Securities Products & Suitability

Question 1

What describes the number of common shares for which a convertible bond may be exchanged?

Answer 1

conversion ratio

The conversion ratio is the number of common shares for which a convertible bond may be exchanged.

Question 2

Which of the following statements about the risk characteristics of a convertible bond are true?

1. A convertible bond is less risky than a similar straight bond
2. A convertible bond is more risky than common stock
3. A convertible bond is more risky than a straight bond but less risky than common stock
4. A convertible bond is as risky as common shares

Answer 2

3 only

A convertible security provides more upside potential and risk than a straight bond, but less upside potential and less risk than the common stock.

Question 3

You are the owner of a $1,000 convertible bond that was issued at par. The conversion option allows you to exchange the bond for 10 shares of common stock. What is the bond’s conversion price?

Answer 3

$100

A convertible bond’s conversion price is calculated by dividing its issue price by the conversion ratio (number of shares for which it may be exchanged). In this case the issue price of $1,000 is divided by 10 to obtain the conversion price of $100.

Question 4

What is the purpose of a balance sheet?

Answer 4

• A one-time snapshot of the company’s assets and liabilities.
• The formula for the balance sheet is:
  Assets - Liabilities = Net Worth

Question 5

What are assets or liabilities easily accessible or payable within one year called?

Answer 5

“Current” Assets and Liabilities

These assets include cash on hand, prepayments, and accounts receivable with terms less than one year. This also applies to short-term loans or accounts payable.

Question 6

What is the purpose of separating short-term assets and liabilities?

Answer 6

Evaluate a Company’s Liquidity

By separating short term assets and liabilities, we can create a set of ratios that give insight to the short term access to cash or the amount of upcoming liabilities that must be paid.

Question 7

Define:

Acid Test

Answer 7

• The acid test is an even more conservative analysis of the liquidity of a company. The formula is:
• Acid Test = (Current Assets - Inventory) / Current Liabilities
• The idea here is, inventory is considered a current asset but is not necessarily easily convertible into cash. By removing it from current assets, it gives a more conservative estimate of the cash available to pay liabilities.

Question 8

Define:

Secured Bonds

What are the three major types?

Answer 8

1. Collateral Trust Bonds - secured by placing financial collateral with a trustee
2. Mortgage Bonds - the bond is secured by property, such as real estate
3. Equipment Trust Bonds - backed by equipment

Question 9

What is another name for a company’s unsecured debt?

Answer 9

Debentures

Question 10

How do zero coupon bonds differ from coupon bonds?

Answer 10

• They are issued at a deep discount and make no regular coupon payments.
• Their risk profile is also different: their market price is much more sensitive to rate changes than that of coupon bonds.

Question 11

Zero coupons pay no interest; how does the IRS capture taxes?

Answer 11

In a zero coupon bond, even though the investor does not receive any income until maturity, they are still required to pay taxes each year on the annual accretion.

Question 12

Why are zero coupon bond prices so volatile?

Answer 12

Because zero coupon bonds do not pay annual cash flows, they do not provide a buffer to changing rates and therefore are more volatile to changing rates.

Question 13

What is a suitable use of zero coupon bonds from an investor’s point of view?

Answer 13

Since zeros mature at par, they are suitable for long term planning purposes where the investor wants a known lump sum available in the future.

Example: A parent wants to have a $50,000 lump sum available in 20 years to pay for their child’s graduate education. It would be suitable for them to buy $50,000 zero bonds now at a deep discount, knowing they will mature at $50,000.

Question 14

What are EuroDollar bonds?

Answer 14

EuroDollar bonds are US dollar demoninated bonds that are issued and/or traded outside of the US.

Question 15

How does the money market differ from the bond market?

Answer 15

Much Shorter Maturity

Although money markets have shorter maturities than the bond market, by defintion usually one year or less, they are just as important to funding the day-to-day operations of corporations and represent a very liquid, multi-billion dollar market.

Question 16

Who issues commercial paper?

Answer 16

Corporations

Commerical paper is issued by corporations as is used to raise short-term cash. These securities typically have a maximum maturity of nine months (270 days).

Question 17

For what purpose are bankers acceptance (BA) notes typically used?

Answer 17

To Finance International Trade

Question 18

What is a repo agreement and why do banks use them?

Answer 18

To Raise Short Term Cash

If a broker-dealer needs to raise cash, it can sell collateral to another party with an agreement to repurchase that same collateral at a defined price at some point in the future. The difference between the original sale price and the repurchase price is the interest charged for this loan.

Question 19

What are the specific tax benefits of U.S. government treasury bonds?

Answer 19

U.S. Treasuries are exempt from state and local taxes.

Question 20

For what return objective are T-Bills unsuitable for some investors?

Answer 20

T-Bills are very short term instruments sold at a discount and they provide no coupon payments. Because they have no cash flows, T-Bills, like zeroes, offer no current income. Investors seeking current income during a given period, such as retirement income, should avoid T-Bills.

Question 21

Describe the auction process of T-Bills.

Answer 21

T-Bills are offered weekly at auction, where primary dealers bid for the bills using their own capital and orders from customers. T-Bills are bought at discount in amounts of $1,000 to $1 million and mature in 13 and 26 weeks. The purchase price of T-Bills at auction is expressed as a percentage: a bid of 10 means that dealer is bidding that auction at a 10% discount to par.

Question 22

Describe how Treasury notes differ from T-Bills.

Answer 22

1. Notes mature between 2 and 10 years versus T-Bills, which mature in one year or less
2. Notes are issued with coupons and pay interest, unlike T-Bills, which are zeros
3. T-Bills are quoted as a discount off of par, while T-Notes are quoted as a percentage of par in increments of 1/32

Question 23

Describe how Treasury bonds differ from T-Bills.

Answer 23

1. Treasury bonds typically mature in 30 years whereas T-Bills have maturities of one year or less
2. T-Bonds are issued with coupons and pay interest, unlike T-Bills, which are zeros
3. T-Bills are quoted as a discount off of par, while T-Bonds are quoted as a percentage of par in increments of 1/32

Question 24

What are Treasury Receipts and how are they created?

Answer 24

Synthetic Zero Coupon Bonds

Treatury receipts are created by selling another security backed by the interest payments and principal of T-Bills and T-Notes. They are sold at a discount and pay no interim cash flows. Even though they are backed by treasuries, they do not carry any guarantee.

Question 25

What are STRIPS and how are they created?

Answer 25

• Separate Trading of Registered Interest and Principal of Securities (STRIPS)
• STRIPS work almost exactly like treasury receipts. but are backed by the government. A simple bond is split into two parts, its interest payment and it’s principal amount, and sold separately. The principal-only security works just like a zero coupon bond and is sold at a discount.

Question 26

What are TIPS?

Answer 26

Treasury Inflation Protection Securities (TIPS)

TIPS are issued with a fixed coupon, but in order to protect against inflation, the notional is linked to the Consumer Price Index.

Although the coupon is fixed, the interest payment will change as the notional changes and can both increase or decrease with inflation or deflation.

Question 27

What type of investor is suitable for TIPS?

Answer 27

Long-term investors

Investors who buy and hold TIPS usually are investing for things far into the future and are concerned about inflation eroding their purchasing power.

Question 28

Where do TIPS trade relative to other Treasury securities?

Answer 28

TIPS trade at lower yields

Anytime a fixed income instrument has some feature that will benefit the investor, it will trade at a lower yield relative to a nearly identical asset without that feature. So two-year TIPS always will trade with a lower yield than the two-year Treasury note.

Question 29

What types of government securities have no secondary market?

Answer 29

U.S. savings bonds

There is no secondary market for these bonds and to be sold must be redeemed with the U.S. Treasury.

Question 30

What are the two government-sponsored enterprises (GSE)?

Answer 30

1. Freddie Mac - Federal Home Loan Mortgage Corporation (FHLMC)
2. Fannie Mae - -Federal National Mortgage Association (FNMA)

As GSEs, they are not formally backed by the government but are presumed to carry government backing – a presumption tested during the financial crisis.

Question 31

How is Ginnie Mae (GNMA) different from Fannie and Freddie?

Answer 31

Fannie and Freddie are both government sponsored enterprised that have an implied but not explicit backing of the US government. Ginnae Mae is a government agency, which has an explicit backing of the US government and thus would be considered safer.

Question 32

What are the general yield characteristics of government sponsored enterprise debt relative to treasury or corporate debt?

Answer 32

Higher than treasuries - lower than corporates

Because the debt is not a direct obligation of the government, investors demand a higher yield for that small risk. Because GSE’s debt is significantly safer than corporate debt, they will carry a lower yield.

Question 33

What are the characteristics of GNMA debt?

Answer 33

Higher yield than treasuries

Even though backed by the U.S. Government, GNMA debt trades with a higher yield than do treasuries.

As mortgages that make up GNMA debt pay down, the principal notional of the bond is reduced every month and GNMA debt also pays interest every month.

The reason for the higher yield is the uncertainty of maturity.

