Chapter 5 - Other Managed Products

Question 1

Which of the following companies issue a fixed number of shares in their initial public offering?

I. Closed end companies
II. Open end companies
III. REITS
A) I and III only
B) I and II only
C) I, II and III
D) II and III only

Answer 1

Correct Answer:
A) I and III only

Answer Explanation
Closed end companies and REITS issue a fixed number of shares in their initial public offering. Open end companies issue shares continually through an ongoing primary offering.

Textbook Reference
Please see textbook section 5.1.2

Question 2

All of the following are characteristics of limited partners in a limited partnership EXCEPT
A) Passive role in management of the partnership
B) Right to receive a share of losses and income from the partnership
C) Limited liability
D) The right to bind the partnership into legal contracts

Answer 2

Correct Answer:
D) The right to bind the partnership into legal contracts

Answer Explanation
Limited partners cannot execute or bind contracts on behalf of the partnership. That role belongs to the general partner. Limited partners have limited liability in return for their passive role in managements. They receive a proportionate share in the losses and gains of the partnership based on the units they own.

Textbook Reference
Please see textbook section 5.2.3

Question 3

An investment in a private equity fund
A) Is not subject to registration and disclosure requirements under the Securities Act of 1933
B) Is most likely owned by accredited and institutional investors and not retail investors
C) Is highly liquid
D) Is considered a relatively low-risk investment

Answer 3

Correct Answer:
B) Is most likely owned by accredited and institutional investors and not retail investors

Answer Explanation
Private equity is subject to registration and disclosure requirements of the Securities Act of 1933. Sold to mostly accredited investors and institutional investors, it is often not accessible to retail investors because of the high dollar investment minimums, lack of liquidity, and long-term time horizons. Private equity is considered relatively high risk because of the high underperformance risk of many startup companies.

Textbook Reference
Please see textbook section 5.4.2

Question 4

All of the following statements about the structure of a REIT are true EXCEPT
A) REITs must be jointly owned by a minimum of 100 persons
B) REITS must have a minimum of 90% of their total assets invested in real estate
C) REITS must have transferable interests
D) REITS must be set up as a corporation

Answer 4

Correct Answer:
B) REITs must have a minimum of 90% of their total assets invested in real estate

Answer Explanation
REITS are required to have a minimum of 75% of their asset invested in real estate and must derive at least 75% of their gross income from rents or mortgages. Except q

Textbook Reference
Please see textbook section 5.1.1

Question 5

All of the following statements about hedge fund investments are true EXCEPT
A) They usually employ a high degree of leverage to magnify returns
B) They have highly aggressive trading strategies
C) They are inappropriate for most retail investors
D) If a hedge fund goes bankrupt the investors have the potential to lose more than their investment

Answer 5

Correct Answer:
D) If a hedge fund goes bankrupt the investors have the potential to lose more than their investment

Answer Explanation
The legal structure of a hedge fund protects investors from losing more than their investment in the event of bankruptcy. They are typically established as limited partnerships or limited liability companies or offshore corporations.

Textbook Reference
Please see textbook section 5.3

Question 6

A hedge fund that does not disclose the investments it will make, giving full authority to the fund manager, is called a
A) Discretionary pool
B) Self-directed
C) Blind pool
D) Blank check fund

Answer 6

Correct Answer:
C) Blind pool

Answer Explanation
A blind pool hedge fund permits the fund manager to make the determination of how assets will be invested. The investments that will be made are not disclosed.

Textbook Reference
Please see textbook section 5.3.2

Question 7

Hedge funds are best suited for sophisticated and institutional investors for all of the following reasons EXCEPT
A) Their investment strategies are narrowly defined and highly complex
B) They often require minimum investments of $100,000 or more
C) They may have long periods of illiquidity
D) There is often a lack of transparency into their trading practices

Answer 7

Correct Answer:
A) Their investment strategies are narrowly defined and highly complex

Answer Explanation
The investment strategies of hedge funds are typically not narrowly defined. Instead the fund managers are given a broad range of authority to invest in numerous types of assets and employ complex trading strategies and high degrees of leverage to magnify returns. These factors limit their suitability for typical investors. Hedge funds are generally appropriate for sophisticated and institutional investors that are qualified to understand these risks.

Textbook Reference
Please see textbook section 5.3.4

Question 8

REITs are required to distribute what percentage of their net income to shareholders?
A) 0.75
B) 1
C) 0.5
D) 0.9

Answer 8

Correct Answer:
D) 0.9

Answer Explanation
To qualify as a REIT, a U.S. company must distribute at least 90% of its net income to shareholders as dividends.

Textbook Reference
Please see textbook section 5.1.1

Question 9

A limited partner may be liable for which of the following?

I. Lawsuits against the limited partnership
II. A share of recourse debt
III. Losses of invested principal
IV. Unlimited losses of the partnerships
A) I and II
B) I and IV
C) II and III
D) III and IV

Answer 9

Correct Answer:
C) II and III

Answer Explanation
Limited partners may lose their invested principal and may be responsible for their share of the recourse debt of the partnership. The general partner is responsible for lawsuits against the partnership and unlimited losses of the partnership.

Textbook Reference
Please see textbook section 5.2.3

Question 10

An exchange-traded note is a combination of which two of the following?

