NASAA Series 65 — All Questions

Real gross domestic product differs from nominal GDP in that real GDP:

• a.Measures only the output of the government sector
• b.Is adjusted for inflation, expressing output in constant dollars✓
• c.Includes the value of intermediate goods double-counted at each stage of production
• d.Is always larger than nominal GDP during periods of rising prices

Real GDP adjusts nominal output for inflation using a price deflator, stating production in constant-dollar terms so growth is not overstated by rising prices. During inflation, nominal GDP exceeds real GDP, so the claim that real is larger is the trap. GDP measures total final output, not only government.

A recession is conventionally identified by:

• a.A sustained rise in real GDP over a full year
• b.Any month in which stock prices fall
• c.A single quarter of rising unemployment
• d.Two consecutive quarters of declining real GDP✓

The common shorthand for a recession is two consecutive quarters of falling real GDP, reflecting a broad contraction in output. A one-month stock decline or a single quarter of higher unemployment is not the standard definition. A year of rising GDP describes an expansion.

Stagflation describes the unusual combination of:

• a.Rising output and falling unemployment accompanied by accelerating inflation as demand outstrips capacity
• b.Stagnant growth and high unemployment occurring together with rising prices✓
• c.Falling prices together with weak growth and rising unemployment, as consumers postpone purchases
• d.Rapid growth and low unemployment together with falling prices, as in a productivity-driven boom

Stagflation pairs stagnation (weak growth and high unemployment) with inflation at the same time, as seen in the 1970s. It challenges the usual inverse trade-off between unemployment and inflation captured by the Phillips curve. Strong output with accelerating prices is an overheating economy, weak growth with falling prices is deflationary recession, and rapid growth with falling prices and low unemployment is the opposite of stagflation.

The discount rate set by the Federal Reserve is the interest rate at which:

• a.Corporations borrow short-term from investors by issuing commercial paper, usually at a discount to face value
• b.The Fed lends short-term funds to member banks through the discount window✓
• c.The Treasury sells new bills and notes to primary dealers at its regularly scheduled auctions
• d.Banks lend reserve balances to one another overnight, a rate the FOMC targets and influences through open market operations

The discount rate is what the Fed charges banks that borrow at its discount window. The overnight interbank lending rate is the federal funds rate, which the FOMC targets rather than sets directly, and that is the trap in the last option. Commercial paper rates and Treasury auction yields are determined in the market and are unrelated to the discount rate.

If the Federal Reserve lowers the reserve requirement, the most likely effect is to:

• a.Increase the money supply by allowing banks to lend a larger share of deposits✓
• b.Have no effect on the amount banks can lend
• c.Force banks to hold more cash against their deposits, which in turn pushes market interest rates sharply lower
• d.Reduce the money supply and raise interest rates

A lower reserve requirement frees a larger share of deposits for lending, expanding the money supply and tending to lower interest rates. This is an expansionary monetary tool. Raising the requirement would do the opposite by forcing banks to hold more.

During the expansion phase of the business cycle, which of the following typically occurs?

• a.Increasing GDP, rising consumer spending, and growing corporate profits✓
• b.Falling industrial production and a sharp rise in business inventories as sales slow across most sectors
• c.Rising unemployment and falling consumer spending as businesses cut production and delay investment
• d.Declining GDP for two consecutive quarters, shrinking payrolls and falling consumer demand

An expansion features rising GDP, employment, consumer spending, and corporate profits as demand strengthens. Falling production with unsold inventories, rising unemployment with cutbacks in investment, and two straight quarters of declining GDP with shrinking payrolls all describe a contraction or recession, not an expansion.

An economist who argues the government should increase spending during a downturn to boost aggregate demand is applying which school of thought?

• a.Keynesian economics✓
• b.Supply-side economics
• c.Monetarist economics
• d.Classical laissez-faire economics

Keynesians emphasize aggregate demand and active fiscal policy, favoring government spending and tax changes to smooth the business cycle. Monetarists focus on the money supply, supply-siders on production incentives, and classical economists on minimal intervention.

