Unit 5 and Unit 6

A 7% convertible debenture is selling at 101, and it is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. What is the parity price of the debenture? A)$920 B)$850 C)$910 D)$929

A)$920 To determine the parity price of the bond, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, multiply the current price of the common by the conversion ratio. The result is the parity price of the bond (40 shares × $23 = $920).

A sophisticated client has expressed an interest in becoming more aggressive with their investment strategy. Her current portfolio consists of the following: $50,000 cash $200,000 in retirement accounts $100,000 in various individual stocks in different industries $100,000 in a balance fund She is willing to invest $25,000 for a minimum of 7 to 10 years and accepts that the investment can and will fluctuate in value over time. Which of the following investments would be the most appropriate? A)ABC Capital Appreciation Small-Cap Fund B)DEF Asset Allocation Fund C)MNO High-Yield Bond Fund D)XYZ Value Equity Fund

A)ABC Capital Appreciation Small-Cap Fund For someone who is willing to take the risk and invest for the long haul, a small- or mid-cap growth fund would be appropriate.

After an extensive feasibility study on the viability of a new shopping mall, the City of Mount Vernon decided to issue bonds that depend on the earning requirements of the facilities. All of the following statements are true except A)that the bonds are backed by the full faith and credit of the City of Mount Vernon. B)that investor risk depends on the specific characteristics of the project. C)that the city is issuing revenue bonds. D)that rental revenues collected from shop owners within the mall will pay the bonds' debt service.

A)that the bonds are backed by the full faith and credit of the City of Mount Vernon. These are revenue bonds that will be paid for by the users of the facility, not the taxing power of the municipality. The issuance of revenue bonds depends on the completion of a proper feasibility study. Such a study projects the revenues and costs associated with a project. If the feasibility study does not show sufficient earnings, then the bonds will not be issued. The risk level depends on the characteristics of each particular project.

Your customer, a small-business owner, likes investments that are short term, relatively safe from credit risk, and liquid. He's heard that higher rates of return can be realized from auction rate securities than the rates he is currently getting on the Treasury bills in his portfolio. He asks you to explain them to him. Which of the following would you note as being reasons why they are not suitable for him? I. Auction rate securities are intended as long-term investments. II. Interest or dividend rates are reset at established intervals based on a Dutch auction. III. If the auction fails, holders of ARSs may not have immediate access to their funds. IV. The interest or dividend rate is set as the lowest rate to match supply and demand at the time of the auction. A)I and III B)I and IV C)II and III D)II and IV

A)I and III Auction rate securities (ARSs) are long-term variable rate bonds with maturities of 20 to 30 years tied to short-term interest rates. As long-term instruments, they are not suitable for an investor favoring short-term investments. Additionally, interest rates are reset using a Dutch auction method at predetermined intervals, typically 7, 28, or 35 days. A failed auction can occur due to lack of demand; in this case, no bids are received to reset the rate. This risk would not align the investment objectives of safety and liquidity.

If you invest in a front-end load mutual fund and choose automatic reinvestment, you should expect that I. dividend distributions will be reinvested at net asset value. II. dividend distributions will be reinvested at the public offering price. III. capital gains distributions will be reinvested at net asset value. IV. capital gains distributions will be reinvested at the public offering price. A)I and III B)II and III C)II and IV D)I and IV

A)I and III Mutual funds that offer automatic reinvestment of dividends and gains distributions must do so at net asset value.

If LMN, Inc., has filed for bankruptcy, in what order would interested parties be paid? I. Holders of secured debt II. Holders of subordinated debentures III. General creditors IV. Preferred stockholders A)I, III, II, IV. B)III, I, II, IV. C)IV, I, II, III. D)I, II, III, IV.

A)I, III, II, IV. The liquidation order is as follows: the IRS (and other government agencies), secured debt holders, unsecured debt holders and general creditors, holders of subordinated debt, preferred stockholders, and common stockholders.

If you were reading sales literature about a mutual fund that claimed its objective is to be a single source investment for most equity investors, it would most likely be describing A)a blend/core fund. B)a growth/income fund. C)a target date fund. D)a specialized fund.

A)a blend/core fund. A blend/core fund combines equities with different market characteristics. There are stocks fitting a growth style and others with a value style. It will include some high quality "blue-chip" stocks and some on the other end of the risk spectrum. Target date funds have different portfolios for each targeted date and will include both equity and fixed income securities. The portfolio of a growth/income would have much overlap with that of a blend/core fund, but more emphasis is placed on including stocks for their dividend payout. A specialized fund would concentrate in either a specific geographic area or industry and is not going to be recommended as the only fund for the investor's portfolio.

