FINRA Series 65 Exam 174 Questions with Verified Answers,100% CORRECT, Exams of Business Economics

Download FINRA Series 65 Exam 174 Questions with Verified Answers,100% CORRECT and more Exams Business Economics in PDF only on Docsity! FINRA Series 65 Exam 174 Questions with Verified Answers 1. Investment Advisory Representative (IAR) - CORRECT ANSWER 1. Upon passing the series 65 the agent may represent an registered investment adviser (RIA) and receive fee based compensation. The fee based compensation may be based on a percentage of the assets under management or as an hourly or flat fee for providing a personalized financial plan. There are no prerequisites for taking the series 65 exam and the candidate does not need to be sponsored by a FINRA member firm to take the test. 2. The series 66 is the uniform combined state law exam and qualifies a candidate to represent both an investment adviser and a broker dealer. After passing the series 66 an agent may receive both fee based compensation for representing an investment adviser and transition based compensation for executing customer orders. The series 66 is a combination of the series 63 exam and the series 65 exam. Candidates do not have to be sponsored by a FINRA member firm to take the series 66 exam. However, the series 7 exam is the co requisite for the series 66 exam and a candidate who has passed the series 66 exam may not conduct any business until they have passed the series 7 exam. All candidates must be sponsored to take the series 7 exam. If you have passed the series 7 exam and have not taken the series 63 exam, the series 66 may be the right exam to take. Keep in mind that while the series 66 has fewer questions than the series 65. If you have not passed the series 7 or will not be taking the series 7 exam you must take the series 65 exam. the financial effect of making student loan payments for 20 years after graduating from college can be easily seen - CORRECT ANSWER the financial effect of making student loan payments for 20 years after graduating from college can be easily seen. For example, a college graduate who owes $60,000 in student loans at 3% interest will have to pay $332.76 per month for 20 years to get that paid off. If that amount was instead diverted into a Roth IRA that grows at 6% for that same time period (with no further contributions after 20 years), then the student would have almost $600,000 of tax-free money by age 65. No poll or study is necessary to see the enormous impact that student loan debt can have on a borrower's retirement preparedness. (For more, see: Student Loans: What to Do When You Can't Repay Them.) Certificate of Deposit (CD) - CORRECT ANSWER 1. a time deposit at a commercial bank and insured by the FDIC that restricts holders from withdrawing funds on demand. 2. bears a maturity date ranging from one month to five years at a fixed interest rate and can be issued in any denomination. Negotiable Certificates of Deposit (NCD) (Jumbo CD) - CORRECT ANSWER 1. a large certificate of deposit that is typically purchased by institutional/company investors. 2. Unlike a regular CD, NCDs pay periodic interest, usually twice a year and cannot be cashed in before reaching maturity, but can be easily sold in the open market before that time. 3. minimum face value of $100,000, but typically are $1 million or more. Treasury Bills (T-bills) - CORRECT ANSWER 1. short-term securities that mature in 3-months, 6-months or 1-year. 2. exempt from state and local taxes. 3. purchased at less than par. 4. issued in denominations at $1,000, $5,000, $10,000, $25,000, $50,000, $100,000 and $1 million. 5. all Treasuries are considered to be risk-free (safest investments in the world). Treasury Notes (T-notes) - CORRECT ANSWER 1. a maturity between 1 and 10 years. 2. exempt from state and local taxes. 3. purchased at face value and pay out interest payments semi-annually. 4. bought through a bank or directly from US gov't. 5. can be sold in a large secondary market (liquidity). Treasury Bond (T-Bond) - CORRECT ANSWER 1. a maturity of more than 10 years. 2. exempt from state and local taxes. 3. purchased at face value and pay out interest payments semi-annually. Partial Deduction S / HH = >$61,000 but <$71,000 MFJ / QW = >$98,000 but <$118,000 MFS = <$10,000 No Deduction S / HH = $71,000 or more MFJ / QW = $118,000 or more MFS = $10,000 or more SIMPLE IRA (Savings Incentive Match Plan for Employees) - CORRECT ANSWER 1. allows employees (including self-employed individuals and employers to contribute to Traditional IRAs set up for employees. 