Winning 65

Question 1

The Form 8-K

Answer 1

used to report significant events of importance to investors

Form 8-K must be filed with the SEC no later than four business days after the event

Question 2

The Form 10-K

Answer 2

company’s annual filing and that is due, depending on the size of the company, 60 to 90 days after the end of the fiscal year.

Question 3

Standard deviation

Answer 3

Measures security’s volatility versus its own historical performance.

Question 4

Wrap fee

Answer 4

Wrap fee disclosure documents must be filed with the Administrator.
Nonmaterial changes filed with the within 90 days of fiscal year end.
The disclosure document must contain the information required by Appendix 1 of Form ADV Part 2A.
flat fee account

Question 5

Net redemptions

Answer 5

The number of shares being liquidated by investors exceeds those being purchased

annual expenses /average annual assets

Question 6

Brady Bond is

Answer 6

Common is zero-coupon US Treasuries, selected to mature at roughly the same time as the specific Brady Bond. An investor purchasing a Brady with collateralized principal knows that at maturity, a third-party paying agent will receive a payment from the US Treasury that will be used to repay the principal on the Brady issue. In the event of default, the bondholder will receive the principal collateral on the maturity date.

Question 7

Safe harbor under 404(c)

Answer 7

In order to qualify for the safe harbor under 404(c), the portfolio selections must include at least three different asset classes, such as equity, debt, and cash equivalent.

Question 8

Treasury bills

Answer 8

All Treasury securities are issued in book entry form. Treasury bills are always issued at a discount and are never callable.

Question 9

Formula for the cash flow from operations

Answer 9

The most common formula for the cash flow from operations computation is net income plus the depreciation expense taken for the year.
net income plus the depreciation expense

Question 10

ODD

Answer 10

options disclosure document (ODD)

at or before account approval

Question 11

Agent transfers employment from a broker-dealer registered with the SEC

Answer 11

the agent, the former broker-dealer, and the current broker-dealer must all notify the Administrator.

Question 12

Income tax filing due date

Answer 12

For partnership, LLCs, S corporation returns March 15. C corporations, April 15th for a calendar-year filer.

Question 13

Futures

Answer 13

Futures contracts are traded on exchanges and, therefore, have standardized terms.

Question 14

Forwards

Answer 14

In forwards, the terms of each contract are separately negotiated.

Question 15

The price-to-earnings ratio PE

Answer 15

The 2 components of the price-to-earnings ratio are the current market price and the earnings per common share. When a company has a high P/E ratio, it means that investors are placing greater value on expected growth in earnings.
The price-earnings (PE) ratio is a valuation ratio used to calculate the value of a stock. For example, if a stock has a PE of 20, it means that the security is priced at 20 times earnings.

Question 16

Rights offering

Answer 16

Rights offerings are usually very short-lived (30 to 45 days). The subscription price is below the current market value. It is issued to current stockholders. The rights are marketable.

Question 17

Government National Mortgage Association (GNMA)

Answer 17

Government National Mortgage Association (GNMA) obligations are mortgage-backed securities that pass-through principal and interest and are backed by the U.S. government. However, the interest is taxed on all levels; federal, state and local.

Question 18

Government National Mortgage certificates

Answer 18

Government National Mortgage certificates carry higher interest rates than U.S. Treasury securities because of prepayment or reinvestment risk.

Question 19

The Federal National Mortgage Association (FNMA

Answer 19

The Federal National Mortgage Association (FNMA) is a publicly held corporation that provides mortgage capital in much the same fashion as GNMA. However, Fannie Maes are backed by the general credit of the FNMA and not by the full faith and credit of the U.S. government,

Question 20

The Federal Intermediate Credit Banks (FICBs)

Answer 20

The Federal Intermediate Credit Banks (FICBs) lend money to credit companies, agricultural institutions, and commercial banks which in turn lend the money to farmers.

Question 21

A large-cap growth fund

Answer 21

A large-cap growth fund is the most appropriate choice for a moderate-risk client because large capitalization stocks are generally less volatile than small-cap stocks and provide long-term capital growth

Question 22

Dodd-Frank Act of 2010

Answer 22

Pension consultant’s AUM reaches $200 million, it has the choice of 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.

Question 23

Form ADV Part 2 as its brochure = Advisory Contract

Answer 23

The Investment Adviser Registration Depository (IARD) is an electronic filing system that facilitates investment adviser registration, regulatory review, and the public disclosure information of investment adviser firms. The IARD is used for filing Form ADV Parts 1 and 2.

