Series 7 Prac exam 4

An investor opens a long position in one XYZ Nov 140 put @7. Disregarding any commissions, if the option is exercised, on settlement date the investor A) must pay $14,000. B) receives $700. C) must pay $700. D) receives $14,000.

d Explanation When an investor takes a long position in an option, it means that the investor has purchased the option. When a put is exercised, the holder must deliver the stock on settlement date. At that time, proceeds representing the strike price ($140) for 100 shares ($14,000) are received.

An investor buys a yield-based Sep 70 call on a 30-year T-bond for a premium of 2.50. At expiration, if the yield on the most recently issued T-bond is 7.95%, what is the investor's gain or loss? A) $700 gain B) $700 loss C) $950 loss D) $950 gain

A Explanation A Sep 70 call means that the holder is buying a 7% yield. The investor can close the option at its intrinsic value (7.95 − 7.00 = 0.95; 0.95 × 10 × $100 = $950 received upon close). Subtract the $250 premium paid for a total profit of $700.

A customer invests $20,000 in a direct participation program and signs a recourse note for $50,000. During the first year of operation, the customer receives a cash distribution of $15,000 from the partnership. At year's end, the customer receives a K-1 statement reporting his share of partnership losses of $75,000. How much of the loss may the customer deduct from passive income? A) $55,000 B) $35,000 C) $0 D) $75,000

A Explanation A limited partner can only deduct partnership losses to the extent of his basis. To determine basis, add the original investment ($20,000) to any recourse debt assumed by the investor ($50,000). Recourse debt adds to basis as the partner is liable for this amount. Cash distributions received reduce basis ($15,000). At year's end, the investor's basis and the amount he can deduct from passive income is $55,000.

An investor writing an XYZ Oct 50 put could cover that put with A) an XYZ Oct 55 put. B) an XYZ Jul 55 put. C) an XYY Oct 60 put. D) an XYZ Oct 45 put.

A Explanation A short put can be covered with a long put. The long put must have an exercise price the same or higher than the short put and an expiration date at least as long as the short put. The only choice meeting both criteria is the October 55 put. Two other ways to cover a short put is with short stock and cash. An XYY put will not cover an XYZ put. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.

Which of the following registers the securities and packages the program for a limited partnership? A) Syndicator B) General partner C) Limited partners D) Property manager

A Explanation A syndicator handles the registration of the limited partnership units.

A technical analyst is least concerned with A) declaration of increased dividends. B) trading volume. C) new highs and lows. D) open short positions.

A Explanation A technical analyst is interested in statistics about market or price performance, not the fundamental factors, the market, or the company's dividend policy. Technical analysts are interested in trading volume as a market statistic, new highs and lows, and open short positions, which could indicate future buying potential in the security.

When examining the portfolio of a municipal bond client, you notice that every bond is Aaa or Aa rated. In addition, each bond matures at about the same time and the coupon rates do not vary by more than 50 basis points. You also notice that over 10 different states are represented by the issuers with no state being represented more than twice. It would appear that this client has used A) geographical diversification. B) interest rate diversification. C) duration diversification. D) quality diversification.

A Explanation Diversification is a proven way of mitigating certain risks. A popular method in the municipal bond industry is to diversify by purchasing bonds issued in different parts of the country. There are other forms of diversification, but none of those are employed by this client. The coupon rates are all about the same. The quality is all about the same, as are the maturities (duration).

An investor is short stock at $70. If the stock's market price is $40, and the investor anticipates the price will continue to decline, to hedge against a rise in the price, the investor should A) buy a call. B) sell a call. C) buy a put. D) buy a straddle.

A Explanation If the investor buys a call on the stock, he has the right to buy it back (cover his short) at a fixed price. The best way to hedge an unrealized gain on a short stock position is to buy a call.

An investor establishes the following positions: Long 1 XYZ Apr 40 call for 6 Long 1 XYZ Apr 50 put for 8 If both options are sold for intrinsic value when XYZ trades at 44, the investor realizes a loss of A) $400. B) $200. C) $100. D) $1,000.

A Explanation If the opening purchase of the XYZ Apr 40 call was made at 6, and the closing sale of that call was made at 4, the difference of 2 represents a $200 loss. If the opening purchase of the XYZ Apr 50 put was made at 8, and the closing sale of that put was made at 6, the difference of 2 represents a $200 loss. The total loss for the account is $400.

Listed options on U.S. exchanges are available on all of the following currencies except A) the U.S. dollar. B) the Euro. C) the Japanese yen. D) the Canadian dollar.

A Explanation In the U.S., exchange-listed currency option contracts exist on foreign currencies, not on the U.S. dollar. With U.S. exchange-listed currency option contracts, the U.S. dollar is the base currency to which movements in the foreign currency is compared.

One of your customers owns a limited partnership interest in an oil and gas drilling program. The program was successful in finding oil and is expected to operate at a loss for the next year. The loss flowing through to the limited partner is generated by all of these except A) principal repayment on partnership debt. B) accelerated depreciation taken on the drilling equipment. C) depletion on the sale of oil removed from the ground. D) interest payments on partnership debt.

A Explanation Losses occur when expenses exceed revenues. Principal repayments are not an expense. Interest on debt is a deductible expense. Natural resources deplete and the depletion allowance is an expense similar in concept to depreciation, another expense. From a personal standpoint, compare this to your home mortgage−the interest is a deductible expense, but the portion representing payment of principal is not.

Proponents of which of the following technical theories assume that small investors are usually wrong? A) Odd lot B) Short interest C) Volume of trading D) Breadth of market

A Explanation Odd lots are usually traded by small investors; some analysts believe small investors are generally wrong.

Your firm is interested in submitting a bid on a forthcoming general obligation municipal bond issue. Your firm could obtain the appropriate bid worksheets through a service provided by A) The Bond Buyer. B) The Wall Street Journal. C) the Municipal Securities Rulemaking Board. D) Standard & Poor's.

