Misc sample test questions continued Flashcards


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1

If an investor is in the highest federal income tax bracket and is subject to the alternative minimum tax, which of the following securities should an agent recommend? A)Industrial revenue bond. B)Treasury bond. C)General obligation bond. D)Corporate bond.

Municipal bonds are suitable for the portfolio of an investor who is in a high tax bracket because the interest is exempt from federal income tax. A general obligation (GO) bond (is a municipal debt) is a better recommendation than an industrial revenue bond because the interest on industrial revenue bonds is likely subject to the AMT.Treasury bonds are 10-30 yr maturities.. treasury notes are 2-10 yrs -- too long for this person)

Reference: 17.1.7 in the License Exam Manual

2

An elderly widow with no independent income wishes to invest the proceeds from her recently deceased husband's life insurance. Which of the following would be the most suitable recommendation? A)Municipal bonds. B)High grade corporate bond mutual fund. C)Call options. D)Oil and gas exploration program that you know is going to strike.

This customer needs income. Of the answers provided, the bond fund would be the most suitable because it would provide income while maintaining relative safety. While the municipal bonds are probably safer, the benefits of their tax-free income would probably be lost on a client with no independent income.

Reference: 15.3.11 in the License Exam Manual

3

Which of the following statements regarding grantor trusts are CORRECT?

  1. If the grantor has the power to revoke the trust, he is treated as the owner of the trust.
  2. If the grantor or a non-adverse party can control the beneficial enjoyment of the trust, he is treated as the owner of the trust.
  3. The grantor may be taxed on trust income only if the grantor actually received the income.
  4. If the grantor can receive income from the trust, he is treated as the owner of the trust.

A)I, II and IV. B)II and III. C)II, III and IV. D)I and IV.

As long as the grantor has the power directly or indirectly to control the trust, he is treated as the owner. The grantor may be taxed on trust income if the grantor either actually or constructively receives the income.

Reference: 14.4.1.4 in the License Exam Manual

4

During a trip to visit grandchildren, one of your clients suffers a massive heart attack and dies, intestate. Directions for handling the account could only come from the: A)person appointed as administrator of the estate. B)spouse. C)person with a durable power of attorney. D)person named as executor of the estate.

Dying intestate means that there is no valid will. In that case, the state will appoint someone as administrator of the estate with the responsibility of handling all of the affairs of the deceased. Only when there is a will is there an executor and a durable power of attorney is cancelled upon the death of either party to the power. Only if the account were registered as JTWROS with the spouse (or if the spouse were named the executor) would the spouse have any authority.

Reference: 14.5 in the License Exam Manual

5

You have a client whose income from a real estate limited partnership is $11,000. During the same year, your client had net capital losses of $2,000 and losses from an oil and gas drilling program of $6,000. The effect of this investment activity would be to increase the client's taxable income by: A)$9,000. B)$11,000. C)$3,000. D)$5,000.

The $11,000 passive income is offset by the $6,000 of passive loss giving the client $5,000 of passive income. Since capital losses up to $3,000 are deductible from taxable income, we can deduct the $2,000 in net losses giving a net increase to taxable income of $3,000.

Reference: 17.1.4 in the License Exam Manual

6

Which of the following are key assumptions of the Capital Asset Pricing Model (CAPM)?

  1. Investors hold diversified portfolios
  2. Income tax rates are stable
  3. Investors can borrow and lend at the risk-free rate
  4. There is a perfect capital market

A)II and IV B)I, II, III and IV C)I, III and IV D)I and III

CAPM assumes that investors will be looking at a return for taking systematic risk, hence holding diversified portfolios. One of the most important assumptions is that investors will be able to borrow/lend at the risk-free rate. Finally, CAPM assumes a perfect capital market, meaning that all securities are valued properly (their returns will plot to the [SML] security market line, and there are no tax or transaction costs). Income taxes are not a consideration, because not all investors are going to be in the same tax bracket.

Reference: 16.5.2.2 in the License Exam Manual

7

One popular method used to predict the expected return of a stock is the Capital Asset Pricing Model. Analysts using CAPM rely on all of these EXCEPT the:

A)standard deviation of the stock. B)expected return on the market. C)risk-free rate available in the market. D)beta coefficient of the stock.

Under the CAPM, using the SML, we can determine the expected return of any given stock by taking the risk-free rate and adding to that the product of that stock's beta coefficient and the difference between the expected return on the market and the risk-free rate. Standard deviation is not a factor in this computation.

