Series 7 - Mastery Exam III #2 (Q1 - Q110)

A customer has the following investment mix: 25% Growth Stocks 25% U.S. Government Bonds 25% Investment Grade Corporate Bonds 25% Speculative Stocks Which asset classes are MOST susceptible to interest rate risk? I Growth Stocks II U.S. Government Bonds III Investment Grade Corporate Bonds IV Speculative Stocks A I and III B I and IV C II and III D II and IV

The best answer is C. Interest rate risk is the risk that market interest rates rise, forcing down the price of fixed income securities - meaning preferred stocks and bonds.

The President of PDQ Corporation buys PDQ shares in the open market. After holding them for 3 months fully paid, the President wishes to sell the shares. The shares can be sold: A immediately B after holding the securities for an additional 3 months C after holding the securities for an additional 6 months D after holding the securities for an additional 1 year

The best answer is A. "Control stock," which is registered stock of a company bought in the open market by an officer or director of that company, is subject to all Rule 144 requirements when the officer or director wishes to sell, except for the 6-month holding period. The 6-month holding period is required for restricted stock, but not for control stock.

Equity securities of which issuer are the LEAST defensive? A Defense manufacturer B Pharmaceuticals C Soft drink manufacturer D Utilities

The best answer is A. A defensive industry is one which is not greatly affected by economic downturns. Pharmaceuticals, soft drink makers, and utilities are all defensive. If the economy sours, people still buy drugs, cola, and use electricity. The defense industry is the least defensive of the choices offered. In periods of economic slowdowns, the government collects less taxes, and tends to reduce arms and expensive defense systems orders.

Options sales literature that makes a recommendation: I must be preceded or accompanied by the Options Disclosure Document II must be approved in writing by the designated ROP prior to use III must be filed with the exchange 10 days before use IV cannot include projections or show past performance A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is A. All options communications with the public must be approved by the designated ROP (main office compliance ROP) - not the Branch Manager. Any communication that shows past performance; makes a performance projection; or that makes a recommendation; must be accompanied or preceded by the ODD (Options Disclosure Document). Options sales literature usually falls under these rules. Only options communications that are NOT accompanied by the ODD must be filed with the Exchange 10 days in advance of use. These are basically advertisements seen by the general public.

Which statements are TRUE about an issuer making a tender offer for its non-convertible bonds? I The minimum life of the initial offer is 5 business days II The minimum life of the initial offer is 10 business days III Each "sweetening" of the offer must extend the offer for another 5 business days IV Each "sweetening" of the offer must extend the offer for another 10 business days A I and III B I and IV C II and III D II and IV

The best answer is A. An issuer would consider tendering for its outstanding bonds when it has debt outstanding that is not callable, but it has excess funds that it believes would be best used to reduce the amount of debt outstanding. A tender offer is made to the bondholders, who have the choice of tendering or not. Unlike stock tender offers, where the initial offer must be held out for 20 business days, here the initial life of the offer is only 5 business days. (The life is shorter because this tender offer is being made by the issuer, not an outsider.) Unlike stock tender offers, where there is typically a contingency that a minimum number of shares be tendered, these are "any and all offers" - so if a bondholder tenders, he or she will receive the tender price for the bonds. If the issuer does not get enough bonds tendered, the issuer can "sweeten" the offer. This extends the offer by another 5 business days, and the sweetened price is given to all bonds tendered. (While the initial offer specifies a price to be paid, or a price based on a spread to a benchmark debt security, the actual price paid on the tendered bonds is not set until that last business day of the offer).

A 25-year old single client has just started his own small business and is not covered by a retirement plan. He has $5,000 to invest and currently has a low level of income. He wishes to start saving for retirement. The BEST recommendation is a: A Roth IRA B SIMPLE IRA C Traditional IRA D Roth 401(k)

The best answer is A. Anyone with earned income can open an IRA. Because this individual is in a low tax bracket, a Roth IRA contribution, which is non-deductible, makes sense (there is no real benefit from making a deductible contribution to a Traditional IRA). With $5,000 to invest, this is within the $6,000 contribution limit for 2021. Earnings build "tax-free" in a Roth, and distributions taken at retirement age are non-taxable. Also remember that high-earners cannot open a Roth IRA. In contrast, if a Traditional IRA were opened, this individual would get a tax deduction (he is not covered by another qualified plan), but it would have little value because of his low tax bracket. Earnings would build tax deferred and when distributions are taken at retirement age, they would be taxable, so the Roth is the better deal. A 401(k) is an employer-sponsored salary reduction plan under ERISA that requires major paperwork to establish. It allows a contribution of up to $19,500 in 2021, far more than the $5,000 this individual has to invest. This is not suitable for a very young single person starting a small business. A SIMPLE IRA is another qualified retirement plan that is "simpler" to set up than a 401(k), and that is only available to businesses of 100 or fewer employees. It allows for a larger deductible contribution than an IRA ($13,500 in 2021), which is more than this person needs. Also, it is still not as easy to set up as an IRA.

A customer in the highest tax bracket has $500,000 to invest. The customer is subject to the AMT. The BEST recommendation would be an investment grade: A Municipal bond yielding 2.50% that is not subject to the AMT B Municipal bond yielding 2.70% that is subject to the AMT C Treasury bond yielding 3.50% D Corporate bond yielding 3.75%

The best answer is A. Because this customer is in the highest tax bracket, a tax-free municipal bond will give the highest "after-tax" return. Because this customer is subject to the AMT (Alternative Minimum Tax) he should avoid a municipal bond where the interest income is included in the AMT computation (non-essential use private purpose bond issues). The simplified math for this works out as: Choice A yield after federal tax is paid - 2.50% (none of yield is taxed) Choice B yield after federal tax is paid - 1.94% (28% AMT max. tax rate) Choice C yield after federal tax is paid - 2.21% (37% federal max. tax rate) Choice D yield after federal tax is paid - 2.36% (37% federal max. tax rate)

Declines in all of the following would likely result in the FOMC making net purchases of government securities in the open market EXCEPT a decline in (the): A unemployment levels B Consumer Price Index C Gross Domestic Product D bond prices

The best answer is A. Falling unemployment levels means that economic activity is picking up. If this is true, the Fed would not want to stimulate the economy by loosening credit (the purchase of government securities by the Fed injects cash into the banks and loosens credit). A falling gross domestic product could cause the Fed to loosen credit to stimulate activity, as can falling bond prices (if bond prices are falling, yields are rising, which slows activity). A falling consumer price index means that the inflation rate is falling. The Fed will be more likely to loosen credit if inflation is low than if inflation is rising. To counteract rising inflation, the Fed will tighten credit.

An investor goes short against the box to lock in a gain on a stock position that has been held for 11 months. 3 months later, the investor closes the short position with his long shares. Which of the following statements are TRUE? I The holding period of the underlying stock stopped counting as of the short sale date II The holding period of the underlying stock stopped counting as of the delivery to cover the short position III The gain will be taxed as a short term capital gain IV The gain will be taxed as a long term capital gain A I and III B I and IV C II and III D II and IV

The best answer is A. If a customer goes "short against the box" on a stock position that has been held short term, the holding period of the underlying stock stops counting as of the short sale date. The worry of the IRS is that once the long position has been hedged, the customer will simply wait out the extra time needed to enjoy a long term capital gains holding period, which would be taxed at a lower rate. IRS rules require that if one goes "short against the box," any gain is taxable at that point. Thus, a short term holding period cannot be stretched into a long term holding period. Note that there is a 15% maximum long term capital gains tax rate if the position is held over 12 months (20% for very high earners - instead of a 37% maximum tax rate for short term capital gains.)

If a foreign broker-dealer that does not have U.S. based operations wishes to solicit customers in the United States, the broker-dealer: I must establish an SEC-registered U.S. subsidiary II is not required to establish an SEC-registered U.S. subsidiary III can effect its business through another registered U.S. broker-dealer IV cannot effect its business through another registered U.S. broker-dealer A I and III B I and IV C II and III D II and IV

The best answer is A. In order for a broker-dealer to solicit in the U.S., it must be registered with the SEC. For foreign broker-dealers, this means setting up an SEC-registered U.S. subsidiary; or establishing a correspondent relationship with a registered U.S. based broker-dealer.

