9-9 Units 5,6,7

Sales Charge Percentage Dollar cost averaging

(POP - NAV) / POP total dollars invested / # of shares purchased

Define accredited investor

+1mill network minus estate, 200thousand individual, 300thousand couple, looking at more speculative

Under Municipal Securities Rulemaking Board rules, which of the following would indicate a control relationship between a municipal dealer and an issuer? A) A dealer's officer sits on the issuer's board of trustees B) The principal of the dealer lives within the municipality C) The dealer is engaged as an underwriter for the issuer D) The dealer was an underwriter of the municipality's last issue

A Explanation A control relationship exists if someone represents both an issuer and municipal securities dealer.

A county taxes real property at a millage rate of 15. If your customer owns real property in the county and the assessed value is 80% of the current market value of $150,000, the annual tax is A) $1,800. B) $2,250. C) $180. D) $1,200.

A Explanation Ad valorem tax rates are based on mills with one mill being equal to $0.001 (1/10th of a cent).The amount of taxes to be paid on the property is determined by multiplying the millage rate—in this case, one and one half cents (15 mils at $0.001 = $0.015)—times the assessed property value ($120,000). Remember, this county is only taxing on 80% of the assessed value. The market value is irrelevant. For those who have difficulty determining where the decimal point goes, on any question like this, drop the last three 000s from the assessed value and multiply by the millage rate. In this question, that would be $120 times 15 and that equals the correct answer of $1,800.

When the issuer of an insured municipal bond defaults, what does the insurance company do? A) Both principal and interest are returned over the remaining term of the bond. B) Both principal and remaining interest payments are paid immediately to the bondholder. C) Principal is returned immediately, and the interest is paid out based upon the normal schedule. D) Only the principal is returned with the bondholder losing the interest.

A Explanation Both interest and principal are paid as scheduled over time through the life of the bond. The idea is that the bondholder should not see a problem. The insurer will just take up the liability and run with it without missing a beat.

An investor is looking for a fixed-income investment that can provide a reasonable income while offering potential inflation protection. Which of the following would be the best recommendation to meet this investor's objective? A) Convertible bonds B) Common stock C) Cumulative preferred stock D) High-yield bonds

A Explanation Convertible bonds offer the best solution for this client. The bond carries a fixed interest rate, meeting the goal of reasonable income. The ability to convert the bond into common stock offers the potential to keep pace with inflation. Common stock historically has been the best inflation hedge. Why isn't it the correct answer here? Because common stock is not considered a fixed-income investment. Although the cumulative preferred stock is a fixed-income investment, there is no inflation protection (the cumulative feature only provides assurance that past dividends are likely to be paid). High-yield bonds will provide income but, once again, there is no inflation protection. What's more, these are known as junk bonds, and the steady income might be questionable due to the low quality of many of these bonds.

ABC Company has issued $20,000,000 of convertible bonds with a coupon of 5% and a current market value of 120. The conversion price is $40. If all the bonds are converted, how many additional shares of common stock will ABC have outstanding? A) 500,000 B) 600,000 C) 400,000 D) 1,000,000

A Explanation Each bond will convert to 25 shares of common stock ($1,000 ÷ $40). 20,000 bonds were issued ($20,000,000 ÷ $1,000). Therefore, 500,000 additional shares (20,000 × 25) will be outstanding if all the bonds are converted.

Disregarding commissions, and investor purchasing $10,000 face amount of Treasury notes at a price of 98.12 would expect to pay A) $9,837.50. B) $983.75. C) $981.20. D) $9,812.00.

A Explanation Please note that the purchase is not for $1,000, but for $10,000. Treasury notes (and bonds) are quoted in 32nds. This quote of 98.12 is 98 12/32 or 98 3/8% of $10,000.

A corporation has an outstanding issue of 8% convertible debentures with a conversion price of $25. The bond indenture contains an antidilutive clause guaranteeing the debt holders the right to maintain proportionate equity conversion in the corporation. If the company pays a 10% stock dividend to its common shareholders, how will that affect the debenture holders? A) The bonds will now be convertible at approximately 22.73. B) They will receive four shares of the common stock. C) Each debenture holder will receive a check for $100. D) The interest rate on the debentures will increase to 8.8%.

A Explanation The antidilutive provision means the debenture holders will be able to convert into an equivalent share value as before. With a conversion price of $25, the bond is convertible into 40 shares ($1,000 ÷ $25). After the 10% stock dividend, they should be able to have 10% more shares, or 44 shares. That means the conversion price must be reduced. Divide $1,000 by 44 shares and the result is $22.73. Remember, anytime there is a stock dividend, prices go down.

A customer purchases an ABC $100 par 6½% convertible preferred stock at $80. The conversion price is $20. If the common stock is trading 2 points below parity, the price of ABC common is A) $14. B) $16. C) $18. D) $12.

A Explanation The conversion ratio is computed by dividing par value by the conversion price ($100 par ÷ $20 = 5). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($80 ÷ 5 = $16). $16 − 2 = $14.

The City of Columbus issued a 20-year general obligation bond at a price of 50. An original purchaser sold the bond at 75 after holding it for 7 years. For tax purposes, that sale generated A) a $75 capital gain. B) no gain or loss. C) a $250 capital gain. D) a $25 capital gain.

A Explanation The customer has realized a capital gain of $75. Original issue discount bonds must accrete the discount over the life of the bond. In this example, the amount of the discount (par value minus purchase price) is $500 ($1,000 − $500 = $500). The discount divided by the number of years to maturity determines the annual accretion added to the cost basis. In this question, the annual accretion is $25 ($500 divided by 20 = $25). The adjusted cost basis would be the original purchase price ($500) plus seven years of accretion (7 times $25 = $175) for a total of $675. Because the proceeds of the sale were $750, the customer has realized a capital gain of $75 ($750 − $675 = $75).

Which of the following statements describing Section 529 plans is true? A) The maximum lifetime contribution varies from state to state. B) Most state college savings plans require either the owner or the beneficiary of the plan to be a state resident. C) The fees associated with them are generally the same from state to state. D) They can only be opened for children under the age of 18.

A Explanation The features of Section 529 plans, including their contribution limits and fees, vary widely from state to state. Section 529 plans have no age limits as to participation; they are open to both children and adults who plan to attend college or graduate school. For college savings plans, there is no state residency requirement for either owners or beneficiaries of Section 529 plans.

