Here we go again
A front-end sales load is defined as A) the difference between the public offering price and the net asset value of a mutual fund share. B) the commissions paid on the purchase or sale of securities. C) the concessions allowed on the purchase or sale of securities. D) the fee paid to the investment adviser. An investor mentions the term level load fund shares to a registered representative. The investor is referring to A) Class B shares. B) Class C shares. C) shares of a closed-end fund. D) Class A shares.
A Explanation A sales load is the difference between the public offering price and the net asset value per share of the fund. B Explanation Class C shares are referred to as level load because the charges never fluctuate. Shares are purchased at net asset value (no front-end load), and there is a back-end load (CDSC), generally for 12 months. The 12b-1 fees on Class C shares are higher than on Class A shares and remain so until the position is liquidated. Class C shares are most suitable for investors who will not maintain the position for the long term.
An investor purchased a corporate bond with a 6% coupon at a net price of 101. The bond had accrued interest for 45 days. Which of the following statements regarding the confirmation of this trade is correct? A) The total amount due on the purchaser's confirmation will appear as $1,017.50. B) The total amount due on the purchaser's confirmation will appear as $1,025. C) The total amount due on the purchaser's confirmation will appear as $1,010. D) The total amount received on the seller's confirmation will appear as $1,002.50.
A Explanation Accrued interest is always added to the price of a bond. When you buy the bond, you pay that accrued interest, and when you sell a bond, you receive that accrued interest. The principal value is 101, or $1,010. Forty-five days of accrued interest is ⅛ of a 360-day year, or ¼ of a 180-day semiannual interest payment. With a 6% coupon, the bond pays $30 every 6 months. One quarter of that is $7.50 so the total cost to the purchaser is the $1,010 plus the $7.50, or $1,017.50.
Which of the following statements best describes the effect of reinvesting mutual fund distributions? A) The reinvestment of capital gains and dividends results in a higher cost basis. B) Dividends from investment income that are reinvested have tax-deferred status. C) The reinvestment of capital gains and dividends has no effect on cost basis. D) Capital gains that are reinvested have tax-deferred status.
A Explanation Because reinvested distributions are taxed in the year received, the investor's cost basis is increased by the amount of the distribution. This is to prevent those distributions from being taxed twice. They are taxed once as the dividend or capital gain and then, if not added to the cost basis, would be taxed a second time when the shares are sold. Reinvestment of these distributions does not avoid or defer current taxation. This is not the same as receiving a stock dividend where the taxes are deferred until those shares are sold.
An investor had a $20,000 capital loss, a $15,000 capital gain, and $50,000 in income for the year. How much of the income is taxable? A) $47,000 B) $50,000 C) $30,000 D) $20,000
A Explanation Capital losses may be used to reduce taxable income. The first step is to net the gains and the losses. This investor has a net loss of $5,000. Of that net loss, a maximum of $3,000 can be written off against the income for the year. That reduces the investor's taxable income to $47,000. The unused $2,000 of the net loss is carried forward to subsequent tax years until utilized.
Regarding the taxation of dividends received from corporate securities, which of the following are true? Nonqualified dividends are taxed at the rate the investor's ordinary income will be taxed. Nonqualified dividends are not taxed. Qualified dividends are taxed at a maximum rate specified by the IRS and will depend on the investor's income tax bracket. Qualified dividends are taxed at the rate the investor's ordinary income will be taxed. A) I and III B) II and IV C) II and III D) I and IV
A Explanation For income tax purposes, corporate dividends are divided into two categories: qualified and nonqualified. We don't expect you'll be tested on what makes a dividend qualified or not, but you will need to know the difference in taxation. Qualified dividends are taxed at the same rate as long-term capital gains—a rate significantly lower than the ordinary income tax rate levied against nonqualified dividends. That lower rate ranges from 0% to as high as 20%, with an even higher effective rate for those with an extraordinarily high income. For most investors, the rate is 15%, and that is the number you should use in any computations. With ordinary income tax rates on nonqualified dividends as high (currently) as 37%, there is a real benefit for most investors to receive qualified dividends.
If a high-income customer is subject to alternative minimum tax (AMT), which of the following preference items must be added to adjusted gross income to calculate his tax liability? A) Interest on a private-purpose municipal bond B) Interest on a municipal bond issued to finance highway construction C) Distributions from a corporate bond mutual fund D) Income from a municipal security issued to finance parking garages
A Explanation If more than 10% of a bond's proceeds go to private entities, the interest on the bond is a tax preference item for AMT purposes.
An investment banker purchasing what is left unsold from a rights offering is engaging in A) standby underwriting. B) all or none underwriting. C) firm commitment underwriting. D) preemptive rights underwriting.
A Explanation In many cases, when a corporation is issuing new shares, existing shareholders receive preemptive or stock rights to buy these new shares to maintain their current proportionate ownership. In the event some of the rights are not used, the standby underwriter agrees to purchase those unsubscribed for shares.
A customer buys a new issue municipal bond with a dated date of January 1 for settlement on January 31. If the first interest payment date is March 1, how many days of accrued interest will the customer pay to the syndicate? A) 30 B) 60 C) 0 D) 31
A Explanation In this new issue, interest begins to accrue as of the dated date, so the customer (buyer) must pay the syndicate interest from the dated date up to, but not including, the settlement date. The number of days from January 1 up to, but not including, January 31 is 30.
One of your customers has asked you about trading penny stocks. After discussing the risks, the customer decides to go ahead. The firm sends the individual a copy of the special penny stock risk disclosure document. The firm needs the customer's signed and dated acknowledgment of receipt of the document. Trading in penny stocks may not begin in that account until A) at least two business days after sending the statement. B) at least two business days after receiving the statement. C) the day the signed acknowledgment has been received. D) at least $25,000 in equity is in the account.
A Explanation It is SEC Rule 15g-2 that requires the firm to wait at least two business days after sending the risk disclosure document before executing the first penny stock trade for a new customer. The $25,000 is the minimum equity in a pattern day trading account.
You sell a municipal bond that has been advance refunded. It will be called at 102 four years from now. On the confirmation, the yield must be stated as the yield to A) call. B) maturity. C) maturity or yield to call, whichever is lower. D) maturity or yield to call, whichever is higher.
A Explanation Municipal Securities Rulemaking Board rules require that, when a call date has been fixed by a prerefunding, the yield to call so fixed must be reflected on the confirmation statement. Because of the prerefunding, this bond issue will be called at the call date. There is no uncertainty surrounding this event. Therefore, it is appropriate to price the bond to the call date. The old maturity on the bond has no further significance.
If a customer buys a municipal bond at 110, maturing in eight years, but sells the bond six years later at 103½, the customer will have A) a $10 per bond gain. B) a $65 per bond loss. C) a $35 per bond gain. D) a $10 per bond loss.
A Explanation Municipal bonds that are purchased at a premium must be amortized. This bond has a premium of $100, which over eight years, amounts to $12.50 per year. The cost basis of the bond at the time of the sale is $1,100 − (6 × $12.50), or $1,025. If the bond is sold for $1,035, the customer has a gain of $10 per bond.
One of the most common cases of overlapping municipal debt is when a city's portion of the debt is shared with A) the county. B) the federal government. C) the revenue authority. D) the state.