Question 24

Debt-to-equity ratio

Answer 24

Financial leverage is the use of debt capital. The best way to see the extent to which that exists is through the debt-to-equity ratio.

Question 25

Modern portfolio theory (MPT)

Answer 25

Instead of emphasizing particular stocks, modern portfolio theory (MPT) focuses on the relationships among all the investments in a portfolio. This theory holds that specific risk can be diversified away by building portfolios of assets whose returns are not correlated.

Question 26

Depreciation

Answer 26

The basic computation for cash flow is net income plus depreciation expense for that year.
expense items increases a company’s cash flow

Question 27

Alternative minimum tax

Answer 27

Originally created as part of the Tax Reform Act of 1969, the alternative minimum tax (AMT)
The IRS requires middle- and high-income taxpayers to run two sets of numbers when filing income taxes: the regular income tax calculations on Form 1040 and the AMT method on Form 6251. Whichever number is higher is the amount the taxpayer must pay.

Question 28

A stock’s Market capitalization

Answer 28

A stock’s market capitalization is determined by multiplying the price per share times the number of outstanding common shares. For example, if a company had 1 billion shares outstanding and the market price was $20 per share, the company would be said to have a market cap of $20 billion.

price per share times X outstanding common shares

Question 29

The current yield of a callable bond selling at a premium is calculated:

Answer 29

As a percentage of its Current market value.

Question 30

Liquidity ratios

Answer 30

Liquidity ratios measure a firm’s ability to meet its current financial obligations and include the current ratio and acid-test (quick) ratio.

Question 31

Debt/equity ratio = Capitalization ratio

Answer 31

the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company’s overall capital structure.

Question 32

Coverdell Education Savings Accounts

Answer 32

Coverdell Education Savings Accounts allow after-tax contributions of up to $2,000 per student, per year, for children until their 18th birthday. If the accumulated value in the account is not used by age 30, the funds must be distributed and subject to income tax and a 10% penalty, or rolled over into a different Coverdell ESA for another family member.

Question 33

Assessable stock

Answer 33

Assessable stock issued below its par or stated value.

The issuer and/or creditors have the right to assess the shareholder for the deficiency. All stock issued today is nonassessable.

Question 34

Bond’s current yield

Answer 34

annual interest/market price.

Question 35

Form 13(f)

Answer 35

institutional money manager,
$100 million in discretionary
45 days of the end of the quarter.

Question 36

General obligation bond

Answer 36

A general obligation bond is backed by the full taxing authority of the municipality that issued it

Question 37

Revenue bond

Answer 37

A revenue bond depends on the income or revenue from a specific facility to ensure payment to bondholders.

Question 38

Collateral trust bonds and collateralized mortgage obligations

Answer 38

Collateral trust bonds and collateralized mortgage obligations are both types of secured bonds.

Question 39

Risk-free portfolio

Answer 39

Risk elimination can be achieved if two securities with a perfect negative correlation are combined. That is, when one goes up, the other goes down by the same amount. In other words, one is the antipode of the other. –1.0

Question 40

Interest-rate sensitive

Answer 40

Utility and preferred stocks are the most interest-rate sensitive. Utility stocks are interest-rate sensitive because they are highly leveraged. Preferred stocks are interest-rate sensitive because they have a set dividend and fluctuate in price like bonds when interest rates change.

Question 41

Family income statement

Answer 41

Income statements reflect the family’s income and expenses, not assets and liabilities. Dividends represent money received and mortgage interest is money paid out. Credit card debt is a liability and autos are assets.

Question 42

Alternate valuation date

Answer 42

The value per share is the value at the date six months after death, unless the property is sold prior.

Question 43

Discounted cash flow

Answer 43

Determines the value of a debt security by adding the present value of the future coupons to the present value of the maturity value

future coupons + maturity value

Question 44

A covered account

Answer 44

Is an account, primarily for personal, family, or household purposes, that involves or is designed to permit multiple payments or transactions.

Question 45

The Form ADV-E (E for surprise Examination)

Answer 45

Must be completed by investment advisers that have custody of client funds or securities
The independent public accountant performing the surprise examination must submit this Form within 120 days of the time chosen by the accountant for the surprise examination

Question 46

Covered security

Answer 46

Common stock listed on the New York Stock Exchange is a covered security as defined in the NSMIA. Furthermore, any security equal to or senior to that common stock is considered to be covered as well. Warrants and rights are equal to the common stock and the preferred stock and mortgage bonds are senior to the common stock.

