Series 7 Prac exam 8

The IRS will generally consider a direct participation program to be an abusive tax shelter unless the program can show a profit motive. A popular method of measuring the economic viability of a DPP is A) cash flow analysis. B) passive loss analysis. C) the ratio of gains to losses. D) income to debt analysis.

A Explanation On the exam, there are two accepted measures of the economic viability of a DPP. Those are cash flow analysis and internal rate of return (IRR). Cash flow analysis compares the income to the expenses, not the debt.

Listed options expire at A) 11:59 pm ET on the third Friday of the expiration month. B) 4:30 pm ET on the Saturday immediately following the third Friday of the expiration month. C) 4:00 pm ET on the third Friday of the expiration month. D) 3:00 pm ET on the third Saturday of the expiration month.

A Explanation Options expire on the third Friday of the expiration month at 11:59 pm ET.

A customer buys 200 XYZ at 32, 2 XYZ JUN35 calls at 3, and 1 XYZ JUN 35 put at 6.50. Two months later, the customer purchases 1 XYZ JUN 35 put at 4. Before expiration, with XYZ trading at 37, he sells his stock and closes his calls at 2.10 and his puts at 0.25 for A) a loss of $180. B) a gain of $450. C) a loss of $450. D) a gain of $180.

A Explanation The customer opens four positions with debits to his account: 200 shares at $32 per share equals a debit of $6,400; two calls at $300 each equals $600; one put at $650 equals a debit of 650; and finally, an additional put at $400. Let's do the math on this. The total cost of the purchases is $6,400 + $600 + $650 + 400 = $8,050. The stock position is sold for $37 per share for a credit of $7,400. The calls are closed for 2.10 each (a credit of $420), and the puts are closed for a credit of $25 each. The proceeds from the sales are $7,400 + $420 +$50 = $7,870. The difference between the cost ($8,050) and the proceeds ($7,870) represents a loss of $180.

A customer writes 1 XYZ Sep 45 put at 6 and 1 XYZ Sep 35 call at 6 when XYZ is at 40. Before expiration, if XYZ is at 43, and the customer closes her positions at intrinsic value, the customer has A) a $200 gain. B) a $600 loss. C) a $600 gain. D) a $200 loss.

A Explanation We first identify the position. This is a short combination. The investor has sold a put and sold a call on the same stock, but at different strike prices. If the prices and expiration dates were the same, it would be a straddle. When the customer begins the position by selling options, the action is an opening sale. That is, the position was opened by selling an option (in this case, two options). The customer collects $1,200 in premiums for writing the options (6 + 6). The question says the positions were closed at the intrinsic value. You close an opening sale with a closing purchase. That is, the customer buys back the option(s) that were sold. In this case, the price is $200 (45 − 43) to close out the put and $800 to close out the call (43 − 35). Determining gain or loss is simply comparing the $1,200 received to the $1,000 paid and that results in a gain of $200.

Which of the following factors will affect the special memorandum account (SMA) in a long account? Sale of securities in the account Decline in market value of securities Cash deposited by the customers Interest charged on debit balances A) I and III B) II and IV C) I and II D) I and IV

A Explanation Whenever stock is sold, half of the sales proceeds are credited to SMA. Nonrequired cash deposits are credited to SMA in full. SMA only declines when a customer uses it to borrow from the account or to purchase securities; it is not affected by declines in market value or by interest charges.

Given the NAV and asking price per share, which of the following could be open-end investment companies? NAV ASK A) $22.50 $25 B) $10.95 $12 C) $19.00 $20 D) $21.86 $20

C Explanation Open-end investment companies are always priced at net asset value (NAV) plus sales charge (if any). Remembering that makes any choice with an ask price below the NAV an obvious incorrect answer. There is another requirement and that is a maximum sales charge of 8.5% of the ask or public offering price. Only the correct choice fits within that parameter with a sales charge of 5% ($1.00 divided by $20.00). There is another choice that is close, but a bit too high. With an ask price of $12.00 and an NAV of $10.95, the sales charge percentage is 8.75% ($1.05 divided by $12 = 8.75%).

All of the following would be found in a bond resolution for a new municipal issue except A) the issuer's obligations to bondholders. B) covenants to which the issuer must adhere. C) the costs to be incurred by the issuer in connection with the offering. D) a description of the issue.

C Explanation The bond resolution (or the bond contract) spells out the characteristics of the issue (maturities, call features, etc.), the issuer's responsibilities to bondholders, and any restrictive covenants to which the issuer must adhere. Costs to be incurred by the issuer have no impact on bondholders.

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

C 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).

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

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

If a customer has a margin account with a long position worth $20,000 and a debit balance of $8,000, what is the purchasing power of this customer's account? A) $6,000 B) $2,000 C) $8,000 D) $4,000

D Explanation The account has $12,000 of equity. If 50% of the market value is $10,000, the account has $2,000 of excess equity. When Regulation T is 50%, the purchasing power of excess equity is 2:1.

A foreign currency investor is long 40,000 Swiss francs at $0.81. If the investor buys 4 Jul 80 SF puts at 1.25 to hedge, the breakeven point is A) 0.4875. B) 0.5125. C) 0.4975. D) 0.8225.

D Explanation When hedging with puts, the breakeven point is the cost of the underlying investment plus premium paid ($0.81 plus $0.0125 equals $0.8225, or 82.25 cents).

Which of the following statements is an accurate interpretation of FINRA Conduct Rules governing the use of retail communications? A) Institutional communications need not be preapproved by a principal. B) All retail communications must be filed with FINRA before first use. C) All communications with individual clients are considered retail communications. D) Sales and product promotion materials distributed to registered representatives and other employees are retail communications and must be submitted for FINRA review, even though such materials are not intended for public distribution.

A Explanation FINRA does not require principal preapproval of institutional communications. The same is true for internal communications. Not all communications with individual clients are retail communications. Many times, they are correspondence. There could even be an individual client with assets of at least $50 million, and then it would be institutional communication. Prefiling with FINRA can depend on a number of factors such as the product. For example, prefiling of retail communications is required for certain pieces having to do with investment companies and variable annuities, but not for pieces having to do with direct participation programs or collateralized mortgage obligations.

If a customer buys callable municipal bonds, Municipal Securities Rulemaking Board (MSRB) rules state that the confirmation sent to the customer must disclose A) the lower of either the yield to call or yield to maturity. B) the nominal yield only. C) the higher of either the yield to call or yield to maturity. D) the yield that would result if the bonds were called midway between the date they become eligible to be called and their maturity date.