I. a bond
II. a pool of commodities
III. a derivative
IV. a pool of real estate
A) III and IV
B) II and III
C) I and III
D) II and IV

Answer 10

Correct Answer:
C) I and III

Answer Explanation
An ETN combines a bond for the protection of principal with a derivative to boost returns.

Textbook Reference

Question 11

A share of a REIT has a current NAV of $10.00. The NAV is

I. The per share market value of the company’s assets as of the date of the initial public offering
II. The per share measure of the market value of the company’s net assets
III. The price investors will receive when they sell REIT shares
IV. Not necessarily the price investors will receive when they sell REIT shares
A) II and III
B) I and IV
C) II and IV
D) I and III

Answer 11

Correct Answer:
C) II and IV

Answer Explanation
The NAV of a REIT is the per share measure of the market value of the company’s assets. Shares trade on exchanges at a discount or premium based on market supply and demand. Investors will receive the market value when shares are sold.

Textbook Reference
Please see textbook section 5.1.2

Question 12

With regard to investment options and management of LGIPs, all of the following statements are true EXCEPT
A) Stable value LGIPs strive to maintain a constant net asset value per share of $1.00.
B) LGIP investment managers are often paid from a fee based on the assets under management
C) Full liquidity and return of principal is guaranteed to investors in LGIP securities
D) Some LGIPs invest in longer term securities to provide investment growth potential

Answer 12

Correct Answer:
C) Full liquidity and return of principal is guaranteed to investors in LGIP securities

Answer Explanation
As with mutual fund and other equity investments, there is no guarantee that LGIPs will be fully liquid or will not suffer loss of principal. There are stable value LGIPs that strive to maintain a net asset value of $1.00 per share like money market mutual funds, but there is no guarantee to investors. Investment managers of LGIPs are typically paid from a fee charged based on the assets under management.

Textbook Reference
Please see textbook section 5.6.1.1

Question 13

Which two of the following statements about hedge fund regulation are TRUE?

I. They are subject to the Investment Company Act of 1940
II. They are exempt from the Investment Company Act of 1940
III. Large hedge funds must usually register with the SEC
IV. They are usually exempt from the Investment Advisors Act of 1940
A) II and III
B) I and IV
C) II and IV
D) I and III

Answer 13

Correct Answer:
A) II and III

Answer Explanation
Hedge funds are different than most packaged products because they are exempt from the Investment Company Act of 1940 if they follow limitations on the number and types of purchasers. This allows then much greater flexibility in trading strategies and operations. The Investment Advisors Act of 1940 requires that large hedge fund advisors register with the SEC while smaller funds are registered and regulated by the states.

Textbook Reference
Please see textbook section 5.3.1

Question 14

Which two of the following characteristics apply to structured products?

I. Unlimited upside potential with downside protection
II. Limited upside potential with downside protection
III. Limited liquidity
IV. High degree of liquidity
A) I and III
B) II and III
C) I and IV
D) II and IV

Answer 14

Correct Answer:
B) II and III

Answer Explanation
Structured products offer a limit on downside risk. The tradeoff for this protection is a limit on the upside potential. Structured products are not highly liquid. Secondary market trading is limited – they are generally held until maturity.

Textbook Reference
Please see textbook section 5.5

Question 15

Equity REITS offer the potential for all of the following EXCEPT
A) Market transparency
B) Inflation hedging
C) Liquidity
D) Interest income paid on a monthly basis

Answer 15

Correct Answer:
D) Interest income paid on a monthly basis

Answer Explanation
Equity REITs do not produce interest income. They pay dividends to investors that represent their proportionate share of the rental income and capital appreciation earned by the portfolio. Because they trade on exchanges, they offer liquidity and transparency. Real estate is also a natural hedge against inflation, and has historically appreciated at a rate that exceeds the rate of inflation.

Textbook Reference
Please see textbook section 5.1.6

Question 16

Which of the following would have the smallest impact on the share price of an OTC listed REIT?
A) Lack of liquidity
B) Market conditions
C) Pending mortgage applications
D) Occupancy rates

Answer 16

C) pending mortgage applications

Answer Explanation
An OTC REIT would be impacted by lack of liquidity, occupancy rates, and general market conditions. Pending mortgage applications would not have a significant influence on the shares of an OTC REIT.

Textbook Reference
Please see textbook section 5.1.3

Question 17

Limited Partnership interests are typically regulated
A) as private contracts
B) as securities, under federal and state laws
C) as securities, under state law only
D) as insurance products, under state law

Answer 17

B

Answer Explanation
Limited partnership interests are considered securities and are subject to SEC registration and state blue sky laws.

Textbook Reference
Please see textbook section 5.2

Question 18

Which of the following REITS generate revenues from rental income off properties held by the REIT?

I. Equity REITs
II. Mortgage REITS
III. Hybrid REITS
A) I, II, and III
B) I and III only
C) I only
D) II and III only

Answer 18

B

Answer Explanation
Equity REITs and hybrid REITs both own and rent properties that generate revenue from rental income.

Textbook Reference
Please see textbook section 5.1.4

Question 19

Advantages of structured products include which two of the following?