A Explanation Official notices of sale announcing the offering of municipal issues to competitive bidders are published in The Bond Buyer, which offers a service to subscribers—called the New Issue Worksheet and Record Service, which summarizes each notice. It provides information about new issues put up for bid and worksheets for underwriters to determine yields and prices when bidding.

One of your customers has been regularly investing into the shares of an aggressive growth fund. The investor has a long time horizon and does not expect to touch the account for a number of years. In the event of an emergency, federal law would require redemption proceeds forwarded within A) 7 days. B) 2 business days (T+2). C) 30 calendar days. D) 4 business days (S+2).

A Explanation One of the provisions of the Investment Company Act is that redemption requests must be honored within 7 days.

Traders in stock index options are exposed to A) systematic risk. B) call risk. C) redemption risk. D) credit risk.

A Explanation Systematic risk is the possibility that an overall decline in the market will cause a loss in an investment. Index options investors are exposed to the risk that market movement will cause the option positions to move adversely.

A technical analyst would be most interested in A) support levels. B) current ratio. C) corporate earnings. D) price-to-earnings (P/E) ratio.

A Explanation Technical analysts care about price and volume trends in the marketplace, such as support levels. A corporation's earnings, P/E ratio, and current ratio would be of most interest to a fundamental analyst who reviews a company's financial statements in more detail.

Alternative minimum tax (AMT) A) is assessed against high annual income earners and disallows some deductions and exemptions used to calculate adjusted gross income. B) is assessed against low annual income earners and allows special deductions for them to be taken. C) is assessed against high annual income earners and gives them special deductions that lower income earners do not get. D) is assessed against all self-employed individuals.

A Explanation The AMT is assessed against high annual income earners. When calculating adjusted gross income, some deductions and exemptions are disallowed, resulting in a higher taxable adjusted gross income.

When a broker-dealer specializing in new issue municipal bonds needs current information, the usual choice is to consult A) The Bond Buyer. B) EMMA. C) the MSRB. D) The Thomson Municipal Market Monitor.

A Explanation The Bond Buyer, sometimes called the Daily Bond Buyer because it is published daily, is generally considered the "go to" source for information on the primary market for municipal issues. The Thomson Municipal Market Monitor (TM3) offers greater coverage of the secondary market and general news. EMMA contains information for retail, nonprofessional investors, not broker-dealers. The MSRB does contain information on its website, but it does not include the information on new issues that a broker-dealer will find in The Bond Buyer.

A customer, long 100 shares of QRS at 62.50, writes 1 QRS Sep 65 call at 1.50. If the call is exercised, which two statements are true? The gain is $250. The gain is $400. For tax purposes, cost basis per share is $62.50. For tax purposes, cost basis per share is $61. A) II and III B) I and III C) I and IV D) II and IV

A Explanation The customer has paid $62.50 for the stock and has received 1.50 for the call. If the Sep 65 call is exercised, the customer will receive 65 for the sale of the stock. After exercise, the total received is $66.50 ($1.50 + $65). $66.50 received minus $62.50 paid equals four points profit ($400). If a covered call writer is exercised, the cost basis for tax purposes is the purchase price of the stock. Sales proceeds for tax purposes are 66.50 per share (strike price plus premium).

If an investor with no other positions buys 2 DWQ Jun 45 calls at 3, and he exercises the calls when the stock is trading at 47.25 and immediately sells the stock in the market, what is the investor's profit or loss? A) $150 loss B) $75 loss C) $150 profit D) $75 profit

A Explanation The investor exercised the right to buy the stock for 45, and can sell the stock in the market for 47.25 for a gain of 2.25. The gain of 2.25 minus the premium of 3 gives the investor a loss of 0.75 per share. Multiplying the 0.75 loss by 200 (the number of shares) results in a loss of $150.

The MSRB defines an associated person of a broker-dealer who is primarily engaged in municipal securities activities other than retail sales to individuals as A) a municipal financial professional (MFP). B) a municipal securities professional (MSP). C) a municipal securities registered principal (Series 53). D) a municipal securities registered representative (Series 52).

A Explanation These MFPs are involved with functions other that retail sales of municipal bonds. The definition is an outgrowth of the "pay to play" rule because these are the individuals covered by that rule.

A customer contacted her registered representative requesting that her account be updated with her new residential address. The member firm must send a copy of the updated account record to the customer within A) 30 days. B) 45 days. C) 60 days. D) 15 days.

A Explanation Whenever a change is made to a customer record, a copy of that record must be sent to the customer within 30 days.

An investor purchases a U.S. Treasury bond put option. The option is in the money on the last trading day and the investor exercises the put. Which of the following statements is correct? A) On the settlement date, the investor will receive cash in the amount of the intrinsic value. B) The investor will sell the option for its intrinsic value. C) On the settlement date, the investor will deliver the bonds and receive cash in the amount of the intrinsic value. D) On the settlement date, the investor will pay cash in the amount of the intrinsic value.

A Explanation Yield-based options settle in cash. The settlement amount is the intrinsic value. When an investor holding a put option exercises, the debt security is, in essence, being sold to (put to) the writer of the option. Instead of physical delivery of the bonds, settlement is made in cash. It is quite possible the investor will simply sell the option for its intrinsic value. That isn't the correct answer to this question because you are told the investor exercises the put.

Interest received on a California general obligation bond purchased by a San Francisco resident is exempt from A) federal income tax only. B) state and federal income taxes. C) capital gains taxes only. D) state income tax only.

B Explanation A municipal bond is generally exempt from federal and state income taxes in the state in which it was issued. The exemption, or lack thereof, applies to interest, not capital gains.

Special tax bonds are A) self-supporting bonds. B) backed by sales, excise taxes, or both. C) general obligation bonds. D) backed by property taxes.

B Explanation A special tax bond is backed by one or more designated taxes (sales, cigarette, fuel, alcohol, etc.) other than ad valorem taxes. The designated tax need not be directly related to the project purpose. These bonds are not considered self-supporting debt.

company's changing from straight line to accelerated depreciation will increase income in the early years. decrease income in the early years. increase income in the later years. decrease income in the later years. A) I and IV B) II and III C) II and IV D) I and III

B Explanation Accelerated depreciation increases charged expenses during the early years of equipment life but decreases charged expenses during the later years.

