Series 7 part 2
Which of the following is not part of the Federal Farm Credit System (FFCS)? A) Federal Home Loan Bank B) Bank for Cooperatives C) Federal Intermediate Credit Bank D) Federal Land Bank
A Explanation The Federal Land Bank, Bank for Cooperatives, and Federal Intermediate Credit Bank are all parts of the FFCS. The Federal Home Loan Bank is not.
Which of the following is a money market instrument? A) Common stock B) Short-term debt C) Preferred stock D) Long-term debt
B Explanation A money market instrument is short-term debt with one year or less to maturity.
Variable annuities must be registered with the state banking commission. the state insurance commission. the Securities and Exchange Commission (SEC). FINRA. A) II and IV B) II and III C) III and IV D) I and III
B Explanation A variable annuity is a combination of two products: an insurance contract and a mutual fund. Therefore, variable annuities must be registered with the state insurance commission and the SEC.
How many business days after an index option is exercised should a cash settlement occur? A) Five B) One C) Three D) Two
B Explanation Exercised stock index options settle on the next business day.
Tender offers must be open for how many business days from the first publication of the offer? A) 10 B) 20 C) 5 D) 15
B Explanation If the terms are changed, the offer must be open for at least 10 business days from the date of change but never for less the original 20 business days.
With regard to position limits, what is the bullish, or buy side of the market? Long calls Short calls Long puts Short puts A) III and IV. B) I and IV C) I and II D) II and III
B Explanation Long calls give the holder the right to purchase stock, while short puts obligate the writer to buy stock, and both are bullish strategies.
The Securities Exchange Act of 1934 regulates or mandates all of the following except A) extension of credit to customers. B) full and fair disclosure on new offerings. C) creation of the SEC. D) manipulation of the secondary market.
B Explanation The Securities Exchange Act of 1934 created the SEC and regulates the secondary market. The Securities Exchange Act of 1934 does not address full and fair disclosure issues; the Securities Act of 1933 addresses these issues.
All of the following information is included in a municipal bond resolution except A) an authorization to sell the securities. B) compensation paid to the underwriters. C) any call provisions that allow the issuer to redeem the bonds before their scheduled maturity. D) restrictive covenants that are binding on the issuer.
B Explanation The bond resolution is the document in which the issuer authorizes the issuance of municipal securities. Among other things, the resolution describes the characteristics of the proposed issue and the issuer's duties to the bondholders. Compensation paid to the underwriters would be found in the official statement.
In determining a violation of position limits, short calls are aggregated with A) all of these. B) long calls. C) long puts. D) short puts.
C Explanation Position limits are measured by the number of contracts on the same side of the market. Long calls and short puts are on the bull side, and short calls and long puts are on the bear side.
If a customer who is long stock writes out-of-the-money calls against the position, and the calls subsequently expire worthless, for tax purposes, the customer has A) a long-term gain. B) a long-term loss. C) a short-term loss. D) a short-term gain.
D Explanation If short calls expire worthless, the gain (for tax purposes) is considered a short-term capital gain.
FINRA Rule 2231 describes the required frequency of customer account statements. In those cases where there is a highly active customer account, statements must be sent A) annually. B) monthly. C) semiannually. D) quarterly.
D Explanation Unless a customer account contains penny stocks, statements are sent quarterly. For statement purposes, the term activity includes the receipt of dividends or interest, but that does not change the quarterly requirement.
A DMF convertible bond (convertible into 25 shares) has increased 20% above par in market value. Which of the following would you expect the price of the DMF's common stock to be? A) $48 B) $40 C) $32 D) $42
A Explanation $1,000 (par) + 20% = $1,200 / 25 shares = $48. Alternatively, it is ordinarily the 20% increase in the value of the common stock that has caused the bond to increase 20% in value. $1,000 divided by 25 shares equals $40 plus 20% equals $48.
If an investor writes 2 DWQ Jan 60 puts at 3 in September, and the investor buys back the 2 puts at 4.50 two months later, the result for tax purposes is A) a $300 short-term capital loss. B) a $300 short-term capital gain. C) a $150 short-term capital gain. D) a $150 short-term capital loss.
A Explanation A $900 closing cost minus $600 opening proceeds equals a $300 short-term loss
If a March 80 Canadian dollar call option is trading at 6, and the Canadian dollar is at $0.85, which of the following statements is true? A) The contract has intrinsic value. B) The contract is out of the money. C) The contract has no time value. D) The contract is at parity.
A Explanation A call is in the money whenever the market value of the underlying instrument is above the strike price. The Canadian dollar is currently at $0.85 (85 cents), which is above the strike price of $0.80 (80 cents), so this call is in the money, and therefore, has intrinsic value of 0.05 (5 cents). This contract is trading 0.01 greater than the intrinsic value of 0.05. Therefore, it also has a time value of 0.01 (1 cent).
With a bearish outlook on the market, an investor would like to purchase something that will generate income now during current bearish conditions but would also be able to take advantage of capital appreciation should market sentiment turn bullish. Which of the following would be a suitable purchase recommendation that puts the investor in a position to do both? A) Convertible bonds B) Cumulative preferred stocks C) Nonconvertible bonds D) Common stock
A Explanation A convertible bond would generate income from interest payments during the bear market, but if market sentiment becomes bullish, the bond can be converted into common stock, taking advantage of the change in market conditions. None of the remaining choices could fulfill both of these investment objectives.
If a mutual fund's objective is income, it would not hold which of the following securities in its portfolio? A) Income bonds B) Corporate bonds C) Preferred stock D) U.S. T-notes
A Explanation A fund designed to generate current income for its shareholders would not hold an income bond, also known as an adjustment bond. Income bonds pay interest only if the issuer has enough earnings to do so. They are often issued by companies coming out of bankruptcy. As a result, these bonds tend to trade like zeroes.
