Series 7 prac exam 3

All of the following statements regarding a mark to the market are true except A) it requires the use of a due bill. B) it often occurs in connection with margin transactions. C) it occurs because of a change in the stock's market value covered by a contract. D) it may result in a request for additional collateral.

A Explanation A mark to the market occurs when one party to a contract becomes partially unsecured due to a change in the stock's market value covered by a contract. A mark to the market is a request for additional collateral.

If an investor buys 300 shares of FLB, and one month, later buys 1 FLB Jul 50 put, how does this affect the holding period on his stock? A) It erases the holding period on 100 shares. B) It ends the holding period on the put. C) It has no impact on the holding period for any of the shares owned by the investor. D) It erases the holding period on 300 shares.

A Explanation Because the stock has not been held more than 12 months, the put purchase erases the holding period for any shares the put subsequently allows the holder to sell. Because the holder owns one put, this erases the holding period on 100 shares owned. The other 200 shares are unaffected.

Which of the following statements regarding collateralized mortgage obligations (CMOs) is true? A) They can be purchased for as little as $1,000. B) Yield is locked in. C) There is no extended maturity risk. D) There is no prepayment risk.

A Explanation CMOs can be purchased for as little as $1,000 but mainly trade in minimum amounts of $25,000. Both prepayment risk and extended maturity risk apply to these mortgage-backed securities. The only security where yield is locked in is a zero-coupon bond.

Mutual fund Class B shares assess A) a deferred sales load. B) no load. C) a front-end load. D) a level load.

A Explanation Class B shares carry a deferred sales load. This is sometimes referred to as a back-end load. Class A shares carry a front-end load. Class C shares charge a 12b-1 fee quarterly with a small back-end load in the first year.

A corporation's dividend payout ratio is 30%. If the current market value of the stock is $132 per share and the P/E multiple is 22:1, the annual dividend rate is A) $1.80 per share. B) $6.60 per share. C) $3.96 per share. D) $6.00 per share.

A Explanation Here is how this to compute this. The current market price of $132 per share is 22 times the earnings. Dividing $132 by 22 results in earnings per share of $6.00. If the company is paying out 30% of its earnings as a dividend, multiplying $6.00 times 30% results in dividend at a rate of $1.80 per share.c

Insiders (control persons or affiliates) of a company are prohibited from A) selling short their own company's stock. B) buying shares of affiliated issuers. C) engaging in any short sales on stock of competing issuers. D) buying call options on the company's stock.

A Explanation What a conflict of interest it would be for insiders to sell their own company's stock short! Wanting the shares to decline in price, then mismanaging the company into a loss to profit in their personal account at the expense of all the other stockholders? We don't think so and neither does the SEC. There are no restrictions on insiders buying call options on their company's stock nor buying shares of affiliated companies. The short sale restrictions apply only to the insider's company, not any others.

Buying back an option contract that was previously written or selling an option contract that was previously purchased is known as A) exercising. B) closing out a position. C) dollar cost averaging. D) indexing.

B Explanation When an investor sells a security they are long or buys back a security they are short, he is closing out an existing position.

Which of the following characteristics are applicable to real estate investment trusts (REITs)? A) REITs have guaranteed minimum dividends. B) Dividends from REITs are taxed as ordinary income. C) REIT shares cannot be bought or sold in the secondary market and are therefore considered illiquid. D) Any losses from the real estate portfolio flow through to the REIT shareholders.

B Explanation While income flows through to REIT shareholders in the form of dividends, losses do not flow through. When a REIT pays a dividend, it will be taxed as ordinary income, but there are no guaranteed minimum dividend payouts. They trade both on exchanges and over the counter, and are therefore considered to be liquid investments.

Which term describes the following position? Write 1 DOH Jan 30 call Write 1 DOH Jan 40 put A) Diagonal spread B) Short straddle C) Short combination D) Price spread

C Explanation A combination is composed of a long call and long put, or a short call and a short put, each having different strike prices and/or expiration months on the same underlying security.

An investor has researched XYZ Corporation and is convinced the company's stock will soon decline in value. If the investor wishes to act on that conviction, which investment strategy will allow the investor to take advantage of the anticipated decline in share value with the smallest cash investment? A) Purchase a call option B) Purchase a call spread C) Purchase a put option D) Sell the company's stock short

C Explanation Buying a put is a basic option strategy used when one is bearish on a stock. If the stock declines as anticipated, the investor could exercise the put, which allows the stock to be sold at the strike price and then repurchase it at its lower current market price for a profit. The premium paid to buy the put costs less than the margin required if one were to sell the stock short. Purchasing a call or a call spread are bullish options strategies.

Index options are frequently used to protect a portfolio against which of the following risk types? A) Inflation B) Business C) Systematic D) Credit

C Explanation Index options protect investor portfolios from the risk of overall market movement, also known as systematic risk.

All of the following might be used to measure the marketability of a new municipal general obligation issue except A) visible supply. B) placement ratio. C) Revdex. D) S&P's ratings.

C Explanation Revdex is an index of yields on 25 revenue bonds with 30-year maturities that are traded in the secondary market.

An investor writes 1 IBS 280 put for 16.60. The position is closed, and the put is bought for its intrinsic value when IBS is trading at 265.25. The investor realizes A) a $145 profit. B) a $185 loss. C) a $235 loss. D) a $185 profit.

D Explanation The opening sale of the IBS put was made for 16.60, and the closing purchase was made for the intrinsic value of 14.75. The put's intrinsic value is determined by how far the stock's market price is below the strike price. (In this case, 280 minus 265.25.) 16.60 − 14.75 = 1.85 × 100 shares = $185.00. The investor profits because the sale's proceeds exceed the purchase price.

When an insured person becomes disabled or unable to work, that person may not be required to continue paying premiums on the contract if the contract included A) a waiver of premium option. B) a freeriding provision. C) a low-income provision. D) a disability rider.

A Explanation A waiver of premium option allows the premiums on an insurance contract to be waived for a person who has become disabled or otherwise unable to work.

An investor purchases $15,000 worth of stock in a margin account, depositing the Regulation T requirement. If the account is charged with interest amounting to $100, and no other activity has occurred in the account, the new debit balance is A) $7,600. B) $7,500. C) $100. D) $7,400.

A Explanation Because the Regulation T requirement is 50%, the investor deposits $7,500 and is loaned $7,500 (debit balance) for the $15,000 purchase. If the account is charged with $100 interest expense, the new debit balance is $7,600.

All of the following disputes may be resolved using arbitration under the Code of Arbitration Procedure except A) class action suits against a member. B) member against a person associated with a member. C) member against a public customer with consent of the customer. D) member against another member.

A Explanation Class actions brought against member firms are not subject to arbitration under the Code of Arbitration Procedure.

After selling ABC short at 70, a customer holds the position as ABC gradually falls to $53 per share. Which of the following strategies would best protect her gain? A) Buy 55 calls B) Write 55 puts C) Buy 55 puts D) Write 55 calls

A Explanation If the investor buys the 55 calls, she has the right to purchase the stock at $55 per share. If exercised, the investor has a 15-point gain, less the premium paid.

The options exchanges have instituted a policy of position limits. The policy combines certain strategies to determine compliance with these limits. All the following positions would be combined for the purpose of the limits permitted on the same side of the market except A) long ABC Oct 80 calls; long ABC Jan 75 puts. B) short ABC Oct 80 calls; long ABC Jan 75 puts. C) long ABC Oct 80 calls; short ABC Jan 75 puts. D) long ABC Oct 80 calls; long ABC Jan 75 calls.

A Explanation Long calls and short puts are both on the upside of the market (bullish), while short calls and long puts are on the downside of the market (bearish). The only choice where the contracts are on opposite sides of the market are the long calls and the long puts.

A real estate limited partnership is created for $800,000 with 1 general partner and 10 limited partners. Each of the limited partners has an equal 10% share. The proceeds are used to purchase an office building for $2 million. The additional financing is provided by a nonrecourse bank loan. Economic conditions cause the occupancy rate to fall dramatically, and the partnership is dissolved as insolvent. Each limited partner may claim a loss of A) $200,000. B) $120,000. C) $2,000,000. D) $80,000.

A Explanation Losses may only be claimed to the extent of tax basis. The initial $800,000 was divided 10 ways, so each LP had a basis of $80,000. To this was added the share of the financing of $1.2 million. That is another $120,000 basis (10% of $1.2milion) bringing the total to $200,000 ($80,000 + $120,000). That is the maximum loss that can be claimed. It is important to note that nonrecourse financing adds to basis only in RELPs. Because the loan adds to the basis of all LPs equally, you could also solve this by taking the total $2 million investment and dividing it by 10 to arrive at the same $200,000.

A customer sells short 500 XYZ at $80 per share in a margin account. Before regular way settlement, if the stock falls to $60 per share, the minimum maintenance margin requirement is A) $9,000. B) $12,000. C) $10,000. D) $7,500.

A Explanation Minimum in a short margin account is 30% of the current market value, which is $30,000 (500 shares × 60); 30% of $30,000 is $9,000.

Under the Conduct Rules, the maximum sales charge on any transaction involving an open-end investment company share is A) 8.5% of the offering price. B) 9% of the offering price. C) 8.5% of the net asset value. D) 9% of the net asset value.