A client's account shows no activity other than some dividends received. Based on this information, statements must be sent A) monthly. B) quarterly. C) semiannually. D) annually.

B Explanation All customer accounts, other than those containing penny stocks, receive account statements quarterly. For statement purposes, the term activity includes the receipt of dividends or interest, but that does not change the quarterly requirement.

In portfolio theory, the alpha of a security or a portfolio is A) the risk of the portfolio associated with the macroeconomic factors that affect all risky assets. B) the difference in the expected return of the portfolio, given the portfolio's beta, and the actual return the portfolio achieved. C) the portfolio's average return divided by the security's beta. D) a measure of the variance in returns of a portfolio divided by its average return.

B Explanation Alpha is the difference in the expected return of the portfolio, given the portfolio's beta and the actual return the portfolio achieved. The higher the alpha, the better the portfolio has done in achieving excess or abnormal returns.

An investment company that holds which of the following does not meet the definition of a diversified investment company under the Investment Company Act of 1940? A) Four percent of its assets invested in the stock of a major publicly held corporation B) Thirty-three percent of its assets in securities issued by a small-cap new issue C) Eight percent of a given corporation's voting stock in its portfolio D) Eighty percent of its assets in securities of 50 health care companies

B Explanation An investment company that has invested 33% of its assets in any issue, small-cap or not, exceeds the limits set in the 75-5-10 test. This test requires that 75% of the assets be invested in securities issued by companies other than the investment company (regardless of the type of companies) so that no more than 5% of total assets are invested in any one company and no more than 10% of an outside corporation's voting securities are owned by the investment company.

A fundamental analyst is reviewing GEMCO's financial statements. The company has a current ratio of 4:1, a price-to-earnings (P/E) ratio of 12:1, $10 million in 5% debentures, and net income after preferred dividends of $4 million. If the current market price of GEMCO stock is $60 and the company pays dividends at a rate of $0.75 quarterly, the dividend payout ratio is A) 5%. B) 60%. C) 20%. D) 40%.

B Explanation As with many computational problems, there is some unnecessary information given. The current ratio is irrelevant, and so is the information on the debentures. What is needed is the amount available to pay the common so that we can compare that to the amount actually paid. We see that $0.75 in quarterly dividends are paid. That is equal to $3 per year. The next key is determining the earnings. With a market price of $60 per share and a price-to-earnings ratio of 12:1, the earnings per share must be $5. The dividend payout ratio should be thought of as "dividends paid out of earnings made." The dividends paid are $3; the earnings made are $5. That is a 3 to 5 ratio, or, as usually expressed in percentage form, 60%.

An outstanding municipal bond issue has the following characteristics: 7.50% coupon, maturity in 20 years, puttable in five years at 100, callable at 102 in 10 years, declining in a straight line to maturity, and yield to maturity is 6.50%. The issues should now be quoted A) yield-to-put. B) yield to call at 102. C) yield to maturity. D) yield to call at par.

B Explanation Because the bond issue is selling at a premium, the yield to call is less than the yield to maturity. The bonds must be quoted as yield to call at the earliest maturity, which would be the 10-year call at 102. If the bonds were selling at a discount, yield to maturity would be the proper quote. Yield-to-put is not required to be quoted.

In a declining market, which of the following is most volatile? A) A stock with an alpha of +0.5 B) A stock with a beta of 2.0 C) A stock with a beta of 0.5 D) A stock with an alpha of +2.0

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.

The analytical tool used to measure the variability between a particular stock's (or portfolio's) movement and that of the market in general is A) standard deviation. B) beta. C) the correlation coefficient. D) alpha.

B Explanation Beta measures the systematic risk of a stock by comparing the variability between a particular stock's (or portfolio's) movement and that of the market in general. It only measures systematic risk not total risk. The beta coefficient of the market is set at 1.0. If the beta of the stock (or portfolio) is higher than 1.0, it is more volatile than the market. If it is less than 1.0, it is less volatile than the market. Alpha is the tool used to measure how a stock (or an asset manager) performed compared with the investment's expected rate of return based on its beta. Standard deviation measures the total risk of an investment (systematic risk + unsystematic risk). The correlation coefficient measures how two investments move in correlation with each other. A high correlation means they move in step with each other. A negative correlation means they move in opposite directions.

An investor buys 2 LMN 40 calls and pays a premium of 4 each, and also buys 2 LMN 40 puts and pays a premium of 2.50 each. At the time of purchase, LMN is trading at $40.75. On the expiration date, LMN is trading at $32.50. If the investor closes her position for its intrinsic value, excluding commissions, the investor realizes A) a $200 loss. B) a $200 profit. C) a $100 loss. D) a $100 profit.

B Explanation Closing out a position is the opposite of the opening transaction. In this situation, the investor opened by buying two calls for a total of $800, and closed them out by selling for their intrinsic value. (Calls have intrinsic value when the market value is above the strike price; in this situation, there is no intrinsic value.) The investor also bought two puts for a total of $500 and closed them out by selling for their intrinsic value of $1,500. (Puts have intrinsic value when the market value is below the strike price; in this situation, the intrinsic value is $7.50 per contract, or 40 − 32.50 = 7.5 × 2 = 15 × 100 shares = $1,500.) The resulting profit on the position is $200 ($1,500 − $1,300), the total of the premiums paid for all of the options.

On Friday, September 15, an investor goes long 1 OEX Dec 575 call at 7 when the index is at 581.96. At expiration, the investor closes out the long position at intrinsic value when the index is at 580. What amount of money will be deposited in the investor's account on the following Monday, and what will the profit or loss be to the investor? A) $500/$196 loss B) $500/$200 loss C) $696/$196 gain D) $500/$200 gain

B Explanation Index options settle in cash on the next business day. Each point in an index option is valued at $100. On settlement, the investor will receive the difference between 580 and 575 (5 × 100), or $500. With a cost of 7 ($700), this will create a $200 loss.

