Test 2

Question 1

Currency Transaction Reports mandated by Anti-Money Laundering rules require a report to be filed in which of the following situations?

[A] Throughout the course of the trading day, an investor performs several cash transactions in his account which total $12,000.
[B] Activities in a customer’s account involve a cashier’s check in the amount of $3,000 and cash transactions in the account of $8,000.
[C] Activities in a customer’s account involve a personal check in the amount of $1,500 and cash transactions in the account of $7,000.
[D] In one transaction, a customer performs a cash transaction totaling over $9,000.

Answer 1

[A] Throughout the course of the trading day, an investor performs several cash transactions in his account which total $12,000.

The Currency Transaction Report must be filed by a broker-dealer if the total CURRENCY transactions in one business day exceeds $10,000. Checks, both cashiers and personal, are not included.

Question 2

Under the Bank Secrecy Act anti-money laundering rules, if a firm becomes aware of a suspicious transaction, it must file a Suspicious Activity Report within

[A] 10 days
[B] 30 days
[C] 90 days
[D] 180 days

Answer 2

[B] 30 days

A Suspicious Activity Report must be filed within 30 days if the firm becomes aware of any suspicious transactions.

Question 3

From a tax perspective which of the following factors for an investor in a high income tax bracket would be least important when designing his portfolio?

[A] how much to allocate to cash equivalent
[B] actively managed funds vs. passively managed funds
[C] the investment strategies of a prospective, active fund manager
[D] the relative merits of taxable vs. tax exempt portfolio

Answer 3

[C] the investment strategies of a prospective, active fund manager

A high income tax bracket investor will want to minimize his taxes in his taxable portfolio. Cash equivalents are fully taxable. Actively managed funds have more taxable capital gains than passively managed funds. The strategies of a prospective, active fund managers would not matter since you are just considering using them and have not actually hired them yet.

Question 4

In fundamental analysis, an analyst would focus on all of the following EXCEPT

[A] a corporation’s leverage.
[B] moving averages for the corporation.
[C] a corporation’s price to earnings ratio.
[D] management’s profitability track record.

Answer 4

[B] moving averages for the corporation.

Question 5

Under the Uniform Securities Act when a registered Agent of a Broker-Dealer moves their personal residence when does that person’s registration application have to be updated?

[A] The Agent’s registration application would not have to be updated if the address of the firm that they are registered with has not changed. The Agent simply has to notify their broker-dealer.
[B] The Agent’s registration application would have to be updated within 10 business days of the change in address.
[C] The Agent’s registration application would have to be updated promptly.
[D] The Agent’s registration application would have to be updated with the next annual renewal date of the Agent’s registration.

Answer 5

[C] The Agent’s registration application would have to be updated promptly.

Under the Uniform Securities Act, an Agent’s application would have to amended “promptly” when the Agent has change in their home address.

Question 6

Under the USA, all of the following registrants may be required to post a surety bond if they have custody of or discretion over clients’ assets except?

[A] Broker-dealer firms
[B] Investment Adviser firms
[C] Both Individual Investment Advisers and Broker-Dealers
[D] Individual Investment Adviser Representatives

Answer 6

[D] Individual Investment Adviser Representatives

IARs are excluded because they do not have custody or discretion as an individual. It is the “firm” which may have custody and discretion.

Question 7

All of the following statements pertaining to investment advisers (IAs) possessing the funds of clients are TRUE EXCEPT:

[A] Possession of funds by a custodian that meets certain qualifications is acceptable.
[B] At least annually, clients must receive a statement which includes details related to the funds possessed by the firm.
[C] Accounts that contain the funds of clients must be specific to that purpose.
[D] Immediate notification must be given to the client as to where the firm will maintain the client funds.

Answer 7

[B] At least annually, clients must receive a statement which includes details related to the funds possessed by the firm.

All of the statements listed above are true except for the answer about annual statements. Statements must be sent at least quarterly.

Question 8

Greg puts $10,000 into an equity indexed annuity which allows compounding on gains within the annuity. The product has a minimum guaranteed return of 3% annually. Greg’s participation rate is 90% of the S&P 500 index in years exceeding the minimum guaranteed return. There is also a cap of 10% on gains. After 3 years and with no fees taken into consideration, Greg is trying to figure out the value of his equity indexed annuity. Returns were as follows:
Year 1 - 12.5%
Year 2 - -4.0%
Year 3 - 5%
With these returns, Greg should find that the balance of his annuity is approximately which of the following after year 3?

