Notes Flashcards

Question

Euro dolars

Answer 1

Establishes: - client's objective - limitation on investment mgr Used to measure investment mgr's perf. Investment policy statement does NOT include investment selection IPS objectives: Return requirements (can be spcific to goal like retireeing at 55) risk tolerance - important IPS constraints - time horizon, liquidity, taxes, laws & Regs, uniqque circumstances Remeber: IPS establishes RR TTLLU

Answer 2

Ex: There are three stocks in our ABC avg. and their values at $44, $60 and $100. Price weighted average would be $68

Answer 3

is a market cap weighted avg.

Answer 4

a value weighted index of the **smallest** market cap stocks in the russell 3000

Answer 5

broadest index that measures perf of over 3k stocks. Value weighted

Answer 6

value weighted - EUrope Austrailia asia and far east

Answer 7

* Ivnestors are Normal - they have needs and wants but may commit cogtnitive errors * Markets are not efficient - there can be deviations in price from fundamental value. Markets are tough to beat, but they are not efficient * Behavioral Portfolio Theory - investors seperate their money into different compartments * Risk Lone does not determine returns - other factors like momentum and investors likes/dislikes about the stock or company

Answer 8

used to determine TOTAL RISK of an UNDIVERSIFED portfolio SD is a measure of risk and variability of returns measures how much something moves around an average -be prepared to calculate SD and use SD to determine probability of returns Memorize 68, 95, and 99 dpeending on if return is +/- 1, 2, or 3 SD away from avg. Calculting using sigma and sx,sy button “Which of the following assets is most risky” = calculate the SD

Answer 9

* In order to reduce risk (variability of returns) as measured by standard deviation (total risk that is undiversified) then combine assets with a correlation of less than 1 To determine how well-diversified a portfolio is, we also need to know what percentage of the fund’s return variation is associated with variation in the market’s return (R-squared/r=r²⁾ R-Squared: The Coefficient of Determination Indicates the reliability of the model or the **reliability of Beta.** * R-squared indicates the percent of return is due to the market (when the portfolio is being compared to an index). How much of our risk is market risk? **R-squared is calculated by squaring the correlation coefficient.** Correlation = .8 R-squared = .64 or 64% R-squared is a measure of how well diversified your portfolio is. An S&P 500 Index Fund will have a r-squared = 100% A Sector Mutual Fund will have an r-squared between 40-50% In the process of adding new investments to a portfolio, the lowest correlation coefficient makes the best addition. Closest to negative one (-1) is always best. Beta & R-Squared Implications (These have historically been tested by the CFP Board.) * R-Squared will give us insight as to whether or not Beta is an appropriate measure of portfolio risk. * If r-squared is greater than or equal to .70 then YES, Beta is an appropriate measure of risk. * If r-squared is less than .**70 then NO, Bet**a is not an appropriate measure of risk. * As a general rule, .70 would be considered sufficient. But, the higher r-squared is, the more reliable Beta. * * Correlation of +1 = perfectly correlated, 0 = no correlation, -1 = negative correlation

Answer 10

* Coefficient of variation (CV) AKA covariance: A measure of **relative risk** when investments have different average returns. Useful when comparing assets with different returns and risk. * The higher the CV, the greater the risk per unit of return. CV = _Standard Deviation_ Avg. or Expected Return An investor prefers the asset with the lower coefficient of variation because it’s less risk, for each unit of return (which also equates into more return per unit of risk).

Answer 11

Leoptoskurtic - high peak and fat tails (higher chance of extreme events Platykurtic - low peak and thin tails (lower change of extreme events)

Answer 12

process of adding risky securities to a portfolio, but keeping the expected return the same. Balances of asset classes the provide lowest variance (as measured by SD)

Answer 13

The systematic risk of a portfolio is measured by its beta. A mutual fund beta is a weighted average of the betas of the assets in the portfolio. * A fund that experiences price changes less dramatic than the benchmark portfolio has a beta that is less than one * A fund that experiences price changes more dramatic than the benchmark portfolio has a beta that is greater than one Beta measures systematic risk (cannot be diversified away - affects ALL stocks) only and is therefore only relevant when assessing the risk of a well-diversified portfolio (high r-squared). \*beta measures how did our portfolio change when the market changed? Beta 1 = beta of the market Beta less than 1 = less volatile than market Beta greater than 1 = more volatile than market bETA IS a measure of our systematic risk. Best to use for a diversifed portfolio (high rsquared)

Answer 14

Systematic risks are those that affect all securities. As such, _they cannot be diversified away_. it is market risk. * **Market risk** - the tendency for changes in the market to influence stock prices. When the market is increasing, most stocks increase in value. Stocks tend to fall with declines in the market. * **Interest rate risk** - When interest rates decrease, stocks tend to increase in value. When rates rise, stock prices fall. * This is due to increased borrowing costs, attractiveness of alternative investments, and the valuation of securities. **Systematic Risks are ‘PRIME’ – Purchasing Power, Reinvestment Rate, Interest Rate, Market, and Exchange Rate. They are risks that affect all companies at the same time. (Ex: Inflation increasing,** Measured by a statistic known as beta.

