Chapter 11: Direct Participation Programs

Question 1

Direct Participation Program

Answer 1

Limited partnership

Question 2

Limited partnership must avoid 3 of the following corporate characteristics

Answer 2

1. Having centralized management 2. Providing limited liability 3. Having perpetual life 4. Having free transferability of partnership interest

Question 3

Limited partner’s cost basis

Answer 3

Max potential loss for investor

Question 4

Recourse debt

Answer 4

If a limited partner signs a recourse loan, the creditors can pursue personal assets if the partnership defaults on loan

Question 5

Dissolution of partnership (3 ways)

Answer 5

1. Limited partners vote to terminate partnership (GP can’t) 2. Partnership reaches objectives 3. IRS determines partnership is abusive

Question 6

Limited partnership liquidation order

Answer 6

1. Secured creditors 2. General creditors 3. Limited partners 4. General partners

Question 7

Rep requirements for Oil and gas investment

Answer 7

1. Prescreen customers to see if good match for partnership 2. Determine the economic soundness of the program 3. Explain the risks of investing in limited partnerships

Question 8

Intangible drilling costs

Answer 8

-Write offs for drilling expenses -Not actual equipment: wages, fuel, repairs, insurance, etc. -Only when still drilling, once producing this is not applicable -Fully deductible in current year

Question 9

Equipment leasing partnership (2 types)

Answer 9

1. Operating lease = purchases equipment and leases for a short period of time, riskier of the two 2. Full payout lease = purchases equipment and leases for long period of time, income from first lease is enough to cover cost of equipment and financing costs

Question 10

What are the 4 real estate partnership types?

Answer 10

1. Public housing
   
   • safest
2. Existing properties
3. New construction
4. Raw land
   
   • riskiest, goal is appreciation, fewest write offs, even more risky than oil and gas exploratory

Question 11

Tangible drilling costs

Answer 11

-Write offs on items purchased that have salvage value such as storage tanks, well equipment, etc -Straight line basis or accelerated basis -Depreciated (deducted) over several years

Question 12

Depletion

Answer 12

-Tax deduction that allows partnerships that deal with natural resources (such as oil and gas) for decreasing supply of the resource -Only applies to resources sold, not taken out of the ground

Question 13

Oil and gas partnerships (4 types)

Answer 13

1. Exploratory (Wildcatting) = riskiest 2. Developmental 3. Income = safest 4. Combination

Question 14

Subscription agreement

Answer 14

-An application form that potential limited partners must complete -Used by GP to determine if investor is suitable (signs when accepts new partner) -Usually sent with some form of payment

Question 15

All of the following statements are TRUE regarding the subscription agreement EXCEPT

• A. a general partner must sign the agreement to officially accept a limited partner
• B. a registered rep must first examine the subscription agreement to make sure that the investor has provided enough information
• C. after the general partner has signed the subscription agreement, it gives the limited partner power of attorney to conduct business on behalf of the partnership
• D. the subscription agreement is usually sent to the general partner with some form of payment

Answer 15

C. after the general partner has signed the subscription agreement, it gives the limited partner power of attorney to conduct business on behalf of the partnership

• The subscription agreement is a form that the potential limited partner fills out.
• Then the registered rep reviews the document before sending it (with the investor’s payment) to the general partner, who signs to accept the terms.
• The subscription agreement gives the general partner, not the limited partner, power of attorney to make decisions for the partnership.

Question 16

Which of the following types of real estate DPPs has the fewest write offs?

• A. raw land
• B. new construction
• C. existing properties
• D. pubic housing

Answer 16

A. raw land

• Because the DPP isn’t spending money on improving the property and land can’t be depreciated, raw land DPPs have the fewest write offs.

Question 17

A client has money invested in a limited partnership that is expecting to have a significant amount of income over the next one to two years. Which of the following programs would BEST help the client shelter the MOST of that income?

• A. oil and gas exploratory
• B. raw land purchasing
• C. equipment leasing
• D. existing real estate property

Answer 17

A. oil and gas exploratory

• Oil and gas exploratory programs spend a lot of money attempting to find and drill for oil.
• These programs have high IDCs (intangible drilling costs), which are fully tax deductible when the drilling occurs.

Question 18

Which TWO of the following options are in the money if ABC is trading at 62 and DEF is trading at 44?

1. an ABC Oct 60 call option
2. an ABC Oct 70 call option
3. a DEF May 40 put option
4. a DEF May 50 put option

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

Answer 18

B. I and IV

• Start from the strike prices.
• You’re calling up or putting down from the strike prices, not from the market prices.

