NASAA Series 66 — All Questions

An investor buys 100 shares of GHI at $60 and also buys one GHI 55 put for $3. What is the breakeven price on the position?

• a.$55
• b.$57
• c.$52
• d.$63✓

The put premium raises the cost of the position to $63 per share, so the stock must reach $63 to break even. Subtracting the premium to get $57 lowers the cost instead of adding to it. The $55 strike is only the price at which the put starts to pay, and $52 subtracts the premium from the strike, ignoring what was paid for the stock.

An investor buys a call and a put on the same stock with the same strike price and expiration. This long straddle is most profitable when:

• a.The stock moves far enough either way to cover both premiums✓
• b.The stock stays near the strike price right up until expiration
• c.The stock drifts slightly lower while implied volatility declines
• d.The stock rises steadily, but by less than the combined premiums

A long straddle pays off when the price move exceeds the combined premiums, in either direction. Staying near the strike is the best case for the seller. A small move in either direction fails to cover cost. Falling volatility reduces option values, hurting the buyer.

Under the passive activity loss rules, an investor in a direct participation program may generally use passive losses to:

• a.Offset passive income from other passive activities✓
• b.Offset wages and other earned income without any limit
• c.Offset portfolio income such as dividends and interest
• d.Offset only gains from the sale of the same program's units

Passive losses can generally be deducted only against passive income (Internal Revenue Code Section 469), with unused losses carried forward. They do not shelter earned income or portfolio income. Offsetting gains only from the same program is a narrower rule than the law applies.

A U.S. investor owns an American depositary receipt (ADR) for a foreign company. Which statement is correct?

• a.The ADR gives the investor a direct claim on the foreign company's bonds
• b.The ADR trades in the foreign currency, so the investor bears no dollar risk
• c.It trades in dollars, but the investor still bears currency risk✓
• d.The ADR eliminates currency risk because it is denominated in dollars

A U.S. bank holds the foreign shares and issues ADRs that trade in dollars, but the underlying value still moves with the foreign currency. The ADR price reflects exchange rates even though quoted in dollars. ADRs represent equity, not debt.

A company has cumulative preferred stock outstanding, and it skipped last year's $2 per share dividend. What must happen before it pays any common dividend this year?

• a.The common stockholders must vote to approve the preferred payment
• b.The $2 in arrears and the current preferred dividend must be paid first✓
• c.The preferred shares must be converted into common stock
• d.Only the current preferred dividend must be paid; arrears are forgiven

Cumulative preferred stockholders must receive unpaid dividends in arrears plus the current dividend before common holders receive anything. Forgiveness describes non-cumulative preferred. A vote is not required for the payment, and conversion is a separate feature.

Which statement about a Section 3(c)(7) private fund is correct?

• a.Its investors need only meet the accredited-investor test
• b.It is limited to 100 beneficial owners
• c.It must register as an open-end investment company
• d.Its investors must generally be qualified purchasers✓

A 3(c)(7) fund is excluded from the Investment Company Act definition because its securities are owned only by qualified purchasers, such as individuals holding at least $5 million in investments. Meeting only the accredited-investor test is not enough. The 100-owner limit belongs to the 3(c)(1) exclusion, and registering as an open-end company is what the exclusion avoids.Investment Company Act of 1940 Section 3(c)(7); 15 U.S.C. 80a-3(c)(7)

An issuer relying on Rule 506(b) of Regulation D to raise capital may sell to how many non-accredited purchasers in an offering?

• a.No more than 35, each of whom must be financially sophisticated✓
• b.No more than 100, provided each invests at least $50,000 in the offering
• c.No more than 10, provided the issuer has verified each one's finances
• d.None, because only accredited investors may buy in any Regulation D offering

Rule 506(b) allows an unlimited number of accredited investors and up to 35 non-accredited purchasers who, alone or with a purchaser representative, are sophisticated; general solicitation is not allowed. The issuer is not required to verify the finances of non-accredited purchasers, which is the 506(c) requirement for accredited ones. The 100-owner figure belongs to a fund exclusion, not Regulation D. The offering is not limited to accredited investors, so none is wrong.Regulation D Rule 506(b)

An issuer wants to advertise its private offering on social media. Which exemption permits general solicitation?