A client with young children wants to invest $1,500 a year to pay for their ongoing educational expenses. Which recommendation would give the customer tax-free growth and tax-free distributions if these distributions are used to pay for educational expenses? A Coverdell ESA B 529 Plan C 457 Plan D UGMA Account

The best answer is A. The maximum annual contribution to a Coverdell ESA is $2,000 per year per child, so this fits the customer's $1,500 per year contribution amount. Coverdell ESA contributions grow tax-deferred and are tax-free as long as they are used to pay for qualified educational expenses - which includes all school levels (grade school, secondary school, post-secondary school, etc.). A 529 Plan allows for much bigger contribution amounts and could only be used for college - until the 2018 tax law changes! Now that up to $10,000 per year can be taken from a 529 Plan to pay for lower level education expenses, the 529 Plan would be a correct answer as well. So if you see a similar question on the exam, it probably has not been updated, and to get the point, choose Coverdell ESA - and also complain at the test center so they clean up the question! Income in UGMA (Custodial) accounts is taxable annually, so they do not fit the customer's needs. Finally, 457 Plans are retirement plans, not education savings plans. Also note that the question does not address the fact that a Coverdell is not available to high-earning individuals.

An assessment of an existing client's financial status shows the following: Name: Mack McCool Age: 41 Marital Status: Single Income: $160,000 per year Retirement Plan: Yes - 401(k) and IRA Life Insurance: No Risk Tolerance: High Home Ownership: No - Currently rents at $3,000 per month Client Balance Sheet: Assets Cash on Hand: $20,000 Marketable Securities: $220,000 ($10,000 in Money Market Fund; $40,000 in Treasury Notes; $70,000 in Blue Chips; $100,000 in Growth Stocks) Retirement Plans: $158,000 (Invested in Equity Mutual Funds) Auto: $58,000 Home Ownership: None Liabilities Credit Cards Payable: $10,000 Auto Loan: $50,000 Net Worth: $396,000 The customer has decided to purchase a home instead of renting. The price of the home is $750,000 and the customer intends to put down 20% and obtain a mortgage for the balance. The customer explains that he will need the $150,000 down payment in 30 days. The best recommendation to the customer is to liquidate his: A growth stocks and blue chip stocks immediately in the amount of $150,000 to obtain the necessary cash down payment B growth stocks and blue chip stocks in 30 days in the amount of $150,000 to obtain the necessary cash down payment C retirement accounts in the amount of $150,000 to obtain the necessary cash down payment D Net Worth in the amount of $150,000 to obtain the necessary cash down payment

The best answer is A. Since this customer needs $150,000 in cash within 30 days for the down payment on the house, the best thing to do is to liquidate his stock positions now (NOT in 30 days) to get the funds for the down payment. If the customer waited 30 days, these stock positions could suffer a market loss, making it hard to fund the down payment. Liquidation of the pension assets makes no sense, since the customer is 41 years old and must pay regular income tax plus a 10% penalty tax on the liquidation. Net Worth cannot be "liquidated" - it is simply the value left over when all assets are subtracted from all liabilities.

Commercial paper is a(n): I Money Market Instrument II Capital Market Instrument III Exempt Security IV Non-Exempt Security A I and III B I and IV C II and III D II and IV

The best answer is A. Commercial paper is a money market instrument issued by corporations. It is an exempt security under the Securities Act of 1933 as long as its maturity does not exceed 270 days and can be sold without a prospectus.

A corporate issuer declares a reverse 2 for 3 stock split. After the split is effected, which statements are TRUE? I The market price of the corporation's shares will increase II The reported earnings per common share will increase III The number of common shares outstanding will increase IV Each common shareholder's proportionate ownership interest will increase A I and II only B III and IV only C I, II and IV D I, II, III, IV

The best answer is A. In a reverse split, the number of outstanding shares of the corporation is reduced. This increases reported earnings per share. If earnings per share increases, this tends to raise the price of the company's stock in the market. After the reverse split, each shareholder's proportionate ownership interest remains the same. The only difference is that the shareholder's ownership interest is represented by fewer shares.

All of the following statements are true about Federal Reserve open market trading activities EXCEPT open market operations affect: A the National Debt B M 1 levels C the Treasury's accounts D the business cycle

The best answer is A. Open market operations do not affect the national debt. The issuance and redemption of government securities by the Treasury determines the national debt level. Open market operations affect monetary levels such as M1 (currency in circulation and demand deposits); affect the business cycle; and affect the Treasury's accounts, since FRB funding for its trading activities is provided through the Treasury.

A younger female customer, in the highest tax bracket, already has a substantial investment portfolio that is invested in a balance of quality stocks and bonds. She wants an investment that will provide rapid asset growth and is willing to assume risk. The BEST recommendation would be: A Emerging markets fund B Single stock C Municipal bond D Index fund

The best answer is A. Since this customer already has a balanced quality portfolio and is looking for rapid growth, an emerging markets fund would give the customer the rapid growth she is seeking (along with greater risk).

Under the "penny stock rule," an established customer that is exempt from the rule is defined as a person who has effected a securities transaction or made a deposit of funds or securities with that broker-dealer more than: A 1 year previously B 2 years previously C 3 years previously D 5 years previously

The best answer is A. Suitability statements are not required under the "penny stock rule" for so-called "established customers." These are customers who have either had cash or securities in custody of that broker-dealer for at least 1 year; or customers who have bought 3 or more "penny stock" issues previously from that broker-dealer.

ABC stock is currently trading at an all-time high price of $150 per share. Your client contacts you about the stock, stating that he believes that the stock is ripe for a sell off after its next quarterly news announcement. He has $10,000 to use for a trade, but does not want to lose more than this amount. The BEST recommendation to the client is to: A Buy ABC Puts B Short ABC stock C Short an ETF that consists of stocks similar to ABC D Sell ABC Calls

The best answer is A. The key piece of information in this question is that the client does not want to lose more than his investment. If puts are purchased to speculate on a market price decline, the customer can only lose the premium paid if the market rises. If the customer shorts stock, there is unlimited loss potential in a rising market. If the customer sells calls, there is unlimited loss potential in a rising market.

Under the "wash sale rule," a loss on the sale of a security is disallowed, if between 30 days prior to the sale until 30 days after the sale, the customer: I buys a security convertible into that which was sold II buys a call option on the security which was sold III sells a call option on the security which was sold IV sells a put option on the security which was sold A I and II B III and IV C II and III D I and IV

The best answer is A. The wash sale rule states that if a security is sold at a loss, and from 30 days prior to the sale date until 30 days after the sale date, the same security is purchased; or an equivalent security such as a convertible is purchased; or a call option, warrants or rights are purchased; then the loss deduction is disallowed. All of these "equivalents" effectively restore long the position, "washing out" the sale.

When a sales representative wishes to sell an exempt security to an out of state customer, which of the following statements are TRUE? I The broker-dealer must be registered in the state where the sale of the exempt security is going to be made II The broker-dealer does not have to be registered in the state where the sale is going to be made because the security is exempt III The sales representative must be registered in the state where the sale of the exempt security is going to be made IV The sales representative does not have to be registered in the state where the sale is going to be made because the security is exempt A I and III B I and IV C II and III D II and IV

The best answer is A. While exempt securities are not registered under both Federal and State law, broker-dealers and their sales employees that sell these bonds must still be registered under state law in any state in which the securities are offered. It makes no difference that the security being offered is exempt; the agent and broker-dealer offering them in the state must still be registered in the state (since they can offer these securities fraudulently, and the state wants to know where to find these persons if they do so!).

"Phantom income," in a limited partnership: I can occur when the partnership abandons an asset on which there is an outstanding loan II can occur when the partnership abandons an asset on which there is no outstanding loan III is taxable income IV is not taxable income A I and III B I and IV C II and III D II and IV

The best answer is A. "Phantom income" is a rather nasty IRS concept that states that if a loan is forgiven, the amount of the unpaid loan becomes taxable income to the beneficiary. If a partnership loan is forgiven, (or partially forgiven, for example when an asset is given to the lender in return for forgiveness of the loan), "phantom income" is generated to the extent that the loan balance exceeds the asset's market value. "Phantom income" is taxable income, even though no actual cash income is received by the beneficiary.

Crowdfunding offerings are typically: I made by start-up issuers II made by seasoned issuers III purchased by small investors IV purchased by large investors A I and III B I and IV C II and III D II and IV

The best answer is A. Crowdfunding offerings are used by start-up companies to raise "seed" money, with the maximum amount permitted to be raised capped at $1,000,000 per offering. They are targeted at small investors. The investment minimum is only $2,000 and the investor is not required to meet any income or net worth tests. (Test Note: The investment minimum and maximum amount that can be raised are subject to an inflation adjustment every 5 years. In April 2017, they were adjusted to $2,200 and $1,070,000 respectively. For the exam, know the base amounts and the fact that they are indexed for inflation periodically.)