[A] $11,750
[B] $11,840
[C] $12,032
[D] $12,167

Answer 8

[B] $11,840

Greg put $10,000 into the equity indexed annuity.
In year 1, Greg’s returns were 12.5%. 90% participation would be 11.25%, which exceeds the 10% cap.
In year 2, Greg’s returns were negative, so the minimum guaranteed return of 3% kicks into effect.
In year 3, Greg’s returns were 5%. 90% participation would be 4.5%, which is below the cap of 10%.
In year 1, the returns exceeded the 10% cap, so he received 10% in year 1, bringing his balance at the end of year 1 to $11,000 ($10,000 x 1.10 = $11,000). In year 2, the returns were negative, so Greg would receive the minimum guaranteed return of 3% on the balance from year 1 of $11,000, leaving him with $11,330 ($11,000 x 1.03 = $11,330). In year 3, the return was 5%. Greg’s participation rate of 90% means he would receive 4.5% on top of the previous year’s balance of $11,330, leaving him with $11,839.85, closest to $11.840 (5% x 90% = 4.5%, $11,330 x 1.045 = $11,839.85 or $11,840).

Question 9

Which of the following is an example of an indirect investment in real estate?

[A] Agreeing to a lease of a condominium on a long-term basis
[B] An investment in property used for manufacturing plants
[C] A purchase of a mobile home and the lot on which it sits
[D] A purchase of Real Estate Investment Trust shares

Answer 9

[D] A purchase of Real Estate Investment Trust shares

Question 10

All of the following options and option strategies either perform best or require any exercise to be performed at expiration EXCEPT

[A] those which are issued European-Style.
[B] a short straddle options position.
[C] those which are issued American-Style.
[D] an options position using the Black-Scholes method.

Answer 10

[C] those which are issued American-Style.

Question 11

An individual purchases $250-worth of a broad-based index fund on a bi-weekly basis in their 401(k) plan. The individual is

[A] using strategic asset allocation combined with an indexing approach.
[B] taking on significant amounts of risk, both business and market.
[C] utilizing a dollar cost averaging strategy in relation to passive indexing.
[D] a growth-focused investor, using a form of technical analysis.

Answer 11

[C] utilizing a dollar cost averaging strategy in relation to passive indexing.

Question 12

Which of the following statements by an agent would be grounds for denial, suspension, or revocation of registration of a broker-dealer or agent in connection with solicitation of investment company shares?

Stating to a customer the fund’s current yield without disclosing the fund’s most recent average annual return.
Stating to his client that the investment performance of an investment company portfolio is comparable to that of a certificate of deposit, without disclosing the shares are not guaranteed by the FDIC.
Stating to his client that the investment performance of an investment company portfolio is comparable to that of a savings account, without disclosing the shares are not guaranteed by the FDIC.
Stating to a customer the fund’s income and disclosing the fund’s most recent average annual return calculated using the SEC’s calculation methods, and explaining differences.
[A] I and II only
[B] I and III only
[C] I, II, and III only
[D] I, II, III, and IV

Answer 12

[C] I, II, and III only

In order to disclose current yield or income for a fund in association with the solicitation of investment company shares, the agent must disclose the funds most recent average annual return, calculated using the SEC’s calculation for the one, five, and ten year periods and fully explaining the difference between current yield and total return.

Question 13

The written disclosure document that must be furnished by a solicitor to a client under the Investment Advisers Act of 1940 must include all of the following except

[A] any service that the solicitor will be providing to the client
[B] the compensations that the solicitor will receive
[C] the name of the broker dealer that will affect the trades
[D] the name of the investment advisers that will be providing advisory service

Answer 13

[C] the name of the broker dealer that will affect the trades

Question 14

Shawna is a young investor with no need for income from investments due to a high salary for her age. She historically has chosen very conservative investments such as blue-chip stocks and index funds, and she re-invests all dividends. Bob is Shawna’s IAR and agent. He has discussed higher-risk investments with Shawna several times, believing that she would benefit from increasing her risk tolerance but she has been resistant. After some research, Bob calls Shawna and strongly recommends investment in a small-cap fund for some extra capital that Shawna is investing, fully discussing the pros and cons of the small-cap fund. In this case, Bob has

[A] Shawna’s best interest in mind, despite her resistance to taking on investments with greater levels of risk.
[B] made a suitable investment recommendation to Shawna, given her age and income level.
[C] made an unsuitable investment recommendation to Shawna.
[D] failed to make proper disclosure of material facts related to the small-cap fund.

