Mid-term exam (through Unit 6)

The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 85 is approximately A) 6.22%. B) 5.75%. C) 5.88%. D) 4.59%.

A Explanation A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $850 current market price. That is about 5.88%. The YTM must be higher than that because it includes the eventual profit realized when the bond matures at par. There is only one selection that is higher than 5.88%.

Corporate bonds that are guaranteed are A) guaranteed as to payment of principal and interest by another corporation. B) required to maintain a self-liquidating sinking or surplus fund. C) insured by Assured Guaranty Corporation. D) guaranteed as to payment of principal and interest by the U.S. government.

A Explanation A guaranteed corporate bond is one guaranteed by another corporation that typically has a higher credit rating than the issuing corporation and is in a control relationship with it.

One of your customers has maintained a traditional IRA for the past 15 years. Some of her annual contributions were not tax deductible due to her income level and participation in another qualified plan. At age 60, the customer elects to make a lump-sum withdrawal. Which of the following statements is true? A) The portion representing principal from the nondeductible contributions is tax free, while the balance is taxable as ordinary income. B) The portion representing earnings from the nondeductible contributions is tax free, while the balance is taxable as ordinary income. C) The entire withdrawal is taxable as ordinary income. D) The portion representing earnings and principal from the nondeductible contributions is tax free, while the balance is taxable as ordinary income.

A Explanation All earnings, whether from deductible or nondeductible contributions, are tax deferred. Therefore, all earnings are taxable as ordinary income upon withdrawal. Only the nondeductible contribution is returned tax free.

On March 1, an individual, age 40, wants to open and fund a Roth IRA at the maximum permitted level. She earns less than the adjusted gross income level that would limit her contribution. What is the maximum amount that she may place in a new Roth IRA? A) $12,000 B) $14,000 C) $6,000 D) $7,000

A Explanation Based on her age (less than 50), her maximum contribution would be $12,000, specified as $6,000 for two separate years of contributions. Because she is opening the account on March 1, she would be permitted to make contributions for the prior tax year (up until the April 15 tax filing deadline), as well as for the current tax year.

When it comes to issuing a debt security, which of the following features will generally enable the issuing corporation to borrow at the lowest interest rate? A) Convertible B) Cumulative C) Zero-coupon D) Callable

A Explanation Because the convertible feature offers potential growth through the exercise of the conversion option, the interest rate on these securities is generally lower than other debt issues of the same corporation. The call feature increases the reinvestment risk and that is compensated for with a higher coupon. The descriptive adjective cumulative refers to dividend payments on preferred stock, but not to bonds. Because zero-coupon bonds pay nothing until maturity, that added risk requires a higher yield to attract investors.

A registered representative is explaining the characteristics of a Coverdell Education Savings Account (ESA) to a customer. Which of the following statements regarding this type of savings account is correct? Contributions are tax deductible. Contributions are not tax deductible. When used for qualified educational expenses, withdrawals are taxable. When used for qualified educational expenses, withdrawals are not taxable. A) II and IV B) I and III C) I and IV D) II and III

A Explanation Contributions to a Coverdell ESA are made with after-tax dollars. Distributions used for qualified educational expenses are tax free.

A quote of 2.20 bid 2.18 ask would most likely be a quote on A) a T-bill. B) a GO bond. C) a T-note. D) a T-bond.

A Explanation Discounted instruments (such as T-bills) are quoted on a discount-to-yield basis. Even though the number representing the bid is higher than the ask, it would be lower when converted into dollars. That is, the asking price is the face amount less a discount of 2.18%, while the bid price is the face amount less a discount of 2.20%. Just like anything we buy, the greater the discount, the lower the price.

A 65-year-old man called the branch manager to complain about a recent exchange of a deferred variable annuity proposed and performed by the registered representative handling his account. The customer said he was unaware that there would be charges associated with the transaction and was shocked that the account value diminished substantially during a recent downturn in the market. The manager should do which of the following? A) Interview the registered representative to ascertain whether firm procedures were adhered to with regard to suitability and disclosure of charges and risks associated with exchanges. B) Promptly refund the customer's losses and unwind the transaction. C) Document the facts of the complaint and submit a report to FINRA. D) Retrain the registered representative to make exchanges in variable products only by prospectus and require future sales calls to be recorded.

A Explanation Member firms may not recommend to customers the purchase or exchange of a deferred variable annuity unless the associated person has made proper disclosure of the features of variable products, including surrender charges, tax penalties, features of riders, and insurance components, and obtained a reasonable basis to believe the transaction is suitable (see FINRA Rule 2330). Rules only apply to written complaints.

An investor would most likely purchase money market instruments for their A) liquidity. B) appreciation potential. C) inflation protection. D) yields.

A Explanation Money market instruments are frequently referred to as cash equivalents. That is largely due to their high liquidity. Yields on these instruments are very low, and as fixed-income instruments, they offer no appreciation potential or inflation protection.

Which of the following statements regarding negotiable certificates of deposit (CDs) are true? The issuing bank guarantees them. They are callable. Minimum denominations are $1,000. They can be traded in the secondary market. A) I and IV B) II and IV C) II and III D) I and III

A Explanation Negotiable CDs are issued primarily by banks and backed by the issuing bank. The minimum denomination is $100,000. These are sometimes referred to as jumbo CDs.

A customer has invested a total of $10,000 in a nonqualified deferred annuity through a payroll deduction plan offered by the school system where she works. The annuity contract is currently valued at $16,000, and she plans to retire. On what amount will the customer be taxed if she chooses a lump-sum withdrawal? A) $6,000 B) No taxes owed because annuity was nonqualified C) $10,000 D) $16,000

A Explanation Payments into a nonqualified deferred annuity are made with after-tax money; taxes must only be paid on the earnings of $6,000.

The call provisions of a municipal issue would be detailed most completely in A) the bond resolution. B) the legal opinion. C) The Bond Buyer. D) the official notice of sale.

A Explanation The bond resolution is the document that authorizes the issuance of a municipal bond. The resolution also describes the proposed issue's features and the issuer's responsibilities to its bondholders.

A convertible bond has a conversion price of $40 per share. If the market value of the bond rises to a 12.5-point premium over par, which of the following are true? Conversion ratio is 25:1 Conversion ratio is 28:1 Parity price of the common stock is $42 Parity price of the common stock is $45 A) I and IV B) I and III C) II and III D) II and IV

A Explanation The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112.5% × $40 = $45.