All of the following statements are true regarding gift and estate taxes EXCEPT: A gift and estate taxes are regressive B estates of married persons that are willed to the surviving spouse are eligible for an unlimited exclusion from tax C gifts valued up to $15,000 per person in 2021 are excluded from tax D tax liability rests with the donor or estate

The best answer is A. Estates of married persons are eligible for an unlimited spousal exclusion. Gifts of up to $15,000 per person in 2021 are excluded from the tax. Tax liability rests with the donor or estate (since they have the money!) Tax rates on gifts and estates increase with the size of gift or estate - this is known as a progressive tax. Regressive taxes are flat taxes.

Transactions in the interbank market cause direct movements in the prices of: A currencies B currency options C equities D equity options

The best answer is A. Foreign currencies trade in the interbank market.

Rule 144 allows the sale, every 90 days, of: I 1% of the outstanding shares II 10% of the outstanding shares III the weekly average of the prior 4 weeks' trading volume IV the weekly average of the prior 8 weeks' trading volume A I or III, whichever is greater B I or IV, whichever is greater C II or III, whichever is greater D II or IV, whichever is greater

The best answer is A. Rule 144 allows the sale, every 90 days, of the greater of 1% of the outstanding shares of that company; or the weekly average of the prior 4 week's trading volume.

The Chairman of XYZ Corporation, while playing golf with a neighbor, casually mentions that this quarter's earnings are likely to be lower than expected. Based on this information, the neighbor sells short XYZ stock the next day. Which statements are TRUE? I The Chairman has violated the insider trading rules II The Chairman has not violated the insider trading rules III The neighbor has violated the insider trading rules IV The neighbor has not violated the insider trading rules A I and III B I and IV C II and III D II and IV

The best answer is A. Under the Insider Trading Act of 1988, any person who uses material non-public information to trade in a company's stock for profit can be considered to be an "insider." In addition, the Act extends the definition of an insider to "controlling" persons - in this case, the provider of the information. A person who "communicates" material non-public information can be held liable under the Act unless "that person acted in good faith and did not directly or indirectly induce the act constituting the violation." Therefore, both the person trading on the inside information (the "tippee") and the communicator of the information (the "tipper") can be held liable under the Act.

Which of the following are components of total long term capital of a corporation? I Common Stockholders' Equity II Preferred Stockholders' Equity III Long Term Bonded Debt IV Current Liabilities A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is C. A corporation's long term capital consists of common stockholders' equity (common at par; capital in excess of par; and retained earnings); preferred stockholders' equity; and long term debt. These are all sources of long term capital for the corporation. Current liabilities are just that, bills that must be paid within 1 year. They are not a source of capital for a corporation.

A customer, age 60, is ready to retire, and has an investment objective of preservation of capital and current income. The BEST asset allocation mix to recommend to this customer is: A 100% common stocks B 50% common stocks; 50% bonds C 10% common stocks; 90% bonds D 100% bonds

The best answer is B. A customer who has an objective of both income and capital preservation would invest in a balance of common stocks and fixed income securities. The fixed income securities provide income; while the common stocks provide little current income. The common stock values will tend to increase over time, as the economy grows, preserving the customer's capital. However, if interest rates rise, forcing the value of the fixed income securities down; the common stock portion of the portfolio would be minimally affected. If economic conditions deteriorate, forcing the value of the common stocks down; then interest rates would tend to fall. This would push up the prices of the fixed income securities in the portfolio, countering the loss in value of the common stocks. Thus, a relatively even mix of common stocks and fixed income securities best meets this customer's needs. You can always use the guideline that the customer should invest his or her "age" in bonds, with the balance in equities. This would give 60% bonds; 40% equities, which is not a choice here! However Choice B is the closest to this allocation.

The formula for the defensive interval ratio is: A Current Assets / Current Liabilities B Current Assets / Daily Operating Expenses C Annual Sales / Accounts Receivable D Annual Sales / Daily Operating Expenses

The best answer is B. Current Assets / Daily Operating Expenses The defensive interval ratio is a variation on the Current Ratio that measures liquidity. It takes Current Assets and divides it by Daily Operating Expenses to find the number of days that a company can continue to run if it were not able to bring in any more current assets. This is the period of time, or "defensive interval" that the company could continue running in a "worst case" scenario where business has collapsed and it was not generating current assets. For example, a company with daily operating expenses of $100,000 and total current assets of $5,000,000 can operate for $5,000,000 / $100,000 = 50 days before it runs out of money.

Rule 103 of Regulation M requires that a market maker in a stock that is also a syndicate member in an "add-on" offering of that issue, during the 20-day cooling off period: A must effect all trades in that stock on an upbid B must resign as a market maker C cannot fill any orders for that security D can only sell the stock "long" and cannot sell "short"

The best answer is B. Rule 103 of Regulation M covers the situation where a firm in the underwriting group for an add-on securities offering also happens to be a market maker in the stock. The worry of the SEC is that the market maker, during the 20-day cooling off period, would be tempted to aggressively buy the stock to push up the market price. This, in turn, would push up the POP when it is set just prior to the effective date, which would increase the underwriters' spread. To stop this, the SEC requires that either the market maker stop making a market until the effective date; or alternatively, the market maker must act as a "passive" market maker - meaning that it cannot buy the stock at a price higher than the current high bid.

SEC Rule 10b-18 allows an issuer to buy its shares in the open market: A at any price that is reasonably related to the current market B at the highest independent bid or the last reported sale price, whichever is higher C at the lowest independent offer or the last reported sale price, whichever is lower D under no circumstances, since this is considered to be market manipulation

The best answer is B. SEC Rule 10b-18 sets ground rules for issuers or affiliated persons who wish to buy their shares in the open market. If an issuer aggressively buys its stock in the market, or bids for its stock, it can manipulate the market price upwards. Bids and purchases that are made in compliance with Rule 10b-18 will not be considered manipulative activities under Rule 10b-5 ("catch-all" fraud rule). Rule 10b-18 purchases, as they are known: Must be effected through 1 broker/dealer on any given day; Cannot be the opening transaction; Cannot be executed within 10 minutes of market close if the security is "actively traded," otherwise it cannot be executed within 30 minutes of market close; Must be effected at prices no higher than the current market; Cannot exceed 25% of the trading volume in the security that day (except for block purchases handled outside the normal flow of orders).

Timing is the important factor in which portfolio management strategy? A Strategic allocation B Tactical allocation C Rebalancing D Indexing

The best answer is B. Strategic portfolio management is the determination of the percentage allocation to be given to each asset class - for example a portfolio might be strategically allocated as follows: Money Market Instruments 10% Corporate Bonds 30% Large Cap Equities 50% Small Cap Equities 10% Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will underperform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.

A 60-year old man is looking to create a portfolio that will provide current income and preservation of capital. Which of the following portfolios would be the BEST recommendation to the client? A Long term corporate bonds rated AA or better, high yield corporate bonds and blue chip stocks B Treasury bills, a money market mutual fund and bank certificates of deposit C Treasury STRIPS, corporate income bonds and PO tranches D Growth stocks, defensive stocks and foreign stocks

The best answer is B. This customer wants current income and preservation of capital. Choice A provides current income, but does not provide preservation of capital. Long term bonds are subject to loss of value if interest rates rise; high yield corporate bonds have this risk as well as higher default risk; and blue chip stocks also can lose substantial value in a bear market. Choice B meets both objectives. Treasury bills, money market funds and bank certificates of deposit all provide income (but not high levels of income) and safety of principal. Choice C consists of long term securities that do not provide income, and that also have high levels of interest rate risk. Treasury STRIPS are zero coupon Treasury obligations - they have high levels of interest rate risk and do not provide current income. Corporate income bonds only pay interest if the corporation has enough earnings. PO tranches are CMO tranches that pay "Principal Only." Because mortgage payments in the early years are mostly interest and in the later years are mostly principal, they pay very little in the early years and make most of their payments in their later years. Thus, they are most similar to a long-term zero coupon bond with high levels of interest rate risk. Choice D consists only of common stocks, which do not provide for preservation of capital.

A communication sent to 30 retail clients and 10 institutional clients is defined as (a): A Correspondence B Retail Communication C Public Appearance D Institutional Communication

The best answer is B. FINRA has 2 basic definitions of communications with the public: Correspondence: A written or electronic communication made available to 25 or fewer existing or prospective clients Retail Communication: A written or electronic communication made available to more than 25 existing or prospective clients. Excluded from these definitions are institutional communications and public appearances. FINRA creates these 2 main categories of communications because "correspondence" is subject to "post use review and approval" by a manager or principal and is not required to be filed with FINRA; in contrast, retail communications must be approved in advance of use by a principal and can be required to be filed with FINRA. (Also note that the "previous" FINRA rule defined "advertising" (general audience, such as TV, radio, newsprint, websites) and "sales literature" (specific audience, such as a research report, form letter, scripted speech, password-protected website). These now fall into the definition of "retail communications," but advertising and sales literature must still be known for the exam).