All of the following appear on a corporation's balance sheet as fixed assets except A) computer equipment. B) inventory. C) real estate. D) furniture.

B Explanation Inventory is considered a current asset—not a fixed asset—because the company expects to convert its inventory into cash within a short time. The other choices are fixed assets and cannot be liquidated easily.

Which of the following statements regarding the exercise of options contracts are true? The exercise of equity options settles the next business day. The exercise of equity options settles in two business days. The exercise of index options settles the next business day. The exercise of index options settles in two business days. A) II and IV B) II and III C) I and IV D) I and III

B Explanation Listed equity options, if exercised, settle in two business days (regular way settlement for equities). Index options, if exercised, settle on the next business day—and in cash.

A company reported annual earnings of $2.40 per share and paid annual dividends of $0.60. If the dividends were distributed quarterly, what was the amount and payout rate? A) $0.15 at 6.25% B) $0.15 at 25% C) $0.60 at 25% D) $0.60 at 10%

B Explanation One-quarter of $0.60 is $0.15. $0.60 is 25% of $2.40.

FINRA member firms are required to follow the recordkeeping rules of the SEC. Under SEC Rule 17a-4, all of the following records are required to be retained for a minimum of six years except A) customer account records. B) trade confirmations. C) trade blotters. D) customer ledgers.

B Explanation SEC rules require firms to retain blotters and ledgers for at least six years. Customer account records must be kept for at least six years after the account has been closed. Most records have a three-year retention requirement. Copies of trade confirmations are included in that three-year group. Whether a six-year or a three-year record, during the first two years, these records must be kept in an easily accessible place.

An investor opens the following positions: Buy 100 shares of RJN @46; buy 1 RJN Mar 45 put @2½. What is the customer's maximum gain, maximum loss, and breakeven point? A) Maximum gain is unlimited; maximum loss is $350; breakeven point is $42.50. B) Maximum gain is unlimited; maximum loss is $350; breakeven point is $48.50. C) Maximum gain is $4,250; maximum loss is $250; breakeven point is $48.50. D) Maximum gain is $350; maximum loss is $4,250; breakeven point is $42.50.

B Explanation The first step is to identify the position. This is a long stock position with a protective put. That is, the customer has purchased the stock and purchased a put to protect the downside. Using an option as a form of insurance is the primary reason why the industry refers to the price of an option as the premium. On questions with stock and an option, it is usually best to compute the breakeven point first. Breakeven is when the long stock can be sold at the customer's total cost. That cost is the price of the stock ($46) plus the price paid for the option ($2½), or $48.50. If the stock should rise above $45, the customer will let the 45 put expire and maintain the long stock position. An investor with a long stock position has unlimited potential gain. If the stock price should decline, no matter how low it drops, the customer can exercise the long put and sell the stock for $45 per share. That means the maximum loss is the premium paid for the option, ($250) plus the difference between the cost of the stock and the proceeds from the put ($100), or $350. Why doesn't the breakeven follow the "put-down" rule? That rule applies when the only positions are options. Once there is a long or short stock position along with an option position, it is the stock controlling the breakeven.

An investor purchases 200 shares of ABC common stock, but is concerned about market risk. While the investor cannot use diversification to reduce market risk by investing in the same asset class, they can hedge against the risk. Which of the following options positions would be used as such a hedge? A) Buy an ABC put B) Buy 2 ABC puts C) Sell 1 ABC put D) Sell 1 ABC call

B Explanation The investor should buy two ABC put options (the investor is long 200 shares). Options can be used as a hedge (protection) against risk or can be used to provide income. To use as a hedge, the investor should buy (go long) the option. To use as income, the investor should sell (go short) the option. Here the investor is using the option to hedge, so they will be buying the option, not selling. Investors use long puts to hedge a long stock position and long call options to hedge a short stock position.

A margin account customer buys 100 shares of HEX at $70 and writes a HEX Oct 70 call for a premium of 8. What must he deposit? (Regulation T is 50%.) A) $2,000 B) $2,700 C) $4,500 D) $3,700

B Explanation The normal call would be 50% of $7,000, or $3,500. In this example, subtract the premium of $800 that the customer received. (Remember, in a covered call situation, no margin is required for the call.)

Typically, new municipal bond issues are sold to investors before the bonds are issued and available for delivery. An investor receives a when-issued confirmation describing the bonds. What information is included on this confirmation? A) The settlement date B) The trade date C) The total amount due D) The accrued interest

B Explanation The trade is known, so it is on the confirmation. Because the bonds are not available for delivery, the settlement date is unknown. Without a settlement date, accrued interest cannot be computed. Without accrued interest, there is no way to compute the total price.

In March, a customer sells 1 ABC Oct 50 put for 3 and buys 1 ABC Oct 60 put for 11. The customer will experience a pretax profit from these positions if the difference between the premiums narrows to less than $8. the difference between the premiums widens to more than $8. both puts are exercised at the same time. both puts expire unexercised. A) II and IV B) II and III C) I and IV D) I and III

B Explanation This debit spread becomes profitable if the spread widens between the premiums. Credit spreads are profitable if the spread narrows between the premiums. If both puts are exercised, the spread is profitable. If the short 50 put is exercised, the customer buys the stock and sells it for 60 by exercising the long 60 put ($1,000 profit − $800 premiums = net $200 profit).

John purchased a DMF May 90 call and simultaneously sold a DMF Jun 80 call. Which of the following best describes John's position? A) A short spread B) A bear spread C) A bull spread D) A long spread

B Explanation This investor has established a net credit diagonal call spread. He bought the lower premium call (higher strike and earliest expiry) and sold the higher premium call (lower strike and longest expiry). He hopes the spread will narrow to zero (if the market falls below 80 and both calls expire worthless) so he can keep all of the premiums. He is a bear, and so is the spread.

Which of the following is an automated system of delivering information relating to the market for municipal securities? A) The Bond Buyer B) Thomson's Muni News or Muni Market Monitor (Munifacts) C) The Blue List D) INSTINET

B Explanation Thomson's Muni News or Muni Market Monitor (formerly Munifacts) supplies up-to-the-minute information to its subscribers.