In April, a customer buys 1 MCS Oct 50 call for 9 and sells 1 MCS Jul 50 call for 4. What will the customer's profit or loss be if he buys back the July call for $1 and sells the October call for $12? A) $600 profit B) $100 loss C) $600 loss D) $100 profit

A Explanation The net gain is $600 because the client paid a total of 10 (9 + 1) and received a total of 16 (12 + 4).

An investor owns ten ABC 6s of 2045. The debentures have a conversion price of $50 with an anti-dilution provision. After ABC distributes a 20% stock dividend, the investor's position will be A) ten ABC 6s of 2045 with a conversion price of $41.67. B) ten ABC 6s of 2045 convertible into 16.67 shares. C) twelve ABC 6s of 2045 with conversion price of $50. D) ten ABC 6s of 2045 convertible into 20 shares plus forty additional shares.

A Explanation This question deals with the anti-dilution provisions of a convertible security. When there is a stock dividend or a stock split, the holder of the convertible maintains the same equity proportion as before. With a conversion price of $50, the debenture is convertible into 20 shares ($1,000 ÷ $50). After a 20% stock dividend, the holder should be able to acquire 20% more shares. That makes the security convertible into 24 shares. Divide the $1,000 par value by 24 shares and the conversion price is now $41.67.

An investment adviser has a client who wants to save for college for her child. The child will be entering college in five years. This would be an example of A) an investment constraint. B) a capital need. C) planning too late. D) tactical asset allocation.

A Explanation Time constraints include such conditions as liquidity and time horizon, both of which are in play here. It may be true that the client has started too late, but that is not what the exam would be looking for as the correct answer.

Investors placing zero-coupon bonds in their portfolios are most likely to be looking to provide accumulation of capital. current income. protection against reinvestment risk. tax deferral. A) I and III only B) II and IV only C) II and III only D) I and IV only

A Explanation Zero-coupon bonds are always purchased at a discount because they pay no interest. At maturity, the bondholders receive the maturity value. That represents the initial investment plus interest. Therefore, the investors are receiving more capital than invested (capital accumulation). Zero-coupon securities avoid reinvestment risk because there are no periodic interest payments to be reinvested. When you purchase one of these securities, the quoted yield to maturity is exactly what you will earn if you hold it to the end. With no interest payments, there is no current income. There is no tax deferral with a zero. In fact, unless it is a zero coupon municipal bond, there is phantom income; income not currently received but currently taxable.

Which of the following are qualified plans? Payroll deduction Deferred compensation Defined benefit Defined contribution A) I and III B) III and IV C) II and IV D) I and II

B Defined benefit and defined contribution plans are funded with pretax contributions, and are thus qualified plans. Payroll deduction and deferred compensation plans are funded with after-tax contributions and thus are nonqualified plans. pretax = qualified

Under what circumstances will a dilution of equity occur? A) Stock dividend B) The conversion of convertible bonds into common stocks C) Stock split D) Issue of mortgage bonds to replace debentures

B Dilution of equity occurs when stockholders experience a reduction in their percentage ownership of the company. If bonds are converted, more common shares are issued, and the shareholder's equity is diluted. A stock dividend or stock split does not change a stockholder's percentage of ownership. Refunding debts has no effect on stockholders.

A municipal issuer is frequently able to diversify a single municipal bond issue by maturity because A) municipal securities are mostly long term. B) many municipal bonds are serial issues. C) many municipal securities are very marketable. D) every state issues municipal bonds.

B Explanation A way for a municipal issuer to potentially make the issue more attractive is to diversify by having a range of maturities. That way, the issue will appeal to those investors whose needs might be short term, immediate term, or long term. Serial maturity means that within a single issue, portions of the issue mature at intervals, some short term, others intermediate term, and the balance long term. Municipal bonds typically mature serially.

If a U.S. corporation wishes to issue eurodollar bonds, which of the following statements are true? The corporation will be subject to currency risk. The corporation will not be subject to currency risk. The issue must be filed with the SEC. The issue need not be filed with the SEC. A) II and III B) II and IV C) I and IV D) I and III

B Explanation Because eurodollar bonds are denominated in U.S. dollars, a U.S. corporate issuer will not be subject to foreign exchange risk, regardless of the country of issuance. In addition, because the bonds are issued outside the United States, the issue is not registered with the SEC.

Moody's bond ratings are based primarily on an issuer's A) expected marketability of a bond issue. B) financial strength. C) capitalization. D) expected trading volume of a bond issue.

B Explanation Bond ratings are credit ratings for an issuer and measure the issuer's ability to repay principal and interest and, thus, its financial strength.

A registered investment company whose share price fluctuates independently of its net asset value is most likely A) an open-end fund. B) a closed-end fund. C) a unit investment trust. D) an index mutual fund.

B Explanation Closed-end funds' share prices can differ significantly from their NAVs. Open-end (mutual) fund shares are purchased and redeemed at their NAVs. UITs are redeemable at NAV.

A registered representative is explaining the characteristics of a Coverdell Education Savings Account (ESA) to a customer. Which of the following statements regarding this type of savings account is correct? Contributions are tax deductible. Contributions are not tax deductible. When used for qualified educational expenses, withdrawals are taxable. When used for qualified educational expenses, withdrawals are not taxable. A) II and III B) II and IV C) I and IV D) I and III

B Explanation Contributions to a Coverdell ESA are made with after-tax dollars. Distributions used for qualified educational expenses are tax free.

Which of the following statements regarding Coverdell Education Savings Accounts (ESAs) are true? After-tax contributions of up to an indexed maximum per student per year are allowed. Contributions may not be made for students past their 18th birthday. If the account value is not used for educational purposes, it can be rolled over into a traditional IRA. Distributions are always taxable. A) II and IV B) I and II C) III and IV D) I and III

B Explanation Coverdell ESAs allow after-tax contributions of up to $2,000 per student, per year, for children until their 18th birthday. If the accumulated value in the account is not used by age 30, the funds must be distributed and are subject to income tax and a 10% penalty, or they are rolled over into a different Coverdell ESA for another family member.

One of your customers calls you to say that he received a letter saying that his local water works revenue bonds were being defeased. How would that affect the customer? A) The customer will need to file a claim with the appropriate court to receive payment for the bonds. B) The customer would be receiving payment of the principal plus any accrued interest after the defeasance is completed. C) Because of failure to generate sufficient revenue, interest payments are suspended temporarily. D) The maturity date is being automatically extended as called for in the official statement.

B Explanation Defeasance occurs when an outstanding bond issue is paid off prior to maturity through a refunding. Once the creditors (the bondholders) have received their funds, any liens on assets or revenues are terminated.

