Series 7 STC Alternative Products (Ch. 11) Flashcards
A limited partnership could have positive cash flow, but still report a loss from operations. Why might this occur?
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Due to non-cash expenses (e.g., depreciation) being deducted from revenues
Due to operating expenses (e.g., payroll and utility bills) being deducted from revenues
Due to operating expenses being capitalized
Due to the fact that different partnerships may use different accounting methods
Due to non-cash expenses (e.g., depreciation) being deducted from revenues
Cash flow is calculated by adding non-cash expenses (e.g., depreciation, depletion) to income or loss from operations. A positive cash flow is possible despite the fact that the partnership shows a loss from operations.
A registered representative (RR) is discussing investment objectives with one of her clients. The client is convinced that the real estate market is near its bottom and is due to recover in the next 12 to 18 months. Since she has a limited amount of money to invest and wants an investment that’s diversified and liquid just in case she’s wrong, the RR may recommend a:
Real estate limited partnership
Real estate general partnership
Subchapter S Corporation that invests in real estate
Real estate investment trust
Real estate investment trust (REIT)
A limited partnership is a very illiquid investment and is suitable for long-term investors. A general partnership is also illiquid and all partners have unlimited liability. A Subchapter S Corporation lacks liquidity because it’s limited to 100 shareholders. On the other hand, because real estate investment trust (REIT) shares trade in the secondary market, the shares are liquid. REIT shareholders have limited liability and participate in a diversified portfolio of various real estate holdings.
Which of the following statements is TRUE about a business development company (BDC)?
A BDC is subject to SEC registration requirements.
A BDC is a type of DPP in which all income and losses flow through to investors.
A BDC investor must be an accredited investor.
A BDC is an illiquid investment
A BDC is subject to SEC registration requirements.
A business development company (BDC) is a registered investment company that’s also listed on a stock exchange. Unlike traditional mutual funds, a BDC invests in non-listed issuers that are smaller (i.e., developing). A BDC offers a way for non-accredited investors to invest in non-public companies that are typically only available through private placements. A BDC generally passes through at least 90% of its income, but doesn’t pass through losses and is not a direct participation program (DPP).
Is a BDC a DPP?
No (doesn’t pass through losses, only 90% of income)
What type of loan is made to a partnership and only partnership assets are subject to liability, thereby relieving investors from any personal liability for the loan?
Recourse loan
Non-recourse loan
Wrap-around mortgage
Lien
Non-Recourse loan
Non-recourse loans are taken out by the partnership and any assets that are owned by the partnership may be pledged as collateral for the loan. The partnership investors are not personally liable for the loan. Interest payments are deductible from the revenues of the partnership and the principal payments reduce the limited partners’ capital contributions.
An oil and gas program that involves purchasing already producing property and is characterized by few intangible drilling expenses is referred to as a(n):
Exploratory program
Balanced program
Income program
Development program
Income program
An income program seeks to acquire interest in already producing properties and is characterized by few, if any, intangible drilling expenses. The absence of these intangible expenses reduces the attractiveness of an income program as a means of generating passive losses.
Which TWO of the following items will decrease a partner’s basis?
Cash distributions and partnership losses that are passed through
Cash distributions and partnership income
Partnership losses that are passed through and partnership income
Partnership income and partnership debt for which the investor is personally liable
Cash distributions and partnership losses that are passed through
A partner’s tax basis is decreased by cash distributions and by the partner’s distributive share of partnership losses.
A sharing arrangement in which the sponsor of a limited partnership bears no part of the program costs, but shares through a cost-free interest in production, is referred to as:
Reversionary working interest
Disproportionate sharing arrangement
Overriding royalty interest
Functional allocation
Overriding royalty interest
Regarding oil and gas limited partnerships, there are several types of sharing arrangements. When the sponsor bears no part of the program costs, but shares in the production interest through royalties, it’s referred to as an overriding royalty interest.
