Series 7 Unit 14

The SEC requires that all sell orders be identified as either long or short. A person is not considered to be long a security if he A) has sold an in-the-money put option on that security simultaneously with entering the short sale order. B) has title to it. C) owns a security convertible into or exchangeable for the security and has tendered such security for conversion or exchange. D) has purchased the security but the trade has not yet settled.

A Selling a put only obligates the investor to buy the stock when the option is exercised. Merely writing the option does not result in possession of the stock. Having title to it does. Once purchased, the investor is long the stock even if the trade has not yet settled. Turning in a convertible security with conversion instruction has the same effect as entering a purchase order and waiting for settlement.

Market interest rates have risen steadily over the past several months. The market price of which two of the following shares would probably reflect the biggest impact of this change? Growth stock Money market mutual fund Preferred stock Public utility stock A) III and IV B) I and II C) II and III D) I and IV

A Stocks that are interest rate sensitive will reflect the impact of a change to market interest rates more than others. Preferred stock, with its fixed dividend, and utility stocks, with their high degree of debt leverage, are considered interest rate sensitive. The yield of the money market fund will change, but the price is fixed at $1 per share.

At 3:55 pm ET, a registered representative receives a market order from an officer of XYZ to buy 75,000 shares of XYZ for the company's account. The registered representative must A) advise the officer that a safe harbor under SEC Rule 10b-18 no longer exists before placing the order. B) place the order without taking any further action. C) refuse the order. D) advise the officer that a safe harbor under SEC Rule 10b-18 no longer exists before refusing the order.

A Under SEC 10b-18, an issuer purchasing its own securities cannot affect the opening or closing of the security. A safe harbor is available if the issuer is not involved in the first transaction of the day or in any transaction in the last 30 minutes of trading (10 minutes if the security is actively traded). If the issuer were to purchase its own securities during the last 30 minutes of trading, it may be forced to justify that its purchase did not affect the closing price. If a registered representative receives an order from an issuer at 3:55 pm ET, he must advise the issuer that a safe harbor is not available. The representative may then place the order

While reviewing a new customer's investment profile, you determine that the customer is willing to tolerate a high degree of risk and does not anticipate utilizing the invested funds for at least 15 years. What would be a suitable recommendation regarding asset allocation for the customer's portfolio, given the customer's risk tolerance and time horizon criteria? A) 25% debt, 25% equities, 25% money market instruments, and 25% real estate B) 70% equities, 20% debt, and 10% money market instruments C) 45% debt, 45% equities, and 10% money market instruments D) 65% debt and 35% equities

B For an investor who has a long-term investment time horizon and is willing to tolerate higher levels of risk, a recommendation having a higher percentage of the portfolio in equities would be suitable. Of the asset mixes presented, only one has a majority percentage in equities. The remaining choices with higher percentages in debt securities are too conservative.

a customer is in a low federal income tax bracket and his main investment objective is current income, which of the following securities should the agent recommend? A) U.S. government bond B) Investment-grade corporate bond C) Zero coupon bond D) City of Milwaukee general obligation bond

B If an investor is in a low-tax bracket, any benefit from receiving tax-free municipal bond interest is diminished, making municipal bonds a less suitable investment. Zero-coupon bonds pay no interest until maturity, and therefore, are not suitable for someone seeking current income. To maximize income, the best recommendation of the choices listed is the corporate bond, which offers a higher yield than a government bond with a similar maturity. LO 14.a

JJQQ trades in the Nasdaq Stock Market and has announced a tender offer for 10% of the outstanding shares of the company. The tendering price will be set at a 10% premium to the stock's closing price as of Friday, September 1, the cutoff date to tender shares. Investors performing all of these actions would be able to take advantage of the tender offer unless they A) bought JJQQ common stock for cash settlement on September 1. B) bought call options for regular way settlement on Wednesday, August 30. C) purchased the JJQQ stock on Thursday, August 31, for regular way settlement. D) tendered JJQQ convertible bonds on Friday, September 1. Explanation

B Participation in a tender offer (an offer to buy your shares) requires that investors must have engaged in an irrevocable action to acquire the common stock by the time of the cutoff for the tender offer. In this question, that date is September 1. The purchase of JJQQ call options provides the right, but not the obligation, to purchase the stock. In order to participate in the tender offer, the holder of a call option would have to have exercised the option by the cutoff date of the tender offer. The action does not require that the customer's transaction (to acquire the stock or the option) has settled by the tender cutoff date. Similarly, an investor who tendered a convertible bond has also engaged in an action to acquire the JJQQ common stock.

