Series 7- Practice Exam 2
Credit risk involves A) fluctuations in overall interest rates. B) inflationary risks. C) the possibility of issuer default. D) the danger of not being able to sell the investment at a fair market price.
C) the possibility of issuer default. Credit risk is the danger of losing all or part of the invested principal as the result of the issuer's failure. LO 14.a
The derivative-based strategy known as portfolio insurance involves A) the sale of a put on the underlying security position. B) the purchase of a call on the underlying security position. C) the purchase of a put on the underlying security position. D) the sale of a call on the underlying security position.
C) the purchase of a put on the underlying security position. The purchase of a put option to hedge the downside risk of an underlying security holding is called a protective put position, one of many derivative-based strategies collectively known as portfolio insurance. LO 10.g
Which of the following carries the least amount of market risk? A) Common stock B) Treasury bills C) Treasury bonds D) Savings accounts
D) Savings accounts Savings accounts carry no market risk, which, by definition, is the risk that an investor will experience losses due to day-to-day fluctuations in the prices of securities bought and sold in the market. LO 14.a
In a new municipal offering, who is responsible for hiring bond counsel? A) The syndicate manager B) Syndicate members C) The Municipal Securities Rulemaking Board D) The issuer
D) The issuer The issuer hires a bond attorney to render an opinion on the prospective municipal offering. LO 6.a
A blind pool offering A) is connected with oil and gas leases. B) is one in which the properties are purchased on a lottery basis. C) generates nonallocated income. 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
The official statement for a new revenue bond indicates that the flow of funds is based on a net revenue pledge. This means the first payments go to A) pay the interest and principal maturing in the current year. B) renewal and replacement fund. C) the debt service reserve fund. D) pay current operating and maintenance expenses.
D) pay current operating and maintenance expenses. When the flow of funds is described as a net revenue pledge, it means the operating and maintenance expenses are paid first. Following that is the debt service (interest and this year's principal). In a gross revenue pledge, the order is reversed. LO 6.c
If a 40-year-old customer earns $65,000 a year, and his 38-year-old spouse earns $40,000 a year, how much may they contribute to IRAs? A) Only the higher wage earner may contribute to an IRA. B) They may not contribute because their combined income is too high. C) They may contribute up to the maximum annual allowable dollar limit split evenly between both accounts. D) They may each contribute 100% of earned income or the maximum annual allowable dollar limit, whichever is less, to an IRA.
They may each contribute 100% of earned income or the maximum annual allowable dollar limit, whichever is less, to an IRA. Regardless of the amount, individuals or couples may contribute to their IRAs if they have earned income. Each is entitled to contribute 100% of earned income up to the maximum allowed. However, if either or both of them are covered under a qualified plan, limits may exist on the deductibility of the contributions. LO 1.g
If a customer buys 1 ABC Jan 50 call at 2 and 1 ABC Jan 50 put at 4 when ABC is at 49, the customer must deposit A) $600. B) $500. C) $200. D) $400.
A) $600. The customer purchased a straddle and must pay the full cost of both options ($200 + $400 = $600 total premium). LO 16.d
Which of the following is true regarding a 5-for-4 stock split? A) Each shareholder's proportionate equity will be unchanged. B) The par value will be unchanged. C) Retained earnings will be increased. D) The net worth of the company will be reduced.
A) Each shareholder's proportionate equity will be unchanged. Because each shareholder will receive additional stock, the proportional equity will remain the same. LO 3.b
Which of the following is not a type of CMO tranche? A) PSA B) TAC C) PAC D) Z
A) PSA PSA is the Public Securities Association. What does that have to do with CMOs? Plenty. It is the PSA table that is used to project the prepayment schedule for CMO tranches. However, unlike the PAC (planned amortization class) or the TAC (targeted amortization class) and the Z (zero), it is not a tranche. LO 12.d
If an investor is long 5 Dec puts on the Canadian dollar, these options will expire in December on A) the third Friday of the expiry month. B) the Wednesday after the third Saturday. C) the Saturday after the third Friday. D) the Friday preceding the third Wednesday.
A) the third Friday of the expiry month. Currency options, like equity options, expire on the third Friday of the expiry month. LO 10.g
If a moral obligation bond goes into default, the only way bondholders can be repaid is A) through legislative apportionment. B) by waiting for the issuer to become solvent again. C) a court order. D) through an asset liquidation.
A) through legislative apportionment. A moral obligation bondis a state- or local-issued, or state- or local-agency issued, bond. If revenues or tax collections backing the bond are not sufficient to pay the debt service, the state legislature has the authority to appropriate funds to make payments. That is the only way the bondholders can be repaid. The legislature rarely reneges on its moral obligation. LO 6.b
If a customer believes interest rates have peaked, and therefore, wants to buy long-term, fixed-income securities providing semiannual interest payments, you would recommend A) Treasury STRIPS. B) bonds that do not have a call feature. C) premium bonds with low call premiums. D) puttable bond
B) bonds that do not have a call feature. The purchase of noncallable bonds provides the investor with a constant flow of semiannual interest income until maturity. Treasury STRIPS do not make regular interest payments. LO 7.a
The call provisions of a municipal issue would be detailed most completely in A) the legal opinion. B) the bond resolution. C) The Bond Buyer. D) the official notice of sale.
B) the bond resolution. The bond resolution is the document that authorizes the issuance of a municipal bond. The resolution also describes the proposed issue's features and the issuer's responsibilities to its bondholders. LO 6.a
A customer is choosing a payout option for a variable annuity. Maximizing monthly income for the rest of his life is the customer's key objective. This annuitant has no living relatives, so beneficiaries are not a concern. Which of the following options available would best meet the needs of this annuitant? A) A life with a 5-year period certain payout option B) Take random withdrawals from the contract C) A straight life payout option D) A life with a 20-year period certain payout option
C) A straight life payout option The largest monthly check an annuitant can receive for the rest of his life is generated by a straight life (life income or life only) payout option. Though there is no beneficiary designation during the annuitization, this is not an issue for this annuitant. Life with period certain will produce a smaller check for life because the insurance company will guarantee payments to a beneficiary for a certain time designated in the contract, should the annuitant die within that period. But again, the need to designate beneficiaries is not an issue for this annuitant. Random withdrawals do not guarantee how long the money will last because large withdrawals can deplete the funds before the annuitant dies. LO 9.b
Which of the following balance sheet items is not a current liability? A) Accrued taxes B) Accounts payable C) Mortgages D) Long-term debt amount that is due within one year
C) Mortgages Short-term or current liabilities are those entries on a balance sheet that are due in one year or less. Accounts payable, accrued taxes, and that portion of long-term debt due within the year are all current liabilities. Mortgages are generally long-term liabilities, although that portion of a mortgage that is due within the year would be classified on the balance sheet as a current liability. LO 13.c
If a customer has a margin account with a long market value of $140,000 and a debit balance of $60,000, what is the buying power in the account? A) $20,000 B) $0 C) $10,000 D) $5,000
A) $20,000 With Regulation T at 50% (always assumed), the buying power of a margin account is twice the amount of the SMA. With a long market value of $140,000 and a debit balance of $60,000, this account has equity of $80,000. The Regulation T requirement is $70,000 (50% times $140,000). Therefore, there is excess equity (or SMA) of $10,000. The purchasing power is double that ($20,000). LO 16.d
Due to a distribution of stock, the contract size in the JGH Oct 50 call options is 108. A customer purchasing one of these contracts for a premium of 2½ would expect to pay A) $270. B) $330. C) $250. D) $258.
