NASAA Series 65 — All Questions

Under the SEC's current marketing rule, an adviser may use a client testimonial in an advertisement if the adviser:

• a.Uses only testimonials from clients whose accounts outperformed their benchmark
• b.Files the advertisement with the SEC before it is first used
• c.Discloses whether the person was compensated and any material conflicts✓
• d.Uses only unpaid testimonials, since paid ones remain banned

The marketing rule replaced the old flat ban on testimonials with a disclosure and oversight framework. The advertisement must clearly and prominently disclose whether the speaker is a client, whether cash or non-cash compensation was provided, and any material conflicts, and the adviser must have a reasonable basis to believe the testimonial complies and a written agreement with compensated promoters; ineligible persons may not be compensated promoters. Showing only favorable results is not fair and balanced, advertisements are not filed with the SEC for pre-approval, and paid testimonials are allowed when the conditions are met.17 CFR 275.206(4)-1(b)

A company reports net sales of $5,000,000 and cost of goods sold of $3,000,000. Its gross profit margin is:

• a.20%
• b.40%✓
• c.60%
• d.167%

Gross profit = $5,000,000 - $3,000,000 = $2,000,000. Gross profit margin = $2,000,000 / $5,000,000 = 0.40, or 40%. The 60% figure is the cost of goods sold as a percentage of sales, which is the complement of the answer, not the margin itself. Gross margin measures production efficiency before operating expenses, interest, and taxes.

Which withdrawal from a traditional IRA before age 59 1/2 is generally exempt from the 10% early distribution penalty?

• a.A distribution used to purchase a vacation home at a lake resort
• b.A distribution taken to pay off outstanding credit card balances
• c.A distribution moved into the owner's taxable brokerage account
• d.A distribution taken because the owner became permanently disabled✓

Statutory exceptions to the 10% penalty include death, permanent disability, qualified higher education expenses, a first-time home purchase up to $10,000, certain medical expenses, and substantially equal periodic payments. Ordinary consumption, debt repayment, and a second or vacation residence do not qualify. Note that the exception removes the penalty only; the distribution is still ordinary income.

Class C mutual fund shares are generally characterized by:

• a.A deferred load declining over six years and later conversion to Class A
• b.No front-end load, a higher ongoing 12b-1 fee, and a short contingent charge✓
• c.A front-end sales load, lower annual expenses, and breakpoint discounts
• d.No sales charge of any kind, with all fund costs paid by the sponsor

Class C is the level-load share: the investor pays nothing up front, a contingent deferred sales charge usually applies only for about the first year, and the annual 12b-1 fee is comparatively high. That makes Class C relatively cheap for a short holding period and expensive for a long one. Class A charges the front-end load with breakpoints, and Class B is the long-declining deferred load that converts to Class A.

When an adviser advertises the performance of a strategy, presenting gross performance without also showing net performance is:

• a.Prohibited, because fees and expenses materially reduce investor returns✓
• b.Permitted only when the strategy has outperformed its benchmark
• c.Permitted, provided a footnote states that past results may vary
• d.Required, because gross figures allow comparison across advisers

The marketing rule requires that gross performance never be presented without net performance shown with at least equal prominence and calculated over the same period using the same methodology. Fees compound, so a gross-only presentation systematically overstates the investor's experience. Advertised performance must also not be presented in a way that is otherwise materially misleading, such as cherry-picked periods or accounts.Investment Advisers Act of 1940

Under the forward pricing rule, an order to purchase open-end mutual fund shares received at 2:00 p.m. is executed at:

• a.The net asset value that is next computed after the order is received✓
• b.The average net asset value over the five preceding business days
• c.The market price at which the fund's shares last changed hands
• d.The net asset value computed at the close of the prior business day

Open-end funds do not trade intraday. Rule 22c-1 under the Investment Company Act of 1940 requires that purchase and redemption orders be priced at the next net asset value calculated, normally at the close of that trading day. Forward pricing exists to stop investors from buying at a stale price they already know is favorable.

