Unit 5 | Alternative Investments & Other Assets Flashcards
In a direct participation program, liability for the debts of the business falls upon the
A. general partners).
B. limited partner(s).
C. shareholder(s).
D. agents) selling the program.
A. DPPs consist of at least one GP and one LP. The liability of the limited partners is limited to their investment, including commitments made but not yet fulfilled. On the other hand, the general partners bear the liability for the entity’s debts.
One of the ways that investing in a real estate limited partnership (RELP) differs from investing in a REIT is that
A. the DPP pays dividends, while the REIT does not.
B. the REIT passes through at least 90% of its taxable income while the DPP retains it.
C. the DPP is a pass-through vehicle for both income and loss, while the REIT does not pass through losses.
D. DPPs generally have greater liquidity than REITs.
C | DPPs are pass-through entities—all of the tax considerations, income or loss, flow-through to the investors. REITs will distribute at least 90% of their taxable income as dividends, but if there is a loss, none of that benefits the investors. One risk found in the DPP that is not in the REIT is the lack of liquidity.
LO 5.a
A direct participation program is a form of business entity. It may purchase real estate, drill for oil or gas, or engage in other business activities. Which of the following statements is true?
A. Management of the enterprise is generally in the hands of a committee formed by the most significant investors.
B. Management of the enterprise is always in the hands of the general partners).
C. Management of the enterprise is under the control of a committee of limited and general partners.
D. Limited partners may not participate in management affairs until at least one year after the offering is completed.
B | Management of a DPP is solely the province of the general partners). In fact, any limited partner assuming a management role is in danger of forfeiting their status as a limited partner. This question is one of the rare cases where “always” is a correct statement (there are so many exceptions to the rules).
LO 5.b
Inverse ETFs are least suitable for investors
A. with a long time horizon.
B. who are bearish on the market’s future.
C. wishing to take higher than normal risks.
D. who follow an active investment strategy.
A | Inverse and leveraged ETFs are structured so that holding them for more than a few days or weeks becomes unattractive. They are for bearish investors, often referred to as short funds. They are purchased for short-term capital gains; there is no income. Short-term investors are following an active strategy.
LO 5.c
All of the following are characteristics associated with equity-linked notes (ELNs), except
A. they are equity securities.
B. they are considered an alternative pooled investment.
C. they have final payments at maturity linked to the return of an underlying stock or basket of stocks.
D. they are considered to be nonconventional structured investments.
A | Despite their name, equity-linked notes (ELNs) are debt instruments, not equity instruments. They have a partial fixed return and a final payment linked to the performance of a single stock or equity index.
Some are exchange-traded, while others trade OTC. FINRA, which considers ELNs nonconventional structured investments, has expressed concerns that investors might not fully understand ELNs or their associated risks.
LO 5.c
Many investors look at precious metals as a hedge against inflation. Those investors would be most likely to own
A. uranium.
B. cadmium.
C. lead
D. platinum.
D | We like to think of precious metal as something you’d find in a jewelry store. The primary choices on the exam will be silver, gold, and platinum. Some of our students remember precious metals by thinking about the credit cards (or travel status) they have. I have never been on a flight where they praised their lead-level flyers, but silver, gold, and platinum seem to get priority over the rest of the bunch. I’m not sure a good friend would appreciate a uranium bar as a gift.
LO 5.f
The benefits of investing in a DPP would include
I. high liquidity.
II. flow-through of operating losses.
III. limited liability.
IV. immunization against tax audit.
A. I and II
B. I and IV
C. II and III
D. III and IV
C. DPPs are structured as flow-through entities, allowing their investors to receive income without the partnership being taxed first. In addition, if there are losses, they can write off those losses against passive income from other DPPs. As limited partnership vehicles, they offer their investors liability limited to their investment. They generally have very low liquidity, and instead of reducing the tax audit risk, they increase it.
An investor is reading a report that industrial demand for copper is expected to double in the next 5 years. This scenario might lead the investor to
A. buy corn futures.
B. sell copper futures.
C. invest in several copper mining companies.
D. modify the investor’s portfolio to take a larger cash position.
C. When the demand for copper increases, the companies that produce the commodity usually witness a rise in their stock prices. This outcome is because the higher demand for copper increases its market price, leading to more significant profits for these companies. On the other hand, if one expects the demand for copper to decrease, then one might consider selling copper futures. This action is a way of betting on the future price of copper, assuming it will fall. By selling copper futures, one can lock in a selling price for copper at a future date, thereby protecting themselves from potential price drops.
Investors interested in adding precious metals to their portfolios would likely consider
A. coal.
B. diamonds.
C. gold.
D. tin.
C. Of these choices, only gold is considered a precious metal. Diamonds are undoubtedly precious, but they are not a metal. Tin is a metal but is not regarded as precious.
Although there can be many benefits to investing in an oil and gas limited partnership drilling program, risks include
A. limited liquidity.
B. potential for a tax audit.
C. drilling a dry hole.
D. all of the above.
D | These are just some risks in an oil and gas drilling DPP. The dry hole would not apply to real estate or equipment leasing programs, but they have unique issues.
LO 5.g
Among the reasons for investors to consider investing in real estate would be all of the following except
A. the ability to increase returns through leverage.
B. a high correlation with stock market returns.
C. possible tax advantages.
D. potential appreciation.
B | One of the investment advantages of real estate is that returns on real estate generally have a low correlation to stock market returns. That low correlation increases the diversification, lowering the overall risk and likely increasing overall return.
LO 5.g
Although it is widely agreed that adding precious metals to a portfolio can potentially increase returns, doing so is not without risk. Risks that investors face with this asset class include
A. storage cost.
B. lack of income.
C. larger spreads when buying and selling than are found with most equities.
D. all of the above.
D | Most investors in precious metals pay to have the asset in safe storage. This cost is ongoing, and it cannot be offset by income, as would be the case with owning bonds or dividend-paying stock. The nature of this business is such that spreads between the buy and sell price are typically significantly higher than when trading securities.
LO 5.g
