S7 Mock Exam 4 (Part 1)
Your firm is a member of an underwriting syndicate for an issue of municipal bonds. The municipal syndicate release terms letter states that the bonds are being offered net, with a two-point concession and a half-point additional takedown. If your firm sells $100,000 of these bonds to a retail customer, it will receive a credit of A) $2,500. B) $500. C) $2,000. D) $100,000.
A) $2,500. A syndicate member receives the bonds net of the total takedown (which consists of the concession plus the additional takedown). Therefore, the bonds are taken by the syndicate net of 2½ points (2.5% × $100,000 = $2,500). LO 20.b
An investor establishes the following positions: Long 1 XYZ Apr 40 call for 6 Long 1 XYZ Apr 50 put for 8 If both options are sold for intrinsic value when XYZ trades at 44, the investor realizes a loss of A) $400. B) $100. C) $1,000. D) $200.
A) $400. Let's take this one step at a time. Beginning with the call, the opening purchase of the XYZ Apr 40 call was made at 6, and the closing sale of that call was made at the intrinsic value. When the market price of the stock is $44, a 40 call has intrinsic value (is in the money) of 4 points. When something purchased at 6 ($600) is sold for 4 ($400), the difference of 2 represents a $200 loss. Moving on to the put, the opening purchase of the XYZ Apr 50 put was made at 8, and the closing sale of that put was made at intrinsic value. With the market price of the stock at $44, a 50 put has intrinsic value (is in the money) of 6 points (50 - 44). When something purchased at 8 ($800) is sold for 6 ($600), the difference of 2 represents a $200 loss. With each position losing $200, the total loss for the account is $400. LO 10.f
Under SEC Rule 10b-13, a company that is the target of a tender offer must provide its shareholders with a statement indicating acceptance or rejection of the offer within how many business days of the announcement? A) 10 B) 5 C) 20 D) 15
A) 10 Once a tender offer is announced, the target company, within 10 business days of the announcement, must provide its shareholders with a statement indicating acceptance or rejection of the offer and the reasons for the position taken. LO 14.b
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) 109 B) 110 C) 114 D) 108
A) 109 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: 10/20 -7/01 3/19 3 times 30 = 90 +19 = 109 LO 6.e
Which of the following will not affect special memorandum account (SMA)? A) A stock dividend on stock held long in the account B) A long sale at a profit C) A deposit of cash into the account by the customer D) A cash dividend on stock held long in the account
A) A stock dividend on stock held long in the account The value of the stock dividend received will be offset by the decline in current market value (CMV) of the long position on which the dividend is paid. The account's long CMV will not change; it will just be represented by more shares. There will be no change in the overall CMV, debit balance, or equity, and therefore no change in the SMA. On the other hand, a cash dividend means that new money is coming into the account, which will reduce the debit balance and be credited to SMA so the customer may withdraw the dividend, if desired. LO 16.d
A firm must provide a risk disclosure document to a customer before opening which of the following accounts? A) Margin B) Partnership C) Transfer on death D) Custodial
A) Margin All customers opening margin accounts must receive a risk disclosure document describing the risks associated with trading on margin (e.g., that a customer could lose more than the initial investment, or that the firm could sell out securities in the account to meet a maintenance call without providing prior notice to the customer). This document must also be provided to customers on an annual basis. LO 2.g
An investor opens the following positions: Buy 100 shares of RJN @46; buy 1 RJN Mar 45 put @2½. What is the customer's maximum gain, maximum loss, and breakeven point? A) Maximum gain is unlimited; maximum loss is $350; breakeven point is $48.50. B) Maximum gain is $350; maximum loss is $4,250; breakeven point is $42.50. C) Maximum gain is $4,250; maximum loss is $250; breakeven point is $48.50. D) Maximum gain is unlimited; maximum loss is $350; breakeven point is $42.50.