A 58 year-old investor owns a single premium deferred variable annuity with a current value of $500,000. The original investment was $150,000 and the contract has a death benefit provision. If the investor suddenly passes away and the beneficiary receives a lump sum payout, A) the beneficiary will owe ordinary income taxes on $500,000 plus 10% penalty if under 59½. B) the beneficiary will owe ordinary income taxes on $350,000. C) the beneficiary will owe ordinary income taxes on $350,000 plus 10% penalty if under 59½. D) the beneficiary will owe ordinary income taxes on $500,000.

B Explanation When receiving the death benefit in a lump sum, the beneficiary's tax situation is the same as if the owner surrendered the policy with one critical difference. Surrender before reaching age 59½ leads to the 10% tax penalty, but that penalty is waived in the case of death. It is only the deferred earnings (in this question, the $350,000 difference between the initial deposit and the current value) that is subject to taxes. As is always the case with annuities, the taxation is always as ordinary income, never capital gains.

When speaking to a customer about exchange-traded funds (ETFs), a registered representative could accurately state that these funds A) cannot be bought on margin. B) do not have the same potential tax consequences as mutual funds, such as making capital gains distributions annually. C) cannot be purchased using traditional limit or stop orders. D) can be purchased only by paying a sales charge added to the net asset value.

B Explanation With ETFs, portfolio turnover rate is minimized because they do not have to buy and sell shares within their portfolio to accommodate shareholder purchases and redemptions. This can affect the potential tax consequences. While an ETF can make a capital gains distribution, they generally do not—unlike a mutual fund, which generally would make such distributions on an annual basis. ETFs can be traded like other exchange products using traditional stock trading techniques and are priced by supply and demand. Customers pay commissions, not sales charges.

In the underwriting of a new municipal GO bond issue, who would earn the selling concession? A) The syndicate manager B) A selling group member C) A member of the syndicate D) The registered representative who actually sold the bonds

B Explanation When a selling group member is part of the underwriting, their compensation is the selling concession. The manager earns the management fee. The syndicate members earn the takedown.

Buy 1 XYZ Apr 30 Call Sell 1 XYZ Mar 30 Call Dom position? Credit/debit? Narrow/Widen? Attitude?

Bull, Debit, Widen, Dom: Apr 30 call (same SP, longer Expiration because more time value)

A money market mutual fund would be least likely to invest in which of the following assets? A) Bank certificates of deposit B) Repurchase agreements C) U.S. Treasury notes D) U.S. Treasury bills

C Explanation A money market mutual fund typically invests in money market instruments or those with a maturity date not exceeding 397 days. Treasury notes have maturity dates of 2-10 years.

All of the following deal with the secondary market except A) broker's broker. B) Thomson's Muni Market Monitor (formerly Munifacts). C) notice of sale. D) dealer quotes.

C Explanation A notice of sale is published to provide syndicates with information on proposed new (primary market) issues. Dealers are selling out of inventory (secondary trading). A broker's broker executes trades in municipal securities for or on behalf of another Municipal Securities Rulemaking Board member firm. Transactions by a broker's broker could be in both the primary and secondary markets.

If a chart indicates that both the Dow Jones Industrial Average and the advance/decline line have been increasing since January, and the advance/decline line continues to rise, the market should A) turn down sharply. B) not change. C) continue to rise. D) turn down moderately.

C Explanation A rising advance/decline line indicates that more stocks are rising in price than falling. A rising advance/decline line is a bullish indicator.

On January 18, your customer sold 500 shares of MNO for a loss of $5 per share. If on March 1 she bought 3 MNO calls, how much of the loss could she declare for tax purposes? A) $1,000 B) None C) $2,500 D) $1,500

C Explanation Because the purchase of the calls took place more than 30 days after the sale, the transaction is not a wash sale. She may therefore declare the entire $2,500 as a loss

All of the following are suitable objectives for a covered call writer except A) increasing return on a long stock position. B) speculating that a stock will not rise in price. C) profiting from an increase in the price of stock. D) providing downside protection for a long stock position.

C Explanation Covered call writers are not able to benefit from an increase in the price of the underlying stock. For example, you buy stock at $40 and write a 40 call. Now, the stock is 80. Isn't that great? Your long stock position has doubled. Not so fast. With the stock at 80, it is certain that the 40 call will be exercised. So no matter how high the stock goes, the covered writer can't benefit because the call will be exercised and the stock will be sold at the $40 strike price. Why sell covered calls? This strategy provides downside protection to the extent of the premium received, and it increases the rate of return on a long stock position (because of the premium collected).

The Code of Arbitration Procedure would be mandatory to settle disputes between which of these? A member and a registered clearing corporation A member and one of its associated persons An associated person with a statutory discrimination claim against a member A member and a client who has signed a predispute arbitration clause A) I and II B) II, III, and IV C) I, II, and IV D) II and IV

C Explanation Disputes between anyone in the industry, including registered clearing corporations, must go to arbitration, with the exception of statutory discrimination claims, which are claims alleging sexual harassment or discrimination on the basis of, among other things, age, sex, or ethnicity. Such claims may be taken to court instead of arbitration. When a client has signed a predispute arbitration agreement, arbitration is mandatory.

Mutual fund shares represent an undivided interest in the fund, which means that A) the fund can only hold securities of certain companies. B) investors can only purchase full shares. C) each investor owns a proportional part of every security in the portfolio. D) the number of shares outstanding is limited to a predetermined maximum.

C Explanation Each mutual fund shareholder owns an undivided interest in the investment company's portfolio. Because each share represents one class of voting stock, the investor's interest in the fund is reflected by the number of shares owned.

One of the computations in a margin account is that of the SMA. Which of the following actions would cause the SMA to increase? A) The purchase of securities in a long account B) The market value of long securities decreasing C) The market value of short securities decreasing D) The withdrawal of cash from a short margin account

C Explanation Excess equity creates SMA in the account. Excess equity is created when the stock in a margin account moves in a favorable direction. In the case of a short margin account, the equity goes up as the market value of the securities goes down. In the case of a long account, a decline in the market value causes the equity to decrease. The purchase of securities in a long account may decrease SMA if SMA is used to meet the margin call. If not, SMA remains the same; it does not increase. Withdrawing cash will cause the SMA to go down if the funds are withdrawn from the SMA. Otherwise, the SMA remains the same; it does not increase.

