Series 7 midterm

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

A A

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

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

Which of the following investment companies registered under the Investment Company Act of 1940 can include senior securities in its capital structure? A) Open-end management investment companies B) Unit investment trusts C) Closed-end management investment companies D) Face-amount certificate companies

C Only the closed-end company is legally permitted to issue senior securities (preferred stock and bonds).

Payment of interest and principal on which of the following securities is a direct obligation of the U.S. government? A) Federal National Mortgage Association bonds B) Government National Mortgage Association pass-through securities C) Federal Housing Authority bonds D) Federal Home Loan Mortgage bonds

B

Ratio call writing exposes an options investor to which of these? Limited loss Unlimited loss Limited gain Unlimited gain A) I and III B) II and III C) I and IV D) II and IV

B Ratio call writers assume unlimited loss potential in a rising market and limited gain potential in a falling market. Maximum gain—while limited—occurs if the stock is trading at the strike price of the short calls at expiration.

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

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

A customer long 100 shares of XYZ stock who wishes to reduce risk and generate income should A) buy an XYZ call. B) sell an XYZ put. C) buy an XYZ put. D) sell an XYZ call.

D If the customer sells a call, the risk of owning the stock is reduced by the call's premium. Receipt of the premium satisfies the customer's income objective

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

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

Trade confirmations must show yield to call on which of the following bonds? A) 5½%, 5% basis, maturing 2038 B) 6½%, 7% basis, maturing 2038 C) 5½%, 5½% basis, maturing 2038 D) 6½%, at par, callable 2025, maturing 2059

A Bond confirmations must disclose the lower of the yield to maturity (YTM) or yield to call (YTC). On a premium bond, the YTC is the lower of the two. The terminology here shows the coupon, the basis (YTM), and the maturity date (and, in one case, the call date). The 5½% bond with a 5% basis is the only bond trading at a premium because the YTM (or basis) is lower than the coupon. Even though the 6½% bond maturing in 2059 is callable relatively soon, because the bond was purchased at par, CY, YTM, and YTC are all equal to the coupon (nominal) rate, so the investor won't suffer a loss of principal with an early call.

If ABC Corporation reports a loss for the year, it is obligated to pay interest on all of the following except A) adjustment bonds. B) debentures. C) convertible bonds. D) variable rate bonds.

A Even if a corporation reports a loss, the corporation is obligated to pay interest on all of its outstanding debt except for income (adjustment) bonds. Adjustment bonds require interest to be paid only if ABC has sufficient earnings and the payment is declared by the board of directors.

Which of the following securities would most likely have the lowest expense ratio? A) Exchange-traded fund B) Closed-end fund C) Variable annuity D) Balanced mutual fund

A Generally, most exchange-traded funds (ETFs) have a lower expense ratio than comparable mutual funds. Variable annuity expense ratios tend to be higher than mutual funds, and the expense ratio for closed-end funds is similar to that of open-end (mutual) fund

Each of the following is a defined contribution plan except A) a stock option plan. B) a 401(k) plan. C) a profit-sharing plan (qualified). D) a money-purchase pension plan.

A Money-purchase pension plans, 401(k) plans, and qualified profit-sharing plans are all examples of defined contribution plans. An employer may offer stock options that give an employee the right to purchase a specified number of shares of the employer's common stock at a stated exercise price over a stated time period. No actual contribution is made, just payment when the employee decides to exercise the option. Unlike the other choices, this is not a qualified plan.

Investors who are subject to AMT must have which of the following preference items added to adjusted gross income to calculate their tax liability? A) Interest on a private purpose municipal bond B) Interest on a municipal bond issued to finance highway construction C) Income from a municipal security issued to finance parking garages D) Distributions from a corporate bond mutual fund

A On the exam, whenever you see a private purpose municipal bond, the interest on the bond is a tax preference item for the purpose of the alternative minimum tax. LO 6.f

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

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

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

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

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

B

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

B An unqualified opinion means the 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 evaluate the issue's marketability, or safety, debt service requirements.

If an investor in the 27% federal marginal income tax bracket invests in municipal general obligation public purpose bonds nominally yielding 4.5%, what is the tax-equivalent yield? A) 0.0329 B) 0.0616 C) 0.0572 D) 0.1667

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

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

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

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

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

A customer just opened a new account at your firm and gave her lawyer limited power of attorney (POA). Which of the following statements is true? A) Confirmations will only be sent to the party given the POA unless otherwise requested. B) The POA must be renewed on the last business day of April and October. C) The POA ceases upon the death of either party. D) Confirmations of trades will be sent to the account owner and the lawyer.

C Confirmations of trades will always be sent to the account owner. They may only be sent to a third party upon written request of the account owner. A POA need not be renewed and will cease upon the death of either party. It is a good-til-canceled (GTC) order that must be renewed at the end of April and October, not a POA.

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

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

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

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

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

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

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

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

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

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

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

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

A registered representative is contacted by a new client who wishes to transfer his 401(k) plan assets into an IRA at your firm. The amount being transferred is $1,050,000 and the registered representative recommends diversifying into Class C shares of five different funds in the XYZ mutual fund group. This recommendation would be A) suitable because a sum that large is correctly diversified into several different mutual funds in the same fund family. B) unsuitable because diversifying would require investing in at least two different mutual fund groups rather than one. C) unsuitable because a purchase of that size is likely going to reach a significant Class A share breakpoint. D) suitable because the savings of investing in Class C shares having no front-end load would be substantial.

C There are two problems with recommending Class C shares for this client. The first is that the no-front-end-load feature is not a selling point. A typical load on a $1 million purchase of Class A shares is zero, eliminating any benefit of the Class C share. The second point is that Class C shares generally have a higher 12b-1 charge and, even if the fund group was one of a small number that carries a 1% load on this large of a purchase, it wouldn't take long for the lower expense ratio of the Class A shares to result in a better deal for the investor. As a test-taking tip, beware of large purchases of Class C and especially Class B shares ($100,000 or more).

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

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

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

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

With regard to a variable annuity, all of the following may vary except A) the number of accumulation units. B) the value of annuity units. C) the value of accumulation units. D) the number of annuity units.

D During the accumulation phase, the number of accumulation units will increase as additional money is invested. When the contract is annuitized, the annuitant is credited with a fixed number of annuity units. Once annuitized, the number of annuity units does not vary. The value of accumulation and annuity units varies with the investment performance of the separate account.

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

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

Given the following choices, the most suitable investment recommendation for a customer who wants monthly income is A) high-yield bonds. B) utility stocks. C) income bonds. D) GNMAs

D Government National Mortgage Association (GNMA) securities pay a monthly check; utility stocks may pay a quarterly dividend; and income bonds are issued by companies coming out of bankruptcy and are never recommended to investors looking for income. High-yield bonds, also known as junk bonds, pay interest semiannually like other bonds.

If your client wished to purchase a preferred stock that would offer him the highest likelihood of assured income, plus the opportunity to take part in the growth of the company's common stock, which of these features might he consider? Callable Convertible Cumulative Straight A) I and II B) II and IV C) I and III D) II and III

D The convertible feature allows the investor to take part in the company's growth because the price of the common stock will reflect that growth. The cumulative feature, although not guaranteeing dividends, means that any missed dividends will have to be paid before anything can be paid to the common shareholders.

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

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

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

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

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

c In order for a common dividend to be paid when the issuer has noncumulative preferred stock outstanding, the preferred dividend must be satisfied. In this case, the stated dividend is 10% or $10 (10% × par of $100). LO 3.e

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

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