When a corporation issues a debt security, the terms of the loan are expressed in a document known as the bond's deed of trust. The deed of trust is sometimes referred to as A) the indenture. B) the debenture. C) the bond resolution. D) the loan agreement.

A Explanation The indenture, sometimes also referred to as the deed of trust, states the issuer's obligation to pay back a specific amount of money on a specific date. A debenture is a debt security containing an indenture. Bond resolution is a term used for municipal bonds, not corporate debt.

If interest rates increase, the interest payable on outstanding corporate bonds will A) remain unchanged. B) change according to the inverse payout theory. C) increase. D) decrease.

A Explanation The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year regardless of the prevailing interest rates in the market. It is the market price of bonds, not the interest payable, that responds inversely to changes in interest rates.

All of the following terms are associated with general obligation (GO) bonds except A) protective covenants. B) coterminous debt. C) limited tax bond. D) voter referendum.

A Explanation The protective covenants are found in the trust indenture of a revenue bond. Among the more common protective covenants are the rate covenant and the maintenance covenant. The former is a promise to maintain rates sufficient to pay expenses and debt service. The latter is a promise to maintain the equipment and facility/facilities. Coterminous debt, or overlapping debt, exists when a single property is taxed by more than one taxing authority (e.g., when property is taxed by both a school district and a county). Certain GOs may have limitations imposed on increasing any of the taxes that back them and are called limited tax bonds. GO bonds require voter approval.

A bond was issued 3 years ago with a coupon of 6%. The bond matures in 21 years and is callable at 103. Current market interest rates are 8%. Which of the following is most likely true? A) The bond is selling at a discount. B) The bond will be called. C) The bond is selling at a premium. D) The coupon will be changed.

A Explanation This question contains more information than is needed. Simply, this is a bond where interest rates have gone up since it was issued. When interest rates go up, bond prices go down. Bonds are not called when current interest rates are higher than the coupon; the reverse is true.

A customer buys $10,000 worth of new issue municipal bonds at a price of 104, and the bonds have 10 years to maturity. Four years after purchasing the bonds, she sells them at 99. What is the tax loss on these bonds? A) 340 B) 500 C) 400 D) 160

A Explanation To arrive at adjusted cost basis, the premium on a new issue municipal bond must be amortized (subtract). To amortize the premium annually, divide the premium amount (in this case, $400 on the total purchase of 10 bonds????) by the number of years until maturity (10). Thus, the customer writes down the initial cost by $40 per year. After four years, the bonds purchased at a cost of $10,400 will be written down to $10,240 (4 years × $40 per year = $160). If the bonds are sold for $9,900, the tax loss is $340 ($10,240 − $9,900 = $340).

Which of the following securities is an original issue discount obligation? A) 13-week U.S. Treasury bills B) FNMA bonds C) Corporate bonds D) GNMA certificates

A Explanation U.S. Treasury bills are always originally issued at a discount and mature at par, with the investor making the appreciation between the original discounted amount and the par value at maturity. However, this appreciation is treated as interest, not a capital gain.

Which of the following statements regarding Treasury receipts is not true? A) Interest income is taxed at maturity. B) Treasury receipts pay interest at maturity. C) Treasury securities held in trust collateralize the receipts. D) Treasury receipts are not backed by the faith and credit of the U.S. government.

A Explanation Unlike Treasury STRIPS, which are issued directly by the U.S. government, Treasury receipts are indirect obligations of the government. Treasury receipts are issued by investment bankers who buy Treasury securities, place them in trust at a bank, and sell separate receipts against the principal and interest payments. Like most zeroes, interest must be accreted and taxed annually even though it is not received until maturity.

Your client is considering two bonds: an ABC Corporation mortgage bond with a yield to maturity of 9% and a municipal bond issued by the state that she resides in. If your client is in the 32% tax bracket, what is the tax-free equivalent yield for the corporate mortgage bond so that she will be able to compare it to the tax-free municipal bond she is considering? A) 6.12% B) 2.88% C) 13.24% D) 4.10%

A Explanation When the yield on the corporate taxable bond is given and the question asks for the equivalent after-tax yield of a tax-free municipal bond, we calculate that as follows: corporate rate × (1 − investor's tax bracket). In this case, 0.09 × (1 − 0.32) = 0.09 × 0.68 = 0.0612, or 6.12%. Without all of those zeros, it is 9% × 68% = 6.12%. Alternatively, just subtract the 32% tax from 9%. That would be 9% − (9% × 32%) = 9% − 2.88% tax = 6.12%. Remember, because the investor is paying taxes at a rate of 32%, she is keeping only 68% of the income received on a taxable security compared to 100% on a tax-free municipal bond. When the coupon rate of the tax-free security is given and the question is asking about the tax-equivalent yield of that security (it will always be higher than the coupon), we need to divide. Divide the municipal coupon rate by (100% minus the tax bracket). For example, if this question has said that the coupon on the municipal bond was 6.12% and asked for the TEY, you would divide 6.12% by 68%. Do that on your calculator and the result is 9%. The key to remembering which formula works is that when the coupon on the taxable security is given, the answer will always be lower than that coupon. That means subtracting. When the coupon on the tax-free security is given, the answer will always be higher than that coupon and that means dividing.

An investor purchases a municipal bond at par to yield 5.5% to maturity. Two years later, if he sells the bonds at a price equivalent to a 5% yield to maturity, the investor incurs A) a capital gain. B) a capital loss. C) no taxable result at this time. D) tax-free income.

A Explanation Yields fall as bond prices rise. Because the yield to maturity has dropped, the bond is trading at a higher price than when it was purchased. The consequence of the sale is a capital gain because the investor sold the bond that was purchased for par at a premium.

A TIPS bond has a coupon of 3%. Over a two-year period, the annual inflation rate has been 4.5%. At the end of that time, the principal value of the TIPS would be A) $1,093.08. B) $1,061.36. C) $1,090.00. D) $1,060.00.

A Explanation take the simple interest of 4.5% per year. That is $45 per year or $90 for the two years. Add that to the original principal to get $1,090. That is not the correct answer, but the next highest number in the answer choices is.