The XYZ Corporation's A-rated convertible debenture is currently selling for 90. If the bond's conversion price is $40, what is the parity price of the stock? A) $22.50 per share B) $36 per share C) $40 per share D) $44 per share

B Explanation If the bond's conversion price is $40, it means the bond is convertible into 25 shares ($1,000 par value divided by the $40 conversion price). Parity means equal, so what does each share have to be worth so that 25 of them are equal to $900? Dividing $900 by 25 shares results in a parity price of $36. That does not mean the stock is selling for $36 per share (probably a bit less), but at $36, holding the bond or converting into the stock gives the investor equal value. Some students quickly see that the bond is 10% below its par value, so the stock, to be equal, must be 10% below the conversion price. Take 10% off $40 and the result is $36. Either way works.

Reggie owns a convertible bond that converts into 20 shares of common stock. The current market value of the bond was 118½ at the close on Friday, April 1. A 30-day call is announced before the opening on Monday, April 4, at a price of 102. The stock is trading at $57.75. What should Reggie do? A) Hold the bond to maturity B) Convert the bond into the stock C) Redeem the bond at the call price D) Sell the bond

B Explanation Reggie will not be allowed to hold the bond to maturity because it is being called. The real question is whether he should sell the bond, allow it to be called, or convert it to the underlying stock. Now that the call has been announced, the market value of the bond will fall to meet the call price. This occurs as a result of declining demand. (Who wants to buy a bond that is about to be called at a lower price?) Thus, redeeming the bond at the call price and selling the bond would both yield the same results: $1,000 times 102% equals $1,020. If he converts the bond, he will get the following results: 20 shares times $57.75 equals $1,155. Therefore, it makes the most sense to convert the bond.

Which of the following statements regarding savings incentive match plans for employees (SIMPLEs) is not true? A) SIMPLEs are retirement plans for small businesses with100 or fewer employees. B) Employers cannot make matching contributions for employees. C) Employee contributions are pretax. D) Catch-up contributions for those age 50 and older are permitted.

B Explanation SIMPLEs are retirement plans for businesses with no more than 100 employees that have no other retirement plan in place. The employee makes pretax contributions into a SIMPLE up to an annual contribution limit, which can include catch-up contributions for those age 50 and older. The employer is permitted to make matching contributions for employees.

Which of the following investments would be most suitable for an IRA? A) Uncovered call on a stock whose price is extremely stable B) A covered call (selling a call option on a stock owned within the IRA) C) Highly rated general obligation bond D) Short sale of a stock that has just started what is expected to be a prolonged decrease in price

B Explanation Short sales, uncovered calls, and municipal bonds are all inappropriate for individual retirement accounts

When part of an issue of speculative bonds with a 25-year maturity are called, the effect on the remaining bonds will be to A) decrease their quality. B) improve their quality. C) increase their coupon rate. D) decrease their coupon rate.

B Explanation Speculative bonds are those with lower ratings. They are considered to be of lower quality because the risk of timely payment and principal are higher than investment-grade bonds. When a company shows its determination to honor its debt by paying off some of it in advance, the rating associations take note of that and invariably increase the rating. Compare this to your personal credit score. Your score might be relatively low because you have a lot of outstanding debt. As you pay down that debt, your credit score is likely to increase. It is the same logic here.

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) 0.1667 B) 0.0616 C) 0.0572 D) 0.0329

B Explanation The formula for computing tax-equivalent yield is nominal yield divided by (1 − federal marginal income tax rate), so 0.045 / (1 − 0.27) = 6.16%.

An investor purchases a TIPS bond with a 3% coupon. During the first year, if the inflation rate is 8%, the principal value of the security at the end of that year will be closest to A) $1,030.00. B) $1,081.60. C) $1,030.23. D) $1,080.00.

B Explanation The principal value of a TIPS bond is adjusted semiannually by the inflation rate. The exact calculation would be $1,000 × 104% × 104%, which equals $1,081.60. Each six months, the interest is paid on that adjusted principal and that is why the security keeps pace with inflation. There is a shortcut that will always work on the exam. Just recognize that the principal value increases based on the inflation rate compounded semiannually. Take the simple interest rate and choose the next highest number. In this example, 8% simple interest would be $80 (which would always be one of the choices). Because the computation is done twice per year, the compounding effect makes the correct choice slightly higher.

An investor purchases a PQR convertible bond at 98 on June 18, 1994. The bond is convertible at $25, and on June 19, 1995, when the common stock is trading at $26 per share, the investor converts his bond into the stock. For tax purposes, these transactions will result in A) a $40 capital loss. B) neither gain nor loss. C) a $40 capital gain. D) a $60 capital gain.

B Explanation The process of converting a convertible bond into common stock is not a taxable event. When the stock is sold, the taxable event occurs.

If an investor purchased a municipal bond in the secondary market, which of the following would not be a factor in calculating the total dollar amount paid for the bond? A) The settlement date B) The scale C) The coupon rate D) The dated date

B Explanation The scale, or reoffering scale, represents the prices and/or yields (listed by maturity date) at which new issue securities are offered for sale to the public by the underwriting syndicate. Because this question refers to a secondary market purchase, the scale would not apply. When computing the total price of a bond purchase, we need to know the accrued interest. Because interest is computed up to—but not including—the settlement date, clearly that is required information. The dated date is the date from which interest begins to accrue. True, this is only applicable for the first interest payment, but the question doesn't specify that this bond has already made that payment. Remember, secondary market transactions can take place the same day the new issue is released. Finally, it would be impossible to compute the accrued interest without knowing the interest rate being paid by the issuer. There is an important test-taking tip here. Scale has not appeared in the material yet, so we do not expect you to know what it means. But you should know that the other three items are necessary to compute the total purchase price. By process of elimination, scale must be the correct choice. This logic can be helpful on the real exam.

One of your customers calls and asks you about a security with an S&P rating of SP-2. The customer is most likely asking about which of the following? A) Commercial paper B) A municipal note C) Your firm's privacy notice D) A municipal bond

B Explanation The three major rating services each have their own rating system for short-term municipal debt (notes). In the case of Standard and Poor's, the ratings are SP-1, SP-2, and SP-3 in declining order of quality. Regulation S-P (with the hyphen between the S and P) deals with privacy notices. Although it is unlikely to be tested, commercial paper is rated A-1, A-2, A-3, and then into the "Bs."

Which of the following statements concerning Section 529 plans are true? Qualified withdrawals are exempt from federal income tax. Contributions are tax qualified. Up to $10,000 per year can be used for K-12 tuition expenses. Qualified withdrawals may be used for any expenses incurred by a student. A) I and IV B) I and III C) II and IV D) II and III

B Explanation The withdrawals from Section 529 plans are federally tax exempt, but they may be taxed as income in some states. The money that is invested in a Section 529 plan is always after tax. To avoid taxation, the withdrawals must be used for qualified education expenses (e.g., tuition, books, lecture fees, lab fees), including up to $10,000 per year for K-12 education. Withdrawals to pay expenses that are not qualified incur tax liability.

Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 11¼% coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Libby's concerns about the issue could include A) the company might demand that she accept common stock for her bond. B) the issue may be junior-in-lien to another security issue. C) the new barges might sink and the collateral would be gone. D) the conversion price might change, causing the parity price to rise.

B Explanation The word subordinated is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral because the bonds are identified as debentures. Having to convert to common stock is not a threat since she is the one that will, if she desires, exercise the conversion privilege. At least for exam purposes, the conversion ratio is always fixed and does not change.

An investor purchases a newly issued convertible bond at par. The bond is convertible at $25. Three years later, the underlying common stock is trading at $33 per share. If the investor sells the bond at the parity price, A) there is a long-term capital gain of $8 per share. B) there is a long-term capital gain of $320. C) the investor has no gain and no loss. D) there is a long-term capital loss of $175.

B Explanation This question involves several steps. The first is to determine the conversion ratio in shares. A bond convertible at $25 per share has a share conversion rate of 40 shares ($1,000 ÷ $25). The second step is to compute the parity price. That is, what are those 40 shares worth? Multiply 40 shares by $33 per share and that equals $1,320. When the bondholder sells the bonds at parity, that $1,320 is received. The $320 profit over the $1,000 initial cost is a long-term capital gain. An alternative that might be easier for some is to look at the appreciation of the stock. It is $8 per share higher than the conversion price of $25. That represents an increase of 32% (8 ÷ 25). If the bond is at parity with the stock, its price must be 32% higher and that brings us again to the $1,320 price.

A 7% convertible debenture is selling at 101. It is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. If the stock were trading at parity with the debenture, the price of the stock would be A) $43.91. B) $25.25. C) $25.00. D) $40.00.

B Explanation To determine the parity price of the common, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, divide the current price of the bond by the conversion ratio. The result is the parity price of the common stock. (1,010 / 40 = $25.25).

A customer owns a 7.5% ABC convertible bond currently trading at 115. The conversion price is $40. What is the parity price of the common? A) $28.75 B) $46.00 C) $44.00 D) $34.00

B Explanation What does parity price mean? Here is what it says in the LEM: Calculating Conversion Parity Parity means that two securities are of equal dollar value (in this case, a convertible bond and the common stock into which it can be converted). The question is looking for the parity price of the common stock. That is the market price per share, where the total value of the stock received upon conversion equals the market price of the bond. There are two ways to do this. The first is generally the easiest to understand. We are told that the bond has a conversion price of $40. That means you can get 25 shares if you wish to convert. That is because the issuer is basically saying, "We owe you $1,000 and will let you spend it on our stock at $40 per share." Now that we know we can get 25 shares, what does each share have to be worth to equal $1,150? If you divide $1,150 by 25 shares, the result is $46.

In recent years, much publicity has surrounded the rapid growth of start-up businesses. In most cases, the early financing was done privately. When private debt is used at the intermediate stage of a company's development, it is called A) mid-term debt. B) mezzanine debt. C) intermediate debt. D) middle-risk debt.

B Explanation Just as the mezzanine in a theater is between the balcony and the orchestra levels, mezzanine debt represents financing supplied at the intermediate point in a new company's development. The funds are provided on a private basis and the investment carries a high degree of risk. As an alternative investment, it will be suitable for a very narrow range of customers.

Which of the following statements regarding Coverdell ESAs is true? A) Contributions are tax deductible, and distributions for any reason are tax free. B) Contributions are not tax deductible, and distributions for any reason are tax free. C) Contributions are not tax deductible, and distributions are tax free when used for qualified educational expenses. D) Contributions are tax deductible, and distributions are always taxable.

C Coverdell ESAs offer after-tax contributions of up to $2,000 per student, per year for children under age 18. Distributions are tax free as long as the funds are used for education.

A holder of an American depositary receipt (ADR) assumes all of the following risks except A) market risk. B) political risk. C) liquidity risk. D) foreign currency risk.

C Explanation An American depositary receipt (ADR) represents an ownership interest in a foreign domiciled company. The shares trade on the New York Stock Exchange or in the OTC market. The risk of lack of liquidity is absorbed by the presence of trading on U.S. exchanges or in the OTC market. The shares are subject to market risk, political risk, and foreign currency risk.

For U.S. investors holding American depositary receipts (ADRs), dividends received are A) taxed as a capital gain in the United States. B) tax free in both the country of origin and in the United States. C) subject to a foreign withholding tax. D) tax free in the country of origin.

C Explanation Any tax taken on dividends received from ADRs is taken in the country of origin. This is a foreign withholding tax for U.S. investors. The foreign withholding tax may later be taken as a credit against any U.S. income taxes owed by the U.S. investor.

All of the following statements regarding convertible bonds are true except A) holders receive a fixed interest rate. B) the issuer pays a lower interest rate. C) holders receive a higher interest rate. D) holders may share in the growth of the common stock.

C Explanation Because of the possibility of participating in the growth of the common stock through an increase in the market price of the common, the convertible can be issued with a lower interest rate. The interest rate on a convertible, just as with any other fixed-income security, does not change.

Fee-based accounts would tend to be most suitable for investors who follow A) a passive approach to investing. B) a buy-and-hold philosophy. C) an active approach to investing. D) a strategic approach to the market.

C Explanation Because one of the key benefits of a fee-based account is the elimination of transaction fees (commissions), it is most suitable for those who are active traders, such as those who take a tactical approach to investing. The other choices engage in far less trading activity, potentially not being able to take full advantage of all of the benefits of the fee-based program.

All of the following securities are issued at a discount except A) zero-coupon bonds. B) Treasury bills. C) CDs. D) commercial paper.

C Explanation CDs are interest-bearing debt instruments issued by banks at their face value. All of the others are issued at a discount.

All of the following are true regarding nonqualified deferred compensation plans except A) IRS approval is not needed for deferred compensation plans. B) the plans need not be offered to all employees. C) employees may use accumulated funds as collateral for a bank loan. D) income taxes on compensation are not due until constructive receipt.

C Explanation Deferred compensation is a promise made by an employer to defer a certain amount of an employee's salary upon retirement. The employee has no right to the money until retirement, death, or disability, and thus cannot use it as collateral.

