Unit 16 - US Government and State Rules and Regulations

On January 18, your customer sold 500 shares of MNO for a loss of $5 per share. If on March 1 he bought 3 MNO calls, how much of the loss could he declare for tax purposes? A) $1,000. B) He may not declare any loss. C) $1,500. D) $2,500.

Your answer, $2,500., was correct!. Since the purchase of the calls took place more than 30 days after the sale, the transaction is not a wash sale. He may therefore declare the entire $2,500 as a loss. Reference: 15.5.6.3 in the License Exam Manual.

A customer purchases an XYZ municipal bond at 108. It is scheduled to mature in 16 years. After owning the bond for 10 years, he sells the bond at 102. What capital gain or loss must he report for tax purposes at the time of the sale? A) $10 loss. B) $10 gain. C) $20 gain. D) $60 loss.

Your answer, $20 gain., was incorrect. The correct answer was: $10 loss. If a municipal bond is purchased at a premium, the premium must be amortized over the time until maturity. An $80 premium on a 16-year municipal bond indicates that $5 will be amortized each year ($80 divided by 16 = $5). After 10 years, the tax basis would be 103 ($1,030). Since the sale was for 102 ($1,020), the customer has a $10 loss on one bond. Reference: 15.5.7.1 in the License Exam Manual.

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

Your answer, $250 gain., was correct!. The cost per bond is $1,010. The amortization amount each year is 10/20 years, which equals $.50 per year. $.50 per year × 10 years = $5 per bond. After 10 years, the adjusted cost basis is $1,005 per bond. She sells the bonds for $1,030 per bond. $1,030 − $1,005 = $25 per bond 25 × 10 = $250 gain. Reference: 15.5.7.1 in the License Exam Manual.

If a customer buys $28,000 of ABC stock in April of 1999 and at year end, the stock is worth $23,000, how much may the customer deduct on his 1999 tax return? A) $2,000. B) $3,000. C) $5,000. D) $0.

Your answer, $3,000., was incorrect. The correct answer was: $0. Until the customer realizes the loss by selling, there is no tax deduction. Reference: 15.5.6 in the License Exam Manual.

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

Your answer, 3 points of capital gain., was incorrect. The correct answer was: 2 points of ordinary income and 1 point of capital gain. When a municipal bond is purchased in the secondary market at a discount, the annual accretion is taxed as ordinary income. The annual accretion is 1 point per year (4 points divided by 4 years to maturity). Therefore, when the bond is sold 2 years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of 1 point per bond. Also, there is ordinary income taxation on the accretion of 2 points. Reference: 15.5.7.2 in the License Exam Manual.

A customer who sold a bond at a loss must wait how long before he can buy back a substantially identical bond and NOT have the sale classified as a wash sale? A) 30 days. B) 20 days. C) 5 days. D) There is no waiting period.

Your answer, 30 days., was correct!. According to the wash sale rule, a customer who sells a security at a loss cannot buy back a substantially identical security 30 days prior to or 30 days after the sale that established the loss. Reference: 15.5.6.3 in the License Exam Manual.

Regarding a bonds duration, which measures the time it takes for a bond to pay for itself which of the following statements is TRUE? A) A zero coupon bonds duration is less than the bonds maturity B) For interest bearing bonds duration is greater than the bonds maturity C) Interest bearing bonds have no measurable bond duration D) A zero coupon bonds duration is equal to its maturity

Your answer, A zero coupon bonds duration is equal to its maturity, was correct!. A zero coupon bonds duration is equal to its maturity. For interest bearing bonds duration is less than the bond's maturity. Reference: 15.3.3.2 in the License Exam Manual.

An investor owns 3 types of municipal bonds: (1) AA-rated City of New York 8% GOs due 2013; (2) AA-rated Ohio Turnpike Authority 7.9% revenue bond due 2012; and (3) AA-rated University of California 7.8% revenue bond due 2013. What type of diversification does this represent? A) Maturity. B) Price. C) Geographic. D) Quality.

Your answer, Geographic., was correct!. The bonds are from different issuers from around the country and therefore offer geographic diversification. The prices of the bonds will be similar as a result of the similar quality, coupon, and maturity features. Reference: 15.2.2.5 in the License Exam Manual.

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

Your answer, He pays no estate tax., was correct!. Establishing a joint tenants with right of survivorship account allows for the transfer of assets to the survivor upon death. The surviving spouse is not taxed on assets transferred in this manner because under current tax law, there is an unlimited marital deduction. Reference: 15.5.9.2.4 in the License Exam Manual.