The advantages of programs that purchase existing properties as opposed to new construction projects include all of the following factors, EXCEPT:
A more predictable cash flow
More accurate projections of expenses
Depreciation
Lower maintenance costs
Lower maintenance costs
Existing properties may actually have higher maintenance costs since the buildings are older. More predictable cash flows, more accurate projections of expenses, and the ability to depreciate the buildings are all advantages which are associated with partnerships that purchase existing properties.
A loss from a limited partnership’s operations is passed through to a limited partner. On the limited partner’s personal tax return, this loss:
Is fully deductible against the individual’s income from all sources
Is considered a passive loss and may only be deducted against passive income
May only be deducted with the permission of the general partner
Is only deductible when the individual sells the partnership interest
Is considered a passive loss and may only be deducted against passive income
Investment in a limited partnership is considered a passive activity because limited partners don’t materially participate in the operations of the business. Therefore, any losses that are passed through to limited partners are considered passive losses and may only be offset against passive income. Passive losses are deductible at any time there’s passive income and not only when the individual sells her partnership interest.
Which of the following statements concerning hedge funds is TRUE?
These investments are highly liquid.
These investments must be registered with the SEC.
These investments are typically sold to accredited investors.
These investments may charge a maximum load of 8 1/2 %.
These investments are typically sold to accredited investors.
Which of the following items is categorized as an intangible drilling cost?
Pipelines
New pumps
Surface preparation of the drilling site
Well casings
Surface preparation of the drilling site
For tax purposes, 70% of intangible drilling costs are currently deductible when they’re incurred. The remaining 30% of intangible drilling costs are amortized over five years. Intangible drilling costs are typically items that are not depreciable and have no salvage value. Surface preparation costs, labor, and surveys are examples of these types of costs.
A general partner will violate his fiduciary responsibility to the limited partners by taking all of the following actions EXCEPT:
Commingling partnership funds with his own
Competing with the partnership
Releasing facts about partnership changes
Using partnership assets for his own benefit
Releasing facts about partnership changes
Releasing facts about partnership changes is not a violation of a general partner’s fiduciary responsibility to the limited partners. However, a general partner commingling partnership funds with his own, entering into competition with the partnership, and using partnership assets for his own benefit are violations of his fiduciary relationship.
A balanced oil and gas limited partnership is characterized by:
Exploratory drilling only
Development drilling only
On-shore and Offshore drilling
Both exploratory and development drilling
Both exploratory and development drilling
In a limited partnership balanced program, an investor seeks to avoid the high risks, but not forego the high potential returns that are inherent in exploratory programs by mixing developmental and exploratory drilling. The developmental drilling will usually produce enough income to offset some of the high risks of exploratory drilling.
A client is considering the purchase of a fund of hedge funds. Which of the following statements concerning this investment is TRUE?
This type of investment may only be purchased by individual investors who have a net worth of at least $1 million.
This type of investment protects or hedges against market risks.
This type of investment will outperform traditional mutual funds.
This type of investment will have higher fees than traditional mutual funds.
This type of investment will have higher fees than traditional mutual funds.
A fund of hedge funds is a mutual fund that invests in unregistered, private hedge funds. Traditional hedge funds are not required to register with the SEC and are often sold only to accredited investors. A fund of hedge funds is typically registered under the Investment Company Act of 1940 and may be sold to either accredited or non-accredited investors. A fund of hedge funds will typically have higher expenses than a traditional mutual fund and there’s no guarantee that this type of fund will outperform a traditional mutual fund.
All of the following statements are TRUE regarding interval funds, EXCEPT:
They offer limited liquidity due to the fact that clients are only able to redeem their shares at specified times.
They’re only required to calculate their net asset value when investors redeem their shares.
Their fees are generally higher than typical mutual funds and closed-end funds.
They’re more suitable as longer term investments than for short-term trading.
They’re only required to calculate their net asset value when investors redeem their shares.