Svetlana calls her registered representative and places an order to write an XYZ Oct 90 call, and at the same time, write an XYZ Oct 80 put. The orders are executed at a premium of 5 for the call and 9 for the put. Which of the following best describes the customer's investment strategy? A) Bearish B) Neutral C) Mixed D) Bullish

B Explanation A customer who writes both a call and a put on the same underlying security wishes for little or no market movement. This is referred to as a neutral strategy. Technically, the customer has created a short combination (an investment position very similar to a short straddle, with the same investment characteristics), and in this case, a little less risk than a pure straddle because of the spread in the strike prices.

An investor receiving a quote of 102 for a municipal security is probably interested in A) a serial bond. B) a term bond. C) a bond anticipation note. D) a general obligation bond.

B Explanation A quote of 102 is referred to as a dollar quote ($1,020) rather than a yield quote. The most common dollar bonds are those with a term maturity. The other choices are most often quoted on a yield basis rather than a price basis.

A variable-rate municipal bond investment's main advantage is that A) it is likely to increase in value. B) its price should remain relatively stable. C) its interest is exempt from all taxes. D) it is noncallable.

B Explanation A variable-rate bond has no fixed coupon rate. The coupon is tied to a market rate (e.g., T-bond yields) and subject to change at regular intervals. Because the interest paid reflects changes in overall interest rates, the bond price remains relatively close to its par value. Its coupon is always representative of the current market rate. As rates rise, the coupon is adjusted upward. As rates fall, the coupon is adjusted downward.

Your customer, a small-business owner, likes investments that are short term, relatively safe from credit risk, and liquid. He's heard that higher rates of return can be realized from auction rate securities than the rates he is currently getting on the Treasury bills in his portfolio. He asks you to explain them to him. Which of the following would you note as being reasons why they are not suitable for him? Auction rate securities are intended as long-term investments. Interest or dividend rates are reset at established intervals based on a Dutch auction. If the auction fails, holders of ARSs may not have immediate access to their funds. The interest or dividend rate is set as the lowest rate to match supply and demand at the time of the auction. A) II and IV B) I and III C) I and IV D) II and III

B Explanation Auction rate securities (ARSs) are long-term variable rate bonds with maturities of 20 to 30 years tied to short-term interest rates. As long-term instruments, they are not suitable for an investor favoring short-term investments. Additionally, interest rates are reset using a Dutch auction method at predetermined intervals, typically 7, 28, or 35 days. A failed auction can occur due to lack of demand; in this case, no bids are received to reset the rate. This risk would not align the investment objectives of safety and liquidity.

An example of a taxable bond issued by a municipal government is A) a general obligation bond (GO). B) a Build America Bond (BAB). C) Series EE bonds. D) a tax anticipation note (TAN).

B Explanation BABs are municipal issues created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing the cost of issuing municipalities and to stimulate the economy. Bonds to fund municipal projects have traditionally been sold in the tax-exempt arena, but BABs are taxable obligations.

All of the following statements regarding convertible bonds are true except A) the issuer pays a lower interest rate. B) holders receive a higher interest rate. C) holders may share in the growth of the common stock. D) holders receive a fixed interest rate.

B Explanation Because of the possibility of participating in the growth of the common stock through an increase in the market price of the common, the convertible can be issued with a lower interest rate. The interest rate on a convertible, just as with any other fixed-income security, does not change.

A customer with an income objective who resides in a state with a high personal income tax might find it best to purchase A) Corporate bonds with an investment-grade rating. B) Bonds issued by the U.S. Virgin Islands. C) U.S. Treasury STRIPS. D) Mortgage-backed securities issued by the Government National Mortgage Association (GNMA).

B Explanation Bond issued by U. S. Territories, such as the Virgin Islands, are triple tax-exempt. That is, investors do not have to pay federal, state, or local income taxes on the interest. GNMA and corporate debt securities are taxable on all levels. Although the Treasury STRIP is exempt from state income tax, as a zero coupon bond, it provides no income.

A customer buys 300 LMN at $45 per share and writes 3 LMN Aug 45 calls at 4. The customer will profit under all of the following circumstances except A) if LMN remains at $45 through expiration. B) if LMN is below $41 at expiration. C) if LMN is between $41 and $45 at expiration. D) if LMN rises, and the calls are exercised.

B Explanation Breakeven is $41 ($45 − $4). The stock price must be above breakeven for the investor to make a profit.

A bond with a 9% coupon, maturing in 18 years and 6 months, is selling at 120. The yield to maturity is closest to A) 11.66%. B) 7.05%. C) 7.50%. D) 9.00%.

B Explanation Don't waste time trying to do the yield to maturity computation. This bond is selling at a premium (120% of par). Therefore, all of the computed returns must be lower than the 9% nominal (coupon) yield. Only two of them are. The 7.50% represents the current yield ($90 ÷ $1,200). We know from our charts that, just like a seesaw, the farther from the center you go, the bigger the move at the end. That means the nominal yield is the highest, followed by the current yield (CY), the yield to maturity (YTM), and finally the yield to call (YTC) as the lowest. Because only one choice is lower than the CY, you get the correct answer with minimal effort.

A customer, long 100 shares of ABC at 73, writes 1 ABC Apr 75 call at 2 to generate additional income. ABC stock subsequently moves higher, at which time, the customer is exercised. For tax purposes, which of the following statements are true? Cost basis is $73 per share Cost basis is $71 per share Sales proceeds are $75 per share Sales proceeds are $77 per share A) II and III B) I and IV C) I and III D) II and IV

B Explanation If a covered call writer is exercised, cost basis (for tax purposes) is the cost of stock purchased. Sales proceeds are adjusted (strike price plus premium) to reflect the premium received.

If a state agency has issued a moral obligation bond that runs into difficulty and requires the secondary backing to be implemented, what is necessary? A) Voter approval B) Legislative approval C) Administrative approval D) MSRB approval

B Explanation If a state agency that has issued a moral obligation bond requires that secondary backing, the agency must apply to the legislature for approval. If approved by the legislature, the funds will be made available. If not approved, the issue might go into default.

