Understanding Products and Their Risks: practice questions

Correct: A. At a discount the investor also collects the gain to par at maturity, so yield to maturity exceeds current yield, which exceeds the fixed nominal yield. The ranking inverts for a premium bond and converges at par.

• B — That is the ranking for a bond trading at a premium, where the investor absorbs a loss to par.
• C — Current yield ignores the gain to par, so it cannot exceed yield to maturity on a discount bond.
• D — They are equal only at par; a price below par separates all three.

Correct: B. Diversification spreads issuer-specific and sector-specific exposure. Systematic risk is by definition what remains after diversification, which is why it is also called market risk.

• C — Systematic risk affects the whole market and is precisely what diversification cannot remove.
• D — Market risk is another name for systematic risk and is not reduced by diversification.
• A — Interest rate risk affects the market broadly and is managed by duration or hedging, not diversification.

Correct: C. The inverse relationship between price and interest rates is the most reusable fact in section 2. A bond paying a below-market coupon must be priced down until its yield matches what new issues offer.

• D — The direction is wrong; a below-market coupon makes the bond less valuable, not more.
• A — The coupon is fixed but the price is not; the market reprices the bond to adjust its yield.
• B — Credit downgrades affect price too, but the rate move alone is enough to move it.

Correct: D. A letter of intent is forward looking: the investor states an intention to reach a breakpoint and receives the reduced charge on the way there. A right of accumulation is backward looking, counting holdings already owned.

• A — A right of accumulation counts existing holdings toward a breakpoint rather than future purchases.
• B — A net transaction concerns how a trade is priced, not how a sales-charge discount is obtained.
• C — Surrender charges apply to variable contracts and annuities, not to mutual fund breakpoints.

Correct: A. Covered means the writer can deliver from an existing holding if assigned. Writing a call without owning the shares is uncovered or naked, and carries theoretically unlimited risk.

• B — Uncovered describes writing a call without owning the underlying shares.
• C — Index hedging is a different strategy and does not describe writing against owned shares.
• D — American versus European describes when an option may be exercised, not whether it is covered.

Correct: B. The outline's knowledge block for DPPs is exactly three items: pass-through tax treatment, unlisted, generally illiquid. Those three characteristics are what the exam asks about.

• C — Daily redemption at net asset value describes open-end investment companies, not DPPs.
• D — DPPs carry no federal deposit insurance and no guaranteed return; investors bear the risk of the underlying business.
• A — Pass-through treatment is the avoidance of double taxation, which is the point of the structure.