• a.Rule 506(c), if every purchaser is accredited and the issuer verifies it✓
• b.Section 4(a)(2), if the issuer limits its offers to sophisticated investors
• c.Rule 506(b), provided the issuer limits sales to 35 non-accredited purchasers
• d.Rule 144, provided the securities are held for at least six months

Rule 506(c) permits general solicitation if every purchaser is an accredited investor and the issuer verifies it. Rule 506(b) prohibits general solicitation. The statutory private-offering exemption in Section 4(a)(2) also does not allow advertising. Rule 144 is a resale safe harbor, not an offering exemption.Regulation D Rule 506(c)

Which individual qualifies as an accredited investor under Regulation D?

• a.An investor with a securities account balance of more than $500,000
• b.An investor with $1.2 million of net worth, including a $900,000 home
• c.An investor with $150,000 of income in each of the past two years
• d.An investor with $1.2 million of net worth, excluding the home✓

An individual qualifies by net worth over $1 million excluding the primary residence, or by income above $200,000 ($300,000 with a spouse) in each of the last two years with the same expected this year. Counting the home would push this investor under the net worth test. $150,000 is below the income test. An account balance alone is not a standard.Regulation D Rule 501(a)

An affiliate of a reporting company wants to sell control securities under Rule 144. What limits the amount that may be sold during any three-month period?

• a.The greater of 1% of shares outstanding or average weekly volume over four weeks✓
• b.The greater of 5% of the shares outstanding or the average monthly volume of the prior year
• c.The lesser of 1% of the shares outstanding or the average weekly volume over the last four weeks
• d.Ten percent of the shares the affiliate owns, regardless of the trading volume

For affiliates, Rule 144(e)(1) caps sales in any three-month period at the greatest of 1% of the outstanding shares of the class or the average weekly reported trading volume during the four calendar weeks before the notice of sale (a third measure, volume reported under a transaction reporting plan, works the same way). The limit is the higher figure, so a 'lesser of' test is the reverse of the rule. The 5% and monthly-volume figures are not in the rule, and the limit does not depend on a percentage of the seller's own holdings.17 CFR 230.144(e)(1)

A non-affiliate bought restricted stock of a company that files reports under the Exchange Act. After what minimum holding period may the stock generally be resold under Rule 144?

• a.Six months, subject to the current public information condition✓
• b.Two years, whether or not the issuer reports under the Exchange Act
• c.Three months, after which only the volume limitation applies to the sale
• d.One year, regardless of whether the company is a reporting company

For restricted securities of a reporting issuer, the Rule 144 holding period is six months; a non-affiliate is subject to a current-public-information condition from six months until one year, and free of conditions afterward. For a non-reporting issuer the holding period is one year. Three months is not a period under the rule, and the one-year period applies only to non-reporting companies. Two years is not a holding period under the current rule.Securities Act Rule 144

Under Regulation Best Interest, a broker-dealer recommending a security to a retail customer must act in the customer's best interest without placing its own interest ahead. Which set lists the four component obligations?

• a.Registration, disclosure, custody, and fee transparency
• b.Suitability, care, supervision, and compliance
• c.Disclosure, care, conflict of interest, and compliance✓
• d.Disclosure, loyalty, fair dealing, and recordkeeping

Reg BI requires a disclosure obligation, a care obligation, a conflict-of-interest obligation, and a compliance obligation. Suitability was the older standard that Reg BI raised. The other lists mix real topics such as recordkeeping and custody that are not the four components.SEC Regulation Best Interest

When must a registered investment adviser that serves retail investors deliver its Form CRS (relationship summary)?

• a.Only when the adviser recommends a product that carries a commission
• b.Only when the retail investor asks the adviser for a copy in writing
• c.Before or at the time the advisory contract is entered into✓
• d.Within 90 days after the end of the adviser's own fiscal year

Form CRS is a short plain-English summary given to retail investors, and for advisers it must be delivered no later than when the advisory contract is entered into. It is not request-only, and the 90-day window relates to the Form ADV annual amendment. It is not tied to commission products.Form CRS

An investment adviser wants to sell a security from its own account to an advisory client. What does the Advisers Act require?