An interval fund is classified as a type of closed-end fund that continuously offers shares to investors. Investors can continuously purchase interval funds at their net asset value (NAV). However, unlike most closed-end funds, interval fund shares don’t trade above or below their NAV and they don’t trade in the secondary market on an exchange. Instead, investors are allowed to sell a portion of their shares back to the fund at the current net asset value only at preset interval (e.g., monthly, quarterly, semiannually). Since shareholders are only able to exit these funds at certain intervals that are stated in the fund’s prospectus, interval funds are illiquid investments. Due to their limited liquidity, interval funds are suitable for long-term investors, those seeking income-producing investments, and those seeking to diversify their portfolios. In fact, these funds can provide individual investors with access to the types of exotic or alternative investments (e.g., private equity and commercial real estate investments) that are typically limited to hedge funds and institutional investors. The fees and expenses associated with interval funds tend to be higher than other closed-end funds and mutual funds.
The primary reason that real estate investment trusts (REITs) are NOT considered direct participation programs (DPPs) is:
REITs only invest in real estate, while DPPs have a broader spectrum of investments available
REITs pass through income, but not losses
REITs frequently trade on exchanges, whereas DPPs do not
REITs are more likely to alter their portfolios of properties than a DPP
REITs pass through income, but not losses
DPPs are an investment vehicle in which all of the tax consequences are passed through to the participants. The pass throughs include income, losses, and tax credits. REITs pass through income to its shareholders in the form of a dividend. However, with REITs losses are not allocated to investors on a proportionate basis. This feature is unique to DPPs.
Which of the following descriptions BEST defines a business development company (BDC)?
It generally invests in small and/or medium-size companies.
It invests only in publicly traded companies.
It invests in companies whose stock is traded in foreign countries.
It focuses its investments in real estate companies.
It generally invests in small and/or medium-sized companies
A business development company (BDC) raises capital by selling securities to investors and has a structure that’s similar to a closed-end investment company. A BDC uses the money it raises to invest mostly in private companies, small and developing businesses, and financially troubled companies that have difficulty raising capital in public markets. The objective is to help these companies by providing funding when they may not be able to raise capital for themselves. Most BDCs trade on an exchange and, therefore, provide an investor with liquidity. Since BDCs are structured as regulated investment companies, they’re not taxed on their income if they distribute at least 90% of it to investors. Most have an investment objective of providing current income and capital appreciation and will invest their funds in both debt (e.g., loans, as well as subordinated and mezzanine financing) and equities of private small and middle-market companies. Since some of the funds are invested in the equity of non-public companies, when a customer purchases shares of a BDC, it’s similar to buying a publicly traded investment in a private equity firm. BDCs invests mostly in private (not public) companies, and, therefore, don’t invest in small and/or medium size publicly traded companies or initial public offerings.
Upon the sale of a limited partnership interest in a direct participation program, the broker-dealer should have the investor make his check payable to:
The registered representative who sold the security
The broker-dealer
The direct participation program
The party that’s specified in the subscription agreement
The party that’s specified in the subscription agreement
The subscription agreement will also specify the party to whom the check must be made payable.
What type of real estate investment trust (REIT) primarily derives its revenues from rental income and capital gains?
Direct participation program
Equity REIT
Mortgage REIT
Private equity fund
Equity REIT
An equity REIT invests its portfolio in real estate assets and offers investors income that’s derived from rents and the capital gains which are generated by the sale of appreciated property. A mortgage REIT borrows money from a commercial bank and then lends the borrowed funds to building developers at a higher rate.
Which of the following statements is TRUE regarding REITs?
At least 90% of a REIT’s gross income must come from real property.
REITs only pass through income.
Income from mortgage REITs is primarily derived from rental income.
REITs pass through both gains and losses.
REITs only pass through income.
Real estate investment trusts (REITs) are essentially exchange-traded real estate portfolios. In order to qualify as a REIT, at least 75% of the gross income must be derived from real property. Mortgage REITs primarily lend money to commercial developers so that they’re able to buy, build, or operate commercial real estate. Similar to limited partnerships, REITs pass through income; however, unlike partnerships, they don’t pass through losses.
Which of the following statements is TRUE concerning registered, non-traded real estate investment trusts (REITs)?
They offer investors the same amount of liquidity as exchange-traded REITs.
They’re not required to distribute the same percentage of taxable income as exchange-traded REITs.
They’re not required to make periodic disclosures that are required of exchange-traded REITs.