Reference: 16.5.3 in the License Exam Manual

8

There are several popular investment styles and, in many cases, portfolio managers use a blended approach to security selection. If a portfolio manager adhered to a pure value style, he would put most of his focus on

: A)using technical analysis. B)the company’s financial statements. C)projecting future earnings based on past earnings. D)lagging indicators.

The value style of portfolio management looks for stocks that are undervalued. For example, the current market price is near or less than book value per share. The only way to find that out is by looking at the company’s balance sheet.

Reference: 16.3.2 in the License Exam Manual

9

Under Modern Portfolio Theory (MPT), all portfolios that can be constructed from a given set of stocks is referred to as the

A)capital market line B)efficient set C)correlation coefficient D)feasible set

A feasible portfolio is defined as a portfolio that an investor can construct given the assets available. The feasible set is the collection of all feasible portfolios. Once we have the feasible set, we can select the efficient set (the most return for a given amount of risk, or the least risk for a given amount of return).

Reference: 16.5.2.1 in the License Exam Manual

10

Which of the following statements regarding ADRs are TRUE?

  1. The securities are vehicles used to facilitate U.S. trading of foreign securities.
  2. Dividends are received in the foreign currency.
  3. Holders have foreign currency risk.
  4. The receipts are issued by a foreign branch of a domestic bank.

A)I and III. B)II and IV. C)I, II and III. D)I, III and IV.

ADRs are vehicles that facilitate U.S. trading of foreign securities. They are issued in English in the United States by domestic banks. Dividends are declared in the foreign currency but are payable to holders in U.S. dollars, which means that ADR holders are subject to foreign currency risk.

Reference: 4.1.5 in the License Exam Manual

11

ABC Securities is a broker/dealer registered with the SEC and domiciled in Missouri. ABC Securities would not be defined as a broker/dealer in Nebraska under the Uniform Securities Act if it had no offices in Nebraska and:

  1. its only clients were insurance companies.
  2. it had contact with fewer than 6 Nebraska residents in any 12-month period.
  3. its only solicitation of Nebraska residents was through radio advertisements originating in Missouri but received in Nebraska.
  4. it occasionally engaged in firm commitment underwriting with issuers based in Nebraska.

A)I and II. B)I and IV. C)II and III. D)III and IV.

A broker/dealer with no office in the state is not defined as a broker/dealer in that state if its only business is with institutions, other broker/dealers, and issuers when engaged in underwriting their securities. There is no de minimis exemption, and any solicitation of individuals into the state, whether in person or by radio, television, or any publication, requires registration in the state.

Reference: 2.3.1.1.1 in the License Exam Manual

12

Under the NASAA Model Custody Rule, an investment adviser would be permitted to take or have custody of any securities or funds of any client if: A)notification was given to the Administrator that he has or may have custody and custody was not prohibited by that state’s rules. B)the IA maintained adequate net worth or a surety bond. C)permission was obtained from the Administrator and custody was not prohibited by that state’s rules. D)customer permission was obtained prior to entering into the contract.

It is unlawful for any investment adviser to take or have custody of any securities or funds of any client if

  1. The Administrator, by rule, prohibits custody; or
  2. in the absence of rule, the investment adviser fails to notify the Administrator that he has or may have custody.

It is true that there is a minimum net worth or bond required, but that is not part of NASAA's Custody Rule - those requirements are found in Model Rule 202(d)-1, NASAA's Minimum Financial Requirements For Investment Advisers.

Reference: 3.11 in the License Exam Manual

13

Partners with the U.S. in the creation of Brady Bonds were the:

  1. International Monetary Fund (IMF).
  2. Import/Export Bank.
  3. United Nations.
  4. World Bank.

A)III and IV. B)I and II. C)II and III. D)I and IV.

names after former us treasury secretary Nicholas Brady; 1989 to exchange defaulted commercial bank loans in less developed countries..Latin America with an asset that performed

14

An agent of a broker-dealer is currently doing business in one state and would like to conduct business in another state. When checking with the firm's compliance department, the agent would be told which of the following?

A)No registration is necessary if no commission or other remuneration is paid or given directly or indirectly. B)Registration is required only if an offer is directed, accepted, and paid for in that state. C)If the agent is a partner, officer, or director and held that position at the time the broker-dealer was registered in that state, the individual need not register separately. D)No registration is necessary in the other state provided the agent's activities are limited exclusively to effecting transactions in certain exempted securities.

Both the broker-dealer and the agent must be registered in the state where business is to be transacted, unless they both qualify for an exemption from registration in that state (e.g. they have no place of business in the state and their only clients are institutions). At the time the broker-dealer is registered, officers, directors, or partners of the firm who act as agents will be automatically registered as agents.

