CSLB General Building (B) — All Questions

Which feature distinguishes preferred stock from common stock?

• a.Preferred stockholders always have voting rights on corporate matters
• b.Preferred dividends fluctuate with company profits
• c.Preferred stock typically pays a fixed dividend and has priority over common in liquidation✓
• d.Common stock has a stated par-based dividend that must be paid

Preferred stock generally pays a fixed dividend and ranks ahead of common stock for dividends and in liquidation, though it usually lacks voting rights. Common stockholders normally vote but receive dividends only after preferred holders. Preferred dividends do not vary with profits like common dividends can.

A bond is trading at a premium to par. Which relationship is true?

• a.The current yield and yield to maturity are lower than the coupon rate✓
• b.The yield to maturity is higher than the coupon rate
• c.The bond must be in default
• d.The coupon rate equals the yield to maturity

When a bond trades above par (at a premium), its yield to maturity is below its coupon rate, and current yield falls between the two. Bonds trade at a premium when market rates fall below the coupon. A discount bond, by contrast, has a yield to maturity above the coupon.

Duration is best described as a measure of which of the following?

• a.The number of years until a bond matures, exactly
• b.A bond's price sensitivity to changes in interest rates✓
• c.The bond's credit rating quality
• d.The total coupon income a bond will pay

Duration measures how sensitive a bond's price is to interest rate changes; a longer duration means greater price movement for a given rate change. It is expressed in years but is not simply the maturity. Credit quality and total coupon income are separate concepts.

If interest rates rise, what generally happens to the price of an outstanding fixed-rate bond?

• a.The price rises proportionally with rates
• b.The price is unaffected because the coupon is fixed
• c.The bond automatically converts to a floating rate
• d.The price falls✓

Bond prices move inversely to interest rates, so when rates rise, existing fixed-rate bond prices fall. This inverse relationship is a core principle of fixed income. Longer-duration bonds fall more sharply than shorter-duration bonds for the same rate increase.

A bond with a 5% coupon and $1,000 par is purchased for $800. What is its current yield?

• a.6.25%✓
• b.5.00%
• c.4.00%
• d.8.00%

Current yield equals annual coupon income divided by market price, or $50 divided by $800, which equals 6.25%. Because the bond trades at a discount, the current yield exceeds the 5% coupon rate. Current yield ignores any gain realized at maturity.

An open-end investment company (mutual fund) sells and redeems its shares at which price?

• a.A price negotiated between buyer and seller on an exchange
• b.The previous day's closing market price
• c.The net asset value per share, calculated at the next computed valuation✓
• d.A fixed price set at the fund's inception

Open-end mutual fund shares are bought and redeemed based on net asset value (NAV) computed at the next valuation point, a practice known as forward pricing. They are not traded between investors on an exchange. Closed-end funds, by contrast, trade at market prices that may differ from NAV.

Which statement about exchange-traded funds (ETFs) is accurate?

• a.ETFs are redeemed only once per day at net asset value
• b.ETFs trade throughout the day on an exchange at market prices✓
• c.ETFs are prohibited from tracking an index
• d.ETFs cannot be bought on margin or sold short

ETFs trade intraday on exchanges at market-determined prices, unlike open-end mutual funds that transact at end-of-day NAV. Many ETFs are designed to track an index. Because they trade like stocks, ETFs can generally be bought on margin and sold short.

A U.S. Treasury bond differs from a corporate bond in which key respect?

• a.Treasury bonds carry higher default risk
• b.Treasury bonds pay no interest
• c.Treasury interest is exempt from all federal, state, and local taxes
• d.Treasury interest is exempt from state and local income tax but subject to federal tax✓

Interest on U.S. Treasury securities is subject to federal income tax but exempt from state and local income taxes. Treasuries are backed by the full faith and credit of the U.S. government and carry minimal default risk. Corporate bond interest is generally taxable at all levels.

Interest paid on most general obligation municipal bonds is generally treated how for federal tax purposes?

• a.Exempt from federal income tax✓
• b.Fully taxable as ordinary income at the federal level
• c.Taxed at the long-term capital gains rate
• d.Subject to a mandatory 20% federal withholding

Interest on most municipal bonds is exempt from federal income tax, which makes them attractive to investors in higher tax brackets. This tax advantage means municipal yields are often compared on a taxable-equivalent basis. Capital gains on munis, however, can still be taxable.