Question 19

A client previously bought 1 ABC Oct 65 call at 8 when the market price of ABC was 64. He now decides to sell the option. The second option order ticket would be marked

• A. opening sale
• B. opening purchase
• C. closing sale
• D. closing purchase

Answer 19

C. closing sale

Question 20

A client purchased 100 shares of ABC stock at $50 per share. Two weeks later, he sold 1 ABC Oct 55 call at 6. The client held that position for 3 months before selling ABC stock at $52 per share and closing the ABC Oct 55 call at 4. What is the client’s gain or loss in the transactions?

• A. $400 gain
• B. $400 loss
• C. $600 gain
• D. no gain or loss

Answer 20

A. $400 gain

• Money Out = $5,000 + $400 = $5,400
• Money In = $600 + $5,200 = $5,800

Question 21

An investor who owns 1 ABC Oct 40 call option would like to establish a long combination. Which of the following option positions would fulfill his needs?

• A. write 1 ABC Jan 40 put
• B. buy 1 ABC Oct 30 call
• C. buy 1 ABC Oct 40 put
• D. buy 1 ABC Jan 30 put

Answer 21

D. buy 1 ABC Jan 30 put

• A long combination is buying a call and a put for the same security with different expiration and/or different strike prices.
• You can cross off A right away because a long combination requires two purchases.
• Choice C would be correct if the question was asking for a straddle.

Question 22

An investor buys 1 ABC Mar 60 call at 6 and buys 1 ABC Mar 50 put at 3. ABC subsequently increases to 68. The investor exercises the call and immediately sells the stock in the market. After the put expires unexercised, what is the investors gain or loss?

• A. $100 gain
• B. $100 loss
• C. $500 gain
• D. $500 loss

Answer 22

B. $100 loss

• Money Out = $600 + $300 + $6,000 = $6,900
• Money In = $6,800 = $6,800

Question 23

A client purchased 1 Apr 40 call at 9 and shorted 1 Apr 50 call at 3. What is the client’s break even point?

• A. 43
• B. 46
• C. 49
• D. 53

Answer 23

B. 46

• First, focus on the buy and sell. If the investor is buying one option and selling another, you should be able to recognize it as a spread.
• Therefore, you have to find the difference between the two premiums:
  
  • Adjusted premium = 9 - 3 = 6
• Next, because it’s a call spread, you have to add the adjusted premium (after subtracting the larger from the smaller) to the call strike (exercise) price to get the break even point:
  
  • Break even point (call spread) = 40 + 6 = 46

Question 24

A client purchased 1 ABC Mar 60 put at 5 and wrote 1 ABC Mar 65 put at 9 when ABC was trading at 68. Six months later, with ABC trading at 61, the client’s ABC Mar 65 put was exercised. The client held the shares of ABC for another two months before selling them in the market for $62 per share. The client’s Mar 60 put expired without ever going in the money. What is the client’s gain or loss?

• A. $100 loss
• B. $100 gain
• C. $700 loss
• D. $700 gain

Answer 24

B. $100 gain

• Money Out = $500 + $6,500 = $7,000
• Money In = $900 + $6,200 = $7,100

Question 25

A client sold short 100 shares of ABC common stock at $25 per share and bought 1 ABC Aug 30 call at 3 to hedge his position. What is the client's maximum potential loss from this strategy? * A. $300 * B. $800 * C. $2,200 * D. $2,700

Answer 25

B. $800 * Money Out = $300 + $3,000 = $3,300 * Money In = $2,500 = $2,500

Question 26

Which of the following items can be found in the certificate of limited partnership? 1. the goals of the partnership and how long it is expected to last 2. the authority of the general partner to charge a fee for making management decisions for the partnership 3. how the profits are to be distributed 4. the amount contributed by each partner, plus future expected investments * A. I, II, and III * B. II, III, and IV * C. I, III, and IV * D. I, II, III, and IV

Answer 26

* C. I, III, and IV 1. name of partnership 2. partnership's primary place of business 3. names and addresses of limited and general partners 4. the goals of the partnership and how it is expected to last 5. the amount contributed by each party 6. how the profits are to be distributed 7. the roles of the participants 8. how the partnership can be disolved 9. whether a limited partner can sell or assign his interest in the partnership * The authority that allows the general partner to charge a fee for making management decisions is found in the partnership agreement

Question 27

An investor deposited $75,000 to become a member of an oil and gas limited partnership. In addition, he deposited $20,000 in recourse debt. For this calendar year, he reports a $10,000 cash distribution, $30,000 in depreciation, and $25,000 in depletion. What is the investor's cost basis? * A, $10,000 * B. $30,000 * C. $50,000 * D. $70,000

Answer 27

B. $30,000 * cost basis is the maximum amount that can be lost by the investor * the investor deposited a total of $95,000 * cash distribution, depreciation, and depletion reduce cost basis * $95,000 - $10,000 - $30,000 - $25,000 = $30,000