An investor purchases a municipal bond at par for $10,000 on February 15, 1997. On August 15, 1997, if the investor sells the bond for $10,500, for tax purposes, the $500 profit is recognized as A)a short-term capital gain. B)a tax-free capital gain. C)interest income. D)a long-term capital gain.

A)a short-term capital gain. When municipal bonds are purchased at par and subsequently sold at a higher price, the resulting profit is taxed as a capital gain. Only interest income from municipal bonds is exempt from taxation. This gain is not classified as long-term because the investor did not hold the bond for more than one year.

An investor receiving a quote of 102 for a municipal security is probably interested in A)a term bond. B)a general obligation bond. C)a serial bond. D)a bond anticipation note.

A)a term bond. A quote of 102 is referred to as a dollar quote ($1,020) rather than a yield quote. The most common dollar bonds are those with a term maturity. The other choices are most often quoted on a yield basis rather than a price basis.

An example of overlapping debt would be a school district and A)county general debt. B)a water pollution control facility. C)corporate debt of the county's largest employer. D)a local utility power plant.

A)county general debt. Do not combine revenue bonds with GOs to determine overlapping debt. Overlapping debt occurs in real estate taxing situations. Only GOs are backed by real estate taxes.

All of the following terms are associated with general obligation (GO) bonds except A)protective covenants. B)coterminous debt. C)voter referendum. D)limited tax bond.

A)protective covenants. The protective covenants are found in the trust indenture of a revenue bond. Among the more common protective covenants are the rate covenant and the maintenance covenant. The former is a promise to maintain rates sufficient to pay expenses and debt service. The latter is a promise to maintain the equipment and facility/facilities. Coterminous debt, or overlapping debt, exists when a single property is taxed by more than one taxing authority (e.g., when property is taxed by both a school district and a county). Certain GOs may have limitations imposed on increasing any of the taxes that back them and are called limited tax bonds. GO bonds require voter approval.

With the advent of the horseless carriage (a.k.a. the automobile), the Acme Buggy Whip Corporation's revenues fell to the point where it could no longer cover expenses. This led to an involuntary bankruptcy. The priority of payout was A)senior notes, general creditors, preferred stock, common stock. B)general creditors, senior notes, preferred stock, common stock. C)common stock, preferred stock, general creditors, senior notes. D)senior notes, preferred stock, common stock, general creditors.

A)senior notes, general creditors, preferred stock, common stock. Senior debt refers to obligations that have priority in the event of default. It parallels the use of senior when comparing preferred stock to common stock, the most junior of all securities.

The bond resolution includes all covenants between A)the bond counsel and the bondholders. B)the issuer and the bond counsel. C)the issuer and the trustee acting for the bondholders. D)the issuer and the Municipal Securities Rulemaking Board.

C)the issuer and the trustee acting for the bondholders. The bond resolution describes not only the characteristics of the proposed offering, but also the obligations the issuer has to its bondholders.

The Class B shares of the KAPCO Fund carry a conditional deferred sales charge beginning at 5% and reducing each year after the second by 1% per year until eliminated. An investor making an initial purchase of $10,000 of these shares will pay a sales charge of A)$50.00 B)$0.00 C)$100.00 D)$500.00

B)$0.00 Unlike Class A shares, there is no front-end load when purchasing Class B shares. All of the money is invested at the net asset value without any sales charge. Should the investor wish to liquidate shares, there is a back-end load until the end of the seventh year, but that has nothing to do with the question.

A mutual fund has a net asset value (NAV) of $7.80 per share, and the fund pays its underwriter a concession of $0.12 per share. If the fund has a sales load of $0.50 per share and an administrative fee of $0.15 per share, how much does the investor pay per share to purchase a Class A share of this fund? A)$8.42 B)$8.30 C)$7.80 D)$8.57

B)$8.30 The investor pays the public offering price (POP) when purchasing mutual fund shares. For a Class A share upon purchase, the POP is the NAV plus the sales charge. In this case, the NAV is $7.80 and we are told the sales load is $0.50. Adding the two numbers together equals the public offering price of $8.30. The underwriter's concession of $0.12 is part of the $0.50 as is the $0.15 administrative fee.

A bond convertible at $50 is selling at 105% of parity, while the common stock has a current market value of $45. What is the market value of the bond? A)$900 B)$945 C)$1,000 D)$1,045

B)$945 When a bond is convertible at $50, it means the holder can exchange each $1,000 par value bond for the company's common stock at a rate of $50 per share. Dividing $1,000 (always use the par value, not the market value) by $50 results in a conversion rate of 20 shares per bond. With the bond convertible into 20 shares and the market price of each share currently $45, the parity price, the price at which the value of the stock and the bond are the same, is $900, (20 x $45). The question tells us that the bond is selling for 105% of the parity price. That would be $900 x 105% = $945. An alternative method is to recognize that the stock is selling for 10% below its conversion price ($45 is $5 less than $50 and $5 ÷ $50 = 10%). That means the parity price of the bond must be 10% below the par value, or $900 (which is 10% less than $1,000). Once you have the $900, multiply by 105% to arrive at the correct answer of $945.