Answer 14

[C] made an unsuitable investment recommendation to Shawna.

In determining suitability, the client’s age and income are factors, but her investment history and risk tolerance are also key factors. Bob’s “strong” recommendation could come across as pressure to invest in something with which Shawna is not comfortable. For this reason, Bob is making an unsuitable recommendation to Shawna, even though that investment may be suitable for other young investors with the same circumstances. Bob is Shawna’s IAR, so he must also consider his fiduciary responsibility.
Each of the other statements is false. Bob does not have Shawna’s best interest in mind if he is pressuring her into investment choices. Bob’s recommendations are unsuitable given Shawna’s resistance to risk. Bob did not fail to make disclosures related to the small-cap fund.

Question 15

The results of calculations of both the Current Ratio and the Quick Ratio would incorporate

[A] inventory on hand at the company.
[B] the after-tax income of the company.
[C] the current liabilities of the company.
[D] the total revenue of the company for the year.

Answer 15

[C] the current liabilities of the company.

The Current Ratio and Quick Ratio measure corporate liquidity. Both work with current assets and current liabilities.
In the calculation of the Quick Ratio, a company’s inventory is subtracted from Current Assets, which would mean that results found using the Quick Ratio would NOT incorporate inventory. The Quick Ratio is a more stringent measurement of liquidity since inventory is subtracted from current assets.

Question 16

New structured products issued with principal protection have a guarantee of

[A] either full or partial return of the original investment if held to maturity.
[B] either full or partial return of the original investment if sold prior to maturity.
[C] full return of the original investment if held to maturity.
[D] partial return of the original investment if held to maturity.

Answer 16

[A] either full or partial return of the original investment if held to maturity.

Many structured products are issued with a principal protection guarantee of either full or partial return of the original investment if the structured product is held to maturity. You can sell it prior to maturity but the value could be lower than the maturity value. However, the market value could also go higher than the maturity value.

Question 17

A client passes away mid-year. The decedent leaves behind a significant estate which is to be split amongst three beneficiaries who are the client’s adult children. Which of the following would be responsible for the taxes associated with the client prior to her passing mid-year?

[A] The tax liability would be decided by a judge in probate court.
[B] The taxes would be owed equally by the three beneficiaries out of their income for the year of the death.
[C] The taxes would be payable by the client’s estate in the tax year of the client’s death.
[D] Taxes are not paid this year but will be forwarded to the next tax year and will be paid by the beneficiaries.

Answer 17

[C] The taxes would be payable by the client’s estate in the tax year of the client’s death.

The decedent’s estate would be responsible for the taxes in the year of death. Estate taxes would also apply to the client’s estate prior to assets passing to the client’s beneficiaries. Though taxes for the year may reduce what is ultimately passed on to the beneficiaries, the estate is the entity responsible for the taxes, not the beneficiaries. Probate court would be used when the decedent has not left a will.

Question 18

Of the following three choices, which are exempt according to the USA?

I. Transactions taking place between issuers and underwriters
II. Any isolated non-issuer transaction
III. After receiving an unsolicited order, a registered broker-dealer takes care of a non-issuer transaction

[A] I and II only
[B] I and III only
[C] II and III only
[D] I, II, and III

Answer 18

[D] I, II, and III

Isolated non-Issuer transactions (normal secondary market trades), unsolicited transactions, and underwriter transactions are all exempt.

Question 19

Technical analysis would be concerned with all of the following EXCEPT:

[A] Advances and declines
[B] Daily purchases and sales by odd lotters
[C] The price earnings ratio of a stock compared to other securities within the same sector
[D] Moving averages of 200 days and 30 weeks during the past year

Answer 19

[C] The price earnings ratio of a stock compared to other securities within the same sector

Technical Analysis would be concerned with the following factors:

Trading volume
Moving averages
Advances and declines
Odd lot purchases and sales
Timing of purchases and sales
Support and resistance levels
but not with fundamental analysis.

Question 20

Which of the choices below is deemed to be an ‘asset class’?