A Explanation MSRB Rule G-15 states that the confirmation must indicate the lowest possible yield.

All of the following statements about trading index options on the Chicago Board Options Exchange are true except A) market orders entered by a market maker have priority over public orders. B) market makers may trade for their own accounts. C) limit orders are maintained in an order official's book. D) floor brokers may execute orders for others on a commission basis.

A Explanation Public orders must be filled before member orders. This is true if it is stock, bonds, and options of any kind.

If 1 OEX 375 call is purchased at 3.25 and exercised when the S&P 100 closes at 381, the writer delivers which of the following to the holder? A) $325 cash B) $600 cash C) $600 in stocks D) $381 in securities

B Explanation Index options settle in cash. Physical delivery does not occur. The call buyer receives cash equal to the difference between the strike price and the index closing value on the day the option is exercised. With the index closing price of 381 and the strike price at 375, that difference is 6 points. With a multiplier of $100, the settlement is $600.

The call provisions of a municipal issue would be detailed most completely in A) the legal opinion. B) the bond resolution. C) the official notice of sale. D) The Bond Buyer.

B Explanation The bond resolution is the document that authorizes the issuance of a municipal bond. The resolution also describes the proposed issue's features and the issuer's responsibilities to its bondholders.

A due diligence meeting occurs between A) the underwriter and the SEC before the issuance of a final prospectus to insert the public offering price and make any last-minute changes at the SEC's request. B) the FINRA member firm and FINRA's Corporate Finance Department to discuss the fairness of the underwriting spread on a pending public offering. C) the issuing corporation and the underwriters to review and re-examine the full details of the pending underwriting and negotiate final terms to be included in the formal underwriting contract. D) all of these.

C Explanation A due diligence meeting is held between the issuer and the underwriter before the effective date and is one of the final meetings held before the sale of the security so that each party may review all aspects of the issue.

If the customers of a selling group member sell into a penalty stabilizing bid, the selling group member must pay back to the underwriter A) the reallowance. B) the give up. C) the concession. D) the spread.

C Explanation If selling group members liquidate into the stabilizing bid, they may be required to return the concession they were originally paid.

After a mutual fund's 10th year, performance statistics must show results for each of the following periods except A) 1 year. B) 10 years. C) 3 years. D) 5 years.

C Explanation Mutual fund performance statistics must show results for one, five, and 10 years, or for the life of the fund—whichever is shorter

In a municipal underwriting, the interest cost calculation discounts future interest payments to arrive at present value. This interest cost calculation method is A) the net interest cost. B) the simple interest cost. C) the relative interest cost. D) the true interest cost.

D Explanation When an issuer discounts future interest payments to arrive at present value, the interest cost method being used is the true interest cost. This method takes into consideration the time value of money.

Yield-based options expire on A) the third Wednesday of the month. B) the day following the third Friday of the month. C) the day after the last day of trading. D) the last day of trading.

D Explanation Yield-based options expire like stock options—on the third Friday of the expiration month, which is the last day of trading.

If an investor practices value investing, which of the following stock types is he least likely to purchase? A) A stock with a low (P/E) ratio B) A stock that is presently selling for two-thirds of net current assets C) A stock that has exhibited a high dividend yield in the past D) A stock with an above-average price-to-earnings (P/E) ratio

A Explanation A growth investor looks for stocks with above-average (P/E) ratios. Conversely, a value investor focuses on stocks with low P/E ratios, a low price-to-book value, and historically high dividend yields.

A front-end sales load is defined as A) the difference between the public offering price and the net asset value of a mutual fund share. B) the concessions allowed on the purchase or sale of securities. C) the commissions paid on the purchase or sale of securities. D) the fee paid to the investment adviser.

A Explanation A sales load is the difference between the public offering price and the net asset value per share of the fund.

An offering of securities to no more than 35 nonaccredited investors would be associated with A) Regulation D. B) Rule 147. C) Regulation A+. D) Rule 144.

A Explanation Under Rule 506(b) of Regulation D of the Securities Act of 1933, a private placement transaction exemption applies if the offering is limited to a maximum of 35 nonaccredited investors. It is the Rule 506(c) provision that requires 100% of the investors to be accredited.

The ABC Insurance Company is advertising its variable annuity product as "ABC Lifetime Income—income generated from mutual fund returns." This advertisement is A) prohibited because it implies returns from mutual funds. B) prohibited because it doesn't reference an annuity. C) permitted as long as there's no guarantee. D) permitted.

A Explanation Variable contracts or their underlying accounts cannot be advertised as mutual funds. Proprietary terms can be used instead of words such as "annuity."

An investor purchased an interest in a limited partnership, paying $10,000 in cash and signing a recourse note to the partnership under a letter of credit for $40,000. Which of the following statements are true? The investor's tax basis will be $10,000. The investor's tax basis will be $50,000. The investor's maximum loss will be $10,000. The investor's maximum loss will be $50,000. A) II and III B) II and IV C) I and III D) I and IV

B Explanation A recourse note means that the limited partner agrees to pay the note no matter what happens. He is legally liable for the $40,000, which makes both his tax basis and maximum loss potential $50,000.

Which of the following orders would not be reduced on the order book on the ex-dividend date for a cash dividend? Buy limit order Open sell stop order Buy stop order Sell limit order A) I and II B) III and IV C) II and III D) I and IV

B Explanation Open sell limit orders and open buy stop orders, which are placed above the current market, will not be reduced on the order book when a stock goes ex-dividend for a cash dividend.

If a registered representative hosts an investment seminar intending to discuss general investment concepts and a specific mutual fund for which she has performance charts, which of the following statements are true? She may discuss the investment returns of the mutual fund in general, provided she does not use a specific time frame. She may discuss the investment returns of the mutual fund using a specific time frame. She must disclose to the audience all material facts regarding the mutual fund. She may emphasize the positive aspects of the mutual fund and refer prospective investors to the prospectus for further details. A) II and IV B) II and III C) I and IV D) I and III

B Explanation She may discuss the investment returns of the mutual fund, as long as she uses a specific time frame. When discussing an investment, she must disclose all material facts pertaining to the investment—both negative and positive.

An investor sold a corporate bond with a 5% coupon at a net price of 101. The bond had accrued interest for 45 days. Which of the following statements regarding the confirmation of this trade is correct? A) The total amount received on the seller's confirmation will appear as $1,003.75. B) The total amount due on the purchaser's confirmation will appear as $1,035.00. C) The total amount due on the purchaser's confirmation will appear as $1,016.25. D) The confirmation will indicate the current yield based on the price of the bond.

