Series 7 incorrect answers
A customer, who has contributed to an IRA and to an employer matching 401(k) plan continuously for many years, wants to purchase an annuity contract to add additional monthly income once retired. Given that all of the current retirement investments are subject to market risk, the customer wants these new funds to have no market risk exposure. One of the following would achieve that objective but a suitability discussion regarding it's risk should also occur. Which is it? A) Fixed annuity contract with a discussion regarding purchasing power risk B) Variable annuity contract with a discussion regarding legislative risk C) Variable annuity contract with a discussion regarding interest rate risk D) Fixed annuity contract with a discussion regarding timing risk
A Explanation A VA with its investments in the separate account subject to market risk would not align with the customer's objective. Therefore only a fixed annuity could be considered as suitable. However, a discussion should occur regarding the risks that are associated with a fixed annuity; purchasing power risk. The fixed payment that the annuitant receives loses purchasing power over time as a result of inflation. Reference: 3.17.1 in the License Exam Manual
An investor has a portfolio containing 60% equities, 5% debt instruments, and 35% options and futures. Which of the following would best describe this investor's investment style? A) Aggressive B) Moderate C) Moderate/Aggressive D) Conservative
A Explanation All facets of the portfolio point toward aggressive. The dominate factor would be that over one-third of the portfolio consists of securities considered speculative in nature. Those would include derivative products such as options and futures, high yield bonds (i.e., junk bonds), and others. Then note that the equity/debt allocation leans more toward aggressive than moderate, and certainly isn't conservative in any way. Reference: 3.4 in the License Exam Manual
American style options traded on the CBOE are priced higher than European style options on the same underlying stock, having the same expiration because: A) American style options can be exercised at any time until expiration, while European style options can be exercised only at expiration. B) European style options are not adjusted for stock splits and stock dividends. C) European style option positions cannot be traded out of. D) US investors cannot use European style options thus the demand is much less leading to lower premiums.
A Explanation American style options can be exercised at any time until expiration, while European options can be exercised only at expiration. With all other specifications the same, the American style option will have the higher premium because it allows the holder broader exercise rights. Reference: 4.1.0 in the License Exam Manual
Which of the following is NOT an advantage of buying listed call options as compared to buying the underlying stock? A) The call has a time value beyond an intrinsic value that gradually dissipates. B) Buying a call has a lower dollar loss potential than buying the stock. C) Buying a call allows greater leverage than buying the underlying stock. D) Buying a call would require a smaller capital commitment.
A Explanation Call options allow greater leverage than buying the underlying stock and the capital requirements are smaller, allowing for a smaller loss potential. The fact that options expire (i.e., have a time value that erodes as the option nears expiration) is a disadvantage of options. Stock purchases have no time value component-there is no expiration and no resulting value erosion. Reference: 4.2.1 in the License Exam Manual
If an investor has received dividends and capital gains distributions on mutual fund shares she has held for 4 months, the investor will pay: A) capital gains rates on capital gains distributions and ordinary income rates on dividends. B) long-term or short-term capital gains rates, depending on the length of time the customer has held the fund shares. C) no tax until she liquidates the shares. D) ordinary income tax rates on the capital gains and dividends.
A Explanation Capital gains distributions are taxed as capital gains, with their holding status depending on how long the fund has held the securities, not how long the investor has held the mutual fund shares. Dividend distributions are taxed as ordinary income. Reference: 3.14 in the License Exam Manual
Which of the following would protect a short May 50 put? A) Long June 55 put. B) Long June 45 put. C) Long April 55 put. D) Long April 45 put.
A Explanation For a long put to cover a short put, it must have the same or higher strike price and the same or longer expiration. This ensures the investor may sell the stock without financial loss if the short put is exercised and he is forced to buy. Reference: 4.4.1 in the License Exam Manual
Customer A and Customer B each have an open account in a mutual fund that charges a front-end load. Customer A has decided to receive all distributions in cash, while Customer B automatically reinvests all distributions. How do their decisions affect their investments? Receiving cash distributions may reduce Customer A's proportional interest in the fund. Customer A may use the cash distributions to purchase shares later at NAV. Customer B's reinvestments purchase additional shares at NAV rather than at the offering price. Due to compounding, Customer B's principal will be at greater risk. A) I and III. B) II and III. C) II and IV. D) I and IV.
A Explanation If the customer elects to receive distributions in cash while other investors purchase shares through reinvestment, his proportional interest in the fund will decline. The option to have distributions automatically reinvested allows those purchases to be made at NAV but a purchase made later would be made at the POP like any other new purchase. Reference: 3.14 in the License Exam Manual
In which of the following types of offerings does a brokerage firm have no financial obligation for unsold securities? All-or-none. Best efforts. Standby. A) I and II. B) II and III. C) I, II and III. D) I and III.
