Investment Vehicle Characteristics — Series 65 practice questions

The rule of 72 approximates how many years it takes an investment to:

1. Halve at a given rate.
2. Double at a given rate.
3. Grow to $1 million.
4. Match inflation under the applicable rule.

Answer: B — Double at a given rate.

A) That's the rule of 144 for halving via decay. B) Correct — years to double ≈ 72/rate. C) Depends on starting balance. D) Not the rule's purpose.

A direct participation program (DPP), such as a real estate or oil-and-gas limited partnership, is characterized by:

1. Corporate-level taxation followed by shareholder-level taxation on dividends.
2. Guaranteed principal return to limited partners.
3. Daily liquidity comparable to a mutual fund.
4. Pass-through of income, losses, and tax deductions directly to investors without entity-level tax.

Answer: D — Pass-through of income, losses, and tax deductions directly to investors without entity-level tax.

D) Correct — the defining DPP feature is pass-through tax treatment, flowing income, losses, and deductions to investors. A) Double taxation at both the corporate and shareholder level describes a C-corporation, not a DPP. B) No principal return is guaranteed in a DPP; investors bear real loss risk. C) DPPs are illiquid, typically with no active secondary market, unlike daily-priced mutual funds.

Comparing two portfolios' Sharpe ratios, an adviser would generally conclude that the portfolio with the HIGHER Sharpe ratio:

1. Has a higher beta, regardless of return.
2. Generated more excess return per unit of total risk taken.
3. Is guaranteed to have a higher absolute return.
4. Has lower correlation to the S&P 500.

Answer: B — Generated more excess return per unit of total risk taken.

B) Correct — a higher Sharpe ratio indicates better compensation (excess return) for each unit of total risk (standard deviation) assumed. A) The Sharpe ratio doesn't isolate beta; it uses standard deviation, not beta. C) A higher Sharpe ratio reflects risk-adjusted efficiency, not necessarily a higher raw return. D) Sharpe ratio doesn't directly measure correlation to a benchmark index.

A call option gives the holder the right to:

1. Buy at the strike price.
2. Sell at the strike price.
3. Force delivery of dividends.
4. Convert bonds to stock.

Answer: A — Buy at the strike price.

A) Correct — a call is the right to buy. B) That's a put. C) Not an option-holder right. D) Describes a convertible bond feature.

A municipal bond's tax equivalent yield formula is:

1. Muni yield × (1 − tax rate).
2. Muni yield × tax rate.
3. Muni yield ÷ (1 − tax rate).
4. Muni yield + tax rate.

Answer: C — Muni yield ÷ (1 − tax rate).

A) Multiplying by (1 − t) understates the equivalent. C) Correct — TEY = muni yield / (1 − marginal tax rate). B) Multiplying by t is wrong. D) Adding rates is not the formula.

The Sharpe ratio is calculated as:

1. (Portfolio return + risk-free rate) divided by beta.
2. Portfolio return divided by the market's standard deviation.
3. (Portfolio return − market return) divided by beta.
4. (Portfolio return − risk-free rate) divided by the portfolio's standard deviation.

Answer: D — (Portfolio return − risk-free rate) divided by the portfolio's standard deviation.

D) Correct — the Sharpe ratio divides excess return over the risk-free rate by the portfolio's total risk (standard deviation), measuring risk-adjusted return per unit of total risk. A) Adding rather than subtracting the risk-free rate, and using beta, does not describe the Sharpe formula. C) Subtracting market return and dividing by beta describes a different measure (closer to Treynor's numerator with the wrong denominator). B) Dividing by the market's standard deviation, rather than the portfolio's own, is not the Sharpe formula.

Standard deviation, as used in portfolio analysis, MOST directly measures:

1. The correlation between two securities' returns.
2. The total dispersion of returns around the average, capturing both systematic and unsystematic risk.
3. Only the downside risk of a security.
4. The sensitivity of a security's return to market movements.

Answer: B — The total dispersion of returns around the average, capturing both systematic and unsystematic risk.

B) Correct — standard deviation captures total volatility (dispersion of returns), reflecting both systematic and unsystematic components. A) Correlation is a separate statistic describing how two securities move relative to each other. C) Standard deviation reflects both upside and downside dispersion, not downside alone. D) Sensitivity to market movement is what beta measures, not standard deviation.

Which of the following is classified as a leading economic indicator?

1. The unemployment rate.
2. The average duration of unemployment.
3. Building permits for new private housing.
4. The Consumer Price Index.

Answer: C — Building permits for new private housing.

C) Correct — building permits signal future construction activity and are a component of the Index of Leading Economic Indicators. A) The unemployment rate is a lagging indicator. B) Average duration of unemployment is also a lagging indicator. D) CPI is a lagging indicator, confirming inflation that has already occurred.

A U.S. Treasury bill is issued and traded on a:

1. Coupon basis, paying semiannual interest like a Treasury bond.
2. Discount basis, sold below face value with the difference representing the investor's return at maturity.
3. Perpetual basis, with no stated maturity date.
4. Variable-rate basis tied to the prime rate.

Answer: B — Discount basis, sold below face value with the difference representing the investor's return at maturity.

B) Correct — T-bills are short-term (one year or less) instruments sold at a discount to face value, with the investor's return coming from the difference between purchase price and face value at maturity. A) Paying periodic coupon interest describes Treasury notes/bonds, not T-bills. C) T-bills have short, stated maturities; they are not perpetual instruments. D) T-bills aren't structured as variable-rate instruments tied to the prime rate.

A bond selling at a premium has a coupon rate that is:

1. Below prevailing yields.
2. Equal to prevailing yields.
3. Above prevailing yields.
4. Zero under the applicable rule.

Answer: C — Above prevailing yields.

A) A below-market coupon trades at a discount. B) Equal coupon trades at par. C) Correct — above-market coupons drive a premium price. D) Zero-coupon bonds trade at deep discounts.

What is the difference between a general obligation (GO) bond and a revenue bond?

A GO bond is backed by the issuer's full taxing power. A revenue bond is backed solely by revenue from a specific project (toll road, utility, stadium) and carries more project-specific risk if that revenue underperforms.

What is standard deviation in investing?

Measures the dispersion of returns around the mean. Higher SD = more volatile/risky. Used to quantify total risk.

What is an option's time value?

The portion of an option's premium above intrinsic value. Reflects the probability of the option gaining value before expiration. Decreases as expiration approaches.

Portfolio return = 12%, Rf = 3%, SD = 18%. Sharpe ratio?

0.50. Sharpe = (12% − 3%) / 18% = 9% / 18% = 0.50.