C Explanation Accrued interest is always added to the price of a bond. When you buy the bond, you pay that accrued interest, and when you sell a bond, you receive that accrued interest. The principal value is 101, or $1,010. Forty-five days of accrued interest is ⅛ of a 360-day year, or ¼ of a 180-day semiannual interest payment. With a 5% coupon, the bond pays $25 every 6 months. One-quarter of that is $6.25, so the total proceeds to the seller (and cost to the purchaser) is the $1,010 plus the $6.25, or $1016.25. One of the details included on a bond confirmation is the yield to maturity based on the price of the bond, but not the current yield.

An issuer may engage in a primary offering A) once per year. B) once every 90 days. C) as often as it chooses. D) once.

C Explanation There is no limit to how often a company may issue shares in a primary offering. There will be regulatory requirements for each offering, depending on the offering and the type of issuer; however, they may be as common as daily (i.e., mutual funds).

Probably the most significant difference between a business development company (BDC) and any other investment company registered under the Investment Company Act of 1940 is that a BDC A) makes available significant managerial assistance to the investments in their portfolio. B) issues shares that trade actively in the secondary markets. C) qualifies for special tax treatment by distributing at least 90% of its net investment income to owners. D) is required to file annual reports with the SEC.

A Explanation All other registered investment companies are passive investors. That is, they do not take an active role in the management of the companies held in their portfolios. The purpose behind BDCs is just that - help small companies with management issues. BDCs, like most other investment companies, qualify as regulated investment companies by distributing at least 90% of their net investment income. Doing so enables them to avoid tax on the distribution. Like closed-end funds and ETFs, shares of BDCs trade actively in the secondary markets. Many trade on the NYSE and the Nasdaq Stock Market, while others trade OTC. As do all registered investment companies, BDCs file annual reports with the SEC.

As a new registered representative, you overhear some of the "old hands" discussing tracking risk. More than likely, the topic of the conversation is A) index ETFs. B) municipal bond UITs. C) stocks traded on the OTC Link Pink Market. D) railroad stocks.

A Explanation Any investment that attempts to track an index or other benchmark needs to be evaluated in terms of its tracking error. That is, how close does the performance of the portfolio match up to that of the index? This tracking error or risk will, over the long run, cause the performance of ETFs tracking the same index to have differing results.

A sharing arrangement in which only deductible costs are apportioned to the investor, with the sponsor bearing all capitalized costs is called A) a functional allocation. B) a reversionary sharing arrangement. C) a carried interest. D) an overriding royalty arrangement.

A Explanation Functional allocation is a sharing arrangement in which the general partner pays for all tangible drilling costs (capitalized costs), and the limited partners pay for all intangible drilling costs (deductible costs).

Under the de minimis exemption, an initial public offering of common stock may be sold to an account where restricted persons have a beneficial interest, as long as their interest in the account does not exceed A) 10%. B) 20%. C) 5%. D) 25%.

A Explanation If the beneficial interests of restricted persons do not exceed 10% of an account, the account may purchase a new equity issue.

A customer tells a broker to buy 1,500 shares of ABC at 33.60 immediately for the full 1,500 shares. This is A) a fill-or-kill (FOK) order. B) an immediate-or-cancel (IOC) order. C) a good-til-canceled order. D) an all-or-none (AON) order.

A Explanation In an FOK order, the instruction is to fill the entire order immediately at the limit price or better. If this cannot be done, the order will be canceled (killed). An IOC order is similar, except that partial execution is acceptable. An AON order must be filled in its entirety. However, it can be filled over time; it does not require immediate execution.

A customer sells short 1,000 XYZ at 60. Three months later, XYZ is at 44. Which two of the following strategies are the most likely the customer would use to protect her unrealized gain? Sell 1,000 XYZ 45 stop Buy 1,000 XYZ 45 stop Buy 10 XYZ Mar 45 calls Buy 1,000 XYZ 45 stop limit A) II and III B) I and III C) I and IV D) II and IV

A Explanation In this short position, the customer currently has an unrealized gain of 16. She stands to see her unrealized gain begin to erode if the stock price rises, so she could enter a buy stop order above 44 to allow herself to buy and cover her position if a price rise occurs. Purchasing calls would also be effective, because the right to exercise would allow the investor to buy stock at 45 and protect a gain of 15 points less the premium paid. If the buy stop at 45 is correct, why isn't the buy at 45 stop limit correct as well? Good question. Remember, when a stop limit order is triggered, the order becomes a limit order. When the stock rises to 45 (or higher), the customer now has a buy at 45 limit which means pay no more than 45. Once triggered, the stock may never get as low as 45 and the customer's order to buy will not be executed.

A customer is considering adding a real estate investment trust (REIT) to her portfolio. She lists all of the following as advantages. You correct your customer and point out that one of them is not an advantage of investing in REITs. Which of the following is not an advantage of investing in REITs? A) Dividend treatment B) Having a professionally managed portfolio of commercial real estate assets C) Being able to divest of the shares easily D) Using real estate as a potential hedge against the movement of other equity securities the customer owns

A Explanation Of those listed, only dividend treatment can be identified as not being an advantage. While the expectation of receiving dividends is inherently good, dividends paid by REITs to their shareholders are not recognized as qualified and are therefore taxable to the investor at their full ordinary income tax rate. The shares are traded on exchanges or over the counter and are considered liquid, and having professionally managed assets should be a plus. While real estate valuation and price movements are subject to many forces, historically, real estate has provided some hedge against the movements of other equity securities.

One of your customers is concerned about future inflation. Which of the following mutual fund recommendations is likely to be the most suitable? A) A common stock growth fund B) A U.S. Treasury bond fund C) A municipal bond fund D) A balanced fund

A Explanation On this exam, the investment most likely to provide inflation protection is common stock. A balanced fund, one that contains almost equal proportions of common stock and fixed income, is generally thought of as a conservative investment providing both safety through the fixed income and potential growth through the equity. That safety comes at the expense of slower growth. Municipal bonds are only suitable (on the exam) when the question deals with an investor in a high tax bracket. Likewise, Treasury bonds are for those looking for lower income, but with highest safety. Be careful, though. The mutual fund is not guaranteed by the Treasury; only the bonds are.

All of the following are advantages of buying a put versus selling stock short except A) the put's time value, which gradually dissipates, is added to the intrinsic value. B) buying a put has a lower dollar-loss potential than does selling stock short. C) one need not locate securities to be borrowed to buy a put. D) buying a put would require a smaller capital commitment.