2. Employers CANNOT impose any other conditions for participating MORE restrictive than requiring that employee has earned at least $5,000 in compensation during any 2 years before the current calendar year and expects to receive at least $5,000 during the current calendar year. 3. Employer must contribute and employee may contribute (elective salary reduction contributions only). 4. Elective salary reduction contributions cannot exceed $12,500 (2015 and 2016). 5. For employees age 50 or over, a $3,000 "catch-up" contribution is also allowed (2015 and 2016). 6. If employee participates in any other employer plan with elective salary reductions, the total amount of all salary reduction contributions is limited to $18,000 (2015 and 2016). 7. Employer is required to contribute each year either: a. 2% of employees compensation up to the annual limit of $265,000 for (2015 and 2016), or b. a matching contribution up to 3% of compensation (not limited by the annual compensation limit). 8. Employees are always 100% vested but participant loans are NOT permitted and the assets may NOT be used as collateral. 9. Required Minimum Distributions (RMD's) at age 70 1/2. 10. Distributions before age 59-1/2 are subject to a 10% additional tax. 11. Distributions within the first two years of participation, are subject to a 25% additional tax. 12. ideally suited as a start-up retirement savings plan for small business employers with 100 or fewer employees. 13. Employer cannot have any other retirement plan. 14. do not have the start-up and operating costs of a conventional retirement plan and no filing requirement for the employer. 15. established by adopting Form 5304-SIMPLE (employee picks financial institution) Simplified Employee Pension Plan (SEP) IRA - CORRECT ANSWER 1. allows the EMPLOYER ONLY to contribute to Traditional IRAs set up for employees. 2. Contributions an employer can make to an employee's SEP-IRA cannot exceed the lesser of: 25% of the employee's compensation, or $53,000 (for 2015 and 2016). 3. Employees are always 100% vested but participant loans are NOT permitted and the assets may NOT be used as collateral. 4. Required Minimum Distributions (RMD's) at age 70 1/2. 5. Distributions before age 59-1/2 are subject to a 10% additional tax. 6. Flexible annual contributions - good plan if cash flow is an issue. 7. do not have the start-up and operating costs of a conventional retirement plan and no filing requirement for the employer. 8. established by adopting Form 5305-SIMPLE (employer picks financial institution), a SEP prototype or an individually designed plan document, If Form 5305-SEP is used, cannot have any other retirement plan (except another SEP). MyRA - CORRECT ANSWER 1. Designed to be a starter account, places priority on the stability and preservation of money rather than on higher returns with greater risk. 2. The savings in your myRA are invested in a single retirement savings bond issued by the U.S. Department of the Treasury. The bond has a maturity date based on the value ($15,000) and age (30 years) of the account (whichever comes first). 3. Can transition to a private sector Roth IRA that has different risk-return characteristics. Roth IRA - CORRECT ANSWER 1. Maximum contribution of $5,500 ($6,500 if you're age 50 or older), or your taxable compensation if less with excess contributions taxed at 6% per year as long as they remain in the account. 2. Eligibility and permitted contribution amount depends on the individual's tax filing status and MAGI. 3. Can make contributions after you reach age 70 ½. 4. Contributions are non-deductible. 5. Distributions (qualified) are tax-free: a. at least five years after establishing Roth IRA b. to purchase a first home (limit $10,000) c. at least age 59 1/2, or disabled or deceased (in which case the beneficiary collects). 