Supply-side economics primarily emphasizes:

• a.Government spending and deficit financing to raise aggregate demand and close the output gap
• b.Central bank management of interest rates and bank reserves to stabilize prices and employment
• c.Lowering taxes and reducing regulation to encourage production and investment✓
• d.Steady growth in the money supply at a fixed rate each year, regardless of the business cycle

Supply-side economics focuses on incentives to produce, chiefly cutting marginal tax rates and easing regulation to spur output and investment. Deficit spending to lift aggregate demand is the Keynesian approach, central bank management of interest rates and reserves is monetary policy, and a fixed annual growth rate for the money supply is the monetarist rule.

The prime rate is best described as:

• a.The rate on overnight loans of reserve balances between banks, which the FOMC sets as a target
• b.The rate the Federal Reserve charges depository institutions that borrow from its discount window
• c.The yield on three-month Treasury bills, determined at the Treasury's weekly auctions of new bills
• d.The interest rate commercial banks charge their most creditworthy corporate customers✓

The prime rate is what banks charge their most creditworthy customers and serves as a benchmark for many consumer and business loans. It is set by the banks, not the Fed, although it tends to move with the federal funds target. The federal funds rate is the overnight interbank rate, the discount rate is what the Fed charges banks at its discount window, and the T-bill yield is set by market demand at auction.

A company reports current assets of $300,000, inventory of $100,000, and current liabilities of $100,000. Its quick (acid-test) ratio is:

• a.3.0
• b.0.5
• c.2.0✓
• d.1.0

The quick ratio equals (current assets minus inventory) divided by current liabilities: ($300,000 minus $100,000) divided by $100,000 equals 2.0. It excludes inventory as a less-liquid asset. Including inventory gives the current ratio of 3.0, which is the trap.

Using current assets of $300,000 and current liabilities of $100,000, a company's working capital is:

• a.$400,000
• b.$3.00
• c.$200,000✓
• d.$30,000

Working capital equals current assets minus current liabilities: $300,000 minus $100,000 equals $200,000. It measures the short-term liquidity cushion available to fund operations. Adding the two figures ($400,000) is the trap.

A firm has total debt of $6 million and total shareholders' equity of $3 million. Its debt-to-equity ratio is:

• a.0.5
• b.2.0✓
• c.9.0
• d.3.0

Debt-to-equity equals total debt divided by equity: $6 million divided by $3 million equals 2.0. A higher ratio signals greater leverage and financial risk. Inverting the fraction gives the 0.5 trap.

A corporation earns net income of $10 million, pays $1 million in preferred dividends, and has 3 million common shares outstanding. Earnings per share (EPS) is:

• a.$2.70
• b.$9.00
• c.$3.33
• d.$3.00✓

EPS equals net income minus preferred dividends, divided by common shares: ($10 million minus $1 million) divided by 3 million equals $3.00. Forgetting to subtract preferred dividends yields the $3.33 trap. Preferred claims come before common.

A company reports net income of $2 million on shareholders' equity of $20 million. Its return on equity (ROE) is:

• a.10%✓
• b.20%
• c.5%
• d.2%

Return on equity equals net income divided by shareholders' equity: $2 million divided by $20 million equals 10%. ROE gauges how efficiently a firm turns equity capital into profit. It is a core profitability ratio in fundamental analysis.

A company earns $5.00 per share and pays a $1.50 annual dividend. Its dividend payout ratio is:

• a.150%
• b.30%✓
• c.3.3%
• d.50%

The payout ratio equals dividend per share divided by EPS: $1.50 divided by $5.00 equals 30%. The remaining 70% is the retention ratio reinvested in the business. Inverting the fraction gives distractor traps.

A firm has common shareholders' equity of $40 million and 2 million common shares outstanding. Its book value per share is:

• a.$0.05
• b.$20.00✓
• c.$80.00
• d.$2.00

Book value per share equals common equity divided by common shares: $40 million divided by 2 million equals $20.00. It is an accounting measure of net worth per share, not a market price. Multiplying instead of dividing gives the $80 trap.