Answer 15

**Unsystematic Risks**: Risks that are unique to individual firms, industries, or countries. These risks can be diversified away, unlike systematic risks. * *Business risk* - relates to the variability of a firm’s operating income. It is the riskiness of a specific business, which may include the firm’s operations, management style, and philosophy. * *Financial Risk* - related to the capital structure of the firm. **If a firm uses debt to finance the purchase of assets, it increases the financial risk of the firm**. * *Country Risk* – Many U.S. firms have international ties. Country risk is related to uncertainties due to international political and economic risks. **_Unsystematic risks can be diversified away_** Remember “A, B, C, D, E, F G” Accounting, Business, Country, Default, Executive, Financial, Government/Regulation

Answer 16

* Total Risk = Systematic + Unsystematic RIsk * Total risk is measured by **standard deviation** * Systematic risk is measured by **beta**

Answer 17

less than 1

Answer 18

dividing the security risk premium by the market risk premium Ex: if a fund had a return of 20% and the market has a return of 10% the beta is 2

Answer 19

Modern Portfolio Theory - the acceptance by an investor of a given level of risk while maximizing expected return objectives Efficient Frontier - the cruve which illustrates the best possible returns that cuold be expected from all possible portfolios Efficient Portfolio - occurs when an investor's indifference ccurve is tangent ot eh efficient frontier Optimal Portfolio - the one selected from all efficient portfolios \*Investors seek the highest return attainable at any level of risk

Answer 20

assets with correlation of less than 1

Answer 21

You may be asked what measure of risk the CML uses (which is standard deviation) (Forumla is no longer on the provided sheet) CML - is the macro aspect of the CAPM. It specifies the relationship between risk and return in all possible portfolios A portfolio's retur4ns should be on the CML (the CML becomes the new efficient frontier mixing in a risk free asset with a diversifed portoflio) \*Do not usse for individual securities - it is a measure of total portfolio rsk Inefficient portfolios are below the CML.

Answer 22

-calculates the relationship of risk and return of an individual security using the beta (b) as its measure for risk. Also called the Security Market Line \*formula provided on sheet. Remember that the market risk premium is (rm - rf) May be asked “what is the expected return” Use CAPM formula Pg. 38 of pre-study book (investmetn planmnign)

Answer 23

SML uses beta, CML uses SD.

Answer 24

* f r-squared is equal to .70 or greater, then use Treynor and Alpha. * If r-squared is less .70, then use Sharpe. * R-squared indicates how reliable Beta is as a measure of total risk. If Beta is unreliable, then Treynor and Alpha are not reliable. * Remember sharpe ratio is the only one that uses SD, and the others (treynor and jensesn's alpha) use beta **Treynor ratio** is a measure of how much return was achieved for each unit of risk. The higher the treynor ratio the better. is a relative measure of performance **Sharpe** - a measure of portfolio performance using a risk adjusted measure that standardizes returns for their variability. Its a relative measure. A measure of how much return was achieved for each unit of risk. The higher the sharpe ratio the better. Measures risk premiums of the portfolio relative to the total amount of risk in the portfolio **Jensens alpha (AKA alpha)** - a measure of ABSOLUTE performance against a . Distinguishes a manager's outperformance. postive alpha = manager provided more return than was expected for the risk undertaken. negative alpha = maanger provided less return than was expected for the risk undertaken. Alpha of zero expected return= actual return relative to risk taken.

Answer 25

beta = diversified portfolios (treynor and jensens alpha), standard deviation = non-diversified portfolios (sharpe ratio)

Answer 26

R squared less then 70 = not well diversified, so BETA is not an appropriate measure.

Answer 27

**Holding Period Return (HPR)** * A measure of return that includes: * Capital appreciation or loss * Current income * It is the return earned over a specific period of time * HPR is most meaningful if holding period is one year HPR = _[Selling Price - Purchase Price +/- Cash Flows/Dividends]_ Purchase Price * Very simplistic measure, but entirely appropriate for one year investment. * **HPR does not directly address the time over which the investment is held.** * HPR ignores the riskiness of the investment and ignores time value of money * memorize formula (not on sheet) * hint: add dividend to numerator, subtract margin int. paid from numerator * Look at pg. 50 in prestudy book (investment planning)

Answer 28

* Arithmetic mean is a simple average return, but it does not account for compounding. * Assume the following returns: * Year 1: 2% * Year 2: 4% * Year 3: 6% * Year 4: 8% What is the Arithmetic Mean Return? (2% + 4% + 6% + 8%) ÷ 4 = 5% * The disadvantage to the Arithmetic Mean is that it doesn’t take compounding into account.

Answer 29

The geometric (mean) is a compounded rate of return. ⁿ√[(1+r₁) x (1+r₂) x ... (1+r_n)] - 1 GM = Geometric Mean | n = number of returns | r = actual return What is the Geometric Mean? Assume these returns over 3 years: * Year 1: 12% * Year 2: 5% * Year 3: \<2%\> So, the initial $1 investment would be worth $1.1525 in 3 years given the returns. Now use the TVM keys to solve for i (return). N = 3 i = ? = **4.844%** PV = \<1\> PMT = 0 FV = 1.1525 Look at Pg. 54 for cash flow keys

Answer 30

* can be used to calculate a weighted avg. share price, expected returns, beta or duration (process is same for everything) Janis has a portfolio worth $30,000 consisting of three stocks. The expected return for each stock is given, along with its proportionate value of the portfolio. What is the expected return for the portfolio? Stock Expected Return Value A 10% $15,000 B 5% $5,000 C 12% $10,000 **Step 1** Determine the total value of the investment portfolio: $15,000 + $5,000 + $10,000 = $30,000 **Step 2** Determine the weighting of each investment: Stock A: $15,000 / $30,000 = .50 Stock B: $5,000 / $30,000 = .167 Stock C: $10,000 / $30,000 = .333 **Step 3** Multiply the stock weighting by the expected return: Stock A: .50 x .10 = .05 Stock B: .167 x .05 = .0084 Stock C: .33 x .12 = .040 **Step 4** Sum the weighted expected return: .05 + .0084 + .040 = .0984 or 9.84%