A Explanation Open-end investment companies (mutual funds) are limited to a maximum sales charge of 8.5% of the offering price.

Which of the following municipal issues would least likely involve overlapping debt? A) An airport district B) A park district C) A school district D) A library district

A Explanation Overlapping debt refers to property tax districts (areas). Airport issues are usually revenue issues of an authority that has no property taxing powers.

A company's balance sheet dated December 31 shows retained earnings of $100,000. You can deduce from this information that the company A) has had $100,000 in undistributed profits since its inception. B) earned a profit of $100,000 for this year. C) has at least $100,000 in cash. D) has had total net income of $100,000 since its inception.

A Explanation Retained earnings represent the accumulated total of all earnings that have been retained in the company since its inception. It is quite possible that the company did not earn $100,000 in that particular year and does not have $100,000 in cash.

Rule 144A regulates A) the sale of restricted stock to institutional investors. B) personal trading by research analysts. C) the sale of restricted stock by control persons. D) companies traded on the Nasdaq Global Select Market.

A Explanation Rule 144A regulates the trading of restricted securities to institutional investors known as qualified institutional buyers.

All of the following are advantages of buying a put versus selling stock short except A) the put's time value, which gradually dissipates, is added to the intrinsic value. B) buying a put would require a smaller capital commitment. C) buying a put has a lower dollar-loss potential than does selling stock short. D) one need not locate securities to be borrowed to buy a put.

A Explanation Selling short could result in unlimited loss, whereas buying a put limits loss to the premium and requires a smaller capital outlay than does selling short. Remember that short sales must be done in a margin account, and 50% of the short market value (SMV) must be deposited by the short seller. Short sales require locating the securities to be borrowed; buying a put does not. The time value that erodes in a put option is a disadvantage because for each day that elapses, the option's time value decreases.

Municipal bonds offered for sale in the new issue market can be found in A) The Bond Buyer. B) the electronic OTC Pink. C) the Revdex. D) the Investors Business Daily.

A Explanation The Bond Buyer provides primary market information and is published daily.

If a customer buys 300 ABC at 53 and writes 3 ABC Jun 55 calls at 4, and the contracts expire unexercised, the customer's cost basis in ABC stock at expiration is A) $53. B) $57. C) $49. D) $51.

A Explanation The cost basis in the stock remains at the original purchase price. The premium received must be declared by the investor as a capital gain for tax purposes. Premiums on options will only affect the stock's cost basis or sales proceeds if the option is exercised, or if (on the same day) a customer buys stock and buys a put.

The placement ratio in The Bond Buyer indicates the relationship for a particular week between the number of bonds sold and the number of bonds A) offered for sale in the market that week. B) sold by competitive bid that week. C) to be offered in the next 30 days. D) sold in negotiated underwritings that week.

A Explanation The placement ratio shows the relationship between the number of bonds placed (sold) and the total number offered for sale. The ratio can range from 0% to 100%.

If a client bought 100 shares of GM at $88.50, and on the same day, he went long a put at 90 for 4.25 on GM due to expire within the month, what is the breakeven point? A) $92.75 B) $85.25 C) $90.25 D) $84.25

A Explanation The stock is the dominant position. The breakeven point is calculated by adding the cost of the option to the cost of the stock. The stock must rise to $92.75 to break even.

If XYZ common stock has a $4 dividend, a yield of 4.2%, a price-to-earnings (P/E) ratio of 12, and it is trading at $96, its approximate earnings per share (EPS) is A) $8.00. B) $50.40. C) $4.00. D) $48.00.

A Explanation The stock's P/E ratio is price to EPS. Dividing the stock's price by the P/E will give the EPS ($96 / 12 = $8).

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 bond covenants. B) the official statement. C) the feasibility study. D) the flow of funds.

A 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.

A jewelry wholesaler imports Swiss watches. The importer could gain the most protection against currency risk by A) going long calls on the Swiss franc. B) going long puts on the Swiss franc. C) going short puts on the Swiss franc. D) going short calls on the Swiss franc.

A Explanation When it comes to using options as protection, the strongest protection comes from purchasing rather than selling. Options can be used as insurance, and to protect yourself, you buy insurance. Remember the acronym EPIC, which stands for Exporters buy Puts and Importers buy Calls. Because this wholesaler is importing the watches, buying calls is the proper strategy.

An investor long 100 shares of stock writes a call against the long stock position. If the call is exercised, and the investor must deliver the stock, which of the following tax consequences will occur? A) The investor's sales proceeds are the strike price plus the premium. B) Both cost basis and sales proceeds must be adjusted. C) Cost basis is adjusted for the stock. D) There are no adjustments for cost basis or sales proceeds for tax purposes.

A Explanation When the call is exercised, the owner of the stock will be obligated to sell the shares owned at the strike price. The sales proceeds for the stock will be adjusted upward by the amount of the premium received when the call was sold.

A technical analyst would find which of the following to be a bullish indicator? A) More odd-lot purchases than sales B) An increase in the short interest C) More declines than advances D) A head and shoulders top

B Explanation As the short interest increases, it is a bullish signal to technicians. Those short sales are going to have to be covered one day and that buying pressure is bullish on the stock. A head and shoulders top is bearish - it signifies that the market has reached a top. Odd-lot purchasers (the little guy) are always buying and selling at the wrong time. When they are buying more than selling, it is a sign that the market price of the stock is soon going to fall. When the advances outnumber the decliners, it is bullish. When it is reversed, as in the answer choice, it is bearish.

On exercise of the option, the holder of a put will realize a profit if the price of the underlying stock A) exceeds the exercise price. B) falls below the exercise price minus the premium paid. C) exceeds the exercise price plus the premium paid. D) falls below the exercise price.

B Explanation Breakeven for the buyer of a put is the strike price of the option minus the premium paid for the option.

A customer buys 300 LMN at $45 per share and writes 3 LMN Aug 45 calls at 4. The customer will profit under all of the following circumstances except A) if LMN remains at $45 through expiration. B) if LMN is below $41 at expiration. C) if LMN is between $41 and $45 at expiration. D) if LMN rises, and the calls are exercised.

B Explanation Breakeven is $41 ($45 − $4). The stock price must be above breakeven for the investor to make a profit.

An investor wants to profit from a speculative, near-future market advance, but he is uncertain which stocks will be affected. To limit his risk to a specific amount, which of the following actions would best meet his objectives? A) Sell puts on a narrow-based stock index B) Buy calls on a broad-based stock index C) Buy calls on a narrow-based stock index D) Purchase several blue-chip stocks on margin

B Explanation Broad-based index options allow investors to profit on their beliefs about movement in the overall market. Index calls profit the investor if the index closes above the strike price plus the premium paid. The investor has limited risk because only the option's premium can be lost if the market moves downward. Narrow-based index options involve a single market sector only (e.g., technology stocks).

Under the Securities Act of 1933, the Securities and Exchange Commission (SEC) has the authority to issue stop orders regarding a new issue registration filing. approve new issues. review standard registration forms. guarantee the accuracy of the information contained in the registration forms. A) II and III B) I and III C) II and IV D) I and IV

B Explanation During the cooling-off period, the SEC reviews registration statements and can issue stop orders if the registration is not complete or was not filed properly. The SEC does not approve securities or guarantee that any information found within a prospectus is accurate; it only clears the securities for distribution (sale) to the public.

Two years ago, your client purchased 100 shares of ULA common stock at $40 per share. Today, the client buys one ULA Apr 60 put at $2, when the stock's price is $65. At expiration, the ULA stock is selling for $56, and the client exercises his put, delivering the long stock to cover the sale. The client has a gain of A) $700. B) $1,800. C) $200. D) $2,300.

B Explanation Exercise of the put enables the client to sell the stock at the strike price of $60. The stock was originally purchased at $40, so the result is a $2,000 gain in the stock minus the $200 premium paid for the put, for a net gain of $1,800.

You received a signed broker-to-broker transfer initiation form (TIF) from an established customer desiring to transfer a specifically designated part of his account to your firm, which is eligible to use the Automated Customer Account Transfer Service (ACATS). Your firm is obligated to submit the transfer instruction to the carrying member by establishing the instruction in the ACATS A) within 1 business day. B) Immediately. C) within 2 business days. D) within 3 business days.

B Explanation FINRA's Uniform Practice Code requires that the receiving member firms immediately forward the TIF to the firm currently carrying the account. A customer may transfer all or part of the securities held in the account.

An applicant for registration as a registered representative of a FINRA member firm requires disclosure of significant personal information. Among the responsibilities of the member firm is verification of the previous A) three years of residency. B) three years employment. C) five years of residency. D) ten years of employment.

B Explanation Form U4 requires an applicant to provide a 5-year residency history and a 10-year employment history. With regard to the employment history, the member firm must verify the previous 3 years. There is no requirement to verify residency history.

An investor reading the annual report of an investment company notices that among the company's expenses was the payment of interest on outstanding bonds. The company also paid dividends on preferred stock. This investment company is A) an exchange-traded fund. B) a closed-end management investment company. C) a balanced open-end mutual fund. D) a bond and preferred stock mutual fund.

B Explanation It is the closed-end management investment company that is allowed to have bonds and preferred stock in its capitalization. Open-end investment companies (mutual funds and ETFs) can only issue one class of stock (common). Do not confuse an investment company's capitalization with the contents of its portfolio.