A Explanation In a best efforts underwriting, the underwriter serves as an agent with no financial obligation for unsold securities. In an all-or-none (AON) offering, the underwriter agrees to devote its best efforts to sell the issue, but the entire offering is canceled if all shares cannot be sold. In a standby underwriting, the underwriter agrees to purchase any unsold shares remaining after the expiration of a rights offering (firm commitment). Reference: 1.6.5 in the License Exam Manual
A broker/dealer can rehypothecate (repledge) up to: A) 140% of the debit balance in a customer's margin account. B) 50% of the debit balance in a customer's margin account. C) 50% of the equity balance in a customer's margin account. D) 140% of the equity in a customer's margin account.
A Explanation In a margin account, hypothecation is the pledging of customer securities as collateral for the margin loan the customer will receive. The broker/dealer re-pledges (rehypothecates) the securities as collateral to the lending bank. Broker/dealers are permitted to pledge up to 140% of the debit balance in the customer's account. Reference: 7.1.2 in the License Exam Manual
Bondholders may not take action against the corporation if it fails to make interest payments for: A) income bonds. B) subordinated debentures. C) debentures. D) convertible bonds.
A Explanation Income bonds pay interest only if earnings are sufficient and declared by the board of directors. This is not true of any of the other fixed-income securities listed (debentures, subordinated debentures, or convertible bonds). Reference: 3.10.2 in the License Exam Manual
If near term liquidity were the only objective for a client, which of the following pairs of investments would represent the most/least liquid? A) Exchange listed equities/direct participation program (DPP) B) Variable annuity (VA)/money market mutual funds C) 10-year corporate bonds/U.S. T-bills D) Variable annuity (VA)/direct participation programs
A Explanation Of the pairings offered to choose from, exchange listed equities are considered liquid as they could be easily divested of, and DPPs all having predetermined (scheduled) end dates, would be the least liquid. Reference: 5.1 in the License Exam Manual
A customer wants to be a day trader but is interested in the term pattern day trader and asks you to define the term. You state that all of the following are TRUE of pattern day traders EXCEPT A) the buying power in margin accounts is the same as for other customers B) must have a minimum of $25,000 of equity in their account on any day in which trading occurs C) makes 4 or more day trades in a 5-business day period D) in a margin account the minimum maintenance requirement is 25%
A Explanation Pattern day traders are also treated differently when it comes to buying power. Buying power for day traders is 4 times the maintenance margin excess. Maintenance margin excess is defined as the equity in the account above the 25% minimum requirement. For regular customers, buying power is 2 times the special memorandum account. Reference: 7.2.2 in the License Exam Manual
In which of the following will a change in interest rates cause the greatest price fluctuation? A) 7% 30-year U.S. Treasury bond B) 7% AA-rated 1-year municipal note C) Series EE bond D) 7% AAA-rated corporate bond with 8 years until maturity
A Explanation Price fluctuations are the greatest in bonds with the longest terms to maturity. The more risky the instrument, the more price volatility. Long-term bonds have greater risk than short-term bonds. Reference: 3.3.1 in the License Exam Manual
With XYZ trading at $47.50, your customer writes 1 XYZ January 50 put and simultaneously writes 1 XYZ January 45 call receiving $600 in combined premiums. Your customer's market attitude is: A) neutral. B) bearish. C) speculative. D) bullish.
A Explanation This position is a short combination where both contracts are in the money. Breakeven points are 51 and 44. Above or below these points, the customer will lose money. Reference: 4.4.2 in the License Exam Manual
A customer purchases ten 8% Treasury notes at 101-16. What is the dollar amount of this purchase? A) $10,150. B) $10,116. C) $10,812. D) $10,015.
A Explanation Though the denomination of the T-notes purchased is not given, always assume par ($1,000) unless told differently in the question. Remember that government notes and bonds are quoted in 32nds. Therefore, a quote of 101-16 means 101 plus 16/32. 101 plus 1/2 = $1,015; $1,015 × 10 bonds = $10,150. Reference: 3.10.5 in the License Exam Manual
Which of the different sharing arrangements for limited partnerships between the general partners (GPs) and the limited partners (LPs) is generally considered the most common? A) Functional allocation B) Carried interest C) Net operating profits interest D) Overriding royalty interest
A Explanation While both LPs and GPs share equally in the revenues with a functional allocation arrangement, it is most commonly used because it gives the best tax benefits to each. The LPs receive the immediate tax write-offs from the IDCs, whereas the GPs receive continued write-offs from the tangible costs over the course of several years. Reference: 5.2.2 in the License Exam Manual
An option writer liquidates a position by purchasing an option. This order must be marked as: A) a closing purchase. B) an opening purchase. C) an opening sale. D) a closing sale.