A legal opinion issued for a municipal bond covers which of the following? Feasibility of public works projects Creditworthiness of the issuing municipality Tax status of the municipal debt Constitutionality and legality of the municipal debt A) II and III B) III and IV C) I and II D) I and IV

B Explanation Municipal securities are reviewed by specialized lawyers who render a legal opinion. The opinion covers two main issues: constitutionality (i.e., it ensures that the bonds are legal, valid, and binding obligations of the issuer) and verification of the tax status of the debt (i.e., interest on the bonds is exempt from federal income taxes as well as state and local taxes in some cases).

Expressed as a percentage of par, one basis point equals A) one-tenth of 1%. B) one-one hundredth of 1%. C) 10%. D) one-one thousandth of 1%.

B Explanation One basis point equals one-one hundredth of 1% of par. One percent of par ($1,000) equals $10; therefore, 1 basis point equals one-one hundredth of $10, or $0.10 (10 cents).

All of the following statements regarding government and agency securities are true except A) interest paid is always subject to federal income tax. B) they are always directly backed by the federal government. C) they are authorized by Congress. D) they are considered safer than corporate debt securities.

B Explanation Only GNMAs are directly backed by the federal government. FNMAs and FHLMCs are only indirectly backed but are still considered less risky than corporate debt. All are subject to federal taxation, and all were authorized by Congress.

Which of the following statements regarding municipal revenue bond issues are generally true? The bonds' feasibility is dependent on the earnings potential of the facility or project. The bonds are backed by unlimited taxing power of the issuer. User fees provide revenue for bondholders. Revenue bonds are most suitable for investors with high risk tolerance. A) I and IV B) I and III C) II and IV D) II and III

B Explanation Revenue bonds are backed by project earnings (user fees), not taxes, and are generally considered low risk.

Which of the following is an example of sovereign debt? A) Royal Bank of Canada CDs B) U.S. Treasury bonds C) Bank of England notes D) Sony Corporation debentures

B Explanation Sovereign debt represents loans to governments. On the exam, it is likely that the examples will be foreign governments, not U.S. Treasury securities. The Royal Bank of Canada is a privately owned corporation and its debts are not those of the Canadian government. Bank of England notes are the paper currency issued (e.g., the ₤10 and ₤20 notes).

Which of the following securities is sold at auction? A) Freddie Macs B) T-bills C) Corporate bonds D) Ginnie Maes

B Explanation T-bills, T-notes, and T-bonds are sold through auction. These auctions award securities to the most competitive bids. Agency securities are sold through selling groups appointed by the agency.

Amortization of a municipal bond premium does which of the following? Increases cost basis Decreases cost basis Increases reported interest income Decreases reported interest income A) I and IV B) II and IV C) I and III D) II and III

B Explanation Tax law requires municipal bond premiums to be amortized. The effect of amortization is to decrease reported interest income and cost basis. If held to maturity, the cost basis will have been amortized down to par. Therefore, at maturity, there is no reported capital loss.

An investor whose primary objective is a steady income flow would probably be best served by building a portfolio of A) income bonds. B) investment-grade debentures. C) preferred stock. D) cumulative common stock.

B Explanation The "trick" here is to remember that income bonds are issued during a corporate reorganization and only pay interest when and if the company has sufficient earnings. When a bond or debenture is investment grade, the likelihood of receiving timely interest payment is high. Preferred stock is generally a good source of income, but, because the dividends are not an obligation in the way that interest is, the stability of the income is less assured. There is no such thing as cumulative common stock, only preferred.

When creating a diversified municipal bond portfolio, all of the following should be considered except A) the credit rating. B) the denomination of the bonds included in the portfolio. C) the geographic location of the issuer. D) the source of funds backing the bonds.

B Explanation The denomination of the bonds in a portfolio is not relevant to diversification. What difference does it make if the bonds carry a denomination of $1,000 or of $5,000? We diversify by quality by including bonds with different ratings. We recognize that the United States is a large country with some geographic areas outperforming others. That is why we diversify the portfolio by including bonds from different states. Another way to diversify the portfolio is by including GO bonds and revenue bonds.

Who has the final responsibility for debt service on an industrial revenue bond? A) The municipal issuer of the bonds B) The corporation leasing the facility C) The municipal authority established by the issuer D) The MSRB

B Explanation The issuer of industrial revenue bonds is a municipality or an authority established by a municipality. However, no municipal assets or general revenues are pledged to secure the issue. The net lease payments by the corporate user of the facility are the source of revenue for debt service. Therefore, the ultimate responsibility for the payment of the principal and interest on an industrial revenue bond rests with the corporate lessee.

An investor purchases zero-coupon bonds issued by the U.S. Treasury due to mature in 18 years at $100,000. Which of the following might describe the primary reason for selecting that investment vehicle? The investor is 65 years old and needs the reliability of current income. The investor is 45 years old and has purchased these in an IRA rollover account and wants the assurance of funds for retirement. The investor is 30 years old and has a newborn child and wishes to assure funds for a college education. The investor is 20 years old, has just received an inheritance, and wishes to shelter income for as long as possible. A) III and IV B) II and III C) I and IV D) I and II

B Explanation Zero-coupon bonds maturing in 18 years would assure the 45-year-old of the face value at age 63. Being in an IRA, there would be no current taxation, and upon maturity, if desired, the funds could be distributed without the 10% penalty. Zero-coupon bonds are one way to guarantee funds for college education. However, with no current income, they would not be suitable for the 65-year-old and would not offer any tax shelter to the 20-year-old.

Your FINRA member firm takes 100 GO bonds from a municipal bond dealer out-firm for one hour. This means that A) the municipal bond dealer has one hour to change the quoted price. B) after one hour, your firm owns the bonds. C) your firm controls the bonds for one hour. D) the municipal bond dealer has one hour to sell these bonds to another member at a greater price.

C Explanation A municipal securities dealer may quote a bond price that is firm for a certain time. This is called an out-firm with recall quote. Generally, these quotes are firm for an hour (or half hour) with a five-minute recall period. During this time, the municipal dealer cannot offer those bonds to anyone else—they are under the control of your firm.

A corporate bond pays interest on a J/J 15 schedule. An investor purchasing these bonds on Friday, April 17, would pay accrued interest for A) 95 days. B) 92 days. C) 96 days. D) 91 days.