A Explanation Overlapping debt is the issuer's proportionate share of the debt of other local governmental units that either overlap it (the issuer is located either wholly or partly within the geographic limits of the other units) or underlie it (the other units are located within the geographic limits of the issuer). The debt is generally apportioned based upon relative assessed values. The state is never a party to overlapping debt and, because overlapping debt applies only to general obligation (GO) bonds, there is no revenue authority.
The 5% markup policy applies to A) principal over-the-counter (OTC) trades. B) new issues. C) all of these. D) mutual funds. All of the following are subject to the 5% markup policy except A) spreads in new stock offerings. B) markups. C) markdowns. D) commissions.
A Explanation The 5% markup policy applies to agency and principal nonexempt securities and transactions, both exchange and OTC traded. It does not apply to prospectus offerings (mutual funds and new issues). A Explanation The 5% markup policy applies to markups, markdowns, and commissions. New offerings sold by prospectus are exempt from this rule.
In which of the following investment strategies would it be illegal for a mutual fund's portfolio manager to engage? A) Taking a short position in shares of a mid-cap company B) Liquidating a position in shares of a small-cap company C) Going long U.S. Treasury bonds D) Taking a long position in shares of a large-cap company
A Explanation The Investment Company Act of 1940 prohibits mutual funds from engaging in short selling. The fund's objective will affect the type of securities to be held in the portfolio, but they can only be long positions.
A municipality has prerefunded its bond issue maturing in five years. This would mean all of the following except A) a reduction to the coupon rate. B) greater marketability. C) the bonds will be called in more than 90 days. D) a higher rating.
A Explanation The current bond still exists until the specified call date. As such, the coupon has not changed. Advance or prerefunding is refinancing an existing municipal bond issue before its maturity or call date by using money from the sale of a new bond issue. Because the proceeds of the new issue are placed into special U.S. government securities, the rating is automatically at the top. The higher rating increases the marketability. If the refunding is done in 90 days or less, it is called current refunding.
Which of the following would have the least impact in marketing a municipal bond issue? A) The dated date of the issue B) The maturity of the issue C) The size of the block offered D) The rating of the issue
A Explanation The dated date of a bond issue is merely the date on which the issue begins to accrue interest. As such, it would have less to do with the marketing efforts related to a new issue than would items such as the size of the block offered, the rating of the issue (how financially strong it is), and the maturity.
If an investor in the 27% federal marginal income tax bracket invests in municipal general obligation public purpose bonds nominally yielding 4.5%, what is the tax-equivalent yield? A) 6.16% B) 5.72% C) 3.29% D) 16.67%
A Explanation The formula for computing tax-equivalent yield is: nominal yield ÷ (1 − federal marginal income tax rate). Let's plug in the numbers: 0.045 ÷ (1 − 0.27) = 0.045 ÷ 0.73 = 6.16%. This tells the investor that they would have to receive 6.16% interest on a taxable bond to have the same after-tax return as earning 4.5% tax-free. You can check it out by working backwards. If an investor receives 6.16% taxable, they will have to pay 27% (in this person's bracket) in income tax. That is a tax of 1.66% (6.16 x 27% = 1.66). Subtract 1.66 in tax from 6.16 and the result is 4.50%.
Ten municipal bonds were purchased with 9% nominal yield for settlement on February 1, 2015. The maturity date of the bonds is July 1, 2035. What is the number of days of accrued interest on the 10-bond trade? A) 30 B) 29 C) 37 D) 31
A Explanation The maturity month and day will always match one of the two semiannual coupon dates. Because maturity is July 1, the bond pays interest on January 1 and July 1 of each year. With settlement on February 1, the bond accrued interest from January 1 up to, but not including, settlement (30 days).
Because municipal bonds do not trade on any exchange, there is frequently a concern about their marketability. According to most industry experts, which of the following bonds would be the most marketable? A) City of X, rated AAA with a 5% coupon maturing in 5 years B) City of Z, rated BBB with a 6% coupon maturing in 7 years C) City of Y, rated AAA with a 4% coupon maturing in 10 years D) City of A, rated BB with a 7% coupon maturing in 15 years
A Explanation The primary factors affecting marketability of a municipal bond are its rating (the higher the better), its coupon (the higher the better), and the maturity (the shorter the better). The City of X bond scores the highest using these factors.
A customer wishes to redeem 1,000 shares of a mutual fund. The net assets value (NAV) and public offering price are $10, and a redemption fee of 0.5% will be charged. How much will the customer pay in redemption fees? A) $50 B) $9,950 C) $500 D) $9,500
A Explanation The question did not ask how much he would receive upon redemption, but how much he would pay in redemption fees. Mutual fund shares are redeemed at the NAV (bid): 1,000 shares times $10 each equal $10,000. $10,000 × 0.005 (0.5% redemption fee) = $50.
Gargantuan Computers, Inc., (GCI) conducts a rights offering to its current shareholders at $50 per share, plus one right. If the current market price of GCI is $70, what is the value of one right before the stock trades ex-rights? A) 10 B) 3 C) 15 D) 5
A Explanation The stock is trading cum rights (before the ex-date). The formula to calculate the value of one right before the ex-date is follows: CMV minus subscription price divided by the number of rights to purchase one share plus 1. Therefore, one right is valued at $10, computed as ($70 − $50) / 2 = $10.
Reduced sales charges are allowed under all of the following circumstances except A) combining separate purchases made by a client and her business partner in their respective IRA accounts. B) the customer signing a letter of intent. C) additional purchases that qualify for breakpoints under rights of accumulation. D) a lump-sum purchase that qualifies for a breakpoint.
A Explanation Two unrelated adults may not combine transactions to receive a breakpoint.
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) $200 B) $300 C) $700 D) Capital gains not taxable
A Explanation 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.
When a mutual fund computes its net investment income, all of the following are included except A) long-term capital gains. B) expenses. C) interest. D) dividends.
A Explanation When calculating NII, capital gains are not included. It is solely income from dividends and interest that make up the gross investment income. NII is the gross investment income minus the expenses. A regulated investment company is required to distribute a minimum of 90% of its NII to shareholders if it wishes the special tax treatment offered by the IRS. This requirement is also true when it comes to distributing long-term capital gains. The treatment of short-term gains is beyond the scope of the exam.
Each of the following would be disclosed to potential municipal bond buyers in the official statement of a new municipal bond issue except A) the disclosure that it was prepared by the underwriters. B) the issue's purpose. C) the creditworthiness of the issue. D) the source from which interest and principal will be paid.
A Explanation While a broker-dealer acting in an underwriting capacity or in an advisory capacity may assist in preparing the official statement, it is considered to be the responsibility of, and prepared by, the issuer. The official statement identifies the issue's purpose, the source from which the interest and principal will be repaid, information regarding the issuer's financial and economic background, and information relating to the issue's creditworthiness.
A 2-for-1 split does which of the following? Increases the number of outstanding shares Decreases the number of outstanding shares Decreases par value per share Decreases retained earnings A) II and III B) I and III C) I and IV D) II and IV
B Explanation After a 2-for-1 stock split, the number of outstanding shares doubles, and the par value per share decreases by half. Retained earnings are not affected.