I. Real Estate
II. Gold Bullion
III. Collectible Dolls
IV. Stocks listed on NASDAQ

[A] I only
[B] I and III
[C] II and IV
[D] I, II, III, and IV

Answer 20

[A] I only

An “asset class” is a general class of assets. Real estate is the only option listed that fits this description. All of the other choices are too specific. Gold bullion would be under the asset class of precious metals. Collectible dolls would be under collectibles. Stocks listed on NASDAQ would be included in equities.

Question 21

The Uniform Securities Act provides that which of the following statements is/are correct with regard to post registration provisions for registered IA’s whose principal place of business is in a given state?

I. The IA is responsible for scheduling the annual state examination of books and records with the Administrator.
II. The filing of financial statements with the state may be a requirement.
III. By rule or order, the IA must maintain certain records per the Administrator.
IV. If the Form ADV becomes materially inaccurate, it is the IA’s responsibility to update the form.

[A] I and IV only
[B] I, III, and IV only
[C] II, III, and IV only
[D] I, II, III, and IV

Answer 21

[C] II, III, and IV only

All records required to be kept may be examined by the Administrator at any time within or outside of the state. IAs do not schedule their own annual examinations!

Question 22

Of the following portfolios, which would have the greatest volatility?

[A] 80% stocks, 10% bonds, 10% money markets
[B] 80% stocks, 20% bonds
[C] 50% stocks, 10% bonds, and 40% money markets
[D] 20% stocks, 50% bonds, and 30% money markets

Answer 22

[B] 80% stocks, 20% bonds

As a general rule, stocks are more volatile than bonds and bonds are more volatile than money market instruments.

Question 23

According to the Uniform Securities Act, which of the following activities constitutes market manipulation?

I. phony market quotations
II. commingling of clients’ money
III. disseminating false information
IV. making false trades

[A] I, III
[B] II, IV
[C] I, III, IV
[D] I, II, III, IV

Answer 23

[C] I, III, IV

All choices represent “market” manipulation except choice II. Choice II is a violation but is NOT market manipulation.

Question 24

A federally covered investment adviser (IA) instructs its investment adviser representatives (IARs) to add the initials “RIA” (registered investment adviser) after their names on their business cards.

[A] This is permitted because the IAR is registered.
[B] This is permitted because the SEC lacks authority to object to the content of business cards.
[C] This is prohibited by the SEC because the use of “RIA” implies that the IAR is competent
[D] This is prohibited by the SEC because “RIA” may be confused with “IAR.”

Answer 24

[C] This is prohibited by the SEC because the use of “RIA” implies that the IAR is competent

Question 25

All factors considered, which of the following categories of bonds would carry the least amount of risk to an investor?

[A] Corporate Bonds with a AAA rating, maturing in 15 years
[B] Municipal Bonds with a AA rating, maturing in 2 years
[C] US Government Bonds with a AAA rating, maturing in 30 years
[D] Yankee Bonds with a BBB rating, maturing in 10 years

Answer 25

[B] Municipal Bonds with a AA rating, maturing in 2 years

This question evaluates four bond categories that are all investment grade. The BEST answer in terms of all factors being considered would be the Municipal Bonds with a AA rating that mature in 2 years. The reason for this being the best answer is the proximity to maturity, as having money tied up for only 2 years carries significantly less risk than maturities of 10+ years.
In general, US Government Securities are thought to be the ‘safest’, but in this question, we are looking at a 30-year maturity versus a 2-year maturity, which is what puts the Municipal Bonds ahead of the US Government Bonds. Had all maturities been 30 years, the US Government Bonds would be the best answer.

Question 26

All of the following would be factors that would be used to determine if a common stock was classified as a Value Stock EXCEPT?

[A] The current ratio of the common stock.
[B] The stock’s current P/E ratio.
[C] The price of stock versus the sales of the company.
[D] The stock’s price to book value.

Answer 26

[A] The current ratio of the common stock.

Value investors focus on value stocks which are undervalued companies with low price/earning ratios, low price/book ratios and good price/sales reports. The Current ratio is generally not considered when looking at Value Stock indicators.

Question 27

If the rate of inflation remains the same at 2% during the 5-year life of a TIPS bond with a coupon of 3%, what would the nominal value of the bond be at maturity to the nearest dollar?