I. Highly liquid
II. Potential for stronger returns in a low-yield market
III. Limited downside exposure
IV. High degree of transparency
A) I and III
B) II and III
C) II and IV
D) I and II

Answer 19

B

Answer Explanation
Advantages of structured products include their upside potential with downside protection that is limited or guaranteed. They can help produce yield in a low rate environment because of the options and derivative strategies they employ. They are often complex, and are not known for their transparency. Liquidity is also limited.

Textbook Reference
Please see textbook section 5.5.1

Question 20

Which two of the following characteristics best describe LGIPS?

I. They are equity securities
II. They are debt securities
III. They were established to provide an investment option for escrow accounts and sinking funds
IV. They were established as a safe and liquid investment option for cash held by municipal entities
A) I and IV
B) II and III
C) I and III
D) II and IV

Answer 20

A

Answer Explanation
LGIPs are equity securities like mutual funds. Investors own a proportionate share of the investment pool which can be managed by government employees or an external investment firm. They were established to provide safe, liquid and competitive investment options for cash held by municipalities.

Textbook Reference
Please see textbook section 5.6.1

Question 21

All of the following would likely cause a share of a REIT to trade at a discount EXCEPT
A) A decline in property values
B) A decrease in the demand for the shares of the REIT
C) A decrease in demand for new space
D) A reduction in vacancy rates

Answer 21

D

Answer Explanation
A reduction in vacancy rates means that there is a lower supply of available buildings. When the supply is reduced, there is greater demand, which drives the price up. A reduction in vacancy rates would be likely to cause the share of a REIT to trade at a premium. Declining demand for space, declining property values, and decreasing demand for REIT shares would all be likely to cause REIT shares to trade at a discount.

Textbook Reference
Please see textbook section 5.1.2

Question 22

LGIPs and firms which distribute them are exempt from which of the following regulations?

I. Registration and prospectus requirements under the Securities Act of 1933
II. Anti-fraud Rules of the Securities Exchange Act of 1934
III. MSRB Rules
IV. Investment Company Act of 1940
A) II and IV
B) II and III
C) I and II
D) I and IV

Answer 22

D) I and IV

Answer Explanation
Although Local Investment Government Pool Securities function very much like mutual funds, they are not subject to registration and prospectus requirements under the Securities Act of 1933 or the rules that define open end and closed end investment companies under the Investment Company Act of 1940. These securities and firms that sell them are subject to all rules of the MSRB and also to the anti-fraud requirements under the Securities Exchange Act of 1934.

Textbook Reference
Please see textbook section 5.6.1.2

Question 23

Are hedge funds required to register with the SEC?
A) Yes, if they manage private funds with more than $150 million in assets
B) Yes, if they have more than 35 investors
C) All hedges must register, except those operated for the exclusive benefit of family offices.
D) No, because they are exempt from registration under US securities law

Answer 23

A

Answer Explanation
The Dodd–Frank Wall Street Reform Act of 2010 added provisions designed to increase transparency and disclosure in hedge funds. Hedge funds that manage private funds with more than $150 million in assets must register with the SEC.

Textbook Reference
Please see textbook section 5.3.1

Question 24

Which of the following statements is correct?
A) ETFs own the securities in their portfolio, whereas ETNs do not, as they are unsecured debt instruments.
B) ETNs own the securities in their portfolio, whereas ETFs do not, as they are unsecured debt instruments.
C) Both ETNs and ETFs have ownership interests in specified securities in their respective portfolios.
D) Neither ETNs nor ETFs own any securities in their investment portfolios.

Answer 24

A

Answer Explanation
There are securities owned and held in the portfolio of an ETF. An ETN is an unsecured debt instrument of an issuer.

Textbook Reference
Please see textbook section 5.5.1.1

Question 25

All of the following statements about private equity investments are true EXCEPT
A) Investors play a passive role in the investment selections
B) The payoff in private equity firm occurs when a firm is sold or goes public
C) Private equity funds are typically invested in public companies
D) Most funds are raised from institutional and accredited investors

Answer 25

C

Answer Explanation
Note that this is an EXCEPT question. Private equity funds are usually invested in private companies. The payoff for the investment occurs when the firm goes public or is sold.

Textbook Reference
Please see textbook section 5.4

Question 26

A REIT is not required to pay tax on the gains it passes through to investors, if it distributes
A) the majority of gains earned in any tax year.
B) all gains related to completed property sales.
C) 90% of its gains to shareholders.
D) an equal amount of its gains and losses.

Answer 26

C

Answer Explanation
If a REIT passes through 90% of its gains to shareholders, it is not required to pay tax on the amount it passes through.

Textbook Reference
Please see textbook section 5.1.5

Question 27

The document that identifies the general partner and the roles of limited partners in a limited partnership is the
A) Sharing Arrangement
B) Certificate of Limited Partnership
C) Partnership Agreement
D) Subscription Agreement

Answer 27

C

Answer Explanation
A limited partnership’s partnership agreement identifies the general partner and the roles of the limited partners.

Textbook Reference
Please see textbook section 5.2.2

Question 28

An investor who purchases an exchange-traded note may expect to receive an interest payment
A) On a quarterly cycle.
B) If there has been appreciation in the underlying security.
C) Whenever the underlying security pays a dividend.
D) If the board of directors of the underlying security declares a dividend to holders of record.

Answer 28

B

Answer Explanation
An exchange-traded note may make an interest payment to an investor if there has been appreciation in the underlying security. If the underlying security has declined in value, the investor will only receive his principal returned at the instrument’s maturity.

