S7 Mock Exam 2 (Part 3)

Which of the following regarding a municipal bond broker's broker are true? (choose two) I. Protects customer identity II. Must disclose the identity of customers III. Has no inventory IV. Maintains an inventory

I. Protects customer identity III. Has no inventory Municipal brokers' brokers generally purchase and sell securities on an anonymous basis for institutional clients. They are not in the business of making a market; therefore, they maintain no inventory. LO 6.d

A significant increase in which of the following types of orders may cause a bull market to accelerate? A) Buy stops B) Buy limits C) Sell stops D) Short sales

A) Buy stops If the market is rising, only those orders on the order book above the current market will be executed. Buy stops and sell limits are both entered above the prevailing market price. Of these two, only buy orders (in this case buy stops) will accelerate a rise in the market. LO 16.a

If all other factors are equal, an investor would expect which type of preferred stock to pay the highest stated dividend rate? A) Callable B) Convertible C) Cumulative D) Straight

A) Callable When the stock is called, dividend payments are no longer made. With callable preferred stock, to compensate for that possibility, the issuer pays a higher dividend than with straight preferred. Cumulative and convertible preferred have positive characteristics that would justify a lower fixed dividend than straight. LO 3.e

DMF Company has $50 million of convertible bonds (convertible at $50) outstanding. The current market value of DMF's stock is $42. The bond indenture contains a non-dilution feature. If DMF declares a 10% stock dividend, the new conversion price will be A) higher than $50. B) lower than $50. C) the stock's current market price. D) $50.

B) lower than $50. With an anti-dilution feature, the issuer will increase the number of shares available upon conversion if the company declares a stock split or stock dividend. This means the bondholder must be able to convert it to more shares, which requires a lower conversion price. LO 5.d

The dividend payout ratio of common stock is found by dividing the annual dividend per share by A) the capitalization per share. B) the earnings per share. C) the book value. D) the market price.

B) the earnings per share. The key to the question is ratio, which in this case is the relationship between dividends per share and their source of earnings per share. LO 13.d

Municipal Securities Rulemaking Board rules prohibit dealers from entering into which of the following transactions with a mutual fund? A) Acting as a broker's broker for a large block of bonds the fund wishes to sell B) Purchasing the fund's shares to fill customers' orders C) Accepting portfolio trades from the fund as compensation for sales of the fund's shares D) Accepting orders from a fund to buy a new municipal issue

C) Accepting portfolio trades from the fund as compensation for sales of the fund's shares This prohibited practice is known as reciprocal dealing between a broker-dealer and an investment company. The other examples are routine practices. LO 8.j

All of the following are characteristics of unlisted options except A) negotiated expiration dates. B) negotiated exercise prices. C) active secondary trading. D) premiums determined by participants.

C) active secondary trading. Unlike listed options, unlisted options do not trade continuously in an organized secondary market; trades are negotiated between individuals. LO 10.j

Each of the following persons is accredited under Rule 501 of Regulation D except A) an institution. B) an individual with annual income of $200,000 or more in the past two years. C) an individual with a net worth of $200,000 or more. D) an officer of the issuer.

C) an individual with a net worth of $200,000 or more. Accredited investors include individuals with annual incomes of $200,000 or more; individuals with a net worth of $1 million or more, not including net equity in a primary residence; officers or directors of the issuer; and institutions. LO 20.e

Communications with the public include all of the following except A) informational material on a new mutual fund intended for sales personnel. B) institutional sales material. C) independently prepared reprints forwarded to your firm's customers. D) television appearances by an officer of the firm.

A) informational material on a new mutual fund intended for sales personnel. Material intended for internal use only is not considered a communication with the public. LO 19.a

A May and November Treasury bond is traded the regular way on Wednesday, June 8. The number of days of accrued interest is A) 44. B) 38. C) 45. D) 39.