Under ERISA's minimum participation standards, a qualified plan generally may not exclude an employee who has reached age 21 and has completed:

• a.One year of service with the employer✓
• b.Five years of service with the employer
• c.Ten years of service with the employer
• d.Three months of service with the employer

ERISA sets floors, not ceilings, on eligibility. A plan may not impose conditions stricter than age 21 and one year of service, though it is free to be more generous. Separate vesting schedules then govern when employer contributions become nonforfeitable. These minimum standards exist to keep employers from using service requirements to exclude rank-and-file workers.ERISA

Compared with a listed equity REIT, a non-traded REIT typically exposes an investor to:

• a.Lower total fees, because no selling compensation is ever paid to brokers
• b.Less credit risk, because federal deposit insurance covers the shareholders
• c.Greater liquidity risk, because the shares are not listed on an exchange✓
• d.Greater interest rate risk, because it may hold only variable-rate debt

A non-traded REIT has no secondary market, so an investor generally must wait for a limited share repurchase program or a liquidity event that may be years away. Front-end selling and organizational costs are typically higher, not lower, and no federal insurance applies. Liquidity and valuation opacity are the central suitability concerns an adviser must address.

Under the SEC's pay-to-play rule, an adviser that makes a political contribution above the de minimis amount to an official able to influence adviser selection is generally:

• a.Required to refund the contribution and file an amended Form ADV promptly
• b.Permitted to continue if the contribution is disclosed in the firm brochure
• c.Prohibited from advising any government entity for the following five years
• d.Barred from receiving compensation from that government client for two years✓

Rule 206(4)-5 imposes a two-year 'time out' during which the adviser may provide advisory services to that government entity but may not be compensated for them. The rule is prophylactic: no proof of an actual quid pro quo is required, which is why firms maintain preclearance procedures for political contributions by the firm and its covered associates. Disclosure does not cure the violation.Investment Advisers Act of 1940

A firm earns net income of $600,000 on net sales of $8,000,000. Its net profit margin is closest to:

• a.4.8%
• b.13.3%
• c.0.8%
• d.7.5%✓

Net profit margin = net income / net sales = $600,000 / $8,000,000 = 0.075, or 7.5%. The 13.3% figure inverts the ratio ($8,000,000 / $600,000 = 13.3 times, which is not a margin). Net margin captures what survives after every expense, so it is compared across firms in the same industry rather than across industries.

ERISA Section 404(c) offers relief from fiduciary liability for a participant-directed retirement plan when the plan:

• a.Restricts every participant to a single diversified balanced fund option
• b.Is a defined benefit plan in which the trustee chooses investments for all participants
• c.Offers a broad range of options and lets participants direct their accounts✓
• d.Lets participants change their elections just once a year, however volatile the options

Section 404(c) and the Labor Department's regulation shift responsibility for investment results to participants when an individual account plan gives them the opportunity to exercise control and a broad range of investment alternatives, meaning at least three diversified options with materially different risk and return characteristics, plus sufficient information and the ability to change instructions with a frequency suited to market volatility (at least quarterly for the core options). A single balanced fund is not a broad range, a plan where the trustee picks the investments is not participant-directed, and once-a-year changes are too infrequent. The plan fiduciary remains responsible for prudently selecting and monitoring the menu.ERISA s.404(c); 29 CFR 2550.404c-1

The antifraud provisions of Section 206 of the Investment Advisers Act of 1940 apply to:

• a.Only advisers that maintain custody of client funds or securities
• b.Any investment adviser, whether or not that adviser is registered✓
• c.Only advisers that are registered with the SEC in Washington
• d.Only advisers with more than one hundred individual advisory clients

Section 206 reaches any person meeting the definition of investment adviser, including advisers exempt from registration. Registration status determines filing and examination obligations; it does not create or limit the duty not to defraud. This mirrors the Uniform Securities Act, whose antifraud provisions likewise apply to any person who offers or sells securities or gives advice in the state.Investment Advisers Act of 1940