Question 34

What is a significant risk characteristic of GNMA pass-through securities?

Answer 34

Re-investment risk when rates fall

GNMA pass-through securities are comprised of bundles of individual mortgages. In a falling rate environment, more home owners re-finance and that means more of the bonds’ notional is returned to investors, who are then forced to invest that money in the new lower-rate environment.

Question 35

What was the stated purpose of Freddie Mac?

Answer 35

Create a secondary mortgage market

In the past, there was no secondary market within which to sell the mortgages that local and community banks created. This limited the credit available for the housing market. FHLMC buys individual mortgages from these community banks, bundles them, and creates mortgage-backed securities from them.

Question 36

Describe the basic structure of a Collateralized Mortgage Obligation (CMO).

Answer 36

CMOS are mortgage backed securities that have been structured by broker-dealers and cut up into different pieces called tranches. The various tranches will all vary in credit quality, expected maturity, and exposure to pre-payments.

Question 37

What was the primary motivation of creating the CMO security?

Answer 37

Pre-payment risk management

Other pass through securities simply “pass through” interest and principal payments every month. This makes them very sensitive to interest rates as well as to shortened duration of the securities as more and more mortgages fare pre-payed via re-financing.

By creating tranches by credit risk and expected maturity, investors would have more certainty about what they actually were buying.

Question 38

How does a CMO control the expected maturity of a particular tranche?

Answer 38

Re-distributing cash flows

When principal payments are made by a mortgage holder, the CMO trustee will distribute those payments toward the retirement of the first tranche. By estimating the payments, it is possible to control the expected time when that tranche will be paid off. Once each tranche is paid off, the cash flow is directed toward paying off the next tranche.

Note: only the principal payments are re-directed. Normal interest payments are distributed to all the tranches.

Question 39

What type of CMO is the least extension risk?

Answer 39

Planned Amortization Class (PAC)

This type of CMO was created to fill the need for more specific maturity dates even in the event of mortgage prepayments. This prepaid cash is sent to other tranches referred to as a support tranche and the PAC is paid off on a defined schedule.

Question 40

Income taxes are assessed on which types of income?

Answer 40

The IRS taxes all income from wages and salaries, also called “ordinary income”. Investment income - capital gains, interest income, and dividends - are also taxable.

Question 41

How are cash dividends from stock taxed?

Answer 41

If an investor holds the stock for greater than 60 days during the 121 day period surrounding the ex-dividend date, the dividend will be classified as a qualified cash dividend and taxed at a preferential rate. If the investor does not meet that holding period, it will be defined as an ordinary cash dividend and taxed at the investor’s ordinary income rate.

Question 42

What types of capital gains are there?

Answer 42

There are short-term capital gains and long-term capital gains.

Question 43

How are short-term capital gains defined and taxed?

Answer 43

A short-term capital gain is one for which the asset was held 12 months or less. It is taxed as ordinary income, which is the same rate as an investor’s salary.

Question 44

How are long-term capital gains defined and taxed?

Answer 44

Long-term capital gains are assessed on assets held over 12 months. Long-term capital gains are taxed at a preferential rate, meaning a lower rate than what investors pay on their salary.

Question 45

What is the cost basis of a stock?

Answer 45

The cost basis is the effective price for the purpose of calculating taxes. Commissions will increase the cost basis of a stock. The taxable income will be the sale price minus the cost basis.

Question 46

What law governs how investment companies are regulated?

Answer 46

The Investment Company Act of 1940

Question 47

A Unit Investment Trust (UIT) is defined and regulated by the Investment Company Act of 1940. What is a UIT’s typical investment strategy?

Answer 47

A UIT will purchase a defined and fixed portfolio from a broad range of securities (often including stocks, bonds and munis) and has no restrictions on what kind of securities it can buy. Importantly, once the portfolio is created, it is fixed, meaning whatever is in the portfolio stays there. It is not actively managed.

Question 48

What are the fees that investors pay when they purchase UITs?

Answer 48

Similar to mutual funds, because UITs offer redeemable shares, investors pay sales charges when they purchase the units. They do not pay commissions as UITs are not exchange traded products.

Question 49

What is the termination date of a UIT?

Answer 49

The termination date of a UIT is the date when the trust ends and investors receive their proportionate share of the UITs net assets. For a bond UIT, the termination date often coincides with the maturity date of the bonds. For an equity UIT, the termination date is established when the UIT is created.

Question 50

If a UIT is a fixed portfolio of securities but consists of callable bonds, how does the portfolio change if that bond is called away?

Answer 50

The called bond is not replaced by another and will simply be taken out of the basket by the call. In this event, the investor will receive a cash distribution of proceeds. This is also the case as bonds mature. The trust can make any kind of interest payment: monthly, quarterly, or semi-annual.

Question 51

On what exchange can an investor sell their UIT?

Answer 51

None. There are no exchanges for UITs, they must be redeemed with the issuer.

Question 52

What types of management fees are UITs allowed to charge?

Answer 52

UITs are not allowed to charge any management fees since the UIT is fixed and there is no active buying and selling of securities.

Question 53

What are the benefits of a management investment company for investors?

Answer 53

In a management investment company, the investors’ funds are actively managed to acheive an investment objective. This means that the management company hires an investment adviser that will actively trade the portfolio to meet the fund’s goals.

Question 54

There are two types of management companies. What are they?

Answer 54

Open-end funds (aka mutual funds) and closed-end funds

Question 55

A closed-end fund trades most like what security?

Answer 55

Common stock. Similar to shares of a corporation, a closed-end fund have a one time initial public offering for shares that are actively traded on an exchange. Because the shares of a closed-end fund are exchange-traded, similar to common stock, the price of each share is based on supply and demand.

Question 56

An investor that is looking to buy an actively managed investment company security that trades throughout the day would most likely purchase which type of shares?

Answer 56

Closed-end funds would be most appropriate for investors as they combine active management with exchange-trading. Mutual funds also provide active management, but do not issue exchange-traded shares. Instead, the shares are only redeemable with the issuing investment company.

Question 57

What are the two key characteristics of a mutual fund?

Answer 57

Mutual funds, also referrred to as open-end funds, register a continuous offering of redeemable shares. This means that there is no secondary market for mutual funds, the shares are redeemable, meaning bought and sold directly with the mutual fund itself. Also, importantly, mutual funds are actively managed

Question 58

On what exchange do open-ended funds trade?

Answer 58

Mutual funds do not trade on a secondary market. Instead, the shares are reedeemed by the investor with the fund.

Question 59

What defines a diversified investment company?

Answer 59

For an investment company to qualify as diversified, the following 75-5-10 test must be met:

• At least 75% of the fund’s total assets must be invested in securities issued by companies other than the investment company itself
• Of that 75%,
  
  • No more than 5% of the fund’s total assets can be investment in the securities of any one issuer, and
  • No more than 10% of the outstanding voting securities of any one issuer can be owned.

Question 60

One of the benefits of open-end investment companies is professional management. Who hires the manager?

Answer 60

Fund managers are generally hired by the board of directors of the investment company.

Question 61

Define:

advance/decline trend

Answer 61

The difference in up and down days of a security - used in technical analysis as a market movement indicator. When declines outnumber advances by a large amount, that is typically a bearish indicator and when advances outnumber declines by a large amount, that is typically a bullish indicator.

Question 62

The top of a stock’s normal trading range

Answer 62

Resistance

Question 63

The bottom of a stock’s normal trading range

Answer 63

Support

Question 64

Price-weighted index of 30 “blue chip” U.S. stocks of industrial companies

Answer 64

Dow Jones Industrial Average

Question 65

Capitalization-weighted index of 500 stocks, regarded as the standard for measuring large-cap U.S. stock market performance

Answer 65

S&P 500

Question 66

Defines and regulates investment companies, including mutual funds

Answer 66

Investment Company Act of 1940

Question 67

Share value of OTC, non-NASDAQ stock subject to the Penny Stock Cold Calling Rules

Answer 67

Less than $5 per share

Question 68

Under penny stock rules, an established customer is

Answer 68

1) Someone who has made at least three penny stock purchases of different issuers on different days or 2) someone who has held an account with the broker-dealer for at least one year.

Question 69

An unsecured corporate bond

Answer 69

Debenture

Question 70

Security with the most junior claim in a corporate liquidation

Answer 70

Common stock

Question 71

Agency debt that is backed in full by the U.S. government

Answer 71

Ginnie Mae

Question 72

Considered the safest form of debt issued in the U.S.

Answer 72

U.S. Government bonds, notes and bills

Question 73

Taxable at the federal level; may be exempt from taxation at the state level

Answer 73

U.S. Government bonds and notes

Question 74

Of long-term and short-term bonds, which generally pays a higher interest amount?

Answer 74

Long-term bonds

Question 75

Of long-term and short-term bonds, which generally has lower price volatility?