A) $270. With a contract size of 108 shares (likely from an 8% stock dividend) and a premium of $2.50 per share, the total cost is $270. Regardless of the reason for the contract size being other than 100 shares, the price paid for an option is always the premium multiplied by the number of shares in the contract. In this question, that would be a premium of $2.50 per share (2½) times 108 = $270.00. LO 10.j
In which of the following qualified plans might a graduate student teaching two classes daily as a teaching assistant at a state university be able to participate? A) 403(b) B) 401(k) C) 501(c)(3) D) 457(b)
A) 403(b) Students are not eligible to participate in qualified plans. However, if the student is teaching for the public institution and meets the minimum eligibility qualifications, the student is an employee like any other teacher. These plans, also known as tax-sheltered annuities (TSAs), are available for state, municipal, and government employees, as well as employees of nonprofit organizations. Although a teacher at a state university can participate in a 403(b) plan, students who are there solely to attend class are not eligible. LO 1.h
A registered representative must obtain written verification of an investor's net worth for which of the following investments? A) Direct participation program B) Mutual fund C) Variable contract D) Real estate investment trust
A) Direct participation program Before an investor can become a limited partner, the investor must provide a written verification of net worth. The investor is accepted as a limited partner only when the general partner signs the subscription agreement. LO 11.c
An investor is considering purchasing a bond. He has decided on either a 6% municipal bond offered by the state in which he lives or an 8% corporate bond offered by a company with headquarters in his state. He would like you to help him decide which bond will get him the greatest return for his investment. Which of the following items of information must you obtain before you can make a specific recommendation? A) His tax bracket B) How long he has been a resident of his state C) What other securities he owns D) His net worth
A) His tax bracket To make the recommendation, you must do a tax-equivalent yield or tax-free equivalent yield calculation, for which you need the investor's tax bracket. The other items listed do not have any bearing. LO 6.f
A customer opening a margin account must be supplied with a special margin risk disclosure. Which of the following are specific risks disclosed? Customers are not entitled to choose which securities can be sold if a maintenance call is not met. Customers can lose more money than initially deposited. Customers are not entitled to an extension of time to meet a margin call. Firms can increase their in-house margin requirements without advance notice. A) I, II, III and IV B) I, and IV C) II, III and IV D) II and III
A) I, II, III and IV All of these are part of the margin risk disclosure document. LO 2.g
Which of the following statements regarding exchange-traded funds (ETFs) are true? The SEC has classified them as mutual funds. The SEC has classified them as a type of open-end fund. They have operating costs and expenses that are higher than most mutual funds. They have operating costs and expenses that are lower than most mutual funds. A) II and IV B) I and IV C) II and III D) I and III
A) II and IV The SEC has classified ETFs as a type of open-end fund but not a mutual fund. ETFs traditionally have operating costs and expenses that are lower than most mutual funds because they do not have to purchase and sell holdings within the portfolio to accommodate investors purchasing shares or redeeming shares, as is the case with mutual funds. LO 8.h
Which of the following would protect a short May 50 put? A) Long Jun 55 put B) Long Jun 45 put C) Long Apr 55 put D) Long Apr 45 put
A) Long Jun 55 put For a long put to cover a short put, it must have the same or higher strike price and the same or longer expiration. This ensures the investor may sell the stock without financial loss if the short put is exercised, and she is forced to buy. LO 10.h
If a new customer is preparing to buy his first home within the next year, and his investment objective is aggressive growth, which of the following investments would be most suitable for your customer's portfolio? A) T-bills B) High-yield bond fund C) Blue-chip equity fund D) Growth stocks
A) T-bills While his profile indicates aggressive growth, the fact that he will need his funds in a year or less to purchase a home is the major consideration. With such a short time horizon, any equity investment involves too much risk, as does an investment in a high-yield bond fund. Of the choices, T-bills make the most sense. LO 14.a
Which of the following strategies would be considered most risky in a bull market? A) Writing naked calls B) Buying calls C) Writing naked puts D) Buying a put
A) Writing naked calls Writing naked calls provides unlimited liability and the most risk. Buying a call would be an attractive strategy in a bull market with risk limited to calls paid. Writing naked puts risks only the difference between the strike price and zero, less any premium received. Buying a put is a bearish strategy, with risk limited to the amount paid for the put. LO 10.d
An investment adviser representative may describe dollar cost averaging to a customer as A) a funding technique that will cause the average cost per share to be less than the average price per share. B) a program for investing that will ensure profits even in a declining market. C) a means of purchasing more shares when share prices are high. D) a form of a mutual fund withdrawal plan.
A) a funding technique that will cause the average cost per share to be less than the average price per share. Dollar cost averaging is beneficial to the client because it achieves an average cost per share that is less than the average price per share over time. Using a fixed dollar amount each investment period, it enables the investor to purchase more shares when prices are lower and fewer shares when prices are higher. While dollar cost averaging does not ensure profits in any market or ensure against losses, it is an economical and convenient method for acquiring shares. LO 8.e
The Securities Act of 1933 covers all of the following except A) blue-sky laws. B) full and fair disclosure. C) liabilities for misleading filings. D) prospectus requirements.
A) blue-sky laws. The purpose of the Securities Act of 1933 is to provide investors with full disclosure about a new securities issue. The act is federal in scope, whereas blue-sky laws refer to state securities regulations. LO 20.c
Mutual fund shares represent an undivided interest in the fund, which means that A) each investor owns a proportional part of every security in the portfolio. B) investors can only purchase full shares. C) the number of shares outstanding is limited to a predetermined maximum. D) the fund can only hold securities of certain companies.
A) each investor owns a proportional part of every security in the portfolio. Each mutual fund shareholder owns an undivided interest in the investment company's portfolio. Because each share represents one class of voting stock, the investor's interest in the fund is reflected by the number of shares owned. LO 8.e
All of the following are objectives in a direct participation program (DPP) except A) short-term capital gains. B) deferment of taxes. C) deductions against passive income. D) long-term capital gains.