C Explanation Accrued interest on a corporate (or municipal) bond is based on each month containing 30 days. As with all bonds, the accrued interest is paid up to, but not including the settlement date. A trade made on Friday settles the following Tuesday (T+2), April 21. That means 3 months at 30 days each (90 days) plus 6 additional days (we don't count the settlement date) for a total of 96 days. One way to set this up is: 4/21 - 1/15 = 3 months and 6 days = 90 + 6.

A corporate bond pays interest on a J/J 15 schedule. An investor purchasing these bonds on Friday, April 17, would pay accrued interest for A) 95 days. B) 92 days. C) 96 days. D) 91 days.

C Explanation Accrued interest on a corporate (or municipal) bond is based on each month containing 30 days. As with all bonds, the accrued interest is paid up to, but not including the settlement date. A trade made on Friday settles the following Tuesday (T+2), April 21. That means 3 months at 30 days each (90 days) plus 6 additional days (we don't count the settlement date) for a total of 96 days. One way to set this up is: 4/21 - 1/15 = 3 months and 6 days = 90 + 6.

An insured municipal bond is purchased by your client in the secondary market. After the sale, Municipal Securities Rulemaking Board rules would require you to A) send a copy of the official statement. B) indicate that the bonds are insured on the confirmation because this is the only requirement. C) make delivery of the certificates accompanied by evidence of insurance, either on the face of the certificates or in a separate document. D) include a copy of the insurance policy with delivery of the certificates.

C Explanation Although it is likely that the confirmation would include a statement that the bonds are insured, it is also necessary to provide the client with some proof of that insurance, either on the bond itself or, in the case of book entry delivery, as a separate document.

In general, commercial paper, a popular money market instrument, has a maturity not exceeding A) 90 days. B) 365 days. C) 270 days. D) 30 days.

C Explanation Although there are rare cases where the maturity extends as long as 12 months (365 days), for exam purposes, think of CP with a maximum maturity of 270 days (9 months).

U.S. Treasury bills are issued for all of the following maturities except A) 4 weeks. B) 13 weeks. C) 39 weeks. D) 26 weeks.

C Explanation As of the authoring date of this question, Treasury bills are issued for terms of 4, 8, 13, 26, and 52 weeks. The Treasury auctions the 52-week bill every four weeks and the 4-, 8-, 13-, and 26-week bills every week.

The STU Corporation has issued common stock, preferred stock, promissory notes, and mortgage bonds. Should STU enter bankruptcy proceedings, the order of payment against claims would be A) the mortgage bonds, the preferred stock, the common stock, and the promissory notes. B) the preferred stock, the common stock, the mortgage bonds, and the promissory notes. C) the mortgage bonds, the promissory notes, the preferred stock, and the common stock. D) the promissory notes, the mortgage bonds, the preferred stock, and the common stock.

C Explanation In a bankruptcy, secured creditors, such as those with a mortgage against real property, have the first priority. They are followed by unsecured creditors, such as holders of promissory notes, with stock holders coming last. Preferred stock is "preferred" over common stock in both liquidation priority and payment of dividends.

The alternative minimum tax (AMT) is designed to present an alternative tax computation that disallows deductions for certain tax preference items and includes certain nontaxable income. Which of the following is not a tax preference item? A) Certain costs associated with an oil and gas drilling program B) Local income and property taxes C) Interest received on corporate bonds D) Tax-exempt interest received on private purpose bonds

C Explanation Interest on corporate bonds is taxable and included in an investor's adjusted gross income (AGI), but not for the AMT. Tax-exempt interest on private activity bonds and excess intangible drilling costs in an oil and gas DPP are included as tax preferences. In addition, state and local taxes and accelerated depreciation are in the list of preference items.

Treasury STRIPS and Treasury receipts are quoted based on A) 0.125 (⅛ of a point in dollars). B) 0.03125 (1/32 of a point in dollars). C) yield to maturity. D) amortization of premiums.

C Explanation Noninterest-bearing securities, like zeroes, are quoted based on their yield to maturity. They are sold at a discount and mature at par.

Reggie owns a convertible bond that converts into 20 shares of common stock. The current market value of the bond was 118½ at the close on Friday, April 1. A 30-day call is announced before the opening on Monday, April 4, at a price of 102. The stock is trading at $57.75. What should Reggie do? A) Hold the bond to maturity B) Sell the bond C) Convert the bond into the stock D) Redeem the bond at the call price

C Explanation Reggie will not be allowed to hold the bond to maturity because it is being called. The real question is whether he should sell the bond, allow it to be called, or convert it to the underlying stock. Now that the call has been announced, the market value of the bond will fall to meet the call price. This occurs as a result of declining demand. (Who wants to buy a bond that is about to be called at a lower price?) Thus, redeeming the bond at the call price and selling the bond would both yield the same results: $1,000 times 102% equals $1,020. If he converts the bond, he will get the following results: 20 shares times $57.75 equals $1,155. Therefore, it makes the most sense to convert the bond.

Which of the following would be considered an equity security? A) Negotiable CDs B) Exchange-traded notes C) Preemptive rights D) Equity-linked notes

C Explanation Rights (and warrants) are included in the term equity security. Confusingly, equity-linked notes are debt securities, even though the term equity is in the name. On this exam, notes always represent a form of debt security.

The GHI Transportation Company has run into decreased sales and is forced into a bankruptcy liquidation. Which of the following would have the most junior claim? A) Holders of GHI's equipment trust certificates B) Holders of GHI's collateral trust certificates C) Holders of GHI commercial paper D) Holders of GHI's mortgage bonds

C Explanation Secured debt (such as the mortgage bond), the collateral trust certificate, and the equipment trust certificate have first priority in the event of a bankruptcy. Commercial paper is a promissory note relying on the creditworthiness of the issuer.

Which of the following would be most likely to require a mandatory sinking or surplus fund? A) A general obligation B) A public housing authority. C) A water and sewer revenue bond D) A tax anticipation note

C Explanation Sinking or surplus funds force revenue bond issuers to set aside a portion of their revenue for debt retirement.

A TIPS bond has a coupon of 3%. Over a two-year period, the annual inflation rate has been 4.5%. At the end of that time, the principal value of the TIPS would be A) $1,090.00. B) $1,060.00. C) $1,093.08. D) $1,061.36.