6. NO Required Minimum Distributions (RMD's) or 50% penalty at age 70 1/2 (amounts can be left in Roth IRA for as long as they live)! Named for Delaware Senator William Roth, the Taxpayer Relief Act of 1997 established the Roth IRA. In 2015, Roth IRA's accounted for roughly 9% of total IRA assets. Younger and lower-income workers may benefit the most from the Roth IRA. Even those who expect a lower tax rate in retirement can find benefit with the Roth IRA. Many investors simply prefer a tax-free income stream in retirement. The Roth IRA also allows an individual to pass on assets to heirs tax-free upon his death. Required minimum distributions are not a consideration with the Roth IRA. Those who don't need Roth IRA assets in retirement can leave the money to accrue indefinitely. As long as the individual has earned income, he can make contributions to the Roth IRA at any age. Contribution Amount to Roth IRA Limited by MAGI (2015) - CORRECT ANSWER Up to the limit MFJ / QW = < $184,000 S / HH / MFS (did not live with spouse) = < $117,000 Reduced amount MFJ / QW = > $184,000 but < $194,000 MFS (lived with spouse) = < $10,000 account's assets that covers all administrative, commission, and management expenses. 2. protects you from excessive trading by your broker to make more commission. 3. A traditional wrap typically requires an initial investment of at least $25,000. Mutual fund wraps have relatively smaller investment minimums of as low as $2,000. 4. are great if you don't have time to invest on your own and wish to have a money manager take care of your assets. 1. ECONOMIC FACTORS AND BUSINESS INFORMATION - CORRECT ANSWER ... Gross National Product (GNP) - CORRECT ANSWER -the value of goods and services produced by a country's citizens whether they produced these items within its borders or not. -Used by US until 1991 Gross Domestic Product (GDP) - CORRECT ANSWER -the value of goods and services produced within a country's borders. -GDP = C + G + I + NX C = consumer spending G = government spending I = total investments (incl. businesses capital expenditures) NX = nation's total net exports (Exports - Imports) Recession - CORRECT ANSWER 2 consecutive quarters of decline (contraction) in the GDP Depression - CORRECT ANSWER 6 consecutive quarters of decline (contraction) in the GDP Leading Indicators - CORRECT ANSWER used to forecast the ups and downs of the business cycle in the next 3-12 months: -worker's avg work week hours -building permits -stock prices (S&P 500) -the money supply -the index of consumer expectations U.S. Stock Market Crashes Since 1929 - CORRECT ANSWER 1. October 24, 1929 Also called the Great Crash or the Wall Street Crash, leading to the Great Depression. 2. Recession of 1937-38 3. May 28, 1962 The Kennedy Slide of 1962, also known as the Flash Crash of 1962 3.October 19, 1987 Black Monday 4. July 1990 Recession of 1990 5. March 10, 2000 The collapse of the Dot-com bubble. 6. September 11, 2001 7. October 9. 2002 The Stock Market Downturn of 2002 8. September 16, 2008 The Financial crisis of 2007-08 9. May 6, 2010 The Flash Crash of 2010 10. Aug 1, 2011 August 2011 Stock Market Fall Coincident Indicators - CORRECT ANSWER move at the same cycle as current economic cycle we're in: -industrial production -# of employees on payroll (non-agricultural) Lagging Indicators - CORRECT ANSWER typically lag is a few quarters of a year: -unemployment rate/claims -business spending -change in CPI from previous months Monetary Policy - CORRECT ANSWER set by the Federal Reserve Board to control money supply thru: 1. Reserve requirements 2. Discount rate 3. Buy/sell US gov't securities (influences the Prime rate) Federal Discount Rate (most important tool after reserve requirements) - CORRECT ANSWER The interest rate charged banks for loans received from the Federal Reserve Bank's discount window; set by the Federal Reserve Banks, rather than a market rate of interest. Federal funds rate - CORRECT ANSWER overnight interest rate banks lend reserve balances to other banks Regulation T (margin requirements) - CORRECT ANSWER the percentage of money required to be on deposit for margin accounts (50%) LIBOR (London Interbank Offered Rate) - CORRECT ANSWER 1. rate at which banks lend to other banks in the London wholesale money market and around the world. 2. Many US mortgages use 6-month LIBOR as an index 3. set by the BBA (British Banking Association) and includes representatives from 16 banks 4. Total of 35 different LIBOR rates each business day but the most commonly quoted rate is the 3-month U.S. dollar rate. Fiscal Policy - CORRECT ANSWER set by Congress to control money supply thru: 1. raise/lower taxes 2. gov't spending Normal Yield curve - CORRECT ANSWER Typically when short-term interest rates are lower than long-term rates, so the yield curve slopes upwards, reflecting higher yields for longer-term investments. Flat Yield curve - CORRECT ANSWER When the spread between short-term and long-term interest rates narrows; often seen during the transition from a normal yield curve to an inverted one. 2. The EU's goal is to create a barrier-free trade zone and to enhance economic wealth byĺcreating more efficiency within its marketplace. 