Investment Vehicle Characteristics practice questions

Answer: A) 1% of average net assets per year

• ACorrect. Up to 0.75% for distribution and 0.25% for service.
• BIncorrect. That's the maximum sales charge.
• CIncorrect. That's too low.
• DIncorrect. A cap applies.

Answer: B) A sole proprietor whose only other worker in the business is her spouse

A one-participant 401(k) is for a business owner with no employees, or an owner and spouse only. The owner can contribute in two roles: elective deferrals as the employee and nonelective contributions as the employer, up to the overall limit.

• AIncorrect. This business could sponsor a regular 401(k), but a one-participant plan is for an owner with no employees other than a spouse.
• BCorrect. The IRS says a one-participant 401(k) covers a business owner with no employees, or that owner and his or her spouse. The owner can make elective deferrals as an employee and nonelective contributions as the employer.
• CIncorrect. This person has no business of their own to sponsor a plan. A teacher would usually save through an employer plan, such as a 403(b).
• DIncorrect. Contributions must come from compensation or self-employment earned income. Investment income does not count.

Answer: C) Distributions used for qualified medical expenses are not taxed as income

At the federal level, HSAs offer deductible contributions, tax-free earnings, and tax-free distributions for qualified medical expenses. Distributions for other purposes are taxed as income, and before age 65 they also owe a 20% additional tax.

• AIncorrect. Age 55 is when an extra $1,000 catch-up contribution becomes available. After age 65, non-medical distributions avoid the 20% additional tax but are still taxed as income.
• BIncorrect. That describes a 'use-it-or-lose-it' flexible spending arrangement. HSA balances carry over from year to year and stay with the owner after a job change.
• CCorrect. IRS Publication 969 says distributions may be tax-free when used to pay qualified medical expenses. Together with deductible contributions and tax-free earnings, this makes up the triple tax advantage.
• DIncorrect. HSA contributions are subject to fixed annual dollar limits that depend on self-only or family HDHP coverage, plus a catch-up amount for those 55 and older. They are not limited only by earned income.

Answer: C) Subject to the alternative minimum tax

• AIncorrect. It's interest income.
• BIncorrect. The AMT can apply.
• CCorrect. Some investors owe AMT on it.
• DIncorrect. It's paid in cash.

Answer: A) Earnings first

• ACorrect. Gains come out first and are taxed as ordinary income.
• BIncorrect. Earnings come first.
• CIncorrect. Earnings are taxed.
• DIncorrect. Earnings are ordinary income.

Answer: A) At least 70% of assets in eligible portfolio companies, mainly small private or thinly traded U.S. firms

A BDC is a closed-end vehicle that must keep at least 70% of its assets in eligible portfolio companies, which are mostly small and midsize private or thinly traded U.S. businesses. That focus brings higher risk and often high distributions.

• ACorrect. Under the Investment Company Act, a BDC must have at least 70% of its total assets in qualifying assets, mainly eligible portfolio companies. These are U.S. private companies or public companies with small market caps (under $250 million).
• BIncorrect. This describes a money market fund. A BDC takes on much more credit and equity risk by financing smaller companies.
• CIncorrect. These are the REIT asset and income tests. A BDC invests in operating businesses, not mainly in real estate.
• DIncorrect. This describes a unit investment trust. A BDC is an actively managed closed-end vehicle that also must offer managerial assistance to its portfolio companies.

Answer: A) Classified as a partnership, with income passing through to the members

With no election, a domestic LLC with two or more members is taxed as a partnership (pass-through). A single-member LLC is a disregarded entity. Corporate treatment requires an election on Form 8832.

• ACorrect. Under IRS rules, a domestic LLC with at least two members is a partnership by default unless it files Form 8832 to be treated as a corporation. Income and losses pass through to the members.
• BIncorrect. An LLC is taxed as a corporation only if it elects that treatment. A multi-member LLC's default classification is a partnership.
• CIncorrect. Disregarded-entity treatment is the default only for a single-member LLC. This LLC has three members.
• DIncorrect. S corporation status requires an affirmative election, and S corporations may have only one class of stock. It is not an LLC's default classification.

Answer: D) $4,700

• AIncorrect. A stock can only fall to zero.
• BIncorrect. The premium reduces the gain.
• CIncorrect. That's the maximum loss.
• DCorrect. (50 − 3) × 100.

Answer: B) Moves opposite to a benchmark rate

• AIncorrect. That's a regular floater.
• BCorrect. Its price can be very volatile.
• CIncorrect. That's a fixed-rate bond.
• DIncorrect. The formula sets it.

Answer: A) Selects and weights holdings using rules-based factors instead of market cap

Smart beta ETFs follow rules-based indexes that weight securities by factors other than market cap. They usually cost more and rebalance more often than cap-weighted index funds.

• ACorrect. Smart beta indexes screen and weight securities using rules-based factors (such as equal weighting, fundamentals, value or volatility) instead of market capitalization.
• BIncorrect. Smart beta funds track rules-based indexes. They are not discretionary active management.
• CIncorrect. FINRA notes that smart beta products tend to cost more than funds tracking market cap-weighted indexes, though usually less than actively managed funds.
• DIncorrect. Smart beta indexes rebalance more often than market cap-weighted indexes, and that turnover can raise investor costs.