C Explanation TIPS bonds have the special feature of adjusting the principal value every six months by the inflation rate. With an annual rate of 4.5%, the adjustment is 2.25% semiannually. Take the simple interest of 4.5% per year. That is $45 per year or $90 for the two years. Add that to the original principal to get $1,090. That is not the correct answer, but the next highest number in the answer choices is.

An investor purchases an original issue discount municipal bond on the offering at 80. The bond matures in 25 years. Eight years later, the investor sells the bond for 84. The tax consequence of this transaction is A) long-term capital gain of $40. B) tax-free income of $24 and long-term capital gain of $40. C) long-term capital loss of $24. D) ordinary loss of $24.

C Explanation The 20 point ($200) discount accretes over the 25-year life of the bond. That makes the annual accretion $8 per year ($200 divided by 25 years). After 8 years, there has been $64 of accretion ($8 times 8 years). That means the cost basis of the bond is $864. The sale at $840 represents a loss of $24 and has a long-term holding period.

A corporation has an outstanding issue of 8% convertible debentures with a conversion price of $25. The bond indenture contains an antidilutive clause guaranteeing the debt holders the right to maintain proportionate equity conversion in the corporation. If the company pays a 10% stock dividend to its common shareholders, how will that affect the debenture holders? A) They will receive four shares of the common stock. B) Each debenture holder will receive a check for $100. C) The bonds will now be convertible at approximately 22.73. D) The interest rate on the debentures will increase to 8.8%

C Explanation The antidilutive provision means the debenture holders will be able to convert into an equivalent share value as before. With a conversion price of $25, the bond is convertible into 40 shares ($1,000 ÷ $25). After the 10% stock dividend, they should be able to have 10% more shares, or 44 shares. That means the conversion price must be reduced. Divide $1,000 by 44 shares and the result is $22.73. Remember, anytime there is a stock dividend, prices go down.

The City of Columbus issued a 20-year general obligation bond at a price of 50. An original purchaser sold the bond at 75 after holding it for 7 years. For tax purposes, that sale generated A) a $25 capital gain. B) no gain or loss. C) a $75 capital gain. D) a $250 capital gain.

C Explanation The customer has realized a capital gain of $75. Original issue discount bonds must accrete the discount over the life of the bond. In this example, the amount of the discount (par value minus purchase price) is $500 ($1,000 − $500 = $500). The discount divided by the number of years to maturity determines the annual accretion added to the cost basis. In this question, the annual accretion is $25 ($500 divided by 20 = $25). The adjusted cost basis would be the original purchase price ($500) plus seven years of accretion (7 times $25 = $175) for a total of $675. Because the proceeds of the sale were $750, the customer has realized a capital gain of $75 ($750 − $675 = $75).

All of the following statements regarding a municipality's debt limit are true except A) that revenue bonds are not affected by statutory limitations. B) that unlimited general obligation bonds may be issued when a community's taxing power is not restricted by statutory provisions. C) that the debt limit is the maximum amount a municipality can borrow in any one year. D) that the purpose of debt limits is to protect taxpayers from excessive taxes.

C Explanation The debt limit is the maximum amount of debt a municipality can have.

A municipality's net total debt is calculated as A) the total debt plus self-supporting debt minus sinking fund accumulations minus overlapping debt. B) the total debt minus self-supporting debt plus sinking fund accumulations plus overlapping debt. C) the total debt minus self-supporting debt minus sinking fund accumulations plus overlapping debt. D) the total debt plus self-supporting debt plus sinking fund accumulations minus overlapping debt.

C Explanation The net total debt of a municipality is the net overall debt (total debt minus self-supporting debt minus sinking fund accumulations) plus overlapping debt (shared with other municipalities). States cannot have overlapping debt; it is their municipalities that can.

Which of the following statements regarding the flow of funds found within a municipal trust indenture are true? It describes the disbursement of funds for revenue bond issues. It describes the disbursement of funds for general obligation issues. It is found within the official statement. It is found within the bond contract. A) II and III B) II and IV C) I and IV D) I and III

C Explanation The term flow of funds relates to revenue bond offerings only and describes the priority of disbursing revenues from the project. Generally, the revenues are deposited into a general collection account for disbursement into other accounts, as specified in the trust indenture found in the bond contract.

On Monday, June 1, an investor pays 92 to purchase a 5% J&J municipal bond maturing on July 1, 2030. Purchasers of bonds pay accrued interest to the seller, in addition to the market price of the bond. How many days of accrued interest will this seller receive? A) 151 B) 154 C) 152 D) 153

C Explanation There are 152 days of accrued interest. On municipal bonds, the accrued interest calculation uses 30-day months and 360-day years. Interest begins to accrue on the last interest payment date and runs up to, but not including, the settlement date. This J&J bond pays interest on January 1 and July 1 of each year. Therefore, with a June purchase date, the most recent interest payment was on the previous January 1, the day that interest begins to accrue. The trade date is June 1 with a settlement date of June 3 (T+2). The buyer of the bond becomes the owner of the bond on June 3, and from that date forward, the buyer is entitled to the interest. That is why interest payable to the seller stops accruing on June 2. Here is the math. We have 5 months (January, February, March, April, and May) plus 2 days of accrued interest in June. With each month counting as 30 days, that is 150 days + 2 more in June equaling 152 days. How do we know that the J&J dates are the first of the month rather than the 15th? Good question. For the answer, we look to the maturity date of the bond. That is July 1, 2030, and is the clue that the interest payment dates are on the first of the month.

A 7% convertible debenture is selling at 101. It is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. If the stock were trading at parity with the debenture, the price of the stock would be A) $40.00. B) $43.91. C) $25.25. D) $25.00.

C Explanation To determine the parity price of the common, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, divide the current price of the bond by the conversion ratio. The result is the parity price of the common stock. (1,010 / 40 = $25.25).

An investor is concerned about safety. When consulting the ratings, which of the following securities would appear to be least likely to default on its obligation to make timely payment of interest and principal? A) AAA rated common stock B) A rated mortgage bond C) AA rated debenture D) BB rated sovereign debt

C Explanation When it comes to reducing default risk, "the As have it." That is, the more As in the rating, the lower the default risk. True, the common stock is rated triple A, but stock has no obligation to pay interest and repay principal. Why isn't the mortgage bond a safer bet than the debenture? Aren't secured bonds the safest? These are good questions, but the rating services take that into consideration when giving a rating. In their eyes, the debenture, an unsecured debt, merits a double A rating while the mortgage bond, even with the pledged collateral, can only be awarded a single A rating. Sovereign debt, the debt of a country's government, is usually quite safe, but history has shown us that governments can, and do, default. The BB rating here indicates a certain question as to the safety.

