Taxes etc (3rd)

A customer purchased 10 municipal OID bonds at 92. If he holds them to maturity, how much will he be federally taxed?

$0. The key here is OID, which stands for original issue discount. The discount on OID bonds is considered interest. A municipal bond interest is tax free. Therefore the profit realized from the difference between the discounted purchase price and the redemption price at maturity is also considered federally tax free. If the owner lives in the state within which the bonds are issued, they will be state and local tax free as well. Municipal original issue discount bonds must be accreted.

A customer has $12,000 of capital gains, $15,000 of capital losses, and $50,000 adjusted gross income. How much unused loss is carried forward to the following tax year?

$0. After netting capital gain and losses, the customer has a net capital loss of $3,000. Since $3,000 of net losses can be deducted from income in any single tax year, there is no carry forward.

If a customer buys $28,000 of ABC stock in April of 1999 and at year end, the stock is worth $23,000, how much may the customer deduct on his 1999 tax return?

$0. Until the customer realizes the loss by selling, there is no tax deduction.

A corporation in the 35% tax bracket reports operating income of $4 million for the year. The firm also received $200,000 in preferred dividends. Assuming no other items of income or expense, what is the company's tax liability?

$1,421,000. The corporation's $4 million operating income is taxed at a rate of 35%. For tax purposes, corporations can exclude 70% of all dividends received from domestic common and preferred stocks. Thus, 30% of the $200,000 received from preferred dividends is taxed at the 35% tax rate ($200,000 times 30% equals $60,000). The $4 million in income plus the $60,000 in taxable dividends equals $4,060,000 ($4,060,000 multiplied by a 35% tax rate equals taxes of $1,421,000).

A customer purchases an XYZ municipal bond at 108. It is scheduled to mature in 16 years. After owning the bond for 10 years, he sells the bond at 102. What capital gain or loss must he report for tax purposes at the time of the sale?

$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 divided by 16 = $5). After 10 years, the tax basis would be 103 ($1,030). Since the sale was for 102 ($1,020), the customer has a $10 loss on one bond.

On September 1, an investor sold 100 shares of KLP Corporation common stock for a loss of $1 per share. On September 15, he purchased a KLP convertible bond with a conversion price of $40. How much of the original loss may he now declare for tax purposes?

$75. Since he purchased the convertible bond less than 30 days after realizing the loss, the sale of the stock falls under the wash sale rule; Investors who sell securities at a loss, and repurchase them, including their equivalents, 30 days before or after the sale will have the loss disallowed by the IRS. With a conversion price of $40, the bond could be converted into 25 shares (1,000 / 40) of KLP common stock. Hence, the investor has "bought back" the equivalent of 25 shares, and may only declare a $75 loss as the remaining $25 loss will be disallowed.

Capital asset pricing model

- Investors are averse to risk and expect to be rewarded for taking risk - CAPM takes into account systematic risk, the type of risk that investors use diversification to lessen. It assumes that investors are averse to risk, and, if taking on risk, expect to be rewarded for it and, therefore, the pricing of an asset must reflect that.

For interest bearing bonds duration is ________ than the bond's maturity.

- Less - Duration measures the time it takes for a bond to pay for itself

Taxes on nonqualified vs qualified dividends

- Nonqualified (ordinary) dividends are taxed at the investor's ordinary income tax rate, while qualified dividends will be taxed at a maximum rate as specified by the IRS. Whether or not the qualified dividends are taxed at the maximum rate or a lower rate depends on the investor's income tax bracket. The higher the investor's income tax bracket the higher the tax on qualified dividends will be, up to the maximum. - Qualified dividends are considered PORTFOLIO INCOME. Portfolio income includes dividends, interest, and net capital gains derived from the sale of securities.

Dollar-cost averaging

1) an employee stock purchase plan (ESPP) is one way to use dollar-cost averaging. 2) dollar-cost averaging is the investment of a fixed amount of money each period. 3) dollar-cost averaging is a passive investment strategy. 4) The fixed dollar amount buys more shares when the price is lower and fewer shares when the price is higher.

If a municipal bond maturing in 10 years is bought for 110, its cost basis at the end of the sixth year is:

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

An investor purchases a corporate bond at 105 with a 10-year stated maturity and pays $30 of accrued interest. If he elects not to amortize the premium and holds the bond to maturity, what is his cost basis for tax purposes?