A SIMPLE IRA may generally be established by an employer that has:

• a.No more than 100 employees, even if it also maintains another qualified plan
• b.No more than 100 employees and maintains no other qualified plan✓
• c.No more than 500 employees and at least two years of operating history
• d.Any number of employees, as with a SEP IRA, if it sponsors no 401(k) plan

A SIMPLE IRA is open to an employer with no more than 100 employees who earned at least $5,000 in the preceding year, and generally the employer may not contribute to another retirement plan for the same year (the one-plan requirement). Keeping another qualified plan alongside it generally defeats eligibility. A 500-employee ceiling and an operating-history test are not part of the rules, and unlimited size is a feature of the SEP IRA, not the SIMPLE IRA. Employer contributions are mandatory, either a match or a nonelective contribution, and employee deferrals vest immediately.IRS SIMPLE IRA Plan FAQs (100-employee limitation; one-plan requirement)

A mortgage REIT generates most of its income from:

• a.Management fees charged to outside investors in its affiliated funds
• b.Capital gains realized on the sale of commercial buildings it develops
• c.Rental payments collected from the tenants of properties that it owns
• d.The spread between interest earned on mortgage assets and its borrowing cost✓

An equity REIT owns buildings and collects rent. A mortgage REIT owns mortgage loans and mortgage-backed securities, borrows short, lends long, and earns the net interest spread. That leaves it far more sensitive to changes in interest rates and to prepayment behavior than a typical equity REIT.

An SEC-registered adviser whose assets under management decline must generally withdraw and register with the states once its reported assets fall below:

• a.$25 million, the SEC registration threshold before Dodd-Frank
• b.$110 million, the level at which SEC registration becomes mandatory
• c.$100 million, the minimum for SEC registration
• d.$90 million, the buffer set below the $100 million threshold✓

Dodd-Frank created a mid-sized adviser category and the SEC built in a buffer so that ordinary market fluctuation does not force repeated switching. An adviser may register with the SEC at $100 million, must register at $110 million, and need not withdraw until it reports less than $90 million of assets under management on its annual updating amendment. Below that, state registration is required where applicable. Withdrawing at $100 million or $110 million ignores the buffer, and $25 million was the pre-Dodd-Frank SEC threshold.17 CFR 275.203A-1(a)(1)

Compared with a qualified retirement plan, a nonqualified deferred compensation plan generally:

• a.Provides the employer an immediate tax deduction for the amounts deferred
• b.May be offered selectively to chosen executives rather than to all workers✓
• c.Shields the deferred amounts from the claims of the employer's creditors
• d.Must cover every employee who satisfies the plan's age and service tests

The trade-off in a nonqualified plan is discrimination in exchange for security. The employer may pick and choose participants, but the deferred amounts remain an unfunded promise and stay subject to the employer's general creditors if the company fails. The employer's deduction is postponed until the employee actually includes the compensation in income.

A private fund adviser with less than $150 million in assets under management in the United States generally:

• a.Is entirely free of any filing obligation or antifraud responsibility
• b.Must register with every state in which any fund investor resides
• c.Must register with the SEC on the same terms as a retail adviser
• d.Files only limited portions of Form ADV as an exempt reporting adviser✓

The private fund adviser exemption relieves a qualifying adviser of full registration, but it does not create invisibility. An exempt reporting adviser must still file and update specified items of Form ADV Part 1 through the IARD system, remains subject to the antifraud provisions of Section 206, and may be examined. States may also impose their own notice filing requirements.Investment Advisers Act of 1940

A common stock trades at $40 per share and pays a quarterly dividend of $0.30. Its current dividend yield is:

• a.3.33%
• b.13.3%
• c.0.75%
• d.3.0%✓

Annualize the dividend first: $0.30 x 4 = $1.20 per year. Dividend yield = $1.20 / $40.00 = 0.03, or 3.0%. Using the quarterly $0.30 without annualizing produces the 0.75% trap. Dividend yield rises when the share price falls, so a suddenly high yield can signal market doubt about the dividend rather than a bargain.