There are risks inherent in any investment. One risk that index ETFs have that should be used to guide the investor's selection decision is A) market risk. B) tracking risk. C) regulatory risk. D) tax risk.
B Explanation Any investment that attempts to track an index or other benchmark needs to be evaluated in terms of its tracking error. That is, how close does the performance of the portfolio, in our question the EFT, match up to that of the index? This tracking error or risk will, over the long run, cause the performance of ETFs tracking the same index to have differing results. Because the portfolios are essentially the same, the market risk of all ETFs tracking the same index will be the same. That should be true of the tax and regulatory concerns as well. All things being equal, an investor should want the ETF that has the least tracking error.
Which of the following statements regarding a leveraged exchange-traded fund (ETF) are true? The leveraged ETF may be purchased on margin. Securities within the leveraged fund portfolio may be purchased on margin. The leveraged ETF may never be purchased on margin. Securities within the leveraged fund portfolio may never be purchased on margin. A) I and IV B) I and II C) II and III D) III and IV
B Explanation Because an ETF is purchased and sold on an exchange, the rules generally applying to all exchange products, such as purchasing them on margin, would apply. Leveraged funds can use a number of different securities types, including derivative products, and trading techniques, such as trading on margin, as a means of attaining the leveraged returns they promise.
A corporation is having a rights offering. The terms of the offering require eight rights plus $88 to purchase one share. With the stock's current market price at $112 per share, the theoretical value of one right on the ex-rights date is A) $0.30. B) $3.00. C) $0.27. D) $2.67.
B Explanation Because the question is asking about the value on the ex-rights, it means we use the regular formula. That is, the (market price minus the subscription price) divided by the (number of rights it takes to buy one share). Plugging in the numbers gives us ($112 - $88) ÷ (8) = $24 ÷ 8 = $3.00
Which of the following statements regarding callable municipal bonds are true? Call premiums tend to increase over time. Call premiums tend to decrease over time. Call prices are stated as a percentage of the principal amount to be called. Call prices are stated as a percentage of the market value of the bonds to be called. A) I and III B) II and III C) I and IV D) II and IV
B Explanation Call premiums tend to decrease over time. The longer a customer has to hold the bond (and receive semiannual interest), the less of a premium an issuer will pay to take away the bond before maturity. Call prices are always stated as a percentage of the principal amount (par) to be called. For example, a call price of 103 means the issuer will pay $1,030 for each bond called.
The interest from which of the following bonds is subject to federal income tax? State of Nebraska City of Duluth Treasury notes Federal National Mortgage Association (FNMA) A) I and II B) III and IV C) I and III D) II and IV
B Explanation Direct federal debt, such as a Treasury note, is subject to federal income tax but exempt from state tax. FNMA bonds are subject to federal, state, and local taxes. State and city bonds, being municipals, are exempt from federal income tax.
Which of the following statements is true regarding dividend payments on common stock? A) Dividends on common stock are paid at the discretion of the board of directors and are paid as a stated percentage of the corporation's net income. B) Dividends on common stock are paid at the discretion of the board of directors and may be paid even where there are no earnings. C) Dividends on common stock are paid at the discretion of the board of directors and may be paid ahead of preferred stock when necessary to allow the company to remain listed on the exchange. D) Dividends on common stock are paid at the discretion of the board of directors and can be paid only when there are sufficient earnings.
B Explanation Dividends on common stock are paid at the discretion of the corporation's board of directors. Although each stockholder receives an amount proportionate to their holdings, the dividend can be any proportion of the company's earnings. In fact, a corporation can pay a dividend even when there are no earnings. However, no dividend on common stock can ever be paid before payment of the dividends due on preferred stock.
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 Explanation 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.
When analyzing a company's balance sheet, you notice that it is using the first in, first out accounting method to value its inventory. This information is most likely shown A) next to the inventory listing in the current assets portion of the balance sheet. B) in a footnote to the balance sheet. C) at the end of the balance sheet in a summary statement required by the SEC. D) on the cover of the balance sheet or at the top of the first page.
B Explanation Notations regarding accounting methods used, such as those for valuing inventory, would generally be found in the footnotes of the balance sheet.
One of your customers has been regularly investing into the shares of an aggressive growth fund. The investor has a long time horizon and does not expect to touch the account for a number of years. In the event of an emergency, federal law would require redemption proceeds forwarded within A) 2 business days (T+2). B) 7 days. C) 30 calendar days. D) 4 business days (S+2).
B Explanation One of the provisions of the Investment Company Act is that redemption requests must be honored within 7 days.
State and local government securities (SLGS) are purchased by A) institutions. B) state and local governments. C) accredited investors. D) commercial banks.
B Explanation SLGS securities are purchased by municipal issuers that are subject to IRS yield restrictions when they invest the proceeds of a prerefunding. The monies placed in escrow are invested in SLGS, which are government securities whose interest rates are arranged to comply with IRS restrictions.
Which of the following securities would have a Moody's MIG rating? A) GOs B) TANs C) BAs D) T-bills
B Explanation TANs are tax anticipation notes. These are short-term municipal securities and that is what Moody's MIG ratings represent. MIG stands for Municipal Investment Grade. GOs are rated with the normal letter ratings and BAs (bankers' acceptances) and T-bills are not municipal securities.
The mutual fund industry is highly regulated. One of the areas regulated is that of making disclosures. An example of that is that mutual funds must provide reports to their shareholders on A) an annual basis. B) a biannual basis. C) a quarterly basis. D) a biennial basis.
B Explanation The Investment Company Act of 1940 requires that mutual funds provide their shareholders with reports twice per year (biannually). One of the reports is the annual report with audited financial statements (also filed with the SEC), and the other is the semiannual report. Biennial reporting would be every two years.
An investor wants to invest $200,000 in the banking industry sector. The investor would like to use leverage and make this purchase in a margin account. Additionally, she stresses wanting to avoid year-end tax statements showing capital gains liabilities. You would suggest which of the following as suitable, given the investor's criteria? A) Stocks in the three largest U.S. banks B) A bank sector exchange-traded fund (ETF) C) A money market fund holding short-term bank notes D) A bank sector mutual fund
B Explanation The investor's criteria eliminates mutual funds as suitable. Mutual funds make annual capital gains distributions for which the owner incurs a tax liability, and mutual funds cannot be purchased on margin. Conversely, an ETF will rarely make a capital gains distribution, and because they trade like all exchange-traded products, they can be purchased on margin, making them more suitable for this investor. Buying only a few select bank stocks is not a good representation of the entire sector.
A document that allows an investor in Class A shares of a mutual fund to receive a breakpoint on an initial purchase without investing the required breakpoint amount is A) the breakpoint sale memorandum. B) a letter of intent. C) the new account form. D) the rights of accumulation form.
B Explanation The letter of intent (LOI) is a document available to mutual fund investors that allows them to receive breakpoints (discounted sales charges) on the initial and subsequent deposits over a 13-month period. Investors can backdate an LOI up to 90 days to pick up previously invested monies. If backdated, the 13 months begins from that date. There is no rights of accumulation form. Rights of accumulation allow future deposits to receive sales charge discounts when the investment total grows into higher breakpoint levels. A difference between the LOI and rights of accumulation is that the LOI allows for the reduced sales charge starting with the initial payment and rights of accumulation do not apply until the account reaches the breakpoint. The new account form is the opening document of an account and does not provide these benefits. A breakpoint sale is the unethical procedure of selling Class A shares in an amount just below a breakpoint. This usually results in a higher commission to the registered representative and greater cost to the investor.