1050. While most taxpayers do elect to amortize the premium paid for a corporate bond, it is not mandatory. The investor chooses not to amortize, thus his cost basis at maturity is simply what he originally paid for the bond. Accrued interest paid does not affect cost basis.

Your client is interested in a direct participation program (DPP) limited partnership. Which of the following two are most likely to factor into a discussion on suitability of such an investment? 1) Beta. 2) Liquidity. 3) Duration. 4) Age.

2) Liquidity. 4) Age. The key here is to recognize that with DPPs, the customer's age is a relevant consideration in determining suitability. DPPs are long-term and illiquid. For example, it is unlikely that DPPs would be suitable for a customer near retirement age, regardless of the customer's financial situation. Beta, having to do with measuring an investment's volatility as related to the overall market, and duration having to with bonds are not factors that would be associated with DPPs.

Which of the following statements regarding stock dividends are TRUE? 1) They are taxable as ordinary income on receipt. 2) They are not taxable on receipt. 3) Cost basis per share is reduced. 4) Cost basis per share remains the same.

2) They are not taxable on receipt. 3) Cost basis per share is reduced. Stock dividends are not taxed; rather, the basis in each share of stock owned is adjusted downward proportionately.

If a customer wants a year-end tax swap, he can expect to pay more money for the swap if the bonds purchased have a: 1) lower coupon. 2) higher coupon. 3) lower rating. 4) higher rating.

2) higher coupon. 4) higher rating. Higher coupon rates and higher ratings make bonds more valuable.

Rank the following from the safest to the most risky. 1) AAA-rated corporate bonds. 2) Blue-chip stocks. 3) U.S. government securities. 4) Tech stocks.

3) U.S. government securities. 1) AAA-rated corporate bonds. 2) Blue-chip stocks. 4) Tech stocks.

For dividends to be taxed as qualified dividends, the dividend paying investment must be held for more than ____________ days.

60. In order to be taxed as qualified dividends, the investment must have been held for more than 60 days (at least 61 days).

A customer is selling inherited stock. The decedent originally paid $50 per share and on the date of the decedent's death, the stock was worth $60 per share. On the day the customer sells the stock, the price per share is $62. What is the investor's cost basis in the stock?

60. The IRS allows a step-up in basis for inherited stock. The customer's cost basis is the fair market value of the stock on the date that the decedent died.

If an investor swaps identical issues of stock to establish a loss that is disallowed, the transaction is known as:

A wash sale. The wash sale rule disallows claiming a tax loss on the sale of stock if the investor purchases a substantially identical security within 30 days either before or after the date of such sale.

A customer buys 5 municipal bonds maturing in 20 years for 104. If he sells the bonds after 10 years at 103, the customer has a: A) $50 capital gain. B) $100 capital loss. C) $50 capital loss. D) $100 capital gain.

A) $50 capital gain. The premium on the municipal bonds must be amortized. The bonds were bought at 104 and therefore each bond has $40 in premiums (5 bonds X $40 = $200 premium to be amortized over 20 years). This means the cost basis of the bonds ($5,200) decreases by $10 a year ($200 / 20 years = $10). After 10 years amortization, $100 has been amortized (10 years × $10 per year), and the customer has an adjusted cost basis of $5,100. If the bonds are sold for 103 ($5,150), the customer has a $50 taxable capital gain.

If an investor is in the highest federal income tax bracket and is subject to the alternative minimum tax, which of the following securities should an agent recommend? A) General obligation bond. B) Corporate bond. C) Industrial revenue bond. D) Treasury bond.

A) General obligation bond. Municipal bonds are suitable for the portfolio of an investor who is in a high tax bracket because the interest is exempt from federal income tax. A general obligation (GO) bond is a better recommendation than an industrial revenue bond because the interest on industrial revenue bonds is likely subject to the AMT.

If a married couple establishes a JTWROS account with a balance of $1 million and the wife dies, what is the husband's estate tax liability? A) He pays no estate tax. B) He pays federal and state taxes on $500,000. C) He pays federal taxes only on $500,000. D) He pays federal and state taxes on the entire balance.

A) He pays no estate tax. Establishing a joint tenants with right of survivorship account allows for the transfer of assets to the survivor upon death. The surviving spouse is not taxed on assets transferred in this manner because under current tax law, there is an unlimited marital deduction.