A) short-term capital gains. DPPs are used to defer present income into the future and take advantage of time. In doing so, any gains will be taxed at favorable long-term rates. The expected losses in the early years may be taken as deductions against passive income from other sources. LO 11.g
A registered representative of a FINRA member firm is going to present a seminar on retirement planning. It will be a slide show, and no specific advice will be given. The expected attendance is approximately 50 people. Under the FINRA rule on communications with the public, A) the slides are considered a retail communication and need principal approval before first use. B) this is a public appearance and no approvals are necessary. C) this seminar can take place only if the recommendations are tailored to the specific needs of the audience. D) a registered principal is required to attend to ensure that the standards of ethical conduct are maintained.
A) the slides are considered a retail communication and need principal approval before first use. Under the FINRA rule on communications with the public, it is only an unscripted presentation that needs no principal approval. The use of slides changes things, and once more than 25 individuals will see them within a 30-calendar-day period, those slides are retail communications. As such, principal approval is required. Because the question states that no specific advice will be given, suitability of recommendations is irrelevant. However, all presentations at seminars should consider the nature of the audience and keep the presentation at the appropriate level. LO 19.b
When a customer enters a sell order and is in possession of the certificates, a broker-dealer must determine all of the following except A) whether the transfer agent has accepted the securities. B) whether the client can make delivery promptly. C) the location of the securities. D) whether the securities are in deliverable form.
A) whether the transfer agent has accepted the securities. A firm must make an affirmative determination and be reasonably sure the client can make prompt delivery. It isn't until after delivery (after the sell order has been accepted and the trade has taken place) that the transfer agent receives the certificates. LO 17.d
Treasury STRIPS and Treasury receipts are quoted based on A) yield to maturity. B) amortization of premiums. C) 0.125 (⅛ of a point in dollars). D) 0.03125 (1/32 of a point in dollars).
A) yield to maturity. Non interest-bearing securities, like zeroes, are quoted based on their yield to maturity. They are sold at a discount and mature at par. LO 7.a
XYZ Corporation, whose common stock is currently selling for $40 per share, is having a rights offering. The terms of the offering require 10 rights plus $35 to subscribe to one share of stock. Compute the theoretical value of a right before the ex-rights date. A) $3.50 B) $0.45 C) $0.55 D) $0.50
B) $0.45 Because the stock is trading with rights (before the ex-rights date), the formula is (M ‒ S ) divided by (N + 1). Plugging the numbers in, we have ($40 ‒ $35) divided by (10 + 1) = $5.00 ÷ 11 = $0.45. LO 3.f
The ABC Corporation has a long-standing policy of maintaining a dividend payout ratio of 45%. ABC's net income for the year is $12 million, and there are 8 million shares of common stock outstanding. After a 3:2 stock split, the annual dividend per share is A) $1.0125. B) $0.45. C) $0.675. D) $1.50.
B) $0.45. Take this systematically. A dividend payout ratio of 45% means ABC will distribute 45% of its net income to its common shareholders. Forty-five percent of $12 million is $5,400,000 in dividends. If there were 8 million shares before the split, there are now 12 million (8 times 3/2 = 24 divided by 2 = 12). Divide the amount available for common ($5.4 million) by the number of shares (12 million) to arrive at a dividend per share of $0.45. There is another way to compute this. With net income of $12 million and 8 million shares, the pre-split earnings per share is $1.50 ($12 million divided by 8 million = $1.50). The company pays out 45% of its net income as a dividend. That would be $0.675 ($1.50 times 45%). With the 3/2 split, the number of shares has increased by 150%, meaning that the new dividend will be 2/3 of the previous amount. That computes to the same $0.45 per share. LO 13.d
If a customer has a long margin account with a market value of $12,000, a debit balance of $8,000, and special memorandum account (SMA) of $2,000, how much can the customer withdraw from the account? A) $1,500 B) $1,000 C) $2,000 D) $0
B) $1,000 SMA is a line of credit with one restriction: it may not be used if account equity would fall below minimum maintenance. In this account, maintenance equity is $3,000 (25% of $12,000),0 and the current equity in the account is $4,000 ($12,000 MV − $8,000 DB). Therefore, only $1,000 may be withdrawn to keep the current equity at the minimum of $3,000. LO 16.d
A dealer in U.S. government securities quotes a 5-year Treasury note at 89.12-89.16. In dollars, that represents a spread of A) $0.04. B) $1.25. C) $4.00. D) $0.125.
B) $1.25. Treasury notes and bonds are quoted in fractions of 32nds. The spread between the bid and the ask is 4/32nds. In simpler terms, that is 1/8th. Each point is $10.00, so this 1/8th of $10.00 is equal to $1.25. LO 7.b
A customer purchases an XYZ municipal bond at 108. It is scheduled to mature in 16 years. After owning the bond for 10 years, she sells the bond at 102. What capital gain or loss must she report for tax purposes at the time of the sale? A) $10 gain B) $10 loss C) $60 loss D) $20 gain
B) $10 loss If a municipal bond is purchased at a premium, the premium must be amortized over the time until maturity. An $80 premium on a 16-year municipal bond indicates that $5 will be amortized each year ($80 / 16 = $5). Ten years at $5 per year is $50 of amortization. Therefore, after 10 years, the tax basis would be $1,080 minus $50, or $1,030 (103). Because the sale was for 102 ($1,020), the customer has a $10 loss on one bond. LO 6.e
Regarding the use of the term direct participation programs (DPPs) when referring to tax-sheltered investments, which of the following is not a DPP? A) A real estate limited partnership B) A real estate investment trust (REIT) C) An equipment leasing limited partnership D) An oil and gas limited partnership
B) A real estate investment trust (REIT) DPPs include any form of business that allows for the direct pass-through of tax consequences to participants. REITs do not allow for the pass-through of losses. LO 11.b
An investor with a large salary, as well as unearned investment income, is two years from retirement. If she wants to shelter a portion of her income, which of the following programs would provide her with substantial initial write-offs? A) Existing housing B) An oil and gas drilling program C) An oil and gas income program D) Raw land
B) An oil and gas drilling program Oil and gas drilling programs pass through intangible drillings costs, which the partners may use to reduce passive income. LO 11.f
Your client's investment portfolio is 50% growth stocks, 10% foreign stocks, and 40% blue-chip stocks. If the client is interested in further diversification, which mutual fund would best meet that goal? A) Emerging market fund B) Bond fund C) Global equity fund D) Aggressive growth fund
B) Bond fund All of the current holdings are equities. To further diversify the current portfolio, the bond fund would be the best choice of those given to meet this objective. LO 14.a
Which of the following statements regarding convertible bonds is not true? A) Convertible bondholders are creditors of the corporation. B) Coupon rates are usually higher than nonconvertible bond rates of the same issuer. C) If there is no advantage to converting the bonds into common stock, they would sell at a price based on their market value without the convertible feature. D) Coupon rates are usually lower than nonconvertible bond rates of the same issuer.