A Explanation Selling short could result in unlimited loss, whereas buying a put limits loss to the premium and requires a smaller capital outlay than does selling short. Remember that short sales must be done in a margin account, and 50% of the short market value (SMV) must be deposited by the short seller. Short sales require locating the securities to be borrowed; buying a put does not. The time value that erodes in a put option is a disadvantage because for each day that elapses, the option's time value decreases.

An investor has a margin account with the following positions: Long 100 shares ABC, LMV is $40 per share and DR is $1,800 Long 200 shares DEF, LMV is $30 per share and DR is $3,100 Short 100 shares GHI, SMV is $50 per share and CR is $9,000 The combined equity in the account is A) $9,100. B) $1,100. C) $6,100. D) $14,100.

A Explanation The basic equation for the calculation of combined equity is: LMV + CR - DR - SMV = EQ. Plugging in the numbers, we have long market value (LMV) of $10,000 ($4,000 + $6,000). To that we add the credit balance (CR) of $9,000, giving us a total of $19,000. From that, we subtract the debit balance of $4,900 ($1,800 + $3,100) plus the short market value (SMV) of $5,000, or a total of $9,900. $19,000 ‒ $9,900 = equity of $9,100. An alternative is to compute the equity of the longs and the equity of the short separately and add them together. The long equity is LMV of $10,000 minus DR of $4,900 = $5,100. The short equity is the CR of $9,000 minus the SMV of $5,000 = $4,000. Those two total $9,100 in combined equity.

A customer buys 800 shares of ABC at $70 per share in a new margin account. If the price of ABC drops to $50, the minimum maintenance margin requirement for this account is A) $10,000. B) $14,000. C) $20,000. D) $12,000.

A Explanation The minimum maintenance margin requirement for a long account is 25% of the current market value (CMV). The CMV is $40,000 (800 shares × $50 = $40,000). Therefore, minimum maintenance equals $10,000 (25% × $40,000 = $10,000).

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

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

All open orders must be confirmed to the order book A) once a year on the anniversary of the order. B) the last business days of April and October. C) every six months after the order has been entered. D) April 1 and October 1.

B Explanation All open orders must be confirmed the last business day of April and the last business day of October.

A gain on the sale of a long equity put option is A) a short- or long-term capital gain. B) always a short-term capital gain. C) ordinary income. D) always a long-term capital gain.

B Explanation Any trading in options produces only short-term gains or losses; therefore, any gain on the sale of a long put option must always be a short-term capital gain. (If a question wishes you to consider LEAPS, the question will refer to them.)

An investor believes that ICBS, a Nasdaq security, is overpriced at 40. She can sell ICBS short in the over-the-counter (OTC) market under which of the following circumstances? A) Only if she has an outstanding long position B) With no restrictions C) Only at a price higher than the current inside bid D) Under no circumstances

B Explanation As on exchanges, short sales on the Nasdaq Stock Market can occur at any time in the trade sequence.

An investor purchased $10,000 of the Class B shares of the ABC Growth Fund. Sixty days later, the investor received an inheritance of $40,000. The investor contacts you and asks about the possibility of backdating a letter of intent to add the original purchase to this new money and reach the breakpoint at $50.000. You would reply that A) a letter of intent can be backdated up to 90 days so the investor is in luck. B) Class B shares do not have breakpoints because they do not have a front-end load. C) the investor should redeem the Class B shares and then invest the entire $50,000 into the Class A shares to take advantage of the breakpoint. D) it would be wise to put the new money into the Class A shares of the fund and, once that is done, use the conversion privilege to move the old shares to take advantage of the $50,000 breakpoint.

B Explanation Class B shares are sold without a front-end load, so there are no breakpoints and no letter of intent (LOI). In almost every fund, the only way to include that original purchase is to exchange the Class B shares for Class A shares, but that might result in the investor paying both the back-end load to get out of the B shares and the front-end load of the A shares—not a good plan. The registered representative would have to examine the fund's prospectus to determine what is the best step to take. That does not change the correct answer here because, regardless of the investor's decision, Class B shares do not have breakpoints or LOIs.

In general, investors pay a commission to purchase and are charged a commission when selling which of the following investment companies? A) Open-end investment company Class A shares B) Closed-end management investment companies C) Open-end investment company Class B shares D) Unit investment trusts

B Explanation Closed-end funds trade in the secondary markets just like any common stock. Therefore, there is generally a commission charged when purchasing and when selling. Open-end fund Class B shares have no load on the way in, but they will have a back-end load if redeemed before the CDSC period ends. Similarly, Class A shares have a front-end load (always referred to as a sales charge, never a commission) to purchase, but no charge when redeeming. UITs may have a load on the way in and/or may have a redemption charge, but those a not referred to as commissions.

ALFA Enterprises pays a quarterly dividend of $0.15 and has earnings per share of $2.40. What is the dividend payout ratio? A) 6.25% B) 25.00% C) 14.40% D) 30.00%

B Explanation Earnings per share are typically calculated for a year, so the annual dividend of $0.60 ($0.15 × 4) is divided by $2.40 to calculate what percentage of earnings is paid as a dividend—or rather, the dividend payout ratio (0.60 / 2.40 = 25%).

Guarantees on insurance products A) are permissible for principal values in the separate account. B) must be specific to the insurance contract and not associated investments. C) are not allowed. D) are only permissible for companies with an A+ rating from A.M. Best.

B Explanation Guarantees are only permissible for the specific guarantees within an insurance contract. Companies cannot guarantee returns or even principal values in investments, including separate accounts. While high ratings may indicate stability and quality in a company, they cannot be used to make a guarantee.

Which of the following would not be considered institutional communications with the public? A) A letter to another broker-dealer B) An internal memo promoting a new product that will be offered to your firm's institutional customers only C) A letter to a municipality offering your firm's services as an underwriter D) A communication with an individual designated to act on behalf of your institutional customer

B Explanation Institutional communications specifically exclude internal communications. Communications with another member firm, a government entity such as a municipality, or with someone designated to act on behalf of one of your firm's institutional customers would all fall within the definition of institutional communications.