A key consequence of funding an irrevocable trust rather than a revocable trust is that the grantor:

• a.May amend the trust terms at any time until a beneficiary objects
• b.Retains control, and the assets are generally inside the taxable estate
• c.Avoids probate but continues to report all trust income personally
• d.Gives up control, and the assets are generally outside the taxable estate✓

A revocable trust avoids probate but changes nothing for taxes, because the grantor can still take the property back, so the assets remain in the taxable estate. Surrendering that power through an irrevocable trust is what removes the assets from the estate and shifts income taxation, and the price is that the grantor generally cannot amend or revoke the arrangement.

A company's common shares trade at $45 while its book value per share is $30. Its price-to-book ratio is:

• a.15.0
• b.1.5✓
• c.1.15
• d.0.67

Price-to-book = market price per share / book value per share = $45 / $30 = 1.5. The 0.67 figure inverts the ratio. A price-to-book above 1.0 means the market values the company above its accounting net worth, often because of intangible assets or expected growth that the balance sheet does not capture.

Excessive trading in a client's account designed to generate commissions rather than serve the client's objectives is called:

• a.Churning, a prohibited unethical business practice✓
• b.Hypothecation, the pledging of securities as collateral
• c.Arbitrage, a permitted risk-reduction trading strategy
• d.Scalping, buying for oneself ahead of a recommendation to clients

Churning is judged by the frequency and size of trading measured against the client's stated objectives and resources, together with the representative's control over the account; no single turnover number is decisive. Scalping is trading for one's own account ahead of a recommendation to clients, which is a different abuse that does not turn on commissions. Arbitrage is a legitimate strategy, and hypothecation is the routine pledging of securities in a margin account.NASAA Model Rule 102(a)(4)-1(c)

An investor deposits $10,000 in an account paying 6% compounded annually. Ignoring taxes, the balance after two years is:

• a.$11,236✓
• b.$11,000
• c.$12,360
• d.$11,200

Year one: $10,000 x 1.06 = $10,600. Year two: $10,600 x 1.06 = $11,236. Equivalently, $10,000 x (1.06)^2 = $11,236. The $11,200 answer applies simple interest of $600 per year and ignores the $36 of interest earned on the first year's interest, which is exactly the compounding effect the question is testing.

A testamentary trust differs from a living trust because a testamentary trust:

• a.Is funded during the grantor's lifetime and therefore avoids probate
• b.Is created by the decedent's will and therefore passes through probate✓
• c.Must distribute all of its income to charity in the first taxable year
• d.May be revoked by the beneficiaries once the grantor has died

A testamentary trust springs into existence only at death, under the terms of the will, so the property must first pass through the probate court that admits the will. A living (inter vivos) trust is created and funded while the grantor is alive, and assets titled in it bypass probate entirely. Privacy and speed are the usual reasons clients prefer the living trust.

Universal life insurance differs from traditional whole life insurance primarily because universal life:

• a.Provides pure protection for a stated term with no cash value component
• b.Invests all cash value in separate account subaccounts chosen by the owner
• c.Allows the owner to vary premium payments and to adjust the death benefit✓
• d.Requires a level premium for life and guarantees a fixed cash value schedule

Universal life unbundles the policy: within limits the owner may pay more, pay less, or skip a premium, and may raise or lower the death benefit subject to underwriting. Whole life uses a fixed level premium and guaranteed cash values. Investing the cash value in separate account subaccounts describes variable life, and term insurance builds no cash value at all.