A corporation has 1 million shares of common stock outstanding. There is also a $100 par 6% cumulative convertible preferred issue with 100,000 shares outstanding. If the corporation wishes to use a rights offering to raise additional capital by selling 500,000 new shares of common, which of the following statements is true? A) Each preferred share would receive five rights. B) It will require two rights to buy one new share. C) It will require five rights granted to the preferred stockholders to buy one new share. D) Each common share will receive half of a right.
B Explanation The number of rights necessary to acquire one new share is computed by dividing the number of outstanding shares of common stock by the number of new shares being issued. In this question, that is 1,000,000 ÷ 500,000 = 2.
A customer buys five municipal bonds maturing in 20 years for 104. If he sells the bonds after 10 years at 103, the customer has A) a $100 capital gain. B) a $50 capital gain. C) a $50 capital loss. D) a $100 capital loss.
B Explanation The premium on the municipal bonds must be amortized. The tax rules require that when you purchase a bond at a premium, you have to reduce the cost basis of the bond each year. Even though there are five bonds in the question, here's the math on one bond and then we'll multiply by five to get the total amount. The investor buys the bond at 104 or $1,040 and the bond is due to mature in 20 years. Take the $40 premium divided by the 20 years to maturity and that will tell us the amount that we amortize/reduce the cost basis by each year. $40/20=$2. It then tells us that the bond is sold after 10 years. Ten years of amortization is $2 per year x 10 years = $20. That lowers the basis of the bond to $1,020 ( $1,040 - $20 = $1,020). The bonds are sold at 103 or $1,030, so the gain is $10 per bond times five bonds for a total gain of $50.
All of the following are expenses to the operation of mutual funds except A) the legal costs of SEC filings. B) the compensation paid to the underwriter or distributor. C) the custodian bank's charges. D) the fees paid to the fund's investment adviser.
B Explanation The underwriters receive their compensation from the sales charges. Investors pay those charges rather than the fund itself.
An investor, age 36, has a net worth of $650,000, with an annual income of $65,000. Wanting to add to an existing portfolio, the investor is not concerned about generating more income, as that seems to be adequate already. However, the investor does note that keeping taxes to a minimum is an objective. Which of the following funds would be the most suitable, given the investor's objectives? A) Fund Y: invests in companies that have capital appreciation potential; turnover ratio of 100% B) Fund X: invests in companies with long-term growth potential; turnover ratio of 25% C) Fund W: invests in utility companies; turnover ratio of 25% D) Fund Z: invests in preferred shares; turnover ratio of 50%
B Explanation This investor is not concerned about income. This would eliminate the utility and preferred share funds (Fund Z and Fund W). Of the remaining two funds, Fund X and Fund Y both have the same general objective, but the one with the lower turnover ratio would generate less tax liability. The portfolio turnover ratio reflects a fund's holding period of securities being bought and sold by the fund manager. If a fund has a turnover ratio of 100%, the entire portfolio is likely to turn over in a year, and capital gains distributions are likely to be short term and subject to the maximum tax rate. That increases the tax liability, and therefore, is not the best option. By contrast, a 25% turnover ratio means the average holding period of the securities in the portfolio is four years. This would mean that any capital gains distributions are more likely to be long term and subject to a lower tax rate.
Municipal Securities Rulemaking Board rules prohibit dealers from entering into which of the following transactions with a mutual fund? A) Accepting orders from a fund to buy a new municipal issue B) Accepting portfolio trades from the fund as compensation for sales of the fund's shares C) Acting as a broker's broker for a large block of bonds the fund wishes to sell D) Purchasing the fund's shares to fill customers' orders
B Explanation This prohibited practice is known as reciprocal dealing between a broker-dealer and an investment company. The other examples are routine practices.
Most mutual funds operate as regulated investment companies. This means that A) their principal underwriter (sponsor) is a FINRA member. B) they qualify for special tax treatment under Subchapter M of the Internal Revenue Code. C) they register with the SEC under the Investment Advisers Act of 1940. D) they register with the SEC under the Investment Company Act of 1940.
B Explanation Triple taxation of investment income can be avoided if the mutual fund qualifies under Subchapter M of the IRC. To avoid taxation under Subchapter M, a fund must distribute at least 90% of its net investment income to shareholders. The fund then pays taxes only on the undistributed amount. This rule applies to management companies (open-end and closed-end) and UITs. That means ETFs are also included. Although not investment companies registered under the Investment Company Act of 1940, REITs can also take advantage of Subchapter M's tax benefits.
A married couple owns Class A shares of the KAPCO Balanced Fund as follows: The older of the pair has an individual account with a current value of $10,000. The other individual's account is valued at $20,000, and they have a JTWROS account valued at $12,000. KAPCO offers rights of accumulation and has breakpoints at $25,000 (4%), $50,000 (3%), and $100,000 (2%). How much will the sales charge be if they invest an additional $15,000 into the JTWROS account? A) $530 B) $450 C) $600 D) $300
B Explanation We combine all of the accounts under rights of accumulation 20, 12, 10, 15 = 57
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) no taxable result at this time. B) a capital gain. C) tax-free income. D) a capital loss.
B Explanation 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 the bond that was purchased for par at a premium.
For a mutual fund that collects a 12b-1 fee, which of the following statements are true? The fund may use the money to pay for mailing sales literature. Advertising materials must always state that the fund is no load. The fund may use the money to pay for commissions on portfolio transactions. The fund's prospectus must disclose the fee. A) II and III B) III and IV C) I and IV D) I and II
C Explanation 12b-1 fees may be used only to cover promotional and other distribution expenses for funds that are distributors of their own shares; fee amounts must be disclosed in the prospectus. The fund may not use the term no load in any communications with the public if the 12b-1 fee and other service fees exceed 0.25% of average net assets.
A J & J Treasury bond with a 5% coupon due July 1, 2019, is purchased in a cash transaction on February 24. What is the number of days of accrued interest? A) 55 B) 53 C) 54 D) 63
C Explanation A bond begins accruing interest on the prior interest payment date (January 1) and accrues up to, but not including, the settlement date (February 24). Did you notice that this was a cash transaction? That means the settlement date is the same day as the trade (February 24). Normally, Treasury securities settle T+1. If this was a regular-way trade, the accrued interest would be 55 days because settelment would have been February 25. Be careful reading the question; it is easy to skip over critical information. Because accrued interest on government bonds is computed actual days, actual year, 31 days for January plus 23 days for February, it equals 54 days.
A broker's broker does all of the following except A) conceals the identity of the principals. B) assists in placing securities. C) makes a market in securities. D) acts as agent for dealers.
C Explanation A broker's broker acts as the agent in transactions by facilitating the movement of blocks of bonds. The broker's broker is allowed to conceal the identities of the contra-parties, thus protecting investment strategies. A broker's broker does not make a market in securities.
A legal opinion evaluates which of the following features of a municipal issue? Marketability Legality Tax-exempt status Economic feasibility A) I and III B) I and IV C) II and III D) II and IV
C Explanation A legal opinion rendered by bond counsel deals with the tax-exempt status of the proposed issue and its legality. The marketability of the new issue of bonds is dealt with by the syndicate. Economic feasibility relates to revenue bond issues and is performed by independent consultants.
