Investments

Question 1

Grandma is in the 35% federal tax bracket. She lives in New York City. She bought EE education bonds for her grandchildren some years ago. All of her grandchildren also live in New York City. If she redeems the bonds for her grandchildren’s education, taxation will be which of the following?
A. The interest will be taxable at federal, state and local rates (her bracket)
B. The interest will be taxable at federal, state, and local rates (her grandchildren’s bracket)
C. The interest will be taxable at federal rates (her bracket)
D. The interest will be taxable at state and local rates (her bracket)
E. The interest will not be taxable

Answer 1

Question 10: C
In order to qualify for the education interest exclusion, the taxpayer generally must be the parent. The grandparent can take the exclusion only if the grandchild is the grandparent’s dependent (cannot make that assumption). At a 35% federal tax bracket, her income exceeds the EE phaseout. The bond’s interest is subject to federal but not state and local taxes.

Question 2

Which of the following instruments is generally used to finance import/export transactions?
A. Euro dollars
B. ADRS
C. Yankee bond
D. Banker’s acceptance

Answer 2

Question 11: D
Banker’s Acceptances are used to provide financial backing for import/export transactions. With maturities not exceeding 270 days, they are money market securities.

Question 3

Which of the following statements correctly describes I bonds?
I. Series I bonds earn interest for up to 30 years.
II. Series I bonds accrue earnings based on both a fixed rate of return and the semiannual inflation rate.
III. The special tax benefits available for education savings with Series EE bonds also apply to Series I bonds.
IV. The difference between the purchase price and the redemption value is taxable interest (redeemed or
matures).
A. All of the above
B. 1, 1I
C. 1, I1, I11
D. II, IV
E. III, IV

Answer 3

Question 12: A
I bond earnings are based on both a fixed rate of return and the semiannual inflation rate. I bonds are taxed the same way EEs are taxed. Like EE bonds, the I bonds earn interest for up to 30 years.

Question 4

Asset
Ownership
Balance
Various Certificates of Deposit
Sarah
100,000
Money Market Deposit Account
Sarah
$50,000
IRA Rollover
Sarah
$200,000
Passbook Savings
Joint with son
$100,000
Checking Account
Joint with daughter
$100,000
Savings Account
Joint with husband
$250,000

How much is currently insured by the FDIC?
A. $725,000
B. $750,000
C. $800,000
D. $825,000

Answer 4

Question 14: C
handled as follows.
Sarah is insured for $150,000 for the CD and money market and $200,000 for the IRA. The joint accounts are
$150,000 single + $200,000 IRA +$225,000 JT + $225,000 JT = $800,000
Remember: Insurance coverage is per titling, not per account.

Question 5

Question 15
Presuming an annual coupon, which of the following bonds produces the highest amount of income per initial cost?
A. 6.5% coupon purchased for $800
B. 7.5% coupon purchased for $850
C. 10% coupon purchased for $1,100
D. 11% coupon purchased for $1,200

Answer 5

Question 15: D
Calculate the current yield for all of the bonds shown:
A. $65 / $800 = 8.13%
B. $75/ $850 = 8.82%
C. $100 / $1,100 = 9.09%
D. $110 / $1,200 = 9.17%

Question 6

Question 4
Assume that Al can choose between buying 100 shares of stock at $300 per share or buying a call option ($300
exercise price) for $20. How much can he lose if the stock falls by 25% and the option expires worthless?
I. If Al buys and sells the stock, he will lose $7,500.
II. If Al buys the option and it expires worthless, he will lose $2,000.
A. Both I and Il
B. I
C. II
D. Neither I nor lI

Answer 6

A. If the option expires worthless for income tax purposes, the option is considered sold (at expiration) and is
treated as a short-term loss to the buyer. $30,000 x .25 = $7,500. The concept is even more important. Al will
lose less money with the option purchase (maximum $300). If he buys the stock, the potential loss is $7,500.

Question 7

Question 9
On July 30th, an XYZ DEC 55 call has a premium of $6½, and XYZ shares are trading at a market price of $58.
Which of the following are true?
1. The call has no intrinsic value.
I1. The call has an intrinsic value of $3.
III. The call has an intrinsic value of $3½
IV. The call has a time value of $3.
V. The call has a time value of $3½
A. ١, ٧
B. II, V
C. III, IV

Answer 7

B. IN = MP (58) - EP (55), 3 points in the money; therefore, it has an intrinsic value of $3. The rest of the premium
represents time premium.