B) Coupon rates are usually higher than nonconvertible bond rates of the same issuer. Coupon rates are not higher; they are lower because of the value of the conversion feature. The bondholders are creditors. If the stock price falls, the conversion feature will not influence the bond's price. LO 5.c
Which of the following regarding a municipal bond broker's broker are true? Protects customer identity Must disclose the identity of customers Has no inventory Maintains an inventory A) I and IV B) I and III C) II and IV D) II and III
B) I and III Municipal brokers' brokers generally purchase and sell securities on an anonymous basis for institutional clients. They are not in the business of making a market; therefore, they maintain no inventory. LO 6.d
If you invest in a front-end load mutual fund and choose automatic reinvestment, you should expect that dividend distributions will be reinvested at net asset value. dividend distributions will be reinvested at the public offering price. capital gains distributions will be reinvested at net asset value. capital gains distributions will be reinvested at the public offering price. A) II and III B) I and III C) II and IV D) I and IV
B) I and III Mutual funds that offer automatic reinvestment of dividends and gains distributions must do so at net asset value. LO 8.f
If a customer buys a new issue municipal bond at a discount in the primary market, which of the following statements are true? The discount must be accreted. The discount may not be accreted. At maturity, there is a capital gain. At maturity, there is no capital gain. A) I and III B) I and IV C) II and III D) II and IV
B) I and IV If a new issue municipal bond is bought at a discount in the primary market, the discount must be accreted. The accretion is considered interest income, and, as an original issue discount bond, is not taxable. LO 6.f
Which of the following accurately depicts communications with the public designated as correspondence? Review by a principal must occur before use. Review by a principal can occur either before or after use, in accordance with the firm's written procedures. Filing with FINRA is required. Filing with FINRA is not required. A) II and III B) II and IV C) I and IV D) I and III
B) II and IV Correspondence review by a principal can occur either before or after use, in accordance with the firm's written procedures. Filing of correspondence with FINRA is not required. LO 19.c
Which of the following responsibilities did the Municipal Securities Rulemaking Board (MSRB) receive through the Securities Acts Amendments of 1975? Regulation of municipal issuers Establishment of recordkeeping requirements for municipal broker-dealers Enforcement of any municipal regulations it adopts Creation of regulations for participants in the municipal securities secondary market A) I and III B) II and IV C) I and IV D) II and III
B) II and IV The MSRB creates rules for municipal trading and issues interpretations of its rules. It does not regulate issuers or have any enforcement capability. For broker-dealers, MSRB rules are enforced by FINRA. LO 6.a
Which of the following mortgage-backed securities would provide investors with the most predictable maturity date? A) Fannie Maes B) Planned amortization classes (PACs) C) Ginnie Maes D) Targeted amortization classes (TACs)
B) Planned amortization classes (PACs) PACs are planned amortization class collateralized mortgage obligations and have established maturity dates. Prepayment risk is transferred to the PAC companion—or support—class bonds. LO 12.d
If a client who seeks diversification through real estate is concerned about illiquidity associated with investing in real estate, which of the following investments is most suitable? A) Interest in a real estate limited partnership B) Real estate investment trust C) Privately placed investment D) Direct investment in a shopping center renting retail space to a broad variety of stores
B) Real estate investment trust Real estate investment trusts are best suited to the client because they are market-traded securities that provide an investor with a liquid market in which to invest in real estate. LO 11.a
A customer wishes to diversify an investment portfolio to include real estate. However, the customer is concerned that real estate tends to be illiquid. Which of the following would be a suitable recommendation? A) Diversified open-end investment companies B) Real estate investment trusts C) Government National Mortgage Association securities D) Real estate limited partnership offerings
B) Real estate investment trusts REITs (real estate investment trusts) allow investors the opportunity to invest in real estate and provide a high level of liquidity because they are publicly traded on exchanges and OTC. The real estate DPP does provide an opportunity to invest in real estate, but it is considered illiquid because there is generally no available secondary market. When a mutual fund is a diversified company, it means that it complies with the 75-5-10 rule, not that its portfolio is diversified into real estate. GNMA securities are debt obligations and do not provide the equity diversification this investor is seeking. Please note: As pointed out in the LEM, there has been a growth in the number of nontraded REITs. Obviously, they do not have the liquidity of those that are publicly traded. For exam purposes, unless something in the question indicates that the REIT is nontraded, you can safely assume it is a liquid investment. LO 11.a
The RJN Corporation has issued warrants where each warrant offers the holder the right to purchase one share of RJN's common stock for $20 per share. The warrants are exercisable anytime within the next five years. Chelsea purchases 80 warrants for $2 each. If three years after the purchase, the market price of RJN common stock has risen to $25 per share and Chelsea sells the warrants for their intrinsic value, she has realized A) a long-term capital gain of $400. B) a long-term capital gain of $240. C) a short-term capital gain of $400. D) a short-term capital gain of $240.
B) a long-term capital gain of $240. The intrinsic value of a warrant is the difference between the exercise price and the current market price. Being able to purchase stock at $20 per share when the market price is $25 per share means the warrant is intrinsically worth $5. With 80 warrants, the sale proceeds are $400 (80 times $5 each). Don't forget that Chelsea paid $2 for each warrant, a cost of $160 (80 times $2). That makes her net gain $240 ($400 proceeds minus $160 cost). The gain is long-term because she held the warrants longer than 12 months. LO 3.i
All of the following may be included in an advertisement for a collateralized mortgage obligation (CMO) issue except A) a disclosure of the CMO's coupon rate and final maturity date. B) a statement that the CMO is guaranteed by the U.S. government. C) a disclosure that payment assumptions may or may not be met. D) a generic description of the CMO tranche.
B) a statement that the CMO is guaranteed by the U.S. government. The U.S. government does not issue or back CMOs. It is also misleading to state or imply that a CMO's anticipated yield or average life is guaranteed. CMOs must include the coupon rate and the final maturity date, a generic description of the CMO tranche, and disclosure that payment assumptions may or may not be met. LO 19.d
All of the following statements regarding municipal bond official statements are true except A) a retail customer must receive an official statement no later than the settlement date. B) an official statement must be delivered only upon request of a retail customer. C) the Municipal Securities Rulemaking Board (MSRB) does not require issuers of new municipal securities to prepare a final official statement. D) all retail purchasers of a new municipal bond issue must receive a final official statement.