[A] $1,000
[B] $1,060
[C] $1,104
[D] $1,160

Answer 27

[C] $1,104

The Future Value formula is: Principal X ( 1 + Rate)^# of years. Par value of a bond is $1,000 and the inflation rate is 2%. Future Value = $1,000 X (1+.02)^5 years.

1. We do what is in the parenthesis first.
   (1 + .02) = 1.02 (.02 represents 2% inflation)
2. Next we deal with the power. The Power means, we multiply the number times itself 5 times. We use 5 because that is the number provided in the question.
   (1. 02)^5 = 1.02 X 1.02 X 1.02 X 1.02 X 1.02 = 1.10408
3. Lastly, we plug it back into the equation.
   $1,000 X 1.10408 = $1,104.

Question 28

An IA recommends that a client purchase a 20-year Treasury Bond at par with a coupon of 6%. The IA tells the client that he will “earn a 6% return per year if the bond is held to maturity.” This statement is

[A] allowed so long as the return to the client was disclosed.
[B] allowed because the Treasury guarantees the coupon payment.
[C] not allowed because IA’s cannot guarantee specific returns.
[D] not allowed because it is possible for the client to sell the security before maturity.

Answer 28

[C] not allowed because IA’s cannot guarantee specific returns.

The Model Rules prohibit an IA from guaranteeing an investment result. Even though the likelihood of default is extremely low when dealing with US Treasury Securities, it is possible that the treasury could default on an interest or principal payment.

Question 29

A Monte Carlo Simulation

[A] includes a simulation of expected returns which attempts to identify a mean return over time.
[B] identifies results across various real-world studies resulting in a singular predicted outcome.
[C] documents that market performance ultimately impacts all securities in the same manner when measured over extended time periods.
[D] uses a frequency distribution table to indicate potential outcomes that can range significantly.

Answer 29

[D] uses a frequency distribution table to indicate potential outcomes that can range significantly.

A Monte Carlo simulation uses a wide and randomized series of data points across a distribution table in order to identify potential outcomes when there is a random nature to results.
For example, a Monte Carlo simulation can be used to identify the probability of various results when rolling dice (two die with the numbers 1-6), where the results of each roll are random (a number between 1 and 12), but where certain numerical outcomes are more probable than others given the input.

Question 30

Which of the following considerations must an Investment Adviser make in relation to the NASAA Investment Adviser Information Security and Privacy Rules?
I. Use one form of ID for access to systems
II. Train staff to recognize suspicious emails
III. Install anti-virus software
IV. Use cloud-based servers

[A] I and II only
[B] II, III and IV only
[C] I, II, and III only
[D] I, II, III, and IV

Answer 30

[B] II, III and IV only

Under the NASAA Investment Adviser Information Security and Privacy Rules, IA firms must make considerations to train staff to recognize suspicious emails, install anti-virus software, use cloud-based servers, and use TWO forms of ID for access to systems, not one.

Question 31

Due to a busy schedule, an investment adviser hires a research company to complete an analysis on a stock. The adviser uses this analysis in a buy recommendation that is published in a quarterly newsletter and sent to clients. In order to best assure compliance with the Uniform Securities Act, the investment adviser should

[A] provide in the newsletter the name of the research company that was hired to complete the analysis.
[B] disclose to clients what the invesment adviser paid for this analysis.
[C] provide an historical performance track record of the stock recommendations made by this research company.
[D] buy the security analyzed for the investment adviser’s personal portfolio.

Answer 31

[A] provide in the newsletter the name of the research company that was hired to complete the analysis.

In order to best assure compliance with the Uniform Securities Act, the investment adviser should provide the name of the research company in the newsletter. None of the other choices would better assure compliance with the Uniform Securities Act.

Question 32

Which pricing methodology, model, or theory uses the following formula? Expected Return = Risk-Free Rate of Return + [Beta x (Market Return - Risk-Free Rate of Return)]
[A] Modern Portfolio Theory (MPT)
[B] Sharpe Ratio
[C] Capital Asset Pricing Model (CAPM)
[D] Discounted Cash Flow Methodology (DCF)

Answer 32

[C] Capital Asset Pricing Model (CAPM)

In CAPM, Expected Return = Risk-Free Rate of Return + [Beta x (Market Return - Risk-Free Rate of Return)]. In other words, CAPM evaluates the expected return of an asset or investment by setting it equal to the risk-free rate of return plus a risk premium adjusted with beta (via the beta)–assuming investors demand higher returns for greater risks.
Modern Portfolio Theory attempts to optimize returns for a given level of risk, or optimize risk for a given level of returns.
Sharpe Ratio is a measure of the risk-adjusted return relative to a portfolio’s volatility.
It is calculated as: The return of the portfolio - Risk Free Return / Standard Deviation.
Discounted Cash Flow Methodology involves discounting returns to assign value in today’s dollars, either via a number (Net Present Value) or a percentage (Internal Rate of Return).