A Explanation Writers liquidate (close) their short positions by purchasing back an option of the same series as the one they wrote. This order is known as a closing purchase transaction. Reference: 4.6.3 in the License Exam Manual
A new client, age 25, earning $41,000 annually has saved $20,000 to allocate for the first time to an investment portfolio. The client conveys that while he would like to see some growth, an investment with moderate risk and some downside protection are important objectives for his first time investing. Aligning with the client's investment experience and objectives, which of the following would be the most suitable? A) Equities index fund B) Balanced fund C) Money market fund D) Municipal bond fund
B Explanation A balanced fund, which consists of both equities and debt instruments, not only aligns with the growth objective but also offers some downside protection against falls in market due to the debt portion of its portfolio. Equity index funds move with the markets and offer no downside protection. A money market fund would not align with growth and a municipal bond fund would have no benefit for an investor in a lower income bracket. Reference: 3.13.14 in the License Exam Manual
An investor owns $100,000 of convertible bonds with a conversion price of $50. By depositing these bonds into his account, how many covered calls could he write? A) 2000. B) 20. C) None. D) 50.
B Explanation A covered call means that the seller of the options has 100 shares of stock to "cover" each call. These bonds are convertible into 20 shares for each $1,000, making a total of 2,000 shares. At 100 shares per contract, that's enough stock to cover 20 calls. Reference: 4.3.2 in the License Exam Manual
The determination as to whether an OTC stock is eligible for purchase on margin is made by: A) FINRA. B) the Federal Reserve Board. C) the FDIC. D) the SEC.
B Explanation All decisions regarding initial margin eligibility are the role of the Federal Reserve Board. Reference: 7.1.3 in the License Exam Manual
If an investor interested primarily in speculation does not expect the price of DWQ stock to change, he or she will: A) write a straddle and buy stock. B) write an uncovered straddle. C) buy a straddle. D) write a straddle and short the stock.
B Explanation An investor who expects prices to remain stable writes an uncovered straddle (short straddle). In selling the put and call at the same terms, the writer collects double premiums. Both expire if the price remains stable, but if the price moves, one side loses money. Short straddles carry unlimited loss potential because of the uncovered call. Reference: 4.4.2 in the License Exam Manual
In a rising market, which of the following is least volatile? A) A stock with an alpha of 2.0. B) A stock with a beta of 0.5. C) A stock with a beta of 2.0. D) A stock with an alpha of 0.5.
B Explanation Beta is a measure of a stock's volatility relative to the overall market, as measured by the S&P 500. A stock with a beta of 2.0 will move twice as fast as the overall market, while a stock with a beta of 0.5 will move half as fast as the overall market. Reference: 3.4.2 in the License Exam Manual
An investor wants to purchase fixed-income securities (bonds) as a safe haven because he is uncomfortable with risk associated with stock volatility currently in the market. Before making a suitable recommendation, a registered representative should advise that bonds are interest rate sensitive in all environments bond prices are always stable when equities are volatile bond prices can rise sharply when interest rates rise bond prices may fall as interest rates begin to rise A) I and III B) I and IV C) II and III D) II and IV
B Explanation Bonds are interest rate sensitive in all environments. Their prices have an inverse relationship to interest rate movements. Therefore, if interest rates begin to rise, bond prices will fall, exposing investors who sought them out as a safe haven to risk they might not have been aware of. Reference: 3.3.1 in the License Exam Manual
Which statements regarding oil and gas limited partnerships are TRUE? Developmental programs are more risky than exploratory programs. Exploratory programs are more risky than developmental programs. Successful developmental programs provide higher returns than exploratory programs. Successful exploratory programs provide higher returns than developmental programs. A) I and III. B) II and IV. C) II and III. D) I and IV.
B Explanation Exploratory oil and gas direct participation programs drill in areas where there are no proven oil reserves. While the chances of success are relatively small, successful exploratory wells provide large returns to investors. Developmental programs drill in areas adjacent to sites where proven oil reserves exist; while the probability of success is favorable, the returns will not be as great as a successful exploratory program. Reference: 5.2.2 in the License Exam Manual
Which of the following would be the least considered factor in determining if a particular type of options trading is suitable for a customer? A) Willingness to assume risk B) Ability to meet margin calls C) Understanding the strategy being employed D) Understanding maximum gain or loss potential
B Explanation Remember that while most firms require that options trades be done in margin accounts, options purchases are not marginable. Therefore, of the choices listed, the ability to meet margin calls would be the least considered factor regarding suitability. Reference: 4.6.3 in the License Exam Manual
A resident of a state who acquires stock pursuant to Rule 147 (intrastate offerings) is prohibited from selling the stock to a nonresident of that state for how many months? A) 3 B) 6 C) 12 D) 18
B Explanation Rule 147 stock cannot be sold to a nonresident of the state for a period of six months after the purchase date. Reference: 1.7.3 in the License Exam Manual
Which of the following would be of least interest to a technical analyst? A) Trading volume. B) PE ratio. C) Advance/decline line. D) Short interest ratio.