Question 47

Treasury Inflation Protected Securities (TIPS)

Answer 47

Treasury Inflation Protected Securities (TIPS) adjust the principal value each 6 months to account for the inflation rate. Therefore, the real rate of return will always be the coupon.

Question 48

Internal Rates of Return (IRR)

Answer 48

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.

Question 49

Economic indicators

Answer 49

Increases in building permits are indicative of increased, future business activity - leading economic indicator.
Increases in personal income reflect current, activity - coincident indicator.
Buildup in inventories - lagging economic indicator.

Question 50

Liquidity

Answer 50

Real estate is most illiquid. REITs provide investors with liquidity through trading in the secondary markets. A bond mutual fund is a redeemable security; the issuer provides liquidity. Unit investment trusts are more liquid than real estate because they are redeemable securities.

Question 51

OCC Options Disclosure Document

Answer 51

By providing the owner with an options disclosure document entitled Understanding the Risks and Uses of Options, the broker-dealer satisfies the risk disclosure requirements. There are 2 alternatives for meeting the delivery requirement. It may be done before or at the time the broker-dealer approves that customer’s options account or accepts the customer’s first order to trade the listed options covered by the ODD.

Question 52

Legal entities tax forms

Answer 52

Legal entities that pass through income or loss use the Form K-1
Sole proprietorships generally complete Schedule C of the individual Form 1040,
C corporations are taxed themselves by filing a Form 1120
S corporations file a Form 1120s along with a K-1 for each shareholder).
Limited liability, C corp, S corp 1120
Sole proprietorships Form 1040
Limited liability, S corp 1120 K-1

Question 53

Margin account

Answer 53

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

Question 54

Price-to-book

Answer 54

This ratio shows the relationship between a company’s stock price and the company’s book value.

price per share/ stockholders’ equity per share.

Question 55

Simple & Complex Trust

Answer 55

A simple trust is one that is required to distribute all accounting income in the year earned, has no charitable beneficiaries, and does not distribute principal in the current year. A complex trust is one that is allowed to accumulate income, has a charitable beneficiary, or distributes principal. All trusts are complex in their final year because all principal must be distributed when the trust terminates.

Question 56

The IRS requires that RMDs

Answer 56

The IRS requires that RMDs commence no later than April 1 of the year following the year that the owner turned 70-½ years old. She turned 70-½ on January 16, 2012. Therefore, distributions must commence by April 1, 2013.

Question 57

What generally happens to outstanding fixed-income securities when the rate of inflation slows?

Answer 57

When the rate of inflation slows and is expected to remain stable, coupons on new issue bonds will often decline to offer lower yields. The prices of outstanding bonds will go up to adjust to the lower yields on bonds of similar quality.

Question 58

ETN”s

Answer 58

Exchange-traded notes (ETNs) are unsecured debt securities generally issued by financial institutions such as banks. Prices can be impacted by changes in the issuer’s credit rating, even though the value of the underlying securities has not changed.

Question 59

Quick ratio/acid-test ratio

Answer 59

The quick ratio, sometimes called the acid-test ratio, is computed by taking a company’s
current assets minus the inventory and then dividing that by the current liabilities.

current assets - inventory ( / current liabilities)

Question 60

Not included in the fee disclosure template.

Answer 60

commissions;
markups and markdowns; and
advisory fees for those firms that are also registered as investment advisers.

Question 61

Futures

Answer 61

Among the ways in which futures differ from options is that both parties, long and short, are obligated to execute the contract. At expiration date, if not exercised before, the buyer must purchase at the contract price and the seller must deliver at the contract price. In the case of options, the buyer (long position) is the one who chooses to exercise or not, and it is the seller (short position) who becomes obligated to perform.

Question 62

Incentive stock options

Answer 62

NSOs are treated as ordinary income when exercised while ISOs can result in long-term capital gains if certain holding periods are met.

Question 63

Investment advisory contract

Answer 63

If an advisory firm is formed as a partnership and there is a change in the majority of partners, this is considered to be an involuntary assignment to the new partnership. In this case, client approval is required.
partnership with two partners and adds five partners.

Question 64

How much does the investor pay per share to purchase a Class A share of this fund?