The primary purpose for creating ERISA was to A) establish a means for self-employed persons to provide for their own retirement. B) provide all employees, both government and nongovernment, with an additional source of retirement income in the event that the Social Security system defaults. C) protect employees from the mishandling of retirement funds by corporations and unions. D) promote a retirement fund for government employees.

C Explanation ERISA was created to protect the retirement funds of union members and employees of large corporations. ERISA guidelines state that all qualified retirement plans must be in writing, segregate funds from corporate or union assets, make prudent investments, report to participants annually, and not be discriminatory. All of these activities are audited under ERISA.

The following is taken from the S&P Bond Guide: FLB Zr 37 87 87½. What is the coupon rate on this bond? A) 8.70% B) 0.37% C) 0% D) 8.75%

C Explanation FLB is the issuer, Zr means zero coupon, 37 indicates the year of maturity (2037), 87 is the bid price ($870), and 87½ is the asked price ($875).

An investor wishes to open a cash account and give trading authorization to a sibling. The required documentation would include which of the following? A) A joint account agreement B) A new account form signed by the investor C) A limited power of attorney D) CIP information on the sibling

C Explanation If a new client wants to open a cash account and give trading authority to a third party, a limited power of attorney is required. A limited power of attorney gives the third party trading authority but prohibits that party from withdrawing assets from the account. Because this is a new account, a new account form is required, but it does not have to be signed by the client. CIP information on the new client is required, but not on the person with the POA.

In a scheduled premium variable life insurance policy, all of the following are guaranteed except A) a minimum death benefit. B) the ability to borrow at least 75% of the cash value after the policy has been in force at least three years. C) a minimum cash value. D) the right to exchange the policy for a permanent form of insurance, regardless of health, within the first 24 months.

C Explanation In a variable life insurance policy, a minimum death benefit is guaranteed, but no cash value is guaranteed. There is a contract exchange privilege during the first 24 months, allowing the conversion of the variable policy to a comparable form of permanent insurance, and the 75% cash value loan minimum applies after the third year of coverage.

You have a high-income client who wishes to maximize his after-tax interest income. Which of the following investments might not meet your client's objective? A) AA-rated general obligation bond B) AA-rated revenue bond C) AA-rated industrial development bond D) AA-rated municipal note

C Explanation Industrial development bonds are private-purpose bonds, and the interest income could subject the holder to the alternative minimum tax. Thus, the interest income may not be completely tax free.

A quotation on a municipal security between dealers is assumed to be A) a workable quote. B) a nominal quote. C) a bona fide quote. D) an indication of interest.

C Explanation Municipal bond quotations between dealers are required to be bona fide, or firm, quotes. They are required to be fair and reasonably related to the current market.

Among the requirements of Regulation SP is that a broker-dealer must provide an initial and annual privacy policy statement to A) shareholders. B) retail consumers. C) retail customers. D) business customers.

C Explanation Regulation SP deals with protection of client information. Initially, and annually, the firm's privacy policies must be disclosed to its retail (individual) customers. Remember, consumer has a special meaning under SP. It is a one-time relationship, such as someone who received stock as a gift and wants to sell it through the member firm, take the money, and conduct no further dealings. Business and institutional clients are not covered by the regulation.

All of the following option strategies could be effectively used in a bear market except A) a short call. B) a credit call spread. C) a short straddle. D) a debit put spread.

C Explanation Short straddles are appropriate only in flat or neutral markets. The writer will lose in a rising market (the call will be exercised) or a falling market (the put will be exercised). Short calls and short call spreads are bearish, as are debit (long) put spreads.

Which of the following is an issuer of federal agency securities? A) The California Urban Development Authority B) The U.S. Treasury C) The Tennessee Valley Authority D) The Indiana Highway Authority

C Explanation The TVA is a federal agency formed as an act of Congress in 1933. As such, the debt securities it issues are considered federal agency securities. Treasury issues are simply that—issues of the Treasury, not an agency. The other two choices are municipal bonds.

A municipal revenue issue's flow of funds statement is contained in A) the agreement among underwriters. B) the legal opinion. C) the bond contract. D) the notice of sale.

C Explanation The bond contract describes the nature of the contract and the issuers' duties to bondholders. The bond contract is a more expansive document than a bond resolution. The contract is comprised of the bond resolution (or trust indenture) and other security agreements and laws in force at the time of bond issuance.

An investor seeking income combined with a conservative level of risk would purchase A) AAA-rated convertible debentures. B) unrated income bonds. C) AA-rated mortgage bonds. D) junk bonds.

C Explanation The conservative level of risk eliminates the income bonds and the junk bonds. Income bonds pay interest only if the issuer has the funds to do so. Junk bonds are named such because of their high risk. Even though the convertible debentures have a higher rating than the mortgage bonds, the difference is relatively insignificant at that level and either would be suitable for the conservative investor. However, because of the convertible feature, it is always true on the exam that the income return is lower than non-convertible issues. Therefore, the most suitable for this investor would be the mortgage bonds.

ABC Corporation has an outstanding 8% convertible bond that is callable at 102. Currently, the bond is trading at 101. The conversion price is $40, and the common stock is currently trading at $39.50. ABC announces a call at 102. To realize the greatest profit, a bondholder should A) continue to hold the bonds and receive interest payments. B) convert the bonds into common and sell the converted shares. C) tender the bonds. D) sell the bonds at the current market price.

C Explanation The investor would realize the greatest sales proceeds by tendering the bond to the corporation for 102. Selling the bond at its current market value of 101 is not an attractive option. Converting the bond to common stock would result in 25 shares ($1,000 par converted at $40 = 25 shares) sold at $39.50 per share ($39.50 × 25 = $987.50). Once the call date passes, the issuer ceases interest payments making it unattractive to continue to hold the bonds.

Responding to the student loan crisis, the SECURE Act now permits qualified withdrawals from Section 529 plans to include payments of A) student loan principal up to an annual maximum of $10,000 per child. B) student loan interest up to a maximum of $10,000 per family. C) student loan interest up to a lifetime maximum of $10,000 per child. D) student loan interest up to a maximum of $10,000 per year.

C Explanation The lifetime limit is $10,000 of interest or principal per child. If the child who is the beneficiary of the plan does not use all the money by graduation, the remaining funds can be used to pay the interest or principal (subject to the standard limits) for other siblings.

From first to last, in what order would claimants receive payment in the event of bankruptcy? Holders of secured debt Holders of subordinated debentures General creditors Preferred stockholders A) IV, I, II, III B) I, II, III, IV C) I, III, II, IV D) III, I, II, IV

C Explanation The liquidation order is as follows: secured debt holders, unsecured debt holders (including general creditors), holders of subordinated bonds, preferred stockholders, and common stockholders.