D) 39. Accrued interest on government bonds is based on actual days in a year. Settlement occurs on the next business day. This bond pays interest in May and November, with the most recent payment on May 1. Interest has accrued on this bond for 31 days in May and 8 days in June, for a total of 39 days. The settlement date is Thursday, June 9. LO 6.e

To fill a customer buy order for 800 WXYZ shares, your firm requests a quote from a market maker for 800 shares. The response is "bid 15, ask 15.25." If the order is placed, the market maker must sell A) 800 shares at no more than $15 per share. B) 800 shares at $15 per share. C) 100 shares at $15.25 per share. D) 800 shares at $15.25 per share.

D) 800 shares at $15.25 per share. A market maker is responsible for honoring a firm quote. If no size is requested by the inquiring trader, a quote is firm for 100 shares. In this example, the trader requested an 800-share quote, so the market maker is responsible for selling eight round lots of 100 shares at the ask price of $15.25 per share. LO 16.b

In a discretionary account where the investment objective is preservation of capital with moderate income, all of the following practices are unsuitable except A) maintaining a fixed asset allocation mix, which includes some underperforming sectors. B) marking order tickets solicited or unsolicited when discretion is used. C) frequent and profitable short-term trading in volatile stocks. D) marking the investment objective on the new account form as high risk.

A) maintaining a fixed asset allocation mix, which includes some underperforming sectors. In some test questions, the best way to select the correct choice is when three of the four options are clearly wrong. This is an example of that case. Preservation of capital is certainly not a high-risk objective and does not call for frequent trading in any stock, volatile or not. Orders in a discretionary account are not considered unsolicited (the client is not the one placing the orders). Allocating the portfolio to fixed-income assets (bonds and preferred stock) would seem to be the most appropriate step to take. LO 2.g

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 common share will receive half of a right. B) Each preferred share would receive five rights. C) It will require two rights to buy one new share. D) It will require five rights granted to the preferred stockholders to buy one new share.

C) It will require two rights to buy one new share. 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. Preferred stock does not receive preemptive rights; the information about the 100,000 shares is included as irrelevant information (makes the question more difficult for some and is something the test loves to do). LO 3.f

Included in the working capital computation of a corporation are all of the following except A) cash on hand. B) investments in marketable securities. C) convertible bonds outstanding. D) accounts payable.

C) convertible bonds outstanding. The working capital of a corporation is equal to its current assets minus its current liabilities (a current liability is payable within 12 months). Because all bonds—convertible or not—issued by the corporation are long-term liabilities, they are not included in the working capital computation. Marketable securities and cash are current assets, and accounts payable are current liabilities—all of which are included in the calculation of working capital. LO 13.d

One of your clients is an active investor using a tactical asset allocation strategy. As such, the client engages in numerous transactions every month. With each transaction, the client pays a separate transaction fee. Your firm has just begun offering an account to its clients whereby the client can pay one flat fee to cover all the trades in that account. You immediately bring this news to the client and suggest making the change. What type of account is this? A) A margin account B) A wrap-fee account C) A pattern day trading account D) A fee-based account

D) A fee-based account With a fee-based account, the customer pays one fee that covers all transactions in an account. This account is most suitable for active, rather than passive investors. A wrap-fee account is one where a fee, usually based on assets under management, is charged to a customer to cover various services provided by a firm. Those services would include portfolio management and transaction fees. Firms that offer wrap-fee accounts are required to be registered as investment advisers as well as broker-dealers. LO 1.a

When does pension payment liability affect the credit rating of a municipality? A) When funds are invested presently to meet future pension needs B) Never C) When the return on funds invested to meet future needs exceeds anticipated payments D) When funds needed to make payments exceed funds available

D) When funds needed to make payments exceed funds available The credit rating for a municipality's debt would be adversely affected if funds needed to make payments exceeded funds available. This is an unfunded pension liability and can result if monies set aside to make future payments are not enough or if poor investment decisions deplete the funds. LO 6.d

A registered primary offering of common stock differs from a registered secondary offering of common stock in that A) the primary offering must be registered with the SEC, while the secondary offering is already registered. B) only the primary offering is sold by prospectus. C) the proceeds of the primary offering are received by the issuing company, while the proceeds of the secondary offering are received by the underwriting syndicate. D) the proceeds of the primary offering are received by the issuing company, while the issuer receives none of the funds from a secondary offering.