A couple opens a joint account with your firm. It is registered as JTWROS. If one of the couple passes away, FINRA rules require that account records be kept for a minimum of A) three years after the surviving person closes the account or passes away. B) three years after the death of the initial person. C) six years after the surviving person closes the account or passes away. D) six years after the death of the initial person.

C Explanation FINRA and MSRB rules require that customer account records be kept for at least six years after the account is closed. Because the assets in a JTWROS account remain intact after the death of a co-owner, the recordkeeping requirements extend until the account is finally closed. Even though, technically, the account is retitled in the name(s) of the surviving owner(s), the information from the original account is kept for that entire period.

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.

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.

An aggressive investor is willing to risk $25,000 to align with his bearish outlook on the overall market. He notes liquidity being important if he needs to divest quickly, and risk taken needs to be commensurate with the upside potential. Which of the following would align most suitably with these objectives? A) Hedge fund B) Shorting broad-based index calls C) Broad-based market inverse index fund D) Narrow-based index fund

C Explanation Inverse, or reverse, funds attempt to deliver returns that are opposite of those returned by the index they are tracking. If the index fell, aligning with this investor's bearish market outlook, a broad-based inverse index fund should do well, generating positive returns as the index performs negatively. When shorting calls, gains are limited to the premiums collected, and losses are potentially unlimited, which embody too much risk with not enough gain. Hedge funds are not deemed to be liquid and can be eliminated based on the investor's desire to get out quickly. An index fund (not inverse or reverse) moves with the market, and losses would occur if the markets faltered as this investor expects.

The Class A shares of the GEMCO Balanced Fund carry a sales charge of 4.5%. If the next computed net asset value per share is $32.74, purchase orders will be filled at a price of A) $31.27 per share. B) $32.74 per share. C) $34.28 per share. D) $34.21 per share.

C Explanation Mutual funds sell at the public offering price (POP). That POP includes the sales charge—in this case, 4.5%. The sales charge is a percentage of the POP, not the NAV. The computation is the NAV divided by (100% - the sales charge). In our question, that is $32.74 ÷ 0.955, or $34.28 per share.

In addition to their tax advantages, municipal bonds are often purchased for their safety. Your client wishing to purchase municipal bonds with the utmost in safety should buy A) moral obligation bonds. B) double-barreled bonds. C) New Housing Authority bonds. D) general obligation bonds.

C Explanation NHAs, sometimes called Public Housing Authority or PHA bonds, have the backing of the federal government. As such, they are the safest of all municipal securities.

All of the following must be sold with a prospectus except A) closed-end funds in the primary market. B) an IPO of common stock. C) closed-end funds in the secondary market. D) open-end funds in the primary market.

C Explanation Securities sold in the secondary market do not have a prospectus delivery requirement.

All of the following are true of stockholders' equity except A) that it is also called net worth. B) that it is reflected in the book value of the stock. C) that it is carried as an asset on the balance sheet. D) that it consists of stock issued, capital surplus, and retained earnings.

C Explanation Stockholders' equity or net worth (total assets less liabilities) is what a stockholder is entitled to should a company liquidate.

A customer buys 10 Dec 91.50 calls on the Canadian dollar for 6.70. ($10,000 CD per contract). At the time of purchase, the spot rate for the Canadian dollar was 92.25. What is the margin requirement for the purchase? A) $3,350 B) $9,225 C) $6,700 D) $9,150

C Explanation The client purchased 10 calls at 6.70 for a total of $6,700. Because—with the exception of LEAPS—options cannot be purchased on margin, the margin requirement is 100% of the premium.

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 her stock by exercising the put, the result is A) a loss of $150. B) a gain of $875. C) a gain of $850. D) a gain of $575.

C 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).

The common stock of Porcine Meat Products, Inc., is currently selling at $60 per share. It has a P/E ratio of 12:1 and pays an annual dividend of $3 per share. That would make Porcine's dividend payout ratio equal to A) 36%. B) 12%. C) 60%. D) 5%.

C Explanation The dividend payout ratio is computed by dividing the dividend by the earnings per share. We know the dividend is $3, but how much are the earnings? With a P/E ratio of 12 to 1, the price of $60 is 12 times the earnings per share. Divide $60 by 12 and the EPS = $5 per share. If Porcine earned $5 and paid out $3 of it as dividends, it paid out 3/5th or 60%.

EC Rule 498 permits delivery of an abbreviated prospectus, usually referred to as a summary prospectus, in the sale of A) unit investment trusts. B) closed-end investment companies. C) open-end investment companies. D) investment-grade bonds.

C Explanation The summary prospectus, authorized under SEC Rule 498, is only effective when the product being sold is an open-end investment company.

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) I or III B) II or III C) I or IV D) II or IV

C 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.

Long an ABC Apr 60 call and short an ABC Apr 70 call is A) a net credit spread. B) a calendar spread. C) a net debit spread. D) a straddle.

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 her account.

An investor purchased a REIT from her broker-dealer in an SEC-registered public offering. The following year, she asked her registered representative for a quote. When told there is no current quote available, you would gather that this is A) an unregistered REIT. B) a hybrid REIT. C) an untraded REIT. D) an OTC traded REIT.

C Explanation Untraded or unlisted REITs are those not traded in the secondary markets (exchanges or OTC). Therefore, there is limited to no liquidity. As described in the question, this security is registered with the SEC, so it is not a private placement. Hybrid REITs are those that take equity and debt positions. With this lack of liquidity, you can expect suitability standards to be higher, and the trades would be subject to increased regulatory review.

