- An investment of $2,000 made 10 years ago is now worth $8,000. Using the Rule of 72, the approximate compounded annual rate of return is
Correct answer: 14.4%
The money quadrupled, which is two doublings spread over 10 years, so one doubling took 5 years. The Rule of 72 divides 72 by the years per doubling: 72 divided by 5 is approximately 14.4%. Every wrong answer here divides 72 by the wrong doubling period. Dividing by the full 10-year holding period gives 7.2%, which is the rate that would merely double the money rather than quadruple it. Dividing by 7 years gives 10.3% and dividing by 4 years gives 18%; neither 7 nor 4 is the doubling period that two doublings across 10 years produces.
- If an investment can be expected to return 8%, using the rule of 72, what is the present value needed to have $50,000 for a child's education in 18 years?
- $25,000
- $2,777
- $12,500
- $6,250
Correct answer: $12,500
Under the rule of 72, dividing 72 by the expected return shows the number of years it will take for a deposited sum to double. 72 divided by 8 equals 9 years. Over an 18-year period, there will be 2 doublings. So, dividing the future value ($50,000) by 4 solves for the present value required.
- A client who wishes to have $50,000 available to help fund a 3-year-old child's college education in 15 years estimates that if the portfolio can earn 7%, a deposit of $18,122.30 will be required today. This deposit is referred to as
- The present value
- The future value
- The internal rate of return
- The net present value
Correct answer: The present value
This is a present value computation where the future value, time period, and earnings rate are known.
- A client owns an investment-grade bond that has a coupon of 7% and is priced to yield 5.4%. If similarly rated bonds are being issued today with coupons of 5%, it would be expected that the client's bond
- Has a negative net present value
- Has a positive net present value
- Will be selling at a discount from par
- Has a zero net present value
Correct answer: Has a positive net present value
With a discount rate of 5% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 7% coupon rate will be selling at a premium (interest rates down, prices up). We are told that this bond is offering a yield of 5.4%, which is more than the current market rate. Because a present value computation using a 5.4% rate would reflect a lower value than a 5% rate (the higher the discount rate, the lower the value), the bond can be purchased at a price below its present value. Any time that occurs, the instrument has a positive net present value (the difference between the price and the present value).
- One of the critical components of making suitable recommendations is the ability to evaluate risk. Risk measurement tools would include all of the following EXCEPT
- Sharpe ratio
- Beta
- Standard deviation
- Future value
Correct answer: Future value
Future value measures the time value of money and has no relationship to risk.
- An investment of $5,000 made 10 years ago is now worth $20,000. Using the Rule of 72, the approximate compounded annual rate of return is
Correct answer: 14.4%
The account quadrupled, which is two doublings across 10 years, or one doubling every 5 years. The Rule of 72 gives 72 divided by 5, or approximately 14.4%. Dividing 72 by the full 10-year period gives 7.2%, the rate that would merely double the money. Treating the growth as three doublings gives 72 divided by 3.33, or 21.6%. Dividing the 300% total gain by 10 years gives 30%, a simple average that ignores the compounding the Rule of 72 is built on.
- Which of the following statements is NOT correct?
- Internal rate of return (IRR) is a method of determining the exact discount rate to equalize cash inflows and outflows, thus allowing comparison of rates of return on alternative investments of unequal size and investment amounts.
- Net present value (NPV) is the difference between the initial cash outflow (investment) and the future value of discounted cash flows.
- Net present value analysis (NPV) is a commonly used time value of money technique employed by businesses and investors to evaluate the cash flows associated with capital projects and capital expenditures.
- Time-weighted returns show performance without the influences of additional investor deposits or withdrawals from the account.
Correct answer: Net present value (NPV) is the difference between the initial cash outflow (investment) and the future value of discounted cash flows.
Net present value (NPV) is the difference between the initial cash outflow (investment) and the present value of discounted cash flows (NPV = PV of CF − cost of investment). That is why it is called net present value instead of net future value.
- A bond is paying $100 per year in annual interest and is selling at par. If the discount rate is 10%, the net present value is
- Positive
- The same as the coupon
- Negative
- Zero
Correct answer: Zero
A bond paying $100 in interest per year has a coupon rate of 10%. Whenever the coupon rate is equal to the discount rate, the NPV is zero. That is, the present value of a bond paying 10% interest when the current market rate is demanding a 10% interest rate is the bond's par value (as is the case with this bond).
- A measurement of investment return that takes the time value of money into consideration is
- Annualized rate of return
- Risk-adjusted rate of return
- Internal rate of return
- Time-weighted rate of return
Correct answer: Internal rate of return
The internal rate of return is the discount rate that equates the present value of an investment's cash inflows with the present value of its outflows, so every cash flow is weighted by when it arrives and the measure reflects the time value of money. An annualized rate of return simply restates a result on a per-year basis and says nothing about when the cash flows arrive. A time-weighted rate of return deliberately removes the effect of the size and timing of cash flows so that separate periods can be linked, which is the opposite of weighting money by time. A risk-adjusted rate of return compares return with volatility.
- One of your clients owns shares of the NERP Corporation's senior preferred stock. He is concerned about NERP's financial solvency and wonders where he would fall in the event of NERP declaring bankruptcy. The proper response is, the client's claim is
- After the creditors and the common stockholders
- After the creditors, but ahead of the common stockholders
- Ahead of all claims because his stock has a senior claim
- After the secured creditors, but ahead of the unsecured creditors because of the senior claim
Correct answer: After the creditors, but ahead of the common stockholders
In a corporate bankruptcy, the first claim is that of secured creditors. They are followed by the unsecured creditors. After all creditors have been satisfied, any remaining funds are used to pay off the preferred stock up to its par value, and finally, if there is anything left, it goes to the common stockholders. When a preferred stock is named as a senior preferred, it generally means that there is more than one class of preferred stock outstanding and this one has priority over the others.
- The STU Corporation has issued common stock, preferred stock, promissory notes, and mortgage bonds. Should STU enter bankruptcy proceedings, the order of payment against claims would be
- The preferred stock, the common stock, the mortgage bonds, and the promissory notes
- The mortgage bonds, the promissory notes, the preferred stock, and the common stock
- The mortgage bonds, the preferred stock the common stock, and the promissory notes
- The promissory notes, the mortgage bonds, the preferred stock, and the common stock
Correct answer: The mortgage bonds, the promissory notes, the preferred stock, and the common stock
In a bankruptcy, secured creditors, such as those with a mortgage against real property, have the first priority. They are followed by unsecured creditors, such as holders of promissory notes, with stockholders coming last. Preferred stock is "preferred" over common in both liquidation priority and payment of dividends.
- An investment adviser is analyzing 4 bonds of similar quality for a client. Bond A has a coupon of 6%, matures in 12 years, and is currently priced at 50. Bond B has a coupon of 8%, matures in 9 years, and is currently priced at 50. Bond C has a coupon of 4%, matures in 18 years, and is priced at 45. Bond D has a coupon of 12%, matures in 6 years, and is priced at 50. Based on NPV, which of these bonds represents the better value?
Correct answer: Bond C
Because you don't have the proper calculator to do a real PV calculation, NASAA expects you to use the rule of 72. Remember, under that rule, dividing 72 by the interest rate tells you the number of years it will take for a deposit to double. Or, if you divide 72 by the number of years, it will tell you the interest rate required for a present deposit to double. Finally, a positive NPV is when you can buy the bond for less than its present value. So, let's look at all 4 choices. Bond A, at 6%, takes 12 years to double. That's exactly the time to maturity, so the PV of this bond should be approximately $500 (a quote of 50). The same is true of bonds B and D—their PV should be approximately $500 (72÷8%=9 years; 72÷12%=6). Because their price is the same as the PV, the NPV is zero. However, with bond C, 72 divided by 4% equals 18 years, so this bond also has a PV of approximately $500 (50), but it can be purchased for less than that: 45 ($450). Therefore, with an NPV of $50, bond C is the best value. One final point: If you are stuck and have to guess, note that 3 of the 4 bonds are selling for $500 with the other priced at $450. If they are all going to mature at $1,000, a good guess would be that the cheapest one is the best deal.
- Mr. and Mrs. Rose, advisory clients of yours, request a meeting with you to discuss the options available if they wish to deposit a lump sum to save for college tuition for their child. All of these would be factors to consider EXCEPT
- The Roses’ salaries
- The expected inflation rate
- Current college costs
- The age of the child
Correct answer: The Roses’ salaries
When making a lump sum investment, salary is not a factor. The funds will have to come out of savings or investments. This is basically a present value computation. In order to project how much will be needed, we need to know what the current tuition is, the rate at which it is expected to inflate, and the number of years we have until the child starts college. That will give us the three components of present value: total amount needed, earnings rate, and length of investment.
- The difference between present value and net present value represents
- The credit risk premium
- The internal rate of return
- The initial cash outlay
- The discounted cash flow
Correct answer: The initial cash outlay
When computing the net present value, we remember that the word net means that something must be subtracted. The number subtracted is the initial cost of the investment.
- If the net present value of a series of discounted cash flows is less than zero, one could conclude that
- The internal rate of return equals the discount rate
- The discounted cash flows are lower than the investment outlay
- The return on investment is higher than the internal rate of return
- The rate of return is higher than the cost of capital
Correct answer: The discounted cash flows are lower than the investment outlay
A negative net present value of a series of discounted cash flows means the investment outlay exceeds the discounted cash flows. Net present value is the difference between the initial cash flows and the present value of future cash inflows. If the net present value is negative, the present value of future cash flows is less than the initial investment. An investment with a negative net present value is generally an undesirable investment.
- An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 5.75%, then the NPV is
- Negative
- Between 5.75% and 6%
- Zero
- Positive
Correct answer: Negative
Any time an investment's IRR is less than the required rate of return, the NPV is negative (and should probably be avoided). NPV is expressed as a dollar amount. It is the IRR that is expressed as a percentage.
- An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 6.32%, then the NPV is
- Between 6% and 6.32%
- Negative
- Positive
- Zero
Correct answer: Positive
Anytime an investment's IRR is more than the required rate of return, the NPV is positive (and should probably be selected). The NPV is expressed as a dollar amount. It is the IRR which is expressed as a percentage.
- One way in which internal rate of return (IRR) differs from most return computations is that
- It reflects the effect of inflation on real returns
- It is stated as a simple, uncompounded annual yield
- It takes into consideration the time value of money
- It applies just to debt securities held to maturity
Correct answer: It takes into consideration the time value of money
The internal rate of return is a discounted cash flow measure: each cash flow is weighted by the date it arrives, so the computation reflects the time value of money, which most return computations ignore. Adjusting a return for the change in the price level produces a real rate of return, not an internal rate of return. The internal rate of return compounds rather than averaging, so it is not a simple uncompounded figure. It is applied to equity, real estate and partnership cash flows as well as to bonds, so it is not confined to debt held to maturity.
- The Smiths are saving money for a down payment on a house. The Smiths have $25,000 in cash, and they estimate that in 5 years they will have approximately $31,000 if they deposit their cash in a savings account that compounds interest yearly. To calculate the $31,000 amount, the Smiths determined
- The internal rate of the return on the $25,000
- The net present value of the $25,000
- The present value of $25,000
- The future value of the $25,000
Correct answer: The future value of the $25,000
To determine the money's worth at a future date (in this case, 5 years), the Smiths calculated the future value of the funds. Future value is a compounded rate of return, and in this case, the $25,000 was compounded at 5% per year for 5 years. The present value of an investment is the opposite of future value.
- An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 6%, then the NPV is
Correct answer: Zero
When an investment's IRR equals the required rated of return, the NPV is zero. If the IRR is higher than the required rate of return, the NPV is positive; if the IRR is lower than the rate of return, the NPV is negative.
- Which of the following statements regarding internal rate of return (IRR) is TRUE?
- IRR cannot be used effectively to measure return on investments with even cash flows, such as bonds.
- IRR is a discount rate at which the net present value (NPV) of an investment is equal to zero.
- IRR ignores the time value of money.
- If the IRR is higher than the cost of borrowing to fund an investment, the investment is likely to be unprofitable.
Correct answer: IRR is a discount rate at which the net present value (NPV) of an investment is equal to zero.
Internal rate of return (IRR) is a discount rate at which the net present value (NPV) of an investment is equal to zero. IRR can be used to measure return on bonds because of their even cash flows and on those stocks that pay stable dividends for the same reason. IRR accounts for the time value of money. If the IRR is higher than the cost of borrowing to fund the investment, the investment should be profitable.
- The present value of a dollar
- Is the amount of goods and services a dollar buys at a future price level
- Is the value a dollar invested today will grow to by a stated future date
- Is the sum invested today at a given rate to reach a stated future amount
- Is the same as its future value when the level of interest rates is fixed
Correct answer: Is the sum invested today at a given rate to reach a stated future amount
Present value answers a single question: how much must be committed today, at a given interest rate, for the investment to be worth a specified amount on a specified future date. The quantity of goods and services a dollar buys is purchasing power, an inflation concept rather than a discounting concept. The amount a dollar grows to by a future date is future value, the mirror image of present value; the two are equal only at a zero interest rate, not merely when rates hold steady. A positive rate always makes present value smaller than future value.
- Which of the following statements with regards to net present value and internal rate of return is correct?
- If the net present value equals zero, then the internal rate of return is less than the required rate of return.
- If the net present value is less than zero, then the internal rate of return is greater than the required rate of return.
- If the net present value is greater than zero, then the internal rate of return is greater than the required rate of return.
- If the net present value equals zero, then the internal rate of return is greater than the required rate of return.
Correct answer: If the net present value is greater than zero, then the internal rate of return is greater than the required rate of return.
Any time the net present value is greater than zero (a positive NPV), the internal rate of return is greater than the required rate of return and the investment should be made. If the net present value is zero, then the internal rate of return equals the required rate of return.
- If you were using the discounted cash flow method to determine the appropriate value of a security, you would want to purchase that security when
- The rating of the security has just been upgraded
- The current market price is above the PV
- The current market price is below the PV
- The current market price equals the PV
Correct answer: The current market price is below the PV
Those who use the DCF to value a security would recommend purchasing when the current market price is below the PV—that is, when the NPV is positive.
- One of your clients has $150,000 in his 401(k) plan at work. He is assuming the portfolio will increase in value at a rate of 7% compounded annually for the next 5 years. If that is the case, the portfolio value at the end of that 5-year period will be closest to
- $160,500.
- $240,867.
- $210,383.
- $202,500.
Correct answer: $210,383.
This is a straightforward future value computation. The proper way to do this is to enter the beginning value ($150,000) into your calculator, and then multiply times 107% five consecutive times. We'll get you started: 150,000 x 107% = $160,500 x 107% = $171,735 x 107% = $183,756 (and do this 2 more times to get $210,383). If that is too challenging, then use the "shortcut" – it always works. Figure the answer using simple interest. The starting value is $150,000. Seven percent growth is $10,500. Do that for 5 years and it is $52,500. Add that to the initial value and you have $202,500. Then, select the next highest number because that takes into consideration the compounding effect.
- Which of the following incorrectly states the relationship between NPV, IRR, and required return?
- If NPV > 0, then IRR > required return.
- If NPV > 0, then IRR < required return.
- If NPV < 0, then IRR < required return.
- If NPV = 0, then IRR = required return.
Correct answer: If NPV > 0, then IRR < required return.
If the NPV is a positive number, the investor's internal rate of return (IRR) is greater than the required rate of return (it is a good buy). When used with bonds, the required rate of return is the current market interest rate. Conversely, if the NPV is a negative number, the investor's IRR is less than the required rate of return (not a good buy). When the NPV is zero, the investor's IRR is equal to the required rate of return.
- Using the net present value method, a potential investment should be undertaken if the present value of all cash inflows minus the present value of all cash outflows (which equals the net present value) is
- Less than zero
- Equal to zero
- Positively correlated
- Greater than zero
Correct answer: Greater than zero
NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a proposed investment is positive, it should be accepted. However, if NPV is negative, the investment should probably be rejected because cash flows will also be negative.
- When a bond's NPV is zero, it is usually an indication that
- The bond is mispriced
- The bond is a zero-coupon bond
- The market is highly efficient
- The bond is highly rated
Correct answer: The market is highly efficient
An NPV of zero indicates that there is no difference between the bond's present value and its current market price. That usually indicates a highly efficient market.
- If the required rate of return is higher than anticipated in a present value calculation, the effect would be that
- The present value would be lower
- The present value would be higher
- The yield to maturity would increase
- The future value would be higher
Correct answer: The present value would be lower
Try to follow me on this one. The present value computation is used to determine how much money must be deposited now (in the present) to reach a specified future goal when you know how many years you have to reach that goal. One critical component of the formula is the rate of return. As a simple example, if you need $100,000 in 18 years for your newborn's college education and you expect to earn 4%, using the rule of 72, you'll have to deposit $50,000 now (present value) to reach the goal. However, if it turns out that the earnings rate is higher than anticipated—say, 8%—you would only need to deposit half as much today ($25,000). Therefore, we answer this question by indicating that a higher rate of return will require a lower present value (deposit).
- The rate that produces a net present value of a series of discounted cash flows equal to zero is called
- The average rate of return
- The return on investment (ROI)
- The internal rate of return (IRR)
- The opportunity cost of investing
Correct answer: The internal rate of return (IRR)
The internal rate of return is the rate that produces a net present value of a series of discounted cash flows equal to zero. If the NPV is above zero (positive NPV), then the IRR is greater than the required return; if below zero (negative NPV), then the IRR is less than the required return.
- Which of the following securities has an easily determinable internal rate of return?
- 6% Ginnie Mae
- 7% corporate bond
- Zero-coupon bond
- 5% municipal bond
Correct answer: Zero-coupon bond
The only security that does not have reinvestment risk (the risk that periodic interest payments cannot be reinvested at the same yield as the bond providing the interest payments) is a zero-coupon bond such as Treasury STRIPS. With a zero-coupon bond, there are no periodic interest payments to reinvest, so a yield can be locked in. The interest rate that discounts the redemption price (par) to the discounted purchase price is the locked-in yield, which is the same as the internal rate of return, also referred to as the yield to maturity.
- Which of the following best describes net present value?
- The difference between the sum of the discounted cash flows that are expected from an investment and its initial cost
- The discount rate that results in a return of zero for a series of future cash flows
- The amount of money that must be invested today at some specified rate of return to equal a targeted value in a specified number of years
- It is the true interest yield expected from an investment expressed as a percentage
Correct answer: The difference between the sum of the discounted cash flows that are expected from an investment and its initial cost
Net present value is a computation taking into consideration future cash flows, discounted to the present, and comparing that to the capital investment necessary to obtain those flows. It is always expressed in monetary units and, if positive, indicates a potentially worthwhile investment.
- A bond's yield to maturity reflects its
- Taxable equivalent return
- Internal rate of return
- Return based on annual interest as a percentage of current price
- Nominal return
Correct answer: Internal rate of return
Yield to maturity reflects the internal rate of return on a bond. Internal rate of return (IRR) equates the cost of an investment to the cash flows produced by that investment.
- All of the following statements regarding an investment's internal rate of return (IRR) are true EXCEPT
- IRR is most often used with growth stocks
- IRR is the one rate of return that results in an investment having a net present value (NPV) of 0
- Investments are acceptable when their internal rates of return exceed the investor’s required rate of return
- IRR expresses the rate of interest that matches the initial investment with the present value of future cash flows
Correct answer: IRR is most often used with growth stocks
It is possible, although very difficult, to calculate IRR for investments with uneven cash flows such as growth stocks where dividends are generally not reliable. IRR is the rate of interest that equates the initial investment with the present value of future cash flows; it is the rate of return that results in an investment having a net present value of 0.
- Which of the following statements is most accurate regarding the net present value (NPV) and internal rate of return (IRR) on a bond?
- IRR assumes the cash flows are reinvested annually.
- NPV assumes that cash flows can be reinvested at the bond’s IRR.
- IRR assumes the cash flows are reinvested at market interest rates.
- NPV assumes the cash flows can be reinvested at market interest rates.
Correct answer: NPV assumes the cash flows can be reinvested at market interest rates.
The first step in finding the NPV is to compute the present value (PV). The PV is computed by taking the future cash flows and discounting them by a "discount" rate. That rate is the current market interest rate. So, if NPV is based on PV and PV assumes reinvestment at the discount rate, that assumption must hold true for figuring NPV. In the case of the IRR, that is the yield to maturity of a bond and assumes that the cash flows are reinvested at that IRR. For example, a bond with a YTM of 7% assumes that all reinvestments will be made at that 7% rate. The periodic cash flow on a bond comes from the semiannual interest payments making reinvestments semiannually, not annually.
- To make a quantitative evaluation using the present value computation, which of the following is NOT needed?
- Account value at the end of the period
- Time period involved
- Account value at the beginning of the period
- Anticipated rate of return of the portfolio
Correct answer: Account value at the beginning of the period
Present value is calculated to determine the amount required now to have a specified value at some time in the future. It is what we are looking for so we don't have it now.
- A client owns an investment-grade bond with a coupon of 5% that is priced to yield 6.7%. If similarly rated bonds are being issued today with coupons of 7%, it would be expected that the client's bond
- Will be selling at a premium over par
- Has a zero net present value
- Has a positive net present value
- Has a negative net present value
Correct answer: Has a negative net present value
With a discount rate of 7% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 5% coupon rate will be selling at a discount (interest rates up, prices down). We are told that this bond is offering a yield of 6.7%, which is less than the current market rate. Because a present value computation using a 6.7% rate would reflect a higher value than a 7% rate (the higher the discount rate, the lower the value), that would mean that the bond can be purchased at a price above its present value. Anytime that occurs, the instrument has a negative net present value (the difference between the price and the present value).
- Present value is a computation that is frequently used to determine the amount of a deposit needed now to meet a future need, such as a college education. If an investor uses an expected return of 8% but the actual return over the period is 10%, the future value will be
- The same as anticipated
- Lower than anticipated
- Higher than anticipated
- Too varying to tell
Correct answer: Higher than anticipated
Present value is the amount deposited to meet a future goal based on an expected rate of return. If the return is higher than expected, the ending result will be greater (a good thing).
- An investor places $10,000 into BCD common stock 12 years ago. Today, that stock has a market value of $20,000. Using the Rule of 72, the internal rate of return on BCD is closest to
Correct answer: 6%.
The Rule of 72 indicates that the approximate return required for a number to double in 12 years can be determined by dividing 72 by 12. That results in a return nearest to 6%.
- Your client has $10,000 to invest today and expects to earn an after-tax return of 8% to send his daughter to college in 12 years. Which of the following is needed to determine whether the investment is likely to satisfy the client's goal?
- Consumer Price Index
- Present value
- Client’s marginal federal income tax bracket
- Expected cost of college
Correct answer: Expected cost of college
To determine whether the investment will satisfy the goal, the investment adviser representative needs to know the amount needed to pay for college. The information we have here will allow us to compute the future value: $25,181.70. This may not be enough to pay for even 1 year of college 12 years from now.
- A client owns an investment-grade bond with a coupon of 7%. If similarly rated bonds are being issued today with coupons of 5%, and the market is efficient, it would be expected that the client's bond
- Will be selling at a discount from par
- Has a zero net present value
- Has a positive net present value
- Has a negative net present value
Correct answer: Has a zero net present value
With a discount rate of 5% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 7% coupon rate will be selling at a premium (interest rates down, prices up). If the market is efficiently pricing that bond, its market price should be equal to its present value, resulting in an NPV of zero.
- Your client has $10,000 to invest and expects to earn an after-tax return of 8% to send his daughter to college in 12 years. Which of the following items will help determine whether the investment is likely to satisfy the client's goal?
- Consumer Price Index
- Client's marginal federal income tax bracket
- Present value
- Expected cost of college
Correct answer: Expected cost of college
To determine whether the investment will satisfy the goal, the investment adviser representative needs to know the amount needed to pay for college. While the investment will be worth $25,181.70, this may not be enough to pay for even one year of college 12 years from now.
- One of your clients wishes to give her daughter $200,000 to start her own business. The daughter expects to be finished with graduate school and an internship in 8 years. The expected rate of return is 9%. Using the Rule of 72, calculate the amount the client must deposit today to meet that future goal.
- $100,000
- $112,500
- $72,000
- $144,000
Correct answer: $100,000
In this question, we are told to use the Rule of 72 to compute the present value. That is, the sum required today (present) to reach a stated future goal. With an earnings rate of 9%, the rule tells us that money will double in 8 years (72 divided by 9 = 8). With an 8-year accumulation period and a goal of $200,000, the deposit required to reach that by doubling is $100,000.
- The time value of money is part of the computation for
- The risk-adjusted return
- The after-tax return
- The internal rate of return
- The real rate of return
Correct answer: The internal rate of return
One of the unique features of IRR is that it is a compounded rate using the time value of money.
- Twelve years ago, an investor placed $2,500 into an account. The account is now worth $10,000. Using the Rule of 72, you can determine that the approximate annual return was
Correct answer: 12%
Under the Rule of 72, we can determine an earnings rate by dividing 72 by the number of years it takes for money to double. In this case, the money had quadrupled. That means it has doubled twice in 12 years or, every 6 years. Dividing 72 by 6 years results in an annual return of 12%.
- A client is meeting with you to discuss the best way to invest today to meet the goal of funding their child's college expenses. The least important information needed to determine the amount to deposit is
- Age of the child
- Parent’s salary
- Expected inflation rate
- Current college costs
Correct answer: Parent’s salary
Because this question is looking for the initial deposit, salary is not as important a factor as the other three.
- When determining whether to make an investment in a real estate limited partnership, Bill is concerned with the discount rate that equates the net investment cash inflows to the net investment cash outflows. Which calculation is Bill using to make this prudent investment decision?
- The net present value
- The discounted payback period
- The required rate of return
- The internal rate of return
Correct answer: The internal rate of return
The internal rate of return is defined as the discount rate at which an investment's net cash inflows equal its net cash outflows, which is exactly the figure Bill is solving for. Net present value applies a discount rate that is supplied in advance and reports a dollar surplus or shortfall rather than solving for the rate. The required rate of return is the hurdle Bill will compare the answer against once he has it, not the calculation that produces it. The discounted payback period measures how long the discounted cash flows take to recover the original outlay.
- Securities analysts would agree that it makes sense to purchase a fixed-income security when its net present value (NPV) is
- Zero
- Negative
- Variable
- Positive
Correct answer: Positive
A positive NPV means the security is available for a price below its present value—it is a good buy. With a negative NPV, the price is too high. With a zero NPV, it is accurately priced.
- Your client wants to have $1 million in her investment account when she retires at age 70. She is currently 50 and has about $215,000 available to invest today. You tell her that if the portfolio can earn at a compounded rate of 8%, she will reach her goal. That 8% rate is
- The internal rate of return
- The future value rate
- The present value rate
- The market rate of return
Correct answer: The internal rate of return
The internal rate of return is the earnings rate required to reach a specified future value from an amount that is currently available to invest. This is a future value computation, but there is no such term as future value rate.
- Which of the following statements best represents a bond's present value?
- Present value is the discounted future repayment of principal.
- Present value is the sum of all the discounted future payments.
- Present value represents the internal rate of return (IRR) of the bond.
- Present value is the sum of all the discounted future interest payments.
Correct answer: Present value is the sum of all the discounted future payments.
The correct answer is the standard "textbook" statement. There are two future cash flows from a bond. First is the periodic interest payments and second is the repayment of the principal at maturity. The PV of the bond is the sum of the discounted value of both.
- In general, one would prefer to purchase a bond when its current market price is
- More than its present value
- Less than its present value
- Less than its future value
- The same as its present value
Correct answer: Less than its present value
When a bond can be purchased for less than its present value, it has a positive net present value (NPV). For example, if the present value of a bond is $600 and it can be purchased for $565, it has an NPV of $35 and should be an attractive investment. Every bond selling at a discount has a market price that is less than its future value (par), so that doesn't tell us anything about its NPV.
- Bond X has an internal rate of return (IRR) of 7%. Bond Y has an IRR of 9%. Both bonds pay interest semiannually. If the required rate of return is
- 7%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y.
- 7%, the net present value (NPV) of Bond Y will exceed the NPV of Bond X.
- 9%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y.
- 9%, both bonds will have a positive NPV.
Correct answer: 7%, the net present value (NPV) of Bond Y will exceed the NPV of Bond X.
We know that when a bond's IRR equals the required rate of return (the discount rate), the NPV of that bond is zero. That is the case with Bond X when the required rate of return is 7%. When the bond's IRR is above the required rate of return, it has a positive NPV. That is the case with Bond Y whose IRR is higher than the 7% required return. With a required return of 9%, Bond X has a negative NPV and Bond Y's NPV is zero. That is the technical explanation. The simple explanation is to compare the IRR with the required rate of return. Anytime the IRR is above the required rate, you've got a good deal (and that is what a positive NPV tells us).
- You have determined that the net present value (NPV) of your client's investment is positive. If your client's required rate of return is 8%, which of the following is most likely the investment's internal rate of return (IRR)?
Correct answer: 9%
If the NPV is a positive number, the investment's IRR must be greater than the investor's required rate of return. In this question, the required rate of return is 8% so the IRR (actual return) must be higher than that. There is only one choice higher than 8%. Remember, when the NPV is positive, it is a good investment.
- Which of the following statements regarding the time value of money is NOT correct?
- Future value is the future amount to which a sum of money today will increase on the basis of a defined interest rate and period.
- Compound interest is interest earned on interest.
- Future value of an ordinary annuity is the future amount to which a series of deposits of equal size will increase.
- Compound interest is interest earned on the initial investment.
Correct answer: Compound interest is interest earned on the initial investment.
Compound interest is interest earned on interest that has been added to the original principal. For example, $1,000 earning 5% compounded annually earns $50 the first year and then 5% of $1,050 or $52.50 the 2nd year.
- Selmer Jones has just inherited some money and wants to set some of it aside for a vacation in Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In order to determine how much of the money must be set aside now and held for the trip, he should use the 5% as a
- Required rate of return
- Opportunity cost
- Nominal rate of return
- Discount rate
Correct answer: Discount rate
This is a present value question. Selmer needs to figure out how much the trip will cost in one year, and use the 5% as a discount rate to convert the future cost to a present value. Thus, in this context the rate is best viewed as a discount rate. Although you would never have to compute it, for each $1,000 Selmer needs, he would have to put away $952.38 (the present value of $1,000 at 5% in 1 year).
- Present value is a computation frequently used to determine the amount of deposit needed now to meet a future need, such as a college education. If an investor uses an expected return of 8%, but the actual return over the period is 6%,
- The present value was insufficient to meet the objective
- The yield to maturity will be lower than anticipated
- The accumulated value will meet the objectives
- The future value will not be able to be computed
Correct answer: The present value was insufficient to meet the objective
Present value is the amount deposited to meet a future goal based on an expected rate of return. If the return is lower than expected, the amount deposited will not grow to the required amount (a bad thing).
- There are several measures of central tendency used by investment analysts. Included would be all of the following EXCEPT
- Arithmetic mean
- Weighted median
- Moving average
- Statistical mode
Correct answer: Moving average
A moving average smooths a price series across a rolling window and is used to judge the direction of a trend, which makes it a technical analysis tool rather than a measure of central tendency. An arithmetic mean, a weighted median and the mode are all measures of central tendency: a mean averages the observations, the median is the middle observation once they are ranked, and the mode is the observation that occurs most frequently.
- The terms mean, median, and mode are all measures of
- Correlation coefficient
- Standard deviation
- Central tendency
- Beta coefficient
Correct answer: Central tendency
Central tendency is usually defined as the center or middle of a distribution. The three most common tools used are mean, median, and mode.
- If an investor wished to compute the mean return of her portfolio, she is going to
- Compute using straight-line averaging
- Compute the standard deviation
- Find the arithmetic mean
- Find the median
Correct answer: Find the arithmetic mean
Unless something else is specified, whenever the mean return is referenced, it is always the arithmetic mean (the simple average).
- Over the past 5 years, a stock has had returns of +16%, + 5%, −4%, +12% and +8%. This results in an arithmetic mean of
Correct answer: 7.4%
The arithmetic mean is the simple average of all the numbers. When adding them together (remembering to subtract the one year of negative returns, we arrive at a total of 37 divided by 5, which is equal to 7.4%).
- Here are the past seven years of returns for XYZ common stock, 17%, 3%, 13%, 3%, 5%, 9%, 8%. As a measure of central tendency, the value 8 is most accurately described as
- The mean
- The median
- The mode
- The standard deviation
Correct answer: The median
The median is the number in the middle of distribution. In this case, arranging the numbers from lowest to highest (3, 3, 5, 8, 9, 13, 17), the number with as many below as above is 8. Mean = (3+3+5+8+9+13+17)÷7=8.28. Mode = most frequent observation = 3.
- An analyst has been charting previous 9 year's returns for a stock and displays the following results: 5%, 5%, 8%, −3%, 10%, 12%, 5%, 17% and 22%. If you were asked the mode of these returns, you would reply
Correct answer: 5%
The mode of a series of numbers is that number that has the largest number of occurrences. In this case, 5% appears 3 times, more than any other number. Note that the mode is not similar to the mean (in this example 9%) or the median (in this case 8%).
- When it comes to computing market returns, it is TRUE to state that
- The median return is always above the arithmetic mean return
- The modal return is always above the arithmetic mean measure
- The median return is always above the geometric mean measure
- The geometric mean is never above the arithmetic mean return
Correct answer: The geometric mean is never above the arithmetic mean return
The geometric mean takes a root of the product of the return relatives instead of averaging the returns. It equals the arithmetic mean when every period's return is identical and is lower whenever the returns differ, so it can never come out above the arithmetic mean. The median can sit above, below or exactly on the arithmetic mean depending on the shape of the distribution, and the same is true of the mode, so neither comparison holds as a rule. There is likewise no fixed relationship between the median and the geometric mean.
- An investor has $100,000 to invest. If the account's estimated annual return is 8% and the investor plans to withdraw $20,000 at the end of each year, approximately how long will the money last?
- 7.55 years
- 6.65 years
- 5 years
- 8.33 years
Correct answer: 6.65 years
This is a simple calculation with a financial calculator, but the test center does not let you use one. So, if you get a question like this (and have time – don't waste it if it means you won't get to the easy questions at the end of the exam), you can do it long-hand as shown in the study materials. For those without a study materials, it goes like this: Beginning of year (BOY) End of year (EOY) $100,000 ×108% $108,000 − then subtract $20,000 $88,000 ×108% $95,040 $75,040 ×108% $81,043.20 $61,043.20 ×108% $65,926.66 $45,926.66 ×108% $49,600.79 $29,600.70 ×108% $31,968.85 $11,968.85 ×108% $12,926.36 Therefore, the investor can withdraw the planned $20,000 for 6 full years and will have slightly less than enough for 65% of the full payment in the 7th year.
- A wealthy client wishes to endow her favorite charity with a lump-sum gift that, with an assumed rate of return of 4% per annum, will provide $2,500 per month in perpetuity. What amount does the client need to deposit?
- $750,000
- $100,000
- $75,000
- $1,000,000
Correct answer: $750,000
A monthly income of $2,500 is equal to $30,000 per year. At a 4% earning rate, $750,000 must be deposited to generate that amount (30,000÷4%).
- A client wishes to endow an annual scholarship of $40,000 at her alma mater. If the investment can provide a perpetual return of 4.2% per annum, the lump sum deposit required to provide this income is
- $168,000.00.
- $952,380.95.
- $1,052,631.50.
- $417,536.53.
Correct answer: $952,380.95.
This is an income in perpetuity computation. Divide the annual requirement ($40,000) by the annual return (4.2%) to get the correct answer. You should be able to "eyeball" this one. If the return were 4%, you would need $1 million to generate $40,000 per year. With a rate of 4.2%, you would need slightly less. There is only one answer that is slightly less than $1 million (and that would be true on the actual exam).
- Which of the following rates of return is used by investment professionals as the risk-free rate?
- Overnight federal funds rate
- Ninety-one day Treasury rate
- Commercial bank prime rate
- Central bank discount rate
Correct answer: Ninety-one day Treasury rate
Investment professionals use the ninety-one-day Treasury bill rate as the risk-free rate: the obligation is backed by the U.S. government so there is no credit risk, the term is short enough that interest rate risk is negligible, and the market is deeply liquid. The overnight federal funds rate is the rate banks charge each other for reserves and carries bank credit exposure. The commercial bank prime rate is a lending rate banks set for their strongest corporate borrowers. The central bank discount rate is an administered policy rate charged to member banks borrowing from the Federal Reserve.
- Which of the following statements is NOT true?
- A stock with a beta of 0.8 will move 20% less than the market.
- A stock with a beta of 1.2 will move 20% more than the market.
- Beta is a volatility measure of a security compared with the overall market.
- Beta is a measure of a security's deviation from its historical average returns.
Correct answer: Beta is a measure of a security's deviation from its historical average returns.
A measure of a security's deviation from its historical average returns is the security's standard deviation. Beta measures a security's volatility in relation to the overall market. Stocks with a beta greater than 1 are more volatile than the market and stocks with a beta less than 1 are less volatile than the market.
- A stock's beta coefficient is a measure of the stock's
- Profitability relative to its group
- Consistency of its dividend payment
- Institutional ownership relative to outstanding shares
- Volatility relative to the market
Correct answer: Volatility relative to the market
Beta measures a stock's volatility relative to the overall market. A beta above 1 indicates a more volatile stock, while a beta below 1 describes a stock less volatile than the market.
- Which of the following statements is correct?
- Beta is a measure of relative unsystematic risk for stock or portfolio returns.
- Portfolio managers have a goal of reaching zero alpha.
- A stock or portfolio’s beta increases as its alpha declines.
- Beta is a measure of relative systematic risk for stock or portfolio returns.
Correct answer: Beta is a measure of relative systematic risk for stock or portfolio returns.
Beta is used to measure the variability between a particular stock's (or portfolio's) movement and that of the market in general. That refers to systematic rather than unsystematic risk. When it comes to alpha, the goal is a positive alpha and there is no correlation between the beta and alpha of a stock or portfolio.
- XYZ Corporation has a beta of 1.0, and ABC has a beta of 1.4. XYZ has returned 12% and ABC 14.8%. Based on this information, ABC had alpha of
Correct answer: −2%
Alpha is the extent to which a security's performance exceeds (or falls short of) that of the market compared to what would be expected based on its beta. A key to this question is that XYZ's beta of 1.0 equals the beta of the market. A stock with a beta of 1.4 would be expected to perform 40% better in an up market than the market itself. Because XYZ with a beta of 1.0 gained 12%, ABC should return 140% of that or 16.8% (12%×1.4). With an actual return of 14.8%, ABC underperformed the expected by 2% and that is why it has a negative alpha.
- Which of the following statements best describes the risk-free rate of interest?
- The arithmetic mean of the CPI over the past 12 months
- The rate of interest required to produce a net present value (NPV) of zero
- The rate of interest in excess of the pure time value of money
- The rate of interest earned on the 91-day U.S. Treasury bill
Correct answer: The rate of interest earned on the 91-day U.S. Treasury bill
The rate of interest earned on short-term U.S. Treasury securities, generally the 91-day T-bill (might be called the 13 week or 3 month bill on the exam), is referred to as the risk-free rate. The rate of interest in excess of the pure time value of money is called the risk premium, not the risk-free rate. CPI and NPV have nothing to do with the risk-free interest rate.
- Cecil has a discretionarily-managed account with Pelf Reliable Advisors (PRA), an investment adviser registered in States C, D, and G. Over the past year, the portfolio produced a 12% return with a beta of 1.05. The risk-free rate is 3.5%, and the overall market returned 10.85%. Based on this information, calculate alpha and determine if PRA added any value to the portfolio.
- Alpha = 1.15%; the adviser outperformed the market by 1.15%
- Alpha = -1.21%; the adviser underperformed the market by 1.21%
- Alpha = 0.78%; the adviser underperformed the market by 2.72%
- Alpha = 0.78%; the adviser outperformed the market by 0.78%
Correct answer: Alpha = 0.78%; the adviser outperformed the market by 0.78%
The alpha for this portfolio is +0.78% (rounded). A positive alpha indicates that Pelf outperformed the market on a risk-adjusted basis. As with most calculations, there are two ways to solve for the answer. Let's use the guide's formula first. When the riskfree (RF) rate is given, the formula is (actual return - RF rate) - (beta x [market return - RF rate]). Plussing in the numbers, we have (12% minus 3.5%) minus (1.05 times [10.85% minus 3.5%]). That breaks down to 8.5% minus (1.05 times 7.35%) or 8.5% minus 7.72% = +0.78%. An alternative method is as follows: 12% – [3.5% + 1.05 (10.85% – 3.5%)] = 12% – [3.5% + 7.7175] = 12% – 11.2175 = +0.7825.
- Beta is most frequently measured against which of the following?
- Dow Jones Industrial Average
- S&P 500
- Nasdaq Composite Index
- S&P 100
Correct answer: S&P 500
The index most commonly used to analyze the beta of an individual security or portfolio is the S&P 500. Companies (portfolios) with a beta of 1.0 would be expected to move in tandem with the market, while companies with a beta greater than 1.0 would be more volatile than the market as a whole. Companies with a beta less than 1.0 should show a rate of change less than that of the market as a whole.