Which of the following investments is most suitable for an investor seeking monthly income? A) Money-market mutual fund. B) Mutual fund investing in small-cap issues. C) Zero-coupon bond. D) Growth stock.

A) Money-market mutual fund. The money-market mutual fund is the most suitable investment for an investor seeking monthly income. The other securities offer higher long-term growth potential, but they are not designed to provide monthly income.

An investor purchases a municipal bond at par to yield 5.5% to maturity. Two years later, if he sells the bonds at a price equivalent to a 5% yield to maturity, the investor incurs: A) a capital gain. B) tax-free income. C) a capital loss. D) no taxable result at this time.

A) a capital gain. Yields fall as bond prices rise. Because the yield to maturity has dropped, the bond is trading at a higher price than when it was purchased. The consequence of the sale is a capital gain, because the investor sold at a premium the bond that was purchased for par.

Income from all of the following is partially exempt to a corporate investor EXCEPT: A) income from convertible bonds. B) income from common stock. C) income from preferred stock. D) income from preferred stock mutual funds.

A) income from convertible bonds. Seventy percent of dividend income received from investments in common stock and preferred stock is excluded from taxation for a corporate investor. This exclusion applies to dividends from mutual funds where all of the portfolio securities are preferred or common stock.

The ABCD Corporation has a beta coefficient of 1.25. Your client's portfolio contains $20,000 of ABCD. After a rise in the overall market of 10%, we would expect the value of this client's ABCD to: A) increase by $2,500. B) increase by $2,000. C) decrease by 25%. D) increase by $5,000.

A) increase by $2,500. A stock with a beta coefficient of 1.25 could be expected to rise in value at a rate 25% greater than the overall market. Since the market has increased by 10%, this stock should increase by 12.5% or $2,500 (10% × 1.25 × $20,000 = $2,500).

Changing any of the following characteristics of the stocks and bonds in an investor's portfolio would likely add diversification EXCEPT the: A) securities' relative prices. B) issuer's geographic location. C) industries in which she is investing. D) types of securities.

A) securities' relative prices. Portfolio diversification is rarely achieved by price alone. Geographic diversification disburses risk if growth rates vary in separate parts of the country. Diversifying holdings among industries helps as different economic situations affect some industries more than others. Diversifying types of securities helps as bonds react differently from stocks and real estate to changing economic situations.

Investors who are subject to the alternative minimum tax (AMT) will lose the tax benefits normally associated with A) tax preference items B) gains associated with variable annuity portfolios C) losses on options positions D) capital losses

A) tax preference items Certain items receive favorable tax treatment from the IRS. One example is tax-exempt interest on private-purpose municipal revenue bonds. These types of items are known as tax preference items. For investors who are subject to the alternative minimum tax (AMT), the benefits normally associated with tax preference items are lost, because these items must be added back into the investor's taxable income.

All of the following require prior notification by a registered representative to his broker/dealer EXCEPT A) when he volunteers on the telephones for a fund-raising campaign for the local college B) when he is invited to sit on the board of directors of a local business C) when he assists in the private distribution of securities for a non-profit organization D) when he takes a part-time job during the holiday season to earn extra money

A) when he volunteers on the telephones for a fund-raising campaign for the local college Volunteer fund raising for the local college, since it is not a business or securities activity, would not require prior notification of his broker/dealer.

Paying a premium of $10 per bond, Ms. Tracey Pringle bought 10 municipal bonds with 20 years to maturity. Ten years later, she sold the bonds for 103. For tax purposes, she has a: A) $300 loss. B) $250 gain. C) $200 gain. D) $200 loss.

B) $250 gain. The cost per bond is $1,010. The amortization amount each year is 10/20 years, which equals $.50 per year. $.50 per year × 10 years = $5 per bond. After 10 years, the adjusted cost basis is $1,005 per bond. She sells the bonds for $1,030 per bond. $1,030 − $1,005 = $25 per bond 25 × 10 = $250 gain.

If a customer has $9,000 of capital losses and $2,000 of capital gains in a tax year, that year's consequences are a: A) $3,000 loss deduction with no carry forward. B) $3,000 loss deduction with $4,000 carry forward. C) $7,000 loss deduction with no carry forward. D) $9,000 loss deduction.

B) $3,000 loss deduction with $4,000 carry forward. For tax purposes, the customer can net gains with losses. In this case, the customer's net losses are $7,000. However, there is an annual capital loss deduction limit of $3,000. Therefore, the investor can deduct $3,000 this year and carry forward $4,000 to the following tax year.

