the client's beta relative to that of the market should lower his or her exposure to market risk. Diversification, safety ratings, and price/earnings ratios should be considered when evaluating unsystematic risk, which is the risk associated with a particular issuer's securities.

Answer 67

B An adviser may never take orders from someone other than his or her customer unless that party has been granted written third-party trading authority in advance of the trade.

Answer 68

B Although corporate retained earnings or undistributed net income is shown on the balance sheet as a component of stockholders' equity, retained earnings are not reflected in the footnotes and are not a liability. Stockholders’ equity is also known as net worth and is what the shareholders would receive if the company were liquidated.

Answer 69

C Under Section 404(c) of ERISA, the retirement plan must offer at minimum three different investment choices. These choices must be different in risk and reward possibilities. Although 12 equity choices is a broad number of choices, they are all equity choices. The plan must also offer a fixed income choice as well as a money market choice. In this way, three different risk categories are covered — equity is the highest risk, bond fund below that, and money market fund as the least risky.

Answer 70

C The Prudent Man Rule requires that each investment be judged on its own merits. Thus, a fiduciary could be held liable for a loss in one investment which, when viewed in isolation, may have been imprudent at the time it was acquired but as a part of a total investment strategy, was a prudent investment in the context of the investment portfolio taken as a whole.

Answer 71

C The prime rate is the interest rate that banks set for their best commercial customers.

Answer 72

B The USA requires that the Administrator follow these procedures when intending to take disciplinary action against someone registered in the state.

Answer 73

A Remember the teeter-totter: if interest rates go up, then yields go up and price goes down. When interest rates go up, any new bond being issued at that point would have to pay a higher coupon rate.

Answer 74

C Tax rules state that the partial withdrawal of annuity funds is taxed as interest first and principal last. Although the $5,000 withdrawal is less than the cost basis, the entire $5,000 is taxable as ordinary income and is subject to the IRS 10% premature distribution penalty since she is less than age 59 ½.

Answer 75

A When a corporation issues debt (bonds), they are borrowing money. The money that is borrowed must be paid back. When the bond reaches maturity (typically in 30 years), the corporation pays the bondholder back the principal amount ($1,000). When a corporation issues shares of stock (equity), it is selling pieces of ownership. The corporation does not owe the shareholder any money. Some corporations will pay dividends to shareholders, but they are never under any obligation to do so. Dividends paid to stockholders are taxable to the stockholder. As an owner of the corporation, the stockholder has voting rights.

Answer 76

C Open-end mutual funds are not traded in the secondary market. Open-end funds are sold at their asking price and redeemed at their NAV per share. Closed-end mutual funds, on the other hand, trade in the secondary market at a price based upon supply and demand. The closed-end mutual fund share may be trading above or below its net asset value per share.

Answer 77

D The Uniform Prudent Investor Act is centrally concerned with the investment responsibilities arising under the private gratuitous trust, which is the common vehicle for conditioned wealth transfer within the family. Nevertheless, the prudent investor rule also bears on charitable and pension trusts, among others.