One of the benefits of adding a sinking fund provision to a municipal bond issue is that the bond will generally A) receive more favorable tax treatment. B) be issued without a call provision. C) be issued with an interest rate lower than without the sinking fund. D) have a longer maturity.
C Explanation Adding a sinking fund provision to a bond issue invariably results in a higher rating for the security. The fact that money is put aside to repay the principal on a regular basis offers greater safety. A higher rating results in a lower coupon, not a higher one. After all, the higher the rating, the lower the risk, and that means the issuer is able to borrow at a lower cost. Although the sinking fund itself does not change the maturity date, having a sinking fund enables the issuer to use partial calls to redeem the bond ahead of the final maturity date. A sinking fund has nothing to do with tax treatment.
A mutual fund's unrealized loss last month results in which of the following? Lower net asset value (NAV) per share Lower dividend payments to shareholders Reduction in the proceeds payable to shareholders who liquidate their shares Higher tax liability to shareholders A) I and IV B) II and III C) I and III D) II and IV
C Explanation An unrealized loss is the same as a decrease in NAV. An investor receives less at redemption than she would have if the redemption had taken place before the asset's depreciation.
Municipal brokers' brokers deal with all of the following except A) bank dealers. B) institutions. C) individuals. D) municipal dealers.
C Explanation As the term suggests, a municipal broker's broker deals with other dealers and institutions, not with the general public.
One of your customers owns 100 shares of GTS common stock. The purchase was made two years ago at a price of $51 per share. GTS has recently declared a 3:2 stock split. At the customer's request, as soon as the new shares are in the account, you sell them and $2,000 from the proceeds of the sale is credited to the customer's account. Based on this information, the tax impact of this transaction is A) a long-term capital loss of $1,333 and a short-term capital loss of $667. B) a long-term capital loss of $1,400. C) a long-term capital gain of $300. D) a short-term capital gain of $300.
C Explanation Immediately after the stock split, the total investment of the initial position remains unchanged at $5,100 (100 shares at $51 per share). After the stock split, the customer owns 150 shares (3/2 times 100 = 150 shares). Therefore, the adjusted cost basis per share is $34 ($5,100 divided by 150 shares). Those 50 shares were sold for $2,000 and have a cost basis of $1,700 ($34 times 50). That is a profit of $300.
The alternative minimum tax (AMT) is designed to present an alternative tax computation that disallows deductions for certain tax preference items and includes certain nontaxable income. Which of the following is not a tax preference item? A) Certain costs associated with an oil and gas drilling program B) Tax-exempt interest received on private purpose bonds C) Interest received on corporate bonds D) Local income and property taxes Investors who are subject to the alternative minimum tax (AMT) will lose the tax benefits normally associated with A) losses on options positions. B) gains associated with variable annuity portfolios. C) tax preference items. D) capital losses.
C Explanation Interest on corporate bonds is taxable and included in an investor's adjusted gross income (AGI), but not for the AMT. Tax-exempt interest on private activity bonds and excess intangible drilling costs in an oil and gas DPP are included as tax preferences. In addition, state and local taxes and accelerated depreciation are in the list of preference items. C Explanation 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 AMT, the benefits normally associated with tax preference items are lost because these items must be added back into the investor's taxable income.
One of your clients was at a recent social gathering and heard a friend talking about a recent investment in an interval fund. How would you describe this investment? A) It is a closed-end investment company that computes its net asset value at certain specified intervals. B) It is an investment company where an investor's money market account is debited at certain specified intervals to purchase shares of the fund. C) It is a closed-end investment company where, at certain specified intervals, investors are able to sell their shares back to the company at net asset value. D) It is an option available in many qualified retirement plans where, as certain specified intervals, the asset allocation is changed as the investor ages.
C Explanation Interval funds are closed-end investment companies that permit shareholders to sell their shares back to the company at net asset value. The frequency varies by fund and can range from monthly to annually.
One of your customers calls to tell you he just lost his job and is uncertain when he will find another one. The primary asset in his account is the Grosvenor Aggressive Growth Fund, distributed by Huntsman Fund Distributors, a FINRA member firm. Huntsman has a number of other funds, all with a conversion privilege. Which of the following would likely be the most suitable recommendation to your client? A) Sell the Grosvenor Aggressive Growth Fund and invest the proceeds into a more conservative fund. B) Use the conversion privilege to convert from the common stock of the Grosvenor Aggressive Growth Fund into the bonds issued by the fund. C) Use the conversion privilege to move from the Grosvenor Aggressive Growth Fund into a more conservative fund in the Huntsman family. D) Stay where you are in the Grosvenor Aggressive Growth Fund because being out of a job means you will need the extra growth potential.
C Explanation It would seem that a newly unemployed customer should move from an aggressive position to a conservative one. One of the features offered by many mutual fund distributors is the ability to convert or exchange the shares of one fund for those of another at net asset value (no sales charge). That would appear to be the most suitable recommendation here. Selling the shares of the Grosvenor Aggressive Growth Fund and investing them into another fund offered by a different distributor could lead to a front-end load (Class A shares) or a back-end load (Class B shares). The customer will avoid these charges when using the conversion privilege. Mutual funds issue common stock only; there is no conversion into bonds.
If an investor is in the highest federal income tax bracket and is subject to the alternative minimum tax (AMT), which of the following securities should an agent recommend? A) Industrial revenue bond B) Corporate bond C) General obligation (GO) bond D) Treasury bond
C Explanation 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 GO bond is a better recommendation than an industrial revenue bond because the interest on industrial revenue bonds is likely subject to the AMT.
The Class A shares of the GEMCO Balanced Fund carry a sales charge of 4.5%. If the next computed net asset value per share is $32.74, purchase orders will be filled at a price of A) $31.27 per share. B) $32.74 per share. C) $34.28 per share. D) $34.21 per share.
C Explanation Mutual funds sell at the public offering price (POP). That POP includes the sales charge—in this case, 4.5%. The sales charge is a percentage of the POP, not the NAV. The computation is the NAV divided by (100% - the sales charge). In our question, that is $32.74 ÷ 0.955, or $34.28 per share.
Because municipal bonds do not trade on any exchange, there is frequently a concern about their marketability. According to most industry experts, which of the following bonds would be the most marketable? A) $10,000 of State N general obligation bonds rated AA B) $50,000 of State M general obligation bonds rated Aa C) $100,000 of State L general obligation bonds rated AA D) $5,000 of State O general obligation bonds rated Aa
C Explanation One of the many factors in the marketability of municipal bonds is the size of the block. With the normal block size being $100,000, municipal dealers will have an easier time trading the State L bonds. Note that S&P and Moody's ratings are the same.
An investor purchases an original issue discount municipal bond on the offering at 80. The bond matures in 25 years. Eight years later, the investor sells the bond for 84. The tax consequence of this transaction is A) long-term capital gain of $40. B) tax-free income of $24 and long-term capital gain of $40. C) long-term capital loss of $24. D) ordinary loss of $24.
