Unit 17: Alternative Investments

Question 1

Direct Participation Programs:

Answer 1

Allow the economic consequences of a business to flow-through to investors.

A DPP is just a different way to invest in a business rather than buying the company’s stock.

Question 2

Because most DPPs are privately placed,

Answer 2

they are considered illiquid, and investors must commit money for a long time. Even those which are publicly traded do not have the liquidity of other investments.

Question 3

Any income received by a partner is considered:

Answer 3

passive and the same is true for losses. The effect of this is that any passive losses can only be deducted as a loss against passive income.

Question 4

An investor should choose to invest in a specific limited partnership because:

Answer 4

• It is economically viable
• The investor can make use of the potential tax benefits
• The GPs has/have demonstrated management ability and expertise in running similar programs
• The program’s objectives match the investor’s objectives and do so within a time frame that meets the investor’s needs
• The start-up costs and projected revenues are in line with the start-up costs and revenues of similar ventures

Question 5

A person seeking current taxable passive income should not invest in an oil and gas exploratory drilling program. Why not?

Answer 5

It may tax years before any income is generated.

Question 6

General Partner (GP)

Answer 6

the active investors in a limited partnership and assume responsibility for all aspects of the partnership’s operations

• GP maintains a minimum 1% financial interest in the partnership
• Liability for the debts of the business falls upon the GP

Question 7

Limited Partner (LP)

Answer 7

passive investors with no management or day-to-day decision-making responsibilities

Question 8

Exchange-Traded Notes (ETNs) are registered under:

Answer 8

Securities Act of 1933

Question 9

Exchange-Traded Notes (ETNs) are:

Answer 9

• Made as debt instruments
• Type of exchange-traded debt security offering a return linked to a market index or other benchmark rather than periodic interest payments
• Value is calculated and published at the end of each day by the ETN issuer

Question 10

What are the risks of ETNs?

Answer 10

• Credit risk (they are unsecured debt obligations)
• Market risk
• Call, early redemption, and acceleration risk
• Conflicts of interest

Question 11

Leveraged ETF

Answer 11

attempt to deliver a multiple of the return of the benchmark index they are designated to track

Question 12

Inverse (Reverse) Funds

Answer 12

sometimes referred to as short funds, attempt to deliver returns that are opposite of the benchmark index they are tracking

Question 13

FINRA warns investors that most leveraged and inverse ETFs

Answer 13

“reset” daily, meaning that they are designed to achieve their state objective on a daily basis..

In most cases, these would not be suitable investments for buy and hold investors or those with other than a very short time horizon.
Example: “The long-term expected value of your ETNs is 0.

Question 14

When funds are traded on an exchange,

Answer 14

they are known as ETFs. If they are exchanged traded, they are priced by supply and demand, can be purchased on margin, and bought and sold throughout the trading day, like all exchange-traded products.

Question 15

When funds are not exchange-traded,

Answer 15

they would be priced, purchased, and redeemed like all investment company shares.

Question 16

Structured Products

Answer 16

built (structured) to meet specific needs. In most cases, they involve structuring a debt issue in such fashion as to provide lower borrowing costs to the issuer while increasing potential returns to the lender

Question 17

Structured Notes with Principal Protection

Answer 17

any structured product that combines a bond with a derivative component and that offers a full or partial return of principal at maturity. Usually a zero-coupon bond.

Question 18

Risks of Structured Products:

Answer 18

• Little or no liquidity
• Returns are not fully realized until maturity (better for long-term investors)
• Credit risk
• Lack of efficient pricing

Question 19

Viaticals

Answer 19

apply to those with a terminal illness and a life expectancy of 24 months or less regardless of their age

Question 20

Life Settlements

Answer 20

apply to those who, although generally at least 65 years old, are in decent health with a life expectancy of at least 2 years that can run 10 years or longer

Question 21

Risks of Viaticals/Life Settlements:

Answer 21

• No active secondary market, so it’s difficult to arrive at a fair evaluation and the investor may wind up paying too much for the policy
• Chance that the insured will live longer than anticipated which causes the return to be lower
• The possibility that the insurance company will not be financially able to honor the claim
• The intangible moral issue of the investor knowing that the sooner the insured dies, the greater the return

Question 22

What are the most common commodities?

Answer 22

crude oil and coffee

Question 23

What other commodities are traded?

Answer 23

aluminum, nickel, copper, lead, gold, silver

Question 24

What are the advantages of DPPs?

Answer 24

• Investment is managed by others
• Flow-through of income and certain expenses
• Limited liability

Question 25

What are the disadvantages of DPPs?

Answer 25

• Liquidity risk
• Legislative risk
• Risk of audit
• Depreciation recapture

Question 26

What are the advantages of real estate?

Answer 26

• Historically, hedge against inflation
• Provides rental income, a portion of which may be tax-advantaged due to depreciation and interest deductions
• High leverage (mortgages)
• Not generally correlated with stock market returns
• Section 1031 tax-free exchanges

Question 27

What are the disadvantages of real estate?

Answer 27

• Lack of liquidity
• The risk of vacancy which causes loss of income
• High leverage can work against the investor in a down market
• The individual may not have the skills necessary to manage the property and hiring someone else could eliminate or greatly reduce the profits

Question 28

What are the advantages of commodities?

Answer 28

• Potential hedge against inflation
• Diversification
• Potential returns

Question 29

What are the disadvantages of commodities?

Answer 29

• Principal risk
• Volatility
• Exposure to Foreign Market
• High Cost
• Lack of income
• **There is no income with any commodity, only the chance for capital gains.

Question 30

The sale price of a life settlement is always

Answer 30

more than the cash value and less than the face value.