• a.A written notice to the SEC that is filed within 30 days after the trade
• b.Written disclosure and client consent before the trade is completed✓
• c.Nothing, because the principal trade is permitted if the price is fair
• d.A verbal agreement of the client, confirmed at the end of the quarter

Section 206(3) makes it unlawful to act as principal with a client without disclosing the capacity in writing and getting the client's consent before completion of the transaction. A later notice to the SEC, delayed confirmation, or a fair price alone does not satisfy the requirement.Investment Advisers Act Section 206(3)

An advisory contract with a registered investment adviser must provide that it may not be assigned without:

• a.The consent of the clearing firm
• b.The written consent of the client✓
• c.The approval of the SEC staff
• d.Notice to the state Administrator

Section 205(a)(2) requires the contract to prohibit assignment without client consent, and a change of control of the adviser is treated as an assignment. Neither the SEC, a clearing firm, nor the Administrator must approve it.Investment Advisers Act Section 205(a)(2)

The Section 28(e) safe harbor allows an investment adviser that has investment discretion to pay a broker more than the lowest commission for research and brokerage services if the adviser:

• a.Uses the research only for the specific account that paid the commission
• b.Obtains each affected client's written consent before every transaction
• c.Determines in good faith that the commission is reasonable for the value received✓
• d.Discloses each commission rate to the SEC every quarter in a filing

Section 28(e) protects an adviser who makes a good-faith determination that the commissions are reasonable for the brokerage and research received, covering the whole of the client accounts. Per-trade consent, account-by-account use, and quarterly reports to the SEC are not conditions.Securities Exchange Act Section 28(e)

For a registered investment company, the Investment Company Act limits the proportion of the board that may be made up of interested persons to:

• a.No more than 40%
• b.No more than 25%
• c.No more than 60%✓
• d.No more than 75%

Section 10(a) provides that no more than 60% of the board may be interested persons, so at least 40% must be disinterested. The statement of 40% as the cap flips that ratio. The other numbers are not in the statute.Investment Company Act Section 10(a)

Under the Insider Trading and Securities Fraud Enforcement Act of 1988, a person who trades on material nonpublic information may face a civil penalty of up to:

• a.Three times the profit gained or loss avoided✓
• b.Twice the total commissions paid on the trades
• c.Five times the value of the securities that were purchased
• d.The amount of the profit gained, and nothing more

ITSFEA authorizes a civil penalty of up to three times the profit gained or loss avoided, in addition to criminal penalties, and extends liability to controlling persons. A penalty tied to commissions, one capped at the profit, or one based on the securities' value does not match the Act.Insider Trading and Securities Fraud Enforcement Act of 1988

A director buys 1,000 shares of her company at $20 and sells them four months later at $26. Under Section 16(b), what is the consequence?

• a.The profit is taxed as ordinary income but is otherwise unaffected
• b.The company can recover the entire $6,000 profit from that round trip✓
• c.Nothing, because 16(b) only applies to trades by the 10% owners
• d.The company can recover the profit only if she used inside information

Section 16(b) applies strict liability to officers, directors, and 10% holders: any short-swing profit from a purchase and sale within less than six months belongs to the company, whether or not inside information was used. Directors are covered by the rule. Tax treatment is separate from disgorgement.Securities Exchange Act Section 16(b)

A registered investment adviser with a December 31 fiscal year end must file its annual updating amendment to Form ADV within how many days after that date?

• a.180 days
• b.30 days
• c.90 days✓
• d.120 days

Rule 204-1 requires the annual updating amendment within 90 days after the end of the adviser's fiscal year. 30 days is shorter than the requirement, and 120 and 180 days are longer than the rule allows.Form ADV

According to the SEC's 2019 interpretation, an investment adviser's federal fiduciary duty to its clients consists of:

• a.A duty of care and a duty of loyalty to the client✓
• b.A duty of registration and a duty of recordkeeping
• c.A duty of best execution and a duty of confidentiality
• d.A duty of disclosure and a duty of suitability

The SEC interpretation describes the fiduciary duty as a duty of care, which includes the duty to provide advice in the client's best interest and to seek best execution, and a duty of loyalty, which requires placing the client's interest first. The other pairs list true topics but not the two components.Advisers Act fiduciary duty (SEC Release IA-5248)

A single filer has modified adjusted gross income of $260,000, including $40,000 of net investment income. Under the net investment income tax rules, how is the 3.8% tax computed?