Reference: 2.3.1.2 in the License Exam Manual

15

An investment adviser representative may share in the profits and losses of a customer's account:

under NO conditions

16

A consent to service of process allows the Administrator to:

A)ensure that the legal appeal process is expedited as a result of the Administrator's access to information. B)verify the accuracy and completeness of registration without obtaining the registrant's prior approval. C)terminate a registrant's application. D)to be the registrant's attorney to receive service of any lawful process in any noncriminal suit, action or proceeding against the registrant, or the registrant's successor.

The consent to service of process provides the Administrator with power of attorney to accept legal papers on behalf of registrants. This power of attorney does not grant the Administrator the authority to terminate the registration at will nor does it empower the Administrator to verify information or expedite the registration process.

Reference: 2.4.2 in the License Exam Manual

17

Anyone who represents an issuer in effecting transactions between the underwriter and the issuer:

A)is excluded from the definition of agent under the Uniform Securities Act. B)must be registered as an agent. C)must be registered as an investment adviser. D)

Under the Uniform Securities Act, a person representing an issuer in securities transactions between an underwriter and an issuer is not deemed an agent and is exempt from the agent registration requirements of the act.

Reference: 2.3.2.2.2 in the License Exam Manual

18

The Investment Advisers Act of 1940 requires that investment advisers make certain disclosures to their customers through the delivery of the adviser's brochure. However, there are instances where the Act grants an exemption if the client is

  1. a broker-dealer
  2. an insurance company
  3. an investment company
  4. a person receiving impersonal advice for which the annual fee is less than $500

A)I, II and III B)III and IV C)I and II D)I, II, III and IV

There are two exemptions from the brochure rule. The first is if the client is an investment company. The other is if the advice being rendered is impersonal and the charge is less than $500 ($500 as well under the USA) per year.

Reference: 3.10.3.4 in the License Exam Manual

19

Investing in which of the following would maximize after-tax income and diversify the portfolio for a high tax bracket investor? A)Short-term municipal notes B)Preferred stock mutual fund C)GNMAs D)A unit investment trust whose portfolio consists of municipal bonds

The key word here is "diversify". Muni bond UITs will own a number of different tax-exempt municipal issues. Short-term municipal notes, although paying tax-free interest, will not offer as high a return due to the short maturities and do not indicate that there is diversification as to issuers.

Reference: 7.1.4 in the License Exam Manual

20

A commodities speculator purchases a 1,000 bushel wheat futures contract at 50 cents per bushel. At expiration, the settlement price is 45 cents per bushel.

This individual A)has a $50 loss B)​effectively hedged the long wheat position C)must make delivery of the wheat D)has a $50 gain

the buyer is bullish, thinks prices will go up. The buyer is bearish. If prices go up, buyer wins, if price goes down - the seller wins. Wiklopedia had good exampless...

The simple math is, the individual bought at 50 cents and sold at 45 cents, losing 5 cents per bushel. Multiply 5 cents ($.05) times 1,000 bushels and the loss is $50.​ ​It is the seller who is obligated to deliver; the buyer of the contract must accept delivery (unless there was an offsetting transaction prior to expiration). This individual was long the futures contract, not long (the owner of) the wheat.

Reference: 9.1.5.5.2 in the License Exam Manual

21

MT Securities is a broker/dealer registered in 42 states. MT Securities makes a market in over 100 different stocks and participates in the underwriting of approximately 22 IPOs per year. Which of the following actions would be prohibited under NASAA's Statement of Policy on Dishonest and Unethical Business Practices of Broker/Dealers and Agents?

A)Adding to its inventory of a stock in which it makes a market, hoping to gain from market appreciation. B)Purchasing shares of a security in which it makes a market from a client at one price and then reselling those shares to another client at a higher price. C)Acquiring shares of an IPO as part of the underwriting syndicate and holding a small portion for the firm's investment account, hoping to gain from market appreciation. D)Purchasing shares of an IPO from the issuer and then reselling those shares to the public at a higher price.

Members of the underwriting syndicate on an IPO are prohibited from withholding shares of that issue in their own accounts; they must make a bona fide public offering. As a market maker, the firm is permitted to adjust the size of its inventory to take advantage of market conditions. All underwriters purchase new issue shares at one price and then resell at the public offering price, and market makers buy at the bid and sell at the ask.

Reference: 2.11.18 in the License Exam Manual

22

Which of the following is NOT a characteristic of a real estate investment trust (REIT)?