A) Maximum gain is unlimited; maximum loss is $350; breakeven point is $48.50. The first step is to identify the position. This is a long stock position with a protective put. That is, the customer has purchased the stock and purchased a put to protect the downside. Using an option as a form of insurance is the primary reason why the industry refers to the price of an option as the premium. On questions with stock and an option, it is usually best to compute the breakeven point first. Breakeven is when the long stock can be sold at the customer's total cost. That cost is the price of the stock ($46) plus the price paid for the option ($2½), or $48.50. If the stock should rise above $45, the customer will let the 45 put expire and maintain the long stock position. An investor with a long stock position has unlimited potential gain. If the stock price should decline, no matter how low it drops, the customer can exercise the long put and sell the stock for $45 per share. That means the maximum loss is the premium paid for the option, ($250) plus the difference between the cost of the stock and the proceeds from the put ($100), or $350. Why doesn't the breakeven follow the "put-down" rule? That rule applies when the only positions are options. Once there is a long or short stock position along with an option position, it is the stock controlling the breakeven. Breakeven is solved by making both sides equal. That is, how much must the money- in side receive to be equal to the money-out side? The investor will break even when $4,850 comes in. That makes breakeven $48.50 per share. The investor profits when the RJN can be sold for more than $48.50 per share. What is the most the investor can lose? The RJN stock can fall to zero. However, the investor can exercise the 45 put and bring in $4,500. That results in a maximum possible loss of $350. How high can the stock's price go? There is no limit (the stock price could rise to infinity) so the maximum potential profit is unlimited. LO 10.h
A customer buys 100 DEF at 70, but several months later, the stock is trading at 82.85. The customer, concerned about a possible pullback, buys 1 DEF Aug 80 put at 1.50. If the stock subsequently falls to 77.25, and the customer sells her stock by exercising the put, the result is A) a gain of $850. B) a gain of $875. C) a loss of $150. D) a gain of $575.
A) a gain of $850. The customer bought 100 shares at 70 and sold them at 80 by exercising the put for a gain of $1,000. However, it cost $150 to buy the put, so the customer's gain is $850. In other words, breakeven for long stock-long put is the cost of stock purchased (70) plus the premium paid (1.50). Breakeven is 71.50, and the customer sold stock at 80 (80 − 71.50 = 8.50-point gain). LO 10.h
If an American exporter will be paid 25 million Japanese yen when her goods arrive in 45 days, her best hedge is to A) buy yen puts. B) buy yen calls. C) sell yen calls. D) sell yen puts.
A) buy yen puts. The exporter does not want to see the value of the yen fall. If she owns yen puts, and the yen does fall, her profit on the puts would help compensate for the decrease in the value of the yen. Selling yen calls would also provide protection if the yen fell in value, but only to the extent of the premium received. Exporters buy puts to hedge; importers buy calls on the foreign currency to hedge. LO 10.g
Many fixed-income investors diversify their portfolios by maturity. If one were investing in CMOs, that would be done by buying A) different tranches. B) yield-based options. C) different issuers. D) serial bonds.
A) different tranches. Although CMOs technically have maturity dates, it is rare for one to ever last that long. The standard way to vary the expected return of principal is by using different tranches. Serial bonds are generally issued by municipalities and are not mortgage-backed. Different issuers has nothing to do with maturities and yield-based options might be used as a hedge, but not to diversify maturities. LO 12.d
If a municipal firm purchases a block of municipal bonds in anticipation of a price increase, the firm is engaged in A) position trading. B) hedging. C) short selling. D) arbitrage.
A) position trading. The dealer is buying for its inventory (position trading). Although the term market maker is not generally used, most municipal bond trading take place when municipal securities dealers buy and sell out of their own accounts. LO 13.g
Your FINRA member firm takes 100 GO bonds from a municipal bond dealer out-firm for one hour. This means that A) your firm controls the bonds for one hour. B) after one hour, your firm owns the bonds. C) the municipal bond dealer has one hour to change the quoted price. D) the municipal bond dealer has one hour to sell these bonds to another member at a greater price.
A) your firm controls the bonds for one hour. A municipal securities dealer may quote a bond price that is firm for a certain time. This is called an out-firm with recall quote. Generally, these quotes are firm for an hour (or half hour) with a five-minute recall period. During this time, the municipal dealer cannot offer those bonds to anyone else—they are under the control of your firm. LO 6.a
A customer establishes the following positions: Buy 100 JMB at 28 Buy 1 JMB Dec 25 put at 2 What is the maximum potential loss? A) $200 B) $500 C) $3,000 D) $2,800
B) $500 The investor loses money on the long stock position when the market value falls. With the purchase of the put, the investor can sell the stock for no less than the strike price, but also loses the premium. In this example, the investor loses a maximum of $3 on the stock (28 − 25) plus the premium of $2, for a total loss of $500 on 100 shares. LO 10.d
Which of the following is considered a double-barreled bond? A) Build America Bonds B) Bridge authority revenue bonds guaranteed by the full faith and credit of a city C) Moral obligation bonds D) Dome stadium bonds with provisions for emergency ceiling support
B) Bridge authority revenue bonds guaranteed by the full faith and credit of a city Double-barreled bonds are backed not only by a specified source of revenues, but also by the full faith and credit of a municipal issuer with authority to levy taxes. Even though they are rated and traded as if they were general obligation bonds, it is proper to include them in the revenue category because the initial backing is from revenue. The additional backing of PHAs is the full faith and credit of the U.S. government—not the issuer. The additional backing of moral obligation bonds are legislative appropriations, which are not mandatory. LO 6.b
Which of the following agency securities has the strongest backing of timely payment of principal and interest? A) FHLMCs B) GNMAs C) Treasury notes D) FNMA
B) GNMAs Of the agency securities listed here, the only one that is a direct obligation of the U.S. government is the GNMA. The others are quite safe but are only a moral obligation. Please do not be fooled by the Treasury note - that is not an agency security. This is a perfect example of why it is so important to carefully read the question. This is a perfect example of why it is so important to carefully read the question. LO 7.c
All of the following debt instruments pay interest semiannually except A) municipal general obligation bonds. B) Ginnie Mae pass-through certificates. C) municipal revenue bonds. D) industrial development bonds.