If a municipal bond maturing in 10 years is bought for 110, its cost basis at the end of the sixth year is A)100. B)104. C)101½. D)106.

B)104. To establish the new cost basis, determine the amount of the premium to be amortized yearly. For this bond, the $100 premium is amortized over 10 years: $100 divided by 10 equals $10. Then, multiply the annual amortization amount by the number of years the bond is held ($10 × 6 = $60). Finally, subtract the amount of the amortized premium from the original cost of the bond ($1,100 − $60 = $1,040, or 104).

One of your customers buys a new issue municipal revenue bond on March 19. The trade settles on March 21, and the bond pays interest on February 1 and August 1. If the dated date of the bond is March 1, how many days of accrued interest are due? A)24 B)20 C)55 D)19

B)20 Interest started accruing from the dated date of the bond (March 1). Interest accrues up to, but not including, settlement. Therefore, 20 days of accrued interest are due. The customer's first interest payment the following August will represent interest that has accrued from the dated date.

A municipal revenue bond indenture contains a net revenue pledge. The following are reported for the year: $30 million of gross revenues, $18 million of operating expenses, $4 million of interest expenses, and $2 million of principal repayment. What is the debt service coverage ratio? A)3:1 B)2:1 C)5:1 D)9:1

B)2:1 Under a net revenue pledge, bondholders are paid from net revenue, which equals gross revenue minus operating and maintenance expenses. In this example, net revenue is $12 million ($30 million − $18 million). Debt service is the combination of interest and principal repayment. Here, debt service is $6 million ($4 million + $2 million). To compute the debt service ratio, divide net revenue by debt service: $12 million divided by $6 million equals a ratio of 2:1.

Which of the following bodies may not incur overlapping debt? A)A county highway department B)A state government C)A school district D)A parks and recreation department

B)A state government Overlapping debt is debt of another issuing body that is paid by property taxes of residents. School districts, parks and recreation departments, highway departments, and library systems are all paid through real estate taxes (GOs). State debt is least likely to be overlapping, as states do not generally tax real estate.

You are reviewing a company's financial statements to assist a customer. What kind of information is most likely to be found in the footnotes to those financial statements? A)The name, address, and contact information for the firm's chief executive officer B)Accounting methods used C)The names of the company's most formidable competitors D)The length of time each director has served on the board of directors

B)Accounting methods used Footnotes to a company's financial statements will contain important financial information such as accounting methods used, as well as important management philosophy that may impact the company's overall financial health and performance.

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 B shares B)Closed-end management investment companies C)Open-end investment company Class A shares D)Unit investment trusts

B)Closed-end management investment companies 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.

A convertible bond has a conversion price of $40 per share. If the market value of the bond rises to a 12.5-point premium over par, which of the following are true? I. Conversion ratio is 25:1 II. Conversion ratio is 28:1 III. Parity price of the common stock is $42 IV. Parity price of the common stock is $45 A)II and III B)I and IV C)II and IV D)I and III

B)I and IV The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112.5% × $40 = $45.

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 not permissible because municipal securities dealers are not allowed to execute trades for the portfolios they underwrite. B)It is not permissible because it violates the MSRB anti-reciprocal rule. C)It is permissible because it suggests a more reciprocal arrangement between the two parties. D)It is permissible because MSRB rules do not cover municipal bond issuers or funds.

B)It is not permissible because it violates the MSRB anti-reciprocal rule. 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.

If a customer buys a Mount Vernon Port Authority municipal bond in the secondary market at 109 and holds the bond to maturity, what are the tax consequences? A)Capital loss of $90 B)No capital gain or loss C)Capital loss of $9 D)Capital gain of $9

B)No capital gain or loss The investor's cost basis of bonds purchased at a premium is adjusted by amortization of the premium. In this case, there is a $90 premium that will have been completely amortized at maturity. At maturity, the adjusted cost basis equals the face value, and no loss or gain is realized.

An investor purchases 100 shares of a bond ETF at a price of $50 per share on September 5, 2019. On November 1, 2019, and February 1, 2020, the fund distributes a $0.50 per share dividend. On May 11, 2020, the investor sells all the shares at $57 per share. What are the 2020 tax consequences of the sale? A)Short-term capital gain of $600 B)Short-term capital gain of $700 C)Short-term capital gain of $700, dividend income of $50 D)Short-term capital gain of $700, interest income of $50

B)Short-term capital gain of $700 Taxation of an ETF is similar to that of a mutual fund. The question asks about the tax consequences of the sale, so we ignore the dividend distributions. Buying at $50 per share in September and selling at $57 per share the next May is a $700 capital gain over a period of less than one year. It is not part of the question, but the dividends would be taxed as interest because they are coming from bonds.