C Explanation The 20 point ($200) discount accretes over the 25-year life of the bond. That makes the annual accretion $8 per year ($200 divided by 25 years). After 8 years, there has been $64 of accretion ($8 times 8 years). That means the cost basis of the bond is $864. The sale at $840 represents a loss of $24 and has a long-term holding period.
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) II and III B) I and IV C) II and IV D) I and III
C Explanation 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.
Which of the following would be of least concern to a registered representative recommending a municipal security to a customer? A) Municipal security's rating B) Customer's state of residence C) Availability of the security D) Customer's tax status
C Explanation The customer's state of residence and tax status are essential when determining suitability of a municipal security. The security's rating is also important because it measures the bond's safety and quality and should align with the customer's risk tolerance. While the availability may pose a challenge for the broker-dealer and could potentially add to the cost of the transaction, it would be of the least concern regarding suitability unless the cost was in some way prohibitive.
An investor wishes to invest $5,000 into the KAPCO Balanced Fund, an open-end investment company. How many shares will the investor receive if the next computed NAV per share after receipt of the order is $41.30 and the fund has a sales charge of 4%? A) 121.065 B) 43.021 C) 116.225 D) 116.414
C Explanation The investor will pay the POP (public offering price) of $43.02 per share. That price is computed by dividing the NAV of $41.30 by (100% ‒ 4%). Remember, the 4% sales charge is a percentage of the offering price, not the NAV. Dividing the $5,000 investment by the POP of $43.02 results in a purchase of 116.225 shares.
A customer has been following several investment company quotes in the newspaper. She notices that the GEM Fund has a net asset value (NAV) of $12 and a public offering price (POP) of $12.50, and that the ABC Fund has an NAV of $11.50 and a POP of $10.98. The customer should conclude that A) both are open-end funds. B) ABC is an open-end fund and GEM is a closed-end fund. C) GEM may be an open- or closed-end fund, and ABC is a closed-end fund. D) ABC and GEM are both unit investment trusts.
C Explanation The price for open-end funds is determined by adding the sales charge to the NAV. An open-end fund can never have a POP less than its NAV; therefore, ABC cannot be an open-end fund. Open: POP > NAV
Which of the following statements regarding Section 529 education savings plans are true? Contributions are considered gifts under federal law. Contributions are tax deductible under federal law. Earnings generated are taxable each year. Earnings generated are tax deferred. A) II and IV B) I and III C) I and IV D) II and III
C Explanation Under federal law, contributions made into Section 529 plans are considered gifts and are not deductible at the federal level. Furthermore, earnings generated each year are tax deferred and, on withdrawal, are tax free at the federal level—if used for qualified education expenses.
A customer bought a bond that yields 6.5% with a 5% coupon. If the bond matures at this point, the customer will receive A) $1,065. B) $1,050. C) $1,025. D) $1,000 plus a call premium.
C Explanation Upon redemption of a bond, whatever current interest rates may be, the investor receives par ($1,000) plus the final semiannual interest payment ($25 in this case), for a total of $1,025.
A customer buys a municipal bond in the secondary market at 96 that has four years to maturity. Two years later, the customer sells the bond at 99. The tax consequences of this investment are A) three points of capital gain. B) three points of ordinary income. C) two points of ordinary income and one point of capital gain. D) two points of capital gain and one point of ordinary income.
C Explanation 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 one point per year (four points divided by four years to maturity). Therefore, when the bond is sold two years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of one point per bond. Also, there is ordinary income taxation on the accretion of two points.
A customer buys a municipal bond in the secondary market at 96 that has four years to maturity. Two years later, the customer sells the bond at 99. The tax consequences of this investment are A) three points of ordinary income. B) three points of capital gain. C) two points of ordinary income and one point of capital gain. D) two points of capital gain and one point of ordinary income.
C Explanation 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 one point per year (four points divided by four years to maturity). Therefore, when the bond is sold two years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of one point per bond. Also, there is ordinary income taxation on the accretion of two points.
A county taxes real property at a millage rate of 15. If your customer owns real property in the county and the assessed value is 80% of the current market value of $150,000, the annual tax is A) $2,250. B) $180. C) $1,200. D) $1,800.
D Explanation Ad valorem tax rates are based on mills with one mill being equal to $0.001 (1/10th of a cent).The amount of taxes to be paid on the property is determined by multiplying the millage rate—in this case, one and one half cents (15 mils at $0.001 = $0.015)—times the assessed property value ($120,000). Remember, this county is only taxing on 80% of the assessed value. The market value is irrelevant. For those who have difficulty determining where the decimal point goes, on any question like this, drop the last three 000s from the assessed value and multiply by the millage rate. In this question, that would be $120 times 15 and that equals the correct answer of $1,800.
A member of the investment banking department of ABC Securities is explaining some of the advantages and disadvantages of rights and warrants to the board of directors of XYZ Corporation. Which of the following statements could he make? The exercise prices of stock rights are usually below current market value (CMV) of the underlying security at time of issue. The exercise prices of warrants are usually above CMV of the underlying security at time of issue. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer. A) I, II, and III B) I only C) I and II D) I, II, III, and IV
D Explanation All are true statements. The exercise prices of stock rights are usually below CMV of the underlying security at the time of issue. The exercise prices of warrants are usually above CMV of the underlying security at the time of issue. Both rights and warrants may trade in the secondary market and have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer.
A city has issued bonds to construct a new sewage treatment facility. If the bonds are not backed by the full taxing authority of the city, all of the following statements about the bond issue are true except A) if earnings fall short of the amount needed to make principal and interest payments, the debt service reserve can be used. B) the interest on these bonds is not considered a preference item for the alternative minimum tax. C) there is no debt limitation on the issue. D) the disbursement of principal and interest payments must be approved semiannually by the state public service commission.
D Explanation As an exclusion question, we are looking for the false statement. The public service commission would have no approval power over revenue bond interest and principal payments. Because the bond is not backed by the taxing authority of the city, it is a revenue bond rather than a general obligation bond. The funds for payment of interest and repayment of principal are generated through the fees paid by those using the city's water and sewage facilities. Being a public, rather than private, facility, these would not be alternative minimum tax bonds.
An investor has received a cash dividend on a stock that they have owned for over 10 years. It is the first dividend the company has paid. The cash dividend would be taxable to the investor as A) a return of principal. B) a short-term capital gain in the year in which it is received. C) a long-term capital gain in the year in which it is received. D) income in the year in which it is received.
D Explanation Cash dividends are always treated as income and are taxable to the investor in the tax year in which they are received by the investor. In those cases where the dividend is qualified, it will be taxed at a lower rate than the investor's ordinary income. That does not affect this question because the answer is the same if the dividend is qualified or not. A capital gain occurs when an investor sells an asset for more than its cost basis.
A representative wishes to execute an order for a customer's discretionary account. The municipal dealer has a control relationship with the issuer of the security to be purchased. Under Municipal Securities Rulemaking Board rules, the representative A) No authorization needed B) must wait until the firm terminates the control relationship. C) may refer the customer to a firm that has no control relationship. D) must have specific authorization from the customer.
D Explanation Even in a discretionary account, a registered representative may not exercise discretion when a control relationship exists between the issuer and the dealer without first receiving the customer's permission.