One of your clients who is interested in purchasing some investment company shares brings to your attention a fund with a net asset value per share (NAV) of $22.13 and an asking price of $21.02. The client asks for an explanation, and you would respond, A) "This is an open-end investment company with a front-end load of 5%." B) "This is a closed-end investment company whose selling price is based on supply and demand, not NAV." C) "This is a closed-end investment company with a front-end load of 5%." D) "This is obviously a mistake because an investment company never sells at a price below its NAV."

B Explanation One of the characteristics of closed-end investment companies is that their selling price is frequently at a discount to the NAV. Because the shares are not continuously offered, as is the case with an open-end company, the shares are priced based on supply and demand. That means they can sell at, above, or below the net asset value per share. They trade in the secondary markets like any stock and one usually pays a commission, not a sales load when buying or selling.

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) real estate investment trusts (REITs). C) S corporations. D) new-construction real estate direct participation programs.

B Explanation 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.

At expiration, if the market price of the underlying common stock and the strike price are the same, all of the following customer positions will show a profit except A) short straddles. B) long straddles. C) short calls. D) short puts.

B Explanation The contracts will not be exercised if options expire at the money. Therefore, writers will show a profit, but buyers will not.

One of your customers is long 400 shares of MMLJ common stock. The price of the stock has risen sharply since the customer purchased it. The customer is concerned about a price pullback and asks you to recommend a hedging strategy. You recommend that the client A) buy 1 MMLJ put. B) buy 4 MMLJ puts. C) buy 1 MMLJ call. D) buy 4 MMLJ calls.

B Explanation The customer is long the stock and so needs protection should the price of the stock fall, and a long put could give such protection. Buying a put on a long position is the strategy known as a protective put. Because the customer is long 400 shares, they need four puts to hedge the position. If the customer had been short the stock, they would use long calls to hedge.

All of the following have an impact on the marketability of a block of municipal bonds except A) the length of time until the bonds mature. B) the dated date of the bonds in the block. C) the price and date of call provisions. D) the quantity and quality of the bonds in the block available.

B Explanation The dated date has no effect on marketability. A close call date or low call premium can make an issue less marketable because the chance of a call is greater. Maturity, quality, and the size of the block affect marketability.

A resident of Minnesota is in the 28% federal tax bracket and the 4% state tax bracket. This person must pay both federal and state taxes on A) federal home loan bank notes. B) Federal National Mortgage Association (FNMA) pass-throughs. C) Minneapolis Housing Authority bonds. D) Treasury bills.

B Explanation The interest income from most U.S. government and agency securities is exempt from state and local—but not federal—taxes. Mortgage-backed securities (such as FNMA and GNMA obligations) are subject to federal, state, and local taxes. The interest on municipal issues (like the Minneapolis Housing Authority bonds) is exempt from federal taxes and, because this investor is a Minnesota resident, state taxes as well.

A customer wishes to close a short option position. The order ticket must be marked as A) an opening purchase. B) a closing purchase. C) an opening sale. D) a closing sale.

B Explanation The investor opened with a sale, so the position must close with a purchase.

If a customer buys a Mount Vernon Port Authority municipal bond in the secondary market at 109 and holds the bond to maturity, what are the tax consequences? A) Capital loss of $90 B) No capital gain or loss C) Capital gain of $9 D) Capital loss of $9

B Explanation The investor's cost basis of bonds purchased at a premium is adjusted by amortization of the premium. In this case, there is a $90 premium that will have been completely amortized at maturity. At maturity, the adjusted cost basis equals the face value, and no loss or gain is realized.

The largest portion of an underwriting spread is A) the stabilizing bid. B) the concession. C) the manager's fee. D) the underwriting fee.

B Explanation The largest portion of the spread is the concession.

If a registered representative is seeking to sell shares of an investment company to a client, which of the following statements would be accurate and permissible regarding her recommendation? When the client redeems his shares, he will not immediately know their dollar value. If the client invests just before the dividend distribution, he can benefit by receiving the added value of that dividend. If the client purchases the shares of two or more funds in the same family of funds, he may be entitled to a reduced sales charge. The purchase of Class B shares always provides the greatest return on investment. A) I and IV B) I and III C) II and IV D) II and III

B Explanation The purchase of two funds in the same family of funds may qualify an investor for combination privileges. At redemption, he will receive the next price calculated (forward pricing), which is not yet known. Class B shares, or deferred sales charge shares, may or may not provide the best return. Share class suitability can depend on the amount invested and the client's individual needs. Lastly, while the dividend is received if the fund shares are purchased before the ex-dividend date, there is no added value. The fund share price is reduced by the amount of the dividend on the ex-dividend date, just as it would be for a cash dividend paid on equity securities.

In March, a customer sells 1 ABC Oct 50 put for 3 and buys 1 ABC Oct 60 put for 11. The customer will experience a pretax profit from these positions if the difference between the premiums narrows to less than $8. the difference between the premiums widens to more than $8. both puts are exercised at the same time. both puts expire unexercised. A) II and IV B) II and III C) I and IV D) I and III

B Explanation This debit spread becomes profitable if the spread widens between the premiums. Credit spreads are profitable if the spread narrows between the premiums. If both puts are exercised, the spread is profitable. If the short 50 put is exercised, the customer buys the stock and sells it for 60 by exercising the long 60 put ($1,000 profit − $800 premiums = net $200 profit).

In early September, a customer buys 100 shares of MCS stock for $83 per share and simultaneously writes 1 MCS Mar 90 call for $4 per share. The customer will break even when MCS stock is at A) $94. B) $79. C) $87. D) $86.

B Explanation This is a covered call writer. If the stock rises above $90, the writer will be exercised and will make $700 on the stock (buy at $83, deliver at $90) and keep the $400 received in premiums. If the stock declines, the call expires unexercised. The writer can lose $400 on the stock (the premiums earned) and still break even. This occurs at $79 ($83 − $4). Breakeven is the cost of stock purchased minus premiums.

For which of the following would the net revenue-to-debt service ratio be applicable? A) Tax anticipation notes B) Hospital bonds C) General obligation bonds D) School bonds

B Explanation This is the coverage ratio. Because revenue bonds are only backed by funds generated by a specific source, it is important that net revenues exceed debt service requirements. Hospitals are often built with the proceeds of revenue bond issues.

If a customer buys 1 OEX Feb 350 call at 5, then sells 1 OEX Feb 335 call at 16 when the underlying index is at 344, the breakeven point is A) $340. B) $346. C) $342. D) $339.

B Explanation To determine a call spread, add the net premium to the lower strike price to find the breakeven point. The net premium is the difference between the premium paid (5) and the premium received (16), or 11 (335 + 11 = a breakeven point of 346).

Based on the exhibit below, what is Company JQZ's acid-test ratio? Company JQZ Current AssetsCurrent LiabilitiesCash16 MMAcct Payable52 MMAcct Receivable110 MMWages Payable12 MMInventory70 MMTaxes Payable7 MMInsurance Payable0.5 MMFixed AssetsLong-term LiabilitiesPlant & Equip292 MM1st Mortgage Bonds61 MMDepreciation64 MMUnsecured Debenture73 MM A) 2.68:1 B) 2.05:1 C) 1.76:1 D) 2.55:1

C Explanation Company JQZ's acid-test ratio is 1.76:1. The acid-test ratio (also known as the quick assets ratio) is calculated by subtracting the inventory from the current assets and dividing that total by the current liabilities. The sum of the current assets equals 196 MM ($196,000,000). Subtracting inventories (70 MM) equals quick assets of 126 MM. The sum of the current liabilities equals 71.5 MM. The acid-test ratio is calculated as 126 MM ÷ 71.5 MM = 1.76, or a ratio of 1.76:1. Some might find it easier to just add together all the current assets besides the inventory. That would be the cash ($16 million) plus the accounts receivable ($110 million) to arrive at the same $126 million of quick assets.

A client has purchased a nonqualified variable annuity from a commercial insurance company. Before the contract is annuitized, your client, age 60, withdraws some funds for personal purposes. What is the taxable consequence of this withdrawal to your client? A) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn B) Capital gains taxation on the earnings withdrawn in excess of the owner's basis C) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis D) A 10% penalty plus the payment of ordinary income tax on funds withdrawn in excess of the owner's basis

C Explanation Contributions to a nonqualified annuity are made with the owner's after-tax dollars. Distributions from such an annuity are computed on a last-in, first-out basis, with the income taxed first. Once the cost basis is reached, any further withdrawals are a nontaxable return of principal. Because the client is older than 59½ at the time of distribution, the additional 10% penalty tax is not incurred.

All of the following characteristics regarding industrial development bonds (IDBs) are true except A) the bonds are issued by municipalities or other governmental units. B) funds from the lease are used to pay the principal and interest on the bonds. C) the bonds are normally backed by the full faith and credit of the municipality. D) the funds are used to construct a facility for a private corporation.

C Explanation IDBs are issued by a municipality, and the proceeds are used to construct facilities or purchase equipment for a private corporation. The corporation leases the facilities or equipment, and funds from the lease are used to repay investors. In addition to a first mortgage on the property, IDBs are backed by the full faith and credit of the corporation (not the municipality).