- If your customer is pursuing an aggressive stock buying strategy, which of the following is most suitable for him?
- ABC stock with a beta coefficient of 1.0
- GHI stock with a beta coefficient of 1.20
- Convertible bonds of a mid-cap company
- DEF stock with a beta coefficient of 0.93
Correct answer: GHI stock with a beta coefficient of 1.20
Beta coefficients greater than 1.0 signify that the stock will fluctuate more than the market as a whole. In general, the higher the beta, the greater the risk. Such risk-taking is appropriate for investors who seek aggressive stock-buying strategies and have both the financial ability and the temperament to withstand downturns in the market.
- An investor's portfolio has a beta coefficient of 0.85. If the overall market declined by 10% over the course of a year, the portfolio's value has likely
- Increased by 10.85%
- Decreased by 8.5%
- Increased by 8.5%
- Decreased by 11.76%
Correct answer: Decreased by 8.5%
A beta coefficient of 0.85 means that the portfolio is considered to be 0.85 times as volatile as the overall market. Therefore, if the market declines by 10%, the portfolio with a beta of 0.85 is likely to decline by only 8.5% (0.10×0.85).
- XYZ Corporation has a beta of 1, and ABC has a beta of 1.4. XYZ has returned 12% and ABC 18.8%. Based on this information ABC had alpha of
Correct answer: 2%
Alpha is the extent to which a security's performance exceeds (or falls short of) what would be expected based on its beta. A stock with a beta of 1.4 would be expected to perform 40% better in an up market than one with a beta of 1.0. Because XYZ with a beta of 1.0 gained 12%, ABC should return 140% of that or 16.8% (12%×1.4). With an actual return of 18.8%, ABC beat the expected by 2% and that is its alpha. More accurately, this question should also include the risk-free rate, but if, as in this case, it doesn't, the computation is easier. If the RF rate was shown, then that would have to be subtracted from "both sides." If the RF was 2%, then the computation would be (12%−2%)×1.4=14%. Then, we subtract the 2% RF rate from the 18.8 to get 16.8%. The difference between 16.8% and 14% would be alpha of 2.8%.
- If a stock has a beta of less than 1.0, the stock's price will
- Swing more widely than the market in both directions
- Fall further than the market during a market decline
- Hold steady while the broader market rises and falls
- Rise less sharply than the market during any advance
Correct answer: Rise less sharply than the market during any advance
Beta measures how far a stock's price moves relative to a broad market index. A beta below 1.0 means the stock moves less than the market does, so when the market advances the stock gains less than the index. Swinging more widely than the market in both directions, and falling further than the market on a decline, both describe a beta above 1.0. Holding steady while the market moves would describe a beta near zero, which is not what a beta of less than 1.0 states.
- A stock traded on the Nasdaq Stock Market has a beta of 1.20. One could expect that the stock's volatility compared to the S&P 500 would be
- Too variable to tell
- 20% less volatile
- 20% more volatile
- Negatively correlated to the S&P
Correct answer: 20% more volatile
Beta is a measurement of a security's volatility when compared with the overall market, best measure by the S&P 500. The "market" is assigned a beta of 1.00, so when the beta is higher than 1.00, the stock has greater volatility and when lower than 1.00, the volatility is less.
- Assume Frank has a portfolio with an actual return of 10.50% for the past year. The portfolio beta equals 1.25, the return on the market equals 9.75%, and the risk-free rate of return equals 3%. Based on this information, what is the alpha for Frank's portfolio and did it out outperform or underperform the market?
- −0.9375%, underperform
- −1.6875%, underperform
- +9.1875%, outperform
- +3.3750%, outperform
Correct answer: −0.9375%, underperform
The formula for alpha: α=(actual return−risk-free rate)−(β×[market return−RF]). If we plug in the numbers, we get (10.5%−3%)−(1.25×[9.75%−3%])=7.5%−(1.25×6.75)=7.5%−8.4375=−.9375 The alpha for Frank's portfolio equals −0.9375%, indicating that his portfolio underperformed the market based on the level of assumed investment risk.
- In portfolio theory, the alpha of a security or a portfolio is
- The difference in the expected return of the portfolio, given the portfolio's beta, and the actual return the portfolio achieved
- A measure of the variance in returns of a portfolio divided by its average return
- The portfolio's average return in excess of the risk-free rate divided by the standard deviation in returns of the portfolio
- The risk of the portfolio associated with the macroeconomic factors that affect all risky assets
Correct answer: The difference in the expected return of the portfolio, given the portfolio's beta, and the actual return the portfolio achieved
Alpha is the difference in the expected return of the portfolio, given the portfolio's beta and the actual return the portfolio achieved. The higher the alpha, the better the portfolio has done in achieving excess or abnormal returns. The risk of the portfolio associated with the macroeconomic factors that affect all risky assets is systematic risk. The portfolio's average return in excess of the risk-free rate divided by the standard deviation in returns of the portfolio is the Sharpe ratio or measure. The measure of the variance in returns of a portfolio around its average return is the standard deviation.
- An investment adviser representative is researching a security and notices that its beta is zero. Which of the following securities is probably the subject of that research?
- A public utility stock
- An ETF tracing the index of gold stocks
- A 91-day U.S. Treasury bill
- A 5-year U.S. Treasury note
Correct answer: A 91-day U.S. Treasury bill
A beta of zero means an investment whose price is not generally affected by fluctuations in the stock market. One could say that makes them free of market risk. The traditional example of that is the 91-day T-bill. All of the other choices would typically have a low beta, but none would have a beta of zero.
- A customer's portfolio has a beta coefficient of 1.1. If the overall market increases by 10%, the portfolio's value is likely to
- Decrease by 10%
- Increase by 10%
- Increase by 11%
- Decrease by 11%
Correct answer: Increase by 11%
A beta of 1.1 means the portfolio is considered to be 1.1 times more volatile than the overall market. If the market is up 10%, the portfolio with a beta of 1.1 is likely to be up 11%.
- When a stock has a beta of less than 1, this indicates that
- It will have a high level of systematic risk
- It will, on average, give a return below that of the market
- It will have a high level of unsystematic risk
- It will, on average, give a return in excess of that of a stock with a beta of greater than 1
Correct answer: It will, on average, give a return below that of the market
Beta tracks a stocks co-movement with the overall market. Because the "market" has a beta of 1.0, any stock with a lower beta will generally not have price movement equal to the market. Beta is a measurement of systematic risk, and low-beta stocks have less than high beta ones. Beta has no relationship to unsystematic risk.
- Which of the followings measures should be used to assess the risk-adjusted return of an active portfolio manager?
Correct answer: Alpha
Alpha is a measure of risk-adjusted return. It is the return in excess of the compensation for risk. It is often used to assess the performance of active managers.
- Which of the following are likely to have a low beta?
- Automobile maker stocks
- Public utility stocks
- Software maker stocks
- Aerospace supplier stocks
Correct answer: Public utility stocks
Public utility revenues are rate-regulated and demand for power and water changes little across the business cycle, so utility share prices move less than the market and their betas are low. Automobile makers, software makers and aerospace suppliers are cyclical businesses: revenues swing with interest rates, consumer credit, corporate technology budgets and defense or airline order books, so their shares typically move more than the market and carry high betas.
- Which of the following purchases is most suitable for an investor pursuing an aggressive investment strategy?
- DOH stock with a beta coefficient of 0.7
- GHI stock with a beta coefficient of 1.3
- LMN stock with a beta of -0.6
- AMF stock with a beta coefficient of 1.0
Correct answer: GHI stock with a beta coefficient of 1.3
Beta coefficients greater than 1.0 signify that the stock will fluctuate more than the market as a whole. In general, the higher the beta, the greater the risk. Such risk-taking is appropriate for investors who seek aggressive investment strategies.
- Assume Frank has a portfolio with an actual return of 10.50% for the past year. The portfolio beta equals 1.25, the return on the market equals 9.75%, and the risk-free rate of return equals 3%. Based on this information, what is the alpha for Frank's portfolio and did it outperform or underperform the market?
- +9.1875%, outperform
- −1.6875%, underperform
- +3.3750%, outperform
- -.9375%, underperform
Correct answer: -.9375%, underperform
The alpha for Frank's portfolio equals −.9375% indicating that his portfolio underperformed the market based on the level of assumed investment risk. Let's do the computation. As with most math, there are two ways to arrive at the correct answer. The method shown in the study materials follows the formula: (Actual return - RF rate) - (beta x [market return - RF rate]). Plugging in the numbers we get, (10.5% minus 3%) - (1.25 x [9.75% - 3%]). That breaks down to 7.5% - (1.25 x 6.75%) or 7.5% - 8.4375% = negative .9375% Alternatively some might prefer this formula for alpha: alpha = actual return – [risk-free rate + beta x(market return – RF)]. If we plug in the numbers, we get .105 – [.03 +1.25 x(.0975 - .03)] = −.009375, or−.9375%.
- In a rising market, which of the following is least volatile?
- A stock with an alpha of 0.5
- A stock with an alpha of 2.0
- A stock with a beta of 2.0
- A stock with a beta of 0.5
Correct answer: A stock with a beta of 0.5
Beta is a measure of a stock's volatility relative to the overall market, as measured by the S&P 500. A stock with a beta of 2.0 will move twice as fast as the overall market, while a stock with a beta of 0.5 will move half as fast as the overall market.
- 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 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
Correct answer: −0.3
Alpha is obtained by comparing how a security actually performed to the performance one would have expected based on 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 0.8, 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 on the criteria given, the IAR would have selected Security C.
- Julian and Jane are discussing risk-return measures. Julian states that "beta is used when looking at the performance of a fund or portfolio and refers to the extent of any outperformance against its benchmark." Jane disagrees and says that "outperformance of a fund or portfolio is actually measured by standard deviation." Which of the following statement is correct?
- Only Jane is correct.
- Both Julian and Jane are correct.
- Both are incorrect.
- Only Julian is correct.
Correct answer: Both are incorrect.
Both Julian and Jane are incorrect. It is alpha, not beta, that is used when looking at the performance of a fund or portfolio. Alpha refers to the extent of any outperformance of a portfolio against its benchmark. Standard deviation is used for measuring volatility, not performance.
- If a security has an anticipated return of 8.7% and a standard deviation of 14.6%, you would expect the returns to have a 95% probability (assuming a normal distribution) of falling between
- −5.9 and +23.3%
- −20.5 and +37.9%
- 0 and 37.9%
- 8.7 and 23.3%
Correct answer: −20.5 and +37.9%
A security with a normal distribution has a 95% probability of falling within 2 standard deviations of its anticipated return. In this case, that would be −20.5% and +37.9%, which is computed by calculating return movements of 29.2% (14.6×2) in either direction.
- The statistical measurement that indicates how much an investment's returns have fluctuated compared with its average return over a period of time is known as
- The beta coefficient
- The standard deviation
- The Sharpe ratio
- The duration statistic
Correct answer: The standard deviation
Standard deviation measures the dispersion of an investment's periodic returns around that investment's own average return, which is exactly the fluctuation the question describes; a high figure signals a higher level of risk. The beta coefficient measures movement against a market index rather than around the investment's own average. The Sharpe ratio divides excess return by standard deviation to rank return earned per unit of risk, so it consumes the dispersion figure without measuring it. The duration statistic estimates a bond's price sensitivity to a change in interest rates.
- A senior citizen had the following scenarios presented to him by his IAR. Which one had the lowest volatility?
- Stock high return: +9%; low return: −2%; Standard Deviation: 4.9%
- Stock high return: +5%; low return: −1%; Standard Deviation: 3.6%
- Stock high return: +18%; low return: −4%; Standard Deviation: 8%
- Stock high return: +12%; low return: −2%; Standard Deviation: 5.5%
Correct answer: Stock high return: +5%; low return: −1%; Standard Deviation: 3.6%
The higher the standard deviation, the higher the volatility and the higher the risk. So, the lower the standard deviation, the lower the volatility and the lower the risk.
- When analyzing a security's standard deviation, which of the following statements accurately describes observations according to a normal frequency distribution curve?
- Approximately 84.1% of all observations lie within one standard deviation of the mean
- Approximately 99.7% of all observations lie within one standard deviation of the mean
- Approximately 68.3% of all observations lie within one standard deviation of the mean
- Approximately 50.0% of all observations lie within one standard deviation of the mean
Correct answer: Approximately 68.3% of all observations lie within one standard deviation of the mean
On a normal frequency distribution roughly two-thirds of the observations, about 68.3%, fall inside one standard deviation on either side of the mean. Each of the other figures is a real number from the same curve attached to the wrong band. About 84.1% of observations fall BELOW one standard deviation above the mean, a total that counts the whole lower half of the curve as well. About 99.7% fall inside three standard deviations, not one. About 50.0% fall inside roughly two-thirds of one standard deviation, so it understates the coverage of a full one standard deviation band.
- Plymouth Standard's common stock has an average return of 12%; its returns fall within a range of –2% to +26% approximately 68% of the time. Which one of the following numbers is closest to the standard deviation of returns of Plymouth Standard's stock?
Correct answer: 14%
A standard deviation of 14% means an investor can expect a return on an investment to vary ±14 from the average return approximately 68% of the time. A return of +26% minus the 12% average return equals 14%. Likewise, the difference between the -2% return and the average of 12% is also 14%.
- A concern of some investors is the volatility of a security. Securities with a higher volatility exhibit a greater variability in their returns. A statistical measure used to predict the volatility of a security by examining the dispersion in a set of historical returns is
- Beta coefficient
- Standard deviation
- Geometric average
- Return correlation
Correct answer: Standard deviation
Standard deviation summarizes how widely a security's historical returns are dispersed around their own average, and that dispersion is the standard proxy for the volatility the question describes. The beta coefficient compares the security's movement with a market index, so it captures market-related risk rather than total dispersion. A geometric average reports the compounded rate of return achieved over the period and says nothing about spread. Return correlation describes how closely two series move together, not how far one series varies from its own mean.
- The statistical measurement that indicates how much an investment's returns have fluctuated, compared to its average return, over a given period of time is known as
- Bond convexity
- R-squared value
- Standard deviation
- Beta coefficient
Correct answer: Standard deviation
Standard deviation states how far an investment's returns have varied from that investment's own average return over the measurement period, and the higher the figure the higher the risk. Bond convexity describes how a bond's price sensitivity itself changes as yields move. The R-squared value reports the proportion of an investment's movement that is explained by its benchmark. The beta coefficient scales movement against that benchmark rather than against the investment's own average return.
- Which of the following statements concerning equity securities is not correct?
- Equity securities represent a lending interest in a corporation.
- Equity securities provide a residual claim, after payment of all obligations to fixed-income claims, on the income and assets of a corporation.
- Common stock is an equity security representing an ownership interest in a corporation.
- Preferred stock is an equity security with an intermediate claim (between the bondholders and the common stockholders) on a firm's assets and earnings.
Correct answer: Equity securities represent a lending interest in a corporation.
Equity securities represent an ownership interest in a corporation. Preferred stock, as a senior security, has a claim ahead of common, but behind debt securities.
- Which of the following statements about equity securities is NOT true?
- Preferred stock is usually nonvoting.
- Common stock is less sensitive to interest rate risk than preferred stock.
- Preferred stock is an equity security while common stock is a hybrid.
- Preferred stock pays a fixed dividend.
Correct answer: Preferred stock is an equity security while common stock is a hybrid.
Both common and preferred stock are equity securities. Common stock is never referred to as a hybrid; there are times when preferred stock is because of those features that are similar to a debt security. The dividend on preferred stock is fixed, and shares do not have voting rights. The price of a common share generally doesn't fluctuate with changes to interest rates in the same manner as that of preferred stock.
- Investments in which of the following offer the best long-term protection against inflation?
- Corporate bonds
- Fixed annuities
- Common stock
- Government bonds
Correct answer: Common stock
Common stocks have historically offered returns that outpace inflation over the long term.
- All of the following represent ownership in corporation except
- Preferred stock
- Common stock
- Mortgage bonds
- Convertible preferred stock
Correct answer: Mortgage bonds
Ownership in a corporation resides in its equity securities. All stock is equity while all bonds are debt.
- A corporate bond that pays interest semiannually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 10%. What is the value of the bond today if the coupon rate is 8%?
- $1,221.17
- $922.78
- $1,144.31
- $1,051.23
Correct answer: $922.78
How did we calculate that? We used tool that you won't have available at the test center (a financial calculator), but there is a great tool you will have – common sense. When a bond has a yield to maturity that is greater than its coupon rate, the bond must be selling at a discount and that only leaves one possible answer. The only way to get a 10% return on an 8% bond is to buy it at a price below par.
- A company's dividend on its common stock is
- Specified in the company charter
- Voted on by shareholders
- Mandatory if the company is profitable
- Determined by its board of directors
Correct answer: Determined by its board of directors
A common stock's dividend payment and amount are determined by the company's board of directors.
- Mitch purchased a 30-year bond for 9743 with a stated coupon rate of 8.5%. What is the approximate yield to maturity for this investment if Mitch receives semiannual coupon payments and expects to hold the bond to maturity?
Correct answer: 8.67%
No calculation is necessary here. Why not? Because anytime a bond is purchased at a discount from par (9743% is a discount), the YTM must be greater than the nominal (coupon) rate. There is only one choice greater than 8.5%. It isn't about your computational skills; it is about your understanding the relationship between prices and yields.
- Which of the following expressions describes the current yield of a bond?
- Annual interest payment divided by par value
- Yield to maturity divided by current market price
- Annual interest payment divided by current market price
- Yield to maturity divided by par value
Correct answer: Annual interest payment divided by current market price
The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond.
- An investor in an equity security
- Is assured of a minimum rate of return
- Has a say in the day-to-day operations of the business
- Acquires an ownership interest in the company
- Becomes a creditor of the company
Correct answer: Acquires an ownership interest in the company
Equity means ownership, and this is a characteristic shared by both common and preferred stock. Holders of debt securities are creditors, and, there are no guarantees when it comes to returns on equity securities. Only common stockholders have voting rights, but, even then, those rights don't deal with daily operations because the vote is generally used at the annual meeting to vote for members of the board of directors.
- An investor holding which of the following equity securities would NOT expect to have preemptive rights?
- Preferred stock
- Common stock acquired in a private placement
- Control stock
- Common stock
Correct answer: Preferred stock
Preferred stockholders do not have preemptive rights. Preemptive rights allow common stockholders to subscribe to additional issues of shares before they are offered to the public, to maintain their percentage ownership.
- The primary defining characteristic of an equity security is
- Voting rights
- It represents ownership in a corporation
- The ability to keep pace with inflation
- It pays dividends, usually quarterly
Correct answer: It represents ownership in a corporation
What does the term "equity" mean? It means ownership and that is the single most significant fact about an equity security, whether common or preferred stock. Many pay dividends, but that is not at the core of being an equity security. Equity securities include preferred stock, which, with its fixed dividend, does not offer inflation protection and does not have voting rights.
- On the initial public offering, an investor buys a $10,000 Aa-rated, 20-year corporate bond with a 4% coupon rate. One year later, the prevailing market rate is 5% and the bond has had its rating increased to Aa1. Which of the following is most likely TRUE with reference to the current market price of this bond?
- Premium
- Discount
- Cannot be determined from the information given
- Par value
Correct answer: Discount
When interest rates go up, bond prices go down. Had interest rates remained the same, the slight improvement in rating would have probably caused the bond to sell at a very slight premium, but that rating increase is not nearly strong enough to offset a 25% increase in market interest rates.
- A common stockholder's rights include all of the following EXCEPT
- The right to determine the par value of the stock
- Electing the board of directors
- The receipt of dividends, if declared by the board of directors
- Preemptive rights
Correct answer: The right to determine the par value of the stock
Par value is an accounting decision made by the company when the stock is first issued and is not something voted on by shareholders. Common stockholders are the owners of a corporation. This basic form of ownership entitles them to all of the privileges discussed here. It also allows them to transfer their ownership, inspect company records, vote on corporate objectives, and lay claim to any residual assets in the event of a liquidation.
- The current yield of a callable bond selling at a premium is calculated
- To its maturity date
- As a percentage of its market value
- As a percentage of its call price
- As a percentage of its par value
Correct answer: As a percentage of its market value
Current yield for any security is always computed on the basis of the current market value.
- A bond is selling at a premium over par value. Therefore, its
- Current yield is less than its nominal yield
- None of the above
- Yield to maturity is greater than its current yield
- Nominal yield is less than its current yield
Correct answer: Current yield is less than its nominal yield
Any bond selling at a premium will yield less than the coupon rate (nominal yield). Conversely, of course, a bond trading at a discount will certainly yield more. Remember, there is an inverse relationship between bond prices and bond yields.
- Richard purchased a 30-year bond for 10321 with a stated coupon rate of 8.5%. What is the approximate yield to maturity for this investment if Richard receives semiannual coupon payments and expects to hold the bond to maturity?
Correct answer: 8.19%
No calculation is necessary here. Why not? Because anytime a bond is purchased at a premium over par (10321% is a premium), the YTM must be less than the nominal (coupon) rate. There is only one choice lower than 8.5%. It isn't about your computational skills; it is about your understanding the relationship between prices and yields.
- A customer purchased new issue bonds at par 2 years ago. Since then, the CPI has declined by almost half and the current yield on his bonds has also declined. Which of the following best describes the value of the bonds he purchased?
- Their market price has increased.
- Their market price has declined.
- This cannot be determined from the information presented.
- Their market price has remained unchanged.
Correct answer: Their market price has increased.
Because inflation is down and bond yields have declined, the bonds are selling for a premium due to an increase in value.
- Which of the following statements about dividends on common stock is NOT true?
- Corporations are contractually obligated to pay dividends to their shareholders each year
- Only those who are owners of the stock on the record date will receive dividends
- Dividends may be paid in cash, property, or stock
- Dividends represent a pro rata distribution of corporate profits to shareholders
Correct answer: Corporations are contractually obligated to pay dividends to their shareholders each year
Dividends are the share of a corporation's profits that the corporation pays to shareholders as owners of the corporation. Dividends are not paid to shareholders automatically, and shareholders have no contractual right to receive dividends. Instead, dividends must be declared by the corporation's board of directors. The board of directors may elect to pay a dividend in cash, property, or stock.
- A corporation issued a bond with a coupon of 6%, callable at 103. The bond matures in 2059. Current interest rates are 8%. It is most likely that
- The bond is trading at a discount price
- The bond is trading over the call price
- The issuer will redeem the bonds at 103
- The current yield is under the 6% level
Correct answer: The bond is trading at a discount price
Bond prices move inversely with interest rates. With market rates at 8% and this bond paying a fixed 6% coupon, buyers will take it only at a price below par, so it trades at a discount; the call price and the maturity date are surplus information. A price below par is well under the 103 call price, so the bond is not trading above it. Issuers redeem bonds early when rates have fallen and cheaper refunding is available, not when rates have risen. Because current yield is the fixed coupon divided by a discounted price, the current yield here is above 6%, not below it.
- A $1,000 bond with a nominal yield of 8% will pay how much interest each year?
- $80.00
- $40.00
- $800.00
- $160.00
Correct answer: $80.00
The nominal yield (or coupon rate) is the interest rate stated on the bond and is the rate the bondholder promises to pay on the bond until the bond matures. A $1,000 bond with an 8% nominal yield will pay $80 per year in interest.
- A bond offered at par has a coupon rate
- Greater than its yield to maturity
- Equal to its current yield
- Less than its current yield
- Less than its yield to maturity
Correct answer: Equal to its current yield
When a bond is selling at par, its coupon or nominal rate, current yield, and yield to maturity are all the same.
- A customer buys a 10-year 6% AAA bond at par when it was issued. Two years later, if the CPI has increased from 2% to 4%, the price of the bond most likely
- Has stayed at par
- Has increased
- Cannot be determined
- Has declined
Correct answer: Has declined
When inflation is on the rise, interest rates often rise. When interest rates increase, bond prices may be expected to decline.
- The price of which of the following will fluctuate most with a change in interest rates?
- Short-term bonds
- Common stock
- Money market instruments
- Long-term bonds
Correct answer: Long-term bonds
Long-term debt prices fluctuate more than short-term debt prices as interest rates rise and fall.
- A bond's yield to maturity is
- The annualized return of a bond if it is held to call date
- The annualized return of a bond if it is held to maturity
- Determined by dividing the coupon rate by the bond's current market price
- Set at issuance and printed on the face of the bond
Correct answer: The annualized return of a bond if it is held to maturity
The yield to maturity is the annualized return of a bond if it is held to maturity. The computation reflects the internal rate of return and is frequently referred to as the market required rate of return for a debt security. The rate set at issuance and printed on the face of the bond is the nominal or coupon rate. Dividing the coupon rate by the current market price of the bond provides the current yield. The return of a bond if it is held to the call date is the YTC.
- The current yield on a bond with a coupon rate of 5.5% selling at 110 is
Correct answer: 5%
The current yield of any security, equity, or debt is always the income return (dividend or interest) divided by the current market price. In this case, it is the annual interest of $55 ($1,000 x 5.5%) divided by $1,100 and that equals 5%.
- One of your clients is considering allocating about 10% of her portfolio to commodities. Her current portfolio is a mix of stocks, bonds, and broad market index ETFs. Relative to her existing portfolio, you would explain to her that the primary benefit of the commodity investment is most likely
- Commodities will generate a steady stream of dividends and interest income
- Commodities reliably outperform stocks and bonds over a short holding time
- Commodities show low or negative correlation with the rest of her holdings
- Commodities are cheaper to trade and hold than her broad market index ETFs
Correct answer: Commodities show low or negative correlation with the rest of her holdings
The reason for adding a small commodity sleeve to a portfolio of stocks, bonds and broad index funds is diversification: commodity returns have historically shown low, and at times negative, correlation with equity and fixed income returns, so the blended portfolio carries less volatility than its parts. Commodities pay neither dividends nor interest, so they cannot make portfolio income more reliable. A small commodity allocation is a long-term diversification decision rather than a short-term performance play, and commodity positions generally cost more to trade and hold than broad index ETFs, not less.
- Which of the following investments is least appropriate for a client primarily concerned with liquidity?
- Direct participation program
- Municipal bond mutual fund
- Bank savings account
- Preferred stocks
Correct answer: Direct participation program
There is little secondary market liquidity for direct participation programs (DPPs); of those securities listed, they are the least appropriate for a client seeking liquidity.
- If near-term liquidity is the only objective for a client, which of the following pairs of investments represents the most/least liquid?
- Common stock listed on the NYSE/unit in a direct participation program
- Units of a variable annuity accumulation/shares of a money market fund
- Units of a variable annuity in payout/units of a real estate syndicate
- Bonds of a ten-year BBB-rated issuer/bills issued by the U.S. Treasury
Correct answer: Common stock listed on the NYSE/unit in a direct participation program
Exchange-listed common stock can be sold in seconds at a quoted price, making it highly liquid, while an interest in a direct participation program has no ready secondary market and is among the least liquid holdings a client can own, so that pair runs in the order the question asks for. Accumulation units are liquid, but money market fund shares carrying check-writing are more liquid still, so that pair is reversed. Annuity units in the payout phase and real estate syndicate units are both illiquid, so neither can be the most liquid. Treasury bills are more liquid than corporate bonds, so that pair is reversed as well.
- Commodities contracts are available on
- Platinum
- Pearls
- Diamonds
- Emeralds
Correct answer: Platinum
You might like diamonds, pearls, emeralds, and rings with those stones mounted in a platinum setting. Only platinum is a precious metal with commodity contracts available.
- Lisa Brownard is considering investing in gold. She owns a portfolio of stocks, bonds, and money market securities. Relative to her existing portfolio, the primary benefit of the gold investment is most likely
- The investment horizon is longer than that of stocks and bonds, balancing the duration of the portfolio
- Gold values are tied to cyclical industries
- Gold is a renewable resource so Brownard can profit from the investment for many years
- Low correlation between traditional asset returns and gold
Correct answer: Low correlation between traditional asset returns and gold
The returns on gold and other precious metals exhibit low correlation with stock and bond returns. Investment experts generally cite this as the key advantage to investing in hard assets. Precious metals do not generally follow cyclical industries. Indeed, most look at them as countercyclical investments. Investment time horizon is whatever the investor makes it. Investors can hold stock indefinitely and buy bonds with short or long maturities, depending on portfolio objectives. Gold is not a renewable resource.
- Commodity contracts are available on many different types of commodities. One of those types is precious metals. Included in the definition of a precious metal would be all of the following except
- Silver
- Gold
- Diamonds
- Platinum
Correct answer: Diamonds
Diamonds may be more valuable than any of the other choices, but they are not a metal.
- One reason for including commodities in an investment portfolio is because they have a high correlation to
- The stock market
- The inflation rate
- The bond market
- The U.S. dollar.
Correct answer: The inflation rate
Commodity prices tend to have a high correlation with the inflation rate. As inflation goes up, the value of the dollar generally falls. The relationship is inverse, a characteristic of negative correlation. As inflation increases, interest rates invariably do the same leading to a decrease in bond prices. Stock prices have a random correlation to commodities, generally negative.
- With respect to liquidity and potential for diversification, in comparing alternative investments to exchange-traded stocks, the markets for alternative investments are generally:
- Less liquid and provide less opportunity for diversification
- Less liquid and provide more opportunity for diversification
- More liquid and provide less opportunity for diversification
- More liquid and provide more opportunity for diversification
Correct answer: Less liquid and provide more opportunity for diversification
Alternative investments can provide exposure to unique risks and trading strategies and thus provide good diversification to a stock and bond portfolio. The markets for alternative investments are generally less liquid than most listed stocks.
- An investment adviser representative has several clients who are interested in adding precious metals to their portfolios. Which of the following is the IAR most likely to recommend?
- Aluminum
- Platinum
- Copper
- Nickel
Correct answer: Platinum
The only one of these considered a precious metal is platinum. For the exam, there are likely only going to be 3 precious metals: gold, silver, and platinum.
- Which of the following statements regarding a zero-coupon corporate bond is TRUE?
- Bonds selling at a premium have a yield lower than the coupon rate.
- The investor reports the difference between the purchase price and maturity value as ordinary income at maturity.
- The investor has phantom income, which must be reported on an annual basis.
- These bonds have higher reinvestment risk as to interest than bonds paying semiannual interest.
Correct answer: The investor has phantom income, which must be reported on an annual basis.
A zero-coupon corporate bond is issued at a deep discount and pays no current interest. The annual accretion (the imputed interest earned each year) is taxable as ordinary income annually even though no cash is received—this is called phantom income. Because the bond pays no interim coupons, it has no reinvestment risk, and the discount is reported annually rather than entirely at maturity.
- Which of the following would be considered a precious metal?
- Platinum
- Aluminum
- Titanium
- Chromium
Correct answer: Platinum
The precious metals are gold, silver, platinum and palladium. They are scarce, hold value in their own right and trade as investment assets, which is why platinum is the answer. Aluminum, titanium and chromium are base or industrial metals: they are valued for structural and alloying properties, are produced in far larger volumes, and are priced as manufacturing inputs rather than as stores of value.
- DERP Corporation has issued 5% convertible debentures maturing in 2040. The conversion price is $40 and the common is currently trading at $48 per share. One would expect the DERP debentures to be selling somewhat
- Above $1,200
- Below $1,000
- Above $1,000
- Below $1,200
Correct answer: Above $1,200
The first step here is to compute the parity price. A conversion price of $40 means the debenture is convertible into 25 shares of the common stock (par of $1,000 divided by $40 = 25 shares). With a current market price of $48 per share, the parity price of the convertible would be $1,200 (25 x $48). Because convertible securities generally sell at a slight premium over their parity price, the debentures should have a current market value a bit higher than $1,200.
- The DERP Corporation has an outstanding convertible bond issue that is convertible into 8 shares of stock. If the current market price of the bond is 80, the parity price of the stock is
- $125 per share
- $100 per share
- $80 per share
- $64 per share
Correct answer: $100 per share
Parity means equal. With a conversion ratio of 8 shares per bond, the investor can convert the bond into 8 shares. If the bond is currently selling for $800, then, to be of equal value (parity), the 8 shares must be selling at $100 each.
- Mr. Beale buys 10M 6.6s of 10 at 67. What will his annual interest be?
- $820.00
- $660.00
- $670.00
- $1,000.00
Correct answer: $660.00
Interpret "10M" as "$10,000 worth of." Beale receives the nominal yield of the bonds, which is 6.6% of $10,000. The M is from the roman numeral for 1,000.
- When an investor owns a convertible security where, upon conversion, the account value would remain the same, it is considered that the convertible and the common are selling at
- The nominal yield
- The arbitrage level
- Equivalent value
- Parity
Correct answer: Parity
Parity means equal. When one could convert the security and realize the same value, it is said that both are at parity.
- BFJ Corp's 5% convertible bond is trading at 120. The bond is convertible at $50. An investor buying the bond now and immediately converting into common stock, would receive
- 2.4 shares
- 24 shares
- 20 shares plus cash for fractional shares
- 20 shares
Correct answer: 20 shares
The conversion ratio always uses the par value ($1,000), never the current market price. With a par value of $1,000 and a conversion price of $50 per share, this bond is convertible into 20 shares ($1,000 / $50). Remember, the number of shares in a conversion never changes. When the market price changes, the parity price changes, but that isn't relevant to this question.
- A client of yours owns some convertible preferred stock. She notices an article in the business section of her local newspaper that reports the company is going to pay a 20% stock dividend on their common stock. She wants to know how this will affect her?
- She receives the 20% stock dividend on her preferred shares as well
- Her conversion privilege is adjusted to give 20% more common shares
- The conversion price would be raised 20% to offset the added shares
- Nothing changes for her unless and until she converts to the common
Correct answer: Her conversion privilege is adjusted to give 20% more common shares
Convertible securities are almost always sold with an antidilution clause. When the issuer declares a stock dividend or splits its stock, the clause adjusts the conversion terms so that the holder's potential common position is unchanged in percentage terms, which here means the privilege converts into 20% more common shares than before. A stock dividend declared on the common is not paid to preferred holders, so she receives no additional preferred shares. The antidilution adjustment lowers the conversion price rather than raising it, and it takes effect when the stock dividend is paid, not only at the moment she converts.
- Current market interest rates are 6%. A bond with an 8% coupon would be most likely to have a net present value of zero when the bond is
- Called for redemption
- Selling at a discount
- Selling at par
- Selling at a premium
Correct answer: Selling at a premium
A bond's NPV is most likely to be zero when its IRR is equal to the current market interest rate. In this case, that would be 6%. The only way for a bond with an 8% coupon to have a yield to maturity of 6% is if the bond is selling at a premium.
- A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of
Correct answer: 5.56%
Current yield is determined by dividing the annual interest payment by the current market price of the bond ($50 ÷ $900 =5.56%). Years to maturity is not a factor in calculating current yield.
- A bond with a par value of $1,000 and a nominal yield of 6% paid semiannually is currently selling for $1,300. The bond matures in 25 years and is callable in 15 years at $1,080. In the computation of the bond's yield to call, which of these would be a factor?
- Present value of $1,080
- 50 payment periods
- Interest payments of $30
- Future value of $1,300
Correct answer: Interest payments of $30
The YTC computation involves knowing the amount of interest payments to be received, the length of time to the call, the current price, and the call price. With a 15-year call, there are only 30 semiannual interest payment periods, not 50. The present value is $1,300 and the future value is $1,080; the reverse of the numbers indicated in the answer choices.
- What happens to outstanding fixed-income securities when interest rates decline?
- Yields increase
- Prices increase
- No change
- Coupon rates increase
Correct answer: Prices increase
When interest rates drop, prices will rise, decreasing effective yield. Thus, there is an inverse relationship between interest rates and bond prices.
- High-yield bonds are frequently called junk bonds. Which of the following expresses the highest rating that would apply to a junk bond?
Correct answer: BB
Investment-grade bonds run from a highest Standard and Poor's rating of AAA (Aaa − Moody's) down to BBB (Baa − Moody's). When the rating gets to BB (or Ba) the bond is considered high yield, or a junk bond.
- One of the likely consequences of a rating downgrade on a bond is
- The issuer will exercise the call feature and retire the bonds
- The issuer will lift the coupon rate to compensate the holders
- The market price of the bond will fall in the secondary market
- The current yield on this bond will fall below its coupon rate
Correct answer: The market price of the bond will fall in the secondary market
A downgrade tells the market the issuer's credit risk has risen, so buyers demand a higher yield to hold the bond, and the only way an outstanding bond can deliver a higher yield is for its price to fall. A call becomes less likely rather than more, because the issuer would have to refund into a market that now prices its credit more expensively. The coupon is fixed when the bond is issued and the issuer has no power to raise it. Because current yield is the fixed coupon divided by a lower price, current yield rises above the coupon rate instead of dropping below it.
- Bond prices are quoted as a percentage of
- Stated value
- Conversion value
- Market value
- Par value
Correct answer: Par value
Bond prices are quoted as a percentage of par value. On the exam, the par value of bonds is always $1,000.
- An investor purchases a Treasury note and the confirmation shows a price of $102.25. Rounded to the nearest cent, the investor's cost, excluding commissions, is
- $1,022.50.
- $1,027.81.
- $102.25.
- $1,020.25.
Correct answer: $1,027.81.
Treasury notes are quoted in 32nds where each 32nd equals $.3125. The 102 in the quote equals $1,020 and the 25/32 is an additional $7.81 bringing the total to $1,027.81.
- If a technician believed in the importance of volume, which of the following would indicate bullish sentiment?
- Prices decrease on light volume.
- Prices increase on light volume.
- Prices increase on heavy volume.
- Prices decrease on heavy volume.
Correct answer: Prices increase on heavy volume.
Technicians watch volume changes along with price movements as an indicator of changes in supply and demand. A price increase on heavy volume relative to the stock's normal trading volume is interpreted as an indication of bullish activity.
- All the following factors support fundamental analysis while assessing a wide range of qualitative factors except
- The company’s business model
- The company’s stock price trend
- The company’s management team’s quality and experience
- The company’s competitive position
Correct answer: The company’s stock price trend
The company's stock price trend is important to technical analysis. Remember that a technician "charts prices and volume over time". The others are factors to consider in fundamental analysis.
- A fundamental analyst would be most interested in which of the following?
- The price-to-earnings ratios of the companies in a major stock index
- The outstanding short interest reported for a big listed corporation
- The 200-day moving average of a widely followed broad market average
- The support and resistance levels drawn on a daily stock price chart
Correct answer: The price-to-earnings ratios of the companies in a major stock index
Fundamental analysis values a company from its earnings, assets and industry position, and the price-to-earnings ratio is the classic fundamental yardstick for what investors are paying for a dollar of earnings. Short interest, moving averages and support and resistance levels are all technical indicators: each is built from the price and volume record of the security rather than from the issuer's business results, and each is used to judge timing rather than value.
- Sortel Industries has preferred stock outstanding that pays annual dividends of $3.75 a share. If an investor wants to earn a rate of return of 8.5%, how much should she be willing to pay for a share of Sortel preferred stock?
Correct answer: $44.12
This is a middle school math question. It is asking, 3.75 is 8.5% of what number? The computation is: 3.75÷0.085 = $44.12.
- To a technical analyst, the resistance level signifies the price at which a stock's supply would be expected to
- Remain constant
- Decrease substantially
- Increase substantially
- Cause the stock price to ""break out""
Correct answer: Increase substantially
This is about comparing support and resistance levels. Most stock prices remain relatively stable and fluctuate up and down. The lower limit to these fluctuations is called a support level – the price range where a stock appears cheap and attracts buyers. The upper limit is called a resistance level – the price range where a stock appears expensive and initiates increased selling. This selling represents an oversupply of the stock which results in downward pressure on the stock.
- A technical analyst (chartist) with a long position in a particular stock would most likely enter a sell stop order below that stock's
- Support level
- Previous high
- Resistance level
- 200-day moving average
Correct answer: Support level
Sell stops are entered below the market. They are used to turn an order into a market order if the current market value falls below the stop level. In technical analysis, support levels are theoretical levels where the market supports the stock price (keeps it from falling below the stated level). A technical analyst who makes investment decisions by watching the technical graphs and numbers would enter a sell stop below a support level in order to sell out if the support level is breached. A breakthrough of a support level is believed to forecast a major market price decline.
- Which of the following is used in technical analysis in an attempt to modify fluctuations of stock prices over the long term into a smoothed trend?
- Moving averages
- Support and resistance
- Consolidation
- Trend lines
Correct answer: Moving averages
To avoid the volatility frequently present in stock price trends, analysts will frequently use moving averages. These averages reduce short-term distortions to a minimum.
- A technical analyst would be most interested in which of the following?
- Working capital
- 200-day moving averages
- Capitalization ratios
- Price-to-earnings ratios
Correct answer: 200-day moving averages
Technical analysts try to predict the market by examining price and volume trends. They expect the market to act in the future as it has in the past. Technical analysts are not interested in the fundamental aspects of a company, such as its financial statement ratios.