D) the proceeds of the primary offering are received by the issuing company, while the issuer receives none of the funds from a secondary offering. A primary offering is always the sale of new shares. Therefore, the proceeds of the offering always go to the issuer. In the case of a registered secondary, the seller is generally a large stockholder, such as an institution or perhaps a founder of the company. That means the proceeds go to that seller. As registered issues, sales of both require a prospectus. Please note that it is possible that a company with treasury stock might register it for resale. That would be a registered secondary where the issuer receives the funds, but it is very unlikely the exam would go there. When testing, stick with the normal conditions unless the exam asks for an exception. LO 20.c

Which of the following statements describe the conduit theory of taxation? I. A fund is not taxed on earnings it distributes, provided distributions equal 90% or more of net investment income. II. Earnings distributed by a regulated investment company are taxed three times. III. Dividends and interest are passed through to the investor without the fund being taxed. IV. Dividends and interest accumulate tax free to the shareholder.

I. A fund is not taxed on earnings it distributes, provided distributions equal 90% or more of net investment income. III. Dividends and interest are passed through to the investor without the fund being taxed. Under the conduit, or pipeline, theory of taxation, a fund is liable for taxes only on the income retained, provided it distributes at least 90% of its net investment income. The investor benefits because the income is only taxed twice (at the corporate level and at the individual level) and avoids taxation at the fund level. There is no tax-free accumulation for the shareholder. LO 8.f

Which of the following statements regarding Section 529 education savings plans are true? I. Contributions are considered gifts under federal law. II. Contributions are tax deductible under federal law. III. Earnings generated are taxable each year. IV. Earnings generated are tax deferred.

I. Contributions are considered gifts under federal law. IV. Earnings generated are tax deferred. 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. LO 6.g

If you invest in a front-end load mutual fund and choose automatic reinvestment, you should expect that I. dividend distributions will be reinvested at net asset value. II. dividend distributions will be reinvested at the public offering price. III. capital gains distributions will be reinvested at net asset value. IV. capital gains distributions will be reinvested at the public offering price.

I. dividend distributions will be reinvested at net asset value. III. capital gains distributions will be reinvested at net asset value. Mutual funds that offer automatic reinvestment of dividends and gains distributions must do so at net asset value. LO 8.f

The term high-yield bond would apply to a bond with a Moody's rating of A) Ba. B) BBB. C) Baa. D) BB.

A) Ba. High-yield bonds are those whose ratings fall below investment grade. Investment grade is the top four. Using Moody's descriptions, ratings run from Aaa to Aa to A to Baa to Ba to B and then below. The first rating below the top four is Ba. That is equivalent to a BB rating from Standard & Poor's (but the question asks specifically about Moody's). LO 4.f

Proponents of which of the following technical theories assume that small investors are usually wrong? A) Odd lot B) Breadth of market C) Short interest D) Volume of trading

A) Odd lot Odd lots are usually traded by small investors; some analysts believe small investors are generally wrong. LO 13.e

The writer of an IRX U.S. Treasury bill yield-based option, if exercised, must A) deliver cash equal to the intrinsic value of the contract. B) receive Treasury bills C) receive cash.equal to amount the contract is in-the-money D) deliver T-bills.equal to the dollar amount of T-bills in the contract