An investor purchases a zero coupon bond at a price of 64. The bond matures in nine years. Five years later, the investor sells the bond at a price of 80. This would result in A) a long-term capital gain of $160. B) a long-term capital loss of $200. C) a long-term capital loss of $40. D) no gain and no loss.

C Explanation This question deals with accretion of the discount. The discount here is $360 (the difference between the $640 paid and the $1,000 maturity value). With nine years until maturity, the annual accretion is $360 divided by nine, or $40 per year. After five years, the bond's basis has increased by $200 ($40 times 5 years) to $840. The sale at $800 represents a long-term loss of $40.

One of your customers, age 52, wishes to open an IRA. His annual income is more than $200,000 and consists entirely of income from rental real estate and income from a trust fund. What amount may your customer contribute to his IRA this year? A) $5,500 B) $7,000 C) $0 D) $6.000

C Explanation To open an IRA, a person needs earned income. Income from rental real estate is passive income, while income from a trust fund is portfolio income. This customer has no earned income.

Which of the following statements about warrants is not true? A) Warrants may be attached to another of the issuer's securities. B) Warrants have an exercise price above the current market price of the common stock when issued. C) Warrants may not be traded in the secondary market. D) Warrants have longer lifetimes than rights.

C Explanation Warrants usually have lifetimes of 2 to 10 years; rights expire in 30 to 45 days. A corporation may attach warrants to other securities, such as bonds, to make the bonds more marketable. Warrants have no intrinsic value when issued and may expire without ever having intrinsic value. Before expiration, they may be, and often are, traded in the secondary market.

ABC Corporation has issued a convertible preferred stock with a par value of $100. The stock is convertible at $40. The current market price of the stock is $80. It would be correct to state that the conversion ratio is A) 2:1. B) 4:10. C) 2.5:1. D) 4:5.

C Explanation When a $100 par preferred has a conversion price of $40, the stockholder can convert into 2.5 shares. That is a 2.5:1 ratio. The current market price of the stock is only relevant if the question asks about the parity price (which is $32).

A callable municipal bond maturing in 30 years is purchased at 102. The bond is callable at par in 15 years. If the bond is called at the first call date, the effective yield earned on the bond is A) the same as the yield to maturity. B) higher than the yield to maturity. C) lower than the yield to maturity. D) not determinable.

C Explanation When a bond is purchased at a premium ($1,020) and called for redemption, the investor's effective yield is the yield to that call date. That will be lower than the bond's yield to maturity because the premium is lost sooner.

Which of the following individuals could most likely open an account at a FINRA member firm without notifying or receiving permission from their employer? A) A life insurance agent who sells variable annuities B) A government security trader employed by a member C) An individual who sells only fixed annuities D) A purchases and sales clerk of a member

C Explanation Whenever an employee of a FINRA member wants to open a securities account with another FINRA member firm or financial institution, the employee must give prior written notice to his employer and receive prior written consent from his employer before the account can be opened. Someone selling fixed annuities only is most likely not associated with a member firm, while anyone selling variable annuities must be.

The market attitude of a customer who establishes a credit call spread is A) neutral. B) bullish. C) bearish. D) speculative.

C In a call spread, a customer is buying one call and selling another with different strike prices and/or expirations. In any spread, one of the options is dominant. In a short call spread, the short call position is dominant because it has the higher premium; writing calls is bearish.

Which of the following callable municipal bonds trading on a 7% basis is most likely to be called? A) 7.5% coupon, callable at 105 in 2030 B) 6.5% coupon, callable at 100 in 2030 C) 6.5% coupon, callable at 105 in 2030 D) 7.5% coupon, callable at 100 in 2030

D Explanation An issuer will call the higher coupon bonds before calling the lower coupon bonds. Of the two bonds with coupons of 7.5%, the one with the lower call price will likely be called first.

An individual younger than age 70½ may contribute to a traditional IRA A) provided she does not own a self-employed retirement plan such as a SEP. B) provided she is not a minor. C) provided she is not covered by a qualified retirement plan through an employer. D) if she has earned income.

D Explanation Any individual under age 70½ with earned income may contribute to a traditional IRA, even minors.

The type of brokerage account that does not pass assets to other participants at the death of a participant is A) transfer on death. B) community property. C) joint tenants with rights of survivorship (JTWROS). D) tenants in common.

D Explanation At the death of a participant in a tenants in common account, the decedent's assets do not pass to the other members. Rather, they pass to the estate of the deceased. With JTWROS, at the death of a participant, the assets are distributed equally to the surviving members. In those states where community property is the law, upon the death of a spouse, the assets in the account generally pass to the surviving spouse. Transfer on death is simply a designation that allows an account to avoid probate court. It is not available with tenancy in common.

An investor would like to make an intermediate-term investment in a debt security whose duration is equal to its maturity. Which of the following AAA-rated bonds should the registered representative recommend? A) ABC 8% 10-year bond maturing in five years B) DEF 10-year 8% bond maturing in eight months C) MNO zero-coupon bond maturing in eight months D) XYZ zero-coupon bond maturing in five years

D Explanation Because they make no interim payments, zero-coupon bonds have a duration equal to maturity. Of the choices offered, only XYZ is both intermediate-term (2 to 10 years to maturity) and zero-coupon.

KLM Company has 10 million convertible bonds outstanding that are convertible at $25. The bonds contain an antidilution feature. If KLM declares a 10% stock dividend, the new conversion price will be A) $22.50. B) $50.00. C) $45.45. D) $22.73.

D Explanation Before the stock dividend, an investor would have received 40 shares of stock for each $1,000 bond ($1,000 / $25). A 10% stock dividend would now give an investor 44 shares on conversion (40 shares + 10% = 4 shares more). $1,000 / 44 shares = $22.73 per share for the new conversion price.

All of the following statements regarding commercial paper are correct except A) it is quoted on a discount yield basis. B) interest is received at maturity. C) it is unsecured. D) it is quoted as a percentage of par.

D Explanation Commercial paper is short-term, unsecured corporate debt. It is issued and traded at a discount of face value and does not pay periodic interest. Like all zeroes, it is quoted on a discounted yield basis.

All of the following statements regarding 529 plans are true except A) earnings accumulate tax free if the money is used for qualified educational purposes. B) a beneficiary of a 529 plan may also be the beneficiary of a Coverdell Education Savings Account. C) anyone can make a contribution on behalf of a beneficiary. D) contributions are made with pretax dollars at the federal level.