Question 8

If an investor wanted to purchase a mutual fund that would have the lowest correlation with a U.S. common stock fund, which fund would that investor most likely select?
A. A global fund
B. An international fund
C. An emerging market fund
D. A Japan fund
E. A European fund

Answer 8

C. The correlation coefficient between the U.S. large cap market and an emerging markets fund is low.
Emerging markets: Less developed countries
Global: World (including US)
International: Non-U.S./foreign only

Question 9

Which of the following statements about correlation coefficient is true?
I. A negative correlation coefficient will reduce the portfolio risk.
II. A negative correlation coefficient will increase the portfolio risk.
III. A negative correlation coefficient will make the beta negative.
IV. A negative correlation coefficient will increase the portfolio standard deviation.
A. I, III
B. II, III
C. II, IV
D. III, IV
E. I

Answer 9

A. Negative correlation will reduce the overall portfolio beta. The formula for beta includes the correlation coefficient. When correlation coefficient is negative, the beta will be negative.

Question 10

Tim owns two common stocks, Companies A and B. Company A just acquired Company C. The standard deviation of stock A was unchanged by the acquisition. How will the covariance of two stocks (A and B) be affected if the new Company C is negatively correlated to Companies A and B?
A. The covariance remains unchanged
B. The covariance increases
C. The covariance decreases
D. The covariance becomes positive
E. The covariance becomes negative

Answer 10

C. Covariance has a direct relationship to the correlation coefficient. The new acquisition is negatively correlated with both Company A and B. That should reduce the covariance but probably not make it negative. A is weighted at 40% and B is weighted at 40%. They are highly correlated. So, C is negatively correlated but it is only 20% of the total holdings. The weighting is still positive. The standard deviation formula uses weighting.

Question 11

At the beginning of the current year, one U.S. dollar buys 80 Japanese yen. At the end of the year, one U.S. dollar buys 100 Japanese yen. What happened to the U.S. dollar during the current year?
A. The U.S. dollar was revalued
B. The U.S. dollar was devalued.
C. The U.S. dollar was inflated.
D. The U.S. dollar was deflated

Answer 11

Question 13: A
The U.S. dollar was revalued. Revaluation is an increase in the currency’s value.

Question 12

Carlos invests $10,000 (U.S. dollars) in Tex Mex Foods (Mexican Exchange) when the exchange rate is 29 pesos to the dollar. Tex Mex increases in value by 20%. If Carlos sells Tex Mex when the exchange rate is 30 pesos to the dollar, what will he receive in U.S. dollars?
A. $10,900
B. $11,600
C. $12,100
D. $12,414

Answer 12

Question 14: B
Initially invested $10,000 x 29 =
+ 20% increase in Tex Mex value
290,000
58,000
Pesos
Pesos
348,000
Pesos Convert to U.S. dollars 348,000 ÷ 30 = $11,600

Question 13

Clyde buys stock at $60 per share (200 shares on margin. The initial margin requirement is 50% under Regulation T. The margin interest is 12% annually. After 3 months, he sells the stock for $65. What is Clyde’s holding period return?
A. 6.83%
B. 8.83%
C. 13.67%
D. 16.67%

Answer 13

Question 9: C
($6,500 - $3,090) - $3,000 = $410 = 13.67 (HPR)
$3,000
$3,000
Factor in the margin interest ($90 for the quarter). He bought 100 shares. He only paid for 50 shares. The other 50 shares were bought on margin with borrowed funds.

Question 14

Manny Hattan lives in New York City (Manhattan). She is in a 32% federal tax bracket and pays 10% NY state tax and 5% NY city tax. If she purchases Treasury bonds that pay 10%, what is her after-tax rate of return?
A. 5.7%
B. 6.2%
C. 6.8%
D. 8.5%
E. 10%

Answer 14

C. Treasuries are not subject to state or city taxes but are subject to federal tax. 10% (1-32) = 6.8%

Question 15

Which of the following elements is not factored in calculating the intrinsic value using the DDM (Dividend Discount Model)?
A. Beta
B. Gross earnings of the company
C. Dividends actually paid
D. The risk-free return

Answer 15

B. Beta is used to calculate the required rate of return. r = r, + (rm - rs). B that is used in Answer A and D. The DDM
used the dividend paid (Do). Gross earnings (Answer B) is not a factor.

Question 16

Which type of bond below would be the least affected by an interest rate change?
A. Short duration bond
B. Long maturity bond
C. Low coupon bond
D. Large duration bond

Answer 16

A. The shorter a bond’s duration, the less volatile it is when interest rates change (shift). The other bonds would be affected more.

Question 17

Which type of bond below would be most affected by an interest rate change?
A. Short duration bond
B. High coupon bond
C. Short maturity bond
D. Long maturity bond

Answer 17

D. The longer a bond’s maturity, the more sensitive it is to interest rate changes. The other 3 bonds would be little affected. Notice, the question doesn’t ask what is least affected.