3. The EU has become one of the largest producers in the world, in terms of GDP, and the euro has maintained a competitive value against the U.S. dollar. 4. EU and non-EU members must agree to many legal requirements in order to trade with the EU member states. 5. The current formalized incarnation of the European Union was created in 1993 with 12 initial members. Since then, many additional countries have since joined. a. FINANCIAL STATEMENTS - CORRECT ANSWER ... Cash basis - CORRECT ANSWER 1. Revenue (counted when received, earned or unearned) 2. Expenses (real time) 3. Profit (counted when received) 4. Cash (real time) Accrual basis - CORRECT ANSWER 1. Revenue (counted when earned) 2. Expenses (real time) 3. Profit (counted when earned, whether received or not) 4. Cash (real time) 5. Accounts receivable (will get later - count as asset now) 6. Deferred revenue (received but unearned) Fundamental Analytics - CORRECT ANSWER deals with examining financial statements. Fundamental analysts use the financials statements to find Price/sales, price/book and price/earnings ratios. Technical Analytics - CORRECT ANSWER Technical analysts believe that the historical performance of stocks and markets are indications of future performance so they use charts and other tools to identify patterns that can suggest future activity by analyzing statistics generated by market activity, such as past prices and volume. Trading volume would be a tool considered by a technical analyst. Dividends - CORRECT ANSWER 1. A taxable payment declared by a company's board of directors and given to its shareholders out of the company's current or retained earnings, usually and at most, quarterly. 2. May be cash (cash dividend) or in the form of stock (stock dividend) or other property. 3. Not required but are most often by companies beyond the growth phase who no longer benefit from reinvesting profits. Retained Earnings (or undistributed profits) - CORRECT ANSWER 1. are earnings that not paid out as dividends but instead reinvested. 2. are a component of stockholder's equity. Balance Sheet - CORRECT ANSWER a snap shot at a given point in time: 1. Assets a. Cash b. Inventory c. Accounts Receivable d. Property, Plant and Equipment Total Assets: 2. Liabilities a. Accounts Payable b. Notes Payable Total Liabilities: 3. Owner's Equity a. Common Stock b. Retained Earnings Total Owner's Equity: Total Liabilities + Total Owner's Equity: Current Ratio - CORRECT ANSWER 1. a tighter comparison for companies in the same industry. 2. Formula: = Current Assets / Current Liabilities Working capital - CORRECT ANSWER 1. a measurement of a company's liquidity. 2. Formula: = Current Assets - Current Liabilities Quick Ratio - CORRECT ANSWER 1. the "acid test" ratio for if a company may not be able to sell its inventory in 1 year. 2. Formula: = (Current Assets - Inventory) / Current Liabilities Shareholder (owner's) equity - CORRECT ANSWER 1. is just another name for the net worth of the company. Retained (or undistributed profits) are a component of stockholder's equity. 2. Formula: Shareholder equity = total assets - total liabilities OR Shareholders equity = share capital + retained earnings - treasury shares Share capital - CORRECT ANSWER the value of the assets of a company held as shares Income Statement (also known as a P&L or profit and loss statement) - CORRECT ANSWER tells what happens over a period of time: 1. Revenue a. Sales b. Cost of Goods Sold c. Gross Profit 2. Expenses a. Rent b. Salaries and Wages c. Advertising d. Insurance e. Total Expenses 5. Has NO automatic set par value. Par value set by the board of directors. Restricted stock - CORRECT ANSWER 1. is common stock of a company that is not freely saleable (subject to Rule 144). 2. There are two categories of restricted stock: private placement and control stock. Private placement stock - CORRECT ANSWER Restricted shares of stock that are unregistered non-exempt. Control stock - CORRECT ANSWER Restricted shares of stock held by an insider of the corporation. Rule 144 - CORRECT ANSWER 1. sets forth the holding period requirement of 6 months for a reporting issuer and 1 year for a non-reporting issuer. 2. sets forth the method of sale and volume restrictions for Control stock. Authorized stock - CORRECT ANSWER 2. the maximum number of shares that a corporation is legally permitted to issue, as specified in its articles of incorporation, also known as "authorized shares" or "authorized capital stock. 