Answer 64

POP = NAV + sales charge.

The investor pays the public offering price (POP) when purchasing mutual fund shares. For a Class A share upon purchase, the POP is the NAV plus the sales charge.

Question 65

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:

Answer 65

The mode of a series of number is that number that has the largest number of occurrences. In this case, 5% appears three 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%).

Question 66

Legal entities

Answer 66

Legal entities that pass through income or loss use the Form K-1 to indicate the amount of that income or loss attributable to the individual shareholder/member/partner. Sole proprietorships generally complete Schedule C of the individual Form 1040, and C corporations are taxed themselves by filing a Form 1120 (S corporations file a Form 1120s along with a K-1 for each shareholder).

Question 67

Holding period return

Answer 67

Holding period return is the total return on an investment over the period it was held. In order to compute this, one must know the income received (dividends) plus any capital appreciation (the difference between the purchase price and the sale price if sold, or current market price if still held). If you read the question carefully, it refers to a security “held” in her portfolio. Therefore, we don’t have a sale date.

Question 68

Market capitalization

Answer 68

A stock’s market capitalization is determined by multiplying the price per share times the number of outstanding common shares. For example, if a company had 1 billion shares outstanding and the market price was $20 per share, the company would be said to have a market cap of $20 billion. This would put it into the category of “la

Question 69

Balance sheet equation

Answer 69

Total assets equal total liabilities plus total shareholders’ equity.

Question 70

Mr. Beale buys 10M 6.6s of 10 at 67. What will his annual interest be?

Answer 70

Interpret “10M” as “$10,000 worth of.” Mr. Beale receives the nominal yield of the bonds, which is 6.6% of $10,000.
$660.00

Question 71

Wrap fee

Answer 71

Wrap fee disclosure documents must be filed with the Administrator and must contain the information required by Appendix 1 of Form ADV Part 2A. Amendments must be filed promptly with the Administrator if the disclosure document becomes inaccurate in any material way. Nonmaterial changes to wrap fee disclosure documents must be filed with the Administrator within 90 days of fiscal year end.

Question 72

After-tax yield

Answer 72

The only return (as far as yield is concerned) is the $500 of dividends. Remember, non-qualifying dividends do not “qualify” for the 15% rate. Subtracting 30% for taxes leaves $350 which, when divided by the $10,000 initial cost, is an after-tax yield of 3.5%. If the question had asked about total return, then the $500 unrealized profit would have been included, although there would have been no tax on it.

Question 73

Risk premium

Answer 73

The risk premium is a premium demanded for internal and external risk factors. It is the amount of total return in excess of the risk-free rate. In this case, the total return is 7% (the dividend return is included in the total) minus the 2% T-bill rate.

Question 74

Current yield on mutual funds

Answer 74

The current yield on mutual funds is calculated by dividing the annualized yield ($.25 × 4 = $1) by the POP. In this case, $1 ÷ $30 = .0333 × 100 = 3.33%. In calculating the current yield, the law prohibits the inclusion of capital gains and growth.

Question 75

Calculate the risk-adjusted return also Sharpe Ratio.
90-day T-bill rate: 4% -
Actual return:14%
Standard deviation 5.0 /

Answer 75

Any question asking about the risk-adjusted return is going to be referring to the Sharpe Ratio. This is shown as a simple number and is calculated by subtracting the risk-free rate (90-day T-bill) from the actual return and dividing that remainder by the standard deviation. In this example, 14%−4% = 10% divided by 5 = 2.

Question 76

Under Section 203A of the Investment Advisers Act of 1940,

Answer 76

Under Section 203A of the Investment Advisers Act of 1940, any IAR with a federal covered adviser who has no place of business in a state is not required to register in that state even when the number of clients they have in a state exceeds the de minimis level. Holding a public seminar on a quarterly basis in the same location would be considered having a place of business in Georgia (even though attendance is limited to Club members only – they are still members of the general public).

Question 77

Current yield on a bond

Answer 77

The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond.

Question 78

Notify the state Administrator of the termination

Answer 78

With more than $110 million in assets under management, Kapco is a federal covered adviser. In that case, the IAR is the one who notifies the Administrator of being terminated.

Question 79

A bond’s duration

Answer 79

Duration measures a bond’s price volatility by weighting the length of time it takes for a bond’s cash flow to pay for itself. If 2 bonds with differing coupon rates have identical maturities, the one with the lower coupon has the longer duration. The cash flow from an interest-bearing bond makes its duration shorter than its maturity. Bonds with longer duration carry greater price volatility. Duration is expressed in years (time) rather than in percentage.