Which of the following is true regarding a 5-for-4 stock split? A) Each shareholder's proportionate equity will be unchanged. B) The net worth of the company will be reduced. C) The par value will be unchanged. D) Retained earnings will be increased.
A Explanation Because each shareholder will receive additional stock, the proportional equity will remain the same.
GC, Inc., is proposing an additional public offering of common stock. It conducts a rights offering to its current shareholders at $55 per share, plus five rights. If the market price of GCI is $70 after the ex-rights date passes, what is the value of one right? A) 3 B) 2.5 C) 15 D) 5
A Explanation Because the stock is selling ex (after ex-rights), the formula is ($70 − $55) / 5. ($70 − $55 = $15) ($15 / 5 = $3).
Which of the following statements regarding collateralized mortgage obligations (CMOs) is true? A) CMO returns are affected by interest rate changes. B) CMOs may not trade at a premium. C) CMO earnings are tax exempt. D) CMOs are considered high-yield bonds.
A Explanation CMOs, like other mortgage-backed securities, respond to changes in interest rates. When interest rates decline, certain CMO tranches are subject to prepayment risk. CMOs are corporate instruments, and their interest is taxable at all levels.
A quote of 2.20 bid 2.18 offered would most likely be a quote on A) a T-bill. B) a Ginnie Mae bond. C) a general obligation bond. D) a T-bond.
A Explanation Discounted instruments (such as T-bills) are quoted on a discount yield basis. Even though the number representing the bid is higher than the ask, it would be lower when converted into dollars. The greater the yield, the lower the price.
When a person is calculating cost basis for a nonqualified variable annuity, the person is using A) the after-tax dollars contributed. B) the earnings in excess of dollars contributed. C) the pretax dollars contributed. D) the dollars contributed minus any gains at the time of payout.
A Explanation For a nonqualified variable annuity, cost basis for the annuitant would use the after-tax dollars contributed.
The purchaser of a general obligation (GO) municipal bond should be concerned with property tax assessments. the maintenance covenant. market risk. feasibility studies. A) I and III B) II and IV C) I and IV D) II and III
A Explanation GO bonds are issued by municipalities and, like all debt instruments, are subject to interest rate changes (market risk). Ad valorem (property taxes) are the primary source of debt funding for municipal GO bonds and are based on property assessments. Feasibility studies and maintenance covenants are associated with municipal revenue bonds where user fees from municipal projects and facilities are used to fund the debt.
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) 108 C) 114 D) 110
A Explanation Interest accrues on municipal bonds on a 360-day-year basis, with all months having 30 days. This bond pays interest on January and July 1 (J & J 1). Therefore, July, August, and September each have 30 days of accrued interest, and October has 19 days of accrued interest; this totals 109 days. Settlement date is Friday, October 20.
Which of the following customer accounts requires the sending of monthly customer statements? A) An account containing penny stocks B) A margin account C) An options account D) A discretionary account
A Explanation It is the account containing penny stocks where the customer must receive a monthly statement. In all other cases, the required frequency is not less than quarterly.
All of the following ratios are measures of the liquidity of a corporation except A) debt/equity ratio. B) current ratio. C) acid test ratio. D) quick ratio.
A Explanation Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid test (quick) ratio. However, the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure.
Many investors diversify by adding foreign securities to their portfolios. Those who do so with ADRs are least likely to be concerned with A) liquidity risk. B) market risk. C) political risk. D) currency risk.
A Explanation Most ADRs actively trade on the exchanges or OTC market. As such, their liquidity is generally quite good. Because the investment is in a foreign corporation, there is foreign currency risk. Market risk is universal anytime you are investing in something traded in "the market." Political risk is always a concern when investing overseas. It is true that it is not very high in most developed markets, but it is still there and more prevalent than liquidity risk.
Most business development companies (BDCs) are classified as A) a closed-end investment company. B) a unit investment trust. C) an open-end investment company. D) an exchange-traded fund.
A Explanation Most BDCs register as closed-end investment companies (CEF) and trade in similar fashion in the secondary markets. Federal law places some restrictions on the investment flexibility of a BDC that are not required of regular CEFs. A major difference between BDCs and the other investment companies is the active role played in the management of the businesses in the portfolio. That is what business development is abouthelping smaller businesses develop into larger ones.
Which of the following is least important to a municipal bond analyst? A) Legality of the issue B) Debt service to annual revenues C) Tax collection ratio D) Revenue collection record
A Explanation Municipal bond analysts are concerned with the financial aspects of municipal bonds to ensure that they do not default. Various financial ratios and collection records are critical to their analysis. The legality of the municipal issue, as determined by the legal opinion, is important to issuers.
Nonstatistical factors used in comparing one mutual fund to another would include all of the following except A) management fees. B) reinvestment privileges. C) conversion or exchange privileges. D) withdrawal plan options.
A Explanation Nonstatistical factors are those that cannot be quantified. That is, you cannot put an exact number on them. Management fees are a measurable statistic. The other factors listed are features, but do not have numbers, as such, attached to them.
The main purpose of dividend reinvestment in a mutual fund accumulation plan is to A) compound the growth of a mutual fund investment. B) avoid commissions or sales charges. C) avoid taxes. D) protect against capital loss.
A Explanation Reinvesting dividends compounds the growth of the fund with periodic purchases of new shares. Taxes are due on dividends whether or not they are reinvested. Capital gains or losses will occur whether or not dividends are reinvested. The purchase of additional shares with reinvested dividends may increase the capital gain or loss in proportion to the dividends reinvested. Avoiding commissions or sales charges is not the main rationale for reinvesting dividends, even though sales charges are not applied to reinvested dividends.
Annual dividends per common share divided by earnings per share (EPS) is A) the dividend payout ratio. B) the quick ratio. C) the dividend yield. D) the current return.