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

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

A 3% bond with 20 years to maturity is being issued by a syndicate with a reoffering yield of 4%. What is the term used to describe this bond? A) Original issue premium. B) Original issue discount. C) Secondary market discount. D) High-yield bond

B) Original issue discount. Because the bond is being issued by a syndicate, it is a new issue (i.e., an original issue). Because the yield (4%) is higher than the coupon (3%), it is an original issue discount.

If an employee of an NYSE member wants to take a second job, which of the following statements is TRUE? A) Prior notice to the NYSE is required B) Prior written notice to the member firm is required C) Prior written notice to the member firm and prior written permission to the employee is required D) Prior permission of the NYSE is required

B) Prior written notice to the member firm is required Prior written notice to the member firm from the employee is required. While no prior written permission of the firm is required, the member firm does have the right to reject or restrict and outside affiliations if they feel a conflict of interest exists.

Which of the following best describes a growth investment? A) Investment appreciation is tax-deferred. B) Value of the investment increases over time. C) Both principal and accumulating interest and dividends increase over time. D) Only interest and dividends are reinvested.

B) Value of the investment increases over time. Growth refers to an increase in an investment's value over time. Interest and dividends are income.

A portfolio that invests in blue-chip stocks and growth stocks can best be described as: A) an aggressive portfolio. B) a growth and income portfolio. C) a balanced portfolio. D) a high-yield portfolio.

B) a growth and income portfolio. A growth and income portfolio typically combines conservative blue-chip securities for their stability and capital preservation with growth stocks for their appreciation potential. An aggressive portfolio contains securities of smaller companies that have the potential for significant capital appreciation. A balanced portfolio invests in both stocks and bonds.

The effect of using the FIFO method for a sale of some of the securities that were purchased separately during a period of rising prices will be: A) an increase in the cost basis of the securities. B) an increase in the taxable profits of the investor. C) a decrease in the profits of the investor. D) a decrease in the tax liabilities of the investor.

B) an increase in the taxable profits of the investor. FIFO (first in, first out) is an inventory accounting term used to standardize the determination of which items are sold first. In this case, if different purchases are made of the same stock, and the per-share price is higher each time, then if a portion (but not the entire inventory) is sold at one price, the taxable gain will be maximized. If LIFO (last in, first out) were used, the taxable gain would be minimized, and the lower cost basis securities would remain in the portfolio.

A 27-year-old client is in the lowest tax bracket and seeks an aggressive long-term growth investment. If his investment adviser representative recommends a high-rated general obligation municipal bond, the IAR has: A) committed no violation because municipal bonds are well suited for the market's volatility. B) made an unsuitable recommendation based on the client's needs and objectives. C) recommended a suitable investment because GOs are good long-term investments. D) made an unsuitable recommendation, since a municipal revenue bond would have been more appropriate.

B) made an unsuitable recommendation based on the client's needs and objectives. In recommending a conservative, tax-exempt investment to this customer, the investment adviser representative has failed to make a suitable recommendation given the client's objectives. Municipal bonds are better suited for individuals in high tax brackets and offer little upside appreciation potential.

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

B) marketability risk. It is difficult to sell a large block of securities in a thinly traded stock without a substantial discount to market price. This is known as liquidity or marketability risk.

A registered representative employed by a broker dealer must notify the employer in writing and be permitted by the employer to do all of the following EXCEPT A) take an evening job as a bartender B) own a small financial interest in a publicly traded retail company C) serve as an officer of another business organization D) own an interest in any other organization engaged in the securities business

B) own a small financial interest in a publicly traded retail company Registered representatives must notify their employer in writing and be permitted to engage in any other business, serving as an officer or director of another business organization, or own any interests in a privately held financial services company. Publicly held shares do not require consent provided there is no control relationship (defined as 10% or more ownership).

Several years ago, one of your customers bought an OID municipal bond at $960. The bond has now matured. For federal income tax purposes, the discount is: A) taxed each year as ordinary income. B) tax free. C) taxed at maturity as ordinary income. D) taxed as a long-term capital gain.

B) tax free. When buying an original issue discount (OID) municipal bond, the discount must be accreted each year and treated as interest income. Because interest income from a municipal bond is tax free at the federal level, the discount is not taxed if the bond is held to maturity. If the customer had purchased a discount in the secondary market, the discount would have been accreted and taxed as ordinary income.