Textbook Reference
Please see textbook section 5.5.1

Question 29

Some of the largest universities in the United States are investing 10% or more of their endowments in private equity funds. What do their investment objectives tend to be?
A) Long-term capital appreciation and diversification
B) Current income and liquidity
C) Safety and liquidity
D) Tax-sheltered growth and income

Answer 29

A

Answer Explanation
Private equity funds are long-term investments that may require holding periods of 10 years or more, and their main objective is capital appreciation. A second objective is diversification, and this is achieved in two ways. Over time, private equity funds can produce different streams of returns than stocks and bonds. They also help investors diversify among the majority of companies in the US that are not public.

Textbook Reference
Please see textbook section 5.4.2

Question 30

A city wishes to take advantage of liquidity and professional management in the investment of excess funds. An investment that is appropriate for this purpose is
A) VRDO.
B) LGIP.
C) BAB.
D) COP.

Answer 30

B

Answer Explanation
Local Government Investment Pools (LGIPS) are formed by states to give local governments a money market like option for investment of excess funds.

Textbook Reference
Please see textbook section 5.6.1

Question 31

The composition of an exchange-traded note is usually a
A) Stock and a bond
B) A bond and an option
C) Mutual fund and an option
D) A stock and an option

Answer 31

B

Answer Explanation
An exchange-traded note is typically comprised of a bond, for principal protection, plus an option, for equity exposure.

Textbook Reference
Please see textbook section 5.5.1

Question 32

A type of investment that offers freely tradeable shares and limited liability, along with certain tax benefits, is a(n)
A) Preferred shares in a blue-chip company
B) Convertible debenture
C) Hedge fund
D) Master limited partnership

Answer 32

D

Answer Explanation
A master limited partnership combines the tax benefits of a limited partnership with the liquidity of a publicly traded security.

Textbook Reference
Please see textbook section 5.2.6

Question 33

Cash dividends paid on common shares held for fewer than 60 days are
A) taxable to individuals but not to other corporations
B) taxable as a capital gain
C) exempt from state tax but subject to federal income tax
D) taxable as ordinary income

Answer 33

D

Answer Explanation
Cash dividends on stock are taxable as ordinary income if the stock is held for fewer than 60 days. If held for greater than 60 days, it is taxed at a preferential rate.

Textbook Reference
Please see textbook section 5.1.6

Question 34

An unregulated investment fund that can engage in a variety of investment strategies is known as a(n)
A) endowment
B) mutual fund
C) money market fund
D) hedge fund

Answer 34

D

Answer Explanation
Hedge funds are unregulated investment vehicles that use one or more investment strategies with the aim of generating substantial returns to investors. Investors in hedge funds are generally accredited investors.

Textbook Reference
Please see textbook section 5.3.1

Question 35

Which of the following types of REITs is most likely to generate interest income for investors?
A) Balanced REIT
B) Equity REIT
C) Mortgage REIT
D) Hybrid REIT

Answer 35

C

Answer Explanation
Mortgage REITs pass through interest that has been earned on mortgages in the portfolio as income to investors.

Textbook Reference
Please see textbook section 5.1.4

Question 36

A representative is considering the recommendation of a limited partnership interest to a customer seeking portfolio diversification. The recommendation of a partnership interest should be based on
A) The overall economic benefit of owning the partnership interest, including the income and the potential for appreciation of the assets held by the partnership
B) All of these reasons are equally important in making a suitable recommendation of a limited partnership interest
C) Its ability to generate substantial tax losses to shelter income if the client is in a high tax bracket
D) The potential for the partnership to pass through income tax credits and expense deductions to offset earnings from other successful investments

Answer 36

A

Answer Explanation
An interest in a limited partnership should be judged on its economic merits, not its tax benefits. Of primary importance in making a suitable recommendation of a limited partnership interest are its potential to generate income and appreciation of the assets it holds.

Textbook Reference
Please see textbook section 5.2

Question 37

The management and performance fees received by a hedge fund manager are
A) usually higher than the fees charged for other types of funds.
B) always guaranteed by the investment committee of the fund.
C) never less than the weighted average returns of the stock market over a 90- day period.
D) typically lower than the same fees paid on other fund classes.

Answer 37

A

Answer Explanation
Hedge fund managers receive management and performance fees which are typically higher than the fees charged for other types of funds.

Textbook Reference
Please see textbook section 5.3.2

Question 38

Who pays income taxes on profits earned by a limited partnership?
A) The general partner
B) The partnership
C) It depends on how the partnership is structured
D) All partners

Answer 38

D

Answer Explanation
All profits and losses are distributed to individual partners and reported to the IRS on personal income tax returns. The partnership files only an “information return,” called a Schedule K-1, with the IRS.

Textbook Reference
Please see textbook section 5.2.5

Question 39

Mortgage REITs offer investors the potential for all of the following EXCEPT
A) An ownership interest in properties held within the portfolio
B) Dividends that are paid each year
C) The opportunity to participate in the recovery of housing markets and overall economic growth
D) A steady income stream

Answer 39

A

Answer Explanation
Mortgage REITs offer an ownership interest in mortgages held within a portfolio, not the actual properties. Investors in mortgage REITs own shares that pay relatively high dividends, which provide an income stream to investors. Because mortgage REITs provide financing for homeowners and commercial entities, investors help support the recovery of housing markets and overall economic growth.