Regarding municipal discount bonds, which statements are TRUE? I Municipal original issue discount bonds must be accreted II Municipal original issue discount bonds may be accreted III Municipal market discount bonds must be accreted IV Municipal market discount bonds may be accreted A I and III B I and IV C II and III D II and IV

The best answer is B. The discount on original issue discount municipal bonds must be accreted annually. It is reported annually as municipal interest income earned (non-taxable), and the cost basis of the bond is adjusted upwards by this amount. If the bond is held to maturity, the entire discount has been accreted and there is no capital gain or loss at maturity. The discount on market discount municipal bonds is treated as taxable interest income earned. This is nothing more than a "tax grab" by the Federal government - the idea being that wealthy people buy municipal bonds, so if there is a way that they can be taxed without jeopardizing their basic Federal income tax-free status, why not? The holder can either accrete the discount annually as taxable interest income earned and adjust the cost basis of the bond upwards by this amount; or can wait until the bond is sold or matures to report the accumulated "earned" discount as taxable interest income at that point (this is the better choice from a tax standpoint).

End of Year Retained Earnings = 400,000 Earnings For Common = $1,000,000 ABC Corporation's dividend payout ratio is: A 30% B 40% C 54% D 59%

The best answer is B. The dividend payout ratio is: Dividend Payout Ratio = Common Dividends / Earnings For Common $400,000 / $1,000,000 = 40% dividend payout ratio

Under Internal Revenue guidelines, a short term profit on securities is one which results from a A short sale of securities that are subsequently repurchased at a higher cost at any date in the future B long sale, at a price higher than the security's cost basis, made within one year following purchase C sale of securities within 30 days of purchase D sale of securities by an insider at a profit within 6 months of purchase

The best answer is B. Under Internal Revenue rules, a profit (or loss) is considered to be short term if a position is liquidated after being held for 1 year or less. Short term capital gains are taxed at a maximum rate of 37% (the maximum individual tax rate). If the position is held for over 1 year (1 year and 1 day), then any gain or loss is long term. Gains on assets held over 12 months are taxed at a maximum rate of 15%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.) Anytime you sell short a security, and subsequently repurchase the shares at a higher cost, you have a short term loss (all gains and losses whenever you sell short are considered "short term" since there never was a holding period!). Do not confuse the IRS definition of short term with the SEC definition for purposes of the insider trading rules. Under the Securities Exchange Act of 1934, "short swing" profits by insiders are those derived within a 6 month period and must be paid back to the issuer.

A corporate investor may exclude from taxation, part of: I cash dividends received from common stock investments II cash dividends received from preferred stock investments III interest received from convertible bond investments IV interest received from non-convertible bond investments A I only B I and II C III and IV only D I, II, III

The best answer is B. Corporate investors may exclude 50% of dividends received (both common and preferred) from taxation. Interest income received is 100% taxable (unless it is tax free municipal interest income).

If a gift of securities is made to a charity, which of the following statements are TRUE? I The donor gets to deduct the market value of the securities if the securities have been held for over 1 year II The donor gets to deduct the market value of the securities regardless of the length of time they were held III The cost basis to the recipient is the same as the donor's IV The cost basis to the recipient is the same as the market value of the securities on the gift date A I and III B I and IV C II and III D II and IV

The best answer is B. If a gift of securities is made to a charity, the donor gets to deduct the fair market value of the securities from his taxes (as long as the securities have been held at least 1 year). The cost basis to the recipient is the market value at the time of the gift.

A customer buys 1 ABC Jul 50 Put @ $3. The customer lets the contract expire. Which statement is TRUE? A The holder has a $300 capital loss as of the date the contract was purchased B The holder has a $300 capital loss as of the date the contract expires C The holder has a $4,700 capital gain as of the date the contract was purchased D The holder has a $4,700 capital loss as of the date the contract expired

The best answer is B. If the holder of an option contract allows the option to expire, he or she has a capital loss equal to the premium paid as of the expiration date.

Which of the following usually acts as the stabilizing market maker? A Issuer B Managing underwriter C Any member of the syndicate D Any member of the selling group

The best answer is B. Only 1 stabilizing bid is permitted at any time, typically placed by the manager of the syndicate.

An unaffiliated investor is permitted to sell "144" shares without being subject to the volume limitations: A under no circumstances B after holding the securities for 3 months C after holding the securities for 6 months D after holding the securities for 1 year

The best answer is C. Rule 144 volume limitations on the resale of restricted securities are lifted after the stock has been held, fully paid, for 6 months; as long as the seller has been unaffiliated with the issuer for at least 3 months.

A customer has an account holding $310,000 of securities and $290,000 of cash. If the broker-dealer were to fail, which statement is TRUE regarding the status of the account in an SIPC liquidation? A The customer will become a general creditor for $40,000 owed B The customer will become a general creditor for $100,000 owed C SIPC will provide coverage for $310,000 of securities only D SIPC will provide coverage for $250,000 of cash only

The best answer is B. SIPC covers customer claims against a failed broker-dealer for a total of $500,000, inclusive of maximum cash coverage of $250,000. For any claims above these limits, the customer becomes a general creditor of the failed broker-dealer. This customer has $310,000 of securities and $290,000 of cash, for a total claim of $600,000. $250,000 of the cash is covered, leaving $40,000 uncovered. The remaining $250,000 of coverage is applied against the $310,000 securities position, leaving $60,000 of securities uncovered. The customer becomes a general creditor for the $100,000 total of the uncovered claims.

Under Rule 144, a customer wishing to sell must file the 144 "Notice of Sale" with the SEC: A 10 business days prior to the placement of the sell order B at, or prior to, the placement of the sell order C 10 business days after the placement of the sell order D 90 days after the placement of the sell order

The best answer is B. The Form 144 is simply a notification to the SEC that stock will be sold in compliance with the Rule - the SEC does not approve of the sale. The Form must be filed by the seller at, or prior to, with the placement of the sell order.

Which of the following maintain "Do Not Call" lists? I SEC II Member firm III FTC IV FINRA A I and IV B II and III C I, II, III D I, II, III, IV

The best answer is B. There is both a Federal "Do Not Call" list requirement and a FINRA "Do Not Call List" requirement. The Federal List is maintained by the FTC (Federal Trade Commission). FINRA requires each member firm to keep its own "Do Not Call" list. FINRA itself does not keep the list, nor does the SEC.

A 30-year old single individual wishes to invest for retirement. He is employed at a high paying job at a stable employer, has a high risk tolerance and, has no current income needs from his investments. The BEST asset allocation to recommend to the customer is: A 50% common stocks / 50% bonds B 100% common stocks / 0% bonds C 0% common stocks / 100% bonds D 33% common stocks / 33% bonds / 33% cash

The best answer is B. This customer can assume risk, has no current income needs, and has a 40-50 year investment time horizon. The best answer is Choice B, since the customer should be weighted at least 70% in common stocks (100% minus one's age as a general guide). This is not offered as an answer, but because this individual has a "high risk" tolerance and a stable job, the equity allocation can be increased.

Which statement is TRUE concerning "wrap accounts"? A Wrap accounts must be registered with the SEC and sold with a prospectus B To sell a wrap account, the registered representative must also be licensed as an investment adviser representative by the State C To sell a wrap account, the registered representative must also be licensed to sell insurance products by the State D Wrap accounts cannot be sold by registered representatives

The best answer is B. Wrap accounts "wrap" all services provided into a fee arrangement that is not transaction based - instead, the fee might be a fixed annual dollar fee; or a fee based on percentage of assets under management. Wrap accounts are defined as advisory products in most States, and a State investment adviser representative license is required (Series 65 or 66 exam) in addition to the federal Series 7 license needed to sell all securities.

When the market is reaching an "overbought" condition, it is expected that the next market move will be: A upwards B downwards C sideways D either upwards or downwards

The best answer is B. An overbought condition in the market occurs when the market price averages are increasing daily, but the strength of the market (the number of issues advancing versus the number of issues declining) is weakening. The market is reaching an "overbought" condition, and is approaching a peak. Thus, the next market move is likely to be a decline.

A customer buys 1 ABC Jan 50 Call @ $4 when the market price of ABC is $51. The stock then moves to $58 and the customer exercises the option and sells the stock at the market. The tax consequence is a: A capital loss of $400 B capital gain of $400 C capital gain of $800 D capital gain of $1,000

The best answer is B. If a customer exercises a call, he is buying the stock at the strike price. The customer's cost basis is the purchase price of the stock ($50) plus the premium paid ($4) = $54. Since the customer sold the stock at $58, he or she will have a capital gain of $400.