2. is listed in the capital accounts section of the balance sheet. Outstanding shares/stock - CORRECT ANSWER 1. a company's stock currently held by all its shareholders, including share blocks held by institutional investors and Restricted shares owned by the company's officers and insiders (excluding treasury stock held by the company itself). 2. are shown on a company's balance sheet under the heading "Capital Stock." 3. used in calculating a company's market capitalization, earnings per share (EPS) and cash flow per share (CFPS) Preferred stock - CORRECT ANSWER 1. represent partial ownership but NO voting rights. 2. pays a fixed dividend, if any at all, before any dividends are paid to common stock, that does not fluctuate. 3. takes precedence over common stock in the event of a liquidation. 4. For investors looking for income. 5. Automatically have a par value of $100. Types of Preferred Stock: Preferred stock may be issued with special features added to enhance their marketability when the stated dividend payment is less than that offered by competing issues of preferred stock in the marketplace: - CORRECT ANSWER 1. Straight Preferred: This type of preferred stock has no other special features beyond the stated dividend payment. 2. Cumulative -has the right to receive skipped or missed dividends. 3. Participating -gives the shareholder the right to participate in earnings in excess of the stated dividend. 4. Convertible -gives the investor the privilege of exchanging their preferred stock at any time and receiving common stock. The rate of conversion (conversion ratio) is fixed at the time of issue and is stated on the preferred stock certificate. Corporate Liquidation Order of Seniority: - CORRECT ANSWER 1. IRS 2. Secured bondholders 3. Debentures (are unsecured) 4. Preferred stock 5. Common stock Rights Offering - CORRECT ANSWER allow the common stockholder (NOT Preferred Stockholders) to purchase the additional shares at a discount price for a short period of time, usually 30 days prior to the public offering. Treasury stock - CORRECT ANSWER stock that are sold and then bought back by the company. Incentive stock options - CORRECT ANSWER 1. the option to buy stock in a particular company, is a right granted by a corporation to a particular person (typically executives) to purchase treasury stock. 2. not traded on the open market. Warrant - CORRECT ANSWER 1. allow the holder to purchase additional stock or bonds at a predetermined price in the future. 2. Different from rights in that warrants are issued for long periods of time (several years) and with a stated exercise price above the current market price so usually, the warrant will not be exercised unless the price of the stock is greater than the exercise price of the warrant. American Depository Receipts (ADRs) - CORRECT ANSWER 1. a negotiable receipt for a given number of shares of stock in a non-American corporation whereas dividends are sent to the registered owner. 2. All rights normally held by common shareholders, except pre-emptive rights, are given to the holder of the ADR. 3. May be traded OTC or on exchanges. Three main categories of financial instruments: - CORRECT ANSWER 1. debt (i.e., bonds and mortgages and 2. stocks (i.e., equities or shares) 3. derivatives (forwards, futures, options, swaps, and variations such as collateralized debt obligations and credit default swaps. Fixed-income securities - CORRECT ANSWER you know the exact amount of cash you'll get back if you hold the security until maturity. b. BONDS - CORRECT ANSWER 1. any securities that are founded on debt (you lend to a company or government, they pay you interest semi-annually until maturity, and then the face value. 2. are debt (whereas stocks are equity) that represent a financial interest (not ownership) in a company as a creditor. 3. traded over-the-counter (OTC). 4. In liquidation bondholders get paid first. Par (also known as face value or principal) - CORRECT ANSWER 1. the amount of money paid back once a bond matures. 2. newly issued bonds usually sell at par, which is normally $1,000 for Corporate bonds. 3. bonds can trade at par, or at a price above the face value (at a premium) or below face value (at a discount). (the missing rate) - CORRECT ANSWER 1. the interest rate used in discounted cash flow (DCF) analysis to determine the present value of future cash flows. 