B Explanation Technical analysts rely on price and trading trends to determine when to buy or sell stock. They are not interested in the specific financial information of an issuer; PE ratios are of greater interest to fundamental analysts. Reference: 3.6 in the License Exam Manual
Where must the SEC's no-approval clause appear in a prospectus? A) It is not mandatory, but, if used, it must appear on the first page. B) On the cover. C) On the last page, under the name of the fund. D) Anywhere as long as it is conspicuous.
B Explanation The SEC wants investors to know that it does not approve or disapprove new issues. The disclaimer statement must appear on the cover of all prospectuses. Reference: 1.6.8 in the License Exam Manual
The document attesting to the formation of a limited partnership, filed with designated authorities, is called: A) the registration statement. B) the certificate of limited partnership. C) the offering memorandum. D) the subscription agreement.
B Explanation The Uniform Limited Partnership Act requires that two or more persons sign and swear to a certificate of limited partnership. It is filed with the state and is a public document available for review. Reference: 5.1.2 in the License Exam Manual
convertible bond has a conversion price of $40 per share. If the market value of the bond rises to a 12½ point premium over par, which of the following are TRUE? Conversion ratio is 25:1. Conversion ratio is 28:1. Parity price of the common stock is $42. Parity price of the common stock is $45. A) II and III. B) I and IV. C) I and III. D) II and IV. Explanation The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112½% × $40 = $45. Reference: 3.10.2 in the License Exam Manual
B Explanation The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112½% × $40 = $45. Reference: 3.10.2 in the License Exam Manual
A customer is short 100 XYZ shares at 26 and long 1 XYZ 30 call at 1. What is the maximum potential loss on the positions? A) Unlimited. B) 500. C) 400. D) 2500.
B Explanation The customer has protected his short stock position from loss by purchasing a call. If the market rises, the call is exercised, allowing the customer to buy his stock at the option strike price of 30 to cover the short position. The most the customer can lose is $400 on the stock position (the difference between the option strike price and the stock price) plus the premium paid for the option ($400 + $100 = $500). Reference: 4.3.3 in the License Exam Manual
Trading in expiring options series concludes the same day as expiration at A) 12:00 pm ET B) 4:00 pm ET C) 11:00 pm ET D) 5:00 pm ET
B Explanation The official close is 4:00 pm ET on the 3rd Friday of the expiration month. Expiring options may be exercised until 5:30 pm ET on the same day. Reference: 4.6.1 in the License Exam Manual
If MCS is trading at 43 and the MCS Apr 40 call is trading at 4.50, what is the intrinsic value and the time value of the call premium? A) Intrinsic value 3; time value 4.50. B) Intrinsic value 3; time value 1.50. C) Intrinsic value 1.50; time value 3. D) Intrinsic value 4.50; time value 0.
B Explanation The option is in-the-money by 3 points (the strike price on the call is 40 and the market price is 43). This sets a minimum premium of $3 per share. Because the actual premium is 4.50, the balance of 1.50 represents time value. Reference: 4.1.4 in the License Exam Manual
On which of the following positions does the potential loss equal the premium? A) Covered calls. B) Long puts. C) Uncovered puts. D) Covered puts.
B Explanation The premium paid to acquire the option represents the most an investor stands to lose on a long option position. "Covered" and "uncovered" are terms that relate to short option positions. Reference: 4.2.3 in the License Exam Manual
An investor is short stock at 60. The current market price of the stock is 35, and he anticipates it will continue to decline. If he thinks the price will rise temporarily and if he does not wish to close out his short position, his best strategy to prevent a loss would be to: Buy an XYZ 35 call. Sell an XYZ 35 call. Buy an XYZ 35 put. Sell an XYZ 35 put. A) II or IV. B) I or IV. C) II or III. D) I or III.