Question 18

XYZ Company’s stock closed yesterday. The following data applies:
$50
$2
$3
$50 - $52
What is the stock’s yield?
A. 4.0%
B. 6.0%
C. 66.7%
D. 5.8%
E. 3.8%

Answer 18

A. $2 / $50 = 4%

Question 19

Which of the following statements support the EMH?
I.
An individual investor can randomly select a diversified portfolio of securities and earn a return consistent with the market as a whole.
II. Once a portfolio has been selected, there is no need to change it.
III. Technical analysis outperforms a buy-and-hold strategy.
IV. The prices of securities do not reflect all available information.
A. I, 1I, I
B. 1,II, IV
C. 1,11
D. III, IV
E. I, V

Answer 19

C. The prices of securities fully reflect all information. Technical analysis will not produce superior results.

Question 20

What is the most important consideration relative to the Markowitz efficient frontier?
A. Return
B. Covariance
C. Risk
D. Correlation

Answer 20

C
Answers A, B, and D play a supporting role in determining the efficient frontier. But answer C is the most fundamental, distinguishing characteristic of the efficient frontier.

Question 21

In regard to the CML, which of the following statements is true?
1. The CML can evaluate a diversified, margined portfolio.
II. The CML can be used to evaluate a security’s performance.
III. The CML includes a portfolio of 100% treasury bills.
IV. The point of tangency of the CML with the efficient frontier represents a portfolio with a proportional percentage of all possible risky assets.
A. 1, 11
B. 1, ١١, ١٧
C. I, III, IV
D. II, III
E. II١, I٧

Answer 21

C. The CML cannot be used to evaluate a single security.

Question 22

what way is a financial ratio considered to be the most useful?
A. A single ratio across different industries over time
B. A single ratio within the same industry over time
C. Several ratios across different industries over time
D. Several ratios with the same industry over time

Answer 22

D. To identify the most promising stock within a particular industry, several ratios within the same industry can be compared. One ratio by itself means little (Answer B), but several ratios together may give a clear picture of the firm’s strengths and weaknesses. Then they may be compared at a given time for several firms within the same industry.

Question 23

Assume that the returns on a managed portfolio are regressed against the returns on a market index. The resulting alpha shows which of the following?
A. The amount of the portfolio’s price movement explained by the market.
B. The degree of diversification in the portfolio.
C. The amount of unsystematic risk in the portfolio.
D. The return added to the portfolio by the portfolio manager

Answer 23

D. Alpha indicates how the portfolio manager performed relative to a benchmark which is generally a stock index.

Question 24

Which of the following is true about the arbitrage pricing theory?
A. Security movements are explained by a relationship between risk and return.
B. The expected value of each factor is zero.
C. Pricing of securities in different markets can differ for significant lengths of time.
D. Unexpected changes in inflation and anticipated shifts in risk premium will influence security prices.

Answer 24

B. APT argues that unanticipated shifts in risk premium will influence security prices. Answer D says anticipated shifts. This is incorrect for APT.

Question 25

Under the Black/Scholes option pricing model, which of the following variables will decrease the value of a call A. An increase in the price of the stock. B. An increase in the strike price. C. An increase in the time to expiration. D. An increase in the volatility of the stock. E. An increase in interest rates.

Answer 25

B. A call with a higher exercise price would have less value than another call with the same remaining time to expiration but with a lower exercise price. The right to buy lower is worth more. All other answers increase.

Question 26

Which statement below concerning straddles is correct? A. A straddle entails simultaneously buying a call and writing a call on the same stock but with different exercise prices or exercise dates. B. A straddle entails simultaneously buying a put and call on the same stock with the same exercise price and expiration date. C. A straddle entails buying two calls on the same stock having different exercise prices. D. A straddle generally entails buying two calls on the same stock having different expiration months.

Answer 26

Question 2: B Answers A, C and D describe an option spread. A straddler buys one call and one put on the same stock with the same exercise price and expiration.

Question 27

Question 43 Which company is most likely to pay a dividend next year? A. Company A B. Company B C. Company C D. Company D Stock Price Earnings Dividend Yield Company A $50 $2.00 4% Company B $40 $2.00 5% Company C $20 $2.00 7% Company D $30 $2.00 6%

Answer 27

C. $20 x 7% = $1.40 dividend. The other companies' dividends equal or are close to equaling the issuers earnings.

Question 28

Which investment listed below could provide both leverage and a reasonable hedge against inflation? A. Equity mutual fund B. Equity REIT C. Mortgage REIT D. Blind pool

Answer 28

Question 40: B Equity REITs can be leveraged. Equity REITs own the properties. Historically, real property increases in value in inflationary times. An equity mutual fund or a mortgage REIT is a poor hedge against inflation. In a truly inflationary time (1981), stock did poorly. There is not enough information about the blind pool to make the judgement as to whether to invest in the limited partnership.

Question 29

Which of the statements below regarding no-load funds is not accurate? A. They have no sales charges. B. They have no management expenses. C. There is a continuous offering and redemption of shares. D. The shares sell at NAV. E. The shares are redeemed at NAV.