An investor has losses on the sale of municipal bonds. Which of the following, for tax purposes, is true? A)The losses can be applied only against gains on the sale of other debt instruments (bonds). B)The losses can be applied against the gains on the sale of any other security. C)The losses can be applied only against gains on the sale of other municipal bonds. D)No losses on municipal bonds can be applied against gains on sales of any securities.

B)The losses can be applied against the gains on the sale of any other security. Losses on the sale of one investment can generally be deducted against gains on the sale of any other investment.

Which of the following would not be found in a municipal revenue bond resolution? A)Reporting requirements regarding revenues collected B)Underwriting agreement C)Terms of the rate covenant D)Conditions of the maintenance covenant

B)Underwriting agreement The bond resolution, which is also referred to as the bond contract, contains the requirement for the municipality to properly keep the facilities books, reporting requirements regarding revenues collected, conditions of the maintenance covenant, and terms of the rate covenant. The underwriting agreement is between the municipality and underwriters, and it spells out the terms agreed to for the underwriting of a new issue.

All of the following items of information must be included in a municipal securities confirmation except A)whether the securities are fully registered or book entry. B)an extraordinary call provision. C)the date of maturity that has been fixed by a call notice. D)the capacity in which the broker-dealer acted.

B)an extraordinary call provision. Municipal Securities Rulemaking Board rules require that certain information be included on all municipal confirmations, including the capacity in which the firm acted in filling the order, whether the bonds are in registered or book entry form, and any relevant call provisions. Information on catastrophe or extraordinary call provisions is not included on a confirmation because catastrophes have no planned dates of occurrence.

A retired person seeking to maximize income with reasonable safety and liquidity should most likely consider investing in A)an intermediate-term government bond fund. B)an intermediate-term, high-grade corporate bond fund. C)a long-term government bond fund. D)a large-cap growth fund.

B)an intermediate-term, high-grade corporate bond fund. In all these cases, liquidity should not be a problem because mutual funds have a seven-day redemption requirement. However, interest rate risk increases as the maturities lengthen, so the intermediate-term portfolios offer that benefit, albeit at a slight reduction in income. The high-grade corporate bonds will offer a greater return with slightly more risk than the government bonds. If the question had said the investor wished to minimize risk, then the government bond fund would have been a better selection.

Mutual fund shareholders are often advised to enroll in automatic dividend reinvestment programs. In those programs, the investor can elect to have all distributions, or just those from income or just those from capital gains, automatically reinvested in additional shares of the fund. Among the advantages to the investor would be A)the additional shares are not subject to 12b-1 fees. B)automatic compounding of the investment. C)deferral of taxes until the shares are sold. D)the additional shares are purchased below the NAV.

B)automatic compounding of the investment. Similar in concept to the compounding of interest in a savings account, when distributions are reinvested rather than withdrawn, the capital has an opportunity to compound. Taxes are due in the year for which the distribution is paid (no tax break here). The shares are purchased at NAV; there are never cases where mutual fund shares are purchased below the NAV. If the fund has a 12b-1 charge, it would apply to the reinvested shares just as any other shares.

Flag Mountain Floating Rate Capital, a business development company (BDC), has the majority of its assets invested in debt securities. Income distributions are made in the form of A)capital gains. B)dividends. C)a return of capital. D)interest.

B)dividends. Business development companies (BDCs) are closed-end investment companies registered under the Investment Company Act of 1940. In addition, they are regulated investment companies (RICs) under the Internal Revenue Code, meaning that BDCs must distribute at least 90% of their net investment income (NII) as dividends to shareholders. ** This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.

In most cases, a mutual fund is structured as a corporation. Because of certain tax regulations, it is important for the fund to compute its net investment income. That computation is A)dividends minus interest received on portfolio securities, minus the operating expenses of the fund. B)interest minus dividends received on portfolio securities, minus the operating expenses of the fund. C)interest plus dividends received on portfolio securities, minus the operating expenses of the fund. D)interest plus dividends received on portfolio securities, plus realized capital gains, minus the operating expenses of the fund.

B)interest minus dividends received on portfolio securities, minus the operating expenses of the fund. The net investment income (NII) of a mutual fund is the gross investment income of the fund minus the fund's operating expenses. The gross investment income is the sum of the interest and dividends received on the holdings in the fund's portfolio. Subtracting the operating expenses results in the net investment income. In general, mutual funds will qualify as regulated investment companies and follow the pipeline or conduit theory. Doing so requires that a minimum of 90% of the NII be distributed to investors in the form of dividends. Any portion not distributed is taxable to the fund. Capital gains distributions are treated separately and also have a 90% distribution requirement.