An investor purchases five Mount Vernon Port Authority J & J 1 bonds in a regular way transaction on Wednesday, October 18. How many days of accrued interest are added to the bond's price? A) 114 B) 109 C) 108 D) 110

B Explanation Interest accrues on municipal bonds on a 360-day-year basis, with all months having 30 days. This bond pays interest on January and July 1 (J & J 1). Therefore, July, August, and September each have 30 days of accrued interest, and October has 19 days of accrued interest; this totals 109 days. Settlement date is Friday, October 20. The easiest way to do these accrued interest questions is to set the dates up numerically. That is, the settlement date is 10/20 and the previous interest payment date is 7/01. Do the subtraction:

A client purchased 500 shares of JSSP common stock at $28 a share in July of 202X. The following June, the client wrote 2 October 35 calls at 5 each against the stock position. If the market price of JSSP was $39 at expiration, what was the client's realized gain? A) $1,700 B) $2,400 C) $1,000 D) $4,300

B Explanation Investors have a gain or loss only upon the sale of an asset. In this case, the only shares involved are the 200 shares covering the two short call options. The investor paid $5,600 ($28 times 200 shares). With the stock selling at 39 at expiration date of those two calls, they will be exercised because they are 4 points in-the-money. That means the investor will receive $7,000 ($35 times 200). The investor adds to that the $1,000 premium ($500 times 2) when the calls were written. The total credit to the account is $8,000. That is $2,400 more than the $5,600 the investor paid for those 200 shares. See the T-chart below. Bear in mind that although the customer was long 500 shares of JSSP stock, only two (covered) calls were written. When the market price reached 39 at expiration, the two calls were in-the-money and were exercised; however, the customer was not obligated to sell the remaining 300 shares of stock and there was no indication in the question that the customer liquidated the entire position.

The diversification and professional management offered by many investment companies tends to lower the investor's risk. That does not mean elimination of risk. Of the following, it is likely the greatest risk would be investing in A) an equity UIT. B) a 2x ETF. C) a high-yield bond mutual fund. D) an broad market index fund.

B Explanation Leveraged funds (2x or 3x) are considered the investment companies carrying the highest risk. Although high-yield bonds, at least on an individual basis, are considered high risk, the diversification and professional management of the mutual fund reduce (do not eliminate) the risk.

Which of the following are exempt from the registration provisions of the Securities Act of 1933? Variable contracts issued by life insurance companies Bonds issued by the State of Alaska Shares of Mutual funds registered under the Investment Company Act of 1940 Commercial paper maturing in 90 days A) II and III B) II and IV C) I and III D) I and IV

B Explanation Municipal bonds are always exempt from registration under federal law, as is commercial paper with a maturity of 270 days or less. It is state law that adds the $50,000 minimum denominations and top three rating categories to the exemption requirements. Variable contracts issued by insurance companies, i.e., variable annuities and variable life, are not exempt from registration with the SEC. Mutual fund shares must comply with the registration requirements of the Securities Act of 1933 (they are a continuous new issue). They also register as open-end management investment companies in accordance with the Investment Company Act of 1940.

Which of the following investments would likely have a lock-up period? A) Class B shares B) A principal-protected fund C) A target date fund D) A unit investment trust

B Explanation Principal-protected funds guarantee that the investor's return will never be less than the original investment, less any sales load. In order to honor the guarantee, the investor must agree to maintain the investment for the guarantee period. If not, the guarantee will generally be void. In essence, this means the investment is "locked-up" for that period.

New issue municipal bond orders are allocated according to priorities the syndicate sets in advance. The MSRB requires syndicates to establish priority allocation provisions for orders. Which of the following is the most common priority? A) Group net, presale, designated, member B) Presale, group net, designated, member C) Member, designated, presale, group net D) Presale, designated, group net, member

B Explanation Remember our abbreviation: PGDM (Pro Golfers Don't Miss) and that will get you the correct answer to any of these order allocation questions.

A firm underwriting of a municipal bond issue usually has a number of different broker-dealers involved. Those who earn a commission on each sale they make are performing in the role of A) a selling syndicate member. B) a selling group member. C) a registered representative. D) the syndicate manager.

B Explanation Selling syndicate members use selling group members to expand their reach. These selling group members receive a selling concession (a commission) on each sale they make. They have no financial commitment and return any unsold bonds to the syndicate member. Although registered representatives will typically earn a commission on the bonds they sell, the question asks about the broker-dealers involved in the underwriting. Be sure to answer the specific question asked.

A customer buys 1 XYZ Aug 50 put at 1 and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58. If XYZ is at 52 at expiration, the customer has A) a gain of $600. B) a loss of $400. C) a loss of $600. D) a gain of $400.

B Explanation The 50 put expires because it is out of the money. The customer can close the position in the 65 put by purchasing it for its intrinsic value ($1,300) or, because the option is thirteen points in the money, it will be exercised. If exercised, the stock is purchased for $6,500 but is only worth $5,200. In either case, the investor loses $1,300. Because the account was credited $900 when the spread was established, there is a net $400 loss ($1,300 − $900). Please note that in test questions like this, the put writer who is exercised never buys and holds the stock; it is immediately sold at the current market price. Alternately, breakeven is 56 (65 − 9), and the spread is bullish. Therefore, the customer makes money above 56 and loses below 56. Because the stock is at 52 at expiration, the customer has a $400 loss (56 to 52).

A customer is long an ABC Apr 40 call and is short an ABC Jul 40 call. Which of the following best describe his position? Bullish Bearish Calendar spread Vertical spread A) II and IV B) II and III C) I and III D) I and IV

B Explanation The July call will have a higher premium than the April call because it has more time value. Because the customer is selling the call with the higher premium, he is counting on the July call to go unexercised, which would allow him to keep the premium as a profit. That means the market value of the underlying security must either stay the same or decline. Therefore, this customer's position is bearish. Because the options expire in different months, the trade is a calendar spread

If a limited partnership interest is sold, the gain or loss in the sale is the difference between the sales proceeds and A) the total of the deductible losses taken by the investor. B) the adjusted basis. C) the total of tax preference items allocated to the investor. D) the original basis.

B Explanation The adjusted basis is a limited partner's cost basis at any point in time. Gain or loss on the sale of the partnership is determined by comparing the sales proceeds to the adjusted basis.

All of the following would be found in the money market except A) Treasury bills. B) preferred stock. C) repurchase agreements. D) commercial paper.

B Explanation The money market consists of short-term, high-quality debt instruments. This would not include preferred stock, which is an equity instrument.

Investor information about the financial condition of a municipal issuer is most likely found in A) The Bond Buyer. B) the official statement. C) the legal opinion. D) the official notice of sale.

B Explanation The official statement, which is the disclosure document used in new municipal offerings, will describe the issue's financial condition in detail.