D Explanation Contributions are made with after-tax dollars. Withdrawals are tax free at the federal level if used for qualified higher education expenses. 529 = after-tax contributions

Which of the following statements regarding Roth IRAs are true? Contributions are made with pretax dollars. Earnings accumulate tax free. Distributions are not taxable if a holding period and age requirement are satisfied. Only cost basis is taxable at the time of distribution. A) II and IV B) I and III C) I and II D) II and III

D Explanation Contributions to Roth IRAs are made with after-tax dollars, and distributions are received tax free (both cost basis and earnings) if holding period and age requirements (5 years and 59½ years) are met.

Interest received from which of the following federal agency securities is exempt from all state and local taxation? A) Federal National Mortgage Association bonds B) Federal Home Loan Mortgage Corporation bonds C) Government National Mortgage Association pass-through securities D) Farm Credit System bonds

D Explanation FCS securities are part of a small group of federal agency securities where the interest is exempt on a state and local (but not federal) level. A key to remembering is that any agency with the title mortgage is fully taxable.

A convertible bond callable at 101 is trading at 105. The bond is a 4% bond convertible at $25. The common stock is trading at $27. If an investor bought the bond and converted, her profit would be A) $75. B) $40. C) $20. D) $30.

D Explanation First, calculate the number of shares each bond will convert to: $1,000 (par) divided by $25 per share equals 40 shares per bond. With market value at 105, each bond costs $1,050. What is the stock parity price? $1,050 divided by 40 shares equals $26.25 per share. Current market value of the stock minus stock parity price equals profit (or loss). $27.00 − $26.25 = $0.75 per share × 40 shares = $30.

ABC Corp. has outstanding a 10% noncumulative preferred stock. Two years ago, ABC omitted its preferred dividend. Last year, it paid a dividend of $5 per share. In order to pay a dividend to common shareholders, each preferred share must be paid a dividend of A) $15. B) $25. C) $5. D) $10.

D Explanation In order for a common dividend to be paid when the issuer has noncumulative preferred stock outstanding, the preferred dividend must be satisfied. In this case, the stated dividend is 10% or $10 (10% × par of $100).

All of the following would be reasons for an employer to choose a nonqualified plan over a qualified plan except? A) the nonqualified plan provides greater flexibility. B) the nonqualified plan can discriminate in favor of highly compensated employees. C) the nonqualified plan is not subject to ERISA reporting and disclosure requirements. D) the nonqualified plan provides an immediate income tax deduction for the employer.

D Explanation Nonqualified plans do not provide a tax deduction to the employer until the employee receives the economic benefit as income at some point in the future. They are, however, more flexible because they do not have to comply with ERISA reporting and nondiscrimination requirements.

Investors in zero-coupon corporate bonds would find all of the following to be true except A) the discount must be accreted and is taxed annually. B) the bond's duration is equal to its length to maturity. C) the discount is in lieu of periodic interest payments. D) the discount must be accreted annually with taxation deferred until maturity.

D Explanation On a corporate zero-coupon bond, the discount is accreted on an annual basis and investors receive a Form 1099-OID indicating the amount of taxable accretion earned for the year. That is one of the reasons why these bonds are favored for tax-sheltered accounts, such as an IRA, or for UTMA accounts where the child's income might be very low. One of the important characteristics of these bonds is that their duration is equal to the length to maturity. This gives them a longer duration than coupon bonds of the same length and is the reason for their greater price volatility.

Bob and Tori are a married couple in their 40s filing a joint tax return. Both contribute to their employer's qualified retirement plan and will have a combined adjusted gross income of $4,000,000 this year. Bob and Tori are A) not permitted to contribute to their traditional IRAs. B) permitted to make tax-deductible contributions to their traditional IRAs. C) permitted to make fully deductible contributions to their traditional IRAs, as long as their contributions to their employer-sponsored plans do not exceed certain limits. D) permitted to make nondeductible contributions to their traditional IRAs.

D Explanation Once both parties to a joint tax return participate in qualified employer-sponsored retirement plans, there are limits beyond which contributions are no longer tax-deductible. The exam will never ask for those exact numbers because they change every year. As example of the numbers is found in your LEM. That said, the earnings level for this couple is so far above the allowable limits that you are expected to recognize that their contributions would not be tax favored. The key point this question is making is that anyone with earned income, regardless of how much, can open a traditional IRA and receive tax deferral on the earnings in the account. Compare this to the Roth IRA, where there is a limit beyond which contributions are nonallowable.

Sam Brown has several stock rights. Which of the following is not an alternative regarding these stock rights? A) Exercising the stock rights before expiration to purchase shares of stock B) Gifting the rights to his son to exercise C) Selling in the open market at the prevailing market price D) Redeeming them from the issuer for cash

D Explanation Rights are not redeemable by the issuer. They may be sold in the secondary market or given to someone else to trade or exercise. If exercised, rights are exchanged for an appropriate number of shares of the underlying common stock.

An investor purchased a new issue corporate zero-coupon bond for $600. The bond has a maturity of 20 years. Six years later, the investor sells the bond for $700. For tax purposes, this would result in A) a capital gain of $20. B) a capital gain of $100. C) a capital loss of $280. D) a capital loss of $20.

D Explanation The $400 discount is accreted over the 20 years to maturity. That is an annual accretion of $20. After 6 years, that is $120, making the tax basis of the bond $720. Because the sale at $700 is $20 less than the basis, the investor has a long-term capital loss.

The Investment Company Act of 1940 contains a number of terms used to describe investment companies. When used as an adjective, the term diversified would apply to which type of investment company? A) Face-amount certificate company B) Unit investment trust C) Business development company D) Management company

D Explanation The Investment Company Act of 1940 divides investment companies into three principal classifications. Those are the face-amount certificate company, the UIT, and the management company. Management companies are further divided into open-end and closed-end companies. The act goes one step further and has management companies divided again into diversified and nondiversified companies. It is not expected that you will have to know what a BDC (business development company) is.

All of the following are suitability considerations when a registered representative recommends a municipal bond purchase to a customer except A) the customer's state of residence being the same as the location of the issuer. B) the customer's tax bracket. C) the issuer's debt rating. D) whether or not the bond is in the broker-dealer's inventory to sell.

D Explanation The customer's state of residence and tax bracket are important because these factors help establish the tax benefits offered by the municipal bond. The issuer's debt rating is important in evaluating the credit risk assumed by the investor. The bond's availability in the dealer's inventory is not a suitability factor.

If interest rates increase, the interest payable on outstanding corporate bonds will A) decrease. B) change according to the inverse payout theory. C) increase. D) remain unchanged.

D Explanation The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year, regardless of the prevailing interest rates in the market. It is the market price of bonds—not the interest payable—that responds inversely to changes in interest rates.