A)Potential dividends from investment income or capital gains distributions B)Shares are traded on exchanges much like the stocks of other companies C)Relatively low marketability D)Pooling of capital to purchase properties or mortgage loans

A real estate investment trust (REIT) is a company that pools its capital to purchase properties and/or mortgage loans. Investors buy REIT shares and, in turn, receive dividends from investment income or capital gains distributions. REIT shares are traded on exchanges much like the stocks of other companies. This provides relatively high marketability, especially compared to most other types of real estate investments.

Please note: We recognize that, over the past few years, there has been an enormous growth in non-traded REITs (exactly what that says – they don't trade; there is limited or no liquidity). However, we have received no feedback about that issue and, unless something in the question refers to a non-traded REIT, assume that all REITs are publicly traded either on the stock exchanges or OTC.

Reference: 7.1.7 in the License Exam Manual

23

The Uniform Securities Act considers which of the following to be investment advisers subject to registration in the state?

  1. An adviser with no place of business in the state who advises wealthy customers in the state on a fee basis only.
  2. An adviser with a place of business in the state whose total fee income in the state amounts to $150.
  3. An adviser with no place of business in a state who only provides advice on fixed annuities.
  4. An adviser with a place of business in the state who only provides advice to open-end investment management companies registered under the Investment Company Act of 1940.

A)I and II. B)I only. C)I, II and IV. D)I, II and III.

Unless the adviser is federal covered, any adviser with a place of business in the state, no matter to whom the advice is sold, is required to register with the state. An adviser with no place of business in the state is only exempt if the advice is given to certain institutional type clients, such as insurance companies and banks, not individuals, wealthy or not. Since fixed annuities are not securities, advising on them does not require registration. Remember, if any of your clients are registered investment companies, you must be a federal covered adviser making registration with state non-applicable.

Reference: 3.4 in the License Exam Manual

24

Which of the following qualifies under the Section 28(e) safe harbor provisions for soft-dollar compensation?

A)Rent-free use of unused space in the broker-dealer's office. B)Reimbursement for travel expenses incurred to attend a seminar on the latest compliance trends for registered investment advisers. C)Clearance and settlement services provided by the broker-dealer. D)Providing access to the broker-dealer's computerized accounting system, allowing the investment adviser to prepare its financial statements.

Section 28(e) of the Securities Exchange Act of 1934 provides a safe harbor for research and brokerage services provided in exchange for directed transactions. Clearance and settlement of trades is a qualifying brokerage service.

Reference: 3.18 in the License Exam Manual

25

A broker-dealer registered in multiple states must meet the record retention requirements of:

A)the state where the principal office of the broker-dealer is located. B)the state where the BD is incorporated. C)the state with the most stringent requirement. D)the SEC.

One of the effects of the NSMIA was to establish the pre-emption of federal law over state law. A broker-dealer registered in multiple states is going to be registered with the SEC as well. NSMIA amended the Securities Exchange Act of 1934 (the 34 Act) to add section 15(h)(1) which reads as follows:

"No law, rule, regulation, or order, or other administrative action of any State or political subdivision thereof shall establish capital, custody, margin, financial responsibility, making and keeping records, bonding, or financial or operational reporting requirements for brokers, dealers, municipal securities dealers, government securities brokers, or government securities dealers that differ from, or are in addition to, the requirements in those areas established under this title."

However, had this question been dealing with an investment adviser registered on the state level, then it would have been the requirements of the state where the principal office of the adviser is located.

Reference: 2.4.5.1 in the License Exam Manual

26

To protect against possible inflation, your clients purchase some TIPS with a 2.5% coupon. If, over the next 6 years, the annual inflation rate is 6%, the principal value of each TIPS will be closest to A)$1,360 B)$1,161 C)$1,150 D)$1,426

The principal of a TIPS is adjusted every 6 months for the inflation rate. With an inflation rate of 6%, that means a 3% adjustment, twice per year. With the simple calculator provided at the test center, you would take the initial $1,000 and multiply that times 103% and continue to do that 12 times (there are 12 semiannual periods in 6 years). See the LEM for a shortcut that will always work.

Reference: 5.1.1.4 in the License Exam Manual

27

An investor in a high tax bracket who invested in a DPP should have which of the following characteristics?

  1. Need for tax benefits.
  2. Substantial liquid assets.
  3. Ability to identify both risks and merits of the program.
  4. Ability to commit money for a long time.