- Kellie is a senior equity analyst for a large brokerage firm. She primarily uses fundamental analysis techniques to assist her in picking stocks for her firm's clients. Today, she is reviewing the XYZ Corporation. The company is a manufacturer of computer keyboards and is currently going through an expansion phase. Which of the following techniques would Kellie be least likely to use to determine whether to buy, sell, or hold this company's stock?
- She may consider trends towards tablets and smart phones.
- She may review the company’s stock 200-day moving average.
- She may examine the overall state of the economy, the computer industry, and then XYZ Corporation.
- She may calculate the intrinsic value of the stock using one or more of the stock valuation models.
Correct answer: She may review the company’s stock 200-day moving average.
Reviewing the company's stock 200-day moving average is a technique used by technical analysts (chartists). All of the other techniques are used by fundamental analysts. The process of examining the economy, the specific industry, and the specific company is a reflection of top-down fundamental analysis.
- Which of the following might be used by an analyst to approximate a reasonable price for a common stock?
- Book value per share
- The dividend discount model
- The current payout ratio
- Yield to maturity calculation
Correct answer: The dividend discount model
The dividend discount model prices a share as the present value of the dividends it is expected to pay, so it produces an estimate of what the stock ought to be worth today. Book value per share is an accounting figure taken from the balance sheet and routinely differs from market price by a wide margin. The payout ratio shows what portion of earnings is being distributed but does not translate into a price. Yield to maturity is a debt calculation that requires a fixed maturity date, which common stock does not have.
- An analytical tool used to project the current value of a common stock using projected future dividends is
- The future value computation
- The dividend payout ratio
- The price-to-earnings ratio
- The dividend discount model
Correct answer: The dividend discount model
There are two widely accepted forms of common stock price projection using dividends—the dividend discount model and the dividend growth model.
- All of the following statements regarding technical analysis are correct except
- Technical analysts use terms such as trendline, support, and resistance in analyzing stocks
- Technical analysts rely heavily on financial ratios in their analysis of stocks
- Technical analysts rely on charts to predict the future prices of stocks
- Technical analysts attempt to predict the future movement of stock prices based on past trends
Correct answer: Technical analysts rely heavily on financial ratios in their analysis of stocks
Technical analysts do not rely on financial ratios in their analysis of stocks. Instead, they rely on charts of past price history and volume to predict future price movements. It is fundamental analysis where financial ratios are important.
- Which of the following would be of least interest to a chartist?
- The ratio of a stock's price to its reported earnings
- The volume of shares traded in the stock last quarter
- The size of the open short interest in the same stock
- The advance/decline line for the broader stock market
Correct answer: The ratio of a stock's price to its reported earnings
A chartist studies market action. Trading volume, the open short interest that may fuel later buying, and breadth measures such as the advance/decline line are all technical inputs drawn from the market itself. The relationship between a stock's price and the earnings its issuer has reported is the price-to-earnings ratio, a fundamental measure built from the company's financial statements rather than from its price history, so it is the item a chartist has the least use for.
- An investor believes that he can study the history of security trades and security markets in order to identify buying opportunities. Furthermore, he prepares and studies charts on the past prices of the securities he is most interested in purchasing for his portfolio. He uses these charts to try to predict the future activity of a particular stock. What type of strategy is this investor using to make his investment decisions?
- Ratio analysis
- Tactical asset allocation
- Technical analysis
- Fundamental analysis
Correct answer: Technical analysis
Technical analysis is an attempt by an analyst to predict the direction of a security's future market price. Such terms as moving average, trendline, and support and resistance level are then used by an analyst to determine when the time is right to purchase (or sell) the security.
- A stock has been in a downtrend for several days. When its price decreases to near $30, many investors enter orders to buy the stock and the price increases to $31. This is most likely an example of
- A resistance level
- A reversal
- A support level
- A change in polarity
Correct answer: A support level
The downtrend reached a support level where buying demand sustained the price. A resistance level is a price at which selling pressure emerges that stops an uptrend.
- An analyst uses the dividend growth model to assist in determining appropriate stocks to recommend. This analyst would consider all of the following factors EXCEPT
- Required rate of return
- Current dividend
- Growth of the dividend
- Market capitalization
Correct answer: Market capitalization
The classic definition of the dividend growth model is "a stock valuation model that deals with dividends and their growth, discounted to today." The market capitalization is the number of outstanding shares multiplied by the current market price per share and has nothing to do with the company's dividend policies.
- When using the dividend discount model,
- Future expected dividends are discounted to compute the present value of the stock
- The discount rate is generally lower than the expected rate of return
- Best results are obtained from stocks that pay irregular dividends
- the degree of accuracy in forecasting the price of preferred stock is less than that obtained by using the dividend growth model
Correct answer: Future expected dividends are discounted to compute the present value of the stock
This method of common stock valuation takes the investor's expected future dividend returns and then discounts that amount by the expected rate of return to arrive at the supposed present value. Expected (or required) rate of return is a component of both the dividend discount model and the dividend growth model, and only the DDM is used for preferred stocks because the dividend can never increase. When using any dividend model, the greater the regularity of dividends, the more accurate the forecast.
- An investor purchases a Treasury note and the confirmation shows a price of $102.21. Rounded to the nearest cent, the investor's cost, excluding commissions, is
- $1,022.10.
- $1,022.21.
- $1,026.56.
- $102.21.
Correct answer: $1,026.56.
Treasury notes are quoted in 32nds where each 32nd equals $.3125. The 102 in the quote equals $1,020 and the 21/32 is an additional $6.56 bringing the total to $1,026.56.
- A bond selling for $20 above par would be quoted
Correct answer: 102
Bonds are quoted in percentages of $1,000 (par) (1% of $1,000 = $10). The proper quote would be 102; 102 is 102% of $1,000.
- Mr. Beale buys 10M RAN 6.6s of 32 at 67. What is his total purchase price?
- $6,600
- $6,700
- $10,200
- $10,000
Correct answer: $6,700
For those of you not familiar with bond listings, this means that Beale bought $10,000 (10M) of the RAN Corporation bonds with a 6.6% coupon (interest rate stated on the face of the bond) that mature in 2032 (32). The price is 67, which represents 67% of $10,000, or $6,700.
- Which of the following analyze corporate financial statements and trends in sales and income?
- Technicians
- Chartists
- Fundamentalists
- Market timers
Correct answer: Fundamentalists
Fundamental analysts obtain information from corporate financial statements, as well as other relevant sources. Technical analysts review market charts, while fundamental analysts are concerned with the earnings ability of corporations derived from corporate financial statements.
- In the technical analysis of the value of securities, which of the following items is NOT important?
- The breadth of market volume
- The amount of a company's past earnings
- A prevailing market trend in response to shifts in supply and demand
- Resistance and support levels
Correct answer: The amount of a company's past earnings
The amount of a company's past earnings is a factor used in the fundamental analysis of securities, but not technical analysis. Technicians rely on market trends and supply and demand factors, as well as chart indications such as resistance and support levels.
- The type of analysis that attempts to value securities by examining general economic trends and the growth potential and productivity of individual companies is
- Technical analysis
- Credit analysis
- Holding period analysis
- Fundamental analysis
Correct answer: Fundamental analysis
There are two main approaches to valuing securities. Fundamental analysis takes the approach described in this question. The other approach—technical analysis—relies on charts of past performance to forecast future price movements.
- During the analysis of XYZ stock, a technical analyst concludes that XYZ's support level has been broken. Being a technician, the most appropriate decision should be to
- Rate the stock as a buy
- Rate the stock as a hold
- Purchase additional shares of the stock
- Rate the stock as a sell
Correct answer: Rate the stock as a sell
If a support level is broken, this provides a sell signal. Once the stock has lost its support, expectations are that it will continue to fall. The breaking of a resistance level, as the price of the asset gathers momentum to the upside, indicates a buying opportunity.
- A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year or for the 2 previous years. How much must the company pay the customer per share before it may pay dividends to the common stockholders?
Correct answer: $24.00
If the company is going to pay a common stock dividend, it must pay the preferred dividends first. A cumulative preferred stockholder must also receive all dividends in arrears. There are $16 due in back dividends, in addition to $8 this year, for a total of $24.
- Which of the following statements best describes cumulative preferred stock?
- Unpaid dividends accumulate and must be paid before common dividends
- Owners vote their shares cumulatively when the directors are elected
- Owners also share in any extra dividends paid to common shareholders
- A passed dividend is lost and gone once the board declines to pay it
Correct answer: Unpaid dividends accumulate and must be paid before common dividends
Cumulative preferred stock carries a continuing claim to every dividend the board passes. Those unpaid dividends build up as arrears, and the arrears together with the current preferred dividend must be satisfied before the common shareholders receive anything. Cumulative voting is a method of electing directors and has no connection to the cumulative feature on preferred stock. Sharing in an extra dividend alongside the common describes participating preferred. Losing the claim to a passed dividend describes noncumulative preferred, which is the opposite feature.
- One of the features of convertible preferred stock is that
- The owner has the opportunity to participate in the growth of the company
- The dividend is paid ahead of all other securities
- The holder is able to select the conversion price
- The owner has the opportunity to convert the stock into the issuer’s bonds
Correct answer: The owner has the opportunity to participate in the growth of the company
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. Interest on debt securities is paid before the dividends on any stock. When it comes to preferred stock, there is frequently a "pecking order", such as a prior lien preferred or first preference preferred that would come ahead of the other preferred shares.
- Reasons why a corporation might issue a convertible preferred stock would include
- A lower cost of capital than issuing any convertible debt issue
- A deduction against income for the dividends paid on the shares
- The right for holders to convert the shares into issuer's bonds
- The chance for holders to share in the company's future profits
Correct answer: The chance for holders to share in the company's future profits
The attraction of any convertible security is the privilege of converting into the issuer's common stock, which lets the buyer share in the company's future growth and profits; that upside is what the issuer is selling and why buyers accept the terms. It is not the cheaper choice, because preferred stock ranks behind debt and its dividend rate must therefore be set above the interest rate the issuer would pay on convertible bonds. Preferred dividends are paid out of after-tax income and give the issuer no deduction. A convertible preferred converts into common stock, not into the issuer's bonds.
- A company that has issued cumulative preferred stock
- Forces conversion of the preferred that is trading at a discount to par, thereby eliminating the need to pay past-due dividends
- Pays past and current preferred dividends before paying dividends on common stock
- Pays the current dividends on the preferred, but not the past dividends on the preferred, before paying a dividend on the common
- Pays the preferred dividend before paying the coupons due on its outstanding bonds
Correct answer: Pays past and current preferred dividends before paying dividends on common stock
Current and unpaid past dividends on cumulative preferred stock must be paid before common stockholders can receive a dividend. Bond interest is always paid before dividends. Dividends in arrears on cumulative preferred have the highest priority of dividends to be paid.
- One of the rights of those owning common stock is the opportunity to vote on issues brought up at the corporation's annual meeting. To be eligible to cast a vote,
- Ownership must be established by the record date
- The stockholder must be a natural person
- The company must be current on its dividends to preferred stockholders
- The stock must be paid for in full before the annual meeting
Correct answer: Ownership must be established by the record date
Only stockholders who are on the company's books by the record date are eligible to vote.
- A fundamental analyst would be interested in all of the following EXCEPT
- Corporate annual reports
- Innovations within the automotive industry
- Daily trading volumes on the NYSE
- Statistics of the U.S. Department of Commerce on disposable income
Correct answer: Daily trading volumes on the NYSE
Trading volume interests the technical analyst, who looks at fluctuations in the market, not at fundamental economic values.
- One of the rights of being a stockholder is the ability to vote on important corporate matters, such as the election of members to the board of directors. The date that determines which shareholders are eligible to votes is
- The election date
- The ex-dividend date
- The last day of the company’s fiscal year
- The record date
Correct answer: The record date
The record date is a date announced by the company as the official date you must be an owner on the company's records in order to participate in the annual meeting and corporate election. A fact not tested is there is no standard regarding how far in advance of the voting date this should be other than it must be at least the normal settlement period, currently 2 business days.
- Which of the following has the least exposure to inflation risk?
- Common stock
- Fixed annuity
- Preferred stock
- Cash
Correct answer: Common stock
The returns on common stock have historically outperformed inflation, making them less vulnerable to loss of purchasing power among the choices presented. Cash is a store of present purchasing power that inflation will erode. Fixed annuities have more exposure to inflation than common stock because their payments are fixed in nominal dollars. Preferred stock has the same exposure to inflation risk as do all fixed income instruments.
- Which of the following is not included in fundamental analysis of a company?
- A study of the annual financial statements the firm files
- A study of the direction of the country's overall economy
- A study of this firm's rank and standing in that industry
- A study of the stock's historical price and volume record
Correct answer: A study of the stock's historical price and volume record
Fundamental analysis works from the business itself: the economy the firm operates in, the industry it competes in, and the financial statements that report what it earned and what it owns. Studying the historical record of the stock's own price and trading volume is technical analysis, which reads market action instead of earnings power and financial condition, so it is the single item that falls outside fundamental analysis.
- Which of the following statements regarding preemptive rights is TRUE?
- Which of the following statements regarding preemptive rights is TRUE
- Common stockholders do not have the right to subscribe to a rights offering.
- Preferred stockholders do not have the right to subscribe to a rights offering.
- Neither common nor preferred stockholders have the right to subscribe to a rights offering.
Correct answer: Preferred stockholders do not have the right to subscribe to a rights offering.
Preferred stockholders have a preference as to liquidation and distribution of dividends, but the right to maintain a proportionate interest in the company only applies to common stock.
- When reviewing potential securities to select for an investor's portfolio, a technical analyst would be most likely to evaluate
- The daily trading volume
- The price-to-earnings ratio
- The price-to-book ratio
- The management tenure
Correct answer: The daily trading volume
A technical analyst charts price and volume over time. The other choices are of interest to a fundamental analyst.
- A technical analyst would be least concerned with
- Total short interest
- Reported book value
- The advance/decline line
- Daily trading volume
Correct answer: Reported book value
A technical analyst reads market action, so total short interest, market breadth measured by the advance/decline line, and daily trading volume are all directly relevant to the work. Book value is reported on the issuer's balance sheet and describes the accounting worth of the business rather than the behavior of its share price, which makes it a fundamental input and the item of least concern to a technician.
- A client has 100 shares of GHI when the stock undergoes a split. After the split, the client has
- Greater exposure
- No effective change in the value of the position
- A proportionately increased interest in the company
- A proportionately decreased interest in the company
Correct answer: No effective change in the value of the position
When a stock splits, the number of shares each stockholder has either increases or decreases (in the case of a reverse split). The customer experiences no effective change in position because the proportionate interest in the company remains the same.
- A fundamental analyst researching a stock is concerned with all of the following EXCEPT
- Management efficiency
- Capitalization ratio
- The stock's market price as a multiple of the company's earnings
- Volume of shares traded
Correct answer: Volume of shares traded
A fundamental analyst is concerned with the economic climate, the inflation rate, how an industry is performing, a company's historical earnings trends, how it is capitalized, and its product lines, management, and financial statement ratios, such as the P/E ratio. A technical analyst is concerned with trading volumes or market trends and prices.
- Which of the following statements is TRUE?
- A growth company would be more likely to pay a cash dividend than a stock dividend.
- Dividends have a significant influence on the value of the corporation's stock.
- A stock split increases the owner’s proportionate share of the company.
- A corporation is required to pay a cash dividend to stockholders if the earnings are sufficient, especially if it is of preferred stock.
Correct answer: Dividends have a significant influence on the value of the corporation's stock.
Dividends play a large role in what someone is willing to pay for the stock. For example, the dividend discount model (DDM) values a stock as the discounted present value of future dividends. A company is not required to pay dividends. A growth company will tend to pay no cash dividends but rather use the money for expansion.
- If a convertible bond is purchased at its $1,000 par value and is convertible at $83.33 per common share, what is the conversion ratio of common shares per bond?
- 2 shares for each bond
- 8 shares for each bond
- 12 shares for each bond
- 1.2 shares for each bond
Correct answer: 12 shares for each bond
The conversion ratio is determined by dividing the par value of the bond, or $1,000, by its conversion price of $83.33 per common share. This results in a conversion ratio of 12 shares for each bond.
- A technical analyst is least likely to consider which of the following when selecting securities?
- Corporate earnings
- Short interest ratio
- Advance/decline line
- Trend lines
Correct answer: Corporate earnings
Corporate earnings would be of least interest to a technical analyst, who is interested in market statistics indicative of future buying, market statistics that could reflect price or market trends, and trading volume.
- ABC Corporation has a 10% noncumulative preferred stock outstanding at $100 par value. Two years ago, ABC omitted its preferred dividend, and last year, it paid a dividend of $5 per share. To pay a dividend to common shareholders this year, each preferred share must be paid a dividend of
Correct answer: $10.00
This stock has a par value of $100 and a dividend rate of 10%. That means the annual dividend will be 10% of the $100 par, or $10. Because this is noncumulative preferred stock, the company must pay only this year's full stated dividend of $10 per share before paying dividends to the common shareholders. Any dividends from previous years that were not paid are ignored. If this had been a cumulative preferred stock, all of the dividends in arrears (past unpaid) would have to be paid before the common shareholders could get a dividend. In that case, it would have been $10 for two years ago, $5 for the balance of last year's dividend, and $10 for this year's (a total of $25).
- Many fixed-income investors are looking to avoid loss of principal. Which of the following would likely have the lowest degree of exposure to credit risk?
- Baa-rated municipal revenue bond
- A-rated general obligation municipal bond
- Ba-rated corporate mortgage bond
- Aa-rated corporate debenture
Correct answer: Aa-rated corporate debenture
A bond's rating takes into consideration all factors, including collateral and tax base. The higher the rating, the lower the credit risk.
- Which of the following would NOT be of interest to a technical analyst?
- Volume
- P/E ratio
- Advance/decline line
- Moving averages
Correct answer: P/E ratio
A technical analyst charts movement in market price and volume over a period of time. The price-to-earnings ratio is a tool used by fundamental analysts.
- A corporation has issued a 4% $60 par convertible stock with a conversion price of $20. With the preferred stock selling at $66 per share, an investor holding 100 shares of this stock would benefit by converting if the price of the common stock was
- Below $22 per share
- Above $18.20 per share
- Above $20 per share
- Above $22 per share
Correct answer: Above $22 per share
With a conversion price of $20 and a par value of $60, this preferred stock is convertible into 3 shares of the company's common stock. We divide the current price of the preferred ($66) by the 3 shares to arrive at the parity price of $22. If the common stock is selling for more than the parity price, the investor can benefit by converting and selling the stock in the marketplace.
- John and his sister, Alice, open a margin account as JTWROS. John contributes $50,000, and Alice contributes $25,000. They have agreed that Alice will trade the account, and they will share in the profits and losses equally. As their agent, you would gather information regarding suitability for
- Either, because in a JTWROS account the owners share equally
- John, because he has made the larger contribution
- Both, because information regarding all owners is relevant
- Alice, because she will be trading the account
Correct answer: Both, because information regarding all owners is relevant
When determining suitability and making recommendations to the owners of a joint account, it is the agent's responsibility to know each and every customer, regardless of their contribution or participation level.
- Rendering investment advice requires knowing certain information about your client. Which of these would be the least reliable source of that information?
- Client’s income tax returns
- Face-to-face meeting with the client
- Your firm’s confidential planning questionnaire
- Client’s Facebook page
Correct answer: Client’s Facebook page
There are a number of ways to gather information about your client's financial resources, but it is highly unlikely that a social media page would be one of them.
- Your firm onboards a new investment advisory client. Which of the following would be the most appropriate way to obtain information about the client's objectives and constraints?
- A questionnaire completed by the client's spouse in his place
- A review of the client's recent brokerage and bank statements
- A telephone call to the client's accountant and estate lawyer
- A face-to-face interview with the client at the client's home
Correct answer: A face-to-face interview with the client at the client's home
Objectives and constraints belong to the client, and the fullest picture comes from sitting down with the client directly, asking follow-up questions and seeing the household circumstances first hand. A questionnaire filled in by a spouse records someone else's understanding of the client's goals. Account statements show what the client currently owns but not why it was bought or what the client is trying to achieve. Calling the client's accountant and lawyer collects third-party information and raises confidentiality problems before the client has authorized any disclosure.
- An investment adviser should develop an investment policy based on the needs and objectives of the client. When the client is a business entity structured as a general partnership, the investment policy would have to consider
- The number of limited partners
- The mean requirement of the wealthiest and the poorest partner
- The liability of the general partner
- The objectives of all the partners on a collective basis
Correct answer: The objectives of all the partners on a collective basis
Because all income and gains pass through to the partners, and because there is unlimited personal liability for all general partners, we must examine the objectives of each of them to determine proper suitability.
- An investment adviser is conducting the initial meeting with a new advisory client. Which of the following is least necessary when gathering information necessary to fulfill the engagement?
- Recording the marginal federal tax bracket the client falls in
- Selecting the specific securities to be bought for the account
- Noting the number and ages of the client's dependent relatives
- Gauging the client's own experience with and appetite for risk
Correct answer: Selecting the specific securities to be bought for the account
The initial meeting exists to collect facts. The client's tax bracket, family obligations, and experience with and attitude toward risk all shape the recommendations that will follow, so each of them is gathered at this stage. Choosing which particular securities to buy is the output of the process rather than an input to it: the adviser can only make that choice after the objectives and constraints have been collected and evaluated, so it is the least necessary item during information gathering.
- An investment adviser would be least likely to gather information about a new client
- From social media
- During a face-to face interview
- On a smartphone app
- By using a questionnaire
Correct answer: From social media
There are many different ways to gather the necessary information about a new client, but it is highly unlikely that an investment adviser would rely on social media posts.
- The Jones family has scheduled an initial visit with a financial planner. Mr. Jones has an annual salary of $70,000, and this is their first attempt at financial planning. Which of the following should be the first step taken by the financial planner?
- Determine a reasonable fee for designing the plan
- Set goals and dates for reaching them
- Pay off credit card debt
- Establish an emergency fund
Correct answer: Establish an emergency fund
There are many questions on the exam where you will be forced to choose between two possible answers, only one of which is correct. In many cases, it is strictly a matter of opinion, but only NASAA's opinion counts. This is one of them. Goal setting is important, but the regulators feel that the first step in any plan is making sure that there is a "rainy day" fund. We can argue about that because some will say that a good plan can be used to establish that fund where none has existed before. But, please go with the right choice.
- The study of why people often make decisions using rules of thumb rather than rational analysis, basing those decisions on factors economists traditionally don't consider, such as fairness, past events, and aversion to loss, is known as
- Behavioral finance
- Systematic risk
- Risk tolerance
- Irrational finance
Correct answer: Behavioral finance
Today, through the study of behavioral finance, it is accepted that behavioral biases can cause investors to make financial decisions that are irrational.
- Which of the following items would be found on a family balance sheet?
- Annual salary
- Income taxes paid
- Dividends and interest received
- Spouse’s engagement ring
Correct answer: Spouse’s engagement ring
A balance sheet, whether for a family or a business, shows assets and liabilities, not income and expenses. The ring is certainly an asset; the others are income or expenses.
- An investment adviser representative is preparing a financial plan for a new client. As part of the data collection process, the IAR needs to collect the relevant information to analyze the client's cash flow. Included in the cash flow statement would be all of the following EXCEPT
- Salary
- Income taxes
- Assets
- Interest on savings
Correct answer: Assets
The income statement is the basis for an individual's cash flow statement. Rather than assets and liabilities, as would be found on a balance sheet, the concern is measuring income and expenses.
- Your client often makes irrational financial decisions because she bases her decisions on information that should have no influence on the decision at hand. The client's behavior is known as
- Overconfidence
- Confirmation bias
- Anchoring
- Herd mentality
Correct answer: Anchoring
Making irrational decisions based on information that should have no influence on the decision at hand is known as anchoring. Herd mentality is the tendency to follow the actions of a larger group, whether rational or not. Confirmation bias is the tendency to pay attention to information that supports one's preconceived opinions while disregarding accurate, unsupportive information. Overconfidence occurs when an investor considers her abilities to be much better than they actually are.
- A business organized as a sole proprietorship wishes to open an advisory account. When preparing an investment policy statement, the IA would have to consider the objectives of
- The sole proprietor
- The active partners
- The voting members
- The common stockholders
Correct answer: The sole proprietor
A sole proprietorship has no legal existence apart from the individual who owns it, so the business and the owner are the same taxpayer and the same investor. The investment policy statement is therefore built around that one person's objectives, time horizon and risk tolerance. Partners are the owners of a general or limited partnership, members are the owners of a limited liability company, and stockholders are the owners of a corporation; none of those entity forms is present here.
- For which of the following business entities would suitability be based on the objectives of all the owners on a collective basis?
- Pension plan
- General partnership
- C corporation
- Sole proprietorship
Correct answer: General partnership
Because all the partners in a general partnership share collective liability, the investment policy to be followed in the business's account is based on the collective suitability of all partners. Although the suitability is based on the owner of a sole proprietorship, there is only one owner, so a question asking about collective suitability doesn't ring true for that.
- An individual's net worth is
- The amount by which the individual's assets exceed the liabilities
- The total of the individual's assets before the debts are deducted
- The bottom line shown on that individual's annual income statement
- The individual's yearly income left over once taxes have been paid
Correct answer: The amount by which the individual's assets exceed the liabilities
Net worth is the personal balance sheet figure that remains after everything the individual owes is subtracted from everything the individual owns. Adding up the assets alone produces gross assets, which overstates the position by the whole amount of the debt. A personal income statement records inflows and outflows across a period and produces cash flow or savings, not net worth. Income remaining after taxes is disposable income, a flow measured over a period rather than a statement of accumulated wealth.
- John and Jane have a net worth of $20,000 and total assets of $150,000. If their revolving credit and unpaid bills totals $8,000, how much are their total liabilities?
- $138,000
- $130,000
- $150,000
- $122,000
Correct answer: $130,000
The balance sheet formula is assets − liabilities = net worth. Therefore, $150,000 − liabilities = $20,000, where liabilities = $130,000. Did you answer $122,000? That is the amount of the liabilities other than the revolving credit, but that is not what the question is asking for.
- Pemberton bought a stock share at $50 and wants to earn a profit, so he decided he will never sell it below $52. The company has now underperformed for multiple quarters as per street analysts, and the stock is down to $48. Pemberton continues to hold the stock in line with his original plan. In this case, Pemberton may be exhibiting
- Overconfidence bias
- Regret aversion bias
- Herding bias
- Anchoring bias
Correct answer: Anchoring bias
In behavioral finance, an anchoring bias is when people tend to base their decisions on reference points that are often arbitrarily chosen. In this case, Pemberton "anchored" his selling price to the $50 he paid for it and will not recognize changes in the market.
- To maintain the proper portfolio balance for a client, it would be most appropriate to review the portfolio at least
- Every 10 years
- Every two years
- Client and portfolio review is not necessary
- Annually
Correct answer: Annually
Most advisers would suggest that a client's life situation and portfolio should be reviewed at least annually. More frequently would not be inappropriate.
- One of your clients has a tendency to follow the actions of a larger group of people when making financial decisions, whether those actions are rational or not. The client's behavior is an example of
- Herd mentality
- Anchoring
- Confirmation bias
- Overconfidence
Correct answer: Herd mentality
This behavior is known as herd mentality. Confirmation bias is the tendency to pay attention to information that supports one's preconceived opinions, while disregarding accurate, unsupportive information. Overconfidence occurs when an investor considers his abilities to be much better than they actually are. Anchoring occurs when a person makes an irrational decision based on information that should have no influence on the decision.
- Tactical Evaluation and Research (TEAR), a federal covered investment adviser, suggests the purchase of stock in a major tobacco company. The client explains that he doesn't want to invest in tobacco stocks because his father passed away from lung cancer. What kind of reason is this?
- Economic pressures
- Environmental harm
- Deep-seated values
- Geographic factors
Correct answer: Deep-seated values
The client is refusing the investment because of a personal conviction formed by his father's death, not because of anything about the security's prospects. Convictions a client holds strongly, and that govern what the client is willing to own, are values, and an adviser must respect them when constructing the portfolio. Economic pressures would refer to the client's own cash flow or to the outlook for the business. Environmental harm refers to damage caused by an issuer's operations, which is not what growing tobacco represents for this client. Geographic factors would refer to where the issuer or the client is located.
- Which economic concept attempts to explain why investors behave irrationally?
- Efficient market hypothesis (EMH)
- Laffer curve
- Modern portfolio theory (MPT)
- Behavioral finance
Correct answer: Behavioral finance
There is a premise that investors are irrational when it comes to making investment decisions. The study of this is known as behavioral finance.
- All of the following statements regarding a client's attitudes, beliefs, and values are correct except
- A client's attitudes reflect the opinions, values and wants a client holds
- Beliefs are attitudes revealing how a client understands some part of life
- Values are the attitudes and beliefs about which the client feels strongly
- A client's attitudes and beliefs matter little when the facts are gathered
Correct answer: A client's attitudes and beliefs matter little when the facts are gathered
Nonfinancial considerations belong inside the information gathering stage, not after it. The adviser has to understand what the client believes and cares about, because those attitudes decide which recommendations the client will accept and follow through on, so it is incorrect to say they matter little while the facts are being gathered. The other three statements are accurate: attitudes express the opinions, values and wants a client holds; beliefs are a type of attitude that reveal how the client understands part of his life; and values are the attitudes and beliefs the client feels strongly about.
- Which of the following items is NOT necessary to establish before helping a client open an investment account?
- Zero balance on all credit cards
- Emergency fund
- Established short- and long-term investment goals
- Adequate life insurance
Correct answer: Zero balance on all credit cards
Although credit card debt may carry a high interest rate, no investment plan should be started without an emergency fund, adequate life insurance, and a set of goals. In fact, it is possible that the client is carrying the balance because of a very low promotional rate.
- Caroline considers her investment skills to be much greater than they actually are. She takes credit for many decisions that have positive results but blames the economy when her investments do poorly. Caroline's behavior is an example of
- Regret aversion
- Confirmation bias
- Overconfidence
- Anchoring
Correct answer: Overconfidence
Caroline's behavior is an example of overconfidence. Confirmation bias is paying attention to information that supports a preconceived opinion and poorly made decision, while disregarding accurate, unsupportive information. Anchoring is making irrational decisions based on information that should have no influence on the decision at hand. Regret aversion is when the investor prepares herself in such a way as to avoid distress over an adverse outcome.
- In a trust, the person who establishes the trust and decides on its terms is
- The beneficiary
- The grantor
- The fiduciary
- The trustee
Correct answer: The grantor
The grantor, sometimes called the settlor, is the person who establishes the trust and specifies its terms. The person who administers the trust is the trustee, and the person who receives distributions from the trust is the beneficiary. Interestingly, trust law would permit the grantor to also be the beneficiary and/or the trustee.
- A client of yours is getting older and is concerned about having her wishes met relating to medical issues when she is no longer capable of communicating them. The most appropriate vehicle for her would be
- A joint and survivors will
- A life support will
- An incapacitation will
- A living will
Correct answer: A living will
A living will, more commonly known as an advance health care directive or medical directive, is used to convey the individual's wishes for life support and other similar issues involving end-of-life matters. The other terms are bogus.
- Alvin's spouse is a trustee of a trust established by Henrietta Flood, which directs income from the trust be paid to Alvin, for as long as he lives. Alvin's son, Floyd, will receive the principal upon Alvin's death. Floyd would like to receive some of the principal before Alvin's death, and Alvin does not object. How should his spouse, the trustee, act in this situation?
- Distribute part of the trust principal to Floyd, as Alvin now consents
- Continue the income payments to Alvin and hold the principal for Floyd
- Ask a court to approve an early distribution of the principal to Floyd
- Divide the trust's annual income between Alvin and Floyd going forward
Correct answer: Continue the income payments to Alvin and hold the principal for Floyd
A trustee is bound by the terms of the trust document. This trust directs the income to Alvin for as long as he lives and the principal to Floyd only at Alvin's death, and nothing in the facts gives the trustee discretionary power to vary that. Alvin's consent does not enlarge the trustee's authority, because the trustee owes duties to the remainder beneficiary as well as to the income beneficiary. Splitting the income with Floyd would take from Alvin what the trust directs him to receive, and asking a court to reform the trust would require grounds these facts do not supply.
- One of your clients approaches you about setting up a trust. If your client assumes the role of grantor, what additional roles may be taken?
- Beneficiary
- Trustee
- As the grantor, no other roles may be taken
- Beneficiary and/or Trustee
Correct answer: Beneficiary and/or Trustee
Under trust law, the grantor of a trust, sometimes referred to as the settlor, may also be the beneficiary and the trustee.
- A client with a sizable estate would probably find it most efficient to pay estate taxes with
- Cash
- Proceeds from a life insurance policy
- Proceeds from the liquidation of a diversified portfolio
- Proceeds from the liquidation of a tax-deferred retirement plan
Correct answer: Proceeds from a life insurance policy
In general, people with estates where there is a potentially large estate tax liability find that the most efficient way to pay those taxes is through a life insurance policy.
- Which of the following is most commonly used when the author wants to express end of life wishes?
- A testamentary trust
- A living trust
- A revocable trust
- A living will
Correct answer: A living will
Sometimes referred to as a medical directive or advanced care directive, a living will is used to express the author's end-of-life wishes such as organ donation, when to withdraw life-prolonging treatment, and so forth.
- If an investment adviser's client wishes to save current income taxes by placing certain investments in a charitable trust, ethically, the investment adviser should
- Recommend the client consult with a qualified attorney
- Refuse to discuss the trust with the client because the adviser is not an attorney
- Help the client draft the appropriate documents following a discussion of the advantages of the arrangement
- Urge the client to consult with an attorney who pays a referral fee to the investment adviser
Correct answer: Recommend the client consult with a qualified attorney
Presuming the adviser is not a licensed attorney, he should recommend the client see a qualified attorney. However, it is ethical to discuss the nature of a charitable trust with the client.
- Because a trust account is managed for the beneficial interest of the beneficiary, the investment adviser representative handling the account can
- Have funds withdrawn from the account at the direction of the beneficiary
- Arrange to have the trust’s funds pledged to support a loan for the trustee
- Place the securities in the trust fund in a noncustodial brokerage account
- Have a check drawn on the account payable to the trustee for trustee expenses
Correct answer: Have a check drawn on the account payable to the trustee for trustee expenses
The trustee can be reimbursed for trustee expenses that are reasonable. A trust account must be managed by the trustee and not by the beneficiary. Only the trustee can direct a withdrawal of funds, provided the withdrawal is done in a manner consistent with the trust document. Trust funds must be placed in custodial accounts (not to be confused with custodian for minors), not in noncustodial accounts.
- A major benefit of a revocable trust is that
- The settlor cannot also be the beneficiary
- The assets are not included in the grantor’s estate
- The grantor retains control of the assets
- The grantor saves on income taxes
Correct answer: The grantor retains control of the assets
Among the benefits of a revocable trust is that the grantor (settlor) retains all control over the assets. There are no tax benefits, and the grantor can be the beneficiary (and trustee) if the trust is set up that way.
- One of the situations that investment adviser representatives may encounter is the death of a client. When that happens, orders may be accepted from
- The deceased client’s spouse
- The trustee in intestacy
- The deceased client’s children
- An individual with a durable power of attorney
Correct answer: The trustee in intestacy
In most cases, your clients will have a will. (Editorial comment – not on the exam, but you are acting in your clients' best interest when you strongly urge them to prepare a proper will.) When the deceased has not written a will, he is considered to have died intestate. The appointment of the person who will administer the estate is based on state law. That person may be called the administrator of the estate or the trustee in intestacy. The spouse may be appointed to that role, but would be acting as the trustee, not as the spouse and same is true of the children. A durable power of attorney is dissolved upon the death of either principal to the power.
- One of your customers has a substantial savings account at the local S&L. The customer has several grandchildren and wants the flexibility of being able to change the beneficiary allocations as their financial conditions change. You should recommend that the customer investigate the use of
- A durable power of attorney (POA)
- An irrevocable trust
- A Uniform Transfers to Minors Act (UTMA) account
- A Totten trust
Correct answer: A Totten trust
A Totten trust allows for the transfer of ownership of a bank account to a beneficiary or beneficiaries after the owner's death. It is the predecessor of today's POD (pay on death) and TOD (transfer on death) accounts. Beneficiary names and/or percentages can be changed at will. An irrevocable trust can't be changed; there is no flexibility. In an UTMA account, once the money is allocated, the decision is irrevocable (and who says the grandchildren are minors). The durable POA gives a designated person the authority to manage the affairs of the account, and this customer wants the control.
- With respect to taxation, an investment adviser representative should NOT
- Discuss how the tax rules and rates apply to a recommended security
- Recommend selling a losing position so a client harvests a tax loss
- Explain the taxable status of the interest paid on a municipal bond
- Prepare the trust and will documents required to carry out the plan
Correct answer: Prepare the trust and will documents required to carry out the plan
Drafting trust instruments and wills is the practice of law, and an investment adviser representative who prepares them is practicing law without a license no matter how tax-driven the plan is; those documents must be drawn by an attorney. Explaining how the tax rules bear on a recommendation, explaining whether the interest paid on a particular security is taxable, and recommending a sale that realizes a loss are all ordinary parts of giving investment advice, and the adviser is expected to raise them.
- A trust document's investment policy emphasizes that the fiduciary must follow SRI. When you are asked by the trustee to explain what that means, you would reply,
- Sustainable reasonable investing
- Safe responsible investing
- Socially responsible investing
- Systemic responsible investing
Correct answer: Socially responsible investing
Socially responsible investing (SRI) is an impact investment strategy which seeks to consider both financial return and social good. In general, socially responsible investors encourage corporate practices that promote environmental stewardship, consumer protection, human rights, and diversity. You might also see SRI referred to as sustainable responsible (not reasonable) investing.
- In the banking industry, the term POD refers to an account similar to the TOD designation used by broker-dealers. An old, but sometimes still used term to describe this kind of account, is
- Demand deposit account (DDA)
- Revocable trust
- Totten trust
- Passbook savings account
Correct answer: Totten trust
The name comes from a 1904 decision in a New York case called In re Totten. The court ruled that someone could open a bank account as a trustee for another person, who had no right to the money until the account owner died. The account owner is the trustee, in control of money that will eventually go to the trust beneficiary, and could change beneficiaries as desired. But whether the arrangement is called a Totten trust or a POD account, the result is the same.
- Mr. and Mrs. Williams are a retired couple receiving most of their income from a diversified portfolio of high-quality bonds and preferred stock. One of the reasons that life insurance might be a useful addition to their overall planning is that
- The death benefit supplies cash so their income assets are not sold
- The premiums on the policy are deductible on their joint tax return
- Policy dividends are taxed as ordinary income in the year they come
- The policy's cash value is excluded from their taxable gross estate
Correct answer: The death benefit supplies cash so their income assets are not sold
This couple lives on the income their bonds and preferred stock produce. If the estate has to raise cash at death for final expenses, taxes and administration, those very holdings would have to be liquidated and the survivor's income would drop. Life insurance delivers that cash directly, so the income-producing portfolio can be left intact, and that liquidity is the planning reason to own it. Premiums on personal life insurance are not deductible. Policy dividends are treated as a return of premium and are not taxable when received. Cash value is part of the policy, and a policy the insured owns is included in the taxable estate rather than excluded from it.
- In general, the first step an investment adviser should take with a new client is
- Making suitable recommendations
- Monitoring the portfolio
- Explaining the risks of investing
- Information gathering
Correct answer: Information gathering
Until the investment adviser has gathered the necessary information, no recommendations can be made. An explanation of the risks comes after gathering the information because that informs the IA of the investor's risk tolerance and investing experience.
- In administering a joint account, a member firm's responsibilities concerning suitability determination and information disclosure apply to
- The person with the greatest capital contribution
- The person whose Social Security number is on the account
- All persons who jointly own the account
- The person with trading authority for the account
Correct answer: All persons who jointly own the account
Suitability rules apply to all owners in a joint account.
- Which type of individual account allows for investments held in that account to go straight to a named beneficiary outside of probate?
- Advisory account
- TOD account
- Testamentary account
- Account titled JTWROS
Correct answer: TOD account
A simple way for an individual account owner to ensure that the assets in the account pass directly to the named beneficiary is to use the Transfer on Death (TOD) option. Although the assets in a JTWROS account pass to the survivor without probate, the question specifies an individual, not a joint account.
- A customer has just died. If his wife asks you what amount of federal estate tax will be imposed on the transfer of their personal property to her name, which of the following responses would be best?
- The amount may be prorated over the next 4 years.
- Consult a qualified tax specialist.
- The amount of tax will depend on your late husband's tax bracket.
- The amount of tax will depend on the size of the estate to be transferred.
Correct answer: Consult a qualified tax specialist.
Specific tax advice should be referred to a qualified tax adviser such as an accountant or tax attorney. No federal estate tax is imposed as a result of the marital exclusion as long as the spouse is a U.S. citizen.