A customer purchases a 6% municipal bond in the secondary market on a 7% basis. The effective after-tax yield is A) 0.06 B) greater than 7% C) 6 to 7% D) 0.07

C) 6 to 7% In every case but one, the yield to maturity is the effective after-tax yield to a municipal-bond buyer. The one exception is a bond bought at a discount in the secondary market. In this case, the annual accretion is taxed as ordinary income. The discount, which is included in the stated yield to maturity, is taxable, reducing the effective after-tax yield to somewhere between the coupon of 6% and the yield to maturity of 7%.

If a high-income customer is subject to AMT, which of the following preference items must be added to adjusted gross income to calculate his tax liability? A) Interest on a municipal bond issued to finance highway construction. B) Distributions from a corporate bond mutual fund. C) Interest on a private purpose municipal bond. D) Income from a municipal security issued to finance parking garages.

C) Interest on a private purpose municipal bond. If more than 10% of a bond's proceeds go to private entities, the interest on the bond is a tax preference item for alternative minimum tax purposes.

A convertible corporate bond with an 8% coupon yielding 7.1% is available, but may be called some time this year. Which feature of this bond would probably be least attractive to your client? A) Current yield. B) Coupon yield. C) Near-term call. D) Convertibility.

C) Near-term call. The near-term call would mean that no matter how attractive the bond's other features, the client may not have very long to enjoy them.

An investor has accumulated 3000 shares of XYZ common stock over several years via several separate purchases. If the investor sells 1000 shares and chooses to identify the specific shares sold for tax purposes, he must: A) Identify the specific shares to be sold prior to the transaction. B) Notify the IRS no later than the last business day of the month the trade occurred in. C) Notify the broker dealer who handled the sell transaction within 3 business days of the trade date. D) Notify FINRA on the trade date.

C) Notify the broker dealer who handled the sell transaction within 3 business days of the trade date. The IRS mandates that when an investor wishes to identify the specific shares sold for tax purposes the broker dealer who handled the sell transaction must be notified within 3 business days of the sale. For stock transactions this means by the settlement date.

A couple in a high tax bracket is interested in minimizing its tax liability while diversifying its portfolio. Which of the following best fits its investment objectives? A) GNMAs. B) Preferred stock. C) Tax-exempt unit trusts. D) Corporate convertible bonds.

C) Tax-exempt unit trusts. Municipal unit trusts provide tax-free income to unit holders. Unit holders have an undivided interest in the underlying portfolio of municipal bonds. The trust consists of a number of different issues, and therefore has an element of diversification.

A security you purchased several years ago has appreciated substantially in value. You have decided to donate the investment to your favorite charity. What will the cost basis be to the charity that receives your gift? A) Zero since you gave the position to the charity as a contribution, having paid taxes on the gain while you held it. B) Your cost basis plus any capital gains taxes that you have paid on the security. C) The value of the securities at the time the charitable donation is made. D) Your cost basis, created at the initial purchase of the security.

C) The value of the securities at the time the charitable donation is made. If a donation is made to a registered charity, the charity's cost basis is fair market value as of the date of the contribution.

A municipal bond is purchased in the secondary market at 102½. The bond has 5 years to maturity. Two years later, the bond is sold for 102. The tax consequence to the investor is: A) no capital gain or loss. B) a capital loss of $20 per bond. C) a capital gain of $5 per bond. D) a capital loss of $5 per bond.

C) a capital gain of $5 per bond. Municipal bonds bought at a premium, either in the new issue or secondary market, must be amortized. The amount of the premium is 2½ points or $25. As the bond has 5 years to maturity, the annual amortization amount is $5 per bond. After 2 years, the bond's basis has been amortized down to 101½. At that point, a sale at 102 generates a capital gain of $5 per bond.

A married couple who files jointly has a $5,000 long-term capital loss with no offsetting capital gains. Regarding the tax treatment of this loss, all of the following statements are true EXCEPT: A) capital losses can be deducted dollar for dollar against capital gains. B) the maximum they can deduct this year is $3,000. C) capital losses can be used to offset capital gains only. D) they can carry forward $2,000 to future years.

C) capital losses can be used to offset capital gains only. Capital losses are deducted from ordinary income and, therefore, reduce tax liability. The maximum that individuals or married couples can deduct is $3,000 annually. If the long-term capital loss exceeds the maximum, the excess is carried forward to future years until the loss is exhausted. Under current IRS regulations, $1 in losses results in $1 in deductions.