Textbook Reference
Please see textbook section 5.1.4

Question 40

In order to qualify under “pass through” rules, REITS must do which two of the following?

I. Derive at least 75% of their income from dividends, interest and property income
II. Derive at least 90% of their income from dividends, interest and property income
III. Distribute at least 75% of their taxable income to shareholders as dividends
IV. Distribute at least 90% of their taxable income to shareholders as dividends
A) I and III
B) II and IV
C) I and IV
D) II and III

Answer 40

C

Answer Explanation
To qualify for the pass through of income under IRS rules, REITs must derive at least 75% of their income from dividends, interest and property income, and distribute at least 90% of their taxable income to shareholders as dividends

Textbook Reference
Please see textbook section 5.1.1

Question 41

Hedge fund managers generally employ lock up periods for all of the following reasons EXCEPT
A) To keep lower amounts of cash on hand
B) To provide greater investment flexibility
C) To commit to investments that are not liquid
D) To close the fund to new investors

Answer 41

D

Answer Explanation
A lock up period is not used to prohibit new investment into a hedge fund. Instead, it limits liquidity by imposing a time frame during which investors cannot withdraw assets. This allows the fund to pursue higher returns by limiting the amount of cash on hand, facilitating investment in illiquid assets, and permitting greater overall investment flexibility.

Textbook Reference
Please see textbook section 5.3.3.1

Question 42

The procedure for dissolving a limited partnership is defined by
A) federal law.
B) the applicable state statute.
C) the partnership agreement.
D) nothing, because limited partnerships have continuous life.

Answer 42

C

Answer Explanation
The dissolution date and procedures for dissolving a limited partnership are established by the partnership agreement, which both general and limited partners must sign.

Textbook Reference
Please see textbook section 5.2.4

Question 43

Registered hedge fund investment managers

I. Are always required to register under the Investment Company Act of the 1940
II. Are generally exempt from registration under the Investment Company Act of the 1940
III. Have fiduciary duty to manage assets on behalf of fund investors
IV. Are exempt from anti-fraud provisions of the Securities Exchange Act of 1934
A) II and III
B) II and IV
C) I and IV
D) I and III

Answer 43

a) II and III

Answer Explanation
Hedge fund managers are typically exempt from registration under the Investment Company Act of 1940. However, most have fiduciary responsibility for the management of fund assets and are subject to the anti-fraud provisions of the Securities Exchange Act of 1934.

Textbook Reference
Please see textbook section 5.3

Question 44

To qualify for favorable income tax treatment, a REIT must distribute what percentage of its taxable income to shareholders?
A) At least 50%
B) At least 90%
C) At least 75%
D) 100%

Answer 44

B) At least 90%

Answer Explanation
REITS are required to distribute at least 90% of their taxable income to shareholders. By doing so, they qualify for pass-through tax status – i.e., no income tax at the REIT level.

Textbook Reference
Please see textbook section 5.1.5

Question 45

A pre-packaged security that was created to meet specific investor needs that cannot be met from standardized financial instruments available in the market describes a(n)
A) Investment Program
B) Asset Allocation Ladder
C) Derivative
D) Structured Product

Answer 45

D) Structured Product

Answer Explanation
There is no single uniform definition of structured products. They are simply a pre-packaged, often customized investment strategy. Structured products are based on derivatives, and can be linked to the performance of baskets of securities, options, indices, commodities, loans, debt issuances and/or foreign currencies, and swaps.

Textbook Reference
Please see textbook section 5.5

Question 46

A Real Estate Investment Trust (REIT) is a security that is categorized as a(n)
A) type of direct participation program (DPP).
B) Real estate limited partnership.
C) neither an investment company nor a direct participation program (DPP).
D) Investment company portfolio.

Answer 46

C

Answer Explanation
A Real Estate Investment Trust is legally structured as a trust; it is not a type of investment company or direct participation program.

Textbook Reference
Please see textbook section 5.1

Question 47

Which two of the following characteristics apply to structured products?

I. Unlimited upside potential with downside protection
II. Limited upside potential with downside protection
III. Limited liquidity
IV. High degree of liquidity
A) II and IV
B) I and III
C) II and III
D) I and IV

Answer 47

C) II and III

Answer Explanation
Structured products offer a limit on downside risk. The tradeoff for this protection is a limit on the upside potential. Structured products are not highly liquid. Secondary market trading is limited – they are generally held until maturity.

Textbook Reference
Please see textbook section 5.5

Question 48

An advantage of investing in a public REIT for a retail investor is that
A) The investor can choose to an own an interest in specific properties that are held by the REIT
B) There is liquidity and pricing transparency similar to that of publicly traded stock.
C) The SEC has approved them for sale
D) An investor will not lose principal value

Answer 48

B

Answer Explanation
REIT investors own a share of all the real estate properties that are held in the portfolio. Public REITs trade on exchanges so there is liquidity and pricing transparency for investors. Investors are subject to loss of principal. The SEC does not approve or disapprove investments, even if the securities are registered. The SEC releases them for sale and ensures that enough information is available to investors to make sound investment decisions.