B) an official statement must be delivered only upon request of a retail customer. A final official statement must be delivered to retail buyers of a new issue on or before the settlement date. The MSRB does not regulate issuers, but does make the preparation of a final official statement a requirement of its member firms. LO 20.d
Customers will have a potentially unlimited loss if they are A) long 100 shares of ABC stock and short 1 ABC 50 call. B) short 1 ABC Jan 50 call and short one ABC Jan 50 put. C) long 1 ABC Jan 50 put and long 100 shares of ABC stock. D) short 1 ABC Jan 50 put and long 100 shares of ABC stock.
B) short 1 ABC Jan 50 call and short one ABC Jan 50 put. When trading options, there is one way in which to have a potentially unlimited loss. That is the uncovered (naked) call. When a call option is written without a corresponding long position in the underlying, the writer loses when the price goes up. Because there is theoretically no limit as to how high a stock's price can go, the potential loss is unlimited. In this short straddle position, it is the short call that creates this possibility. With a short put, the lowest a stock's price can go is to zero. With a 50 put, that is a maximum loss of $50 less the premium received. The maximum loss on any long position, stock or option, is what the investor paid for it. LO 10.h
An investor begins a periodic payment deferred variable annuity purchase program. One respect in which this differs from purchasing a mutual fund is that A) the variable annuity contract will generally have lower expenses than the mutual fund. B) the investor in the variable annuity contract reports no taxable consequences during the accumulation period. C) there is a minimum guaranteed return with the variable annuity, while there are no guarantees with the mutual fund. D) the mutual fund will generally have a surrender charge for early withdrawal and variable annuities only charge for surrender when annuitizing.
B) the investor in the variable annuity contract reports no taxable consequences during the accumulation period. One of the features of annuities is the tax deferral of all earnings until the money is withdrawn. Mutual fund distributions are taxable when received. On the other hand, when the annuity accumulation is withdrawn, everything above the cost basis is taxed as ordinary income (10% penalty if younger than 59½)—there is never any capital gains treatment with annuities. Variable annuities invariably have higher expense ratios than mutual funds with similar portfolios. Surrender charges are found with annuities. Do not confuse those with the conditional deferred sales charge (CDSC) applied to certain mutual fund share classes. LO 9.d
One of your clients has a margin account with the following balances: long market value $50,000, debit balance $24,000, short market value $40,000, and credit balance $65,000. The account will be at the minimum maintenance level when A) the long market value is $37,500 and the short market value is $50,000. B) the long market value is $32,000 and the short market value is $50,000. C) the long market value is $32,000 and the short market value is $52,000. D) the long market value is $37,500 and the short market value is $52,000.
B) the long market value is $32,000 and the short market value is $50,000. When there is a combined (mixed) margin account, the maintenance is computed separately for the long and the short positions. The maintenance level on a long margin account is reached when the equity is only 25% of the market value. To find that level, divide the debit balance by 75% or multiply the debit by 4/3. In a short margin account, the maintenance level is when the equity is 30% of the market value of the short stock. To find that level, divide the credit balance by 130% (or 1.3). The math for our question becomes the debit balance of $24,000 ÷ .75 resulting in a quotient of $32,000. Alternatively, multiplying $24,000 times 4 and then dividing by 3 = $96,000 ÷ 3, or $32,000. Continuing to the short account, the credit balance is $65,000. Dividing that by 130% (or 1.3) results in a quotient of $50,000. LO 16.d
An 18-year-old, unmarried high school student sought a safe investment for a $30,000 bequest until after she graduated from college. Her intent is to use the funds for the down payment on a house after graduation. Her agent recommended she choose a variable annuity as a safe haven for the funds. This recommendation is A) suitable due to the death benefit features of a variable annuity. B) unsuitable because her situation exposes her to surrender charges and early withdrawal penalties in exchange for insufficient benefits. C) unsuitable because the return on something as conservative as a variable annuity tends to be low. D) suitable due to the relative safety of the investment.
B) unsuitable because her situation exposes her to surrender charges and early withdrawal penalties in exchange for insufficient benefits. This customer has no spouse or dependents, which negates the value of the death benefit. The funds are not liquid due to the surrender fees, and there is also a 10% penalty on withdrawals before age 59½. LO 9.b
Under SEC rules, all of the following information must be on a customer confirmation except A) whether the member acted as agent or principal. B) whether the trade was solicited or unsolicited. C) whether the member is a market maker in the security bought or sold. D) whether the member has a control relationship with the issuer.
B) whether the trade was solicited or unsolicited. Under SEC Rule 10b-10, a customer trade confirmation must include whether the member acted as agent or principal, if the member is a market maker in the security, if a control relationship exists between the member and the issuer. Whether the trade was solicited or unsolicited is not a required disclosure (although many firms do disclose this information). Confusing fact: This information must be on the order ticket, but not on the confirmation. LO 15.a
A municipal bond is purchased at a discount in the secondary market at 90. The face amount is $10,000, and the bond has 10 years to maturity. If the bond is sold for 97 after five years, what is the taxable gain? A) Capital gains not taxable B) $300 C) $200 D) $700
C) $200 When a municipal bond is bought at a discount in the secondary market, the discount is accreted and taxable as ordinary income. Accretion increases cost basis. Therefore, five years later, the bond's cost basis is 95. At that point, the customer has a two-point capital gain. Had the bond been bought as an original issue discount, the annual accretion is considered interest income and is not taxable. LO 6.e
An investor placed $5,000 into a 200% leveraged index ETF. During the first period, the index against which the ETF was measured rose by 10%. In the second period, the same index fell by 20%. What is the value of the leveraged ETF investment at the beginning of the third period? A) $5,600 B) $4,400 C) $3,600 D) $5,400
C) $3,600 The investment value would be $3,600 at the beginning of the third period. In a leverage ETF, the investment result of the portfolio is a multiple of the performance of the index it is measured against. In this question, the ETF value will increase or decrease by 200% (2 times) of the performance of the index. In the first period, the index rose by 10%; therefore, the ETF rose by 20%. The $5,000 investment would have risen to a value of $6,000 ($5,000 times 20% = $1,000 + $5,000). During the second period, the index fell by 20%. The ETF value would have declined by 40% ($6,000 times 40% = $2,400); therefore, the $6,000 investment value would have declined by $2,400 to $3,600. LO 8.h
In active trading, a bond of standard size rises in price from 98 5/8 to 101¾. This represents a dollar change of A) $3.125. B) $312.50. C) $31.25. D) $0.3125.
C) $31.25. Let's take this step by step remembering that every point in a bond quote equals $10 and every 1/8 of a point equals $1.25 ($10/8=$1.25). Method #1 1) The increase is 3 1/8 points (101 ¾ minus 98 5/8 = 101 6/8 minus 98 5/8 = 3 1/8 2) 3 1/8 = $30 (3 times $10 per point) + $1.25 which equals $31.25 Method #2 1) 101 3/4 = 101 x $10 = $1,010 + 3/4 of $10 = $7.50, total price is $1,017.50. 2) 98 5/8 = 98 x $10 = $980 + 5/8 of $10 = $6.25. total price is $986.25. 3) The difference between the two prices is $1,017.50 minus $986.25 which = $31.25. LO 5.d
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) $100. B) $200. C) $400. D) $1,000.