Answer 31

Internal Rate of Return * The internal rate of return (IRR) is the earnings rate of a series of cash inflows and outflows over a period of time assuming all earnings are reinvested. It equates discounted future cash flows to the present value of an asset. ![]() Look at Pg.59 PV = the present value of the cash flows * CF_n = the cash flow that occurs at period n * i = the rate at which it makes the equation true (referred to as IRR)

Answer 32

* asserts that pricing imbalances cannot exist for any significatn period of time, otherwise investorts will exploit the price imbalance until the market prices are back to equilibrium * attempt to explain return based on factors * attempts to take advantage of pricing imbalnces * standard deviation and beta are NOT input variables into the APT formula

Answer 33

Formula is provided on CFP formula sheet. Make sure to use next year's dividend when determining the value of stock using the constant growth dividend formula Values a stock by discounting the future stream of cash flow Formula = D1/(r-g) where D1 = next expected dividne r= required rate of return g = dividend growth rate D1 is calculated by D0(1+ g) D1 is calculated using the current div. and dividing growth rate P. 65 & Pg. 66 pre-study

Answer 34

Formula is provided on CFP sheet r = (D1/P) + g p = market price r = rate of return

Answer 35

Bond Int. = PMT Par Value = FV Length to maturiy = N Int Rate = I mkt int rate is the rate used to discount a bond to determine what it is currently selling for in the market- Ex: a bond pay $100 per year with a par value of $1,000. Couon payment/par = Coupon Rate of 10%

Answer 36

Current Yield = Coupon Payment/Current Bond Price

Answer 37

YIeld to Maturity - compounded rate of return if an investor buys a bond today and holds it until maturity To calcutae YTM use the following ex: bond paying 10% int. rate (or $50 semi annually), market pricce is $876. 5 yr. period to maturity left, at which time th e$1,000 par value will be paid. Calc: End Mode, 876+/-, PV 5x2=N 50, PMT 1000 FV I/Yr = 6.744 x2 = 13.49% annually Ex #2: Joe purchased a bond for $880 with a 9% coupon. He SOLD the bond after one year when it was paying him a current yield of 10%. What is the holding period return? Answer: 12.5%. (Hint: find the sale price by using the current yield fomula (CY = coupon rate/current market price)

Answer 38

Yield to call - compounded rate of return if an investor buy a bond today and the bond is called (retired) by the issue. Ex: a bond paying 10% interest of $100/yr. ($50 semi annually) the market price is indicated $876. 5 yr. period to maturity at$1,000 par. Bond is callable in 3 yrs. at 1050. What is the YTC? Answer: 16.7779

Answer 39

Discount - Yields in order of highest yield (YTC, YTM, CY, NY) Premium - Yields in order of highest yield (opposite of discount) (NY, CY, YTM, VTC) Remember: if things are at a discount at the mall, CALL mom's cell.

Answer 40

-when purchasing a bond, the buyer pays the seller interest that has accrued since the last int. payment new buyer receives full amount of interest due at the next int. payment buyer receives a 1099 int that reflects the full periods int rec'd, however, buyer is entitled to a deduciotn equal to amt of accrued int. paid to seller Ex: Pg. 99 investmeplent planning

Answer 41

Answer: IRA. Zero coupon bonds generate phantom income

Answer 42

**Liquidity Preference Theory** - yield curve results in lower yields for shorter maturities bc some investors prefer liquidity and are willing to pay for liquidity in the form of lower yields Longer term yields should be higher than ST yields because of added risks with LT maturities **Market Segmentation Theory** - YC depends on a supply and demand at a given maturity and there are markets for given maturities' with distinct buyers and sellers at each maturity **Expectations Theory** - YC reflects investor's inflation expectation. Since investors are uncertain or believe inflation will be higher in the future, LT yields are higher than ST yields. When inflation is expected to be lower in the future, LT yields will be lower than ST rates (AKA inverted YC) Unbiased expectations Theory - related to the term structure of int. rates. Today's LT int rates have imbedded in them expectations about future ST rates. CFP provided formula (1RN = Pg. 101)

Answer 43

duration - the weighed avg. maturity of all cash flows. - bigger duration = more price sensitivity to int. rate change - modified duration is a bond's price sensitivity to changes in in.t. rates bond portfolio should have a duration equal tot he investor's time horizon to be effectively immunized Duration Calc is provided on CFP sheet There is a direct relationship bw duration and term of the bond. As term increases or decrease, duraiton will increase or decrease. There is an inverse relationship bw coupon rate/YTM and duration \*a zero coupon bond will always have a duration equal to its maturity As coupon rate increases, the duration decreases. Ex Bond A 30 yr. zero coupon, duration = 3-. A 30 yr., 5% coupon, duration = 27, Bond C 30 yr., 10% coupon duration = 25 Duration understates the price appreciation when int. rates decrease and overstates the price deprecation when inr rates increase

Answer 44

Formula is on your CFP sheet

Answer 45

- has both debt and equity features - dividend does not flucutate like a common stock dividend - no maturity date like a bond - price of preferred stock is more closely tied to int. rates than the common stock Tax Advantage: Corps receive a 50 or 65% deduction of dividends (preferred and common) based on percentage of ownership of the company paying the dividends Stated dividend rate as a percentage of par Ex: XYZ preferred pays a 5% dividend with a par value of $20. Thereofre the preferred stock would pay $20 x 5% = $1/sh. Which of the following types of investor benefits most from tax advantages of preferred stocks? Answer: Corporate

