Investment Advisor Financial Investment 5 — Questions and Answers
Question 1: Which investment vehicle allows an investor to gain exposure to commodity prices without directly owning physical commodities?
- Money market funds
- Commodity futures ETFs (Correct answer)
- Fixed annuities
- Treasury STRIPS
Correct answer: Commodity futures ETFs
Commodity futures ETFs hold futures contracts on commodities, providing price exposure without the need to store or take physical delivery of the underlying asset.
Question 2: What is the primary advantage of Treasury Inflation-Protected Securities (TIPS) over nominal Treasury bonds?
- TIPS offer higher nominal yields in all market conditions
- TIPS principal adjusts with the Consumer Price Index, preserving purchasing power (Correct answer)
- TIPS are exempt from state and federal income taxes
- TIPS have shorter durations than equivalent nominal Treasuries
Correct answer: TIPS principal adjusts with the Consumer Price Index, preserving purchasing power
TIPS principal is adjusted based on CPI changes, so both the principal value and interest payments rise with inflation, protecting real purchasing power.
Question 3: An investor who is 'long' a put option on a stock profits when:
- The stock price rises above the strike price
- The stock price falls below the strike price (Correct answer)
- The stock pays a higher-than-expected dividend
- Implied volatility decreases sharply
Correct answer: The stock price falls below the strike price
A long put gives the holder the right to sell shares at the strike price; the option gains intrinsic value when the stock price falls below that strike.
Question 4: What is the difference between the 'growth' and 'value' investment styles?
- Growth investors focus on dividend income; value investors focus on capital gains
- Growth investors target companies with high expected earnings growth; value investors seek underpriced securities (Correct answer)
- Growth investing is only for equity markets; value investing applies to bonds
- Value investors hold positions for days; growth investors hold for years
Correct answer: Growth investors target companies with high expected earnings growth; value investors seek underpriced securities
Growth investors pay a premium for companies with strong expected earnings expansion, while value investors look for stocks trading below their intrinsic worth.
Question 5: Which of the following scenarios describes 'sequence of returns risk' for a retiree?
- Earning consistent 6% returns for 30 years regardless of market timing
- Experiencing large portfolio losses early in retirement while taking withdrawals (Correct answer)
- Receiving dividends that increase faster than inflation during the accumulation phase
- Holding too much cash relative to equities throughout retirement
Correct answer: Experiencing large portfolio losses early in retirement while taking withdrawals
Sequence of returns risk means that large losses early in retirement, combined with ongoing withdrawals, can permanently deplete a portfolio even if average long-term returns are acceptable.
Question 6: A stock's P/E ratio is 25 and the industry average P/E is 15. This most likely suggests the market believes the stock:
- Has below-average growth prospects
- Is undervalued relative to peers
- Has higher-than-average expected earnings growth or lower risk (Correct answer)
- Will cut its dividend in the near term
Correct answer: Has higher-than-average expected earnings growth or lower risk
A premium P/E relative to peers typically reflects market expectations of faster earnings growth or lower perceived risk for that company.
Question 7: What is the main characteristic of a 'zero-coupon bond'?
- It pays interest monthly rather than semi-annually
- It is sold at a deep discount and pays no periodic interest, returning face value at maturity (Correct answer)
- It adjusts its coupon rate with changes in short-term interest rates
- It is issued only by the U.S. federal government
Correct answer: It is sold at a deep discount and pays no periodic interest, returning face value at maturity
Zero-coupon bonds are issued at a discount to face value, make no periodic coupon payments, and return the full face value at maturity; the difference represents the investor's return.
Investment Advisor Financial Investment 5
Which investment vehicle allows an investor to gain exposure to commodity prices without directly owning physical commodities?