- One of the tasks of an investment adviser representative is gathering information to complete a client financial profile. Among the sources of this information would be all of the following except
- The client’s life insurance policies
- The client’s social media accounts
- The client’s bank and brokerage statements
- The client’s tax returns
Correct answer: The client’s social media accounts
Although there are some people who divulge a great deal of personal information on their social media accounts, those are not the most reliable sources of the financial numbers an IAR needs to properly evaluate a client's financial position. Tax returns, bank and brokerage account statements, and life insurance policies (especially those with cash value) are a window to the client's assets.
- Several investors open an account in joint tenancy. Financial information is required on which of the following investors?
- The majority of the investors
- Only the one authorized to trade the account
- All the investors
- The largest investor only
Correct answer: All the investors
When a joint account is opened, financial information should be obtained on all the account owners.
- One of your clients has named you as the trustee for a trust he has established. The beneficiary of the trust approaches you with a request for a disbursement that is contrary to the provisions of the trust document. In accordance with the provisions of the Uniform Prudent Investor Act, you should
- Follow the wishes of the beneficiary
- Follow the terms of the trust
- Contact the grantor
- Do nothing
Correct answer: Follow the terms of the trust
Trust law requires that the trustee act in accordance with the terms of the trust document at all times.
- If a client wishes the assets in her account to pass directly to specific beneficiaries after her death, her account should be titled
- Testamentary account
- TOD
- JTWROS
- TIC
Correct answer: TOD
TOD (transfer on death) provides that, upon the death of the account holder, the assets pass to the named beneficiary or beneficiaries without going through probate.
- A wealthy individual has set up a GRAT. Should she die during the time the trust is active, how are the remaining assets in the trust taxed?
- The original value plus any appreciation passes to the beneficiaries but is subject to gift tax.
- No tax is due if the grantor should die during the term of the trust.
- The original value plus any appreciation is taxed as part of the grantor’s estate.
- The original value plus any appreciation passes to the beneficiaries and is taxed as ordinary income.
Correct answer: The original value plus any appreciation is taxed as part of the grantor’s estate.
One of the risks in setting up a GRAT is that if the grantor dies during the term of the trust (usually 3–10 years), the assets put in the GRAT, plus any appreciation, are included in her estate.
- A grantor retained annuity trust is a planning tool designed to pass assets to beneficiaries (usually children) in a way to minimize
- Estate taxes
- Income taxes
- Excise taxes
- Property taxes
Correct answer: Estate taxes
A GRAT is an estate planning tool designed to pass assets to beneficiaries (usually children) in a way to minimize gift and/or estate taxes. Because incidents of ownership remain with the grantor, all income is taxed to the grantor.
- Which of the following is NOT a characteristic of a corporation?
- Existence terminates when an owner dies.
- Owners have no personal liability for corporate debts.
- Ownership interests are evidenced by shares of stock.
- It is considered an entity apart from its owners.
Correct answer: Existence terminates when an owner dies.
A corporation is an entity that has an existence separate from its owners. Therefore, the existence of a corporation does not terminate when an owner dies. Also, because the owners and the corporation are distinct entities, the owners are not personally liable for the corporation's debts.
- Your advisory client is an 86-year-old woman who is presently in the hospital, unable to communicate due to a severe stroke. For the past 6 years, she has followed the practice of making annual gifts of stock to her children and grandchildren on her birthday. Because her 87th is coming up later this month, her oldest son approaches you and asks you to continue the policy.
- You should go to the hospital and see if she can blink her eyes to indicate yes or no.
- With 6 years of prior history, you know this is what she would want you to do so you go ahead as in previous years.
- You may only follow the provisions of her will.
- Without a proper durable power of attorney being produced, you cannot do anything.
Correct answer: Without a proper durable power of attorney being produced, you cannot do anything.
Unless proper written authorization has been provided, such as with a durable power of attorney, you cannot do anything without the client's consent. If she fails to recover and passes away, then the terms of the will must be followed by the executor.
- When comparing a private equity fund to a public one, it would be incorrect to state that the private fund has
- Stronger governance
- Higher risk
- Less liquidity
- Lower reporting costs
Correct answer: Stronger governance
The first step is to notice that the question is looking for the statement that is not correct. Corporate governance is an area where public shareholders look to ensure that the management is performing in ways that not only maximize operating results, but also represent high standards of business ethics. In the case of private funds, there are very few shareholders and they generally take less of an interest in ESG (environment, social, and corporate governance) matters. Private funds are not liquid and because they are private, they do not have the costs of regular reporting to the SEC. In general, private funds are considered a higher-than-average risk investment.
- One of your clients dies. You could legally take instructions regarding the individual's estate from
- A CPA who prepared the deceased’s tax return
- A person with durable power of attorney
- The administrator in intestacy
- The spouse of the deceased
Correct answer: The administrator in intestacy
If an individual dies without a will (intestate), the state will appoint an administrator in intestacy who, just as an executor for one who had a will, has control over the deceased's assets. A durable power of attorney, just like any other power, expires upon the death of either party to the power.
- One of the ways in which a simple trust differs from a complex trust is that simple trusts
- Add any undistributed income to the corpus of the trust
- Pay out all of their distributable net income each year
- Make a payment of principal to all of the beneficiaries
- Claim a charitable deduction for the money they pay out
Correct answer: Pay out all of their distributable net income each year
A simple trust is defined by the requirement that it distribute all of its distributable net income to the beneficiaries every year. The other three choices describe complex trusts. Only a complex trust may accumulate income and add it to corpus, only a complex trust may pay out principal, and only a complex trust may take a deduction for amounts paid to charity. A simple trust may do none of the three.
- An investment constraint that is unique to private foundations is the requirement to
- Invest 5% of its own assets each year in qualifying securities
- Donate 5% of its gross income each year to unrelated charities
- Hold 5% of its assets each year in short-term cash equivalents
- Pay out 5% of its assets each year as qualifying distributions
Correct answer: Pay out 5% of its assets each year as qualifying distributions
Section 4942 of the Internal Revenue Code requires a private foundation to pay out each year an amount equal to 5% of its net investment assets in qualifying distributions. The payout is measured against assets, not income, so distributing 5% of income does not satisfy it, and the recipient need not be an unrelated charity. Nothing in the law requires any share of assets to be placed in particular investments or held in cash.
- A living will is used to
- Avoid the cost and time of probate
- Ensure that the author’s assets are properly distributed after death
- Eliminate, or at least reduce, estate taxes
- Express the author’s end-of-life wishes
Correct answer: Express the author’s end-of-life wishes
Sometimes referred to as a medical directive or advanced care directive, a living will is used to express the author's end-of-life wishes, such as organ donation, "pulling the plug," and so forth. It has nothing to do with a last will and testament describing the distribution of assets after death.
- 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 person with a durable power of attorney
- The spouse
- The person named as executor of the estate
- The person appointed as administrator of the estate
Correct answer: The spouse
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 canceled 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.
- Which of the following would be used to provide end-of-life instructions once a person becomes incapacitated?
- A living will
- A durable power of attorney
- A living trust
- An incapacitated will
Correct answer: A living will
The purpose of a living will is to give clear instructions regarding end-of-life decisions, such as organ donation or when to "pull the plug." There is no such thing as an incapacitated will. A living trust deals with how assets are distributed, and a durable power of attorney grants authorization to a person to legally act on behalf of someone who cannot do so.
- One of your existing clients wishes to open a new account in the name of his spouse and enter orders on her behalf.
- The agent could be liable if the stock declines in value.
- This action is prohibited unless the spouse signs a trading authorization.
- This practice is ordinary and acceptable.
- This action is prohibited unless the customer signs a trading authorization on behalf of his spouse.
Correct answer: This action is prohibited unless the spouse signs a trading authorization.
Effecting transactions without specific written authority from the beneficial owner of the account is prohibited. This customer cannot sign trading authorization on behalf of his spouse. The spouse must sign the authorization.
- Mr. Hawkins sets up a revocable trust for the benefit of his adult daughter, Madeleine. His wife may draw from it only if she needs to. Income on the trust will be taxed to
- The trust because it is a separate legal entity
- Mr. Hawkins as the donor
- Madeleine as the primary beneficiary
- Mrs. Hawkins as the contingent beneficiary
Correct answer: Mr. Hawkins as the donor
Because Mrs. Hawkins has an economic interest, this is a grantor trust. Thus, all income will be taxed to the donor, Mr. Hawkins.
- An estate account is opened with Family Asset Protectors (FAP) a registered investment adviser. Management decisions regarding the account must be made at the direction of the
- Investment adviser
- Attorney with guardianship over the surviving children
- Estate’s executor or administrator
- The estate’s principal beneficiaries
Correct answer: Estate’s executor or administrator
Only the estate executor (or administrator when the individual dies intestate) can make investment management and distribution decisions. This does not mean that the executor must make the investment decisions for the account, only that decisions as to who will do the management are within his purview. A guardian with authority over the children does not necessarily have power over the estate unless the guardian is also the administrator or the executor of the estate.
- Because a trust account is managed for the beneficial interest of the beneficiary, the investment adviser representative can
- Place the securities in the trust fund in a noncustodial brokerage account
- Arrange to have the trust's funds pledged to support a loan for the trustee
- Have a check drawn on the account payable to the trustee for expenses
- Have funds withdrawn from the account at the direction of the beneficiary
Correct answer: Have a check drawn on the account payable to the trustee for expenses
The trustee can be reimbursed for expenses that are reasonable. A trust account must be managed by the trustee and not by the beneficiary. Only the trustee can withdraw funds, provided the withdrawal is done in a manner consistent with the trust document. Trust funds must be placed in custodial or trust accounts, not in noncustodial accounts.
- As with all investors, it is important that trusts have an investment policy statement (IPS). If the beneficiary of a trust requests that the trustee use trust assets to enter an order that is considered a prohibited transaction under the IPS, the trustee should
- Decline the order and report the matter to the Administrator
- Enter the order after first amending the trust's written IPS
- Decline the order because the trust's written IPS forbids it
- Enter the order after the grantor issues his written consent
Correct answer: Decline the order because the trust's written IPS forbids it
A trustee is a fiduciary and the IPS is the document that governs how the trust's assets are managed, so a transaction the IPS prohibits must be refused whatever the beneficiary asks for. Nothing obliges the trustee to report the request to the Administrator; the beneficiary has asked for something imprudent, not something fraudulent. Amending the IPS to accommodate the order defeats the purpose of having one, and the grantor's consent cannot authorize a trustee to act outside the trust's own investment policy.
- One of your longtime advisory clients has been critically injured in an automobile accident. The client is in the ICU at the local hospital, unable to communicate. You would be able to accept orders for the account
- From the attorney who drew up the client's own estate plans
- From a person who holds a written durable power of attorney
- From the spouse who is the named beneficiary on the account
- From the executor who is named in the client's current will
Correct answer: From a person who holds a written durable power of attorney
While a client is incapacitated, orders may be accepted only from someone with written trading authority over the account, and a durable power of attorney is the instrument that survives the client's incapacity. Drafting the client's estate plan gives an attorney no authority over the brokerage account. A named beneficiary has no rights at all while the account owner is alive, and an executor's authority begins only at death.
- As a registered investment adviser, you have managed $10 million of a customer's funds for several years. The customer asks you to prepare a trust for his children, to transfer $3 million of his funds into the trust, and to trade the trust with the same objectives as the existing account. You should
- Draft the trust document and have the attorney review it later
- Advise the customer that a tax specialist must draft the trust
- Explain that advisory accounts may not be opened for any trust
- Refer the customer to an attorney who will establish the trust
Correct answer: Refer the customer to an attorney who will establish the trust
Drafting a trust is the practice of law, so the adviser should send the customer to a qualified attorney and then manage the trust's account once it exists. Preparing the document first and having it reviewed afterward is still practicing law without a license. A tax specialist advises on the tax consequences of a trust but does not draft it, and there is no prohibition on opening an advisory account for a trust.
- The type of business organization in which one person owns the entire business and there is no legal distinction between that individual and the business is
- A sole proprietorship
- A corporation
- A general partnership
- A limited partnership
Correct answer: A sole proprietorship
A sole proprietorship is the simplest form of business organization, because one person owns the entire business and there is no legal distinction between the owner and the business. This means that the owner is personally responsible for the business's debts. A partnership always requires 2 or more owners. Although 1 person can own an entire corporation, a corporation is a legal entity separate and distinct from its owner(s).
- Which of the following would likely be stressed in a socially responsible fund?
- Lower than average expenses
- Higher-than-average returns
- Ethical and moral investing
- Avoidance of foreign securities
Correct answer: Ethical and moral investing
Socially responsible investing (SRI) is an impact investment strategy which seeks to consider both financial return and social good. In general, socially responsible investors encourage highly ethical corporate practices that promote environmental stewardship, consumer protection, human rights, and diversity.
- A man is planning to start his own glass-sculpturing business. He wants to be able to deduct his anticipated losses for the first 2 years. He anticipates that the enterprise will borrow money from lenders and is willing to personally guarantee the debt. He also wants to attract other investors but does not want to give up control of the day-to-day business decisions. What business form do you recommend?
- Limited partnership
- C corporation
- S corporations
- General partnership
Correct answer: Limited partnership
A limited partnership with him as general partner would allow for additional investment capital without giving up management control. C corporations do not allow deductibility of losses; S corporations do not allow guaranteed debt to be included in the taxpayer's basis. General partnerships could allow the other partners to more easily control the day-to-day operations than a limited partnership, in which the other investors (presumably limited partners) would not be permitted to take a role in the running of the business.
- When advisory clients wish to structure their portfolios to support companies that engage in social or environmental policies that they agree with, it is known as
- Sector rotation
- Prudent investing
- Program-related investing
- Impact investing
Correct answer: Impact investing
Impact investing is the intentional allocation of capital to companies whose social or environmental conduct the investor wishes to support, alongside a financial return. Sector rotation shifts a portfolio between industry sectors according to the business cycle and has no social dimension. Prudent investing describes the standard of care a fiduciary owes rather than a strategy. A program-related investment is a below-market investment a private foundation makes to further its charitable purpose, so it is not something advisory clients generally do.
- In a trust account, the person who makes the account management decisions is
- The beneficiary
- The nontrustee custodian
- The investment adviser representative
- The trustee
Correct answer: The trustee
A trust is a legal entity that designates a person (the trustee) to manage the trust's assets for the benefit of another person (the beneficiary or beneficial owner).
- If a customer who has granted a durable power of attorney to her son dies, which of the following statements regarding the power of attorney is TRUE?
- It remains in effect until the son cancels it.
- It is canceled on the death of either principal.
- It remains in effect until the executor of the estate cancels it.
- It remains in effect only if the son is the sole heir to the estate.
Correct answer: It is canceled on the death of either principal.
When the customer or her son dies, the power of attorney also expires. However, a durable power of attorney will survive a declaration of mental incompetence and is useful in those cases where a parent suffers from dementia.
- A professional tennis player comes to you seeking advice on setting up a trust. She is interested in giving to charity and also wants discretion as to when income is distributed to the beneficiaries, her parents. Which trust do you advise she use?
- Complex trust
- Charitable lead trust
- Simple trust
- Charitable remainder trust
Correct answer: Complex trust
Only a complex trust allows the two features that she requires. Simple trusts may not make charitable contributions, and they provide no discretion on income distribution. The two types of charitable trusts mentioned provide no ongoing discretion as to when income is distributed or who the beneficiaries are.
- Samantha Wells, a British citizen temporarily working in the United States, wants to form a business venture with other investors. She is looking for favorable tax treatment of earnings and losses. She also wants to limit the number of investors, but is willing to share control of the enterprise with others to attract them. What business form do you advise to her?
- S Corporation
- General Partnership
- Limited Partnership
- C Corporation
Correct answer: General Partnership
Limited partnerships would not work because the other investors have limited say in how the enterprise is run. C corporations do not provide favorable tax treatment of gains or losses. While an S corporation appears to be the right answer, only U.S. citizens or resident aliens can own one.
- A registered broker-dealer would not be able to open an account for
- Two unrelated individuals
- The CEO of a company whose stock is NYSE-traded
- A person deemed mentally incompetent
- The estate of a deceased individual
Correct answer: A person deemed mentally incompetent
A broker-dealer can only open an account with a legal person. Those deemed mentally incompetent are not persons under the law. Deceased individuals are not persons either, but their estate is so an account may be opened in the name of the estate. Although the CEO's account would have to be monitored for any hint of insider trading, one's position in a listed company is not an impediment to opening a brokerage account. There is no legal requirement that the owners of a joint account be related; friends are fine as are business partners.
- Under industry rules, customers who wish to trade options must receive a copy of the options disclosure document (ODD)
- At or before the mailing of the confirmation representing the first options trade
- At or before account approval
- At or before the mailing of the next monthly statement
- Within 15 days of account approval
Correct answer: At or before account approval
All prospective options customers must receive a copy of the ODD at or before the time the account is approved to trade options. It is the options account agreement that must be signed and returned to the broker-dealer within 15 days of account approval.
- Which of the following actions should be taken by an agent when a client decides to open an options account?
- Assure that an options agreement has been signed prior to the first trade taking place
- Review with the client the risks involved when trading options before the first options trade
- Obtain approval from the designated options supervisor to open the account no later than 1 business day after the first options trade
- Provide an options disclosure document no later than 15 days after the first trade
Correct answer: Review with the client the risks involved when trading options before the first options trade
It is imperative that suitability and risk be addressed with the client before allowing option trading to take place. The ODD must be delivered no later than with account opening, and the options agreement must be returned no later than 15 days after the account opening. An options account must be approved by a designated supervisor prior to any trading takes place in the account.
- All of the following permit investments into various securities, such as stocks, bonds, and mutual funds EXCEPT
- An HSA
- A traditional IRA
- A Roth IRA
- An FSA
Correct answer: An FSA
Flexible spending accounts (FSAs) allow deductions from an employee's paycheck. That money is held by the company and is used to pay allowable claims by the employee. A health savings account (HSA) permits the employee to invest in a wide variety of securities. IRAs, traditional and Roth, have always permitted investment flexibility.
- Your clients, a married couple, are trying to decide whether to open an account as joint tenants with right of survivorship or tenants by the entirety. You might point out to them that one of the differences to consider is that:
- A JTWROS account requires the consent of both parties to make a trade
- Only the JBE account avoids probate upon the death of the first tenant
- Any 2 people can open a JBE account, while JTWROS accounts are limited to married couples
- A JBE account requires the consent of both parties to make a trade
Correct answer: A JBE account requires the consent of both parties to make a trade
One of the unique characteristics of the joint by the entirety (JBE) account is that the consent of the other party is necessary in order for one of the parties to enter a trade. With a JTWROS account, either party can enter trades independently. Both JTWROS and JBE avoid probate and the JBE is limited to married couples only.
- Under the Uniform Gifts to Minors Act, Ralph wants to give some stock to his brother's son, Jose. His nephew's father, Bob, is the legal guardian. If Ralph wants to name himself as custodian, which of the following needs to be done?
- Ralph must get written consent from Bob, who is the legal guardian
- Ralph must file papers and be appointed custodian by a state court
- Ralph must open the account and name himself as the sole custodian
- Ralph must select Bob, who is the legal guardian, as the custodian
Correct answer: Ralph must open the account and name himself as the sole custodian
Opening an UGMA or UTMA account requires no court order and no documentation beyond the account form itself. The donor opens the account in the minor's name, using the minor's Social Security number, and names one adult as custodian; the donor may name himself. The guardian's consent is not required, no court appoints the custodian, and the custodian and the legal guardian need not be the same person.
- An investment adviser registered in 4 states would be permitted to enter into an advisory contract with all of the following prospective clients except
- A large registered broker-dealer
- A public charitable foundation
- A registered investment company
- A major university endowment
Correct answer: A registered investment company
An adviser to a registered investment company must register with the SEC, and a federal covered adviser does not register in any state. An adviser whose registration is with four states therefore cannot take on an investment company as an advisory client. Broker-dealers, charitable foundations and university endowments are all ordinary advisory clients that a state-registered adviser may contract with.
- Which of the following is among the items of information that must be entered on a new account form?
- Names of other broker-dealer firms already holding accounts for the prospective customer
- What educational degree(s) the accountholder has earned
- Names and addresses of at least 2 of the prospective customer's neighbors as personal references
- Names of all persons who will have access to the account
Correct answer: Names of all persons who will have access to the account
The facts that are required on a new account form are aimed at facilitating the operation of the account, properly identifying the customer, and guarding against money laundering and other illegal activities. Of the choices offered, only the names of those with access to the account would help with these goals, so this item of information is the only one on the list that is required.
- Construction of an investment policy statement (IPS) requires identifying the client's objectives and constraints. Which of the following would not be in the list of constraints?
- Time horizon
- Liquidity risk
- Taxes
- Risk tolerance
Correct answer: Risk tolerance
This is a bit sneaky. In order for an investment adviser to enter into an advisory contract with an investment company, the adviser must be SEC registered (federal covered). Federal covered investment advisers are never registered in any states.
- Which of the following investments could be found in an UTMA but not an UGMA?
- Sector mutual fund
- Real estate
- Bonds
- Preferred stock
Correct answer: Real estate
The Uniform Transfer to Minors Act (UTMA) allows virtually any kind of asset, including real estate, to be transferred to a minor. UGMA accounts, on the other hand, are limited to gifts of cash, securities (such as stocks, bonds, or mutual funds), and insurance policies.
- An investment adviser would be able to enter into an advisory contract with all of the following except
- A minor
- A philanthropic foundation
- A closed-end investment company
- Three brothers in a joint account
Correct answer: A minor
Investment advisers can only enter into advisory contracts for those who are persons, as defined in the Uniform Securities Act. There are three nonpersons: minors, deceased persons, and those declared mentally incompetent. How do we know the brothers are adults? Because it doesn't say they are minors – don't read something into a question to make it more difficult.
- Which of the following items is NOT required under the customer identification program (CIP)?
- Sex
- Visa details for non-citizens
- Physical address
- Date of birth
Correct answer: Sex
The CIP does not ask if the account holder is male or female.
- Among the benefits of an HSA is
- Funds may be used for various medical expenses once the low deductible has been met
- Up to $10,000 per year may be accumulated
- Funds not used for health expenses may be invested in mutual funds and other securities
- The amount that may be contributed is based on the number of dependents
Correct answer: Funds not used for health expenses may be invested in mutual funds and other securities
Unlike an FSA (flexible spending account), employee contributions to a health savings account (HSA) not used for medical expenses may be invested in a wide variety of securities. Although mutual funds are the most common, many providers offer the opportunity to invest in stocks and bonds. Remember, one of the eligibility requirements for an HSA is a high, not low, deductible. Currently, the maximum contribution is $3,450 for an individual or $6,850 if family coverage, regardless of the number of dependents covered.
- A client is completing a new account form that contains questions about the investor's investing experience and knowledge. More than likely, what type of account is being opened?
- Margin
- Options
- Discretionary
- Retirement
Correct answer: Options
One question asked on a new options account form that is not required on a normal brokerage account opening is investment experience and knowledge (e.g., number of years, size, frequency, and type of transactions) for options, stocks and bonds, commodities, and other financial instruments.
- Ms. Abbot has a joint account with her sister. She enters a sell order in the account and instructs that the proceeds check be made out to her only. If your firm sends the check but makes it payable to both Ms. Abbot and her sister, this is an example of
- The proper joint account procedure
- An unfortunate error that can be reconciled with the broker-dealer through a process called reclamation
- An unlawful practice because the transaction was unauthorized
- Not following instructions, a prohibited practice under the Uniform Securities Act
Correct answer: The proper joint account procedure
In joint accounts, either party may act. However, by law, all checks must be made payable to all owners, so the firm is following required procedure.
- If a customer would like to open a custodial UGMA or UTMA account for his nephew, a minor, the uncle can
- Open the account provided the proper trust arrangements are filed first
- Be custodian for the account only if he is also the minor’s legal guardian
- Open the account and name himself custodian
- Open the account, but he needs a legal document evidencing the nephew’s parents’ prior approval of the account
Correct answer: Open the account and name himself custodian
The donor may name himself the custodian of an UGMA or UTMA account. No documentation of custodial status is required to open an UGMA account, and the custodian is not required to be the minor's legal guardian.
- Under UTMA, which of the following are allowable distributions for the benefit of the minor?
- Clothing expense for child who has gone thru a growth spurt
- The cost to attend a summer camp
- A percentage of housing expenses, such as the utilities for his bedroom
- A percentage of food expense
Correct answer: The cost to attend a summer camp
You cannot use UTMA (or UGMA) money for the basics of food, clothing and shelter; those are the responsibility of the parent. An optional expense, such as summer camp, vacation, sports league registration, would be permitted.
- The term security would include which of the following?
- Simple IRA plans
- Bond trust indentures
- Section 529 plans
- Fixed annuity contracts
Correct answer: Section 529 plans
Section 529 plans are municipal fund securities and are therefore securities. A SIMPLE IRA is a retirement plan, and retirement plans are not included in the definition. An indenture is the contract setting out the issuer's obligations and the bondholders' rights; it describes a security but is not itself one. A fixed annuity carries no investment risk for the purchaser and is specifically excluded from the definition of a security.
- Which of the following types of businessowners has unlimited liability for the business's debts?
- Limited partner
- Member of a limited liability company (LLC)
- Owner of a sole proprietorship
- Shareholder of a corporation
Correct answer: Owner of a sole proprietorship
The owner of a sole proprietorship has unlimited personal liability for the debts of the business, and this is one of the main disadvantages of sole proprietorships. Limited partners, members of limited liability companies, and shareholders of corporations are not personally liable for the debts of the business.
- In an account opened by 2 individuals as joint tenants with rights of survivorship, all of the following are true EXCEPT
- In the event of death, the other party assumes full ownership of the account
- Stock certificates may be delivered in the name of either party
- Mail may be directed to the joint owner agreed upon by both parties to the account
- Orders may be entered by either party
Correct answer: Stock certificates may be delivered in the name of either party
In a JTWROS account, each party has an equal, undivided interest in the account. Upon the death of 1 party in a 2-party account, the other party assumes full ownership of the account. Orders may be entered by either party, and mail may be directed to either party. However, disbursements of cash or securities must be in the name of all parties to the account.
- When does a deliberate omission of a fact in a securities sale constitute fraud?
- If the omitted fact was later disclosed in a formal prospectus
- If the omission occurred during a public offering of new stock
- If a reasonable investor would have relied on the omitted fact
- If the seller believed that the omitted fact was actually true
Correct answer: If a reasonable investor would have relied on the omitted fact
A deliberate omission is fraudulent when the omitted information is material, and information is material when a reasonable investor would use it in making an investment decision. Later disclosure in a prospectus does not cure a fraudulent sale that has already taken place. The antifraud provisions reach both new issues and secondary market trades, so the type of transaction is irrelevant. What the seller believed goes to the seller's state of mind, not to whether the omission was material.
- A feature of which of the following business entities is limited liability for owners, as well as flow-through of income?
- General partnership
- Sole proprietorship
- Limited partnership
- C corporation
Correct answer: Limited partnership
Limited partnership interests offer both flow-through of income (or loss) along with limited liability. The general partnership has full liability, as does the sole proprietorship. C corporations have limited liability, but no flow-through.
- The federal legislation that requires broker-dealers to verify the identity of any person opening an account is
- The Uniform Securities Act of 1956
- The Insider Trading and Securities Fraud Enforcement Act of 1988
- The Securities Exchange Act of 1934
- The USA PATRIOT Act of 2001
Correct answer: The USA PATRIOT Act of 2001
The USA PATRIOT Act (the full title is Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism) requires firms to obtain identifying information on each new customer, verify the identity of each new customer, maintain records relating to identity verification, and determine if any new customer appears on a list of known or suspected terrorist groups compiled by the Office of Foreign Assets Control (OFAC). This is accomplished through the customer identification program (CIP).
- When does a customer have to receive the OCC Options Disclosure Document?
- Before the fifteenth day following approval of the options account
- Within five business days after the customer's first options trade
- With the trade confirmation for the customer's first options order
- Before the firm accepts the customer's first covered options order
Correct answer: Before the firm accepts the customer's first covered options order
The options disclosure document must reach the customer no later than the time the broker-dealer approves the options account or accepts the customer's first covered options order under the ODD, whichever of the two comes sooner. Delivery keyed to a number of days after approval, to a number of days after the first trade, or to the confirmation of that trade all arrive after the customer has already taken options risk, which is what the disclosure requirement exists to prevent.
- Obtaining all of the following complies with the regulations regarding customer identification programs (CIPs) EXCEPT
- A tax identification number issued to the holder of that account
- A post office box listed instead of a residential street address
- A date of birth for each individual customer opening the account
- A residential or business address for each holder of the account
Correct answer: A post office box listed instead of a residential street address
A customer identification program must collect a physical residential or business address; a post office box standing alone does not show where the customer actually is, so accepting one in place of a street address does not comply. Name, date of birth, taxpayer identification number and a physical street address are the required CIP data points for a natural person, so obtaining the other three does comply.
- An advantage of structuring a business operation as an S corporation rather than a C corporation would be
- Limited liability
- Simplicity when raising capital through a public offering
- The C corporation is limited to a maximum of 100 shareholders while no such limit exists for the S corporation
- Avoiding double taxation
Correct answer: Avoiding double taxation
An S corporation is a pass-through entity: income is taxed once at the shareholder level, avoiding the double taxation (corporate tax plus tax on dividends) that applies to a C corporation. Limited liability is available to both S and C corporations, and a C corporation—not an S corporation—is the form better suited to raising capital through a public offering. It is the S corporation that is capped (currently at 100 shareholders), not the C corporation.
- Small corporations that satisfy certain criteria can elect not to pay income tax at the corporate level but instead pass their earnings through to their shareholders. These corporations are known as
- C corporations
- R corporations
- S corporations
- Q corporations
Correct answer: S corporations
An S corporation elects to pass its earnings through to shareholders, who report the income on their personal returns, avoiding tax at the corporate level. C corporations are taxed at the entity level; 'R corporations' and 'Q corporations' are not real entity types.
- If 150 investors want to form a corporation to limit their financial liability to the amount of money they invest and do not want to be responsible for any debt that the corporation incurs, they would most likely form
- A C corporation
- A general partnership
- An S corporation
- A proprietorship
Correct answer: A C corporation
With 150 investors, the group exceeds the S corporation shareholder limit (currently 100), so a C corporation is the appropriate choice. A C corporation provides the limited liability they want—shareholders risk only their invested capital—whereas a general partnership and a sole proprietorship expose owners to unlimited personal liability.
- A woman wants to buy from an agent who is not registered in her state. She decides to use a friend's address in the state in which the agent is licensed. This action is
- Acceptable because the agent can do business only with those who have a residence address in those states in which he is registered
- Not acceptable because there are no circumstances under which you are permitted to use someone else's address as yours
- Not acceptable because the other party does not know you are using the address
- Acceptable as long as she has her friend's permission to use the address
Correct answer: Not acceptable because there are no circumstances under which you are permitted to use someone else's address as yours
There are no circumstances under which a customer may use someone else's address as her own to do business with an agent not registered in her home state. Doing so is an attempt to evade state registration requirements and is not acceptable, regardless of the friend's permission.
- Suzie McQueen has a very successful interior design shop she has run as a sole proprietorship. She has just celebrated her 60th birthday and has been giving thought to an eventual sale of the business. She wants your opinion on whether she should incorporate or change to a partnership. You might respond that
- The partnership form of business structure would be the easiest for ultimate transfer of ownership
- The corporate form of business structure would be the easiest for ultimate transfer of ownership
- The corporate form of business structure would be the least expensive to form
- The partnership form of business structure would enable Suzie to maximize her sale price
Correct answer: The corporate form of business structure would be the easiest for ultimate transfer of ownership
The corporate form of business structure is the easiest for the ultimate transfer of ownership because ownership is represented by shares of stock that can be readily sold or transferred. Transferring a partnership interest is more cumbersome, and corporations are generally more expensive—not less—to form than partnerships or proprietorships.
- As defined in the Uniform Securities Act, the term person would include I. a limited partnership II. a political subdivision III. an unincorporated association IV. the executor of an estate for a deceased individual
- I and IV
- II and III only
- I, II, III, and IV
- I, II, and III only
Correct answer: I, II, III, and IV
The Uniform Securities Act defines person very broadly to take in individuals and essentially every form of legal entity. A limited partnership, a political subdivision such as a city or county, an unincorporated association and the executor of a deceased person's estate are all persons. The act excludes only a deceased individual, a minor and someone judged mentally incompetent, and an executor is none of those, so all four items belong.
- An agent omits facts that a prudent investor requires to make informed decisions. Under the Uniform Securities Act, this action is
- Fraudulent for exempt securities only
- Fraudulent for nonexempt securities only
- Not fraudulent if there was willful intent to omit the information
- Fraudulent for both exempt and nonexempt securities
Correct answer: Fraudulent for both exempt and nonexempt securities
An investor relies on material facts to make investment decisions. The omission of a material fact in the sale, purchase, or offer of a security is fraudulent, whether the security offered is exempt or nonexempt.
- The federal law dealing with privacy matters for financial institutions is
- Regulation S-P
- Regulation D
- Regulation FD
- Regulation S-ID
Correct answer: Regulation S-P
Regulation S-P is the SEC privacy rule for financial institutions; it governs the notices a firm must send about its privacy policies and the safeguarding of customer records. Regulation D governs private placements. Regulation FD requires an issuer to disclose material information to all investors at the same time. Regulation S-ID is the identity theft red flags rule, which requires a program for detecting theft rather than a policy on the privacy of customer information.
- Review of an SEC-registered investment adviser's policies and procedures designed to prevent violation of the federal securities laws must take place no less frequently than
- Quarterly
- Monthly
- Semiannually
- Annually
Correct answer: Annually
It is the job of the adviser's chief compliance officer (CCO) to review those policies and procedures annually for their adequacy and the effectiveness of their implementation.
- Jessica is an investment adviser representative for an SEC-registered investment adviser. She lives in State X and receives a letter from a former college friend requesting a contribution to the friend's political campaign for governor of State Y. As it happens, Jessica's firm provides advisory services to State Y's employee retirement fund and Jessica actively solicits business from other state agencies. Which of the following actions would be permitted to Jessica under the SEC's pay-to-play rule without causing any concerns to her firm?
- Donating a maximum of $350 to the campaign
- Donating a maximum of $250 to the campaign
- Sending a letter to the friend indicating that the rules would not permit her to contribute to the campaign
- Donating a maximum of $150 to the campaign
Correct answer: Donating a maximum of $150 to the campaign
Jessica's solicitation activities define her as a covered employee. The rule allows covered employees to make contributions of up to $350 per official or candidate per election in which they can vote, or $150 for other elections. Because the friend is running for governor in a state that Jessica cannot vote, the lower limit applies.
- Under rule 206(4)-7 of the Investment Advisers Act of 1940, each investment adviser registered with the SEC is required to adopt and implement written policies and procedures designed to prevent violation of the federal securities laws. Ensuring that this is done is the role of
- The chief executive officer (CEO)
- The chief compliance officer (CCO)
- The chief operating officer (COO)
- The chief financial officer (CFO)
Correct answer: The chief compliance officer (CCO)
Although all of these "C" level officers have an important role to play, it is the CCO who is responsible for administering the policies and procedures designed to prevent violation of the federal securities laws and review those policies and procedures annually for their adequacy and the effectiveness of their implementation.
- During your training, you overhear your manager discussing the Chinese wall. This is probably referring to
- Internal controls that hold customer securities separate from firm inventory
- Internal limits that restrict the firm's overnight proprietary trading books
- Internal reviews that monitor employee trading in outside brokerage accounts
- Internal barriers that keep nonpublic information inside a single department
Correct answer: Internal barriers that keep nonpublic information inside a single department
A Chinese wall, now more often called an information barrier, is the set of internal procedures that keeps material nonpublic information from passing between departments of the same firm, so that what investment banking learns about a client's merger never reaches the trading or sales desks. Segregating customer securities from firm inventory is the customer protection rule, overnight position limits are a market risk control, and monitoring employees' outside accounts is a personal trading rule. None of the three restricts the flow of information between departments.
- Which of the following statements regarding investment adviser compliance rules is TRUE?
- If the chief compliance officer (CCO) conducts appropriate annual compliance reviews, interim review is generally not necessary.
- Compliance procedures should be designed to prevent violations, as well as detect existing violations.
- The CCO must have at least 3 years’ experience in securities industry compliance.
- Compliance procedures should review the accuracy of disclosures made to clients and investors, although it is not necessary that they review disclosures made to regulators.
Correct answer: Compliance procedures should be designed to prevent violations, as well as detect existing violations.
Although the CCO should conduct annual compliance reviews, he should also recognize the necessity for interim reviews in light of such events, including changes in business arrangements and regulatory developments. There is no specific experience requirement that the CCO must fulfill; however, the CCO should be knowledgeable in securities law. Compliance procedures should review the accuracy of disclosures made to regulators, clients, and investors.
- The Investment Advisers Act of 1940 requires advisers to prepare and adhere to a code of ethics. Which of the following is charged with the responsibility of enforcing that code?
- Administrator of the state in which the IA has its principal office
- Chief compliance officer of the IA
- Each individual IAR
- The SEC
Correct answer: Chief compliance officer of the IA
Each federal covered investment adviser must have an individual designated as the chief compliance officer (CCO). It is that person's responsibility to make sure that the code of ethics is being followed. Although each individual IAR must follow that code, it is the CCO with the supervisory responsibility.
- All of the following statements regarding the role of the chief compliance officer of an investment adviser are correct EXCEPT
- The chief compliance officer should have a minimum of 5 years’ experience in securities compliance in matters involving public customers or accounts
- The chief compliance officer should be competent and knowledgeable regarding the applicable federal securities laws
- The identity of an investment adviser's chief compliance officer must be disclosed on the Form ADV
- The chief compliance officer should be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the adviser
Correct answer: The chief compliance officer should have a minimum of 5 years’ experience in securities compliance in matters involving public customers or accounts
There is no specific experience requirement for the chief compliance officer of an investment adviser; he should be competent and knowledgeable regarding the applicable federal securities laws. Additionally, the chief compliance officer should be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the adviser.
- For purposes of safeguarding customer information, which of the following would be considered a covered account?
- A margin account in the name of the Interglobal Hedge Fund
- An account in the name of the State of X employee pension fund
- An account in the name of the Wells Morgan Bank
- A margin account in the name of Mary Beth Simmons
Correct answer: A margin account in the name of Mary Beth Simmons
The term covered account does not apply to institutional customers, such as banks, pension funds, and investment companies.
- Richard Alan is a longtime customer of yours and usually calls in orders identifying himself as Dick. Today, you receive a call requesting that half of the available funds in his account be wired to an offshore bank. When you say that his voice sounds different, he replies that he has a sore throat and that is why he doesn't sound like himself. Then you recall, when you answered the phone, he said that this is Mr. Richard Alan calling. At first you thought he was having fun, but now you might suspect
- He is having financial difficulties he wishes to hide from you
- Identity theft
- This is a different Richard Alan who is a client of the firm
- His illness is more serious than a sore throat
Correct answer: Identity theft
In many cases, the individual agent is the first line of defense against identity fraud. Spotting red flags like those posed in this question are critical to preventing losses to the company and the client.
- The powers of the Administrator include the ability to determine
- Minimum net worth requirements for investment advisers
- Maximum net capital requirements for broker-dealers
- Minimum net worth requirements for agents who exercise discretion
- Surety bond requirements for investment advisers who do not exercise discretion or maintain custody
Correct answer: Minimum net worth requirements for investment advisers
The Administrator can determine minimum, not maximum, net capital for broker-dealers (but not in excess of SEC requirements) and, for investment advisers, net worth. If the investment adviser does not exercise discretion (or maintain custody), no surety bond is required. Agents who exercise discretion may need a surety bond, but not a minimum net worth.
- The compliance rules of the Investment Advisers Act of 1940 require all of the following EXCEPT
- A written set of policies designed to prevent securities law violations
- The appointment of a chief compliance officer for the advisory business
- An annual review of the adequacy of the adviser's compliance procedures
- An audit of the firm's compliance procedures by an independent outsider
Correct answer: An audit of the firm's compliance procedures by an independent outsider
The compliance rule under the Investment Advisers Act of 1940 requires three things: written policies and procedures reasonably designed to prevent violations, an annual review of the adequacy of those policies, and the designation of a chief compliance officer. The annual review may be performed internally by the firm's own chief compliance officer, so nothing in the rule calls for an outside or independent audit.
- It is not uncommon to find financial planners who use their home as the base of their operations. When a financial planner who works from home is also registered as an agent of a broker-dealer, she must
- Have cybersecurity policies and procedures in place to guard client data
- Register the residence with the state Administrator as a separate branch
- Restrict client information to computers bought and supplied by the firm
- Separate her office physically from the living quarters of the residence
Correct answer: Have cybersecurity policies and procedures in place to guard client data
An agent's home office is treated as an extension of the broker-dealer's office, so customer data held there must be covered by the firm's cybersecurity policies and procedures. There is no requirement to register a residence as a branch office simply because an agent works from it, no rule barring a personally owned computer as long as adequate safeguards are in place, and no requirement that the workspace be walled off from the rest of the home.