The trust indenture of a revenue bond includes a statement explaining rates will be maintained at a level sufficient to cover the debt service and operating expenses. This statement would be found in that part of the indenture dealing with A) the official statement. B) the flow of funds. C) the feasibility study. D) the bond covenants.

D Explanation The trust indenture of a bond contains the protective bond covenants. Within the bond covenants can be found the rate covenant, which is a statement explaining that rates or user fees will be maintained at a level sufficient to cover the debt service and operating expenses for the bond issue.

Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 11¼% coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Libby's concerns about the issue could include which of the following? A) She should not be concerned, as the bonds will be first in liquidation. B) The company might demand that she accept common stock for her bond. C) The new barges might sink, and the collateral would be gone. D) The issue may have a junior claim to another security issue.

D Explanation The word subordinated is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral, as the bonds are identified as debentures, and having to convert to common stock is not a threat because she is the one that will, if she desires, exercise the conversion privilege.

If a customer writes 2 ABC Feb 90 puts at 8 and buys 2 ABC Feb 80 puts at 2, which of the following statements are true? The spread is bullish. The spread is bearish. The breakeven point is 84. The breakeven point is 86. A) II and III B) II and IV C) I and IV D) I and III

D Explanation This is a credit put spread (the net credit being 6 points per share) in which the breakeven point is calculated by subtracting the net premium (debit or credit) from the higher strike price (90 - 6 = 84). A credit put spread is like the net sale of a put, and buying the lower strike price in any spread (put or call) is bullish.

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) $700 B) Capital gains not taxable C) $300 D) $200

D 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.

An investor owns a 6% bond issued by ABC Corporation that is callable at 102 ($1,020) next May 1. All of the following statements are true regarding the call except A) up until May 1, the investor has call protection. B) it is likely that once the bond is called, the investor will also be exposed to reinvestment risk. C) when bonds are called, they are usually called at a premium to par. D) the bond is probably being called by the issuer because interest rates went up.

D Explanation When interest rates fall, look for a call! If interest rates fall to, say, 4%, the issuer would want to get rid of the 6% debt and perhaps issue a new bond at the 4% rate. Up until the call date, the investor has call protection; as of the call date and every date thereafter, the investor has call risk.

Several investors open an account in joint tenancy. Which of the following statements regarding the account is true? A) Checks need not be endorsed by all parties to the account in order to be deposited. B) Only one designated account holder need sign a margin agreement or other forms pertinent to the account. C) Checks may be made payable to one tenant of the account. D) Mail need only be sent to one of the parties to the account.

D Explanation While mail only needs to be sent to one of the parties to the account, checks for disbursements from the account must be made payable to all parties and endorsed by all parties in order to be deposited. Any required forms pertinent to the account, such as a margin agreement or options agreement, must be signed by all parties.

Your new customer lists tax-free income as an investment objective but notes that he will need access to $50,000 within the next four to six months for a down payment on a vacation home he is purchasing. To meet the objective of tax-free income, a registered representative considers municipal securities for the $50,000. Which of the following municipal securities recommendations would be the least suitable? A) A bond anticipation note (BAN) B) A variable rate demand note (VRDN) C) A tax anticipation note (TAN) D) An auction rate security (ARS)

D Explanation An ARS is a long-term instrument tied to short-term interest rates and, therefore, would not be suitable for someone with a short-term time horizon. Each of the remaining answer choices are short-term notes aligning better with the customer's need to access the funds in the next four to six months.

DERF Corporation has a significant amount of cash on hand. The chief financial officer (CFO) has suggested to the chief executive officer (CEO) that it might be wise to pay off $10 million of the company's outstanding debt. There are four bond issues outstanding, and your broker-dealer is approached for advice on determining which issue to repay. Which of these four issues would the firm recommend? A) $10 million @6% due in 20 years, callable at par B) $30 million @12% due in 15 years, non-callable C) $25 million @5% due in 5 years, callable at 104 D) $15 million @8% due in 10 years, callable at 101

D Looking for the highest interest cost but needs to be callable Explanation Anytime we have extra cash, it can make sense to pay off debt. Corporations feel the same way. When it comes to deciding which debt to repay, the wisest move is to pay down the debt with the highest interest cost. In this case, that would be the 12% bond. However, that bond is non-callable. Based on the inverse relationship between interest rates and bond prices, the 12% bond is going to be selling at a higher price than any of the others. Any savings in interest payments would be more than offset by the price the company would have to pay to buy the bond in the open market. The next highest interest rate is 8% and that bond will cost us a slight premium of $10 per bond to call. Although the 6% bond is callable at par, the company would be far better off removing an 8% debt than one at 6%. In fact, the 1 point call premium is saved after the first semiannual interest payment. A partial call, calling in $10 million of the 8% bond, should be the recommendation.

UGMA (Uniform Gifts to Minors Act) vs UTMA (Uniform Transfers to Minors Act) -Contribution limits/tax/deductibles -Time of transfer -Taxable contributions

DOES NOT HAVE TO BE USED FOR COLLEGE Both have no contribution limits or limit who can contribute. All contributions are after-tax, which means no tax benefits/ deductions UGMA: You can invest in stocks, bonds, and mutual funds The UTMA: allows more assets including physical assets, such as real estate, art, and cars. UGMA automatically transfers to your child's custody when they turn 18 years old. The UTMA offers more options. In many states, you can choose an age between 18 and 25 Parents. relatives and friends may contribute up to $15,000 ($30,000 for a married couple) tax-free. Anything beyond this amount triggers a tax liability.

Only ___________ income from municipal bonds is exempt from taxation The bond resolution (AKA the Bond ___________) spells out 1. 2. 3. All of the following items of information must be included in a municipal securities confirmation except A) the capacity in which the broker-dealer acted. B) an extraordinary call provision. C) whether the securities are fully registered or book entry. D) the date of maturity that has been fixed by a call notice.

Only interest income from municipal bonds is exempt from taxation The bond resolution (or the bond contract)spells out: 1. the characteristics of the issue (maturities, call features, etc.), 2. the issuer's responsibilities to bondholders, 3. any restrictive covenants to which the issuer must adhere. B Explanation Municipal Securities Rulemaking Board rules require that certain information be included on all municipal confirmations, including the capacity in which the firm acted in filling the order, whether the bonds are in registered or book entry form, and any relevant call provisions. Information on catastrophe or extraordinary call provisions is not included on a confirmation because catastrophes have no planned dates of occurrence.

Define vesting.

when an employer contribution to a plan becomes the employee's money. The vesting schedule lets the employees know when they will become fully vested.