Submitted by: Michael Pappas

Question: 1

Which of the following statements regarding closed-end investment companies is false?

A. A closed-end investment company may not issue preferred stock.

B. Shares of a closed-end company may sell for below the fund’s net asset value.

C. Closed-end companies may be either diversified or non-diversified.

D. The closed-end investment company does not pay taxes on the dividend and capital gain income it earns and distributes to its shareholders.

Answer: A

Reference:

Explanation:

The false statement is that a closed-end investment company may not issue preferred stock. Although open-end companies (mutual funds) are prohibited from doing so, this is not a restriction governing closed-end companies. Closed-end companies shares sell on exchange floors and may trade below net asset value. Closed-end companies may be either diversified or non-diversified, and the income earned by the company and distributed to its shareholders is not taxed at the investment company level. It is taxed at the shareholder level only.

Question: 2

Pete Prophet, the manager of a bond mutual fund, is expecting interest rates to increase. All

else equal,

which of the following bonds would be the best investment under this assumption?

A. a Treasury strip with 15 years to maturity

B. a bond with a 10% coupon and 5 years to maturity

C. a bond with a 5% coupon and 10 years to maturity

D. a zero-coupon corporate bond with 12 years to maturity

Answer: B

Reference:

Explanation:

If Pete is expecting interest rates to increase, the bond with a 10% coupon and 5 years to maturity is the best investment. If interest rates increase, bond prices fall, so he will want to invest in the bond that will have the lowest percentage decrease in price. This will be the bond with the shortest duration, which is the bond described in Choice B. It has the highest coupon and the fewest years to maturity.

Question: 3

Which of the following do not fall under the category of “advertisement,” as defined by FINRA?

I. scripts used in telemarketing the products of the member firm

II. a website maintained by the member firm

III. research reports that the member firm distributes to both its existing clients and its prospective clients

IV. sales material that a member firm distributes only to its institutional clients

A.

I only

B.

IV only

C.

I, III, and IV only

D.

III and IV only

Answer: C

Reference:

Explanation:

Only the materials described in Selections I, III, and IV do not fall under the category of “advertisement,” as defined by FINR

A. Scripts (Selection I) and research reports (Selection II) are considered to be “sales literature,” not advertisements. Sales material that is distributed only to

institutional investors (Selection IV) is in a category all by itself.

Question: 4

Which of the following statements regarding a Coverdell Education Savings Plan (ESA) are true?

I. There are income limitations regarding those who may contribute to an ESA.

II. There is a maximum annual aggregate amount that can be contributed to a single beneficiary’s account.

III. Contributions to an ESA are tax deductible.

IV.

The monies must be used prior to the beneficiary’s 30th birthday for education-related expenses in order to avoid paying both taxes and a penalty.

A.

I and II only

B.

I and III only

C.

I, II, and IV only

D.

I, II, III, and IV

Answer: C

Reference:

Explanation:

Only Statements I, II, and IV regarding an ESA are true. The ability to establish one is limited to those with an adjusted gross income specified by government guidelines, and there is a maximum annual aggregate amount that can be contributed to a single beneficiary’s account regardless of how many contributors there are to that account. If the monies are not used for education-related expenses prior to the beneficiary’s 30th birthday, there is a mandatory distribution requirement, at which point the distribution will be taxed as ordinary income and a 10% penalty will be assessed.

Question: 5

In mid-September, the stock of Amazon.com, Inc. (AMZN) is selling for $147.A January call option on the stock is selling for $6.10 and has a strike price of $160. This call option is:

A. at the money.

B. in the money.

C. out of the money.

D. overpriced. No one should pay $6.10 for the right to buy a share of stock for $160 when its current market price is only $147.

Answer: C

Reference:

Explanation:

If Amazon.com is selling for $147 and the strike price on the option is $160, the call option is said to be out of the money since, even if an investor were given the option free, he would not benefit from exercising it at this time. If he did so, he would be paying $160 for a stock that is selling for only $147 on the open market. Even so, the option is not necessarily overpriced at $6.10 because the option has what is known as “time value” on it. The stock of Amazon.com has several months during which it could rise well above the $160 strike price on the option.

Question: 6

Mr. Cashout recently sold some mutual fund shares that he owned. The sale resulted in longterm capital gain income of $6,000. He also sold some shares of a stock he had purchased during the year and realized a short-term capital gain on the sale of $2,000. The sale of another individual stock resulted in a short-term capital loss of $3,500. Mr. Cashout also had some bonds that he had bought at a premium mature, resulting in a long-term capital loss of $500. What is Mr. Cashout’s net capital gain or loss from these transactions?