A call option gives the holder which right?

• a.The obligation to sell the underlying asset at the strike price
• b.The right to sell the underlying asset at the strike price
• c.The right to buy the underlying asset at the strike price✓
• d.The obligation to buy the underlying asset at the market price

A call option grants its holder the right, not the obligation, to buy the underlying asset at a fixed strike price before expiration. A put option, by contrast, grants the right to sell. The option writer, not the holder, takes on an obligation.

An investor who buys a put option is generally expressing which market view?

• a.Bullish on the underlying asset
• b.Bearish on the underlying asset✓
• c.Neutral, seeking only income
• d.Expecting no change in volatility

Buying a put gives the right to sell at the strike price, which becomes valuable if the underlying asset's price falls, reflecting a bearish outlook. Puts can also hedge a long position. A call buyer, by contrast, is typically bullish.

A fixed annuity differs from a variable annuity primarily because a fixed annuity:

• a.Places investment risk on the contract owner
• b.Provides returns tied to separate account subaccounts
• c.Is regulated as a security requiring a prospectus
• d.Guarantees a stated rate of return with the insurer bearing investment risk✓

A fixed annuity guarantees a set rate of return, and the insurance company bears the investment risk. A variable annuity's value fluctuates with separate account subaccounts, placing investment risk on the owner and requiring securities registration and a prospectus. That risk shift is the central distinction.

Which of the following best describes a zero-coupon bond?

• a.It is issued at a discount and pays no periodic interest, maturing at par✓
• b.It pays a higher coupon than comparable bonds
• c.It pays interest monthly rather than semiannually
• d.It cannot be issued by the U.S. Treasury

A zero-coupon bond is sold at a deep discount and makes no periodic interest payments, returning full par value at maturity. The investor's return is the difference between the purchase price and par. Treasury STRIPS are a common example of zero-coupon instruments.

A hedge fund is typically offered to which type of investor and under what structure?

• a.Retail investors through a publicly registered continuous offering
• b.Any investor, with daily liquidity and low minimums
• c.Accredited or qualified investors through a private, less-regulated structure✓
• d.Only government pension plans by statute

Hedge funds are generally sold through private placements to accredited or qualified investors and are subject to lighter regulation than registered funds. They often use leverage, derivatives, and limited liquidity with lock-up periods. High minimum investments are common, restricting broad retail access.

A real estate investment trust (REIT) must generally distribute what portion of its taxable income to shareholders to maintain favorable tax treatment?

• a.At least 50%
• b.At least 90%✓
• c.No more than 25%
• d.Exactly 100% in all cases

To qualify for pass-through tax treatment, a REIT must distribute at least 90% of its taxable income to shareholders as dividends. This high payout is why REITs are valued for income. REITs let investors gain real estate exposure without directly owning property.

Which bond carries the greatest interest rate risk, all else equal?

• a.A 2-year bond with a high coupon
• b.A 5-year bond with a high coupon
• c.A 5-year zero-coupon bond
• d.A 30-year zero-coupon bond✓

Interest rate risk increases with longer maturity and lower coupons, both of which lengthen duration. A 30-year zero-coupon bond has the longest duration and thus the greatest price sensitivity to rate changes. Shorter maturities and higher coupons reduce that sensitivity.

A convertible bond gives the holder the right to:

• a.Exchange the bond for a set number of the issuer's common shares✓
• b.Demand early repayment of principal at any time
• c.Receive a floating interest rate tied to inflation
• d.Vote on corporate board elections while holding the bond

A convertible bond can be exchanged for a predetermined number of the issuer's common shares, letting holders participate in stock appreciation. This conversion feature usually allows the issuer to offer a lower coupon. Bondholders do not vote unless and until they convert to stock.

Commercial paper is best described as which of the following?

• a.A long-term corporate bond secured by real estate
• b.A government-guaranteed savings instrument
• c.Short-term, unsecured corporate debt used for near-term financing✓
• d.A perpetual security with no maturity date

Commercial paper is short-term unsecured corporate debt, typically maturing in 270 days or less, used to fund short-term needs like payroll and inventory. It is a money-market instrument issued at a discount. It is not government guaranteed and carries the issuer's credit risk.

An American Depositary Receipt (ADR) allows a U.S. investor to do which of the following?