Which of the following documents would describe the roles of the general and limited partners in a limited partnership offering? A) The prospectus B) The partnership agreement C) The subscription agreement D) The certificate of limited partnership

B Explanation The partnership agreement describes the roles of the general partners (GPs) and the limited partners (LPs). The certificate of limited partnership is a document filed with the limited partnership's home state for legal recognition. The LPs complete the subscription agreement (essentially the request to purchase) disclosing important personal information. The most important is the financial information, such as income and net worth. The GPs use that in determining suitability. The subscription agreement is not effective, and the LPs are not accepted into the partnership, until it is signed by the GPs. The prospectus is a document that discloses all material facts regarding the investment to investors. Note that if the program is a private placement, in lieu of a prospectus, the investor receives a private placement memorandum containing essentially the same information.

A company is offering a private placement, with the intent of selling shares to nonaccredited investors up to the 35 allowed for in Regulation D. Which of the following is true? A) While the offering can be advertised to anyone, only accredited investors could be solicited to purchase shares. B) Anyone may be solicited. C) The offering may not be advertised. D) The offering can be advertised to anyone except the 35 nonaccredited investors.

C Explanation Advertising private placements is considered a solicitation to sell. If the securities are advertised, all purchasers must be accredited, or the company must reasonably believe they are. In this instance, the intent is to sell to up to 35 allowable nonaccredited investors; with that intent clearly stated, the offering could not be advertised to anyone.

All of the following are characteristics of a direct participation program (DPP) except A) its revenue, deductions, and tax credits are reported to the IRS. B) its revenue, deductions, and tax credits are proportionally given to investors. C) it pays federal income taxes. D) the most common structure used for a direct participation program is the limited partnership.

C Explanation As long as a direct participation program avoids at least two of the four characteristics of a corporation, it can remain a reporting-only entity to the IRS. That means it does not pay federal income taxes. Revenue, deductions, and tax credits (if any) are reported the IRS on Form 1065 and distributed proportionally to the investors on the Schedule K-1. The typical business organization of a DPP is a limited partnership having at least one general partner and at least one limited partner.

With bonds subject to a gross revenue pledge, the first priority will be to pay A) the sinking or surplus fund. B) the first lien on the property. C) bond interest and principal. D) operation and maintenance.

C Explanation Bonds subject to a gross revenue pledge (gross lien revenue bonds) are backed by the gross revenues of the facility (meaning revenues before expenses). In this case, the first money disbursed is for payment of interest and principal. However, most revenue bonds only pledge net revenues to pay off revenue bonds. In the more common net revenue pledge, the first priority is operation and maintenance; the second priority is interest and principal.

Excess margin securities are defined as securities in excess of A) the minimum maintenance margin requirements. B) 70% of the customer's debit balance. C) 140% of the customer's debit balance. D) the customer's debit balance.

C Explanation Excess margin securities are securities in excess of 140% of the customer's debit balance. Margin securities (140% of the debit balance) are at a bank collateralizing the customer's debit. For example, if a customer purchases $20,000 of stock, the customer will put up $10,000 and borrow $10,000. The member will take $14,000 of the stock to a bank to collateralize the $10,000 debit. The balance ($6,000) of the stock must be placed in segregation (excess margin securities).

To determine the winning bid on an net interest cost (NIC) basis, an issuer will do which of the following? Add any premium to total interest cost Subtract any premium from total interest cost Add any discount to total interest cost Subtract any discount from total interest cost A) I and III B) II and IV C) II and III D) I and IV

C Explanation Interest cost to the issuer is reduced by any premiums received by the issuer when the bonds are initially sold or is increased by any discounts the issuer must accept when the bonds are initially sold. Reducing interest cost by the amount of any premium received or increasing interest cost by the amount of the discount the bonds are sold at is how the issuer will arrive at the NIC.

One of your clients was at a recent social gathering and heard a friend talking about a recent investment in an interval fund. How would you describe this investment? A) It is a closed-end investment company that computes its net asset value at certain specified intervals. B) It is an option available in many qualified retirement plans where, as certain specified intervals, the asset allocation is changed as the investor ages. C) It is a closed-end investment company where, at certain specified intervals, investors are able to sell their shares back to the company at net asset value. D) It is an investment company where an investor's money market account is debited at certain specified intervals to purchase shares of the fund.

C Explanation Interval funds are closed-end investment companies that permit shareholders to sell their shares back to the company at net asset value. The frequency varies by fund and can range from monthly to annually.

Which of the following statements is true? A) All retail communications require submission to the FINRA Department of Advertising. B) Institutional communications material always requires prior principal approval. C) Institutional communications do not require prior principal review if associated persons receive training in the firm's procedures governing institutional communications. D) All retail communications require prior principal approval.

C Explanation Member firms have a choice of procedures to follow when it comes to institutional communications. Review prior to use is the preferred option for many firms. The alternative is proper training of associated persons as to the firm's procedures governing institutional communications, documentation of such education and training, and surveillance and follow-up to ensure that such procedures are implemented and adhered to. Evidence that these supervisory procedures have been implemented and carried out must be maintained and made available to FINRA upon request. Not all retail communications must be filed with FINRA and not all retail communications must have prior principal approval. For example, any retail communication that does not make any financial or investment recommendation or otherwise promote a product or service of the member does not require prior principal approval or filing with FINRA

As interest rates fall, prices of straight preferred stock will A) remain unaffected. B) fall. C) rise. D) become volatile.

C Explanation Preferred stock is interest rate sensitive. As rates fall, prices of preferred stocks tend to rise, and vice versa.

All of the following are excluded from the FINRA filing requirement for communications with the public except A) retail communications that only identify the member firm. B) retail communications posted on an interactive forum online. C) retail communications posted online that require a login to access. D) correspondence.

C Explanation Retail communications, unless specifically exempted, must be filed with FINRA. There is no exemption for requiring a login to access. Correspondence does not need to be filed with FINRA nor does retail communications only identifying the member firm or posted on an online interactive forum.

Although municipal securities are exempt from SEC registration, full disclosure is still required with the use of A) an offering circular. B) the offering memorandum. C) an official statement. D) an MSRB-authorized prospectus.

C Explanation The disclosure document for a new municipal bond issue is the official statement (OS). It is the equivalent of a prospectus for a registered issue. A preliminary official statement (POS), equivalent to the red herring for a new stock issue, may have preceded the OS.

Annual dividends per common share divided by earnings per share (EPS) is A) the current return. B) the dividend yield. C) the dividend payout ratio. D) the quick ratio.