A Explanation The dividend payout ratio is the annual dividend per share to common stockholders divided by the earnings per share (EPS). Alternatively, it is the total common dividends paid divided by the net income after preferred dividends. It measures the percentage of earnings available to common paid out in the form of dividends to common stockholders. Investors looking for current income from stocks generally seek high dividend payout ratios. Investors looking for growth prefer stocks with low dividend payout ratios, wanting the company to reinvest its earnings into growing the company. The quick ratio measures liquidity only. The dividend yield is the same as the current rate of return on a stock. That is the annual dividend divided by the current market price.
Which of the following statements regarding corporate zero coupon bonds are true? Interest is paid semiannually. The discount is in lieu of periodic interest payments. The discount must be accreted and is taxed annually. The discount must be accreted annually with taxation deferred until maturity. A) II and III B) I and IV C) II and IV D) I and III
A Explanation The investor in a corporate zero coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. That discount from par represents the interest that will be earned at maturity date. However, the discount is accreted annually, and the investor pays taxes yearly on the imputed interest.
A client invests $100,000 in a tax shelter as a limited partner, giving him a 10% interest in the program. However, the general partners cannot meet the program's expenses. A mortgage balance of $3 million remains, and the property of the program is liquidated for $1 million. How much does the investor get back from his original investment? A) $0 B) $10,000 C) $33,000 D) $100,000
A Explanation The limited partner will not receive any return of his investment. In a failed program, the partnership's creditors are paid first with any sale proceeds—before the limited partners receive any money. Because the limited partners had not signed a recourse agreement, even though the partnership still owes $2 million on the mortgage, the limited partners are not liable for any money beyond their original investments.
If a customer buys 100 shares of MTN at 60, buys an MTN 60 call at 3, and buys an MTN 60 put at 3, the investor's maximum gain would be A) unlimited. B) $5,400. C) $600. D) $6,000.
A Explanation There is no limit to how high a stock's price can rise. Because this investor owns both the stock and an option to buy, the potential for gain is theoretically unlimited.
An investor opens a long position in one XYZ Nov 140 put @7. Disregarding any commissions, if the option is exercised, on settlement date the investor A) receives $14,000. B) must pay $700. C) must pay $14,000. D) receives $700.
A Explanation When an investor takes a long position in an option, it means that the investor has purchased the option. When a put is exercised, the holder must deliver the stock on settlement date. At that time, proceeds representing the strike price ($140) for 100 shares ($14,000) are received.
Which of the following terms are associated with over-the-counter (OTC) trading? Market maker Specialist Auction market Negotiated market A) II and III B) I and IV C) I and III D) II and IV
B Explanation The OTC market is a negotiated market. Within it, market makers are broker-dealer firms that provide a source for stock that customers wish to buy and a repository for stock that customers wish to sell.
An investor owns 300 shares of XYZ common stock, currently selling for $50 per share. The investor also owns 100 shares of XYZ's 5% $100 par preferred stock currently trading at $90 per share. A 2:1 stock split is declared. After the payment date, the investor will own A) 300 shares of common at $50 per share and 200 shares of the preferred at $45 per share. B) 600 shares of common at $25 per share and 100 shares of the preferred at $90 per share. C) 600 shares of common at $25 per share and 200 shares of the preferred at $45 per share. D) 150 shares of common at $100 per share and 100 shares of the preferred at $90 per share.
B Explanation A stock split is always of common stock. In a 2:1 split, the number of shares doubles, and the price is 50% of the presplit price, which means 600 shares at $25 per share. The stock split has no effect on the preferred stock.
A county taxes real property at a millage rate of 15. If your customer owns real property in the county and the assessed value is 80% of the current market value of $150,000, the annual tax is A) $180. B) $1,800. C) $1,200. D) $2,250.
B Explanation Ad valorem tax rates are based on mills with one mill being equal to $0.001 (1/10th of a cent).The amount of taxes to be paid on the property is determined by multiplying the millage rate—in this case, one and one half cents (15 mils at $0.001 = $0.015)—times the assessed property value ($120,000). Remember, this county is only taxing on 80% of the assessed value. The market value is irrelevant. For those who have difficulty determining where the decimal point goes, on any question like this, drop the last three 000s from the assessed value and multiply by the millage rate. In this question, that would be $120 times 15 and that equals the correct answer of $1,800.
A customer who has $100,000 in government bonds, $35,000 in NYSE-listed equity securities, $4,000 in penny stocks, and no account activity in the last eight months must have a statement sent A) semiannually. B) monthly. C) weekly. D) quarterly.
B Explanation Any account that has penny stocks in it, regardless of whether there was activity or not, must be sent a statement at least monthly.
If a customer buys 2 Canadian dollar 78 calls and writes 2 Canadian dollar 80 calls, this position is A) a diagonal call spread. B) a bull call spread. C) a credit call spread. D) a horizontal call spread.
B Explanation Bull positions in options spreads are established by buying the option with the lower strike price.
The cost of the asset is $100,000, and it will be depreciated on a straight-line basis with no salvage value. This means that A) for the next five years, the company will issue a check to the manufacturer for $20,000. B) for the next five years, the company will have an operating expense deduction of $20,000. C) at the end of five years, the company will have $100,000 in reserve to put toward the purchase of a replacement. D) for the next five years, the company will issue a check to the depreciation account for $20,000.
B Explanation Depreciation is not a liability (i.e., a bill to be paid). Depreciation is the annual expense (write-off) representing the loss in value of a fixed asset over a set period. In this question, that period is five years. Straight-line depreciation means equal amounts each year. With a zero salvage value, the entire cost is depreciable. The $100,000 cost divided by five years is $20,000 per year. No "cash" is involved, which is why depreciation is frequently referred to as a noncash expense.
When reviewing a money market fund portfolio, one would not expect to find A) negotiable CDs. B) common stock. C) T-bills. D) T-bonds with less than one year to maturity.