Answer 75

Short-term bonds

Question 76

The degree of risk associated with an issuer’s ability to repay the principal

Answer 76

Credit or default risk

Question 77

A bond that is rated BBB or above by Standard and Poor’s

Answer 77

Investment Grade

Question 78

Risk that a bond may be called prior to maturity

Answer 78

Call risk

Question 79

Specific time period from date of issue when a bond cannot be called

Answer 79

Call Protection Period

Question 80

Type of bond issue that is not typically callable

Answer 80

U.S. Government bonds (Treasury bonds)

Question 81

Risk that proceeds from a called bond cannot be invested as favorably

Answer 81

Reinvestment risk

Question 82

Bonds backed only by the good faith of the issuing corporation

Answer 82

Unsecured bonds or debentures

Question 83

Typically backed by real estate holding of a corporation

Answer 83

Mortgage bond

Question 84

Typically secured by other securities owned by the corporation

Answer 84

Collateral Trust bond

Question 85

Secured by physical assets owned by the company

Answer 85

Equipment trust certificates

Question 86

Allow for the exchange of debt for equity issued by the same corporation

Answer 86

Convertible debt

Question 87

The stated number of common shares a bondholder receives upon conversion

Answer 87

Conversion ratio

Question 88

The point at which there is neither profit or loss in a conversion

Answer 88

Conversion parity

Question 89

Purchased at a deep discount; pays no interest during the life of the bond

Answer 89

Zero-coupon bond

Question 90

The amount of interest paid prior to maturity on a Treasury Bill

Answer 90

None, T-Bills are zero coupon securities

Question 91

U.S. Government instrument that matures in 1 year or less

Answer 91

Treasury Bill

Question 92

U.S. Government instrument sold through weekly auctions

Answer 92

Treasury Bill

Question 93

U.S. Government instrument that is quoted on an annualized discounted yield basis

Answer 93

Treasury Bill

Question 94

U.S. Government instruments that matures within 2 -10 years

Answer 94

Treasury Note

Question 95

U.S. Government instruments that typically mature in 20 - 30 years

Answer 95

Treasury Bonds

Question 96

U.S. government instruments that are quoted in 32nds

Answer 96

Treasury Notes and Treasury Bonds

Question 97

Inflation-indexed bonds issued by the U.S. Treasury

Answer 97

TIPS

Question 98

U.S. government zero-coupon bond instrument that has no reinvestment risk

Answer 98

STRIP

Question 99

Three government entities that issue mortgage-backed securities

Answer 99

Ginnie Mae, Fannie Mae and Freddie Mac

Question 100

Agency that provides student loans

Answer 100

Sallie Mae

Question 101

Investment risk most associated with mortgage-backed securities

Answer 101

Prepayment risk

Question 102

Investment risk that coincides with early payment of a mortgage-backed securities

Answer 102

Reinvestment risk

Question 103

Distinct maturity categories of CMOs

Answer 103

Tranches

Question 104

Frequency of interest payments on mortgage-backed securities

Answer 104

Monthly

Question 105

Mortgage-backed securities with the implied backing of the U.S. government

Answer 105

Fannie Mae and Freddie Mac

Question 106

Debt securities that provide immediate term financing

Answer 106

Money market securities

Question 107

Denomination of CMOs

Answer 107

$1,000

Question 108

Protects convertible bondholders from a reduction in ownership percentage

Answer 108

Anti-dilution covenant

Question 109

The relationship of the coupon rate of a corporation’s convertible debt to its non-convertible debt

Answer 109

Lower

Question 110

The type of risk rated by Moody’s, Standard & Poor’s and Fitch

Answer 110

Default or Credit Risk

Question 111

The risk that the issuer will not be able to pay the principal and interest owed on outstanding debt securities

Answer 111

Default or Credit Risk

Question 112

A bond which can be sold at face value back to the issuer prior to maturity at pre-determined times

Answer 112

Puttable bond

Question 113

Corporate secured bonds that have the highest priority claim

Answer 113

Mortgage bonds

Question 114

Type of corporate security that is backed by the title to newly acquired equipment

Answer 114

Equipment trust certificate

Question 115

Two companies that rate bond issues

Answer 115

Moody’s and Standard and Poor’s (also Fitch)

Question 116

Type of bonds often issued by corporations emerging from bankruptcy that pay interest only if income is available

Answer 116

Income bond

Question 117

The stock price at which a convertible bond can be exchanged for shares of common stock

Answer 117

Conversion price

Question 118

Zero coupon securities created from U.S. Treasury notes and bonds by brokerage firms

Answer 118

Treasury receipts

Question 119

Percentage of net investment income that a REIT must distribute to avoid corporate taxation

Answer 119

90%

Question 120

For a REIT, the minimum percentage of investment assets that must be invested in real estate

Answer 120

75%

Question 121

The minimum percentage of gross income that a REIT must derive from rents or mortgage interest

Answer 121

75%

Question 122

Where REIT shares or certificates of beneficial interest can be purchased

Answer 122

OTC or on a stock exchange

Question 123

Type of investment that passes through real estate income but not losses

Answer 123

REIT

Question 124

Permit after-tax contributions of up to $2,000 per student for children under age 18 for educational purposes

Answer 124

Coverdell Education Account (Education Savings Account)

Question 125

Age at which funds from Coverdell accounts must be distributed or rolled into an ESA for another family member

Answer 125

30

Question 126

Federal tax status of contributions made to Section 529 plan

Answer 126

After-tax

Question 127

Tax advantage available for 529 plan contributions in many states to state residents

Answer 127

Contributions to 529 plan sponsored by that state are tax deductible on state tax returns

Question 128

Tax rate increases as income increases

Answer 128

Progressive tax

Question 129

Taxes that are levied equally regardless of income

Answer 129

Regressive taxes

Question 130

An example of a regressive taxes

Answer 130

Sales taxes

Question 131

Two examples of progressive taxes

Answer 131

Income, estate

Question 132

Three types of income subject to taxation

Answer 132

Earned, passive, portfolio

Question 133

Three taxable forms of portfolio income

Answer 133

Interest, dividends and capital gains

Question 134

Minimum holding period for lower long-term capital gains tax rate

Answer 134

1 year and 1 day

Question 135

Short-term holding period for capital gains tax computation

Answer 135

1 year or less

Question 136

Maximum amount of capital loss that can be used to offset current income each year

Answer 136

$3,000

Question 137

Period of time for which capital losses can be carried forward

Answer 137

Indefinitely

Question 138

Transaction which disqualifies capital loss because substantially similar securities are repurchased within 30 days

Answer 138

Wash sale

Question 139

Number of days before or after a sale for a loss for which a purchase of substantially similar securities must be avoided

Answer 139

Thirty days

Question 140

Under the wash sale rule, purchases of any of these four securities of the same issuer are considered substantially identical to purchases of the issuer’s stock

Answer 140

Long calls, rights, warrants and convertible bonds

Question 141

Three accounting methods available for determining which shares to liquidate

Answer 141

FIFO, share identification, average basis

Question 142

Method of share identification assigned by the IRS if no other method is chosen

Answer 142

FIFO

Question 143

How are qualified cash dividends taxed?

Answer 143

They are taxed at a preferential rate (meaning lower rate) than the investors ordinary income

Question 144

Cash dividends that are eligible for taxation at the same rate as long-term capital gains

Answer 144

Qualified

Question 145

Minimum holding period of stock for dividends to be classified as qualified

Answer 145

Sixty-one days during the 121-day period surrounding the ex-dividend date

Question 146

Tax implication of stock splits and stock dividends

Answer 146

Reduction to cost basis; no current taxation

Question 147

The amount of investment in property; used to determine the gain or loss at time of sale

Answer 147

Cost basis

Question 148

The accounting method that allows an investor to select which shares to liquidate for tax purposes

Answer 148

Share identification

Question 149

Shares that would be liquidated first to result in the lowest possible capital gain

Answer 149

Shares with highest cost basis

Question 150

The date which determines the amount of the tax deduction for charitable donations of appreciated property

Answer 150

Date the donation is made

Question 151

The amount of tax deduction available for gifts of securities made to family members or others

Answer 151

None, as only charitable donations receive a tax deduction

Question 152

The recipient’s cost basis for gifts of securities from family members or others

Answer 152

Original cost basis of the donor

Question 153

The cost basis of securities that are left to an heir

Answer 153

Market value of the securities on the date of the death of the owner

Question 154

The current annual gift tax exclusion amount

Answer 154

$17,000

Question 155

The tax provision that allows married persons to transfer their entire estate to the surviving spouse at death without taxation

Answer 155

Unlimited marital deduction

Question 156

The person responsible for payment of gift taxes due

Answer 156

Donor

Question 157

Interest on bonds of these two issuers is taxable at the federal, state and certain local levels

Answer 157

Corporations and agencies

Question 158

Interest on bonds of this issuer is taxable at the federal level but exempt from taxation at the state and local level

Answer 158

U.S. Government

Question 159

Amount of gift tax that applies on gifts between spouses

Answer 159

No gift tax regardless of amount

Question 160

Tax treatment of withdrawals from Section 529 Plans

Answer 160

Tax free withdrawals (after-tax contributions)