C Explanation The dividend payout ratio is the annual dividend per share to common stockholders divided by the earnings per share (EPS). Alternatively, it is the total common dividends paid divided by the net income after preferred dividends. It measures the percentage of earnings available to common paid out in the form of dividends to common stockholders. Investors looking for current income from stocks generally seek high dividend payout ratios. Investors looking for growth prefer stocks with low dividend payout ratios, wanting the company to reinvest its earnings into growing the company. The quick ratio measures liquidity only. The dividend yield is the same as the current rate of return on a stock. That is the annual dividend divided by the current market price.

Pristine Brokerage Services, (PBS), accepted as a FINRA member firm seven months ago, is planning a direct mail campaign to several thousand potential investors. The topic of the campaign deals with owning real estate through direct participation programs. Under FINRA Rule 2210 on communications with the public, this is considered A) a retail communication that needs approval, but not filing, by a designated PBS principal. B) correspondence and needs review, not approval by a designated PBS principal. C) a retail communication and must be filed with FINRA at least 10 business days before first use or publication. D) a retail communication and must be filed with FINRA within 10 business days of first use or publication.

C Explanation The key here is that PBS is within its first year of membership. As such, any retail communications (and a communication to more than 25 existing and/or potential clients within a 30-day period is retail communications) must be filed with FINRA at least 10 business days before first use. Retail communications must be approved by a designated principal before filing with FINRA. A more complete answer would have had both the approval and the filing, but sometimes a test question focuses on a single point such as this one does.

If your client expected short-term interest rates to fall, you might recommend that the client A) write a Treasury bill yield-based call. B) buy a Treasury bill yield-based call. C) buy a Treasury bill yield-based put. D) buy a Treasury bond yield-based put.

C Explanation The key to debt options is that the investor is betting on the movement of interest rates, not the price of the security. As with any other investment based on downward movement (put down), the strategy called for here is buying a U.S. Treasury bill put option. Why not the Treasury bond put? Because the question refers to short-term rates and Treasury bonds are a play on long-term ones.

A group of underwriters has agreed to engage in a mini-max underwriting for a new issue of equity securities with the issuer of those securities. Which of the following best describes this underwriting agreement? A) A mini-max agreement is a best efforts underwriting, setting a maximum amount the underwriters are willing to purchase from the issuer in the event all shares cannot be sold and a ceiling, or maximum, on the dollar amount of securities the issuer is willing to sell. B) A mini-max agreement is a firm underwriting setting a maximum amount the underwriters are willing to purchase from the issuer in the event all shares cannot be sold and a minimum dollar amount of securities the issuer is willing to sell. C) A mini-max agreement is a firm underwriting setting a floor, or minimum, which is the least amount the issuer needs to raise to move forward with the underwriting, and a ceiling, or maximum, on the dollar amount of securities the issuer is willing to sell. D) A mini-max agreement is a best efforts underwriting setting a floor, or minimum, which is the least amount the issuer needs to raise to move forward with the underwriting, and a ceiling, or maximum, on the dollar amount of securities the issuer is willing to sell.

D Explanation A mini-max agreement is a type of best efforts underwriting agreement. In a best efforts agreement, the underwriters are not purchasing unsold shares from the issuer. There are two components to a mini-max agreement. The first sets a floor, or minimum, amount the issuer needs to raise to move forward with the underwriting, and the other sets a ceiling, or maximum, dollar amount of securities the issuer is willing to sell.

A registered representative of a FINRA member firm uses her personal smartphone to send a client a text message about a security in the client's portfolio. This practice is A) considered a retail communication and must have principal approval. B) not permitted under FINRA rules; all electronic communications must be on company-owned devices. C) a personal message and does not come under the FINRA rules on communications with the public. D) considered an electronic communication and must be reviewed by a principal.

D Explanation Although many member firms do not permit use of personal devices, that is a firm's decision, not a FINRA rule. When permitted, a single message like this is considered correspondence delivered electronically. As with all correspondence, review by a principal is required. This review may be on a pre- or post-use basis. A text message sent to more than 25 persons within a 30-day period becomes retail communication.

Regarding rules addressing acting in concert, each of the following must observe position and exercise limits except A) two or more individuals who have an agreement to act together. B) an individual with accounts at several brokerage firms. C) an investment adviser placing exercise orders for his discretionary accounts. D) a registered representative (RR) accepting unsolicited orders to exercise options.

D Explanation An individual investor or a group of investors acting in concert must observe position and exercise limits. These limits apply to an individual adviser acting for a group of discretionary accounts and to an individual who has accounts with several firms. Acting in concert does not apply to an RR simply accepting exercise order instructions from customers.

A municipal securities dealer informed XYZ municipal bond fund that it was the leading retailer of XYZ shares and that, in return, XYZ should employ the dealer in effecting more transactions for the fund's portfolio. Which of the following statements regarding the request is true? A) It is permissible because MSRB rules do not cover municipal bond issuers or funds. B) It is not permissible because municipal securities dealers are not allowed to execute trades for the portfolios they underwrite. C) It is permissible because it suggests a more reciprocal arrangement between the two parties. D) It is not permissible because it violates the MSRB anti-reciprocal rule.

D Explanation An investment company must select a dealer to execute its portfolio transactions based on services provided. It is a violation of the anti-reciprocal rule (Municipal Securities Rulemaking Board Rule G-31) for an investment company to choose a firm to trade its portfolio based solely on sales of units or shares of the fund.

A father opens four custodial accounts for each of his children with the same mutual fund company. He invests $15,000 in each account. The fund company has breakpoints at $50,000, $100,000, and $200,000. The sales charge is A) based on a $15,000 investment and is levied for each account. B) based on the total $60,000 investment and qualifies for the $100,000 breakpoint. C) ineligible for a breakpoint discount because these are custodial accounts. D) based on the total $60,000 investment and qualifies for the $50,000 breakpoint.

D Explanation An investment made by one person in four custodial accounts for his children at the same fund company would qualify for the breakpoint that is applicable to the total amount invested. In this case, $60,000 was invested, so the applicable breakpoint is at $50,000.

An unqualified legal opinion means that A) the underwriter has failed to disclose sufficient information to qualify the issue. B) the interest is not exempt from state or local taxes. C) the issue is legal, but certain contingencies may limit the flow of funds in the future. D) the bond counsel has rendered an opinion without any qualifying limitations.