Net overall debt of a municipality is A)net direct debt minus overlapping debt. B)net direct debt plus overlapping debt. C)funded debt minus overlapping debt. D)funded debt plus overlapping debt.

B)net direct debt plus overlapping debt. Net overall debt of a municipality is defined as net direct debt plus overlapping debt.

All of the following statements regarding Section 529 plans are true except A)contributions to a 529 plan may be subject to gift taxation. B)the income level of the contributor can affect the annual contribution amount. C)the assets in the account are controlled by the account owner, not the child. D)states impose very high overall contribution limits.

B)the income level of the contributor can affect the annual contribution amount. Unlike Coverdell ESAs, the income level of the contributor will not affect annual contributions under a Section 529 plan.

A purchase or redemption order for investment company shares must be executed at a price based on A)the best net asset value computed the same day the fund receives the order. B)the net asset value next computed after the fund receives the order. C)the net asset value last computed before the fund receives the order. D)the net asset value computed at the close of trading on the NYSE the day before the fund receives the order.

B)the net asset value next computed after the fund receives the order. Purchase or redemption of mutual fund shares occurs at the first net asset value calculated after the fund receives the order. This is known as forward pricing.

The term trading flat means A)the bond is sold without markup or commission. B)there is no accrued interest. C)the bond is in default. D)the price of the bond has remained level.

B)there is no accrued interest. When a bond trades flat, the buyer does not owe accrued interest to the seller. Trading flat means there is no accrued interest due. While it is true that a bond in default trades flat, one cannot say that the term trading flat means the bond is necessarily in default.

Your client owns stock in the TXR Fund and has received dividends of $950 this year. The client has taken $450 of this and used it to purchase additional shares of TXR. For tax purposes, your client must report A)$1,400. B)$450. C)$950. D)$500.

C)$950. All of the dividends received must be reported. Reinvesting any or all of the money in TXR shares does not reduce the client's tax liability on dividends received.

A customer in the 28% tax bracket wants to buy a municipal GO bond with a 7.5% yield that matures in 6 years. The tax-equivalent yield of this bond is A)0.026. B)0.075. C)0.104. D)0.060.

C)0.104. To calculate the taxable return, use the tax-free equivalent yield formula: municipal bond yield ÷ (1 − investor's tax bracket). Using this formula, 0.075 ÷ (1 - 0.28) = 0.104, or 10.4%. This means the investor, who is in the 28% tax bracket, must earn 10.4% in taxable interest to equal the 7.5% tax-free municipal interest yield.

On February 13, your customer buys an 8% Treasury bond maturing in 2019 for settlement on February 14. If the bonds pay interest on January 1 and July 1, how many days of accrued interest are added to the buyer's price? A)14 B)43 C)44 D)45

C)44 Accrued interest for government bonds is figured on an actual-days-elapsed basis. The number of days begins with the previous coupon date and continues up to, but not including, the settlement date. The bonds pay interest on January 1. There are 31 days of accrued interest for January. The bonds settle February 14. There are 13 days of accrued interest for February. Do not count the settlement date (31 + 13 = 44 days).

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)2 business days (T+2). B)30 calendar days. C)7 days. D)4 business days (S+2).

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

Which of the following are considered sources of debt service for general obligation (GO) bonds? I. Tolls on roads II. Real estate taxes III. Revenue generated by a hospital IV. Liquor license fees A)I and III B)II and III C)II and IV D)I and IV

C)II and IV General revenues of the municipality, such as real estate taxes or licensing fees, may be used to pay the debt service on a GO bond. Usage revenue, such as that generated from toll roads or hospitals, would be associated with funding revenue bonds.

A legal opinion issued for a municipal bond covers which of the following? I. Feasibility of public works projects II. Creditworthiness of the issuing municipality III. Tax status of the municipal debt IV. Constitutionality and legality of the municipal debt A)I and IV B)II and III C)III and IV D)I and II

C)III and IV Municipal securities are reviewed by specialized lawyers who render a legal opinion. The opinion covers two main issues: constitutionality (i.e., it ensures that the bonds are legal, valid, and binding obligations of the issuer) and verification of the tax status of the debt (i.e., interest on the bonds is exempt from federal income taxes as well as state and local taxes in some cases).

Which of the following statements regarding revenue bonds issued by a state or municipality is true? A)Interest and principal payment is backed by the full faith and credit of the issuer. B)Interest and principal payment is guaranteed. C)Interest will be paid only if the enterprise owned and operated by the state or municipality has sufficient earnings to cover the interest payments or the debt service reserve. D)The bonds carry an unqualified promise to pay interest and principal backed by the power of the issuer to levy taxes.