B Explanation Money market instruments are short-term, high-quality debt securities. This includes treasuries with less than one year to maturity and negotiable CDs. Because common stock is equity, it is not found in money market funds.
All of the following items of information must be included in a municipal securities confirmation except A) the capacity in which the broker-dealer acted. B) an extraordinary call provision. C) the date of maturity that has been fixed by a call notice. D) whether the securities are fully registered or book entry.
B Explanation 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.
All of the following issue mortgage-backed securities except A) Ginnie Mae. B) Sallie Mae. C) Fannie Mae. D) Freddie Mac.
B Explanation Sallie Mae is the name for the Student Loan Marketing Association, which does not issue mortgage-backed securities. Ginnie Mae, Fannie Mae, and Freddie Mac do issue mortgage-backed securities.
An issuer may be able to diversify a single municipal bond issue by maturity because A) many municipal securities are very marketable. B) many municipal bonds are serial issues. C) municipal securities are mostly long term. D) every state issues municipal bonds.
B Explanation Serial maturity means that within a single issue, portions of the issue mature at intervals. Municipal bonds typically mature serially.
Which of the following securities would have a Moody's MIG rating? A) BAs B) TANs C) T-bills D) GOs
B Explanation TANs are tax anticipation notes. These are short-term municipal securities and that is what Moody's MIG ratings represent. MIG stands for Municipal Investment Grade. GOs are rated with the normal letter ratings and BAs (bankers' acceptances) and T-bills are not municipal securities.
The 5% markup policy applies to A) all of these. B) principal over-the-counter (OTC) trades. C) new issues. D) mutual funds.
B Explanation The 5% markup policy applies to agency and principal nonexempt securities and transactions, both exchange and OTC traded. It does not apply to prospectus offerings (mutual funds and new issues).
A customer opens the following options position: Long 1 ALE Feb 40 put @3¼; short 1 ALE Feb 45 put @6¼. What is the customer's maximum gain, maximum loss, and breakeven point? A) Maximum gain is $200; maximum loss is $300; breakeven point is $42. B) Maximum gain is $300; maximum loss is $200; breakeven point is $42. C) Maximum gain is $300; maximum loss is $200; breakeven point is $43. D) Maximum gain is $200; maximum loss is $300; breakeven point is $43.
B Explanation The first step is to identify the position. This is a credit put spread. It is a credit spread because the option sold brought in a higher premium than the one purchased. The credit of $300 is the most the investor can make. This is a bullish spread (the customer bought the low strike price and sold the high strike price). If the customer is correct and the stock rises above $45, the options will expire unexercised and the customer will keep that net credit of $300. If the customer is wrong and the price of the ALE stock falls below $40, the short put at 45 will be exercised, causing the customer to purchase the stock at $45. Then, the customer will exercise the long 40 put and sell that stock at $40. This results in a loss of $500 reduced by the $300 net credit, or $200 maximum loss. It is always easier to recognize that the maximum loss is the difference in strike prices minus the maximum profit. In this question, the spread is 5 points and the maximum profit is the credit of 3 points. That makes the maximum loss the remaining 2 points. Breakeven follows the put-down rule. Subtract the net premium from the higher strike price ($45 - 3 = $42).
The managing partner of a limited partnership has responsibility for all of the following except A) organizing the business. B) providing unlimited capital for the partnership business. C) paying partnership's debts. D) managing the operations.
B Explanation The general partner organizes and manages the partnership; he assumes unlimited liability, paying all partnership debts. However, it is the limited partners who provide the bulk of the capital.
If interest rates increase, the interest payable on outstanding corporate bonds will A) decrease. B) remain unchanged. C) increase. D) change according to the inverse payout theory.
B Explanation The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year, regardless of the prevailing interest rates in the market. It is the market price of bonds—not the interest payable—that responds inversely to changes in interest rates.
A bond issued by a Swiss company, sold outside the United States and the issuer's country, but for which the principal and interest are stated and paid in U.S. dollars, is the definition of a A) Eurobond. B) Eurodollar bond. C) Francodollar bond. D) Matterhornbond.
B Explanation The key to a Eurodollar bond is that everything is in U.S. dollars. The issuer is either a non-U.S. corporation or government, and the security is not issued in the United States.
One form of debt security attractive to many high net worth investors is the collateralized mortgage obligation (CMO). A CMO is a pool of mortgages structured into maturity classes called A) series. B) tranches. C) terms. D) serials.
B Explanation The maturity classes on a CMO are called tranches (the French word for slice). A CMO pays principal and interest from the mortgage pool monthly; however, it repays principal to only one tranche at a time. Series bonds, bonds with a serial maturity, and term bonds are most commonly found in municipal securities.
A corporation has 1 million shares of common stock outstanding. There is also a $100 par 6% cumulative convertible preferred issue with 100,000 shares outstanding. If the corporation wishes to use a rights offering to raise additional capital by selling 500,000 new shares of common, which of the following statements is true? A) It will require five rights granted to the preferred stockholders to buy one new share. B) It will require two rights to buy one new share. C) Each preferred share would receive five rights. D) Each common share will receive half of a right.
B Explanation The number of rights necessary to acquire one new share is computed by dividing the number of outstanding shares of common stock by the number of new shares being issued. In this question, that is 1,000,000 ÷ 500,000 = 2.
An investor purchases 1,000 shares of PLEX common stock at a price of $153 per share. Shortly afterward, with PLEX selling for 149 per share, a purchase of 10 PLEX 150 puts at 4 takes place. What is the investor's breakeven point? A) $153 per share B) $157 per share C) $113 per share D) $149 per share
B Explanation This investor is looking for the price to go up. The purchase price was $153 and the cost of the "insurance" (the put option) was 4. That means that the investor will not start making money until the stock rises above the cost of the stock plus the cost of the put ($153 plus $4 = $157). In a question like this, the current market price of the stock and the exercise price of the option are irrelevant. Breakeven on long stock and long put is the cost of the stock plus the cost of the put. As is always the case when computing breakeven, the number of shares and number of option contracts is meaningless−breakeven is the same price for one or one thousand.