- Under the Securities Exchange Act of 1934, which of the following statements regarding reports required to be filed with the SEC is TRUE?
- Institutional investment managers who exercise discretion over accounts valued at $100 million or more need not file reports if all their clients are insurance companies.
- Institutional investment managers who exercise discretion over accounts valued at $100 million or more of 13(f) securities must file reports quarterly.
- Persons who become the beneficial owner of more than 2% of a security registered under the Securities Exchange Act of 1934 must file a report within 5 days.
- Persons who become the beneficial owner of more than 5% of a security registered under the Securities Exchange Act of 1934 must file a report within 2 days.
Correct answer: Institutional investment managers who exercise discretion over accounts valued at $100 million or more of 13(f) securities must file reports quarterly.
The requirement for reports of beneficial ownership is that anyone who becomes the owner of more than 5% of a security registered under the Securities Exchange Act of 1934 must file a report within 10 days; therefore, neither 2 days nor 5 days is correct. The requirement for institutional investment managers is that they must file reports quarterly (13F) if they exercise discretion over accounts valued at $100 million or more of 13(f) securities. Whether the institutional investment manager's clients are insurance companies is not relevant.
- If having discretion over $100 million or more in 13(f) securities, which of the following would be exempt from filing a Form 13F?
- A trustee
- An investment adviser that manages mutual fund assets
- A natural person who exercises investment discretion over the account of any other natural person or entity
- A natural person who exercises investment discretion over her own account
Correct answer: A natural person who exercises investment discretion over her own account
An institutional investment manager is also a natural person or an entity that exercises investment discretion over the account of any other natural person or entity. For example, an investment adviser that manages private accounts, mutual fund assets, or pension plan assets is an institutional investment manager; so is the trust department of a bank. A trustee is an institutional investment manager, but a natural person who exercises investment discretion over her own account is not an institutional investment manager.
- The practice of stealing an individual's personal information for criminal activity is generally referred to as
- An unethical business practice
- Felonious assault
- Identity theft
- Credit monitoring
Correct answer: Identity theft
This is the standard definition of identity theft.
- Protection of the investing public is one of the major objectives of the SEC. Much of the protection comes from the disclosure requirements enveloping the industry. Among the disclosure forms used is Form 13F. To come under the SEC's requirement to file a Form 13F, an institutional manager must have discretion over
- More than 10% of the outstanding voting securities of a reporting company
- A portfolio of at least $100 million
- A portfolio of at least $50 million
- A portfolio of at least $100 million of 13(f) securities
Correct answer: A portfolio of at least $100 million of 13(f) securities
VAn institutional money manager, with at least $100 million in 13(f) securities under discretionary management, is required to file Form 13F. This form must be filed within 45 days of the end of the quarter.
- In an effort to make things easier for her clients, an agent redacts certain material information from sales literature relating to a sophisticated investment product her firm is offering. The agent
- Is offering better service to her clients by making the decision-making process easier
- Is properly including information necessary for an investor to make an informed investment decision
- Has violated the Uniform Securities Act by adding information to sales literature
- Is acting in a fraudulent manner by failing to include material information
Correct answer: Is acting in a fraudulent manner by failing to include material information
Material information must always be disclosed. There is never a case where it may be omitted from sales literature (or any other presentation).
- Your advisory customer calls to check on her account value at 9:00 am, but you were unavailable at the time. It is now 2:00 pm and you are able to call her back. If between 9:00 am and 2:00 pm her account value dropped from $711,500 to $710,000, what should you tell her?
- Your account value cannot be determined until the market closes.
- Your account has a value of $711,500.
- Your account is valued at $710,000 at this time.
- Your account was down to $699,700 earlier today but is up to $711,500.
Correct answer: Your account is valued at $710,000 at this time.
All other choices are clearly a misrepresentation of account status.
- If an agent misrepresents the price of a customer's stock by $10 per share to encourage the client to sell, this activity is
- A misrepresentation and a fraudulent act
- Allowed if the customer ultimately makes a profit in the account
- Allowed if the agent views the difference as a service charge
- A misrepresentation but not a fraudulent act
Correct answer: A misrepresentation and a fraudulent act
The agent has committed a fraudulent act by willfully misrepresenting the value of the stock to encourage the customer to sell a security.
- Registration with the SEC as an investment adviser would be required for a person who
- Limits the advice offered strictly to securities issued or guaranteed by the U.S. government
- Acts as the investment adviser to an investment company registered under the Investment Advisers Act of 1940
- Acts as the investment adviser to an investment company registered under the Investment Company Act of 1940
- Limits the advice offered strictly to securities listed on the New York Stock Exchange (NYSE)
Correct answer: Acts as the investment adviser to an investment company registered under the Investment Company Act of 1940
If a person acts under contract to an investment company registered under the Investment Company Act of 1940 (investment companies do not register under the Advisers Act; only advisers do) is required to register with the SEC. Excluded from the definition of investment adviser are those whose only advice deals with securities issued or guaranteed by the U.S. government. With the exception of managing a registered investment company, registration with the SEC is based on assets under management (AUM), not the type of security advised on. A person whose advice relates solely to securities on the NYSE is required to register with the SEC only if AUM reaches $110 million.
- NASAA's Statement of Policy on Unethical or Dishonest Business Practices of Broker-Dealers and Agents prohibits excessive activity in the account of a client for the purpose of generating commissions. This activity, frequently called churning, would likely be excused
- When the account has outperformed the S&P 500 Index
- If the investor is considered an accredited investor under SEC Rule 501
- When the agent has been granted discretionary authority
- Under no circumstances
Correct answer: Under no circumstances
Churning, the practice of excessive activity in a client's account for the purpose of generating commissions, is never an excusable practice.
- Which of the following would be considered when determining whether excessive trading has occurred in a client's account?
- The number of years the account has been opened
- The size of the companies issuing the securities
- The nature of the client's financial objectives
- The performance of the account in comparison to other client's accounts
Correct answer: The nature of the client's financial objectives
An agent is engaging in unethical conduct if she induces a client to trade securities too frequently in view of the financial resources, investment objectives, and character of the client's account. Frequent trading and trading in large amounts is not necessarily wrong. It is only wrong if the trades are not suitable for a particular client. Thus, the only factor listed that must be considered in determining whether trading is excessive is the nature of the client's financial objectives.
- The SEC has enumerated specific items that must be included in Investment Adviser written compliance manuals EXCEPT
- The advisory firm must review policies and procedures at least on an annual basis
- The advisory firm should indicate the educational requirements necessary for employment
- The advisory firm should implement procedures for allocating investment opportunities such as best executions among clients
- The advisory firm must monitor the consistency of portfolios with guidelines established by clients, disclosures, and regulatory requirements
Correct answer: The advisory firm should indicate the educational requirements necessary for employment
Guidelines under SEC rules require (at minimum) that the chief compliance officer of each federal covered investment adviser conduct an annual review of its compliance procedures. Among the duties of the compliance officer is to monitor the consistency of portfolios with guidelines established by clients, disclosures, and regulatory requirements. The firm should implement procedures for allocating investment opportunities such as best executions among clients. If the firm does have internal educational requirements, that would be found in its HR manual, not in its compliance manual.
- Under the Investment Advisers Act of 1940, which of the following is TRUE about the use of the term "investment counsel" by investment advisers?
- Advisers may use it only if advising is their principal business and a large part of it is continuous individual advice
- Advisers may use it only if they are practicing attorneys and a large part of their practice is securities defense work
- Advisers may use it only if they are registered with the Commission and manage no less than one hundred million dollars
- Advisers may use it only if they are registered in every state and have had no disciplinary complaints for twelve years
Correct answer: Advisers may use it only if advising is their principal business and a large part of it is continuous individual advice
Two conditions must both be met before an adviser may call itself investment counsel: rendering investment advice must be the adviser's principal business, and a substantial part of that business must consist of investment supervisory services, meaning continuous advice based on each client's individual needs. Being an attorney is irrelevant to the title, and neither SEC registration at a particular level of assets under management nor a clean disciplinary record in a state confers the right to use the term.
- The purpose of the Investment Advisers Act of 1940 is to provide
- Standards at the federal level for the regulation of investment advisers
- Minimum standards of performance for those registered as investment advisers
- Regulation for investment companies and their operations
- Standards among the various states for the regulation of investment advisers
Correct answer: Standards at the federal level for the regulation of investment advisers
The purpose of the Investment Advisers Act of 1940 is to provide federal standards for the regulation of investment advisers. Providing standards among the various states for the regulation of investment advisers is the purpose of the Uniform Securities Act. Providing regulation for investment companies and their operations is the purpose of the Investment Company Act of 1940.
- The responsibility for administering the Investment Advisers Act of 1940 lies with
- The Investment Advisers Association (IAA)
- The SEC
- FINRA.
- The Administrator
Correct answer: The SEC
The Investment Advisers Act of 1940 is federal law and that comes under the jurisdiction of the SEC.
- Which of the following investment advisers would be permitted to use the term "investment counsel"?
- A professional providing a market timing service with an annual subscription fee of $995, with this service attempting to maximize profits by suggesting entry and exit points for over 100 listed stocks
- A firm whose exclusive business is placing clients' assets into model portfolios
- An investment adviser who has been admitted to the bar in the state in which the firm's principal office is located
- A financial planner offering a wide range of services to his clients, including tax planning, estate planning, insurance planning, and investment advice
Correct answer: A firm whose exclusive business is placing clients' assets into model portfolios
In order for the term "investment counsel" to be used, two criteria must be met. First, the principal business of the adviser must be the rendering of investment advice. Second, the nature of the advice must meet the definition of investment supervisory service. That means giving continuous investment advice to clients based on their individual needs. That is frequently accomplished by selecting model portfolios most appropriate to the client's needs. The financial planner clearly is not principally in the business of offering investment advice because he describes his service as offering a wide range of services, of which advice is only a part. The exam frequently uses that wording to indicate that advice is not the principal activity. While the publisher's principal business activity may be offering advice, nothing about the description indicates that individual client accounts are being monitored.
- Registration as an investment adviser or investment adviser representative under the Uniform Securities Act is required of
- An economics professor at a local community college who gives lectures in the evenings to public groups about portfolio analysis for which he charges a nominal fee
- A tax attorney who, as an incidental part of his tax practice, recommends that his high-tax-bracket clients investigate the use of municipal bonds in their portfolios
- An agent of a broker-dealer who recommends model portfolios to clients in exchange for them executing their trades through him
- An officer of a trust company handling investments for trust accounts
Correct answer: An economics professor at a local community college who gives lectures in the evenings to public groups about portfolio analysis for which he charges a nominal fee
If you are putting yourself out to the public as providing investment advice and charging a fee for doing so, you must register. The exceptions to this are if your giving of investment advice is incidental to your primary reason of doing business and if you are not charging specifically for the giving of that advice. Trust companies and their employees are specifically excluded from the definition of "investment adviser." A tax attorney making recommendations incidental to his legal practice and not charging specifically for the making of those recommendations is also not an investment adviser. The professor would have also been exempt from registration except for the fact that compensation was received for securities-related advice. Agents who are compensated only on the basis of recommended trades are not receiving special compensation and are, therefore, not considered to be in the business of giving advice.
- Which of the following persons does NOT meet the definition of providing investment advice as a business outlined in SEC Release IA-1092?
- Accountant who charges clients an additional fee for providing investment advice
- A management consultant whose only investment advice is suggesting to a couple of small business clients who had invested their surpluses in speculative securities that they should find something less risky
- A financial planner who provides specific investment advice as part of his fee- based services and also makes specific securities recommendations to his clients in his capacity as an agent for a broker-dealer
- Attorney who advertises the availability of investment advice
Correct answer: A management consultant whose only investment advice is suggesting to a couple of small business clients who had invested their surpluses in speculative securities that they should find something less risky
The management consultant's advice to clients is more like personal opinion than investment advice as a business. In the other 3 choices, investment advice is offered as part of the individual's regular business. Lawyers, accountants, teachers, and engineers (LATE) are not generally considered investment advisers provided the advice is incidental to their regular profession.
- The term "investment counsel" can be used by investment advisers
- With a primary business of rendering investment advice
- Who are registered with the SEC under the Investment Advisers Act of 1940
- Who are also registered as broker-dealers
- Who are also attorneys
Correct answer: With a primary business of rendering investment advice
While this choice is only half correct, under the Investment Advisers Act of 1940, the term "investment counsel" may be used by any adviser that meets two standards: the adviser performs investment supervisory services, and the adviser provides advice as the primary business of the firm. No other special qualifications or registrations are needed.
- Which of the following would NOT be considered to be in the business of an investment adviser?
- A person who provides investment advice but is compensated only through commissions on the sale of stock
- An accountant who provides occasional investment advice but receives no separate fee for the service
- A person compensated for investment advice, although this service is not a primary part of the business
- A person compensated for investment advice, but who provides the advice only to institutions
Correct answer: An accountant who provides occasional investment advice but receives no separate fee for the service
In applying the business standard, the following criteria are used: (1) Does the person hold himself out as an investment adviser, or does he provide investment advice on a frequent or regular basis? (2) Does the person receive any compensation, regardless of whether it is paid separately or included in any other compensation? (3) If the person engages in other financial service activities in connection with the advice, it cannot be used to avoid the business standard. In looking at these criteria, it would appear that all choices listed are considered investment advisers. However, under exclusions from the definition, accountants who give advice solely incidental to the conduct of their profession and who receive no special compensation for this advice are excluded from the definition along with lawyers, engineers, teachers, and broker-dealers.
- When, if ever, would a broker-dealer be required to register as an investment adviser?
- If it receives commissions on the securities it recommends to buyers
- If it charges its customers a separate fee for investment management
- If it exercises trading discretion over any of its customer accounts
- If it publishes reports that recommend specific bonds to its clients
Correct answer: If it charges its customers a separate fee for investment management
Broker-dealers are excluded from the definition of investment adviser only while their advice is incidental to the brokerage business and they receive no special compensation for it. Charging a distinct fee for advice or for managing an account is special compensation and the exclusion is lost. Ordinary commissions on trades are not special compensation, and exercising discretion and publishing research are both part of the brokerage business, so neither one on its own requires the firm to register as an adviser.
- Under the Uniform Securities Act, which of the following statements is TRUE about an investment adviser who does not have an office in a state and solicits no more than 5 clients in that state?
- He must register unless all five of his clients are savings banks
- He is exempt from the antifraud rules that this state law imposes
- He must instead file a signed consent to service of process there
- He is not required to register as an adviser in that jurisdiction
Correct answer: He is not required to register as an adviser in that jurisdiction
An adviser with no place of business in a state and no more than five clients there during any twelve-month period is not an investment adviser in that state at all under the de minimis exemption, so no registration is required. The exemption does not depend on the clients being institutions. It also does not touch the antifraud provisions, which reach any person in connection with a securities transaction, and a consent to service of process accompanies an application this adviser does not have to file.
- Under which of the following circumstances may attorneys and accountants claim an exclusion from the definition of investment adviser under the Investment Advisers Act of 1940?
- They charge a separate fee for the provision of investment advice from that received for their professional services.
- The investment advisory activities have grown to represent 30% of their business.
- They advertise that they are available to provide investment advice.
- The advice is incidental to the practice of their profession.
Correct answer: The advice is incidental to the practice of their profession.
Under the Investment Advisers Act of 1940, lawyers, accountants, teachers, and engineers (LATE) giving investment advice that is incidental to their professions are not considered investment advisers. If they receive a fee for the advice, hold themselves out to the public as doing so, or offer excessive advice that is no longer incidental to their practice (as 30% of the practice would indicate), they lose this exclusion and must register as investment advisers.
- What is the official designation of the person or agency that enforces the USA in each state?
- Registrar
- Administrator
- Issuer
- Transfer agent
Correct answer: Administrator
The USA specifies that a state's securities Administrator has the authority to enforce the act in that state. A transfer agent is the person or corporation responsible for recording the names and holdings of registered security owners.
- Under the Investment Advisers Act of 1940, which of the following is considered an investment adviser?
- The trust officer of a commercial bank who manages investment accounts for clients
- A person who publishes a regular newsletter of advice on U.S. Treasury bonds and other U.S. government securities
- A lawyer who specializes in consulting on investing in securities
- A syndicated columnist who gives weekly reports and recommendations on investments
Correct answer: A lawyer who specializes in consulting on investing in securities
Publishers and writers of general, regular, paid circulation publications (newspapers and magazines) are excluded from the definition of investment adviser. Under the federal law, anyone giving advice dealing only with U.S. government securities is excluded from the definition, as are those who work for banks and trust companies. The lawyer is not excluded because the advice provided is not incidental to the profession; it is the lawyer's specialty.
- The Uniform Securities Act would NOT provide an exemption from registration as an investment adviser to an investment adviser who
- Has no place of business in the state and advises three insured commercial banks
- Has no place of business in the state and advises eleven ordinary retail clients
- Has no place of business in the state and advises two active broker-dealer firms
- Has no place of business in the state and advises four other registered advisers
Correct answer: Has no place of business in the state and advises eleven ordinary retail clients
An adviser with no place of business in the state is exempt when its clients in that state are limited to institutions such as banks and insurance companies, to broker-dealers, or to other investment advisers, whatever the number of them. There is also a de minimis exemption for retail clients, but it is capped at five during a twelve-month period. Eleven retail clients is well past that cap, so this adviser gets no exemption and must register.
- Under the Uniform Securities Act, which of the following is an investment adviser?
- A licensed estate lawyer who charges a separate fee for designing portfolios
- A bank trust department officer who advises the bank's own fiduciary clients
- A coin dealer who charges wealthy customers a fee for appraising collections
- A columnist who names specific securities each week for a general readership
Correct answer: A licensed estate lawyer who charges a separate fee for designing portfolios
An attorney is excluded only while the investment advice is incidental to the practice of law. Charging a separate fee to build portfolios is a business of its own, so this lawyer meets all three prongs of the definition and is an investment adviser. Banks and their trust departments are excluded outright. Advice about coins is not advice about securities. A columnist writing for a general readership gives impersonal advice of general circulation and falls within the publisher exclusion.
- Which of the following must register as an investment adviser under the Investment Advisers Act of 1940?
- A person who advises clients about investing in registered investment funds
- A person who advises insurance companies about investing in corporate bonds
- A person who advises customers about investing in undeveloped real property
- A person who advises collectors about investing in vintage coin collections
Correct answer: A person who advises clients about investing in registered investment funds
An investment adviser under the Investment Advisers Act of 1940 is a person who, for compensation, is in the business of advising others about securities. Shares of a mutual fund registered under the Investment Company Act of 1940 are securities, so this person must register. Real estate and rare coins are not securities, so advice about them falls outside the act, and an adviser whose only clients are insurance companies is expressly exempt from registration under the act.
- All of the following have legal standing as persons under the Uniform Securities Act EXCEPT
- Ll of the following have legal standing as persons under the Uniform Securities Act EXCEPT
- Unincorporated organizations
- Trusts where the interests of the beneficiaries are evidenced by a security
- Minor children
Correct answer: Minor children
The definition of a person under the act includes, among others, individuals, joint-stock companies, unincorporated organizations, and trusts where the interests of the beneficiaries are evidenced by a security. Minor children are not persons under the act.
- Which of the following does NOT meet the compensation test for defining investment advisers under SEC Release 1A-1092?
- An insurance agent sells a life insurance policy and receives a commission on that policy. During the sale of the insurance policy, the agent provides some securities investment advice
- A real estate agent advertises that she will give free advice regarding investing the proceeds from the sale of any home she lists
- Subscription payments received by a publisher of a newsletter providing impersonal securities-related advice
- Your next-door neighbor recommends the purchase of a certain security from his broker, which you eventually do
Correct answer: Your next-door neighbor recommends the purchase of a certain security from his broker, which you eventually do
Compensation may take the form of, but is not limited to, fees, payments for subscriptions, salaries, or commissions. Compensation does not have to be direct. The commission on the insurance policy is considered indirect compensation covering the investment advice given by the insurance agent. The same logic holds for the real estate agent—she doesn't give advice unless you list your home with her. Nothing in the neighbor's advice involves compensation.
- Which of the following would be excluded from the definition of investment adviser under the Uniform Securities Act?
- A finance teacher at a local community college who offers weekend seminars on comprehensive financial planning at a very reasonable price
- The publisher of a weekly newsmagazine, sold on newsstands, that contains at least 5 stock recommendations per issue
- A civil damages attorney who advertises that he is available to assist clients in suggesting appropriate investments for their successful claims
- A broker-dealer charging a separate fee for investment advice
Correct answer: The publisher of a weekly newsmagazine, sold on newsstands, that contains at least 5 stock recommendations per issue
Publishers of general circulation newspapers and magazines are excluded from the definition of investment adviser. A broker-dealer loses its exclusion the moment it offers advice for a separate charge, as does an attorney who holds himself out as offering investment advice. Normally, a teacher is excluded, but not when charging for advice, as would appear to be the case here. On this examination, the term "comprehensive financial planning" always includes securities advice.
- Under the SEC Release IA-1092, who of the following would be considered to be in the business of rendering investment advice?
- A financial planner who charges no fee for developing a financial plan, but takes commissions on recommended trade
- An individual who provides investment advice to family members, but receives no compensation
- An accountant who provides investment advice to clients as an incidental part of the business
- An agent who receives no separate compensation for investment advice but who takes commissions on recommended trades
Correct answer: A financial planner who charges no fee for developing a financial plan, but takes commissions on recommended trade
A financial planner who takes commissions from a broker-dealer on recommended trades is considered to be compensated for giving advice and is therefore in the business of rendering investment advice. Agents and broker-dealers who do not charge separately for advice are excluded from the definition of investment adviser. Lawyers, accountants, teachers, and engineers are not considered to be in the business of rendering investment advice, as long as any advice given is incidental to the practice of the profession.
- Which of the following is NOT considered to be in the business of investment advising?
- An insurance agent who compares whole life policies with bank savings products
- An insurance agent who advises on securities regularly as a secondary sideline
- A planner who recommends securities and also earns fees from selling insurance
- An analyst who publishes impersonal research about securities for a yearly fee
Correct answer: An insurance agent who compares whole life policies with bank savings products
This item asks about the business prong of the definition, not about the whole definition. An agent who compares a life policy with a bank product is discussing two things that are not securities and is paid only for selling insurance, so the agent is not in the business of advising about securities. Giving securities advice regularly puts a person in the business even when it is a small part of the work, recommending securities while being paid to sell insurance does not escape the standard, and preparing reports about securities for a fee is squarely within it.
- Which of the following statements is not true of investment advisers under the Uniform Securities Act?
- Only written advice concerning investments is covered by the act.
- A natural person may register as an investment adviser.
- Compensation is a key factor in determining whether a person is required to register as investment adviser.
- Investment advice includes advice regarding the value of securities, as well as recommendations to buy or sell.
Correct answer: Only written advice concerning investments is covered by the act.
One of the three prongs defining an investment adviser under both state and federal law is the giving of investment advice. That advice can be in written or oral form. Any person, as defined in the USA, may register as an investment adviser. Even though we tend to think of the investment adviser as the company you will be working for, a significant percentange of state-registered investment advisory firms are sole proprietorships (one-person shops). Investment advice includes advice as to the value of securities, as well as recommendations to buy or sell. Compensation is another one of the three prongs in determining whether a person is defined as an investment adviser.
- Under the Uniform Securities Act, which of the following is included in the definition of an investment adviser?
- A publisher paid a yearly subscription fee for its general market commentary
- A broker-dealer paid a stated fee for recommending a portfolio of securities
- A commercial bank offering portfolio advice to all of its wealthy depositors
- A dealer paid a fee for appraising valuable antique furniture and sculptures
Correct answer: A broker-dealer paid a stated fee for recommending a portfolio of securities
A broker-dealer that charges a flat fee for analyzing objectives and recommending a portfolio is receiving special compensation for securities advice, which takes it outside the broker-dealer exclusion and makes it an investment adviser. A publisher of general, non-specific commentary is excluded, banks are excluded from the definition outright, and appraising antique furniture and sculptures is not securities advice.
- Blue-sky laws pertain to all of the following EXCEPT
- The regulation of securities trading in other countries
- The registration of securities within a state
- The registration of securities salespeople in a state
- The regulation of securities transactions in a state
Correct answer: The regulation of securities trading in other countries
Blue-sky (Uniform Securities Act) laws refer to state securities regulation in the state. Blue-sky laws require new securities to be registered with the state and regulate trading of securities in a state.
- Which of the following statements describes a person who provides investment advice on a regular basis but does not charge fees, yet would be considered an adviser under Release IA-1092?
- A retired director who writes unpaid newspaper columns on equities that send many readers to his former firm
- A tenured professor who gives free public lectures on investing and names specific stocks from his own model
- A retired planner who advises pension plans and gets free vacations and office space from the managers hired
- A Treasury official who comments publicly on market conditions and on what they may mean for small investors
Correct answer: A retired planner who advises pension plans and gets free vacations and office space from the managers hired
Release IA-1092 treats any economic benefit as compensation, and the benefit need not come from the person who receives the advice. The retired planner is in the business of advising pension plans, actually gives that advice, and is paid for it in vacations, equipment and office space, so all three prongs are met. The retired director, the professor and the Treasury official each receive nothing of value for the advice and none of them is in the business of giving it.
- Under the Investment Advisers Act of 1940, who is not excluded from the definition of investment adviser when their investment advice is solely incidental to the individual's profession?
- Insurance agents
- School teachers
- Public accountants
- Practicing engineers
Correct answer: Insurance agents
The professionals excluded from the definition of investment adviser when their advice is solely incidental to their practice are lawyers, accountants, teachers and engineers. Insurance agents are not on that list, so an insurance agent who gives investment advice is not excluded on this ground and may fall within the definition.
- An investment adviser has its home office in Wisconsin. Its only business is with trust companies, large employee benefit plans, and insurance companies. It has no place of business in Colorado but provides investment advice to two Denver banks, both chartered under Colorado banking laws. There is a new Administrator in Colorado, and it is his opinion that this IA should be required to register in his state. A careful reading of Section 201 of the Uniform Securities Act would indicate that
- The firm need not register because it keeps no office there and that alone settles the question
- The firm need not register because it already has advisory business in more than a single state
- The firm need not register because it has no office there and its only clients are institutions
- The firm must register because the only banks it serves are licensed under that state's own law
Correct answer: The firm need not register because it has no office there and its only clients are institutions
Section 201 excludes from state registration an adviser with no place of business in the state whose clients there are limited to institutions such as banks, trust companies, insurance companies, other advisers and large employee benefit plans. Two Colorado-chartered banks are exactly that, so the Administrator is wrong. Having no office in the state is not enough on its own, because more than five retail clients there would force registration, and operating in several states is not a ground of exemption either.
- A person is excluded from the definition of investment adviser under the Investment Advisers Act of 1940 if the investment advice and reports are restricted to
- U.S. government securities
- Foreign securities
- Securities listed on a national stock exchange
- Bank and insurance company securities
Correct answer: U.S. government securities
Among the exclusions found in the act is one for persons whose advice relates exclusively to securities issued or guaranteed by the U.S. government.
- Which of the following investment advisers, with no place of business in the state, does not qualify for the de minimis exemption?
- An investment adviser who, during the preceding twelve-month period, has had 5 or fewer retail clients.
- An investment adviser who, during the preceding twelve-month period, has had fewer than 6 retail clients.
- An investment adviser who, during the preceding twelve-month period, has had no more than 6 retail clients.
- An investment adviser who, during the preceding twelve-month period, has had no more than 5 retail clients.
Correct answer: An investment adviser who, during the preceding twelve-month period, has had no more than 6 retail clients.
The de minimis exemption limits the number of retail clients to a maximum of 5 during the preceding 12 months. There are 3 ways to say that: 1. Fewer than 6. 2. Five or fewer. 3. No more than 5.
- An investment adviser with no place of business in the state is exempt from registration with the state when making recommendations to all of the following EXCEPT
- An accredited individual investor living in the state who buys exempt issues
- A commercial bank chartered in the state that manages its client investments
- An endowment fund that supports a private university chartered in that state
- A manufacturer seeking advice about the underwriters for its own stock issue
Correct answer: An accredited individual investor living in the state who buys exempt issues
The exemption for an adviser with no place of business in the state covers institutional clients such as banks, insurance companies, investment companies, large employee benefit plans and college endowments. It does not cover natural persons; being accredited does not change that, and neither does the exempt status of the securities recommended. Advising a company about which underwriters to use for its own offering is not securities advice to an advisory client and falls outside the definition altogether.
- Out-of-state investment advisers with no office in this state are not required to be registered if only advising
- On stocks listed on the NYSE
- Insurance companies
- On preferred stock
- On growth issues
Correct answer: Insurance companies
It is not the securities they advise on but their clients that count. Out-of-state investment advisers with no office in this state must be registered under the Uniform Securities Act unless their only clients are insurance companies, registered investment companies, banks or other institutional investors, broker-dealers, and other investment advisers.
- Under both state and federal law, there are a number of exclusions from the definition of investment adviser. Which of the following would not qualify for an exclusion?
- A CPA who gives high tax bracket clients a chart showing the tax-equivalent yield of municipal bonds
- A publisher of a newsletter that is paid to make reports to be used in the sale of specific securities
- A personal injury attorney who recommends that clients consult with a CFP® for advice on how to deal with the large settlements they receive
- An economist who teaches a course in fundamental analysis at a local community college
Correct answer: A publisher of a newsletter that is paid to make reports to be used in the sale of specific securities
Although there is an exclusion for publishers, it must be of general and regular circulation and not be the recipient of compensation from the issuers of any securities covered.
- Which of the following is required to register in a state under the Uniform Securities Act?
- ABC State Bank, which provides investment advice in its branches throughout the state
- An investment adviser who has no place of business in the state and communicates with only 5 advisory clients in the state for the year
- An investment adviser who has a place of business in the state and whose only clients in the state are insurance companies, banks, and broker-dealers
- A broker-dealer who has no place of business in the state and whose only clients in the state are limited to insurance companies, banks, and broker-dealers
Correct answer: An investment adviser who has a place of business in the state and whose only clients in the state are insurance companies, banks, and broker-dealers
Because the investment adviser has a place of business within the state and is acting as investment adviser in the state, it must register, regardless of the fact that the only clients are financial institutions. Notice that the state registration rules are different for broker-dealers and investment advisers. Banks are exempt from registration as broker-dealers or as investment advisers, as are investment advisers with no place of business in the state and fewer than 6 clients in the state in a 12-month period (de minimis standard).
- Under the Uniform Securities Act, which of the following persons has to register as an investment adviser?
- A broker-dealer who gives investment advice that is incidental to the course of its business and for which no special compensation is received
- An attorney who writes a legal opinion for a municipal bond indenture
- An agent of a broker-dealer who gives investment advice within the course of his duties with the firm for which a fee is charged
- A broker-dealer who gives advice for which he charges a specific fee
Correct answer: A broker-dealer who gives advice for which he charges a specific fee
Broker-dealers need not register as investment advisers unless they charge a separate fee for providing investment advice. If the advice is strictly incidental and without a separate charge, the BD is not an investment advisor. Attorneys are not investment advisers provided their investment advice is incidental to their practice. Giving a legal opinion on a municipal security indenture is not investment advice. Agents giving advice for which a fee is charged must register as investment adviser representatives and their BDs as investment advisers.
- Which of the following parties is most likely to be considered an investment adviser under the Investment Advisers Act of 1940?
- The trust department of Citibank, which handles billions of dollars in trust assets
- Dow Jones, Inc., publisher of The Wall Street Journal
- A CPA who manages investment accounts for 50 clients and charges hourly fees for the service
- An expert in fixed-income securities whose only clients are individuals and whose only recommendations deal with securities issued or guaranteed by the U.S. Treasury
Correct answer: A CPA who manages investment accounts for 50 clients and charges hourly fees for the service
The Investment Advisers Act of 1940 excludes accountants providing investment advice from the definition of investment adviser only when the advice is given on an incidental basis and with no specific compensation. A publisher of periodicals of general circulation, whether or not the publication covers financial matters, is excluded from the definition, as is an adviser whose advice is exclusively limited to U.S. government securities. Banks are also excluded from the definition of investment adviser under the act.
- A broker-dealer is NOT considered an investment adviser if
- Advisory services are limited to fifteen accounts and are billed every quarter
- Advisory services are supplied only to institutions and are billed every month
- Advisory services are described in the firm's brochure and are reviewed yearly
- Advisory services are incidental to brokerage and no separate fees are charged
Correct answer: Advisory services are incidental to brokerage and no separate fees are charged
A broker-dealer keeps the exclusion from the definition of investment adviser only while its advice is incidental to the brokerage business and it receives no special compensation for that advice. Once a separate charge appears the exclusion is gone, so billing quarterly or monthly for advice makes the firm an adviser no matter how few accounts it has or who the clients are. Describing the service in a brochure and reviewing it annually says nothing about how the advice is paid for.
- Under the Uniform Securities Act, a state-registered investment adviser whose only office was in State N would NOT have to register in State O if its only clients were
- Complex trusts
- 6 or fewer retail clients
- Individual accredited investors
- Trust companies
Correct answer: Trust companies
A state-registered investment adviser can make use of the de minimis exemption if it has no place of business in a state and its only clients are institutions, such as bank and trust companies, investment companies, and insurance companies. Don't confuse a trust with a trust company—trusts are not institutions unless it specifically states a pension or profit-sharing trust, and even then, it only qualifies if it has assets of not less than $1 million. No individual, regardless of wealth, is an institution and the de minimis limit is fewer than 6 (sometimes shown as 5 or fewer).
- A person who renders investment advice solely with respect to securities issued by the U.S. government
- Is excluded from the definition of investment adviser under federal law and is, therefore, exempt from state registration requirements
- Is exempt from state registration under the Uniform Securities Act but must be federal registered under the Investment Advisers Act of 1940
- Must be registered both with the SEC and the state
- Need not be federal registered under the Investment Advisers Act of 1940 but must register in any state in which it has an office
Correct answer: Is excluded from the definition of investment adviser under federal law and is, therefore, exempt from state registration requirements
A person who renders advice solely with respect to securities issued or guaranteed by the U.S. government is excluded from the definition of investment adviser under the Advisers Act and is therefore a federal covered adviser under the NSMIA of 1996.
- Alpha-Beta Advisers (ABA) has its principal office in State X. ABA limits its clientele to insurance companies that are authorized to do business in State X. Which of the following best describes the registration requirements for ABA?
- SEC only
- Both the SEC and State X
- State X only
- Neither the SEC nor State X
Correct answer: State X only
Dealing exclusively with insurance companies makes this advisory firm exempt from registering with the SEC. However, unlike those who are excluded from the definition of investment adviser, being exempt does not make ABA a federal covered adviser. Although advisers dealing solely with institutions, such as insurance companies, are not deemed to be investment advisers in the state, that only applies when there is no place of business in the state. Obviously, with its home office in State X, that does not apply to ABA, so it would have to register in that state.
- Under the Uniform Securities Act, all of the following may provide investment advice incidental to their normal business without requiring registration as an investment adviser EXCEPT
- A teacher
- A lawyer
- An economist
- An engineer
Correct answer: An economist
The Uniform Securities Act, (and the Investment Advisers Act of 1940 as well), does not exclude economists from the definition of investment adviser as it does lawyers, accountants, teachers, and engineers who give advice that is incidental to the practice of their profession. Remember the acronym LATE—lawyers, accountants, teachers, and engineers. Do not be fooled by the E in economist.
- Under the Investment Advisers Act of 1940, which of the following are excluded from the definition of an investment adviser?
- Insurance companies
- Accountants who advise on securities (only) for a fee
- Banks and trust companies
- Attorneys who advise on securities (only) for a fee
Correct answer: Banks and trust companies
The act excludes the following from the definition: banks or trust companies; publishers of bona fide publications of general circulation (newspapers and magazines); persons advising about certain securities (U.S. government or agency issues); broker-dealers not receiving special compensation for giving advice; and persons whose advice is incidental to their profession, such as lawyers, accountants, engineers, and teachers
- Under all of the following circumstances, the USA requires investment advisers with no place of business in the state to register EXCEPT
- When an adviser only provides advice to registered investment companies
- When an adviser with numerous clients in the state has not been subject to disciplinary action within any state within the last 10 years
- When an adviser has maintained assets of $100 million or more for 7 out of the last 10 years
- When an adviser only provides investment advice to 401(k) plans with assets of $250,000 or more
Correct answer: When an adviser only provides advice to registered investment companies
An adviser that only provides investment advice to investment companies registered under the Investment Company Act of 1940 is federal covered and does not have to register in a state, regardless of whether or not it has a place of business there. An adviser that provides advice only to 401(k) plans or other tax qualified employee benefit plans with $1 million in assets (not $250,000) is not required to register in a state in which it does not have a place of business. The assets of the adviser is not what determines becoming a federal covered adviser; it is assets under management and the determining factor is the AUM now, not the range over the previous 10 years.
- Which of the following persons must register as an investment adviser under the Uniform Securities Act?
- An accountant who makes no pretense of providing investment advisory services but gives incidental advice to clients as a small part of accounting services provided
- An investment adviser who only serves institutional clients and whose only office is in this state
- An investment adviser whose advice is limited to securities issued or guaranteed by the U.S. government and who has 3 places of business in the state
- An investment adviser representative with no place of business in the state who has dealt with 7 retail clients during the most recent 12 month period
Correct answer: An investment adviser who only serves institutional clients and whose only office is in this state
The Uniform Securities Act requires those defined as investment advisers to register with the state. Accountants are excluded when their advice is incidental to their profession and no additional compensation is charged. Advisers whose only advice is on securities issued or guaranteed by the government are excluded from the definition of investment adviser under the Investment Advisers Act of 1940. This means they are federal covered investment advisers, not required to register with the Administrator even with offices in the state. As long as there is an office in the state, unless the adviser is federal covered (as described in the previous sentence), there is no exemption from registration in that state. The IAR has exceeded the de minimis limits and would have to register in the state, but as an IAR, not as an IA.
- An investment adviser need not register in a state if it has
- No place of business in the state and only advises 3 insurance companies located in the state
- A place of business in the state and only advises employee benefit plans with more than $1 million
- A place of business in the state and advises fewer than 5 banks
- No place of business in the state, does not direct business communications in the state, and advises more than 5 high-net-worth individuals located in the state
Correct answer: No place of business in the state and only advises 3 insurance companies located in the state
An investment adviser need not register in a state if it has no place of business in the state and advises such institutional clients as insurance companies or banks. The number of clients is irrelevant as long as they all are of an institutional nature. Without exception, the USA requires an investment adviser to register in a state if it has a place of business in the state. With no place of business in the state, registration would not have been required regardless of the number of banks who were clients. With 5 or fewer noninstitutional clients, regardless of their net worth, no registration would be necessary under the de minimis provisions of the USA.
- Under the Uniform Securities Act, all of the following persons with no place of business in the state are exempt from registration as an investment advisers EXCEPT
- Advisers whose only clients are three savings banks chartered in the state
- Advisers whose only clients are six individuals who live within that state
- Advisers whose only clients are two federal covered advisers in that state
- Advisers whose only clients are four mutual funds registered under the act
Correct answer: Advisers whose only clients are six individuals who live within that state
An adviser with no place of business in a state keeps the de minimis exemption only while it has fewer than six clients there in twelve months, so six individual clients exceeds the limit and registration is required. The other three are institutional or professional clients of the kind the act exempts without regard to how many of them there are, so an adviser dealing only with savings banks, federal covered advisers or registered mutual funds stays exempt.
- Under the Uniform Securities Act, all of the following persons may provide investment advice incidental to their normal business without requiring registration as an investment adviser EXCEPT
- An economist
- An engineer
- A teacher
- A lawyer
Correct answer: An economist
The Uniform Securities Act does not grant an economist exemption from registration, but it does offer an exemption to teachers, lawyers, and engineers if the investment advice is incidental to their business; thus the acronym LATE for lawyers, accountants, teachers, and engineers.
- The sole proprietor of an insurance business that exclusively provides advice on fixed-income annuity contracts
- Must register as a broker-dealer with the SEC
- Must register as an investment adviser representative under the USA
- Must register as an investment adviser under the Investment Advisers Act of 1940
- Need not register under any securities laws
Correct answer: Need not register under any securities laws
The sole proprietor of an insurance business need not register under the Uniform Securities Act or Investment Advisers Act. He provides advice on fixed-income annuities only, which are insurance products, not securities. Regulations under the USA, as well as federal securities laws, only apply to securities.
- Searching Out New Growth (SONG) is a venture capital fund. As such, all of the following statements are true EXCEPT
- SONG’s investment adviser is exempt from registration
- SONG must have less than $150 million in assets in the fund
- SONG is not registered under the Investment Company Act of 1940
- SONG only issues securities which are, except in extraordinary circumstances, non-redeemable
Correct answer: SONG must have less than $150 million in assets in the fund
Although venture capital funds are included in the general definition of private funds, unlike the private equity fund, there is no ceiling on the size of the fund before the adviser loses the exemption. Advisers to VC funds are exempt from registration. The funds themselves do not register with the SEC under the Investment Company Act of 1940 (and don't register with the states as well). These investments do not offer ready liquidity.