Question 33

Before executing a recommended trade for a customer, an agent of a broker-dealer must make reasonable efforts to obtain which of the following pieces of information about the customer?

I. Financial resources and tax status
II. Marital status and financial resources of extended family members
III. Investment objectives and risk tolerance
IV. Other information considered relevant and reasonable by the agent

[A] I and II only
[B] I, II, and III only
[C] I, III, and IV only
[D] I, II, III, and IV

Answer 33

[C] I, III, and IV only

The agents of a broker-dealer are subject to the “know-your-customer” rules. These rules require the agent to obtain specific information such as the client’s financial resources, tax status, marital status, investment objectives, risk tolerance, and other information that is relevant and reasonable in determining suitability and making recommendations to the client.
The financial resources of extended family members would not be part of knowing a specific customer and would not be relevant to a specific customer’s account, though an agent may use that information to solicit and acquire additional accounts.

Question 34

An investment adviser intends to charge 5% per month based on assets managed. The IA will disclose the fees in both Form ADV and in the advisory contract. Are the adviser’s actions appropriate?

[A] Yes, if complete disclosure is made and the client has agreed to the fees.
[B] Yes, provided the client signs the contract.
[C] No, this is a violation of the Investment Advisers Act of 1940 even with full disclosure.
[D] No, advisory fees can only be charged quarterly, not monthly.

Answer 34

[C] No, this is a violation of the Investment Advisers Act of 1940 even with full disclosure.

Excessive fees charged by an IA cannot be justified by disclosure. A fee of 5% per month is clearly excessive (Most fees are in the range of 1% to 2% of assets under management per year). The law does not specify a permissible fixed percentage. Instead, it provides that the fee should be comparable to fees charged by other IAs for the same or similar services.

Question 35

The Dividend Discount Model is used to determine which of the following items?

[A] Preferred stock values
[B] Common stock values
[C] A common stock’s growth rate and cash flows
[D] A preferred stock’s growth rate and cash flows

Answer 35

[B] Common stock values

The Dividend Discount Model provides a tool for establishing the value of a common stock using the dividends paid as well as a given rate less the anticipated growth rate of dividends.

Question 36

In order to comply with NASAA Statements of Policy, when must the prospectus of a mutual fund be delivered to a client?

[A] Such a prospectus must be delivered on or prior to the due date of the confirmation of the transaction in the mutual fund.
[B] Such a prospectus must be delivered to the client within three days of the client signing the client agreement.
[C] Such a prospectus must be delivered at the time that a client agreement is signed by the client.
[D] Such a prospectus must be delivered when solicitations are being made of a client.

Answer 36

[A] Such a prospectus must be delivered on or prior to the due date of the confirmation of the transaction in the mutual fund.

NASAA Statements of Policy state that the prospectus of a mutual fund must be delivered to the client no later than the due date of confirmation of the transaction.

Question 37

Which of the following laws does not apply to the regulation of mutual funds?

[A] The Investment Company Act of 1940
[B] The Securities Act of 1933
[C] The Glass-Steagal Act of 1933
[D] The Securities Exchange Act of 1934

Answer 37

[C] The Glass-Steagal Act of 1933

The Glass-Steagal Act of 1933 separated commercial and investment banking. It did not regulate mutual funds. For all intents and purposes, its regulations have, for the most part, been repealed.

Question 38

A 62 year old client calls you to report that they have received news that they have earned $5,000 on a $30,000 fixed annuity. Your client is wondering what the tax ramification will be on the $5,000. Your client is in the 28% tax bracket. Which of the following is correct with regard to this situation?

[A] They will pay $750 on the long-term gain.
[B] They will pay $1,400 on the earnings.
[C] They will pay no tax unless the clients withdraw the earning from the annuity.
[D] They will pay $2,500 on the earnings.

Answer 38

[C] They will pay no tax unless the clients withdraw the earning from the annuity.