Under NASAA model rules, an investment adviser representative may borrow money from a client only when the client is:

• a.A lending institution in the business of making loans✓
• b.A client who gives informed written consent after full disclosure
• c.An accredited investor with a net worth above $1 million
• d.A close relative of the representative

Borrowing from a client creates a direct conflict between the representative's interest and the client's, so Model Rule 102(a)(4)-1(f) prohibits it unless the client is a broker-dealer, an affiliate of the adviser, or a financial institution engaged in the business of loaning funds. Disclosure and written consent do not cure the conflict. Wealth does not matter, and a family relationship is not an exception.NASAA Model Rule 102(a)(4)-1(f)

Securities held in a joint tenancy with right of survivorship account:

• a.Pass to the deceased tenant's estate for distribution under the will
• b.Must be liquidated by the broker-dealer within ten days of a death
• c.Are divided among all named heirs under state intestacy statutes
• d.Pass directly to the surviving tenant outside of the probate process✓

Survivorship is a feature of the account title itself, so the deceased tenant's interest transfers to the survivor by operation of law and never enters probate or the will. In a tenants in common account the opposite is true: the decedent's fractional share goes to the estate and is distributed under the will or state intestacy law.

An agent who promises to buy back a customer's shares at the original purchase price if the stock declines has:

• a.Created a lawful private repurchase agreement with the client
• b.Provided a permitted service known as a standby commitment
• c.Guaranteed the customer against loss, a prohibited practice✓
• d.Satisfied the suitability standard for a conservative investor

Guaranteeing a customer against loss, or guaranteeing a specific gain, is expressly prohibited under NASAA's model rules on dishonest and unethical practices. Only an issuer or a third party such as an insurer may guarantee a security's payments. The prohibition protects the integrity of the risk disclosure that a securities recommendation depends on.Uniform Securities Act

Compared with an ordinary annuity that pays the same amount for the same number of periods, an annuity due has:

• a.A higher present value, because each payment arrives at the beginning of the period✓
• b.An unpredictable present value, because the payer chooses the timing each period
• c.An identical present value, because the number of payments does not change
• d.A lower present value, because each payment arrives at the end of the period

In an annuity due each cash flow is received one period sooner than in an ordinary annuity, so each is discounted for one less period and the present value is higher. Rent and insurance premiums are typical annuities due; bond coupons and most loan payments are ordinary annuities. The count of payments is the same in both, which is why timing alone drives the difference.

For a given annuitant and account value, which annuity settlement option produces the largest monthly payment?

• a.Life only, because payments cease at the annuitant's death✓
• b.Installment refund, because any unused principal is repaid to the heirs
• c.Life with 20-year period certain, because payments are guaranteed
• d.Joint and last survivor, because payments cover two lives

The insurer sizes each payment against how long it expects to pay. Life only (straight life) carries no guarantee to anyone after the annuitant dies, so the expected payout period is shortest and each check is largest. Every added guarantee, whether a refund feature, a certain period or a second life, lengthens or secures the expected obligation and lowers the payment. Life only also carries the greatest risk of forfeiture for the annuitant's heirs.

Under the net present value method, a proposed capital project should be accepted when:

• a.The total undiscounted inflows exceed the accounting profit reported for the project
• b.The present value of the expected cash inflows exceeds the initial cost of the project✓
• c.The discount rate applied to the project is greater than its internal rate of return
• d.The payback period is longer than the estimated useful life of the new equipment

Net present value discounts every expected future cash flow back to today at the required rate of return and subtracts the outlay. A positive NPV means the project earns more than the required rate and adds value. A discount rate above the internal rate of return produces a negative NPV, and a payback period longer than the asset's life means the outlay is never recovered.

The federal unlimited marital deduction allows a decedent to:

• a.Exclude from income all assets inherited by any immediate family member
• b.Deduct the surviving spouse's living expenses from the taxable estate
• c.Transfer up to $1 million each year to a spouse without any gift tax
• d.Transfer any amount to a surviving U.S. citizen spouse free of estate tax✓

Property passing outright to a surviving spouse who is a U.S. citizen qualifies for an unlimited marital deduction, so no federal estate tax is due at the first death. The tax is deferred rather than eliminated, because whatever remains is taxable in the survivor's estate. Special rules and a qualified domestic trust apply when the surviving spouse is not a U.S. citizen.