Customers seeking to open an options account may have the account approved by A) the registered investment adviser managing the client's portfolio. B) the branch manager, only as long as they have a Series 10 registration or are a Registered Options Principal (ROP). C) the branch manager initially as long as it is subsequently approved by a principal who has a Series 10 registration or is a Registered Options Principal (ROP). D) the registered representative handling the account.

C Explanation In general, an options account will be approved by a Limited Principal with a Series 10 license or a Registered Options Principal (ROP). If the branch office manager is not a Registered Options Principal or a Limited Principal—General Securities Sales Supervisor, account approval or disapproval shall, within ten (10) business days, be submitted to and approved or disapproved by a Registered Options Principal or a Limited Principal—General Securities Sales Supervisor.

Your married customers, ages 48 and 50, have a combined annual income of more than $200,000. They are concerned about the effects of rising inflation, and because they are heavily invested in bonds, they seek to invest a portion of their portfolio in a fund that will provide additional diversification. Which of the following mutual funds is the most suitable for these customers? A) NavCo Tax-Free Municipal Bond Fund B) XYZ Government Income Fund C) ATF Overseas Opportunities Fund D) ABC Investment-Grade Bond Fund

C Explanation Investment in an overseas equity fund will provide diversification not necessarily subject to U.S. inflation. The tax-free fund will not provide additional diversification or the best hedge against inflation. A high-grade bond fund will not add diversification.

Once exercised, a contract may not be traded to another individual. The assigned party must either deliver (for a ____) or buy (for a ____) the stock in ___ business days

Once exercised, a contract may not be traded to another individual. The assigned party must either deliver (for a call) or buy (for a put) the stock in two business days (regular way settlement for stock transactions).

A UK company exports sweaters to the U.S. and will be paid in U.S. dollars upon delivery. To hedge foreign-exchange risk using listed currency options, the UK company should A) sell British pound puts. B) sell British pound calls. C) buy British pound calls. D) buy British pound puts.

C Explanation Normally, exporters buy puts on foreign currency to hedge. There are no listed currency options available on the U.S. dollar, so the British company should buy calls on its own currency.

You are having a discussion with one of your clients regarding suitable investments. The client is in a high-income tax bracket and has a high net worth as well. During the conversation, your client mentions several investments that she is thinking about that might be beneficial to her now. Of those listed, which would be the best recommendation? A) Noninvestment-grade corporate bonds B) A corporate blue-chip balanced mutual fund C) Municipal bonds D) A real estate investment trust (REIT)

C Explanation Of the choices listed, only municipal bonds offer a tax consequence suitable for high-income, high-net-worth investors in the form of tax-free interest payments. Corporate bond interest, mutual fund dividends, and income earned from REITs are all taxable.

Pooling assets such as auto loans and mortgages into investment vehicles for sale to the public is the process known as A) monetization. B) aggregation. C) securitization. D) capitalization.

C Explanation Pooling assets, such as mortgages and various other types of loans into financial instruments allows them to be sold to general investors more easily than selling them individually. This process is called securitization. Remember, if someone owes you money, it is their debt but your asset.

A technical analyst is concerned with all of the following trends except A) support levels. B) reversals. C) price-to-earnings (P/E) ratios. D) changes in the DJIA.

C Explanation Technical analysts are more interested in forecasting market trends and securities prices than in studying individual corporations. Therefore, they are concerned with market prices, trading volumes, changes in the Dow Jones Industrial Average, reversals, support and resistance levels, advance/decline lines, short interest, and many other factors that might help them with buying and selling decisions. Fundamental analysts, on the other hand, concentrate on a stock's intrinsic quality and are concerned with P/E ratios and earnings per share.

The name of the FINRA system that tracks both NYSE and NASDAQ transactions is A) TRACE (Trade Reporting and Compliance Engine). B) OATS (Order Audit Trail System). C) TRF (Trade Reporting Facilities). D) DMM (Designated Market Maker).

C Explanation The TRF is the only FINRA system that tracks transactions on the NYSE and Nasdaq, including OTC (over-the-counter) transactions. OATS only tracks Nasdaq transactions. TRACE tracks corporate and government agency bond transaction in the OTC market. DMM's are the specialists who work at each of the trading posts on the NYSE. They are responsible for maintaining a liquid and orderly market for stocks.

A trade for 325 shares may be settled by all of the following deliveries except A) 3 certificates for 90 shares, 3 for 10 shares, and one for 25 shares B) 325 one-share certificates C) 4 certificates for 80 shares and one for 5 shares D) one certificate for 300 shares and 5 certificates for 5 shares

C Explanation The Uniform Practice Code requires that deliveries be made in certificates that can be aggregated into lots of 100s or multiples of 100. There is no way to take the 80s and the 5 and make a lot of 100. With 325 one-share certificates (like paying a bill with pennies), you can make three separate stacks of 100 and then one of 25. The 90s and 10s can be aggregated and give three stacks of 100 with the final 25 being in one certificate. The 300-share certificate is a multiple of 100, and the remaining certificates add up to the odd lot of 25 shares.

An investor purchases a GFC Jan 40 call @ 4 and sells a GFC April 30 call @ 9. This is an example of A) a vertical spread. B) a horizontal spread. C) a diagonal spread. D) a variable hedge.

C Explanation The investor has created a diagonal spread. An investor that buys and sells the same type of option has created a spread. If the strike prices and/or the expiration months of the options are different, it is a diagonal spread.

A customer bought a 10% interest in a real estate limited partnership by investing $100,000. The partnership buys a $4 million property with the funds, making a down payment of $800,000 and financing the balance with a nonrecourse mortgage of $3.2 million. Subsequently, the partnership cannot meet the mortgage payment; the lender forecloses when the remaining mortgage balance is $3 million, auctioning off the property for $1 million. How much of the investment will the customer recover? A) $10,000 B) $32,000 C) $0 D) $100,000

C Explanation There is a lot more information in this question than necessary. Simply put, the deal went bankrupt—the asset was sold for less than the mortgage. That means the investor's $100,000 is totally lost.

To be exempt under Regulation D of the Securities Act of 1933, the sale of securities must be limited with respect to the number of A) agents authorized to sell the security. B) shares issued. C) broker-dealers who offer the securities. D) nonaccredited investors to whom the security is sold.

D Explanation Regulation D provides a private placement exemption for securities that are sold to no more than 35 nonaccredited investors. There is no limit to the number of shares that can be issued or the number of accredited investors who may purchase the shares.

If a customer sells $5,000 worth of stock in a restricted margin account, the special memorandum account (SMA) will be A) credited by $5,000. B) debited by $2,500. C) credited by $2,500. D) debited by $5,000.

C Explanation When securities are sold in a restricted account, 50% of the proceeds are credited to SMA. In other words, the customer is permitted to remove 50% of the proceeds from the account, but the balance must remain in the account to reduce the debit balance.

Which of the following positions meets the IRS definition of a married put? A) Buy 100 shares of ABC at $50 per share and simultaneously sell one ABC 50 put B) Buy one ABC 50 put and sell one ABC 55 put C) Buy one ABC 50 call and buy one ABC 50 put D) Buy 100 shares of ABC at $50 per share and simultaneously buy one ABC 50 put

D Explanation A married put is a specific type of protective put. Anytime a put option is purchased while the investor is long the underlying stock, it is considered a protective put because it is a hedge against a move to the downside. When the put and stock are bought at the same time, the strategy is known as a married put and has a special tax benefit. Normally, purchasing a put option on stock held less than the long-term holding period causes the existing holding period on the stock to be erased. In the case of the married put, the holding period of the stock is not affected.

A customer would buy index calls if she is A) bearish on a particular blue-chip stock. B) bullish on a particular over-the-counter stock. C) bearish on the Fortune 500 stocks. D) bullish on the broad market.

D Explanation An index option is based on the value of the broad market, not the value of an individual security. A person who believes the overall market is rising could take a bullish position and buy calls on the index's value.

All of the following actions must be completed before a customer entering her first option trade except A) delivery of an Options Clearing Corporation disclosure booklet. B) approval by a sales supervisor. C) completion of the new account form. D) completion of the options agreement.

D Explanation Customers do not have to complete (sign) the options agreement before entering an order, although under exchange rules, the agreement must be signed and returned by the customer within 15 days of account approval.

One broker-dealer receives a don't know (DK) notice from another. Which of the following would be a reason for a DK to be sent? A) The broker-dealer who sent the DK wants to know if the other broker's customer wants to trade more stock at the same price. B) The broker-dealer who sent the DK is alerting the other broker that one of their clients has opened a new account with them. C) The broker-dealer who sent the DK is confirming that the trade specifications are good. D) The broker-dealer who sent the DK was expecting 200 shares of ABC common stock and received 200 shares of ABC preferred shares.

D Explanation DKs are sent between brokers when a delivery is made that is not expected or when the specifications of the delivery do not match what was expected.

An individual who invests in an undeveloped land limited partnership would be most interested in A) operating expense deductions. B) depreciation. C) depletion. D) appreciation.

D Explanation Investors seek appreciation when investing in undeveloped land limited partnerships.

According to modern portfolio theory (MPT), an investor can reduce the level of risk through diversification. Adding which of the following securities would tend to reduce the portfolio's overall risk? A) A security with a leveraged correlation B) A security with equal correlation C) A security with positive correlation D) A security with negative correlation

D Explanation MPT states that the lower an asset's correlation to the overall portfolio, the greater the diversification. Greater diversification equals lower risk. Adding a security with a negative correlation offers the lowest risk. Adding a security to the portfolio that has a -1.0 correlation reduces the overall risk due to the greater diversification. The higher the security's positive correlation, the less diversification, leading to greater risk.

