Series 65 – Uniform Investment Adviser Law Exam Investment Vehicle Characteristics 2 — Questions and Answers
Question 1: What is the main risk associated with a callable bond from an investor's perspective?
- The bond may default at maturity
- The issuer may call the bond when interest rates fall, forcing reinvestment at lower rates (Correct answer)
- The bond's price will rise sharply when called
- The bondholder loses all accrued interest when the bond is called
Correct answer: The issuer may call the bond when interest rates fall, forcing reinvestment at lower rates
Callable bonds expose investors to reinvestment risk because issuers typically call bonds when rates fall, forcing investors to reinvest proceeds at lower prevailing rates.
Question 2: Which of the following is a characteristic of a money market fund?
- High volatility and potential for significant capital gains
- Typically maintains a stable $1.00 net asset value and invests in short-term, high-quality instruments (Correct answer)
- Primarily invests in small-cap equities
- Provides long-term capital appreciation with moderate risk
Correct answer: Typically maintains a stable $1.00 net asset value and invests in short-term, high-quality instruments
Money market funds aim to maintain a constant $1.00 NAV by investing in short-term, highly liquid, high-quality instruments such as Treasury bills and commercial paper.
Question 3: What is the difference between a growth stock and a value stock?
- Growth stocks pay higher dividends; value stocks reinvest all earnings
- Growth stocks are expected to grow faster than the market; value stocks trade below their perceived intrinsic value (Correct answer)
- Growth stocks are only found in international markets; value stocks are domestic
- Growth stocks have lower P/E ratios than value stocks
Correct answer: Growth stocks are expected to grow faster than the market; value stocks trade below their perceived intrinsic value
Growth stocks are shares in companies expected to grow earnings faster than the market average, while value stocks trade at prices considered below their fundamental worth.
Question 4: What does it mean when a bond is trading at a premium?
- The bond's coupon rate is below the current market interest rate
- The bond's market price is above its face (par) value (Correct answer)
- The bond has a higher credit rating than average
- The bond matures sooner than expected
Correct answer: The bond's market price is above its face (par) value
A bond trades at a premium when its market price exceeds its face value, typically because its coupon rate is higher than current market interest rates.
Question 5: What is the primary purpose of a hedge fund?
- To provide guaranteed returns with no risk
- To use diverse and often complex strategies to generate absolute returns regardless of market conditions (Correct answer)
- To replicate the performance of a broad market index
- To provide tax-free income to qualified investors
Correct answer: To use diverse and often complex strategies to generate absolute returns regardless of market conditions
Hedge funds use a wide range of strategies including leverage, short selling, and derivatives to seek absolute returns that are not necessarily correlated with market performance.
Question 6: Which of the following best describes a variable annuity?
- A fixed insurance contract with guaranteed returns
- An insurance product with an investment component where the value varies based on the performance of subaccounts (Correct answer)
- A government bond with adjustable coupon payments
- A savings account with variable interest rates
Correct answer: An insurance product with an investment component where the value varies based on the performance of subaccounts
Variable annuities are insurance contracts where the value and payout depend on the performance of investment subaccounts chosen by the contract holder.
Series 65 – Uniform Investment Adviser Law Exam Investment Vehicle Characteristics 2
What is the main risk associated with a callable bond from an investor's perspective?