Answer 46

conversion value is the value of the convertible bond in terms of the stock into which it can be converted -primary benefits: even if stock doesn't do well, investor has a floow built in. Floor = par value of bond the investor will receive if the convertible is held until maturity CV = [PAR/CP]x Ps Ps = price of the common stock CP is the conversion price (1,000 / CP is the conversion ratio or the number of shares the convertible can be converted into)

Answer 47

* to determine how much an investor is willing to pay for a piece of property, use the formula attached. * Capitalized Value = NOI/Capitalization Rate AKA required rate of return * * Capitalized Rate = NOI/Cost * Important: NOI does not include depreciation or amort, which are NOT cash expenses. IT also excludes payments on debt services since this is a financing expense, NOT an operatin one Lisa expects a potential rental property investment to have gross revenue of $1,000,000 annually. She anticipates $150,000 in maintenance expense, $300,000 in salaries, $100,000 in utilities, $200,000 in depreciation and a mortgage payment of $150,000. Her principal payment would be $50,000 and interest expense would be $100,000. How much should Lisa pay for the rental property if her required rate of return is 12%? 1. $4,166,667 2. $3,750,000 3. $3,333,333 4. $2,916,667 Solution **Solution:** The correct answer is B. Lisa's expenses would be $150,000 in maintenance, $300,000 in salaries, $100,000 in utilities. **_Formula item_** **_Amount_** Gross potential rental receipts 1,000,000 + Other income 0 = Gross potential income 1,000,000 - Vacancy and collection losses 0 = Gross income before expenses 1,000,000 - Operating expenses (excluding interest & depreciation) 550,000 = Net Operating Income 450,000 Divide NOI by capitalization of 12% = 3,750,000 Mortgage and principal payment of a mortgage is a financing expense, not an operating expense and should not be used in calculating NOI. NOTE: There is a second method of calculating NOI. If you back out ALL expenses instead of just operating expenses, you will need to add back in interest expense and depreciation expense.

Answer 48

**Closed End** - shares trade in same manner that publicly traded stocks trade. Shares trade at premium or discount to NAV. Because cap is closed, manager has lots of flexibly for managing assets within the fund. Does not have to plan for cash redemptions. Supply and demand for shares drives price **Open end** - have unlimited numbers of shares. Additional contributions = more shares issued. Shares are bought and redeemed directly from fund family. Shares trade at NAV. NAV = (assets - liab)/shares outstanding. Open-end funds determine the market value of their assets at the end of each trading day. **Unit Investment Trust** - can be equity or fixed income unit investment trust. They are passively managed and self-liquidating. Managed by trustee ( no investment mgr). Issues “units” not shares.

Answer 49

Agg Growth = small caps and offers greatest potential for cap appreciation Growth = equities with high p/e, low or no divs, growing ER and and revenue rapidly Growth and Inc = invests in equities and income producing assets value fund = invests in undervalued equities Bond fund = liquid bond investment Balanced = mix of bonds and stocks MMF - highly liquid, good for emergency fund index funds = tracks perf of various market indices. Passive investment strategy. Sector funds = invests in sectors of the u.s. economy Asset Allocation Funds = well diversified portfolios inlucidng stock, FI and international Global funds - U.S. AND international International = excludes U.S. securities

Answer 50

* No Load Funds - do not charge a sales commission when purchased or redeemed * Load Funds - sales commision when purchased of redeemed. Ex A shares and C shares * A Shares - front end load. 12b-1 fee. No back end load. Ok for LT invsetors * B SHares - back end load. high 12b1 fee. no Front end load. * C shares - no front end load. Small back end load. Appropriate for ST investors

Answer 51

represents Index. low cost of ownership - typically passive investmetns Can be passive or managed

Answer 52

must pay out 90% of investment income to shareholders to maintain tax exempt status. Comapny passes tax burden to its sharehodlers * low correlation with stock market (good for diversification) * real estae is a hedge against inflation * Because of this special tax treatment, most REITs pay out 100 percent of their taxable income to their shareholders and, therefore, owe no corporate tax. Because of their unique tax benefits, **REITs have the ability to attract tax-exempt investors and foreign investors with favorable tax treatmen**

Answer 53

represents foreign stock held in domestic banks' foregin branch. dividends are paid in USD. **Do not eliminate exchange rate risk** Trade on U.S. exchanges and denominated in USD

Answer 54

* Common ALt investmetns - real estate, REITS, CMOs, LPs, hedge funds, collectibles (LT gain = 28% tax), precious metals, crypto

Answer 55

Stock Price - Strike Price (how much the option is in the money) Premium = fundamental value + time value Ex Strike Price = $75, Current STock Price = $76. Premium = 2.75 ( 1 fundamental value + 1.75 time value)

Answer 56

100 shares Ex: One option contract with a premium of $2 will cost $200

Answer 57

Call = right to buy a specific number of shares at a specific price (strike) within a period of time (american) or a specified future date (European) put option = right to sell a specified number of shares at a specified price (strike) within a specified period of time (American) or specified future date (European).