Question 161

Tax nature of contributions to Section 529 Plans

Answer 161

After tax contributions

Question 162

Annual contribution to a Coverdell ESA is

Answer 162

$2,000 per beneficiary (non-deductible)

Question 163

Investment requirement and pass-through requirement for REITs to qualify for favorable tax treatment

Answer 163

75% of assets invested in real estate and 90% of income passed through to investors

Question 164

Two types of Investment Companies defined by the Investment Company Act of 1940

Answer 164

Unit Investment Trust and Management Company

Question 165

Management company shares that may trade at a price more or less than their net asset value

Answer 165

Closed-ended Investment companies

Question 166

Three types of securities that closed-end companies can issue

Answer 166

Common shares, preferred shares and bonds

Question 167

An investment company that meets the 75-5-10 test

Answer 167

Diversified

Question 168

Type of management company that can issue shares continuously

Answer 168

Open-end

Question 169

Type of management company that issues a fixed number of shares in a single offering

Answer 169

Closed-end

Question 170

Type of management company that can issue only equity shares

Answer 170

Open-end

Question 171

Type of management company that can issue both equity and debt

Answer 171

Closed-end

Question 172

Type of management company shares that are redeemed by the issuer

Answer 172

Open-end

Question 173

Type of management company shares that trade in the secondary market

Answer 173

Closed-end

Question 174

The difference between the Public Offering Price and Net Asset Value

Answer 174

Sales load

Question 175

Type of management company shares that are priced by formula

Answer 175

Open-end

Question 176

Type of management company shares that are priced by supply and demand

Answer 176

Closed-end

Question 177

An investment company which issues redeemable securities and is not actively managed

Answer 177

Unit investment trust

Question 178

The price at which an investor purchases closed-end company shares

Answer 178

Ask price

Question 179

Type of management company that offers shares through a continuous primary offering

Answer 179

Open-end

Question 180

The only type of securities that mutual funds can issue

Answer 180

Common shares

Question 181

Form that mutual funds send shareholders annually to report taxability of distributions

Answer 181

1099

Question 182

Section of the Investment Company Act of 1940 that permits funds to charge ongoing fees for marketing and distribution

Answer 182

Section 12b-1

Question 183

Securities legislation that defines management companies and registration requirements

Answer 183

Investment Company Act of 1940

Question 184

Maximum sales charge for mutual funds permitted by FINRA rules

Answer 184

8.5% of POP

Question 185

Maximum annual 12b-1 fee permitted by the Investment Company Act of 1940

Answer 185

.75% of average annual net assets

Question 186

Quantity purchase discounts that apply to individuals who purchase funds within the same fund family

Answer 186

Breakpoints

Question 187

Document that allows an investor to receive a discounted sales charge on current and future funds invested within the same fund family

Answer 187

Letter of Intent

Question 188

Maximum duration of a Letter of Intent

Answer 188

13 months

Question 189

The maximum time allowed to backdate a Letter of Intent

Answer 189

90 days

Question 190

Allows for reduction of sales charges on subsequent purchases based on combining additional purchases with prior share appreciation

Answer 190

Rights of accumulation

Question 191

Maximum time limit for Rights of Accumulation

Answer 191

There are no time limits imposed on Rights of Accumulation

Question 192

FINRA violation which involves encouraging a customer to purchase shares at a point below an available sales charge reduction

Answer 192

Breakpoint sale

Question 193

Mutual fund share class with a front end sales load

Answer 193

Class A shares

Question 194

Mutual fund share class with a back-end load and 12b-1 fees

Answer 194

Class B shares

Question 195

Mutual fund share class with 12b-1 fees charged quarterly

Answer 195

Class C shares

Question 196

The pricing concept that defines the purchase and redemption of mutual fund shares at the next calculated price

Answer 196

Forward pricing

Question 197

Life insurance company contract designed to provide a stream of guaranteed income payments for life

Answer 197

Annuity

Question 198

The insurance company account in which variable annuity payments are invested

Answer 198

Separate account

Question 199

A directly managed variable annuity’s category of registration under the Investment Company Act of 1940

Answer 199

Open-end management company

Question 200

The two phases of a variable annuity contract

Answer 200

Accumulation phase and Annuity phase

Question 201

The benchmark rate used during annuitization for determining the amount of income paid from month to month

Answer 201

Assumed Interest Rate

Question 202

The impact on the monthly payment from a variable annuity, as compared to the previous month, if the separate account performance is greater than the AIR

Answer 202

Increase

Question 203

The transition from the accumulation to the payout phase of a variable annuity

Answer 203

Annuitization

Question 204

The penalty that applies if funds are withdrawn from an annuity before age 59 1/2.

Answer 204

10% penalty on earnings

Question 205

Price at which open-end company shares are purchased

Answer 205

Public Offering Price (POP)

Question 206

Price at which open-end company shares are redeemed

Answer 206

Net Asset Value (NAV)

Question 207

An investment company fund with assets concentrated in a single industry

Answer 207

Specialized or sector fund

Question 208

A management investment company with no provision for redeeming outstanding shares

Answer 208

Closed-end

Question 209

Performs customer service functions on behalf of the mutual fund

Answer 209

Transfer agent

Question 210

Responsible for the safekeeping and segregation of a mutual fund’s securities

Answer 210

Custodian

Question 211

Implements the investment strategy and invests on behalf of the mutual fund

Answer 211

Investment adviser

Question 212

Defines the fund’s investment objectives and oversees the direction of the fund

Answer 212

Board of Directors

Question 213

Board Members who are independent or not connected with the mutual fund’s key functions

Answer 213

Noninterested Parties

Question 214

The amount of mutual fund Board members that must be noninterested

Answer 214

Majority (*note that for funds that do not charge a 12b-1 fee, the board must only be made up of 40% noninterested persons)

Question 215

Also known as the sponsor or distributor, and is responsible for selling and marketing funds shares

Answer 215

Underwriter

Question 216

Compensated by a percentage of a mutual fund’s assets

Answer 216

Investment adviser

Question 217

Paid a fee by a mutual fund to perform their functions

Answer 217

Custodian and transfer agent

Question 218

Paid from sales charges to perform its function

Answer 218

Underwriter

Question 219

The type of interest an investor owns in a mutual fund portfolio

Answer 219

Undivided

Question 220

Type of security typically held by mutual funds with growth objectives

Answer 220

Common stock

Question 221

Three types of securities that are held by mutual funds with income objectives

Answer 221

Bonds, preferred stock, blue chip common stock

Question 222

Type of mutual fund that is focused on generating capital gains, and tends to reinvest most earnings

Answer 222

Growth fund

Question 223

Type of mutual fund with low portfolio turnover and low expenses that tracks market performance

Answer 223

Index fund

Question 224

Type of mutual fund that invests in stock for appreciation and bonds for income

Answer 224

Balanced

Question 225

Type of mutual fund that authorizes the fund adviser to rebalance the percentage of holdings between cash and different investment categories

Answer 225

Asset allocation fund

Question 226

Usually sold with no sales or liquidation fees

Answer 226

Money market funds

Question 227

NAV of a single share of a money market fund

Answer 227

$1

Question 228

Mutual fund that offers tax-exempt income to shareholders

Answer 228

Municipal bond fund

Question 229

Type of mutual fund that is best suited to an investor seeking maximum safety

Answer 229

U.S. government bond fund

Question 230

Maximum remaining maturity of funds held within a money market portfolio according to SEC rules

Answer 230

13 months

Question 231

Fund expenses/average net assets

Answer 231

Expense ratio

Question 232

Expresses the rate at which a fund replaces the securities held in its portfolio

Answer 232

Portfolio turnover ratio

Question 233

Type of fund that is likely to have a high expense and portfolio turnover ratio

Answer 233

Aggressive growth fund

Question 234

The maximum amount of 12b-1 fee a no-load fund can charge

Answer 234

0.25%

Question 235

Fund’s NAV/Number of Shares Outstanding

Answer 235

NAV per share

Question 236

The impact on NAV per share when portfolio securities increase in value

Answer 236

Increase in NAV

Question 237

The impact on NAV per share when shares are sold or redeemed

Answer 237

No impact

Question 238

NAV + Sales Charge

Answer 238

POP

Question 239

Another name for a back-end load

Answer 239

Contingent deferred sales charge

Question 240

Equation to calculate a mutual fund share’s POP

Answer 240

NAV/(100% - sales charge %)

Question 241

Objective is to purchase mutual fund shares at a lower average cost per share than average price per share

Answer 241

Dollar cost averaging

Question 242

Three types of mutual fund systematic withdrawal plans

Answer 242

Fixed share, fixed percentage and fixed time withdrawal plans

Question 243

A risk associated with the loss of buying power from a fixed annuity’s payment

Answer 243

Purchasing power risk

Question 244

The annuity payout option the provides the largest monthly income amount

Answer 244

Life income (also called life only or straight life)