Which of the following municipal bonds may be paid by a state's legislative apportionment of funds to service the debt? A) Special tax B) Special assessment C) Industrial development revenue D) Moral obligation

C If a moral obligation bond goes into default, bondholders do not have the right to sue to force a tax to pay off the bonds. The only way bondholders can recover the principal is through legislative apportionment. The issuer's legislative body has to appropriate funds to pay off the bonds. With a moral obligation bond, issuers have the moral, but not legal, obligation to service the debt.

A legal opinion that has restrictions placed on it by the municipality's bond counsel is called A) a restricted opinion. B) a contingent opinion. C) an unqualified opinion. D) a qualified opinion.

D A qualified opinion is one where the bond counsel to the municipality places certain legal restrictions (qualifications) on the issue that must be disclosed to purchasers. An unqualified opinion has no restrictions.

An investor purchased a corporate bond with a 6% coupon at a net price of 101. The bond had accrued interest for 45 days. Which of the following statements regarding the confirmation of this trade is correct? A) The total amount due on the purchaser's confirmation will appear as $1,025. B) The total amount due on the purchaser's confirmation will appear as $1,010. C) The total amount received on the seller's confirmation will appear as $1,002.50. D) The total amount due on the purchaser's confirmation will appear as $1,017.50.

D Explanation Accrued interest is always added to the price of a bond. When you buy the bond, you pay that accrued interest, and when you sell a bond, you receive that accrued interest. The principal value is 101, or $1,010. Forty-five days of accrued interest is ⅛ of a 360-day year, or ¼ of a 180-day semiannual interest payment. With a 6% coupon, the bond pays $30 every 6 months. One quarter of that is $7.50 so the total cost to the purchaser is the $1,010 plus the $7.50, or $1,017.50.

All of the following regarding Section 529 education savings plans are true except A) they are not subject to income limitations. B) there are high contribution limits. C) withdrawals at the federal level for qualified education expenses are tax free. D) tax-deductible contributions are at the federal level.

D Explanation Contributions are made with after-tax dollars and are not deductible.

Which of the following secures an industrial revenue bond (IDR)? A) Trustee guarantees B) State taxes C) Municipal taxes D) Corporate net lease payments

D Explanation Corporate net leases back up IDRs, which means the credit of the bond is as good as the credit of the corporation that signs the net lease.

Which of the following employer-sponsored plans is not required to meet the nondiscrimination provisions of ERISA? A) Defined benefit plans B) 401(k) plans C) Keogh plans D) Deferred compensation plans

D Explanation Deferred compensation plans, by design, are nonqualified and not subject to ERISA. Therefore, they may discriminate as to who may participate. In any question on the exam, a qualified plan sponsored by a business will most likely have to comply with ERISA

Two years ago, your client purchased 100 shares of ULA common stock at $40 per share. Today, the client buys one ULA Apr 60 put at $2, when the stock's price is $65. At expiration, the ULA stock is selling for $56, and the client exercises his put, delivering the long stock to cover the sale. The client has a gain of A) $200. B) $700. C) $2,300. D) $1,800.

D Explanation Exercise of the put enables the client to sell the stock at the strike price of $60. The stock was originally purchased at $40, so the result is a $2,000 gain in the stock minus the $200 premium paid for the put, for a net gain of $1,800.

Ginnie Mae pass-throughs will pay back both principal and interest A) semiannually. B) annually. C) quarterly. D) monthly.

D Explanation Ginnie Mae securities are called pass-through certificates because the monthly home mortgage payments, which consist of both principal and interest, pass through to the Ginnie Mae investor monthly.

One of your customers buys a new issue municipal revenue bond on March 19. The trade settles on March 21, and the bond pays interest on February 1 and August 1. If the dated date of the bond is March 1, how many days of accrued interest are due? A) 19 B) 24 C) 55 D) 20

D Explanation Interest started accruing from the dated date of the bond (March 1). Interest accrues up to, but not including, settlement. Therefore, 20 days of accrued interest are due. The customer's first interest payment the following August will represent interest that has accrued from the dated date.

It would be most unusual to see which of the following issued at a discount? A) Banker's acceptance B) Treasury bill C) Commercial paper D) Jumbo CD

D Explanation Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. Unlike those issued at a discount, they are interest bearing.

Moody's Investment Grade (MIG) ratings are applied to A) money market instruments. B) municipal bonds. C) corporate bonds. D) municipal notes.

D Explanation Moody's Investment Grade ratings are applied to municipal notes, which are short-term municipal debts such as bond anticipation notes (BANs).

Investors wishing to protect the fixed-income portion of their portfolios from inflation risk would find which of the following choices most suitable? A) AAA-rated corporate bonds B) Cumulative preferred stock C) Common stock D) TIPS bonds

D Explanation The Treasury Inflation-Protected Securities bonds (TIPS) are designed to do just that. Each six months, the principal amount of the bond adjusts based on changes to the cost of living. The interest and principal on the corporate bonds is fixed, as is the dividend on the preferred stock. Although common stock is generally the choice for inflation protection, the question is referring to the fixed-income portion of the portfolio, not the equity portion.

All of the following statements regarding a municipality's collection ratio are true except A) a high collection ratio is more favorable than a low collection ratio. B) the collection ratio is calculated as follows: taxes collected divided by taxes assessed. C) the collection ratio measures the municipality's property tax collections. D) a poor collection ratio might mean the municipality is likely to default on its revenue bonds.

D Explanation The collection ratio measures taxes collected versus taxes assessed. It is a tool used in analyzing general obligation bonds, which are backed by the taxing authority of the issuer. Revenue bonds are backed by user fees, not taxes.

An investor purchased 10 GO bonds at a discount of 2 points per bond. The bonds mature in 10 years. After holding the bonds for 5 years, they were sold at par. For tax purposes, the investor has A) no gain and no loss. B) a $50 gain. C) a $100 loss. D) a $100 gain.