A) deliver cash equal to the intrinsic value of the contract. The IRX is the 13-week Treasury bill. It is generally accepted that this security, more than any other, directly reflects changes in interest rates. Investors in yield-based options are making a bet on the future trend of interest rates. Just as with equity options, we use the phrase "call up and put down." That is, if the investor believes interest rates will rise, the strategy is to buy a call option. If a decline in rates is expected, the investor will buy a put option. Like some other of the non-equity based options, upon exercise, yield-based options settle in cash. That is because there is no delivery of the underlying security. If you buy an IRX call and exercise it, you're not going to be buying Treasury bills. The writer must deliver the in-the-money amount in cash. LO 10.g

Each of the following securities trade and interest except A) zero coupon bonds. B) municipal revenue bonds. C) Treasury bonds. D) negotiable CDs.

A) zero coupon bonds. Trading and interest means trading with accrued interest. Debt instruments that pay interest periodically (e.g., municipal bonds or Treasury bonds) trade with accrued interest. LO 6.e

A customer enters an order to sell 100 TCB at 49 stop limit. Before the order, TCB was trading at 49.25. Subsequent trades are reported on the tape as follows: TCB 49.10, 48.75, 48.85, 49, 49.25 What trade triggered the order? A) 49 B) 48.75 C) 48.85 D) 49.25

B) 48.75 A stop order remains dormant until there is a transaction at or better than the stop price. Our example is a sell stop limit order where the stop price and limit price are the same. A sell stop order is triggered (elected) by the first trade that is at or below the stop price of 49. In this case, it is 48.75. At that point, a limit order to sell at 49 or better (higher) is entered. If this question asked for the execution price, it would be the trade of 49. LO 16.a

Investors should always be aware of taxes applicable to investments they own. Which of the following taxes might be associated with income derived from American depositary receipts (ADRs) but not income from other investments? A) Excise tax B) Foreign income tax C) State income tax D) Federal income tax

B) Foreign income tax In most countries, a withholding tax on dividends is taken at the source. To the holder of an ADR, this would be a foreign income tax. The foreign income tax paid may be taken as a credit against U.S. income taxes owed. LO 3.g

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

B) Original issue discount Because the bond is being issued by a syndicate, it is a new issue (i.e., an original issue). Because the yield (4%) is higher than the coupon (3%), it is an original issue discount. LO 6.f

All of the following statements about the special memorandum account (SMA) are true except A) non-required cash deposits generate SMA. B) SMA in a long margin account decreases when the market value decreases. C) the SMA balance may be used to meet the Regulation T requirement for purchases. D) it is a line of credit.

B) SMA in a long margin account decreases when the market value decreases. The amount of SMA in a long account decreases only when it is used, and is unaffected by market value decreases. LO 16.d

A registered representative's customer is speaking of a variable life insurance contract she owns. She makes several statements regarding the contract. Which of the following is not an accurate statement concerning a variable life insurance contract? A) The policy provides a minimum guaranteed death benefit. B) The death benefit can never be more than the guaranteed benefit. C) The portion of the premium invested in the insurance company's general account is used to provide for the minimum guaranteed amount of the death benefit. D) There is no guarantee regarding the investment results of the separate account.

B) The death benefit can never be more than the guaranteed benefit. The minimum guaranteed death benefit is provided by that portion of the payment invested in the insurance company's general account. The remainder of the premium is invested in the separate account. While there is no guarantee on how investments in the separate account will perform, depending on its investment performance, the separate account could provide for a larger death benefit than the minimum guaranteed amount. LO 9.a

A broker-dealer has set up a prime brokerage account for one of its customers. This customer is most likely A) an individual retail customer. B) an institutional customer. C) an investment club. D) two spouses, each having individual accounts and a joint account together.

B) an institutional customer. A prime brokerage account is one in which a customer—generally an institutional customer—selects one member firm (the prime broker) to provide custody and other services, while other firms—called executing brokers—handle all trades placed by the customer. LO 1.b

All of the following might be found in a money market fund's portfolio except A) negotiable CDs. B) common stock. C) T-bills. D) banker's acceptances.