2. Example: Let's say you expect $1,000 in one year. To determine the present value of this $1,000 (what it is worth to you today), you would need to discount it by a particular interest rate (discount rate of 10%). $1,000 / (1.00 + 0.10) = $909.09 if you expect to receive the $1,000 in one year. $909.09 / (1.00 + 0.10) = $826.45 if you expect to receive the $1,000 in two years. Internal Rate of Return (IRR) - CORRECT ANSWER 1. the percentage rate of growth a project or investment is expected to generate. 2. also called the minimum required rate of return -is the rate in which the future cash flows discounted back to their present values minus the initial cost of the investment is equal to zero. 3. If the IRR is higher than the hurdle rate it is a good investment. 4. A bond's YTM is the bond's IRR. Reinvestment Risk - CORRECT ANSWER the likelihood that interest rates will be lower than they were at the time of the bond purchase. Zero coupon bonds are the only fixed-income instruments to have no reinvestment risk purchasing power (or inflation) risk (inherent in fixed securities) - CORRECT ANSWER if the rate of inflation exceeds the bond's fixed nominal interest rate and it is held to maturity and redeemed at its par value. interest rate risk - CORRECT ANSWER the risk that the bond's value will drop in the secondary market if interest rates in the economy go up. business risk - CORRECT ANSWER the risk of default. c. CALCULATING RETURNS & RISKS - CORRECT ANSWER ... What is Mean of a group of numbers? - CORRECT ANSWER 1. is the average of a group of numbers 2. calculated by adding all the numbers up and dividing by how many numbers there are. What is Median of a group of numbers? - CORRECT ANSWER 1. the middle number in a sorted list of numbers. 2. determined by first arranging numbers in order from lowest to highest. If there is an odd amount of numbers, the median value is the number that is in the middle. If there is an even amount of numbers in the list, the middle pair are added together and divided by two. What is Mode of a group of numbers? - CORRECT ANSWER 1. the number that returned or occurred most frequently. 2. A set of numbers can have more than one mode (this is known as bimodal) if there are multiple numbers that occur with equal frequency, and more times than the others in the set. 3. If no number in a set of numbers occurs more than once, that set has no mode. There are four basic steps involved in portfolio construction: - CORRECT ANSWER - Security valuation -Asset allocation -Portfolio optimization -Performance measurement Modern portfolio theory (MPT) - CORRECT ANSWER 1. is a theory on how risk- averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward. 2. According to the theory, it's possible to construct an "efficient frontier" of optimal portfolios offering the maximum possible expected return for a given level of risk. What is an Efficient Frontier? - CORRECT ANSWER 1. a modern portfolio theory tool/graph that shows investors the best possible return they can expect from their portfolio, given the level of risk that they're willing to accept. 2. Illustration: Graph shows expected return on the vertical axis and standard deviation on the horizontal axis, with a curve upon whose line optimal portfolios are constructed to balance maximum returns with any risk taken. Portfolios behind the line are inefficient and those above the line are not possible. 5 Technical Risk Ratios used in MPT - CORRECT ANSWER 1. Beta 2. Standard Deviation 3. R squared 4. Sharpe Ratio 5. Alpha Beta - CORRECT ANSWER 1. measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. 2. the tendency of a security's returns to respond to swings in the market: A beta of 1 indicates that the security's price will move with the market. A beta of less than 1 means that the security will be less volatile than the market (Many utilities stocks). A beta of greater than 1 indicates that the security's price will be more volatile than the market (most high-tech, Nasdaq-based stocks). 3. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Standard Deviation (also known as historical volatility) - CORRECT ANSWER 1. defined as a measure of the dispersion of a set of data from its mean, but applied to the annual rate of return of an investment to measure the investment's volatility and tells us how much the return on the fund is deviating from the expected normal returns. 2. calculated as the square root of variance. 