A customer is long 10 XYZ Jan 60 calls, and XYZ declares a 20% stock dividend. On the ex-date, the customer will have A) 10 XYZ Jan 50 calls (100 shares per contract). B) 10 XYZ Jan 60 calls (100 shares per contract). C) 10 XYZ Jan 50 calls (120 shares per contract). D) 12 XYZ Jan 60 calls (120 shares per contract).

C Explanation When adjusting options contracts for stock dividends and fractional splits, the number of contracts held will not change. The number of shares covered by each contract is increased (100 shares × 120%) so that in this example, each adjusted contract now represents 120 shares. The effective exercise price is adjusted so that the position value remains the same before and after the adjustment. Therefore, the new strike price will be 50 ($6,000 / 120 shares = $50).

An investor takes a short position in one XYZ Nov 140 call @7. Disregarding any commissions, if the option is exercised, on settlement date, the investor A) must pay $700. B) receives $700. C) receives $14,000. D) must pay $14,000.

C Explanation When an investor takes a short position in an option, it means the investor has sold, or written the option. When a call option is exercised, the seller is obligated to deliver the stock at the exercise (strike) price. A strike price of $140 for 100 shares results in the seller receiving $14,000 on settlement date.

With ABC trading at 39, a customer buys 1 ABC Mar 40 call and sells 1 ABC Mar 35 call. A profit occurs if the spread widens. the spread narrows. ABC declines sharply. both contracts are exercised. A) I and III B) III and IV C) II and III D) II and IV

C Explanation Whenever there is a question where the choices are widen or narrow, you first need to determine if the spread is a debit or a credit. A debit spread is one where the option you buy costs more than what you receive for the one you sell. A credit spread is the opposite—the one you are selling has a higher price than the one you are buying. In this question, the premiums are not given, so we have to figure out which is the more expensive option. We have a 35 call and a 40 call. Which of those is more valuable? The ability to buy the stock at 35 or buy it at 40? The lower the exercise (strike) price of a call, the greater the value, so we know the premium on the 35 call will be higher than that of the 40 call. Therefore, selling the 35 and buying the 40 is going to be a credit spread because more money will come from the sale of the 35 that will go out for the purchase of the 40. Once we know it is a credit spread, we go to the answer choice narrow. And, when we want the spread to narrow, we want the options to expire, so IV cannot be correct. That sort of backs us into knowing that III is true, but let's be sure. We identify spreads as bullish or bearish, and the way to see that is, bulls buy low and sell high. When looking at this question, we see the option bought is the high strike price, and the one sold is the low strike price, so this must be a bearish position. Bears want the market price to fall, so yes, III is accurate.

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

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

If an investor has a fixed-annuity contract with an insurance company, which of the following risks is assumed by the investor? A) Mortality risk B) Value of each annuity unit each month C) Investment risk D) Purchasing power risk

D Explanation An investor who purchases a fixed-annuity contract assumes purchasing power risk. Fixed annuities pay a fixed monthly benefit that loses purchasing power if there is inflation.

When comparing portfolios, a registered representative dealing with a risk averse client would most likely recommend the one whose beta is A) 0.88. B) 1.40. C) 1.00. D) 0.23.

D Explanation Beta is a measure of a stock's volatility relative to the overall market. Risk averse investors are better served with lower volatility investments. The beta of the overall market is 1.0. The lower the beta the lower the volatility and the reverse.

All of the following accounts are permitted to write calls except A) a mutual fund against a long stock position. B) a custodian in an UTMA account against a long stock position. C) an individual in a margin account. D) a corporation against its own stock.

D Explanation Corporations are not permitted to write calls against their own stock. If exercised, they would have to issue shares at the strike price, and this would have a dilutive effect on shareholders.

One of your customers calls you to say that he received a letter saying that his local water works revenue bonds were being defeased. How would that affect the customer? A) Because of failure to generate sufficient revenue, interest payments are suspended temporarily. B) The maturity date is being automatically extended as called for in the official statement. C) The customer will need to file a claim with the appropriate court to receive payment for the bonds. D) The customer would be receiving payment of the principal plus any accrued interest after the defeasance is completed.

D Explanation Defeasance occurs when an outstanding bond issue is paid off prior to maturity through a refunding. Once the creditors (the bondholders) have received their funds, any liens on assets or revenues are terminated.

Which of the following is not a factor when a communication to be distributed to the public is either being reviewed or approved within the broker-dealer? A) Whether statements of benefits are balanced with statements of potential risks B) The nature of the audience to which the communication is intended to be distributed C) Whether achieving past performance results has been implied D) Whether the piece will be distributed in written form or via electronic media

D Explanation FINRA holds broker-dealers to certain general standards regarding all member firm communications. Consideration must be given to whether all statements in a communication are clear and not misleading, are balanced regarding the representation of risk and reward, do not omit material facts or make exaggerated claims, and do not imply that past performance can be projected to future outcomes. These standards would apply and be the same, whether the communication was distributed in written or electronic form.

If a customer is long ABC Sep 30 calls, and the stock becomes subject to a trading halt on the floor of the NYSE, the customer is permitted to A) enter a closing sale. B) establish a long straddle. C) establish a long call spread. D) issue exercise instructions.

D Explanation If trading in the underlying security is halted, options trading on that security is also halted. However, the customer may still issue exercise instructions to the Options Clearing Corporation because this is an off-floor transaction.

The market attitude of a customer who establishes a debit put spread is A) bullish. B) neutral. C) speculative. D) bearish.

D Explanation In a put spread, a customer is buying one put and selling another with different strike prices and/or expirations. In any spread, one of the options is dominant. In a long put spread, the long put position is dominant because it has the higher premium. Buying puts is bearish.

A customer buys a new issue municipal bond with a dated date of January 1 for settlement on January 31. If the first interest payment date is March 1, how many days of accrued interest will the customer pay to the syndicate? A) 60 B) 31 C) 0 D) 30

D Explanation In this new issue, interest begins to accrue as of the dated date, so the customer (buyer) must pay the syndicate interest from the dated date up to, but not including, the settlement date. The number of days from January 1 up to, but not including, January 31 is 30.