A company has earnings before interest and taxes (EBIT) of $8 million and interest expense of $2 million. Its interest coverage ratio is:

• a.4 times✓
• b.0.25 times
• c.16 times
• d.2 times

The interest coverage ratio equals EBIT divided by interest expense: $8 million divided by $2 million equals 4 times. A higher ratio indicates a greater ability to service debt from operating earnings. Inverting the ratio gives the 0.25 trap.

A savings instrument pays a stated (nominal) annual rate of 6% compounded quarterly. Its effective annual yield is:

• a.Exactly 6%, because quarterly compounding changes only when interest is credited, not the annual yield
• b.Less than 6%, because each quarterly credit of 1.5% is smaller than the stated annual rate
• c.Greater than 6%, because interest is earned on interest more than once a year✓
• d.Equal to 1.5%, because the effective yield is measured over a single quarterly compounding period

More frequent compounding raises the effective annual yield above the stated nominal rate; 6% compounded quarterly equals about 6.14% effective, using (1 plus 0.06 divided by 4) raised to the fourth power minus 1. Only annual compounding leaves the two equal. The 1.5% is only the rate for one quarter, and four quarterly credits that each earn interest on prior interest cannot total less than the stated 6%.

Using the Rule of 72, an investment earning 6% compounded annually will take approximately how long to double?

• a.8 years
• b.6 years
• c.18 years
• d.12 years✓

The Rule of 72 estimates doubling time by dividing 72 by the annual rate: 72 divided by 6 equals 12 years. It is a quick approximation for compound growth. Subtracting or misdividing produces the trap answers.

What is the approximate present value of $5,000 to be received in 3 years, discounted at 8% annually?

• a.About $4,600
• b.About $3,969✓
• c.About $5,000
• d.About $6,299

Present value equals the future amount divided by (1 plus the rate) raised to the number of periods: $5,000 divided by 1.08 cubed equals about $3,969. Discounting reduces the amount below $5,000; compounding forward to about $6,299 is the trap.

An analyst who studies the advance/decline line and moving-average crossovers to forecast price direction is engaged in:

• a.Discounted cash flow valuation of the firm
• b.Credit analysis of the issuer's balance sheet
• c.Technical analysis of market and price data✓
• d.Fundamental analysis of earnings quality

Advance/decline lines, moving averages, and chart patterns are technical-analysis tools that study price and volume history to predict direction. Fundamental and credit analysis instead examine a company's financials and intrinsic value.

Two assets have a correlation coefficient of +0.3. This indicates:

• a.A strong positive relationship, so the assets nearly always move together and offer little diversification
• b.A weak negative relationship, so the assets tend to move in opposite directions and offset each other's losses
• c.No relationship at all, so the assets' returns are completely independent
• d.A weak positive relationship, so combining them still provides meaningful diversification✓

A correlation of +0.3 is a weak positive relationship: the assets tend to move in the same direction, but only loosely. Because it is well below +1.0, blending them still lowers portfolio risk. A strong positive relationship would be near +1.0, which is where diversification disappears. A negative relationship would require a coefficient below zero, and a coefficient of zero, not +0.3, means no linear relationship.

A weakening U.S. dollar relative to foreign currencies generally:

• a.Helps U.S. importers by lowering the cost of foreign goods
• b.Guarantees lower domestic inflation over the coming year
• c.Helps U.S. exporters by making their goods cheaper abroad✓
• d.Has no effect on international trade flows

A weaker dollar makes U.S. exports cheaper and more competitive abroad, helping exporters, while making imports more expensive. This is a currency-risk consideration for international investing. It does not guarantee lower inflation and typically raises import prices.