B) common stock. A money market mutual fund portfolio will consist of money market instruments, which are short-term, high-quality debt securities. They include treasuries with less than one year to maturity and negotiable CDs. Because common stock is equity, it is not found in money market funds. LO 8.g

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

B) employees may use accumulated funds as collateral for a bank loan. 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. LO 1.f

A client with an options account contacts the registered representative handling the account with instructions to open the following spread: Buy 1 ABC 100 call and Sell 1 ABC 105 call at a 5-point debit. Under FINRA rules, this order A) will be executed at the next available trade meeting the 5-point limit. B) should be refused. C) is for a bull call spread. D) should be turned in immediately.

B) should be refused. The order should be refused because it is impossible for it to be profitable. This is a bull call spread (but that is not the correct answer here because it has nothing to do with FINRA rules) and will become profitable when the spread widens. With strike prices of 100 and 105, it can never widen more than 5 points. If the client paid 5 points for the spread, once commissions are factored in, the client must lose money and certainly cannot profit. FINRA looks at this as an uneconomic position, and the firm should refuse to take the order. LO 10.h

Advertising relating to municipal securities must be approved by which of the following? A) The Securities and Exchange Commission (SEC) B) A designated supervisory analyst C) A general securities principal or municipal securities principal D) The Municipal Securities Rulemaking Board (MSRB)

C) A general securities principal or municipal securities principal According to MSRB rules, advertising (communications with the public) must be approved by either a municipal securities principal or a general securities principal. LO 19.c

Which of the following insures general obligation bonds? A) Syndicate manager B) Securities Investors Protection Corporation (SIPC) C) National Public Finance Guarantee Corp. and AMBAC D) Federal Deposit Insurance Corporation (FDIC)

C) National Public Finance Guarantee Corp. and AMBAC Outstanding municipal general obligation bonds have been insured by the National Public Finance Guarantee Corp. and AMBAC. Insured bonds are typically AAA-implied rated. SIPC protects customer accounts against broker-dealer failure. The FDIC protects customer deposits against bank failure. LO 6.d

An individual with $100,000 to invest will require these funds in six months for the purchase of a house. In which of the following circumstances did the registered representative act correctly? A) The registered representative convinced the client to purchase a $100,000 lump sum fixed annuity on the basis of its backing by an insurance company. B) The registered representative convinced the client to invest in an IPO on the basis of its high-growth prospects. C) The registered representative convinced the client to invest in a Treasury bill on the basis of its safety. D) The registered representative convinced the client to invest in a REIT as a hedge against the rise of real estate values until the client purchases the house.

C) The registered representative convinced the client to invest in a Treasury bill on the basis of its safety. Investment in a Treasury bill is the only suitable investment among the choices listed. Purchase of annuities and a REIT are long-term investments not suitable to an individual who wants to invest funds on a short-term basis. Although an IPO may be liquid, it is not suitable for short-term funds earmarked for the purchase of a house because there is too much risk to the principal. LO 7.a

If a registered representative receives a call from a custodian wishing to buy shares of a new issue security, she should A) accept the order only if it is placed in a margin account. B) talk the investor into buying another stock. C) discuss and review suitability. D) refuse to accept an order.

C) discuss and review suitability. There are no restrictions that specifically apply to the purchase of new issues in a custodial account, provided the registered representative has discussed and reviewed the suitability of the investment. LO 2.f

Under Rule 506(c) of Regulation D, advertising is permitted when A) the advertisements have been approved by a principal. B) there are no more than 35 non-accredited investors. C) the issue is limited to accredited investors. D) the advertisements have been filed with FINRA.