- A discussion referring to blue-sky laws would include all of the following EXCEPT
- A state securities law that grants state securities Administrators the power to deny or revoke a broker-dealer's or an agent's registration within its state
- State laws that are designed to protect the public against fraud in securities sales within a state
- The Securities Act of 1933 and Securities Exchange Act of 1934
- Forms requiring issuers selling securities in the state to comply with state securities laws
Correct answer: State laws that are designed to protect the public against fraud in securities sales within a state
Blue-sky laws are state securities laws. The Securities Act of 1933 and the Securities Exchange Act of 1934 are federal securities laws.
- As defined in the Investment Advisers Act of 1940, all of the following would be considered investment advisers EXCEPT
- A professional plumber with excellent stock market skills who as a hobby and without pay, manages portfolios for 8 of his neighbors
- A tax attorney who manages investment portfolios for 50 clients
- A civil engineer making investment decisions for $5 million held in escrow while a bridge for which she is the project manager is being constructed
- A portfolio manager who limits advice to municipal securities exclusively
Correct answer: A professional plumber with excellent stock market skills who as a hobby and without pay, manages portfolios for 8 of his neighbors
To be an investment adviser under the Investment Advisers Act of 1940, a person must (1) give advice about securities, (2) be in the business of doing so, and (3) receive compensation. The plumber manages portfolios as an unpaid hobby, so he fails the compensation prong and is not an investment adviser. The tax attorney managing 50 clients' portfolios, the engineer managing $5 million, and the portfolio manager limiting advice to municipal securities all give securities advice for compensation as a business.
- Which of the following is specifically excluded from the definition of investment adviser under the Investment Advisers Act of 1940, when that person's investment advice is solely incidental to the practice of their profession?
- Athlete's financial manager
- Aeronautical engineer
- Pension consultant
- Financial planner
Correct answer: Aeronautical engineer
A professional whose investment advice is solely incidental to the practice of a profession not otherwise listed is excluded—but the specifically named professionals are Lawyers, Accountants, Teachers, and Engineers (the LATE exclusion). An aeronautical engineer falls under the 'engineers' exclusion. An athlete's or entertainer's financial manager, a pension consultant, and a financial planner are all considered investment advisers.
- Both state and federal law contain a number of exclusions from the definition of investment adviser. Which of the following choices is unlikely to qualify for an exclusion?
- A retired mechanical engineer who charges clients a fee for portfolio advice
- A practicing lawyer who gives his clients free opinions on securities values
- A magazine columnist who writes about banking policy and the economic future
- A commercial bank that buys securities for the custodial accounts it manages
Correct answer: A retired mechanical engineer who charges clients a fee for portfolio advice
Engineers are excluded only when the advice is incidental to the practice of the profession. An engineer who charges a fee for advice about securities is doing something else entirely and falls within the definition of investment adviser. The lawyer takes no compensation, so one prong of the definition is missing. The columnist writes on general economic subjects and is covered by the publisher exclusion, and banks are excluded from the definition outright.
- ABC Advisers, a federal covered investment adviser, is moving the firm's headquarters to a new office park in the suburbs. ABC is required to file this change with the SEC
- Within 90 days
- Promptly
- Within 60 days
- Within 30 days
Correct answer: Promptly
Any material change that affects an investment adviser's ADV must be filed promptly with the SEC (or Administrator if state-registered) and a change of address would certainly be material.
- Registration with the state as an investment adviser would be required for a person with an office in this state who
- Only gives advice on securities issued by or guaranteed by the government of the United States
- Manages the portfolio of the KPF Balanced Fund, a registered open-end investment company with $22 million in net assets
- Manages $13 million in assets for 4 clients
- Serves as a pension consultant to the XYZ Employees Retirement Plan, covering 1,200 employees with total assets of $278 million
Correct answer: Manages $13 million in assets for 4 clients
A person with an office in the state managing $13 million for 4 clients is a state-covered (mid-sized) adviser—below the $100 million threshold for SEC (federal) registration—so state registration is required. An adviser giving advice solely on U.S. government securities and one managing a registered investment company are federal-covered (the fund manager registers with the SEC), and the pension consultant to a plan with $278 million in assets qualifies for SEC registration under the pension-consultant threshold.
- A pension consultant who advises corporate retirement plans with assets of $135 million must register with which of the following?
- SEC
- Both the state and the SEC
- The state
- Either the state or the SEC
Correct answer: The state
Under the Dodd-Frank Bill, until a pension fund manager has at least $200 million in AUM, registration with the states is required. Once the $200 million level is reached, SEC registration becomes an option.
- Platinum Investment in Growth Group, Inc. (PIGGI) is registered in and has its principal office in State W. PIGGI has near-term plans to open offices in State A and B. In an effort to test the waters, PIGGI mails several hundred flyers to prospects in those 2 states. Under the Uniform Securities Act,
- These flyers could be mailed, but no accounts can be opened until PIGGI is registered in States A and B
- As long as PIGGI did not maintain an office in either of these states, the flyers could be mailed
- These flyers could not be mailed until PIGGI was registered in States A and B
- As a federal covered investment adviser, the flyers would need filing with the SEC
Correct answer: These flyers could not be mailed until PIGGI was registered in States A and B
Any attempt to hold oneself out as offering investment advice as part of a business would require the person to be registered in the state, unless that person qualifies for an exclusion or exemption. Nothing in this question implies that an exclusion or an exemption applies. We know that PIGGI is not a federal covered investment adviser (and therefore does not need to file its flyers with the SEC) because we are told it is registered in State W—federal covered advisers don't register in any state.
- An investment adviser to a private fund wishes to qualify for the exemption offered under the Uniform Securities Act when the fund has no more than 100 investors. In order to qualify,
- Each investor must own at least $5 million in securities when the fund shares are first acquired
- Each investor must have at least 1.1millionmanagedbytheiradviseror2.2 million net worth
- The adviser must have no felony or fraud convictions among those affiliates in the past 12 years
- The adviser must have less than $110 million of private fund assets in its own direct management
Correct answer: Each investor must have at least 1.1millionmanagedbytheiradviseror2.2 million net worth
A fund with no more than 100 investors is a 3(c)(1) issuer, and the state exemption for its adviser requires every investor to be a qualified client, meaning at least 1.1millionmanagedbythatadviseroranetworthabove2.2 million excluding the primary residence. The 5millioninvestmentstestbelongstoa3(c)(7)fundunderfederallawandcarriesnoinvestorcap.Thedisqualifyingfelonywindowis10yearsratherthan12,andtheprivatefundadviserassetceilingis150 million rather than $110 million.
- Under the Investment Advisers Act of 1940, an adviser is required to be registered with the SEC if
- The adviser's advice relates solely to securities issued or guaranteed by the U.S. government.
- The adviser's clientele is exclusively federal credit unions and the adviser has less than $100 million in assets under management
- The adviser is the publisher of a news magazine of general and regular circulation
- The adviser's clients are investment companies registered under the Investment Company Act of 1940
Correct answer: The adviser's clients are investment companies registered under the Investment Company Act of 1940
Advisers to registered investment companies are required to be SEC-registered. Under the Advisers Act, as modified by the Dodd-Frank Act, advisers are exempt from SEC registration if they manage less than $100 million in assets and have no investment company clients. Persons are excluded from the Advisers Act definition of investment adviser if they are publishers of news or business/financial publications of general and regular circulation or if their advice relates solely to U.S. government securities.
- The chief compliance officer (CCO) of a registered investment adviser would generally not have responsibility for the actions of
- Ministerial personnel of the firm
- An agent registered with an affiliated broker-dealer
- Supervisory personnel of the firm
- An investment adviser representative of the firm
Correct answer: An agent registered with an affiliated broker-dealer
The CCO of an investment adviser is responsible for compliance with all relevant rules and procedures applying to all personnel of the investment adviser. Agents with an affiliated broker-dealer come under the supervisory jurisdiction of the compliance officer of that BD.
- Under current regulations, registration with the SEC is optional for all of the following investment advisers EXCEPT
- Grand Visions Advisers LLP, a proprietorship with $104 million in advisory assets
- Midwestern Asset Managers, with $53 million required to register across 17 states
- CEF Advisers, a partnership that manages a $90 million registered closed-end fund
- Benefit Specialists, a pension consultant that has $225 million in pension assets
Correct answer: CEF Advisers, a partnership that manages a $90 million registered closed-end fund
Registration with the SEC is mandatory rather than optional for an adviser to a registered investment company, whether the fund is open-end or closed-end, so a 90millionclosed−endfundstillmakesregistrationcompulsory.Registrationisoptionalforanadviserwithatleast100 million but less than 110millionundermanagement,foramid−sizedadviserthatwouldotherwisehavetoregisterinfifteenormorestates,andforapensionconsultantonceitsplanassetsreach200 million.
- Under the Investment Advisers Act of 1940, for how many years must an investment adviser maintain the records required by regulation?
- No requirement
- 5 years
- 3 years
- 1 year
Correct answer: 5 years
The Investment Advisers Act requires records to be kept readily accessible for a period of 5 years from the end of the fiscal year in which the record was made. The records must be kept in the principal office of the firm for the first 2 years and are subject to SEC examination at any time.
- Jefferson, Adams, and Washington (JAW) is a pension consulting firm whose only office is on Constitution Avenue in Washington, D.C. JAW has only one advisory client—a U.S. government employees pension fund with assets of $4 billion. What are this firm's registration requirements?
- It must register with the SEC because the AUM is so high.
- It does not have to register because its only client is the U.S. government.
- It may choose to register with either the D.C. Administrator or the SEC.
- It can only register with the SEC because the District of Columbia is not a state.
Correct answer: It may choose to register with either the D.C. Administrator or the SEC.
Under the provisions of the Dodd-Frank Act of 2010, pension consultants providing advisory services to employee benefit plans having at least $200 million of assets may register with the SEC (even though the consultant does not itself have those assets under management). JAW's only client has $4 billion in assets, well in excess of the minimum of $200 million required to allow the firm to choose between state or SEC registration. Under the USA, the District of Columbia (along with Puerto Rico and any U.S. territory or possession) is included in the definition of state. If an investment adviser only gives advice on securities issued or guaranteed by the U.S. government, it is excluded from the definition of investment adviser and doesn't register anywhere, but that is not the same as having the government as your only client.
- A federal covered IA files a petition for bankruptcy. The firm must
- Do nothing until the court decides the disposition of the firm's assets
- Notify the Administrator immediately
- Notify the SEC immediately
- Notify all of its clients immediately
Correct answer: Notify the SEC immediately
As a federal covered investment adviser, the responsible regulatory body is the SEC.
- Which of the following would meet the USA's definition of federal covered adviser? An investment adviser who
- Is registered with the SEC under the Investment Advisers Act of 1940
- Is required to register in fifteen or more states because of clients
- Is doing business on an interstate basis with clients in many states
- Is advising ERISA plans that own five hundred million in plan assets
Correct answer: Is registered with the SEC under the Investment Advisers Act of 1940
A federal covered adviser is one registered with the SEC under section 203 of the Investment Advisers Act of 1940, and every adviser so registered is federal covered. An adviser that would have to register in fifteen or more states may choose SEC registration but is not covered until it does so. Doing business across state lines says nothing about where the adviser itself registers, and a pension consultant becomes eligible for SEC registration at $200 million of plan assets without being required to take it.
- Which of the following firms would be a federal covered adviser?
- XYZ Broker-Dealer with custody over $50 million of clients' invested assets
- DEF Fund Managers, a corporation managing an unregistered hedge fund with $20 million in assets
- ABC Money Managers, a partnership with $112 million under management
- GHI Consultants, a sole proprietorship managing $15 million belonging to high-net-worth individuals
Correct answer: ABC Money Managers, a partnership with $112 million under management
The structure of the adviser is irrelevant; if assets under management equal $110 million or more, SEC registration is required. If the investment company is registered under the Investment Company Act of 1940, the adviser must be registered, regardless of size. The hedge fund is an unregistered fund, so the rule does not apply. A broker-dealer is excluded from the definition of investment adviser if investment advice is incidental to its business. Custody has nothing to do with giving advice.
- Under the Uniform Securities Act, if no denial or proceedings are pending, when does an investment adviser registration become effective?
- No sooner than 15 days
- When the Administrator so orders, but not to exceed 30 days
- When the Administrator so orders, but not to exceed 90 days
- 60 days after application or an amendment is filed
Correct answer: When the Administrator so orders, but not to exceed 30 days
Registrations become effective at noon on the 30th calendar day after the date of filing if there are no denial orders or pending proceedings.
- Serenity Strategic Investments (SSI) is an investment adviser registered in four states. SSI's most previous annual updating amendment showed AUM of $108 million. Six months later, a favorable market resulted in SSI's AUM growing to $120 million. Unfortunately, several large clients left, so at the end of SSI's year, its AUM was down to $94 million. Which of the following statements is CORRECT?
- SSI remains state-registered because its AUM is less than $100 million.
- SSI must become registered with SEC within 90 days of exceeding $110 million.
- SSI has the choice of remaining state-registered or registering with the SEC.
- SSI may remain SEC registered as long as AUM is at $90 million or more.
Correct answer: SSI remains state-registered because its AUM is less than $100 million.
The key to answering this question is remembering that, for purposes of SEC registration, it is the AUM (technically known as the RAUM – Regulatory AUM) shown on the annual updating amendment to the Form ADV that is the determining factor. We are told that SSI is state registered, something permitted when reported AUM is $108 million, although it was eligible to register with the SEC. The mid-year increase has no effect on registration, only that at the end of the year. Because SSI will report $94 million on the next annual update, it will remain state registered and does not have the option to register with the SEC because its AUM is below $100 million. The only time the $20 million buffer down to $90 million enables an investment adviser to remain registered with the SEC is just that—the IA is already registered with the SEC and can stay there.
- Which of the following investment advisers would be required to register with the state?
- An IA who expects to have $132 million in AUM within 120 days
- An IA whose annual updating amendment showed a drop in AUM from $109 million to $87 million
- An IA who is under contract to manage a registered investment company
- An IA whose annual updating amendment showed a drop in AUM from $141 million to $99 million
Correct answer: An IA whose annual updating amendment showed a drop in AUM from $109 million to $87 million
No IA can remain registered with the SEC with assets under management (AUM) of less than $90 million (except those who manage registered investment companies). It takes $100 million in AUM to be able to initially register with the SEC; thereafter, the IA must maintain at least $90 million to remain SEC-registered.
- Emmet opened an investment advisory service 3 years ago and raised $50 million in capital from family, friends, and contacts and then closed to new investors. If Emmet's stock picks expanded assets under management to $110 million, Emmet
- Must register for the first time with the state Administrator
- Is not required to take any action
- Must update his registration with the state Administrator
- Must register with the SEC
Correct answer: Must register with the SEC
When the annual updating amendment filed by a state-registered investment advisory firm indicates that the $110 million threshold has been reached, the firm has 90 days to register with the SEC.
- Under certain conditions, the Uniform Securities Act provides that an Administrator may require a minimum net worth standard be met by an investment adviser. Which of the following would be an allowable asset in the computation of an investment adviser's net worth?
- Advances or loans to partners in the case of an IA organized as a partnership
- Copyrights
- Accounts payable
- Accounts receivable
Correct answer: Accounts receivable
For purposes of the USA, the term "net worth" means an excess of assets over liabilities, as determined by generally accepted accounting principles. Accounts receivable are a current asset, while accounts payable are a current liability. The USA specifically disallows intangibles, such as copyrights and goodwill, and advances or loans to partners (or officers if a corporation) are excluded as well.
- A state-registered investment adviser maintains custody of client funds and securities. On Thursday, the chief financial officer of the firm informs the chief compliance officer that their net worth is $31,578. Under the provisions of the Uniform Securities Act, the firm would
- Do nothing, as their net worth is far in excess of the minimum requirement of $10,000
- Send a detailed financial report to the Administrator by the close of business Monday
- Need to increase the amount of their surety bond
- Send a detailed financial report to the Administrator by the close of business Friday
Correct answer: Send a detailed financial report to the Administrator by the close of business Monday
A state-registered investment adviser who maintains custody of client assets must maintain net worth of at least $35,000 or a bond of the same amount (not both). If the net worth should fall below the minimum, by the close of the next business day after discovery (Friday in our example), notice of the deficiency must be sent to the Administrator of the state in which the principal office of the adviser is located. Then, by the close of business the day after that (Monday in our example), a detailed financial report, including the number of clients served by the adviser, must be sent to the Administrator. The firm would need to increase their net worth, not the bond.
- In which of the following cases would the Uniform Securities Act require registration of an investment adviser who had no place of business in the state?
- He had more than 5 noninstitutional clients who were residents of the state.
- Under no circumstances is registered required if there is no place of business in the state.
- He had more than 5 institutional clients domiciled in the state.
- His website was seen by residents of the state.
Correct answer: He had more than 5 noninstitutional clients who were residents of the state.
The de minimis exemption applies when there is no place of business in the state and the adviser has no more than 5 noninstitutional (retail) clients in the state during any 12-month period.
- Under the Uniform Securities Act, the recordkeeping requirements established by the Administrator for out-of-state investment advisers wishing to register in his state are subject to the limitations of
- The rules imposed by the Administrator of any state where it registers
- The rules imposed by the Administrator of the adviser's own home state
- The rules imposed by the federal Investment Advisers Act of 1940 alone
- The rules imposed by the Securities Exchange Act of 1934 on custodians
Correct answer: The rules imposed by the Administrator of the adviser's own home state
For a state-registered investment adviser, an Administrator may not impose recordkeeping requirements beyond those of the Administrator in the adviser's home state, which is what keeps an adviser registered in several states from facing a different set of books in each one. Applying every state's rules is the outcome the limitation exists to prevent. The Investment Advisers Act of 1940 sets the records for SEC-registered advisers, who do not register with any state, while the Securities Exchange Act of 1934 sets the records kept by broker-dealers and other market participants, not for state-registered advisers.
- The agreement that the Administrator can receive subpoenas on behalf of a registered agent, broker-dealer, or investment adviser involved in any securities sale that violates the Uniform Securities Act is
- The consent to service of process
- The right of rescission
- The agreement to actionable offenses
- The right of retribution
Correct answer: The consent to service of process
Every applicant for registration and every issuer must file an irrevocable consent to service of process appointing the Administrator as attorney to receive service of any lawful process in any civil suit, action, or proceeding. It has the same legal effect as if the person had been served personally.
- The USA places a number of recordkeeping requirements on investment advisers. Records required to be kept by all state-registered investment advisers include all of the following EXCEPT
- A list of every account over which this adviser is granted discretion
- A journal of the cash receipts and disbursements made by this adviser
- A copy of every written advertisement mailed to ten or more customers
- A record by security of each client's interest and its exact location
Correct answer: A record by security of each client's interest and its exact location
A security record showing each client's interest in a given security and the location of that security is required only of an adviser that has custody of client assets, so it is not a record every state-registered adviser must keep. A list of discretionary accounts, a journal of cash receipts and disbursements, and copies of advertisements sent to ten or more people are all required of every state-registered investment adviser.
- Under the Uniform Securities Act, which of the following investment advisers with no place of business in the state must register with the state as an investment adviser?
- An adviser rendering advice to employee benefit plans with at least $1 million in assets
- An adviser managing more than $110 million in assets
- An adviser rendering advice to no more than 10 individual clients within a 12-month period
- An adviser rendering advice solely to broker-dealers
Correct answer: An adviser rendering advice to no more than 10 individual clients within a 12-month period
An investment adviser with no office in the state would be exempt from registration in the state if the adviser renders advice to no more than 5 noninstitutional clients (not 10) in a 12-month period. If an investment adviser has no office in the state, and renders advice solely to broker-dealers, insurance companies, banks, investment companies, governmental agencies, or employee benefit plans with assets of $1 million or more, the adviser is exempt from registration with the state. If the adviser manages assets of $110 million or more, the adviser would be required to register with the SEC, not the state.
- To register a sole proprietorship as an investment adviser in a state, the application for initial registration (Form ADV) must be filed with the appropriate party. This application must include all of the following except
- Any information to be furnished or disseminated to any client or prospective client
- The appropriate fees
- A consent to service of process
- A copy of the articles of incorporation for the business
Correct answer: A copy of the articles of incorporation for the business
Articles of incorporation only apply to corporations. Sole proprietorships are not incorporated. To register as an investment adviser in a state, Form ADV is filed with the Administrator or with a central registration depository designated by the Administrator. The application must include, among other things, a consent to service of process, appropriate fees, and the brochure or any other information that will be used to solicit clients.
- Among the clients of a broker-dealer could be
- A foundation
- A deceased individual
- A minor
- An individual declared mentally incompetent
Correct answer: A foundation
Clients could include any person, as defined in the Uniform Securities Act. Minors, deceased individuals, and mentally incompetent individuals are not persons.
- A broker-dealer would not be able to open an account for
- A city
- The estate of a deceased person
- A deceased person
- A trust
Correct answer: A deceased person
Broker-dealers can only open accounts for those who are persons, as defined in the Uniform Securities Act. There are three nonpersons: minors, deceased persons, and those declared mentally incompetent. Remember, the term "person" is very broad and includes political subdivisions such as cities and states. Even though the deceased individual is not a person, that individual's estate is.
- One major difference between the customer identification program (CIP) and the new account opening rules of the regulatory bodies is that
- The CIP only applies to individuals while the rules of the regulators apply to retail and institutional accounts
- The CIP requires date of birth while the regulators only require proof of legal age
- The CIP requires a residence address for individuals while the regulatory bodies will accept a PO Box
- The CIP requires a statement of the customer’s goals while the regulators only require current financial information
Correct answer: The CIP requires date of birth while the regulators only require proof of legal age
The CIP requires the actual date of birth, not just proof of legal age. The CIP has no interest in the goals of the investor, just the identity. In both cases, a PO Box may only be used after supplying a physical residence address and both the CIP and the rules of the regulators apply to retail and institutional accounts.
- Two sisters might wish to open an account as tenants in common (TIC) rather than JTWROS in order to
- Send each sister's share to her own heirs rather than the survivor
- Give each of them a whole undivided interest in the account assets
- Keep one of them from taking assets out without the other's assent
- Let the account pass outside probate at the death of either sister
Correct answer: Send each sister's share to her own heirs rather than the survivor
A tenancy in common has no right of survivorship: when one cotenant dies, her fractional share passes to her estate and then to her heirs, which is exactly why two sisters would choose it over JTWROS. An undivided interest in the account is a feature of both TIC and JTWROS, so it is no reason to prefer one. Neither form restricts a cotenant's right to withdraw assets, although certificates and checks must be issued in all names. It is JTWROS, not TIC, that passes property outside probate to the surviving owner.
- All of the following actions must be completed prior to customers entering their first option trade EXCEPT
- Receipt of a completed options agreement
- Delivery of the options disclosure document (ODD)
- Completion of the new account form
- Approval by a designated options supervisor
Correct answer: Receipt of a completed options agreement
Customers do not have to complete (sign) the options agreement prior to entering an order; under current rules, the agreement must be signed and returned by the customer within 15 days of account approval.
- Which of the following documents would aid an investment adviser in its responsibility to fully understand the needs of a client when making investment recommendations?
- An investment policy statement.
- A proxy voting policy.
- A communications agreement.
- A restricted list.
Correct answer: An investment policy statement.
The IPS is the key document that defines an investor's risk and return objectives and any constraints for their investment.
- All of the following activities could result in the revocation of an agent's registration EXCEPT
- Borrowing money or securities from a retail customer of the firm
- Trading in a client's account so as to generate more commissions
- Recommending a stock on the strength of the inside corporate tip
- Omitting from a client presentation a fact of no material weight
Correct answer: Omitting from a client presentation a fact of no material weight
The Uniform Securities Act requires disclosure of MATERIAL facts. Leaving out a known fact that is not material to the client's decision is therefore not a prohibited practice, so it could not support revocation. Borrowing money or securities from a retail customer, churning an account to generate commissions, and recommending a security on the basis of material nonpublic corporate information are all prohibited business practices for which an agent's registration can be revoked.
- Fraud would include the willful omission of
- The public offering price in a preliminary prospectus
- Any material fact
- A material fact, but only one that might be pertinent to making an investment decision
- Any fact
Correct answer: Any material fact
In order for the action to be fraud, it must be willful. But not all willful acts are fraudulent, depending on what is and is not a material fact. Material facts are those that a potential investor uses to make an investment decision. Nonmaterial facts may be omitted because they don't affect the selection process. If they are not pertinent, they are not material. The preliminary prospectus (red herring) does not include the public offering price, so there is nothing being omitted.
- Wealth Creation Advisers (WCA) is a federal covered investment adviser specializing in consulting to pension plans. WCA's principal office is located in State L. The governor of State L is running for re-election. If WCA were to make a $350 contribution to the campaign, under the SEC's pay-to-play rule,
- WCA could not be paid for advisory work done for any State L agency for two years
- WCA must end all advisory work for any State L agency for the next two full years
- WCA may rely on the de minimis exemption since its own chief office is in State L
- WCA would be fined by the SEC and made to hand the $350 contribution back at once
Correct answer: WCA could not be paid for advisory work done for any State L agency for two years
Under the SEC's pay-to-play rule, a contribution by the adviser or a covered associate to an official who can influence the award of advisory business triggers a two-year ban on RECEIVING COMPENSATION for advisory services to that government entity. The advisory relationship itself may continue; the firm simply cannot be paid for it, so the option barring WCA from rendering services at all overstates the rule. The de minimis figure of $350 applies only to an individual who may vote for the candidate, never to the firm itself. The rule imposes the compensation time out, not an automatic suspension of the firm's SEC registration.
- Written policies and procedures reasonably designed to safeguard customer information from cyber security threats would include all of the following EXCEPT
- Maintaining minimum required cyber insurance
- Encrypting personal client identifiable data
- Requiring annual firm cybersecurity training
- Conducting periodic outside risk assessments
Correct answer: Maintaining minimum required cyber insurance
No regulator sets a minimum amount of cyber insurance a broker-dealer or investment adviser must carry, so carrying a required minimum cannot be a component of written cybersecurity policies. Encrypting personally identifiable client information, training staff on cybersecurity each year, and assessing the risk posed by vendors and other third parties are all standard elements of the written policies and procedures firms must adopt to safeguard customer information.
- 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
- There is no limit to the amount that can be contributed to an UTMA
- Withdrawals for other than qualified education expenses are not subject to any penalties
- Contributions to the UTMA are made with after-tax dollars
- There are no earnings limits for making UTMA contributions
Correct answer: 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 nonqualified educational 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.
- The child of one of your clients is headed off for a year of graduate study at the University of Oxford in England. The Section 529 plan used to fund the child's undergraduate study still has about $20,000 in the account. Because Oxford is on the U.S. Department of Education's list of approved institutions, qualified expenses would include which of the following?
- The full cost of an off-campus luxury apartment
- Dues to sports clubs or societies
- The full cost of tuition and required fees
- Textbooks used to supplement the required reading assignments
Correct answer: The full cost of tuition and required fees
The list of qualified expenses is rather small and includes mandatory tuition and fees, as well as room and board on campus. If off-campus, the qualified portion is limited to basically the amount that would be charge for on-campus accommodations. Although required textbooks are qualified, any texts purchased to supplement one's study are not.
- A tax-advantaged medical savings account available to employees enrolled in a high-deductible health plan is
- An HSA
- An FSA
- Medicare, Part C.
- A Section 162 plan
Correct answer: An HSA
One of the requirements for enrolling in an HSA is that the individual be covered under a health plan with a high deductible. No such requirement applies to a flexible spending account (FSA). Medicare Part C, sometimes known as Medicare Advantage, is government health coverage and does not generally apply to those who are covered by health insurance at a place of employment (and Medicare is not tested on the exam). A Section 162 plan is an executive bonus plan, generally involving life insurance and has never been covered on the exam.
- Which of the following statements regarding Section 529 plans is CORRECT?
- Qualified expenses could include tuition for attendance at a foreign university.
- Qualified expenses would include all residence costs incurred by a full-time student.
- Residents of some states receive a deduction on their federal income tax returns.
- Funds not used for qualified expenses by age 30 must be distributed or rolled over.
Correct answer: Qualified expenses could include tuition for attendance at a foreign university.
As of the date of this question, there are approximately 330 institutions of higher learning located outside of the United States where Section 529 plans may be used to pay qualified expenses. The expense for room and board (residence cost) qualifies only to the extent that it isn't more than the greater of the following 2 amounts: The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution It is the Coverdell ESA that has the age 30 requirement and some states offer deduction on the state income tax return, not the federal one.
- Under UTMA, the custodian must be
- Appointed by the court
- A trustee
- An adult
- A member of the minor’s family
Correct answer: An adult
The only requirement to be the custodian of an UTMA (or UGMA) account is being of legal age (an adult).
- The unethical business practice of purchasing and selling a security for the purpose of creating an appearance of market activity is known as
- Front running
- Matched orders
- Breakpoint sales
- Excessive trading
Correct answer: Matched orders
Matched orders, sometimes called painting the tape, occur when a purchase and a sale of the same security are coordinated in substantially the same size, at substantially the same time and price, so that the tape shows activity and price movement the market did not generate. Front running is trading ahead of a known block order for one's own benefit. Breakpoint sales are recommendations that keep a fund purchase just below a level at which the sales charge would drop. Excessive trading is churning an account for commissions. All three are prohibited practices, but none of them is defined by the creation of apparent market activity.
- An employer offers its employees the opportunity to use tax-deductible funds to pay for health costs, as long as they enroll in a high-deductible health plan. This would be a description of
Correct answer: An HSA
A health savings account (HSA) requires that the employee enroll in a health insurance plan with a high deductible. The flexible spending account (FSA) makes no stipulation regarding the deductible.
- Which of the following is the beneficial owner of securities in an UTMA account?
- The minor
- The custodian
- The donor
- The guardian
Correct answer: The minor
The minor is always the beneficial owner under an UTMA account. The custodian merely exercises her best judgment in handling investment decisions on the minor's behalf.
- Which of the following does not provide for a change of beneficiary?
- Section 529 plan
- Coverdell ESAs
- Roth IRA
- UTMA accounts
Correct answer: UTMA accounts
The nature of an UTMA (or UGMA) account is that the donor or custodian cannot change the beneficiary of the account. All transfers (or gifts) to minors are irrevocable, making a change legally impossible. In the case of the education plans (ESA or 529), if the beneficiary does not use the money, a family member may be named as the beneficiary for the remaining balance. The beneficiary of an IRA, Roth or traditional, can always be changed by the owner. And, please don't read into the question – "But what about if the ex-spouse is named beneficiary in the divorce decree?" If that is what the question wants, it will be mentioned.
- A customer buys 200 shares of a common stock at $30 per share. On a day when the stock's price is down $5, the customer calls her agent and inquires as to its current price, and the agent tells her the price is around where she bought it. In the next few weeks, the stock's price turns around and the customer liquidates the shares at $35 per share realizing a $5 per share profit excluding commission. In the above situation, the agent has acted
- Properly, because the interim price fluctuation did not impact the customer's results
- Properly, because he prevented the customer from losing a profit opportunity
- Fraudulently, because accurate quotes must be provided to the customer at all times
- Fraudulently, because the customer could easily discern that the price quoted by the agent did not match readily available quotes in the financial media
Correct answer: Fraudulently, because accurate quotes must be provided to the customer at all times
The agent must provide customers with accurate market quotes at all times. Deliberately giving an incorrect price quote is a fraudulent activity.
- Under the antifraud provisions of the Uniform Securities Act, agents are prohibited from all of these EXCEPT
- Failing to state nonmaterial facts
- Engaging in any fraudulent or deceitful practice in the normal course of business
- Engaging in any practice that the Administrator defines by rule as unethical
- Employing any device, scheme, or artifice to defraud
Correct answer: Failing to state nonmaterial facts
Nonmaterial facts are those that do not impact an investor's decision-making process. Omitting them would not be a fraudulent activity, as would be the case if the facts were material.
- An order is received from one of your clients to purchase 200 shares of GEMCO common stock at 45 GTC. Two days later, while at a luncheon meeting with a different client, you are informed by that individual that the inside scoop is that GEMCO is going to be the subject of an FBI investigation. An hour after you return from lunch, you see an execution report for the 200 shares at 44.90. Under the Insider Trading and Securities Fraud Enforcement Act of 1988, you
- Are not in violation because the order was placed before you learned of the inside information
- Are in violation because you should have called the client immediately and had the ordered canceled
- Are not in violation because the trade was the result of an unsolicited order
- Are in violation because you should have canceled the order the moment you received the tip
Correct answer: Are not in violation because the order was placed before you learned of the inside information
Violations of the insider trading rules can only happen when a person acts on the information. Because the order was placed on the books prior to the agent's learning of the inside information, there is no violation. There is no obligation to cancel the order, and contacting the client would be making use of the inside information.
- The NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives and Federal Covered Advisers generally prohibits an IA from disclosing any confidential account information without specific consent of the client. However, disclosure would be permitted to
- The client’s spouse when this is a joint account
- The client’s accountant who is representing him before the IRS
- The client’s attorney representing him in a lawsuit
- The client’s friends on his Facebook account
Correct answer: The client’s spouse when this is a joint account
In the case of a joint account, all owners are entitled to any information relating to the account. The trick here is that the IRS can compel disclosure in a tax case, but the client's CPA can't.
- James Jones, quarterback for a National Football League franchise team, deliberately misstated material information in the private sale of securities he owned. Jones claims he is not subject to the antifraud provisions of the Uniform Securities Act because he is not a registered agent and, secondly, the securities involved are exempt from registration requirements of the act. Which of the following statements is TRUE?
- The antifraud provisions of the USA apply to any person who acts fraudulently in connection with the offer, sale, or purchase of a security.
- Jones's failure to accurately state material facts does not constitute fraud because the securities he sold were exempt from registration.
- As a professional athlete, Jones is not in the securities business and is therefore not subject to the antifraud provisions of the act.
- The antifraud provisions of the USA do not apply to Jones because he is not suitably trained nor does he have a securities license.
Correct answer: The antifraud provisions of the USA apply to any person who acts fraudulently in connection with the offer, sale, or purchase of a security.
The antifraud provisions of the USA apply to any person who acts fraudulently in connection with the offer, sale, or purchase of a security, even in the case of an isolated nonissuer transaction like this. While Jones, as a private individual, is not subject to the registration provisions of the act, he is liable for fraud when selling securities, whether registered or not. The fact that Jones is not trained in the securities business does not exempt him from the prohibition against fraud when engaged in the sale of securities.
- An agent has a client who is relatively new to investing in securities, having been a bank CD purchaser most of her life. One of the client's holdings is a stock that the agent recommended, and its market price has recently fallen by over 10%. Knowing her fear of loss, the agent comforts her by continuing to report that the stock is moving upwards with the market. This action is
- Fraudulent unless the agent receives permission from a designated supervisor
- Permitted because the client is not selling anytime soon and why cause her to be upset
- Fraudulent because the agent has a fiduciary responsibility to the client to manage the account in her best interests
- Fraudulent because it is equivalent to giving fictitious quotations
Correct answer: Fraudulent because it is equivalent to giving fictitious quotations
Fictitious quotations, not giving accurate prices, is a fraudulent practice, even when done to make the client feel better.
- The head of research for your firm has just prepared a very positive report on DEF Industries, Inc. The report will be placed on the firm's website later today, and copies will be mailed to clients for whom the security is deemed appropriate. Tonight, this analyst will be appearing on CNBC and will be describing why he has issued this strong buy recommendation. As an investment adviser representative, you would
- Be required to wait until the analyst's television interview is aired
- Be required to direct clients to the firm's website before commenting
- Be barred from calling clients until that report is general knowledge
- Be permitted to contact the clients with the recommendation right now
Correct answer: Be permitted to contact the clients with the recommendation right now
A research report prepared by the firm's own analysts is the firm's work product, not material nonpublic information about the issuer, so it is not inside information. An investment adviser representative may pass the recommendation along to suitable clients as soon as she has access to the report; she need not wait for the website posting, for the television interview, or for the report to become general public knowledge, and there is no requirement to route clients to the website before discussing the security.
- Under Rule 206(4)-7, it is unlawful for an investment adviser registered with the Commission to provide investment advice unless the adviser has adopted and implemented written policies and procedures reasonably designed to prevent violation of the Advisers Act by the adviser or any of its supervised persons. Under this rule, investment advisers are required to perform a review of the adequacy of the policies and procedures established pursuant to this section and the effectiveness of their implementation no less frequently than
- Quarterly
- Semiannually
- Annually
- Biannually
Correct answer: Annually
The rule requires that a review be performed no less frequently than annually.
- Which of the following is NOT a fraudulent business practice when committed by a registered broker-dealer?
- Conducting transactions that do not result in the transfer of ownership between buyers and sellers
- Engaging in trades between other broker-dealers to increase or decrease the price of securities
- Trading securities between house accounts and customer accounts to create trading volume or the appearance of interest in a security
- Acting as agent for both buyer and seller on a transaction
Correct answer: Acting as agent for both buyer and seller on a transaction
A broker-dealer may act as agent for both buyer and seller in a transaction. In other words, the BD can have one client sell and another client buy and act as the go-between. All the other activities represent market manipulation and are therefore fraudulent practices.
- Under the Uniform Securities Act, which of the following statements regarding the use of material facts is TRUE?
- Omitting material facts when selling securities is a fraudulent practice.
- The agent must not use material facts, unless they are the only ones available.
- The client is the final arbiter on what is material and what is not.
- Restrictions apply only to sales as to the use of material facts, not to the purchases of securities.
Correct answer: Omitting material facts when selling securities is a fraudulent practice.
Material facts are essential to making informed investment decisions; to omit them is fraudulent or deceitful. The agent must ensure that all relevant material facts are presented.
- An agent's customer says that ABC Corporation is about to be bought out. The customer wishes to place an order to buy ABC common stock based upon this yet unreleased information, which he claims he learned from an officer in the company. How should the agent respond in this situation?
- Accept the order as entered and mark that ticket as unsolicited
- Pass the tip on at once to the state's securities Administrator
- Ask senior agents in the branch whether the tip sounds credible
- Take it to the supervisory principal named in the firm's manual
Correct answer: Take it to the supervisory principal named in the firm's manual
Information about a pending buyout obtained from a corporate officer and not yet released is inside information. The agent must not act on it and must escalate it internally: the firm's written supervisory procedures name the principal responsible for handling such matters, and that is who the agent notifies. Accepting the order is prohibited no matter how the ticket is marked. Repeating the information to other agents spreads it further and is expressly improper. There is no requirement that the agent report the tip to the state Administrator.
- Which of the following is NOT true regarding the Securities Exchange Act of 1934?
- The act prohibits the simultaneous purchase and sale of a security to create the appearance of trading.
- The act prohibits the spread of false rumors to induce others to trade.
- The act bars the use of arbitrage by broker-dealers.
- The act proscribes the use of wash trades.
Correct answer: The act bars the use of arbitrage by broker-dealers.
Arbitrage is a legal activity, usually performed by traders at broker-dealers, which takes advantage of momentary discrepancies in the price of a security in different markets. The act prohibits any form of manipulation of securities prices or any practices that would influence the market price of a security. This includes wash trades, which are simultaneous purchases and sales that create the appearance of trading activity, and the use of rumors to induce others to trade.
- Walt and Bryan are old friends who are agents with different broker-dealers. Bryan attends one of Walt's investment seminars and, at a prearranged point in the presentation, stands up and exclaims that his rich brother-in-law wisely purchased the same investment. This action is
- Only problematic if someone invests in the product and loses money
- A dubious sales practice but not strictly prohibited
- A legitimate sales tactic known as priming the pump
- A deliberate attempt to mislead and deceive investors
Correct answer: A deliberate attempt to mislead and deceive investors
This tactic is a deliberate attempt to mislead investors and get them to invest; it would likely be considered fraudulent.
- A major stockholder of XYZ Corporation makes frequent purchases and sales of this stock on the open market to give the impression that it is actively traded. This unethical practice is best described as
- Pegging
- Front running
- Wash trades
- Positioning
Correct answer: Wash trades
A wash trade occurs when there is no real change in beneficial ownership. Purchases and sales are offset, but the volume of trading creates the illusion of substantial interest in the stock.
- An investment adviser may release confidential information about a client in all of the following instances EXCEPT
- When the client also maintains an account at an affiliated broker-dealer
- With the consent of the client’s spouse who is a signatory to the advisory contract
- When the law requires such release
- With the client's consent
Correct answer: When the client also maintains an account at an affiliated broker-dealer
The adviser may disclose client information with the client's consent, the consent of a joint account holder, or if the disclosure is required by law. Having an account at an affiliated broker-dealer is irrelevant. It is unethical conduct for an investment adviser to disclose the identity, business affairs, or investments of a client to any third party. The adviser has a fiduciary responsibility to respect the confidential nature of the relationship.