Which of the following statements regarding nonsystematic risk are true? It is the risk that an individual stock will not perform well. It is the same as market risk. Diversification reduces it. Diversification does not reduce it. A) II and III B) II and IV C) I and IV D) I and III

D Explanation Nonsystematic risk is company risk—the risk that an individual investment will perform poorly. Diversification can reduce most nonsystematic risks.

Which of the following orders would not be reduced on the order book on the ex-dividend date for a cash dividend? Buy limit order Open sell stop order Buy stop order Sell limit order A) I and IV B) II and III C) I and II D) III and IV

D Explanation Open sell limit orders and open buy stop orders, which are placed above the current market, will not be reduced on the order book when a stock goes ex-dividend for a cash dividend.

SEC Regulation 14E requires that tender offers be open for at least A) 30 calendar days. B) 15 calendar days. C) 10 business days. D) 20 business days.

D Explanation Regulation 14E requires that tender offers be open for at least 20 business days and remain open for at least 10 business days after any change to the offering price.

Which of the following would be considered in analyzing the credit worthiness of a revenue bond issuer? Per capita debt Debt service coverage Management Debt to assessed valuation A) I and II B) III and IV C) I and IV D) II and III

D Explanation Revenue bonds are paid out of revenues from a particular project or facility, not from tax revenue. Therefore, debt service coverage and the personnel in charge of managing the facility are important. Overall debt of the issuer would be important in analyzing a general obligation bond backed by the issuer's full faith and credit.

The Bond Buyer's revenue index is which of the following? A) Yields of municipal revenue bonds with 20 years to maturity B) A daily composite average of municipal revenue bond yields C) A daily balance of municipal revenue bond prices D) Yields of municipal revenue bonds with 30 years to maturity

D Explanation The Bond Buyer's revenue index is an average yield of 25 revenue bonds with 30 years to maturity.

The interest on which of the following instruments is subject to taxation at the federal, state, and local levels? A) Revenue bonds B) Public Housing Authority bonds C) Treasury notes D) Collateralized mortgage obligations (CMOs)

D Explanation The interest on corporate debt securities is subject to taxation at the federal, state, and local levels, and CMOs are issued by corporations. Interest on Treasury instruments is taxable at the federal level only. Interest on municipal instruments is exempt from taxation at the federal level, and possibly the state level, if the holder is a resident of the state of issue. Public Housing Authority bonds and revenue bonds are types of municipal issues, which are tax free at the federal level.

An investor purchased 100 shares of ABC common stock at $50 per share on June 17, 2019. On May 11, 2020, with the ABC selling at $60, the investor hedges by purchasing one ABC Oct 55 put at 2. Immediately prior to the expiration date, ABC is selling for $45 per share and the put option is exercised using the long stock for delivery. This would result in A) a long-term capital gain of $500. B) a short-term capital gain of $500 and a short-term capital loss of $200. C) a long-term capital gain of $300. D) a short-term capital gain of $300.

D Explanation The investor purchased a protective put against a long position that had a short-term holding period. That means the holding period of the stock is erased and does not restart until the earliest of the date the investor disposes of the stock, exercises the put, sells the put, or the put expires. That means this investor's gain will be short term. The gain is the difference between the cost and the proceeds. When exercising a put, the cost of the stock is the investor's cost basis. The exercise price minus the option premium paid is the sale price. In our question, the cost is the $50 initial purchase price ($5,000 total). The sale price is the 55 strike minus the $2 premium, or $5,300. That results in a short-term capital gain of $300.

Due to a distribution of stock, the contract size in the JGH Oct 50 call options is 108. A customer purchasing one of these contracts for a premium of 2½ would expect to pay A) $258. B) $250. C) $330. D) $270.

D Explanation With a contract size of 108 shares (likely from an 8% stock dividend) and a premium of $2.50 per share, the total cost is $270. Regardless of the reason for the contract size being other than 100 shares, the price paid for an option is always the premium multiplied by the number of shares in the contract. In this question, that would be a premium of $2.50 per share (2½) times 108 = $270.00.

An investor purchased 100 shares of AMNZ stock five years ago at $200 per share. With AMNZ currently selling at a price in excess of $1,000 per share, the investor would like to generate some income. Which of the following strategies would you recommend? A) Sell an AMNZ put B) Buy an AMNZ call C) Buy an AMNZ put D) Sell an AMNZ call

D Explanation The only way to generate income is to sell something. Because the investor already owns 100 shares of AMNZ, selling a put is probably not the right suggestion. If the stock price goes down, the put will be exercised and the investor will have to buy 100 shares of the stock at the strike price. Selling the call while owning the underlying stock makes this a covered call. It provides income from the premium and offers some downside protection. If the stock goes up, the option will likely be exercised and the investor will have to deliver the stock purchased years ago. This will result in a long-term capital gain equal to the difference between the investor's cost ($200) and the proceeds received (the strike price plus the premium).

The derivative-based strategy known as portfolio insurance involves A) the purchase of a call on the underlying security position. B) the sale of a put on the underlying security position. C) the sale of a call on the underlying security position. D) the purchase of a put on the underlying security position.

D Explanation The purchase of a put option to hedge the downside risk of an underlying security holding is called a protective put position, one of many derivative-based strategies collectively known as portfolio insurance.

A client writes 1 Jan 60 put and buys 1 Jan 50 put. This is A) a debit bear spread; the investor breaks even at a price greater than 60. B) a credit bull spread; the investor breaks even at a price less than 50. C) a debit bear spread; the investor wants the price fall below 50. D) a credit bull spread; the investor wants the price to stay above 60.

D Explanation This is a put credit spread, and bulls sell puts. The 60 put is worth more because it has a higher strike price. Long the lower put is bullish; short the lower put is bearish.

An index option differs from an equity option in that A) trading ends earlier in the day. B) premiums tend to be somewhat higher. C) they use European-style exercise. D) the exercise settlement is in cash.

D Explanation When an index option is exercised, settlement takes place in cash on the next business day.

Customer A and Customer B both have an open account in a mutual fund that charges a front-end load. Customer A has decided to receive all distributions in cash, while Customer B automatically reinvests all distributions. How do their decisions affect their investments? Receiving cash distributions may reduce Customer A's proportional interest in the fund. Customer A may use the cash distributions to purchase shares later at net asset value (NAV). Customer B's reinvestments purchase additional shares at NAV rather than at the offering price. Due to compounding, Customer B's principal will be at greater risk. A) I and III B) II and III C) I and IV D) II and IV

A Explanation If the customer elects to receive distributions in cash while other investors purchase shares through reinvestment, the customer's proportional interest in the fund will decline. The option to have distributions automatically reinvested allows those purchases to be made at NAV, but a purchase made later would be made at the public offering price like any other new purchase.

Compared with selling short, it would not be correct to state that buying a put option A) offers a high potential profit. B) has a lower loss potential. C) does not require meeting the locate requirement for short sales. D) requires a smaller capital commitment.

A Explanation In both cases, the investor profits when the price of the underlying asset declines. The maximum profit is when the price of the asset reaches zero. That makes the maximum profit on the long put equal to the strike price minus the premium. Because there is no cost in selling short (the margin deposit requires a capital commitment, but is the investor's money), the maximum profit is the entire decline to zero. For exam purposes, we disregard commissions. Buying a put requires a smaller capital commitment than does shorting the stock and has a lower loss potential (the premium only) because selling short involves unlimited risk. When selling stock short on an exchange, the shares to be borrowed must be located before the sale. This is not a requirement when buying a put.

An investor, age 36, has a net worth of $650,000, with an annual income of $65,000. Wanting to add to an existing portfolio, the investor is not concerned about generating more income, as that seems to be adequate already. However, the investor does note that keeping taxes to a minimum is an objective. Which of the following funds would be the most suitable, given the investor's objectives? A) Fund X: invests in companies with long-term growth potential; turnover ratio of 25% B) Fund W: invests in utility companies; turnover ratio of 25% C) Fund Z: invests in preferred shares; turnover ratio of 50% D) Fund Y: invests in companies that have capital appreciation potential; turnover ratio of 100%

A Explanation This investor is not concerned about income. This would eliminate the utility and preferred share funds (Fund Z and Fund W). Of the remaining two funds, Fund X and Fund Y both have the same general objective, but the one with the lower turnover ratio would generate less tax liability. The portfolio turnover ratio reflects a fund's holding period of securities being bought and sold by the fund manager. If a fund has a turnover ratio of 100%, the entire portfolio is likely to turn over in a year, and capital gains distributions are likely to be short term and subject to the maximum tax rate. That increases the tax liability, and therefore, is not the best option. By contrast, a 25% turnover ratio means the average holding period of the securities in the portfolio is four years. This would mean that any capital gains distributions are more likely to be long term and subject to a lower tax rate.

A customer holds the following positions: Short 100 XYZ shares at 40 Short 1 XYZ Oct 40 put at 5 With XYZ trading at 35, the customer is assigned an exercise notice on the put, and he uses the stock purchased to cover the short stock position. This results in A) a $500 gain. B) a $1,000 loss. C) a $500 loss. D) a $1,000 gain.