Answer 58

* **Intrinsic Value** Call option: stock price - strike price Put option = strike price stock price **Intrinsic value cannot be less than 0** **Time Value** Premium - intrinsic value

Answer 59

Two compoentnes: premium paid or rec'd AND the instrinsic value of the option STOPS - **St**ock gain or loss, options gain or loss (if you own underlying stock)\_, premium paid or rec'd, shares controlled or ownerf

Answer 60

Usually associated with buying a put

Answer 61

-Black/Scholes - used to determine the value of a CALL option. All variables have a direct relationship on the price of the option, except the strike price. As the strike price increases, the option decreases in value. Variables include: current price of underlying asset, time until expiration, risk free rate of return, volatility of underlying asset Put/Call Parity - attempts to value a PUT option based on the value of a corresponding call option Binomial Pricing Model - attempts to value an option based on the assumption that a stock can only move in one of two directions

Answer 62

* Call options = two potential tax consequences. If contract expires worthless, premium paid = ST loss and premium rec'd is ST gain. Contract exercised, prem is added to SP to increase the basis in the underlying stock. If underlying stock is held for more than 12 months = LTG Put option - (not likely to be tested)

Answer 63

options that have longer expiration periods than traditional options. Expiration periods last for 2+ years (traditional optins are 9 months) Premium paid is higher

Answer 64

-long term call options issued by the CORPORATION Expiration period much longer than options (1-5 yrs) Warrant terms are NOT standardized

Answer 65

(2) types of Futures Contracts: Commodities - oil, pork bellies, wheat Financial futures - currency, int rate, stock indices Option contracts= holder has RIGHt to \_\_\_, futures = holder has OBLIGation to make or take delivery of the underlying asset Futures contracts are market to market (gain or loss in cash is credited/debited to your acct on a daily basis * The spot price is the price of a commodity or asset to be delivered today. The spot price is also called the cash price. * A futures price is the price of the commodity or asset at some time in the future. * While prices may vary, there is a relationship between the spot price and the futures price. As the delivery date draws closer, the futures price converges with the spot price for that commodity. EXAMPLE Joe is a speculator in the futures market. He believes that coffee prices will increase in the future. Joe decides to buy a coffee futures contract, which has the following characteristics: Contract Size: 37,500 pounds Futures Price - 6 months: $1.2515 per pound By entering into the contract, Joe has agreed to buy 37,500 pounds of coffee at a price of $1.2515 six months from now. Assume that the price of coffee six months from now is $1.36. Since Joe has locked in a price of $1.2515, he has made a nice profit. He will pay $46,931.25 ($1.2515 x 37,500) and the coffee will be worth $51,000 ($1.36 x 37,500). Joe’s profit is $4,068.75. If prices had decreased to $1.20 per pound, Joe would have a loss of $1,931.25 ($1.2515 - $1.20 = $.0515 per pound). Long & Short Positions Investors can take long or short positions in futures contracts. Purchasing a contract is termed a long position (take delivery). Selling a contract is called a short position (make delivery). * A long position increases in value if the underlying security or commodity increases in value * A short position increases in value if the underlying security or commodity decreases in value. (sell a contract = short) Ex. Client bought an orangr grove. Wants to lock in future price of crop Since she is LONG the asset, you would want to take a short positions in the futures contract

Answer 66

Answer: II and IV only.

Answer 67

**Solution:** The correct answer is A. Put options that lock in the price at which the security may be sold may be used to protect an investor from a drop in bond prices caused by rising interest rates. Options are derivatives. They derive their value from an underlying investment. Reinvestment risk, default risk, and call risk have no associated value. Interest rates do have an associated value.

Answer 68

**Solution:** The correct answer is D. Raw land may appreciate, but provides no income. A fixed premium annuity provides income, but no growth. Mortgage REITs offer income but no growth. Convertible bonds offer income as a bond and growth potential when converted to a stock.

Answer 69

**Solution:** The correct answer is B. UITs have no money manager, just a trustee, the fees will be lower. You can sell back to the fund or wait until maturity. Due the tendency of Muni-Bond Fund managers to attempt to maximize profits by buying and selling various bonds, there are generally taxable gains to be dealt with in most of these funds. High Yield and Government Bond funds offer no tax advantage. Tax Free Money fund is highly liquid and the client stated they did not require much liquidity, nor does it have a moderately competitive interest rate.

Answer 70

All are true except IV

Answer 71

**Solution:** The correct answer is C. A long position in a futures contract is when the investor buys a futures contract. A short position in a futures contract is when the investor sells a futures contract. A long hedge means that the investor owns (buys) the futures contract to insure a certain price of a commodity that he or she does not yet own. Hedging is taking an opposite futures position than the investor's inherent underlying position.

Answer 72

**Solution:** The correct answer is A. The ladder bond strategy staggers maturities and in doing so, reduces the exposure to interest rate risk. "B" is incorrect because longer term maturities experience the biggest percentage increase when interest rates decrease. Laddering bonds requires purchasing short and intermediate term bonds, along with long term bonds. "C" is incorrect because laddering bonds to avoid the wash sale rule is not the primary objective, reducing interest rate risk is the primary objective. "D" is incorrect because bond immunization suggests the portfolio has eliminated interest rate and reinvestment rate risk. Laddering bonds does not eliminate either interest rate or reinvestment rate risk, however it does reduce interest rate risk.

Answer 73

**Solution:** The correct answer is A. The Municipal Bond Insurance Association provides protection against bond default (safe). Munis will provide steady income and they are tax advantaged. Treasury zeroes pay tax on accrued but unrealized income (phantom income.) CMOs, GNMAs, and Mortgage REITs all have volatility of payment and all run the risk of being paid off early if mortgagees decide to refinance their obligations.

Answer 74

**Solution:** The correct answer is D. Hard assets are generally considered a hedge against inflation, which will lead to price appreciation and potential capital gains.

Answer 75

**Solution:** The correct answer is D. Options "I", "III" and "IV" all generate taxable income during their inclusion in Lily's portfolio: T-bills upon maturity, GNMA when income is paid, and Treasury zeros as the interest accrues within the bond, even though Lily will see no return paid to her. This is known as phantom income and it is fully taxable.