A)II and III. B)II, III and IV. C)I, II, III and IV. D)

DPPs (direct participation programs)..pass through all expense gains etc, real estate, cattle programs, condo securities, s corp stuff, oil and gas programs...are appropriate for investors who can benefit from substantial tax deductions or credits, are not bothered by illiquidity, understand the business risks and benefits involved, and can stay in the program until completion.

Reference: 10.2.4 in the License Exam Manual

28

Which of the following investment analysis tools can be used most efficiently to predict the probability of outcomes of portfolio performance recognizing that variables such as holding periods and rates of return are generally uncertain?

A)Technical analysis. B)Monte Carlo analysis. C)Efficient market hypothesis. D)Fundamental analysis.

Monte Carlo analysis uses simulations to predict the probability of portfolio performance in light of multiple and uncertain variable conditions. Technical analysis focuses on price patterns. Fundamental analysis focuses on economic, industry, and business conditions. The efficient market hypothesis argues that analysis itself has little, if any, value.

Reference: 16.5.4 in the License Exam Manual

29

An investor owns a long-term U.S. Treasury bond with a 5% coupon and 15 years to maturity. The client wishes to sell and receives a quote from a dealer of 104.22. This number represents the:

A)offer price. B)yield to maturity. C)premium. D)bid price.

If you are looking to sell, the dealer will pay you his bid price. Had the question said the client wanted to buy, then the quote would have been the offer (ask) price. What does the 5% coupon and the 15 years to maturity have to do with the question? NOTHING. And, knowing that treasuries are quoted in 32nds has nothing to do with it either. And, one more thing. The price quote is above 100 so it is at a premium, BUT, the better answer is bid price because the question is referring to the quote.

Reference: 18.2.3 in the License Exam Manual

30

A new client wants your recommendation on available investment options. You prepare a client profile which reveals that the investor is 66 years of age, has a low risk tolerance and is in a low tax bracket. The investor's primary objectives are safety and income. Of the following, the most suitable choice would be

A)a municipal bond mutual fund investing solely in AAA and AA rated bonds B)insured bank certificates of deposit C)large cap common stock D)a growth and income mutual fund

Whenever you see "low tax bracket," the answer cannot be municipal bonds. With a low risk tolerance, the only suitable choice for "safe" income would be insured bank CDs.

Reference: 15.3.1 in the License Exam Manual

31

Which of the following statements is TRUE regarding Section 529 Plans?

  1. Funds withdrawn for qualified education expenses are always free of federal income tax.
  2. Funds withdrawn for qualified education expenses are always free of state income tax.
  3. The maximum contribution limits are determined on a federal level.
  4. The maximum contribution limits are determined on a state level.

A)II and IV. B)I and III. C)II and III. D)I and IV.

Section 529 Plan withdrawals are exempt from federal income tax if used for the right expenses. In almost all cases, if the plan is one operated by your state of residence, it will be exempt from your state's income tax. But, if you elect to contribute to a plan operated by another state, more than likely, any withdrawals will be subject to your state's income tax. Because the plans are state operated, the maximum contribution limits are set by each state.

Reference: 20.7.2 in the License Exam Manual

32

If a portfolio manager wished to reduce inflation risk, which of the following would be most appropriate to add to the portfolio?

A)Fixed annuities issued by an insurance company with Best's highest rating. B)Tangible assets. C)AAA bonds. D)Preferred stock.

Tangible assets, such as real estate, precious metals, and other commodities, tend to keep pace with inflation. Fixed dollar investments do not.

Reference: 16.4.1 in the License Exam Manual

33

Which of the following attributes of common stock best describes why internal rate of return (IRR) is not generally used to determine the return on common stock? A)Uneven cash flows and no maturity. B)Uneven cash flows. C)Uneven cash flows, no maturity date and price. D)Common stock does not have a net present value.

Internal rate of return (IRR) best measures investments with a known price and maturity. The internal rate of return is the discount rate that makes the future value of an investment equal to its present value. The yield to maturity on a bond is actually its internal rate of return.

Reference: 12.1.1.5 in the License Exam Manual

34

commercial paper

Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Both yield and maturity are open to negotiation. Because commercial paper is issued with maturities of no more than 270 days, it is exempt from registration under the Securities Act of 1933.

Reference: 6.1.1 in the License Exam Manual

35

One of the features of convertible preferred stock is that:

A)convert the stock into the issuer’s bonds. B)the owner has the opportunity to participate in the growth of the company. C)the dividend is paid ahead of all other securities. D)the holder is able to select the conversion price.