While looking at a chart for QRS common stock, a technical trader wants to have an order in position in the event that QRS moves higher and breaks out on the chart. A buy stop order would be placed A) just below the support level. B) just above the resistance level. C) just below the resistance level. D) just above the support level.
B Explanation To take advantage of a stock moving higher and breaking out on a chart, a technical trader would place a buy stop order just above the resistance level. Technical traders believe that if a stock breaks the resistance level, it will move to and trade within a higher price range. Using a buy stop order placed just above the resistance level ensures that the purchase is not made until the stock has broken through the resistance.
All of the following are characteristics of Treasury receipts except A) they are stripped bonds. B) accumulated interest is not subject to federal taxation. C) the certificates may represent either the principal or the interest portion of the securities that were deposited with a trustee. D) they are zero-coupon bonds.
B Explanation Treasury receipts are zero-coupon instruments, which are purchased at a discount and mature at face value. Although interest is not paid annually on receipts, investors receive a 1099 original issue discount that reports the amount of interest imputed for that year. This interest must be reported to the IRS as taxable income.
A municipality is allocating the revenues from an industrial revenue bond under a net revenue pledge. The first priority is A) bond interest. B) operation and maintenance. C) sinking fund payment. D) reserve funds.
B Explanation Under a net revenue pledge, operations and maintenance are paid first, with debt service following. In a gross revenue pledge, debt service is paid before operations and maintenance.
All of the following are risks associated with most mutual funds except A) market risk. B) liquidity risk. C) tenure risk. D) expense risk.
B Explanation Under federal law, mutual funds must redeem shares within seven days of receipt of the investor's request. There is never a need to find a buyer for the shares. Therefore, mutual funds have little to no liquidity risk. As with any investment, there is market risk for most mutual funds (little to none with money market funds, but they would have to be specified in the question). Expense risk is the uncertainty as to future expenses incurred by the fund. The higher the expense ratio, the lower the performance. Management fees, transaction costs, and regulatory filing fees can change. Another risk is that the management team that has brought the fund great success in the past might leave or be terminated. That is what tenure risk is all about.
Unrealized gain in a mutual fund portfolio does which of the following? Increases the dividends paid to shareholders Represents the undistributed income and the growth in market value of securities held in the portfolio Is realized by shareholders only when they redeem their shares Has no effect on shareholders until the annual long-term capital gains distribution is paid A) I and IV B) II and III C) II and IV D) I and III
B Explanation Unrealized gains result from asset appreciation and undistributed income. This increase in value is reflected in an appreciation of the mutual fund shares. Investors realize this appreciation only by selling their shares.
Although most REITs are traded actively in the secondary markets, an investor purchasing a nontraded mortgage REIT is exposed to which risk not found with others? A) Business risk B) Liquidity risk C) Interest rate risk D) Default risk
B Explanation When a REIT is nontraded, its liquidity is limited. Therefore, nontraded REITs should only be recommended to those clients who can afford liquidity risk. The other risks apply to traded and nontraded REITs.
A firm may assign option exercises using which of the following methods? First-in, first-out (FIFO) Last-in, first-out (LIFO) Random assignment Based on holders of the smallest positions A) II and III B) I and IV C) I and III D) II and IV
C Explanation A firm may assign an exercise either randomly or using the FIFO accounting method. LIFO is not permitted, nor is assigning by position size, smallest, or largest.
Your FINRA member firm takes 100 GO bonds from a municipal bond dealer out-firm for one hour. This means that A) after one hour, your firm owns the bonds. B) the municipal bond dealer has one hour to sell these bonds to another member at a greater price. C) your firm controls the bonds for one hour. D) the municipal bond dealer has one hour to change the quoted price.
C Explanation 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.
A bond would be considered speculative below which of the following Standard & Poor's (S&P) ratings? A) BB B) B C) BBB D) A
C Explanation A rating of BBB is the lowest investment-grade rating assigned by S&P. Any rating beneath this is considered speculative.
A company set up to invest in real estate, mortgages, construction, and development loans that must distribute at least 90% of its net income to avoid paying taxes on the income distributed is called A) a unit investment trust. B) a trust indenture. C) a real estate investment trust. D) an open-end investment company.
C Explanation A real estate investment trust, to avoid tax on its income, must distribute 90% of its net investment income to investors.
The XYZ Corporation has issued some 4% callable bonds maturing in 20 years. The bonds are callable at 102 commencing in 10 years. Regarding these bonds, which of the following statements is not correct? A) XYZ will most probably call these bonds when it can refund the issuer at a lower interest rate. B) The bonds will likely be called in a declining interest rate market, forcing the bondholders to reinvest at lower rates. C) These bonds will appreciate faster in declining interest rate markets than comparable bonds without a call feature. D) The call premium generally will not compensate the bondholder for the loss of interest if the bond is called.
C Explanation All things being equal, callable bonds will not show as much appreciation in a declining interest rate market as bonds without a call feature. Logically, as interest rates fall, those bonds will be called making them less attractive than bonds where the higher interest rate payments will continue until maturity. It is correct that the premium ($20 in this question) is generally not going to equal the amount of interest that the investor would have been able to earn on the bond. It is some compensation, but not full. The bonds will be called when interest rates have declined, and the investor will now have the cash but faces the reinvestment risk of having to put the money to work at those lower interest rates.