C) the issue is limited to accredited investors. Rule 506 of Regulation D of the Securities Act of 1933 has two parts. Rule 506(b) prohibits any advertising of the private placement, while Rule 506(c) permits it. The primary condition to be met is that the issue is offered solely to accredited investors. It is Rule 506(b) that has a limit of 35 non-accredited investors, but that has nothing to do with the advertising restriction. Regulation D applies to issuers, not broker-dealers, so there is no principal to go to for approval. LO 20.e

A married couple both hoping to retire within the next five to seven years have expressed having a low-risk tolerance regarding the stock market. They have a combined income of $350,000. Given this information, which of the following portfolio mixes would be most suitable? A) Treasury bills, corporate bonds, preferred stock B) Direct participation programs, real estate investment trusts, preferred stock C) Treasury bills, common stock, options D) Treasury notes, municipal bonds, GNMAs

D) Treasury notes, municipal bonds, GNMAs In light of their low risk tolerance, U.S. government securities would certainly be suitable, and the time frame noted for retirement allows for middle term T-notes to be useful. Given their higher income level, tax-free municipal bonds could also have a place in the portfolio. Longer term GNMAs would accommodate monthly income, should that be desirable upon retirement. The remaining product suggestions are either illiquid (DPPs) or do not align with their risk aversion (common, preferred, options, and REITs). LO 11.h

Programs allowing for the direct pass-through of losses and income to investors include all of the following except A) oil and gas drilling direct participation programs. B) new-construction real estate direct participation programs. C) S corporations. D) real estate investment trusts (REITs).

D) real estate investment trusts (REITs). REITs allow for the direct pass-through of income, but not losses. The other choices are forms of business that allow for pass-through of income and losses. LO 11.b

All of the following information must be disclosed on a municipal bond confirmation of sale except A) the source of revenue backing a municipal revenue bond. B) in-whole call dates. C) the name of the guaranteeing corporation in an industrial development revenue bond issue. D) the dated date on a municipal bond that has been outstanding for two years.

D) the dated date on a municipal bond that has been outstanding for two years. On the dated date, new issue interest starts to accrue. Once the issue makes its first interest payment to bond holders, the dated date is no longer used to compute accrued interest because there is a prior interest payment date. LO 6.h

Which of the following statements regarding tax-deferred, noncontributory, defined benefit plans are true? I. Contribution amounts are fixed. II. Contribution amounts vary. III. Benefit payments are fixed. IV. Benefit payments vary.

II. Contribution amounts vary. III. Benefit payments are fixed. In an employer-sponsored defined benefit plan, the contribution amounts vary according to the assumptions used. The benefit amount, however, will be fixed per person based on a formula combining age, years of service, salary, et cetera. LO 1.h

A customer requests that his broker-dealer hold his fully paid for stock. Which of the following are required? I. A written stock power from the customer II. Full power of attorney from the customer to the broker-dealer III. The securities must be segregated from those of the firm and other customers IV. The customer must be informed that the securities may be withdrawn by him at any time

III. The securities must be segregated from those of the firm and other customers IV. The customer must be informed that the securities may be withdrawn by him at any time The broker-dealer must segregate the customer's fully paid for securities and inform the customer that the securities can be withdrawn at any time. LO 16.d

Which of the following statements regarding corporate zero coupon bonds are true? I. Interest is paid semiannually. II. The discount is in lieu of periodic interest payments. III. The discount must be accreted and is taxed annually. IV. The discount must be accreted annually with taxation deferred until maturity.

The discount is in lieu of periodic interest payments. The discount must be accreted and is taxed annually. The investor in a corporate zero coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. That discount from par represents the interest that will be earned at maturity date. However, the discount is accreted annually, and the investor pays taxes yearly on the imputed interest. LO 5.a

All U.S. exchange-listed foreign currency options I. are settled in the underlying foreign currency. II. are settled in cash (U.S. dollars). III. expire on the third Friday of the expiration month. IV. expire every Friday of each month.

are settled in cash (U.S. dollars). expire on the third Friday of the expiration month. U.S. exchange-listed currency options are settled in cash (U.S. dollars) and expire on the third Friday of the expiration month, just like equity options do. LO 10.g