A bond's duration is: A) identical to its maturity for an interest-bearing bond. B) expressed as a percentage. C) longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon. D) an indication of a bond's yield that ignores its price volatility.

C) longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon. Duration measures a bond's price volatility by weighting the length of time it takes for a bond's cash flow to pay for itself. If two bonds with differing coupon rates have identical maturities, the one with the lower coupon has the longer duration. The cash flow from an interest-bearing bond makes its duration shorter than its maturity. Bonds with longer duration carry greater price volatility. Duration is expressed in years (time) rather than in percentage.

Your customer owns shares of LMN stock that have gone up in value. He does not wish to sell the shares now because he does not want to realize the capital gain. To lock in the gain without selling those shares, he sells shares of LMN stock short, holding both the long and short positions simultaneously. You recognize this tax strategy as A) commingling B) a wash sale C) selling or shorting against the box D) advance or pre-refunding

C) selling or shorting against the box Selling or shorting against the box is a tax strategy used to defer capital gains into the next tax year. Selling shares short of a company when you are already long effectively locks in any gain you have on the long position. For every dollar gained in the long position, you lose one in the short position, and vice versa. Ultimately, in the next tax year, the long shares are used to replace the borrowed shares for the short position, which effectively closes both positions, and any gain would then be taxable. The IRS mandates that certain other criteria be met to utilize this tax strategy.

The risk that time value may erode the premium of an equity option even while the underlying issuer remains financially sound is an example of __________ risk.

Capital Risk. Capital risk is generally associated with equity instruments, such as common stock, and equity-related derivatives, such as options. It is the risk that invested dollars can be lost as the result of circumstances unrelated to an issuer's financial strength.

__________________________________________________ allows the investor to exclude 70% of the dividends from taxation.

Corporate ownership of another company's stock Under the inter-corporate dividend exclusion rule, if a corporation owns stock in another corporation, 70% of the dividends received is excluded from taxation.

Credit Risk

Credit risk is the danger of losing all or part of the invested principal as the result of the issuer's failure.

A customer buys a municipal bond in the secondary market at 96 that has 4 years to maturity. Two years later, the customer sells the bond at 99. The tax consequences of this investment are: A) 2 points of capital gain and 1 point of ordinary income. B) 3 points of capital gain. C) 3 points of ordinary income. D) 2 points of ordinary income and 1 point of capital gain.

D) 2 points of ordinary income and 1 point of capital gain. When a municipal bond is purchased in the secondary market at a discount, the annual accretion is taxed as ordinary income. The annual accretion is 1 point per year (4 points divided by 4 years to maturity). Therefore, when the bond is sold 2 years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of 1 point per bond. Also, there is ordinary income taxation on the accretion of 2 points.

A municipal bond originally issued at 90 with a 10-year maturity will have a compound accreted value (CAV) after 5 years equal to: A) 5. B) 10. C) 100. D) 95.

D) 95. CAV is the cost basis of the bond, in this case, after 5 years accretion. There are 10 points to accrete (the difference between the issue price of 90 and par) over 10 years. One point each year will be added, so after 5 years, the adjusted cost basis will be 90 + 5, or 95.

Interest income from all of the following are exempt from state and local taxation EXCEPT: A) Treasury bills. B) Series EE savings bonds. C) Treasury bonds. D) FNMA mortgage-backed issues.

D) FNMA mortgage-backed issues. As a general rule, the interest income from U.S. government and agency securities is subject to federal taxation only; it is generally exempt from state and local taxation. However, the interest income from mortgage-backed securities is fully taxable.

Your customer's portfolio consists of 40% long-term government bonds, 20% preferred stock, and 40% common shares of utility companies. Which of the following may have the single largest impact on the entire portfolio? A) Corporate earnings B) Oil and gas price movements C) Foreign currency fluctuations D) Interest rate movements

D) Interest rate movements Of the four answer choices, interest rate movement is the most likely to impact each of the portfolio components. Interest rates and bond prices have an inverse relationship, and their movement often determines whether investors might seek out investment alternatives with higher returns, such as dividend paying utilities and fixed dividend preferred shares.