- Bryan, an agent registered with a broker-dealer, buys 1,000 shares of XYZ Corp. in his own account. In recommending XYZ Corp. to his customers, Bryan informs them that he believes in the company so much that he put his own money in the stock. This practice is
- An illegitimate sales tactic
- Not an unethical sales practice
- Only unethical if Bryan sells his shares after informing his clients of his intention to do so
- Only unethical if investors lose money in the investment
Correct answer: Not an unethical sales practice
This practice is ethical, providing it is accurate and not employed in a coercive manner. It would be expected that when Bryan decides to sell his position, he would not do so prior to notifying his clients with a position in that stock. Otherwise, this would be an ethical problem.
- A customer and his spouse own shares in the ABC Fund as joint tenants with rights of survivorship. If the customer dies, what happens to the shares in the account?
- The spouse would own all the shares.
- The account would be frozen until the estate was settled.
- Ownership of the shares must be determined by probate court.
- Half the shares would belong to the spouse, and the remaining half would be distributed to the customer's estate.
Correct answer: The spouse would own all the shares.
In a JTWROS account, securities pass to the surviving owner. The account does not have to be frozen but can continue to enter orders.
- The customer identification program (CIP) requires that certain information relating to new customers be obtained. Included in that requirement for individual clients who are citizens of the United States are all of the following EXCEPT
- The recorded birth date of the customer
- The current employment status of the customer
- The Social Security number of the customer
- The physical residence address of the customer
Correct answer: The current employment status of the customer
The customer identification program requires four items for an individual who is a U.S. citizen: name, date of birth, a physical residence address, and a taxpayer identification number, which for a citizen is the Social Security number. Employment status is routinely collected when a new account is opened because it bears on suitability, but it is not one of the CIP items the rule requires.
- All of the following statements relating to an account registered as tenants in common are true EXCEPT
- Cotenants can own unequal percentages of the assets in the account
- Married couples choose this form far less often than joint tenancy
- A deceased cotenant's share of the account passes to the survivors
- Each cotenant owns an undivided interest in all the account assets
Correct answer: A deceased cotenant's share of the account passes to the survivors
Tenancy in common carries no right of survivorship, so a deceased cotenant's share passes to that person's estate rather than to the other cotenants; that is the statement that is not true. The remaining statements are accurate: cotenants may hold unequal fractional percentages, married couples far more commonly use joint tenancy with right of survivorship, and each cotenant owns an undivided interest in the whole portfolio rather than in specific securities.
- All the following information must be obtained from new individual customers EXCEPT
- Social Security number
- Date of birth
- Physical address
- Educational background
Correct answer: Educational background
A customer's educational background is not required to open a new account. In the case of an account opened in the name of a business, the business address and tax identification number are required.
- Which of the following individuals may NOT open a joint account?
- Business colleagues
- Two spouses
- Parent and a minor
- Three sisters
Correct answer: Parent and a minor
Any 2 or more persons can have a joint account, but a minor is specifically excluded from the definition of a person.
- Although all new accounts must be approved by a designated supervisor before any trading activity may take place, there is one type of account that must be approved by a specially qualified supervisor. That would be
- A margin account
- An options account
- An IRA
- A discretionary account
Correct answer: An options account
Because trading options (puts and calls) generally involves a higher degree of risk than stocks, bonds, or mutual funds, a designated supervisory person with knowledge about options must approve the account opening.
- If a new joint tenants with rights of survivorship account is opened by two related individuals, all of the following statements are true EXCEPT
- In the event of death, the decedent's interest in the account goes to the other party
- Mail may be sent to either party (with the permission of each party)
- Orders may be given by either party
- Checks may be drawn in the name of either party
Correct answer: Checks may be drawn in the name of either party
While either party may enter an order, any money or securities delivered out of the account must be in the names of both owners.
- One of the portions of the USA PATRIOT Act of 2001that affects the opening of an account for a new customer is
- The requirement to obtain suitability information
- The “know-your-customer rule”
- The customer identification program
- The Transportation Security Administration (TSA)
Correct answer: The customer identification program
The customer identification program (CIP) is mandated by the PATRIOT Act and requires that broker-dealers (and other financial institutions) obtain certain specified information about new customers. The "know-your-customer" rule was written many decades before the PATRIOT Act. The PATRIOT Act, through the CIP, is concerned with validating identity, not suitability.
- If a businessowner's goal is to establish an entity that features ease in raising capital, which of these entities is the most appropriate?
- A general business partnership
- A limited liability company
- A subchapter S corporation
- A sole proprietorship business
Correct answer: A limited liability company
The limited liability company is the most appropriate of these forms when the owner's goal is ease in raising capital, because it places no limit on the number of members and no restriction on their nationality. A subchapter S corporation may have no more than 100 shareholders and none may be a nonresident alien. A general partnership must admit new partners, each of whom takes on unlimited liability, and a sole proprietorship has a single owner and can raise outside equity only by changing form.
- A feature of which of the following business entities is limited liability but no flow-through of earnings or losses?
- Sole proprietorship
- LLC
- Corporation
- Limited partnership
Correct answer: Corporation
The corporation (always assume C corporation unless it says different on the test) offers limited liability to its shareholders, but there is no flow-through of income or loss. LLCs and limited partnerships offer both and the sole proprietorship has unlimited liability.
- Under the provisions of the Internal Revenue Code, which of the following business forms is not required to file a separate tax return?
- LLC
- S corporation
- Limited partnership
- Sole proprietorship
Correct answer: Sole proprietorship
In the case of a sole proprietorship, any tax consequences (income or loss) are reported on the owner's personal Form 1040, Schedule C. The other entities file either a Form 1065 (limited partnership and LLC) or a Form 1120S (S corporation). Although a one member LLC is treated like a sole proprietorship, unless that was stated as a choice, the LLC has multiple members.
- Which of the following business accounts does not require considering the suitability of the owners?
- S corporation
- General partnership
- C corporation
- Sole proprietorship
Correct answer: C corporation
Because the C corporation is an entity separate from its shareholders, suitability for a C corporation account is based solely on the company itself. All of the others provide flow-through of income and loss to the individual owners so it is important to view the collective suitability of the individual owners (or single owner in the case of the sole proprietorship).
- There are many different legal ways to structure a new business entity. One of these is the general partnership. Among the benefits of using this structure would be
- Substantial capital can be raised with little effort and low cost
- Ease of formation
- The 50% dividends received exclusion
- Limited liability
Correct answer: Ease of formation
Compared with a corporation, it is generally easier to form (and dissolve) a partnership. General partners have full liability and there is no 50% dividends received exclusion for partnerships; that only applies to corporations. C corporations are the entity for raising a lot of capital.
- An S corporation is characterized by
- Limited lifetime
- More than 100 shareholders
- Unlimited personal liability
- Flow-through tax treatment
Correct answer: Flow-through tax treatment
Shareholders of an S corporation have limited liability, are limited to no more than 100 shareholders, and receive flow-through tax treatment.
- A form of business structure that exposes all personal assets of the owner to creditors is
- The C corporation
- The sole proprietorship
- The LLC
- The limited partnerships
Correct answer: The sole proprietorship
One of the reasons why few large businesses are organized as sole proprietorships is the fact that all personal assets, not just those of the business, are placed at risk if the business fails. In each of the other choices, the maximum potential loss is the amount of the investment.
- Under the Uniform Securities Act, a person whose business model is selling reports on a subscription basis concerning specific securities to investors based on their individual objectives will be defined as
- A broker-dealer agent
- An excluded publisher
- A securities analyst
- An investment adviser
Correct answer: An investment adviser
A person who, for compensation and as a regular business, publishes securities reports for individual investors on a paid subscription basis falls squarely within the definition of an investment adviser. The publisher exclusion is lost here because the reports are tailored to each subscriber's individual objectives rather than being of general and regular circulation. An agent represents a broker-dealer in effecting securities transactions, and neither that role nor the job title of securities analyst is a definition found in the Uniform Securities Act.
- Which of the following factors determine(s) whether a person is considered an investment adviser under the Investment Advisers Act of 1940? I. The specificity of the advice II. The business engaged in III. Whether compensation is received
- I, II, and III
- I and II, not III
- I and III, not II
- II and III, not I
Correct answer: I, II, and III
The definition of investment adviser under the Investment Advisers Act of 1940 rests on a three-part test, and all three factors listed are part of it: whether the person gives advice about securities that is specific enough to count as advice, whether the person is in the business of doing so, and whether compensation is received for it. A person who fails any one of the three prongs is not an investment adviser under the act, so no combination of only two of them describes the test.
- Which of the following is NOT a person as defined by the Uniform Securities Act?
- A small unincorporated investment club.
- XYZ Dry Cleaners, Inc., whose shareholders all work on the premises and also offer financial advice to customers who request it.
- A child prodigy for whom his mother, as custodian, opened an account at a major securities firm.
- Guelph, a small city outside of Toronto, Ontario, that maintains an investment account at a brokerage house to invest surplus funds.
Correct answer: A child prodigy for whom his mother, as custodian, opened an account at a major securities firm.
Under the Uniform Securities Act, the term "person" has a specific meaning. "Person" refers to an individual, corporation, association, joint-stock company, trust, unincorporated organization, government, or political subdivision of a government. A minor child, is not a person legally capable of entering into contracts. Adults must open custodial accounts on behalf of minor children.
- Under the Uniform Securities Act, an accountant who charges hourly fees for securities recommendations in the regular course of his accounting practice is
- Included in the definition, since accountants are not on that act's list of exclusions
- Included in the definition, since he is paid for securities advice in regular practice
- Excluded from the definition, since this advice is billed hourly in a regular practice
- Excluded from the definition, since the advice he gives is incidental to that practice
Correct answer: Included in the definition, since he is paid for securities advice in regular practice
The Uniform Securities Act reaches any person who, for compensation, is in the business of advising others about securities. This accountant charges separately for securities recommendations as a regular part of his practice, so he is compensated for the advice and is captured by the definition. The professional exclusion is available only where the advice is solely incidental to the profession and carries no separate charge, which is not the case here, so the incidental rationale fails on these facts. How the fee is computed, hourly or by commission, is irrelevant to the test. Accountants are among the professions the act names, so the reasoning that they are absent from the act's list is wrong even though its conclusion happens to be right.
- A federal covered registered investment adviser who receives compensation for advice and whose business is primarily as an investment adviser may describe its business as investment counsel if
- It maintains custody of customer funds and/or securities
- It receives SEC approval to use the definition
- A substantial part of his business is providing investment supervisory services
- It maintains its registration by filing an updating amendment to its Form ADV annually
Correct answer: A substantial part of his business is providing investment supervisory services
The Investment Advisers Act of 1940 prohibits the use of the term "investment counsel," unless the principal business of the person is as an investment adviser and a substantial part of the business is providing investment supervisory services (i.e., continuous advice for individual client portfolios).
- As defined in the Uniform Securities Act, an investment adviser
- Is any person who, for compensation, engages in the business of advising issuers on methods of raising capital
- Is any person who, for compensation, engages in the business of executing transactions in securities for others
- Must be organized as a corporation or a partnership
- Is any person who, for compensation, engages in the business of advising others as to the value of securities
Correct answer: Is any person who, for compensation, engages in the business of advising others as to the value of securities
Under Section 401 of the USA, an investment adviser is any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities.
- Registration as an investment adviser is required for any firm in the business of giving advice on the purchase of
- Apartments undergoing a conversion to condominiums
- Rare convertible automobiles
- Gold coins
- Convertible bonds
Correct answer: Convertible bonds
Only those individuals in the business of giving advice on securities are required to register as investment advisers; only the convertible bonds are securities.
- Which of the following statements best describes an investment supervisory service as described by the Investment Advisers Act of 1940?
- An investment advisory firm offers nondiscretionary services on a non-client-specific basis.
- An investment adviser sends monthly newsletters to 200 clients offering nonspecific advice.
- An investment adviser provides continuous advice based on the client's individual needs.
- No actions are taken in client accounts without first being approved by a senior supervisory person.
Correct answer: An investment adviser provides continuous advice based on the client's individual needs.
An investment supervisory service is an individualized service delivered to a specific client on a continual basis. General nonspecific advice given across the board is deemed impersonal advisory services. Only when an investment adviser provides investment supervisory service, and the adviser's principal business activity is the giving of advice, may the term "investment counsel" be used.
- Under the Securities Act of 1933, the term "person" would NOT refer to which of the following?
- An unincorporated amateur athletic club
- A nonprofit, charitable corporation
- A deceased individual
- A subdivision of a government
Correct answer: A deceased individual
There are 3 specific "nonpersons" on this exam. They are 1) deceased individuals, 2) an individual declared mentally incompetent, and 3) a minor. A person can be almost any entity, including a corporation, partnership, unincorporated association, subdivision of a government, trust that issues shares of ownership (such as a unit investment trust), or a natural person (an individual).
- An investment adviser whose primary business is the rendering of investment advice providing investment supervisory services is entitled to use the term
- Investment counsel
- Financial planner
- Pension consultant
- Senior adviser
Correct answer: Investment counsel
The term investment counsel may only be used by those advisers whose primary function is the rendering of investment advice with individual continuous monitoring of the accounts.
- Under SEC Release IA-1092, a financial planner would not be considered an investment adviser when
- He is a licensed insurance agent and credits the commission earned on the sale of insurance policies included in a comprehensive financial plan against the fee charged for the plan
- He does financial planning as part of offering a wrap fee program as a licensed agent of a broker-dealer
- There is an up-front fee charged for creating a comprehensive financial plan, even when the plan is not put into place
- The extent of his planning is limited to wills, estates and trust creation
Correct answer: The extent of his planning is limited to wills, estates and trust creation
Wills, estates, and trusts are not securities, so any advice given on them does not make one an investment adviser. Look for the term "comprehensive financial plan" because that always includes securities advice and, as long as a fee is charged, even when the advice is not followed, registration as an IA (or perhaps IAR) is required. Wrap fee programs may only be offered by IAs or IARs.
- Harrison is a Certified Financial Planner (CFP®) with an office in the state and a telephone directory listing under the category "Financial Planners." Harrison has, for fees, written more than 100 comprehensive financial plans for various individual clients. However, only 20% of the plans' content entails advice regarding securities and investments. Which of the following statements best describes Harrison's status as an investment adviser under the USA?
- He must register, since he is paid for securities advice and holds out as a planner
- He must register, since he has written and sold more than one hundred plans for pay
- He need not register, since securities are but one small part of what he is selling
- He need not register, since he holds a credential that exempts him from all of that
Correct answer: He must register, since he is paid for securities advice and holds out as a planner
The Uniform Securities Act captures a person who, in the regular course of business, advises others about securities for compensation. Harrison charges fees, includes securities advice in his plans as a matter of routine, and lists himself under Financial Planners, so he holds himself out as one and must register. The securities portion of his work is not incidental, because advising on investments is part of the service he sells rather than a byproduct of something else, so the twenty percent figure does not save him. The number of plans he has written is not the test. A recognized professional designation can excuse an applicant from the qualification examination, but it never excuses registration itself.
- The USA provides either an exclusion from the definition or an exemption from registration as an investment adviser for certain persons. Which of the following would be required to register?
- A bank trust officer with less than $250 million in assets under management
- A CFP® who provides a full range of financial planning to clients on a fee-only basis
- A teacher who teaches a course in the local high school on consumer economics
- An engineer employed by an oil company selling limited partnership interests to public investors who provides estimates of recoverable reserves
Correct answer: A CFP® who provides a full range of financial planning to clients on a fee-only basis
Unless excluded or exempted, anyone charging a fee for investment advice must register. Banks and their employees are excluded. Engineers and teachers fall under the late exclusion as long as the advice is incidental to their profession and no special compensation is received.
- Under the Uniform Securities Act, a person who is in the business of providing advice on trading futures contracts in addition to advising clients on securities issued or guaranteed by the U.S. government is
- Not required to be a registered investment adviser in the state
- Required to be a registered agent in the state
- Required to be a registered investment adviser representative in the state
- Required to be a registered investment adviser in the state
Correct answer: Not required to be a registered investment adviser in the state
The Uniform Securities Act excludes futures contracts from the definition of security. To be defined as an investment adviser, the advice must be on securities. That brings us to the U.S. government securities. A person whose securities advice is limited to those issued or guaranteed by the U.S. government is included in the definition of a federal covered adviser. Federal covered advisers are included in the list of persons who are not deemed to be investment advisers under the USA. Therefore, this person is not considered an investment adviser in a state and is not required to register as one.
- Martin holds both the CPA and the CFP designations. Within the previous year, if he has provided portfolio advice to approximately 40 clients, is Martin required to register as an investment adviser?
- Yes, because he provides investment advice on a more than incidental basis.
- No, because he falls under the de minimis exemption having relatively few clients.
- No, because he is a CPA.
- Yes, because he could receive commission income from investment clients.
Correct answer: Yes, because he provides investment advice on a more than incidental basis.
Although Martin is an accountant, he provides investment advice on a more than incidental basis (typically regarded as more than 10 client contacts per year). Nothing indicates that Martin will be executing commissionable trades; only providing advice.
- Under the Uniform Securities Act, all of the following are excluded from the definition of an investment adviser EXCEPT
- Banks and chartered institutions
- Broker-dealers and their agents
- Advisers on municipal securities
- Federally covered advisory firms
Correct answer: Advisers on municipal securities
Municipal bonds are exempt securities, but giving advice about them is still giving advice about securities, and nothing in the Uniform Securities Act excludes a person who does so from the definition of investment adviser. The other three are excluded by name: banks and other chartered depository institutions, broker-dealers and their agents whose advisory work is solely incidental and separately uncompensated, and federal covered advisers, which are left out of the state definition so that the same firm is not regulated twice.
- Which of the following is responsible for the administration of the USA in a state?
- State judiciary system
- The Administrator
- Executive department
- Securities and Exchange Commission
Correct answer: The Administrator
On this exam, the chief state regulator is the Administrator. The Securities and Exchange Commission is the federal agency, not state agency, that oversees and regulates securities on a national level.
- The Uniform Securities Act's definition of investment adviser would include
- A person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities
- An investment adviser representative of an advisory firm who makes securities recommendations on a regular basis for compensation
- A temporary employee hired to assist in administrative responsibilities of an advisory firm
- Any person who is a federal covered investment adviser
Correct answer: A person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities
A person who, on a regular basis for compensation, offers specific investment advice to clients as to the value of securities meets the 3-prong test as an investment adviser.
- An investment adviser registered in State A who has no office in State B is exempt from registration in that state if, during any 12-month period, the adviser limits its retail clients in State B to no more than
Correct answer: 5
Under the Uniform Securities Act, an investment adviser registered in at least one state (State A) is exempt from registering in another state (State B) if the adviser meets the requirements of the de minimis exemption. That exemption applies when the investment adviser has no place of business in the state (State B) and has no more than 5 noninstitutional clients in that state in a 12-month period.
- A support level is the price range at which a technical analyst would expect
- The demand for a stock to increase substantially
- The supply of a stock to increase substantially
- The demand for a stock to decrease substantially
- The supply of a stock to decrease substantially
Correct answer: The demand for a stock to increase substantially
Most stock prices remain relatively stable and fluctuate up and down from their true value. The lower limit to these fluctuations is called a support level, the price range where a stock appears cheap and attracts buyers. The upper limit is called a resistance level. Generally, a support level will develop after a stock has experienced a steady decline from a higher price level. Technicians believe that at some price during the decline, those investors who have been waiting for a reversal to get into the stock will now buy. When the price reaches this support price, demand surges, and price and volume begin to increase again. Other terms that may be used in this context are overbought and oversold. Overbought generally refers to the resistance level. Interest in buying the stock has begun to dry up and the price of the stock plateaus. Oversold is when the opposite occurs: there are few sellers to be found and the price of the stock bottoms. In either case, the next move is a reversal: down when the stock is overbought and up when oversold.
- One respect in which an LLC differs from an S corporation is that
- There is more favorable tax treatment afforded to members of an LLC
- Not only income, but losses, if generated, pass through to investors in an LLC
- There is no statutory limit on the number of investors in an LLC
- An LLC can be formed with as little as a single investor
Correct answer: There is no statutory limit on the number of investors in an LLC
There is no limit to the number of investors (members) in an LLC, while current regulations limit the number of investors (shareholders) in an S corporation to 100. The tax treatment is the same, and both can be formed with a single owner.
- Among the advantages of forming an S corporation rather than a C corporation for a new business enterprise is
- Shareholders’ losses are limited to the amount of their investment
- Any losses flow through to the investors
- The ease in raising substantial amounts of capital
- Unlike the C corporation, which is limited to 100 investors, there is no such limit for an S corporation
Correct answer: Any losses flow through to the investors
An S corporation offers the benefit of flow-through of both income and losses (losses being a particular benefit for a start-up because they usually take some time to become profitable). It is the S corporation rather than the C corporation that is limited to 100 investors. Both offer the benefit of limited liability. The C corporation is superior for raising large amounts of capital.
- The type of trust created by a will that becomes operative at death is
- A testamentary trust
- A revocable trust
- A living trust
- A Q-tip trust
Correct answer: A testamentary trust
As in "last will and testament."
- Increasingly, many institutional investors, especially those in the philanthropic arena, are using ESG factors when considering where to invest their funds. Those factors are most accurately described as
- Environmental, social, and governance
- Exchange, sensitivity, and growth
- Exchange, sales, and general
- Earnings, systematic, and governmental
Correct answer: Environmental, social, and governance
The ESG business factors that should be considered when analyzing a firm are a company's environmental, social, and governance risk exposures.
- The distributable net income (DNI) of a simple trust would not include
- Interest received on municipal bonds
- Realized capital gains
- Interest received on corporate bonds
- Dividends received
Correct answer: Realized capital gains
It is capital gains that are reinvested in the corpus (body) of a simple trust which are not part of DNI. Although the interest on municipal bonds in not taxable, it is still included as part of the DNI.
- Under the Investment Advisers Act of 1940, which of the following is included in the definition of an investment adviser?
- A research analyst who holds himself out as an expert in foreign currency trading
- A research service that sells reports on the market values of gold to speculators
- A lawyer who advertises both legal and investment advice to high net worth buyers
- A bank that advertises a broad range of trust and custody offerings to depositors
Correct answer: A lawyer who advertises both legal and investment advice to high net worth buyers
Lawyers are one of the professions excluded from the definition of investment adviser, but only while any investment advice they give is solely incidental to the practice of law. Once the lawyer advertises investment advice as a service he offers, the advice is no longer incidental and the exclusion is lost, so he is included in the definition. Foreign currencies and gold are not securities, so neither the currency analyst nor the gold research service is advising on securities. Banks are excluded from the definition under the Investment Advisers Act of 1940.
- Under the Uniform Securities Act, a person who exclusively provides advice on commodities is
- A registered investment adviser representative
- Not a registered investment adviser
- An options representative
- A registered insurance agent
Correct answer: Not a registered investment adviser
A person who only provides advice on commodities is not a registered investment adviser. To be an investment adviser under the Uniform Securities Act, advice must be given on securities. The act specifically excludes commodities from the definition of security.
- Which of the following is specifically excluded from the definition of an investment adviser providing the investment advice is solely incidental to the business in which the person is engaged?
- Sports representative who advises on securities for a fee
- Industrial engineer
- Movie star's business manager who handles the star's investment portfolio
- Pension manager
Correct answer: Industrial engineer
Lawyers, accountants, engineers, teachers, and broker-dealers whose advice is incidental to their profession and who do not charge a separate fee for investment-related advice are excluded from the definition under the Investment Advisers Act of 1940.
- Under the Uniform Securities Act, investment advisers are exempt from registration in a state where they have no office if they direct business communications with no more than 5 retail clients within
- 12 months
- 2 years
- 30 days
- 6 months
Correct answer: 12 months
If investment advisers have no office in a state, they are not defined as investment advisers and are exempt from registration if either of the following conditions applies: their only clients within the state are other investment advisers or broker-dealers, financial institutions (banks, savings and loans, trusts), institutional investors (certain pension funds, insurance companies, investment companies), or government agencies or other political entities; and they have no more than 5 clients within the state in a 12-month period (de minimis exemption).
- State laws provide for exclusions from the definition of investment adviser. Which of the following persons is specifically excluded under the Uniform Securities Act?
- Investment adviser representatives
- Broker-dealers receiving special compensation
- Economists whose advice is strictly incidental to their professional activity
- Bank subsidiary offering investment advice
Correct answer: Investment adviser representatives
The USA specifically excludes IARs from its definition of investment adviser. Excluded are banks but not subsidiaries offering investment advice. Once broker-dealers receive special compensation, such as in a wrap fee program, they lose their exclusion. Economists are not included in the list of exclusions.
- Which of the following persons are included in the definition of investment adviser?
- A financial planner or other person that provides investment advisory services to others for compensation
- A publisher of a bona fide newspaper, news magazine, or business or financial publication of general and regular circulation
- A bank whose deposits are insured by the FDIC
- Any person that the Administrator excludes by rule or order
Correct answer: A financial planner or other person that provides investment advisory services to others for compensation
A financial planning firm or other person that, as an integral component of other financially related services, provides investment advisory services for compensation is an investment adviser. A publisher of a bona fide newspaper, news magazine, or business or financial publication of general and regular circulation, a bank, or any other person that the Administrator specifies by rule or order are excluded from the definition of an investment adviser.
- If an investment adviser is registered in another state and has no place of business within an Administrator's state, the adviser is exempt from registration under the Uniform Securities Act if
- The adviser has municipalities as most of its clients in that state
- Fewer than fifteen residents of the state are paying for the advice
- The adviser has no more than five clients residing within the state
- Most of the adviser's clients in that state happen to be accredited
Correct answer: The adviser has no more than five clients residing within the state
An investment adviser with no place of business in a state qualifies for the de minimis exemption if it has had no more than five clients who are residents of that state during the preceding twelve months. Fifteen is not the state threshold; it comes from a federal private adviser exemption and does not apply here. The character of the clients does not matter under this exemption: having mostly municipalities or mostly accredited investors as clients neither creates the exemption nor takes it away, since the count of resident clients is what the statute measures.
- The Investment Advisers Act of 1940 lists several specific exclusions from the definition of investment adviser. Which of the following are included in that listing?
- Publishers of newsletters issued in response to market activity
- Pension consultants advising plans on the selection of managers
- Attorneys whose securities advice is incidental to law practice
- Sports agents who advise players about investing their earnings
Correct answer: Attorneys whose securities advice is incidental to law practice
Attorneys are part of the group of professionals the Investment Advisers Act of 1940 excludes by name, and the exclusion holds so long as any investment advice is solely incidental to the practice of law. The publisher exclusion is narrower than it looks: it reaches publications of general and regular circulation, not a newsletter issued from time to time in reaction to market events, so that publisher is included in the definition rather than excluded from it. Release IA-1092 brought pension consultants and sports and entertainment representatives inside the definition.
- Under the Investment Advisers Act of 1940, the exclusion for providing investment advice that is solely incidental to the practice of a profession is NOT available to
- Agents who sell and lease real estate
- Attorneys who draw up and file trusts
- Teachers who set and mark class tests
- Engineers who plan and test new roads
Correct answer: Agents who sell and lease real estate
The Investment Advisers Act of 1940 and the releases interpreting it name lawyers, accountants, teachers and engineers as the professionals who may give investment advice without being investment advisers, provided the advice is solely incidental to the practice of the profession. Real estate agents are not on that list, so the incidental professional exclusion is not available to them no matter how incidental the advice may be.
- Under the provisions of the Uniform Securities Act, it is NOT necessary for an investment adviser to register when it
- Has a place of business in the state but deals exclusively with federal covered advisers
- Is headquartered in a state where it conducts most of its business with broker-dealers only
- Has no place of business in the state and deals with savings and loan associations only
- Has a place of business in the state but has conducted business with 3 individual investors during the preceding 12 consecutive months
Correct answer: Has no place of business in the state and deals with savings and loan associations only
An adviser who has no place of business in the state and deals only with savings and loan associations is not required to register with the state securities Administrator. An adviser with a place of business in the state must register with the Administrator whether clients are exclusively broker-dealers or federal covered advisers and regardless of the number of clients.
- Under the Uniform Securities Act, who must register as an investment adviser?
- A financial planner with no place of business in a state and who advises only trust companies
- An accountant who provides advice solely incidental to the business
- A bank that provides investment advice
- A registered broker-dealer who receives compensation for providing investment advice
Correct answer: A registered broker-dealer who receives compensation for providing investment advice
Registered broker-dealers that provide advice only incidentally to their business are exempt from the definition if they do not receive compensation. However, a broker-dealer that receives compensation for investment advice must register. A financial planner with no place of business in a state and who advises only trust companies is exempt from registration. Out-of-state advisers (with no office in the state) are not defined as investment advisers within a state if their only clients within the state are other investment advisers or broker-dealers, financial institutions, or institutional investors. Banks are excluded from the definition of investment adviser, as are accountants who provide advice only incidentally to their business.
- Which of the following persons is NOT excluded from the definition of investment adviser if their advice given is incidental to the individual's profession?
- Teacher
- Economist
- Engineer
- Lawyer
Correct answer: Economist
The exclusion applies to lawyers, accountants, engineers, and teachers, provided there is no separate fee for their investment-related advice. Economists are not specifically named in the exclusion.
- Which of the following would have to register as an investment adviser under the Uniform Securities Act?
- A bank trust department that manages accounts for its own depositors
- An accountant who advises on investments incidental to his tax audit
- A retired engineer who charges fees for seminars on aerospace stocks
- An economics professor who gives talks to business groups on markets
Correct answer: A retired engineer who charges fees for seminars on aerospace stocks
The engineer must register. He is paid for the securities advice he gives, and the advice is the service being sold rather than something incidental to engineering work, so neither the professional exclusion nor any other exclusion reaches him. Banks and their trust departments are excluded by name. The accountant keeps the professional exclusion because the investment advice is incidental to the tax work and carries no separate charge. The professor is not in the business of advising others about securities, since occasional lectures to business groups are neither regular nor compensated as advice.
- Under the Uniform Securities Act, an investment adviser would be exempt from registration in a state in which he has no place of business if he
- Had no more than 15 clients in that state within the past 12 months
- Had no more than 10 clients in that state within the past 12 months
- Had no more than 5 clients in that state within the past 12 months
- Is registered as a broker-dealer
Correct answer: Had no more than 5 clients in that state within the past 12 months
An adviser who had no more than 5 clients in a state within the prior 12-month period or deals exclusively with institutions is not required to register in a state in which he has no place of business.
- There are a number of exclusions from the definition of investment adviser. Which of the following would NOT qualify for an exclusion under the Uniform Securities Act?
- An accountant who conducts seminars on the tax benefits of contributing to IRAs, both traditional and Roth
- A financial planner who conducts seminars for the local PTA, where he presents the benefits of term life insurance
- A lawyer who charges an hourly fee for preparing trust documents for individuals referred to her by an investment adviser
- A teacher at the local high school who receives nominal compensation for giving investment advice to engineers
Correct answer: A teacher at the local high school who receives nominal compensation for giving investment advice to engineers
The LATE exclusion applies when advice is given by one of the listed professionals on an incidental basis. When a teacher (or any of the others) is compensated specifically for giving advice, regardless of the amount, the exclusion is lost. To be defined as an investment adviser, one must give advice on securities; term life insurance is not a security. Similarly, preparing trust documents is not securities advice, even if the clients are referred by an investment adviser. Finally, one of the roles of an accountant is giving tax advice, and IRAs are not securities.
- Who of the following is not exempt from registration as an investment adviser under the Investment Advisers Act of 1940?
- An adviser managing $125 million, whose only office sits in State F and whose 110 clients all live there, advising on listed stocks
- An adviser with $125 million under management, dealing solely with people who live in State G, none being a fund, on unlisted stock
- An adviser managing $125 million inside the United States, whose clients are seven private funds and no one else in the entire year
- An adviser managing $125 million inside the United States, whose clients are insurance firms based in one or two of the many states
Correct answer: An adviser managing $125 million, whose only office sits in State F and whose 110 clients all live there, advising on listed stocks
The intrastate exemption under the Investment Advisers Act of 1940 sets no ceiling on the number of clients, so the 110 State F residents are not the problem; the exemption is lost the moment the adviser gives advice on securities listed on a national exchange, and this State F adviser does exactly that. With 125millionundermanagementitalsopassesthethresholdatwhichSECregistrationismandatory,soitisnotexempt.TheStateGadviserkeepstheintrastateexemptionbecausenoneofitsclientsisaprivatefundandnoneoftheadvicetouchesexchangelistedsecurities.Aprivatefundadviserwithlessthan150 million under management in the United States is exempt however many funds it advises, and an adviser whose only clients are insurance companies is exempt as well.
- In which of the following cases is the exemption from registration with the SEC not based on the value of assets under management?
- An investment adviser with assets under management of less than $25 million
- An investment adviser that acts as an adviser solely to private funds and has assets under management in the United States of less than $150 million
- An investment adviser that acts as an adviser solely to one or more venture capital funds
- An investment adviser that acts as an adviser solely to one or more national banks
Correct answer: An investment adviser that acts as an adviser solely to one or more national banks
It is only in the case of the adviser to venture capital funds where there is no dollar limitation on AUM. Private fund advisers with AUM of $150 million or more must register, and "small" investment advisers, those with less than $25 million in AUM, are generally prohibited from SEC registration. If the investment adviser's only clients are insurance companies, the adviser is exempt from SEC registration even if the firm has billions in AUM, but that exemption does not apply when the only clients are banks.
- The Investment Advisers Act of 1940 would consider each of the following investment advisers to be exempt from registration EXCEPT
- An adviser whose only clients are insurance companies
- An adviser whose only clients are banks
- An adviser who maintains an office in only one state, advises only residents of that state (none of whom is a private fund), and gives advice relating solely to securities not traded on any national exchange
- An adviser whose only clients are venture capital funds
Correct answer: An adviser whose only clients are banks
Advising banks only does not qualify one for the exemption. Advisers who only service insurance companies or venture capital funds are exempt, as are advisers performing intrastate who do not give advice to private funds or on listed securities.
- With respect to safety of principal, of the following investments, the least risky is
- Common stock
- Equity options
- Exchange-listed warrants
- Corporate AA debentures
Correct answer: Corporate AA debentures
The least risky investment listed is the corporate debenture because, as a debt instrument, it has priority over the others.
- DERP Corporation's 5% convertible debentures maturing in 2030 are currently selling for 120. The conversion price is $40. One would expect the DERP common stock to be selling
- Somewhat above $30 per share
- Somewhat below $48 per share
- Somewhat above $48 per share
- Somewhat below $30 per share
Correct answer: Somewhat below $48 per share
The first step here is to compute the parity price. A conversion price of $40 means the debenture is convertible into 25 shares of the common stock (par of $1,000 divided by $40 = 25 shares). With a current market price of $1,200, the parity price of the stock would be $48. Because convertible securities generally sell at a slight premium over their parity price, the stock should have a current market value a bit less than $48 per share.
- The XYZ Corporation's A-rated convertible debenture is currently selling for 90. If the bond's conversion price is $40, what is the parity price of the stock?
- $44 per share
- $36 per share
- $22.50 per share
- $40 per share
Correct answer: $36 per share
If the bond's conversion price is $40, it means the bond is convertible into 25 shares ($1,000 par value divided by the $40 conversion price). Parity means equal so, what does each share have to be worth so that 25 of them are equal to $900? Remember, bonds are quoted as a percentage of the $1,000 par value so a price of 90 means $900. Dividing $900 by 25 shares results in a parity price of $36. That does not mean the stock is selling for $36 per share (probably a bit less), but at $36, holding the bond, or converting into the stock, gives the investor equal value. Some students quickly see that the bond is 10% below its par value so the stock, to be equal, must be 10% below the conversion price. Take 10% off $40 and the result is $36. Either way works.
- An investor owns a debenture convertible into 20 shares of the issuer's common stock. After a 2-for-1 stock split, the terms of the debenture provide for conversion into 40 shares. This is because the debenture has
- An antidilution clause
- Increased its par value to $2,000 to account for the split
- Preemptive rights
- Warrants attached
Correct answer: An antidilution clause
Most convertible securities are sold with antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends.
- When a trustee is managing the trust assets, which of the following is the most important consideration?
- The current income, liquidity, and tax needs of the beneficiaries
- The safety, marketability, and yield of the securities being held
- The custody, brokerage, and turnover costs charged to the account
- The purposes, terms, and distribution rules of the trust document
Correct answer: The purposes, terms, and distribution rules of the trust document
A trustee's first duty is to the trust instrument itself. The purposes the settlor set out, the terms of the document, and the distribution requirements it imposes govern everything else the trustee does, and the remaining considerations are subordinate to them. The needs of the beneficiaries, the safety and yield of the portfolio, and the cost of running the account all matter, but each of them is weighed within the framework the trust document establishes rather than in place of it.
- A major benefit of a revocable trust is
- The settlor cannot also be the beneficiary
- The grantor retains control of the assets
- The assets are not included in the grantor’s estate
- The grantor saves on income taxes
Correct answer: The grantor retains control of the assets
Among the benefits of a revocable trust is that the grantor (settlor) retains all control over the assets. There are no tax benefits and the grantor can be the beneficiary (and trustee) if the trust is set up that way.
- If the Smiths want to open a joint account at AAA Securities Corporation and have their securities transferred to their 3 daughters upon the death of the last surviving account holder, their agent should recommend that the Smiths open
- A joint account with right of survivorship shared by both of the spouses
- A joint account with right of survivorship plus a transfer on death form
- A tenants in common account plus a transfer upon death document for them
- A joint account with right of survivorship plus a full power of attorney
Correct answer: A joint account with right of survivorship plus a transfer on death form
Joint tenancy with right of survivorship gives the whole account to the surviving spouse when the first of them dies, and a transfer on death registration then names the three daughters as beneficiaries who take the securities when the survivor dies. Both pieces are needed: survivorship alone leaves the account in the survivor's estate, and a power of attorney ends at death and directs nothing. A transfer on death registration is available only on individual and joint tenancy accounts, so it cannot be added to a tenancy in common.
- When a will calls for property to be distributed per stirpes, it means that
- The property is divided into as many equal shares as there are surviving children of the designated ancestor, with nothing going to surviving descendants of deceased children
- The property is divided into as many equal shares as there are surviving children and grandchildren of the designated ancestor
- The property is divided into as many equal shares as there are surviving children of the designated ancestor and deceased children who left surviving descendants
- All living descendants of the ancestor receive equal shares in the property remaining after all estate expenses are paid
Correct answer: The property is divided into as many equal shares as there are surviving children of the designated ancestor and deceased children who left surviving descendants
When a will calls for a per stirpes distribution of assets, it provides that if any named beneficiary predeceases the testator (the maker of the will), surviving children of that individual share in the share that the individual would have received. For example, if the testator had 3 children and 1 of them died first, any children of the deceased would share in their parent's portion (they would split one-third of the estate between them).
- An investment advisory firm requires all new clients to complete a 4-page questionnaire before conducting the first meeting. This would be known as
- The investment adviser’s brochure
- Fulfilling the requirements of the CIP
- The information-gathering stage
- The client disclosure document
Correct answer: The information-gathering stage
The first step in any adviser's relationship with a client is information gathering. A popular way of doing this is by using a questionnaire.
- Form PF must be filed by
- State-registered private fund managers, regardless of the amount of assets under management
- SEC-registered advisers with at least $150 million in private fund assets under management
- SEC-registered advisers with no more than $150 million in private fund assets under management
- SEC-exempt reporting advisers
Correct answer: SEC-registered advisers with at least $150 million in private fund assets under management
Form PF is the form used by those private fund managers who are registered with the SEC and whose private fund AUM reaches or exceeds the $150 million threshold. Exempt reporting advisers are, as the term implies, exempt from reporting. State-registered advisers don't report on the form because, among other things, if they reached the $150 million mark, they'd have to register with the SEC.
- Reticent Asset Management (RAM) is claiming an exemption from registration with the state because it is an adviser to private funds. One of the requirements to qualify for this exemption is
- All investors must be qualified clients
- There can be no more than 10 investors during any 12-month period
- All investors must be accredited
- Private fund assets under management cannot exceed $110 million
Correct answer: All investors must be qualified clients
On the state level, the exemption requires that all investors meet the USA's definition of qualified client. That means the investor must have a net worth of at least $2.2 million or at least $1.1 million in assets under management with the adviser. This is a more stringent test than that for accredited investors. In addition, accredited investor is a federal term, and this question is about state law. There is no limit placed on the number of investors (don't confuse this with the private placement exemption for registration of the security). The limit on AUM is $150 million (this is not to be confused with the AUM limits on becoming registered with the SEC).
- The term "private fund", as defined under federal and state law, would not apply to
- A hedge fund
- An issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that act
- A leveraged ETF
- A venture capital fund
Correct answer: A leveraged ETF
ETFs are publicly traded. Hedge funds and venture capital funds meet the definition of a private fund which is, "an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that act."
- If an investment adviser files an initial registration with a state on June 30, which of the following statements regarding the filing fee to be paid is TRUE?
- The fee will be prorated from the filing date.
- No filing fee is required until December 31.
- The full year's fee must be paid.
- The fee will be prorated from the effective date.