B) Ginnie Mae pass-through certificates. Ginnie Maes pay interest on a monthly basis, not semiannually. LO 7.c
Which of the following best describes the investment characteristics of a high-quality long-term municipal bond? A) High inflation risk, high market risk B) High inflation risk, low default risk C) Low inflation risk, high market risk D) Low inflation risk, low default risk
B) High inflation risk, low default risk A longer term bond will be subject to more inflation risk. Because the quality of the bond is high, the level of default risk should be low. LO 14.a
Which of the following listed option orders can be combined to form a spread order? I. Buy 1 XYZ Jul 30 put II. Sell 1 XYZ Jul 35 call III. Sell 1 XYZ Jul 35 put IV. Buy 1 ABC Jul 30 call
B) I and III Spreads are deemed to be of the same class; class is defined as the same underlying security and the same type of option. Options II and III would be a short straddle. The ABC call cannot be combined with anything because you'd be combining ABC stock with XYZ stock. LO 10.e
Which of the following statements regarding Treasury bills are true? I. They are sold in minimum denominations of $10,000. II. They are offered with maturities ranging up to 52 weeks. III. Their interest is exempt from taxation at the state level. IV. They are callable by the U.S. Treasury at any time before maturity.
B) II and III Treasury bills are sold in minimum denominations of $100 and are not callable before maturity. T-bills are regularly offered with maturities from four weeks to as long as 52 weeks from issuance and are issued at a discount. Interest on Treasury bills is taxable at the federal level only. LO 7.b
If 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) Investment-grade corporate bond 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
A retired customer was unhappy with the low yields paid by her CDs. In their first meeting, her registered representative recommended Class B shares of a long-term government bond fund, emphasized the safety of government bonds, and provided her with a prospectus. After signing a statement saying she had read and understood the prospectus, the customer invested all of her money in the fund. A year later, interest rates rose, and the value of the fund declined. Having assumed the fund was government guaranteed, she was upset and became increasingly so when she learned that the deferred sales charge could cause her to lose additional money if she were to redeem her shares. Which of the following statements is true? A) Because the fund invests in government bonds, it is government guaranteed and is therefore just as safe as a CD. B) The representative should have fully explained the features, charges, price fluctuations, and other characteristics of a bond fund before having the customer make such a substantial investment commitment. C) Because her money was originally in a single investment, it was suitable to move her funds into another single investment. D) Because no one can predict interest rate moves, and the customer had read the prospectus, the bond fund was an appropriate investment.
B) The representative should have fully explained the features, charges, price fluctuations, and other characteristics of a bond fund before having the customer make such a substantial investment commitment. This customer is used to low-risk investments. The prospectus must not only be supplied, but the risks must be fully explained as well. LO 20.c
A customer sells short 100 shares of XYZ at 58 and buys 1 XYZ Jan 60 call for 3. If the stock price falls to $52, the customer buys back the stock and closes the option at 1 for A) a gain of $300. B) a gain of $400. C) a loss of $400. D) a loss of $300.
B) a gain of $400. The customer made $600 on the short stock position ($58 to $52) and lost $200 on the call (bought for 3, sold at 1). Overall, the gain is $400. LO 10.h
If a chart indicates that both the Dow Jones Industrial Average and the advance/decline line have been increasing since January, and the advance/decline line continues to rise, the market should A) turn down sharply. B) continue to rise. C) turn down moderately. D) not change.
B) continue to rise. A rising advance/decline line indicates that more stocks are rising in price than falling. A rising advance/decline line is a bullish indicator. LO 13.e
A separate account will invest in a number of different securities. The separate account is not likely to invest in A) corporate stock. B) municipal bonds. C) money market funds. D) equity funds.