B Explanation This client is temporarily bullish on the stock, but, in the long term, feels that it will continue to decline so the short stock position is to be maintained. If the client is correct, a near-term rise in the price of XYZ will cause the long 35 call to be in the money and the investor can sell the call at a profit. Likewise, the short 35 put will be out of the money and will expire with the investor earning the premium. Reference: 4.3.3 in the License Exam Manual
An investor, age 36, has a net worth of $650,000 with an annual income of $65,000. Wanting to add to an existing portfolio the investor is not concerned about generating more income as that seems to be adequate already. However the investor does note that keeping taxes to a minimum is an objective. Which of the following funds would be the most suitable given the investors objectives? A) Fund Z—Invests in preferred shares; turnover ratio of 50% B) Fund X—Invests in companies with long term growth potential; turnover ratio of 25% C) Fund W—Invests in utility companies; turnover ratio of 25% D) Fund Y—Invests in companies that have capital appreciation potential; turnover ratio of 100%
B Explanation This investor is not concerned about income. This would eliminate both the utility fund and the preferred share fund, which are associated with income due to the dividends one would expect. Of the remaining 2 funds, growth and appreciation oriented, the one with the lower turnover ratio would generate less tax liability. The portfolio turnover ratio reflects a funds holding period of securities being bought and sold by the fund manager. If a fund has a turnover ratio of 100%, the entire portfolio is likely to turnover in a year and capital gains distributions are likely to be short term and subject to the maximum tax rate, increasing the tax liability and therefore, not the best option. By contrast a 25% turnover ratio means the average holding period of the securities in the portfolio is 4 years. This would mean that any capital gains distributions are more likely to be long term and subject to a lower tax rate. Reference: 3.13 in the License Exam Manual
For a mutual fund that collects a 12b-1 fees, which of the following statements are TRUE? The fund may use the money to pay for mailing sales literature. Advertising materials must always state that the fund is no-load. The fund may use the money to pay for commissions on portfolio transactions. The fund's prospectus must disclose the fee. A) III and IV. B) I and II. C) I and IV. D) II and III.
C Explanation 12b-1 fees may be used only to cover promotional and other distribution expenses for funds that are distributors of their own shares; fee amounts must be disclosed in the prospectus. The fund may not use the term" no-load "in any communications with the public if the 12b-1 fee and other service fees exceed .25% of average net assets. Reference: 3.15.5 in the License Exam Manual
Which of the following is an equity security? A) Government National Mortgage Association pass-through certificate. B) Collateralized mortgage obligation. C) Real estate investment trust share. D) Mortgage-secured bond.
C Explanation A REIT share is an equity security that represents undivided ownership in a portfolio of real estate investments. The other choices are debt securities. Reference: 3.12.4 in the License Exam Manual
A customer invests $18,000 in a mutual fund and signs a letter of intent for $25,000 in order to qualify for a breakpoint. One year later, the shares are valued at $25,100 even though he has made no new investments. Which of the following statements regarding the above situation is TRUE? A) Shares held in escrow will be liquidated at the appreciated value. B) The investment no longer qualifies for a breakpoint. C) The representative should remind the customer that he signed a letter of intent 12 months ago. D) The letter of intent is considered to be fulfilled.
C Explanation A letter of intent must be met with dollars invested within 13 months. The customer needs to invest an additional $7,000 to fulfill his letter of intent. The representative should remind the customer of his intention to qualify for the reduced sales charge. Reference: 3.15.2 in the License Exam Manual
When determining a position limit, a member firm aggregates which of the following customer positions? Long calls and long puts. Long calls and short puts. Short calls and short puts. Short calls and long puts. A) I and III. B) II and III. C) II and IV. D) I and IV.
C Explanation Contracts on each side of the market are used for determining position limits. Long calls and short puts are on the same side (bullish); long puts and short calls are on the same side (bearish). Reference: 4.6.1 in the License Exam Manual
Covered call writing normally occurs in a A) rising market. B) falling market. C) stable market. D) volatile market.
C Explanation Covered call writing normally occurs in a stable market. In a rising market, writing calls against a long stock position limits upside potential. In a falling market, the calls only provide downside protection to the extent of the premium received. Reference: 4.3.2 in the License Exam Manual
SEC rules require that open-end management companies distribute dividends to their investors from the firm's: A) capital gains. B) portfolio earnings. C) net investment income. D) gross revenue.
C Explanation Dividends must be paid from the net investment income. Reference: 3.14.2 in the License Exam Manual
Your clients' option position has been adjusted due to a 2 for 1 stock split. Which of the following regarding this 2 for 1 adjustment is TRUE? A) The strike price will remain unchanged. B) The number of shares per contract will increase. C) The number of contracts owned will increase. D) The strike price will increase. 4.6.3 in the License Exam Manual
C Explanation For even splits (i.e., 2 for 1 or 3 for 1), the number of contracts owned will increase proportionately. The number of shares per contract will remain unchanged and the strike price will decrease proportionately. Reference:
All of the following positions have limited loss potential EXCEPT: A) short stock/long call. B) long stock/short call. C) short stock/short put. D) long stock/long put.
C Explanation If the stock rises the put will expire leaving the customer short stock with an unlimited loss potential. Reference: 4.3.4 in the License Exam Manual
Index options are frequently used to protect a portfolio against which of the following risk types? A) Credit. B) Inflation. C) Systematic. D) Business.