Answer 76

**Solution:** The correct answer is A. All answers except "A" constitute private placement.

Answer 77

**Solution:** The correct answer is A. Both SEC and FINRA call for voluntary negotiations first. Barring success with this level of contact both SEC and FINRA require arbitration.

Answer 78

**Solution:** The correct answer is D. The red herring is so called because of the red lettering notifying prospective investors of its status as a prospectus without prices included.

Answer 79

**Solution:** The correct answer is D. The Securities Act of 1933 regulates securities in the primary markets.

Answer 80

**Solution:** The correct answer is D. The Securities Act of 1933 governs the registration requirements of all newly issued, publicly offered securities.

Answer 81

**Solution:** The correct answer is C. Option "A" - The Investment Advisors Act of 1940 regulates advisors. Option "B" is incorrect because the Act of 1934 regulates the secondary market. Option "C" - The Act of 1933 regulates both IPOs and secondary offerings. Option "D" - The organized exchanges and previously issued securities are governed by the Securities and Exchange Act of 1934. Companies raise billions of dollars by [issuing securities](https://en.wikipedia.org/wiki/Initial_public_offering) in what is known as the [primary market](https://en.wikipedia.org/wiki/Primary_market). Contrasted with the [Securities Act of 1933](https://en.wikipedia.org/wiki/Securities_Act_of_1933), which regulates these original issues, the Securities Exchange Act of 1934 regulates the [secondary trading](https://en.wikipedia.org/wiki/Secondary_market) of those securities between persons often unrelated to the issuer, frequently through brokers or dealers

Answer 82

**Solution:** The correct answer is D. Options "II" and "III" are correct statements. Option "I" is incorrect because the Security Act of 1933 pertains to new securities. Option "IV" is untrue because the Investment Advisers Act of 1940 addresses registration requirements and conduct of advisers, but does not deal with investment safety.

Answer 83

**Solution:** The correct answer is A. Strategic asset allocation is concerned with allocating the wealth of a client among various asset classes, consistent with the clients' investment objectives, time horizons and risk preferences. Tactical asset allocation is concerned with shifting wealth between asset classes to take advantage of expected price level changes (timing) arising from broad movements in the business cycle.

Answer 84

**Solution:** The correct answer is A. Strategic asset allocation is concerned with allocating the wealth of a client among various asset classes, consistent with the clients' investment objectives, time horizons and risk preferences. Tactical asset allocation is concerned with shifting wealth between asset classes to take advantage of expected price level changes (timing) arising from broad movements in the business cycle.

Answer 85

**Solution:** The correct answer is C. If one believes that markets are not efficient, a passive or indexed or buy and hold strategy would not address this inefficiency. An active management style would strive to take advantage of these inefficiencies.

Answer 86

**Solution:** The correct answer is D. Option "A" is incorrect because open-end funds are both passively and actively managed. Option "B" is incorrect because open-end fund shares are traded directly with the fund, not on the secondary market. A closed-end fund has a fixed number of shares offered by an investment company through an initial public offering. Open-end funds (which most of us think of when we think mutual funds) are offered through a fund company that sells shares directly to investors. A closed-end fund is launched through an initial public offering (IPO) in order to raise money for investment. The fund then trades in the open market just like a stock or an ETF. Open-End Funds Mutual funds are open-end funds. There is no limit to the number of shares that they can issue. (Some issuers do close their funds to new investors, as there are downsides to a fund that swells to a gigantic level of assets.) When investors purchase shares in a mutual fund, more shares are created to accommodate them, When investors sell their shares back to the company, the shares are taken out of circulation. If a large number of shares are sold (called a redemption), the fund may have to sell some of its investments in order to pay the investor. You can't watch an open-end fund in the same way you watch your stocks because they don't trade on the open market. The funds do not trade on the open market. Their shares can only be sold back to the company that issued them. Open-end funds are priced only once per day. At the end of each trading day, the funds are repriced based on the number of shares bought and sold. Their price is based on the net asset value of the shares.

Answer 87

**Solution:** The correct answer is B. 12b1 fees are used for marketing and distribution costs. All other costs, such as legal, accounting and analysis are paid through management fees. Commissions are paid using either a front load or a back load.

Answer 88

**Solution:** The correct answer is B. Unit investments do not make additions to investments once the trust has been structured. Shares are not bought or sold after structuring and the portfolio is self-liquidating.

Answer 89

**Solution:** The correct answer is C. If an investor can find out I, II and III, he or she will not likely require IV. Though it may reinforce the investor's findings, the third party analysis is unnecessary at that point. Third party analysis looks at the exact same information you see from the fund. They cannot use inside information, only public information. Even if they attend due diligence meetings with the mutual fund managers, that is still public information. While you may find the format a third party puts the information in useful, or trust in their commentary or buy/hold/sell recommendations, it is based on information you have access to. As a planner, you should be doing that research on any company or investment you offer your client.

Answer 90

**Solution:** The correct answer is B. Closed-end funds generally sell at either a premium or a discount to par value. When purchased at a discount, they afford investors an opportunity to realize up-side capital appreciation

Answer 91

**Solution:** The correct answer is D. Liquidity preference states that investors prefer liquidity, therefore, short-term money pays less. The market segmentation theory states that supply and demand explain at various maturities the shape of the yield curve.

Answer 92

**Solution:** The correct answer is C. Riding the yield curve refers to the purchase of debt instruments in anticipation of fluctuations in the rates of return on both long and short-term instruments. Rising rates of interest require repositioning a portfolio in advance of the rise in order to avoid significant price drops. These moves are based on anticipated changes in the yield curve.