• a.On the whole $260,000, because income exceeds the $200,000 threshold
• b.On $40,000, the lesser of net investment income and the $60,000 excess✓
• c.On none of it, because the tax applies only to married couples filing jointly
• d.On the $60,000 excess over $200,000, which exceeds the net investment income

The 3.8% NIIT applies to the lesser of net investment income or the excess of MAGI over the threshold ($200,000 for single filers, $250,000 for joint filers). Here the excess is $60,000 and the net investment income is $40,000, so tax applies to $40,000. Taxing the whole income or the full excess misreads 'lesser of', and single filers are covered.

An investor sells a stock at a loss and buys the same stock back 15 days later. What happens to the loss for federal income tax purposes?

• a.It is disallowed permanently, and the basis of the new shares is unaffected
• b.It is allowed, but only as a deduction against ordinary income
• c.It is disallowed currently and added to the cost basis of the new shares✓
• d.It is allowed in full, because the repurchase occurred after the sale

The wash sale rule disallows a loss if the investor buys substantially identical securities within 30 days before or after the sale; the disallowed loss increases the basis of the replacement shares, so it is deferred. Full deduction ignores the 30-day window. A deduction against ordinary income is not a wash sale outcome either. Permanent loss of the deduction ignores the basis increase in the new shares.

An investor places $500 into a mutual fund on the first day of each month for a year, regardless of price. This approach is known as dollar cost averaging. What is a typical effect of this strategy?

• a.It guarantees a profit if the market ends the year higher
• b.More shares are bought when the price is low and fewer when it is high✓
• c.It buys the same number of shares each month regardless of price
• d.It guarantees that the investor will not lose money in a falling market

Fixed-dollar purchases buy more shares at low prices and fewer at high prices, which lowers the average cost per share relative to the average price. It does not guarantee profits or protect against loss in a falling market, and the share count changes with the price.

A client has a 4-year-old child and wants to save for college through a 529 plan. Which statement about the federal tax treatment is most accurate?

• a.Contributions are deductible on the federal return, and withdrawals are tax-free
• b.Earnings are taxed each year, but contributions are returned tax-free
• c.Earnings grow tax-deferred, and qualified education withdrawals are tax-free✓
• d.Earnings are taxed as ordinary income at withdrawal, even if spent on tuition

A 529 plan has no federal deduction for contributions; earnings grow tax-deferred and are free of federal tax when used for qualified education expenses. Annual taxation of earnings describes a taxable account, and earnings are taxed as ordinary income only on non-qualified withdrawals.

A client with a $400,000 portfolio is retiring and plans a first-year withdrawal of 4% of the portfolio, with later withdrawals rising by inflation. What is the first-year withdrawal?

• a.$1,600, found by multiplying $400,000 by 0.4%
• b.$100,000, found by dividing $400,000 by 4
• c.$10,000, found by dividing $400,000 by 40
• d.$16,000, found by multiplying $400,000 by 4%✓

First-year withdrawal = $400,000 x 0.04 = $16,000, with later amounts adjusted for inflation. Dividing by 40 gives $10,000 and misreads the rate as 2.5%. Dividing by 4 treats the percentage as a divisor and gives $100,000, a quarter of the portfolio. Moving the decimal two places gives $1,600, a tenth of the intended amount.

A portfolio returned 8% with a standard deviation of 12% while the risk-free rate was 2%. What is its Sharpe ratio?

• a.0.67
• b.0.50✓
• c.0.833
• d.0.17

Sharpe ratio = (portfolio return - risk-free rate) / standard deviation = (8% - 2%) / 12% = 0.50. The figure 0.67 divides the raw return by the standard deviation and forgets to subtract the risk-free rate. The figure 0.17 divides the risk-free rate, not the excess return, by the standard deviation. The figure 0.833 adds the risk-free rate to the return instead of subtracting it.

In Modern Portfolio Theory, a correlation coefficient of -0.5 between two assets means that:

• a.the assets move in opposite directions exactly half of the time, so the diversification benefit is negligible
• b.the assets always move in opposite directions by half as much, so the portfolio becomes risk-free
• c.the assets tend to move in opposite directions, though not in lockstep, which lowers portfolio risk✓
• d.the assets move in the same direction, only more weakly than a coefficient of +1.0 would imply

A coefficient of -0.5 is a moderate negative relationship: when one asset rises the other tends to fall, but not by a fixed amount or every time. Correlation measures the strength of a linear relationship, not the share of periods in which prices diverge, so reading it as a 50% frequency is wrong. Only a coefficient of exactly -1.0 would remove all risk, and a negative sign means opposite, not same-direction, movement.