A Explanation When exercised, the customer is forced to buy stock at 40 that is used to cover the short position for no gain or loss. Because the premium of $500 was received, the investor has a gain of $500 on this position.

A customer who has contributed to an IRA and an employer matching 401(k) plan continuously for many years, wants to purchase an annuity contract to add additional monthly income once retired. Given that all of the current retirement investments are subject to market risk, the customer wants these new funds to have no market risk exposure. One of the following options would achieve that objective, but a suitability discussion regarding its risk should also occur. Which option is it? A) Variable annuity contract with a discussion regarding legislative risk B) Fixed-annuity contract with a discussion regarding purchasing power risk C) Variable annuity (VA) contract with a discussion regarding interest rate risk D) Fixed-annuity contract with a discussion regarding timing risk

B Explanation A VA with its investments in the separate account subject to market risk would not align with the customer's objective. Therefore, only a fixed annuity could be considered as suitable. However, a discussion should occur regarding the risks that are associated with a fixed annuity: purchasing power risk. The fixed payment that the annuitant receives loses purchasing power over time as a result of inflation.

In rating a general obligation (GO) bond, all of the following factors would be considered by an analyst except A) the total outstanding debt. B) the flow of funds. C) the tax collection ratio. D) the public's attitude toward debt.

B Explanation GO bonds are backed by the full faith and credit of a municipal issuer, which is based on its ability to levy and collect taxes. Therefore, among the considerations for an analyst, total outstanding debt, the tax collection ratio, and the public's attitude toward more municipal debt are prominent. The flow of funds is one of the protective covenants associated with municipal revenue bonds.

Which of the following is not included in the definition of an investment company under the Investment Company Act of 1940? A) An open-end fund B) A hedge fund C) A closed-end fund D) A unit investment trust

B Explanation Hedge funds do not meet the definition of investment company as described in the act. The three types of investment companies are the face amount certificate company, the unit investment trust, and the management investment company (closed-end and open-end).

All of the following statements regarding a market not-held order are true except A) it gives the floor broker discretion over the price or time of execution. B) it is given to a specialist (designated market maker). C) a small portion may be filled at a time. D) the order ticket must be marked, not held.

B Explanation In a market not-held order, the client agrees not to hold the broker responsible if she cannot fill the complete order. Such an order allows the floor broker to use her judgment on the best execution strategy. Specialists (designated market makers) cannot accept market not-held orders.

The MSRB classifies municipal securities into two categories: notes and bonds. They define bonds as any municipal debt security with a maturity of A) 10 years or more. B) 5 years or more. C) 1 year or more. D) 2 years or more.

B Explanation Municipal notes have a maximum maturity of less than five years. Once the municipal security is issued with a maturity of 5 years or longer, it is considered a municipal bond.

A client, age 27, is new to investing. With $20,000 saved thus far and $400 to allocate toward investing monthly, his goal is to purchase a home in three to five years. Which is the most suitable recommendation? A) Invest in both equity and corporate debt mutual funds so that a portfolio of stocks and bonds is established. B) Invest in a money market mutual fund to build up more cash reserves. C) Open a long margin account to take advantage of the leverage that margin purchases can create using small amounts of money. D) Use leveraged index funds (2 or 3×) to maximize gains potential for the small investment amounts.

B Explanation Securities or strategies with longer time horizons than that of the goal to purchase a home should not be used until the client has established more liquid cash reserves. The money market mutual fund would be most appropriate because it is liquid and conservative. The balanced fund is not appropriate for someone with a two- to five-year goal, and margin accounts or leveraged funds entail risk unsuitable for a conservative investor with a short investment time horizon.

Several years ago, an investor purchased 100 shares of XYZ stock at $50 per share. XYZ is now trading at $90. Although the investor is still bullish on the stock, there is a concern that there might be a retreat after the next earnings report is released. Which of the following options strategies would provide some downside protection at no cost to the investor? A) Write an XYZ 90 put B) Write an XYZ 90 call C) Buy an XYZ 90 call D) Buy an XYZ 90 put

B Explanation The best downside protection would come from buying the XYZ 90 put. However, buying the put would mean paying a premium and the question specifies "at no cost." That leaves the two short choices as the only possibilities. When you are long the stock, writing a covered call produces income. The income protects the downside to the extent of the premium received. Writing a put will also generate income. However, if the stock price goes down (something the investor is concerned about), the put will be exercised and the investor will have to buy an additional 100 shares at the strike price. Therefore, this position does not offer any downside protection.

ASK COACH A customer is short 10 ABC Dec 50 calls at 2.50 and short 10 ABC Dec 50 puts at 3.50. Before expiration, ABC declines to 40.50, and the customer is assigned on his put position while his short calls expire worthless. A month later, he liquidates his long position at 45 for A) a loss of $1,500. B) a gain of $1,000. C) a loss of $7,500. D) a gain of $7,500.

B Explanation The customer opens two short positions on 10 contracts each, so his account is credited with premiums of $2,500 for the calls and $3,500 for the puts. The calls expire worthless, but the short puts are exercised, so the investor must buy the stock at the strike price. This results in a debit of $50,000 ($5,000 per contract × 10 contracts), and the stock is then sold at a credit of $45,000.

An investor opens the following options position: Buy 1 BOB Jan 60 call @4; Buy 1 BOB Jan 55 put @2½. What is the investor's maximum gain, maximum loss, and breakeven point? A) Maximum gain is unlimited; maximum loss = $650; breakeven points are $53.50 and $61.50. B) Maximum gain is unlimited; maximum loss = $650; breakeven points are $48.50 and $66.50. C) Maximum gain is unlimited; maximum loss is $1,800; breakeven points at $48.50 and $66.50. D) Maximum gain is $650; maximum loss is unlimited; breakeven points are $53.50 and $61.50.

B Explanation The first step is to identify the position. This is a long combination—a long put and a long call with different terms. That means we are going to have two breakeven points. The maximum gain is unlimited because one of the positions is a long call. The maximum loss is the amount paid for the combination (the two premiums totaling $650). Breakeven follows the call-up and put-down rules. Add the premium to the strike of the call ($60 + $6½ = $66.50) and subtract the premium from the strike of the put ($55 ‒ $6½ = $48.50).

Which of the following statements regarding Treasury receipts are true? Interest is paid annually. Interest is paid at maturity. Interest is taxed annually. Interest is taxed at maturity. A) I and III B) II and III C) II and IV D) I and IV

B Explanation Treasury receipts are zero-coupon bonds issued by broker-dealers. Zero-coupon bonds pay all of their interest at maturity. They are issued at a discount and redeemed at par, and the difference represents the interest earned. For zeroes with a maturity of more than one year, the interest (or discount) must be accreted each year—and is taxable that year as income. This is called imputed interest.

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

B Explanation Unlike listed options, unlisted options do not trade continuously in an organized secondary market; trades are negotiated between individuals.

A client bought 100 XYZ at $65 per share and sold an XYZ 65 call at 8. Closing the short call at 10 and selling XYZ at 68 would result in A) a $500 profit. B) a $100 loss. C) a $100 profit. D) a $500 loss.

C Explanation Let's use the T-chart to show the flow of the money. The client bought 100 shares of the stock at $65 per share, so $6,500 went out (a debit). At the same time, the call was sold for a premium of 8, which brought in $800 (a credit). The short call was closed out (bought back something you sold) at 10, so we put $1,000 in the out (DR) column, and the stock was sold for $6,800, which goes in the in (CR) column. That means, $6,500 plus $1,000 went out, and $6,800 plus $800 came in. That is a total of $7,500 out and $7,600 in, for a net gain of $100.

A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor withdraws $25,000. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $6,250. B) $0.00 C) $8,750 D) $17,500.

C Explanation Only the deferred growth is taxable on a LIFO (last-in, first-out) basis. In this case, it is the amount of the withdrawal in excess of the cost of $25,000. Using LIFO, all of the withdrawal is part of the $47,000 in earnings that have been generated. That $25,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is under 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $25,000. Remember, all annuities are nonqualified unless stated otherwise in the question.

Your client makes two municipal bond purchases from your firm's trading desk. One of the bonds has a nominal yield of 5% and a basis of 6%. The other has a coupon rate of 7.5% and a yield to maturity of 6%. If your client holds both bonds to maturity, the tax consequences when receiving the principal will be A) a capital gain on the first bond and no capital loss on the second one. B) a capital gain on the first bond and a capital loss on the second one. C) no gain and no loss. D) tax-free income on the first bond and no capital loss on the second one.

C Explanation The first bond is selling at a discount. We know that because the basis (yield to maturity) of 6% is higher than the coupon or nominal rate of 5%. The second bond is selling at a premium. We know that because the yield to maturity (basis) of 6% is lower than the coupon or nominal rate of 7.5%. Because the bonds were purchased from the firm's trading desk, we know these are secondary market trades rather than a purchase of new issue from the syndicate. Municipal bonds purchased in the secondary market at a discount have that discount accreted and taxed as ordinary income each year. By maturity date, the discount has been fully accreted, so there is no gain and no loss. The same is true with municipal bonds purchased at a premium. The premium is amortized each year over the life of the bond so that at maturity there is no gain and no loss.