B) municipal bonds. The earnings on dollars invested into a variable annuity accumulate tax deferred, which is why variable annuities are popular products for retirement accumulation. As with all tax-deferred accounts, municipal bonds are not appropriate investments because interest earned on municipals is already tax exempt at the federal level. LO 9.a
State and local government securities (SLGS) are purchased by A) commercial banks. B) state and local governments. C) accredited investors. D) institutions.
B) state and local governments. SLGS securities are purchased by municipal issuers that are subject to IRS yield restrictions when they invest the proceeds of a prerefunding. The monies placed in escrow are invested in SLGS, which are government securities whose interest rates are arranged to comply with IRS restrictions. LO 6.d
Qualified distributions from Roth IRAs are A) 100% taxable. B) tax free. C) taxable only to the extent of earnings. D) tax deferred.
B) tax free. If a withdrawal from a Roth IRA is a qualified distribution, the withdrawal is tax free. A qualified distribution is made after a five-year holding period and after the taxpayer has reached age 59½. LO 1.g
In the case of an unsolicited order, a prospectus must be delivered to the purchaser of a unit investment trust A) before the purchase. B) with the purchase confirmation. C) before the month's end. D) between 45 days and 18 months following the initial deposit.
B) with the purchase confirmation. A purchaser of newly issued securities must receive a prospectus no later than by receipt of the purchase confirmation. However, any solicitation must be preceded or accompanied by a prospectus. LO 20.c
Your customer is interested in a leveraged fund and makes the following statements about leveraged funds to you. Which of the statements is not true? A) The funds attempt to return a multiple of the return of a benchmark index they are tracking, perhaps two or three times. B) There are no unusual risks associated with these funds, other than those incurred with any index tracking fund. C) These funds sometimes use derivatives products to achieve their stated goals. D) Some leveraged funds are exchange-traded products.
Because the fund objective is to achieve returns that are a multiple of the returns of the benchmark index, the result could be a multiple of any loss incurred by the benchmark index, as well. In addition, because these funds use derivatives products to achieve their stated objectives, they may not be suitable for some people, given the additional risks associated with those products. LO 8.h
A customer with a moderate income from a secure job is in the 28% tax bracket. She has a small diversified portfolio and has $10,000 she would like to invest in a limited partnership. If she is willing to accept only a moderate amount of risk, which of the following limited partnerships would be the most appropriate recommendation? A) A new-construction real estate limited partnership B) A raw land real estate limited partnership C) An oil and gas income program D) An exploratory oil and gas drilling program
C) An oil and gas income program The customer is not in a high tax bracket and would not be able to take full advantage of the tax benefits produced by an exploratory oil and gas program or by new-construction real estate limited partnerships. A raw land real estate partnership is usually speculative. Of the answers listed, the income and moderate risk from an oil and gas income program would be of greatest benefit to this investor. LO 11.e
If near-term liquidity were the only objective for a client, which of the following pairs of investments would represent the most/least liquid? A) Variable annuity/direct participation programs B) Variable annuity/money market mutual funds C) Exchange-listed equities/direct participation program D) 10-year corporate bonds/U.S. T-bills
C) Exchange-listed equities/direct participation program Of the pairings offered to choose from, exchange-listed equities are considered liquid, as they could be easily divested of, and direct participation programs, which all have predetermined (scheduled) end dates, would be the least liquid. LO 11.g
If a customer has $9,000 of capital losses and $2,000 of capital gains in a tax year, that year's consequences are A) a $7,000 loss deduction with no carryforward. B) a $3,000 loss deduction with no carryforward. C) a $3,000 loss deduction with $4,000 carryforward. D) a $9,000 loss deduction.
C) a $3,000 loss deduction with $4,000 carryforward. For tax purposes, the customer can net gains with losses. In this case, the customer's net losses are $7,000. However, there is an annual capital loss deduction limit of $3,000. Therefore, the investor can deduct $3,000 this year and carry forward $4,000 to the following tax year. LO 3.i
All of the following characteristics regarding industrial development bonds (IDBs) are true except A) the bonds are issued by municipalities or other governmental units. B) funds from the lease are used to pay the principal and interest on the bonds. C) the bonds are normally backed by the full faith and credit of the municipality. D) the funds are used to construct a facility for a private corporation.