They’re not suitable for the same investors as exchange-traded REITs.
They’re not suitable for the same investors as exchange-traded REITs.
Most REITs are traded on an exchange (e.g., the NYSE) and offer investors a high degree of liquidity. The shares of non-traded REITs are not listed on an exchange and therefore they offer very limited liquidity to investors. Both non-traded and exchange-traded REITs invest in various types of real estate and are subject to the same tax consequences (90% distribution on taxable income). Since both types are registered, they’re required to make the same disclosures to investors.
Which of the following BEST describes an interval fund?
A closed-end fund that’s listed on an exchange and invests in small and middle market issuers
An open-end investment company whose shares can only be purchased at specific intervals (e.g., monthly)
An unregistered investment fund that’s designed for accredited investors only
A closed-end fund whose shares do not trade in the secondary market and can only be sold at preset times
A closed-end fund whose shares do not trade in the secondary market and can only be sold at preset times
Interval funds are closed-end investment companies, but their shares are not listed on a stock exchange. Investors can continuously purchase interval fund shares at their net asset value (NAV). However, unlike mutual fund shares, investors can only sell interval fund shares at preset intervals. Business development companies (BDCs) invest in smaller companies.
A customer who has consistently invested in mutual funds is considering a first-time investment in a hedge fund. When comparing mutual funds to hedge funds, which of the following statements is NOT TRUE?
Mutual funds are subject to more regulatory oversight than hedge funds.
Hedge funds often use a higher degree of leverage than mutual funds.
Mutual funds pool investors’ money and manage the portfolio, whereas hedge funds manage each investor’s assets separately.
Mutual funds may be suitable for many customers, whereas hedge funds are generally only suitable for sophisticated, wealthy investors.
Mutual funds pool investors’ money and manage the portfolio, whereas hedge funds manage each investor’s assets separately.
Both mutual funds and hedge funds pool investors’ money to manage the assets. However, unlike mutual funds, hedge funds are often exempt from regulatory oversight, use leverage, and employ aggressive financial strategies (e.g., short selling and placing large bets on individual companies or sectors of the market). Hedge funds typically have high minimum investment requirements which make them suitable only for professional and wealthy investors.
A type of oil and gas limited partnership that involves the acquisition of leases for drilling in unproven areas is referred to as a(n):
Development program
Balanced program
Wildcat operation
Income program
Wildcat Program (Exploratory)
A type of oil and gas limited partnership that involves the acquisition of leases for drilling in unproven areas is referred to as a wildcat (or exploratory) operation. This is a high risk venture because the areas don’t have proven reserves and could result in drilling a dry well. As a result, the investor could lose most (or all) of his investment.
An individual has $7,000 of passive loss due to his participation in an oil and gas partnership. To which of the following types of income may the loss be applied?
Active income
Portfolio income
Passive income
Investment income
Passive income
Passive losses may only be deducted against passive income. In any year, if passive losses exceed passive income, the excess losses are carried forward indefinitely to offset future passive income. When the partnership is sold, passive losses being carried forward become deductible against any source of income.
All of the following entities are permitted to pass through both income and losses, EXCEPT:
A general partnership
A real estate investment trust (REIT)
A limited partnership
A Subchapter S Corporation
A real estate investment trust (REIT)
Which of the following is an advantage of investing in a hedge fund?
It offers fee structures that are different than what’s assessed by a regulated investment company.
It utilizes investment strategies which could potentially outperform the market as a whole.
Its investment returns are guaranteed by the fund manager.
It distributes quarterly performance reports to investors.
It utilizes investment strategies which could potentially outperform the market as a whole.
For most investors, an advantage of investing in hedge funds is that they engage in sophisticated investment strategies, which could potentially outperform the market. Some of the disadvantages of hedge funds include the lack of liquidity, less transparency than other investments, and higher fees.
All of the following statements are TRUE about hedge funds, EXCEPT:
They are liquid investments.
They may employ leverage.
They may concentrate assets into a few positions.
They may engage in short selling.
They are liquid investments.