C) $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
If a customer buys 1 OXY Oct 50 call at 3, and the holder exercises the option when the stock is trading at 60, what is the cost basis of the 100 shares? A) $6,000 B) $6,300 C) $5,300 D) $5,000
C) $5,300 The cost basis of acquiring the shares is 100 multiplied by the strike price of 50, which equals $5,000, plus the cost of the call, which is $300. Total cost or cost basis is $5,300. LO 10.i
BAKE-ALL, a U.S. manufacturing corporation, has purchased shares of stock in RE-FORM, a U.S. corporation that refines raw materials. RE-FORM pays a dividend to its shareholders. For BAKE-ALL corporation, taxes will be due on what percentage of the dividends received from RE-FORM? A) 70% B) 0% (all dividends received are tax free) C) 50% D) 100%
C) 50% When a U.S. corporation receives dividends from another U.S. corporation it has invested in, 50% of the dividends received are excluded from taxation (tax free). Therefore, 50% of the remaining dividends received are taxable. LO 13.g
Your customer redeemed 200 of her 500 Kapco common shares without designating which shares were redeemed. Which of the following methods does the IRS use to determine which shares she redeemed? A) Wash sale rules B) Last in, first out (LIFO) C) First in, first out (FIFO) D) Identified shares
C) First in, first out (FIFO) When a customer does not choose a method, the IRS uses FIFO. This will likely result redeeming shares with the lowest cost basis first, which creates a greater taxable gain. LO 13.h
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) I and IV B) I and III C) II and III D) II and IV
C) II and III 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. LO 5.a
Which of the following governmental bodies receive the least amount of their revenues from property taxes? A) Municipalities B) School districts C) State governments D) County governments
C) State governments State governments generally do not assess property (ad valorem) taxes. These are assessed by local governments. Generally, state governments receive most of their income from sales and income taxes. LO 6.b
The manager of ABC Municipal Securities is interested in bidding on some general obligation bond issues that will be available in the coming months. Where would the manager find information about these forthcoming issues? A) The Washington Post B) Electronic Municipal Market Access (EMMA) C) The Bond Buyer D) Standard & Poor's Bond Guide
C) The Bond Buyer Municipalities publish their official notices of sale soliciting bids from interested parties in The Bond Buyer. The notice gives the details of the bonds put up for bid and how to bid on the issue. The Standard & Poor's Bond Guide gives details of outstanding issues and their ratings. The EMMA is an online site primarily for retail nonprofessional investors. LO 13.f
One of your customers calls you to say that he received a letter saying that his local water works revenue bonds were being defeased. How would that affect the customer? A) The customer will need to file a claim with the appropriate court to receive payment for the bonds. B) Because of failure to generate sufficient revenue, interest payments are suspended temporarily. C) The customer would be receiving payment of the principal plus any accrued interest after the defeasance is completed. D) The maturity date is being automatically extended as called for in the official statement.
C) The customer would be receiving payment of the principal plus any accrued interest after the defeasance is completed. Defeasance occurs when an outstanding bond issue is paid off prior to maturity through a refunding. Once the creditors (the bondholders) have received their funds, any liens on assets or revenues are terminated. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback. LO 6.d
The issuer of an American depositary receipt (ADR) is A) a foreign branch of a foreign bank. B) a domestic branch of a foreign bank. C) a domestic bank. D) a foreign branch of a domestic bank.
C) a domestic bank. The ADR is issued by a domestic bank. Everything is in English and in U.S. dollars. The foreign certificates are usually held on deposit at a foreign branch of the domestic bank, and the ADRs are issued domestically. LO 3.g
A customer of a registered representative is considering a hedge fund investment and asks what the lock-up period means? The registered representative correctly explains that it is A) the minimum length of time the hedge fund portfolio manager intends to hold any single investment within the portfolio. B) the length of time required to have the hedge fund registered with the SEC, during which time, the fund may not sell any shares. C) a time when liquidation of fund shares is prohibited by the fund, meaning there is an element of illiquidity to be considered. D) a time when the fund manager will not make any changes (purchases or sales) within the hedge fund portfolio.
C) a time when liquidation of fund shares is prohibited by the fund, meaning there is an element of illiquidity to be considered. Hedge funds generally employ a lock-up provision to ensure that capital invested by shareholders will remain with the fund long enough to ensure the manager's ability to implement the intended fund strategy, then begin to see the results of that strategy. There is no standard lock-up period, which can differ from fund to fund, and it should always be noted that during the lock-up period, the investment is essentially rendered illiquid. LO 12.b
A municipal finance professional (MFP) is A) employed by a municipality to oversee the issuance of municipal bonds. B) an employee of the Municipal Securities Rulemaking Board (MSRB) specializing in seeing that broker-dealers adhere to the MSRB rules and regulations regarding the sales of municipal bonds to retail customers. C) an employee of a broker-dealer engaged in municipal security representative activities other than retail sales or who solicits municipal securities business for the broker-dealer. D) an elected official of a municipality having some decision-making authority regarding new municipal bond issues.
C) an employee of a broker-dealer engaged in municipal security representative activities other than retail sales or who solicits municipal securities business for the broker-dealer. Per the MSRB, an MFP is an associated person of a broker-dealer who is primarily engaged in municipal securities representative activities other than retail sales to individuals, who solicits municipal securities business for the broker-dealer, or who is in the supervisory chain above MFPs. LO 6.h
All of the following must register as an investment company under the Investment Company Act of 1940 except A) a new stock fund created by GHI Mutual Fund Distributors. B) an initial public offering for shares of a closed-end management company. C) an initial public offering for common shares of Amalgamated Investments, a holding company. D) certificates issued by a face amount certificate company.
C) an initial public offering for common shares of Amalgamated Investments, a holding company. Holding companies are not included in the definition of investment company under federal law. Amalgamated Investments would register with the SEC, just as any other offering of common stock. Investment companies, such as management companies (open-end or closed-end), unit investment trusts (UITs), and face amount certificate companies (FACs) all register under the Investment Company Act of 1940 as investment companies. LO 8.a
Tamika is a registered representative with Financial Engineers, LLC, a FINRA member broker-dealer. The firm uses an investment policy statement (IPS) to help design financial plans for their clients. One of Tamika's current clients plans to purchase a new boat seven months from now. When using the IPS, this would be considered A) an investment objective. B) a financial objective. C) an investment constraint. D) a long-term goal.