C Explanation Index options protect investor portfolios from the risk of overall market movement, also known as systematic risk. Reference: 4.5.1 in the License Exam Manual
In a rising interest-rate environment which of the following risks associated with mortgage-backed securities such as a collateralized mortgage obligation (CMO) is of least consequence to a potential investor? A) Interest rate risk B) Credit risk C) Prepayment risk D) Extension risk
C Explanation Prepayment risk is the risk that mortgage holders will refinance or repay their mortgages early as a result of falling interest rates. Therefore in a rising interest rate environment it would be less of a concern for a CMO investor. Extension risk is the risk that mortgage payments will be missed or slower than anticipated in a faltering economic environment. Credit and interest rate risks are always of concern with CMOs. Reference: 3.10.3 in the License Exam Manual
Which of the following factors is (are) considered when determining whether underwriting compensation is fair and reasonable? 1.The size of the offering. 2.The type of underwriting commitment. 3.The market conditions. 4.The profitability of the underwriter. A) II and IV. B) I and III. C) I and II. D) II and III.
C Explanation Relevant factors considered by FINRA in determining the fairness of underwriting compensation include the size of the offering (total dollar amount), the type of commitment (firm commitment or best efforts), the type of securities (i.e., stocks or bonds), the form of compensation (i.e., cash or stock), the total value of all forms of compensation, the underwriter's relationship to the issuer, and any form of potential conflicts of interest. Reference: 1.6.7 in the License Exam Manual
When analyzing a DPP investment, a method that takes into account the revenues and expenses is: A) technical analysis. B) fundamental analysis. C) cash flow analysis. D) liquidity analysis.
C Explanation Revenues and expenses are cash items and would be analyzed by cash flow analysis. Reference: 5.2.4 in the License Exam Manual
The 5% markup policy applies to: A) All of these. B) mutual funds. C) principal OTC trades. D) new issues.
C Explanation The 5% markup policy applies to agency and principal nonexempt securities and transactions both exchange and OTC traded. It does not apply to prospectus offerings (mutual funds and new issues). Reference: 8.5.7 in the License Exam Manual
The Securities Exchange Act of 1934 regulates or mandates each of the following EXCEPT: A) extension of credit to customers. B) manipulation of the secondary market. C) full and fair disclosure on new offerings. D) creation of the SEC.
C Explanation The Securities Exchange Act of 1934 created the SEC and regulates the secondary market. The Securities Exchange Act of 1934 does not address full and fair disclosure issues; the Securities Act of 1933 addresses such issues. Reference: 1.6.1 in the License Exam Manual
All of the following are true concerning a market's beta EXCEPT: A) it shows that if a stock's beta is 1.2 and the market moves by 5%, the stock would move by 6%. B) it is by definition equal to 1. C) it provides a measurement of a range that the market may move in any given day. D) it serves as a benchmark for measuring the relative volatility of a stock or portfolio against the movement of the market itself.
C Explanation The beta is a benchmark and does not indicate anything about market movement as a whole. It only measures the movement of a particular security or portfolio as compared to the movement of the entire market. Reference: 3.4.2 in the License Exam Manual
A customer buys 200 XYZ at 39 and writes 2 XYZ Feb 40 calls at 3. When the stock rises to 44 the customer is exercised for a gain of: A) 1600. B) 200. C) 800. D) 400.
C Explanation The customer bought 200 shares at 39 and was forced to sell them at 40 for a $200 gain. In addition, the customer received $600 in premium income so the overall gain is $800. Alternatively, the breakeven point for covered call writing is cost of shares purchased less premium received (39 − 3 = 36). As the customer is bullish, gain occurs above 36. However, for this customer, the stock can go no higher than 40 because she will be exercised (40 − 36 = 4 points × 200 shares = $800). Reference: 4.3.2 in the License Exam Manual
Long an ABC Apr 60 call and short an ABC Apr 70 call is a: A) straddle. B) net credit spread. C) net debit spread. D) calendar spread.
C Explanation This is a vertical spread, not a calendar spread. To determine whether it is a net credit or debit, look at the strike prices. For call options with the same expiry month, the lower strike price will always have a higher value. In this case, the investor is long the higher valued option, which gives a net outflow of cash to enter the entire position (more money was spent on the lower strike price call than received for the higher strike price call). Therefore, the investor has a net debit for his account. Reference: 4.4.1 in the License Exam Manual
If the strike price of a yield-based option is 62.50, this represents a yield of: A) 0.000625. B) 0.625. C) 0.0625. D) 0.00625.
C Explanation To calculate the percentage yield of the underlying Treasury security, divide the strike price by 10 (62.50 / 10 = 6.25%). Reference: 4.5.2 in the License Exam Manual
Unrealized gain in a mutual fund portfolio does which of the following? Increases the dividends paid to shareholders. Represents the undistributed income and the growth in market value of securities held in the portfolio. Is realized by shareholders only when they redeem their shares. Has no effect on shareholders until the annual long-term capital gains distribution is paid. A) I and IV. B) I and III. C) II and III. D) II and IV.