Of the choices offered the best answer is “C”. The earning in a fixed or variable annuity are tax deferred. There will be no current tax liability unless the client withdraws the earnings from the annuity.

Question 39

One of your clients owns a permanent life insurance policy. He needs cash. He knows that he can cash surrender the policy but he doesn’t want to lose his life insurance protection. He asks you about how a policy loan works. You should tell him all of the following EXCEPT:

[A] The loan will have to be paid back with interest.
[B] Outstanding policy loans that are unpaid at death will be subtracted from the policy proceeds.
[C] The loan amount is not subject to federal income taxes.
[D] The amount that the policyholder can borrow is generally limited to 50% of the cash surrender value.

Answer 39

[D] The amount that the policyholder can borrow is generally limited to 50% of the cash surrender value.

Policy loans are generally available up to 100% of the cash value of a permanent Policy. (The limit for variable life is generally 90% of the cash value.) If the policyholder defaults on the repayment of a policy loan there are no negative consequences because the interest will continue to accrue and the insurance company is fully collateralized by the cash values.

Question 40

In which of the following scenarios is an investment advisory firm REQUIRED to register with the SEC as a Federal Covered Adviser?

[A] The firm has clients in 13 states.
[B] The firm only provides advice related to federal covered securities.
[C] The firm manages over $150 million in assets within one state only.
[D] In order to open an account at the firm, new clients must be accredited investors.

Answer 40

[C] The firm manages over $150 million in assets within one state only.

The only item listed that would require the firm to register at the federal level would be managing $150 million in assets. An investment manager with over $100 million in assets under management has the option of registering with the states or with the SEC at the federal level. An investment manager with over $110 million in assets under management is required to register with the SEC at the federal level.
The previous thresholds for these numbers were $25 million and $30 million. We recommend being familiar with all to ensure the capability of answering old questions in the real exam database.
Having clients in multiple states, recommendations related to federal covered securities, and requiring new clients to be accredited are not, by themselves, grounds for the requirement of registration at the federal level.

Question 41

Bridgette is new to investing and has approximately $10,000 to invest. In opening up her account, she discusses her desire for growth and diversification with an agent. She also informs the agent that she would like to have access to the funds in about 2 years. Of the choices listed, which is BEST for Bridgette given her objectives and time horizon?

[A] Class A mutual fund shares
[B] Class B mutual fund shares
[C] Class C mutual fund shares
[D] The agent should recommend that she create her own diversified portfolio of common stocks.

Answer 41

[C] Class C mutual fund shares

The best recommendation here is going to be the Class C mutual fund shares. These shares will have no sales load, provide diversification, can provide for growth if the right fund is chosen, and allow for easy access to the funds in 2 years’ time.
Class A and B shares will have a sales load that makes these shares less than ideal for a 2-year time horizon. Bridgette is new to investing and does not have a significant amount of money to invest, so creation of her own diversified portfolio of common stocks is also not ideal in this scenario.

Question 42

ABC Corporate Bond has a 10 year maturity, a coupon rate of 4%, a current yield of 4.25%, and a yield to maturity of 4.50%.
A 10-year Treasury Bond has a coupon rate of 3.25%, a current yield of 3.375%, and a yield to maturity of 3.50%.
When viewing both the corporate and Treasury Bond, it is accurate to state that the Bond Credit Spread is

[A] $0.75 annually as far as payout according to coupon rate is concerned.
[B] 22%, because that accounts for the percentage difference between the two bonds.
[C] 75 basis points, which is the difference between the coupon rate on the Treasury Bond and the coupon rate on the corporate bond
[D] 100 basis points, which is the difference between the yield on the Treasury Bond and the yield on the corporate bond.

Answer 42

[D] 100 basis points, which is the difference between the yield on the Treasury Bond and the yield on the corporate bond.

A Bond Credit Spread is the measure of the difference between the yield on a Corporate Bond verses the yield on a Treasury Bond with similar or the same maturity.
In this question, the yield to maturity of the 10-year Treasury Bond is 3.5%, while the yield to maturity of the 10-year corporate bond is 4.5%. This equates to a difference of 100 basis points.
Bond credit spreads are not measured as an actual coupon payout difference per year, as a percentage of difference between YTM, or as a basis point difference between coupon rates on bonds.