C)Interest will be paid only if the enterprise owned and operated by the state or municipality has sufficient earnings to cover the interest payments or the debt service reserve. Because revenue bonds are not backed by the full faith and credit of the municipality that issues them, the earnings of the revenue-producing project must be large enough to cover the interest and principal payments.

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)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. 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 types of mutual funds has capital appreciation as its investment objective? A)Balanced B)Municipal bond C)Specialized D)Income

C)Specialized An objective of high-capital appreciation is most likely realized by a stock fund. A specialized fund is one that invests in stocks of one particular industry or region, and its main objective is capital or price appreciation.

An investor purchased 10 GO bonds at a discount of 2 points per bond. The bonds mature in 10 years. After holding the bonds for 5 years, they were sold at par. For tax purposes, the investor has A)a $100 loss. B)no gain and no loss. C)a $100 gain. D)a $50 gain.

C)a $100 gain. The cost per bond is $980. The accretion amount each year is $20. $20 ÷ 10 years = $2 per year. $2 per year × 5 years = $10 per bond accretion, making the adjusted cost basis $990 per bond. When the bonds are sold at par ($1,000), there is a profit of $10 per bond × 10 bonds, which equals a $100 gain.

Disclosure to customers of control relationships is required in A)primary distributions. B)principal transactions. C)all of these. D)agency transactions.

C)all of these. The nature of any control relationship or conflict of interest must be disclosed to customers. This includes both primary (new issue) and secondary transactions, regardless of whether the firm acts as agent or principal.

An investor who makes transactions once a month using dollar cost averaging would A)allocate assets equally among cash, stocks, and bonds. B)buy stock in a rising market and sell stock in a falling market. C)buy the same dollar amount of stock. D)buy the same number of shares of a stock.

C)buy the same dollar amount of stock. In the dollar cost averaging investment strategy, the number of dollars invested each month remains constant. Accordingly, the investor will automatically buy more shares when the price is low to reduce the average cost per share.

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

C)do not have the same potential tax consequences as mutual funds, such as making capital gains distributions annually. 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.

An investor purchases a PQR convertible bond at 98 on June 18, 1994. The bond is convertible at $25, and on June 19, 1995, when the common stock is trading at $26 per share, the investor converts his bond into the stock. For tax purposes, these transactions will result in A)a $40 capital gain. B)a $40 capital loss. C)neither gain nor loss. D)a $60 capital gain.

C)neither gain nor loss. The process of converting a convertible bond into common stock is not a taxable event. When the stock is sold, the taxable event occurs.

A registered representative's compensation consists of trailer commissions. The most likely reason for this is A)the registered representative is sharing the account with another representative. B)the registered representative has entered into a deferred compensation package with the firm. C)some of the representative's customers own mutual funds with 12b-1 charges. D)some of the representative's customers own stock in trucking companies.

C)some of the representative's customers own mutual funds with 12b-1 charges. Trailer commissions are a feature when you have customers owning mutual funds with 12b-1 charges. In most cases, those charges are levied every year and, over time, can add up to considerable compensation to the representative.

The market price of a convertible bond depends on all of the following except A)current interest rates. B)the value of the underlying stock into which the bond can be converted. C)the conversion prices of bonds from similar companies. D)the rating of the bond.

C)the conversion prices of bonds from similar companies. A convertible bond's current market price will be impacted by the value of the underlying stock into which the bond can be converted, current interest rates, and the rating of the bond. Conversion prices are not set in competition; therefore, the conversion prices of similar bonds would be of no concern regarding price.

A municipal A & O bond is issued on October 1, 2010, with a 10-year stated maturity. If a trade in this bond settles on April 1, 2020, how many days' worth of accrued interest will be added to the price of the bond? A)90 B)180 C)1 D)0

D)0 Interest on a municipal bond begins to accrue on the previous payment date and ends the day before settlement date. Always assume a bond pays interest on the first of the month unless told differently. In this case, interest is payable on April 1 and October 1 each year. Whenever a bond trade settles on a payment date, it trades flat (without accrued interest).

On Monday, June 1, an investor pays 92 to purchase a 5% J&J municipal bond maturing on July 1, 2030. Purchasers of bonds pay accrued interest to the seller, in addition to the market price of the bond. How many days of accrued interest will this seller receive? A)151 B)153 C)154 D)152

D)152 There are 152 days of accrued interest. On municipal bonds, the accrued interest calculation uses 30-day months and 360-day years. Interest begins to accrue on the last interest payment date and runs up to, but not including, the settlement date. This J&J bond pays interest on January 1 and July 1 of each year. Therefore, with a June purchase date, the most recent interest payment was on the previous January 1, the day that interest begins to accrue. The trade date is June 1 with a settlement date of June 3 (T+2). The buyer of the bond becomes the owner of the bond on June 3, and from that date forward, the buyer is entitled to the interest. That is why interest payable to the seller stops accruing on June 2. Here is the math. We have 5 months (January, February, March, April, and May) plus 2 days of accrued interest in June. With each month counting as 30 days, that is 150 days + 2 more in June equaling 152 days. How do we know that the J&J dates are the first of the month rather than the 15th? Good question. For the answer, we look to the maturity date of the bond. That is July 1, 2030, and is the clue that the interest payment dates are on the first of the month.