Which of the following statements regarding fixed municipal unit trusts are true? The trust is managed. The trust is not managed. The portfolio can be traded. The portfolio cannot be traded. A) II and III B) I and III C) I and IV D) II and IV
D Explanation Fixed unit trusts are not managed; the portfolio of securities does not change. As bonds mature or are called, the proceeds are distributed pro rata to the unit holders. These units are redeemable by the issuer or its agent.
The purchaser of a general obligation (GO) municipal bond should be concerned with property tax assessments. the maintenance covenant. market risk. feasibility studies. A) II and III B) II and IV C) I and IV D) I and III
D Explanation GO bonds are issued by municipalities and, like all debt instruments, are subject to interest rate changes (market risk). Ad valorem (property taxes) are the primary source of debt funding for municipal GO bonds and are based on property assessments. Feasibility studies and maintenance covenants are associated with municipal revenue bonds where user fees from municipal projects and facilities are used to fund the debt.
All of the following characteristics regarding industrial development bonds (IDBs) are true except A) funds from the lease are used to pay the principal and interest on the bonds. B) the funds are used to construct a facility for a private corporation. C) the bonds are issued by municipalities or other governmental units. D) the bonds are normally backed by the full faith and credit of the municipality.
D Explanation IDBs are issued by a municipality, and the proceeds are used to construct facilities or purchase equipment for a private corporation. The corporation leases the facilities or equipment, and funds from the lease are used to repay investors. In addition to a first mortgage on the property, IDBs are backed by the full faith and credit of the corporation (not the municipality).
You sell a municipal bond that has been advance refunded. It will be called at 102 four years from now. On the confirmation, the yield must be stated as the yield to A) maturity or yield to call, whichever is higher. B) maturity or yield to call, whichever is lower. C) maturity. D) call. When an issuer of a preferred stock exercises the call, it is usually at a price somewhat above the stock's par value. This excess over par is A) the yield to call. B) the call premium. C) the call price. D) the call privilege.
D Explanation Municipal Securities Rulemaking Board rules require that, when a call date has been fixed by a prerefunding, the yield to call so fixed must be reflected on the confirmation statement. Because of the prerefunding, this bond issue will be called at the call date. There is no uncertainty surrounding this event. Therefore, it is appropriate to price the bond to the call date. The old maturity on the bond has no further significance. B Explanation Call premium is the term used to describe that excess over par that the issuer pays when calling in the preferred stock (or callable bond).
If a municipal bond with 10 years to maturity is purchased from the issuer for 110, and after two years, it is sold for 110, the bondholder must report A) capital loss of two points. B) no capital gain or loss. C) capital gain of 20 points. D) capital gain of two points.
D Explanation Municipal bonds bought at a premium must be amortized. The amount of the premium is 10 points. With 10 years to maturity, the annual amortization is one point. After two years, the bond's cost basis has been amortized down to 108. If at that point it is sold for 110, there is a two-point capital gain.
A new municipal bond issue had a dated date of January 1, 2018. The first coupon was due on August 1, 2018. The customer bought for settlement on September 1, 2018. How many months of accrued interest must he pay at settlement? A) Six months B) Eight months C) Seven months D) One month
D Explanation On a new bond issue, the issuer sets the dated date. That is the date from which interest first begins to accrue. It is not unusual for the first interest payment date to be more than six months from the dated date. That is known as a long coupon (longer than six months). Therefore, on August 1, 2018, seven months of interest was paid (January through the end of July). The customer did not purchase the bond until late August and owes interest only from the August 1, 2018, coupon payment date up to, but not including, the September 1 settlement date (one month).
The municipality's share of debt issued by authorities that draw revenues from the same sources as the municipality is known as A) defeased debt. B) contiguous debt. C) assessable debt. D) overlapping debt.
D Explanation Overlapping debt occurs when two or more issuers are taxing the same property to service their respective debt. For example, the City of Charlotte is in Mecklenburg County. Both the city and county issued general obligation (GO) bonds. The property taxes paid by the residents of both jurisdictions (the city and the county) will repay both bonds.
Which of the following securities typically carries the highest dividend rate? A) Convertible preferred B) Participating preferred C) Straight preferred D) Callable preferred
D Explanation Straight preferred is the benchmark rate. As the name suggests, there are no conversion or participating features. Compared to straight preferred, both convertible and participating preferred tend to carry lower dividend rates, as the investor has been given something extra—the right to convert into common shares at a fixed price or the right to earn more than the stated rate if the issuer has a good year and the board of directors elects to make an additional dividend payment. Callable preferred allows the issuer to call the securities away from the investor. From an investor's point of view, this is not an incentive. Therefore, callable preferred tends to pay higher rates.
An investor purchases 100 shares of a bond ETF at a price of $50 per share on September 5, 2019. On November 1, 2019, and February 1, 2020, the fund distributes a $0.50 per share dividend. On May 11, 2020, the investor sells all the shares at $57 per share. What are the 2020 tax consequences of the sale? A) Short-term capital gain of $700, interest income of $50 B) Short-term capital gain of $700, dividend income of $50 C) Short-term capital gain of $600 D) Short-term capital gain of $700
D Explanation Taxation of an ETF is similar to that of a mutual fund. The question asks about the tax consequences of the sale, so we ignore the dividend distributions. Buying at $50 per share in September and selling at $57 per share the next May is a $700 capital gain over a period of less than one year. It is not part of the question, but the dividends would be taxed as interest because they are coming from bonds.
All of the following municipal securities are quoted on a yield basis except A) secured bonds. B) serial bonds. C) tax anticipation notes. D) term bonds.
D Explanation Term bonds, or dollar bonds, are quoted like corporate bonds as a percentage of par. All other municipals are quoted in basis.
A customer of your broker-dealer is bullish on U.S. equity securities across a broad spectrum of industries. He would like to participate in an anticipated upward movement of an equity stock index. Which of the following investments would you recommend as being closely related to the movement of equities in general? A) American depositary receipts (ADRs) B) Real estate investment trusts (REITs) C) Variable rate demand obligations (VRDOs) D) Standard & Poor's depository receipts (SPDRs)
D Explanation The SPDR is an index fund designed to replicate and track the performance of the S&P 500, a broad-based equity index.
All of the following information is included in a municipal bond resolution except A) restrictive covenants that are binding on the issuer. B) any call provisions that allow the issuer to redeem the bonds before their scheduled maturity. C) an authorization to sell the securities. D) compensation paid to the underwriters.
D Explanation The bond resolution is the document in which the issuer authorizes the issuance of municipal securities. Among other things, the resolution describes the characteristics of the proposed issue and the issuer's duties to the bondholders. Compensation paid to the underwriters would be found in the official statement.
As a registered representative, you recommend the purchase of the ABC Fund family corporate bond mutual fund to a customer whose objective is current income. The customer agrees to the purchase and you enter the order. What type of securities has the investor purchased? A) Government bonds B) Corporate bonds C) Preferred stock D) Common stock
D Explanation The customer has purchased common stock in the mutual fund because that is the only security an open-end management investment company (mutual fund) can issue. Using the customer's invested funds, the fund manager purchases securities for the fund portfolio that will meet the fund's investment objectives. For a corporate bond fund, the principal purchases for the portfolio would be corporate bonds. Likewise, if the fund were the ABC Preferred Stock Fund, the investment manager would purchase preferred stocks. Please do not confuse how a mutual fund raises capital for the manager to invest (it issues common stock shares in the fund) with what the manager invests in with that money.