Any convertible security, preferred stock or debenture, is convertible into the issuer’s common stock. As a result, if the business is successful, the common stock’s price will rise to the point where conversion is a wise idea. Although the investor can generally select when to convert, the conversion price or ratio is set at the time of issuance.

Reference: 4.1.4 in the License Exam Manual

36

Rule 482 of the Securities Act of 1933 permits the use of an omitting prospectus if it does not:

A)describe how and where to obtain the fund's prospectus. B)omit a statement of the fund's expense ratio. C)make reference to the mutual fund's past performance. D)contain an application to purchase shares of the fund.

An omitting prospectus is a mutual fund tombstone advertisement. It must include information on obtaining a prospectus and may include the fund's past performance. It will never include an application to purchase shares and may or may not make mention of the fund's expense ratio.

Reference: 1.4.4.1 in the License Exam Manual

37

Monte Carlo simulation

The statistical method used to determine the return profile of a security or portfolio that recreates potential outcomes by generating random values based on the risk and return characteristics of the securities themselves is known as the:

38

market order to sell (Bid) or buy (Offer/Ask)

A market order to sell is filled at the highest bid while a market order to buy is filled at the lowest offer (ask).

39

A state securities Administrator does NOT require the filing of: advertising and sales literature relating to the sale of exempt securities.

A state securities Administrator may require the filing of advertising and sales literature relating to the sale of nonexempt securities, financial reports from broker-dealers and investment advisers, and pamphlets and marketing letters used by broker-dealers in an attempt to increase their business. Exempt securities are not required to register with the state Administrator and, therefore, are exempt from the filing requirements for advertising and sales literature.

Reference: 2.8 in the License Exam Manual

40

The market price of a convertible bond depends on all of the following EXCEPT:

A)the conversion prices of bonds from similar companies. B)the value of the underlying stock into which the bond can be converted. C)the rating of the bond. D)current interest rates.

There are two factors that impact the current market price of all bonds; current interest rates and the rating of the bond. A third factor is unique to convertible bonds and that is the conversion value. The conversion value is based on the price of the underlying stock into which the bond can be converted. Comparing the conversion price of one issuer’s bond to another’s tells us nothing about the value of a specific bond.

Reference: 5.2.2 in the License Exam Manual

41

An Administrator may deny or suspend a registration in all of the following situations

The Administrator may restrict a registration on the basis of lack of training and knowledge, but not for a lack of experience alone. The Administrator may deny a registration if the applicant was convicted of a misdemeanor involving securities within the last 10 years. The Administrator may deny a registration if the applicant has been the subject of an adverse order entered by the Administrator of another state within the past 10 years. Registrations may be suspended if agents or investment adviser representatives are not properly supervised.

Reference: 2.14.4.1 in the License Exam Manual

42

To stimulate a sluggish economy using fiscal policy measures, policymakers would:

A)increase income taxes. B)reduce the money supply. C)reduce income taxes. D)increase the money supply.

Reducing income taxes is a fiscal policy (congress & president - - spending & taxation) tool intended to increase overall demand for goods and services. Adjusting the money supply is a monetary policy tool (Federal Reserve - money supply).

Reference: 11.1 in the License Exam Manual

43

An investment adviser representative is looking for a suitable investment for a client. The IAR wishes to find something that will offer an attractive return commensurate with its systematic risk. The choices have been narrowed down to Security C and Security L and the selection will be based on alpha. C has a beta of 1.0 and earned 13% while L has a beta of 0.8 and earned 10.1%. The alpha of Security L is:

A)+0.3 B)+2.9 C)−2.9 D)−0.3

Alpha is obtained by comparing how a security actual performed to the performance one would have expected based upon its beta. A beta of 1.0 is used to indicate the expected volatility of the overall market. Because Security C has a beta of 1.0, its 13% return matches that of the “market”. With a beta of .8, one would expect Security L to produce a lower return, but how much lower? Its return should be 80% of the “market” or, in this case, 80% of 13% which computes to 10.4%. However, its actual return fell short of that by 0.3% giving it a negative alpha of 0.3. Had its actual return been 10.7%, it would have had a 0.3 positive alpha. Although this question doesn’t ask it, based upon the criteria given, the IAR would have selected Security C.

Reference: 12.2.5 in the License Exam Manual

44

A customer opens a margin account with a broker-dealer and signs a loan consent agreement. The loan consent agreement allows the firm to.....

loan out the customer's margin securities....A signed loan consent agreement permits a firm to loan out a customer's margin securities. This is the only part of the margin documentation that is optional.