In the purchase of Class A shares, many mutual funds provide quantity discounts to those reaching breakpoints specified in the fund's prospectus. To qualify for the quantity discount, purchases of which of the following may not be combined under the definition of any person? A)Spouses investing in a joint account and individual accounts B)A trustee of an irrevocable trust and the beneficiary of that trust C)A parent's account and the parent's child in a UTMA account D)A parent and a 35-year-old child investing in separate accounts

D)A parent and a 35-year-old child investing in separate accounts For the purpose of qualifying for breakpoints, the definition of any person includes family units, but only minor children are included. Adults, other than spouses, are separate persons. Purchases made by trustees or other fiduciaries may be combined with purchases in the accounts of the beneficiary of the fiduciary account.

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

D)A principal-protected fund 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.

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)general obligation bonds. B)double-barreled bonds. C)moral obligation bonds. D)New Housing Authority bonds.

D)New Housing Authority bonds. 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.

Given the current business climate, an investor believes that a number of industries will be going through a consolidation over the next two to three years. Willing to invest $30,000 in the opportunity to profit if the consolidation occurs, which of the following would be the most suitable recommendation? A)Corporate bond fund B)Sector fund C)Buy call options on select stocks D)Special situation fund

D)Special situation fund A special situation fund can be specific to mergers and acquisitions within a particular industry or among many and would be a suitable choice, given the investor's opinion that consolidation may occur. Sector funds focus on only one industry or area, and corporate bond funds would have no advantages in cases of industry consolidation. Purchasing standard option contracts on select companies would be extremely speculative, and their nine-month life cycle would require that the positions be reinstated over a two- to three-year period, adding to commission costs.

Five years ago, the ABCD mutual fund bought 200,000 shares of Comet Industries at an average price of $42.25. After a series of accounting scandals, the shares are now trading at $6. If the fund decides to sell its shares, what will be the impact of the sale of Comet shares on the net asset value (NAV) of the ABCD fund? A)The NAV will fall B)This depends on whether the fund can claim a tax loss on the sale C)The NAV will rise D)The NAV will not change

D)The NAV will not change Portfolio holdings in a mutual fund are marked to the market each day. Therefore, the NAV of the fund already reflects the current value of each security in its portfolio, including Comet Industries. When the fund sells the position, the value of the stock is replaced by an equivalent amount of cash, so NAV does not change.

Which of the following statements describing Section 529 plans is true? A)Most state college savings plans require either the owner or the beneficiary of the plan to be a state resident. B)They can only be opened for children under the age of 18. C)The fees associated with them are generally the same from state to state. D)The maximum lifetime contribution varies from state to state.

D)The maximum lifetime contribution varies from state to state. The features of Section 529 plans, including their contribution limits and fees, vary widely from state to state. Section 529 plans have no age limits as to participation; they are open to both children and adults who plan to attend college or graduate school. For college savings plans, there is no state residency requirement for either owners or beneficiaries of Section 529 plans.

While acting in a financial advisory capacity to a municipal issuer, a municipal securities dealer wants to be part of a syndicate in the underwriting of one of the issuer's new bonds. Which of the following statements regarding this situation is true? A)Only an approval by the SEC could allow the broker-dealer to function in both capacities. B)The dealer would be allowed to participate and collect fees for both advisory and underwriting services supplied. C)The dealer must obtain the MSRB's written approval before signing the syndicate letter. D)This is recognized by the MSRB as a potential conflict of interest; municipal rules generally prohibit a broker-dealer from acting in both capacities.

D)This is recognized by the MSRB as a potential conflict of interest; municipal rules generally prohibit a broker-dealer from acting in both capacities. MSRB rules to eliminate conflicts of interest generally prohibit broker-dealers from acting in both an advisory capacity to an issuer and as an underwriter of the issuer's bonds. The MSRB rules do address certain allowable exceptions, but neither MSRB written approval nor the approval of the SEC would be required should the conditions of the allowable exceptions exist.

According to MSRB rules, a control relationship would exist between a municipal securities firm and an issuer when A)the firm recently completed a negotiated underwriting for the municipality. B)the firm has an inventory of the issuer's bonds. C)senior officers of the firm live in the municipality. D)an officer of the firm is in a position of authority over the issuer.