A stock with a beta of 1.0 would be expected to:

• a.move about 1% whenever the overall market moves by 1%✓
• b.stay unchanged whatever the overall market does
• c.fall about 1% when the overall market rises by 1%
• d.move about 2% when the overall market moves by 1%

Beta measures sensitivity to the market, and a beta of 1.0 means the security moves roughly in step with it. A beta of 2.0 would produce the 2% swing. A beta of 0 would leave the price unaffected by market moves. A beta of -1.0 would produce the mirror-image move.

Alpha, in a portfolio context, is best described as:

• a.the expected return of the overall market for the coming year
• b.the return earned above or below what CAPM predicts for the portfolio's beta✓
• c.the volatility of the portfolio's returns relative to its benchmark
• d.the extra return earned over the risk-free rate per unit of total risk

Alpha is the difference between the return actually earned and the return the capital asset pricing model predicts from the portfolio's systematic risk, so a positive alpha means the manager added value. The expected market return is an input to CAPM, not alpha. Volatility relative to a benchmark describes tracking error or beta, not a risk-adjusted excess return. Excess return per unit of total risk is the Sharpe ratio.

A bond pays 3% nominal interest during a year in which inflation is 4%. What is the approximate real return?

• a.+3%, the nominal return alone
• b.+7%, the sum of both rates
• c.+4%, the inflation rate alone
• d.-1%, a loss of purchasing power✓

Real return is approximately the nominal return minus inflation: 3% - 4% = -1%, so purchasing power fell. The answer +3% ignores inflation altogether. The answer +7% adds inflation to the nominal return instead of subtracting it. The answer +4% reports the inflation rate itself rather than the return after inflation.

Present value is inversely related to the discount rate. Which statement follows from this?

• a.The discount rate has no effect on cash flows received far in the future
• b.A higher discount rate lowers the present value of the same future cash flow✓
• c.A higher discount rate raises the present value of the same future cash flow
• d.A higher discount rate raises present value only once the rate passes 5%

Present value divides a future amount by (1 + r) raised to the number of periods, so a larger r produces a smaller present value, and the effect grows with time. The claim that a higher rate raises value reverses the relationship. Distant cash flows are the most sensitive to the discount rate, not immune to it. There is no 5% threshold; the inverse relationship holds at every rate.

Standard deviation, as a measure of investment risk, describes:

• a.how widely an investment's returns have varied around their long-run average✓
• b.the return earned per unit of risk above the risk-free rate
• c.how closely an investment's returns follow the overall market
• d.the probability that an investment will lose money in any given year

Standard deviation measures the dispersion of returns around the mean, so a higher figure means more volatility. Tracking the market is what beta describes. Return per unit of risk is the Sharpe ratio. Standard deviation is not a probability of loss; it measures the spread of outcomes in both directions.

A mutual fund has an R-squared of 95 relative to its benchmark index. This indicates that:

• a.about 95% of the fund's return variation is explained by the benchmark✓
• b.the fund is 95% likely to outperform the benchmark index next year
• c.the fund beat its benchmark by an average of 95 basis points a year
• d.about 95% of the fund's holdings are also held by the benchmark index

R-squared ranges from 0 to 100 and shows how much of a fund's return variation is explained by the benchmark, so a high figure means the fund behaves like the index. It says nothing about the amount of outperformance, which is alpha. It is a statistical fit, not a count of overlapping holdings. It gives no probability of future outperformance.

A client in the 37% federal bracket is considering a municipal bond yielding 3%. What taxable yield is needed to match it after federal tax?

• a.4.76%✓
• b.3.00%
• c.8.11%
• d.1.89%

Taxable-equivalent yield = tax-free yield / (1 - tax rate) = 3% / 0.63 = 4.76%. Multiplying 3% by 0.63 gives 1.89%, which applies the tax in the wrong direction. Dividing by the tax rate itself gives 8.11%, forgetting to subtract it from 1. A taxable bond yielding 3.00% would leave the client with less than the municipal bond after tax.