The City of Columbus issued a 20-year general obligation bond at a price of 50. An original purchaser sold the bond at 75 after holding it for 7 years. For tax purposes, that sale generated A) a $250 capital gain. B) a $25 capital gain. C) no gain or loss. D) a $75 capital gain.
D Explanation The customer has realized a capital gain of $75. Original issue discount bonds must accrete the discount over the life of the bond. In this example, the amount of the discount (par value minus purchase price) is $500 ($1,000 − $500 = $500). The discount divided by the number of years to maturity determines the annual accretion added to the cost basis. In this question, the annual accretion is $25 ($500 divided by 20 = $25). The adjusted cost basis would be the original purchase price ($500) plus seven years of accretion (7 times $25 = $175) for a total of $675. Because the proceeds of the sale were $750, the customer has realized a capital gain of $75 ($750 − $675 = $75).
In most cases, new municipal bond issues are accompanied by a legal opinion. That legal opinion is drafted by bond counsel hired by A) the syndicate. B) the MSRB. C) the managing underwriter. D) the municipal issuer.
D Explanation The legal opinion is written by an independent law firm hired by the municipal issuer. The underwriter or syndicate can also hire counsel, but that is not the official legal opinion attached to the bond.
A corporation pays a 10% stock dividend to common stockholders. All the following are true regarding this dividend except A) the cost basis per share is adjusted based on the stock dividend. B) the total value of the position is unchanged when the dividend is paid. C) the dividend is taxable in the year the sale of the shares takes place. D) the beauty of stock dividends is that they are nontaxable.
D Explanation The stock dividend is taxable, but unlike cash dividends, which are taxed when received, stock dividends are taxable in the year the shares are sold. When the stockholder receives the additional shares, the cost basis is adjusted on a per-share basis with the total value of the position remaining unchanged.
An investor purchased 200 shares of Hightown National Bank (HNB) common stock at $120.06 per share. Thirteen months later, HNB pays a 15% stock dividend. Three months after that, the investor sells the shares received from the stock dividend at $112.57 per share. The tax consequence to the investor is A) $245.10 short-term capital gain. B) $122.55 short-term capital gain. C) $$1,879.10 long-term capital gain. D) $245.10 long-term capital gain.
D Explanation The total value of the initial position is unchanged, remaining at $24,012 (200 times $120.06). After the stock dividend the investor owns 230 shares (200 times 15% = 30 + 200 = 230). Therefore, the adjusted cost basis is $100 per share ($24,012 divided by 230 = $104.40). The question tells us that the investor sells those 30 additional shares at $112.57 per share. That is a difference of $8.17 per share. Multiply that gain by 30 shares and the result is a profit of $245.10.
An investor purchased 200 shares of Hightown National Bank (HNB) common stock at $120.06 per share. Thirteen months later, HNB pays a 15% stock dividend. Three months after that, the investor sells the shares received from the stock dividend at $112.57 per share. The tax consequence to the investor is A) $245.10 short-term capital gain. B) $$1,879.10 long-term capital gain. C) $122.55 short-term capital gain. D) $245.10 long-term capital gain.
D Explanation The total value of the initial position is unchanged, remaining at $24,012 (200 times $120.06). After the stock dividend the investor owns 230 shares (200 times 15% = 30 + 200 = 230). Therefore, the adjusted cost basis is $100 per share ($24,012 divided by 230 = $104.40). The question tells us that the investor sells those 30 additional shares at $112.57 per share. That is a difference of $8.17 per share. Multiply that gain by 30 shares and the result is a profit of $245.10. It is a long-term gain because the holding period of shares received from a stock dividend or stock split begins with the initial purchase, not the receipt of the new shares. It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same. If you have to guess, or are running out of time, when you see two identical numbers with the only difference being short- or long-term gain, in almost all questions, one of those two is the correct answer. Now you have a 50% chance of guessing correctly and, if you remember that the holding period always begins with the initial purchase, then the odds are 100% in your favor.
Dollar cost averaging (DCA) will always result in a lower cost per share than the price paid per share except A) when the price for each purchase is fluctuating.. B) when the price for each purchase is decreasing. C) when the price for each purchase is increasing. D) when the price for each purchase is the same.
D Explanation There are two requirements for a dollar cost averaging program to work. The first is that the same amount must be invested at each specified interval. The second is that the price per transaction does not remain the same. If that is the case, then the average cost per share and average price paid per transaction are the same. The price needs to move for DCA to show a benefit.
Reduced sales charges are allowed under all of the following circumstances except A) a lump-sum purchase that qualifies for a breakpoint. B) additional purchases that qualify for breakpoints under rights of accumulation. C) the customer signing a letter of intent. D) combining separate purchases made by a client and her business partner in their respective IRA accounts.
D Explanation Two unrelated adults may not combine transactions to receive a breakpoint.
A shareholder invested in a mutual fund and has signed a letter of intent to invest $25,000. Her original investment was $13,000, and her current account value is $17,000. For her to complete the letter, she must deposit A) $8,000. B) $27,000. C) $13,000. D) $12,000.
D Explanation Under a letter of intent, the full contribution is required for the letter to be completed. Appreciation is not considered.
It would be correct to describe a warrant in all of the following ways except A) it may be used as a sweetener for a bond issue. B) it has a longer life than a stock right. C) warrants do not have voting rights. D) the exercise price is generally slightly below the current market price.
D Explanation Warrants always carry an exercise price that is above the current market price of the underlying security. The upside potential is viewed as a sweetener for other issues, particularly bonds. This results in the issuer borrowing at a lower interest cost. Unlike preemptive (stock) rights that have a short life, warrants do not expire for a long time, sometimes five years or longer.
The DCAV corporation has declared a 10% stock dividend. Which of the following is true regarding the shareholders receiving the stock dividend? A) The stock dividend would decrease their percentage of ownership within the corporation. B) The stock dividend would increase the cost basis per share. C) The stock dividend would increase their percentage of ownership within the corporation. D) The stock dividend would not be taxable upon receipt by the shareholder.
D Explanation When a stock dividend is paid, the shareholders receive a dividend of additional shares instead of cash. The effect of this is an increase in the number of share with a reduction in the cost basis of each share. Because there is no monetary impact, there is no current taxation. The stock dividend would decrease their original cost basis. Although the stock dividend is not taxable upon receipt, it would be taxable upon the sale of the shares if sold for more than the adjusted cost basis. Stock dividends have no effect on a shareholder's proportionate ownership of the corporation.
What are the tax consequences an investor incurs when exercising the conversion privilege within a family of funds? A) There are no tax consequences because the funds are all part of one family. B) There are no tax consequences if completed within 60 days. C) There are no tax consequences, as long as this is done through a Section 1035 exchange. D) The investor treats the exchange as a sale and new purchase.
D Explanation When exchanging one fund for another in the same fund family, the exchange is done at NAV. This avoids any sales charges. The IRS considers this as the sale of the old fund (capital gain or loss applies) and the purchase of the new fund. That begins a new cost basis and holding period. The Section 1035 exchange allowing investors to move from one investment to another without current tax consequences is applicable only to insurance products.