Answer 93

**Solution:** The correct answer is A. Preferred stocks are riskier than debt due to the lack of a maturity date on preferred issues. **Preferreds have fixed dividends** and, although they are never guaranteed, the issuer has a greater obligation to pay them. Common stock dividends, if they exist at all, are paid after the company's obligations to all preferred stockholders have been satisfied.

Answer 94

**Solution:** The correct answer is D. Preferred stocks are non-voting shares. The description of Option "A" is of common stocks' cumulative voting rights. Option "B" refers to convertibility, while Option "C" addresses participating preferred stocks.

Answer 95

**Solution:** The correct answer is C. The corporate dividend-received deductions are based on ownership. TCJA of 2017 updated the amounts. If a corporation owns 20% or less, the have a DRD of 50%. If 20% or more (and less than 80%) of the corporation paying the dividend is owned by the company receiving the dividends, then up to 65% of the dividend is tax free. If ownership is greater than 80% (affiliated corporations) the DRD is 100%. DRD = dividend-received deductions

Answer 96

**Solution:** The correct answer is A. The market prices of preferred stocks do tend to act more like bond prices than common stocks, especially if the preferred stock has a set maturity date. **Preferred stocks rise in price when interest rates fall and fall in price when interest rates rise**.

Answer 97

**Solution:** The correct answer is D. All of the above statements are descriptions of the Original Issue Discount bond. Read this question carefully, a **tax-exempt** Original Issue Discount (OID) bond was purchased.

Answer 98

**Solution:** The correct answer is B. Baa is the lowest bond rating in Moody's Rating System, while BBB is the lowest investment grade in the S&P bond rating system.

Answer 99

1. I and III only.

Answer 100

**Solution:** The correct answer is D. Income bonds (Choice "A") are high risk bonds, usually issued by financially troubled firms. Debentures (Choice "B") are unsecured debt. High-yield bonds are lower quality than investment grade and cost the issuer more in interest payments. The airplanes would serve as collateral on the Equipment Trust Certificates.

Answer 101

**Solution:** The correct answer is B. Price = Loan ÷ (1 - MM) = (23 × . 50) ÷ (1 - .35) = 17.69

Answer 102

**Solution:** The correct answer is C. Required equity: $50 × .25 = 12.50 per share Actual equity: $50 - $50 = 0 (current price- loan amount) To meet required equity: $12.50 per share × 200 shares = $2,500

Answer 103

v**Solution:** The correct answer is B. ## Footnote The $36.00 per share price is divided by the $3.00 earnings per share resulting in a price/earnings multiplier of 12. The increase of earnings by 25% results in a projected earnings of $3.75 next year. This new earnings times the P/E multiplier of 12 (assuming the P/E ratio remains constant) results in a price of $45.00. The dividend information provided is unnecessary in answering the question.

Answer 104

**Solution:** The correct answer is C. This is a related party sale of loss property. Dual basis rules will apply. David will have a double basis in the stock, determined as follows: If the purchaser’s sale price isless than FMVbetween the original basis & FMVgreater than the original basisThen the purchaser’s basis used is$1,800 (Loss Basis)no gain or loss$3,000 (Gain Basis)

Answer 105

**Solution:** The correct answer is C. Step #1: Apply the constant growth dividend formula to value the stock as of year 3. V = 3.01(1.06) ÷ (.12 - .06) V = 53.18 Step #2: Use uneven cash flows to determine the NPV of the stock at time period zero (today). CF0 = 0 CF1 = 2.25 CF2 = 2.75 CF3 = 3.01 + 53.18 = 56.19 I = 12 NPV = ? Answer: $44.20

Answer 106

**Solution:** The correct answer is D. Step #1: Determine the dividend to be paid each year. Year 1: 3.00 × (1.05) = 3.15 Year 2: 3.15 × (1.07) = 3.37 Year 3: 3.37 × (1.08) = 3.64 Step #2: Apply the constant growth dividend formula to value the stock as of year 3. V = 3.64 (1.06) ÷ (.10 - .06) V = 96.46 Step #3: Use uneven cash flows to determine the NPV of the stock at time period zero (today). CF0 = 0 CF1 = 3.15 CF2 = 3.37 CF3 = 3.64 + 96.46 = 100.10 I = 10 NPV = ? Answer: $80.86

Answer 107

**Solution:** The correct answer is D. Company A has a smaller amount of its assets financed by equity, therefore, with the same earnings in net income as Company B, the level of return on the equity of Company A would be greater. Sample information (net income is provided, not calculated in this sample information): A: Assets $10M; Liabilities $6M; Equity $4M; EBIDTA = $1M; I/Y = 5% Net Income = $700K; ROE = $700,000 ÷ $4M = 17.5% B: Assets $10M; Liabilities $2M; Equity $8M; EBIDTA = $1M; I/Y = 5% Net Income = $900K; ROE = $900,000 ÷ $8M = 11.25% EBIDTA = Earnings before interest, taxes, depreciation, and amortization

Answer 108

1. 100 shares 2. 80 shares 3. 50 shares 4. 20 shares **Solution:** The correct answer is A. The conversion ratio is used here (PAR/Conversion Price) to determine how many shares are available upon conversion. $1,000 / $10 = 100 shares.

Answer 109

**Solution:** The correct answer is C. The calculated value as a debt instrument here is $699.07, but when the conversion value puts the rate at $850, you can be certain that the bond is selling in the market place at its convertible value of $850, not its debt value of $699. The conversion price is not given; however, (1,000 ÷ CP) is the conversion ratio, which is given (100 shares). Therefore: CV = 100 shares × P_s CV = 100 × 8.50 CV = $850

Answer 110

**Solution:** The correct answer is C. The value of the bond as a debt instrument is considered separately from its convertibility and is calculated using the bond formula or the present value methodology on the calculator. However, should the conversion value be greater than the "debt value" of the bond, it will sell for the higher price.