C) the bonds are normally backed by the full faith and credit of the municipality. IDBs are issued by a municipality, and the proceeds are used to construct facilities or purchase equipment for a private corporation. The corporation leases the facilities or equipment, and funds from the lease are used to repay investors. In addition to a first mortgage on the property, IDBs are backed by the full faith and credit of the corporation (not the municipality). LO 6.b
If an M&N 1 corporate bond issued at par with a 6% coupon is later purchased in August for 97 plus accrued interest of $16, how much taxable interest must the investor report for the year? A) $30 B) $16 C) $60 D) $14
D) $14 The purchaser of a bond pays the seller the interest that has accrued since the last interest payment date. A purchaser in August will pay the interest that has accrued since May 1. Then, on November 1, the investor will receive the entire six months of interest. We are told that the investor paid $16 in accrued interest. That is income to the seller. Then, when the November payment of $30 (6% coupon is $30 semiannually) is made, the investor must report the amount over the accrued interest paid out as income. In our question, that is $30 minus $16 = $14. LO 6.e
A customer is short 100 XYZ shares at 26 and long 1 XYZ 30 call at 1. What is the maximum potential gain for the customer? A) $5,200 B) $2,600 C) $500 D) $2,500
D) $2,500 The customer has hedged his short stock position from a market advance by buying the call. If the market falls, the investor can make a maximum of $26 per share if the stock price falls to zero, less the premium of 1 paid to buy the call, for a maximum gain of $2,500 (26 − 1 = 25). Let's look at this on a T-chart: LO 10.h
Which of the following statements regarding discretionary accounts is not true? A) Each discretionary order must be reviewed promptly by a principal. B) The customer must grant written authorization to the broker-dealer or a designated individual to exercise discretion in the account. C) The account may not be accepted unless approved, in writing, by a principal of the member firm. D) The customer must approve each order before or after it is executed.
D) The customer must approve each order before or after it is executed. To establish a discretionary account, a customer must grant trading authority in writing. Furthermore, the firm must indicate its willingness to handle the account on a discretionary basis through the signature of a principal of the firm. All orders, including those for discretionary accounts, must be reviewed and endorsed promptly but not before execution. LO 2.g
All of the following corporate transactions are nontaxable to investors when received except A) stock splits. B) reverse stock splits. C) stock dividends. D) cash dividends.
D) cash dividends. The receipt of a cash dividend is a taxable event. Stock splits are nontaxable because although the number of shares owned changes, the cost basis of the shares is adjusted to keep the total investment unchanged. Stock dividends are adjusted in the same way as stock splits, so they are also nontaxable events. It is not until shares received as part of a stock split or stock dividend are sold that there is a taxable event (gain or loss). LO 3.i
A blind pool offering A) generates nonallocated income. B) is connected with oil and gas leases. C) is one in which the properties are purchased on a lottery basis. D) is one in which 25% or more of the properties are not specified.
D) is one in which 25% or more of the properties are not specified. Many times, large real estate or oil and gas programs are offered in the form of a blind pool. In a blind pool, 25% or more of the specific properties (in real estate) or sites (in oil and gas) have not been identified at the time of the offering. When investing in a blind pool, the participants are relying on the expertise of the program sponsor to select locations that will prove profitable. LO 11.g
All of the following are suitable objectives for a covered call writer except A) providing downside protection for a long stock position. B) speculating that a stock will not rise in price. C) increasing return on a long stock position. D) profiting from an increase in the price of stock.
D) profiting from an increase in the price of stock. Covered call writers are not able to benefit from an increase in the price of the underlying stock. For example, you buy stock at $40 and write a 40 call. Now, the stock is 80. Isn't that great? Your long stock position has doubled. Not so fast. With the stock at 80, it is certain that the 40 call will be exercised. So no matter how high the stock goes, the covered writer can't benefit because the call will be exercised and the stock will be sold at the $40 strike price. Why sell covered calls? This strategy provides downside protection to the extent of the premium received, and it increases the rate of return on a long stock position (because of the premium collected). LO 10.d
In a customer's margin account, a broker-dealer must segregate A) 100% of the long market value. B) 50% of the equity balance. C) 140% of the debit balance. D) the excess securities above 140% of the accounts debit balance.
D) the excess securities above 140% of the accounts debit balance. A broker-dealer may hypothecate (pledge) 140% of a customer's debit balance. Any customer securities in excess of 140% of the debit balance must be physically segregated. LO 16.d
The MSRB defines an associated person of a broker-dealer who is primarily engaged in municipal securities activities other than retail sales to individuals as A) a municipal securities registered principal (Series 53). B) a municipal securities registered representative (Series 52). C) a municipal securities professional (MSP). D) a municipal financial professional (MFP).
These MFPs are involved with functions other that retail sales of municipal bonds. The definition is an outgrowth of the "pay to play" rule because these are the individuals covered by that rule. LO 6.h