In many ways, hedge funds are investments that resemble mutual funds; however, they’re typically only offered to very wealthy investors. Hedge funds often employ aggressive financial strategies such as short selling, the use of leverage (borrowed funds), and establishing large speculative positions in individual companies or sectors of the market. These funds are not generally required to register with the SEC due to the accredited status of their investors, and they don’t typically offer daily redemption privileges.
How are listed REITs initially sold?
Directly onto the exchange in an at-the-market offering
In an exempt private placement that’s conducted under Regulation D
In an offering that’s registered with the SEC
In an exempt transaction that’s conducted under Regulation S
In an offering that’s registered with the SEC
Public REITs are initially sold in an offering that’s registered with the SEC. After their initial issuance, listed REITs are exchange traded. This means that they’re more liquid and easier to value than REITs that are non-listed.
Which of the following investments is NOT subject to the Investment Company Act of 1940?
Hedge funds
Inverse ETFs
Mutual funds
Leveraged ETFs
Hedge funds
Hedge funds are exempt from the Investment Company Act of 1940. On the other hand, mutual funds and ETFs are subject to the Act.
How are PRIVATE REITs initially sold?
Through a Rule 144 transaction
In an exempt private placement that’s conducted under Regulation D
In an offering that’s registered with the SEC
In an exempt transaction that’s conducted under Regulation A
In an exempt private placement that’s conducted under Regulation D
Private REITs are initially sold in an exempt private placement that’s conducted under Regulation D. After their initial issuance, private REITs are not listed and don’t trade on the exchanges. As a result, they’re illiquid and often difficult to value.
When the building of additional projects in an area causes the supply to exceed demand and result in a lower return on all projects, this is referred to as:
The crossover point
Overdevelopment
Recapture
Depreciation
Overdevelopment
When building additional projects in an area results in a lower return on all projects due to supply exceeding demand, this is referred to as overdevelopment.
According to the Securities and Exchange Commission (SEC), a limited partnership:
Is not required to register with the agency under any circumstances
Must register with the agency unless it qualifies for an exemption under the provisions of the Securities Act of 1933
Must register with the agency because limited partnerships cannot be exempt from registration
Is not regulated by the agency
Must register with the agency unless it qualifies for an exemption under the provisions of the Securities Act of 1933
Real estate investment trusts (REITs) provide which of the following to their investors?
High current yields
Pass through of losses
Tax-free dividend income
High correlation with equity markets
High current yields
REITs are pooled investment vehicles that provide their investors with ownership in a real estate portfolio. To alleviate their tax burden, REITs typically distribute (pass through) 90% of their income to shareholders; therefore, they offer a high current yield. However, REITs don’t pass through losses and their dividends are taxed as ordinary income. Real estate investments are often uncorrelated with equity markets and provide a way to diversify an equity portfolio.
New construction projects are characterized by their:
Lack of leverage
Liquidity
Long duration
Immediate cash flow
Long duration
New construction projects are usually characterized by their long duration. They’re illiquid and often highly leveraged. Immediate cash flow is a characteristic of real estate partnerships that purchase existing properties.
In a limited partnership, the acceptance of a limited partners is recognized when:
The proposed limited partner signs the subscription agreement
The limited partner’s check is cashed
The general partner signs the subscription agreement
The certificate of limited partnership is filed
The general partner signs the subscription agreement
Once a general partner accepts a limited partner’s subscription, the limited partner is considered a participant in the partnership. This acceptance of a limited partner is evidenced by the general partner’s signature on the subscription agreement.
Which of the following statements BEST describes how investors buy and sell shares of Business Development Companies (BDCs) after their issuance?
BDC shares are purchased and sold at the next calculated NAV.
BDC shares are purchased at the next calculated NAV, but can only be sold at specific intervals.
BDC shares trade in the secondary market and are purchased and sold at the current market price.
BDCs don’t permit investors to buy or sell their shares in the secondary market.
BDC shares trade in the secondary market and are purchased and sold at the current market price.
Since most BDC shares trade on an exchange, they provide investors with liquidity. Investors buy and sell shares in the secondary market at their current market price.