A preemptive right granted to existing common shareholders allows them to:

• a.Receive dividends ahead of preferred holders, since common holders are first in line for quarterly payments
• b.Buy the company's outstanding bonds at par before the bonds mature, ahead of other investors
• c.Purchase newly issued shares to maintain proportional ownership, usually at a subscription price below the current market price✓
• d.Require the company to buy back their shares at book value whenever they choose to sell

A preemptive (subscription) right lets existing holders buy new shares, typically below market and for a short period, so their percentage ownership is not diluted. It applies to new stock issues, not to bonds. It gives no dividend priority, since preferred holders are paid before common holders, and it gives no right to force a buyback at book value.

A cumulative preferred stock differs from straight (noncumulative) preferred because cumulative preferred:

• a.Accrues any skipped dividends, which must be paid in full before common dividends resume✓
• b.Gives holders a vote on every corporate matter, just like common stock
• c.Pays extra dividends above the stated rate whenever the company's earnings are unusually strong
• d.Can be exchanged for the issuer's common stock at the holder's option

Cumulative preferred accumulates unpaid dividends as arrears, and all arrears must be paid before common shareholders receive anything. Straight preferred does not accumulate missed dividends. Extra dividends in strong years describe participating preferred, exchange into common stock describes convertible preferred, and preferred stock generally carries no vote on ordinary corporate matters.

The distinguishing feature of participating preferred stock is that holders may:

• a.Collect any skipped dividends in full, with all arrears paid before common stockholders receive anything
• b.Exchange their shares for common stock at a fixed conversion ratio set when the preferred is issued
• c.Demand that the issuer redeem the shares at a set price on a date specified when issued
• d.Receive extra dividends beyond the stated rate when the company has strong earnings✓

Participating preferred can share in additional dividends above its fixed rate when profits are high, on top of its stated preference. Collecting skipped dividends first describes cumulative preferred, exchange into common describes convertible preferred, and redemption at a set price describes callable or putable preferred.

A callable preferred stock exposes the investor primarily to the risk that:

• a.The shares will fall in price when interest rates fall, since preferred prices move in the same direction as rates
• b.The holder will be forced to convert into common stock at a price set by the issuer
• c.The issuer will redeem the shares, often when rates fall, forcing reinvestment at lower yields✓
• d.Rising interest rates will force the issuer to raise the dividend rate on the shares

A call feature lets the issuer redeem preferred, typically after rates decline, creating reinvestment risk for the holder, the same reason issuers call bonds. The call favors the issuer, not the investor. Fixed-rate preferred rises in price, not falls, when rates fall; forced conversion describes a convertible with a call-for-conversion; and a dividend that resets upward describes adjustable-rate preferred, not callable preferred.

A convertible bond has a par of $1,000 and is convertible into common stock at $50 per share. If the common stock trades at $60, the conversion (parity) value of the bond is:

• a.$833
• b.$1,000
• c.$1,200✓
• d.$600

The conversion ratio equals par divided by the conversion price: $1,000 divided by $50 equals 20 shares. Parity value equals 20 shares times the $60 stock price, or $1,200. Because parity exceeds par, the conversion feature is in the money.

A bond's yield increases from 4.00% to 4.50%. This is a change of:

• a.0.05 basis points
• b.5 basis points
• c.500 basis points
• d.50 basis points✓

One basis point equals 0.01%, or one one-hundredth of one percent. A move of 0.50% therefore equals 50 basis points. Confusing tenths or whole percents produces the trap answers.

For a bond trading at a discount to par, which ordering of yields is correct?

• a.Coupon rate is greater than current yield, which is greater than yield to maturity
• b.Yield to maturity is greater than current yield, which is greater than the coupon rate✓
• c.Current yield is greater than yield to maturity, which is greater than the coupon rate
• d.All three yields are equal

At a discount, yield to maturity is highest because the investor also gains as the price rises toward par; current yield falls between the coupon and the YTM. The reverse ordering, with the coupon highest, applies to a premium bond.

The nominal yield of a bond refers to:

• a.The fixed coupon (interest) rate stated on the bond as a percentage of par✓
• b.The total return earned if the bond is held to maturity, combining coupon income with any gain or loss realized at final redemption
• c.The annual interest divided by the current market price
• d.The bond's yield after adjusting for inflation

Nominal yield is the stated coupon rate on par value. Annual interest divided by market price is the current yield, and total return to maturity is the yield to maturity; those are the traps. Nominal yield does not adjust for inflation.