Textbook Reference
Please see textbook section 5.1.3

Question 49

Which of the following is a key difference between a limited partnership (LP) and a master limited partnership (MLP)?
A) An MLP hires professional managers to act as general partners
B) An LP has more favorable tax treatment
C) An LP has more liquidity
D) An MLP is exchange-traded and has more easily transferable interests

Answer 49

D

Answer Explanation
MLPs are publicly offered limited partnership, and they usually are traded on exchanges, with large numbers of limited partners and freely transferable interests.

Textbook Reference
Please see textbook section 5.2.6

Question 50

An investment opportunity that allows investors to hold an ownership interest in real property in many locations and in many economic sectors is a
A) Mortgage backed security
B) Commodity fund
C) Equity REIT
D) GNMA

Answer 50

C

Answer Explanation
An equity REIT allows investors to own a proportionate interest in a portfolio of real estate properties in a variety of locations and sectors for a modest investment. REITs are viewed as a valuable portfolio diversification investment.

Textbook Reference
Please see textbook section 5.1.4

Question 51

All of the following are characteristics of limited partners in a limited partnership EXCEPT
A) The right to bind the partnership into legal contracts
B) Limited liability
C) Right to receive a share of losses and income from the partnership
D) Passive role in management of the partnership

Answer 51

A

Answer Explanation
Limited partners cannot execute or bind contracts on behalf of the partnership. That role belongs to the general partner. Limited partners have limited liability in return for their passive role in managements. They receive a proportionate share in the losses and gains of the partnership based on the units they own.

Textbook Reference
Please see textbook section 5.2.3

Question 52

Why are most direct participation programs (DPPs) structured as limited partnerships or limited liability companies?
A) To enable large amounts of investors to participate
B) To give limited partners the same voting rights as equity shareholders
C) To increase share liquidity for investors
D) To offer pass-through tax benefits to investors

Answer 52

D

Answer Explanation
DPPs usually are structured as a limited partnership or limited liability companies to offer tax pass-through benefits to investors. This avoids double taxation on distributions to investors.

Textbook Reference
Please see textbook section 5.2.5

Question 53

All of the following statements are true regarding private REITS EXCEPT
A) They are sold to public, accredited and institutional investors
B) They lack liquidity
C) They do not trade in the public markets
D) They are exempt from many disclosure requirements under the Securities Act of 1933

Answer 53

A

Answer Explanation
Because they are exempt from disclosure requirements under the Securities Act of 1933, private REITs (aka private placement REITs) cannot be traded publically.

Textbook Reference
Please see textbook section 5.1.3

Question 54

Investment advantages that can be provided by equity REITs include all of the following EXCEPT
A) Asset class diversification
B) The potential to reduce portfolio volatility
C) A low performance correlation to other assets like stock and bonds
D) A pass through of losses that can shelter other investment income

Answer 54

D

Answer Explanation
Equity REITS do not pass through losses to investors, so do not function as tax shelters. They offer investors a unique asset class that has a low correlation to others like stock and bonds. Real estate investments respond to market conditions differently than other types of investments so help reduce portfolio volatility.

Textbook Reference
Please see textbook section 5.1.1

Question 55

Which two of the following statements regarding hedge fund registration are TRUE?

I. Hedge funds of less than $100 million in assets must register with the SEC
II. Hedge funds of more than $150 million in assets must register with the SEC
III. Hedge funds are exempt from the Investment Company Act of 1940
IV. Hedge funds are exempt from the Investment Advisors Act of 1940
A) I and IV
B) II and III
C) II and IV
D) I and III

Answer 55

B

Answer Explanation
Hedge funds are subject to the Investment Advisors Act of 1940 due to heightened regulatory requirements established by the Dodd Frank Wall Street Reform Act. Hedge funds with more than $150 million in assets must register with and are regulated by the SEC; those with assets of $100 million or less must register with and are regulated by the states.

Textbook Reference
Please see textbook section 5.3.1

Question 56

Which of the following statements regarding a REIT is true?
A) It is an investment vehicle that pass through income and losses to investors.
B) It is a type of direct participation program (DPP) that gives investors access to a broad range of real estate assets.
C) It may be a publicly traded investment product that passes through income but not losses to investors.
D) It is a mostly illiquid investment that pass through losses to investors.

Answer 56

C

Answer Explanation
A Real Estate Investment Trust (REIT) is an investment vehicle legally structured as a trust, not a DPP. The trust passes through income to investors, but not losses. Many REITs are liquid investments, meaning they can be traded on securities exchanges. This is an important distinction to make when comparing an REIT to a DPP.

Textbook Reference
Please see textbook section 5.2

Question 57

An investment in a private equity fund
A) Is most likely owned by accredited and institutional investors and not retail investors
B) Is considered a relatively low-risk investment
C) Is highly liquid
D) Is not subject to registration and disclosure requirements under the Securities Act of 1933

Answer 57

A

Answer Explanation
Private equity is subject to registration and disclosure requirements of the Securities Act of 1933. Sold to mostly accredited investors and institutional investors, it is often not accessible to retail investors because of the high dollar investment minimums, lack of liquidity, and long-term time horizons. Private equity is considered relatively high risk because of the high underperformance risk of many startup companies.