Which of the following positions has an unlimited dollar risk? A) Short 1 ABC Jan 35 call; long 1 ABC Jan 40 call B) Short 100 shares of ABC; long 1 ABC call C) Short 1 ABC Jan 50 put; short 100 shares of ABC D) Short 1 ABC Jan 50 put
C Explanation An investor faces unlimited dollar risk when short stock, short a naked call, or when a short stock position is combined with a short put. In this position, the unlimited risk of the stock is only protected on the upside by the premium received.
A 38-year-old investor places $25,000 into a qualified single premium deferred variable annuity. Twenty-two years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $16,450. B) $25,200. C) $18,000. D) $11,750.
C Explanation Because this is a qualified annuity, the entire withdrawal is taxable. The surrender value of $72,000 has a cost basis of $0.00. That $72,000 is taxed at the marginal rate of 25%. Because the investor is older than 59½ (38 + 22 = 60), there is no additional 10% penalty tax. Effectively, this is a 25% tax on $72,000.
To reduce a client's exposure to systematic risk in his equity portfolio, you would look at which of the following factors? A) Investment return compared to the inflation rate B) Earnings history C) Beta D) Credit rating
C Explanation Beta is a measure of a portfolio's volatility compared to the volatility of the overall market. Because systematic risk is risk associated with investing in the market, lowering the client's volatility (beta) relative to that of the market should lower her exposure to market risk. Credit rating is used to measure default risk on debt securities, and earnings history would assist you in the measurement of business risk (unsystematic risk).
When a well-established corporation needs short-term borrowing for working capital needs, it will most likely issue A) a letter of credit. B) preemptive rights. C) commercial paper. D) a jumbo CD.
C Explanation Commercial paper is the most common tool for corporations to raise short-term funds. A letter of credit is issued by a bank. On the exam, this would usually take the form of bankers' acceptances for those in the import/export business. Banks issue CDs, and preemptive rights are used for the sale of common stock. Stock is long-term capital.
Which of the following are a direct obligation of the U.S. government? A) Government bond mutual funds B) Treasury receipts C) Ginnie Maes D) Fannie Maes
C Explanation Direct debt is backed in full by the U.S. government. The Government National Mortgage Association is owned by the U.S. government; thus, Ginnie Maes are fully backed. Treasury receipts are zero-coupon bonds based on U.S. government debt instruments but are created and issued by broker-dealers and, as such, are not direct obligations of the U.S. government.
FINRA Rule 2310 defines a direct participation program as "a program which provides for flow-through tax consequences regardless of the structure of the legal entity or vehicle for distribution including, but not limited to, oil and gas programs, real estate programs, agricultural programs, cattle programs, condominium securities, Subchapter S corporate offerings and all other programs of a similar nature, regardless of the industry represented by the program, or any combination thereof." The rule places limits on the overall expenses and amount of broker-dealer compensation considered fair and reasonable. That limit is A) 10% of the gross proceeds. B) 5% of the gross proceeds. C) 15% of the gross proceeds. D) 2% of the gross proceeds.
C Explanation If the organization and offering expenses exceed 15% of the gross proceeds, FINRA considers that too high. The 10% limitation is on the amount of compensation received by a member firm for selling interests in the DPP. The 2% is the maximum charge in a DPP rollup if the firm wishes to solicit votes from the limited partners. The 5% is the FINRA markup policy and that does not apply to DPPs.
Which of the following are fair and equitable methods for the assignment of options contracts by a brokerage firm to a customer? A) First-in, first-out or to the customer with the largest open position in that option B) Last-in, first-out or to the customer with the largest open position in that option C) First-in, first-out or random selection D) Last-in, first-out or random selection
C Explanation Options Clearing Corporation (OCC) rules allow broker-dealers to assign customers using first-in, first-out or random selection methods. In addition, the OCC also states that any other fair method is allowed.
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) Financial planning software B) Research reports C) Reimbursement for meal expenses incurred while attending an investment seminar D) Registration fees to attend an investment seminar
C Explanation 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).
As the price of the volatility market index (VIX) rises, investors should expect A) a decrease in call premiums only. B) a decrease in put premiums only. C) call and put option premiums to rise. D) call and put option premiums to fall.
C Explanation The VIX is a measure of investor expectations regarding market volatility. If the VIX is rising, this reflects an expectation of an increase in market volatility. More market volatility will generally cause all options premiums—both puts and calls—to increase to some extent.
Your client currently holds XYZ stock in her portfolio. You notice that the put-call ratio for options trading on XYZ stock has been increasing over the past several days. The increase in the ratio would indicate that A) for the underlying XYZ stock, more calls than puts are being traded. B) investors are becoming more and more bullish on XYZ stock. C) for the underlying XYZ stock, more puts than calls are being traded. D) for the underlying XYZ stock, straddles are being purchased.
C Explanation The ratio is a measure of puts traded to calls traded and is calculated by dividing the number of traded puts by the number of traded calls (puts / calls). As the ratio increases, it reflects that more puts than calls are being traded and is therefore a more bearish indicator of investor sentiment.
All of the following are used to determine the suitability of recommendations made to a municipal bond customer except A) the customer's marital status. B) the structure of the customer's existing portfolio. C) the customer's tax bracket. D) the customer's state of residence.
C Explanation To determine suitability when recommending municipal bonds, an agent would consider the customer's tax bracket, state of residence (intrastate issues may be double or triple tax exempt), and existing portfolio structure. Some students ask us, "Doesn't the marital status affect the customer's tax bracket?" Yes, it does, but that information is included in the choice the customer's tax bracket.
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) 5:1 C) 2:1 D) 9:1
C Explanation 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.
Your client with a short call position in the S&P 100 index (OEX) is assigned an exercise notice. The obligation is fulfilled by delivering A) 100 shares of a particular stock in the index selected by the option holder. B) a long call in the OEX at the same or lower strike price. C) cash equal to the difference between the closing value of the index and exercise price. D) 100 shares of each of the 100 stocks in the index.