3. the higher the deviation (more spread apart) the greater the volatility. capital asset pricing model (CAPM) - CORRECT ANSWER a model that calculates the expected return of an asset based on its beta and expected market returns. Alpha coefficient (also known as the "Jensen index") - CORRECT ANSWER 1. measures the value added by an active manager; it is the abnormal rate of return on a security or portfolio in excess of what would be predicted by a model like the capital asset pricing model (CAPM). 1. ownership in a publicly-traded corporation (stock) or 2. a creditor relationship with or a corporation (bond) or governmental body or 3. rights to ownership as represented by an option. Stocks - CORRECT ANSWER 1. Equity investment securities. 2. buying and selling conducted on exchanges. 3. represent an ownership interest in a company. Mutual Funds - CORRECT ANSWER a collection of stocks and bonds which enables you (as part of a group) to pay a professional manager to select specific securities for you. Commodity - CORRECT ANSWER an economic good or service when the demand for it has no qualitative differentiation across a market, that formerly carried premium margins, such as generic pharmaceuticals and multivitamin supplements and as an example, a 50 mg tablet of calcium of equal value to a consumer no matter what company produces and markets it, now sold in bulk and are available at any supermarket with little brand differentiation across its supply base, often by the diffusion of the intellectual capital necessary to acquire or produce it efficiently. Fungibility - CORRECT ANSWER 1. means "capable of being substituted in place of one another" the characteristic of a good or a commodity whose individual units are capable of mutual substitution. (e.g., one ounce of pure gold is equivalent to any other ounce of pure gold) 2. Other fungible commodities include sweet crude oil, company shares, bonds, precious metals, and currencies. 3. Fungibility refers only to the equivalence of each unit of a commodity with other units of the same commodity (not for another ommodity). Derivatives - CORRECT ANSWER 1. a contract that derives its value from the performance of an underlying entity, such as an asset, index, or interest rate. 2. includes forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. 3. used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation or getting access to otherwise hard-to-trade assets or markets. 4. Most are traded over-the-counter. Collateralized debt obligation (CDO) (a derivative) - CORRECT ANSWER 1. pays investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. 2. interest and principal payments are divided into tranches from low risk/high rate to high risk/lower rate (If some loans default and the cash collected by the CDO is insufficient to pay all of its investors, those in the lowest, most "junior" tranches suffer losses first. The last to lose payment from default are the safest, most senior tranches). 3. Separate special purpose entities—rather than the parent investment bank— issue the CDOs and pay interest to investors. Mortgage-backed securities (MBS) - CORRECT ANSWER 1. an asset-backed security that is secured by a pool of mortgages issued by investment banks or, in the US government-sponsored enterprises like Fannie Mae or Freddie Mac then sold to investors. 2. may be set up where the interest and principal payments from the homebuyer "pass-through" to the MBS holder. credit default swap (CDS) (a derivative - often referred to as a credit derivative contract) - CORRECT ANSWER 1. is the most common form of credit derivative. 2. may involve bonds or mortgage-backed securities. 3. the buyer of a CDS makes payments to the CDS's seller up until the maturity date of a contract. In return, if the debt issuer defaults then the seller will pay the buyer the security's premium as well all interest payments. However, anyone can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs). Strike price (or exercise price) - CORRECT ANSWER the fixed price at which the owner of the option can buy (in the case of a call), or sell (in the case of a put), the underlying security or commodity. Spot price (or market price) - CORRECT ANSWER the market price of the underlying security or commodity on the day an option is taken out; it may be fixed at a discount or at a premium. Forwards (a derivative) - CORRECT ANSWER 1. a non-standardized contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today. The difference between the spot and the forward price is either the premium or the discount. 