Question 245

The annuity payout option that guarantees that income will be paid for the lives of two individuals

Answer 245

Joint life with last survivor

Question 246

An annuity which begins paying income within 60 days of purchase

Answer 246

Immediate annuity

Question 247

An annuity in which purchase payments are deposited according to a premium payment schedule until payments are started

Answer 247

Periodic payment deferred annuity

Question 248

An annuity that provides both fixed and variable annuity benefits

Answer 248

Combination annuity

Question 249

The insurance company account in which fixed annuity payments are invested

Answer 249

General account

Question 250

A risk assumed by the owner of a variable annuity

Answer 250

Investment risk

Question 251

Type of annuity that guarantees the rate of return that will be earned on the investment

Answer 251

Fixed annuity

Question 252

The fee charged by an insurance company for guaranteeing annuity income for life

Answer 252

Mortality fee

Question 253

Disclosure document that must be provided to investors when variable annuities or mutual funds are sold

Answer 253

Prospectus

Question 254

An accounting measure used to determine the owner’s interest in the separate account when purchasing a variable annuity

Answer 254

Accumulation unit

Question 255

Letters of intent for mutual funds can be backdated for

Answer 255

90 days

Question 256

The most suitable mutual fund share class for a substantial fund investor with a long term perspective

Answer 256

Class A

Question 257

To levy maximum sales charge, fund must offer both

Answer 257

breakpoints and rights of accumulation

Question 258

Distributions from 403(b) plans are

Answer 258

100% taxable

Question 259

The four phases of the economic cycle

Answer 259

Expansion, peak, trough and contraction

Question 260

Measures the general rate of increase or decrease in prices paid for certain standard goods

Answer 260

Consumer Price Index (CPI)

Question 261

What is considered the most volatile interest rate

Answer 261

Federal funds rate

Question 262

Uses charts and historic trading patterns to determine when to move in to and out of the markets

Answer 262

Technical analysis

Question 263

Bases investment decisions on broad-based market trends, and analysis of financial firm financial reports

Answer 263

Fundamental analysis

Question 264

Defensive, Cyclical or Growth Industry?

Food

Answer 264

Defensive

Question 265

Defensive, Cyclical or Growth Industry?

Utilities

Answer 265

Defensive

Question 266

Defensive, Cyclical or Growth Industry?

Steel

Answer 266

Cyclical

Question 267

Defensive, Cyclical or Growth Industry?

Automobile

Answer 267

Cyclical

Question 268

Defensive, Cyclical or Growth Industry?

Technology

Answer 268

Growth

Question 269

Basic balance sheet equation

Answer 269

Assets - Liabilities = Net Worth

Question 270

Financial statement that summarizes revenues and expenses

Answer 270

Income statement

Question 271

Features charting and market timing

Answer 271

Technical analysis

Question 272

Predicts company performance based on financial statements and overall economic health

Answer 272

Fundamental analysis

Question 273

Characterized by falling stock markets, rising inventories, declining GDP

Answer 273

Contraction

Question 274

Characterized by low unemployment , increased business activities

Answer 274

Expansion

Question 275

In a liquidation, where do bondholders stand relative to equity holders?

Answer 275

In the event of a liquidation, bondholders have senior status and they are in line for assetsahead of both common and preferred stockholders.

Question 276

What is the meaning of call protection?

Answer 276

This is a period of time defined in the bond’s indenture during which the bond cannot be called, no matter what happens to interest rates.

Question 277

What risk does an investor face if their bond is called?

Answer 277

The investor will face reinvestment rate risk as they will need to take the proceeds from their bond and reinvest them back into the market at a time when interest rates are falling.

Question 278

How can a lower rating impact bond trading?

Answer 278

Lower prices and potential greater volatility

Question 279

How are Treasury bonds quoted?

Answer 279

Treasuries are quoted in 32nd of a point. So, a Treasury bond trading at 98-16, is trading at 98-16/32. This bond would have a dollar value of $985.

Question 280

What distinguishes the return profile of a convertible bond from a common debt issue?

Answer 280

• A convertible bond has a mixed return profile, with elements of equity returns as well as some of the security of a fixed-income instrument.
• A convertible bond is “convertible” into common equity at some defined ratio. So, as stock returns rise, the implied option to convert the bond into stock drives appreciation of the underlying bond.

Question 281

Define:

Convertible Bond Parity

Answer 281

At parity, an investor is indifferent between holding the convertible bond or converting into the underlying shares of stock because either way they have the same total value.

Question 282

If a bond is trading at $950 and has a coonversion price at $50, how many shares is the bond convertible into?

Answer 282

To determine the number of shares the investor can convert into, you must calculate the conversion rate, which is the par value of the bond divided by the conversion price. Be careful to use par rather than the market price of the bond for this calculation.

$1,000/$50 = 20 shares

Question 283

If a bond is convertible into 25 shares and is trading at $980, what is the parity price?

Answer 283

To calculate the parity price of the stock, take the market value of the bond dividend by the conversion ratio.

$980/25 = $39.20

Question 284

If the convertible bond is trading at $960 and is convertible into 15 shares, what is the parity price?

Answer 284

To calculate the parity price of the stock, take the market value of the bond dividend by the conversion ratio.

$960/15 = $64

Question 285

The duration of a bond is equal to:

Answer 285

Duration is a measure of sensitivity to interest rate changes. Therefore, duration is the percentage change in price that corresponds to a given change in interest rates. For exam purposes, they will not make you calculate duration, though it is important to understand that bonds with a longer duration are more volatile to changing interest rates.

Question 286

The main difference between a fund with a global style and a fund with an international style is that a(n):

Answer 286

global fund makes both foreign and domestic investments

Global funds invest in both domestic and international securities, whereas international funds invest in international securities only.

Question 287

What is the payout ratio of a common stock?

Answer 287

Payout ratio measures the percentage of a company’s earnings that are paid to stockholders as a dividend. It is calculated as annual dividends per share/ earnings per share.

High-growth companies that reinvest earnings into the company may declare no divdend and therefore not have a payout ratio. Other companies, such as utility companies, that traditionally have offered higher dividends will have higher payout ratios.

Question 288

How do investment companies report taxable income to investors?

Answer 288

The investment company will send the investor a Form 1099.

Question 289

What are two factors that impact bond price volatility?

Answer 289

coupon; maturity

Long-term, low coupon bonds (including zeros) will be most impacted by a change in interest rates.

Question 290

The risk that a bond will be called prior to maturity is known as

Answer 290

Call Risk

Call risk is the risk that a debt security will be called prior to maturity. This will occur in an environment when interest rates are falling.

Question 291

Collateral trust bonds are backed by:

Answer 291

the issuer’s securities portfolio (e.g. stocks and bonds it owns)

Question 292

at type of corporate debt is backed by legal a claim on some specified property of the issuer in the event of default?

Answer 292

Secured

Secured bonds are backed by collateral, to provide protection against issuer default.

Question 293

For a given change in yield, bonds with higher coupons undergo:

Answer 293

Smaller price changes than those on bonds with lower coupons

This relationship shows that bond price volatility is inversely related to coupon size.

Question 294

All else equal, the longer the maturity of a bond:

Answer 294

The greater the price volatility

The longer the maturity of a bond, the greater the price volatility resulting from a change in market yields.

Question 295

How does a sinking fund impact credit risk?

Answer 295

A sinking fund reduces default risk because it requires the issuer to set aside cash each year to have enough to redeem the bonds at maturity.

Question 296

Treasury bills, notes, and bonds are first sold:

Answer 296

In auction

Question 297

A portfolio manager wishes to construct a portfolio of bonds that will exhibit very little market value sensitivity to changes in interest rates.

Which of the following strategies would be consistent with this desire?

A. The portfolio manager should purchase as many zero coupon bonds as possible.

B. The portfolio manager should purchase bonds with relatively long maturities.

C. The portfolio manager should purchase high coupon bonds with short maturities.

D. The portfolio manager should purchase a wide variety of bonds with exposure to as many maturities as possible. It would also help to obtain a good mix of both high coupon bonds and equal weighting in low and zero coupon bonds.

Answer 297

C

When all other factors are constant, bonds with short maturities and relatively high coupons will be less sensitive to changes in interest rates.

Question 298

T-bills have a maturity of:

Answer 298

One year or less

Question 299

How is interest income from mortgage-backed securities issued by government agencies treated for tax purposes?

Answer 299

The interest income is taxable at all levels

Question 300

The presence of a sinking fund provision will have what impact on the yield of an issue?

Answer 300

Reduces the yield on a bond issue

The presence of a sinking fund provision is preferred by the bondholder because it reduces the level of risk on the bond as the issuer will be setting aside capital each year to retire the bond. Because of this reduce risk, the issuer can pay investors a lower yield.

Question 301

The presence of a call provision has what impact on a bond’s yield?

Answer 301

Increases the yield on a bond issue

A call provision is exercised when market interest rates have fallen far enough below the bond yield to make exercise profitable for the issuer. This would be to the disadvantage of the bondholder, because the bondholder would then have to give up the high rates previously received. Investors charge the issuer for including call provisions via a higher yield.