C) an investment constraint. Investment constraints are obstacles or restrictions that must be met in order to meet goals. In this case, we are dealing with a liquidity constraint—in seven months, cash will be necessary to make the purchase. LO 2.e
After a company splits its stock 2 for 1, an investor who owns 100 shares receives A) notice that the investor's 100-share certificate now represents 200 shares. B) another certificate for 200 shares. C) another certificate for 100 shares. D) notice to send in the current certificate to be replaced by a new certificate for 200 shares.
C) another certificate for 100 shares. After a 2-for-1 split, the transfer agent will send the investor another certificate for 100 shares. The investor is not required to return the existing stock certificate. LO 3.b
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) a return of capital. B) interest. C) dividends. D) capital gains.
C) 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. LO 8.f
If interest rates increase, the interest payable on outstanding corporate bonds will A) increase. B) decrease. C) remain unchanged. D) change according to the inverse payout theory.
C) remain unchanged. 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. LO 4.e
It would be expected that your firm would employ heightened suitability standards when evaluating recommendations for A) nonvoting common stock. B) cumulative preferred stock. C) structured products. D) sovereign debt.
C) structured products. The higher the risk of the investment, the greater the need for checking suitability. Structured products, such as equity-linked notes and exchange-traded notes, are considered complex products. In many cases, FINRA has discovered that registered representatives had inadequate understanding of the investment, leading to their making unsuitable recommendations. LO 4.g
Municipal bonds are not normally sold short because A) short sales are prohibited by municipal statute. B) the transaction is expensive to execute. C) the municipal bond market is illiquid. D) short sales are prohibited by Municipal Securities Rulemaking Board rules.
C) the municipal bond market is illiquid. While there is no law or industry rule prohibiting short sale of municipal bonds, it is not a common practice. To short a security, it must be borrowed, and because most municipal securities are thinly traded, it is often difficult to locate the specific issue needed to cover the short position. LO 16.c
When an investor purchases Class A shares of a mutual fund in their brokerage account at a FINRA member firm, the sales charge is apportioned to all of the following except A) the member firm underwriting the offering of the shares. B) the broker-dealer holding the account. C) the mutual fund. D) the registered representative making the sale.
C) the mutual fund. The sales charge (sales load) on a mutual fund is shared by those who had a hand in making the sale. The majority goes to the broker-dealer holding the customer's account. That is the source of compensation to the broker-dealer's registered representative handling the customer's account. As a continuous new issue, there is a FINRA member firm underwriting (distributing, sponsoring) the mutual fund and it retains a small portion. No mutual fund ever receives any of the sales charge. LO 8.d
A registered representative is convicted of misdemeanor DUI; therefore, A) this must be updated on the Form U4 within 30 days. B) this must be updated on the Form U4 within 10 days. C) updating of the Form U4 is not required. D) the employing broker-dealer is likely to suspend the registered representative.
C) updating of the Form U4 is not required. When the conviction is for a misdemeanor, only if it involves a financial matter is it considered a material event requiring an update to the Form U4. If this were a reportable offense, the updating would have to be done within 30 days. It would be highly unusual for a firm to discipline an associated person for this infraction. Even then, regulators are the ones who suspend a registration, not the member firm. LO 18.a
An affiliate holding restricted stock wishes to sell shares under Rule 144. He has held the shares, fully paid, for six months, and the issuer has 2.4 million outstanding shares. Form 144 is filed on Monday, April 10, and the average weekly trading volume for the past four weeks is 24,500 shares per week. The maximum number of shares the customer can sell with this filing is A) 24,250. B) 23,000. C) 24,000. D) 24,500.
D) 24,500. Under Rule 144, after holding the fully paid restricted shares for six months, the affiliate can begin selling. For affiliates, volume restrictions always apply. They can sell the greater of 1% of the total shares outstanding or the weekly average of the past four weeks' trading volume (the four weeks preceding the Form 144 filing). In this case, 1% of the total shares outstanding is 24,000 (1% × 2.4 million). The weekly average of the past four weeks' trading volume is 24,500. Therefore, the most the affiliate can sell during the 90 days following the Form 144 filing is 24,500 shares. LO 20.f
A customer is long 1 XYZ Jan 50 put. To create a bull put spread, the customer must sell a Jan A) 50 call. B) 45 put. C) 50 put. D) 55 put.
D) 55 put. In any spread, put or call, if the customer is buying the lower strike price, the spread is bullish. Therefore, to create a bull put spread, the customer (who is long the 50 put) must sell a put with a higher strike price. A bull put spread is also called a short put spread. LO 10.e
What options trading program would be most appropriate for a retired customer with a portfolio of low-cost basis blue-chip stocks who is seeking income from his portfolio? A) Selling straddles B) An option purchasing program C) An uncovered call writing program D) A covered call writing program
D) A covered call writing program The most conservative option strategy is writing covered calls. In addition to the income from the call premium, this client could also receive dividends on his stock if any were paid. Purchasing options brings no income to the account, and uncovered call writing and short straddles have unlimited risk. LO 10.d
Your manager notifies you that a new municipal revenue bond issue you have been working on has been oversubscribed. How is the order acceptance priority for this issue determined? A) As outlined in the legal opinion B) As outlined in the indenture C) On a first-come, first-served basis D) As outlined in the agreement among underwriters
D) As outlined in the agreement among underwriters The priority of filling municipal orders is established by the managing underwriter in the release terms letter sent to the syndicate once the bid is won. This letter is an amendment to the agreement among underwriters. The priority is also disclosed in the official statement. LO 20.b
Which of the following is defined as profits after taxes and interest paid, less preferred dividends, divided by the number of shares of outstanding common stock? A) Price to earnings B) Book value per share C) Cash flow per share D) Earnings per share (EPS) Explanation
D) Earnings per share (EPS) Dividing net income after taxes, interest, and payment of preferred dividends by the number of common shares outstanding determines EPS. LO 13.d
A registered representative is explaining the characteristics of a Coverdell Education Savings Account (ESA) to a customer. Which of the following statements regarding this type of savings account is correct? Contributions are tax deductible. Contributions are not tax deductible. When used for qualified educational expenses, withdrawals are taxable. When used for qualified educational expenses, withdrawals are not taxable. A) I and IV B) II and III C) I and III D) II and IV
D) II and IV Contributions to a Coverdell ESA are made with after-tax dollars. Distributions used for qualified educational expenses are tax free. LO 1.g
Before effecting an initial penny stock transaction for a new customer, the registered representative must confirm whether the person is an established customer. obtain a signed risk disclosure document from the customer. obtain a signed suitability statement from the customer. determine suitability based on financial condition, investment experience, and investment objectives. A) I, II, III, and IV B) I and II C) I and IV D) II, III and IV
D) II, III and IV According to the penny stock rules, registered representatives must provide risk disclosure information to all penny stock buyers, which customers must sign. In addition, they must determine suitability based on financial information, investor experience, and objectives supplied by the buyer. If an investor is not considered an established customer, they must sign a suitability statement, as well. In this case, we are told this is the initial trade by a new customer, so we are not going to confirm status as an established customer. LO 3.j
Which of the following orders is reduced on the order book on the ex-dividend date for a cash dividend? A) Buy stop order B) Sell limit order C) Buy stop limit order D) Limit order to buy
D) Limit order to buy Only orders placed below the market price are reduced for cash dividends on the order book. Buy limits and sell stops are entered below the market price. LO 16.a
An investor opens the following options position: Long 1 RAV Mar 50 put @5¾; short 1 RAV Mar 45 put @3. What is the investor's maximum gain, maximum loss, and breakeven point? A) Maximum gain is $275; maximum loss is $225; breakeven point is $47.25. B) Maximum gain is $225; maximum loss is $275; breakeven point is $47.75. C) Maximum gain is $275; maximum loss is $225; breakeven point is $47.75. D) Maximum gain is $225; maximum loss is $275; breakeven point is $47.25.