Which of the following forms of soft-dollar compensation paid by a broker-dealer to an investment adviser is not allowable under the safe harbor provisions of Section 28(e)? A) Research reports B) Reimbursement for meal expenses incurred while attending an investment seminar C) Financial planning software D) Registration fees to attend an investment seminar

B Payment for travel expenses, furniture, or equipment is not allowable under Section 28(e) of the Securities Exchange Act of 1934. Payment for seminars, research, and financial planning software are permissible under the safe harbor provisions of Section 28(e).

A client, age 27, is new to investing. With $20,000 saved thus far and $400 to allocate toward investing monthly, his goal is to purchase a home in three to five years. Which is the most suitable recommendation? A) Invest in both equity and corporate debt mutual funds so that a portfolio of stocks and bonds is established. B) Invest in a money market mutual fund to build up more cash reserves. C) Open a long margin account to take advantage of the leverage that margin purchases can create using small amounts of money. D) Use leveraged index funds (2 or 3×) to maximize gains potential for the small investment amounts.

B Securities or strategies with longer time horizons than that of the goal to purchase a home should not be used until the client has established more liquid cash reserves. The money market mutual fund would be most appropriate because it is liquid and conservative. The balanced fund is not appropriate for someone with a two- to five-year goal, and margin accounts or leveraged funds entail risk unsuitable for a conservative investor with a short investment time horizon.

A client, who is a manager of a large pension plan, has recently changed the plan's portfolio weighting from 80% equities and 20% fixed income to 40% equities, 40% short-term Treasury debt, and 20% cash and cash equivalents. More than likely, this is an indication that the client's outlook concerning the market is A) unknown. B) neutral. C) bearish. D) bullish.

C Because the client has reallocated the portfolio into highly conservative assets, one would think the manager is expecting a bear market. This new allocation is an attempt to protect against incurring losses from the anticipated market decline.

An investor, age 57, wants to amend an existing portfolio to have a greater percentage be in fixed-income (debt) instruments. Current market sentiment is that interest rates are very high and likely to begin contracting soon. The investor agrees and asks for your thoughts regarding what those debt instruments might be. The most suitably aligned with the market sentiment would be A) variable-rate municipal bonds. B) callable corporate bonds. C) noncallable corporate bonds. D) money market fund.

C If one anticipates that interest rates will be falling, noncallable bonds would be better, as there is no risk of them being called and you can continue to earn the higher rate the bonds were issued with. Anything with a variable rate will have the interest payable adjusted to align with current rates, and therefore, would not desirable when rates are falling. Money market funds are not debt instruments, and again, the returns they pay reflect trending interest rates.

A mutual fund invested in bonds with medium-length maturities. As the bonds matured, the fund reinvested the proceeds and purchased long-term bonds with maturities of up to 20 years. What might have happened to the fund if the reinvestment had occurred during a period when interest rates were rising? Decrease in yield Decrease in income Increase in yield Increase in income A) II and III B) I and II C) III and IV D) I and IV

C The longer a bond's maturity, the greater the risk to the investor. As a result, long-term bonds generally pay higher interest rates than medium- or short-term bonds. If a fund replaces medium-term bonds with long-term bonds, the bonds would pay higher interest rates, and thus generate more income. Additionally, as interest rates increase, so do yields.

An investor is long 500 shares of DEFG common stock, short 200 shares of DEFG common stock, and short 300 shares of DEFG 5% preferred stock. A tender offer for DEFG common shares is announced. Under SEC rules, this investor is permitted to tender A) 800 shares. B) 0 shares. C) 300 shares. D) 500 shares.

C The rules permit tendering of net long shares. That means the difference between the long and short positions. In this question, the investor is net long 300 shares: the difference between the 500 long and the 200 short. The preferred shares are not relevant because the tender is only for the common stock.

An investor who purchases 20-year Aaa rated corporate zero-coupon bonds would be least concerned with A) default risk. B) interest rate risk. C) reinvestment risk. D) purchasing power risk.

C Zero-coupon securities have no reinvestment risk because there are no interest payments to reinvest. All fixed-income securities have purchasing power (inflation risk), especially when the maturity is as long as 20 years. The same is true for interest rate risk. In fact, zero-coupon bonds, because of their long duration, are the most sensitive to changes in interest rates. Is there default risk? Yes, even with a triple A rating. A lot can happen in 20 years.

Shareholder approval is required for all of the following corporate events except A) the issuance of convertible bonds. B) stock splits. C) the acceptance of a tender offer from a nonaffiliated company. D) dividends.

D Shareholder approval is not required for the payment of dividends but is normally required for actions that increase (or potentially increase) the number of shares outstanding, such as stock splits and the issuance of convertible bonds. A corporation's acceptance of a tender offer requires shareholder approval.