A. a net long-term capital gain of $4,500

B. a net long-term capital gain of $4,000

C. a net short-term capital loss of $4,000

D. a net long-term capital gain of $8,000

Answer: B

Reference:

Explanation:

If Mr. Cashout sold mutual fund shares for a long-term capital gain of $6,000, had bonds that matured that resulted in a short-term capital loss of $500, and realized a short-term capital gain of $2,000 and a short-term capital loss of $3,500 on the sale of shares of individual stocks that he owned, he has a net long-term capital gain of $4,000. The long-term gains and losses are netted first: $6,000 – $500 = $ 5500 long-term gain. Then the short-term gains and losses are netted: $2,000 – $3,500 = -$1,500. The short-term capital loss can be used to offset part of the long-term capital gain, resulting in a ($5500 $ 1,500 =) $4,000 long-term capital gain.

Question: 7

Your nephew has asked you to help him formulate a financial plan for his family. Scott is 27 years old and has been employed as an associate with a law firm for two years. Sarah, his wife, is 26 years old and works in the human resources department of a large corporation. The couple is childless now, but they plan to begin a family in a few years. Together, they have accumulated $10,000 in a savings account and recently inherited $40,000 cash. They expect to be able to start saving at least $5,000 annually since their incomes more than meet their current needs. They each have employer-provided health insurance and retirement plans. Both have excellent upward mobility potential in their careers. They currently pay taxes at the marginal rate of 15%. Scott tells you that although they regularly read some of the more popular financial investment magazines, neither feels particularly knowledgeable about the world of investments. Based on this information, which of the following statements is true?

A. A greater than average percentage of their money should be invested in money market mutual funds to meet their needs for liquidity.

B. A greater than average percentage of their money should be invested in municipal bonds to minimize their currently high tax bill.

C. Although some money should be allocated to bond funds for diversification purposes, bond funds should be underweighted in favor of stock funds.

D. Purchasing power risk is not an issue in their situation.

Answer: C

Reference:

Explanation:

Given that Scott and Sarah already have a nice nest egg started at their relatively young ages and are expecting to be able to contribute more to it, with no obvious need for current income, some of their money should be allocated to bond funds for diversification purposes, but bond funds should be underweighted in favor of stock funds. Purchasing power risk is an issue for them, and bond funds do not provide the inflation hedge that stock funds do. At the current time, municipal bond funds should not be selected since they pay taxes at a low marginal tax rate. This allocation may need to be changed down the road a bit as their tax rate (and other circumstances) change. Only a minimal amount of money should be allocated to a money market fund since the couple has no need for current income, and money market funds offer low returns.

Question: 8

Brian is single and 32 years old. He is employed as a buyer for a large sporting goods retail chain and participates in an employer-matched 401(k) plan. He remembers hearing about the benefits of passively managed portfolios in a college investments course he took. Therefore, he is directing 100% of his 401(k) monies into an S&P 500 Index fund. He has also been investing all of his discretionary income into a regular account with the same S&P 500 Index fund. Brian’s goal is to retire no later than his 55th birthday. Is this the best investment strategy for him?

A. Yes. He is investing in a diversified portfolio of stocks that is passively managed, so he isn’t having to pay big management fees.

B. Yes. Because index funds are passively managed, they don’t have as high a turnover rate, and lower turnover rates result in lower tax bills for the investor. Brian gets diversification and a lower tax bill.

C. Question: The S&P 500 Index consists only of large, domestic stocks, so Brian isn’t as diversified as he could be, and his investments may not grow fast enough for him to retire on his 55th birthday.

D. Both A and B are reasons that Brian’s strategy is the best strategy for him.

Answer: C

Reference:

Explanation:

No, investing all of his retirement savings and all his discretionary income into the same S&P 5 00 Index fund is not the best strategy for Brian because the S&P 500 Index consists only of large domestic stocks, so Brian isn’t as diversified as he could be, and his investments may not grow fast enough for him to retire on his 55th birthday. Although the S&P 500 Index fund is passively managed, which results in lower management fees and lower tax bills, Brian could spread his money among other index funds that offer these same benefits as well. For example, he could invest in a small cap index fund, a mid-cap index fund, and even a foreign stock index fund, such as an EAFE Index fund. This would give him even more diversification potential, and since the stocks in which these funds invest are a bit riskier, the funds offer a higher expected return, which should advance him toward his retirement goal more quickly. Brian’s investment horizon is sufficiently long for him to be able to handle the risk. Furthermore, investing all of one’s money in a single fund-even a single S&P 500 Index fund-isn’t the best strategy, especially if one has a lot of money to invest as Brian does. Not all S&P 500 Index funds perform equally well.

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