Question 302

Are T-Bills issued with fixed coupons?

Answer 302

No

T-bills are sold at a discount from their par value. This discount provides the yield on the obligations. Unlike other U.S. government obligations, there are no coupon payments on T-bills.

Question 303

The interest income from U.S. government securities is subject to which level of taxation?

Answer 303

Federal income tax

The interest income from U.S. government securities is exempt from state and local taxes, but is subject to federal income tax.

Question 304

Treasury and agency bonds are traded in increments of:

Answer 304

1/32 of one percent of par value

Treasury and agency bond prices are quoted as percentages of par value. The smallest increment of change in the quoted price is 1/32 of one percent. For example, the smallest possible change on a bond last traded at 98% of par value is a change to 98 1/32% or 97 31/32% of par value.

Question 305

As a portfolio manager, you have a significant portion of your bond portfolio maturing in the next few weeks. You are concerned that rates have dropped since you purchased these bonds and that the yields that you will get by reinvesting the proceeds will be smaller than what you now are receiving. This type of risk associated with investing in debt securities is known as

Answer 305

Reinvestment rate risk

Question 306

An investor has several mortgage-backed securities in their portfolio. If interest rates fall significantly, they would be most concerned with

Answer 306

Prepayment risk

Question 307

What tranche pays to interest until all preceding CMO tranches are repaid?

Answer 307

Z-tranche

Question 308

Unlike other fixed income securities, mortgage-backed securities do not have a fixed maturity date. This is because

Answer 308

the borrower has the option to prepay the mortgage at any time

Question 309

What is the role of a support tranche in a CMO structure?

Answer 309

To provide prepayment protection to PAC tranches.

Question 310

An increase in the average life of a mortgage-backed security is referred to as?

Answer 310

Extension risk

Extension risk occurs when interest rates rise and homeowners do not prepay their mortgages as quickly as initially expected.

Question 311

What is extension risk?

Answer 311

It is the risk that when interest rates rise, mortgage prepayments fall and therefore the time horizon of the mortgage-backed securities will increase.

Question 312

Rising rates tend to slow the prepayments on mortgage-backed securities. This risk is referred to as

Answer 312

extension risk

Question 313

Which CMO tranche protects investors against both prepayment and extension risk?

Answer 313

Planned amortization class (PAC) CMOs

Question 314

What type of CMO class protects against prepayment, but not extension risk?

Answer 314

Targeted Amortization Class (TACs) CMOs

Question 315

Which pays a higher yield, a TAC bond or a PAC bond?

Answer 315

A PAC bond (Planned Amortization Class CMO) aims to protect against both prepayment and extension risk. A TAC bond (Targeted Amortization Class CMO) protects only against prepayment risk. Because a TAC bond offers less protection, it offers a higher yield to investors.

Question 316

You hear an investor say:

“PAC bondholders have priority over principal payments in a CMO. As such, the cash flows to PACs are more stable and their exposure to extension risk is greatly reduced at the expense of increased prepayment risk.”

Is this correct?

Answer 316

This is incorrect as the cash flow structure of a Planned Amortization Class CMO provides protection against both extension and prepayment risk

Question 317

As interest rates fall, homeowners will often refinance their outstanding mortgages. The risk this creates for investors in mortgage-backed securities is

Answer 317

prepayment risk

Question 318

Principal-Only CMOs will increase in value when

Answer 318

interest rates fall and prepayment accelerate.

Question 319

Interest-Only CMOs will increase in value when

Answer 319

interest rates rise and prepayments fall as this will extend the number of interest payments that the investor will receive.

Question 320

When compared to agency CMOs, private label CMOs have greater

Answer 320

credit risk

Non-agency securities do not carry the support or guarantee of the federal government as do agency securities. Therefore, they have greater default risk and pay higher yields to investors.

Question 321

When comparing agency versus private label CMOs, which typically has a higher credit quality and lower yield?

Answer 321

Agency CMOs are backed by Ginnie, Fannie, and Freddie MBS. Therefore, because the underlying MBS have the explicit or implied backing of the US Government, these securities will be safe than private label CMOs which are backed by MBS issued by private institutions.

Question 322

The analysis of a company based on its financial statements and business prospects is referred to as

Answer 322

fundamental analysis

Question 323

What type of mutual fund invests in both U.S. and foreign stocks?

Answer 323

Global funds

Global funds contrast with nternational mutual funds which nvest wholly outside the United States.

Question 324

If a US investor wants to be liquid shares of a foreign company, they can purchase

Answer 324

American Depository Receipts (ADRs)

Question 325

Which type of bonds have the most senior position in a company’s corporate structure?

Answer 325

secured debt

Secured bonds are the most senior bonds in a firm’s capital structure and have the lowest risk of distress or default.

Question 326

What type of bonds only pay interest if the company is profitable?

Answer 326

income bonds

Income bonds are issued by company’s emerging from bankruptcy. They only pay interest if the company is profitable and therefore are not actually appropriate for investors that are seeking income.

Question 327

Convertible bonds generally pay lower interest rates than non-convertible debentures of comparable risk because:

Answer 327

Investors are given the benefit to convert their shares into the company’s underlying equity

Question 328

Which of the following is/are true about debentures?

1. Debentures are not backed by any specific collateral.
2. If the issuer does not make interest and principal payments, debenture holders can declare the firm bankrupt and claim any unpledged assets to pay off the debentures
3. Debentures have a higher yield than comparable secured bonds,

Answer 328

I, II, and III

Debentures are unsecured corporate debt. Because debentures are not backed by any collateral, they have higher yields than comparable secured bonds.

Question 329

ADRs pay dividends in what currency?

Answer 329

US Dollars

When a foreign company declares a dividend, a bank will convert that foreign dividend payment into US dollars for the ADR holder.

Question 330

What type of mutual fund is most appropriate for an investor looking to add short-term liquidity to their portfolio?

Answer 330

money market fund

Question 331

Corporate bonds can contain a variety of features and forms. Which of the following descriptions of these features is inaccurate?

• A sinking fund allows an issuer, at its discretion, to set aside cash each year to redeem the bonds at maturity
• Call provisions specify when a firm can issue a call for the bond before maturity, thus redeeming a portion of its outstanding debt
• Debentures promise interest and principal payments, but do not pledge specific assets (collateral) to back their promise
• Income bonds have payment schedules but only are payable if the company earns the income required to make the payments

Answer 331

A sinking fund is a required deposit each year, not at the company’s discretion

Question 332

An individual wants to invest in a foreign stock, but is considered about having to select individual companies to invest in. What type of security can she invest in?

Answer 332

International mutual funds

ADR’s, American Shares, and Direct purchase can be inconvenient and/or relatively illiquid. International mutual funds provide a convenient way to achieve the benefits of international diversification on a small scale.

Question 333

How are REIT dividends taxed for investors?

Answer 333

All REIT dividends are taxed as ordinary income. There is no preferential rate for REIT dividends.

Question 334

In order for REITs to pass through gains to investors and avoid corporate taxes, which three qualifications must be met?

Answer 334

• At least 75% of the income must be derived from real estate
• At least 75% of all the assets must be invested in real estate
• At least 90% of net investment income must be distributed to shareholders

Question 335

Do REITs pass through gains and losses to investors?

Answer 335

REITs only pass through gains and not losses to shareholders. Losses are reflected by the value of the shares declining.

Question 336

Define:

Real Estate Investment Trust

Answer 336

An actively managed pool of capital that invests in real estate or real-estate-related assets (i.e., mortgages). These investments combine professional management, diversification, exchange-trading, and tax benefits, since gains (but not losses) are passed through to investors.

Question 337

Define:

Equity REIT

Answer 337

A type of REIT that owns income-producing real estate. Equity REITs’ revenues typically come from rent on the property they own and from sales of the properties they hold.

Question 338

Define:

Mortgage REIT

Answer 338

A type of REIT that invests in mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest they earn on the mortgages they hold as well as the sales of these mortgages to other investors.

Question 339

Can an individual make tax-deductible contributions to a 529 Plan?

Answer 339

No, all contributions to a 529 Plan must be made with after-tax dollars.

Question 340

What are the three different types of annuity payout options?

Answer 340

1. Life annuity
2. Life annuity with period certain
3. Joint and last survivor

Question 341

Define:

Life annuity

Answer 341

An annuity payout structure that makes monthly payments for the life of the owner of the annuity. When the owner dies, all payments cease.

Question 342

Define:

Joint and Last Survivor Annuity

Answer 342

An annuity payour structure that makes montly payments over the life span of two individuals (e.g. a husband and then once the husband dies their wife until she dies).

Question 343

When recommending an exchange of annuities, a registered representative should consider whether the investor has replaced another annuity in the past

Answer 343

36 months

Question 344

What are the tax-consequences of a 1035 exchange?