An investor opens the following options position: Long 1 PKE Apr 60 put @4 and short 1 PKE Apr 55 put @2. What is the investor's maximum gain, maximum loss, and breakeven point? A) Maximum gain is $300; maximum loss is $200; breakeven point is $57.00. B) Maximum gain is $200; maximum loss is $300; breakeven point is $58.00. C) Maximum gain is $300; maximum loss is $200; breakeven point is $58.00. D) Maximum gain is $200; maximum loss is $300; breakeven point is $57.00.

C Explanation The first step is to identify the position. This is a debit put spread. It is a debit spread because the option purchased cost more than the one sold. The debit of $200 is the most the investor can lose. This is a bear put spread. We know that because the investor purchased the option with the higher strike price and sold the one with the lower strike price. The goal is for the stock's price to decline to the point where both options are exercised. For example, if the market price of PKE should fall below 55, the owner of the 55 put will exercise, causing the seller to purchase the stock for $5,500. The seller can then exercise the long 60 put and deliver the stock purchased at 55 for 60. That is a profit of $500 less the cost of the options (the debit of $200), or $300. The quick way to do this is to subtract the net premium (the $200 debit) from the difference in strike prices (5 points) and the result is the same $300 profit. The breakeven point follows the put-down rule. Subtract the net premium (the $2 debit) from the higher strike price, resulting in a breakeven point at $58.

The management fees paid by an investment company are part of A) the sales load. B) the custodial fees. C) the operating expense of the fund. D) the underwriting agreement.

C Explanation The management fees paid by an investment company are part of the operating expenses of the fund. Custodial fees are also part of the operating expenses. A sales load is a selling cost contained within the underwriting agreement.

Which of the following may be affected when a company buys machinery for cash? Shareholders' equity Current assets Total liabilities Working capital A) I and IV B) I and III C) II and IV D) II and III

C Explanation The purchase of machinery for cash will reduce current assets and working capital.

Under SEC Rule 17a-4, all of the following records must be retained for 6 years except A) the general ledger. B) blotters. C) trial balances. D) the stock record.

C Explanation Trial balances are a 3-year record. Six-year records include blotters, the general ledger, the stock record, customer statements, and customer account information.

The City of Podunk has an outstanding 25-year maturity issue that is callable in seven years. It has prerefunded the issue and established an escrow account containing the proper government securities with face amounts and maturities approximating the call provisions of the original issue. In quoting the original issue, which of the following must be used? A) Current yield B) Yield to maturity C) Yield to call D) The lower of the yield to call or the yield to maturity

C Explanation When a bond issue is prerefunded, the issuer is going to redeem the bond on the first call date. The yield must be quoted to call.

If a customer buys 100 shares of stock and writes one out-of-the-money call against her long position, the breakeven point is A) the strike price less premium. B) the strike price plus premium. C) the cost of stock purchased less premium. D) the cost of stock purchased plus premium.

C Explanation When the investor owns stock and sells a call, the call is covered. Breakeven is computed by subtracting the premium from the stock's purchase price.

An investor sells short 100 shares at 50 and sells a 50 put at 5. If the put is exercised when the stock is trading at 45, the investor realizes A) neither a gain nor a loss. B) a gain of $1,500. C) a gain of $500. D) a gain of $1,000.

C Explanation When the short put is exercised, the investor buys stock at $50 that she can use to cover the $50 short sale. The investor realizes no gain or loss on the stock, but she collected $500 in premiums, for a gain of $500.

One of your customers has made periodic purchases of shares of the Castel Growth Fund over the past several years. The customer has decided to take a profit and sell some of those shares. When the investor's tax return is prepared for the year in which the sale of those shares occurs, it is necessary to establish a cost basis of the shares sold. Which of the following methods is available for mutual funds, that is not available for determining the cost basis of stock? A) FIFO B) Dollar cost averaging C) Share identification D) Average cost basis

D Explanation The Internal Revenue Service allows using the average cost basis to determine the cost basis of redeemed mutual fund shares. Investors cannot use this method when selling shares of any security other than a mutual fund. The other methods of determining cost basis are FIFO and share identification. FIFO is the default method used by the IRS if an investor fails to choose. Share identification can frequently result in a lower tax bill, especially if the security was purchased at different intervals at varying prices.

The type of REIT in which the issuer purchases real estate properties that produce income as well as mortgages on income-producing real estate properties is A) an equity REIT. B) a mortgage REIT. C) a participating REIT. D) a hybrid REIT.

D Explanation A hybrid REIT receives its name from the fact that it combines the strategy of an equity REIT and a mortgage REIT. On the equity side, it takes an ownership position in real estate properties. The goal is income from rentals with possible capital appreciation when the properties are sold in the future. On the mortgage side, they provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities (MBS) and earning income from the interest on these investments. Therefore, the hybrid REIT deserves the name because it is a mixture of both types of REITs. A participating trust has nothing to do with REITs and will not be the subject of a question on your exam.

Which of the following are defined as securities? Fixed annuities Variable Annuities Options Bank CDs insured by the FDIC A) II and IV B) I and IV C) I and III D) II and III

D Explanation A security is any investment for profit with management performed by a third party. In addition, an element of risk must be present. Fixed annuities are not considered securities, as return is guaranteed by the insurance company issuer. Similarly, CDs are insured, thereby eliminating risk and guaranteeing a return.

If a customer establishes a debit spread, the customer profits if the spread widens. the spread narrows. the option expires. the options are exercised. A) II and IV B) II and III C) I and III D) I and IV

D Explanation Because debit spreads are closed as credits, the customer profits if the spread widens. In addition, to realize maximum profit, both contracts must be exercised. If they expire, the customer loses the net debit paid for a maximum loss.

A Japanese manufacturer sells recorders to a U.S. retailing firm. The manufacturer is to receive USD$1 million in 90 days. How can he best protect himself against a decline in the dollar? A) Sell yen calls B) Sell yen puts C) Buy yen puts D) Buy yen calls

D Explanation Because he is receiving U.S. dollars, his risk is that the U.S. dollar will go down in value against the Japanese yen. If the dollar goes down against the yen, the yen will rise. Therefore, to protect his risk against a rising yen, he should buy yen calls. The yen calls will increase in value if the yen rises.

The unqualified legal opinion on a municipal bond states that A) the bond has passed the additional bonds test (parity test). B) the bond is marketable. C) the issuer is creditworthy. D) the issuer has the authority to issue bonds that are legal, valid, and enforceable obligations of the issuer.

D Explanation Bond counsel attests that, to the best of its knowledge, the issuer has the legal right to issue the securities in question. In the case of tax-exempt bonds, the interest the issuer will pay on the bonds is exempt from federal taxation, and the bonds are exempt from federal registration requirements. The legal opinion does not go to the issue's marketability—or safety—debt service requirements.

A registered representative left ABC Securities in order to work for MNO Securities. Six months later, the representative contacted a former client in an attempt to gain the client's business at MNO Securities. MNO A) must provide educational materials regardless of contact method. B) may not continue further contact with ABC's customer. C) must provide educational materials to the customer if the contact was made in writing. D) does not need to provide educational materials about the transfer.

D Explanation Educational material only needs to be provided if contact is made with the customer within three months of the representative's employment with the new firm.

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

D Explanation Establishing a JTWROS account allows for the transfer of assets to the survivor upon death. The surviving spouse is not taxed on assets transferred in this manner because under current tax law, there is an unlimited marital deduction.

The principal tax benefit of investing in an exploratory oil and gas drilling program is derived from A) depreciation expenses. B) recapture. C) capital appreciation. D) intangible drilling costs (IDCs).

D Explanation IDCs, which are a significant portion of all drilling costs, are a major tax advantage to a limited partner and are tax deductible in the year in which they are incurred. IDCs are costs that, after incurred, hold no salvage or ongoing value. Examples include labor and geological survey.

Paying for a securities transaction with all of the following could raise concern about the possibility of money laundering except A) a postal money order. B) a travelers' check. C) cash. D) a personal check.

D Explanation If the amount is large enough, the use of currency to pay for a securities transaction could be a "red flag" indicating potential money laundering. Personal checks are not included as currency for purposes of the money laundering rules because the source of funds is easily traceable.

Which of the following would be considered improper by FINRA? A) A registered representative giving a $500 wedding gift to her brother who is one of her clients. B) A mutual fund distributor offering a member firm a free training seminar held at the distributor's home office for up to two representatives selected by the member firm. C) A member firm awarding a $1,000 cash bonus to any employee who, during the next month, sells at least $100,000 of any mutual funds the firm has sales agreements with D) A member firm awarding a $1,000 cash bonus to any employee who, during the next month, sells at least $100,000 of the company's proprietary mutual fund

D Explanation No compensation, especially in the form of a bonus, may be conditioned on the sale of a specific product. This is particularly egregious behavior when the product is proprietary. Paying a $1,000 bonus for reaching a sales goal is fine, as long as no specific product is targeted. Training seminars, even with all expenses paid by a fund distributor, are fine as long as the firm selects the attendees based on other considerations than sales of that distributor's funds and the location is appropriate. It would be hard for FINRA to fault this wedding gift to a brother in spite of the client relationship.

The Investment Company Act of 1940 prohibits a closed-end management investment company from pursuing all of these activities except A) holding more than 3% of another investment company's outstanding shares. B) buying securities on margin. C) taking short positions in securities. D) paying dividends.