C Explanation Unrealized gains result from asset appreciation and undistributed income. This increase in value is reflected in an appreciation of the mutual fund shares. Investors realize this appreciation only by selling their shares. Reference: 3.15 in the License Exam Manual
Which of the following would be in compliance with the CBOE and OCC Rules concerning the nondiscriminatory assignment of an option exercise notice by a firm to one of its customers? A) Assignment to the customer with the largest position in the underlying security. B) Assignment to the customer with the largest position in the option. C) Assignment to the customer with the oldest position in the option. D) Assignment to the customer with the smallest position in the option.
C Explanation You cannot discriminate between large and small customers. First in, first out (FIFO) is not considered to be discriminatory. Reference: 4.6.3 in the License Exam Manual
Regarding Regulation D (Private Placement) offerings, which of the following statements is TRUE? A) Purchasers need not be provided or have access to offering information normally provided by a prospectus. B) The SEC requires no filings be made by the issuer. C) The amount of capital that can be raised via a private placement is limited. D) Registration with the SEC is not required.
D Explanation Regulation D offerings are exempt transactions and therefore no SEC registration is required. However, issuers must still file information with the SEC on Form D regarding the issue. This filing will contain all of the information a potential investor might want to know, similar to the information contained on a prospectus. There is no limit to the amount of capital that can be raised via a Regulation D private placement transaction. Reference: 1.7.2 in the License Exam Manual
A taxpayer's most advantageous tax benefit is: A) straight-line depreciation. B) a tax deduction. C) a depletion allowance. D) a tax credit.
D Explanation A tax credit reduces a person's tax liability dollar for dollar. Deductions, depreciation and depletion reduce taxable income. Reference: 5.2.4 in the License Exam Manual
Under one of the provisions allowing a company to qualify under Rule 147 for an intrastate exemption, what percentage of an issuer's gross business revenues must be derived from sales within the company's home state? A) 100% B) 90% C) 70% D) 80%
D Explanation Any one of the three 80% test provisions can be met to qualify for a Rule 147 Intrastate exemption. One of the provisions states that at least 80% of an issuer's gross revenue must be derived from the company's home state. In addition, there is a fourth test which may be used; a majority of the issuer's employees are based in the state. Reference: 1.7.3 in the License Exam Manual
Which of the following statements regarding CMOs is TRUE? A) Yield is locked in. B) There is no prepayment risk. C) There is no extended maturity risk. D) They can be purchased for as little as $1,000.
D Explanation CMOs can be purchased for as little as $1,000 but mainly trade in minimum amounts of $25,000. Both prepayment risk and extended maturity risk apply to these mortgage-backed securities. The only security where yield is locked in is a zero coupon bond. Reference: 3.10.3 in the License Exam Manual
From the point of view of a corporate issuer, the most conservative means of raising capital would be the issuance of: A) preferred stock. B) convertible preferred stock. C) convertible bonds. D) common stock.
D Explanation Common stock issues add to the capital of a corporation and do not saddle it with additional cash flow demands. This approach is the most conservative. Because of the desire of bondholders and preferred stockholders to receive their interest and dividends, respectively, the issuance of preferred stock or bonds creates additional and ongoing demands on a corporation's cash flow. Reference: 1.6 in the License Exam Manual
Regarding the taxation of dividends received from corporate securities, which of the following are TRUE? Nonqualified dividends are taxed at the rate the investor's ordinary income will be taxed. Nonqualified dividends are not taxed. Qualified dividends are taxed at a maximum rate specified by the IRS and will depend on the investor's income tax bracket. Qualified dividends are taxed at the rate the investor's ordinary income will be taxed. A) II and III B) I and IV C) II and IV D) I and III
D Explanation For income tax purposes, corporate dividends are divided into 2 categories; qualified and non-qualified. We don't expect you'll be tested on what makes a dividend qualified or not, but you will need to know the difference in taxation. Qualified dividends are taxed at the same rate as long-term capital gains, a rate significantly lower than the ordinary income tax rate levied against non-qualified dividends. That lower rate ranges from 0% to as high as 20% with an even higher effective rate for those with an extraordinarily high income. For most investors the rate is 15% and that is the number you should use in any computations. With ordinary income tax rates on non-qualified dividends as high (currently) as 37%, there is a real benefit for most investors to receive qualified dividends. Reference: 3.14.1 in the License Exam Manual
If a father makes a gift of securities to his 10-year-old daughter, gift taxes would be based on the: A) cost of the securities. B) market value of the securities as of April 15 of the year in which the gift is made. C) market value of the securities as of December 31 of the year in which the gift is made. D) market value of the securities on the date of gift.
D Explanation If a gift tax is due, it is paid by the donor and based on the gift's value on the date it is given. Reference: 3.14.7 in the License Exam Manual
When determining whether a tax swap of municipal bonds will result in a wash sale, each of the following are considered EXCEPT: A) coupon. B) maturity. C) issuer. D) principal amount.