Correct answer: The full year's fee must be paid.
While some states make exceptions for filings late in the year, under the USA there is no pro rating of filing fees. The full year's fee must be paid with the initial registration request.
- If a federal covered adviser's fiscal year ends on November 30, 2017, it must file its annual updating amendment to its Form ADV no later than
- February 28, 2018
- January 18, 2018
- March 30, 2018
- December 31, 2017
Correct answer: February 28, 2018
The annual updating amendment to Form ADV must be filed within 90 days of the adviser's fiscal-year end.
- Foster Advisers, based in New Jersey, manages $135 million in funds for New Jersey-based clients. As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which of the following statements best describes the registration requirement for Foster Advisers?
- Foster Advisers is required to register as an adviser with the SEC and has no requirement to notify the Administrator of the New Jersey Department of Securities.
- Foster Advisers is required to register with the Administrator of the New Jersey Department of Securities.
- Foster Advisers is required to register as an adviser with the SEC and notify the Administrator of the New Jersey Department of Securities of its operation.
- Foster Advisers is required to register with both the SEC and the Administrator of the New Jersey Department of Securities.
Correct answer: Foster Advisers is required to register as an adviser with the SEC and notify the Administrator of the New Jersey Department of Securities of its operation.
Since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, investment advisers with $110 million or more in assets under management must register with the SEC. These advisers are called federal covered advisers. Investment managers who manage less than $100 million must register with the state Administrator. Advisers with at least $100 million but less than $110 million of assets under management have the option to register with either their state Administrator or with the SEC. Once the $110 million level is reached, registration with the SEC is mandatory. With $135 million under management, Foster Advisers must register with the SEC. Foster Advisers is subject to the additional requirement of notifying the administrators of the securities departments of states in which it maintains offices or clients of its operations. At the state level, a notification fee (but not registration) is generally required. One aim of the NSMIA was to eliminate dual registration of investment advisers with the states and the SEC. Investment advisers are not required to register at both state and federal levels.
- Included in the Investment Advisers Act of 1940 are a number of different recordkeeping requirements. Wealth Preservation Specialists is a covered adviser that is organized as a partnership. If the firm were to dissolve, partnership agreements must be kept for
- 5 years after the dissolution
- 5 years from the date of organization
- 3 years after the dissolution
- The lifetime of the firm
Correct answer: 3 years after the dissolution
Both the Investment Company Act of 1940 (applicable here because this is a covered adviser) and the NASAA Model Rule on Recordkeeping require that investment advisers maintain certain records, such as partnership agreements and corporate articles of incorporation, for a period of no less than 3 years after dissolution.
- Under the Investment Advisers Act of 1940, an adviser's registration usually becomes effective how many days after it is filed?
Correct answer: 45
In the absence of any denial order or pending proceedings, registrations of federal covered investment advisers (and broker-dealers) will become effective on the 45th calendar day after the date of filing (the date received in the SEC's office). The SEC may specify an earlier date.
- The document that gives the Administrator the right to process complaints against a registrant is known as
- An order to stop doing business
- A writ of injunction from court
- A durable power of attorney agreement
- A consent to service of process
Correct answer: A consent to service of process
The consent to service of process is filed with the application and appoints the Administrator as the registrant's agent for receiving legal papers, which is what gives the Administrator the power to process complaints and lawsuits against the registrant. A stop order halts the effectiveness of a registration and does not concern service of legal papers. An injunction is relief the Administrator asks a court to grant, not a document the registrant files. A durable power of attorney relates to authority over a client's account.
- One of the exemptions from registration under state and federal law applies to investment advisers to private funds. One characteristic of all private funds is that
- Their advisers are exempt from filing reports on Form ADV
- They have assets of less than $150 million
- They are not registered as investment companies
- They have no more than 100 investors
Correct answer: They are not registered as investment companies
Private funds lose that distinction if they become registered as investment companies under the Investment Company Act of 1940. It is the adviser to a private fund who has a limitation on the amount of AUM, not the fund. In some cases, specifically when using the 3(c)(7) exemption, there is no limit to the number of investors. In many cases, the advisers to these funds, although exempt from registration, are considered exempt reporting advisers and must file a Form ADV Part 1 answering most of the questions on the Form.
- A consent to service of process required by an Administrator is
- An agreement that the registrant will obey the advertising standards the Act sets
- An agreement that legal papers served on the Administrator will bind a registrant
- An agreement that the registrant will properly perform the duties the Act imposes
- An agreement that the Administrator may seek a court order against the registrant
Correct answer: An agreement that legal papers served on the Administrator will bind a registrant
A consent to service of process appoints the Administrator as the registrant's agent for receiving legal papers, so a summons or subpoena served on the Administrator has the same effect as one served on the registrant itself. It is not a promise about advertising, and it is not a general undertaking to perform the duties the Uniform Securities Act imposes, both of which flow from the statute rather than from this document. Nor does it give the Administrator the power to enjoin anyone; injunctive relief comes from a court on the Administrator's application.
- The National Securities Markets Improvement Act of 1996 (NSMIA)
- Overcame the restrictions of selling securities in interstate commerce
- Defined the term ""federal covered adviser""
- Created the concept of fraud, as used in the Uniform Securities Act
- Created a national market system
Correct answer: Defined the term ""federal covered adviser""
The NSMIA defined the term "federal covered adviser," referring to advisers who must register with the SEC or who are excluded from the definition of "investment adviser" under the Investment Advisers Act of 1940. Fraud is a legal concept and is prohibited by the Uniform Securities Act. Selling securities in interstate commerce is not fraudulent, provided the antifraud provisions securities laws are observed. The roots of a national market system began with the Securities Amendments Act of 1975.
- Federally registered investment advisers are obligated to maintain certain books and records as specified by the SEC. Which of the following statements regarding adviser recordkeeping is NOT true?
- Records originally created on computer may be stored in electronic media.
- Records must be kept for 6 years.
- Written records may be reduced to microfilm.
- Records are subject to surprise audits by the SEC.
Correct answer: Records must be kept for 6 years.
Records of an adviser must be maintained for 5 years. Records are subject to surprise audits by the SEC, written records may be reduced to microfilm, and records originally created on a company's computer may be stored in electronic media.
- Under the NASAA Model Rule on financial requirements for investment advisers, investment advisers who have custody of customer funds are usually required to have a net worth in the amount of
- $35,000
- $10,000
- $50,000
- $5,000
Correct answer: $35,000
The NASAA Model Rule on financial requirements for investment advisers, unless an exception exists, requires an investment adviser with custody of customer funds or securities to have a minimum net worth in the amount of $35,000. If the adviser does not have custody of customer funds or securities but does have discretionary power over customer accounts, the minimum net worth amount is reduced to $10,000. In the event the adviser wishes to post a bond because it doesn't meet the net worth requirement, it must be an amount determined by the Administrator based upon the number of clients and the total assets under management of the investment adviser.
- On last year's annual updating amendment filed with the SEC, Alpha Investment Advisers indicated that it had more than $140 million in assets under management. Due to a reduction in the size of the firm, this year's annual updating amendment shows that assets under management have fallen to the $75 million level and are expected to remain there. Which of the following actions are required for Alpha?
- Withdraw from SEC registration within 90 days of the adviser's fiscal year-end
- Withdraw from SEC registration immediately
- Do nothing and continue as a federal covered adviser
- Withdraw from SEC registration within 180 days of the adviser's fiscal year-end
Correct answer: Withdraw from SEC registration within 180 days of the adviser's fiscal year-end
If an adviser reports on its annual updating amendment that it has less than $90 million under management and it is not otherwise eligible to register with the SEC, it must withdraw from SEC registration within 180 days of the adviser's fiscal year-end by filing Form ADV-W. The adviser could consult the securities departments of states in which it maintains offices or conducts business to determine the appropriate state registration requirements.
- According to the Investment Advisers Act of 1940, for how many years must books and records be maintained for an account after the end of the year in which the last transaction occurred?
- 2 years
- 10 years
- 1 year
- 5 years
Correct answer: 5 years
Those investment advisers registered with and regulated by the Securities and Exchange Commission (SEC) must adhere to SEC Rule 204-2 regarding the maintenance of records. The rule states the required records must be kept for 5 full years from the end of the fiscal year during which the last entry was made on the record. The first 2 years, records must be kept in the principal office of the adviser and the balance of the time, easily accessible. They are subject to SEC examination at any time.
- Certain documents belonging to a federal covered investment adviser must be kept for a period of time after the enterprise closes. Those documents are
- Sent to the SEC for safekeeping
- Sent to the Administrator for safekeeping
- Required to be shredded
- The responsibility of the investment adviser
Correct answer: The responsibility of the investment adviser
Broker-dealers and investment advisers must keep certain records for a period of 3 years after the termination of the business. How and where those records are maintained is the responsibility of the firm, not the regulators. This is a separate requirement from the one that has active broker-dealers keeping records for 3 years and investment advisers for 5.
- Under the Investment Advisers Act of 1940, for how many years must records be kept after the end of the fiscal year in which an entry was made?
- 2 years
- 10 years
- 1 year
- 5 years
Correct answer: 5 years
Records must be kept for a full 5 years — the first 2 years in a in the firm's principal office — and are subject to SEC examination at any time. The 5-year requirement governs records of business activities. Additional rules require the articles of incorporation or partnership documents of the advisory firm and other business organizational documents to be kept for 3 years after termination of the enterprise.
- All of the following are exempt from registration requirements with the SEC under the Investment Advisers Act of 1940 as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 EXCEPT
- An adviser with 50 clients, none of whom is a private fund, all within one state, that furnishes no advice on exchange-listed securities
- Someone who gave investment advice to 11 private funds throughout the Midwest last year and has total assets under management of $120 million
- Investment advisers whose only clients are insurance companies
- Investment advisers with $110 million or more in assets under management
Correct answer: Investment advisers with $110 million or more in assets under management
Investment advisers with $110 million or more of assets under management are subject to registration with the SEC under the Investment Advisers Act of 1940 and the Dodd-Frank Act. Federal exemptions apply to advisers whose clients are all in one state, whose principal office is in that state, and whose clients (none of whom are private funds) are not furnished advice on exchange-traded securities. Private fund managers are exempt from SEC registration until their AUM in the U.S. reaches $150 million.
- The term "federal covered investment adviser" would apply to a person who
- Limits the advice offered strictly to securities listed on the New York Stock Exchange (NYSE)
- Limits the advice offered strictly to securities issued or guaranteed by the U.S. government or 1 of its political subdivisions
- Is registered as such under the Investment Advisers Act of 1940
- Is registered as such under the Investment Company Act of 1940
Correct answer: Is registered as such under the Investment Advisers Act of 1940
Only federal covered investment advisers register under the Investment Advisers Act of 1940. Even if the person only gives advice on exchange-listed securities (which are federal covered securities), that does not make the person federal covered. After all, if the AUM is under $100 million, registration is only possible with the state(s), unless meeting an exception. Although the term "federal covered adviser" does apply to those who limit their advice to securities issued or guaranteed by the U.S. government, it would not apply if advice is given on political subdivisions (states, cities, etc.).
- Investment advisers who manage investment portfolios that total less than $100 million must register with
- The SEC only
- Both a state and the SEC
- A state only
- Neither the SEC nor a state
Correct answer: A state only
Investment advisers who manage less than $100 million of investment assets are prohibited from registering with the SEC and are required to register with a state Administrator unless exempt under the laws of that state. Please do not confuse this with an SEC-registered IA whose AUM may drop to as low as $90 million with continued SEC registration allowed. Any question about that rule will state that AUM has "dropped."
- All of the following information is required on the SEC registration Form ADV EXCEPT
- The disciplinary history of the firm's officers and directors
- The basis upon which the adviser's compensation is calculated
- The form of business organization the adviser has established
- The personal securities holdings of the firm's own principals
Correct answer: The personal securities holdings of the firm's own principals
Form ADV asks for the name of the advisory business, the form of organization it uses, the way the adviser is compensated, and disclosure about control persons including their disciplinary history. It does not call for a list of the securities the firm's principals own personally. Personal holdings are reported inside the firm under its code of ethics rather than on the registration form.
- An investment adviser sends a notice offering a research report she has recently prepared to a group of 25 new members of the local Lions Club. Under the NASAA Model Rule on recordkeeping for investment advisers, the firm must keep a copy of the notice along with
- The date the Administrator approved the research report
- A memorandum describing the list and its source
- A copy of the full roster of the local chapter
- The names of those members to whom the report was sent
Correct answer: A memorandum describing the list and its source
If an investment adviser sends any notice, circular, or other advertisement offering any report, analysis, publication, or other investment advisory service to more than 10 persons, the investment adviser shall not be required to keep a record of the names and addresses of the persons to whom it was sent, except if the notice, circular, or advertisement is distributed to persons named on any list, then the investment adviser shall retain with the copy of the notice, circular, or advertisement a memorandum describing the list and its source.
- Which of the following firms in the business of rendering investment advice for compensation would be considered a federal covered adviser?
- JKL Pension Consultants, a management firm providing services to employee benefit plans, and currently has $179 million under management
- ABC Money Managers, a partnership with $115 million under management
- GHI Consultants, a sole proprietorship, managing $82 million belonging to high-net-worth individuals
- DEF Fund managers, a corporation managing an unregistered hedge fund with $10 million in assets
Correct answer: ABC Money Managers, a partnership with $115 million under management
It makes no difference what the structure of the adviser is. As long as the assets under management are $110 million or more, SEC registration is required. If the investment company is registered under the Investment Company Act of 1940, the adviser must be registered, regardless of size. The hedge fund is an unregistered fund, so the rule does not apply to it. Pension consultants are not eligible for SEC registration until their AUM reaches $200 million.
- When filing the consent to service of process, which of the following is TRUE?
- It is not required of investment adviser representatives, only investment advisers.
- It is supplied with the initial registration and remains on file permanently.
- It expires simultaneously with the registration on December 31.
- It must be filed annually on the dates specified by the Administrator.
Correct answer: It is supplied with the initial registration and remains on file permanently.
The consent to service of process is supplied with the initial registration and remains on file permanently.
- The SEC requires investment advisers registered under the Investment Advisers Act of 1940 to maintain certain books and records for a minimum of
- 6 years
- 3 years
- 1 year
- 5 years
Correct answer: 5 years
Investment advisers must keep most records for 5 years from the end of the fiscal year in which the record was created. The first 2 years, the records must be kept easily accessible in the principal office of the IA. Broker-dealers have a requirement of 3 years rather than 5 years.
- All of the following statements regarding the registration of an investment adviser in a state are true EXCEPT
- If the investment adviser is not an individual, any officer or partner active in the advisory business is automatically registered as an investment adviser representative
- The annual renewal process involves payment of the appropriate fees and refiling of the consent to service of process
- The initial application must include a consent to service of process along with Form ADV and the appropriate fees
- The adviser's registration expires on December 31 each year
Correct answer: The annual renewal process involves payment of the appropriate fees and refiling of the consent to service of process
The consent to service is a permanent document that remains on file with the Administrator; it need not be resubmitted for yearly renewal. The initial application for registration must include a consent to service of process along with Form ADV and the appropriate fees. If the investment adviser is not an individual, all officers or partners of the business entity that play an active role in the giving or supervision of giving advice are automatically registered as IARs.
- Under the Uniform Securities Act, which of the following statements is TRUE regarding registration of an investment adviser if the application has not been amended?
- Unless the Administrator specifies an earlier date, registration becomes effective at noon on the 15th day.
- Unless the Administrator specifies an earlier date, registration becomes effective at noon on the 90th day.
- Unless the Administrator specifies an earlier date, registration becomes effective at noon on the 30th day.
- Unless the Administrator specifies an earlier date, registration becomes effective at noon on the 60th day.
Correct answer: Unless the Administrator specifies an earlier date, registration becomes effective at noon on the 30th day.
Absent a denial order or a pending proceeding, an investment adviser's registration becomes effective at noon on the thirtieth calendar day after the application is filed, and the Administrator may specify an earlier date. The application is treated as filed on the day it is received in the Administrator's office rather than the day the applicant mails it, so counting begins from receipt.
- Under the terms of the Uniform Securities Act, which of the following is an investment adviser for purposes of state regulatory jurisdiction?
- A commercial bank with an office in the state that advises on banking matters
- An accountant in the state who gives advice on stocks incidental to that work
- A subsidiary of a bank holding company that manages $20 million in that state
- A federal covered adviser that has a number of advisory clients in that state
Correct answer: A subsidiary of a bank holding company that manages $20 million in that state
A commercial bank is excluded from the definition of investment adviser under the Uniform Securities Act, but an investment advisory subsidiary of a bank holding company is not, so a subsidiary in the state managing $20 million is an investment adviser for state purposes and registers with the Administrator. A federal covered adviser is excluded from the state definition to avoid duplicate regulation, even though it has clients in the state. An accountant whose securities advice is incidental to the accounting work keeps the professional exclusion.
- Under both state and federal law, the executive office of the investment adviser from which the officers, partners, or managers of the investment adviser direct, control, and coordinate the activities of the investment adviser is properly referred to as
- The registered office
- The home office
- The office of supervisory jurisdiction (OSJ)
- The principal office and place of business
Correct answer: The principal office and place of business
This is the way it is defined in the act. It is generally the home office, but you must chose the answer that best meets the terminology referred to in the question. Office of supervisory jurisdiction (OSJ) is a FINRA term and is not applicable on this exam.
- Under the Uniform Securities Act, Paul must register as a state-registered investment adviser if he
- Opens an investment advisory business as a sole proprietor in New Jersey with the intention of advising individual clients on the advisability of investing in securities. Paul will have $100 million in AUM within 120 days of opening.
- Becomes a full-time employee of AAA Investment Advisers, Inc., where he will advise clients whose assets under his discretion will exceed $200 million
- Sells registered securities on a commission basis for a registered broker-dealer
- Opens an investment advisory business as a sole proprietor in New Jersey with the intention of advising individual clients on the advisability of investing in securities. Paul will have $90 million in AUM within 120 days of opening.
Correct answer: Opens an investment advisory business as a sole proprietor in New Jersey with the intention of advising individual clients on the advisability of investing in securities. Paul will have $90 million in AUM within 120 days of opening.
Being in the business of advising individual clients on the advisability of investing in securities requires one to register as an investment adviser, either with the state or the SEC. The key is the assets under management. If a new IA reasonably believes that he will have AUM of at least $100 million within the first 120 days of registering, he is permitted to register with the SEC. Of course, if it reaches $110 million, then SEC registration is required. Reaching $90 million is not enough and, therefore, registration with the state would be the only option here. As a full-time employee of AAA Investment Advisers, Inc., he would have to register as a registered investment adviser representative and will not be a registered investment adviser (the firm). Selling registered securities under the supervision of a broker-dealer would require an agent registration with the state and the SEC.
- An agent and a broker-dealer maintain wrap fee accounts for several of their customers. Which of the following registrations is required?
- The firm must register as an investment adviser.
- Neither the broker-dealer nor the agent is required to have any license other than their regular securities license.
- The agent must be registered as an investment adviser.
- Only the registered principal would need to be registered in the state(s) in which they do business.
Correct answer: The firm must register as an investment adviser.
Once a broker-dealer handles wrap fee accounts, it loses the exclusion from the definition of investment adviser. Therefore, the firm must be registered with either the state or the SEC. Any agents handling these accounts would be registered as investment adviser representatives.
- Under the Uniform Securities Act, when must a consent to service of process be filed with the Administrator?
- With the original application and renewal
- It need not be filed, unless requested by the Administrator
- With the original application only
- When a case is pending
Correct answer: With the original application only
Initial applications for registration must be accompanied by a consent to service of process. This document becomes a permanent part of the application and appoints the Administrator to accept subpoenas on behalf of the applicant.
- Which of the following is NOT included in Form ADV Part 2A?
- The methods of analysis or strategy the adviser uses in trading
- The types of investments the adviser picks or sells for clients
- The states where the adviser is registered or plans to register
- The fees or other charges the adviser collects from its clients
Correct answer: The states where the adviser is registered or plans to register
Part 2A of Form ADV is the brochure delivered to clients, and it describes the adviser's fees and compensation, its methods of analysis and investment strategies, and the types of investments it recommends. The list of states in which the adviser is registered or intends to register is not part of the brochure; that information appears in Part 1, which is a regulatory filing rather than a client disclosure document.
- An investment adviser (IA) has its primary office in State A. They have branches in states B and C, and they advertise in states D, E, and F. What net capital requirements must they meet?
- Whichever state is the highest
- Where its principal office is located
- The state where the largest number of its clients reside
- All the states combined
Correct answer: Where its principal office is located
The Administrator of every state, other than State A, follows the rule that every investment adviser that has its principal place of business in a state other than his state need maintain only the minimum capital as required by the state in which the investment adviser maintains its principal place of business, provided the investment adviser is licensed in that state (State A) and is in compliance with that state's minimum capital requirement.
- A firm is registered as an investment adviser under the Investment Advisers Act of 1940. It has decided to raise its annual management fee from $1,500 to $1,800 and require that it be paid 1 year in advance instead of quarterly. The firm would
- Need SEC permission to make this change
- Be in violation of the law that prohibits pre-payments more than 6 months in advance
- Now come under the requirement to include a balance sheet as part of its brochure
- Continue doing business as before because the firm was already charging more than $1,200 per year
Correct answer: Now come under the requirement to include a balance sheet as part of its brochure
For federal covered investment advisers, a prepayment in excess of $1,200 and for periods of 6 months or more in advance (substantial prepayment) requires the adviser to submit an annual audited balance sheet as part of its ADV Part 2 (and brochure). Previously, even though the firm's fee was in excess of $1,200, because it was collected on a quarterly basis, the firm did not fall under the balance sheet rule. Had this been a state-registered IA, the answer would have been the same, even though the dollar limit is $500 rather than $1,200. That is for the reason given above—the former fee was charged quarterly and the substantial prepayment definition requires both exceeding a stated dollar amount ($500 or $1,200) and it being for 6 months or more in advance.
- Long-Term Financial Solutions, Inc. (LTFSI), an investment adviser registered in five states, files a Form ADV-W indicating the business is closing. It is being acquired by another federal covered adviser, Gold and Sylver Advisers, LLC. Which of the following statements is correct?
- Gold and Sylver will not have to amend their Form ADV Part 1 until the filing of their annual updating amendment.
- LTFSI is responsible for ensuring that a copy of the LTFSI corporate charter is preserved for at least three years after the acquisition.
- As the successor firm, Gold and Sylver Advisers must keep copies of the LTFSI corporate charter for at least three years after LTFSI’s acquisition.
- Gold and Sylver must notify all clients of LTFSI that their advisory contracts have been assigned.
Correct answer: LTFSI is responsible for ensuring that a copy of the LTFSI corporate charter is preserved for at least three years after the acquisition.
When an investment adviser ceases to exist, either through going out of business or being succeeded by another firm (as is the case here), it is their responsibility to ensure that articles of incorporation, charters, minute books, and stock certificate books of the investment adviser and of any predecessor be preserved until at least three years after termination of the enterprise. Although it is true the contracts have been assigned to the successor firm (Gold and Sylver), the consent for that had to be obtained by LTFSI. A change of this nature requires prompt amendment to the Form ADV Part 1.
- If a federal covered adviser's fiscal year ends on October 31, 2017, it must file its annual updating amendment to its Form ADV no later than
- January 29, 2018
- December 31, 2017
- March 30, 2018
- February 28, 2018
Correct answer: January 29, 2018
The annual updating amendment to Form ADV must be filed within 90 days of the adviser's fiscal-year end.
- With regard to the keeping of records, the Uniform Securities Act states that investment advisers must keep records for
- 5 years
- 3 years, the first 2 in the principal office of the adviser
- 5 years, the first 2 in the principal office of the adviser
- 3 years
Correct answer: 5 years, the first 2 in the principal office of the adviser
For state-registered investment advisers, records must be kept for a total of 5 years. For the first 2 of those years, they must be located in the principal office of the adviser.
- An adviser always inquires into her clients' investment objectives, financial situations, and needs. The investment adviser is
- Determining whether she has any inherent conflicts of interest with her clients
- Violating her ethical obligation regarding confidentiality of client information
- Obtaining the information required to fulfill her professional obligation regarding suitability
- Giving herself an unethical advantage regarding how much the client can afford to spend on an advisory fee
Correct answer: Obtaining the information required to fulfill her professional obligation regarding suitability
Investment advisers are under a professional obligation to inquire into a client's investment objectives, financial situation, and needs, and to make recommendations consistent with that information. Conflicts of interest would not arise based on an individual client's suitability profile. Conflicts of interest result from actions of the adviser, regardless of the needs of the client.
- If an investment adviser uses a client questionnaire to determine a client's financial situation, the adviser is
- Acting ethically, as the information is necessary to determine the suitability of recommendations
- Acting correctly to determine if a conflict of interest exists
- Acting unethically, as client information is confidential
- Acting unethically, as this information may be used to determine how large an advisory fee to charge
Correct answer: Acting ethically, as the information is necessary to determine the suitability of recommendations
Advisers must make reasonable inquiry into the client's needs, investment objectives, and financial situation to make suitable recommendations. Advisers must keep client information confidential and not disclose the information to any third party without the client's consent. Conflicts of interest must be disclosed, but that is not the reason for obtaining client information. The adviser's fee may be based on the services performed, advice provided, and/or assets under management, but not on the client's financial situation.
- An investment adviser would be least likely to gather financial planning information about a client from
- A 2-hour lunch meeting
- A detailed financial planning questionnaire
- The client’s Tweets
- An hour-long WhatsApp chat
Correct answer: The client’s Tweets
There are a number of ways to gather information about your client's financial resources, but it is highly unlikely that a social media page would be one of them.
- An individual owns assets worth $500,000 and has debts of $300,000. What is the individual's net worth?
- $300,000.00
- $500,000.00
- $800,000.00
- $200,000.00
Correct answer: $200,000.00
An individual's net worth equals the individual's assets minus his liabilities. Therefore, if someone has assets of $500,000 and debts of $300,000, the person's net worth is $200,000.
- From your meetings with Avery, you realize there is a tendency to follow the actions of a larger group of people when making financial decisions. It makes no difference if those actions are rational or not. Choose the behavioral finance theory that explains Avery's behavior.
- Confirmation bias
- Herding
- Anchoring
- Overconfidence
Correct answer: Herding
This is an excellent example of herding (following the herd). Confirmation bias is the tendency to pay attention to information that supports one's preconceived opinions, while disregarding accurate, unsupportive information. Overconfidence occurs when investors consider their abilities to be much better than they actually are. Anchoring occurs when a person makes an irrational decision based on information that should have no influence on the decision.
- Which of the following is the least significant consideration in making an investment recommendation to a client?
- Age
- Investment objectives
- Net worth
- Education
Correct answer: Education
When making suitable investment recommendations, agents must take the client's age, net worth, and investment objectives into consideration. A client may not have a college education, but may be more sophisticated financially than someone holding a PhD in English literature.
- An investment adviser is eligible to register with the SEC if it
- It expects to reach $100 million under management over the next 120 days
- It would otherwise be required to register in at least 10 further states
- It has more than 100 people who serve as its own adviser representatives
- It has advised more than 15 individual clients during the past 12 months
Correct answer: It expects to reach $100 million under management over the next 120 days
An adviser is eligible for SEC registration once it has $100 million in assets under management, and an adviser that reasonably expects to reach that level within 120 days may register now rather than waiting. The multistate exception applies to an adviser that would have to register in fifteen or more states, not ten. Neither the number of investment adviser representatives a firm employs nor the number of clients it has advised has any bearing on eligibility for SEC registration.
- A state-registered investment adviser suddenly incurs a liability that materially affects its net worth, causing it to drop below the required minimum. Which of the following statements is TRUE?
- It must notify the Administrator right away once it learns of the shortage
- It must notify the Administrator before the close of the next business day
- It must increase its surety bond by enough to cover the reported shortfall
- It must file an amendment to that registration within the next thirty days
Correct answer: It must notify the Administrator before the close of the next business day
The NASAA model rule sets a specific deadline rather than the usual prompt notice standard: an investment adviser whose net worth falls below the required minimum must notify the Administrator by the close of business on the next business day. A report of its financial condition follows by the close of business on the day after that. Increasing the surety bond does not cure a net worth deficiency, and there is no thirty day amendment window for this event.
- USAAdvisers is registered in 10 Midwest states. Regarding financial requirements, USAAdvisers must meet those of
- The state in which its principal office is located
- The SEC
- Each state in which it has a place of business
- The state with the most stringent financial requirements
Correct answer: The state in which its principal office is located
Unlike broker-dealers, investment advisers register with either the SEC or the state(s), but never both. Therefore, we know this must be a state-registered adviser not under the jurisdiction of the SEC. Under the Uniform Securities Act, when it comes to financial requirements, bonding, recordkeeping, and so forth, as long as the adviser meets the requirements of the state in which the principal office is located, the other states have no further claim.
- Under the Uniform Securities Act, which of the following statements relating to the registration requirements of investment advisers is TRUE?
- An amendment takes effect fifteen days after it is filed with the Administrator
- A registration expires one year after its effective date unless it gets renewed
- A registration takes effect thirty days after the mailing and not after receipt
- A registration takes effect at noon on the thirtieth day without pending denial
Correct answer: A registration takes effect at noon on the thirtieth day without pending denial
A registration becomes effective at noon on the thirtieth day after the application is filed, provided no denial order or stop order proceeding is under way, and the Administrator may set an earlier date. The clock runs from the day the application reaches the Administrator's office, not from the day the applicant mails it, so counting from the mailing is wrong. Filing an amendment starts the waiting period over and the amended registration becomes effective thirty days later, not fifteen. Registrations of securities professionals run to December 31 and must be renewed then, rather than expiring one year after they took effect.
- A federal covered investment adviser is a person
- Registered under, or excluded by the exclusions in, the Uniform Securities Act
- Registered under, or excluded by the exclusions in, the Exchange Act of 1934
- Registered with, or excluded by the rules of, the Administrators Association
- Registered under, or excluded by the definition in, the Advisers Act of 1940
Correct answer: Registered under, or excluded by the definition in, the Advisers Act of 1940
A federal covered investment adviser is one that is registered under the Investment Advisers Act of 1940 or is excluded from that act's definition of investment adviser. Registration under a state's Uniform Securities Act is state registration and is what federal covered status displaces. The Securities Exchange Act of 1934 governs broker-dealers and the markets, not adviser status. Advisers register with the SEC or with the states; the North American Securities Administrators Association is a membership body for regulators and takes no registrations.
- Under the Uniform Securities Act, which of the following must register with the state securities Administrator?
- Advisers to a mutual fund that is registered under the Investment Company Act
- Advisers keeping a place of business in the state managing under $100 million
- Advisers that are holding $100 million or more in the assets under management
- Advisers without an office in the state whose clients are all insurance firms
Correct answer: Advisers keeping a place of business in the state managing under $100 million
An investment adviser that maintains a place of business in the state and has less than 100millioninassetsundermanagementisastateregisteredadviserandmustregisterwiththeAdministrator,whoeveritsclientshappentobe.Anadvisertoaregisteredinvestmentcompanyandanadvisermanaging100 million or more are federal covered advisers, which register with the SEC and only notice file with the state. An adviser with no office in the state whose only clients are insurance companies is not an investment adviser in that state at all.
- Which of the following is required to register as an investment adviser with the state securities Administrator?
- The author of a book on money and banking that was sold to residents of the state in which it is published
- A person with no office in the state whose only advisory clients are investment companies and banks in the state
- A newly formed investment advisory firm with $145 million in assets under management
- An investment advisory firm that opens an office in the state with less than $100 million in assets under management
Correct answer: An investment advisory firm that opens an office in the state with less than $100 million in assets under management
An investment adviser must register in a state if it manages less than $100 million in assets. Publishers of general circulation books are exempt from state registration, as are advisers with no offices in the state whose only customers are institutions, such as banks and investment companies, in the state. Investment advisers with $110 million or more in assets under management must register with the SEC, not the state Administrator.
- Under the Uniform Securities Act, if not denied, an application for registration as investment adviser will generally become effective how soon after filing?
- 15 days
- 30 days
- 10 days
- Immediately
Correct answer: 30 days
If not denied and no disciplinary proceedings are instituted, an application for registration becomes effective at noon on the 30th day after being filed.
- Peterson Financial Planning is a small personal financial planning partnership in Missouri that has $10 million in assets under management. As a result of the Dodd-Frank Act, which of the following statements best describes the registration requirement for Peterson Financial Planning?
- Peterson Financial Planning is required to register as an investment adviser with the SEC but has no requirement to register with the Administrator of the Missouri Department of Securities.
- Peterson is required to register as an adviser with both the SEC and the Administrator of the Missouri Department of Securities.
- Peterson Financial Planning is required to register as an adviser with the Administrator of the Missouri Department of Securities.
- Peterson Financial Planning is required to register as an investment adviser with the SEC and to notify the Administrator of the Missouri Department of Securities of its operation.
Correct answer: Peterson Financial Planning is required to register as an adviser with the Administrator of the Missouri Department of Securities.
With less than $25 million under management, Peterson Financial Planning is considered a "small" investment adviser and must register with the state. Advisers managing at least $25 million but less than $100 million are considered "mid-size" investment advisers and, unless qualifying for an exception, must also register with the state. Investment advisers with at least $100 million in AUM, but not $110 million, register with the SEC or the state. Once the $110 million level is reached, SEC registration is mandatory.
- Create A Large Legacy (CALL), Inc., is a state-registered investment adviser with offices in States X, Y, and Z. CALL currently does not have a place of business in State W, but does have 5 retail clients who are residents there. Opening an account for which of the following prospective clients domiciled in State W would now require CALL to register in State W?
- An insurance firm that opens an account with a balance of $750,000
- A trust for four minor children holding total assets of $5 million
- A county in this state seeking advice on $250,000 of surplus funds
- An employee benefit plan that now holds total assets of $2 million
Correct answer: A trust for four minor children holding total assets of $5 million
Institutional clients do not count toward the de minimis limit, and insurance companies, banks, government instrumentalities such as a county, and employee benefit plans holding at least $1 million are all institutional regardless of the amount involved. A personal trust set up for four minor children is a retail client no matter how large it is, because it is not an employee benefit plan. Adding one retail client to the five the firm already has in State W carries it past the de minimis limit of five and requires registration there.
- A person may NOT engage in business as an investment adviser in a state unless
- The person is registered as an investment adviser or is otherwise exempt
- The person is organized as a family corporation or a limited partnership
- The person is registered as a broker-dealer or as an investment agent
- The person is hired by investment companies or by employee benefit plans
Correct answer: The person is registered as an investment adviser or is otherwise exempt
The Uniform Securities Act makes it unlawful to transact business as an investment adviser in a state unless the person is registered there or qualifies for an exemption or exclusion from registration. The form of the business is irrelevant; an adviser may be a sole proprietorship, a partnership or a corporation. Registration as a broker-dealer is a separate matter and does not authorize advisory business. An adviser whose only clients are registered investment companies or large employee benefit plans may well be federal covered or excluded, but that is one route to exemption rather than the general rule the statute states.
- Under the NASAA Model Rule on financial requirements for investment advisers, unless an exception exists, investment advisers who have discretionary powers but NOT custody of customer funds are usually required to have a net worth in the amount of
- $10,000.00
- $5,000.00
- $50,000.00
- $35,000.00
Correct answer: $10,000.00
The NASAA Model Rule on financial requirements for investment advisers, unless an exception exists, requires an adviser who does not have custody of customer funds or securities but has discretionary power over customer accounts to have a minimum net worth of $10,000.
- Kapco Advisers, a federal covered investment adviser operating on a calendar-year basis, published a list of recommended securities in January 2015. A copy of this must be maintained until at least
- December 31, 2020
- January 31, 2020
- January 31, 2017
- December 31, 2017
Correct answer: December 31, 2020
Investment adviser records, including copies of advertisements, must be kept for at least 5 years from the end of the fiscal year in which the record originated—in this case, 5 years from the end of 2015.
- On April 15, ABC Advisers, Inc., made application for registration as an investment adviser with State X. Absent a denial or stop order, registration will become effective
- May 1
- April 30
- April 15
- May 15
Correct answer: May 15
If no denials or stop orders are in effect and no proceedings are pending to do so, registration automatically takes effect at noon on the 30th day after the application was filed.
- Under the Uniform Securities Act, most books and records of investment advisers must be maintained for
- 3 years, the first 2 in the firm’s principal office
- 2 years
- 1 year
- 5 years, the first 2 in the firm’s principal office
Correct answer: 5 years, the first 2 in the firm’s principal office
With few exceptions, the accounting records, correspondence, and advertising of investment advisers must be kept for a minimum of 5 years after the end of the year in which they were created, the first 2 years in the firm's principal office (on premises).
- ABC Advisers changes its name to XYZ Advisers and also changes its location. Under the Investment Advisers Act of 1940, it must
- Amend Form ADV promptly
- Notify FINRA within seven days
- Notify the Administrator
- Amend Form ADV in advance
Correct answer: Amend Form ADV promptly
If information on certain parts of Form ADV becomes out of date, a federal covered adviser must file a prompt amendment with the SEC (a state-registered adviser would have to do the same with the Administrator under the USA). Information requiring immediate amendment includes name, address, telephone number, organization type changes (corporation, sole proprietorship, and partnership), degree of control over clients' funds, sources of funding, management organization, or any information relating to disclosure to clients. If any other information on the form changes (nonmaterial information), the SEC requires the form to be amended within 90 days of the end of the adviser's fiscal year.
- Judy is in the business of giving general investment advice, suggesting appropriate asset allocation percentages, but not recommending specific securities. George's business model is giving investment advice and recommending specific securities. Assuming that both receive compensation, who must register as an investment adviser under the Uniform Securities Act?
- Both
- Neither
- Only Judy
- Only George
Correct answer: Both
Two of the 3 critical elements in the definition of investment adviser are whether the person provides advice regarding securities and receives compensation for doing so. (The third element is "being in the business" and the question states that both are). Even without recommending specific securities, the fact that Judy suggests asset allocation percentages constitutes investment advice. Both Judy and George provide advice regarding securities for compensation and must register, unless specific exemptions apply.
- Each of the following statements about postregistration provisions is true EXCEPT
- A correcting amendment to the Form ADV must be filed with the Administrator if any information filed becomes inaccurate or incomplete
- The securities Administrator does not have the authority to conduct an onsite examination of an investment adviser registered in his state if the adviser does not have an office in that state
- A registered investment adviser may be required to file advertisements
- Investment advisers must comply with recordkeeping rules
Correct answer: A correcting amendment to the Form ADV must be filed with the Administrator if any information filed becomes inaccurate or incomplete
Administrators have the authority to conduct an onsite examination of a registered investment adviser, even if there is no place of business maintained in the Administrator's state. Under the Act, Administrators may require the filing of advertising used by broker-dealers and investment advisers, who must also comply with certain recordkeeping requirements and file correcting amendments.
- MidWest Advisory Services has $175 million in assets under management and has offices in 10 Midwest states. Regarding recordkeeping requirements, MidWest must meet those of
- The SEC
- The state with the most stringent financial requirements
- Each state in which it has a place of business
- The state in which its principal office is located
Correct answer: The SEC
With $175 million in AUM, MidWest is a federal covered adviser. As such, all financial requirements, bonding, recordkeeping, and so forth requirements are those of the SEC, not any of the states.
- According to the Investment Advisers Act of 1940, the SEC must either grant investment adviser registration or begin proceedings to determine whether registration should be denied within how many days of filing?
Correct answer: 45
The SEC is required by the Investment Advisers Act of 1940 to either grant an adviser registration or begin proceedings to determine whether the registration should be denied within 45 days of application.
- Under the Uniform Securities Act, all of the following are exempt from state registration as investment advisers EXCEPT
- Publishers of financial publications that are not addressed to clients' specific individual investment situations
- Financial planners who provide fee-based investment advisory services to clients
- Investment advisers with no office in the state who only advise employee benefit plans with assets of more than $1 million
- Investment adviser representatives
Correct answer: Financial planners who provide fee-based investment advisory services to clients
Financial planners who provide fee-based investment advisory services to the public generally must register with their state securities Administrator, as long as their total assets under management are less than $100 million. Investment advisers with no office in the state, who only advise employee benefit plans with assets of more than $1 million, need not register with state securities Administrators. Investment adviser representatives do not register as investment advisers but as investment adviser representatives. Financial publishers who do not publish specific investment advice are exempt from state registration.
- A state-registered investment adviser with discretionary authority over client accounts discovered on Monday, that the firm's net worth is below the required amount. He must notify the administrator and then file a report no later than the
- Close of business Monday, close of business Friday
- Close of business Monday, close of business Wednesday
- Close of business Tuesday, close of business Friday
- Close of business Tuesday, close of business Wednesday
Correct answer: Close of business Tuesday, close of business Wednesday
Unless otherwise exempted, every investment adviser registered or required to be registered under the Act shall by the close of business on the next business day notify the Administrator if such investment adviser's net worth is less than the minimum required. After transmitting such notice, each investment adviser shall file by the close of business on the next business day a report with the Administrator of its financial condition.