Reference: 18.1.2 in the License Exam Manual

45

Which of the following are included in the definition of federal covered security?

  1. ABC common stock, domiciled in Delaware, listed on the NYSE, and sold to a resident of Delaware.
  2. ABC common stock, domiciled in Delaware, listed on the NYSE, and sold to a resident of Maryland.
  3. City of Portland, Maine, GO bond sold to a resident of Augusta, Maine.
  4. City of Portland, Maine, GO bond sold to a resident of Augusta, Georgia.

A)I, II and IV. B)II, III and IV. C)I, II, III and IV. D)I and II.

Any security listed on the NYSE, regardless of the corporation's or the customer's state of domicile, is a federal covered security. Municipal bonds, exempt securities under the Securities Act of 1933, are also federal covered securities with one significant exception: if the issuer is a political entity in this state and it is sold to a resident of this state, it is not considered a federal covered security in this state.

Reference: 2.6.2 in the License Exam Manual

46

A significant increase in importing of goods into the United States would have what effect on the strength of the U.S. dollar? A)Fluctuation both ways. B)Weaken. C)No effect. D)Strengthen.

Importing tends to weaken the dollar because it indicates an outflow of money from the United States to foreign countries. Much of this outflow is in the form of debt. When our debt (deficit in balance of payments) gets too high, there is international concern about our ability to pay our debts and a reluctance in accepting U.S. dollars as payment for goods. Therefore, the dollar weakens.

Reference: 11.3.4 in the License Exam Manual

47

Under the Uniform Securities Act, which of the following statements are TRUE regarding private placements?

  1. They are offered to no more than 10 persons in a state in a 12-month period.
  2. They may be offered to an unlimited number of institutional investors.
  3. Institutional buyers need not be purchasing for investment.

A)I and III. B)II and III. C)I, II and III. D)I and II.

Private placements are transactions resulting from offers to no more than 10 noninstitutional persons (retail clients) in 12 months for investment purposes only. The offeror must be convinced that buyers are purchasing for investment. This means no immediate resale intentions are allowed on the buyer's part. No commissions may be paid, directly or indirectly, for these transactions. However, sales to institutional purchasers are exempt from the limitations regarding number of sales, resale restrictions, and commissions. They may, therefore, be offered to more than 10 persons. (Remember that the term person is defined very broadly in the act.)

Reference: 2.8.2 in the License Exam Manual

48

Be careful on language - - STOCK dividends would not be included in AGI....

Stock dividends (dividends paid as additional shares of stock rather than in cash), adjust the investor’s cost basis and don’t come into play until the stock is sold.

49

An investor regularly reads financial blogs on the Internet and they are filled with articles suggesting that the economy is headed for a slump. Some are even saying that there will be price deflation. If these projections are accurate, the best place for the investor to place funds would probably be:

A)common stock. B )U.S. treasury bonds. C)commercial real estate. D)gold.

When the economy is headed downward, safety is the imperative and nothing is as safe (at least for exam purposes) as U.S. Treasuries. Gold, and most other commodities, are a hedge against inflation, not deflation. In “down” times, real estate, both residential and commercial, usually underperforms.

Reference: 11.1.2.3 in the License Exam Manual

50

If the value of the U.S. dollar increases with respect to other currencies, it would make

  1. U.S. exports, like heavy equipment, more competitive in foreign markets.
  2. U.S. exports, like heavy equipment, less competitive in foreign markets.
  3. foreign imports into the United States, such as cars, less competitive in U.S. markets.
  4. foreign imports into the United States, such as cars, more competitive in U.S. markets.

A)I and III. B)II and IV. C)II and III. D)

When the value of the U.S. dollar rises in relation to other currencies, exported products become more expensive in those foreign markets and are less competitive. On the other hand, imported products become less expensive in U.S. markets and are more competitive.

Reference: 11.3.4 in the License Exam Manual

51

There are provisions in the IRS Code which allow certain forms of business to avoid being subject to income tax on the business level. The list would include all of the following EXCEPT:

A)S corp. B)limited partnership. C)LLC. D)sole proprietorship.

In the case of a sole proprietorship, the owner reports any income on his personal Form 1040, Schedule C. The other entities do not pay tax themselves - any income flows through to the members (LLC), stockholders (S corp) and partners (ltd. Partnership).

Reference: 14.3.5 in the License Exam Manual

52

Which of the following are key assumptions of the Capital Asset Pricing Model (CAPM)?