Regarding the topic of outside business activity for associated persons of a FINRA member firm, which of the following statements is NOT TRUE? A) An associated person cannot work for any business other than his member firm without his employing broker/dealer's knowledge. B) A passive investment such as the purchase of a limited partnership unit, is not considered an outside business activity. C) Prior written notice must be provided to the member before any outside business activity may occur. D) Member firms must grant permission in writing prior to any outside business activity on the part of the associated person.

D) Member firms must grant permission in writing prior to any outside business activity on the part of the associated person. While the member firm has the right to reject or restrict any outside business affiliations if a conflict of interest exists, their prior written approval is not required before the business activity can begin.

Which of the following is federally tax exempt for a corporation? A) Foreign corporate stock dividends. B) Preferred stock dividends. C) Capital gains. D) Municipal bond interest.

D) Municipal bond interest. Municipal bonds are tax exempt for corporations as well as for individuals. Preferred stock dividends are taxable but at a reduced rate for corporations due to the 70% dividend exclusion. That break does not apply to the dividends on foreign securities. Regardless of the security, capital gains are taxable.

A customer purchases $100,000 of original issue discount municipal bonds. How will this trade be considered for tax purposes when the bonds mature? A) Taxable as short-term gain. B) Taxable as long-term gain. C) Fully taxable on capital gain. D) No capital gain.

D) No capital gain. Original issue discount profit at maturity is treated as part of the tax-free interest on a municipal bond. However, for a municipal bond bought at a discount in the secondary market, the discount is considered ordinary income subject to tax.

If a registered representative owns a vacation home and wants to rent it out during the summer, which of the following statements is TRUE? A) No notification is required, provided the vacation home is located in the state where the member firm has its principal office. B) Prior notification must be made to the member firm under the rules on outside affiliations. C) Prior notification must be made to the member firm under the rules on private securities transactions. D) No notification is required.

D) No notification is required. Rental income is passive income. Passive investments are excluded from the notification requirements of the outside affiliations rule. Similarly, renting a vacation home is not a private securities transaction.

Most rating services rate which of the following? A) Marketability. B) Durability. C) Reinvestment risk. D) Quality.

D) Quality. The rating services are concerned with quality, which is defined as the ability of the issuer or guarantor to pay (default risk).

Three years ago, a customer purchased 300 shares of ACE Fund. He sold the shares on August 15 for a loss of $400. He then purchased 300 shares of the same fund on September 4 of the same year. If the investor is in a 10% tax bracket how will the loss be treated for tax purposes in the current year? A) 10% of the loss is deductible. B) The loss is only deductible to the extent that gains of an equal or greater amount were incurred. C) The loss is fully deductible. D) The loss is not deductible.

D) The loss is not deductible. Because the customer repurchased the shares within 30 days of the loss transaction the loss is disallowed under the wash sale rule and therefore not deductible. A wash sale occurs when the same shares are purchased within 30 days before or after the date of sale that the loss is incurred.

An investor purchases 1,000 shares of ABC at $42 per share. One year later, the stock is trading at $50 per share and the investor receives 50 shares of ABC as a stock dividend. How will this dividend be currently taxed? A) As a $2,100 capital gain. B) As $2,500 ordinary income. C) As a $2,500 capital gain. D) The shares are not subject to taxation.

D) The shares are not subject to taxation. Shares received per a stock dividend are not currently taxable. Instead, shareholders who receive stock dividends must adjust their cost basis in the shares downward. The total number of new shares, multiplied by their new adjusted basis, must equal the shareholder's total interest before the stock dividend was received.

A customer buys a new issue municipal bond at a discount. If held to maturity, the amount of the discount is: A) taxed as a short-term capital gain. B) taxed as a long-term capital gain. C) accreted and taxed as ordinary income. D) accreted and is not taxed.

D) accreted and is not taxed. Original issue discounts are accreted, which allows for a step-up in cost basis. Accretion on original issue discount municipal bonds is not taxed.

For tax purposes, cash dividends are taxable to stockholders as of the: A) declaration date. B) ex-date. C) record date. D) payable date.

D) payable date. Cash dividends are not taxable until paid.

What does domicile of the investor mean?

Geographic location of the investor

If a customer, while out of town, receives a margin call for securities purchased a day earlier, which of the following actions would be appropriate? I. The customer overnights a personal check to cover the call. II. The broker servicing the account writes a personal check to cover the call. III. The brokerage firm transfers the position to its trading account until the customer returns. IV. The customer uses a wire transfer of funds to cover the call.