A municipal bond yields 2.5% and a Treasury of similar risk yields 3.5%. An investor indifferent between them has an implied marginal federal tax rate of about:

• a.28.6%✓
• b.71.4%
• c.35.0%
• d.1.0%

The break-even rate is 1 - (municipal yield / taxable yield) = 1 - 2.5/3.5 = 28.6%. The figure 71.4% is the ratio itself (2.5/3.5), not one minus it. The 35.0% figure is simply a familiar bracket and is not derived from the yields. The 1.0% figure is the gap between the yields, not a tax rate.

When the yield curve inverts, so that short-term Treasury rates exceed long-term rates, the usual interpretation is that:

• a.recessions have often followed, as markets price in slower growth and lower future rates✓
• b.inflation expectations have risen sharply across the whole maturity range of Treasuries
• c.short-term borrowing now costs less than long-term borrowing, the usual upward-sloping shape
• d.corporate earnings are expected to accelerate over the next year, as in an expansion

An inverted curve reflects expectations of weaker growth and eventually lower rates, and historically it has often preceded recessions, though it is not a certain predictor. Short-term loans costing less than long-term loans describes a normal, upward-sloping curve. Accelerating earnings would be consistent with expansion, not inversion. Rising inflation expectations would normally push long-term yields up and steepen the curve.

The economy records two consecutive quarters of declining real GDP. Which phase of the business cycle does this describe?

• a.A peak, where output turns downward
• b.A trough, where output turns upward
• c.A contraction, with output falling✓
• d.An expansion, with output still rising

Two or more consecutive quarters of falling real GDP is the common working definition of a contraction. In an expansion output is rising, not falling. A peak is the turning point at the top, after which output starts to decline, so it is not itself a period of declining output. A trough is the turning point at the bottom, after which output starts to rise again.

Which of the following is a leading economic indicator?

• a.Nonfarm payroll employment levels
• b.Industrial production at factories
• c.The average prime rate banks charge
• d.Building permits for new housing✓

Building permits are a leading indicator because construction approvals tend to change before the broader economy turns. Payroll employment and industrial production are coincident indicators that move with the economy. The average prime rate is a lagging indicator that follows turning points.

A coincident economic indicator is one that:

• a.moves with the economy and confirms the current phase of the cycle✓
• b.stays stable throughout the cycle and is used as a baseline
• c.changes after the economy has turned and confirms a trend already under way
• d.changes ahead of the economy and signals a coming turning point

Coincident indicators, such as industrial production and personal income, move at about the same time as the overall economy. Indicators that change ahead of turning points are leading indicators. Indicators that change after the turn, such as the average duration of unemployment, are lagging. An indicator that does not change with the cycle would be of no use for analyzing it.

The Federal Reserve wants to stimulate a weak economy. Which action would most directly support that goal?

• a.Raising the reserve requirement for banks
• b.Purchasing Treasury securities in the open market✓
• c.Selling Treasury securities from its portfolio
• d.Raising the discount rate charged to banks

Open market purchases add reserves to the banking system, push short-term rates down, and encourage lending and spending. Raising the discount rate makes borrowing from the Fed more expensive. Raising reserve requirements leaves banks with less to lend. Selling securities drains reserves and tightens credit, which slows the economy.

Fiscal policy differs from monetary policy in that fiscal policy is set by:

• a.the Federal Reserve through interest rates and the money supply
• b.the SEC through its rules governing the securities markets and exchanges
• c.Congress and the President through taxation and government spending✓
• d.the Treasury Department through the sale of savings bonds only

Fiscal policy is the government's use of taxes and spending, decided by Congress and the President. Control of interest rates and the money supply is monetary policy, carried out by the Federal Reserve. Savings bond sales are a financing tool, not a policy lever, and do not define fiscal policy. The SEC regulates securities markets and does not set economic policy.

How do rising market interest rates typically affect stock valuations?

• a.raise the present value of expected future earnings, because discount rates are higher
• b.affect stock prices only when inflation is above 3% in that same year
• c.have no lasting effect on stock prices, since earnings alone drive valuations
• d.lower the present value of expected earnings and make bonds more competitive✓

Higher rates raise the discount rate applied to future earnings, which lowers their present value, and they make fixed-income yields more attractive relative to stocks. A higher discount rate lowers present value rather than raising it. Rates are one of the main inputs to valuation models, so they matter for stock prices. No inflation threshold is needed for the effect to operate.