Municipal bonds purchased in the primary market at a premium to par: A may be amortized B must be amortized C must be accreted D may be accreted

The best answer is B. New issue premium municipal bonds must be amortized on a straight line basis over the life of the bond. Each year, the amortization amount reduces non-taxable interest income received; and reduces the bond's cost basis. If the bond is held to maturity, the bond's cost basis has been adjusted to par and since it is redeemed at par, there is no tax deductible capital loss. Amortization is required for both new issue premium and market premium municipal bonds.

Under IRS regulations, a gain or loss upon current disposition of an asset is first considered to be long term if the asset has been held for over: A 6 months B 1 year C 2 years D 5 years

The best answer is B. Under IRS rules, a security's holding period is considered to be long term if it exceeds 1 year. Gains on assets held over 12 months are taxed at a maximum rate of 15%. (Note that this rate is raised to 20% for individuals in the highest tax bracket.)

Which statements are TRUE about trustees performing their duties under the Trust Indenture Act of 1939? I The trustee is appointed by the issuer II The trustee is elected by the bondholders III The trustee protects the interests of the issuer IV The trustee protects the interests of the bondholders A I and III B I and IV C II and III D II and IV

The best answer is B. Under the requirements of the Trust Indenture Act of 1939, trustees are appointed by the issuer (who pays the trustee); however, the trustee is appointed to protect the interests of the bondholders.

The percentage depletion allowance offered of oil and gas program investors is based upon oil: A discovered B recovered C sold D stored

The best answer is C. The percentage depletion deduction is currently 15% of oil revenue, that is, oil sold. Any small producer of oil and gas may use the percentage depletion deduction as the method for recovering the monies paid for the mineral rights.

Interest income from which of the following is SUBJECT to state and local taxes? A Federal Intermediate Credit Bank issues B Federal Home Loan Bank issues C Federal National Mortgage Association issues D U.S. Treasury Bills

The best answer is C. Both Fannie Mae and Ginnie Mae mortgage backed pass through certificates are fully taxable by both the Federal and State governments - since these are issuers of mortgage backed pass through certificates. Since the mortgage interest payments are deductible at both the Federal and State levels, the recipient of the mortgage interest payments (the holders of the certificates) must pay tax at both the Federal and State levels. Otherwise, as a general rule (there are some exceptions), interest earned on U.S. Government and agency obligations is subject to Federal income tax but is exempt from state and local tax.

Which statements are TRUE about market discount corporate bonds? I The discount may be taxable as a capital gain at maturity II The discount may be accreted over the life of the bond and taxed annually as interest income III The discount need not be accreted over the bond's life and will be taxed as interest income earned when the bond matures or is sold A I and II only B I and III only C II and III only D None of the above

The best answer is C. Corporate bonds bought in the secondary market at a discount are termed "market discount bonds." There is an option of accreting the discount and paying tax annually on the accretion amount at full tax rates; or of waiting until the bond is redeemed or sold to pay the tax on the earned market discount at full tax rates. If the holder accretes the bond and holds it until maturity, there is no capital gain or loss, since the entire discount has been accreted and taxed over the bond's life. If the holder opts not to accrete the bond, the bond will be redeemed at par and the entire market discount is taxed as interest income received at maturity (not as capital gains).

An offer of IPO shares made to an officer of a publicly held company is considered to be spinning if the publicly held company is: A in the financial services industry B not a seasoned issuer C an investment banking client of the broker-dealer D followed by the research department of the broker-dealer

The best answer is C. FINRA prohibits the "spinning" of IPO shares. This is a "quid pro quo" arrangement where a member firm gives officers of public companies IPO allocations in return for receiving underwriting business from that company (since the officers are in a position to direct that business to the member firm). An executive officer or director of a publicly held company cannot receive a new issue allocation if the company is currently an investment banking client of the member; if the member has received investment banking compensation from the company in the past 12 months; or if the member expects to be retained by the company to provide investment banking services to the company in the upcoming 3 months (which is the case in this question).

Regarding secondary market bonds, all of the following statements are true EXCEPT: A municipal discount bonds may be accreted B corporate discount bonds may be accreted C municipal premium bonds may be amortized D corporate premium bonds may be amortized

The best answer is C. For all market discount bonds, the market discount is treated as taxable interest income, with the holder having the option of accreting the bond annually and paying tax on the accretion amount; or waiting until sale or redemption to pay the tax on the entire accreted market discount amount. For market premium bonds, municipal market premiums must be amortized over the life of the bond; for all other bonds, the holder has the option of amortizing the market premium. Please note that the rules for original issue discount and premium bonds are different. The discount on both original issue discount corporate and municipal bonds must be accreted annually. The premium on original issue premium municipal bonds only must be amortized. The premium on corporate bonds may be amortized or can be left intact - the choice is up to the investor.

Monetarist Theory states that: A increased government spending will stimulate the economy B tax rate reductions and lower government spending will stimulate the economy C the actions of the Federal Reserve control the level of economic output D tax rate increases and increased transfer payments will stimulate the economy

The best answer is C. Monetarist Theory states that economic growth is controlled by the Federal Reserve's actions. If the Federal Reserve allows the money supply to grow at a pace consistent with real economic growth, there is balance. The theory holds that if the Federal Reserve allows the money supply to grow more rapidly than real economic growth, interest rates will fall, stimulating borrowing and investment. Conversely, if the Federal Reserve allows the money supply to grow more slowly than real economic growth, interest rates will rise, reducing borrowing and investment.

Types of direct participation programs include: I Oil Drilling II Agricultural Production III Equipment Leasing IV Real Estate Investment Trust A I and III only B II and IV only C I, II, III D I, II, III, IV

The best answer is C. Real Estate Investment Trusts are not Direct Participation Programs. These are stock companies, similar to closed end investment companies, which invest in real estate, short term construction, and mortgages. As a stock company, they do not allow for flow through of gain and loss. Direct participation program types include oil drilling programs; agricultural production; and equipment leasing programs. When set up as partnerships, these ventures allow the partners to directly share in income and loss.

Changes in which of the following would affect a corporation's "alpha" coefficient? A Standard and Poor's 100 Index volatility B Advance / Decline Ratio C Corporate Management D Short Interest

The best answer is C. The "alpha" coefficient is a measure of so-called stock specific risk, that is the relative risk of that stock's price moving positively or negatively, independent of general market movements. (The "beta" coefficient is a measure of a stock's price volatility relative to the market as a whole). Thus, the events that would affect "alpha" are those that relate solely to that company or industry, such as a change of corporate management. The other measures given are technical indicators of the market as a whole, and would have no impact on "alpha."

Which of the following securities are NOT required to be registered with the SEC? I American Depositary Receipts II Eurodollar Debt III Foreign Government Debt IV Municipal Debt A I and II only B III and IV only C II, III, IV D I, II, III, IV

The best answer is C. ADRs (American Depositary Receipts) are non-exempt securities and must be registered with the SEC under the Securities Act of 1933. ADRs are the way that most foreign corporate issues trade in the United States. The bank that structures the ADRs handles the registration. Municipal debt, U.S. Government debt and Foreign Government debt are all exempt. Eurodollar bonds are sold outside the U.S. and thus do not fall under the Act.

A couple wants to invest for the college education of their 4 children. The children are 1, 5, 10, and 16 years old. What is the biggest suitability concern when making an investment recommendation? A Tax deferral B Investment growth C Investment time horizon D Liquidity

The best answer is C. The oldest child is 16 years old and will be entering college in 2 years. Any investment recommendation must take into account that liquidation of positions to pay for college must commence in 2 years. This is the investment time horizon that must be used for any recommendation. Liquidity is also a concern - any assets chosen as an investment must be able to be liquidated quickly when funds are needed in 2 years. However, first we must choose assets with a 2-year investment time horizon, and then second, these must be assets that can be liquidated easily (little liquidity risk).

The Self Regulatory Organizations (SROs) are: A private companies B government sponsored enterprises C membership organizations D publicly traded companies

The best answer is C. The self regulatory organizations are membership organizations. Note that the self regulatory organizations are now divested from the actual trading marketplaces. For example, FINRA is the SRO; and NYSE and NASDAQ are the stock exchanges. Both of these exchanges are publicly traded entities. The SRO is a membership organization that writes and enforces rules for members, audits members for compliance, and that collects dues from members to pay for these activities.

In 2021, a customer buys a 2% U.S. Government bond maturing in 2026 at 102-16. The customer elects to amortize the bond premium for tax purposes. If the bond is sold after 2 years, its cost basis at that time is: A 102-8 B 102 C 101-16 D 101-8

The best answer is C. This Government bond costs 102-16, or 102 and 16/32nds = 102 1/2, so the premium is 2 1/2 points. Since the bond has 5 years to maturity, the annual amortization amount is 2 1/2 points divided by 5 years = 1/2 point per year. If the bond is sold after 2 years, 1 point of the premium will have been amortized. Thus, the bond's adjusted cost basis is 102 1/2 - 1 = 101 1/2. Converting to Government bond quotes (in 32nds), this equals 101-16. Both Government and corporate bond premiums may be amortized, if elected by the owner - and this is the best choice for the owner because the annual amortization reduces the taxable interest income received from the bond.