An investor purchases 100 shares of XYZ common stock for $70 and sells it one year later for $50. Which of the following activities would violate the wash sale rule? Purchasing an XYZ call option 20 days after the sale. Purchasing an XYZ put option 20 days after the sale. Purchasing 100 shares of XYZ common stock 20 days after the sale. Selling short 100 shares of XYZ common stock 20 days after the sale. A) III and IV. B) I and III. C) II and IV. D) I and II.

Your answer, I and III., was correct!. The wash sale rule is violated when an investor sells a security at a loss and purchases the same or a substantially identical security within 30 days of the sale date. The IRS considers a call option substantially identical to the underlying stock because it represents the right to buy the shares. Reference: 15.5.6.3 in the License Exam Manual.

Losses by an investor on the sale of municipal bonds can be applied against the investor's gains on the sale of which of the following? Other municipal bonds. Corporate bonds. Equity securities. Real estate. A) I and II. B) I, II, III and IV. C) I only. D) I, II and III.

Your answer, I, II, III and IV., was correct!. Losses on the sale of any investment can be deducted against gains on the sale of any other investment. Reference: 15.5.6.1.3 in the License Exam Manual

A customer purchases a municipal bond in the secondary market at 84 and he holds the bond to maturity. Since the customer must accrete the discount, what are the tax consequences at maturity? A) No capital gain or loss. B) Capital gain of $16. C) Capital gain of $160. D) Capital loss of $16.

Your answer, No capital gain or loss., was correct!. When a municipal bond is purchased in the secondary market at a discount, the discount must be accreted for cost-basis purposes. Note that the accretion on a discount municipal purchased in the secondary market is taxable as ordinary income. At maturity, the customer's cost basis has been accreted to par. Therefore, there is no reported gain or loss on redemption. Reference: 15.5.7.2 in the License Exam Manual.

Mr. and Mrs. Smith, both nearing retirement, want to reallocate $200,000 of their $500,000 portfolio of blue-chip stocks to an investment that would add to their monthly income after retirement. Of the possible investment choices below, which would be the most suitable recommendation given their investment objective? A) GNMA securities B) High-yield corporate bonds C) Exchange-traded notes D) Preferred shares of stock

Your answer, Preferred shares of stock, was incorrect. The correct answer was: GNMA securities Of the answer choices given, only Ginnie Mae (GNMA) securities would offer monthly income. Additionally, GNMAs are backed by the US government, which adds to their suitability for this couple nearing retirement. None of the remaining answer choices offer monthly income, and 2 of them (high-yield corporate bonds and exchange-traded notes) have unique risk associated with them, making them unsuitable for those near or in retirement. Reference: 15.2.2 in the License Exam Manual.

Market timing is normally associated with which of the following portfolio management styles? A) Strategic asset allocation. B) Tactical asset allocation. C) Passive management. D) Modern portfolio theory.

Your answer, Tactical asset allocation., was correct!. Tactical asset allocation, which attempts to capitalize on short-term market swings, is a market timing strategy. Reference: 15.4.2.2 in the License Exam Manual

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

Your answer, Value of the investment increases over time., was correct!. Growth refers to an increase in an investment's value over time. Interest and dividends are income. Reference: 15.4.3.1 in the License Exam Manual.

A customer sells short 100 shares of GHI on February 26, 2000, at $40 per share. He covers his short on March 10, 2002, at $32 per share. For tax purposes, the $800 will be treated as: A) a capital loss in 2000. B) a capital gain in 2000. C) ordinary income in 2002. D) a capital gain in 2002.

Your answer, a capital gain in 2002., was correct!. Investors profit on short positions when the market value of the stock falls. In this situation, the market value of the stock has fallen from 40 to 32 for a profit of $8 per share. This gain of $800 (100 shares) is reportable when the shares are delivered to cover the short position. It is a long-term capital gain. Reference: 15.5.6.1.1 in the License Exam Manual.

When a FINRA member places a third party between it and the best available market, it is a violation known as: A) commingling. B) locking markets. C) interpositioning. D) backing away.

Your answer, backing away., was incorrect. The correct answer was: interpositioning. This is the definition of the term "interpositioning". A member's obligations to his customer are generally not fulfilled when he channels transactions through another broker/dealer or some person in a similar position, unless he can show that, by doing so, he reduced the costs of the transactions to the customer. Reference: 15.1.4.6 in the License Exam Manual.

If a registered representative purchases a limited partnership unit without providing prior written notice to his employing firm, the representative: A) has violated FINRA's rule prohibiting outside business activities. B) is in compliance with FINRA rules because the partnership is a passive investment. C) has violated FINRA's rule against interpositioning. D) must have his firm's written approval before receiving any distributions.