Question 80

Exempt issuers under the Uniform Securities Act

Answer 80

Any state or Canadian province, or political subdivision thereof, is considered an exempt issuer. Foreign governments with whom the United States has diplomatic relations, but not their political subdivisions, are considered exempt issuers. SEC-registered investment companies are non-exempt issuers under the USA. That is, the act does not include them in the list of exempt issuers. However, under the NSMIA, they are federal covered securities and, as such, do not register with the states other than filing a notice. All the more so, hedge funds that are NOT registered with the SEC would not be exempt issuers.

Question 81

Short sale

Answer 81

In a short sale, an investor borrows stock, most commonly from the broker-dealer, to sell at the market. The investor is hoping that the price of the stock will decline. If she is correct, she will have the broker-dealer purchase the stock at the current market price and replace the borrowed stock. The difference between the sale price and the purchase price represents the investor’s profit. Of course, if the price of the stock rises, the replacement cost will be higher than the sale price, resulting in a loss.

Question 82

Dividend Growth Model

Answer 82

The classic definition of the Dividend Growth Model is “a stock valuation model that deals with dividends and their growth, discounted to today”.
the net present value of future dividends.

Question 83

Tax-equivalent yield

Answer 83

The computation for the tax-equivalent yield of a municipal bond is performed by dividing the bond’s coupon rate by (1 − the investor’s tax bracket). If the bond has a coupon of 4% and the investor is in the 20% bracket, the tax-equivalent yield is 4% divided by (1 − .20) or 4% divided by .80 = 5%

Question 84

Federal law

Answer 84

Regulation S-P deals with privacy of customer information for financial institutions. Regulation FD requires public companies to make full disclosure of material information to all investors at the same time.

Question 85

OTC over-the-counter

Answer 85

The OTC market is considered to be a negotiated market in contrast to a stock exchange, which is an auction market.

Question 86

Balance sheet

Answer 86

A balance sheet shows a company’s assets, liabilities, and stockholders’ equity on a specific date.

Question 87

Write a call option

Answer 87

The writing (selling) of an option always generates premium income to the writer. If the call is exercised, the writer must sell the stock so this is not a way to add to your portfolio. In general, option writers only realize short-term gains, not long-term.

Question 88

Leverage

Answer 88

Leverage is the use of borrowed money. This is reflected in a company’s debt to equity ratio. Of these choices, the only one that is borrowed money is the bonds.

Question 89

Stock splits

Answer 89

When a stock splits, the number of shares each shareholder holds increases. However, the value of each share decreases proportionately. The client experiences no effective change in the value of his ownership share.

Question 90

Security generally becomes effective

Answer 90

A registration statement for a security becomes effective 20 days after it is filed, unless the SEC orders a delay.

Question 91

After-tax return

Answer 91

The after-tax return is computed by taking the total return (appreciation plus income) and taking the investor’s tax rate into consideration. The inflation rate is necessary for the inflation-adjusted or real rate of return.

Question 92

Bonds and interest rates

Answer 92

The general rule of thumb is that bonds with long-term maturities will have greater fluctuations in price than will short-term maturities, given the same move in interest rates. Furthermore, discounted bonds, with their lower coupon rates, have a longer duration than a bond selling at a premium and will respond more favorably to falling rates than will those premium bonds. Thus, the 30-year discounted bond will move faster than the others.

Question 93

Simple trust

Answer 93

A simple trust is one that is required to distribute all accounting income in the year earned, has no charitable beneficiaries, and does not distribute principal in the current year. A complex trust is one that is allowed to accumulate income, has a charitable beneficiary, or distributes principal. All trusts are complex in their final year because all principal must be distributed when the trust terminates.

Question 94

Beta

Answer 94

The measurement that compares a stock’s price history to the movement of the total market index for the same period is beta

Question 95

Standard deviation

Answer 95

Standard deviation indicates how much an investment’s returns have fluctuated from its average returns over a period of time,

Question 96

R-squared

Answer 96

R-squared measures whether an investment’s returns tend to go up and down at the same time as the markets

Question 97

Duration

Answer 97

Duration measures how sensitive a bond will be to small changes in interest rates.