Which of the following statements are TRUE regarding the requirements of the MSRB for handling written customer complaints? I All customer complaints must be resolved II If the customer alleges in a complaint that there has been a monetary loss, the MSRB must be notified III The municipal principal must handle the resolution of each written customer complaint IV The municipal principal must retain a file of all customer complaints with their resolution A I and III B II and IV C I, III, and IV D I, II, III, IV

The best answer is C. Written customer complaints should be resolved. The MSRB requires that such complaints be handled under the supervision and review of the municipal securities principal; and that records of complaints with their resolution (if any) be retained for 6 years (FINRA only requires a 4 year retention period for complaint records). There is no requirement to notify the MSRB about the complaint. If the MSRB received a copy, they couldn't do anything anyway, since they don't enforce their rules. They would simply hand the complaint to FINRA, who enforces MSRB rules for broker-dealers.

Which statement is TRUE regarding purchase limitations under Regulation A? A Non-accredited investors buying Tier 1 offerings are subject to purchase limitations B Accredited investors buying Tier 1 offerings are subject to purchase limitations C Non-accredited investors buying Tier 2 (Regulation A+) offerings are subject to purchase limitations D Accredited investors buying Tier 2 (Regulation A+) offerings are subject to purchase limitations

The best answer is C. There are no purchase limitations on Tier 1 (up to $20 million) Regulation A offerings. However, Tier 2 offerings (up to $50 million, also known as Regulation A+) are subject to purchase limitations only for non-accredited purchasers. (Regulation D - the private placement exemption - sets the requirements for "accredited" investors - these are wealthy individuals.) Non-accredited investors buying a Tier 2 Regulation A offering cannot invest an amount that is the greater of 10% of that person's annual income or net worth. Note that there is no similar limitation on Tier 1 purchases.

Customer Name: Jane Smith Age: 41 Marital Status: Single Dependents: 1 Child, Age 7 Occupation: Corporate Manager Household Income: $120,000 Net Worth: $150,000 (excluding residence) Own Home: Yes Investment Objectives: Saving For College; Saving for Retirement Investment Experience: 10 years Current Portfolio Composition: $140,000 Market Value 50% Money Market Fund 50% Corporate Bonds This client has just inherited $100,000 and wants to use the funds to pay for her child's college education. She also has asked whether her current portfolio meets her goal of maximizing saving for retirement. Based on this information, the best recommendation to the client is to: A deposit the additional $100,000 to the money market fund to ensure that the funds will be available to pay for college B open a 529 Plan with the $100,000 inheritance, investing in a growth fund; and liquidate both the money market fund holding and the corporate bond holdings, using the proceeds to buy growth stocks C open a 529 Plan with the $100,000 inheritance, liquidate $50,000 of the money market fund and $50,000 of the corporate bonds, using the proceeds to buy growth stocks D open an UGMA account with the $100,000 inheritance investing in growth stocks

The best answer is C. This customer is looking to use her $100,000 inheritance to fund her kid's college education. A 529 plan is best for this, since it grows tax-deferred and distributions used to pay for college are tax free. Since the kid is only age 7, a growth fund investment is most suitable, since the child has 10-11 years before college starts. Note that a UGMA (custodial account) does not allow for tax deferral, so it is not the best choice. The customer also wants to save for retirement and she is only age 41, so she has at least 25 years to go before retiring. Her portfolio is way too conservatively invested for someone this age - it will grow at a very low rate since it is only invested in money market funds and corporate bonds. At this age, the customer should be invested 60-70% in growth stocks, with the balance in safer investments. So the best choice is to liquidate most of the money market fund and corporate bond holding, and invest the proceeds in growth stocks (Choice C). Choice C still leaves the customer with $20,000 in the money market fund (for emergencies) and she still has a small investment in corporate bonds ($20,000), but the remaining $100,000 will now be in growth stocks. This is a good mix for a 41 year old person looking to save for retirement. Also note that Choice B is not the best choice because the customer should still have a small portion of her portfolio in safer and more liquid securities (for emergencies) like a money fund.

Which technical indicator is considered to be bearish? A Head and shoulders "bottom" formation B Saucer formation C Breakout through a support level D Oversold market

The best answer is C. A bearish technical indicator is a breakout through a support level. If a stock moves through a support level, it is breaking out to the downside. A head and shoulders "bottom" formation is bullish since the market has bottomed out and is trending upwards. A "saucer" formation is bullish since the market has bottomed out and is trending upwards. If the market is "oversold," this means that sellers have pushed prices down too low. Thus, the market is underpriced and ready to move higher (bullish).

Under MSRB rules, which of the following may be changed by mutual agreement between municipal dealers? I Confirmation contents II Time of delivery III Place of delivery IV Settlement date on a "When, As, and If Issued" ("WAII") Transaction A I and II only B III and IV only C II, III, IV D I, II, III, IV

The best answer is C. By mutual consent, municipal firms are free to change the place or time of a securities delivery; and can set the settlement date of a "When, As, and If Issued" securities transaction. (In a "WAII" trade, the actual settlement date is not known until the new issue of municipal securities is delivered and the offering has been closed between the syndicate and the issuer). Confirmation contents are explicitly "spelled out" by the MSRB and cannot be changed.

Generally, which of the following statements are TRUE regarding the taxation of a municipal security? I Capital gains from selling municipal bonds are taxable only on the State and Local levels II Capital gains from selling municipal bonds are fully taxable III Interest income received from municipal bonds is taxable only on the State and Local levels IV Interest income received from municipal bonds is fully taxable A I and III B I and IV C II and III D II and IV

The best answer is C. Capital gains on municipal securities are taxable at the Federal, State and Local levels. Only the interest income from municipal securities is exempt from Federal income tax; The interest income is still subject to State and Local tax unless the bond is purchased by a resident of that State.

Diversification of a portfolio among asset classes: A increases the rate of return achieved over the investment time horizon B reduces the rate of return achieved over the investment time horizon C reduces the variability of the rate of return over the investment time horizon D increases the variability of the rate of return over the investment time horizon

The best answer is C. Diversification reduces the variability of investment returns over the investment time horizon. In a diversified portfolio, some investments will be under-performing and some will be over-performing, tending to average out the rate of return. Thus, variability of the rate of return is reduced.

Which statements are TRUE about asset classes and investment time horizons? I Equity investments are the better choice for short term time horizons II Interest bearing investments are the better choice for short term time horizons III Equity investments are the better choice for long term time horizons IV Interest bearing investments are the better choice for long term time horizons A I and III B I and IV C II and III D II and IV

The best answer is C. Equity investments typically produce a higher rate of return with higher volatility - thus a long time horizon is needed to achieve consistent results with equity investments. Interest bearing investments produce a lower rate of return with lower volatility - thus they are suitable for portfolios with short time horizons.

Which of the following are progressive taxes? I Sales taxes II Excise taxes III Estate taxes IV Gift taxes A I and II B II and III C III and IV D I, II, III, IV

The best answer is C. Estate and gift tax rates increase with the size of estate or gift, so these are progressive taxes. Sales and excise tax rates stay the same, whether the purchaser is rich or poor, so these are regressive taxes.

All of the following are reported on Form 1099-DIV EXCEPT: A cash dividends paid B qualifying cash dividends paid C interest paid on taxable bonds D capital gains distributions paid by mutual funds

The best answer is C. Form 1099-DIV is the report to the IRS by issuers of cash dividends paid and capital gains distributions made by mutual funds. Dividends that "qualify" for the lower 15% (or 20% for higher earners) tax rate are reported in a separate box on the form. Interest paid on taxable bonds and tax-free bonds is reported on Form 1099-INT.

Gross Domestic Product (GDP) consists of all of the following EXCEPT: A Consumer spending B U.S. Government spending C Foreign Government spending D Fixed investment

The best answer is C. Gross domestic product is the entire output of the U.S. economy. It includes individual consumption, government spending, and fixed investment. Since it measures output within the United States only, foreign spending and investment is excluded.

A growth investor would consider a company's: A Price / Earnings ratio B Price / Book Value ratio C Stock price appreciation rate D Market share

The best answer is C. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments. Value investors invest in undervalued companies - as measured by low Price/Earnings ratios and low Price/Book Value ratios - that have good market prospects. Thus, they also consider product line, market share, management, etc.