C Explanation Unlike equity options, index options are settled in cash only. Upon exercise, cash equal to the amount that the option is in the money (i.e., excess of market value over strike for a call or excess of strike over market value for a put) is delivered on the settlement date.
A client buys 1 Jul 50 call and writes 1 Jul 60 call. This is A) a debit bear spread. B) a credit bull spread. C) a debit bull spread. D) a credit bear spread.
C Explanation We have to answer two questions: is this a bull or bear spread, and is it a debit or credit spread? Looking at the first question, the goal of a bull is to always buy low and sell high. In the case of options, that refers to the strike prices (not the premiums). In this question, the purchased option has a 50 strike, and the sold option has a 60. That looks like buy low/sell high, so this is a bull call spread. But how can we determine if this is a debit (more money out than in) or a credit spread (the reverse) when the premiums are not shown? Simple. What would you pay more for? The option to buy stock at $50 per share or buy it at $60 per share? When it comes to a call option, the cheaper it can be exercised, the more valuable the option. So, the premium for the $50 call must be higher than the $60. If that is so (as it must be), then the investor is spending more to buy the 50 than is being received when selling the 60. More money out than in is a debit spread.
Which of the following statements about municipal brokers' brokers is not true? A) They do not perform retail trades with individual investors. B) They do not maintain inventories. C) They perform specialized trades for institutions. D) They perform trades on a principal basis only.
D Explanation A broker's broker does not maintain an inventory of bonds. Therefore, they do not act as principals; they act as agents only in trades between dealers or institutions. They do not do retail business.
One of the goals of target date funds is to help manage A) inflation risk. B) retirement risk. C) liquidity risk. D) investment risk.
D Explanation Although not always successful, target date funds adjust the asset allocation as the investor gets closer to retirement age (or whatever date is selected). In so doing, the goal is to reduce the overall investment risk. As mutual funds, liquidity risk is not a concern. In practice, they actually do not do a great job of managing inflation risk because the portfolio becomes heavily invested in fixed income as the target date approaches. This leaves the investor with little in the way of equities to protect against inflation. Retirement risk is not a term used in the industry.
In which of the following strategies would the investor want the spread to widen? Buy 1 RST May 30 put, write 1 RST May 25 put Write 1 RST Apr 45 put, buy 1 RST Apr 55 put Buy 1 RST Nov 65 put, write 1 RST Nov 75 put Buy 1 RST Jan 40 call, write 1 RST Jan 30 call A) III and IV B) II and III C) I and IV D) I and II
D Explanation An investor wants a debit spread to widen (I and II). As the difference between premiums increases, so does potential profit because the investor may sell the option with the higher premium and buy back the option with the lower premium. With credit spreads, investors profit if the spread between the premiums narrows.
The longest initial maturity for U.S. T-bills is A) 39 weeks. B) 2 years. C) 13 weeks. D) 52 weeks.
D Explanation As money market instruments, the longest initial maturity of Treasury bills is 52 weeks. Those bills are auctioned once a month. T-bills of shorter maturities are auctioned weekly. The shortest initial maturity is four weeks.
All of the following will cover a short call except A) a long position in the underlying stock. B) an escrow receipt for the stock. C) a long call with a lower strike price and later expiration. D) cash equal to the aggregate exercise value.
D Explanation Cash never covers a short call because the cost to purchase the stock in the market for delivery at the strike price is unknown. If assigned, the customer must sell (deliver) at the strike price.
Each of the following choices are potential sources of funds associated with the backing of a revenue bond issue except A) concessions. B) lease payments. C) ticket revenues. D) fines.
D Explanation Fines received by a municipality or a state may be used to service the debt of a general obligation bond. Often fines are levied for reasons that include parking tickets, traffic violations, and the late payments of taxes. Concessions and lease payments are sources of funds commonly associated with airport revenue bond issues. Ticket revenue is another term for user fees, as would be the case for the ridership revenue of a municipal bus service.
One of your customers owns 100 shares of GTS common stock. The purchase was made two years ago at a price of $51 per share. GTS has recently declared a 3:2 stock split. At the customer's request, as soon as the new shares are in the account, you sell them and $2,000 from the proceeds of the sale is credited to the customer's account. Based on this information, the tax impact of this transaction is A) a short-term capital gain of $300. B) a long-term capital loss of $1,333 and a short-term capital loss of $667. C) a long-term capital loss of $1,400. D) a long-term capital gain of $300.
D Explanation Immediately after the stock split, the total investment of the initial position remains unchanged at $5,100 (100 shares at $51 per share). After the stock split, the customer owns 150 shares (3/2 times 100 = 150 shares). Therefore, the adjusted cost basis per share is $34 ($5,100 divided by 150 shares). Those 50 shares were sold for $2,000 and have a cost basis of $1,700 ($34 times 50). That is a profit of $300. Alternatively, you could say that 50 shares sold for $2,000 represents a selling price of $40 per share ($2,000 divided by 50 shares), which is a $6 per-share profit ($40 minus the $34 cost basis). Fifty shares times $6 equals a profit of $300. The gain is long-term because the holding period of securities received through a stock split (or stock dividend) is that of the original purchase. If you have to guess, or are running out of time, when you see two identical numbers with the only difference being short- or long-term gain, in almost all questions, one of those two is the correct answer. Now you have a 50% change of guessing correctly and, if you remember that the holding period always begins with the initial purchase, then the odds are 100% in your favor.
A customer has an investment objective of keeping pace with inflation while assuming moderate risk. Which of the following recommendations would best meet the customer profile? A) Variable life insurance policy B) IPO C) Money market fund D) Variable annuity
D Explanation Insurance companies introduced the variable annuity as an opportunity to keep pace with inflation. For this potential advantage, the investor, rather than the insurance company, assumes the investment risk. A variable life insurance policy should be purchased primarily for its insurance features, not its investment features.