Which of the following regarding taxation of collateralized mortgage obligation (CMO) interest is true? A) It is taxed only on the state level. B) It is taxed only on the federal level. C) It is exempt from all taxation. D) It is subject to federal, state, and local taxes.

D Explanation Interest earned on all mortgage-backed securities is fully taxable.

All of the following ratios are measures of the liquidity of a corporation except A) acid test ratio. B) current ratio. C) quick ratio. D) debt/equity ratio.

D Explanation Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid test (quick) ratio. However, the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure.

Which of the following is the most stringent test of liquidity taken from a corporation's balance sheet? A) Current ratio B) Current assets / current liabilities C) Assets / current liabilities D) (Current assets - inventory) / current liabilities

D Explanation Of the answers given, the quick ratio (or the acid test) is the most stringent because it excludes inventory in the calculation. The current ratio is defined as current assets divided by current liabilities.

If an investor purchases 2 Dec 81.50 Swiss franc calls at 2.5 (each contract is 10,000 francs), how much does the investor pay for the position? A) $2,500 B) $250 C) $81,500 D) $500

D Explanation One call offered at 2.5 is equal to $250 multiplied by two contracts, for a total premium of $500.

If interest rates fall, which of the following statements regarding collateralized mortgage obligations are true? Prepayment risk will increase. Prepayment risk will decrease. Prices of each tranche will rise. Prices of each tranche will fall. A) II and IV B) I and IV C) II and III D) I and III

D Explanation Prepayment risk is the risk that the underlying mortgages will be paid off sooner than expected. If rates fall, mortgage holders will refinance, paying off the existing high-rate mortgages with lower rate mortgages. Thus, a tranche with an expected average life of 5.5 years may be extinguished in two years because of an acceleration in prepayments. As rates fall, prices of the remaining tranches will rise.

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

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

An analyst interested in measuring the breadth of market movement as an indicator of future market direction would monitor A) the betas of the S&P 500 stocks. B) the Value Line Index. C) the Dow Jones Industrial Average. D) the advance/decline line.

D Explanation The advance/decline line, which measures the number of stocks that have advanced versus the number of stocks that have declined, is an indicator of the breadth of the market's advance or decline.

If a customer buys 1 FLB Oct 50 call at 3 and she exercises the option to buy 100 shares when the market is at 60, what is the cost basis of the 100 shares? A) $5,000 B) $6,300 C) $6,000 D) $5,300

D Explanation The cost basis of the 100 shares is the total amount the investor spent to acquire them. She paid $300 to purchase the call option. When she exercised the call, she purchased 100 shares of FLB at $50 per share for $5,000, so the cost basis is $5,300.

The opening quote for issues listed on the NYSE is set by A) the exchange. B) the floor brokers based on the level of opening orders. C) the third-market makers. D) the designated market maker.

D Explanation The designated market maker is responsible for setting the opening quote for issues listed on the NYSE. The set quote is based on orders in hand.

A customer establishes the following positions: Buy 100 JMB at 28 Buy 1 JMB Dec 25 put at 2 What is the maximum potential loss? A) $2,800 B) $3,000 C) $200 D) $500

D Explanation The investor loses money on the long stock position when the market value falls. With the purchase of the put, the investor can sell the stock for no less than the strike price, but also loses the premium. In this example, the investor loses a maximum of $3 on the stock (28 − 25) plus the premium of $2, for a total loss of $500 on 100 shares.

The manager of a portfolio that consists predominately of large- and mid-cap stocks could hedge against a market downturn and generate additional income by A) buying broad index puts. B) selling broad index puts. C) buying broad index calls. D) selling broad index calls.

D Explanation The only way to generate income through the use of options is to sell them. If concerned that the market may fall, selling calls is the appropriate strategy.

The premium on the XYZ Jan 30 calls is 3 - 3.15, while the premium on the XYZ Jan 30 puts is quoted at 2.25 - 2.35. A customer establishing a short straddle receives total premiums of A) $550. B) $537. C) $545. D) $525.

D Explanation To establish a short straddle, the customer sells a call and a put at the bid price. The premiums received are $300 for the call and $225 for the put, for a total of $525.

One of your customers is interested in purchasing the shares of a new issue from a local manufacturing company. The issue is for $15 million of common stock. The investor's net worth is $95,000 and net income is $75,000 per year. The plan is to invest $15,000 into this stock. Under Regulation A of the Securities Act of 1933, this investment is A) not permitted because it represents more than 10% of the customer's net worth. B) not permitted because it represents more than 10% of the customer's net income. C) not permitted because Regulation A requires investors to be accredited. D) permitted.

D Explanation Under Regulation A, an offering of $20 million or less in a 12-month period is a Tier 1 offering. Unlike a Tier 2 (up to $50 million) offering, there are no restrictions based on net worth or net income

XYZ Corporation owns 18% of the voting common stock of ABCD Enterprises. In the current tax year, XYZ receives $250,000 in dividend income from its investment in ABCD. If XYZ has a marginal tax rate of 21%, what is its tax liability on the dividend income received? A) $52,500 B) $9,450 C) $0 D) $26,250

D Explanation Under the intercorporate dividend exclusion rule, if a corporation owns stock in another corporation, 50% of the dividends received is excluded from taxation. Therefore, only 50% of the $250,000 received is subject to tax (50% × $250,000 = $125,000). Applying a tax rate of 21% to $125,000 results in a tax liability of $26,250.

Index options differ from stock options in which of the following ways? A) The expiration date is the third Friday of the expiration month. B) The trade settlement date is the next business day. C) They are subject to closing purchases as well as closing sales. D) The exercise settlement is in cash.

D Explanation When an index option is exercised, cash is paid to the option holder for the amount in the money. In contrast, exercising a stock option involves delivering the underlying stock. Both index options and stock options have the same expiration date and the same trade settlement date. Closing transactions can be purchases or sales for any option, regardless of the underlying asset.

Which of the following securities underlies a yield-based option? A) Revenue bonds B) Income bonds C) Debentures D) Treasury securities

D Explanation Yield-based interest rate options are based on the yields of Treasury bills, notes, and bonds.