Answer 111

**Solution:** The correct answer is D. Use the formula for calculating conversion value of a bond. Keep in mind the conversion value may be different from the intrinsic value of the bond (which in equilibrium is the market price of the bond). ``` CV = (PAR ÷ Cp) x Ps CV = (1,000 ÷ 45.45) x Ps CV = $22 x $52 CV = 1,144 ``` ``` Cp = conversion price: PAR / shares (1,000 / 22 = 45.45) Ps = Price of the stock ``` Convertible Bonds The conversion ratio can also be found by taking the bond's par value, which is **generally $1,000**, and dividing it by the share price. A stock trading for $40 has a conversion ratio equal to $1,000 divided by $40, or 25.

Answer 112

**Solution:** The correct answer is D. Use the expected rate of return and the intrinsic value formulas to calculate the correct answer to this problem. Expected rate of return: E_r = (D1 ÷ P) + g Intrinsic Value: V = (D1) ÷ (r - g) D1 = .64 × 1.17 = .7488 Expected Return = (.7488 ÷ 36.50) + .17 = .1905 or 19.05% Intrinsic Value = .7488 ÷ (.20 - .17) = $24.96

Answer 113

**Solution:** The correct answer is D. Step 1: N = 5 i = ? = .08 PV = \<1.36\> PMT = 0 FV = 2 Step 2: D1 = 2 × 1.08 (from Step 1) = 2.16 Step 3: V = (D1) ÷ (r - g) = 2.16 ÷ (.12 - .08) = 54

Answer 114

Because employees with ISOs don’t need to pay taxes immediately upon exercising their options, ISOs are generally more tax-advantaged than NSOs. [Those exercising ISOs](https://www.brightonjones.com/blog/amt-stock-options/) only pay taxes when they sell their shares. If an employee keeps the shares until at least one full year after vesting and at least two years after the grant date, the gains qualify as capital gains instead of ordinary income. The good news is that ordinary or capital gains taxes aren’t due on ISOs until you file your taxes for the calendar year in which they’re sold. The AMT can take away some of the financial cushion of ISOs. If you hold onto your ISOs, you will need to report the difference between the grant price and exercise price as part of your alternative minimum taxable income. AMT is a critical component in working through an [ISO exercise and hold strategy](https://www.brightonjones.com/blog/amt-stock-options/). NSOs are different. Regardless of whether you hold your stock options or sell them, the spread (the difference between the exercise price and grant price) is counted as part of your earned income and taxed at your ordinary income rate. NSOs taxes are withheld at the time of exercise. Non-qualified stock options are taxed on the “bargain element” (difference between the market price and the strike price) as ordinary income when exercised. (Market Price – strike price) × Number of Shares × Tax Rate = Tax

Answer 115

**Solution:** The correct answer is C. Because Nick is not an employee, we know that his options are non-qualified. We cannot be sure about Betty's without more information.

Answer 116

**Solution:** The correct answer is A. In the case of NQS Options, the option is not taxed at the grant if the exercise price is equal to or greater than the fair market value of the stock.

Answer 117

**Solution:** The correct answer is C. N = 7 × 2 i = ? PV = \<920\> PMT = 55 FV = 1,000 After solving for i, be sure to multiply your answer by 2 since it's semi-annual compounding.

Answer 118

**Solution:** The correct answer is A. In the process of adding new investments to a portfolio, the lowest correlation coefficient makes the best addition. Closest to negative one (-1) is always best.

Answer 119

**Solution:** The correct answer is B. It’s not necessary to use the standard deviation of a two asset portfolio formula to answer this question. Since there’s a 50/50 weighting for each asset, simply take a simple average of the standard deviations (.40 + .20) / 2 = .30. Since the correlation is less than 1, the standard deviation for the portfolio will be less than the simple average. If correlation was equal to 1, then the standard deviation would be equal to 30%.

Answer 120

**Solution:** The correct answer is D. The most favorable correlation between two securities would always be -1 (negative one). That is they move against each other. Therefore, the most negative choice available here would be the best choice.

Answer 121

Agency Relationship and Types of Authority _Express authority_ - given via written documents _Implied authority_ - authority the public perceives, agent accepts premiums, signs on the door, business cards on the desk, letterhead, acceptance of premiums _Apparent authority_ - authority that the public perceives due to business cards, sign on the wall and letterhead but no authority actually exists because the agency agreement expired

Answer 122

Estoppel * Estoppel is where through a legal process, you are denied a right you might otherwise be entitled to under the law. * Estoppel applies when one party relies on information from another party and that information causes harm to the party that relied on the information. * The party that made the statements can be estopped from denying the statements. Ex: Walter and his wife walk into his insurance agent’s office and take out a $10 million life insurance policy on Walter’s life, with his wife as the beneficiary. Walter’s wife asks the insurance agent if the policy will pay a death benefit if he commits suicide and the agent responds “yes.” Two days later, Walter is found dead from an apparent suicide. Walter’s wife then tries to collect the $10M death benefit under the policy, however the policy has a “Suicide Clause” that stipulates that if the insured commits suicide within two years of the policy being issued, then the premiums will be returned and no death benefit is paid. Although the insurer will attempt to produce the policy and suicide provision, the insurer may be estopped from denying paying of the claim based on information the agent expressed to Walter’s wife.

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