Textbook Reference
Please see textbook section 5.4.2

Question 58

A limited partner in a limited partnership may engage in which of the following?
A) An active operations role in the day-to-day management of the partnership
B) An exercise of the partnership democracy
C) The admission of additional limited partners through a review of subscription agreements
D) Responding to a lawsuit on behalf of the limited partnership

Answer 58

B

Answer Explanation
Limited partners are not permitted to play an active role in the management of the partnership. If they overstep their passive role, they risk the loss of limited liability. Responding to lawsuits and accepting new limited partners are responsibilities of general partners.

Textbook Reference
Please see textbook section 5.2.3

Question 59

The type of REIT that loans money to help purchase property or purchases other forms of property indebtedness from other lenders is a(n)
A) Equity REIT
B) Agency REIT
C) Mortgage REIT
D) Hybrid REIT

Answer 59

C

Answer Explanation
Mortgage REITs loan money for mortgages to buyers of real estate and also purchase existing mortgages or mortgage-backed securities from other lenders.

Textbook Reference
Please see textbook section 5.1.4

Question 60

A general partner in a limited partnership is prohibited from
A) Loaning money to a limited partnership
B) Holding an interest of more than 5% in the partnership
C) Competing with the partnership through another entity for personal gain
D) Raising capital through recourse loans

Answer 60

C

Answer Explanation
General partners cannot engage in conflicts of interest with the partnership they manage. Competing directly for personal gain with the partnership is a prohibited conflict of interest. GPs may loan money to their partnership, but may not borrow from the partnership. They must hold a minimum interest of 1% in the partnership but are not prohibited from holding a larger interest.

Textbook Reference
Please see textbook section 5.2.3

Question 61

Passive income is earned from which of the following?

I. Partnership interests in which no active management role is assumed
II. Portfolio income
III. A part-time business performed outside of business hours which an individual manages
A) I and II only
B) I, II, and III
C) II and III only
D) I only

Answer 61

D) I only

Answer Explanation
The IRS defines three main categories of income: active income, passive income and portfolio income. Passive income does not include earnings from wages or active business participation, nor does it include income from dividends, interest or capital gains.

Textbook Reference
Please see textbook section 5.1

Question 62

Which of the following statements about REITs is TRUE?
A) Investors may purchase common shares in a REIT, but not preferred stock or debt securities
B) A REIT must distribute at least 90% of its taxable income to investors in the form of dividends
C) REITS are issued through private placements only
D) REITs do not trade in the secondary market

Answer 62

B

Answer Explanation
REITS are required to distribute at least 90% of their taxable income in the form of dividends. REITs issue securities through public offerings and private placements, and their securities trade in the secondary markets. They may issue common shares, preferred shares and debt securities.

Textbook Reference
Please see textbook section 5.1.1

Question 63

With regard to investment options and management of LGIPs, all of the following statements are true EXCEPT
A) LGIP investment managers are often paid from a fee based on the assets under management
B) Some LGIPs invest in longer term securities to provide investment growth potential
C) Full liquidity and return of principal is guaranteed to investors in LGIP securities
D) Stable value LGIPs strive to maintain a constant net asset value per share of $1.00.

Answer 63

C

Answer Explanation
As with mutual fund and other equity investments, there is no guarantee that LGIPs will be fully liquid or will not suffer loss of principal. There are stable value LGIPs that strive to maintain a net asset value of $1.00 per share like money market mutual funds, but there is no guarantee to investors. Investment managers of LGIPs are typically paid from a fee charged based on the assets under management.

Textbook Reference
Please see textbook section 5.6.1.1

Question 64

Which of the following companies issue a fixed number of shares in their initial public offering?

I. Closed end companies
II. Open end companies
III. REITS
A) I, II and III
B) I and III only
C) I and II only
D) II and III only

Answer 64

B) I and III only

Answer Explanation
Closed end companies and REITS issue a fixed number of shares in their initial public offering. Open end companies issue shares continually through an ongoing primary offering.

Textbook Reference
Please see textbook section 5.1.2

Question 65

Limited partnership interests which are sold without specific definition of the assets that are held are

I. blind pool programs
II. blank check programs
III. More risky than other LP investments
IV. Less risky of LP investments
A) II and IV
B) II and III
C) I and III
D) I and IV

Answer 65

C) I and III

Answer Explanation
Blind pool programs are limited partnerships that don’t define the assets that are held. Because investors don’t know what they are getting into they have higher risk.

Textbook Reference
Please see textbook section 5.2

Question 66

Which of the following business structures allows for pass through of losses to investors?
I. Limited partnerships
II. Subchapter S corporations
III. Limited liability corporations
A) II and III only
B) I and III only
C) I only
D) I, II, and III

Answer 66

d) I, II, and III

Answer Explanation
Limited partnerships, Subchapter S corporations, and limited liability corporations are all structures that allow for pass through of both gains and losses to investors. These structures allow “direct participation” by investors

Textbook Reference
Please see textbook section 5.2

Question 67

Most hedge funds are offered to investors through
A) A Secondary offering
B) A private placement
C) A shelf offering
D) An IPO

Answer 67

B) A private placement

Answer Explanation
Hedge funds are sold through private placements to accredited and institutional investors. They are exempt from the SEC registration process for public offerings.