An investor age 50 takes a partial withdrawal from a nonqualified deferred annuity that has grown above its cost basis. The withdrawal is generally:

• a.Taxed as ordinary income on the earnings first, plus a 10% penalty✓
• b.Treated entirely as a tax-free return of the owner's after-tax basis
• c.Excluded from gross income because annuity contracts are tax-exempt
• d.Taxed as a long-term capital gain on the full amount withdrawn

Nonqualified annuity withdrawals follow last-in, first-out ordering: earnings are deemed distributed before the after-tax principal. Those earnings are ordinary income, never capital gain, and because the owner is under age 59 1/2 an additional 10% penalty applies to the taxable portion. Basis comes out tax-free only after the earnings have been exhausted.

An investment adviser representative who is also a registered agent of a broker-dealer and earns commissions on the trades he recommends must:

• a.Rebate all commissions earned into the client's advisory account
• b.Obtain the Administrator's written approval before each transaction
• c.Disclose the capacity in which he acts and the resulting conflict✓
• d.Choose one registration and withdraw from the other within 30 days

Dual registration is lawful, but it creates a conflict because the same recommendation generates transaction-based compensation. The fiduciary duty and NASAA's rules require full and fair disclosure of the capacity in which the person is acting and of the compensation received, made before or at the time of the transaction so the client can evaluate the advice.Uniform Securities Act

Under the Uniform Prudent Investor Act, a trustee's investment decisions are evaluated:

• a.Against a fixed statutory list of legally permitted trust investments
• b.Solely by whether each individual holding produced a positive return
• c.In the context of the total portfolio rather than security by security✓
• d.By comparing results with the best-performing mutual fund each year

The prudent investor standard adopts modern portfolio theory: a holding that would look speculative in isolation may be entirely appropriate as part of a diversified whole, so the trustee is judged on the overall strategy and its risk-return objectives. The older legal list approach has been abandoned, and trustees are expected to diversify and may delegate investment functions prudently.

An adviser that receives ongoing 12b-1 payments from mutual funds it recommends to advisory clients must:

• a.Report the payments only if they exceed 1% of the firm's total revenue
• b.Fully disclose the payments and the conflict of interest they create✓
• c.Omit them from disclosure because the fund, not the client, pays them
• d.Credit the payments against the advisory fee as federal law requires

Third-party compensation gives the adviser a financial incentive to favor one fund share class over a cheaper one, which is exactly the conflict the fiduciary duty of loyalty targets. The adviser must disclose the arrangement fully and fairly in its brochure and manage the conflict. Enforcement actions over undisclosed 12b-1 fees and revenue sharing have been a recurring SEC priority.Investment Advisers Act of 1940

The exclusion ratio applied to payments from an annuitized nonqualified annuity determines:

• a.The share of the separate account invested in fixed-income subaccounts
• b.The maximum commission an agent may receive on the initial purchase
• c.The portion of each payment treated as a tax-free return of cost basis✓
• d.The percentage of the contract that may be surrendered without a charge

When a nonqualified annuity is annuitized, each payment is part return of the owner's after-tax investment and part taxable earnings. The exclusion ratio is the investment in the contract divided by the expected total return, and it fixes the tax-free fraction of every payment. Once total basis has been recovered, later payments become fully taxable as ordinary income.

A charitable lead trust differs from a charitable remainder trust because the charitable lead trust:

• a.May be revoked by the donor once the charity receives one payment
• b.Pays income to the donor first and leaves the remainder to charity
• c.Pays income to charity first and leaves the remainder to the family✓
• d.Distributes the entire principal to charity in the first taxable year

The names describe who is in line. In a charitable LEAD trust, the charity leads: it receives the income stream for a term, and the remaining principal then passes to noncharitable beneficiaries such as children. In a charitable REMAINDER trust, the donor or another individual takes the income and the charity receives what remains. Both are irrevocable split-interest arrangements.