If the dollar falls against foreign currencies, all of the following statements are true EXCEPT: A U.S. goods are cheaper to foreign countries B U.S. exports are likely to rise C foreign currencies buy fewer dollars D foreign imports are likely to fall

The best answer is C. If the dollar falls, U.S. goods become cheaper to foreigners and foreign goods become more expensive in the U.S. Thus, exports are likely to rise and imports are likely to fall. Since the dollar is cheaper, foreign currencies buy more dollars and/or goods.

Customer Z is a single 26-year-old man who earns $125,000 annually. He informs you that he is getting married and that his new wife's income of $75,000 per year will put them into the highest federal tax bracket. The couple will have investable income of $25,000 per year. The couple wishes to buy a house in 5 years that will be substantially more expensive than the condominium in which they currently reside. To meet the customer's needs for the large cash down payment in 5 years and to reduce taxable income, the BEST recommendation is to: A open a margin account and invest in income bonds B open an Individual Retirement Account and invest in tax-deferred variable annuities C open a cash account and invest in mutual funds holding high yielding common and preferred stocks D open a trust account and invest in Treasury STRIPs

The best answer is C. Income bonds are not a reliable source of income or principal repayment (since payment depends on earnings of the issuer), and the interest is 100% taxable. Tax-advantaged investments like variable annuities should never be purchased in tax-deferred accounts. The annual accretion on Treasury STRIPS is taxable, unless the bonds are held in a tax-deferred account. Only Choice C makes sense - since cash dividends are taxed at a maximum rate of 15% (reducing taxable income), and the mutual fund shares can be easily liquidated in 5 years to make the house down payment.

Under FINRA rules, which of the following accounts would be considered to be "discretionary"? A An omnibus account run by an investment adviser for his clients B An account where a third party power of attorney has been given by the customer to another individual C An account where the broker has the power to decide when and what to trade without specific customer authorization D A partnership account where only one of the partners has trading authorization

The best answer is C. A discretionary account is one where the broker has the power to decide what and how much to trade. The customer gives a written power of attorney to the broker allowing discretion to be exercised.

A portfolio of securities that moves in both the same direction and same velocity as the market as a whole would have a Beta equal to: A +0 B -0 C +1 D -1

The best answer is C. A portfolio with a "beta" coefficient of +1 is one that moves in both the same direction and same velocity as the market as a whole. A portfolio with a "beta" coefficient of +2 is one that moves in the same direction as the market as a whole, but which moves twice as fast as the market. A portfolio with a "beta" coefficient on -1 is one that moves at the same velocity as the market as a whole, but it moves in the opposite direction to the market.

What portfolio construction is most appropriate for a retired doctor who is age 75? A 100% common stocks B 75% common stock / 25% bonds C 25% common stock / 75% bonds D 100% bonds

The best answer is C. As one gets older, portfolio composition should shift to "safer" assets that generate reliable income. The general rule is to take "100 minus the investor's age" to get the appropriate investment portion to be held in stocks. Since this investor is age 75, this gives 25% of the portfolio holding in stocks; with the remaining 75% of the holding in bonds. Note that a 100% bond holding is not appropriate because people are living much longer and they need the "extra return" that is provided by stocks that can grow in value, on top of the somewhat lower fixed return provided by bonds.

Which of the following time stamps are on an order ticket? I Time of order entry II Time of trade execution, if executed III Time of order cancellation, if canceled IV Time of trade reporting on the Consolidated Tape A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is C. FINRA requires that all order tickets sent to an exchange be stamped with the time of: Order entry; Order execution; and Order cancellation, if canceled. There is no time stamp on the order ticket for the time the trade was reported to the Consolidated Tape. These time stamps are now recorded electronically.

A registered representative wants to speak to a group of clients about a private placement in a 2-year old company. The invited clients have a stated minimum net worth of $1 million. The representative is soliciting them to buy privately placed shares of the company because it is in a growth business due to the aging of the population in the U.S. - the company's business is the refurbishment of medical equipment in hospitals. In the Private Placement Memorandum (PPM), the company states that investors are expected to receive a 15% annual cash dividend and could also enjoy capital appreciation. What should the representative do before offering the security to these clients? A Nothing, because they all receive protection under anti-fraud Rule 10b-5 under the Securities Exchange Act of 1934 B Nothing, because all of the investors are accredited under Regulation D of the Securities Act of 1933 C The registered representative should review the revenue and expenses as detailed in the PPM to see if it is feasible for the company to pay a 15% cash dividend D The registered representative must get a signed attestation from each attendee that they received the PPM

The best answer is C. FINRA requires that when a private placement is offered, the broker-dealer or its representatives must conduct a reasonable investigation concerning that security and the issuer's representations about it. FINRA states that a broker-dealer "may not rely blindly upon the issuer for information concerning a company and it cannot rely on information provided by the issuer in lieu of its own reasonable investigation." The fact that a BD's customers are accredited does not obviate this investigation. The BD must conduct a reasonable investigation concerning the: issuer and its management; business prospects of the issuer; assets held by the issuer; claims being made; and intended use of the proceeds of the offering. Note that if registered securities are being offered, this detailed "due diligence" investigation by the BD offering the investment is not required - it is only a requirement for private placement offerings (because in a registered securities offering, the issuer and underwriters perform the required due diligence). Also note that there is no requirement for a signed receipt that each attendee received a Private Placement Memorandum.

A customer has purchased 10,000 shares of Ladbroke's stock, a British gaming company. The stock is not traded in the United States. Ladbroke's declares and pays a dividend of 1,500 British Pounds, which when converted to dollars equals $2,000. Britain imposes a 15% withholding tax on dividends repatriated outside its borders. How is the dividend reported on this investor's U.S. tax return? A No dividends are reported, since the investment is made outside the United States B $1,700 of dividends are reported, since $300 was withheld in Britain C $2,000 of dividends are reported D $2,000 of dividends are reported, along with a $300 tax credit for monies withheld in Britain

The best answer is D. If a direct investment is made in a foreign security, that foreign country often withholds tax on dividends repatriated out of that country. If this occurs, the tax withheld is applied as a tax credit on that person's U.S. tax return. Thus, this person who received $2,000 of dividends, but who has $300 of taxes withheld on those dividends in Britain, would report the entire $2,000 of dividends received, along with a $300 tax credit for the tax withheld in Great Britain.

A 67-year old woman has heavily invested her portfolio in growth securities. She realizes that as she approaches retirement, she needs to reallocate her portfolio for more income. However, she does not want to give up the growth objective. What would be the best investment recommendation for the funds that she will reallocate away from growth securities in her portfolio? A Income stocks and emerging markets stocks B Income stocks and cyclical stocks C Cyclical stocks and emerging markets stocks D Income stocks and blue-chip stocks

The best answer is D. Income stocks will certainly provide income. Cyclical stocks may pay a decent dividend or they might not - furthermore, they might cut their dividend in a period of recession, since they are negatively impacted by the economic cycle - so these do not meet the objective of "more income." Emerging markets stocks will certainly provide growth, but with a high risk level for a 67-year old who is approaching retirement. Blue chip stocks should grow as fast as the overall market, are relatively "safe" investments for a 67-year old, and could also provide additional dividend income. Therefore, of the choices offered, Choice D is the best. Also note that it could be argued that if this 67-year old was highly risk tolerant, then some allocation to emerging markets stocks might make sense, but that is not addressed in the question and we have to take the "best" of the choices offered.

The "Efficient Market Theory" states that: I undervalued securities should exist II undervalued securities should not exist III overvalued securities should exist IV overvalued securities should not exist A I and III B I and IV C II and III D II and IV

The best answer is D. The "Efficient Market" Theory holds that prices of securities in the market fully reflect all publicly available information, so that undervalued or overvalued securities should not exist. Thus, securities selection based on any type of analytical method is irrelevant. In reality, most individuals believe that the market is only "partly" efficient in pricing securities - so that undervalued and overvalued securities will always exist. These could be identified by both fundamental and/or technical analysis.

All of the following statements are true about accrued interest EXCEPT accrued interest is: A added to the amount that the buyer must pay B added to the amount that the seller will receive C an offset to the buyer's interest income received D included in the seller's sales proceeds

The best answer is D. The accrued interest is added to the amount that the buyer must pay on the confirm; accrued interest is added to the amount that the seller will receive on the confirm. It is an offset to the buyer's interest income received for that year; it is an addition to the seller's interest income received for that year for tax purposes. Accrued interest is not included in the cost basis or sale proceeds for tax purposes.