A banker's acceptance is best described as a money-market instrument that:

• a.Pays a variable dividend tied to bank profits
• b.Represents an ownership interest in a pool of residential mortgages and passes through monthly principal and interest to its certificate holders
• c.Is a short-term time draft used to finance international trade, guaranteed by a bank✓
• d.Is a long-term unsecured corporate bond

A banker's acceptance is a short-term, bank-guaranteed time draft that facilitates import and export trade, trading at a discount in the money market. It is not a mortgage security, a long-term bond, or an equity instrument.

In a repurchase agreement (repo), a dealer:

• a.Sells securities and agrees to buy them back later at a slightly higher price, effectively a short-term collateralized loan✓
• b.Permanently sells securities with no obligation to repurchase them, transferring full title to the buyer so the dealer keeps no further claim of any kind once the initial sale settles
• c.Lends stock to a short seller for an indefinite term
• d.Issues new equity shares to the public

A repo is a short-term financing tool: the dealer sells securities and repurchases them shortly after at a higher price, and the difference is the implied interest. It is a common, collateralized money-market transaction, not a permanent sale.

Eurodollars are best defined as:

• a.Shares of European companies traded in the U.S. as dollar-denominated depositary receipts
• b.U.S. dollar-denominated deposits held in banks outside the United States✓
• c.Bonds issued in euros by U.S. corporations and sold to European investors
• d.Euro-denominated deposits held in banks inside the European Union

Eurodollars are U.S.-dollar deposits held at banks outside the United States; a Eurodollar bond is a dollar bond sold outside the U.S. The prefix denotes where the money sits, not the euro currency. Depositary receipts on foreign shares are ADRs, a bond issued in euros is a euro-denominated bond, and euro deposits in EU banks are simply euro accounts.

A U.S. Treasury note is a government security that:

• a.Has an original maturity of more than 10 years and pays interest every six months
• b.Has an original maturity of more than 1 year up to 10 years and pays semiannual interest✓
• c.Matures in one year or less and is sold at a discount, with no stated coupon
• d.Pays semiannual interest that is exempt from federal income tax but fully subject to state income tax

Treasury notes have original maturities of more than one year up to ten years and pay semiannual coupons. Maturities beyond ten years describe Treasury bonds, and maturities of one year or less sold at a discount describe T-bills. Treasury interest is the reverse of the last choice: it is federally taxable and exempt from state and local income tax.

Treasury STRIPS are best described as:

• a.Treasury securities that pay semiannual interest and whose principal adjusts with the CPI each period
• b.Short-term Treasury discount securities that mature in four to 52 weeks
• c.Agency securities that separate a mortgage pool's interest and principal payments into separate classes
• d.Zero-coupon securities created by separating a Treasury bond's interest and principal payments✓

STRIPS separate a Treasury's coupon and principal into individually tradable zero-coupon pieces sold at a discount and maturing at face value. They generate taxable phantom income annually even though no cash interest is received. CPI-adjusted principal describes TIPS, four-to-52-week discount paper describes T-bills, and splitting a mortgage pool into interest-only and principal-only classes describes mortgage strips, not Treasury STRIPS.

Which statement about federal agency securities is accurate?

• a.GNMA securities are backed only by the credit of the mortgage pool, while Fannie Mae and Freddie Mac securities are fully backed by the Treasury
• b.Securities of GSEs such as Fannie Mae and Freddie Mac are not directly backed by the full faith and credit of the Treasury, unlike GNMA✓
• c.Interest on agency securities is always exempt from federal income tax
• d.All agency securities, including those of Fannie Mae and Freddie Mac, carry the full faith and credit of the U.S. government

GNMA (Ginnie Mae) carries the full faith and credit of the U.S. government, but government-sponsored enterprises like Fannie Mae and Freddie Mac carry only implied backing, so they yield slightly more for the added credit risk. The backing is therefore not reversed between them, and not all agency issues carry the government's full faith and credit. Agency interest is generally taxable at the federal level.