Textbook Reference
Please see textbook section 5.3.1

Question 68

Features of ETNs include all of the following EXCEPT
A) An owner of an ETN holds equity securities with voting rights
B) ETNs can be liquidated prior to maturity by selling them on an exchange or to the issuer
C) Unlike ETFs or mutual funds, investors in ETNs do not receive an annual distribution
D) ETNs have a maturity date and are backed only by the credit of the issuer

Answer 68

A

Answer Explanation
ETNs are debt notes that are unsecured and backed by the credit of the issuer. They are designed to blend some of the features of ETFs with debt securities, and track performance of market indices to yield profits for investors. ETNs are traded on major exchanges, but investors can also hold these debt securities until maturity. They are considered more tax efficient than mutual funds or ETFs because there is no annual distribution of capital gains from the fund. Gains or losses are realized only when the investment is sold.

Textbook Reference
Please see textbook section 5.5.1

Question 69

An investor would like to purchase a basket of equity securities with performance linked to a broad market index. The investor also prefers the option of intra-day marketability. Which of the following securities is most appropriate for this investor?
A) ELK
B) ETN
C) Mutual fund
D) ETF

Answer 69

D) ETF

Answer Explanation
Exchange Traded Funds (ETF) are funds that trade like a stock. ETFs combine popular features of stock/bonds and mutual funds. Like a mutual fund, an ETF is a collection of stocks or bonds. And like a stock, ETFs can be purchased or sold throughout the day as long as the market is open. Certain ETFs track the performance of an index and keep costs to owners relatively low because of minimal trading of the securities that comprise the fund.

Textbook Reference
Please see textbook section 5.5.1

Question 70

A limited partner in a limited partnership is prohibited from
A) Accepting a proportionate share of the recourse loans of the partnership
B) Receiving a share of partnership losses
C) Investing partnership assets
D) Inspecting the books and records of the limited partnership

Answer 70

C) Investing partnership assets

Answer Explanation
The investing of partnership assets is a role of the general partner. A limited partner that attempts to take this responsibility is no longer a passive investor. In this case, the limited partner becomes fully liable for the debts of the partnership like the general partners. Limited partners are permitted to inspect the books and records, sue the GP, receive a share of partnership distributions, and take on a proportionate share of the recourse debt of the partnership.

Textbook Reference
Please see textbook section 5.2.1

Question 71

An exchange-traded note is a type of
A) Secured corporate bond
B) Municipal bond
C) Unsecured corporate debt
D) Mutual fund

Answer 71

C) Unsecured corporate debt

Answer Explanation
An exchange-traded note is a type of unsecured corporate debt.

Textbook Reference
Please see textbook section 5.5.1

Question 72

Which of the following trading strategies that is used heavily by hedge funds can typically not be used by mutual funds?
I. Short selling
II. Leverage
III. Investment in illiquid securities
A) I, II and III
B) III only
C) I and II only
D) II and III only

Answer 72

A) I, II, and III

Answer Explanation
While hedge funds are free to use a wide combination of trading strategies, mutual funds typically cannot sell short, use leverage or invest in highly illiquid securities.

Textbook Reference
Please see textbook section 5.3.5

Question 73

A structured product is best defined as which of the following?
A) A trust that owns and operates real estate related assets
B) A funding pool raised from retail and institutional investors for investment in equity positions in high potential companies
C) A professionally managed investment company that offers exchange traded interests in a pool of securities
D) An investment product that produces a return based on the performance of one or more underlying securities

Answer 73

D

Answer Explanation
Structured products produce a return based on the performance of one or more underlying securities. Market linked CDs and structured notes are common examples of structured products.

Textbook Reference
Please see textbook section 5.5

Question 74

A limited partner may be liable for which of the following?

I. Lawsuits against the limited partnership
II. A share of recourse debt
III. Losses of invested principal
IV. Unlimited losses of the partnerships
A) II and III
B) I and IV
C) I and II
D) III and IV

Answer 74

A) II and III

Answer Explanation
Limited partners may lose their invested principal and may be responsible for their share of the recourse debt of the partnership. The general partner is responsible for lawsuits against the partnership and unlimited losses of the partnership.

Textbook Reference
Please see textbook section 5.2.3

Question 75

Arrange the steps that are followed in the liquidation of a limited partnership from first to last.

I. General creditors are paid
II. Secured claims are paid
III. General partners receive their share of profits and contributed capital
IV. Limited partners receive their share of profits and contributed capital
A) II, I, III, IV
B) IV, III, II, I
C) I, II, III, IV
D) II, I, IV, III

Answer 75

D) II, I, IV, III

Answer Explanation
The order of liquidation of a limited partnership is as follows:
I. Secured lenders
II. General creditors
III. Limited partners profits
IV. Limited partners return of contribution
V. General partner fees
VI. General partner share of profits
VII. General partner return of contributed capital

Textbook Reference
Please see textbook section 5.2.4

Question 76

A conflict of interest exists in a real estate limited partnership if the general partner

I. receives compensation from the partnership
II. borrows from the partnership
III. owns or leases property adjacent to property of the partnership
IV. is involved in more than one real estate limited partnership
A) III and IV
B) I and II
C) II and III
D) I and III

Answer 76

C) II and III

Answer Explanation
A general partner must avoid conflicts of interest with the partnership. The general partner cannot borrow from the partnership and, if it is a real estate limited partnership, cannot compete with the partnership by purchasing or leasing adjacent property.

Textbook Reference
Please see textbook section 5.2.3