Answer 344

A 1035 exchange allows an investor to transfer funds from one annuity provider to another without any tax consequences. Importantly, although this is a tax-free exchange, other fees, such as surrender chargers, may apply.

Question 345

The primary purpose of the statement of cash flows is to

Answer 345

provide information about a company’s sources and used of cash during the accounting period.

Question 346

Define:

Quick Ratio

Answer 346

(Current Assets - Inventory) / Current Liabilities

Question 347

If a company’s stock has a beta of greater than 1, how does the stock’s systemic risk compare to the overall market?

Answer 347

higher

If the beta for an asset is 1, it has the same systematic risk as the market. If beta is greater than 1, it has higher systematic risk than the market , which means that it is more volatile than the overall market.

Question 348

What is the definition of the current ratio?

Answer 348

current assets / current liabilities

Question 349

Define:

403(b) plan

Answer 349

Also referred to as a tax-sheltered annuity, this plan is a qualified retirement plan offered by nonprofit organizations and education institutions. Other than the fact that these are offered by public entities rather than private corporations, they work similar to 401(k)s in that they allow eligible employees to make tax-deductible contributions.

Question 350

Define:

fixed annuity

Answer 350

An annuity contract that guarantees the owner a fixed rate of return over the life of the contract. To generate this fixed return, all premiums are invested in the insurance company’s general account. Because investors are guaranteed a return, fixed annuities are not considered a security.

Question 351

Define:

general account

Answer 351

The account of an insurance company in which customer premiums are invested
into conservative options that deliver a guaranteed fixed rate of return. All premiums for a fixed annuity are invested into this account.

Question 352

Define:

immediate annuity

Answer 352

A type of annuity in which payments for life begin shortly after the contract is issued and contributions are made by the annuitant.

Question 353

Define:

minimum death benefit

Answer 353

An insurance-like feature in an annuity contract that states that if the owner dies during the accumulation phase, which is the period in which she is making contributions to the plan, her beneficiary will receive the greater of the current value of the contract or the amount contributed.

Question 354

Define:

single-premium deferred annuity

Answer 354

A type of annuity where the annuitant contributes a lump sum that accumulates earnings until a future date decided by the contract owner. On this date, payments for life begin for the annuitant.

Question 355

Define:

mortality guarantee

Answer 355

The guarantee in an annuity contract that says the holder will receive payments as long as they live, no matter how long that may be.

Question 356

Define:

earned income

Answer 356

Income earned by an individual through their job, including salary, wages, and bonus.

Question 357

Define:

estate tax

Answer 357

The federal tax on the transfer of assets after a person’s death.

Question 358

Define:

First In, First Out (FIFO)

Answer 358

The method used by the IRS to determine which shares the investor is selling against if they do not identify their position. Under FIFO, the IRS will use the cost basis of the shares held the longest to calculate the taxable gain or loss.

Question 359

Define:

long-term capital gains

Answer 359

Capital gains generated from securities that were held for one year and one day or more. Taxed at a preferential rate, which is a lower rate than what one would pay on their salary (i.e lower than ordinary income).

Question 360

Define:

short-term capital gains

Answer 360

Capital gains generated from securities that were held for one year or less. Taxed as ordinary income, which is the rate the investor pays on their salary.

Question 361

Define:

capital loss deduction

Answer 361

If an investor has any remaining capital losses after offsetting their capital gains, they can use up to $3,000 in capital losses to reduce their taxable ordinary income. Any excess losses can be carried forward to be used in future years.

Question 362

Define:

wash sale rule

Answer 362

States that if an investor sells a security for a loss, they cannot go into the market and repurchase the same or substantially the same security within 30 days of the sale. If an investor violates the wash sale rule, the loss is disallowed for tax purposes (e.g. they cannot use it to offset capital gains or reduce their ordinary income).

Question 363

Define:

beta

Answer 363

A measure of the volatility of a stock or portfolio compared to the overall market. A security that has a beta of 1.0 will track the market, a beta of more than 1.0 indicates the price will be more volatile than the market, and a beta of between 0 and 1.0 indicates that the security will be less volatile than the market.

Question 364

Define:

odd lot

Answer 364

An order for less than 1 round lot (100 shares).

Question 365

Define:

odd lot theory

Answer 365

A technical analysis theory that assumes that smaller investors are always buying or selling at the wrong time. Therefore, someone should take the opposite direction in the market as odd-lot traders who are buying and selling in small volumes.

Question 366

Define:

diluted earnings per share

Answer 366

Calculated as a company’s net income divided by its diluted outstanding shares. A company’s diluted share count includes employee stock options, warrants, and convertible bonds that, if exercised or converted, would increase the number of oustanding shares and thus dilute the existing shareholders of the company.

Question 367

Define:

earnings per share

Answer 367

Calculated as a company’s net income divided by its reported outstanding shares.

Question 368

Define:

working capital

Answer 368

A measure of a company’s liquidity, which is calculated as current assets minus current liabilities.

Question 369

Define:

dividend payout ratio

Answer 369

Measures the percentage of earnings that a company pays to its shareholders. It is calculated as dividends per share dividend by earnings per share.

Question 370

Define:

529 Plan

Answer 370

A type of municipal fund security that offers individuals a tax-advantaged means to savefor education, such as high school, college, or graduate school. Specifically, these accounts allow for after-tax contributions, which grow tax-free. Distributions for qualified education expenses, such as tuition, books, and supplies, are completely tax-free.

Question 371

Define:

callable preferred stock

Answer 371

A type of preferred stock that can be repurchased by the company at its discretion. The company is most likely to exercise this call feature when interest rates are falling in order to issue new stock with a lower dividend. Because of the call risk faced by the investor, callable preferred generally pays a higher dividend than non-callable preferred stock from the same issuer.

Question 372

Define:

cumulative preferred stock

Answer 372

A type of preferred stock that requires the company to pay any previously skipped dividend payments to these investors before any dividends can be paid to a common stockholder.

Question 373

Define:

participating preferred stock

Answer 373

A type of preferred stock that allows holders to receive an additional dividend on top of the stated rate if some predetermined event occurs.

Question 374

Define:

purchasing power risk

Answer 374

The risk that as inflation increases, the purchasing power of an investor’s fixed coupon will decrease—essentially, that the fixed coupon payment will not go as far for the investor as the price of goods and services rises.

Question 375

Define:

non-systematic risk

Answer 375

The risk that one specific company’s value will lower, be it due to poor management decisions or product recalls. An investor can protect against this risk by owning a diversified portfolio.

Question 376

Define:

mortgage backed securities

Answer 376

Pools of mortgages that have been securitized and turned into bonds, typically by Ginnie, Fannie, and Freddie. These securities pay monthly interest to investors (similar to mortgages) and help to enhance the liquidity of the mortgage market.

Question 377

Define:

planned amortization tranche

Answer 377

A CMO tranche that protects against both prepayment and extension risk.

Question 378

Define:

plain-vanilla CMO tranche

Answer 378

A type of CMO that pays interest on all tranches simultaneously, but only pays principal to one tranche at a time. Once that tranche is retired, subsequent principal payments are made to the next tranche in line.

Question 379

Define:

tranche

Answer 379

The unique classes of a CMO, each consisting of different credit qualities, expected maturities, and exposures to prepayments.

Question 380

Define:

aggressive growth fund

Answer 380

An equity mutual fund that invests in stocks of riskier companies that are expected to appreciate at a much faster rate than the market average. Stocks of these companies rarely pay dividends; instead earnings are reinvested further for research and development.

Question 381

Define:

rights of accumulation

Answer 381

Offer investors an opportunity to receive breakpoints on new mutual fund purchases based on the current value of those customers’ invested funds.

Question 382

Define:

breakpoint sale

Answer 382

A prohibited sales practice in which a registered representative tries to earn a higher commission by encouraging the sale of mutual fund shares at an amount just below the point where the sales charge is reduced.

Question 383

Define:

selling dividends

Answer 383

A prohibited practice in which a registered representative sells a mutual fund to an investor right before the fund pays out a dividend. This is a violation because the dividend distribution creates a tax liability for the investor, as the investor must immediately pay taxes on the distribution.

Question 384

Define:

net investment income

Answer 384

Net investment income is the total profits that an individual earns from their investments. For mutual fund investments, this would include any dividends plus interest income plus net capital gains (capital gains minus capital losses).

Question 385

Define:

preferred stock fund

Answer 385

A mutual fund that invests in preferred stock in order to generate dividend income for investors.

Question 386

Define:

voluntary accumulation plan

Answer 386

A benefit offered by a mutual fund that allows existing shareholders the right to purchase more shares at regular intervals with no additional sales charge.

Question 387

Define:

back-end load

Answer 387

A back-end sales charge that investors pay when they redeem their mutual fund shares within a certain number of years. Generally, this fee will decrease each year the investor holds the shares.

Question 388

Define:

Class A share

Answer 388

A type of mutual fund share that has a front-end sales charge, which investors pay when they buy into the fund. This share class tends to be the most economical for investors, as it offers breakpoints and has lower 12b-1 fees than other classes of shares.