D) Maximum gain is $225; maximum loss is $275; breakeven point is $47.25. The first step is to identify the position. This is a debit put spread. It is a debit spread because the option purchased cost more than the one sold. The debit of $275 is the most the investor can lose. This is a bear put spread. We know that because the investor purchased the option with the higher strike price and sold the one with the lower strike price. The goal is for the stock's price to decline to the point where both options are exercised. For example, if the market price of RAV should fall below 45, the owner of the 45 put will exercise, causing the seller to purchase the stock for $4,500. The seller can then exercise the long 50 put and deliver the stock purchased at 45 for 50. That is a profit of $500 less the cost of the options (the debit of $275). The breakeven point follows the put-down rule. Subtract the net premium (the $2.75 debit) from the higher strike price resulting in a breakeven point at $47.25. LO 10.h
A businessowner pays himself a salary of $80,000 per year. He employs his spouse and pays her $45,000 per year. What is the maximum contribution they may make to their traditional IRAs? A) They cannot make contributions because their joint incomes are too high. B) They can contribute 100% of the lower income to one IRA only. C) No traditional IRA contributions can be made by businessowners or their spouses. D) They can each contribute 100% of earned income or the maximum allowable limit, whichever is less, to their individual IRAs.
D) They can each contribute 100% of earned income or the maximum allowable limit, whichever is less, to their individual IRAs. They both may make annual contributions of 100% of earned income up to the maximum allowable limit, whichever is less, to their own respective IRAs. LO 1.g
With regard to municipal bonds, an extraordinary call is most commonly invoked when A) property tax proceeds exceed expectations enabling the municipality to retire its GO bonds ahead of schedule. B) the economic cycle indicates that interest rates will be sharply increasing. C) it appears that the issuer's credit rating will be downgraded. D) a catastrophe destroys the facility backing a revenue bond.
D) a catastrophe destroys the facility backing a revenue bond. An extraordinary call is frequently referred to as a catastrophe call. Because the payments on a revenue bond are generally supported by a revenue-producing facility, destruction or damage to that facility is considered a catastrophe. In most cases, the proceeds from the insurance policy protecting that facility are used to call in the bonds. LO 6.b
An investor purchases a GFC Jan 40 call @ 4 and sells a GFC April 30 call @ 9. This is an example of A) a variable hedge. B) a horizontal spread. C) a vertical spread. D) a diagonal spread.
D) a diagonal spread. The investor has created a diagonal spread. An investor that buys and sells the same type of option has created a spread. If the strike prices and/or the expiration months of the options are different, it is a diagonal spread. LO 10.e
A customer wants to open a new cash account and give her sibling trading authorization. The required documents to accommodate her request would be A) a margin agreement and a loan consent form. B) a new account form and a loan consent agreement. C) a margin agreement and a limited power of attorney. D) a new account form and a limited power of attorney.
D) a new account form and a limited power of attorney. When a customer wants to give trading authorization or discretionary privileges to a third party in a cash account, a member firm requires a new account form (as with all new accounts) and a limited power of attorney. A limited power of attorney gives the third party trading authority but prohibits that party from withdrawing assets (cash or securities) from the account. LO 1.d
When a corporation has an IPO, the shares being offered for sale are A) issued shares. B) treasury shares. C) outstanding shares. D) authorized shares.
D) authorized shares. Prior to its issuance, shares are termed "authorized," meaning they have been authorized to be issued to the public - whether that issuance be a sale, gift, or through a stock option. Once they have been issued, the shares become "issued" stock. If it were subsequently purchased back, the shares would become treasury stock. Outstanding shares are issued shares that have not been repurchased as treasury stock. LO 20.a
During a trading halt, an investor can A) execute a limit order. B) close an existing position. C) execute a market order. D) cancel an order placed before the halt.
D) cancel an order placed before the halt. If trading is halted in a security, investors cannot buy or sell the security. An open order can be canceled during a trading halt. LO 16.e
The principal tax benefit of investing in an exploratory oil and gas drilling program is derived from A) recapture. B) depreciation expenses. C) capital appreciation. D) intangible drilling costs (IDCs).
D) intangible drilling costs (IDCs) IDCs, which are a significant portion of all drilling costs, are a major tax advantage to a limited partner and are tax deductible in the year in which they are incurred. IDCs are costs that, after incurred, hold no salvage or ongoing value. Examples include labor and geological survey. LO 11.f
Programs allowing for the direct pass-through of losses and income to investors include all of the following except A) oil and gas drilling direct participation programs. B) new-construction real estate direct participation programs. C) S corporations. D) real estate investment trusts (REITs).
D) real estate investment trusts (REITs). REITs allow for the direct pass-through of income, but not losses. The other choices are forms of business that allow for pass-through of income and losses. LO 11.b
The rules on opening an options account contain a number of differences from the normal cash account at a broker-dealer. One of those differences is, if applicable, A) the need to determine if the customer is of legal age. B) obtaining the name of the customer's employer (if employed). C) the requirement to obtain the signature of the principal approving the account. D) the requirement to obtain the signature of the registered representative handling the account.
D) the requirement to obtain the signature of the registered representative handling the account. For a normal account, FINRA requires the signature of the principal approving the account, but not that of the registered representative who will be handling that account. For options, that additional signature is necessary. The other choices are required on any new account form, options or not. LO 10.j
Stop orders may be used for each of the following except A) to protect profits on long positions. B) to establish positions. C) to protect profits on short positions. D) to lock in a specific price to close out a position.
D) to lock in a specific price to close out a position. Stop orders are contingent orders that are triggered when the stock trades at or through a stated price. When triggered, they become market orders to buy or sell. They are used by technical traders to establish positions above or below resistance and support levels, respectively. Stop orders never guarantee a specific execution price. LO 16.a