D Explanation In judging whether bonds purchased are substantially identical to bonds sold for a loss, the tax code considers maturity, issuer, and coupon rate. If at least two of the three are different, a wash sale will generally not result. Reference: 3.14.8 in the License Exam Manual
If 1 OEX 375 call is purchased at 3.25 and exercised when the S&P 100 closes at 381, the writer delivers which of the following to the holder? A) $325 cash. B) $381 in securities. C) $600 in stocks. D) $600 cash.
D Explanation Index options settle in cash. Physical delivery does not occur. The call buyer receives cash equal to the difference between the strike price and the index closing value on the day the option is exercised. Reference: 4.5.1 in the License Exam Manual
Which of the following would NOT be considered institutional communications with the public? A) A letter to a municipality offering your firm's services as an underwriter B) A letter to another broker/dealer C) A communication with an individual designated to act on behalf of your institutional customer D) An internal memo promoting a new product that will be offered to your firm's institutional customers only
D Explanation Institution communications specifically exclude internal communications. Communications with another member firm, a government entity, such as a municipality or with someone designated to act on behalf of one of your firm's institutional customers, would all fall within the definition of institutional communications. Reference: 1.1.1 in the License Exam Manual
A blind pool offering: A) is connected with oil and gas leases. B) is one in which the properties are purchased on a lottery basis. C) generates nonallocated income. D) is one in which 25% or more of the properties are not specified.
D Explanation Many times, large real estate or oil and gas programs are offered in the form of a blind pool. In a blind pool, 25% or more of the specific properties (in real estate) or sites (in oil and gas) have not been identified at the time of the offering. When investing in a blind pool, the participants are relying on the expertise of the program sponsor to select locations that will prove profitable. Reference: 5.2.4 in the License Exam Manual
Under which of the following circumstances may a member firm sell a new equity issue to one of its nonregistered employees? A) Amount purchased is small and not disproportionate to the size of the issue. B) Permission of a principal is obtained. C) Transaction is consistent with the employee's normal investment practice. D) Under no circumstances.
D Explanation Member firms and employees of members (registered and nonregistered) are prohibited from buying a new equity issue at the public offering price. Reference: 1.7.6 in the License Exam Manual
With no other positions, a customer sells short 100 TIP at 40 and sells 1 TIP Oct 40 put at $5. At what stock price will the customer break even? A) 40. B) 50. C) 35. D) 45. Explanation On the downside, the short position fully covers the short put and the profit is the $500 premium. On the upside above 40, the short put expires and the short stock position loses money. The first 5 points of loss (40 to 45) on the short stock position are offset by the premiums received. Above 45, losses begin and are potentially unlimited. Reference: 4.3.4 in the License Exam Manual
D Explanation On the downside, the short position fully covers the short put and the profit is the $500 premium. On the upside above 40, the short put expires and the short stock position loses money. The first 5 points of loss (40 to 45) on the short stock position are offset by the premiums received. Above 45, losses begin and are potentially unlimited. Reference: 4.3.4 in the License Exam Manual
Listed options expire at A) 3:00 pm ET on the third Saturday of the expiration month B) 4:30 pm ET on the Saturday immediately following the third Friday of the expiration month C) 4:00 pm ET on the third Friday of the expiration month D) 11:59 pm ET on the third Friday of the expiration month
D Explanation Options expire on the third Friday of the expiration month at 11:59 pm ET. Reference: 4.6.1
Which of the following investors would be exempt from filing form 144 when selling securities they own? A) An affiliated person selling unregistered shares. B) An investor selling shares acquired in a Regulation D private placement. C) An employee of the company selling unregistered shares. D) An employee of the company selling registered shares purchased in the open market.
D Explanation Rule 144 regulates the sale of control or restricted securities. Securities bought in a registered public offering are not restricted and therefore an employee of the company selling registered shares need not file form 144. Unregistered shares or securities purchased in a private placement are restricted and Rule 144 would apply. Reference: 1.7.4 in the License Exam Manual
A customer buys 100 DEF at 70, but several months later, the stock is trading at 82.85. The customer, concerned about a possible pullback, buys 1 DEF Aug 80 put at 1.50. If the stock subsequently falls to 77.25 and the customer sells his stock by exercising the put, the result is: A) gain of $875. B) loss of $150. C) gain of $575. D) gain of $850.
D Explanation The customer bought 100 shares at 70 and sold them at 80 by exercising the put for a gain of $1,000. However, it cost $150 to buy the put so the customer's gain is $850. In other words, breakeven for long stock-long put is the cost of stock purchased (70) plus the premium paid (1.50). Breakeven is 71.50 and the customer sold stock at 80 (80 − 71.50 = 8.50-point gain). Reference: 4.3.1 in the License Exam Manual