2. negotiated on OTC. Options (a derivative) - CORRECT ANSWER 1. a financial contract between two parties whereas the buyer of the call option has the right, but not obligation (seller is obligated), to buy from seller at a a certain price (the strike price) for a certain time (the expiration date). The buyer pays a fee (called a premium) for this right. 2. An option that conveys to the owner the right to buy something at a certain price is a "call option"; an option that conveys the right of the owner to sell something at a certain price is a "put option". For clarity, the call option is more frequently discussed. 3. A European call option allows the holder to exercise the option (i.e., to buy) only on the option expiration date. An American call option allows exercise at any time during the life of the option. Long - CORRECT ANSWER means the holder of the position owns the security and will profit if the price of the security goes up Short - CORRECT ANSWER 1. the sale of a security that is not owned by the seller, or is borrowed. 2. belief that a security's price will decline, enabling it to be "actually" bought at the lower price to make a profit. 3. the risk of loss on a short sale is theoretically infinite. Unit Investment Trust (UIT) - CORRECT ANSWER 1. a fixed, unmanaged portfolio of stocks and bonds sold are redeemable "units" for a specific period of time. 2. provides capital appreciation and/or dividend income. 3. Each unit typically costs $1,000. 4. may be help by owners as either a regulated investment corporation (RIC) or a grantor trust. Regulated Investment Corporation (RIC) - CORRECT ANSWER held by investors who are joint owners. Grantor Trust - CORRECT ANSWER investors hold proportional ownership. Exchange Traded Funds (ETF) - CORRECT ANSWER 1. a type of investment company organized as either an open-end mutual fund or unit investment trust that trades like a stock on a stock exchange and looks like a mutual fund. 2. tracks an underlying index and so are considered passively managed (most mutual funds are considered actively managed). 3. Since are traded on stock exchanges can be traded intraday, like traditional stocks and bonds. (Will allow an investor to hold it for a few hours while the price continues to rise and then sell it at a profit before the close of business). 4. allows investors to trade the entire market as though it were one single stock (such as short selling and trading on margin). 5. need a broker to purchase, so must pay a commission. 6. advantages of very low expenses, diversification and tax avoidance that allows in-kind redemptions for the shares of stocks that the ETFs track, (taxes deferred until the investment is sold). Also, some ETFs don't have large capital gains distributions or pay dividends (because of the particular kinds of stocks they track). 7. invest in increments of $1,000 or more. Net Asset Value (NAV) - CORRECT ANSWER 1. a mutual fund or ETF's price per share, which is calculated by dividing the total value of all the securities in its portfolio, less any liabilities, by the number of fund shares outstanding. 2. Mutual funds pay out virtually all of their income and capital gains. As a result, changes in NAV are not the best gauge of mutual fund performance, which is best measured by annual total return. 3. Because ETFs and closed-end funds trade like stocks, their shares trade at market value (supply & demand), which can be a dollar value above (premium) or below (discount) NAV. Affiliated person - CORRECT ANSWER is anyone who could exercise control over the investment company, such as: the investment adviser, officers, directors, and employees. Also a company that the investment company owns at least 5% of the voting stock or vice-versa. And the person who deposits the assets of a UIT into the custodian banks. Interested person - CORRECT ANSWER 1. The Investment Company Act of 1940 requires that at least a majority (more than 50%) of the board be non-interested persons whose only affiliation with the fund is as a member of the board. 2. An interested person includes: All broker dealers Anyone who has been an attorney, investment adviser, affiliated person, or the principal underwriter for the investment company within the last two years The principal underwriter Employees of the investment adviser Most affiliated persons Immediate family of an affiliated person Anyone else the SEC designates