D Explanation Paying dividends is an acceptable activity of any management investment company. Indeed, most of them function as regulation investment companies where, under the conduit theory, they must pay out at least 90% of their net investment income in the form of dividends to shareholders. No registered investment company may purchase securities on margin. Closely related to that is the prohibition against selling short (which must be done in a margin account). A fund may not own more than 3% of the outstanding shares of another investment company.

Five years ago, the ABCD mutual fund bought 200,000 shares of Comet Industries at an average price of $42.25. After a series of accounting scandals, the shares are now trading at $6. If the fund decides to sell its shares, what will be the impact of the sale of Comet shares on the net asset value (NAV) of the ABCD fund? A) This depends on whether the fund can claim a tax loss on the sale B) The NAV will rise C) The NAV will fall D) The NAV will not change

D Explanation Portfolio holdings in a mutual fund are marked to the market each day. Therefore, the NAV of the fund already reflects the current value of each security in its portfolio, including Comet Industries. When the fund sells the position, the value of the stock is replaced by an equivalent amount of cash, so NAV does not change.

Which of the following are excluded from the Trade Reporting and Compliance Engine (TRACE) reporting requirements? A) Collateralized mortgage obligations (CMOs) B) Government agency bonds C) Asset-backed securities (ABSs) D) Money market securities

D Explanation TRACE is the FINRA-approved trade reporting system for corporate, government agency, and Treasury securities trading in the over-the-counter (OTC) secondary market. While most corporate debt securities, ABS, and CMOs are TRACE-eligible, there are exclusions, such as debt of foreign governments, money market instruments, and debt securities that are not Depository Trust Company eligible.

An investor purchases 100 shares of a bond ETF at a price of $50 per share on September 5, 2019. On November 1, 2019, and February 1, 2020, the fund distributes a $0.50 per share dividend. On May 11, 2020, the investor sells all the shares at $57 per share. What are the 2020 tax consequences of the sale? A) Short-term capital gain of $600 B) Short-term capital gain of $700, interest income of $50 C) Short-term capital gain of $700, dividend income of $50 D) Short-term capital gain of $700

D Explanation Taxation of an ETF is similar to that of a mutual fund. The question asks about the tax consequences of the sale, so we ignore the dividend distributions. Buying at $50 per share in September and selling at $57 per share the next May is a $700 capital gain over a period of less than one year. It is not part of the question, but the dividends would be taxed as interest because they are coming from bonds.

An investor has an established margin account with a short market value (SMV) of $4,000 and a credit balance of $6,750, with Regulation T at 50%. How much excess equity does the investor have in the account? A) $2,750 B) $2,000 C) $1,500 D) $750

D Explanation The Regulation T requirement and equity must be calculated before excess equity can be determined. The Regulation T requirement is 50% of the SMV of $4,000 ($2,000). Equity is calculated by subtracting the SMV of $4,000 from the credit balance of $6,750 ($2,750). Excess equity is calculated by subtracting the Regulation T requirement of $2,000 from the equity of $2,750 ($750).

The document attesting to the formation of a limited partnership, filed with designated authorities, is called A) the registration statement. B) the offering memorandum. C) the subscription agreement. D) the certificate of limited partnership.

D Explanation The Uniform Limited Partnership Act requires that two or more persons sign and swear to a certificate of limited partnership. It is filed with the state and is a public document available for review.

Within a firm commitment underwriting, which document details the responsibilities and liabilities of each firm? A) Registration statement B) Letter of intent C) Underwriting agreement D) Agreement among underwriters

D Explanation The agreement among underwriters, also called the syndicate letter, is signed by representatives of all syndicate members and establishes a joint account to sell newly issued securities.

If a customer buys 1 FLB Oct 50 call at 3 and she exercises the option to buy 100 shares when the market is at 60, what is the cost basis of the 100 shares? A) $6,000 B) $5,000 C) $6,300 D) $5,300

D Explanation The cost basis of the 100 shares is the total amount the investor spent to acquire them. She paid $300 to purchase the call option. When she exercised the call, she purchased 100 shares of FLB at $50 per share for $5,000, so the cost basis is $5,300.

The City of Columbus issued a 20-year general obligation bond at a price of 50. An original purchaser sold the bond at 75 after holding it for 7 years. For tax purposes, that sale generated A) a $250 capital gain. B) no gain or loss. C) a $25 capital gain. D) a $75 capital gain.

D Explanation The customer has realized a capital gain of $75. Original issue discount bonds must accrete the discount over the life of the bond. In this example, the amount of the discount (par value minus purchase price) is $500 ($1,000 − $500 = $500). The discount divided by the number of years to maturity determines the annual accretion added to the cost basis. In this question, the annual accretion is $25 ($500 divided by 20 = $25). The adjusted cost basis would be the original purchase price ($500) plus seven years of accretion (7 times $25 = $175) for a total of $675. Because the proceeds of the sale were $750, the customer has realized a capital gain of $75 ($750 − $675 = $75).

An investor opens the following positions: Sell short 100 shares of FAB @72; buy 1 FAB Jun 70 call @5. What is the customer's maximum gain, maximum loss, and breakeven point? A) Maximum gain is $6,700; maximum loss is $300; breakeven point is $77. B) Maximum gain is $300; maximum loss is $6,700; breakeven point is $67. C) Maximum gain is $300; maximum loss is unlimited; breakeven point is $77. D) Maximum gain is $6,700; maximum loss is $300; breakeven point is $67.

D Explanation The first step is to identify the position. This is a short sale with a protective call. That is, the customer has shorted the stock and purchased a call to protect the upside. This investor will break even when the stock's price is equal to the sale price ($72) minus the premium paid ($5), or $67. Short sellers lose when the price of the stock goes up. That means a short sale has potentially unlimited risk of loss. A way to ensure that the loss is limited is to purchase a call on the stock. If the stock should rise significantly above the $72 received on the short sale, instead of having to cover the short in the market at that high price, the investor will exercise the long call and be able to cover at $70. That means the maximum loss is the $500 premium paid for the protection less the difference between the sale proceeds ($7,200) and the cost of exercising the call ($7,000). That is $500 minus $200, resulting in a maximum loss of $300. If the stock's price falls, and it can decline to zero, the investor's cost to cover is zero, resulting in a profit of $7,200 minus the premium of $500 ($6,700). Why doesn't the breakeven follow the "call-up" rule? That rule applies when the only positions are options. Once there is a long or short stock position along with an option position, it is the stock controlling the breakeven.

A customer buys 800 shares of ABC at $70 per share in a new margin account. If the price of ABC drops to $50, the minimum maintenance margin requirement for this account is A) $12,000. B) $20,000. C) $14,000. D) $10,000.

D Explanation The minimum maintenance margin requirement for a long account is 25% of the current market value (CMV). The CMV is $40,000 (800 shares × $50 = $40,000). Therefore, minimum maintenance equals $10,000 (25% × $40,000 = $10,000).

An investor purchased 100 shares of ABC common stock at $60 per share on March 2, 2019. At the same time, an ABC Oct 55 put was purchased at $2. On June 2, 2020, the investor sold the stock for $85 per share. As a result, the tax consequences are A) $2,300 short-term capital gain. B) $2,500 short-term capital gain. C) $2,500 long-term capital gain. D) $2,300 long-term capital gain.

D Explanation The purchase of the put on stock at the same time as the purchase of the stock makes this a married put. This means that the purchase of the put does not affect the holding period of the stock. When the stock was sold in June 2020, the holding period was 15 months, well over the long-term requirement. As far as the math, the cost is $62 per share ($60 cost of the stock plus $2 for the put). The sale price was $85, the gain is $23 per share, $2,300.

The term trading flat means A) the price of the bond has remained level. B) the bond is in default. C) the bond is sold without markup or commission. D) there is no accrued interest.

D Explanation When a bond trades flat, the buyer does not owe accrued interest to the seller. Trading flat means there is no accrued interest due. While it is true that a bond in default trades flat, one cannot say that the term trading flat means the bond is necessarily in default.

ABC Corporation raised capital through an offering of equity securities. Which component of the balance sheet has changed as a result? A) Current liabilities B) Long-term liabilities C) Fixed assets D) Current assets

D Explanation When equity securities are issued, cash (a current asset) and net worth increase. Fixed assets and liabilities remain unchanged as a result of the offering.

Which of the following statements regarding the Federal Farm Credit System securities are not true? A) Interest is tax exempt at the state and local levels. B) They issue short-term notes and long-term bonds. C) The proceeds are used to make loans to farmers. D) They are direct obligations of the U.S. government.

D Explanation With the exception of Ginnie Mae, all agency securities are indirect obligations of the U.S. government.

An investor is long 10 XYZ calls with a strike price of 40 in his general account. XYZ stock is currently selling at 48. In addition to the fully paid calls, the account also contains a $3,000 credit balance. Cash withdrawal from the account would not be allowed to exceed A) $11,000. B) $3,000. C) $5,000. D) $6,000.

b Explanation It must be assumed from the information given that the account has only fully paid for call options plus an additional $3,000 cash (credit balance). The investor can withdraw the cash because the options are fully paid for. The question here is whether or not he can withdraw additional cash to borrow against the value of the options contracts. The answer is no, he cannot borrow against long option positions. In other words, options have no loan value.