Question 98

Positive margin

Answer 98

Positive margin means that you were successful in your use of the leverage afforded by using margin (borrowed money). That means that the investor’s total return exceeds the cost of the borrowed money. It is possible to actually sell the security for a price above its original purchase price, but not more than the total of the cost plus the interest. That would result in negative margin.

Question 99

Advance/decline line

Answer 99

The advance/decline line, which measures the number of stocks that have advanced versus the number of stocks that have declined, is an indicator of the breadth of the market’s advance or decline.

Question 100

Current yield

Answer 100

Current yield is determined by dividing annual interest (coupon) payment by the current market price of the bond ($50 / $900 = 5.6%). Years to maturity is not a factor in calculating current yield
5% coupon

Question 101

Common stock only

Answer 101

Earnings per share and book value per share are computations relevant to common stock only.

Question 102

Keynesians

Answer 102

Keynesians advocate government intervention in the workings of the economy through increased government spending, which in turn increases aggregate demand.

Question 103

Closed-end investment

Answer 103

It is only the closed-end investment company where shares trade at a premium or discount to the NAV per share.

Question 104

Monetarists

Answer 104

Monetarists believe that the economy and inflation are best controlled through the management of the money supply rather than through fiscal policy stimulation.

Question 105

Performance

Answer 105

Unless the portfolio’s performance is better than the extra risk taken, the manager has not beaten the performance benchmark, the S&P 500, on a risk-adjusted basis. Risk-adjusted return is calculated by computing the Sharpe ratio. Total return comprises the yield plus the growth in value of an investment over time and is not related to risk. The expected return is an estimate of the probable return an investment may yield, whereas inflation-adjusted return is the nominal return reduced by the inflation rate. Neither of these returns is related to risk. Inflation-adjusted returns are often compared to a benchmark such as the Consumer Price Index (CPI). Unadjusted rates of return are called nominal rates of return.

Question 106

Regulation S-P

Answer 106

Regulation S-P deals with privacy of customer information for financial institutions.

Question 107

Regulation FD

Answer 107

Regulation FD requires public companies to make full disclosure of material information to all investors at the same time.

Question 108

The expected rate of return

Answer 108

The expected return is computed by taking the probability of each possible return outcome and multiplying it by the return outcome itself. In this example, if you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning 20%, and a 20% chance of earning -10%, the expected return would be equal to 10%:
= (0.4 × 0.1) + (0.4 × 0.2) + (0.2 × -0.1),
= .04 + .08 = .12 − .02,
= 0.10,
= 10%.
You probably will not have to do this calculation on the exam, but you should know the concept.

Question 109

Holding period return (HPR)

Answer 109

To compute holding period return, you calculate the total return for that holding period. Total return combines any dividend income plus appreciation (or minus depreciation).

Question 110

Bond valuations

Answer 110

Bond valuations using discounted cash flow take into consideration the present value of the bond’s future cash flows. That is, the greater the value of the interest payments to be received in the future, the higher the price of the bond. When market interest rates decline, because the coupon rate of the existing bond is fixed, the present value of those interest payments increases, creating a higher value for the bond.

Question 111

Dividend Discount Model

Answer 111

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.

Question 112

Internal rate of return.

Answer 112

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.

Question 113

Current yield

Answer 113

The current yield on a stock is computed by dividing the annual dividend rate by the current market price. With EPS of $2.50 and a 40% payout ratio, the annual dividend is $1.00. This dollar divided by the current market price of $50 results in a current return of 2%.

Question 114

Correlation coefficient

Answer 114

The correlation coefficient ranges from -1.0 to +1.0 and reveals the degree to which two or more variables relate to each other. A high degree of correlation means that the portfolio is not well diversified. Well-diversified portfolios contain some elements of negative correlation. Although a bond portfolio will frequently be diversified by including bonds of varying duration, this question specifies an equity portfolio so correlation is the appropriate choice.

Question 115

Form ADV Part 2

Answer 115

The Form ADV Part 2 (both parts) is acceptable for use as the firm’s brochure. Part 1 is for registration purposes, and Part 1B is only used by state-registered advisers (as this firm is). Part 2, Appendix 1 is used for investment advisers who offer wrap fee programs. As a state-registered investment adviser, SCAM does not file any forms with the SEC.