Answer 29

B. All funds charge shareholders an expense fee for operating expenses which include manager costs.

Question 30

Lately, Laura Foster, age 70, has a lot of aches and pains. She is concerned about the possibility of having to go into a nursing home. She owns approximately $500.000 in various investments but most are in long-term qualitv investments. She has no long-term care insurance. What is a good way to allocate Laura's investments? A. Liquidate all investments and invest in money market instruments. B. Purchase $70,000 of laddered CDs (maximum maturity one year) and leave the remainder of her portfolio alone. C. Purchase $500,000 of CDs, T-bills, and money market Instruments. D. Purchase $70,000 of treasury bonds and leave remainder of her portfolio alone.

Answer 30

Question 29: B The $70,000 might pay for a good part the first year of the nursing home expenses. The question says, "possibility of going," not that she will be going into a nursing home.

Question 31

When is a publicly traded corporation most likely to issue new bonds? 1. When previously issued bonds are selling at a premium. II. When previously issued bonds are selling at a discount. III. When interest rates are expected to rise. IV. When interest rates have fallen. A. 1, II1 B. 11, III C. II, IV D. I, III, IV E. ١, ١٧

Answer 31

Question 14: D A corporate issuer would try to sell bonds before interest rates rise. In Answers I and IV, interest rates have fallen. The company could issue new bonds at today's lower interest rates.

Question 32

Input variables needed to create portfolios under the Markowitz model do not include which of the following? A. Covariance B. Correlation coefficient C. Standard deviation D. Return E. Beta

Answer 32

E. The Markowitz Model uses standard deviation as a risk measurement (covariance, correlation coefficient, and return). It does not factor Beta.

Question 33

Curt Curious asks you if the mutual fund shown below is a wise investment and whether he should buy it. You research the mutual fund and find out the following: Dynamic Mutual Fund Alpha Beta -7 SD T-Bills 22% 18% 3% What would a CFp® professional be most likely to recommend? A. Do not purchase the mutual fund because its alpha is negative 7. B. Purchase the mutual fund because its beta is low. C. Purchase the mutual fund because R' is a significant consideration. D. Do not purchase the mutual fund because its standard deviation is high.

Answer 33

D. With a low R?, the standard deviation (Sharpe) becomes important. The R? is too low to use the alpha answer. Alpha measures (as a percentage) the contribution of the portfolio manager. With a standard deviation of 18%, this mutual fund will have a wider dispersion from the expected (average) return. Investors prefer assets with the least risk for a given expected return. A low beta alone is generally not a motivating reason to buy a particular mutual fund.

Question 34

Last month, Mrs. Jackson, age 65, inherited a $500,000 IRA from her deceased husband. She states that she needs approximately $50,000 a year to cover her expenses. In addition, her Social Security retirement benefits will increase to $1,200 per month. How would a CFP® professional most likely recommend she invest the $500,000 IRA if she appears to be a conservative investor? A. A balanced portfolio of stocks and bonds B. A growth mutual fund C. A FDIC insured account earning 6% {5 year CD) D. A 30-year Treasury bond with a 7% (current yield)

Answer 34

Question 63: D The Treasury bond generates $35,000 of income per year without invading principal. That plus the $14,400 annual benefit from SS of approximately $50,000 should cover expenses. She needs the income now. She probably has a 25-30-year life expectancy. Inflation is NOT an issue. Answer C will have potentially significant reinvestment risk at maturity (5 years) and falls short of her income objective. The FDIC account would only be insured up to $250,000 (under current law).

Question 35

Question 64 An American investor bought 10,000 shares of a Japanese stock when the yen was trading at 120 yen to the dollar. After purchasing the stock, the stock increased in value by 15%. The investor then sold the stock when the yen was 130 to a dollar. What was the investor's return? A. No solution B. -3.84% C. +6.15% D. +8.45%

Answer 35

Question 64: C $1 = 120 yen 1 + return X1.15 138 yen 130 yen = $1 / 130 = $1.0615 138 yen $1.0615 - $1 .0615 = 6.15%

Question 36

What characteristics differ between T-bills and T-notes? 1. Risk I. Typical buyer IlI. Denominations that are issued N. Cash flow A. 1, 1I B. 1, 1, III, IV ٢٠ ١,١١١,١٧ D. III

Answer 36

Question 61: B T-bills are considered the safest of all possible assets (riskless). The main buyers of bills are corporations with excess short-term cash. Individual investors usually purchase bills indirectly through money market accounts. Denominations are different (T-notes maximum of $100,000). T-bills are sold at discount and mature in 12 months or less. T-bills do not pay interest and mature for full face value. T-notes pay federally taxable interest every 6 months. They may offer too little risk and return for an aggressive investor.