D Explanation An unqualified legal opinion means that the bond counsel found no problems with the issue. A qualified opinion means that the issue is legal, but certain contingencies exist. For example, the bond counsel might render a qualified opinion because authority to tax is in question or the issuer does not have clear title to the property.

Which of the following could an analyst use to establish the rate of return on a direct participation program (DPP)? Present value Internal rate of return Yield to maturity First-in, first-out A) I and IV B) III and IV C) II and III D) I and II

D Explanation Analysts use both present value and internal rate of return to establish a DPP's rate of return. Both involve assumptions based on future cash flows generated by the program.

A technical analyst is least likely to consider which of the following when selecting securities? A) Short interest ratio B) Advance/decline line C) Trend lines D) Corporate earnings

D Explanation Corporate earnings would be of least interest to a technical analyst, who is interested in market statistics indicative of future buying, market statistics that could reflect price or market trends, and trading volume.

A customer is long 650 shares of DEF stock trading at $32 per share in a margin account, and the debit balance in the account is $9,200. If DEF pays a 10% stock dividend, what will the effect be on the customer's account? A) The debit balance will be reduced. B) The equity will increase. C) The market value will increase. D) The equity will remain the same.

D Explanation Even though the investor receives more shares, the price per share falls; there is no effect on the market value of the customer's holdings.

The underwriting manager of a Western underwriting syndicate has committed to sell $250,000 worth of bonds out of a total offering of $1 million. There are 10 underwriters of this new issue. The firm sells its entire share, but $100,000 worth of the total bonds remains unsold. What is the manager's remaining liability? A) $25,000 B) $10,000 C) $100,000 D) $0

D Explanation In a divided (Western) syndicate, each syndicate member is responsible only for its own underwriting obligation. Because the underwriting manager sold its share, it is not liable for the unsold bonds. Rather, the manager will confirm the bonds to each member that did not sell its participation.

An individual purchases a single premium deferred variable annuity. There will be income tax ramifications in all of the following situations except A) during the payout period. B) death prior to annuitization. C) surrender of the contract. D) during the accumulation period.

D Explanation One of the features of annuities, fixed and variable, is that there are no taxes during the accumulation phase. However, anytime money comes out of the account, whether when annuitized, surrendered voluntarily, or not (as in death), any earnings are subject to taxation.

If a customer wishes to purchase a nonexempt security in a cash account, Regulation T requires a broker-dealer to receive payment in full A) within 3 business days. B) before the purchase. C) within 10 business days. D) within 4 business days.

D Explanation Regulation T requires that a broker-dealer receive payment in full—from a customer making a purchase of this type in a cash account—no later than four business days after the trade date (regular way settlement plus two additional business days).

A customer is short 100 shares of DFI at 35, and the market price is 35.25. If she believes a near-term rally will occur, which of the following strategies would best hedge her position? A) Write a DFI call with an exercise price of 40 B) Buy a DFI call with an exercise price of 40 C) Write a DFI put with an exercise price of 40 D) Buy a DFI call with an exercise price of 35

D Explanation The best hedge for a short stock position is to buy a call, not sell a put. If the stock price rises, the investor has the right to exercise the call and use the stock to close out the short position. To obtain the most protection, the call's strike price should equal the short sale price.

A customer opens the following options position: Long 1 KALE Oct 70 put @4¼; short 1 KALE Oct 80 put @10. What is the customer's maximum gain, maximum loss, and breakeven point? A) Maximum gain is $425; maximum loss is $575; breakeven point is $75.75. B) Maximum gain is $575; maximum loss is $425; breakeven point is $75.75. C) Maximum gain is $425; maximum loss is $575; breakeven point is $74.25. D) Maximum gain is $575; maximum loss is $425; breakeven point is $74.25.

D Explanation The first step is to identify the position. This is a credit put spread. It is a credit spread because the option sold brought in a higher premium than the one purchased. The credit of $575 is the most the investor can make. This is a bullish spread (the customer bought the low strike price and sold the high strike price). If the customer is correct and the stock rises above $80, the options will expire unexercised and the customer will keep that net credit of $575. If the customer is wrong and the price of the KALE stock falls below $70, the short put at 80 will be exercised, causing the customer to purchase the stock at $80. Then, the customer will exercise the long 70 put and sell that stock at $70. This results in a loss of $1,000 reduced by the $575 net credit, or $425 maximum loss. It is always easier to recognize that the maximum loss is the difference in strike prices minus the maximum profit. In this question, the spread is 10 points and the maximum profit is the credit of 5¾ points. That makes the maximum loss the remaining 4¼ points. Breakeven follows the put-down rule. Subtract the net premium from the higher strike price ($80 - 5.75 = $74.25).

The result of dollar cost averaging is to A) obtain a lower average price per share than average cost per share. B) take advantage of a nonfluctuating market. C) take advantage of a bullish market by buying more shares in a rising market. D) obtain a lower average cost per share than average price per share.

D Explanation The result of dollar cost averaging is to obtain a lower average cost per share than the average price per share. This is accomplished by making regular investments of a fixed amount when prices are fluctuating.

A registered representative is reading an article in a popular magazine about the advantages of tax deferral in retirement planning. There is a note that reprints of the article are available. In order to send these reprints to existing and prospective customers, A) the name of the underwriter who commissioned the article must be prominently displayed. B) filing a copy with FINRA is required. C) approval by a principal is required within 10 days after first use. D) member alterations to the contents are only to make it consistent with applicable regulatory standards or to correct factual errors.

D Explanation This is an example of an independently prepared reprint. It is a form of retail communications and can be used only if the preparer is independent of the member firm. In most cases, these are used "untouched." However, if there are factual errors or statements contrary to FINRA standards, they must be fixed. Preapproval by a principal is required and there is no filing necessary with FINRA. If the publisher is independent but received money from an issuer or underwriter for authoring the article, it may not be used.

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) must pay $14,000. D) receives $14,000.

D 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.

Which of the following regarding yield-based (interest rate) debt options is true? A) Their strike prices reflect dollar amounts. B) Calls are purchased by those who believe prices of debt securities are rising. C) Debt securities are delivered to the contract owner when exercised. D) They are European-style exercise.

D Explanation Yield-based debt options are European-style contracts, meaning that they can only be exercised on the last day of trading. All yield-based contracts, when exercised, are settled in cash. There is no delivery of debt instruments when these contracts are exercised. All strike prices reflect yield. (35 strike price represents 3.5% yield.) Yield-based options are a bet on future interest rates, not prices. Calls are bought by those who believe rates are going up (prices down) and puts by those who believe rates are going down (prices up).