Your answer, is in compliance with FINRA rules because the partnership is a passive investment., was correct!. The prohibitions against outside business activities do not apply to a passive investment. Holding a limited partnership interest does not entitle the representative to actively manage the partnership; thus, the representative is not in violation. Reference: 15.1.2.2 in the License Exam Manual.

An investor purchases 100 shares of CDE on December 20, 2000, for $2,000. On the same day, he purchases 100 shares of QRS for $2,000. On January 3, 2001, he sells the CDE stock for $1,700 and the QRS stock for $2,200. On January 24, 2001, he purchases 200 shares of CDE for $3,000. What capital gains or losses did he realize from these transactions? A) $300 loss in QRS and $200 gain in CDE. B) $200 gain in QRS. C) $300 loss in CDE and $200 gain in QRS. D) $300 loss in CDE.

Your answer, $300 loss in CDE and $200 gain in QRS., was incorrect. The correct answer was: $200 gain in QRS. The investor in this example has a $200 capital gain to report on the purchase of QRS stock for $2,000 and its subsequent sale for $2,200. Because the investor repurchased the stock within 30 days of selling it for a loss, the loss is disallowed. Reference: 15.5.6.3 in the License Exam Manual.

Which of the following statements are TRUE? Systematic risk can be diversified away. Systematic risk cannot be diversified away. Nonsystematic risk can be diversified away. Nonsystematic risk cannot be diversified away. A) II and IV. B) II and III. C) I and IV. D) I and III.

Your answer, II and III., was correct!. Systematic risk, which affects all investments, cannot be diversified away. Nonsystematic risk, or company risk, can. Reference: 15.3.2.7 in the License Exam Manual.

Which of the following are taxable to an investor? Stock dividends. Cash dividends. Stock splits. Interest income on foreign bonds. A) II and IV. B) I and III. C) I and IV. D) II and III.

Your answer, II and IV., was correct!. Stock dividends and stock splits are not taxable to investors. As the result of either, the customer has 2 nickels instead of a dime. The effect of a split on stock dividends is to reduce the investor's cost basis. Cash dividends, however, are taxable, as is the interest income from foreign bonds.

Institutional managers are moving to increase their cash position. This action would be viewed as: A) bullish. B) bearish. C) neutral bull. D) neutral.

Your answer, bearish., was correct!. When investment managers liquidate securities to increase their cash positions, stock prices are likely to fall. Reference: 15.4.2 in the License Exam Manual.

Your client, age 62, single and just retired with no mortgage, currently owns some growth stocks and AAA rated corporate bonds. He would like to diversify in a way that might add to his current income in order to supplement his pension plan distributions. He tells you he is financially comfortable and willing to accept moderate risk. Of the following choices, which would be the most suitable recommendation for this individual? A) Selling naked call options to generate income B) Equity income fund C) Corporate bonds with non-investment grade ratings and higher yields D) New property direct participation real estate program (DPP)

Your answer, Equity income fund, was correct!. Of these choices, an equity income fund would be the most appropriate. These funds seek current income through dividend-paying stocks and generally have a secondary objective of moderate growth. None of the remaining choices would align with the client's moderate risk criteria. Reference: 15.2.2.2 in the License Exam Manual.

If your customer is pursuing an aggressive stock buying strategy, which of the following is most suitable for him? A) GHI stock with a beta coefficient of 1.20. B) ABC stock with a beta coefficient of 1.0. C) DEF stock with a beta coefficient of .93. D) Convertible bonds of a mid-cap company.

Your answer, GHI stock with a beta coefficient of 1.20., was correct!. Beta coefficients greater than 1.0 signify that the stock will fluctuate more than the market as a whole. In general, the higher the beta is, the greater the risk. Such risk-taking is appropriate for investors who seek aggressive stock-buying strategies and have both the financial ability and the temperament to withstand downturns in the market. Reference: 15.3.3.1 in the License Exam Manual.

mother makes a gift of appreciated securities to her 10-year-old son. The son's cost basis in the stock is the: A) market value of the securities on April 15 of the year the gift is made. B) original cost of the securities to the mother. C) market value of the securities on December 31 of the year the gift is made. D) market value of the securities on the date of the gift.

Your answer, original cost of the securities to the mother., was correct!. When a gift of securities is made while the donor is alive, the original cost of the securities is the cost basis, not the value of the security on the date of the gift. Market value at date of gift is used to determine if gift taxes are applicable. Reference: 15.5.9.1.2 in the License Exam Manual.