A debenture is a corporate bond that is:

• a.Secured by a first mortgage on the issuer's land and buildings
• b.Backed only by the general credit and good faith of the issuer, with no specific collateral✓
• c.Backed by securities of other companies that the issuer deposits with a trustee for the bondholders
• d.Secured by equipment such as railcars or aircraft, with the trustee holding title until the debt is repaid

A debenture is unsecured debt backed solely by the issuer's creditworthiness. A mortgage bond pledges real property, a collateral trust bond pledges securities held by a trustee, and an equipment trust certificate pledges equipment. Each of those is secured, which a debenture is not. Debentures are also not government guaranteed.

A collateralized mortgage obligation (CMO) is best described as a security that:

• a.Passes interest and principal from a mortgage pool straight through to investors pro rata
• b.Is a bond issued by a state housing agency and backed by the state's full taxing power
• c.Is a debt security backed by pools of auto loans or credit card receivables
• d.Divides the cash flows from a pool of mortgages into tranches with different maturities and risk profiles✓

A CMO repackages the cash flows from a pool of mortgages into tranches that receive principal in sequence, distributing prepayment and interest-rate risk differently across tranches. A straight pass-through certificate shares every payment pro rata with no tranches. A CMO is not a municipal housing bond and is not backed by auto loans or credit card receivables, which are asset-backed securities.

Under the Investment Company Act of 1940, the three classifications of investment companies are:

• a.Open-end companies, closed-end companies, and unit investment trusts
• b.Diversified companies, non-diversified companies, and face-amount certificate companies
• c.Management companies, unit investment trusts, and real estate investment trusts (REITs)
• d.Face-amount certificate companies, unit investment trusts, and management companies✓

Section 4 of the Act divides investment companies into three principal classes: face-amount certificate companies, unit investment trusts, and management companies. Open-end and closed-end companies are the two subclasses of management companies, and diversified and non-diversified are a separate subclassification of management companies. REITs are not a class under the Act.15 USC 80a-4

For a management company to call itself diversified under the Investment Company Act of 1940 (the 75-5-10 test), with respect to 75% of its assets it must ensure that:

• a.No more than 5% is in any one issuer and it owns no more than 10% of any issuer's voting securities✓
• b.No more than 10% is in any one issuer and it owns no more than 5% of that issuer's outstanding voting stock
• c.No more than 5% is in any one issuer and no more than 25% is in any one industry
• d.All 100% of its assets meet the 5% and 10% limits, with no unrestricted portion

The 75-5-10 test requires that, for 75% of total assets, no more than 5% be invested in any single issuer and no more than 10% of any one issuer's voting securities be held. The two percentages are not reversed, the limits apply to 75% of assets and not all of them, and the remaining 25% is unrestricted. The 25% industry limit is a separate concentration policy, not part of the diversification test.15 USC 80a-5(b)(1)

A mutual fund has total assets of $100 million, total liabilities of $2 million, and 4.9 million shares outstanding. Its net asset value (NAV) per share is:

• a.$20.41
• b.$0.49
• c.$20.00✓
• d.$2.04

NAV per share equals net assets divided by shares outstanding: ($100 million minus $2 million) divided by 4.9 million equals $98 million divided by 4.9 million, or $20.00. Liabilities must be subtracted before dividing.

Under FINRA rules, the maximum sales charge on the purchase of an open-end mutual fund is:

• a.8.5% of the public offering price✓
• b.5% of net asset value
• c.There is no maximum
• d.12% of total fund assets

FINRA caps mutual fund sales charges at 8.5% of the public offering price, and the full 8.5% is allowed only if the fund offers breakpoints, rights of accumulation, and reinvestment of distributions at NAV. The charge is figured on the POP.