Question 116

Internal rate of return (IRR)

Answer 116

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

Question 117

When investors tend to increase their investments in debt securities into those on the short end of the spectrum, it generally leads to

Answer 117

Investors buying short-term debt rather than long-term debt will have the effect of driving the prices of short-term instruments up and, as a result, their yields down. This will give us the normal, or positive, yield curve.

Question 118

The formula for computing the combined equity in a mixed margin account is

Answer 118

current market value of the long positions, plus the credit balance in the short account, minus the current market value of the short positions, minus the debit balance in the long account

Question 119

Predictability of income

Answer 119

Discounted cash flow evaluates the expected cash flow from an investment and then factors in the time value of money. Obviously, if there is no predictable cash flow (as there is with the interest payments on a bond), there are no reliable numbers to plug into the formula.

Question 120

To reflect a more accurate picture of economic results, gross domestic product is adjusted:

Answer 120

By adjusting GDP for inflation, one can measure economic activity with less distortion. A constant dollar adjustment is made to remove the effects of inflation.

Question 121

Required minimum distribution (RMD)

Answer 121

The IRS requires that RMDs commence no later than April 1 of the year following the year that the owner turned 70-½ years old. She turned 70-½ on January 16, 2012. Therefore, distributions must commence by April 1, 2013.

Question 122

A portfolio manager is attempting to select securities for one of her clients. Company A has a beta of 0.9 and returned 13% for the year. Company B has a beta of 1.3 and returned 18% for the year. The market return for the year was 14%. Based on alpha, the portfolio manager would likely select

Answer 122

Company A has a slightly positive alpha, while company B’s is slightly negative. Because this question does not include the risk-free rate, the alpha is simply reflecting how the company’s return compared with what one would have expected based on its beta. Company A should have returned 90% of the market return of 14%. That would be 12.6%, and its actual return was 13%, giving it a 0.4% alpha. Company B should have returned 1.3 times the market, or 18.2%. With an 18% return, B had a negative alpha of 0.2%.

Question 123

Given the following information, calculate the risk-adjusted return
90-day T-bill rate: 4%
Actual return:14%
Beta = 1.4
CPI 3%
Standard deviation 5.0

Answer 123

Any question asking about the risk-adjusted return is going to be referring to the Sharpe Ratio. This is shown as a simple number and is calculated by subtracting the risk-free rate (90-day T-bill) from the actual return and dividing that remainder by the standard deviation. In this example, 14%−4% = 10% divided by 5 = 2.

Question 124

When a corporation issues a long-term bond, one of the factors influencing the bond’s interest rate is the credit rating of the issuer. Another factor is the:

Answer 124

Money is a commodity, and its cost is determined by supply and demand. When the cost of money is higher, borrowers incur a higher interest rate. The call loan rate impacts broker-dealers, not issuers of bonds. The par value of the bond has nothing to do with the cost of borrowing and, with almost no exception, all corporate bonds pay taxable interest so that is not a variable factor.

Question 125

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Answer 125

Current assets divided by current liabilities is the current ratio, a ratio that measures the liquidity of a firm. Gross profit divided by net sales is a profitability ratio that measures the gross profitability of the firm’s business operations, not its liquidity. Net income divided by average total equity is the return on stockholders’ equity which measures the efficiency of common shareholders’ investment or equity in the firm. Dividend amount divided by earnings per share is the dividend payout ratio which measures how much of a company’s earnings are distributed to common stockholders.

Question 126

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Answer 126

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.

Question 127

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Answer 127

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 18 years from now 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).

Question 128

Short Sale

Answer 128

In a short sale, an investor borrows stock, most commonly from the broker-dealer, to sell at the market. The investor is hoping that the price of the stock will decline. If she is correct, she will have the broker-dealer purchase the stock at the current market price and replace the borrowed stock. The difference between the sale price and the purchase price represents the investor’s profit. Of course, if the price of the stock rises, the replacement cost will be higher than the sale price, resulting in a loss.

Question 129

Arithmetic mean

Answer 129

The arithmetic mean is the simple average of all of 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%.

Question 130

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Answer 130

Under Section 203A of the Investment Advisers Act of 1940, an investment adviser representative of a covered investment adviser is required to register only in those states in which that IAR maintains a place of business. Even though the firm has a California office, nothing here indicates that Alvin plans to establish one there. If Alvin had been associated with a state-registered IA, then, once the clients had been residents of California for 30 days, Alvin would have to begin counting them towards the 5 in any 12 months de minimis limit which, once exceeded, would require registration as an IAR in CA.