Customer Name: Charlie Customer Age: 69 Marital Status: Single - Widowed Dependents: None Occupation: Retired Household Income: $31,000 (Social Security and Pension) Net Worth: $130,000 (excluding residence) Own Home: Yes $220,000 Value, No Mortgage Investment Objective: Current Income Risk Tolerance: Low Investment Time Horizon: 20 years Investment Experience: 0 years Current Portfolio Composition: Cash in Bank: $130,000 After reviewing this customer's profile sheet, which recommendation would be most appropriate? A The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year TIPS to meet the customer's desire for current income and his low risk tolerance requirements B The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year STRIPS to meet the customer's desire for current income and his low risk tolerance requirements C The customer should mortgage his house for $100,000 at current market interest rates and use the proceeds to buy 20 year income bonds to provide current income D The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year Treasury Bonds to meet the customer's desire for current income and his low risk tolerance requirements

The best answer is D. This customer is age 69, with no current investments or investment experience. The customer has a fairly low retirement income and needs additional current income to live comfortably. This customer really only has 2 assets to tap for potential current income. He owns a fully paid house worth $220,000; and has $130,000 of cash in the bank. One way to supplement income is for the customer to get a reverse mortgage on the house, but this is not a banking exam, so we will not go near that possibility! The other way to supplement income is to invest the cash in the bank in an investment that is safe and that gives current income. Treasury Bonds pay interest semi-annually at a higher rate than that earned on bank deposits, and are really safe, so these would be the best recommendation. STRIPS do not provide current income since they are a zero-coupon Treasury obligation so these will not work. TIPS give a lower current interest rate than regular Treasury bonds, in return for protecting the investor against inflation - however the inflation protection is not "paid" until maturity, so again, these will not give the greatest additional current income.

Which bond recommendation would be the LEAST safe for an individual who seeks income that is free from federal income tax? A AA-rated revenue bond that is escrowed to maturity B AAA-rated general obligation bond C PHA bond D Double-barreled bond

The best answer is D. This one is special! A bond that is escrowed to maturity (ETM) is backed by escrowed U.S. Government securities - so it becomes the "safest" municipal bond because it becomes government backed. A PHA bond is a Public Housing Authority revenue bond - this is backed by the rental income from subsidized housing, and also backed by the full faith and credit of the U.S. Government to make it marketable. Again, this is another "safest" municipal bond because it is government backed. AAA rated general obligation bonds are extremely safe - they are backed by unlimited tax collections and have a top credit rating. Finally, a double-barreled bond is a revenue bond that is additionally backed by a municipality's "full faith and credit" if the revenues fall short, so it has a back-up G.O. backing. It is also extremely safe - just not as safe as the other choices. Note that this choice does not have a credit rating as a guide - if it did, it would be much easier to answer this question!

A wealthy, sophisticated investor with a high risk tolerance has just turned extremely bullish on the market. To profit from this, the BEST recommendation to the client would be to: A buy index calls B buy index puts C buy inverse ETFs D buy leveraged ETFs

The best answer is D. This customer has just turned "extremely bullish" on the market, meaning he thinks that equities are going to rise rapidly in price. The customer is wealthy, sophisticated, and has a high risk tolerance. The most aggressive choice offered is the leveraged ETF. Assume it is a 300% leveraged ETF based on the S&P 500 Index. If the index rises by 15%, this ETF should rise by 3 x 15% = 45%. (Of course, if the customer is wrong and the index falls, then the customer loses big time!) The purchase of an inverse ETF is not appropriate because it moves opposite to the general market, so if the market rises, it falls. Of course, if the customer were to short an inverse ETF, then if the market moved up, the inverse ETF would fall in value, for a profit on the short position - but this is not offered as a choice.

A registered representative sends a prospecting letter to customers stating that significant profits can be achieved by purchasing call options in a rising market. This claim: A is prohibited under the rules of the options exchanges B must be balanced by a statement that trading options can also result in significant losses C can only be made if it is documented by actual customer examples which occurred within the past year D is permitted and does not require any prior approval

The best answer is D. A customer who receives any options communication that makes a recommendation; shows past performance; or includes a performance projection; must get the latest Options Disclosure Document (ODD) at or prior to the receipt of the material.

Delivery of which of the following options communications containing a recommendation must be accompanied or preceded by an Options Disclosure Document? I Options Advertising II Options Correspondence III Options Sales Literature A I only B I and II C II and III D I, II, III

The best answer is D. A customer who receives any options communication that makes a recommendation; shows past performance; or includes a performance projection; must get the latest Options Disclosure Document (ODD) at or prior to the receipt of the material.

A broker-dealer who acted as financial advisor to a municipality in structuring a new issue now wishes to act as underwriter in the bond offering. Which statement is TRUE? A This is permitted without restriction B This is only permitted for competitive bid underwritings C This is only permitted for negotiated underwritings D This is prohibited for both competitive bid and negotiated underwritings

The best answer is D. A financial advisor to a municipality receives an advisory fee for helping a municipality structure a new bond issue, with the goal of getting the lowest interest cost for the issuer. An underwriter for a new municipal issue wants to get the highest interest rates possible on the bonds, because it makes them easier to sell. Thus, there is an inherent conflict of interest between the two. The MSRB rule on this is simple - the financial advisor cannot be the underwriter. It makes no difference if the underwriting is competitive bid or negotiated.

A "saucer" formation is a(n): A uptrend B downtrend C reverse upward trend D reverse downward trend

The best answer is D. A saucer formation is bullish since the market has bottomed out and is now moving back upwards. It is a downtrend that has reversed itself

Under SEC Rule 145, all of the following corporate distributions by an issuer are exempt from the requirement to file a registration statement EXCEPT: A stock dividend B fractional stock split C whole stock split D stock spin off

The best answer is D. Corporate distributions that result in an issuer distributing the exact same class of security to existing shareholders do not require a registration statement filing with the SEC. Thus, a corporation distributing a stock dividend or splitting its stock would not require a registration statement filing. However, if a corporation spins off a subsidiary to its shareholders, the shareholders are receiving stock in a different company, so a registration statement must be filed for those shares

When making a recommendation of corporate commercial paper to a customer, which risk is the MOST important consideration? A Inflation (purchasing power) risk B Call risk C Market risk D Credit risk

The best answer is D. Credit risk is the risk that the issuer cannot make interest and principal payments as due. Since Commercial Paper is unsecured, investors are buying a security backed only by "faith and credit" - so credit quality is the major consideration. Because commercial paper is short term, there is minimal purchasing power risk and market risk. Over a short term time horizon, short term interest rates cannot rise much. Commercial Paper, like all money market instruments, is non-callable so this risk is not a factor.

The Securities Acts Amendments of 1975 which established the Municipal Securities Rulemaking Board allow the MSRB to do all of the following EXCEPT: A create regulations covering municipal related recordkeeping B create regulations covering disclosure on new issues (Official Statements) C create regulations for determining fair and reasonable mark-ups and commissions D enforce any regulations that it adopts

The best answer is D. The MSRB is empowered to create regulations for participants in the municipals market, but has no enforcement power. Enforcement is performed by the banking and securities regulators. The MSRB has set rules related to municipal recordkeeping and disclosure. It also sets guidelines for municipal firms to use when setting commissions and mark-ups to customers, so that the charges are fair.

A customer sells 1 ABC Oct 50 Call @ $3 and the contract is assigned. What are the sale proceeds for tax purposes? A $3 B $47 C $50 D $53

The best answer is D. When a call option is exercised by the holder, the Options Clearing Corporation "assigns" the contract to any one of the individuals or firms that sold that option on a random basis. When a call contract is assigned, the writer is selling the stock. The sale proceeds are equal to all monies received for the stock - $50 per share strike price plus $3 per share received in premiums equals a $53 per share sale proceeds. Notice that this is the same as the breakeven.

A woman is the owner of 200,000 shares of XYZ stock. XYZ is a publicly traded company with 1,000,000 shares outstanding. Which of the following statements are TRUE? I She is considered an "insider" under the Securities Exchange Act of 1934 II She is prohibited from selling XYZ stock short III She must report trading activity to the SEC IV She must be registered with the SEC as a holder of more than 5% of the company's stock A I and II B II and III C I, II, III D I, II, III, IV

The best answer is D. All of the statements are true. A holder of 10% or more is considered an insider. Insiders are prohibited from selling that company's stock short and must report their trading activity to the SEC (within 2 business days of each trade). Any holder of 5% or more of a company's stock must file with the SEC under Section 13D.

In January, 20XX a customer buys 100 shares of ABC stock at $30 per share and pays a $2 commission per share. The customer receives $1 in cash dividends during the year. The customer's cost basis in the stock is: A $28 per share B $30 per share C $31 per share D $32 per share

The best answer is D. When the stock is purchased, any commission paid is not deductible - it is part of the cost basis of the shares. Thus, the cost basis for tax purposes is $30 + $2 commission = $32 per share. The $1 dividend received is included in taxable income for this year, and is not part of the stock's cost basis.