A client verbally instructs an adviser to buy 500 shares of a specific stock, but the client has never signed a discretionary agreement. The adviser may:

• a.Execute a similar trade that the adviser considers more appropriate
• b.Execute the order as instructed, because the client chose the trade✓
• c.Place the order only after the Administrator approves the account
• d.Refuse the order until written trading authorization is delivered

Discretion means the adviser selects the security, the amount, or whether to buy or sell. Here the client made all three decisions, so no discretionary authority is being exercised and the order may be entered. Choosing only the time or the price of a client-specified order is likewise not discretion, though a written authorization is still required before the adviser selects trades on its own.Uniform Securities Act

Section 1035 of the Internal Revenue Code permits a contract owner to:

• a.Exchange one annuity contract for another without current tax on the gain✓
• b.Convert a nonqualified annuity into a Roth IRA entirely free of income tax
• c.Withdraw annuity earnings before age 59 1/2 without any penalty tax at all
• d.Deduct nonqualified annuity premiums from current-year gross income

A 1035 exchange lets an owner move from one life insurance or annuity contract to another of a permitted type without triggering tax on accumulated gain; the old basis carries over. It does not create a deduction, waive the early distribution penalty, or turn nonqualified money into Roth money. Advisers must still weigh new surrender charges and a fresh surrender period before recommending an exchange.

An adviser may disclose confidential client account information without the client's consent when:

• a.Responding to a lawful subpoena or a regulatory examination request✓
• b.A family member of the client telephones and asks for an account balance
• c.An affiliated insurance agency wants to market policies to those clients
• d.A prospective client asks for references from the firm's existing accounts

Regulation S-P and state privacy rules require notice and, for many disclosures, an opportunity to opt out, but they contain exceptions for disclosures required by law, including subpoenas, court orders, and examinations by securities regulators. Marketing to clients through affiliates, giving references, and speaking to relatives all require client authorization.Investment Advisers Act of 1940

An investor who donates long-term appreciated stock directly to a qualified public charity generally:

• a.Receives no deduction unless the shares are sold before the transfer
• b.Deducts fair market value and avoids tax on the unrealized appreciation✓
• c.Recognizes the gain at once and deducts only the after-tax proceeds
• d.Deducts the original cost basis and pays tax on the unrealized gain

Gifting appreciated securities held more than one year produces a double benefit: subject to adjusted-gross-income percentage limits, the donor deducts the full fair market value, and neither donor nor charity pays capital gains tax on the built-in appreciation. Selling the shares first and donating cash wastes that advantage by triggering the gain. Property held one year or less is generally limited to a basis deduction.

The internal rate of return on an investment is best defined as the discount rate that:

• a.Makes the net present value of all expected cash flows equal to zero✓
• b.A lender charges the investor to finance the purchase of the asset
• c.Reflects the rate of inflation expected over the investment's holding period
• d.Equals the average annual accounting profit divided by the initial outlay

The internal rate of return is the break-even discount rate: apply it to the cash flows and the present value of inflows exactly equals the outflow, so NPV is zero. For a bond held to maturity, the IRR of the cash flows is the yield to maturity. Accounting profit measures, borrowing costs, and inflation expectations are all separate concepts.

An investor who writes a call option without owning the underlying stock faces:

• a.No meaningful market risk, because the premium is collected up front
• b.An unlimited maximum loss, because the stock price has no upper bound✓
• c.A maximum loss equal to the strike price multiplied by 100 shares
• d.A maximum loss limited to the premium received when the option was sold

The uncovered (naked) call writer must deliver stock at the strike price no matter how high the market goes, and there is no theoretical ceiling on a share price, so the loss is theoretically unlimited. Writing a call against shares already owned (a covered call) caps the risk, because the shares are available for delivery. The premium received is the writer's maximum gain, not a limit on the loss.