An open-end fund has a net asset value of $9.20 per share and a maximum sales charge of 8%. Its public offering price (POP) is:

• a.$8.46
• b.$10.00✓
• c.$9.94
• d.$9.20

POP equals NAV divided by (1 minus the sales charge percentage): $9.20 divided by 0.92 equals $10.00. The sales charge is figured on the POP, not the NAV, so simply adding 8% of NAV to reach $9.94 is the trap.

A 12b-1 fee charged by a mutual fund is:

• a.A contingent deferred sales charge that declines over time and is paid only when the investor redeems shares
• b.A one-time front-end sales charge deducted from the amount invested at purchase
• c.An annual fee deducted from fund assets to cover distribution and marketing costs✓
• d.A management fee paid to the investment adviser for selecting the portfolio's securities

A 12b-1 fee is an ongoing annual charge against fund assets for distribution, marketing, and sometimes shareholder servicing. A fund charging more than 0.25% generally may not call itself no-load. It is not a back-end sales charge (a contingent deferred sales charge), not a front-end load, and not the management fee that pays the adviser.

Class B mutual fund shares are typically characterized by:

• a.A level annual charge of about 1% through 12b-1 fees plus a one-year deferred sales charge, with no conversion
• b.A contingent deferred sales charge that declines the longer the shares are held, often converting to Class A over time✓
• c.A front-end load paid at purchase and reduced by breakpoints for larger investments
• d.Sales available only to institutions, with no sales charge and no 12b-1 fee

Class B shares carry a back-end contingent deferred sales charge that decreases over the holding period and usually convert to lower-cost Class A shares after several years. A front-end load reduced by breakpoints describes Class A shares, a level annual charge with a short deferred charge and no conversion describes Class C shares, and institutional shares have neither sales charges nor 12b-1 fees.

During the pay-in (accumulation) phase of a variable annuity, an investor's contributions purchase:

• a.Accumulation units, whose number varies as contributions are made while their value fluctuates with the separate account✓
• b.Units of the insurer's general account, which credit a guaranteed minimum interest rate
• c.Fixed-dollar credits whose value never falls below the premiums contributed
• d.Annuity units, which set the size of each monthly payment for the rest of the contract

Contributions buy accumulation units during the pay-in phase; at annuitization these convert to a fixed number of annuity units whose value then varies with separate-account performance to determine each payment. Annuity units belong to the payout phase. General-account credits with a guaranteed minimum describe a fixed annuity, and a variable annuity gives no guarantee that value stays above premiums paid.

In a variable annuity, if the separate account's actual return exceeds the assumed interest rate (AIR), the next monthly annuity payment will:

• a.Increase relative to the prior payment✓
• b.Decrease relative to the prior payment
• c.Remain fixed for the life of the contract
• d.Fall to zero

Payments rise when actual performance exceeds the AIR, stay level when it equals the AIR, and fall when it lags the AIR. The AIR is a benchmark used to set payments, not a guaranteed return.

An equity-indexed annuity (EIA) credits interest based on:

• a.The performance of the investor's chosen subaccounts, with no guaranteed minimum credited interest
• b.A fixed rate declared by the insurer that is guaranteed not to change for the life of the contract
• c.The performance of a stock index, subject to features such as a participation rate and a cap, with a guaranteed minimum✓
• d.The full price return of a stock index, with no participation rate or cap on gains and no minimum

An EIA is a fixed annuity that links credited interest to an index such as the S&P 500 but limits gains through participation rates and caps, while guaranteeing a minimum return. Subaccount performance with no guarantee describes a variable annuity, a rate that never changes describes a traditional fixed annuity, and an uncapped index return with no minimum is not how an EIA credits interest.

Compared with term life insurance, whole life insurance:

• a.Fluctuates in value with a separate investment account chosen by the policyholder
• b.Is always cheaper for the same death benefit
• c.Provides coverage only for a set number of years with no savings element
• d.Builds cash value and provides lifelong coverage as long as premiums are paid✓

Whole life offers permanent coverage plus a cash-value component at higher premiums than term. Term provides pure death-benefit protection for a stated period with no cash value, which is the trap. Variable life ties value to a separate account.