Which of the following types of risk cannot be eliminated through diversification under the modern portfolio theory? A) Liquidity risk B) credit risk C) Business risk D) Systematic risk
D Explanation Market risk—sometimes referred to as systematic risk—cannot be diversified away. The risk of investing in a single industry or sector can be diversified away by investing in several industries with returns not correlated to each other. Credit risk can be diversified away by investing in a number of bonds rather than just one or two. The same is true with business risk - a broad portfolio survives the "death" of a single company. A general downturn in the market, however, cannot be eliminated through diversification.
All of the following statements regarding planned amortization class (PAC) collateralized mortgage obligations are true except A) PACs have companion tranches. B) PACs have a more certain maturity date than comparable TACs. C) PACs have a lower-than-average prepayment risk. D) PACs have higher yields than comparable TACs.
D Explanation PACs have two companion tranches: one to absorb prepayments and one to buffer against extension risk. Because there is less risk and a more certain maturity date, PACs tend to have lower yields than comparable TACs.
Which of the following statements regarding a bond quoted as QRS Zr 32 is true? A) The bond pays $12 interest annually. B) The bond pays $120 interest annually. C) The interest payable is tax free. D) The bond pays no interest until maturity.
D Explanation QRS Zr 32 represents a zero coupon bond issued by the QRS Company maturing in 2032. Zero coupon bonds are bought at a discount and mature at face value. If a bond is held to maturity, the difference between the purchase price and the maturity price is considered interest, though it is taxed on a yearly basis.
An investor in an equipment-leasing direct participation program (DPP) using straight-line depreciation would probably not be concerned about A) the quality of the management. B) legislative risk. C) liquidity risk. D) the likelihood of recapture.
D Explanation Recapture of deductions is a concern when accelerated, but not when straight-line depreciation is used. In any business, there is always concern about the quality of the management. By and large, DPPs are not liquid investments, so an investor needing a quick sale may have problems. The nature of DPPs tends to make them more sensitive to legislative risk than most other securities.
The bond resolution includes all covenants between A) the issuer and the bond counsel. B) the bond counsel and the bondholders. C) the issuer and the Municipal Securities Rulemaking Board. D) the issuer and the trustee acting for the bondholders.
D Explanation The bond resolution describes not only the characteristics of the proposed offering, but also the obligations the issuer has to its bondholders.
If an American exporter will be paid 25 million Japanese yen when her goods arrive in 45 days, her best hedge is to A) sell yen puts. B) buy yen calls. C) sell yen calls. D) buy yen puts.
D Explanation 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.
A customer establishes the following positions: Buy 100 JMB at 28 Buy 1 JMB Dec 25 put at 2 What is the maximum potential loss? A) $2,800 B) $200 C) $3,000 D) $500
D Explanation The investor loses money on the long stock position when the market value falls. With the purchase of the put, the investor can sell the stock for no less than the strike price, but also loses the premium. In this example, the investor loses a maximum of $3 on the stock (28 − 25) plus the premium of $2, for a total loss of $500 on 100 shares.
The Bond Buyer's 30-Day visible supply includes issues of notes sold on a competitive basis. issues of bonds sold on a competitive basis. issues of notes sold on a negotiated basis. issues of bonds sold on a negotiated basis. A) I and II B) III and IV C) I and III D) II and IV
D Explanation The visible supply includes only bonds. Notes are not considered because they do not compete directly with the bonds.
Upon notification of the death of a client, which of the following actions would not need to be taken by the registered representative assigned to the account? A) Canceling all good-til-canceled (GTC) orders currently entered for the account B) Marking the account Deceased until all proper documentation has been received C) Canceling all day orders currently entered for the account D) Obtaining the names of the beneficiaries of the estate for the purpose of notifying all parties
D Explanation Upon being notified of the death of a client, the registered representative assigned to the account should cancel all open orders (GTC and day) and mark the account Deceased. The firm should not permit any trades until proper documents are received from the estate representative. There is no requirement, nor is it the responsibility of the firm to contact the decedent's attorney or beneficiaries.
A municipal bond, issued with a covenant that states, "If revenue collections are not sufficient to meet debt service requirements, the issue will be backed by the full faith and credit of the municipality," is known as A) a moral obligation bond. B) a contingent liability bond. C) a Section 8 bond. D) a double-barreled bond.
D Explanation When a municipal bond is backed by both a source of revenue and the taxing ability of the issuer, this is referred to as a double-barreled bond.
What happens to outstanding fixed-income securities when market interest rates drop? A) Short-term fixed-income securities are affected most. B) The yields increase. C) The coupon rates increase. D) The prices increase.
D Explanation When interest rates drop, the price of outstanding bonds rises to adjust to the lower yields on bonds of comparable quality.
Under Regulation FD, if an officer of an issuer makes an unintentional disclosure of nonpublic, material information to an institutional investor, the issuer A) is not required to take any specific action because the disclosure was unintentional. B) must file Form 8-K at or prior to month end. C) must prepare and distribute a press release by the close of business on the following day. D) must promptly make public disclosure of the same information.
D Explanation Whenever an issuer unintentionally discloses nonpublic, material information to any person outside of the issuer, the issuer must promptly make public disclosure of the same information. "Promptly" means as soon as practical—more specifically, no later than 24 hours after known by a senior officer, or the start of the next day's trading on the New York Stock Exchange, whichever is later. The press release by the end of the following day would likely be too late. It is unlikely that the exam will ask anything about Form 8-K, but when required, that form has a 4-day filing requirement.
Revenue bond rate covenants require the user fees to be high enough to cover all of the following obligations of the issuing authority except A) the debt service. B) the operations and maintenance. C) the debt service reserve fund. D) the optional call provisions.
D Optional call provisions are at the option of the issuer. Rate covenants of an issue will not require enough to be collected to cover a call on the bonds.