The death benefit paid to a named beneficiary of a life insurance policy is generally:

• a.Taxed as a long-term capital gain in the year the claim is paid
• b.Taxed to the beneficiary on all amounts above the premiums paid
• c.Received free of federal income tax by the named beneficiary✓
• d.Taxed as ordinary income to the beneficiary in the year received

Life insurance proceeds paid by reason of the insured's death are excluded from the beneficiary's gross income. Interest earned after death, such as on a settlement option that holds the proceeds, is taxable. Income tax treatment is separate from estate tax: if the insured held incidents of ownership, the proceeds may still be includable in the insured's gross estate.

Under the Uniform Securities Act, the Administrator may inspect the books and records of a registered investment adviser:

• a.Only during the ten business days that follow an annual renewal filing
• b.Only after obtaining a search warrant from a court of proper jurisdiction
• c.At any reasonable time, within or outside the state, without prior notice✓
• d.Only when a written customer complaint has been filed against the firm

The Administrator has broad authority to conduct announced or unannounced examinations of registrants' records at any reasonable time, and that authority extends to records located outside the state. The Administrator may also issue subpoenas, take testimony under oath, and require records to be kept in a prescribed form, all without a court order or a triggering complaint.Uniform Securities Act

A growth investment style typically emphasizes companies with:

• a.Small market capitalizations, heavy debt loads, and shrinking gross margins
• b.Above-average earnings expansion, high price-earnings ratios, low payouts✓
• c.Below-average price-to-book ratios, high dividend yields, and stable sales
• d.High current income, low price volatility, and long dividend track records

Growth managers pay up for companies whose revenue and earnings are expanding faster than the market, and those firms usually reinvest cash rather than pay large dividends, so multiples are high and yields are low. Value managers do the reverse, buying low multiples and higher yields. Style matters for suitability because growth portfolios are typically more volatile and less income-producing.

An investor buys a put with a $40 strike price for a $2 premium. The breakeven price of the underlying at expiration is:

• a.$36
• b.$40
• c.$38✓
• d.$42

For a long put, breakeven equals strike minus premium: $40 - $2 = $38. At $38 the put's intrinsic value of $2 exactly offsets the $2 paid, so the position nets zero. Below $38 the buyer profits; above $40 the put expires worthless and the $2 premium is the maximum loss. Strike plus premium ($42) is the breakeven for a long CALL, which is the intended trap.

An insurance company authorized to do business in a state issues both fixed and variable annuity contracts. Under the Uniform Securities Act:

• a.Both contracts are exempt securities because the insurer is authorized
• b.The fixed annuity is an exempt security, but the variable annuity is not✓
• c.Neither contract is a security, so state registration can never apply
• d.The variable annuity is an exempt security, but the fixed annuity is not

The Act's exempt securities list includes insurance and endowment policies and annuity contracts under which the insurer promises to pay a fixed sum, issued by an insurer authorized to do business in the state. A VARIABLE annuity is expressly outside that exemption because its value depends on separate account performance, so it is a security requiring registration and a licensed representative.Uniform Securities Act

A retailer reports cost of goods sold of $6,000,000 and average inventory of $1,500,000. Its inventory turnover ratio is:

• a.9.0 times
• b.4.0 times✓
• c.2.5 times
• d.0.25 times

Inventory turnover = cost of goods sold / average inventory = $6,000,000 / $1,500,000 = 4.0 times per year. That implies roughly 365 / 4 = 91 days of inventory on hand. A falling turnover ratio can warn that merchandise is not selling and that write-downs may follow.

A customer telephones an agent and asks to buy a nonexempt, unregistered security without any prompting from the firm. This trade is:

• a.Permitted only when the customer is an accredited investor
• b.An exempt transaction, because the customer's order was unsolicited✓
• c.An exempt security, because the buyer initiated the contact first
• d.Prohibited, because the security is not registered in that state

Unsolicited nonissuer transactions are exempt TRANSACTIONS under the Uniform Securities Act, so the registration requirement does not attach even though the security itself is not registered or exempt. The Administrator may require the customer to sign an acknowledgment that the order was unsolicited. Note the vocabulary trap: the exemption attaches to the transaction, never to the security.Uniform Securities Act