I. The customer overnights a personal check to cover the call. IV. The customer uses a wire transfer of funds to cover the call. Personal checks as well as wire transfers can be used to meet the call, but a broker may never loan money to a customer. Furthermore, the brokerage firm may never transfer a customer's position to its proprietary trading account pending the customer's return to satisfy a customer's margin call.

If a customer buys a corporate bond at a discount in the secondary market, which of the following statements are TRUE if the bond is held to maturity? I. The discount is taxable as ordinary income. II. The discount is taxable as a long-term capital gain. III. The interest income is taxable as ordinary income. IV. The interest income is not taxable.

I. The discount is taxable as ordinary income. III. The interest income is taxable as ordinary income. The discount on a corporate bond purchased in the secondary market must be accreted and is taxable as ordinary income, not as a capital gain. Furthermore, the interest income on corporate bonds is fully taxable.

Amortization of a municipal bond premium does which of the following? I.Increases cost basis. II.Decreases cost basis. III.Increases reported interest income. IV.Decreases reported interest income.

II.Decreases cost basis. IV.Decreases reported interest income. Tax law requires municipal bond premiums to be amortized. The effect of amortization is to decrease reported interest income and cost basis. If held to maturity, the cost basis will have been amortized down to par. Therefore, at maturity, there is no reported capital loss.

In constructing a profile for your customer, you wish to assemble information on both financial and nonfinancial investment considerations that affect your customer. Which of the following qualify as financial investment considerations? I.Your customer's tolerance of various forms of risk. II.Your customer's dependants and their ages. III.Your customer's liquid net worth. IV.Your customer's monthly credit card payments.

III.Your customer's liquid net worth. IV.Your customer's monthly credit card payments. Liquid net worth and expenses such as credit card payments involve concrete sums of money and cash flow and thus, are financial. Number of dependants and risk tolerance should be considered regarding suitability and making appropriate recommendations but they are nonfinancial considerations.

Gift tax

In accordance with gift tax regulations as mandated by the IRS, an individual may give a gift of up to a specified dollar limit per person in one year with no gift tax liability. If the gift exceeds the IRS specified dollar limit it is the donor who is responsible for any tax. The gift tax is a progressive tax, which means that as the size of the gift increases, the percentage of applicable tax will also increase. The IRS specified gift tax limit is subject to change from year to year.

If a customer owns a $10,000 8% U.S. Treasury Bond and she is in the 28% federal tax bracket and a 2-½% state tax bracket, what amount of tax will she pay on the income received from the bond?

Interest on U.S. Treasury bonds is taxable at the federal level only; $800 of interest taxed at 28% = $224.

The risk of a bond decreasing in value during periods of inflation is known as:

Interest rate risk. Interest rate risk is the possibility that interest rates might rise, causing bond prices to fall. Periods of inflation are accompanied by rising interest rates.

FINRA rules do not allow cash or non-cash payment for customer referrals to anyone who ____________________________.

Is not a FINRA member.

How are dividends taxed?

On all levels

Uncovered short sales are reported as what?

Short-term gains and losses no matter how long the holding period.

Taxes for stock dividends and stock splits

Stock dividends and stock splits are not taxable to investors.

A customer buys $10,000 worth of new issue municipal bonds at a price of 104 and the bonds have 10 years to maturity. Four years after purchasing the bonds, she sells them at 99. What is the tax loss on these bonds?

To arrive at adjusted cost basis the premium on a new issue municipal bond must be amortized (subtract). To amortize the premium annually, divide the premium amount (in this case, $400 on the total purchase of 10 bonds) by the number of years until maturity (10). Thus, the customer writes down the initial cost by $40 per year. After 4 years, the bonds purchased at a cost of $10,400 will be written down to $10,240 (4 years $40 per year = $160). If the bonds are sold for $9,900, the tax loss is $340 ($10,240 − $9,900 = $340).

If, within 30 days of the date of sale, the customer buys back the security or the right to buy it back (a ________ option), the loss is disallowed. It will also be disallowed if the customer writes deep in-the-money puts on the security sold within 30 days. A deep in-the-money put will likely be exercised, forcing the customer to buy stock.

call

Once all capital gains have been offset, $3,000 of net capital losses may be used to offset __________________

ordinary income annually.

Securities can be gifted to charity and deducted at their fair market value, as long as __________________?

they have been held more than 1 year.