A prospect is heavily invested in the common stock of an employer's company, ABC, relative to other investments. The stock has performed well over the last 15 years and the prospect is very happy with the investment. After reviewing financial and nonfinancial criteria, you have determined that A) owning too much ABC stock has increased credit risk to an unacceptable level. B) he should begin to liquidate the ABC stock using the FIFO accounting method. C) because ABC has performed well over a 15-year period, he should keep the stock but sell it if inside information indicates a fall in value is imminent. D) selling a portion of ABC and using the proceeds to purchase mutual funds will reduce his nonsystematic risk.

D This prospect is exposed to a significant amount of business (nonsystematic) risk, as indicated by the large investment in ABC common stock. Business risk can be reduced by diversifying the portfolio; therefore, recommending the sale of a portion of the ABC stock and using the proceeds to purchase mutual funds is suitable. There will be tax considerations, but the use of FIFO accounting will likely expose the prospect to higher capital gains taxes than other accounting methods and may not be the best approach to liquidation.

A registered representative of a FINRA member firm has developed a LinkedIn friendship with a registered investment adviser. This has resulted in the investment adviser directing transactions for many of their clients to this representative's broker-dealer. The broker-dealer is promoting an all-day seminar with presentations to be delivered by a number of outstanding economists and securities analysts. The seminar location is in a hotel ballroom down the street from the member firm's office. The firm has invited the investment adviser to attend as its guest. That location requires the adviser to fly in the night before and stay at the hotel. As the broker-dealer's guest, which of the following expenses are reimbursable by the broker-dealer without violating the safe harbor provisions of Section 28(e)? A) The travel expenses, but not the registration fee B) The registration fees for the seminar plus the hotel room for the night C) The registration fees for the seminar plus all of the travel expenses D) The registration fees for the seminar

D Under the safe harbor provisions of Section 28(e) of the Securities Exchange Act of 1934, broker-dealers are permitted to extend seminar invitations to investment advisers with whom they do or hope to do business. The only expense reimbursable by the broker-dealer is the fee to attend the seminar.

Reinvestment risk is the chance that, after purchasing a bond, interest rates A) fall. B) remain stable. C) rise. D) become volatile.

A Reinvestment risk is the danger that after purchasing a bond, interest rates will fall. This means that the fixed interest payments received over the remaining life of the bond will be reinvested at lower rates. The good news is that the price of the bond has probably risen due to falling rates.

A customer is very concerned about investments that may not keep pace with inflation. He asks which securities would have the least exposure to inflation risk. Which of the following would be the best answer? A) Fixed annuity B) Common stock C) Preferred stock D) Cash

B

An investor who is 50 years old would like to save for a child's college education, which begins in 10 years. The investor is willing to take a moderate amount of risk. Which of the following would be the least appropriate recommendation? A) Fund a variable annuity and use equity-based subaccounts B) Buy an BBB zero-coupon bond that matures in 10 years C) Fund an existing IRA with a municipal bond fund D) Open a Coverdell Education Savings Account

B Although investing within an IRA in anticipation of needing the money after age 59½ is a pretty good idea, municipal bonds, which provide federally tax-free income, are not appropriate for retirement accounts. The federally tax-free interest income will be fully taxable upon withdrawal. In addition, municipal bonds are low risk, not moderate risk, as indicated in the question.

Prompt disclosure of unintentional selective disclosure of material corporate information is a requirement of A) Regulation S-P B) Regulation SHO C) SEC Rule 10b-18 D) Regulation FD

D

Your client's investment portfolio is 50% growth stocks, 10% foreign stocks, and 40% blue-chip stocks. If the client is interested in further diversification, which mutual fund would best meet that goal? A) Emerging market fund B) Global equity fund C) Aggressive growth fund D) Bond fund

D All of the current holdings are equities. To further diversify the current portfolio, the bond fund would be the best choice of those given to meet this objective.

A wealthy client owns a large percentage of a thinly traded common stock. When this client wants to sell a major portion of her securities, she will immediately face A) market risk. B) credit risk. C) interest rate risk. D) marketability risk.

D It is difficult to sell a large block of securities in a thinly traded stock without a substantial discount to market price. This is known as liquidity or marketability risk. Technically, the terms are not identical, but for test purposes, consider it so.

Institutional managers are moving to increase their cash position. This action would be viewed as A) neutral. B) bullish. C) bearish. D) neutral bull.

C When investment managers liquidate securities to increase their cash positions, stock prices are likely to fall.

A portfolio manager using index options is trying to reduce which of the following types of risks? A) Financial B) Purchasing power C) Selection D) Systematic

D tematic risk refers to the impact the overall market has on an equity portfolio's value. Index options help insure portfolios against systematic risk. The purchase of index puts to protect a portfolio is called portfolio insurance.