  1. Investors hold diversified portfolios
  2. Income tax rates are stable
  3. Investors can borrow and lend at the risk-free rate
  4. There is a perfect capital market

A)I, III and IV B)I, II, III and IV C)I and III D)II and IV

CAPM assumes that investors will be looking at a return for taking systematic risk, hence holding diversified portfolios. One of the most important assumptions is that investors will be able to borrow/lend at the risk-free rate. Finally, CAPM assumes a perfect capital market, meaning that all securities are valued properly (their returns will plot to the [SML] security market line, and there are no tax or transaction costs). Income taxes are not a consideration, because not all investors are going to be in the same tax bracket.

53

During your annual review with your clients, Matt and Sally Eberhart, they indicate that they think it is time to start putting away some money for college for their 3 year-old son. They ask you to describe the advantage of using an UTMA account over a Coverdell ESA. You would likely point out all of the following as advantages EXCEPT A)withdrawals for other than qualified education expenses are not subject to any penalties. B)there is no limit to the amount that can be contributed to an UTMA. C)there are no earnings limits for making UTMA contributions. D)contributions to the UTMA are made with after-tax dollars.

We're looking for a feature possessed by the UTMA that is not found in an ESA, but in both cases, contributions are made with after-tax dollars. Therefore, you would not describe that as an advantage. Unlike the ESA where couples earning in excess of $220,000 per year are not eligible to contribute, no such ceiling is imposed on those donating or transferring property to an UTMA. Unlike the ESA, where there is a 10% tax penalty on the earnings withdrawn for non-qualified eductional expenses, no such penalty applies to an UTMA. Unlike the ESA which has a $2,000 per year per child limit, there is no limit to the amount that one can give to an UTMA. However, unlike the ESA, where all earnings are tax-free if used for qualified educational expenses, earnings in an UTMA are taxable and, if over a certain amount, might be taxed at the parent's top marginal rate.

Reference: 20.8 in the License Exam Manual

54

One measure of a corporation's intrinsic value is its book value per share. When performing this computation, the value of which of the following would normally be subtracted from the corporation's net worth?

  1. Cash
  2. Wages payable
  3. Patents
  4. Preferred stock

A)I and II B)III and IV C)I and IV D)II and III

The computation of book value per share is basically net tangible worth per share of common stock. Therefore, we subtract both the par value of the preferred stock and the value listed on the balance sheet for the intangible assets, such as patents.

Reference: 11.4.1.5 in the License Exam Manual

55

Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of his state, his total tax equivalent yield would be:

A)Approximately 12.90%. B)Slightly more than 5.33%. C)Slightly less than 5.33%. D)4%.

When an individual owns a municipal bond issued in his state of residence, not only is the interest tax-free on a federal basis, but, (at least in all cases on the exam), it is non-taxed in that state. Therefore, the tax equivalent yield here is slightly higher than it would be if we only computed using the federal tax rate. Since that would be 4.0% divided by .75 (100% minus the 25% tax bracket) or 5.33%, saving on state income taxes would increase the yield slightly. (tax yield is what return you need to make the security equivalent to another return)

Reference: 5.3.1.5 in the License Exam Manual

56

Which of the following statements is (are) TRUE?

  1. A person with a place of business in the state who transacts business exclusively with banks and savings institutions is not a broker-dealer under the Uniform Securities Act.
  2. A person excluded from the definition of investment adviser under the Investment Advisers Act of 1940 who offers investment advice to individual investors residing in this state, and has less than $25 million in assets under management, is subject to the jurisdiction of the state Administrator.
  3. A person included in the definition of an investment adviser under the Investment Advisers Act of 1940, who manages funds on a regular basis as a business headquartered in a state, is subject to payment of filing fees required by the state Administrator.
  4. Broker-dealers who supply incidental investment advice and make securities recommendations to customers who pay commissions for the execution of their trades are not investment advisers subject to state or federal registration.

A)I and IV. B)II and III. C)III and IV. D)I and II.

A person who conducts business exclusively with banks and savings institutions is a broker-dealer under the USA if he has a place of business in the state. Had the person no place of business in the state and conducted business exclusively with banks and savings institutions, he would not be considered a broker-dealer subject to the regulatory control of the state Administrator. Under the NSMIA, any person excluded from the definition of investment adviser under the Investment Advisers Act of 1940 is considered a federal covered adviser. Therefore, regardless of the amount of money under management, the state has no jurisdiction. A federal covered adviser may be subject to payment of state filing fees. Broker-dealers who supply investment advice incidental to their business and receive no special compensation for it are not investment advisers.

Reference: 3.4 in the License Exam Manual