A bond with a $1,000 par value is trading at $950. The bond is trading:

• a.at a premium, so its coupon rate is above prevailing market yields
• b.at par, so a buyer faces neither gain nor loss at maturity
• c.at a discount, so its yield to maturity is higher than its coupon rate✓
• d.at a discount, so its current yield is below its coupon rate

A bond priced below par trades at a discount, which happens when its coupon is below what the market now demands, so the yield to maturity exceeds the coupon. A premium price would be above par. Only a price of $1,000 is at par, and a buyer at $950 gains $50 at maturity. For a discounted bond the current yield (coupon divided by price) is higher than the coupon rate, not lower.

Stagflation is best described as an economy with:

• a.rapid growth with falling prices and rising employment
• b.slow or negative growth together with high inflation✓
• c.rapid growth with low unemployment and stable prices
• d.slow growth with falling prices and rising unemployment

Stagflation combines stagnant or shrinking output, usually with high unemployment, and high inflation, which is hard to fight because measures that cure one problem worsen the other. Rapid growth with falling prices and rising employment describes a strong, disinflationary expansion. Slow growth with falling prices and rising unemployment describes a deflationary recession, where inflation is absent. Rapid growth with low unemployment and stable prices describes an ideal expansion with no stagnation.

A U.S. investor's foreign stock fund returned +8% in local-currency terms, and the dollar weakened 3% against that currency. What was the investor's approximate return in dollars?

• a.up about 11%✓
• b.up about 5%
• c.up about 8%
• d.down about 3%

When the dollar weakens, the foreign currency buys more dollars, so the currency move adds to the local return: 8% + 3% = about 11%. The figure +5% treats the weaker dollar as a loss. The figure +8% ignores the currency move entirely. The figure -3% counts only the currency and drops the stock gain.

Currency risk in international investing refers to the possibility that:

• a.exchange-rate movements will reduce the dollar value of foreign returns✓
• b.a foreign government will restrict or seize the assets of foreign investors
• c.foreign companies will report under different accounting standards
• d.foreign securities will be hard to sell quickly without a large price concession

Currency risk is the exchange-rate effect on returns when foreign proceeds are converted back to dollars. Restrictions on or seizure of foreign assets are political risk. Difficulty selling without a price concession is liquidity risk. Differences in accounting standards are a disclosure and comparability issue, not an exchange-rate one.

The semi-strong form of the efficient market hypothesis holds that security prices reflect:

• a.all public and private information, so even insiders cannot earn excess returns
• b.only past prices and trading volume, so technical analysis cannot earn excess returns
• c.only the information published in a company's most recent annual report
• d.all public information, so fundamental analysis cannot earn excess returns✓

The semi-strong form says prices already reflect all public information, which defeats both technical and fundamental analysis, though it leaves room for gains from inside information. Reflecting only past price and volume data describes the weak form. Reflecting all public and private information describes the strong form. Prices reflect all public information, not just one report.

In Modern Portfolio Theory, the efficient frontier is:

• a.the line running from the risk-free rate through the market portfolio
• b.the single portfolio with the lowest possible risk, whatever its expected return
• c.the portfolios giving the highest expected return at each level of risk✓
• d.the set of all portfolios that can be built from the securities available

The efficient frontier connects portfolios that are optimal, meaning no other portfolio gives more return for the same risk. The lowest-risk portfolio is only one point on it, the minimum-variance portfolio. The set of all attainable portfolios includes inefficient ones lying below the frontier. The line from the risk-free rate through the market portfolio is the capital market line.

In behavioral finance, loss aversion is the tendency to:

• a.avoid all investment risk, whatever the client's long-term goals
• b.prefer dividend income to capital appreciation when choosing investments
• c.hold winning positions too long, expecting still more gains
• d.feel the pain of a loss more strongly than the pleasure of an equal gain✓

Loss aversion means losses weigh more heavily than equivalent gains, which can lead investors to avoid selling losers. Holding winners too long is not loss aversion; the disposition effect points the other way. A preference for dividends is an income preference, not a bias about losses. Avoiding all risk would be extreme risk aversion and does not describe the bias.