Question 43

It is ACCURATE to state that Real Estate Investment Trusts (REITs)

[A] are subject to single taxation, passing profits on to shareholders in the form of dividends which are taxable as ordinary income.
[B] must distribute 75% of profits in the form of dividends on an annual basis.
[C] offer shares that are considered derivative products, similar to options and futures.
[D] must have at least 90% of assets invested in real estate and real estate related activities.

Answer 43

[A] are subject to single taxation, passing profits on to shareholders in the form of dividends which are taxable as ordinary income.

REITs avoid double taxation by meeting certain criteria. This means that taxation of profits typically only exists at the shareholder level, with dividends being classified as ordinary income to shareholders.
REITs must distribute 90% of profits in the form of dividends on an annual basis and must have at least 75% of assets invested in real estate and real estate related activities. REIT shares are NOT considered derivatives, because the shares represent real assets.

Question 44

The Administrator of California sends a request for financial statements to a small broker-dealer firm. Which of the following are requirements?

I. For firms registered at the Federal and State levels, the State cannot force additional recordkeeping requirements that exceed the Federal requirements.
II. For firms registered at the Federal and State levels, the firm must provide all of the financial statements that are required by the SEC to the Administrator, as well as any additional financial statements which may be required by the State.
III. For firms registered at the Federal and State levels, duplicate financial statements must be sent to all States, regardless of whether the firm is registered in that State or falls under the definition of a broker-dealer in that State.
IV. For firms registered at the Federal and State levels, SEC-required financial statements must be sent to all States where the broker-dealer is registered and there is a requirement to provide such financial statements.

[A] I and III only
[B] I and IV only
[C] II and III only
[D] II and IV only

Answer 44

[B] I and IV only

When a broker-dealer is registered at the Federal level, the broker-dealer is required to abide by Federal laws. These laws supersede the State laws. So if a broker-dealer is registered at the Federal level, the firm would be required to submit all financial statements filed with the SEC to the State Administrator upon request, but would NOT have to go beyond those statements. For firms registered with the SEC and several States, the firm is required to file the SEC-required financial statements where the firm is registered, but the firm is not required to send these financial statements to states where they are not registered (e.g., “all” states).

Question 45

Mark is looking to add a few stocks to his portfolio. He takes time to review the financial statements of several companies and various aspects of the stock price, debt of the company, and various forms of valuation for the company. Mark is using

[A] technical analysis, where the ultimate goal is to identify trends in the price fluctuations of the stock and buy when an upward trend is expected.
[B] fundamental analysis, where the ultimate goal is to identify trends in the price fluctuations of the stock and buy when an upward trend is expected.
[C] technical analysis, where the ultimate goal is to identify undervalued companies and buy with the anticipation that the underlying company’s value will increase.
[D] fundamental analysis, where the ultimate goal is to identify undervalued companies and buy with the anticipation that the underlying company’s value will increase.

Answer 45

[D] fundamental analysis, where the ultimate goal is to identify undervalued companies and buy with the anticipation that the underlying company’s value will increase.

Mark is using fundamental analysis. Fundamental analysis involves review of a company’s financials and seeks to find companies that are undervalued where stock prices should increase as the company’s pricing moves to appropriate levels. This differs from technical analysis, where the goal is to identify trends and patterns in relation to a company’s stock price and buy when an upward trend is expected.

Question 46

Which of the following best describes “Strategic Asset Allocation”?

[A] It is an investment strategy where no trading or re-balancing takes place in the account until a predetermined time such as one year after initial balancing is completed.
[B] It is an investment strategy with a focus on short term asset mixes where there are targeted balanced, but adjustments can be made and are made within a range based on current market condition.
[C] It is an investment strategy where the assets in a portfolio are balanced and generally kept at an assigned balance over the long term.
[D] It is an investment strategy where market timing and stock picking are used to constantly re-balance the portfolio in an attempt to beat a benchmark or expected return.

Answer 46

[C] It is an investment strategy where the assets in a portfolio are balanced and generally kept at an assigned balance over the long term.

Strategic Asset Allocation keeps an assigned balance over the long term. Tactical Asset Allocation focuses on short-term asset mix. Active Asset Allocation includes stock picking and market timing to constantly re-balance to beat a benchmark or expected return. Finally, Passive Asset Allocation refers to the investment strategy where re-balancing is performed at predetermined times such as quarterly, semi-annually, or annually.