Question 389

Define:

Class B share

Answer 389

A type of mutual fund share that has a back-end sales charge which investors pay if they redeem their shares within a specified number of years. This share class typically has higher 12b-1 fees than class A shares and does not offer breakpoints.

Question 390

Define:

Class C share

Answer 390

A type of mutual fund share that has a level-load sales charge. These shares typically have relatively high 12b-1 fees and do not offer breakpoints.

Question 391

Define:

closed-end fund

Answer 391

A type of management investment company that issues a fixed number of exchange-traded shares. Similar to mutual funds, these types of investment companies are actively managed and have a net asset value. However, because an active secondary market exists for these, share prices are based on supply and demand.

Question 392

Define:

contingent deferred sales charge

Answer 392

A back-end sales charge that investors pay when they redeem their mutual fund shares within a certain number of years. Generally, this fee will decrease each year the investor holds the shares.

Question 393

Define:

expense ratio

Answer 393

A calculation of a mutual fund’s expenses, including management fees and operating expenses, divided by the fund’s average annual net assets.

Question 394

Define:

Investment Advisers Act of 1940

Answer 394

A federal legislation that defines and regulates investment advisers.

Question 395

Define:

letter of intent (LOI)

Answer 395

A contract offered by a mutual fund that allows a purchaser to invest in installments and receive breakpoints. An LOI is good for up to 13 months and can be backdated 90 days. If the customer fails to meet the terms, the otherwise applicable sales charges will apply.

Question 396

Define:

load

Answer 396

Also referred to as the sales charge, it is the fee an investor pays when buying a mutual fund share. To calculate the public offering price, the sales load is added to the NAV.

Question 397

Define:

management fee

Answer 397

The fee paid to the investment advisor who is responsible for actively managing the portfolio of a management investment company, such as a mutual fund or closed-end fund. It is typically the greatest expense of any management company.

Question 398

Define:

management company

Answer 398

A type of investment company that actively manages a portfolio of securities to achieve a stated investment objective for investors. This is the most common type of investment company and includes both closed-end funds as well as mutual funds.

Question 399

Define:

money market fund

Answer 399

A mutual fund that consists of money market securities, which are short-term debt instruments with maturities of one year or less. These funds are considered extremely safe and liquid.

Question 400

Define:

open-end management company

Answer 400

Also known as a mutual fund, it is a management investment company that makes a continuous offering of redeemable shares. The portfolio of the fund is actively managed to achieve a clearly defined investment objective. However, because the shares are redeemable, there is no secondary market trading; instead the shares can only be bought from and sold back to the fund.

Question 401

Define:

Reinvestment Privilege

Answer 401

Allow mutual fund investors to reinvest distributions into the fund at the NAV without having to pay any sales charges on these new purchases. Investors must still pay taxes on these distributions, however.

Question 402

Define:

12b-1 fee

Answer 402

Annual fees paid by investors to cover a mutual fund’s marketing and distribution expenses. The maximum 12b-1 fee that a fund can charge is 1% of the fund’s average net assets, though if a fund wants to advertise itself as being no-load (not having a sales charge), then it cannot charge 12b-1 fees of more than 0.25% of the average net assets.

Question 403

Define:

unit investment trust (UIT)

Answer 403

An investment company that issues redeemable securities representing an undivided interest in a trust. As with mutual funds, no secondary market exists for these. However, unlike management companies, there is a fixed portfolio with no active management.

Question 404

Define:

balanced fund

Answer 404

A mutual fund that combines invests in stocks for growth and bonds for income.

Question 405

Define:

dollar cost averaging

Answer 405

A method of purchasing shares in a mutual fund where the investor invests a fixed dollar amount at regular intervals. Over long periods of time, this will typically allow investors to have an average cost per share lower than the average price per share as they will buy more shares when prices are low and fewer when prices are high.

Question 406

Define:

non-diversified management company

Answer 406

An investment company that does not meet the 75-5-10 diversification requirements set forth under the Investment Company Act of 1940.

Question 407

Define:

ETF

Answer 407

An exchange-traded investment company security that is designed to closely track the performance of a specific sector, benchmark, or index. The fund is not actively managed and typically only changes when the underlying benchmark it tracks changes.

Question 408

Define:

Growth Fund

Answer 408

An equity mutual fund that invests in stocks of companies that are expected to appreciate at a faster rate than the market average. Stocks of these companies rarely pay dividends; instead earnings are reinvested further for research and development.

Question 409

Define:

Income Fund

Answer 409

An equity mutual fund that invests in dividend-paying companies including utility stocks, blue chip stocks, and preferred stocks.

Question 410

Define:

Growth and Income Fund

Answer 410

Also referred to as a growth and income fund, it is an equity mutual fund that includes some stock for growth and others that pay high dividends.

Question 411

Define:

mutual fund

Answer 411

Also known as an open-end fund, it is a management investment company that makes a continuous offering of redeemable shares. The portfolio of the fund is actively managed to achieve a clearly defined investment objective. However, because the shares are redeemable, there is no secondary market trading; instead the shares can only be bought from and sold back to the fund.

Question 412

The tax that a mutual fund shareholder pays on capital gains distributions from the fund are based on

Answer 412

the holding period of the fund

As long as the mutual fund held the security in its portfolio for greater than one year, any capital gains that are realized are long-term capital gains for the fund investors regardless of how long they have held the shares of the fund.

Question 413

A mutual fund investors decides to automatically reinvest dividends rather than take a cash distribution. Is this a taxable event?

Answer 413

Yes, mutual fund dividends are taxed when declared by the fund regardless if they are taken in cash or reinvested back into the fund.

Question 414

Systematic withdrawal plan

Answer 414

A mutual fund redemption option which allows investors to withdraw a fixed amount (e.g. fixed dollar amount, fixed percentage of the account, or fixed number of shares) in regular intervals.

Question 415

What investor type is best suited for municipal bond funds?

Answer 415

High income investors who will most benefit from the tax-free interest income provided by municipal bonds

Question 416

What is the maximum amount a mutual fund can charge as sales charge?

Answer 416

A mutual fund can charge no more than 8.5% of the offering price.

Question 417

Who determines the ex-dividend date for a mutual fund?

Answer 417

The board of directors of a mutual fund will set the ex-dividend date. In order to receive the dividend, an investor must purchase shares prior to the ex-dividend date.

Question 418

Breakpoint

Answer 418

Discounts off the sales charge based on the amount of money invested within a mutual fund.

Question 419

What are mutual expenses not covered in a 12b-1 fee?

Answer 419

Management expenses and trading fees

Question 420

An investment company that pursues a sector investment strategy focuses on:

Answer 420

a specific industry

A sector focus strategy generally looks for securities from a particular sector or industry such as financial services, telecommunications, technology, etc.

Question 421

Which types of investment companies are redeemable?

Answer 421

Mutual funds and unit investment trusts

Question 422

What is not a benefit of investing in a fund of funds hedge fund?

Answer 422

lower fees

Fund of funds hedge funds typically charge much higher fees than a direct investment in a hedge fund because the manager in charge of the fund of funds adds its fee on top of the fees charged by the funds that comprise the fund of funds.

Question 423

Define:

Net Asset Value

Answer 423

The value of a mutual fund, calculated as the total assets of the fund divided by its total liabilities. When a customer purchases a share, he pays the public offering price, which includes the NAV plus a sales charge. When a customer sells his shares back to the fund, he receives the NAV.

Question 424

What is an expense ratio of a mutual fund?

Answer 424

• The expense ratio is the total annual expenses divided by the total net assets of the fund.
• This expresses how much of the fund’s return is actually being used to pay expenses and management of the fund. The higher the expense ratio – the less efficient mutual fund.

Question 425

What is the formula for calculating the percentage sales charge of a mutual fund?

Answer 425

(POP - NAV)/POP

Question 426

What percentage of net investment income must a mutual fund distribute to shareholders to avoid taxation?

Answer 426

90%

Question 427

What are two major differences between mutual funds and ETFs?

Answer 427

Mutual funds are actively managed and redeemable (meaning there is no secondary market). ETFs, on the other hand, are not actively managed and are exchange-traded.

Question 428

A mutual fund has an NAV of $18 and charges a sales charge of 3%, calculate the POP.

Answer 428

$18.56

POP = NAV/(100% - SC)

Question 429

How does the portfolio turnover rate for ETFs compare to mutual funds?

Answer 429

Lower

Because ETFs are not actively managed, there is very little turnover of securities within the pool.

Question 430

Because they are passively managed, the capital gains that ETFs generate are typically

Answer 430

minimized

Question 431

Describe the pricing of closed-ended funds

Answer 431

Because they are exchange-traded, closed-end funds may trade at a premium of discount to the NAV based on the supply and demand of the shares

Question 432

Under the penny stock cold-calling rules, what must a registered rep disclose to a client when soliciting a penny stock trade?

Answer 432

• The name of the stock
• The number of shares that they are soliciting
• The current quote
• The commission to be received