• a.Buy U.S. Treasury securities at a discount
• b.Hold shares of a foreign company that trade in U.S. markets and dollars✓
• c.Avoid all currency risk on foreign holdings
• d.Purchase municipal bonds tax-free

An ADR is a negotiable certificate representing shares of a foreign company, allowing U.S. investors to trade in dollars on domestic markets. Despite dollar-denominated trading, ADRs still carry currency risk from the underlying foreign shares. They do not involve Treasuries or municipal bonds.

Yield to maturity (YTM) of a bond takes into account which of the following that current yield ignores?

• a.Only the annual coupon payment
• b.Only the bond's face value
• c.The issuer's dividend policy
• d.The gain or loss realized as the bond price moves toward par at maturity✓

Yield to maturity reflects the total return if a bond is held to maturity, including coupon income plus any capital gain or loss as the price converges to par. Current yield considers only the coupon relative to price. YTM therefore gives a more complete measure of a bond's return.

A unit investment trust (UIT) differs from a mutual fund primarily because a UIT:

• a.Holds a fixed, unmanaged portfolio with a set termination date✓
• b.Actively trades its holdings to beat the market
• c.Has no defined maturity or termination
• d.Issues shares that trade only on an exchange at a premium

A UIT holds a fixed portfolio of securities that is not actively managed and has a predetermined termination date. This contrasts with a mutual fund's actively or passively managed, ongoing portfolio. UIT units are redeemable rather than exchange-traded like closed-end funds.

Which risk is most directly associated with owning a callable bond?

• a.The bond can never be redeemed early
• b.Reinvestment risk is eliminated
• c.The issuer may redeem it early when rates fall, forcing reinvestment at lower yields✓
• d.The coupon automatically increases when the bond is called

A callable bond lets the issuer redeem it before maturity, and issuers tend to call bonds when interest rates fall so they can refinance at lower cost. This exposes the investor to reinvestment risk, having to reinvest proceeds at lower prevailing yields. Call features therefore favor the issuer.

A money market fund seeks to maintain which of the following characteristics?

• a.Maximum long-term capital appreciation
• b.A stable net asset value, typically $1.00 per share, with high liquidity✓
• c.Exposure to volatile equity securities
• d.A guaranteed return insured by the federal government

Money market funds invest in short-term, high-quality instruments and aim to preserve a stable NAV, commonly $1.00 per share, while providing liquidity and modest income. They are not designed for capital appreciation. Although low risk, they are not federally insured like bank deposits.

A futures contract obligates the parties to do which of the following?

• a.Nothing; it is an option that may be abandoned
• b.Only the seller is obligated to perform
• c.Only the buyer is obligated to perform
• d.Both parties to buy or sell the underlying at a set price on a future date✓

A futures contract is a binding agreement in which both the buyer and seller are obligated to transact the underlying asset at an agreed price on a specified future date. Unlike an option, it cannot simply be abandoned without offsetting the position. Futures are standardized and traded on exchanges.

A high-yield (junk) bond is best characterized by which of the following?

• a.A below-investment-grade credit rating and higher default risk✓
• b.A rating of AAA and minimal default risk
• c.A tax-exempt status for all investors
• d.A guarantee by the U.S. Treasury

High-yield or junk bonds carry below-investment-grade ratings (below BBB- or Baa3) and compensate investors for greater default risk with higher yields. They are more sensitive to the issuer's financial health and economic conditions. They are neither government guaranteed nor uniformly tax-exempt.

A Guaranteed Investment Contract (GIC) issued by an insurer is most similar in risk profile to which of the following?

• a.A speculative growth stock
• b.A leveraged commodity future
• c.A fixed-income instrument dependent on the insurer's creditworthiness✓
• d.A tax-free municipal bond

A GIC promises a fixed return over a set period and behaves like a fixed-income instrument, with its safety tied to the issuing insurer's financial strength. It carries credit risk of the insurer rather than market volatility of equities. It is neither speculative nor tax-exempt like a municipal bond.

An investor buys a Treasury bill. How does a T-bill generate its return?

• a.Through semiannual coupon payments
• b.By being purchased at a discount and maturing at face value✓
• c.Through a floating rate reset monthly
• d.By paying dividends tied to Treasury earnings

Treasury bills are short-term securities sold at a discount to face value and pay no periodic interest; the return is the difference between the discounted purchase price and the par value received at maturity. They mature in one year or less. This discount structure distinguishes them from coupon-bearing Treasury notes and bonds.