D)an officer of the firm is in a position of authority over the issuer. MSRB Rule G-22 deals with control relationships. Their interpretive letters indicate that it is only when the individual has the authority to exercise control that the disclosure rules apply. Here is how they put it: "For example, rule G-22 applies if the associated person is the chairman of an issuing authority and, in that capacity, actually makes the decision on behalf of the issuing authority to issue securities. The rule does not apply if the associated person as chairman does not make that decision and does not have the authority alone to make the decision, or if the decision is made by a governing body of which he is only one of several members."

Municipal bonds—known as dollar bonds—are generally quoted A)yield to maturity. B)yield to call. C)net yield. D)as a percentage of par.

D)as a percentage of par. Although municipal bonds are usually quoted on a yield basis, actively traded bonds known as dollar bonds are often quoted as a percentage of par (price). The term dollar bond comes from the quote being made in dollars. Remember that a percentage of par value ($1,000) equals a dollar price.

If a municipal bond has a call provision, this will tend to A)make the bond more attractive to investors because most bonds are called at a premium. B)place a floor on how low the price will decline. C)have no effect on the price. D)make the bond less attractive to investors because a call would terminate the interest payments.

D)make the bond less attractive to investors because a call would terminate the interest payments. The possibility of a call is unattractive to the investor. In most cases, bonds are called when their interest rate is above the current market rate. This means the investor must give up that higher yielding security. It is attractive to the issuer because with a call, the bonds are bought back at par or a small premium, and interest payments end.

The Investment Company Act of 1940 prohibits a closed-end management investment company from pursuing all of these activities except A)holding more than 3% of another investment company's outstanding shares. B)taking short positions in securities. C)buying securities on margin. D)paying dividends.

D)paying dividends. Paying dividends is an acceptable activity of any management investment company. Indeed, most of them function as regulation investment companies where, under the conduit theory, they must pay out at least 90% of their net investment income in the form of dividends to shareholders. No registered investment company may purchase securities on margin. Closely related to that is the prohibition against selling short (which must be done in a margin account). A fund may not own more than 3% of the outstanding shares of another investment company.

A qualified legal opinion issued for a municipal bond underwriting means that A)the bond attorney is qualified to express her opinion on the bond. B)the bond counsel is considered competent. C)the revenue bond issue has certain debt limitations. D)the legal opinion is qualified with restrictions and conditions.

D)the legal opinion is qualified with restrictions and conditions. The word qualified describes the legal opinion, not the attorney (or bond counsel) who issued it. A qualified legal opinion is one in which the bond counsel expresses reservations about conditions that may affect the bond's status. An unqualified legal opinion is rendered without restriction or condition.

The STU Corporation has issued common stock, preferred stock, promissory notes, and mortgage bonds. Should STU enter bankruptcy proceedings, the order of payment against claims would be A)the promissory notes, the mortgage bonds, the preferred stock, and the common stock. B)the preferred stock, the common stock, the mortgage bonds, and the promissory notes. C)the mortgage bonds, the preferred stock, the common stock, and the promissory notes. D)the mortgage bonds, the promissory notes, the preferred stock, and the common stock.

D)the mortgage bonds, the promissory notes, the preferred stock, and the common stock. In a bankruptcy, secured creditors, such as those with a mortgage against real property, have the first priority. They are followed by unsecured creditors, such as holders of promissory notes, with stock holders coming last. Preferred stock is "preferred" over common stock in both liquidation priority and payment of dividends.

An investor purchases a bond on its initial public offering. Even though the bond has a maturity value of $1,000 in 10 years, the offering price is only $600. If the bond is held to maturity, A)there is a $360 long-term capital gain and $40 in ordinary income. B)there is a $400 long-term capital gain. C)$400 is reported as ordinary income. D)there are no tax consequences to report.

D)there are no tax consequences to report. A bond issued at a significant discount from its maturity value is known as an original issue discount bond (OID). In the case of a corporate bond, the computation is more complex than can be tested, but there are two things you need to know: A portion of the discount is taxed as ordinary income each year until maturity, even though it is not actually received. This is called phantom income. Each year's taxable amount is reported on Form 1099-OID. Because a portion of the discount has been taxed each year, at maturity there are no tax consequences—no gain, no interest.

All of the following are suitability considerations when a registered representative recommends a municipal bond purchase to a customer except A)the issuer's debt rating. B)the customer's tax bracket. C)the customer's state of residence being the same as the location of the issuer. D)whether or not the bond is in the broker-dealer's inventory to sell.

D)whether or not the bond is in the broker-dealer's inventory to sell. The customer's state of residence and tax bracket are important because these factors help establish the tax benefits offered by the municipal bond. The issuer's debt rating is important in evaluating the credit risk assumed by the investor. The bond's availability in the dealer's inventory is not a suitability factor.