D Explanation The cost per bond is $980. The accretion amount each year is $20. $20 ÷ 10 years = $2 per year. $2 per year × 5 years = $10 per bond accretion, making the adjusted cost basis $990 per bond. When the bonds are sold at par ($1,000), there is a profit of $10 per bond × 10 bonds, which equals a $100 gain.

One of your customers is in the 37% federal income tax bracket. The customer prefers purchasing corporate bonds over municipal bonds because the corporation's financials are much easier to understand. On the customer's next purchase, the instructions are to find a corporate bond that will yield the same after-tax return as would be received from a municipal bond with a 3.20 coupon. The bond you suggest must have a coupon of A) 8.65%. B) 4.38%. C) 3.20%. D) 5.08%.

D Explanation This is a tax-equivalent yield question. The interest paid on a corporate bond is taxable, while that of the municipal bond is tax free. The formula is: The coupon of the municipal bond divided by (100% − tax bracket). In our question, that would be 3.20% divided by 63%, or 5.08%

Which of the following statements regarding Section 529 education savings plans are true? Contributions are considered gifts under federal law. Contributions are tax deductible under federal law. Earnings generated are taxable each year. Earnings generated are tax deferred. A) II and IV B) II and III C) I and III D) I and IV

D Explanation Under federal law, contributions made into Section 529 plans are considered gifts and are not deductible at the federal level. Furthermore, earnings generated each year are tax deferred and, on withdrawal, are tax free at the federal level—if used for qualified education expenses.

One of your customers buys a new issue municipal revenue bond on March 19. The trade settles on March 21, and the bond pays interest on February 1 and August 1. If the dated date of the bond is March 1, how many days of accrued interest are due? A) 19 B) 24 C) 55 D) 20

D Interest started accruing from the dated date of the bond (March 1). Interest accrues up to, but not including, settlement. Therefore, 20 days of accrued interest are due. The customer's first interest payment the following August will represent interest that has accrued from the dated date.

Calculation for: -dividend yield -Current yield -number of shares for conversation -Parity

Dividend: annual dividend DIVIDED by CMP Current: annual interest DIVIDED by CMP Number: Par value DIVIDED by conversion price Parity: Bond value DIVIDED by Number of shares

Overlapping debt occurs in which product taxing situation? Only ______ munis are backed by this product.

Explanation Do not combine revenue bonds with GOs to determine overlapping debt. Overlapping debt occurs in real estate taxing situations. Only GOs are backed by real estate taxes.

NAV of mutual fund share calculation

Fund NAV / Number of Shares Outstanding

Noninterest-bearing securities, like zeroes, are quoted based on their ___________ and sold at a _______ Whereas treasury notes/bonds are quoted based on ______ and sold at a __________ Jumbo (negotiable) CDs are one of the few money market instruments issued at ___________ and unlike zeroes, they are ___________

Noninterest-bearing securities, like zeroes, are quoted based on their yield to maturity sold on a discount; mature at par T-Note/bonds sold on 1/32nd and sold on a discount Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. They are interest baring.

protective covenants are the found in the trust indenture of a __________ bond What promise is: rate covenant and the maintenance covenant. trust indenture found in the _________________.

Rate: promise to maintain rates sufficient to pay expenses and debt service. Maintenance: promise to maintain the equipment and facility/facilities. trust indenture found in the bond contract.

Average Market Price Number of outstanding shares shareholder equity

Share Price Total / # of Investments Issued shares - treasury shares Assets - liabilities

define TIPS bonds, Treasury Receipts, what client objective do they fulfill?

TIPS: Inflation protection T-Receipts: Zero-Coupon, guarantee return

tax free vs tax deferred

Tax free: Muni's, 529's distrubtions, Roth tax deferred: IRA, 403(b)

Calculation for Tax-free equivalent vs Tax-equivalent yield

Tax-free: Corp X (100% - tax bracket) Tax-equivalent: Muni DIVIDED (100% - Tax bracket)

If you see a dollar quote you know you're probably dealing with a ________ Bond

Term bond (dollar quote) Most others are (yield quote)

unqualified legal opinion

The statement of a bond counsel affirming the compliance of a new municipal bond issue with municipal statutes and tax regulations and expressing no reservations about its validity. Related item(s): legal opinion of counsel; qualified legal opinion.

What is the formula for equivalent after-tax yield of a tax-free municipal bond vs tax-equivalent yield when the coupon on the taxable security is given, the answer will always be ________ than that coupon. That means ____________. When the coupon on the tax-free security is given, the answer will always be _________ than that coupon and that means __________.

corporate rate × (1 − investor's tax bracket) municipal coupon rate divided by (100% minus the tax bracket) when the coupon on the taxable security is given, the answer will always be lower than that coupon. That means subtracting. When the coupon on the tax-free security is given, the answer will always be higher than that coupon and that means dividing.

Define debt service ratio formula ex: The Interstate Bridge Authority has an outstanding revenue bond. For the most recent operating period, the Authority has net revenue of $36 million, operations and maintenance expenses of $16 million, debt service requirements of $18 million, and surplus funds of $2 million. The debt service coverage ratio for the Interstate Bridge Authority's revenue bond is A) 2:1. B) 1:1. C) 2.25:1. D) 1:11:1.

dividing the net revenue by the debt service requirement A Explanation In the absence of a described revenue pledge (net or gross), the net revenue pledge should be used. This means that the debt is serviced after the expenses for operations and maintenance have been satisfied. The net revenue of the project is revenues after subtracting those expenses. In this question, that is the $36 million figure given. The debt service coverage ratio is determined by dividing the net revenue by the debt service requirement. In this question, the debt service coverage ratio would be 2:1 ($36 million divided by $18 million = 2). If you subtracted the $16 million of expenses because you did not notice that we gave you the net revenue, your ratio was 20 divided by 18 = 1.11 to 1. If you added the surplus (not an expense), your ratio was 18 divided by 18 = 1:1. It is not uncommon to have information in a question that is not needed to arrive at the solution.

Rule 144 Controlled person

executive/significant investor (usually accredited) , restriction to sell stock at will. holding period is six months if a selling party is an affiliate of a company, he cannot resell more than 1% of the total outstanding shares during any three-month period

What is the role of the municipal securities broker's broker?

to act as a confidential conduit between municipal dealers with bonds to sell and potential buyers. Anonymity is preserved.